Financial Statements
International Accounting (IFRS)
1014
2024
978-3-3811-1762-8
978-3-3811-1761-1
UVK Verlag
Carsten Berkau
10.24053/9783381117628
Financial Statements follows the international IFRS accounting syllabus as taught at Osnabrück University UAS and developed with its international partner universities. It covers the preparation, disclosure and analysis of financial statements on a bachelor's and master's level. It contains more than sixty case studies with detailed calculations, journal entries, T-accounts, and financial statements.
The content is based on knowledge about international bookkeeping and follows the balance sheet items starting from non-current assets on the debit side and ending with income tax liabilities on the credit side. It covers a full set of financial statements in compliance with IAS 1.10 including the notes and ESG reporting.
Readers can download numerous explanation files, exam tasks with solutions, links to youtube clips produced by the author and spreadsheet files that support the accounting work in academia.
Financial statements is an introduction to international accounting in English. It is a standard textbook for English accounting classes and supports managers and accountants who strive for a transition of their national accounting knowledge towards IFRS.
<?page no="0"?> Layout Carsten Berkau Prof. Dr. Carsten Berkau teaches accounting at Osnabrück University UAS and in South Africa, Malaysia, South Korea and China. Other books: Basics of Accounting / Bilanzen / Management Accounting. www.uvk.de Financial Statements follows the international IFRS accounting syllabus as taught at Osnabrück University UAS and developed with its international partner universities. It covers the preparation, disclosure and analysis of financial statements on a bachelor’s and master’s level. It contains more than sixty case studies with detailed calculations, journal entries, T-accounts, and financial statements. The content is based on knowledge about international bookkeeping and follows the balance sheet items starting from non-current assets on the debit side and ending with income tax liabilities on the credit side. It covers a full set of financial statements in compliance with IAS 1.10 including the notes and ESG reporting. Readers can download numerous explanation files, exam tasks with solutions, links to youtube clips produced by the author and spreadsheet files that support the accounting work in academia. Financial Statements is an introduction to international accounting in English. It is a standard textbook for English accounting classes and supports managers and accountants who strive for a transition of their national accounting knowledge towards IFRS. ISBN 978-3-381-11761-1 Berkau Financial Statements 8 th Edition Financial Statements International Accounting (IFRS) 8 th Edition <?page no="1"?> Financial Statements <?page no="2"?> Professor Dr. Carsten Berkau teaches accounting at Osnabrück University UAS and in South Africa, Malaysia, South Korea and China. Other books: Basics of Accounting / Bilanzen / Management Accounting. <?page no="3"?> Carsten Berkau Financial Statements International Accounting (IFRS) 8 , revised Edition Translated by Keabetswe Sylvia Berkau <?page no="4"?> Umschlagmotiv: © iStockphoto · jfarango Bibliografische Information der Deutschen Nationalbibliothek Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über http: / / dnb.dnb.de abrufbar. 8 th , revised Edition 2024 7 th , revised Edition 2022 6 th , revised and extended Edition 2021 5 th Edition 2020 4 th Edition 2019 DOI: https: / / doi.org/ 10.24053/ 9783381117628 © UVK Verlag 2024 - Ein Unternehmen der Narr Francke Attempto Verlag GmbH + Co. KG, xxDischingerweg 5 · D-72070 Tübingen Das Werk einschließlich aller seiner Teile ist urheberrechtlich geschützt. 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Internet: www.narr.de eMail: info@narr.de Elanders Waiblingen GmbH ISBN 978-3-381-11761-1 (Print) ISBN 978-3-381-11762-8 (ePDF) <?page no="5"?> Berkau: Financial Statements 8e 1-5 I Contents I Contents............................................................................................. 1-5 II Introduction .................................................................................... 1-13 1 Conventions ....................................................................................................1-14 1.1 Accounting Periods........................................................................................1-14 1.2 Accounting Technical Terms .......................................................................1-14 1.3 Account Names..............................................................................................1-14 1.4 Alphabetic Order ...........................................................................................1-14 1.5 Basics ...............................................................................................................1-14 1.6 Bilanzen ...........................................................................................................1-14 1.7 Bookkeeping Entries .....................................................................................1-15 1.8 Bookkeeping Entry Format ..........................................................................1-15 1.9 Calculations.....................................................................................................1-15 1.10 Capital Gain Tax CGT in South Africa ......................................................1-15 1.11 Case Studies ....................................................................................................1-15 1.12 Case Study Text..............................................................................................1-15 1.13 Cash Flow Separation ....................................................................................1-15 1.14 Companies ......................................................................................................1-15 1.15 Cost-Expense-Congruence ...........................................................................1-16 1.16 Country............................................................................................................1-16 1.17 Currency Unit .................................................................................................1-16 1.18 Data Format in Tables...................................................................................1-16 1.19 Data Sheets .....................................................................................................1-16 1.20 Prepayments of Income Taxes .....................................................................1-16 1.21 How it is Done ...............................................................................................1-16 1.22 Income Taxes .................................................................................................1-16 1.23 Journal Entries................................................................................................1-16 1.24 Financial Statements for Taxation ...............................................................1-17 1.25 Names..............................................................................................................1-17 1.26 Language .........................................................................................................1-17 1.27 Learning Objectives .......................................................................................1-17 1.28 Legal Forms of a Business ............................................................................1-17 1.29 Length of a Month/ Year ..............................................................................1-17 1.30 Level of Precision ..........................................................................................1-17 1.31 Links/ QR-Codes ..........................................................................................1-18 1.32 Literature .........................................................................................................1-18 1.33 Non-existing Items ........................................................................................1-18 1.34 Online Materials .............................................................................................1-18 1.35 Payment Terms ..............................................................................................1-18 1.36 Presentation of Accounts..............................................................................1-18 1.37 Pro-Rated Depreciation/ Interest.................................................................1-19 <?page no="6"?> Berkau: Financial Statements 8e 1-6 1.38 Quotation of Law Texts/ Standards ............................................................ 1-19 1.39 Sequence of Bookkeeping Entries............................................................... 1-19 1.40 Sign of Numbers on Financial Statements ................................................. 1-20 1.41 Tax on Capital Returns (Dividend Tax) ..................................................... 1-20 1.42 Transaction Costs .......................................................................................... 1-20 1.43 Value Added Tax, Goods and Service Tax ................................................ 1-20 1.44 VAT Reduction.............................................................................................. 1-20 1.45 Working Definitions...................................................................................... 1-20 1.46 Work-in-Process Account ............................................................................ 1-20 1.47 Writing Management Terms ........................................................................ 1-21 1.48 WWW.............................................................................................................. 1-21 1.49 Youtube Videos ............................................................................................. 1-21 1.50 10-20-30 Rule ................................................................................................. 1-21 2 Financial Statements based on HGB........................................................... 2-22 2.1 What is in the Chapter? ................................................................................. 2-22 2.2 Learning Objectives....................................................................................... 2-22 2.3 Legal Forms for Companies......................................................................... 2-22 2.4 Obligation of Keeping Bookkeeping Records ........................................... 2-23 2.5 Establishment of a Company ....................................................................... 2-23 2.6 Income Tax Calculation................................................................................ 2-24 2.7 Value added tax VAT.................................................................................... 2-24 2.8 C/ S KIELING TAXI GmbH - 20X1 ....................................................... 2-25 2.9 C/ S KIELING TAXI GmbH - 20X2........................................................ 2-32 2.10 Summary ......................................................................................................... 2-39 2.11 Working Definitions...................................................................................... 2-39 2.12 Question Bank ............................................................................................... 2-40 2.13 Solutions ......................................................................................................... 2-41 3 Financial Statements based on IFRSs.......................................................... 3-42 3.1 What is in the Chapter? ................................................................................. 3-42 3.2 Learning Objectives....................................................................................... 3-42 3.3 IFRSs............................................................................................................... 3-42 3.4 How to Access IFRSs ................................................................................... 3-42 3.5 C/ S KENILWORTH MTS Ltd. - 20X1 ................................................... 3-43 3.6 C/ S KENILWORTH MTS Ltd. - 20X2 ................................................... 3-54 3.7 Summary ......................................................................................................... 3-63 3.8 Working Definitions...................................................................................... 3-63 3.9 Question Bank ............................................................................................... 3-64 3.10 Solutions ......................................................................................................... 3-65 4 Accounting for Retailers ............................................................................... 4-66 4.1 What is in the Chapter? ................................................................................. 4-66 4.2 Learning Objectives....................................................................................... 4-66 4.3 Dealerships ..................................................................................................... 4-66 <?page no="7"?> Berkau: Financial Statements 8e 1-6 1.38 Quotation of Law Texts/ Standards ............................................................ 1-19 1.39 Sequence of Bookkeeping Entries............................................................... 1-19 1.40 Sign of Numbers on Financial Statements ................................................. 1-20 1.41 Tax on Capital Returns (Dividend Tax) ..................................................... 1-20 1.42 Transaction Costs .......................................................................................... 1-20 1.43 Value Added Tax, Goods and Service Tax ................................................ 1-20 1.44 VAT Reduction.............................................................................................. 1-20 1.45 Working Definitions...................................................................................... 1-20 1.46 Work-in-Process Account ............................................................................ 1-20 1.47 Writing Management Terms ........................................................................ 1-21 1.48 WWW.............................................................................................................. 1-21 1.49 Youtube Videos ............................................................................................. 1-21 1.50 10-20-30 Rule ................................................................................................. 1-21 2 Financial Statements based on HGB........................................................... 2-22 2.1 What is in the Chapter? ................................................................................. 2-22 2.2 Learning Objectives....................................................................................... 2-22 2.3 Legal Forms for Companies......................................................................... 2-22 2.4 Obligation of Keeping Bookkeeping Records ........................................... 2-23 2.5 Establishment of a Company ....................................................................... 2-23 2.6 Income Tax Calculation................................................................................ 2-24 2.7 Value added tax VAT.................................................................................... 2-24 2.8 C/ S KIELING TAXI GmbH - 20X1 ....................................................... 2-25 2.9 C/ S KIELING TAXI GmbH - 20X2........................................................ 2-32 2.10 Summary ......................................................................................................... 2-39 2.11 Working Definitions...................................................................................... 2-39 2.12 Question Bank ............................................................................................... 2-40 2.13 Solutions ......................................................................................................... 2-41 3 Financial Statements based on IFRSs.......................................................... 3-42 3.1 What is in the Chapter? ................................................................................. 3-42 3.2 Learning Objectives....................................................................................... 3-42 3.3 IFRSs............................................................................................................... 3-42 3.4 How to Access IFRSs ................................................................................... 3-42 3.5 C/ S KENILWORTH MTS Ltd. - 20X1 ................................................... 3-43 3.6 C/ S KENILWORTH MTS Ltd. - 20X2 ................................................... 3-54 3.7 Summary ......................................................................................................... 3-63 3.8 Working Definitions...................................................................................... 3-63 3.9 Question Bank ............................................................................................... 3-64 3.10 Solutions ......................................................................................................... 3-65 4 Accounting for Retailers ............................................................................... 4-66 4.1 What is in the Chapter? ................................................................................. 4-66 4.2 Learning Objectives....................................................................................... 4-66 4.3 Dealerships ..................................................................................................... 4-66 Berkau: Financial Statements 8e 1-7 4.4 Gross Profit Calculation................................................................................4-67 4.5 Trial Balance ...................................................................................................4-67 4.6 Trading Account ............................................................................................4-68 4.7 C/ S RYNEVELD Ltd. .................................................................................4-68 4.8 C/ S TELUK Sdn. Bhd..................................................................................4-84 4.9 Worksheet for T/ B Calculations..................................................................4-84 4.10 Summary .........................................................................................................4-85 4.11 Working Definitions ......................................................................................4-85 4.12 Question Bank................................................................................................4-85 4.13 Solutions..........................................................................................................4-86 5 Basics of Financial Statement Analysis ........................................................5-87 5.1 What is in the Chapter? .................................................................................5-87 5.2 Learning Objectives .......................................................................................5-87 5.3 Company Appraisal .......................................................................................5-87 5.4 Situational Awareness about a Company ....................................................5-87 5.5 C/ S ROSENDAHL Ltd. ..............................................................................5-88 5.6 Steps of F/ S Analysis ....................................................................................5-88 5.7 Defining Information Requirements ...........................................................5-88 5.8 Formal Checking ............................................................................................5-89 5.9 Horizontal Analysis........................................................................................5-89 5.10 Vertical Analysis .............................................................................................5-90 5.11 Basics of Ratio Analysis ................................................................................5-90 5.12 C/ S CAPELIFT (Pty) Ltd. ...........................................................................5-92 5.13 Performance Ratios - CAPELIFT (Pty) Ltd..............................................5-93 5.14 Liquidity Ratios - CAPELIFT (Pty) Ltd.....................................................5-98 5.15 Capital Structure Ratios - CAPELIFT (Pty) Ltd.................................... 5-100 5.16 Market Value Ratios - CAPELIFT (Pty) Ltd.......................................... 5-102 5.17 Summary ...................................................................................................... 5-103 5.18 Working Definitions ................................................................................... 5-104 5.19 Question Bank............................................................................................. 5-104 5.20 Solutions....................................................................................................... 5-104 6 Formal Financial Statement Requirements .............................................. 6-105 6.1 What is in the Chapter? .............................................................................. 6-105 6.2 Learning Objectives .................................................................................... 6-105 6.3 IFRSs Consistency ...................................................................................... 6-105 6.4 Qualitative Characteristics of Financial Information ............................. 6-106 6.5 C/ S BATHURST Ltd. ............................................................................... 6-107 6.6 Statement of Financial Position - BATHURST Ltd.............................. 6-116 6.7 Statement of Profit or Loss - BATHURST Ltd..................................... 6-118 6.8 Statement of Changes in Equity - BATHURST Ltd. ............................ 6-120 6.9 Statement of Cash Flows - BATHURST Ltd......................................... 6-120 6.10 Notes - BATHURST Ltd.......................................................................... 6-121 6.11 ESG-Reporting............................................................................................ 6-126 <?page no="8"?> Berkau: Financial Statements 8e 1-8 6.12 Summary ....................................................................................................... 6-129 6.13 Working Definitions.................................................................................... 6-129 6.14 Question Bank ............................................................................................. 6-129 6.15 Solutions ....................................................................................................... 6-130 7 Non-current Assets on the Balance Sheet ................................................ 7-131 7.1 What is in the Chapter? ............................................................................... 7-131 7.2 Learning Objectives..................................................................................... 7-131 7.3 Initial Recognition ....................................................................................... 7-131 7.4 C/ S GETEN (Pty) Ltd. .............................................................................. 7-132 7.5 Qualifying Assets ......................................................................................... 7-133 7.6 C/ S LANGDAM Bhd. ............................................................................... 7-134 7.7 Subsequent Valuation.................................................................................. 7-136 7.8 C/ S GELLENDORFF LLC. .................................................................... 7-137 7.9 Impairment Loss.......................................................................................... 7-139 7.10 Impairment Loss - GELLENDORFF LLC. .......................................... 7-139 7.11 Revaluations ................................................................................................. 7-148 7.12 C/ S TINNEN Ltd. ..................................................................................... 7-148 7.13 C/ S STEENBERG Ltd. - Case (i) ........................................................... 7-158 7.14 C/ S STEENBERG Ltd. - Case (ii) .......................................................... 7-160 7.15 Disposal of Assets ....................................................................................... 7-162 7.16 C/ S YSTERFONTEIN Ltd. ..................................................................... 7-162 7.17 Investment Property and Assets Held for Sale........................................ 7-166 7.18 C/ S MERSEBURG Ltd. ............................................................................ 7-166 7.19 Assets Held for Sale .................................................................................... 7-167 7.20 C/ S OVERBERG (Pty) Ltd. ..................................................................... 7-168 7.21 Intangible Assets.......................................................................................... 7-169 7.22 C/ S Dentist PAARDEBERG ................................................................... 7-170 7.23 Design and Research Costs ........................................................................ 7-171 7.24 C/ S WESPOORT Ltd................................................................................ 7-171 7.25 Leases ............................................................................................................ 7-172 7.26 C/ S KRIGE (Pty) Ltd. ............................................................................... 7-173 7.27 C/ S RICHTERSVELD (Pty) Ltd. - Lessee ............................................ 7-178 7.28 C/ S RICHTERSVELD (Pty) Ltd. - Lessor ............................................ 7-181 7.29 Short-term Leases ........................................................................................ 7-184 7.30 C/ S JONKERS GmbH.............................................................................. 7-184 7.31 Financial Instruments.................................................................................. 7-185 7.32 C/ S HAWKINS Ltd. / STEYN GmbH - Cross-Border Investments7-186 7.33 C/ S HAVENGA Ltd. - Bonds.................................................................. 7-188 7.34 C/ S NATBERGEN (Pty) Ltd. - Bonds held to Maturity ..................... 7-190 7.35 C/ S DORRINGTON Ltd. / ROTTMAN Ltd. - Pref. Shares ............ 7-192 7.36 Derivatives.................................................................................................... 7-194 7.37 MOLLENBERG Ltd. - Call Option ....................................................... 7-195 7.38 Summary ....................................................................................................... 7-197 7.39 Working Definitions.................................................................................... 7-197 <?page no="9"?> Berkau: Financial Statements 8e 1-8 6.12 Summary ....................................................................................................... 6-129 6.13 Working Definitions.................................................................................... 6-129 6.14 Question Bank ............................................................................................. 6-129 6.15 Solutions ....................................................................................................... 6-130 7 Non-current Assets on the Balance Sheet ................................................ 7-131 7.1 What is in the Chapter? ............................................................................... 7-131 7.2 Learning Objectives..................................................................................... 7-131 7.3 Initial Recognition ....................................................................................... 7-131 7.4 C/ S GETEN (Pty) Ltd. .............................................................................. 7-132 7.5 Qualifying Assets ......................................................................................... 7-133 7.6 C/ S LANGDAM Bhd. ............................................................................... 7-134 7.7 Subsequent Valuation.................................................................................. 7-136 7.8 C/ S GELLENDORFF LLC. .................................................................... 7-137 7.9 Impairment Loss.......................................................................................... 7-139 7.10 Impairment Loss - GELLENDORFF LLC. .......................................... 7-139 7.11 Revaluations ................................................................................................. 7-148 7.12 C/ S TINNEN Ltd. ..................................................................................... 7-148 7.13 C/ S STEENBERG Ltd. - Case (i) ........................................................... 7-158 7.14 C/ S STEENBERG Ltd. - Case (ii) .......................................................... 7-160 7.15 Disposal of Assets ....................................................................................... 7-162 7.16 C/ S YSTERFONTEIN Ltd. ..................................................................... 7-162 7.17 Investment Property and Assets Held for Sale........................................ 7-166 7.18 C/ S MERSEBURG Ltd. ............................................................................ 7-166 7.19 Assets Held for Sale .................................................................................... 7-167 7.20 C/ S OVERBERG (Pty) Ltd. ..................................................................... 7-168 7.21 Intangible Assets.......................................................................................... 7-169 7.22 C/ S Dentist PAARDEBERG ................................................................... 7-170 7.23 Design and Research Costs ........................................................................ 7-171 7.24 C/ S WESPOORT Ltd................................................................................ 7-171 7.25 Leases ............................................................................................................ 7-172 7.26 C/ S KRIGE (Pty) Ltd. ............................................................................... 7-173 7.27 C/ S RICHTERSVELD (Pty) Ltd. - Lessee ............................................ 7-178 7.28 C/ S RICHTERSVELD (Pty) Ltd. - Lessor ............................................ 7-181 7.29 Short-term Leases ........................................................................................ 7-184 7.30 C/ S JONKERS GmbH.............................................................................. 7-184 7.31 Financial Instruments.................................................................................. 7-185 7.32 C/ S HAWKINS Ltd. / STEYN GmbH - Cross-Border Investments7-186 7.33 C/ S HAVENGA Ltd. - Bonds.................................................................. 7-188 7.34 C/ S NATBERGEN (Pty) Ltd. - Bonds held to Maturity ..................... 7-190 7.35 C/ S DORRINGTON Ltd. / ROTTMAN Ltd. - Pref. Shares ............ 7-192 7.36 Derivatives.................................................................................................... 7-194 7.37 MOLLENBERG Ltd. - Call Option ....................................................... 7-195 7.38 Summary ....................................................................................................... 7-197 7.39 Working Definitions.................................................................................... 7-197 Berkau: Financial Statements 8e 1-9 7.40 Questions Bank ........................................................................................... 7-198 7.41 Solutions....................................................................................................... 7-199 8 Business Combinations............................................................................... 8-200 8.1 What is in the Chapter? .............................................................................. 8-200 8.2 Learning Objectives .................................................................................... 8-200 8.3 Group Accounting ...................................................................................... 8-200 8.4 Separate Financial Statements IAS 27 ...................................................... 8-203 8.5 C/ S BRENO Ltd. ....................................................................................... 8-203 8.6 Consolidated Financial Statements ........................................................... 8-209 8.7 C/ S GAMKA/ SWARTBERG Group - Initial Consolidation ............ 8-209 8.8 C/ S GAMKA/ SWARTBERG Group - Subsequent Consolidations. 8-216 8.9 C/ S PORTERSVILLE/ HENDERSON Group ................................... 8-224 8.10 Intra-Group Profit Consolidation............................................................. 8-230 8.11 C/ S PATTEN/ SPYKER .......................................................................... 8-230 8.12 Joint Venture Accounting .......................................................................... 8-238 8.13 C/ S QUICKARMS-RESPONSE-FIRE Joint Operations ................... 8-239 8.14 C/ S CLOSEWATCH - Joint Venture ..................................................... 8-243 8.15 Summary ...................................................................................................... 8-248 8.16 Working Definitions ................................................................................... 8-248 8.17 Question Bank............................................................................................. 8-248 8.18 Solutions....................................................................................................... 8-249 9 Current Assets on the Balance Sheet ........................................................ 9-250 9.1 What is in the Chapter? .............................................................................. 9-250 9.2 Learning Objectives .................................................................................... 9-250 9.3 Current and non-Current Assets............................................................... 9-250 9.4 Inventories ................................................................................................... 9-251 9.5 C/ S GREENACRES Ltd. ......................................................................... 9-252 9.6 Perpetual Inventory System ....................................................................... 9-254 9.7 C/ S GREENACRES Ltd. - Perpetual Inventory System .................... 9-254 9.8 Returns ......................................................................................................... 9-257 9.9 Differences in Inventory Valuation .......................................................... 9-260 9.10 Different Purchase Price Application....................................................... 9-260 9.11 C/ S ROSEFIELD Ltd. .............................................................................. 9-261 9.12 Loss on Valuation ....................................................................................... 9-266 9.13 C/ S HEISTEL (Pty) Ltd............................................................................ 9-266 9.14 Manufacturing Accounting ........................................................................ 9-268 9.15 Overhead Application ................................................................................ 9-269 9.16 C/ S RIEBEECK-KASTEEL (Pty) Ltd................................................... 9-269 9.17 C/ S RIEBEECK-KASTEEL (Pty) Ltd. (i)............................................. 9-273 9.18 C/ S RIEBEECK-KASTEEL (Pty) Ltd. - IAS 2.13 (ii) ......................... 9-273 9.19 Manufacturing Summary Account............................................................ 9-276 9.20 C/ S RIEBEECK-KASTEEL (Pty) Ltd. (iii)........................................... 9-277 9.21 Receivables................................................................................................... 9-278 <?page no="10"?> Berkau: Financial Statements 8e 1-10 9.22 C/ S CHELMSFORD ................................................................................. 9-278 9.23 Securities ....................................................................................................... 9-281 9.24 C/ S NOKOX (Pty) Ltd.............................................................................. 9-281 9.25 C/ S TRAGER GmbH................................................................................ 9-282 9.26 C/ S GRENVILLE AG .............................................................................. 9-283 9.27 C/ S NOKOX (Pty) Ltd. continued........................................................ 9-285 9.28 Prepaid Expenses......................................................................................... 9-287 9.29 Cash and its Equivalents............................................................................. 9-287 9.30 C/ S BAKENSKOP PLC ........................................................................... 9-288 9.31 Summary ....................................................................................................... 9-289 9.32 Working Definitions.................................................................................... 9-289 9.33 Question Bank ............................................................................................. 9-290 9.34 Solutions ....................................................................................................... 9-291 10 Statement of Cash Flows .......................................................................... 10-292 10.1 What is in the Chapter? .............................................................................10-292 10.2 Learning Objectives................................................................................... 10-292 10.3 Cash Flow Statement Obligation.............................................................10-292 10.4 C/ S EIMKE Ltd. ......................................................................................10-293 10.5 Direct Method............................................................................................10-297 10.6 C/ S EIMKE Ltd. - Direct Method ........................................................ 10-297 10.7 Reconciliation of Profits with Operating Cash Flows .......................... 10-298 10.8 Why Step (1)? ............................................................................................. 10-299 10.9 Why step (2)? .............................................................................................. 10-299 10.10 Why Step (3)? ..............................................................................................10-299 10.11 Why Step (4)? ..............................................................................................10-299 10.12 Why Step (5)? ..............................................................................................10-300 10.13 Why Step (6)? ..............................................................................................10-300 10.14 Why Step (7)? ..............................................................................................10-300 10.15 Why Step (8)? ..............................................................................................10-301 10.16 Why Step (9)? ..............................................................................................10-302 10.17 Why Step (10)? ............................................................................................10-302 10.18 C/ S EIMKE Ltd. - Reconciliation Method...........................................10-302 10.19 Derivative Method .....................................................................................10-305 10.20 Summary......................................................................................................10-306 10.21 Working Definitions ..................................................................................10-306 10.22 Question Bank............................................................................................10-306 10.23 Solutions...................................................................................................... 10-307 11 Equity on the Balance Sheet ..................................................................... 11-308 11.1 What is in the Chapter? .............................................................................11-308 11.2 Learnings Objectives .................................................................................11-308 11.3 Equity .......................................................................................................... 11-308 11.4 Issued Capital .............................................................................................11-308 11.5 C/ S YARRA Ltd. ......................................................................................11-309 <?page no="11"?> Berkau: Financial Statements 8e 1-10 9.22 C/ S CHELMSFORD ................................................................................. 9-278 9.23 Securities ....................................................................................................... 9-281 9.24 C/ S NOKOX (Pty) Ltd.............................................................................. 9-281 9.25 C/ S TRAGER GmbH................................................................................ 9-282 9.26 C/ S GRENVILLE AG .............................................................................. 9-283 9.27 C/ S NOKOX (Pty) Ltd. continued........................................................ 9-285 9.28 Prepaid Expenses......................................................................................... 9-287 9.29 Cash and its Equivalents............................................................................. 9-287 9.30 C/ S BAKENSKOP PLC ........................................................................... 9-288 9.31 Summary ....................................................................................................... 9-289 9.32 Working Definitions.................................................................................... 9-289 9.33 Question Bank ............................................................................................. 9-290 9.34 Solutions ....................................................................................................... 9-291 10 Statement of Cash Flows .......................................................................... 10-292 10.1 What is in the Chapter? .............................................................................10-292 10.2 Learning Objectives................................................................................... 10-292 10.3 Cash Flow Statement Obligation.............................................................10-292 10.4 C/ S EIMKE Ltd. ......................................................................................10-293 10.5 Direct Method............................................................................................10-297 10.6 C/ S EIMKE Ltd. - Direct Method ........................................................ 10-297 10.7 Reconciliation of Profits with Operating Cash Flows .......................... 10-298 10.8 Why Step (1)? ............................................................................................. 10-299 10.9 Why step (2)? .............................................................................................. 10-299 10.10 Why Step (3)? ..............................................................................................10-299 10.11 Why Step (4)? ..............................................................................................10-299 10.12 Why Step (5)? ..............................................................................................10-300 10.13 Why Step (6)? ..............................................................................................10-300 10.14 Why Step (7)? ..............................................................................................10-300 10.15 Why Step (8)? ..............................................................................................10-301 10.16 Why Step (9)? ..............................................................................................10-302 10.17 Why Step (10)? ............................................................................................10-302 10.18 C/ S EIMKE Ltd. - Reconciliation Method...........................................10-302 10.19 Derivative Method .....................................................................................10-305 10.20 Summary......................................................................................................10-306 10.21 Working Definitions ..................................................................................10-306 10.22 Question Bank............................................................................................10-306 10.23 Solutions...................................................................................................... 10-307 11 Equity on the Balance Sheet ..................................................................... 11-308 11.1 What is in the Chapter? .............................................................................11-308 11.2 Learnings Objectives .................................................................................11-308 11.3 Equity .......................................................................................................... 11-308 11.4 Issued Capital .............................................................................................11-308 11.5 C/ S YARRA Ltd. ......................................................................................11-309 Berkau: Financial Statements 8e 1-11 11.6 Reserves...................................................................................................... 11-310 11.7 C/ S YARRA Ltd. - 20X0 continued................................................... 11-310 11.8 C/ S YARRA Ltd. - 20X1........................................................................ 11-311 11.9 C/ S YARRA Ltd. - 20X2........................................................................ 11-315 11.10 Retained Earnings...................................................................................... 11-316 11.11 Summary ..................................................................................................... 11-319 11.12 Working Definitions ................................................................................. 11-319 11.13 Question Bank ........................................................................................... 11-319 11.14 Solutions ..................................................................................................... 11-320 12 Statement of Profit or Loss and Other Compreh. Income.................. 12-321 12.1 What is in the Chapter? ............................................................................ 12-321 12.2 Learning Objectives .................................................................................. 12-321 12.3 Statement of Profit or Loss and Other Comprehensive Income ....... 12-321 12.4 C/ S ABINGTON Ltd. - Nature of Expense Method ........................ 12-323 12.5 C/ S SUDHUIZEN PLC - Nature of Expense Method..................... 12-327 12.6 C/ S ABINGTON Ltd. - Cost of Sales Format ................................... 12-334 12.7 C/ S SUDHUIZEN PLC - Cost of Sales Format ................................ 12-338 12.8 Summary .................................................................................................... 12-343 12.9 Working Definitions ................................................................................. 12-343 12.10 Question Bank ........................................................................................... 12-343 12.11 Solutions ..................................................................................................... 12-344 13 Statement of Changes in Equity .............................................................. 13-345 13.1 What is in the Chapter? ............................................................................ 13-345 13.2 Learning Objectives .................................................................................. 13-345 13.3 IFRS Regulations ...................................................................................... 13-345 13.4 C/ S BELMONT Ltd................................................................................ 13-346 13.5 C/ S BELMONT Ltd. - Share Issue/ Treasury Shares ......................... 13-347 13.6 C/ S BELMONT Ltd. - Profit or Loss................................................... 13-349 13.7 C/ S BELMONT Ltd. - Other Comprehensive Income...................... 13-350 13.8 C/ S BELMONT Ltd. - Revaluations..................................................... 13-351 13.9 C/ S BELMONT Ltd. - Appropriation of Profits ................................ 13-352 13.10 Summary ..................................................................................................... 13-354 13.11 Working Definition ................................................................................... 13-354 13.12 Question Bank ........................................................................................... 13-354 13.13 Solutions ..................................................................................................... 13-355 14 Liabilities on the Balance Sheet...................................................14-356 14.1 What is in the Chapter? ............................................................................ 14-356 14.2 Learning Objectives .................................................................................. 14-356 14.3 Liabilities .................................................................................................... 14-356 14.4 Certain Liabilities....................................................................................... 14-357 14.5 C/ S WARWICK Ltd. - Buying Goods on Credit ................................ 14-358 14.6 C/ S BATHURST Ltd. - Bank Loan....................................................... 14-359 <?page no="12"?> Berkau: Financial Statements 8e 1-12 14.7 C/ S MEUL Ltd. - Amortised Costs....................................................... 14-360 14.8 Bonds Issue ................................................................................................14-365 14.9 C/ S BRIZA Ltd. - Bonds ......................................................................... 14-366 14.10 C/ S MEMEL PLC - Annuity and Extra Repayments ..........................14-367 14.11 Provisions....................................................................................................14-371 14.12 C/ S SEENA Ltd. - Measurement of Provisions ..................................14-371 14.13 C/ S HADRA (Pty) Ltd. - Provision for Pension Funds ......................14-373 14.14 C/ S DUMMOND (Pty) Ltd. - Provision of rework.............................14-374 14.15 C/ S SALMAN Ltd. - Provisions due to Onerous Contracts ...............14-379 14.16 Summary......................................................................................................14-381 14.17 Working Definitions ..................................................................................14-381 14.18 Question Bank............................................................................................14-381 14.19 Solutions...................................................................................................... 14-382 15 Abbreviations................................................................................15-383 16 Table of Figures ...........................................................................16-390 17 Links .............................................................................................17-394 18 Literature ......................................................................................18-395 <?page no="13"?> Berkau: Financial Statements 8e 1-12 14.7 C/ S MEUL Ltd. - Amortised Costs....................................................... 14-360 14.8 Bonds Issue ................................................................................................14-365 14.9 C/ S BRIZA Ltd. - Bonds ......................................................................... 14-366 14.10 C/ S MEMEL PLC - Annuity and Extra Repayments ..........................14-367 14.11 Provisions....................................................................................................14-371 14.12 C/ S SEENA Ltd. - Measurement of Provisions ..................................14-371 14.13 C/ S HADRA (Pty) Ltd. - Provision for Pension Funds ......................14-373 14.14 C/ S DUMMOND (Pty) Ltd. - Provision of rework.............................14-374 14.15 C/ S SALMAN Ltd. - Provisions due to Onerous Contracts ...............14-379 14.16 Summary......................................................................................................14-381 14.17 Working Definitions ..................................................................................14-381 14.18 Question Bank............................................................................................14-381 14.19 Solutions...................................................................................................... 14-382 15 Abbreviations................................................................................15-383 16 Table of Figures ...........................................................................16-390 17 Links .............................................................................................17-394 18 Literature ......................................................................................18-395 Berkau: Financial Statements 8e 1-13 II Introduction We prepared this 8 th edition based on the feedback we received from our students and readers in Germany and South Africa. We exchanged one leasing case study, added returns to chapter (4) and ESG reporting to chapter (6). We made formal changes to the Bookkeeping entries. For this English version of the textbook, we disclose all recordings as journal entries. Furthermore, figures in the journal entries as well as in the financial statements are accurate to the nearest full currency unit. Minor wording and data changes have been made to case studies in chapters (4), (7), (9), (11), (12), and (13). The content of Financial Statements focuses on IFRSs. We discuss German law only in chapter (2) for comparison. It also makes it easier for readers who are knowledgeable about German Bookkeeping and Accounting. Financial Statements covers the syllabus of an international Accounting class at bachelor’s and master’s level. We assume readers bring basic knowledge of international Bookkeeping as taught in our textbook Basics of Accounting and the video material related thereto. Financial Statements teaches you how to prepare financial statements in compliance with IFRSs. We follow a case-based teaching method with 64 case studies in this textbook. From the publisher's website, you can follow the link: https: / / files.narr.digital/ 9783381117611/ cases.zip to download materials: 350 exam tasks with solutions and links to the video clips we recorded for you. We write our textbooks as an international academic team from Germany and South Africa. They are based on our teaching experience in Osnabrück/ Lingen (Ems), Cape Town, Enschede, Gqeberha/ George, Grahamstown, Kuantan, Seoul and Shanghai. We thank our colleagues at Hochschule Osnabrück, Prof. Dr. Marion Wendehals, and at our partner universities for their valuable input, in particular Dr Aletta Nethling and Nelly Msiza from CPUT. We also thank Dr. Jürgen Schechler from UVK Verlag for the pleasant cooperation. Dr. Schechler is our lector in Munich, and we enjoy the very friendly and highly efficient cooperation with him for all our textbooks (Basics of Accounting, Bilanzen, Financial Statements, and Management Accounting). In particular, we thank our students and readers for their feedback and questions which helped us to improve the textbook. We trust you enjoy this 8 th edition of Financial Statements! Cape Town, in July 2024 Keabetswe and Carsten Berkau <?page no="14"?> Berkau: Financial Statements 8e 1-14 1 Conventions The below-listed conventions apply merely for case simplifications. Accounting can become complicated, but we reduce its complexity to a level that is appropriate for studying. E.g., we do not follow a chart of accounts and therefore do not apply account numbers to keep our cases simple. In the real Accounting profession, must find the right account - however this is not regarded as necessary if you study Accounting for Management purposes. The conventions below are about legal forms, tax rates, formats, etc. They apply for this textbook, for our Basics of Accounting, for our Management Accounting, and all online study materials in the same way. At this stage of studying Accounting, you might not understand all the conventions. We put them at the beginning of the textbook, so you know where to find them. The sequence is in alphabetic order (English). 1.1 Accounting Periods All Accounting periods start on 1.01.20XX and end on 31.12.20XX. Furthermore, to keep the examples transferable to later years, we indicate decades with an X, as in 20X4. X is followed by Y, then Z. 1.2 Accounting Technical Terms At the end of every chapter, we explain new technical terms. They help you with the understanding of the content. These simple explanations are written for beginners in Accounting. The Accounting technical terms are not as formal and enforceable as the definitions provided by the IASB. 1.3 Account Names All account names are written with capital letters in the text, such as ‘Cash/ Bank account’. However, an account not subjected to our recordings is written in lower letters. For a bank account with Deutsche Bank the writing is in lower letters: bank account. We do not make Bookkeeping entries therein, but Deutsche Bank AG does. However, the Cash/ Bank account applicable to calculate the item cash/ bank on the balance sheet is part of our Accounting work. 1.4 Alphabetic Order For all lists, an alphabetic order or items applies. 1.5 Basics Our Basics refers to the textbook Berkau: Basics of Accounting. You should read our Basics before you start studying Financial Statements. It introduces you to international Bookkeeping and major Accounting concepts without reference to IFRSs. We frequently quote it as the Basics. 1.6 Bilanzen The textbook Berkau: Bilanzen is a close translation of this textbook. All cases and all exhibits are the same. <?page no="15"?> Berkau: Financial Statements 8e 1-14 1 Conventions The below-listed conventions apply merely for case simplifications. Accounting can become complicated, but we reduce its complexity to a level that is appropriate for studying. E.g., we do not follow a chart of accounts and therefore do not apply account numbers to keep our cases simple. In the real Accounting profession, must find the right account - however this is not regarded as necessary if you study Accounting for Management purposes. The conventions below are about legal forms, tax rates, formats, etc. They apply for this textbook, for our Basics of Accounting, for our Management Accounting, and all online study materials in the same way. At this stage of studying Accounting, you might not understand all the conventions. We put them at the beginning of the textbook, so you know where to find them. The sequence is in alphabetic order (English). 1.1 Accounting Periods All Accounting periods start on 1.01.20XX and end on 31.12.20XX. Furthermore, to keep the examples transferable to later years, we indicate decades with an X, as in 20X4. X is followed by Y, then Z. 1.2 Accounting Technical Terms At the end of every chapter, we explain new technical terms. They help you with the understanding of the content. These simple explanations are written for beginners in Accounting. The Accounting technical terms are not as formal and enforceable as the definitions provided by the IASB. 1.3 Account Names All account names are written with capital letters in the text, such as ‘Cash/ Bank account’. However, an account not subjected to our recordings is written in lower letters. For a bank account with Deutsche Bank the writing is in lower letters: bank account. We do not make Bookkeeping entries therein, but Deutsche Bank AG does. However, the Cash/ Bank account applicable to calculate the item cash/ bank on the balance sheet is part of our Accounting work. 1.4 Alphabetic Order For all lists, an alphabetic order or items applies. 1.5 Basics Our Basics refers to the textbook Berkau: Basics of Accounting. You should read our Basics before you start studying Financial Statements. It introduces you to international Bookkeeping and major Accounting concepts without reference to IFRSs. We frequently quote it as the Basics. 1.6 Bilanzen The textbook Berkau: Bilanzen is a close translation of this textbook. All cases and all exhibits are the same. Berkau: Financial Statements 8e 1-15 1.7 Bookkeeping Entries All Bookkeeping entries are printed in bold and cover the whole page’s width to make them visible. 1.8 Bookkeeping Entry Format We write debit entries and credit entries. DR stands for debit recorded and CR for credit recorded. See e.g., a Bookkeeping entry for the acquisition of a motor vehicle: DR Property, Plant, Equipment... 20,000 EUR DR VAT.......................... 4,000 EUR CR Cash/ Bank.................... 24,000 EUR The identifier for Bookkeeping entries in the text, like “Bookkeeping entry (1)” can be found in the accounts as “(1)”, too. In contrast to chapter (2) and to the German version of this textbook Berkau: Bilanzen, we write journal entries in this textbook. 1.9 Calculations For calculations, we only show the currency units with the results. E.g., 10 + 20.50 = 30.50 EUR. Furthermore, figures in calculations come without digits after the decimal point if zero. Results are always printed in bold to find calculated figures in the text easily. 1.10 Capital Gain Tax CGT in South Africa Capital gain tax rate in South Africa is assumed to be at the total income tax rate for companies. No deductions and allowances apply for the sake of simplicity. 1.11 Case Studies We keep case studies in this textbook as easy as possible even as they might look unrealistic. The teaching of Accounting is key. 1.12 Case Study Text We write case studies in a different text format than the normal text (Italic fonts). 1.13 Cash Flow Separation Interest payments are always considered to be finance cash flows, even as IAS 7.33 allows their classification as operating cash flows as well as financing ones. This applies to all case studies. 1.14 Companies Legal forms are not part of our Accounting syllabus. They are covered by our Basics. We only assume that companies discussed in the textbook must prepare financial statements. This is the attitude of the IASB, too. In contrast to IFRSs, we do not refer to companies as “entities”. Once you read the expression entity in the standards, remember they are referring to companies. We apply the technical terms “business”, “firm” and “company”. In this textbook, most companies are limited companies, e.g., GmbH, AG, Pty Ltd., PLC, Inc., etc. <?page no="16"?> Berkau: Financial Statements 8e 1-16 1.15 Cost-Expense-Congruence By default, costs are expenses and vice versa. 1 1.16 Country All cases discussed in this textbook take place in countries where IFRSs apply for single-entity financial statements. Due to teaching in Cape Town, most foreign examples refer to South Africa. 1.17 Currency Unit For all examples, the reporting currency is based on the country of the case study. We use the common threeletter-codes for abbreviation, like ZAR for South African Rand or GBP for British Pound Sterling. 1.18 Data Format in Tables In tables, negative figures are displayed in brackets. E.g., (7.50) equals -7.50 EUR. 1.19 Data Sheets WWee sshhooww tthhee mmoosstt iimmppoorrttaanntt ddaattaa ffoorr ccaassee ssttuuddiieess iinn tthheeiirr ddaattaa sshheeeettss.. TThhiiss iiss oonnllyy ttoo sshhooww mmoosstt ooff tthhee ffiigguurreess ooff aa ccaassee iinn aa ccoommpprreehheennssiivvee ffoorrmm.. TThhee ddaattaa sshheeeettss ddoo nnoott rreeppllaaccee tthhee eexxppllaannaattiioonn ooff tthhee ccaassee iinn tthhee bbooookk.. 1.20 Prepayments of Income Taxes No provisional tax payments are made to the national revenue service in our case studies. Taxes are calculated at the 1 For cost definitions und cost separations, study our textbook Management Accounting, chapter (4). yearend and added to short-term liabilities, mostly to the Income Tax Liabilities account. For German companies, § 249 HGB applies. Therefore, income taxes count as provisions in Germany. 1.21 How it is Done (1) You find How-it-is Done sections in this textbook. (2) They offer you very short and clear instructions for your Accounting work. (3) In open-book exams the instructions given should serve you a cheat sheet. 1.22 Income Taxes For our textbooks, a simplified income tax model applies. Income taxes amount to 30 % of the pre-tax profit EBT. In a real company, replace the simplified calculations by the figures from the tax professionals. 1.23 Journal Entries In this 8 th edition all Bookkeeping entries have been disclosed as journal entries which is the common format in international Accounting classes. However, for the German textbook Berkau: Bilanzen, Bookkeeping entries have been maintained. The journal entries show the date, the relevant accounts and include a narrative. The Bookkeeping entry above will look as below. It now contains information about the date and nature of the <?page no="17"?> Berkau: Financial Statements 8e 1-16 1.15 Cost-Expense-Congruence By default, costs are expenses and vice versa. 1 1.16 Country All cases discussed in this textbook take place in countries where IFRSs apply for single-entity financial statements. Due to teaching in Cape Town, most foreign examples refer to South Africa. 1.17 Currency Unit For all examples, the reporting currency is based on the country of the case study. We use the common threeletter-codes for abbreviation, like ZAR for South African Rand or GBP for British Pound Sterling. 1.18 Data Format in Tables In tables, negative figures are displayed in brackets. E.g., (7.50) equals -7.50 EUR. 1.19 Data Sheets WWee sshhooww tthhee mmoosstt iimmppoorrttaanntt ddaattaa ffoorr ccaassee ssttuuddiieess iinn tthheeiirr ddaattaa sshheeeettss.. TThhiiss iiss oonnllyy ttoo sshhooww mmoosstt ooff tthhee ffiigguurreess ooff aa ccaassee iinn aa ccoommpprreehheennssiivvee ffoorrmm.. TThhee ddaattaa sshheeeettss ddoo nnoott rreeppllaaccee tthhee eexxppllaannaattiioonn ooff tthhee ccaassee iinn tthhee bbooookk.. 1.20 Prepayments of Income Taxes No provisional tax payments are made to the national revenue service in our case studies. Taxes are calculated at the 1 For cost definitions und cost separations, study our textbook Management Accounting, chapter (4). yearend and added to short-term liabilities, mostly to the Income Tax Liabilities account. For German companies, § 249 HGB applies. Therefore, income taxes count as provisions in Germany. 1.21 How it is Done (1) You find How-it-is Done sections in this textbook. (2) They offer you very short and clear instructions for your Accounting work. (3) In open-book exams the instructions given should serve you a cheat sheet. 1.22 Income Taxes For our textbooks, a simplified income tax model applies. Income taxes amount to 30 % of the pre-tax profit EBT. In a real company, replace the simplified calculations by the figures from the tax professionals. 1.23 Journal Entries In this 8 th edition all Bookkeeping entries have been disclosed as journal entries which is the common format in international Accounting classes. However, for the German textbook Berkau: Bilanzen, Bookkeeping entries have been maintained. The journal entries show the date, the relevant accounts and include a narrative. The Bookkeeping entry above will look as below. It now contains information about the date and nature of the Berkau: Financial Statements 8e 1-17 Bookkeeping entry. Note, that in the textbook the column headers “DR” and “CR” are not shown. DR CR @ 2.01.20X1 Property, Plant, Equipment PPE 20,000 Value Added Tax VAT 4,000 Cash/ Bank C/ B 24,000 (acquisition of a business car) 1.24 Financial Statements for Taxation We do not cover tax calculations. Tax statements are only relevant for us to determine income taxes (simplified calculation) and deferred taxes. As deferred taxes matter for revaluations, you find tax Profit and Loss accounts in chapter (7). 1.25 Names We name companies and indicate them by capital letters. E.g., SCHULZE-BRAMMELKAMP Ltd. No links or reference to existing persons or companies are intended. 1.26 Language This textbook is written in South African English. 1.27 Learning Objectives Every chapter starts with the learning objectives and ends with a summary. We also give you a short overview of the content in the What is in the Chapter? -paragraphs. 1.28 Legal Forms of a Business In this textbook, we use Ltd., (Pty) Ltd., Sdn. Bhd., Bhd., AG, GmbH, UG, PLC, Inc., etc. If no legal form is given, assume the company is privately owned, such as SANDPIPER BOOKS for a privately owned bookstore. 1.29 Length of a Month/ Year For workings the below mentioned figures are relevant. 1 month = 21.5 days = 4.3 weeks. 1 year = 12 evenly long months = 365 days = 52 weeks. 1.30 Level of Precision We work exactly to integers or to figures with two digits after the decimal point. Results from workings are rounded, too. We usually calculate in MS-Excel; hence, calculations in the background are more precise than disclosed. All financial statements show figures rounded to the nearest full currency amount. <?page no="18"?> Berkau: Financial Statements 8e 1-18 1.31 Links/ QR-Codes Links provided through QR-codes in the book direct you to further explanations and readings. 1.32 Literature The main source for preparing financial statements are the standards issued by the International Accounting Standard Board IASB. At the end of the textbook, we recommend further readings for you. 1.33 Non-existing Items In case something has not been mentioned it does not exist. 1.34 Online Materials The online materials are at the time of printing this textbook 354 exam tasks with solutions. Their names refer to the chapter and contain a counting figure, like Task_A10.14-Sunlands, which is linked to the textbook Financial Statements (A), chapter 10, and is the 14 th exam task. As higher the count is as newer is the task. 1.35 Payment Terms If nothing has been mentioned about payment terms, payments and receipts are recorded through the Cash/ Bank account. In this textbook, payments/ receipts for taxation and dividends are due in the next following Accounting period. Payments taking place during the year, and which are evenly distributed are recorded on 30.06.20XX or 1.07.20XX. This way, monthly payments are replaced by a comprehensive Bookkeeping entry, e.g., twelve monthly rent payments are recorded as one payment to the extent of the annual rent expense in the middle of the year to keep the number of Bookkeeping entries low. 1.36 Presentation of Accounts Accounts are displayed in a T-format. The figures therein are rounded to the next currency unit. Accounts have a three-letter indicator column used for Bookkeeping entry identification or contra-entry references. All nominal accounts show the Accounting period as a suffix, such as Depreciation-20X4. See the accounts based on the car acquisition and its depreciation (depreciation is amounting to: 20,000/ 5 = 4,000 EUR.): <?page no="19"?> Berkau: Financial Statements 8e 1-18 1.31 Links/ QR-Codes Links provided through QR-codes in the book direct you to further explanations and readings. 1.32 Literature The main source for preparing financial statements are the standards issued by the International Accounting Standard Board IASB. At the end of the textbook, we recommend further readings for you. 1.33 Non-existing Items In case something has not been mentioned it does not exist. 1.34 Online Materials The online materials are at the time of printing this textbook 354 exam tasks with solutions. Their names refer to the chapter and contain a counting figure, like Task_A10.14-Sunlands, which is linked to the textbook Financial Statements (A), chapter 10, and is the 14 th exam task. As higher the count is as newer is the task. 1.35 Payment Terms If nothing has been mentioned about payment terms, payments and receipts are recorded through the Cash/ Bank account. In this textbook, payments/ receipts for taxation and dividends are due in the next following Accounting period. Payments taking place during the year, and which are evenly distributed are recorded on 30.06.20XX or 1.07.20XX. This way, monthly payments are replaced by a comprehensive Bookkeeping entry, e.g., twelve monthly rent payments are recorded as one payment to the extent of the annual rent expense in the middle of the year to keep the number of Bookkeeping entries low. 1.36 Presentation of Accounts Accounts are displayed in a T-format. The figures therein are rounded to the next currency unit. Accounts have a three-letter indicator column used for Bookkeeping entry identification or contra-entry references. All nominal accounts show the Accounting period as a suffix, such as Depreciation-20X4. See the accounts based on the car acquisition and its depreciation (depreciation is amounting to: 20,000/ 5 = 4,000 EUR.): Berkau: Financial Statements 8e 1-19 D C D C (1) 20,000 (1) 4,000 D C D C (1) 24,000 ACC 4,000 D C DPR 4,000 Cash/ Bank C/ B Depreciation-20X1 DPR Accumulated depreciation ACC Property, plant, equipment PPE Value added tax VAT Figure 1.1: Accounts 1.37 Pro-Rated Depreciation/ Interest Although provided as annual rates, depreciation, and interest are calculated monthly accurate to a full month. Remember, all months have the same length. Hence, monthly depreciation and the rate of interest are calculated as the annual depreciation rate divided by 12. In the case of a company holding an asset for a shorter period than a full year, those months will count for depreciation in which the asset is owned for the major duration - more than 15 days. Interest rates are given per annum (/ a) and compounded annually (no compounded interest calculation within a year). For loans taken for shorter periods than a full year, interest is calculated per rate and accurate to the month, too. For a bank loan of 100,000 EUR obtained on 9.06.20X4 with an annual rate of interest of 10 %/ a, the interest paid at the end of the year is: 7 × 100,000 × 10%/ 12 = 5,833.33 EUR. If dates are not the beginning or the end of an Accounting period, the month is underlined to direct your attention thereto, as in 11.06.20X4. By default, interest and repayments take place at yearends, which is on 31.12.20XX. Interest is only calculated for debts, such as bank loans, bonds, etc. Overdrafts of a bank account get ignored. An exception is chapter (37) in the Basics. 1.38 Quotation of Law Texts/ Standards Law texts/ standards are quoted like ‘§ 266 HGB’ or ‘IAS 1.68’. We use the original law names. Note, that IFRS paragraphs can be subjected to changes by IASB. 1.39 Sequence of Bookkeeping Entries The sequence of Bookkeeping entries follows the logical process defined by the text. Bookkeeping identifiers, like “(1), (2), (3) …” do not indicate the sequence of recording. <?page no="20"?> Berkau: Financial Statements 8e 1-20 1.40 Sign of Numbers on Financial Statements Following international procedures, expenses on income statements are recorded as negative. This is known as the (DR)CR format. On the balance sheet, figures usually are positive, retained earnings and treasury stock are exempted. On a cash flow statement receipts are disclosed as positive and payments as negative figures. The statement of equity is in the (DR)CR format, which shows equity and increases thereof as positive and decreases with a minus sign. 1.41 Tax on Capital Returns (Dividend Tax) The tax on capital returns is an income tax. In this textbook, the rate of capital returns is 25 % based on the capital income. Note, for the company declaring the dividend, the tax on capital returns is no company tax, although it owes it. It is a withholding tax in most countries and is levied from private persons. Dividends received by companies are income tax-free - compared to § 8b KStG. 1.42 Transaction Costs We ignore transaction costs, like costs for selling goods/ services, taking out and repaying bank loans, issuing shares or bonds, etc. 1.43 Value Added Tax, Goods and Service Tax VAT stands for value added tax and GST for Goods and Service Tax. Except in, e.g., the United Arabic Emirates or some U.S. states like Delaware, Alaska, consumers pay VAT - sometimes referred to as sales tax when buying goods or services. In this textbook, we apply one single VAT account for input-VAT and output- VAT. The VAT rate is 20 %. We ignore reduced VAT rates as levied in many countries for food, books, etc. 1.44 VAT Reduction It is assumed that every company discussed in this textbook is registered for VAT reduction. Therefore, every company acts as VAT vendor. Note, that in some exercises you might find in the Required paragraph a hint like “Ignore VAT”. The mentioned paragraph it found always at the bottom of a task and tells you exactly what you should do. 1.45 Working Definitions At the end of every chapter, you are provided with short and easily understandable definitions for new Accounting terms. They are merely a glossary and should support your understanding. 1.46 Work-in-Process Account We apply the Work-in-Process account as a reconciliation account for all job orders and call it Work-in-Process WIP. We also use a Work-in-Process account for single job orders but then add the job order ID thereto, like “Work-in-Process 4711” for job order 4711. <?page no="21"?> Berkau: Financial Statements 8e 1-20 1.40 Sign of Numbers on Financial Statements Following international procedures, expenses on income statements are recorded as negative. This is known as the (DR)CR format. On the balance sheet, figures usually are positive, retained earnings and treasury stock are exempted. On a cash flow statement receipts are disclosed as positive and payments as negative figures. The statement of equity is in the (DR)CR format, which shows equity and increases thereof as positive and decreases with a minus sign. 1.41 Tax on Capital Returns (Dividend Tax) The tax on capital returns is an income tax. In this textbook, the rate of capital returns is 25 % based on the capital income. Note, for the company declaring the dividend, the tax on capital returns is no company tax, although it owes it. It is a withholding tax in most countries and is levied from private persons. Dividends received by companies are income tax-free - compared to § 8b KStG. 1.42 Transaction Costs We ignore transaction costs, like costs for selling goods/ services, taking out and repaying bank loans, issuing shares or bonds, etc. 1.43 Value Added Tax, Goods and Service Tax VAT stands for value added tax and GST for Goods and Service Tax. Except in, e.g., the United Arabic Emirates or some U.S. states like Delaware, Alaska, consumers pay VAT - sometimes referred to as sales tax when buying goods or services. In this textbook, we apply one single VAT account for input-VAT and output- VAT. The VAT rate is 20 %. We ignore reduced VAT rates as levied in many countries for food, books, etc. 1.44 VAT Reduction It is assumed that every company discussed in this textbook is registered for VAT reduction. Therefore, every company acts as VAT vendor. Note, that in some exercises you might find in the Required paragraph a hint like “Ignore VAT”. The mentioned paragraph it found always at the bottom of a task and tells you exactly what you should do. 1.45 Working Definitions At the end of every chapter, you are provided with short and easily understandable definitions for new Accounting terms. They are merely a glossary and should support your understanding. 1.46 Work-in-Process Account We apply the Work-in-Process account as a reconciliation account for all job orders and call it Work-in-Process WIP. We also use a Work-in-Process account for single job orders but then add the job order ID thereto, like “Work-in-Process 4711” for job order 4711. Berkau: Financial Statements 8e 1-21 1.47 Writing Management Terms We write academic disciplines, like Accounting, Marketing, Management, etc., in capital letters. 1.48 WWW We provide you with of exercises, exam tasks, solutions and further materials. Pls., check the link: https: / / files.narr.digi 9783381117611/ cases.zip 2 Most of the cases are copied from our exam tasks at Hochschule Osnabrück or its partner universities, in South Africa, China, South Korea, and Malaysia. 2 If this link is copied from the online version of the textbook, remove its line break! 1.49 Youtube Videos On our YouTube channel (Carsten Berkau), we published video materials based on the case studies in this textbook. Follow the link on UVK website related to this textbook. 1.50 10-20-30 Rule In this textbook, the 10-20-30 rule applies. If not mentioned otherwise, the nominal interest rate is 10 %/ a, the VAT rate is 20 % and the total income tax rate is 30 %/ a. <?page no="22"?> Berkau: Financial Statements 8e 2-22 2 Financial Statements based on HGB 2.1 What is in the Chapter? We introduce Accounting based on the German Handelsgesetzbuch HGB. We demonstrate the preparation of financial statements with the case study KIELING TAXI GmbH which is based in Hanover and therefore follows German law for its single-entity financial statements. The taxi company comes with very few business activities to demonstrate the basics of Accounting: its establishment, the acquisition of a motor vehicle, the equipment of the car with taxi appliances, depreciation, payments for labour and operations as well as revenue recognition. In the first Accounting period, the entire profit is carried forward to the year. In 20X2, we demonstrate the Bookkeeping entries and prepare financial statements following HGB standards. An appropriation of profits is discussed with portions of the distributable amount getting accrued to earnings reserves, paid as dividends and carried forward to 20X3. 2.2 Learning Objectives After studying this chapter, you can prepare a balance sheet and an income statement for a company in Germany and achieve sufficient communication skills to talk and write about German Accounting. You got familiarised with the technical Accounting terms understand the major Accounting rules from the German Handelsgesetzbuch HGB. 3 Short for: Gesellschaft bürgerlichen Rechts, check §§ 705 - 741 BGB. The achieved knowledge enables you to compare the HGB to international Accounting standards IFRSs. For foreign students this chapter provides a short introduction to German Accounting. As we consider a lot of simplifications for this textbook, the chapter does not qualify as Bookkeeper but makes you understand what they are doing. 2.3 Legal Forms for Companies In Accounting, the legal form of companies matters. We distinguish private companies and companies in public ownership. Private companies are in the legal form of a sole proprietor, a partnership or a privately owned limited company. A partnership in Germany is called a GbR 3 . Like a single proprietor, the owners of a GbR are held fully (and jointly) reliable for all assets and liabilities of their business. Public companies are limited companies with distributed ownership. If a company's shares are traded publicly at a stock exchange, everyone is allowed to buy its shares. In contrast to private companies, the loss for the owners of a limited company is limited to its equity. Equity comprises of the share capital, reserves and accumulated profits. As owners are not held liable for their company’s debts, creditor protection becomes a major reason for preparing financial <?page no="23"?> Berkau: Financial Statements 8e 2-22 2 Financial Statements based on HGB 2.1 What is in the Chapter? We introduce Accounting based on the German Handelsgesetzbuch HGB. We demonstrate the preparation of financial statements with the case study KIELING TAXI GmbH which is based in Hanover and therefore follows German law for its single-entity financial statements. The taxi company comes with very few business activities to demonstrate the basics of Accounting: its establishment, the acquisition of a motor vehicle, the equipment of the car with taxi appliances, depreciation, payments for labour and operations as well as revenue recognition. In the first Accounting period, the entire profit is carried forward to the year. In 20X2, we demonstrate the Bookkeeping entries and prepare financial statements following HGB standards. An appropriation of profits is discussed with portions of the distributable amount getting accrued to earnings reserves, paid as dividends and carried forward to 20X3. 2.2 Learning Objectives After studying this chapter, you can prepare a balance sheet and an income statement for a company in Germany and achieve sufficient communication skills to talk and write about German Accounting. You got familiarised with the technical Accounting terms understand the major Accounting rules from the German Handelsgesetzbuch HGB. 3 Short for: Gesellschaft bürgerlichen Rechts, check §§ 705 - 741 BGB. The achieved knowledge enables you to compare the HGB to international Accounting standards IFRSs. For foreign students this chapter provides a short introduction to German Accounting. As we consider a lot of simplifications for this textbook, the chapter does not qualify as Bookkeeper but makes you understand what they are doing. 2.3 Legal Forms for Companies In Accounting, the legal form of companies matters. We distinguish private companies and companies in public ownership. Private companies are in the legal form of a sole proprietor, a partnership or a privately owned limited company. A partnership in Germany is called a GbR 3 . Like a single proprietor, the owners of a GbR are held fully (and jointly) reliable for all assets and liabilities of their business. Public companies are limited companies with distributed ownership. If a company's shares are traded publicly at a stock exchange, everyone is allowed to buy its shares. In contrast to private companies, the loss for the owners of a limited company is limited to its equity. Equity comprises of the share capital, reserves and accumulated profits. As owners are not held liable for their company’s debts, creditor protection becomes a major reason for preparing financial Berkau: Financial Statements 8e 2-23 statements in Germany. Business partners of a limited company must be able to check the financial position of a company or its liquidity before they enter in a contract with it to assess their risks. In Germany, limited companies and retailers must apply the German Handelsgesetzbuch HGB. The HGB contains paragraphs dedicated to retailers as well as to limited companies. 2.4 Obligation of Keeping Bookkeeping Records § 242 HGB requires retailers and limited companies to keep Bookkeeping records and to prepare annual financial statements (general purpose F/ S). All retailers 4 keep Bookkeeping records based on § 239 HGB and record a register of assets following § 240 HGB. Retailers classified as small companies get exempted (from applying §§ 238 - 241 HGB) if earning an annual revenue below 600,000 EUR/ a for two following years and reporting an annual surplus not exceeding 60,000 EUR/ a, see §241a HGB. This exemption applies only for retailers that are not limited ones. In addition to retailers, any firm in the legal form of a limited company prepares financial statements based on § 264 HGB. Limited companies in Germany are Gesellschaft mit beschränkter Haftung GmbH (or as a small cousin thereof Unternehmergesellschaft UG (haftungsbeschränkt)) and Aktiengesellschaft AG. AGs are companies based on shares. A GmbH 4 This includes retailers as sole proprietors, partnerships as well as in the legal form of a limited company. is a privately owned limited company, like a PLC or a (Pty) Ltd. in the UK or Australia and South Africa respectively. Study the German company’s acts, GmbHG and AktG for details. Financial statements in Germany include a balance sheet and an income statement (§ 242 HGB). Limited companies additionally prepare an appendix and a business report in compliance with § 264 HGB. The appendix is a part of the financial statements, see § 264 HGB. Therefore, it is relevant for Auditing. The appendix contains further disclosures regarding the balance sheet and income statement based on § 284 HGB. The German expression for a set of financial statements is “der Jahresabschluss”. 2.5 Establishment of a Company To establish a limited company in Germany, it must be registered. The register (Handelsregisterrolle) is kept at local courts (Amtsgericht). The representatives of a limited company appoint an attorney for registration. The attorney drafts a contract, also known as the memorandum of incorporation (MoI) or the articles, that amongst other items determines the purpose of the company, its address, the legal representatives etc. With the set-up of the MOI, Accounting work starts: One document required is the opening balance sheet following § 240 HGB and is prepared in the format prescribed in § 266 HGB. Usually, the opening balance sheet only discloses issued capital and <?page no="24"?> Berkau: Financial Statements 8e 2-24 cash/ bank at the time of incorporation. The issued capital is money the owners contribute and pay into the company’s bank account. A company can also be established with assets other than cash/ bank which then requires further asset items to be disclosed on the balance sheet. 5 After its establishment, limited companies must prepare and disclose financial statements for taxation as well as for commercial purposes. Therefore, companies prepare two sets of financial statements which follow different laws. Commercial financial statements follow the German HGB, and the other ones are based on German income tax law EStG. Financial statements along HGB are published at local courts and financial statements for taxation must be submitted as E-Bilanz at the German revenue service. Both financial statements are prepared by Accountants. As HGB and EStG follow different objectives, one single multi-purpose Jahresabschluss is unlikely. In this textbook, we focus on commercial law HGB in Germany and internationally on IFRSs. Before we put aside the tax statements, we cover two aspects which are relevant for our Accounting work and Bookkeeping: (1) Simplified income tax calculation. (2) Value added tax. 2.6 Income Tax Calculation In Tax classes at the university, details of national income tax calculations are taught. The tax law strives for a fair 5 Read for an example our textbook Basics of Accounting, chapter (33). 6 Check the business plan case study SCHLUCHMAN in our textbook Management Accounting, chapter (6). levy of income taxes. This principle means that a person/ company with high income pays higher tax rates than someone who earns less (tax progression). 6 Therefore, the income tax law follows the capability of taxpayers to contribute to the common welfare of the society. Tax laws include various and detailed regulations and numerous exceptions for income tax adjustments. For this textbook, we simplify the income tax calculation. We multiply a company’s pre-tax profit by a total income tax rate of 30 %. For a real business, you must replace that tax substitute with a detailed tax calculation. 7 2.7 Value added tax VAT. Value added tax VAT is a consumer tax and is paid by buyers of goods or recipients of services. The VAT rate is the same for all consumers. Companies usually are exempted from VAT, as they do not consume but buy goods or services for manufacturing and service rendering purposes. Companies that buy goods or services initially pay input-VAT but get refunded by the revenue service later. Hence, companies are not charged VAT. The refund is received based on a VAT return form submitted to the revenue service. 8 All companies registered for VAT reduction collect output-VAT from their customers on behalf of the revenue service. The output-VAT is paid based on the revenue. Therefore, the expression Umsatzsteuer in Ger- 7 See Schneeloch, D.; Meyering S.; Patek, G.: Betriebliche Steuerlehre. 8 Following our conventions, we consider annual refunding/ paying. <?page no="25"?> Berkau: Financial Statements 8e 2-24 cash/ bank at the time of incorporation. The issued capital is money the owners contribute and pay into the company’s bank account. A company can also be established with assets other than cash/ bank which then requires further asset items to be disclosed on the balance sheet. 5 After its establishment, limited companies must prepare and disclose financial statements for taxation as well as for commercial purposes. Therefore, companies prepare two sets of financial statements which follow different laws. Commercial financial statements follow the German HGB, and the other ones are based on German income tax law EStG. Financial statements along HGB are published at local courts and financial statements for taxation must be submitted as E-Bilanz at the German revenue service. Both financial statements are prepared by Accountants. As HGB and EStG follow different objectives, one single multi-purpose Jahresabschluss is unlikely. In this textbook, we focus on commercial law HGB in Germany and internationally on IFRSs. Before we put aside the tax statements, we cover two aspects which are relevant for our Accounting work and Bookkeeping: (1) Simplified income tax calculation. (2) Value added tax. 2.6 Income Tax Calculation In Tax classes at the university, details of national income tax calculations are taught. The tax law strives for a fair 5 Read for an example our textbook Basics of Accounting, chapter (33). 6 Check the business plan case study SCHLUCHMAN in our textbook Management Accounting, chapter (6). levy of income taxes. This principle means that a person/ company with high income pays higher tax rates than someone who earns less (tax progression). 6 Therefore, the income tax law follows the capability of taxpayers to contribute to the common welfare of the society. Tax laws include various and detailed regulations and numerous exceptions for income tax adjustments. For this textbook, we simplify the income tax calculation. We multiply a company’s pre-tax profit by a total income tax rate of 30 %. For a real business, you must replace that tax substitute with a detailed tax calculation. 7 2.7 Value added tax VAT. Value added tax VAT is a consumer tax and is paid by buyers of goods or recipients of services. The VAT rate is the same for all consumers. Companies usually are exempted from VAT, as they do not consume but buy goods or services for manufacturing and service rendering purposes. Companies that buy goods or services initially pay input-VAT but get refunded by the revenue service later. Hence, companies are not charged VAT. The refund is received based on a VAT return form submitted to the revenue service. 8 All companies registered for VAT reduction collect output-VAT from their customers on behalf of the revenue service. The output-VAT is paid based on the revenue. Therefore, the expression Umsatzsteuer in Ger- 7 See Schneeloch, D.; Meyering S.; Patek, G.: Betriebliche Steuerlehre. 8 Following our conventions, we consider annual refunding/ paying. Berkau: Financial Statements 8e 2-25 many is common. Technically, all companies keep a record of VAT payments and receipts as a VAT accounts. In the end, they pay the excess of output- VAT over input-VAT to the revenue service. In this textbook, a VAT rate of 20 % applies and all companies are registered for VAT reduction by default. 9 Below, we discuss our first case study KIELILNG TAXI GmbH. The case study resembles the case of KENILWORTH METERED TAXI SERVICE Ltd. discussed in the next chapter (3) for studying international Accounting. This way, you can compare German HGB to international Accounting standards IFRSs. 10 2.8 C/ S KIELING TAXI GmbH - 20X1 For the KIELING TAXI GmbH case study, we apply German HGB and make Bookkeeping entries following the DATEV format. 11 Below, you see a data sheet which contains the major information for the case study. Data Sheet for KIELING TAXI GmbH DDoommiicciillee: : GGeerrmmaannyy ((HHaannoovveerr)).. RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. EEssttaabblliisshhmmeenntt: : 11..0011..2200XX11; ; oowwnneerr''ss ccoonn-ttrriibbuuttiioonn: : 5500"000000 EEUURR" 1100"000000 EEUURR tthheerreeooff aass ttaaxxii lliicceennssee.. AAccqquuiissiittiioonn ooff aa ccaarr: : 3300"000000 EEUURR nneett aammoouunntt" ttaaxxii eeqquuiippmmeenntt 55"000000 EEUURR nneett aammoouunntt.. 9 Companies must register for the right of VAT refunding at the revenue service which works automatically with the establishment in Germany: By default, every company is registered for VAT reduction. 10 Note, that the reporting company cannot choose which standards to apply. DDeepprreecciiaattiioonn: : ssttrraaiigghhtt--lliinnee mmeetthhoodd oovveerr 33 yyeeaarrss" rreessiidduuaall vvaalluuee 88"000000 EEUURR.. RReelleevvaanntt AAccccoouunnttiinngg ppeerriiooddss 2200XX11/ / 2200XX22.. RReevveennuuee: : 110000"000000 EEUURR / / 110055"000000 EEUURR.. LLaabboouurr ((ffoorr ddrriivveerrss)): : 5500"000000 EEUURR / / 5555"000000 EEUURR.. OOppeerraattiioonnaall eexxppeennsseess ((VVAATTaabbllee 1122 )): : 1155"000000 EEUURR / / 1166"000000 EEUURR.. AApppprroopprriiaattiioonn ooff pprrooffiittss: : 2200XX11: : nnoonnee / / 2200XX22: : 1100"000000 EEUURR ppaayymmeenntt ttoo oowwnneerrss" 1100"000000 EEUURR aaddddeedd ttoo rreesseerrvveess" rreemmaaiinn-ddeerr ccaarrrriieedd ffoorrwwaarrdd ttoo 2200XX33.. VVAATT rraattee: : 2200 %%.. Mr Kieling starts his taxi business and buys a taxi license in Hanover. His taxi gets registered (by the city of Hanover) under the taxi-number 43. Mr Kieling establishes a privately owned and limited firm KIELING TAXI GmbH. A GmbH follows the German company’s act (GmbHG) and requires a minimum contribution of 25,000 EUR from its owners (all together). A company in the legal form of GmbH needs to be registration at the local court. Mr Kieling makes an appointment with the attorney Dr. Meppen. He contributes 50,000 EUR which is partially paid. 13 Mr Kieling opens an account at Commerzbank in Hanover and deposits 40,000 EUR before he pays his attorney a visit. The remainder portion of the contribution is provided as taxi license, 11 This means we apply a chart of accounts that is in use in Germany and is provided from the company DATEV. 12 VATable is Accounting slang for VAT relevant. 13 The owner’s contribution in this case study is higher than required by law as we avoid discussing loans to keep the case simple. <?page no="26"?> Berkau: Financial Statements 8e 2-26 worth 10,000 EUR. Its valuation is at cost 14 . On 27.12.20X0, Mr Kieling presents proof of payment for his contribution to the company funds by a stamped bank statement and the taxi license. He also provides the attorney with an opening balance sheet in compliance with the formal requirements in § 266 HGB. See the opening balance sheet in Figure 2.1. Following § 244 HGB, Mr Kieling submits the balance sheet in German and all figures in EUR. Debit side [EUR] Credit side [EUR] A. Non-current assets A. Equity I. Intangable assets 10,000 I. Issued capital 50,000 II. Tangable assets II. Capital reserves III. Financial assets III. Earnings reserves IV. Profit/ Loss carried forward B. Current assets V. Annual surplus/ loss I. Inventories II. Receivables and other B. Provisions assets I. Provisions for pension funds III. Securities II. Tax provisions IV. Cash, cash on 40,000 III. Other provisions Bundesbank cash on banks, checks C. Payables C. Accurals on debit side D. Accruals on the credit side D. Deferred taxes on the debit side E. Deferred taxes on the credit side E. Difference of asset offsetting on the asset side 50,000 50,000 Kieling Taxi GmbH BALANCE SHEET as at 1.01.20X1 Figure 2.1: KIELING TAXI GmbH’s opening balance sheet The attorney, Dr. Meppen, prepares the MOI by which Theo Kieling is appointed as chief executive officer (CEO) of KIELING TAXI GmbH. He represents the company. Dr. Meppen submits the MOI at the local court in Hanover which leads to the following: (1) KIELING TAXI GmbH is registered at the registrar in Hanover and (2) the revenue service assigns a German tax-payer ID to the company. KIELING 14 At cost is a technical term in Accounting. It refers to the cost of acquisition as defined under § 255 HGB. TAXI GmbH receives a notification of establishment from the local court as well as from the German revenue service in Hanover 15 . On 2.01.20X1, KIELING TAXI GmbH commences its operations. It now must keep Bookkeeping records and take stock. At the time of incorporation, the company owns the taxi license at a value of 10,000 EUR and 40,000 EUR in the bank account at Commerzbank. 15 Called Finanzamt Hannover. <?page no="27"?> Berkau: Financial Statements 8e 2-26 worth 10,000 EUR. Its valuation is at cost 14 . On 27.12.20X0, Mr Kieling presents proof of payment for his contribution to the company funds by a stamped bank statement and the taxi license. He also provides the attorney with an opening balance sheet in compliance with the formal requirements in § 266 HGB. See the opening balance sheet in Figure 2.1. Following § 244 HGB, Mr Kieling submits the balance sheet in German and all figures in EUR. Debit side [EUR] Credit side [EUR] A. Non-current assets A. Equity I. Intangable assets 10,000 I. Issued capital 50,000 II. Tangable assets II. Capital reserves III. Financial assets III. Earnings reserves IV. Profit/ Loss carried forward B. Current assets V. Annual surplus/ loss I. Inventories II. Receivables and other B. Provisions assets I. Provisions for pension funds III. Securities II. Tax provisions IV. Cash, cash on 40,000 III. Other provisions Bundesbank cash on banks, checks C. Payables C. Accurals on debit side D. Accruals on the credit side D. Deferred taxes on the debit side E. Deferred taxes on the credit side E. Difference of asset offsetting on the asset side 50,000 50,000 Kieling Taxi GmbH BALANCE SHEET as at 1.01.20X1 Figure 2.1: KIELING TAXI GmbH’s opening balance sheet The attorney, Dr. Meppen, prepares the MOI by which Theo Kieling is appointed as chief executive officer (CEO) of KIELING TAXI GmbH. He represents the company. Dr. Meppen submits the MOI at the local court in Hanover which leads to the following: (1) KIELING TAXI GmbH is registered at the registrar in Hanover and (2) the revenue service assigns a German tax-payer ID to the company. KIELING 14 At cost is a technical term in Accounting. It refers to the cost of acquisition as defined under § 255 HGB. TAXI GmbH receives a notification of establishment from the local court as well as from the German revenue service in Hanover 15 . On 2.01.20X1, KIELING TAXI GmbH commences its operations. It now must keep Bookkeeping records and take stock. At the time of incorporation, the company owns the taxi license at a value of 10,000 EUR and 40,000 EUR in the bank account at Commerzbank. 15 Called Finanzamt Hannover. Berkau: Financial Statements 8e 2-27 On 4.01.20X1, KIELING TAXI GmbH buys a used Mercedes-Benz E200 CDI at a cost of acquisition of 30,000 EUR (net value). Cost of acquisition always is the net amount, but to proof the value the invoice from the car dealer must disclose VAT, see § 255 HGB and § 15 UStG. KIELING TAXI GmbH claims a VAT refund of: 30,000 × 20% = 6 6"000000 EEUURR in the next Accounting period. 16 KIELING TAXI GmbH orders a specialised taxi car manufacturer to configure the car for its intended use as a metered taxi. The car is equipped with a yellow taxi light mounted on the roof, a radio for communication with the taxi dispatcher, a meter and seat sensors which cost in total 6,000 EUR (gross value). The manufacturer discloses input-VAT on the bill. VAT amounts to: 5,000 × 20% = 1 1"000000 EEUURR. Following §255 HGB, the total costs of acquisition add up to: 30,000 + 5,000 = 3 355"000000 EEUURR. KIELING TAXI GmbH pays the car dealer and the manufacturer: 35,000 × (1 + 20%) = 4 422"000000 EEUURR per bank transfer. At this stage, we introduce a simplification for the VAT calculation procedure which only applies for the calculation based on the textbook’s VAT rate of 20 %. We insert the How-it-is- Done paragraph below: How it is Done (VAT calculation, based on a 20 % VAT rate) (1a) If the net value is given multiply the net value by 120 % or with 1.2 to calculate the gross value. (1b) If the net value is given and we want to know VAT, multiply by 20 % or divide by 5. (2a) If VAT is known and we want to know the gross value, multiply the VAT amount by 6. (2b) If VAT is known and we want to know the net value, divide by 20 % or multiply by 5 (3a) If the gross value is given and we want to know the net value, divide by 120 % or 1.2. (3b) If the gross value is given and we want to know VAT divide by 120 % and multiply by 20 %. Alternatively, divide the gross value by 6. Depreciation on the taxi follows straight-line method over the useful life of three years 17 . The depreciation table issued by the German finance minister applies for the tax statements and is considered for the commercial financial statements here, too. KIELING TAXI GmbH estimates to sell the car at 8,000 16 That would be in February/ 20X1, but we follow our textbook conventions from chapter (1). EUR (net value) after 31.12.20X3. Therefore, the depreciable amount of the taxi is: 35,000 - 8,000 = 2 277"000000 EEUURR. Annual depreciation is: 27,000 / 3 = 9 9"000000 EEUURR/ / aa. After making deductions for depreciation, KIELING TAXI GmbH carries the car at a value of: 42,000 / 120% - 9,000 = 2 266"000000 EEUURR as per 31.12.20X1. 17 Based on the German Afa-list motor vehicles are depreciated over six years. The Mercedes here is pre-owned. <?page no="28"?> Berkau: Financial Statements 8e 2-28 Depreciation is recorded at the end of the Accounting period. During the Accounting period 20X1, KIELING TAXI GmbH earns 100,000 EUR in revenues with taxi rides. Due to the registration for VAT reduction, the taxi passengers (all together) pay the gross amount which is termed proceeds: 100,000 × 120% = 1 12200"000000 EEUURR. Labour for the drivers is 50,000 EUR/ a and KIELING TAXI GmbH pays for operations 18,000 EUR/ a, the latter one is the gross value. Here, the operational expenses are VATable because they fall under 3 rd party expenses. Their net value is: 18,000 / 120% = 1 155"000000 EEUURR/ / aa. The taxi drivers at KIELING GmbH are paid 50,000 EUR/ a. Observe below the Bookkeeping entries in the journal in Figure 2.2. To keep this case study simple, we record all single business activities as one comprehensive Bookkeeping entry dated to the middle of the Accounting period 20X1 (30.06.20X1). This means, we do not record all taxi rides but make one Bookkeeping entry for all of them together. Nr Amount Date Narrative DR CR OV 10,000 2.01.20X1 Establishment of business Licenses Issued capital 40,000 Cash/ Bank Issued capitall (1) 30,000 4.01.20X1 Acquisition of taxi car P, P, E Cash/ Bank 6,000 VAT Cash/ Bank (2) 5,000 5.01.20X1 Taxi equipment P, P, E Cash/ Bank 1,000 VAT Cash/ Bank (3) 9,000 31.12.20X1 Depreciation taxi car Depreciation P, P, E (4) 100,000 30.06.20X1 Revenue from taxi rides Cash/ Bank Revenue 20,000 Cash/ Bank VAT (5) 50,000 30.06.20X1 Labour Labour Cash/ Bank (6) 15,000 30.06.20X1 Operating expenses Operational exp. Cash/ Bank 3,000 VAT Cash/ Bank Kieling Taxi GmbH JOURNAL 20X1 Figure 2.2: KIELILNG TAXI GmbH’s journal (20X1) The profit or loss calculation determines the pre-tax profit for 20X1. We deduct labour, operational expenses and depreciation from revenues which gives: 100,000 - 50,000 - 15,000 - 9,000 = 2266"000000 EEUURR. The values used for profit calculation are always net of VAT: - Revenue: 100,000 EUR. - Labour: 50,000 EUR. - Operational expenses: 15,000 EUR. - Depreciation: 9,000 EUR. In the next year, KIELING TAXI GmbH pays for income taxes: 26,000 × 30% = 77"880000 EEUURR. We discuss the balance sheet as per 31.12.20X1. It discloses all assets on its left-hand side. At KIELING TAXI GmbH, assets are the motor vehicle and the taxi license as well as cash/ bank. The motor vehicle’s carrying value after depreciation is: 35,000 - 9,000 = 2 266"000000 EEUURR. No depreciation on the license applies as it <?page no="29"?> Berkau: Financial Statements 8e 2-28 Depreciation is recorded at the end of the Accounting period. During the Accounting period 20X1, KIELING TAXI GmbH earns 100,000 EUR in revenues with taxi rides. Due to the registration for VAT reduction, the taxi passengers (all together) pay the gross amount which is termed proceeds: 100,000 × 120% = 1 12200"000000 EEUURR. Labour for the drivers is 50,000 EUR/ a and KIELING TAXI GmbH pays for operations 18,000 EUR/ a, the latter one is the gross value. Here, the operational expenses are VATable because they fall under 3 rd party expenses. Their net value is: 18,000 / 120% = 1 155"000000 EEUURR/ / aa. The taxi drivers at KIELING GmbH are paid 50,000 EUR/ a. Observe below the Bookkeeping entries in the journal in Figure 2.2. To keep this case study simple, we record all single business activities as one comprehensive Bookkeeping entry dated to the middle of the Accounting period 20X1 (30.06.20X1). This means, we do not record all taxi rides but make one Bookkeeping entry for all of them together. Nr Amount Date Narrative DR CR OV 10,000 2.01.20X1 Establishment of business Licenses Issued capital 40,000 Cash/ Bank Issued capitall (1) 30,000 4.01.20X1 Acquisition of taxi car P, P, E Cash/ Bank 6,000 VAT Cash/ Bank (2) 5,000 5.01.20X1 Taxi equipment P, P, E Cash/ Bank 1,000 VAT Cash/ Bank (3) 9,000 31.12.20X1 Depreciation taxi car Depreciation P, P, E (4) 100,000 30.06.20X1 Revenue from taxi rides Cash/ Bank Revenue 20,000 Cash/ Bank VAT (5) 50,000 30.06.20X1 Labour Labour Cash/ Bank (6) 15,000 30.06.20X1 Operating expenses Operational exp. Cash/ Bank 3,000 VAT Cash/ Bank Kieling Taxi GmbH JOURNAL 20X1 Figure 2.2: KIELILNG TAXI GmbH’s journal (20X1) The profit or loss calculation determines the pre-tax profit for 20X1. We deduct labour, operational expenses and depreciation from revenues which gives: 100,000 - 50,000 - 15,000 - 9,000 = 2266"000000 EEUURR. The values used for profit calculation are always net of VAT: - Revenue: 100,000 EUR. - Labour: 50,000 EUR. - Operational expenses: 15,000 EUR. - Depreciation: 9,000 EUR. In the next year, KIELING TAXI GmbH pays for income taxes: 26,000 × 30% = 77"880000 EEUURR. We discuss the balance sheet as per 31.12.20X1. It discloses all assets on its left-hand side. At KIELING TAXI GmbH, assets are the motor vehicle and the taxi license as well as cash/ bank. The motor vehicle’s carrying value after depreciation is: 35,000 - 9,000 = 2 266"000000 EEUURR. No depreciation on the license applies as it Berkau: Financial Statements 8e 2-29 does not expire (given). The closing balance for the Cash/ Bank account is: 40,000 - 36,000 - 6,000 + 120,000 - 50,000 - 18,000 = 5 500"000000 EEUURR. The cash/ bank values are based on gross amounts resulting from: - Contribution: 40,000 EUR. - Taxi acquisition: 36,000 EUR. - Taxi configuration: 6,000 EUR. - Proceeds: 120,000 EUR. - Labour (drivers): 50,000 EUR. - Taxi operations: 18,000 EUR. On the credit side of the balance sheet, KIELING TAXI GmbH discloses equity which is the issued capital of 50,000 EUR and the profit after taxes shown as retained earnings of: 26,000 - 7,800 = 1 188"220000 EEUURR. Underneath equity, an income tax provision of 7,800 EUR is disclosed. KIELING TAXI GmbH considers VAT. The output-VAT results from taxi rides. The input-VAT is: 6,000 + 1,000 + 3,000 = 1 100"000000 EEUURR. The values come from: - Output-VAT from taxi rides: 20,000 EUR. - Input-VAT for car acquisition: 6,000 EUR. - Input-VAT for taxi equipment: 1,000 EUR. - Input-VAT for operating expenditures: 3,000 EUR. KIELING TAXI GmbH’s current VAT liabilities are: 20,000 - 10,000 = 1 100"000000 EEUURR. They are disclosed on the balance sheet as short-term liability. We prepare a balance sheet based on the classification of KIELING TAXI GmbH as a small and limited German company following § 267 HGB. The formal requirements are based on § 266 HGB. Small and limited companies prepare balance sheets following an abridged format. The illustrated Bookkeeping entries and the T-accounts for KIELING TAXI GmbH are available for download. Pls., scan Link 2.A: Link 2.A: KIELING TAXI GmbH Observe below the balance sheet for KIELING TAXI GmbH as per 31.12.20X1 in Figure 2.3. We translated the balance sheet for this textbook. It must be prepared in German. <?page no="30"?> Berkau: Financial Statements 8e 2-30 Debit side [EUR] Credit side [EUR] A. Non-current assets A. Equity I. Intangable assets 10,000 I. Issued capital 50,000 II. Tangable assets 26,000 II. Capital reserves III. Financial assets III. Earnings reserves IV. Profit/ Loss carried forward B. Current assets V. Annual surplus/ loss 18,200 I. Inventories II. Receivables and other B. Provisions assets I. Provisions for pension funds III. Securities II. Tax provisions 7,800 IV. Cash, cash on 50,000 III. Other provisions Bundesbank cash on banks, checks C. Payables 10,000 C. Accurals on debit side D. Accruals on the credit side D. Deferred taxes on the debit side E. Deferred taxes on the credit side E. Difference of asset offsetting on the asset side 86,000 86,000 Kieling Taxi GmbH BALANCE SHEET as at 31.12.20X1 Figure 2.3: KIELING TAXI GmbH’s abridged balance sheet (20X1) German law requires companies to submit financial statements in the format prescribed by §§ 266, 275 HGB to the local court. The formal requirements are strict; items must be named as in the law text and must be listed in their prescribed sequence. On the balance sheet, we notice some items that are not relevant for KIELING TAXI GmbH. We discuss those but keep our explanations short: (a) Accruals are ruled by § 250 HGB. The reporting company discloses expenses that have been paid already but only become expenses in a later Accounting period. We refer to those items as prepaid expenses. 18 18 Study our textbook Basics of Accounting, chapter (18). (b) On the credit side, accruals are recorded for income that is revenue in future Accounting periods. These values are often advanced payments or deposits received from customers. 19 (c) Deferred taxes are income tax considerations for tax income (asset side) or expenditures (credit side) that differ from actual tax calculations based on German EStG. (d) If a company discloses losses that exceed the total of equity, § 268 HGB stipulates, that it must show the difference under the item notcovered loss on the asset side of the balance sheet. In these cases, bankruptcy is likely to happen. Excessive indebtedness requires the 19 Study our textbook Basics of Accounting, chapter (15). <?page no="31"?> Berkau: Financial Statements 8e 2-30 Debit side [EUR] Credit side [EUR] A. Non-current assets A. Equity I. Intangable assets 10,000 I. Issued capital 50,000 II. Tangable assets 26,000 II. Capital reserves III. Financial assets III. Earnings reserves IV. Profit/ Loss carried forward B. Current assets V. Annual surplus/ loss 18,200 I. Inventories II. Receivables and other B. Provisions assets I. Provisions for pension funds III. Securities II. Tax provisions 7,800 IV. Cash, cash on 50,000 III. Other provisions Bundesbank cash on banks, checks C. Payables 10,000 C. Accurals on debit side D. Accruals on the credit side D. Deferred taxes on the debit side E. Deferred taxes on the credit side E. Difference of asset offsetting on the asset side 86,000 86,000 Kieling Taxi GmbH BALANCE SHEET as at 31.12.20X1 Figure 2.3: KIELING TAXI GmbH’s abridged balance sheet (20X1) German law requires companies to submit financial statements in the format prescribed by §§ 266, 275 HGB to the local court. The formal requirements are strict; items must be named as in the law text and must be listed in their prescribed sequence. On the balance sheet, we notice some items that are not relevant for KIELING TAXI GmbH. We discuss those but keep our explanations short: (a) Accruals are ruled by § 250 HGB. The reporting company discloses expenses that have been paid already but only become expenses in a later Accounting period. We refer to those items as prepaid expenses. 18 18 Study our textbook Basics of Accounting, chapter (18). (b) On the credit side, accruals are recorded for income that is revenue in future Accounting periods. These values are often advanced payments or deposits received from customers. 19 (c) Deferred taxes are income tax considerations for tax income (asset side) or expenditures (credit side) that differ from actual tax calculations based on German EStG. (d) If a company discloses losses that exceed the total of equity, § 268 HGB stipulates, that it must show the difference under the item notcovered loss on the asset side of the balance sheet. In these cases, bankruptcy is likely to happen. Excessive indebtedness requires the 19 Study our textbook Basics of Accounting, chapter (15). Berkau: Financial Statements 8e 2-31 company to cease normal business operations to protect its creditors. Below, we resume the case study KIELING TAXI GmbH: KIELING TAXI GmbH prepares a profit or loss statement. Its format follows § 275 HGB. It can be prepared based on the nature of expense method or the cost of sales format. 20 KIELING TAXI GmbH prepares a profit or loss statement following the nature of expense method. It is depicted in Figure 2.4. [EUR] 1. Revenue 100,000 2. Increase/ decrease resulting from finisched and semi-finished goods inventory changes 3. Other recognised finished goods 4. Other operating profit 5. Materials (a) Expenses for raw materials, supplies and for other aquired goods (b) Expenses for 3rd party services 6. Labour (50,000) (a) Salaries (b) Expenses for social payments and expenses for pension provisions and for support 7. Depreciation (9,000) (a) on intangible non-current assets and P, P, E as well as for recognised finished goods and for expenses to commence and enhence operating processes (b) on current assets as far as they exceed normal depreciation 8. Other operating expenses (15,000) 9. Investment revenue 10. Revenue resulting from other securities and lending financial assets 11. Other interest and similar revenue 12. Depreciation on financial assets and current securities 13. Interest and similar expenses 14. Operating profit 26,000 15. Extraordinary Revenue 16. Extraordinary expenses 17. Extraordinary profit 18. Income taxes (7,800) 19. Other taxes 20. Annual surplus/ loss 18,200 Kieling Taxi GmbH STATEMENT of PROFIT and LOSS for the year 20X1 Figure 2.4: KIELING TAXI GmbH’s profit and loss statement (20X1) Mr Kieling holds an annual meeting and decides about the appropriation of profits. Companies can either declare a dividend, add profit to reserves or carry for- 20 Study our textbook Basics of Accounting, chapter (28). ward their profit or loss to the next Accounting period. The latter postpones the decision about the profit appropriation for a year. The owners also can decide to mix the appropriation of profits. <?page no="32"?> Berkau: Financial Statements 8e 2-32 KIELING TAXI GmbH carries forward the entire profit to 20X2. 21 2.9 C/ S KIELING TAXI GmbH - 20X2 Below, we discuss the Accounting period 20X2: At the beginning of the Accounting period 20X2, KIELING TAXI GmbH pays for income taxes and VAT liabilities. In this paragraph, we start to demonstrate all Bookkeeping entries. KIELING TAXI GmbH starts the Accounting period 20X2 with an Opening Balance Sheet account. The company applies accounts based on the chart of accounts in the DATEV-4 format. You can download the DATEV-4 chart of accounts through Link 2.B below. Link 2.B: DATEV-4 chart of accounts A company that starts Bookkeeping for a new Accounting period, will carry forward balancing figures for the items on the prior balance sheet in the 9000-Balancing-Figures account. Study the accounts as per 1.01.20X2 in Figure 2.5. 22 Therein, the standard account numbers and names apply but have been translated into English for teaching purpose. For the opening of accounts, we indicate contra accounts by their four-digitcodes in line with the DATEV-4 chart of accounts. Some accounts do not carry numbers as the Accounting software generates them and therefore, they are not listed in the chart of accounts, e.g., Annual Surplus account. D C D C 2900 50,000 0110 10,000 9000 10,000 2970 18,200 0520 26,000 3020 7,800 1810 50,000 3800 10,000 86,000 86,000 9000-Balancing figures EBK 0110 Licences Figure 2.5: KIELING TAXI GmbH’s accounts (1.01.20X2) 21 To keep this case study simple, we do not study dividends yet. However, we do for 20X2 further below. 22 Technically, Bookkeeping software prevents you from changing or translating accounts’ names. <?page no="33"?> Berkau: Financial Statements 8e 2-32 KIELING TAXI GmbH carries forward the entire profit to 20X2. 21 2.9 C/ S KIELING TAXI GmbH - 20X2 Below, we discuss the Accounting period 20X2: At the beginning of the Accounting period 20X2, KIELING TAXI GmbH pays for income taxes and VAT liabilities. In this paragraph, we start to demonstrate all Bookkeeping entries. KIELING TAXI GmbH starts the Accounting period 20X2 with an Opening Balance Sheet account. The company applies accounts based on the chart of accounts in the DATEV-4 format. You can download the DATEV-4 chart of accounts through Link 2.B below. Link 2.B: DATEV-4 chart of accounts A company that starts Bookkeeping for a new Accounting period, will carry forward balancing figures for the items on the prior balance sheet in the 9000-Balancing-Figures account. Study the accounts as per 1.01.20X2 in Figure 2.5. 22 Therein, the standard account numbers and names apply but have been translated into English for teaching purpose. For the opening of accounts, we indicate contra accounts by their four-digitcodes in line with the DATEV-4 chart of accounts. Some accounts do not carry numbers as the Accounting software generates them and therefore, they are not listed in the chart of accounts, e.g., Annual Surplus account. D C D C 2900 50,000 0110 10,000 9000 10,000 2970 18,200 0520 26,000 3020 7,800 1810 50,000 3800 10,000 86,000 86,000 9000-Balancing figures EBK 0110 Licences Figure 2.5: KIELING TAXI GmbH’s accounts (1.01.20X2) 21 To keep this case study simple, we do not study dividends yet. However, we do for 20X2 further below. 22 Technically, Bookkeeping software prevents you from changing or translating accounts’ names. Berkau: Financial Statements 8e 2-33 D C D C 9000 26,000 9000 50,000 0520 Motor vehicles, cars 1810 Bank account Commerzbank D C D C 9000 50,000 9000 18,200 2900 Issued capital 2970 Profit carried forward D C D C 9000 7,800 9000 10,000 3020 Tax provisions for income tax 3800 VAT payables Figure 2.5: KIELING TAXI GmbH’s accounts (1.01.20X2) continued During 20X2, KIELING TAXI GmbH records the business activities below: (A) Payment of income tax for 20X1 to the extent of 7,800 EUR. (B) Payment of VAT liabilities for 20X1 which are 10,000 EUR. (C) Depreciation on the taxi to the extent of 9,000 EUR. (D) Payment for labour 55,000 EUR. (E) Operational expenses of 16,000 EUR (net amount). (F) Revenue recognition from taxi rides to the extent of 105,000 EUR (net amount). (G) Transfer of 126,000 EUR cash to the Bank account. KIELING TAXI GmbH makes Bookkeeping entries (A) - (F) for its business activities in 20X2. Note, that we apply Bookkeeping entries as this case study follows German Accounting procedures. They are disclosed in the international format instead of “Soll an Haben”. DR 3020 Tax Provisions ......... 7,800 EUR CR 1810 Bank Account CoBa....... 7,800 EUR DR 3800 Output-VAT.............. 10,000 EUR CR 1810 Bank Account CoBa....... 10,000 EUR DR 6222 Depreciation on Cars.... 9,000 EUR CR 0520 Motor Vehicles, Cars.... 9,000 EUR DR 6010 Labour.................. 55,000 EUR CR 1810 Bank Account CoBa....... 55,000 EUR <?page no="34"?> Berkau: Financial Statements 8e 2-34 DR 6300 Operational Expenses.... 16,000 EUR DR 1400 Input-VAT............... 3,200 EUR CR 1810 Bank Account CoBa....... 19,200 EUR DR 1600 Cash.................... 126,000 EUR CR 3800 Output-VAT.............. 21,000 EUR CR 4200 Revenue................. 105,000 EUR DR 1810 Bank Account CoBa....... 126,000 EUR CR 1600 Cash.................... 126,000 EUR Under German Bookkeeping, the contra entry for depreciation is recorded in the asset account. 23 After recording above Bookkeeping entries, KIELING TAXI GmbH calculates its profit as shown in the accounts below in Figure 2.6. With Bookkeeping entry (G), we transfer cash received from proceeds (for taxi rides) to the Bank account. As we apply the DATEV chart of accounts we separate Cash and Bank accounts. Bookkeeping entry (H) 24 adds income tax expenses of 30 % to the Income Tax Provisions account. Based on § 249 HGB, income taxes are disclosed as provisions. 25 KIELING TAXI GmbH decides about an appropriation of its profits on the annual general meeting AGM. The distributable amount is the profit carried forward plus 20X2’s annual surplus: 18,200 + 17,500 = 3355"770000 EEUURR. KIELING TAXI GmbH’s profit appropriation is: - 10,000 EUR additions are accrued to earnings reserves. - 10,000 EUR dividend is paid to owner(s). - 15,700 EUR are carried forward. The appropriation of profits is recorded as Bookkeeping entries (I), (J), and (K). DR 2970 Profit c/ f.............. 10,000 EUR CR 3519 Liabilities to Owners... 10,000 EUR DR 2970 Profit c/ f.............. 8,200 EUR DR Annual Surplus............... 1,800 EUR CR 2960 Other Earnings Reserves. 10,000 EUR DR Annual Surplus............... 15,700 EUR CR Retained Earnings............ 15,700 EUR Observe the accounts at KIELING TAXI GmbH in Figure 2.6 after the appropriation of profits. For teaching purposes, we display the account 9000 twice. It is 23 Compare to the recording of depreciation following international Accounting as discussed in our textbook Basics of Accounting, chapter (17). the opening account (Eröffnungsbilanzkonto EBK) and the closing account (Schlußbilanzkonto SBK). 24 Not shown. 25 In contrast, IFRSs require the disclosure as income tax liabilities. <?page no="35"?> Berkau: Financial Statements 8e 2-34 DR 6300 Operational Expenses.... 16,000 EUR DR 1400 Input-VAT............... 3,200 EUR CR 1810 Bank Account CoBa....... 19,200 EUR DR 1600 Cash.................... 126,000 EUR CR 3800 Output-VAT.............. 21,000 EUR CR 4200 Revenue................. 105,000 EUR DR 1810 Bank Account CoBa....... 126,000 EUR CR 1600 Cash.................... 126,000 EUR Under German Bookkeeping, the contra entry for depreciation is recorded in the asset account. 23 After recording above Bookkeeping entries, KIELING TAXI GmbH calculates its profit as shown in the accounts below in Figure 2.6. With Bookkeeping entry (G), we transfer cash received from proceeds (for taxi rides) to the Bank account. As we apply the DATEV chart of accounts we separate Cash and Bank accounts. Bookkeeping entry (H) 24 adds income tax expenses of 30 % to the Income Tax Provisions account. Based on § 249 HGB, income taxes are disclosed as provisions. 25 KIELING TAXI GmbH decides about an appropriation of its profits on the annual general meeting AGM. The distributable amount is the profit carried forward plus 20X2’s annual surplus: 18,200 + 17,500 = 3355"770000 EEUURR. KIELING TAXI GmbH’s profit appropriation is: - 10,000 EUR additions are accrued to earnings reserves. - 10,000 EUR dividend is paid to owner(s). - 15,700 EUR are carried forward. The appropriation of profits is recorded as Bookkeeping entries (I), (J), and (K). DR 2970 Profit c/ f.............. 10,000 EUR CR 3519 Liabilities to Owners... 10,000 EUR DR 2970 Profit c/ f.............. 8,200 EUR DR Annual Surplus............... 1,800 EUR CR 2960 Other Earnings Reserves. 10,000 EUR DR Annual Surplus............... 15,700 EUR CR Retained Earnings............ 15,700 EUR Observe the accounts at KIELING TAXI GmbH in Figure 2.6 after the appropriation of profits. For teaching purposes, we display the account 9000 twice. It is 23 Compare to the recording of depreciation following international Accounting as discussed in our textbook Basics of Accounting, chapter (17). the opening account (Eröffnungsbilanzkonto EBK) and the closing account (Schlußbilanzkonto SBK). 24 Not shown. 25 In contrast, IFRSs require the disclosure as income tax liabilities. Berkau: Financial Statements 8e 2-35 D C D C 2900 50,000 0110 10,000 EBK 10,000 SBK 10,000 2970 18,200 0520 26,000 3020 7,800 1810 50,000 3800 10,000 86,000 86,000 9000-Balancing figures EBK 0110 Licences D C D C EBK 26,000 (C) 9,000 EBK 50,000 (A) 7,800 SBK 17,000 (G) 126,000 (B) 10,000 26,000 26,000 (D) 55,000 (E) 19,200 SBK 84,000 176,000 176,000 0520 Motor vehicles, cars 1810 Bank account Commerzbank D C D C SBK 50,000 EBK 50,000 (I) 10,000 EBK 18,200 (J) 8,200 18,200 18,200 2900 Issued capital 2970 Profit carried forward D C D C (A) 7,800 EBK 7,800 (B) 10,000 EBK 10,000 SBK 7,500 (H) 7,500 3800 3,200 (F) 21,000 15,300 15,300 SBK 17,800 31,000 31,000 3020 Tax provisions for income tax 3800 Output-VAT D C D C (C) 9,000 P&L 9,000 (D) 55,000 P&L 55,000 6222 Depreciation on cars 6010 Labour D C D C (E) 16,000 P&L 16,000 (E) 3,200 3800 3,200 6300 Operational expenses 1400 Input-VAT Figure 2.6: KIELING TAXI GmbH’s accounts (20X2) <?page no="36"?> Berkau: Financial Statements 8e 2-36 D C D C (F) 126,000 (G) 126,000 P&L 105,000 (F) 105,000 1600 Cash 4200 Revenue D C D C 6010 55,000 4200 105,000 (H) 7,500 P&L 7,500 6222 9,000 6300 16,000 EBT 25,000 105,000 105,000 76XX 7,500 EBT 25,000 A/ S 17,500 25,000 25,000 Profit and Loss 76XX Income tax expenses D C D C (J) 1,800 P&L 17,500 SBK 10,000 (I) 10,000 (K) 15,700 17,500 17,500 Annual surplus 3519 Liabilities to owners D C D C SBK 10,000 (J) 10,000 SBK 15,700 (K) 15,700 2960 Other earnings reserves Retained earnings D C 0520 17,000 2900 50,000 0110 10,000 2960 10,000 1810 84,000 R/ E 15,700 3519 10,000 3020 7,500 3800 17,800 111,000 111,000 9000 Balancing figures SBK Figure 2.6: KIELING TAXI GmbH’s accounts (20X2) continued The Bookkeeping records are for the preparation of financial statements. KIELING TAXI GmbH prepares an income statement based on its Profit and Loss account. The income statement is depicted in Figure 2.7. Note, that in this textbook we usually present income statements in a (DR)CR-format, which means that credit entries like for revenue are positive, and <?page no="37"?> Berkau: Financial Statements 8e 2-36 D C D C (F) 126,000 (G) 126,000 P&L 105,000 (F) 105,000 1600 Cash 4200 Revenue D C D C 6010 55,000 4200 105,000 (H) 7,500 P&L 7,500 6222 9,000 6300 16,000 EBT 25,000 105,000 105,000 76XX 7,500 EBT 25,000 A/ S 17,500 25,000 25,000 Profit and Loss 76XX Income tax expenses D C D C (J) 1,800 P&L 17,500 SBK 10,000 (I) 10,000 (K) 15,700 17,500 17,500 Annual surplus 3519 Liabilities to owners D C D C SBK 10,000 (J) 10,000 SBK 15,700 (K) 15,700 2960 Other earnings reserves Retained earnings D C 0520 17,000 2900 50,000 0110 10,000 2960 10,000 1810 84,000 R/ E 15,700 3519 10,000 3020 7,500 3800 17,800 111,000 111,000 9000 Balancing figures SBK Figure 2.6: KIELING TAXI GmbH’s accounts (20X2) continued The Bookkeeping records are for the preparation of financial statements. KIELING TAXI GmbH prepares an income statement based on its Profit and Loss account. The income statement is depicted in Figure 2.7. Note, that in this textbook we usually present income statements in a (DR)CR-format, which means that credit entries like for revenue are positive, and Berkau: Financial Statements 8e 2-37 all debit entries are shown as negative figures. 26 [EUR] 1. Revenue 105,000 2. Increase/ decrease resulting from finisched and semi-finished goods inventory changes 3. Other recognised finished goods 4. Other operating profit 5. Materials (a) Expenses for raw materials, supplies and for other aquired goods (b) Expenses for 3rd party services 6. Labour (55,000) (a) Salaries (b) Expenses for social payments and expenses for pension provisions and for support 7. Depreciation (9,000) (a) on intangible non-current assets and P, P, E as well as for recognised finished goods and for expenses to commence and enhence operating processes (b) on current assets as far as they exceed normal depreciation 8. Other operating expenses (16,000) 9. Investment revenue 10. Revenue resulting from other securities and lending financial assets 11. Other interest and similar revenue 12. Depreciation on financial assets and current securities 13. Interest and similar expenses 14. Operating profit 25,000 15. Extraordinary Revenue 16. Extraordinary expenses 17. Extraordinary profit 18. Income taxes (7,500) 19. Other taxes 20. Annual surplus/ loss 17,500 Kieling Taxi GmbH STATEMENT of PROFIT and LOSS for the year 20X2 Figure 2.7: KIELING TAXI GmbH’s income statement (20X2) Based on § 276 HGB, small and limited companies are free to combine items (1) - (5) and disclose their gross profit instead. Next, we discuss the balance sheet: A company prepares its balance sheet either before or after the appropriation of profits. In case the appropriation of profits is considered, the company must follow § 268 HGB: If the profit 26 Our convention is not consistent with German law but with all other statements in this textbook. has been fully distributed, the item annual surplus becomes zero and gets omitted. Under a partial appropriation of profits, the item annual surplus is replaced by retained earnings. The item retained earnings 27 then discloses the profit or loss carried forward. KIELING TAXI GmbH opts for disclosure of the balance sheet under consideration of the appropriation of profits. Therefore, it replaces the items profit 27 Different to retained earnings following IFRSs. <?page no="38"?> Berkau: Financial Statements 8e 2-38 carried forward from 20X1 and annual surplus by retained earnings. Retained earnings are amounting to: 18,200 + 17,500 - 10,000 - 10,000 = 1 155"770000 EEUURR. § 267 HGB states that a limited company that does not exceed two of the above threshold values for two following Accounting periods is classified as a small and limited company. The privileges of small and limited companies are: (a) The balance sheet follows an abridged format that requires only the disclosure of items indicated by letters and Roman numerals (§ 266 HGB). (b) Based on § 274a HGB, small and limited companies do not prepare a register of non-current assets as otherwise required by § 268 HGB. (c) Small and limited companies do not explain certain receivables based on § 268 HGB. (d) Small and limited companies do not explain certain payables based on § 268 HGB. (e) § 274a HGB exempts small and limited companies from regulations about accruals and deferred taxes based on §§ 268, 274 HGB. The above exemptions and simplifications apply for KIELING TAXI GmbH. Observe its abridged balance sheet as per 31.12.20X2 in Figure 2.8. Debit side [EUR] Credit side [EUR] A. Non-current assets A. Equity I. Intangable assets 10,000 I. Issued capital 50,000 II. Tangable assets 17,000 II. Capital reserves III. Financial assets III. Earnings reserves 10,000 IV. Retained earnings 15,700 B. Current assets I. Inventories B. Provisions II. Receivables and other I. Provisions for pension funds assets II. Tax provisions 7,500 III. Securities III. Other provisions IV. Cash, cash on 84,000 Bundesbank C. Payables 27,800 cash on banks, checks D. Accruals on the credit side C. Accurals on debit side E. Deferred taxes on the credit side D. Deferred taxes on the debit side E. Difference of asset offsetting on the asset side 111,000 111,000 Kieling Taxi GmbH BALANCE SHEET as at 31.12.20X2 Figure 2.8: KIELING TAXI GmbH’s abridged balance sheet (20X2) §§ 284 - 288 HGB rule the appendix. For small and limited companies, an abridged appendix applies based on § 288 HGB. To study a real appendix, check the financial statements of Lufthansa AG below: <?page no="39"?> Berkau: Financial Statements 8e 2-38 carried forward from 20X1 and annual surplus by retained earnings. Retained earnings are amounting to: 18,200 + 17,500 - 10,000 - 10,000 = 1 155"770000 EEUURR. § 267 HGB states that a limited company that does not exceed two of the above threshold values for two following Accounting periods is classified as a small and limited company. The privileges of small and limited companies are: (a) The balance sheet follows an abridged format that requires only the disclosure of items indicated by letters and Roman numerals (§ 266 HGB). (b) Based on § 274a HGB, small and limited companies do not prepare a register of non-current assets as otherwise required by § 268 HGB. (c) Small and limited companies do not explain certain receivables based on § 268 HGB. (d) Small and limited companies do not explain certain payables based on § 268 HGB. (e) § 274a HGB exempts small and limited companies from regulations about accruals and deferred taxes based on §§ 268, 274 HGB. The above exemptions and simplifications apply for KIELING TAXI GmbH. Observe its abridged balance sheet as per 31.12.20X2 in Figure 2.8. Debit side [EUR] Credit side [EUR] A. Non-current assets A. Equity I. Intangable assets 10,000 I. Issued capital 50,000 II. Tangable assets 17,000 II. Capital reserves III. Financial assets III. Earnings reserves 10,000 IV. Retained earnings 15,700 B. Current assets I. Inventories B. Provisions II. Receivables and other I. Provisions for pension funds assets II. Tax provisions 7,500 III. Securities III. Other provisions IV. Cash, cash on 84,000 Bundesbank C. Payables 27,800 cash on banks, checks D. Accruals on the credit side C. Accurals on debit side E. Deferred taxes on the credit side D. Deferred taxes on the debit side E. Difference of asset offsetting on the asset side 111,000 111,000 Kieling Taxi GmbH BALANCE SHEET as at 31.12.20X2 Figure 2.8: KIELING TAXI GmbH’s abridged balance sheet (20X2) §§ 284 - 288 HGB rule the appendix. For small and limited companies, an abridged appendix applies based on § 288 HGB. To study a real appendix, check the financial statements of Lufthansa AG below: Berkau: Financial Statements 8e 2-39 Link 2.C: Lufthansa AG’s appendix 2.10 Summary German retailers and companies in the legal form of a limited company prepare and report financial statements based on §§ 242 and 264 HGB. The financial statements in Germany include a balance sheet and an income statement. Limited companies also prepare an appendix and a business report. In case a company participates in the capital market and is not obliged to prepare group statements, it must disclose a cash flow statement. (§ 264 HGB). We discussed the case study KIELILNG TAXI GmbH, which is a German limited company and prepares its financial statements over two Accounting periods. After the last one, it appropriates its profits. The balance sheet provided for the 2 nd Accounting period has been set up after profit appropriation. 2.11 Working Definitions Accruals: Item on the balance sheet that is income or expense for a specific time after the balance sheet date. Appendix: Disclosure of information linked to the financial statements and required by §§ 284 - 288 HGB. German financial statements of limited companies must be enhanced by an appendix. Appropriation of profits: Using profit after tax as either addition to reserves, payment to owners or carrying profit or loss forward to the next Accounting period. Balance sheet: Statement of financial position that discloses assets, equity and liabilities in an aggregated form. Bankruptcy: A situation that triggers legal procedures of liquidation due to over-indebtedness or insolvency. Business report: Disclosure of the situation the company is in at the time of reporting and in the nearby future. The business report is required for limited companies that are not classified as small. It also is termed management report. DATEV-4 chart of accounts: Standard list of accounts applicable for electronic transfer of financial statements and accounts. Distributable amount: The amount a company can pay as a dividend to its shareholders without dissolving reserves. It includes the profit carried forward and the annual surplus. In case the company carries forward a loss it must deduct it. Excluded from the distributable amount are contributions to legal reserves (§ 150 AktG) and preference dividends. Financial statements: In Germany, financial statements include: a balance sheet, an income statement and for limited companies an appendix. Limited companies also must prepare a business report. A set of financial statements can include a statement of cash flows, as well. Handelsgesetzbuch HGB: German law for retailers and limited companies that states that financial statements must be prepared and how to do so. <?page no="40"?> Berkau: Financial Statements 8e 2-40 Income statement: Statement of profit or loss that compares income and expenses for profit calculation. Its structure is given by § 275 HGB. Limited company: A company with restrictions about responsibility to the value of its equity. Non-covered loss on the asset side: A loss that exceeds the equity is required to be disclosed on the asset side of the German balance sheet based on § 266 HGB. Provision: Uncertain liability, e.g., for income taxes or other expenses based on § 249 HGB. Provisions require a present obligation at the time of reporting. Value added tax: Tax levied in most countries on consumption. In this textbook, the common VAT rate is 20 %. No reduced VAT rates apply. 2.12 Question Bank (1) A German company in the legal form of a limited company must prepare financial statements which comprise of … 1. … a balance sheet, an income statement, an appendix, and in case of participation on the capital market and no group membership a cash flow statement. 2. … a balance sheet, an income statement, an appendix, a management report and in case of participation in the capital market and group membership a cash flow statement. 3. … a balance sheet, an income statement, an appendix, a management report and in case of participation in the capital market and no group membership a cash flow statement. 4. … a balance sheet, an income statement, a management report and in case of participation in the capital market and group membership a cash flow statement. (2) A German company that earns a pre-tax profit of 80,000 EUR, carrying forward a loss of 20,000 EUR and adding half of the distributable amount to reserves (no other appropriation of profits) discloses as retained earnings: 1. 38,000 EUR . 2. 30,000 EUR . 3. 50,000 EUR . 4. 18,000 EUR . (3) A German company buys a machine and pays a partial amount of 100,000 EUR and adds 44,000 EUR to payables. How much is the cost of acquisition? You must consider VAT. 1. 144,000 EUR . 2. 120,000 EUR . 3. 100,000 EUR . 4. 44,000 EUR . (4) A German company in the legal form of a limited company earns revenue of 5,000,000 EUR and discloses a total of assets of 10,000,000 EUR. No non-covered loss is disclosed on its asset side. The number of employees is 100. How do you classify the company regarding its size based on § 267 HGB? 1. Micro firm. 2. Small limited company 3. Medium-sized limited company. 4. Big corporation. <?page no="41"?> Berkau: Financial Statements 8e 2-40 Income statement: Statement of profit or loss that compares income and expenses for profit calculation. Its structure is given by § 275 HGB. Limited company: A company with restrictions about responsibility to the value of its equity. Non-covered loss on the asset side: A loss that exceeds the equity is required to be disclosed on the asset side of the German balance sheet based on § 266 HGB. Provision: Uncertain liability, e.g., for income taxes or other expenses based on § 249 HGB. Provisions require a present obligation at the time of reporting. Value added tax: Tax levied in most countries on consumption. In this textbook, the common VAT rate is 20 %. No reduced VAT rates apply. 2.12 Question Bank (1) A German company in the legal form of a limited company must prepare financial statements which comprise of … 1. … a balance sheet, an income statement, an appendix, and in case of participation on the capital market and no group membership a cash flow statement. 2. … a balance sheet, an income statement, an appendix, a management report and in case of participation in the capital market and group membership a cash flow statement. 3. … a balance sheet, an income statement, an appendix, a management report and in case of participation in the capital market and no group membership a cash flow statement. 4. … a balance sheet, an income statement, a management report and in case of participation in the capital market and group membership a cash flow statement. (2) A German company that earns a pre-tax profit of 80,000 EUR, carrying forward a loss of 20,000 EUR and adding half of the distributable amount to reserves (no other appropriation of profits) discloses as retained earnings: 1. 38,000 EUR . 2. 30,000 EUR . 3. 50,000 EUR . 4. 18,000 EUR . (3) A German company buys a machine and pays a partial amount of 100,000 EUR and adds 44,000 EUR to payables. How much is the cost of acquisition? You must consider VAT. 1. 144,000 EUR . 2. 120,000 EUR . 3. 100,000 EUR . 4. 44,000 EUR . (4) A German company in the legal form of a limited company earns revenue of 5,000,000 EUR and discloses a total of assets of 10,000,000 EUR. No non-covered loss is disclosed on its asset side. The number of employees is 100. How do you classify the company regarding its size based on § 267 HGB? 1. Micro firm. 2. Small limited company 3. Medium-sized limited company. 4. Big corporation. Berkau: Financial Statements 8e 2-41 (5) Financial statements in Germany following § 244 HGB must be prepared in… 1. … German, in any currency. 2. … English and in EUR. 3. … German and in EUR. 4. … English and in any currency. 2.13 Solutions 1-1, 2-4, 3-2, 4-3, 5-3. <?page no="42"?> Berkau: Financial Statements 8e 3-42 3 Financial Statements based on IFRSs 3.1 What is in the Chapter? We discuss next a case like KIELING TAXI GmbH in chapter (2). Now, we demonstrate the preparation of its financial statements in compliance with International Financial Reporting Standards IFRSs. The case study is about a company based in South Africa where IFRSs apply for single-entity-financial statements. The case study KENILWORTH METERED TAXI SERVICE Ltd. contains the establishment of the company, the acquisition of 10 motor vehicles and their equipment with taxi appliances (roof sign, radio etc.), depreciation, labour recording, payment for operations and revenue recognition. In contrast to chapter (2), all Bookkeeping entries are made in the international format and a full set of financial statements is prepared. Financial statements as ruled by IAS 1.10 are a statement of financial position (balance sheet), a statement of profit or loss and other comprehensive income (income statement), a statement of changes in equity, a statement of cash flows and the notes. Before the case study of KENILWORTH METERED TAXI SERVICE Ltd., we introduce International Accounting Standards IFRSs to provide you with knowledge of how to find, understand and apply IFRS standards. 28 28 You find a more detailed introduction to IFRSs in our textbook Basics of Accounting, chapter (4). 29 Study our textbook Basics of Accounting, chapter (4). 30 International Accounting applies in many parts of the world, including South Korea, the Euro- 3.2 Learning Objectives After studying this chapter, you can record Bookkeeping entries in the international format, and you have seen the preparation of financial statements following IFRSs. You can prepare simple financial statements for Accounting case studies in compliance with IFRSs. Notes and ESG reporting are covered in chapter (6), too. 3.3 IFRSs International Financial Reporting Standards IFRSs are “the law” for international Accounting. In Germany, international Accounting applies for group statements of groups participating in the capital market 29 ; all singleentity financial statements must be prepared following German HGB. 30 IFRSs are issued by the International Accounting Standard Board IASB. Before starting with your Accounting work, learn how to access the standards on a student registration with the IFRS foundation. 3.4 How to Access IFRSs For academic purposes, the IFRS Foundation offers free access to the standards. Follow the link below to learn how to gain access: pean Union, India, Hong Kong, Australia, Malaysia, Pakistan, GCC countries, Chile, Philippines, South Africa, Singapore and Turkey, but not in the United States. In this textbook, we discuss cases with the companies being headquartered in countries which apply IFRSs. <?page no="43"?> Berkau: Financial Statements 8e 3-42 3 Financial Statements based on IFRSs 3.1 What is in the Chapter? We discuss next a case like KIELING TAXI GmbH in chapter (2). Now, we demonstrate the preparation of its financial statements in compliance with International Financial Reporting Standards IFRSs. The case study is about a company based in South Africa where IFRSs apply for single-entity-financial statements. The case study KENILWORTH METERED TAXI SERVICE Ltd. contains the establishment of the company, the acquisition of 10 motor vehicles and their equipment with taxi appliances (roof sign, radio etc.), depreciation, labour recording, payment for operations and revenue recognition. In contrast to chapter (2), all Bookkeeping entries are made in the international format and a full set of financial statements is prepared. Financial statements as ruled by IAS 1.10 are a statement of financial position (balance sheet), a statement of profit or loss and other comprehensive income (income statement), a statement of changes in equity, a statement of cash flows and the notes. Before the case study of KENILWORTH METERED TAXI SERVICE Ltd., we introduce International Accounting Standards IFRSs to provide you with knowledge of how to find, understand and apply IFRS standards. 28 28 You find a more detailed introduction to IFRSs in our textbook Basics of Accounting, chapter (4). 29 Study our textbook Basics of Accounting, chapter (4). 30 International Accounting applies in many parts of the world, including South Korea, the Euro- 3.2 Learning Objectives After studying this chapter, you can record Bookkeeping entries in the international format, and you have seen the preparation of financial statements following IFRSs. You can prepare simple financial statements for Accounting case studies in compliance with IFRSs. Notes and ESG reporting are covered in chapter (6), too. 3.3 IFRSs International Financial Reporting Standards IFRSs are “the law” for international Accounting. In Germany, international Accounting applies for group statements of groups participating in the capital market 29 ; all singleentity financial statements must be prepared following German HGB. 30 IFRSs are issued by the International Accounting Standard Board IASB. Before starting with your Accounting work, learn how to access the standards on a student registration with the IFRS foundation. 3.4 How to Access IFRSs For academic purposes, the IFRS Foundation offers free access to the standards. Follow the link below to learn how to gain access: pean Union, India, Hong Kong, Australia, Malaysia, Pakistan, GCC countries, Chile, Philippines, South Africa, Singapore and Turkey, but not in the United States. In this textbook, we discuss cases with the companies being headquartered in countries which apply IFRSs. Berkau: Financial Statements 8e 3-43 Link 3.A: Download IFRSs for students 3.5 C/ S KENILWORTH MTS Ltd. - 20X1 We demonstrate the application of IFRSs for KENILWORTH METERED TAXI SERVICE Ltd. based in Cape Town. The currency for this case study is South African Rand ZAR. 31 You need knowledge about international Bookkeeping for this case study. 32 Data Sheet for KENILWORTH METERED TAXI SERVICE Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((CCaappee TToowwnn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. EEssttaabblliisshhmmeenntt: : 11..0011..2200XX11; ; sshhaarree ccaappiittaall: : 55"000000"000000 ZZAARR" 1100 ZZAARR/ / sshhaarree.. AAccqquuiissiittiioonn ooff 1100 ccaarrss aatt 336600"000000 ZZAARR/ / ccaarr ggrroossss aammoouunntt" ttaaxxii eeqquuiippmmeenntt 2244"000000 ZZAARR/ / ccaarr ((nneett vvaalluuee)).. DDeepprreecciiaattiioonn: : ssttrraaiigghhtt--lliinnee mmeetthhoodd oovveerr 44 yyeeaarrss" nnoo rreessiidduuaall vvaalluuee.. RReelleevvaanntt AAccccoouunnttiinngg ppeerriiooddss: : 2200XX11 / / 2200XX22.. RReevveennuuee: : 1122"550000"000000 ZZAARR / / 1133"220000"000000 ZZAARR.. 31 For transfer to EUR amounts, apply the exchange rate of 1: 20 at the time of writing. 32 Study our textbook Basics of Accounting, chapters (6) - (19), (31) and (33). For the case studies therein, youtube videos are provided online. LLaabboouurr ffoorr ddrriivveerrss: : 77"000000"000000 ZZAARR / / 88"000000"000000 ZZAARR.. LLaabboouurr ffoorr ddiissppaattcchheerr aanndd mmaannaaggeerr: : 11"665500"000000 ZZAARR / / 11"665500"000000 ZZAARR.. OOppeerraattiioonnaall eexxppeennsseess ((VVAATTaabbllee)): : 22"000000"000000 ZZAARR / / 22"000000"000000 ZZAARR.. RReenntt ((nnoonn--VVAATTaabbllee)): : 1122"000000 ZZAARR/ / mm / / 1122"000000 ZZAARR/ / mm" ppaayymmeenntt oonnee mmoonntthh iinn aaddvvaannccee" ffrroomm 11..0077..2200XX22 oonnwwaarrddss: : 1133"880000 ZZAARR/ / mm.. AApppprroopprriiaattiioonn ooff pprrooffiittss: : 2200XX11: : ccaarrrriieedd ffoorrwwaarrdd / / 2200XX22: : 3300 %% ddiivviiddeennddss" 2200 %% rree-sseerrvveess" 5500 %% ccaarrrriieedd ffoorrwwaarrdd.. VVAATT rraattee: : 2200 %%.. KENILWORTH METERED TAXI SERVICE Ltd. is a taxi company that provides metered taxi services. The company is established in Cape Town by an issue of 500,000 ordinary shares at 10 ZAR/ s each. At the time of incorporation, on 1.01.20X1, the company’s share capital is: 10 × 500,000 = 5 5"000000"000000 ZZAARR. KENILWORTH METERED TAXI Service Ltd. applies IFRSs for its financial statements as it is domiciled in South Africa. The owners pay 5,000,000 ZAR into KENILWORTH METERED TAXI Service Ltd.’s bank account at FNB Bank 33 . The company is registered with the South African Revenue Service SARS and gets registered for VAT reduction. A VAT rate of 20 % applies. 34 The name of the company is KENILWORTH METERED TAXI SERVICE Ltd. which is abbreviated as KMTS Ltd. in the text. The opening statement of financial position (balance sheet) is prepared following IAS 1.54. It is shown below in Figure 3.1. As the establishment and the contribution of the owners took place before 1.01.20X1, the 33 FNB = First National Bank of South Africa. 34 The actual VAT rate in South Africa is 15 %. <?page no="44"?> Berkau: Financial Statements 8e 3-44 share capital as well as the balancing figure of cash/ bank show as opening values in the accounts and do not count for the cash flows because they do not belong to the Accounting period under discussion. A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E Share capital 5,000,000 Intangibles Reserves Financial assets Retained earnings Current assets Liabilities (liab.) Inventory Long-term liab. Acc. receivables A/ R Short-term liab. A/ P Prepaid expenses Provisions Cash/ Bank 5,000,000 Income tax liab. Total assets 5,000,000 Total equity and liab. 5,000,000 Kenilworth Metered Taxi Service Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X1 Figure 3.1: KMTS Ltd.’s opening balance sheet On 2.01.20X1, KENILWORTH METERED TAXI SERVICE Ltd. buys 10 Toyotas at a purchase price (gross value) of 360,000 ZAR/ car and pays them per bank transfer. Next, we record Bookkeeping entry (1). We do not distinguish between cash and bank. In a real business the Bookkeeper must separate these accounts. 35 For the case study, we allocate the cars to the Property, Plant and Equipment account. Alternatively, KENILWORTH METERED TAXI SERVICE Ltd. could apply a Motor Vehicle account as a subordinated account to its P, P, E account. 36 We further do not follow a specific format for the balance sheet structure. IAS 1.57 states explicitly that the standard (IAS 1) does not prescribe the order or format of presentation. We usually apply the same format for the statements of financial positions in the textbook(s). The description of the Bookkeeping entry is in the format of a journal entry. The reporting currency is ZAR. @ 2.01.20X1 Property, Plant, Equipment PPE 3,000,000 Value Added Tax VAT 600,000 Cash/ Bank C/ B 3,600,000 (acquisition of 10 motor vehicles) After the initial motor vehicle recognition, we continue with their equipment 35 Study our textbook Basics of Accounting, chapter (37). 36 As we do not apply a formal chart of accounts for international Accounting, the name of the account is not standardised. This is for simplification of the cases. In general, companies apply a standardised chart of accounts. <?page no="45"?> Berkau: Financial Statements 8e 3-44 share capital as well as the balancing figure of cash/ bank show as opening values in the accounts and do not count for the cash flows because they do not belong to the Accounting period under discussion. A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E Share capital 5,000,000 Intangibles Reserves Financial assets Retained earnings Current assets Liabilities (liab.) Inventory Long-term liab. Acc. receivables A/ R Short-term liab. A/ P Prepaid expenses Provisions Cash/ Bank 5,000,000 Income tax liab. Total assets 5,000,000 Total equity and liab. 5,000,000 Kenilworth Metered Taxi Service Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X1 Figure 3.1: KMTS Ltd.’s opening balance sheet On 2.01.20X1, KENILWORTH METERED TAXI SERVICE Ltd. buys 10 Toyotas at a purchase price (gross value) of 360,000 ZAR/ car and pays them per bank transfer. Next, we record Bookkeeping entry (1). We do not distinguish between cash and bank. In a real business the Bookkeeper must separate these accounts. 35 For the case study, we allocate the cars to the Property, Plant and Equipment account. Alternatively, KENILWORTH METERED TAXI SERVICE Ltd. could apply a Motor Vehicle account as a subordinated account to its P, P, E account. 36 We further do not follow a specific format for the balance sheet structure. IAS 1.57 states explicitly that the standard (IAS 1) does not prescribe the order or format of presentation. We usually apply the same format for the statements of financial positions in the textbook(s). The description of the Bookkeeping entry is in the format of a journal entry. The reporting currency is ZAR. @ 2.01.20X1 Property, Plant, Equipment PPE 3,000,000 Value Added Tax VAT 600,000 Cash/ Bank C/ B 3,600,000 (acquisition of 10 motor vehicles) After the initial motor vehicle recognition, we continue with their equipment 35 Study our textbook Basics of Accounting, chapter (37). 36 As we do not apply a formal chart of accounts for international Accounting, the name of the account is not standardised. This is for simplification of the cases. In general, companies apply a standardised chart of accounts. Berkau: Financial Statements 8e 3-45 on 9.01.20X1. We postpone the discussion of depreciation to the yearend as it is considered an adjustment. Like in the previous case study, the cars are configured as metered taxi cars by a taxi equipment manufacturer. The modification costs 24,000 ZAR/ car. The value is net of VAT. Hence, KENILWORTH METERED TAXI SERVICE Ltd. pays: 120% × 24,000 × 10 = 2 28888"000000 ZZAARR. It is recorded as Bookkeeping entry (2): @ 9.01.20X1 Property, Plant, Equipment PPE 240,000 Value Added Tax VAT 48,000 Cash/ Bank C/ B 288,000 (alteration of 10 motor vehicles by the taxi equipement manufacturer) During the Accounting period 20X1, KENILWORTH METERED TAXI SERVICE Ltd. earns a revenue of 12,500,000 ZAR. Due to its registration as VAT vendor, the passengers must pay the gross amount including output-VAT. This results in total proceeds of: 120% × 12,500,000 = 1 155"000000"000000 ZZAARR. The revenue recognition is recorded as Bookkeeping entry (3) below. We pretend the Bookkeeping entry is recorded in the middle of the year. @ 1.07.20X1 Cash/ Bank C/ B 15,000,000 Value Added Tax VAT 2,500,000 Revenue-20X1 REV 12,500,000 (revenue recognition from taxi rides) The taxi drivers at KENILWORTH METERED TAXI SERVICE Ltd. each earn 500,000 ZAR/ (a × driver). The company employs 14 drivers. Labour for all taxi drivers is: 14 × 500,000 = 7 7"000000"000000 ZZAARR/ / aa. Accounting for labour results in Bookkeeping entry (4) which is recorded on 30.06.20X1. 37 @ 30.06.20X1 Labour-20X1 LAB 7,000,000 Cash/ Bank C/ B 7,000,000 (recording for labour taxi drivers) The dispatcher at KENILWORTH METERED TAXI SERVICE Ltd. earns 37 The consideration as freelancers is for simplification. For studying Accounting for labour, read our textbook Basics of Accounting, chapter (19). 650,000 ZAR/ a. He works in the headquarters on the radio and answers the <?page no="46"?> Berkau: Financial Statements 8e 3-46 phone to take orders from the customers. He assigns the orders to the taxi drivers per radio call. The manager at KENILWORTH METERED TAXI SERVICE Ltd. earns 1,000,000 ZAR/ a. On 30.06.20X1, labour for the dispatcher and manager is recorded as Bookkeeping entry (5). It is: 650,000 + 1,000,000 = 11"665500"000000 ZZAARR/ / aa. @ 30.06.20X1 Labour-20X1 LAB 1,650,000 Cash/ Bank C/ B 1,650,000 (recording for labour dispatcher, manager) Operational expenses for the taxis, e.g., petrol, maintenance, spare parts, repairs, cash wash etc., cost 2,000,000 ZAR/ a. The amount is paid to 3 rd party companies and, therefore, is subjected to VAT. Hence, the paid price is: 120% × 2,000,000 = 2 2"440000"000000 ZZAARR/ / aa. It is recorded as Bookkeeping entry (6) below on 30.06.20X1. We acknowledge all payments to other companies include a VAT portion by default. 38 IAS 2.11 and IAS 16.16 state that the cost of purchase/ acquisition for companies, which are registered for VAT reduction, are always net values. @ 30.06.20X1 Operational Expenses-20X1 OEX 2,000,000 Value Added Tax VAT 400,000 Cash/ Bank C/ B 2,400,000 (costs for operations recognition) For the office building and garage rent, KENILWORTH METERED TAXI SERVICE Ltd. pays 12,000 ZAR/ m. No input-VAT is included in the rent payments. KENILWORTH METERED TAXI SERVICE Ltd. rents from a private owner, who is not registered for VAT reduction. Hence, KENILWORTH METERED TAXI SERVICE Ltd. cannot claim input-VAT for rent payments from the South African Revenue Service SARS. Rent is due one month in advance. However, rent for January 20X1 is paid on 2.01.20X1, because the company did not exist before. Therefore, KENILWORTH METERED TAXI SERVICE Ltd. makes 13 payments for rent in 20X1, the last one is for January 20X2. (All) rent payments together are amounting to: 13 × 12,000 = 115566"000000 ZZAARR. As an expedient, we make one Bookkeeping entry (7) on 30.06.20X1: @ 30.06.20X1 Rent-20X1 RNT 156,000 Cash/ Bank C/ B 156,000 (recording 13 monthly payments for rent) 38 Study our textbook Basics of Accounting, chapter (20) to (23). <?page no="47"?> Berkau: Financial Statements 8e 3-46 phone to take orders from the customers. He assigns the orders to the taxi drivers per radio call. The manager at KENILWORTH METERED TAXI SERVICE Ltd. earns 1,000,000 ZAR/ a. On 30.06.20X1, labour for the dispatcher and manager is recorded as Bookkeeping entry (5). It is: 650,000 + 1,000,000 = 11"665500"000000 ZZAARR/ / aa. @ 30.06.20X1 Labour-20X1 LAB 1,650,000 Cash/ Bank C/ B 1,650,000 (recording for labour dispatcher, manager) Operational expenses for the taxis, e.g., petrol, maintenance, spare parts, repairs, cash wash etc., cost 2,000,000 ZAR/ a. The amount is paid to 3 rd party companies and, therefore, is subjected to VAT. Hence, the paid price is: 120% × 2,000,000 = 2 2"440000"000000 ZZAARR/ / aa. It is recorded as Bookkeeping entry (6) below on 30.06.20X1. We acknowledge all payments to other companies include a VAT portion by default. 38 IAS 2.11 and IAS 16.16 state that the cost of purchase/ acquisition for companies, which are registered for VAT reduction, are always net values. @ 30.06.20X1 Operational Expenses-20X1 OEX 2,000,000 Value Added Tax VAT 400,000 Cash/ Bank C/ B 2,400,000 (costs for operations recognition) For the office building and garage rent, KENILWORTH METERED TAXI SERVICE Ltd. pays 12,000 ZAR/ m. No input-VAT is included in the rent payments. KENILWORTH METERED TAXI SERVICE Ltd. rents from a private owner, who is not registered for VAT reduction. Hence, KENILWORTH METERED TAXI SERVICE Ltd. cannot claim input-VAT for rent payments from the South African Revenue Service SARS. Rent is due one month in advance. However, rent for January 20X1 is paid on 2.01.20X1, because the company did not exist before. Therefore, KENILWORTH METERED TAXI SERVICE Ltd. makes 13 payments for rent in 20X1, the last one is for January 20X2. (All) rent payments together are amounting to: 13 × 12,000 = 115566"000000 ZZAARR. As an expedient, we make one Bookkeeping entry (7) on 30.06.20X1: @ 30.06.20X1 Rent-20X1 RNT 156,000 Cash/ Bank C/ B 156,000 (recording 13 monthly payments for rent) 38 Study our textbook Basics of Accounting, chapter (20) to (23). Berkau: Financial Statements 8e 3-47 Study KENILWORTH METERED TAXI SERVICE Ltd.’s Bookkeeping records in Figure 3.2! The accounts are not balanced-off yet because no adjustments have been recorded at this stage. D C D C OV 5,000,000 (1) 3,600,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 Cash/ Bank C/ B Issued capital ISS D C D C (1) 3,000,000 (1) 600,000 (3) 2,500,000 (2) 240,000 (2) 48,000 (6) 400,000 Property, Plant, Equipment PPE Value addedd tax VAT [20%] D C D C (3) 12,500,000 (4) 7,000,000 (5) 1,650,000 Revenue-20X1 REV Labour-20X1 LAB D C D C (6) 2,000,000 (7) 156,000 Operational expenses-20X1 OEX Rent-20X1 RNT Figure 3.2: KENILWORTH METERED TAXI SERVICE Ltd.’s accounts KENILWORTH METERED TAXI SERVICE Ltd. records the adjustments at the yearend. Adjustments are Bookkeeping entries made in preparation of the financial statements. The 1 st adjustment Bookkeeping entry is for depreciation. In this case study, depreciation applies only for taxis. It is based on a straight-line method under consideration of a useful life of 4 years. No residual value applies. Annual depreciation is based on the cost of acquisition for the cars as well as on their alteration: (3,000,000 + 240,000) / 4 = 8 81100"000000 ZZAARR/ / aa. This follows IAS 16.16. On 31.12.20X1, we record depreciation as Bookkeeping entry (8): In contrast to chapter (2), the credit entry is now made in the Accumulated Depreciation account. This is the default contra account for international Accounting. In the accounts, the adjustment Bookkeeping entries are not identified by numbers, but we use the three-letter code of the contra account as a reference. This means the Bookkeeping entry <?page no="48"?> Berkau: Financial Statements 8e 3-48 (8) is shown in the Depreciation account as ACC and in the Accumulated Depreciation account as DPR. @ 31.12.20X1 Depreciation-20X1 DPR 810,000 Accumulated Depreciation ACC 810,000 (recording depreciation as adjustment) Another adjustment is made for accruals to prepaid expenses. 39 To accrue payments means we record them under cash/ bank, but we allocate them as next year's costs to prepaid expenses. They do not count for the actual Accounting period. The company pays in December 20X1 rent for January 20X2. To allocate the 13 th payment to the business activities in the next year, we must transfer one monthly rent of 12,000 ZAR to the Prepaid Expenses account. At the beginning of the next Accounting period, KENILWORTH METERED TAXI SERVICE Ltd. accumulates the prepaid expenses to the Rent-20X2 account. @ 31.12.20X1 Prepaid Expenses PRE 12,000 Rent-20X1 RNT 12,000 (allocating rent for 20X2 to prepaid expenses) After completion of initial Bookkeeping entries and recording adjustments, we balance-off all accounts. Observe the accounts at KENILWORTH METERED TAXI SERVICES Ltd. below in Figure 3.3. D C D C OV 5,000,000 (1) 3,600,000 c/ d 5,000,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 b/ d 5,000,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 c/ d 4,906,000 20,000,000 20,000,000 b/ d 4,906,000 Cash/ Bank C/ B Issued capital ISS Figure 3.3: KMTS Ltd.’s accounts after adjustments (20X1) 39 Study our textbook Basics of Accounting, chapter (13) and (18). <?page no="49"?> Berkau: Financial Statements 8e 3-48 (8) is shown in the Depreciation account as ACC and in the Accumulated Depreciation account as DPR. @ 31.12.20X1 Depreciation-20X1 DPR 810,000 Accumulated Depreciation ACC 810,000 (recording depreciation as adjustment) Another adjustment is made for accruals to prepaid expenses. 39 To accrue payments means we record them under cash/ bank, but we allocate them as next year's costs to prepaid expenses. They do not count for the actual Accounting period. The company pays in December 20X1 rent for January 20X2. To allocate the 13 th payment to the business activities in the next year, we must transfer one monthly rent of 12,000 ZAR to the Prepaid Expenses account. At the beginning of the next Accounting period, KENILWORTH METERED TAXI SERVICE Ltd. accumulates the prepaid expenses to the Rent-20X2 account. @ 31.12.20X1 Prepaid Expenses PRE 12,000 Rent-20X1 RNT 12,000 (allocating rent for 20X2 to prepaid expenses) After completion of initial Bookkeeping entries and recording adjustments, we balance-off all accounts. Observe the accounts at KENILWORTH METERED TAXI SERVICES Ltd. below in Figure 3.3. D C D C OV 5,000,000 (1) 3,600,000 c/ d 5,000,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 b/ d 5,000,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 c/ d 4,906,000 20,000,000 20,000,000 b/ d 4,906,000 Cash/ Bank C/ B Issued capital ISS Figure 3.3: KMTS Ltd.’s accounts after adjustments (20X1) 39 Study our textbook Basics of Accounting, chapter (13) and (18). Berkau: Financial Statements 8e 3-49 D C D C (1) 3,000,000 (1) 600,000 (3) 2,500,000 (2) 240,000 c/ d 3,240,000 (2) 48,000 3,240,000 3,240,000 (6) 400,000 b/ d 3,240,000 c/ d 1,452,000 2,500,000 2,500,000 b/ d 1,452,000 Property, Plant, Equipment PPE Value added tax VAT [20%] D C D C c/ d 12,500,000 (3) 12,500,000 (4) 7,000,000 b/ d 12,500,000 (5) 1,650,000 c/ d 8,650,000 8,650,000 8,650,000 b/ d 8,650,000 Revenue-20X1 REV Labour-20X1 LAB D C D C (6) 2,000,000 c/ d 2,000,000 (7) 156,000 PRE 12,000 b/ d 2,000,000 c/ d 144,000 156,000 156,000 b/ d 144,000 Operational expenses-20X1 OEX Rent-20X1 RNT D C D C ACC 810,000 c/ d 810,000 c/ d 810,000 DPR 810,000 b/ d 810,000 b/ d 810,000 Depreciation-20X1 DPR Acc depr ACC D C RNT 12,000 c/ d 12,000 b/ d 12,000 Prepaid expenses PRE Figure 3.3: KMTS Ltd.’s accounts after adjustments (20X1) continued The next step is the profit calculation. We close-off 40 all nominal accounts to the Profit and Loss account. All nominal accounts are marked with the Accounting period in Figure 3.3. This makes it easier to distinguish between nominal 40 To learn how to balance-off and close-off accounts, study the textbook Basics of Accounting, chapters (10) and (11). and real accounts. Nominal accounts are: - Rent-20X1. - Labour-20X1. - Operational expenses-20X1. - Depreciation-20X1. - Revenue-20X1. <?page no="50"?> Berkau: Financial Statements 8e 3-50 To read the Profit and Loss account easily, we apply the three-letter-codes as references, too. See the Profit and Loss account in Figure 3.4. We recognise by the three-letter-code clearly which expenses are disclosed and can copy the figures to the income statement. The pre-tax profit of KENILWORTH METERED TAXI SERVICE Ltd. is: 12,500,000 - 2,000,000 - 144,000 - 810,000 - 8,650,000 = 8 89966"000000 ZZAARR. The pre-tax profit is also referred to as the earnings before taxation EBT. The values for the profit calculation are: - Revenue: 12,500,000 ZAR. - Operational expenses: 2,000,000 ZAR. - Rent: 144,000 ZAR. - Depreciation: 810,000 ZAR. - Labour: 8,650,000 ZAR. Based on our income tax model, 30 % multiplied by earnings before taxes gives the total of income taxes. The earnings after taxes EAT (annual surplus A/ S) are: 896,000 × (1 - 30%) = 6 62277"220000 ZZAARR. Check the accounts in Figure 3.4 after the completion of adjustments. D C D C (1) 3,000,000 (1) 600,000 (3) 2,500,000 (2) 240,000 c/ d 3,240,000 (2) 48,000 3,240,000 3,240,000 (6) 400,000 b/ d 3,240,000 c/ d 1,452,000 2,500,000 2,500,000 b/ d 1,452,000 Property, Plant, Equipment PPE Value added tax VAT [20%] D C D C OV 5,000,000 (1) 3,600,000 c/ d 5,000,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 b/ d 5,000,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 c/ d 4,906,000 20,000,000 20,000,000 b/ d 4,906,000 Cash/ Bank C/ B Issued capital ISS D C D C c/ d 12,500,000 (3) 12,500,000 (4) 7,000,000 P&L 12,500,000 b/ d 12,500,000 (5) 1,650,000 c/ d 8,650,000 8,650,000 8,650,000 b/ d 8,650,000 P&L 8,650,000 Revenue-20X1 REV Labour-20X1 LAB Figure 3.4: KMTS Ltd.’s accounts after profit calculation (20X1) <?page no="51"?> Berkau: Financial Statements 8e 3-50 To read the Profit and Loss account easily, we apply the three-letter-codes as references, too. See the Profit and Loss account in Figure 3.4. We recognise by the three-letter-code clearly which expenses are disclosed and can copy the figures to the income statement. The pre-tax profit of KENILWORTH METERED TAXI SERVICE Ltd. is: 12,500,000 - 2,000,000 - 144,000 - 810,000 - 8,650,000 = 8 89966"000000 ZZAARR. The pre-tax profit is also referred to as the earnings before taxation EBT. The values for the profit calculation are: - Revenue: 12,500,000 ZAR. - Operational expenses: 2,000,000 ZAR. - Rent: 144,000 ZAR. - Depreciation: 810,000 ZAR. - Labour: 8,650,000 ZAR. Based on our income tax model, 30 % multiplied by earnings before taxes gives the total of income taxes. The earnings after taxes EAT (annual surplus A/ S) are: 896,000 × (1 - 30%) = 6 62277"220000 ZZAARR. Check the accounts in Figure 3.4 after the completion of adjustments. D C D C (1) 3,000,000 (1) 600,000 (3) 2,500,000 (2) 240,000 c/ d 3,240,000 (2) 48,000 3,240,000 3,240,000 (6) 400,000 b/ d 3,240,000 c/ d 1,452,000 2,500,000 2,500,000 b/ d 1,452,000 Property, Plant, Equipment PPE Value added tax VAT [20%] D C D C OV 5,000,000 (1) 3,600,000 c/ d 5,000,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 b/ d 5,000,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 c/ d 4,906,000 20,000,000 20,000,000 b/ d 4,906,000 Cash/ Bank C/ B Issued capital ISS D C D C c/ d 12,500,000 (3) 12,500,000 (4) 7,000,000 P&L 12,500,000 b/ d 12,500,000 (5) 1,650,000 c/ d 8,650,000 8,650,000 8,650,000 b/ d 8,650,000 P&L 8,650,000 Revenue-20X1 REV Labour-20X1 LAB Figure 3.4: KMTS Ltd.’s accounts after profit calculation (20X1) Berkau: Financial Statements 8e 3-51 D C D C (6) 2,000,000 c/ d 2,000,000 (7) 156,000 PRE 12,000 b/ d 2,000,000 P&L 2,000,000 c/ d 144,000 156,000 156,000 b/ d 144,000 P&L 144,000 D C D C ACC 810,000 c/ d 810,000 c/ d 810,000 DPR 810,000 b/ d 810,000 P&L 810,000 b/ d 810,000 Operational expenses-20X1 OEX Rent-20X1 RNT Depreciation-20X1 DPR Acc depr ACC D C D C RNT 12,000 c/ d 12,000 OEX 2,000,000 REV 12,500,000 b/ d 12,000 RNT 144,000 DPR 810,000 LAB 8,650,000 EBT 896,000 12,500,000 12,500,000 ITE 268,800 b/ d 896,000 R/ E 627,200 896,000 896,000 Prepaid expenses PRE Profit and Loss-20X1 P&L D C D C ITL 268,800 c/ d 268,800 c/ d 268,800 ITE 268,800 b/ d 268,800 P&L 268,800 b/ d 268,800 D C c/ d 627,200 P&L 627,200 b/ d 627,200 Retained earnings R/ E Income tax expenses ITE Income tax liabilities ITL Figure 3.4: KMTS Ltd.’s accounts after profit calculation (20X1) - continued The Profit and Loss account shows the difference between revenue and expenses. We also see how much is profit after taxation. In contrast to the Profit and Loss account, IAS 1.81A - 1.82B do not force the reporting company to disclose all single expenses on the income statement. For instance, KENILWORTH METERED TAXI SERVICE Ltd. can combine operational expenses and rent to an item "other expenses" on its statement of profit or loss and other comprehensive income. Its value is: 2,000,000 + 144,000 = 22"114444"000000 ZZAARR. Find below the income <?page no="52"?> Berkau: Financial Statements 8e 3-52 statement for KENILWORTH METERED TAXI SERVICE Ltd. in Figure 3.5. [ZAR] Revenue 12,500,000 Other income 0 12,500,000 Materials 0 Labour (8,650,000) Depreciation (810,000) Other expenses (2,144,000) Earnings before int. & taxes (EBIT) 896,000 Interest 0 Earnings before taxes (EBT) 896,000 Income tax expenses (268,800) Deferred taxes 0 Earnings after taxes (EAT) 627,200 Kenilworth Metered Taxi Service Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X1 Figure 3.5: KMTS Ltd.’s income statement (20X1) The next statement we prepare is the balance sheet. IAS 1.10 calls it the statement of financial position. For KENILWORTH METERED TAXI SERVICE Ltd., only few items need calculations for their disclosure; most values can be copied from the real accounts. The value for the item property, plant and equipment is derived from the Property, Plant and Equipment account and the Accumulated Depreciation account and gives: 3,240,000 - 810,000 = 22"443300"000000 ZZAARR. The value for accounts payables includes the difference between output-VAT and input-VAT which is the balancing figure of the Value Added Tax account: 1,452,000 ZAR. We only apply one VAT account for the recording of input-VAT (debit side) and output-VAT (credit side). 41 Observe the balance sheet in Figure 3.6. 41 Note, that VAT is no income tax and therefore cannot be disclosed under income tax liabilities. Apply the accounts payables item for the disclosure of VAT liabilities on the balance sheet. <?page no="53"?> Berkau: Financial Statements 8e 3-52 statement for KENILWORTH METERED TAXI SERVICE Ltd. in Figure 3.5. [ZAR] Revenue 12,500,000 Other income 0 12,500,000 Materials 0 Labour (8,650,000) Depreciation (810,000) Other expenses (2,144,000) Earnings before int. & taxes (EBIT) 896,000 Interest 0 Earnings before taxes (EBT) 896,000 Income tax expenses (268,800) Deferred taxes 0 Earnings after taxes (EAT) 627,200 Kenilworth Metered Taxi Service Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X1 Figure 3.5: KMTS Ltd.’s income statement (20X1) The next statement we prepare is the balance sheet. IAS 1.10 calls it the statement of financial position. For KENILWORTH METERED TAXI SERVICE Ltd., only few items need calculations for their disclosure; most values can be copied from the real accounts. The value for the item property, plant and equipment is derived from the Property, Plant and Equipment account and the Accumulated Depreciation account and gives: 3,240,000 - 810,000 = 22"443300"000000 ZZAARR. The value for accounts payables includes the difference between output-VAT and input-VAT which is the balancing figure of the Value Added Tax account: 1,452,000 ZAR. We only apply one VAT account for the recording of input-VAT (debit side) and output-VAT (credit side). 41 Observe the balance sheet in Figure 3.6. 41 Note, that VAT is no income tax and therefore cannot be disclosed under income tax liabilities. Apply the accounts payables item for the disclosure of VAT liabilities on the balance sheet. Berkau: Financial Statements 8e 3-53 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 2,430,000 Share capital 5,000,000 Intangibles Reserves Financial assets Retained earnings 627,200 Current assets Liabilities (liab.) Inventory Long-term liab. Acc. receivables A/ R Short-term liab. A/ P 1,452,000 Prepaid expenses 12,000 Provisions Cash/ Bank 4,906,000 Income tax liab. 268,800 Total assets 7,348,000 Total equity and liab. 7,348,000 Kenilworth Metered Taxi Service Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X1 Figure 3.6: KMTS Ltd.’s balance sheet (20X1) IAS 1.10 rules that a full set of financial statements comprises of a statement of financial position (balance sheet), a statement of profit or loss and other comprehensive income (income statement), a statement of cash flows and a statement of changes in equity. Additionally, notes are required. You find the remaining statements below in Figure 3.7 and Figure 3.18. An example for notes can be found in chapter (6). The cash flow 42 is the difference between the opening value and the closing figure of the Cash/ Bank account. KENILWORTH METERED TAXI SERVICE Ltd.’s cash flow in 20X1 is negative as the closing balance of the cash/ bank item is lower than its opening balance. The cash flow is: 4,906,000 - 5,000,000 = -9 944"000000 ZZAARR. So far, KENILWORTH METERED TAXI SERVICE Ltd.’s business activities burned cash, but we must acknowledge that the negative cash flow mostly results from investments. It is not seldom for companies to disclose negative total cash flows in their first year of operation due to investments. To analyse the details of cash flows, a cash flow statement is prepared. We do not discuss cash flow statements in detail here, but you find the company’s statement of cash flows in Figure 3.7. To understand if and why the book value of the company changes, we disclose the company’s equity development on its statement of changes in equity 43 . Here, equity changed by: 5,627,200 - 5,000,000 = 6 62277"220000 ZZAARR. Check the statement of changes in equity in Figure 3.18. Further explanation about the statement of changes in equity can be found in chapter (13). 42 We discuss cash flow statements in our textbook Basics of Accounting, chapter (32). Further considerations to cash flow statements follow in chapter (10) of this textbook. 43 Study our textbook Basics of Accounting, chapter (30) or in this textbook chapter (13). <?page no="54"?> Berkau: Financial Statements 8e 3-54 Cash flow from operating acitivities [ZAR] [ZAR] Proceeds 15,000,000 Payment for operating expenses (2,400,000) Payment for labour (8,650,000) Payment for rent (156,000) 3,794,000 Cash flow from investing activities Investments (3,888,000) (3,888,000) Cash flow from financing activities 0 Total cash flow (94,000) Kenilworth Metered Taxi Service Ltd. STATEMENT of CASH FLOWS for the period ended 31.12.20X1 Figure 3.7: KMTS Ltd.’s cash flow statement (20X1) Share capital Reserves Retained earnings total [ZAR] [ZAR] [ZAR] [ZAR] as at 1.01.20X1 5,000,000 5,000,000 Profit 20X1 627,200 627,200 as at 31.12.20X1 5,000,000 0 627,200 5,627,200 Kenilworth Metered Taxi Service Ltd. STATEMENT of CHANGES in EQUITY as at 31.12.20X1 Figure 3.8: KMTS Ltd.’s statement of changes in equity (20X1) After we prepared the first Accounting period’s financial statements, we continue with 20X2. Applying international Bookkeeping, we continue all real accounts. All nominal accounts are “fresh” in the new Accounting period because the previous ones have been closed-off to the Profit and Loss account with the recording of adjustments. 44 44 Study our textbook Basics of Accounting, chapter (31). 3.6 C/ S KENILWORTH MTS Ltd. - 20X2 For KENILWORTH METERED TAXI SERVICE Ltd., we observe the company continuing its operations and Accounting work: In contrast 20X1, KENILWORTH METERED TAXI SERVICE Ltd. earns a higher revenue of 13,200,000 ZAR and hires two new taxi drivers. Furthermore, the landlord increases rent from 1.07.20X2 onwards by 15 %. The new rent is: (1 + 15%) × 12,000 = 1133"880000 ZZAARR/ / mm. No other differences <?page no="55"?> Berkau: Financial Statements 8e 3-54 Cash flow from operating acitivities [ZAR] [ZAR] Proceeds 15,000,000 Payment for operating expenses (2,400,000) Payment for labour (8,650,000) Payment for rent (156,000) 3,794,000 Cash flow from investing activities Investments (3,888,000) (3,888,000) Cash flow from financing activities 0 Total cash flow (94,000) Kenilworth Metered Taxi Service Ltd. STATEMENT of CASH FLOWS for the period ended 31.12.20X1 Figure 3.7: KMTS Ltd.’s cash flow statement (20X1) Share capital Reserves Retained earnings total [ZAR] [ZAR] [ZAR] [ZAR] as at 1.01.20X1 5,000,000 5,000,000 Profit 20X1 627,200 627,200 as at 31.12.20X1 5,000,000 0 627,200 5,627,200 Kenilworth Metered Taxi Service Ltd. STATEMENT of CHANGES in EQUITY as at 31.12.20X1 Figure 3.8: KMTS Ltd.’s statement of changes in equity (20X1) After we prepared the first Accounting period’s financial statements, we continue with 20X2. Applying international Bookkeeping, we continue all real accounts. All nominal accounts are “fresh” in the new Accounting period because the previous ones have been closed-off to the Profit and Loss account with the recording of adjustments. 44 44 Study our textbook Basics of Accounting, chapter (31). 3.6 C/ S KENILWORTH MTS Ltd. - 20X2 For KENILWORTH METERED TAXI SERVICE Ltd., we observe the company continuing its operations and Accounting work: In contrast 20X1, KENILWORTH METERED TAXI SERVICE Ltd. earns a higher revenue of 13,200,000 ZAR and hires two new taxi drivers. Furthermore, the landlord increases rent from 1.07.20X2 onwards by 15 %. The new rent is: (1 + 15%) × 12,000 = 1133"880000 ZZAARR/ / mm. No other differences Berkau: Financial Statements 8e 3-55 apply. Remember, in 20X2 no investments take place. For a new Accounting period, we must make preparatory Bookkeeping entries. Usually, these initial Bookkeeping entries relate to the below-listed activities: - Prepaid expenses from last year. - Income tax payments. - VAT payments. - Payments of other short-term liabilities, e.g., resulting from supplies. - Collection of receivables as scheduled. - Payment for dividends. etc. KENILWORTH METERED TAXI SERVICE Ltd. transfers 12,000 ZAR prepaid rent from the Prepaid Expenses account to the Rent-20X2 account. The Bookkeeping entry for this transfer is (A). To distinguish Bookkeeping entries from different Accounting periods we alter the identifiers. For the Accounting period 20X2, we mark the new Bookkeeping entries by capital letters. @ 1.01.20X2 Rent-20X2 RNT 12,000 Prepaid Expenses PRE 12,000 (allocating rent from prepaid expenses to the nominal expense account for 20X2) KENILWORTH METERED TAXI SERVICE Ltd. pays income taxes from 20X1 which are due in 20X2. Another tax payment is for the excess of output-VAT over input- VAT which results in a payment of 1,452,000 ZAR to SARS as well. Observe Bookkeeping entries (B) and (C), both are recorded on 1.01.20X2. @ 1.01.20X2 Income Tax Liabilities ITL 268,800 Cash/ Bank C/ B 268,800 (payment of income tax liabilities for 20X1 to SARS) Value Added Tax VAT 1,452,000 Cash/ Bank C/ B 1,452,000 (payment of VAT liabilities for 20X1 to SARS) Check the accounts after the preparatory Bookkeeping entries are completed in Figure 3.9. As last year’s entries do not matter anymore, we grey them out. <?page no="56"?> Berkau: Financial Statements 8e 3-56 D C D C OV 5,000,000 (1) 3,600,000 c/ d 5,000,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 b/ d 5,000,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 c/ d 4,906,000 20,000,000 20,000,000 b/ d 4,906,000 (B) 268,800 (C) 1,452,000 Cash/ Bank C/ B Issued capital ISS D C D C (1) 3,000,000 (1) 600,000 (3) 2,500,000 (2) 240,000 c/ d 3,240,000 (2) 48,000 3,240,000 3,240,000 (6) 400,000 b/ d 3,240,000 c/ d 1,452,000 2,500,000 2,500,000 (C) 1,452,000 b/ d 1,452,000 Property, Plant, Equipment PPE Value added tax VAT D C D C RNT 12,000 c/ d 12,000 c/ d 810,000 DPR 810,000 b/ d 12,000 (A) 12,000 b/ d 810,000 Prepaid expenses PRE Acc depr ACC D C D C c/ d 627,200 P&L 627,200 c/ d 268,800 ITE 268,800 b/ d 627,200 (B) 268,800 b/ d 268,800 D C (A) 12,000 Rent-20X2 RNT Retained earnings R/ E Income tax liabilities ITL Figure 3.9: KMTS Ltd.’s accounts (20X2) In 20X2, KENILWORTH METERED TAXI SERVICE Ltd. records the Bookkeeping entries below for its business activities: (D) Revenue 13,200,000 ZAR. The proceeds are: 120% × 13,200,000 = 1155"884400"000000 ZZAARR. All passengers pay in cash. The Bookkeeping entry (D) is recorded on 1.07.20X2. <?page no="57"?> Berkau: Financial Statements 8e 3-56 D C D C OV 5,000,000 (1) 3,600,000 c/ d 5,000,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 b/ d 5,000,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 c/ d 4,906,000 20,000,000 20,000,000 b/ d 4,906,000 (B) 268,800 (C) 1,452,000 Cash/ Bank C/ B Issued capital ISS D C D C (1) 3,000,000 (1) 600,000 (3) 2,500,000 (2) 240,000 c/ d 3,240,000 (2) 48,000 3,240,000 3,240,000 (6) 400,000 b/ d 3,240,000 c/ d 1,452,000 2,500,000 2,500,000 (C) 1,452,000 b/ d 1,452,000 Property, Plant, Equipment PPE Value added tax VAT D C D C RNT 12,000 c/ d 12,000 c/ d 810,000 DPR 810,000 b/ d 12,000 (A) 12,000 b/ d 810,000 Prepaid expenses PRE Acc depr ACC D C D C c/ d 627,200 P&L 627,200 c/ d 268,800 ITE 268,800 b/ d 627,200 (B) 268,800 b/ d 268,800 D C (A) 12,000 Rent-20X2 RNT Retained earnings R/ E Income tax liabilities ITL Figure 3.9: KMTS Ltd.’s accounts (20X2) In 20X2, KENILWORTH METERED TAXI SERVICE Ltd. records the Bookkeeping entries below for its business activities: (D) Revenue 13,200,000 ZAR. The proceeds are: 120% × 13,200,000 = 1155"884400"000000 ZZAARR. All passengers pay in cash. The Bookkeeping entry (D) is recorded on 1.07.20X2. Berkau: Financial Statements 8e 3-57 @ 1.07.20X2 Cash/ Bank C/ B 15,840,000 Value Added Tax VAT 2,640,000 Revenue-20X2 REV 13,200,000 (revenue recognition from taxi ride orders) (E) Labour: There are 16 taxi drivers employed. We consider the dispatcher as well as the manager for labour of: 16 × 500,000 + 650,000 + 1,000,000 = 99"665500"000000 ZZAARR. Bookkeeping entry (E) for labour is recorded on 30.06.20X2. @ 30.06.20X2 Labour-20X2 LAB 9,650,000 Cash/ Bank C/ B 9,650,000 (recording labour) (F) Rent increases in the middle of the Accounting period 20X2. As there was a prepayment for 20X2, the Bookkeeping entries for rental payments in total are: 5 × 12,000 + 7 × 13,800 = 1 15566"660000 ZZAARR. As the rent for January was paid in December 20X1, only 5 rental payments at 12,000 ZAR/ m are required. The next following payments are for July/ 20X2 - January/ 20X3 and amount to 13,800 ZAR/ m each. At the end of the year, the rent for January/ 20X3 will be allocated to the Prepaid Expenses account. Below, you see the rent Bookkeeping entry (F) for the 12 single entries together and dated on 30.06.20X2. @ 30.06.20X2 Rent-20X2 RNT 156,600 Cash/ Bank C/ B 156,600 (recording rental payments) (G) Operational expenses are again 2,000,000 ZAR/ a. They are recorded on 30.06.20X2. @ 30.06.20X2 Operational Expenses-20X2 OEX 2,000,000 Value Added Tax VAT 400,000 Cash/ Bank C/ B 2,400,000 (recording operations) We also record adjustments; they are made for depreciation and the rent's accrual. They result in Bookkeeping entries (H) and (I), both recorded on 31.12.20X2. <?page no="58"?> Berkau: Financial Statements 8e 3-58 @ 31.12.20X2 Depreciation-20X2 DPR 810,000 Accumulated Depreciation ACC 810,000 (recording depreciation) Prepaid Expenses PRE 13,800 Rent-20X2 RNT 13,800 (allocating rent for Jan/ 20X3 to prepaid expenses) As in the previous Accounting period, we balance-off all accounts and close-off the nominal accounts for 20X2 to the Profit and Loss-20X2 (P2L) account. Based on our recordings, we now can calculate the profit for 20X2. Observe the accounts for 20X2 in Figure 3.10. D C D C OV 5,000,000 (1) 3,600,000 c/ d 5,000,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 b/ d 5,000,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 c/ d 4,906,000 20,000,000 20,000,000 b/ d 4,906,000 (B) 268,800 (D) 15,840,000 (C) 1,452,000 (E) 9,650,000 (F) 156,600 (G) 2,400,000 c/ d 6,818,600 20,746,000 20,746,000 b/ d 6,818,600 Cash/ Bank C/ B Issued capital ISS D C D C (1) 3,000,000 (1) 600,000 (3) 2,500,000 (2) 240,000 c/ d 3,240,000 (2) 48,000 3,240,000 3,240,000 (6) 400,000 b/ d 3,240,000 c/ d 1,452,000 2,500,000 2,500,000 (C) 1,452,000 b/ d 1,452,000 (G) 400,000 (D) 2,640,000 c/ d 2,240,000 4,092,000 4,092,000 b/ d 2,240,000 Property, Plant, Equipment PPE Value added tax VAT [20%] Figure 3.10: KMTS Ltd.’s accounts after profit calculation (20X2) <?page no="59"?> Berkau: Financial Statements 8e 3-58 @ 31.12.20X2 Depreciation-20X2 DPR 810,000 Accumulated Depreciation ACC 810,000 (recording depreciation) Prepaid Expenses PRE 13,800 Rent-20X2 RNT 13,800 (allocating rent for Jan/ 20X3 to prepaid expenses) As in the previous Accounting period, we balance-off all accounts and close-off the nominal accounts for 20X2 to the Profit and Loss-20X2 (P2L) account. Based on our recordings, we now can calculate the profit for 20X2. Observe the accounts for 20X2 in Figure 3.10. D C D C OV 5,000,000 (1) 3,600,000 c/ d 5,000,000 OV 5,000,000 (3) 15,000,000 (2) 288,000 b/ d 5,000,000 (4) 7,000,000 (5) 1,650,000 (6) 2,400,000 (7) 156,000 c/ d 4,906,000 20,000,000 20,000,000 b/ d 4,906,000 (B) 268,800 (D) 15,840,000 (C) 1,452,000 (E) 9,650,000 (F) 156,600 (G) 2,400,000 c/ d 6,818,600 20,746,000 20,746,000 b/ d 6,818,600 Cash/ Bank C/ B Issued capital ISS D C D C (1) 3,000,000 (1) 600,000 (3) 2,500,000 (2) 240,000 c/ d 3,240,000 (2) 48,000 3,240,000 3,240,000 (6) 400,000 b/ d 3,240,000 c/ d 1,452,000 2,500,000 2,500,000 (C) 1,452,000 b/ d 1,452,000 (G) 400,000 (D) 2,640,000 c/ d 2,240,000 4,092,000 4,092,000 b/ d 2,240,000 Property, Plant, Equipment PPE Value added tax VAT [20%] Figure 3.10: KMTS Ltd.’s accounts after profit calculation (20X2) Berkau: Financial Statements 8e 3-59 D C D C RNT 12,000 c/ d 12,000 c/ d 810,000 DPR 810,000 b/ d 12,000 (A) 12,000 b/ d 810,000 RNT 13,800 c/ d 13,800 c/ d 1,620,000 DPR 810,000 25,800 25,800 1,620,000 1,620,000 b/ d 13,800 b/ d 1,620,000 Prepaid expenses PRE Acc depr ACC D C D C c/ d 627,200 P&L 627,200 c/ d 268,800 ITE 268,800 b/ d 627,200 (B) 268,800 b/ d 268,800 c/ d 1,036,840 P2L 409,640 c/ d 175,560 ITE 175,560 1,036,840 1,036,840 444,360 444,360 b/ d 1,036,840 b/ d 175,560 Retained earnings R/ E Income tax liabilities ITL D C D C (A) 12,000 PRE 13,800 c/ d 13,200,000 (D) 13,200,000 (F) 156,600 c/ d 154,800 P2L 13,200,000 b/ d 13,200,000 168,600 168,600 b/ d 154,800 P2L 154,800 D C D C (E) 9,650,000 c/ d 9,650,000 (G) 2,000,000 c/ d 2,000,000 b/ d 9,650,000 P2L 9,650,000 b/ d 2,000,000 P2L 2,000,000 Labour-20X2 LAB Operational expenses-20X2 OEX Rent-20X2 RNT Revenue-20X2 REV D C D C ACC 810,000 c/ d 810,000 RNT 154,800 REV 13,200,000 b/ d 810,000 P2L 810,000 LAB 9,650,000 OEX 2,000,000 DPR 810,000 EBT 585,200 13,200,000 13,200,000 ITE 175,560 b/ d 585,200 R/ E 409,640 585,200 585,200 D C ITL 175,560 c/ d 175,560 b/ d 175,560 P2L 175,560 Depreciation-20X2 DPR Profit and Loss-20X2 P2L Income tax expensess-20X2 ITE Figure 3.10: KMTS Ltd.’s accounts after profit calculation (20X2) continued <?page no="60"?> Berkau: Financial Statements 8e 3-60 Owners are keen to earn a return on the funds they invested in the business. In a company based on shares, the payment to the owners for their share of the profit is called a dividend. KENILWORTH METERED TAXI SERVICE Ltd. did not pay dividends for 20X1. This means, that its shareholders did not receive a return yet 45 . At the annual general meeting at the beginning of 20X3 when the chief executive officer CEO or chief financial officer CFO reports on the previous Accounting period 20X2 and presents the financial statements, the shareholders of KENILWORTH METERED TAXI SERVICE Ltd. declare a dividend of 30 % of the distributable amount. The amount distributable for dividend payments contains the profit carried forward as well as the annual surplus from 20X2. In the case of KENILWORTH METERED TAXI SERVICE Ltd., the distributable amount shows in the Retained Earnings account, observe Figure 3.11. It is: 627,200 + 409,640 = 1 1"003366"884400 ZZAARR. Based on the decision made by the shareholders, 30 % will be paid out as dividends, which is: 30% × 1,036,840 = 3 31111"005522 ZZAARR. 20 % is accumulated to earnings reserves: 20% × 1,036,840 = 220077"336688 ZZAARR. The remainder is carried forward to the next Accounting period; the annual general meeting will decide in 20X4 about its appropriation. In general, international corporations prepare financial statements under the consideration of the appropriation of profits. KENILWORTH METERED TAXI SERVICE Ltd. records the dividends as payables to its owners. They will be paid in 20X3. The account applicable is the Shareholders for Dividend account. It falls under payables (A/ P account). The additions to earnings reserves do not change the total equity because they result in an equity swop, meaning they remain in the business e.g., for reinvestments. The non-appropriated earnings according to the decision made at the annual general meeting are carried forward to the next Accounting period. No Bookkeeping entry is required for carrying forward profit or loss as the amount just stays in the Retained Earnings account. 46 @ 31.12.20X2 Retained Earnings R/ E 311,052 Shareholders for Dividends A/ P 311,052 (recording devidends as payables) @ 31.12.20X2 Retained Earnings R/ E 207,368 Earnings Reserves E-R 207,368 (addition to earnings reserves) 45 Not to declare dividends is intended to keep the case study simple. 46 An investor holding 10,000 ordinary shares of KENILWORTH METERED TAXI SERVICE Ltd. receives a dividend of: (10,000/ 500,000) × 311,052 = 6,221.04 ZAR. Her/ his return on investment is: 6,221.04 / 100,000 = 6.22%. The investor further benefits from the equity increase of: (1,036,840 - 311,052) / 5,000,000 = 14.52%. <?page no="61"?> Berkau: Financial Statements 8e 3-60 Owners are keen to earn a return on the funds they invested in the business. In a company based on shares, the payment to the owners for their share of the profit is called a dividend. KENILWORTH METERED TAXI SERVICE Ltd. did not pay dividends for 20X1. This means, that its shareholders did not receive a return yet 45 . At the annual general meeting at the beginning of 20X3 when the chief executive officer CEO or chief financial officer CFO reports on the previous Accounting period 20X2 and presents the financial statements, the shareholders of KENILWORTH METERED TAXI SERVICE Ltd. declare a dividend of 30 % of the distributable amount. The amount distributable for dividend payments contains the profit carried forward as well as the annual surplus from 20X2. In the case of KENILWORTH METERED TAXI SERVICE Ltd., the distributable amount shows in the Retained Earnings account, observe Figure 3.11. It is: 627,200 + 409,640 = 1 1"003366"884400 ZZAARR. Based on the decision made by the shareholders, 30 % will be paid out as dividends, which is: 30% × 1,036,840 = 331111"005522 ZZAARR. 20 % is accumulated to earnings reserves: 20% × 1,036,840 = 220077"336688 ZZAARR. The remainder is carried forward to the next Accounting period; the annual general meeting will decide in 20X4 about its appropriation. In general, international corporations prepare financial statements under the consideration of the appropriation of profits. KENILWORTH METERED TAXI SERVICE Ltd. records the dividends as payables to its owners. They will be paid in 20X3. The account applicable is the Shareholders for Dividend account. It falls under payables (A/ P account). The additions to earnings reserves do not change the total equity because they result in an equity swop, meaning they remain in the business e.g., for reinvestments. The non-appropriated earnings according to the decision made at the annual general meeting are carried forward to the next Accounting period. No Bookkeeping entry is required for carrying forward profit or loss as the amount just stays in the Retained Earnings account. 46 @ 31.12.20X2 Retained Earnings R/ E 311,052 Shareholders for Dividends A/ P 311,052 (recording devidends as payables) @ 31.12.20X2 Retained Earnings R/ E 207,368 Earnings Reserves E-R 207,368 (addition to earnings reserves) 45 Not to declare dividends is intended to keep the case study simple. 46 An investor holding 10,000 ordinary shares of KENILWORTH METERED TAXI SERVICE Ltd. receives a dividend of: (10,000/ 500,000) × 311,052 = 6,221.04 ZAR. Her/ his return on investment is: 6,221.04 / 100,000 = 6.22%. The investor further benefits from the equity increase of: (1,036,840 - 311,052) / 5,000,000 = 14.52%. Berkau: Financial Statements 8e 3-61 Below, we disclose only accounts relevant for the appropriation of profits. Study Figure 3.11. D C D C c/ d 627,200 P&L 627,200 c/ d 207,368 R/ E 207,368 b/ d 627,200 b/ d 207,368 c/ d 1,036,840 P2L 409,640 1,036,840 1,036,840 S4D 311,052 b/ d 1,036,840 E-R 207,368 c/ d 518,420 1,036,840 1,036,840 b/ d 518,420 Retained earnings R/ E Earnings reserves E-R D C c/ d 311,052 R/ E 311,052 b/ d 311,052 Shareholder for dividend A/ P Figure 3.11: KMTS Ltd.’s accounts for profit appropriation (20X2) See below the set of financial statements without the notes. Observe Figure 3.12, Figure 3.13, Figure 3.14 and Figure 3.15. [ZAR] Revenue 13,200,000 Other income 0 13,200,000 Materials 0 Labour (9,650,000) Depreciation (810,000) Other expenses (2,154,800) Earnings before int. & taxes (EBIT) 585,200 Interest 0 Earnings before taxes (EBT) 585,200 Income tax expenses (175,560) Deferred taxes 0 Earnings after taxes (EAT) 409,640 Kenilworth Metered Taxi Service Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X2 Figure 3.12: KMTS Ltd.’s income statement (20X2) <?page no="62"?> Berkau: Financial Statements 8e 3-62 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 1,620,000 Share capital 5,000,000 Intangibles Reserves 207,368 Financial assets Retained earnings 518,420 Current assets Liabilities (liab.) Inventory Long-term liab. Acc. receivables A/ R Short-term liab. A/ P 2,551,052 Prepaid expenses 13,800 Provisions Cash/ Bank 6,818,600 Income tax liab. 175,560 Total assets 8,452,400 Total equity and liab. 8,452,400 Kenilworth Metered Taxi Service Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X2 Figure 3.13: KMTS Ltd.’s balance sheet (20X2) Cash flow from operating acitivities [ZAR] [ZAR] Proceeds 15,840,000 Payment for operating expenses (2,400,000) Payment for labour (9,650,000) Payment for rent (156,600) Tax payments (1,720,800) 1,912,600 Cash flow from investing activities 0 Cash flow from financing activities 0 Total cash flow 1,912,600 Kenilworth Metered Taxi Service Ltd. STATEMENT of CASH FLOWS for the period ended 31.12.20X2 Figure 3.14: KMTS Ltd.’s cash flow statement (20X2) <?page no="63"?> Berkau: Financial Statements 8e 3-62 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 1,620,000 Share capital 5,000,000 Intangibles Reserves 207,368 Financial assets Retained earnings 518,420 Current assets Liabilities (liab.) Inventory Long-term liab. Acc. receivables A/ R Short-term liab. A/ P 2,551,052 Prepaid expenses 13,800 Provisions Cash/ Bank 6,818,600 Income tax liab. 175,560 Total assets 8,452,400 Total equity and liab. 8,452,400 Kenilworth Metered Taxi Service Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X2 Figure 3.13: KMTS Ltd.’s balance sheet (20X2) Cash flow from operating acitivities [ZAR] [ZAR] Proceeds 15,840,000 Payment for operating expenses (2,400,000) Payment for labour (9,650,000) Payment for rent (156,600) Tax payments (1,720,800) 1,912,600 Cash flow from investing activities 0 Cash flow from financing activities 0 Total cash flow 1,912,600 Kenilworth Metered Taxi Service Ltd. STATEMENT of CASH FLOWS for the period ended 31.12.20X2 Figure 3.14: KMTS Ltd.’s cash flow statement (20X2) Berkau: Financial Statements 8e 3-63 Share capital Reserves Retained earnings total [ZAR] [ZAR] [ZAR] [ZAR] as at 1.01.20X1 5,000,000 5,000,000 Profit 20X1 627,200 627,200 as at 31.12.20X1 5,000,000 0 627,200 5,627,200 Profit 20X2 409,640 409,640 Dividend 20X2 (311,052) (311,052) Additions Res. 20X2 207,368 (207,368) 0 as at 31.12.20X2 5,000,000 207,368 518,420 5,725,788 Kenilworth Metered Taxi Service Ltd. STATEMENT of CHANGES in EQUITY as at 31.12.20X2 Figure 3.15: KMTS Ltd.’s statement of changes in equity (20X2) 3.7 Summary International Bookkeeping is not much different to the German way of recording business activities. Both Accounting systems apply the double entry system. The preparation of financial statements is based on nominal and real accounts. Internationally, no special opening nor closing accounts apply. IAS 1.10 defines that a full set of financial statements includes a balance sheet (statement of financial position), an income statement (statement of profit or loss and other comprehensive income), a statement of cash flows, a statement of changes in equity and the notes. We discussed the case study KENILWORTH METERED TAXI SERVICE Ltd. in Cape Town and prepared its financial statements for 20X1 and 20X2. In general, companies prepare financial statements under the consideration of the appropriation of profits. The appropriation of profits either adds earnings to reserves or dividends to payables (Shareholders for Dividend account). Profit or loss not appropriated is carried forward to the next Accounting period and shows as a balance brought forward in the Retained Earnings account. 3.8 Working Definitions Appropriation of Profits, under: If financial statements are prepared under the appropriation of profits, dividends and additions to reserves are considered. International Accounting Standards IFRSs: Accounting Standards issued by the International Accounting Standard Board that are either an IAS (International Accounting Standard) or an IFRS (International Financial Accounting Standard). Paragraph: Section of a Standard. Paragraphs are identified by numbers. Set of Financial Statements: In line with IAS 1.10, a set of financial statements comprises a statement of financial position, a statement of profit or loss and other comprehensive income, a statement of changes in equity, a statement of cash flows and the notes. It can include a further balance sheet if <?page no="64"?> Berkau: Financial Statements 8e 3-64 IAS 8 applies regarding changes in Accounting policies. Standard Setter: An organisation that issues standards. For IFRSs, the standard setter is the International Accounting Standard Board headquartered in Canary Wharf, London. Statement of Cash Flows: A statement that shows increases and decreases of the cash/ bank item structured by classifications: operative, investing and financing. Statement of Changes in Equity: A statement that discloses the additions to and deductions from equity items on the balance sheet. Statement of Financial Position: Balance sheet that compares the total of assets to equity and liabilities. Statement of Profit or Loss and Other Comprehensive Income: Income statement based on IFRSs. It discloses operating profits and extraordinary earnings and expenses. 3.9 Question Bank (1) A company reporting following IFRSs must disclose … 1. .… a statement of financial position, an income statement, a statement of cash flows and notes. 2. … a balance sheet, an income statement, a statement of changes in equity, a statement of cash flows and notes. 3. … a statement of financial position, a statement of profit or loss and other comprehensive income, a cash flow statement, a register of non-current assets and the notes. 4. … a balance sheet, an income statement, a statement of cash flows, a statement of changes of liabilities and notes. (2) A company that prepares financial statements under IFRSs must disclose a statement of cash flows …1. … only if participating in the capital market. 2. … in any case. 3. … when a group member. 4. …not as a group member as the parent discloses changes in cash flows in the group statements already. (3) A company that pays 12,000 EUR for labour and makes 1 monthly payment in advance, records labour in the actual Accounting period as below: 1. DR Labour … 12,000 EUR, CR Cash/ Bank … 12,000 EUR. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. 2. DR Labour … 1,000 EUR, CR Prepaid Expenses … 1,000 EUR. DR Labour … 12,000 EUR, CR Cash/ Bank … 12,000 EUR. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. 3. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. DR Labour … 11,000 EUR, CR Cash/ Bank … 11,000 EUR. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. 4. DR Labour … 11,000 EUR, CR Cash/ Bank … 11,000 EUR. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. (4) A company that makes the debit entries Labour: 10,000 EUR, Rent: 1,200 EUR, Prepaid insurance: 450 EUR, Depreciation on factory <?page no="65"?> Berkau: Financial Statements 8e 3-64 IAS 8 applies regarding changes in Accounting policies. Standard Setter: An organisation that issues standards. For IFRSs, the standard setter is the International Accounting Standard Board headquartered in Canary Wharf, London. Statement of Cash Flows: A statement that shows increases and decreases of the cash/ bank item structured by classifications: operative, investing and financing. Statement of Changes in Equity: A statement that discloses the additions to and deductions from equity items on the balance sheet. Statement of Financial Position: Balance sheet that compares the total of assets to equity and liabilities. Statement of Profit or Loss and Other Comprehensive Income: Income statement based on IFRSs. It discloses operating profits and extraordinary earnings and expenses. 3.9 Question Bank (1) A company reporting following IFRSs must disclose … 1. .… a statement of financial position, an income statement, a statement of cash flows and notes. 2. … a balance sheet, an income statement, a statement of changes in equity, a statement of cash flows and notes. 3. … a statement of financial position, a statement of profit or loss and other comprehensive income, a cash flow statement, a register of non-current assets and the notes. 4. … a balance sheet, an income statement, a statement of cash flows, a statement of changes of liabilities and notes. (2) A company that prepares financial statements under IFRSs must disclose a statement of cash flows …1. … only if participating in the capital market. 2. … in any case. 3. … when a group member. 4. …not as a group member as the parent discloses changes in cash flows in the group statements already. (3) A company that pays 12,000 EUR for labour and makes 1 monthly payment in advance, records labour in the actual Accounting period as below: 1. DR Labour … 12,000 EUR, CR Cash/ Bank … 12,000 EUR. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. 2. DR Labour … 1,000 EUR, CR Prepaid Expenses … 1,000 EUR. DR Labour … 12,000 EUR, CR Cash/ Bank … 12,000 EUR. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. 3. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. DR Labour … 11,000 EUR, CR Cash/ Bank … 11,000 EUR. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. 4. DR Labour … 11,000 EUR, CR Cash/ Bank … 11,000 EUR. DR Prepaid Expenses … 1,000 EUR, CR Labour … 1,000 EUR. (4) A company that makes the debit entries Labour: 10,000 EUR, Rent: 1,200 EUR, Prepaid insurance: 450 EUR, Depreciation on factory Berkau: Financial Statements 8e 3-65 building: 600 EUR, Depreciation on motor vehicles: 900 EUR, Operational expenses: 2,400 EUR, discloses the expenses below on the statement of profit or loss and other comprehensive income: 1. Labour: 10,000 EUR, Rent: 1,200 EUR, Prepaid expenses 450 EUR, Depreciation: 1,500 EUR, Other expenses: 2,400 EUR. 2. Labour: 10,000 EUR, Rent: 1,200 EUR, Depreciation: 1,500 EUR, Other expenses: 4,050 EUR. 3. Labour: 10,000 EUR, Depreciation: 1,500 EUR, Other expenses: 3,600 EUR. 4. Labour: 10,450 EUR, Depreciation: 1,500 EUR, Other expenses: 3,600 EUR. (5) A company pays for this year’s rent 1,080 EUR during this Accounting period and must pay another 360 EUR in the next one (for this Accounting period). Before, the 360 EUR are recorded as accounts payables. Rent is subjected to VAT. How much is the rent on the income statement? 1. 900 EUR . 2. 1,080 EUR . 3. 1,200 EUR . 4. 1,440 EUR . 3.10 Solutions 1-2, 2-2, 3-2, 4-3, 5-3. <?page no="66"?> Berkau: Financial Statements 8e 4-66 4 Accounting for Retailers 4.1 What is in the Chapter? This chapter is an introduction to financial statements for retailers in compliance with international Accounting. We also cover common Bookkeeping instruments, e.g., the Trial Balance T/ B and the Trading account T/ A. Accounting for retailers is more demanding than for service companies but simpler in comparison to production firms because no Manufacturing Accounting (calculations) apply. However, retailers must record movements for goods received and released from stock which includes returns to suppliers and from customers. In this chapter, we introduce financing of the business by a bank loan, too. We discuss the case study RYNEVELD Ltd. which is a trader for office paper. The company only deals with one product. We apply a periodic inventory system and prepare a Trading account for its gross profit calculation. To check the correctness of our Bookkeeping entries, we prepare a trial balance before and after recording adjustments. Thereafter, we calculate the company’s profit. The case study RYNEVELD Ltd. comes with 3 Accounting periods from which the 1 st one 20X6 is covered in the textbook. The 2 nd period 20X7 is a task with solution you can find in the online materials. The last period 20X8 is provided as self-marking test. You find a solution form in the online materials which tells you 47 Study our textbook Basics of Accounting, chapter (26). We introduce the perpetual inventory system in chapter (9). your exam result following the German grading system after you entered the solution. 4.2 Learning Objectives After studying this chapter, you can prepare financial statements for retailers making international Bookkeeping entries and you can prepare financial statements under IFRSs. You will apply the relevant standards. You also can calculate the gross and net profit and know the meaning thereof. You can apply a Trading Account and use the Trial Balance before and after adjustments. 4.3 Dealerships Retailers’ business model is to buy goods from suppliers and to sell them on to their customers. In terms of Accounting, we apply a Purchase account to record the goods received. For the gross profit calculation, retailers compare revenues and purchases in the Trading account. We start the Accounting work based on a periodic inventory movement system 47 . Under a periodic inventory system, stock is taken at the beginning and end of each Accounting period and costs of goods sold are determined by a comparison of inventory levels. Retailers calculate their profit in a twostep approach: at first, they calculate <?page no="67"?> Berkau: Financial Statements 8e 4-66 4 Accounting for Retailers 4.1 What is in the Chapter? This chapter is an introduction to financial statements for retailers in compliance with international Accounting. We also cover common Bookkeeping instruments, e.g., the Trial Balance T/ B and the Trading account T/ A. Accounting for retailers is more demanding than for service companies but simpler in comparison to production firms because no Manufacturing Accounting (calculations) apply. However, retailers must record movements for goods received and released from stock which includes returns to suppliers and from customers. In this chapter, we introduce financing of the business by a bank loan, too. We discuss the case study RYNEVELD Ltd. which is a trader for office paper. The company only deals with one product. We apply a periodic inventory system and prepare a Trading account for its gross profit calculation. To check the correctness of our Bookkeeping entries, we prepare a trial balance before and after recording adjustments. Thereafter, we calculate the company’s profit. The case study RYNEVELD Ltd. comes with 3 Accounting periods from which the 1 st one 20X6 is covered in the textbook. The 2 nd period 20X7 is a task with solution you can find in the online materials. The last period 20X8 is provided as self-marking test. You find a solution form in the online materials which tells you 47 Study our textbook Basics of Accounting, chapter (26). We introduce the perpetual inventory system in chapter (9). your exam result following the German grading system after you entered the solution. 4.2 Learning Objectives After studying this chapter, you can prepare financial statements for retailers making international Bookkeeping entries and you can prepare financial statements under IFRSs. You will apply the relevant standards. You also can calculate the gross and net profit and know the meaning thereof. You can apply a Trading Account and use the Trial Balance before and after adjustments. 4.3 Dealerships Retailers’ business model is to buy goods from suppliers and to sell them on to their customers. In terms of Accounting, we apply a Purchase account to record the goods received. For the gross profit calculation, retailers compare revenues and purchases in the Trading account. We start the Accounting work based on a periodic inventory movement system 47 . Under a periodic inventory system, stock is taken at the beginning and end of each Accounting period and costs of goods sold are determined by a comparison of inventory levels. Retailers calculate their profit in a twostep approach: at first, they calculate Berkau: Financial Statements 8e 4-67 the gross profit and thereafter they continue profit calculations towards the net profit (earnings before taxes). Gross profit is the difference between revenue and material expenses. Revenue is the compensation received from customers for goods and services. In general, the retailer receives money for the goods sold. When we refer to material expenses, we mean the cost of goods sold measured at the cost of purchase. Cost of purchase and cost of acquisition refers to the net value after deduction of discounts and rebates. IAS 2.11 and IAS 16.16 apply respectively. 48 The next step is the calculation of earnings before income tax which is also referred to as the net profit. That is the gross profit after deduction of all further expenses, e.g., labour, depreciation, operational expenses etc., but except of income tax expenses. The deduction of income tax expenses is the last step in profit calculation. In this textbook, we simplify income tax calculations by multiplying the income tax rate by the net profit. This easy calculation prevents us from discussing Taxation based on national law. The earnings after taxes are also called annual surplus. In total, the profit calculation follows the structure below: 48 The term purchase cost applies for materials and goods whereas the term cost of acquisition indicates investments which are debited to the Property, Plant, Equipment account. Revenue ./ . Cost of goods sold Gross profit ./ . Further expenses (labour, depreciation, other expenses) Net profit (EBT) ./ . income tax expenses Annual surplus (EAT) 4.4 Gross Profit Calculation We explain the procedure of gross profit calculation by a small case study DEMANN GmbH which is plumber who also acts as retailer for heater spare parts. That way, the company is a retailer and service provider at the same time. You find the case study following the Link 4.A below: Link 4.A: DEMANN GmbH. 4.5 Trial Balance Next, we focus on Bookkeeping and study the trial balance and the Trading account. We explain the concepts by the case study of the office material retailer RYNEVELD Ltd. in George (South Africa). A trial balance is a list of all accounts and their balancing figures. 49 In the old days, Accountants used it for checking 49 The trial balance is introduced in chapter (29) of our textbook Basics of Accounting. <?page no="68"?> Berkau: Financial Statements 8e 4-68 consistency with the double entry system. The Bookkeepers could easily see whether they miscalculated something. On a trial balance, the total of the debit-balanced accounts (b/ d on the debit side) must equal the total of the credit-balanced ones (b/ d on the credit side). 50 Nowadays, Accounting software pre-checks the Bookkeeping entries before recording, which prevents users from faulty entries. The trial balance provides us with an overview of accounts and their balancing figures as well as supports Bookkeeping data transfer e.g., between group companies. 4.6 Trading Account The Trading account is prepared after the Bookkeeping entries have been completed and checked for consistency with the trial balance. Revenues are closed-off to its credit side and material expenses to the debit side. The balancing figure in a Trading account represents the gross profit. A Trading account pairs well with a periodic inventory system. Then material expenses (or cost of goods sold) are calculated as opening inventory balances plus material/ goods receipts (purchases) minus closing stock (inventory level). Note, you must closeoff the Inventory account(s), the Purchase account and the Revenue account to the Trading account. Later, also returns get transferred to the Trading account. We apply the Trading account for RYNEVELD Ltd. 50 Study our textbook Basics of Accounting, chapter (10) - (12). 4.7 C/ S RYNEVELD Ltd. Find below the data sheet for RYNEVELD Ltd. Data Sheet for RYNEVELD Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((GGeeoorrggee)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : RReettaaiilleerr.. AAccccoouunnttiinngg ppeerriioodd: : 2200XX66.. SShhaarree iissssuuee: : 110000"000000 ×× 55 ZZAARR/ / ss.. FFiinnaanncciinngg: : bbaannkk llooaann 220000"000000 ZZAARR; ; iinntteerr-eesstt 66 %%/ / aa" ppaayy--ooffff: : 4400"000000 ZZAARR/ / aa.. RReenntt: : 3366"000000 ZZAARR/ / aa; ; ppaayymmeenntt oonnee mmoonntthh iinn aaddvvaannccee.. SSttoorree eeqquuiippmmeenntt ((PP" PP" EE)): : 220000"000000 ZZAARR; ; ddeepprreecciiaattiioonn: : ssttrraaiigghhtt--lliinnee mmeetthhoodd oovveerr 1100 yyeeaarrss.. PPuurrcchhaasseess: : 225500"000000 ZZAARR.. CClloossiinngg ssttoocckk: : 2222..44 %% ooff aavvaaiillaabbllee ssttoocckk.. RReevveennuuee: : 554455"000000 ZZAARR.. OOppeerraattiioonnaall ccoossttss ((nnoonn--VVAATTaabbllee)): : 1155"000000 ZZAARR/ / mm.. VVAATT rraattee: : 2200 %%.. RYNEVELD Ltd. is incorporated on 1.01.20X6 with an issue of 100,000 ordinary shares at 5 ZAR/ s (face value). On 2.01.20X6, RYNEVELD Ltd. takes out a bank loan of 200,000 ZAR. The annual rate of interest is 6 %/ a and is due at yearends. The loan’s pay-off amount is constantly 40,000 ZAR/ a. It is paid together with interest at yearends. The rent for the shop is 36,000 ZAR/ a; no VAT applies. RYNEVELD Ltd. pays the rent one month in advance. The first payment for January/ 20X6 is paid on 2.01.20X6, for February/ 20X6 on 30.01.20X6 and so on. RYNEVELD Ltd. acquires store equipment shelves, tables etc. for 240,000 ZAR on 2.01.20X6. The price (gross <?page no="69"?> Berkau: Financial Statements 8e 4-68 consistency with the double entry system. The Bookkeepers could easily see whether they miscalculated something. On a trial balance, the total of the debit-balanced accounts (b/ d on the debit side) must equal the total of the credit-balanced ones (b/ d on the credit side). 50 Nowadays, Accounting software pre-checks the Bookkeeping entries before recording, which prevents users from faulty entries. The trial balance provides us with an overview of accounts and their balancing figures as well as supports Bookkeeping data transfer e.g., between group companies. 4.6 Trading Account The Trading account is prepared after the Bookkeeping entries have been completed and checked for consistency with the trial balance. Revenues are closed-off to its credit side and material expenses to the debit side. The balancing figure in a Trading account represents the gross profit. A Trading account pairs well with a periodic inventory system. Then material expenses (or cost of goods sold) are calculated as opening inventory balances plus material/ goods receipts (purchases) minus closing stock (inventory level). Note, you must closeoff the Inventory account(s), the Purchase account and the Revenue account to the Trading account. Later, also returns get transferred to the Trading account. We apply the Trading account for RYNEVELD Ltd. 50 Study our textbook Basics of Accounting, chapter (10) - (12). 4.7 C/ S RYNEVELD Ltd. Find below the data sheet for RYNEVELD Ltd. Data Sheet for RYNEVELD Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((GGeeoorrggee)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : RReettaaiilleerr.. AAccccoouunnttiinngg ppeerriioodd: : 2200XX66.. SShhaarree iissssuuee: : 110000"000000 ×× 55 ZZAARR/ / ss.. FFiinnaanncciinngg: : bbaannkk llooaann 220000"000000 ZZAARR; ; iinntteerr-eesstt 66 %%/ / aa" ppaayy--ooffff: : 4400"000000 ZZAARR/ / aa.. RReenntt: : 3366"000000 ZZAARR/ / aa; ; ppaayymmeenntt oonnee mmoonntthh iinn aaddvvaannccee.. SSttoorree eeqquuiippmmeenntt ((PP" PP" EE)): : 220000"000000 ZZAARR; ; ddeepprreecciiaattiioonn: : ssttrraaiigghhtt--lliinnee mmeetthhoodd oovveerr 1100 yyeeaarrss.. PPuurrcchhaasseess: : 225500"000000 ZZAARR.. CClloossiinngg ssttoocckk: : 2222..44 %% ooff aavvaaiillaabbllee ssttoocckk.. RReevveennuuee: : 554455"000000 ZZAARR.. OOppeerraattiioonnaall ccoossttss ((nnoonn--VVAATTaabbllee)): : 1155"000000 ZZAARR/ / mm.. VVAATT rraattee: : 2200 %%.. RYNEVELD Ltd. is incorporated on 1.01.20X6 with an issue of 100,000 ordinary shares at 5 ZAR/ s (face value). On 2.01.20X6, RYNEVELD Ltd. takes out a bank loan of 200,000 ZAR. The annual rate of interest is 6 %/ a and is due at yearends. The loan’s pay-off amount is constantly 40,000 ZAR/ a. It is paid together with interest at yearends. The rent for the shop is 36,000 ZAR/ a; no VAT applies. RYNEVELD Ltd. pays the rent one month in advance. The first payment for January/ 20X6 is paid on 2.01.20X6, for February/ 20X6 on 30.01.20X6 and so on. RYNEVELD Ltd. acquires store equipment shelves, tables etc. for 240,000 ZAR on 2.01.20X6. The price (gross Berkau: Financial Statements 8e 4-69 value) is paid instantly. The store equipment is depreciated following straightline method over 10 years. No residual value applies. RYNEVELD Ltd. purchases office paper for 300,000 ZAR (gross amount) and pays half of the price in January and the other half in 20X7. At the end of 20X6, RYNEVELD Ltd. takes stock. 22.4 % (in value) of the office paper is still in the storage. During the fiscal year 20X6, RYNEVELD Ltd. earns revenues 51 of 545,000 ZAR. All customers pay in cash and on time. Operational costs, mainly labour, are 15,000 ZAR/ m during 20X6. As the expenses for operations are internal expenses, we do not consider VAT 52 . Below, we discuss the Bookkeeping entries for the business activities and prepare a trial balance for RYNEVELD Ltd. Thereafter, we calculate gross and net profit with the Trading and Profit and Loss account respectively. At the time of incorporation, RYNEVELD Ltd. issues ordinary shares at a total value of: 100,000 × 5 = 5 50000"000000 ZZAARR. The time of the share issue is 1.01.20X6. Therefore, the share issue counts as Bookkeeping entry (1) and becomes cash flow relevant for 20X6: @ 1.01.20X6 Cash/ Bank C/ B 500,000 Issued Capital ISS 500,000 (issue of 100,000 ordinary shares at a nominal value of 5 ZAR/ s) RYNEVELD Ltd. takes out a loan from its house bank. The loan issue is at 200,000 ZAR. This is the nominal value of the loan and referred to as the principal. It is recorded as Bookkeeping entry (2) under interest bearing liabilities. The interest (Bookkeeping entry (3)) for 20X6 is: 6% × 200,000 = 1 122"000000 ZZAARR. Besides of interest, RYNEVELD Ltd. must pay-off 40,000 ZAR every year. The payoff Bookkeeping entry falls under adjustments and is recorded after the preparation of the first trial balance. Observe the Bookkeeping entries (2) and (3) below: @ 1.01.20X6 Cash/ Bank C/ B 200,000 Interst Bearing Liabilities IBL 200,000 (loan issue at 200,000 ZAR (principal)) @ 31.12.20XX Interest-20X6 INT 12,000 Cash/ Bank C/ B 12,000 (payment for interest to the bank) 51 Revenue is always the net amount. 52 In an exam, it is usually given whether operational expenses are subjected to input-VAT. <?page no="70"?> Berkau: Financial Statements 8e 4-70 Rent is 3,000 ZAR/ m and not subjected to VAT. The property owner is not registered for VAT reduction. Rent is paid in advance except for the 1 st payment. Hence, RYNEVELD Ltd. makes 13 rental payments during 20X6 - the last one thereof counts as a prepayment for January/ 20X4. We record the 13 payments as aggregated Bookkeeping entry (4) on 30.06.20X6. The recording of prepaid expenses for the last payment is recorded as adjustment. @ 30.06.20X6 Rent-20X6 RNT 39,000 Interst Bearing Liabilities IBL 39,000 (payment of rent, 13 payments for Jan/ 20X6 until Jan/ 20X7) The acquisition of the store equipment is recorded at cost of acquisition (net value) 200,000 ZAR. VAT applies as the seller is acting as a VAT vendor. The Bookkeeping (5) entry is recorded on 5.01.20X6: @ 5.01.20X6 Property, Plant, Equipment PPE 200,000 Value Added Tax VAT 40,000 Cash/ Bank C/ B 240,000 (acquisition of the store interior) Depreciation on the store equipment falls under adjustments and will be discussed later. Our next Bookkeeping entry is for the purchase of office paper. We make a debit entry in the Purchase account as we apply a periodic system. 53 The purchase is VATable. The input-VAT is recorded as a debit entry in the VAT account as it represents a claim against the South African Revenue Service SARS. Observe Bookkeeping entry (6) below. Based on the purchase terms and conditions, the payment is split into two parts, one is due in 20X6 - the remainder in 20X7. Remember to never split VAT. VAT applies once the deal is closed and when the Bookkeeping entry (6) is recorded. In compliance with the national VAT law, RYNEVELD Ltd. claims the total value of input-VAT to the extent of 50,000 ZAR immediately. @ 6.01.20X6 Purchase-20X6 PUR 250,000 Value Added Tax VAT 50,000 Accounts Payables A/ P 150,000 Cash/ Bank C/ B 150,000 (purchase and receipt of goods; office paper) 53 Study our textbook Basics of Accounting, chapter (26). <?page no="71"?> Berkau: Financial Statements 8e 4-70 Rent is 3,000 ZAR/ m and not subjected to VAT. The property owner is not registered for VAT reduction. Rent is paid in advance except for the 1 st payment. Hence, RYNEVELD Ltd. makes 13 rental payments during 20X6 - the last one thereof counts as a prepayment for January/ 20X4. We record the 13 payments as aggregated Bookkeeping entry (4) on 30.06.20X6. The recording of prepaid expenses for the last payment is recorded as adjustment. @ 30.06.20X6 Rent-20X6 RNT 39,000 Interst Bearing Liabilities IBL 39,000 (payment of rent, 13 payments for Jan/ 20X6 until Jan/ 20X7) The acquisition of the store equipment is recorded at cost of acquisition (net value) 200,000 ZAR. VAT applies as the seller is acting as a VAT vendor. The Bookkeeping (5) entry is recorded on 5.01.20X6: @ 5.01.20X6 Property, Plant, Equipment PPE 200,000 Value Added Tax VAT 40,000 Cash/ Bank C/ B 240,000 (acquisition of the store interior) Depreciation on the store equipment falls under adjustments and will be discussed later. Our next Bookkeeping entry is for the purchase of office paper. We make a debit entry in the Purchase account as we apply a periodic system. 53 The purchase is VATable. The input-VAT is recorded as a debit entry in the VAT account as it represents a claim against the South African Revenue Service SARS. Observe Bookkeeping entry (6) below. Based on the purchase terms and conditions, the payment is split into two parts, one is due in 20X6 - the remainder in 20X7. Remember to never split VAT. VAT applies once the deal is closed and when the Bookkeeping entry (6) is recorded. In compliance with the national VAT law, RYNEVELD Ltd. claims the total value of input-VAT to the extent of 50,000 ZAR immediately. @ 6.01.20X6 Purchase-20X6 PUR 250,000 Value Added Tax VAT 50,000 Accounts Payables A/ P 150,000 Cash/ Bank C/ B 150,000 (purchase and receipt of goods; office paper) 53 Study our textbook Basics of Accounting, chapter (26). Berkau: Financial Statements 8e 4-71 The closing stock of goods at the end of 20X6 is recognised when adjustments are recorded. For now, we ignore the closing stock of goods. The stock-taking takes place on the balance sheet date and must be recorded then. The revenue recognition is at 545,000 ZAR. The proceeds are the gross value thereof and are amounting to: 545,000 × 120% = 665544"000000 ZZAARR. See Bookkeeping entry (7) which is recorded in the middle of the Accounting period: @ 1.07.20X6 Cash/ Bank C/ B 654,000 Value Added Tax VAT 109,000 Revenue-20X6 REV 545,000 (revenue recognition) Operational costs are recorded as Bookkeeping entry (8). The amount is not subjected to VAT and is: 12 × 15,000 = 118800"000000 ZZAARR. @ 30.06.20X6 Operational Expenses-20X6 OEX 180,000 Cash/ Bank C/ B 180,000 (recording of operations e.g., labour) We observe the Bookkeeping entries made so far in Figure 4.1. D C D C (1) 500,000 (3) 12,000 c/ d 500,000 (1) 500,000 (2) 200,000 (4) 39,000 b/ d 500,000 (7) 654,000 (5) 240,000 (6) 150,000 (8) 180,000 c/ d 733,000 1,354,000 1,354,000 b/ d 733,000 Cash/ Bank C/ B Issued capital ISS D C D C c/ d 200,000 (2) 200,000 (3) 12,000 c/ d 12,000 b/ d 200,000 b/ d 12,000 Interest bearing liabilities IBL Interest-20X6 INT Figure 4.1: RYNEVELD Ltd.’s accounts before adjustments <?page no="72"?> Berkau: Financial Statements 8e 4-72 D C D C (4) 39,000 c/ d 39,000 39,000 39,000 b/ d 39,000 Rent-20X6 RNT Prepaid expenses PRE D C D C (5) 200,000 c/ d 200,000 (5) 40,000 (7) 109,000 b/ d 200,000 (6) 50,000 c/ d 19,000 109,000 109,000 b/ d 19,000 Property, Plant, Equipment PPE Value added tax VAT D C D C (6) 250,000 c/ d 250,000 c/ d 150,000 (6) 150,000 b/ d 250,000 b/ d 150,000 Accounts payables A/ P Purchase-20X6 PUR D C D C c/ d 545,000 (7) 545,000 (8) 180,000 c/ d 180,000 b/ d 545,000 b/ d 180,000 Revenue-20X6 REV Operational expenses-20X6 OEX Figure 4.1: RYNEVELD Ltd.’s accounts before adjustments continued Next, we prepare the trial balance to double-check our Bookkeeping entries for consistency with the double-entry system. We enter the balancing figures of the accounts (balance brought down b/ d) in the trial balance. You see the trial balance in Figure 4.2. Compare it to the accounts in Figure 4.1. 54 54 As a trial balance supports monitoring, we do not round figures to the nearest Rand. <?page no="73"?> Berkau: Financial Statements 8e 4-72 D C D C (4) 39,000 c/ d 39,000 39,000 39,000 b/ d 39,000 Rent-20X6 RNT Prepaid expenses PRE D C D C (5) 200,000 c/ d 200,000 (5) 40,000 (7) 109,000 b/ d 200,000 (6) 50,000 c/ d 19,000 109,000 109,000 b/ d 19,000 Property, Plant, Equipment PPE Value added tax VAT D C D C (6) 250,000 c/ d 250,000 c/ d 150,000 (6) 150,000 b/ d 250,000 b/ d 150,000 Accounts payables A/ P Purchase-20X6 PUR D C D C c/ d 545,000 (7) 545,000 (8) 180,000 c/ d 180,000 b/ d 545,000 b/ d 180,000 Revenue-20X6 REV Operational expenses-20X6 OEX Figure 4.1: RYNEVELD Ltd.’s accounts before adjustments continued Next, we prepare the trial balance to double-check our Bookkeeping entries for consistency with the double-entry system. We enter the balancing figures of the accounts (balance brought down b/ d) in the trial balance. You see the trial balance in Figure 4.2. Compare it to the accounts in Figure 4.1. 54 54 As a trial balance supports monitoring, we do not round figures to the nearest Rand. Berkau: Financial Statements 8e 4-73 Account Debit entries Credit entries [ZAR] [ZAR] Cash/ Bank C/ B 733,000 Issued Capital ISS 500,000 Interest bearing Liabilities IBL 200,000 Interest-20X6 INT 12,000 Rent-20X6 RNT 39,000 Property, Plant, Equipment PPE 200,000 Value added Tax VAT 19,000 Purchase-20X6 PUR 250,000 Accounts payables A/ P 150,000 Revenue-20X6 REV 545,000 Operational expenses-20X6 OEX 180,000 Total: 1,414,000 1,414,000 Ryneveld Ltd. TRIAL BALANCE as at 31.12.20X6 Figure 4.2: RYNEVELD Ltd.’s trial balance How it is Done (Trial Balance): (1) Make Bookkeeping entries for all business activities in the accounts. Balance-off all accounts. (2) Prepare a list with lines for each account therein. Make two columns, one for debit entries and the other one credit entries. Enter the balances brought down for all accounts in the columns debit entry or credit entry according to the side they belong to. A debit-balanced account’s balance is entered on the debit side. A credit-balanced account’s balance is entered on the credit side. (3) Compare the totals of the columns for debit and credit. If they equal your Bookkeeping records “are looking good”. However, the trial balance does not prove correctness. We continue with the adjustments. Adjustments are Bookkeeping entries recorded in preparation of financial statements at the end of an Accounting period. For RYNEVELD Ltd., we record the adjustments as below: (a) Depreciation. (b) Pay-off of the bank loan. (c) Reclassification of next pay-off following IAS 1.60. (d) Accruals for rent (e) Gross profit calculation. (f) Net profit calculation. (g) Income tax calculation. <?page no="74"?> Berkau: Financial Statements 8e 4-74 Ad (a): Depreciation RYNEVELD Ltd. records depreciation on its store equipment. Depreciation is based on net amounts. Depreciation on the interior at RYNEVELD Ltd. is: (240,000 / 120%) / 10 = 2 200"000000 ZZAARR. In contrast to the Bookkeeping entries for business activities, we enter the three-letter-code for the contra account in the accounts, like ACC for Accumulated Depreciation account in the Depreciation-20X6 account. @ 31.12.20X6 Depreciation-20X6 DPR 20,000 Accumulated Depreciation ACC 20,000 (recording depreciation on the store interior) Ad (b): Pay-off of the Bank Loan The loan contract with the bank states that RYNEVELD Ltd. must pay-off 40,000 ZAR per annum. The Bookkeeping entry is shown below. For RYNEVELD Ltd.’s bank loan the pay-off is constantly 40,000 ZAR. @ 31.12.20X6 Interest Bearing Liabilities IBL 40,000 Cash/ Bank C/ B 40,000 (paying-off the bank loan following the loan terms and conditions) Ad (c): Reclassification of next Pay-off The upcoming repayment for the loan in 20X7 is 40,000 ZAR. IFRSs require a separation of short-term liabilities from long-term ones. 55 RYNEVELD Ltd. must reclassify the next year’s repayment as short-term liabilities. The Accounts Payables A/ P account applies. 56 @ 31.12.20X6 Interest Bearing Liabilities IBL 40,000 Accounts Payables A/ P 40,000 (reclassification of the pay-off of the bank loan following IAS 1.60) Ad (d): Accruals (Rent) In compliance with IAS 1.27, the income statement is prepared under the accrual basis of Accounting. This re- 55 The current/ non-current distinction can be found in IAS 1.60 and IAS 1.61. 56 The names of the accounts can be misleading. The fact that a loan portion is transferred from the Interest Bearing Liabilities account to accounts payables does not mean that no interest payment is required anymore. The interest in 20X7 considers the principal (nominal value of the bank loan) less repayments in 20X6 and, thus, is based on the amount RYNEVELD Ltd. quires recognising expenses in the Accounting period they are for. Payments or receipts of cash do not matter for the allocation to Accounting periods. owes its bank as of 1.01.20X7. Therefore, the interest-20X7 is: (200,000 - 40,000) × 6% = 9,600 ZAR. The interest calculation does not depend on the account the owing amount is allocated to. On the balance sheet as per 31.12.20X6, there are 120,000 ZAR in the Interest Bearing Liabilities account and 40,000 ZAR in the Accounts Payables account; both figures count for the interest calculation in 20X7. <?page no="75"?> Berkau: Financial Statements 8e 4-74 Ad (a): Depreciation RYNEVELD Ltd. records depreciation on its store equipment. Depreciation is based on net amounts. Depreciation on the interior at RYNEVELD Ltd. is: (240,000 / 120%) / 10 = 2 200"000000 ZZAARR. In contrast to the Bookkeeping entries for business activities, we enter the three-letter-code for the contra account in the accounts, like ACC for Accumulated Depreciation account in the Depreciation-20X6 account. @ 31.12.20X6 Depreciation-20X6 DPR 20,000 Accumulated Depreciation ACC 20,000 (recording depreciation on the store interior) Ad (b): Pay-off of the Bank Loan The loan contract with the bank states that RYNEVELD Ltd. must pay-off 40,000 ZAR per annum. The Bookkeeping entry is shown below. For RYNEVELD Ltd.’s bank loan the pay-off is constantly 40,000 ZAR. @ 31.12.20X6 Interest Bearing Liabilities IBL 40,000 Cash/ Bank C/ B 40,000 (paying-off the bank loan following the loan terms and conditions) Ad (c): Reclassification of next Pay-off The upcoming repayment for the loan in 20X7 is 40,000 ZAR. IFRSs require a separation of short-term liabilities from long-term ones. 55 RYNEVELD Ltd. must reclassify the next year’s repayment as short-term liabilities. The Accounts Payables A/ P account applies. 56 @ 31.12.20X6 Interest Bearing Liabilities IBL 40,000 Accounts Payables A/ P 40,000 (reclassification of the pay-off of the bank loan following IAS 1.60) Ad (d): Accruals (Rent) In compliance with IAS 1.27, the income statement is prepared under the accrual basis of Accounting. This re- 55 The current/ non-current distinction can be found in IAS 1.60 and IAS 1.61. 56 The names of the accounts can be misleading. The fact that a loan portion is transferred from the Interest Bearing Liabilities account to accounts payables does not mean that no interest payment is required anymore. The interest in 20X7 considers the principal (nominal value of the bank loan) less repayments in 20X6 and, thus, is based on the amount RYNEVELD Ltd. quires recognising expenses in the Accounting period they are for. Payments or receipts of cash do not matter for the allocation to Accounting periods. owes its bank as of 1.01.20X7. Therefore, the interest-20X7 is: (200,000 - 40,000) × 6% = 9,600 ZAR. The interest calculation does not depend on the account the owing amount is allocated to. On the balance sheet as per 31.12.20X6, there are 120,000 ZAR in the Interest Bearing Liabilities account and 40,000 ZAR in the Accounts Payables account; both figures count for the interest calculation in 20X7. Berkau: Financial Statements 8e 4-75 At RYNEVALD Ltd., the January 20X7’s rent must be separated from the rent in 20X6 by an accrual. 57 We remove the rent for January/ 20X7 from the expense account and record a debit entry in the Prepaid Expense account. That way, we “park” the expenses and transfer them only in the next Accounting period to the expense account for 20X7. Prepaid expenses are disclosed as asset on the balance sheet. See the Bookkeeping entry below: @ 31.12.20X6 Prepaid Expenses PRE 3,000 Rent-20X6 RNT 3,000 (accrual for rent Jan/ 20X7) Ad (e) Gross Profit Calculation For gross profit calculation, the Trading account applies. 58 In the Trading account, we calculate the gross profit. Further adjustments might apply, if a company returns goods to its supplier or if its customers return goods. See Figure 4.3 for the details. D C INV Opening stock REV Sales revenue PUR Purchases INV Closing stock R.I. Returns inwards R.O. Returns outwards Trading account-20XX T/ A Figure 4.3: Elements of a Trading account Returns 59 are either returns outwards or returns inwards. Returns outwards are recorded for sending goods back to suppliers. The Returns Outwards account applies. We record returns outwards at net values, which are the cost of purchase. This gives an entry on the credit side of the Returns Outwards account. Once closed-off to the Trading account, the item appears therein as credit entry, too. 60 A credit entry is also required in the VAT account to adjust the input-VAT previously (at 57 Study our textbook Basics of Accounting, chapter (18). 58 Study our textbook Basics of Accounting, chapter (22). the time of purchase) recorded. The debit entry is made either in the Accounts Receivables account (for a voucher received), in the Accounts Payables account (if the supplier reduces the bill) or in the Cash/ Bank account (for a refund on cash or per bank transfer). Next, we discuss returns inwards: If customers send back goods, they are recorded on the debit side of the Return Inwards account at their net selling price. Alternatively, you might 59 Study our textbook Basics of Accounting, chapter (20) - (23) to understand the VAT implication of returns. 60 Alternatively, we can credit the Purchase account. <?page no="76"?> Berkau: Financial Statements 8e 4-76 debit the Revenue account. A further debit entry is recorded in the VAT account to adjust output-VAT which was previously recorded (at the time of the sale). The credit entry can be made in the Accounts Payables account (for a voucher issued), in the Accounts Receivables account (for a bill reduction) or in the Cash/ Bank account (for a refund). Regarding an inward return, the stock level depends on the action taken after the inward return is received. The returned goods can either be stored or discarded. This depends on the reason for the return. If goods are faulty and the company cannot repair them, it will cast them away. No stock level adjustments are necessary then. If the customer only made a bad purchase and the goods are still in perfect condition, they will be put in stock and sold on. In the latter case, the company does not benefit nor suffer from the return. Therefore, the company must add returned goods at the same costs as they previously were released, if unknown the best estimate applies. 61 At RYNEVELD Ltd., no returns take place. RYNEVELD Ltd. records input of goods as purchases and takes stock at yearends. As the company is established in 20X6, no opening stock exists. The total of purchases is 250,000 ZAR. No goods are returned by customers. Thus, for recording the debit side of the Trading account, we only make one Bookkeeping entry that closes-off the Purchase account to the Trading account: @ 31.12.20X6 Trading Account-20X6 T6A 250,000 Purchase-20X6 PUR 250,000 (balancing-off purchases to T/ A account) To prepare the credit side of the Trading account, we must close-off the Revenue account and take stock. The revenue is 545,000 ZAR. The stock-taking results in a value of 22.4 % of the purchased goods which is: 22.4% × 250,000 = 5 566"000000 ZZAARR. No goods are returned to suppliers which leaves the Returned Outwards account zero-balanced. On the credit side of the Trading account, we make two entries: @ 31.12.20X6 Revenue-20X6 REV 545,000 Trading Account-20X6 T/ A 545,000 (closing-off revenues to T/ A account) Inventories INV 56,000 Trading Account-20X6 T/ A 56,000 (recording closing inventory after stock taking) 61 Check the case study MONTAGU (Pty) Ltd. for the details and Bookkeeping entries of returns inwards. You find it in our textbook Basics of Accounting, chapter (28). <?page no="77"?> Berkau: Financial Statements 8e 4-76 debit the Revenue account. A further debit entry is recorded in the VAT account to adjust output-VAT which was previously recorded (at the time of the sale). The credit entry can be made in the Accounts Payables account (for a voucher issued), in the Accounts Receivables account (for a bill reduction) or in the Cash/ Bank account (for a refund). Regarding an inward return, the stock level depends on the action taken after the inward return is received. The returned goods can either be stored or discarded. This depends on the reason for the return. If goods are faulty and the company cannot repair them, it will cast them away. No stock level adjustments are necessary then. If the customer only made a bad purchase and the goods are still in perfect condition, they will be put in stock and sold on. In the latter case, the company does not benefit nor suffer from the return. Therefore, the company must add returned goods at the same costs as they previously were released, if unknown the best estimate applies. 61 At RYNEVELD Ltd., no returns take place. RYNEVELD Ltd. records input of goods as purchases and takes stock at yearends. As the company is established in 20X6, no opening stock exists. The total of purchases is 250,000 ZAR. No goods are returned by customers. Thus, for recording the debit side of the Trading account, we only make one Bookkeeping entry that closes-off the Purchase account to the Trading account: @ 31.12.20X6 Trading Account-20X6 T6A 250,000 Purchase-20X6 PUR 250,000 (balancing-off purchases to T/ A account) To prepare the credit side of the Trading account, we must close-off the Revenue account and take stock. The revenue is 545,000 ZAR. The stock-taking results in a value of 22.4 % of the purchased goods which is: 22.4% × 250,000 = 5 566"000000 ZZAARR. No goods are returned to suppliers which leaves the Returned Outwards account zero-balanced. On the credit side of the Trading account, we make two entries: @ 31.12.20X6 Revenue-20X6 REV 545,000 Trading Account-20X6 T/ A 545,000 (closing-off revenues to T/ A account) Inventories INV 56,000 Trading Account-20X6 T/ A 56,000 (recording closing inventory after stock taking) 61 Check the case study MONTAGU (Pty) Ltd. for the details and Bookkeeping entries of returns inwards. You find it in our textbook Basics of Accounting, chapter (28). Berkau: Financial Statements 8e 4-77 The Trading account is depicted in Figure 4.4. Ad (f): Net Profit Calculation For the net profit calculation (earnings before taxation), we deduct all remaining expenses from the gross profit - except for income tax expenses. At RYNEVELD Ltd., those expenses are depreciation, operational expenses, rent and interest. We close-off all expense accounts to the Profit and Loss account. We further close-off the Trading account to the Profit and Loss account which gives us the gross profit as credit entry on the Profit and Loss account. 62 Observe the next Bookkeeping entries. The related accounts are shown in Figure 4.4. @ 31.12.20X6 Profit and Loss-20X6 P6L 20,000 Depreciation-20X6 DPR 20,000 (closing-off depreciation to the P6L account) Profit and Loss-20X6 P6L 180,000 Operational Expenses-20X6 OEX 180,000 (closing-off operatinal expenses to the P6L account) Profit and Loss-20X6 P6L 36,000 Rent-20X6 RNT 36,000 (closing-off rent to the P6L account) Profit and Loss-20X6 P6L 12,000 Interest-20X6 INT 12,000 (closing-off interest to the P6L account) Trading Account-20X6 T/ A 351,000 Profit and Loss-20X6 P6L 351,000 (closing-off the Trading account to the P6L account) Ad (g): Income Tax Calculation The income tax expenses are 30% of the pre-tax profit (EBT). At RYNEVELD Ltd., income taxes are: (351,000 - 20,000 - 180,000 - 36,000 - 12,000) × 30% = 103,000 × 30% = 3 300"990000 ZZAARR. We make a simplified Bookkeeping entry for income taxes as below (shortcut). 63 @ 31.12.20X6 Profit and Loss-20X6 P6L 30,900 Income Tax Liabilities ITL 30,900 (recognition of income tax expenses as liabilities) 62 A net loss would result in a debit entry on the Profit and Loss account. 63 The correct Bookkeeping entry for the income tax expenses would be: DR Income Tax Expenses . . . - CR Income Tax Liabilities . . . followed by: DR P&L-Account . . . - CR Income Tax Expenses . . . We recorded income tax for KENILWORTH METERED TAXI SERVICE Ltd. in chapter (3) by these Bookkeeping entries. Here, we take a short-cut. <?page no="78"?> Berkau: Financial Statements 8e 4-78 After deducting income tax expenses from the pre-tax profit, we arrive at the annual surplus which is closed-off to the Retained Earnings account. 64 At RYNEVELD Ltd., the addition to retained earnings is: 103,000 - 30,900 = 7722"110000 ZZAARR. Observe the Bookkeeping entry below. It would be inverted for recording a loss. In that case, no income taxes would apply based on our tax model. @ 31.12.20X6 Profit and Loss-20X6 P6L 72,100 Retained Earnings R/ E 72,100 (allocation of annual surplus to the R/ E account on the balance sheet) Find below in Figure 4.4 all accounts of RYNEVELD Ltd. after recording adjustments. D C D C (1) 500,000 (3) 12,000 c/ d 500,000 (1) 500,000 (2) 200,000 (4) 39,000 b/ d 500,000 (7) 654,000 (5) 240,000 (6) 150,000 (8) 180,000 c/ d 733,000 1,354,000 1,354,000 b/ d 733,000 IBL 40,000 c/ d 693,000 733,000 733,000 b/ d 693,000 Cash/ Bank C/ B Issued capital ISS D C D C c/ d 200,000 (2) 200,000 (3) 12,000 c/ d 12,000 C/ B 40,000 b/ d 200,000 b/ d 12,000 P6L 12,000 A/ P 40,000 c/ d 120,000 200,000 200,000 b/ d 120,000 Interest bearing liabilities IBL Interest-20X6 INT Figure 4.4: RYNEVELD Ltd.’s accounts after adjustments (20X6) 64 An Annual Surplus account (Jahresüberschusskonto) or Retained Earnings account (Bilanzgewinn- oder -verlustkonto) as required by the German HGB (§ 268 HGB) does not apply for international Accounting. There is only one Retained Earnings account. <?page no="79"?> Berkau: Financial Statements 8e 4-78 After deducting income tax expenses from the pre-tax profit, we arrive at the annual surplus which is closed-off to the Retained Earnings account. 64 At RYNEVELD Ltd., the addition to retained earnings is: 103,000 - 30,900 = 7722"110000 ZZAARR. Observe the Bookkeeping entry below. It would be inverted for recording a loss. In that case, no income taxes would apply based on our tax model. @ 31.12.20X6 Profit and Loss-20X6 P6L 72,100 Retained Earnings R/ E 72,100 (allocation of annual surplus to the R/ E account on the balance sheet) Find below in Figure 4.4 all accounts of RYNEVELD Ltd. after recording adjustments. D C D C (1) 500,000 (3) 12,000 c/ d 500,000 (1) 500,000 (2) 200,000 (4) 39,000 b/ d 500,000 (7) 654,000 (5) 240,000 (6) 150,000 (8) 180,000 c/ d 733,000 1,354,000 1,354,000 b/ d 733,000 IBL 40,000 c/ d 693,000 733,000 733,000 b/ d 693,000 Cash/ Bank C/ B Issued capital ISS D C D C c/ d 200,000 (2) 200,000 (3) 12,000 c/ d 12,000 C/ B 40,000 b/ d 200,000 b/ d 12,000 P6L 12,000 A/ P 40,000 c/ d 120,000 200,000 200,000 b/ d 120,000 Interest bearing liabilities IBL Interest-20X6 INT Figure 4.4: RYNEVELD Ltd.’s accounts after adjustments (20X6) 64 An Annual Surplus account (Jahresüberschusskonto) or Retained Earnings account (Bilanzgewinn- oder -verlustkonto) as required by the German HGB (§ 268 HGB) does not apply for international Accounting. There is only one Retained Earnings account. Berkau: Financial Statements 8e 4-79 D C D C (4) 39,000 PRE 3,000 RNT 3,000 c/ d 3,000 c/ d 36,000 b/ d 3,000 39,000 39,000 b/ d 36,000 P6L 36,000 Rent-20X6 RNT Prepaid expenses PRE D C D C (5) 200,000 c/ d 200,000 (5) 40,000 (7) 109,000 b/ d 200,000 (6) 50,000 c/ d 19,000 109,000 109,000 b/ d 19,000 Property, Plant, Equipment PPE Value added tax VAT D C D C (6) 250,000 c/ d 250,000 c/ d 150,000 (6) 150,000 b/ d 250,000 T/ A 250,000 b/ d 150,000 c/ d 190,000 A/ P 40,000 190,000 190,000 b/ d 190,000 Purchase-20X6 PUR Accounts payables A/ P D C D C c/ d 545,000 (7) 545,000 (8) 180,000 c/ d 180,000 T/ A 545,000 b/ d 545,000 b/ d 180,000 P6L 180,000 Revenue-20X6 REV Operational expenses-20X6 OEX D C D C ACC 20,000 c/ d 20,000 c/ d 20,000 DPR 20,000 b/ d 20,000 P6L 20,000 b/ d 20,000 Depreciation-20X6 DPR Accumulated depreciation ACC D C D C PUR 250,000 REV 545,000 OV 0 GP 351,000 INV 56,000 T/ A 56,000 c/ d 56,000 601,000 601,000 56,000 56,000 P6L 351,000 b/ d 351,000 b/ d 56,000 Trading account-20X6 T/ A Inventories INV Figure 4.4: RYNEVELD Ltd.’s accounts after adjustments (20X6) - continued <?page no="80"?> Berkau: Financial Statements 8e 4-80 D C D C DPR 20,000 T/ A 351,000 c/ d 30,900 P6L 30,900 OEX 180,000 b/ d 30,900 RNT 36,000 INT 12,000 EBT 103,000 351,000 351,000 D C ITL 30,900 b/ d 103,000 c/ d 72,100 P6L 72,100 R/ E 72,100 b/ d 72,100 103,000 103,000 Retained earnings R/ E Income tax liabilities ITL Profit or Loss-20X6 P6L Figure 4.4: RYNEVELD Ltd.’s accounts after adjustments (20X6) - continued How it is Done (Trading Account Based on a Periodic Inventory System): (1) Transfer the opening value of the Inventory account to the Trading account. Make a debit entry in the Trading account and a credit entry the Inventory account. (2) Record all purchases in the Purchase account. Consider input-VAT. At the end of the Accounting period, close-off the Purchase account to the Trading account. (3) Record all sales in the Revenue account. Consider output-VAT. Close-off the Revenue account to the Trading account. (4) In case of returns inwards 65 , record the payments made or vouchers granted and record the net portion of the selling price on the debit side of the Returns Inwards account. Alternatively, record negative revenues. Close-off the Returns Inwards account to the Trading account. If goods are received put them in stock or discard them. If put on stock, they will be considered for stock taking at the end of the Accounting period. (5) Determine the closing stock of inventories (take stock). Record the closing stock of inventories as a debit entry in the Inventory account and a credit entry in the Trading account. (6) If goods are returned to suppliers record them in the Returns Outwards account and consider VAT based on the cost of purchase. Make a debit entry in the Cash/ Bank account or the Accounts Receivables or the Accounts Payables account and credit the VAT account. Make a credit entry in the Returns Outwards account or as an alternative in the Purchase account (negative 65 Returns are covered in our textbook Basics of Accounting, chapter (21) without and in chapter (23 with consideration of VAT). You also can study returns in this textbook’s chapter (4) and (9). <?page no="81"?> Berkau: Financial Statements 8e 4-80 D C D C DPR 20,000 T/ A 351,000 c/ d 30,900 P6L 30,900 OEX 180,000 b/ d 30,900 RNT 36,000 INT 12,000 EBT 103,000 351,000 351,000 D C ITL 30,900 b/ d 103,000 c/ d 72,100 P6L 72,100 R/ E 72,100 b/ d 72,100 103,000 103,000 Retained earnings R/ E Income tax liabilities ITL Profit or Loss-20X6 P6L Figure 4.4: RYNEVELD Ltd.’s accounts after adjustments (20X6) - continued How it is Done (Trading Account Based on a Periodic Inventory System): (1) Transfer the opening value of the Inventory account to the Trading account. Make a debit entry in the Trading account and a credit entry the Inventory account. (2) Record all purchases in the Purchase account. Consider input-VAT. At the end of the Accounting period, close-off the Purchase account to the Trading account. (3) Record all sales in the Revenue account. Consider output-VAT. Close-off the Revenue account to the Trading account. (4) In case of returns inwards 65 , record the payments made or vouchers granted and record the net portion of the selling price on the debit side of the Returns Inwards account. Alternatively, record negative revenues. Close-off the Returns Inwards account to the Trading account. If goods are received put them in stock or discard them. If put on stock, they will be considered for stock taking at the end of the Accounting period. (5) Determine the closing stock of inventories (take stock). Record the closing stock of inventories as a debit entry in the Inventory account and a credit entry in the Trading account. (6) If goods are returned to suppliers record them in the Returns Outwards account and consider VAT based on the cost of purchase. Make a debit entry in the Cash/ Bank account or the Accounts Receivables or the Accounts Payables account and credit the VAT account. Make a credit entry in the Returns Outwards account or as an alternative in the Purchase account (negative 65 Returns are covered in our textbook Basics of Accounting, chapter (21) without and in chapter (23 with consideration of VAT). You also can study returns in this textbook’s chapter (4) and (9). Berkau: Financial Statements 8e 4-81 purchase). Close-off the Returns Outwards account to the Trading account. (7) Determine the balancing figure of the Trading account. If the Trading account is debit balanced (b/ d), the balancing figure is a gross loss. If the Trading account is credit-balanced, the balancing figure is a gross profit. Transfer the gross profit or gross loss to the Profit and Loss account by closing-off the Trading account thereto. The adjusted trial balance is prepared once the adjustments are completed. Check Figure 4.5. As nominal accounts are closed-off either to the Trading account or the Profit and Loss account they do not appear on the adjusted trial balance. Their balancing figures are zero. This applies to the Profit and Loss account as well as to the Trading account. Account Debit entries Credit entries [ZAR] [ZAR] Cash/ Bank C/ B 693,000 Issued Capital ISS 500,000 Interest bearing Liabilities IBL 120,000 Prepaid expenses PRE 3,000 Property, Plant, Equipment PPE 200,000 Value added Tax VAT 19,000 Accounts payables A/ P 190,000 Accumulated Depreciation ACC 20,000 Income Tax Liabilities ITL 30,900 Retained Earnings R/ E 72,100 Inventories INV 56,000 952,000 952,000 Ryneveld Ltd. ADJUSTED TRIAL BALANCE as at 31.12.20X6 Figure 4.5: RYNEVELD Ltd.’s adjusted trial balance (20X6) How it is Done (Adjusted Trial Balance): (1) Prepare a trial balance. (2) Record the adjustments for the profit calculation, e.g., for depreciation, accruals etc. Calculate the earnings before taxes and earnings after taxes. Make Bookkeeping entries for income taxes and retained earnings. In case you prepare financial statements after the appropriation of profits, calculate and record dividends and/ or additions/ reductions to/ from reserves. <?page no="82"?> Berkau: Financial Statements 8e 4-82 Balance-off the Retained Earnings account. In case a company carries forward a profit/ loss, there will be a balance b/ d to be considered for the Retained Earnings account. (3) Transfer the adjustments to the trial balance. We recommend copying the previous trial balance and adjusting the copied version. Therefore, delete the nominal accounts that have been closed-off to the Profit and Loss account. Consider that the Trading account as well as the Profit and Loss account are closed-off, too. No entry in the adjusted trial balance is required for them. After preparing the adjusted trial balance, compare the total of the balancing figures for all listed accounts on the debit column to the credit column. (4) Prepare the income statement based on the information you retrieve from the Trading account and the Profit and Loss account. Prepare the balance sheet based on the real accounts listed on the adjusted trial balance. You might combine accounts for the balance sheet preparation, e.g., the P, P, E account and the Accumulated Depreciation account. Based on the adjusted trial balance, we prepare the balance sheet for RYNEVELD Ltd. Only few changes become necessary to prepare the statement of financial position. We must offset the Property, Plant and Equipment account against accumulated depreciation and add VAT liabilities to the accounts payables. The P, P, E item on the balance sheet gives: 200,000 - 20,000 = 1 18800"000000 ZZAARR and the A/ P item is: 19,000 + 190,000 = 2 20099"000000 ZZAARR. Otherwise, we can copy the values from the adjusted trial balance directly to the balance sheet. Observe RYNEVELD Ltd.’s statement of financial position as shown in Figure 4.6. <?page no="83"?> Berkau: Financial Statements 8e 4-82 Balance-off the Retained Earnings account. In case a company carries forward a profit/ loss, there will be a balance b/ d to be considered for the Retained Earnings account. (3) Transfer the adjustments to the trial balance. We recommend copying the previous trial balance and adjusting the copied version. Therefore, delete the nominal accounts that have been closed-off to the Profit and Loss account. Consider that the Trading account as well as the Profit and Loss account are closed-off, too. No entry in the adjusted trial balance is required for them. After preparing the adjusted trial balance, compare the total of the balancing figures for all listed accounts on the debit column to the credit column. (4) Prepare the income statement based on the information you retrieve from the Trading account and the Profit and Loss account. Prepare the balance sheet based on the real accounts listed on the adjusted trial balance. You might combine accounts for the balance sheet preparation, e.g., the P, P, E account and the Accumulated Depreciation account. Based on the adjusted trial balance, we prepare the balance sheet for RYNEVELD Ltd. Only few changes become necessary to prepare the statement of financial position. We must offset the Property, Plant and Equipment account against accumulated depreciation and add VAT liabilities to the accounts payables. The P, P, E item on the balance sheet gives: 200,000 - 20,000 = 1 18800"000000 ZZAARR and the A/ P item is: 19,000 + 190,000 = 2 20099"000000 ZZAARR. Otherwise, we can copy the values from the adjusted trial balance directly to the balance sheet. Observe RYNEVELD Ltd.’s statement of financial position as shown in Figure 4.6. Berkau: Financial Statements 8e 4-83 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 180,000 Share capital 500,000 Intangibles Reserves Financial assets Retained earnings 72,100 Current assets Liabilities (liab.) Inventory 56,000 Long-term liab. 120,000 Accounts receivables Short-term liab. A/ P 209,000 Prepaid expenses 3,000 Provisions Cash/ Bank 693,000 Income tax liab. 30,900 Total assets 932,000 Total equity and liab. 932,000 Ryneveld Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X6 Figure 4.6: RYNEVELD Ltd.’s balance sheet (20X6) The Income statement is derived from the Trading account and the Profit and Loss account. It fulfils the requirements of IAS 1.82. At RYNEVELD Ltd., no other comprehensive income matters. 66 All revenues and expenses are recorded through profit or loss. The income statement is shown in Figure 4.7. [ZAR] Revenue 545,000 Other income 0 545,000 Materials (194,000) Labour 0 Depreciation (20,000) Other expenses (216,000) Earnings before int. & taxes (EBIT) 115,000 Interest (12,000) Earnings before taxes (EBT) 103,000 Income tax expenses (30,900) Deferred taxes 0 Earnings after taxes (EAT) 72,100 Ryneveld Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X6 Figure 4.7: RYNEVELD Ltd.’s income statement 66 Find an example for other comprehensive income in chapter (12). <?page no="84"?> Berkau: Financial Statements 8e 4-84 We do not discuss RYNEVELD Ltd.’s statement of cash flows and its statement of changes in equity to avoid repetitions. You can download the statements by the Link 4.B below: Link 4.B: RYNEVELD Ltd. We recommend working on task A4.38 which is about 20X7 for the case study RYNEVELD Ltd. 67 4.8 C/ S TELUK Sdn. Bhd. The case study TELUK Sdn. Bhd. is about a trading business for office materials and includes return transactions and recording of bad debts as well. Bad debts are recorded when a company has reason to believe that its debtor is insolvent and thus the debts become irrecoverable. The case study can be downloaded through the QR code in the Link 4.C below: Link 4.C: TELUK Sdn. Bhd. 67 Find the task in the study material portal. 4.9 Worksheet for T/ B Calculations As an alternative method, we explain how to prepare financial statements based on a worksheet for the trial balance. The worksheet method explanation can be downloaded by the QR code in the Link 4.D below: Link 4.D: Worksheet method You find a further example for the preparation of financial statements via the worksheet method below linked to the case study BINNEVELD Ltd. which is a surf shop. Check Link 4.C. Link 4.E: BINNEVELD Ltd. Note, that you do not have to apply the worksheet method for the adjusted trial balance preparation and can apply accounts instead. However, this method can help you to speed up your profit calculation. <?page no="85"?> Berkau: Financial Statements 8e 4-84 We do not discuss RYNEVELD Ltd.’s statement of cash flows and its statement of changes in equity to avoid repetitions. You can download the statements by the Link 4.B below: Link 4.B: RYNEVELD Ltd. We recommend working on task A4.38 which is about 20X7 for the case study RYNEVELD Ltd. 67 4.8 C/ S TELUK Sdn. Bhd. The case study TELUK Sdn. Bhd. is about a trading business for office materials and includes return transactions and recording of bad debts as well. Bad debts are recorded when a company has reason to believe that its debtor is insolvent and thus the debts become irrecoverable. The case study can be downloaded through the QR code in the Link 4.C below: Link 4.C: TELUK Sdn. Bhd. 67 Find the task in the study material portal. 4.9 Worksheet for T/ B Calculations As an alternative method, we explain how to prepare financial statements based on a worksheet for the trial balance. The worksheet method explanation can be downloaded by the QR code in the Link 4.D below: Link 4.D: Worksheet method You find a further example for the preparation of financial statements via the worksheet method below linked to the case study BINNEVELD Ltd. which is a surf shop. Check Link 4.C. Link 4.E: BINNEVELD Ltd. Note, that you do not have to apply the worksheet method for the adjusted trial balance preparation and can apply accounts instead. However, this method can help you to speed up your profit calculation. Berkau: Financial Statements 8e 4-85 4.10 Summary In this chapter, we covered the preparation of financial statements based on trial balance and Trading account. The chapter refers to retailers where the gross profit calculation is important. We applied the periodic inventory system. We also introduced the worksheet method for the preparation of financial statements based on the trial balance. 4.11 Working Definitions Accumulated Depreciation Account: Account applicable to record an asset's lifetime depreciation. Adjusted Trial Balance: Trial balance after all adjustments have been recorded. Gross Profit: Difference between revenue and material expenses. The gross profit calculation is relevant for retailers. Net Profit: Profit after interest and before income taxes. The net profit equals earnings before taxation EBT. Periodic Inventory System: Inventory system where stock-taking is required at the beginning and the end of the Accounting period. Trading Account: Section of the Profit and Loss account that only deals with revenue and material expenses. The balancing figure is the gross profit. Trial Balance: The trial balance is a list of all accounts in use which shows their balancing figures (Bal. b/ d). The total of the balancing figures on the debit side shall equal the total of the balancing figures on the credit side to confirm consistency with the doubleentry system. 4.12 Question Bank (1) A company shows an opening value for inventories of 56,000 EUR. During the Accounting period, the company purchases goods for 300,000 EUR and later for 350,000 EUR. At the end of the Accounting period, stock-taking reveals that there are goods for 100,000 EUR left. The sales are amounting to 850,000 EUR. Depreciation on the store equipment is 40,000 EUR. How much is the company's gross profit? 1. 244,000 EUR . 2. 204,000 EUR . 3. 144,000 EUR . 4. 104,000 EUR . (2) A company records an opening value of inventories of 300 EUR. The closing balance is amounting to 100 EUR. During the Accounting period, there were two purchases, one at 1,000 EUR and the other one at 2,000 EUR (net amounts). The revenue equals 5,000 EUR. How much is the gross profit? 1. 1,200 EUR . 2. 1,800 EUR . 3. 2,200 EUR . 4. 1,600 EUR . (3) A retailer for baseball caps records an opening stock value of: 90 × 34 EUR/ u = 3,060 EUR. During the Accounting period, the retailer purchases 500 baseball caps at 35 EUR/ u of which 50 are returned to the supplier due to quality issues. 344 baseball caps are sold at 70 EUR/ u. 80 customers receive a discount of 10%. The retailer records inventory movements following the <?page no="86"?> Berkau: Financial Statements 8e 4-86 first-in-first-out cost formula. How much is the gross profit? 1. 9,820 EUR . 2. 11,570 EUR . 3. 12,130 EUR . 4. 27,320 EUR . (4) On 2.04.20X4, a company buys a machine at 24,000 EUR gross amount. The seller offers a 10% trade discount on the machine on 1.07.20X4. Depreciation commences in April and is based on the straight-line method over 5 years. How much is depreciation for 20X4? 1. 1,800 EUR . 2. 3,600 EUR . 3. 2,700 EUR . 4. 2,000 EUR . (5) A company buys goods for 100,000 EUR cost of purchase. The opening value of inventories at the beginning of the year amounts to 20,000 EUR. During the Accounting period, the company sold goods valued at 58,000 EUR and returned goods for 18,000 EUR. The sales are 150,000 EUR. How much is the gross profit? 1. 92,000 EUR . 2. 106,000 EUR . 3. 86,000 EUR . 4. 136,000 EUR . 4.13 Solutions 1-1; 2-2; 3-2; 4-3; 5-1. <?page no="87"?> Berkau: Financial Statements 8e 4-86 first-in-first-out cost formula. How much is the gross profit? 1. 9,820 EUR . 2. 11,570 EUR . 3. 12,130 EUR . 4. 27,320 EUR . (4) On 2.04.20X4, a company buys a machine at 24,000 EUR gross amount. The seller offers a 10% trade discount on the machine on 1.07.20X4. Depreciation commences in April and is based on the straight-line method over 5 years. How much is depreciation for 20X4? 1. 1,800 EUR . 2. 3,600 EUR . 3. 2,700 EUR . 4. 2,000 EUR . (5) A company buys goods for 100,000 EUR cost of purchase. The opening value of inventories at the beginning of the year amounts to 20,000 EUR. During the Accounting period, the company sold goods valued at 58,000 EUR and returned goods for 18,000 EUR. The sales are 150,000 EUR. How much is the gross profit? 1. 92,000 EUR . 2. 106,000 EUR . 3. 86,000 EUR . 4. 136,000 EUR . 4.13 Solutions 1-1; 2-2; 3-2; 4-3; 5-1. Berkau: Financial Statements 8e 5-87 5 Basics of Financial Statement Analysis 5.1 What is in the Chapter? In this chapter, we cover the basics of financial statement analysis. For the preparation of a thorough financial statement analysis, you need background knowledge about the industry. Therefore, we only refer to the major metrics that measure performance, liquidity, capital structure, and market valuation and explain their meanings. We apply them on the case study CAPELIFT Ltd., a small service provider in Aviation. 5.2 Learning Objectives After studying this chapter, you know the most important aspects of financial statement analysis and understand the meaning of basic metrics. This will give you a head-start for the preparation of a financial statement analysis. 5.3 Company Appraisal In this chapter, we put you in the position of a company appraiser. We focus on the reading of financial statements not on their preparation. Therefore, you find yourself now on the other side of the Accounting table. We proof the idea of financial analysis where you calculate few ratios and obtain enough knowledge about a company wrong. It would be the same as if your doctor always starts her/ his examination with a great blood count which means the laboratory tests your sample against all diseases possible. In Medicine, the approach is to rather check your blood sample for diseases the doctor expects you to suffer from based on the symptoms you show. We follow a similar approach in Accounting. We prepare metrics to verify an initial hypothesis. We try to prove our initial diagnosis or to falsify it. In the latter case, we must start over again. As we intend analysing financial statements in Aviation, we introduce financial statement analysis based on industry specific metrics - here: by the fictional company CAPELIFT Ltd. In this textbook, we only discuss companies preparing financial statements following IFRSs. We also assume the company’s financial statements have been audited. Auditors check financial statements for correctness. In many countries, Auditing is required by national Company’s Act and is necessary for the approval of financial statements. Auditing is not ruled by IFRSs as it falls under national law. 5.4 Situational Awareness about a Company At the beginning of a financial statement analysis, we check basic financial metrics to obtain an overview. Later we define a hypothesis about the company's situation and check ratios for its proof. At first, we apply standard performance ratios e.g., the return as percentage of sales. If we want to understand e.g., poor performance better, we prepare industry specific ones. E.g., in Aviation the on-time-performance <?page no="88"?> Berkau: Financial Statements 8e 5-88 rate (on time departures divided by the number of flights) is an important metric to measures whether a flight's actual time of departure (push-back time) is within a 15 min tolerance measured against schedule. Airlines check their on-time-performance because their customers' satisfaction depends on punctuality. The on-time-performance is disrupted if the ramp work does not get finished before departure, if the aircraft comes in late from a previous flight, if the crew is not ready, if preflight checks are not completed on time, if the aircraft has write-ups, if boarding is delayed, if the air traffic control does not give push-back/ taxi clearance etc. In financial statement analysis, we usually develop and check industry specific metrics and define subordinate ratios thereto. Digging-in into supporting ratios in financial statement analysis is known to as drill-down. We must understand the industry and the business model of a company, to define metrics for the conduct of a proper financial statement analysis. This means that a single value of a ratio is meaningless, but we must compare metrics between companies of the same industry. Next, we demonstrate the links between metrics and how an initial hypothesis can support a financial statement analysis. We carry out a hypothesis-driven financial analysis for the fictional manufacturer ROSENDAHL Ltd. 5.5 C/ S ROSENDAHL Ltd. ROSENDAHL Ltd. is a production firm for sneakers. We know that the company is a poor performer. Read about ROSENDAHL Ltd. following the Link 5.A below. Link 5.A: ROSENDAHL Ltd. The case of ROSENDAHL Ltd. demonstrates that we must look at the full picture before we can derive conclusions from single metrics. For the analysis of financial statements, the conclusions must point in the same direction. We cannot tolerate contradictions nor inconsistencies. 5.6 Steps of F/ S Analysis For a structured financial statement analysis, we follow the procedure below: (1) Defining information requirements. (2) Formal checks. (3) Horizontal analysis. (4) Vertical analysis. (5) Ratio analysis. 5.7 Defining Information Requirements Our information needs determine the way we carry out a financial statement analysis. The reasons for financial statement analysis can be starting a business relationship with the company, e.g., as a supplier or as a customer, or we assess the company as a potential investor, or we check a com- <?page no="89"?> Berkau: Financial Statements 8e 5-88 rate (on time departures divided by the number of flights) is an important metric to measures whether a flight's actual time of departure (push-back time) is within a 15 min tolerance measured against schedule. Airlines check their on-time-performance because their customers' satisfaction depends on punctuality. The on-time-performance is disrupted if the ramp work does not get finished before departure, if the aircraft comes in late from a previous flight, if the crew is not ready, if preflight checks are not completed on time, if the aircraft has write-ups, if boarding is delayed, if the air traffic control does not give push-back/ taxi clearance etc. In financial statement analysis, we usually develop and check industry specific metrics and define subordinate ratios thereto. Digging-in into supporting ratios in financial statement analysis is known to as drill-down. We must understand the industry and the business model of a company, to define metrics for the conduct of a proper financial statement analysis. This means that a single value of a ratio is meaningless, but we must compare metrics between companies of the same industry. Next, we demonstrate the links between metrics and how an initial hypothesis can support a financial statement analysis. We carry out a hypothesis-driven financial analysis for the fictional manufacturer ROSENDAHL Ltd. 5.5 C/ S ROSENDAHL Ltd. ROSENDAHL Ltd. is a production firm for sneakers. We know that the company is a poor performer. Read about ROSENDAHL Ltd. following the Link 5.A below. Link 5.A: ROSENDAHL Ltd. The case of ROSENDAHL Ltd. demonstrates that we must look at the full picture before we can derive conclusions from single metrics. For the analysis of financial statements, the conclusions must point in the same direction. We cannot tolerate contradictions nor inconsistencies. 5.6 Steps of F/ S Analysis For a structured financial statement analysis, we follow the procedure below: (1) Defining information requirements. (2) Formal checks. (3) Horizontal analysis. (4) Vertical analysis. (5) Ratio analysis. 5.7 Defining Information Requirements Our information needs determine the way we carry out a financial statement analysis. The reasons for financial statement analysis can be starting a business relationship with the company, e.g., as a supplier or as a customer, or we assess the company as a potential investor, or we check a com- Berkau: Financial Statements 8e 5-89 petitor, or we apply for a job in a company of interest etc. There are a lot of reasons for financial statement analysis and our information needs drive the analysis. 5.8 Formal Checking Before we start off, we check whether we got the right financial statements from a reliable source. As analysts we are usually not employed in the Accounting department and do not have access to the books. This means, our analysis is limited to published information (financial statements and the business report). No drill-down towards initial Bookkeeping entries is possible. In some cases, we can find financial statement analysis results from other experts who share their findings with the industry. This information can help us to understand a company’s situation. Keep in mind that financial statement analysis is an interpretation of financial data, not a neutral examination thereof. Therefore, we should not rely on financial statements analysis from others, especially if the intentions for their financial statement analysis are unknown. For correctness of financial statements, we read the auditors’ opinion. Only if the auditor confirms the financial statements are correct and present fairly the financial position, financial performance and cash flows of the company, we analyse them. In contrast 68 E.g., the return on assets ratio requires consideration of whether prepayments are discloses outside of the asset section. In Germany preto financial statement analysis, Auditing is a formal check. Auditors do not share their interpretation about the wellbeing or chances of a company, as they focus on the correctness and the compliance with laws and standards. The financial statements must contain a remark about applied Accounting standards. We narrow our view on financial statements prepared under IFRSs. IAS 1.16 states “An entity whose financial statements comply with IFRSs shall make an explicit and unreserved statement of such compliance in the notes […]”. Financial statements prepared in accordance with other national GAAPs require adjustments to metrics we have in use and are based on IFRSs. E.g., financial statements prepared in Germany require adjustments for items, e.g., accruals or asset valuations. 68 5.9 Horizontal Analysis A horizontal analysis tells the reader of financial statements about the timeline of figures. It provides us with information about the development of metrics in a company e.g., revenue history. It is always a good idea to look at developments under consideration of the common situation in the industry. There might be general developments, e.g., a financial crisis or market changes which explain the company’s position in a volatile environment. We must understand for the history of revpayments are not regarded as assets; internationally, prepayments must be disclosed under current assets. The disclosure affects ratio calculations and their interpretation. <?page no="90"?> Berkau: Financial Statements 8e 5-90 enues whether the whole industry is affected or whether a competitor is increasing its market share. 5.10 Vertical Analysis A vertical analysis tells us about the proportions of single items. E.g., it tells us how much inventory a manufacturer carries as a percentage of its total assets. For the interpretation of vertical analysis, we need to have access to normative information. Normative information exists if a good or best practice is known. However, we do not intend following general rules (golden rule about a balance sheet structure), as you can find in some Finance textbooks. We always strive for a throughout understanding of the business model to decide ourselves whether a metric indicates a good or a bad situation. For illustration of a vertical analysis, we draw pie diagrams. E.g., it shows how much labour a company pays as a percentage of its total of expenses, which might be an important information if the company plans to relocate production facilities to a place where labour costs are different. 5.11 Basics of Ratio Analysis In general, the items on financial statements provide already good information. The purpose of financial statements according to IAS 1.9 is: “[…] to provide information about the financial position, financial performance and the cash flows of an entity that is 69 This refers to the distinction of revenues and other comprehensive income. Usually, revenues useful for a wide range of users in making economic decisions. […].” The balance sheet tells us about the financial position. The statement of profit or loss and other comprehensive income provides us with information about the financial performance and how much thereof is repetitive and how much is extraordinary. 69 The statement of cash flows shows the total cash flow and single cash flows from operations, from investing and financing activities. In total, a lot of an analyst’s information needs, is satisfied by the financial statements already without calculating extra ratios. However, for special information purpose, we determine ratios which combine data derived from various statements, e.g., data from the balance sheet and the income statement for the calculation of a return metric. Ratio analysis is usually based on comparisons. We assess companies for rankings, comparisons or for finding a suitable company based on selection criteria defined on financial ratios. Therefore, metrics measure mainly performance, liquidity, capital structure or market value. We follow with our ratio-based analysis these four information categories. Companies are not comparable per se, e.g., different sizes of companies disturb the meaningfulness of comparisons. Although the statement of profit or loss and other comprehensive income tells us about the financial performance, we cannot compare profits from companies different in size. A are regarded as repetitive whereas other income is seen as exceptional. <?page no="91"?> Berkau: Financial Statements 8e 5-90 enues whether the whole industry is affected or whether a competitor is increasing its market share. 5.10 Vertical Analysis A vertical analysis tells us about the proportions of single items. E.g., it tells us how much inventory a manufacturer carries as a percentage of its total assets. For the interpretation of vertical analysis, we need to have access to normative information. Normative information exists if a good or best practice is known. However, we do not intend following general rules (golden rule about a balance sheet structure), as you can find in some Finance textbooks. We always strive for a throughout understanding of the business model to decide ourselves whether a metric indicates a good or a bad situation. For illustration of a vertical analysis, we draw pie diagrams. E.g., it shows how much labour a company pays as a percentage of its total of expenses, which might be an important information if the company plans to relocate production facilities to a place where labour costs are different. 5.11 Basics of Ratio Analysis In general, the items on financial statements provide already good information. The purpose of financial statements according to IAS 1.9 is: “[…] to provide information about the financial position, financial performance and the cash flows of an entity that is 69 This refers to the distinction of revenues and other comprehensive income. Usually, revenues useful for a wide range of users in making economic decisions. […].” The balance sheet tells us about the financial position. The statement of profit or loss and other comprehensive income provides us with information about the financial performance and how much thereof is repetitive and how much is extraordinary. 69 The statement of cash flows shows the total cash flow and single cash flows from operations, from investing and financing activities. In total, a lot of an analyst’s information needs, is satisfied by the financial statements already without calculating extra ratios. However, for special information purpose, we determine ratios which combine data derived from various statements, e.g., data from the balance sheet and the income statement for the calculation of a return metric. Ratio analysis is usually based on comparisons. We assess companies for rankings, comparisons or for finding a suitable company based on selection criteria defined on financial ratios. Therefore, metrics measure mainly performance, liquidity, capital structure or market value. We follow with our ratio-based analysis these four information categories. Companies are not comparable per se, e.g., different sizes of companies disturb the meaningfulness of comparisons. Although the statement of profit or loss and other comprehensive income tells us about the financial performance, we cannot compare profits from companies different in size. A are regarded as repetitive whereas other income is seen as exceptional. Berkau: Financial Statements 8e 5-91 3,000-employee-consulting firm obviously earns a higher profit than a startup consultant operating as freelancer from home and alone. To compare firms different in size, we calculate ratio as percentages of metrics figuring in the size of the business. E.g., the net profit as a percentage of sales indicates how much cash a company earns per currency unit received. Therefore, the sales factor in the company size. We check the companies A, B, C and D below and receive the data as depicted in Figure 5.1. Company Gross profit Sales GP/ Sales A 200,000.00 848,000.00 23.58% B 300,000.00 1,252,000.00 23.96% C* 500,000.00 1,927,500.00 25.94% D 350,000.00 1,468,400.00 23.84% Figure 5.1: Company data Information for gross profits and sales are taken from income statements. The gross profit tells us how much revenue is left after deduction of material expenses and it shows how much is left for business activities and profit earning. The sales represent cash received from customers A, B, C, D, and tell us about the dimension of the business. Which company performs best? Only if we calculate a ratio like the gross profit as percentage of sales, we can measure which company performs best. Therefore, we divide gross profits by revenues. For every 100 EUR received, company A earns a gross profit of 23.58 EUR, company B: 23.96 EUR, company C: 25.94 EUR and company D: 23.84 EUR. Hence, the best performer is company C. The ratio profit as percentage of sales measures a yield it gives us an outputover-input-ratio. It reflects the efficiency of deployed resources. Ratios are common instruments for financial statement analysis. We can derive them from data from the financial statements. Some data depend on the Accounting period, others are taken from the balance sheet at a certain time. If we take a figure from an income statement, e.g., revenue, it is related to a period, usually one year. In contrast, a figure copied from the balance sheet is derived from the closing balance of a real account and therefore is linked to a specific date, the balance sheet date. For the calculation of ratios as fractions with nominators/ denominators from income statements and balance sheets, we must decide, which data are and under which reference to the time to consider: (a) at the opening values, (b) at the closing values or (c) at the average of the above. In this textbook we follow alternative (b). There are good reasons for alternatives (a) and (c), however, we go for closing values, as they can be derived from one set of financial statements. In other than teaching contexts, we recommend calculating the average value from opening and closing figures; this is alternative (c). <?page no="92"?> Berkau: Financial Statements 8e 5-92 We classify metrics following aspects they can measure: - Performance ratios. - Liquidity ratios. - Capital structure ratios. - Market value ratios. 5.12 C/ S CAPELIFT (Pty) Ltd. To explain the most common ratios, we apply them for the service provider CAPELIFT (Pty) Ltd. Below, we introduce the company. Data Sheet for CAPELIFT (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((CCaappee TToowwnn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : AAvviiaattiioonn.. IIssssuueedd ccaappiittaall: : 77"550000"000000 ZZAARR.. AAccccoouunnttiinngg ppeerriioodd: : 2200XX88.. FFlleeeett: : 11 jjeett" 11 ppiissttoonn eennggiinnee aaiirrccrraafftt.. FFiinnaanncciinngg: : bbaannkk llooaannss; ; iinntteerreesstt: : 55..99 %%/ / aa.. PPiilloottss: : FFrreeeellaanncceerrss.. VVAATT rraattee: : 2200 %%.. CAPELIFT (Pty) Ltd. is a small Aviation firm offering charter flights. The company has two aircrafts, a jet and a single-piston engine aircraft. The company is based at Cape Town Int’l Airport. Both aircrafts are financed by bank loans at an interest rate of 5.9 %/ a. On its balance sheet, the company discloses an issued capital of: 1,000,000 × 7.50 = 77"550000"000000 ZZAARR which is the ordinary share capital. CAPELIFT (Pty) Ltd. owns its aircrafts and carries them as assets. CAPELIFT (Pty) Ltd. has access to a pool of commercial licensed pilots who form their stand-by crew and work on a freelancer basis. They bill CAPELIFT (Pty) Ltd. for their service per flight time and bill travel expenses for lay-overs. CAPELIFT (Pty) Ltd. passes the crew bills on to its customers without further surcharge. CAPELIFT (Pty) Ltd.’s clients are mostly businesspeople who charter the planes for trips to small and domestic airfields in South Africa. See below the financial statements for 20X8. A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 60,000,000 Share capital 7,500,000 Intangibles Reserves 6,000,000 Financial assets Retained earnings 7,000,000 Current assets Liabilities (liab.) Inventory Long-term liab. 50,000,000 Acc. receivables A/ R 10,000,000 Short-term liab. A/ P 16,500,000 Prepaid expenses 2,000,000 Provisions Cash/ Bank 18,000,000 Income tax liab. 3,000,000 Total assets 90,000,000 Total equity and liab. 90,000,000 CapeLift (Pty) Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X8 Figure 5.2: CAPELIFT (Pty) Ltd.’s balance sheet (20X8) <?page no="93"?> Berkau: Financial Statements 8e 5-92 We classify metrics following aspects they can measure: - Performance ratios. - Liquidity ratios. - Capital structure ratios. - Market value ratios. 5.12 C/ S CAPELIFT (Pty) Ltd. To explain the most common ratios, we apply them for the service provider CAPELIFT (Pty) Ltd. Below, we introduce the company. Data Sheet for CAPELIFT (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((CCaappee TToowwnn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : AAvviiaattiioonn.. IIssssuueedd ccaappiittaall: : 77"550000"000000 ZZAARR.. AAccccoouunnttiinngg ppeerriioodd: : 2200XX88.. FFlleeeett: : 11 jjeett" 11 ppiissttoonn eennggiinnee aaiirrccrraafftt.. FFiinnaanncciinngg: : bbaannkk llooaannss; ; iinntteerreesstt: : 55..99 %%/ / aa.. PPiilloottss: : FFrreeeellaanncceerrss.. VVAATT rraattee: : 2200 %%.. CAPELIFT (Pty) Ltd. is a small Aviation firm offering charter flights. The company has two aircrafts, a jet and a single-piston engine aircraft. The company is based at Cape Town Int’l Airport. Both aircrafts are financed by bank loans at an interest rate of 5.9 %/ a. On its balance sheet, the company discloses an issued capital of: 1,000,000 × 7.50 = 77"550000"000000 ZZAARR which is the ordinary share capital. CAPELIFT (Pty) Ltd. owns its aircrafts and carries them as assets. CAPELIFT (Pty) Ltd. has access to a pool of commercial licensed pilots who form their stand-by crew and work on a freelancer basis. They bill CAPELIFT (Pty) Ltd. for their service per flight time and bill travel expenses for lay-overs. CAPELIFT (Pty) Ltd. passes the crew bills on to its customers without further surcharge. CAPELIFT (Pty) Ltd.’s clients are mostly businesspeople who charter the planes for trips to small and domestic airfields in South Africa. See below the financial statements for 20X8. A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 60,000,000 Share capital 7,500,000 Intangibles Reserves 6,000,000 Financial assets Retained earnings 7,000,000 Current assets Liabilities (liab.) Inventory Long-term liab. 50,000,000 Acc. receivables A/ R 10,000,000 Short-term liab. A/ P 16,500,000 Prepaid expenses 2,000,000 Provisions Cash/ Bank 18,000,000 Income tax liab. 3,000,000 Total assets 90,000,000 Total equity and liab. 90,000,000 CapeLift (Pty) Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X8 Figure 5.2: CAPELIFT (Pty) Ltd.’s balance sheet (20X8) Berkau: Financial Statements 8e 5-93 [ZAR] Revenue 50,000,000 Other income 0 50,000,000 Materials 0 Labour (14,000,000) Depreciation (2,500,000) Other expenses (20,550,000) Earnings before int. & taxes (EBIT) 12,950,000 Interest (2,950,000) Earnings before taxes (EBT) 10,000,000 Income tax expenses (3,000,000) Deferred taxes 0 Earnings after taxes (EAT) 7,000,000 CapeLift (Pty) Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X8 Figure 5.3: CAPELIFT (Pty) Ltd.’s income statement (20X8) 5.13 Performance Ratios - CAPELIFT (Pty) Ltd. Financial performance measures whether a company earns money from its business operations. In contrast to productivity, the performance metrics are based on currency units per output or input. We usually express financial success in monetary equivalents received for selling goods or rendering services. It must be related to the effort a company takes to produce the goods or render its services. Performance ratios measure efficiency. In terms of Mathematics, performance is either a difference or a percentage. The primary source for financial performance metrics is the statement of profit or loss and other comprehensive income. It compares revenues to expenses for goods production or service rendering and the sale thereof. Hence, profit measures the absolute financial performance already. In addition to the mere profit calculation, financial performance ratios frequently compare profit to inputs, e.g., capital, sales or investments. In general, we try to exclude the influence of misleading bias from performance measurement, e.g., the impact of national tax payments, bank loans’ interest or dividends etc. For the comparison of performance figures in various industries, we consider major differences which depend on the business model of a company. E.g., a consultancy’s input is not capital but human resources. For that reason, production firms and other capital-intensive industries disclose significant lower returns on capital than companies with a business model based on human capital, like law firms or a doctor’s clinic. <?page no="94"?> Berkau: Financial Statements 8e 5-94 Below, we introduce the most common financial performance ratios and apply them for CAPELIFT (Pty) Ltd.: - Fixed Asset Turnover. - Inventory Turnover. - Return on Capital Employed. - Return on Assets. - Return on Shareholders’ Funds. - Return as Percentage of Sales. - Earnings per Share. - Economic Value Added. Fixed Asset Turnover: The Fixed Asset Turnover measures the revenue as a percentage of noncurrent assets. The revenue is proceeds after deduction of trade rebates/ discounts, output-VAT and further selling costs, e.g., for transportation. Dividing revenues by the total of noncurrent assets tells us whether a company made good investment decisions. A Fixed Asset Turnover is difficult to read if a company offers different products/ services manufactured on the same machinery. Then we must allocate revenues to single investments. This leads to an investment based Fixed Asset Turnover. That metric allows to assess investments ex post and applies for Asset Management decisions. Fixed Asset Turnover is based on carrying values. Hence, a service rendered with deployment of highly depreciated machinery earning the same sales as under deployment of new machines leads to a higher Fixed Asset Turnover. CAPELIFT (Pty) Ltd. could achieve a high Fixed Asset Turnover by deployment of old aircrafts if customers accept this, and the authorities certify their airworthiness. However, if customers request fancy new aircrafts and are not prepared to fly with (and pay for) old ones, revenues and profit will shrink, and the Fixed Asset Turnover goes down with it. The Fixed Asset Turnover in Aviation depends on the deployment rate and load factor. A load factor is the occupation per seat capacity as a percentage. Aircrafts only earn money when airborne. Many airlines compare their pure flight time to a year. The objective is to spend as less time on the ground as possible. Therefore, long haul flights result in higher Fixed Asset Turnovers than domestic flights if flown with the same aircrafts. As passengers are intolerant to delays and cancellations, carriers must hold transportation capacity as stand-by equipment. Hence, the total deployment rate and Fixed Asset Turnover is a traded-off between performance and the reliability of service. Stand-by resources weaken the Fixed Asset Turnover as they cause idle time. CAPELIFT (Pty) Ltd. calculates a Fixed Asset Turnover of: 50,000,000 / 60,000,000 = 8 833..3333%%. The ratio indicates a low performance because CAPELIFT (Pty) Ltd. has a low deployment rate. It does not fly line, and therefore, must charge high prices for individual charter flights. Its customers expect an aircraft availability that matches their travel plans. To boost its Fixed Asset Turnover, CAPELIFT (Pty) Ltd. could think of replacing the fast, but expensive jet. Its Marketing department must research whether customers are prepared to accept longer and less comfortable flight times at lower prices. We discuss further below the plans to acquire a further single-engine piston aircraft. <?page no="95"?> Berkau: Financial Statements 8e 5-94 Below, we introduce the most common financial performance ratios and apply them for CAPELIFT (Pty) Ltd.: - Fixed Asset Turnover. - Inventory Turnover. - Return on Capital Employed. - Return on Assets. - Return on Shareholders’ Funds. - Return as Percentage of Sales. - Earnings per Share. - Economic Value Added. Fixed Asset Turnover: The Fixed Asset Turnover measures the revenue as a percentage of noncurrent assets. The revenue is proceeds after deduction of trade rebates/ discounts, output-VAT and further selling costs, e.g., for transportation. Dividing revenues by the total of noncurrent assets tells us whether a company made good investment decisions. A Fixed Asset Turnover is difficult to read if a company offers different products/ services manufactured on the same machinery. Then we must allocate revenues to single investments. This leads to an investment based Fixed Asset Turnover. That metric allows to assess investments ex post and applies for Asset Management decisions. Fixed Asset Turnover is based on carrying values. Hence, a service rendered with deployment of highly depreciated machinery earning the same sales as under deployment of new machines leads to a higher Fixed Asset Turnover. CAPELIFT (Pty) Ltd. could achieve a high Fixed Asset Turnover by deployment of old aircrafts if customers accept this, and the authorities certify their airworthiness. However, if customers request fancy new aircrafts and are not prepared to fly with (and pay for) old ones, revenues and profit will shrink, and the Fixed Asset Turnover goes down with it. The Fixed Asset Turnover in Aviation depends on the deployment rate and load factor. A load factor is the occupation per seat capacity as a percentage. Aircrafts only earn money when airborne. Many airlines compare their pure flight time to a year. The objective is to spend as less time on the ground as possible. Therefore, long haul flights result in higher Fixed Asset Turnovers than domestic flights if flown with the same aircrafts. As passengers are intolerant to delays and cancellations, carriers must hold transportation capacity as stand-by equipment. Hence, the total deployment rate and Fixed Asset Turnover is a traded-off between performance and the reliability of service. Stand-by resources weaken the Fixed Asset Turnover as they cause idle time. CAPELIFT (Pty) Ltd. calculates a Fixed Asset Turnover of: 50,000,000 / 60,000,000 = 8 833..3333%%. The ratio indicates a low performance because CAPELIFT (Pty) Ltd. has a low deployment rate. It does not fly line, and therefore, must charge high prices for individual charter flights. Its customers expect an aircraft availability that matches their travel plans. To boost its Fixed Asset Turnover, CAPELIFT (Pty) Ltd. could think of replacing the fast, but expensive jet. Its Marketing department must research whether customers are prepared to accept longer and less comfortable flight times at lower prices. We discuss further below the plans to acquire a further single-engine piston aircraft. Berkau: Financial Statements 8e 5-95 Inventory Turnover: The Inventory Turnover is a performance metric mostly applicable in production firms and for retailers. It measures how often stock is virtually replaced/ sold per year. The ratio is used in Logistics to identify fast-moving and slow-moving goods. In Accounting, it is regarded as a performance measurement to calculate how quick goods can be sold. A high Inventory Turnover indicates flexibility as it does not take long to clear stock. This matters, if produced or traded goods depend on trends, e.g., in the fashion industry, or are perishable. Inventory Turnover is very high where companies sell every day’s goods e.g., groceries in discounters. It becomes low for specialised companies that seek to offer a high variety of goods to its customers, such as KaDeWe selling all sorts of expensive chocolate brands in their Berlin’s central department store. In Accounting, we consider the ability of quick selling goods as a high performance. A company selling its goods fast pays low inventory and capital costs. For CAPELIFT (Pty) Ltd., inventories are almost irrelevant. The company does not carry inventories for Aviation gas/ kerosene nor for spare parts as the aircrafts are maintained at a wharf in the airport vicinity. Therefore, we refuse to even calculate an Inventory Turnover for CAPELIFT (Pty) Ltd. Return on Capital Employed: Return on Capital Employed refers to the portion of equity and long-term liabilities that is invested in the company. In contrast, short-term liabilities are not regarded as investments and its costs of capital are usually covered by creditors. Hence, only capital the company pays for - either by dividends or as interest - falls under employed capital. To calculate capital employed we add the total of equity and all longterm liabilities. The nominator is the pre-tax profit to keep the ratio free from income tax bias and make it comparable between various countries where different tax rates apply. CAPELIFT (Pty) Ltd.’s Return on Capital Employed is: 10,000,000 / (7,500,000 + 6,000,000 + 7,000,000 + 50,000,000) = 1144..1188 %%. For interpretation, we must compare the Return on Capital Employed to the rate of interest in South Africa which is approximately at 9 %/ a. Hence, the business model works out in comparison to interest obtainable on the capital market and under consideration of the inflation rate. Return on Assets: The Return on Assets measures the profit before interest and taxes (EBIT) as a percentage of all assets at carrying values. In line with IFRSs, the denominator is the balance sheet’s total. For the nominator, taxes and interest are not deducted to consider the full performance of the company regarding productivity or service rendering. One major problem of the Return on Assets ratio is that highly depreciated machinery increases the ratio although production/ service remains constant. <?page no="96"?> Berkau: Financial Statements 8e 5-96 An UBER driver who makes the same number of rides every year will experience an increase in performance metrics only due to a value decrease caused by depreciation on the car. The Return on Assets applies in companies and groups to rank the productivity of certain plants, branches or subsidiaries. It is free of tax and interest bias and easily to calculate based on financial statements. CAPELIFT (Pty) Ltd.’s Return on Assets is: 12,950,000 / 90,000,000 = 1 144..3399%%. If compared to the rate of interest, we can estimate the (pre-tax) profit margin in case the company would be financed completely by loans. Return on Shareholders’ Funds: Return on Shareholders’ Funds ROSF represents the benefit that is available to investors. The shareholders’ funds include the items of equity: issued capital, reserves and retained earnings. In contrast, the denominator of the return on equity is calculated as book value: total of asset less liabilities. Here, both calculations result in the same denominator. So far, we focussed on performance from the point of view of the company or plant manager. We now take the investors’ seat. ROSF represents returns to the owners as e.g., declared dividends. To use the Return on Shareholders’ Funds as a meaningful performance metric, we must cancel out the 70 In Finance, it is common to calculate the equity as the average over the period derived from opening and closing amounts. As a simplification, we here refer to the above-mentioned impact of the decision about the appropriation of profits as well as of a company’s income taxes. They both should not matter for performance. Therefore, the ROSF is calculated as net profit after tax (NPAT) as a percentage of total equity. The net profit after tax is revenue less all expenses, tax and interest. NPAT also can include extraordinary income, e.g., interest income from bonds. Equity is measured before the appropriation of profits to focus on performance. This means, the equity calculation is before dividends are allocated to payables. 70 The ratio could be based on actual dividends. It is not because dividends are based on profits carried forward from previous years, too. Therefore, they depend on the performance of the past. CAPELIFT (Pty) Ltd.’s Return on Shareholders’ Funds is: 7,000,000 / (7,500,000 + 6,000,000 + 7,000,000) = 3344..1155%%. The figure is high as the company is deep in debts and therefore only discloses low equity and is well performing significantly above the rate of interest on the capital market. Return as the Percentage of Sales (Return of Sales): Return as Percentage of Sales is calculated as annual surplus as percentage of sales. The ratio tells us how much earnings result from the sale of products or services. E.g., we want to know how much profit an airline earns if we method and focus on one balance sheet day only. <?page no="97"?> Berkau: Financial Statements 8e 5-96 An UBER driver who makes the same number of rides every year will experience an increase in performance metrics only due to a value decrease caused by depreciation on the car. The Return on Assets applies in companies and groups to rank the productivity of certain plants, branches or subsidiaries. It is free of tax and interest bias and easily to calculate based on financial statements. CAPELIFT (Pty) Ltd.’s Return on Assets is: 12,950,000 / 90,000,000 = 1 144..3399%%. If compared to the rate of interest, we can estimate the (pre-tax) profit margin in case the company would be financed completely by loans. Return on Shareholders’ Funds: Return on Shareholders’ Funds ROSF represents the benefit that is available to investors. The shareholders’ funds include the items of equity: issued capital, reserves and retained earnings. In contrast, the denominator of the return on equity is calculated as book value: total of asset less liabilities. Here, both calculations result in the same denominator. So far, we focussed on performance from the point of view of the company or plant manager. We now take the investors’ seat. ROSF represents returns to the owners as e.g., declared dividends. To use the Return on Shareholders’ Funds as a meaningful performance metric, we must cancel out the 70 In Finance, it is common to calculate the equity as the average over the period derived from opening and closing amounts. As a simplification, we here refer to the above-mentioned impact of the decision about the appropriation of profits as well as of a company’s income taxes. They both should not matter for performance. Therefore, the ROSF is calculated as net profit after tax (NPAT) as a percentage of total equity. The net profit after tax is revenue less all expenses, tax and interest. NPAT also can include extraordinary income, e.g., interest income from bonds. Equity is measured before the appropriation of profits to focus on performance. This means, the equity calculation is before dividends are allocated to payables. 70 The ratio could be based on actual dividends. It is not because dividends are based on profits carried forward from previous years, too. Therefore, they depend on the performance of the past. CAPELIFT (Pty) Ltd.’s Return on Shareholders’ Funds is: 7,000,000 / (7,500,000 + 6,000,000 + 7,000,000) = 3344..1155%%. The figure is high as the company is deep in debts and therefore only discloses low equity and is well performing significantly above the rate of interest on the capital market. Return as the Percentage of Sales (Return of Sales): Return as Percentage of Sales is calculated as annual surplus as percentage of sales. The ratio tells us how much earnings result from the sale of products or services. E.g., we want to know how much profit an airline earns if we method and focus on one balance sheet day only. Berkau: Financial Statements 8e 5-97 buy a ticket that costs 100 EUR (net value). A high percentage indicates the sale of innovative products and efficient sales/ service/ production procedures. It also represents a good market position of the firm. Typically, a service provider in a monopoly situation achieves a high Return as Percentage of Sales. This is not the case in highly competitive markets, like in car manufacturing, where the companies must innovate their products and offer their customers trade discounts to maintain or to expand their share of the market. The net profit as percentage of sales is usually related to earnings from operations only. Taxation and interest do not affect the Return as a Percentage of Sales. The Return as Percentage of Sales (or Return on Sales ROS) for CAPELIFT (Pty) Ltd. is: 7,000,000 / 50,000,000 = 1 144%%. This means the airline earns an annual surplus of 14 ZAR for every 100 ZAR received from its customers paying for tickets or charter. Earnings per Share: Earnings per Share EPS is a ratio subjected to standardisation by IFRSs. The standard setter dedicated IAS 33 to EPS. We discuss Earnings per Share as a performance measurement. Performance should not be biased by dividend decisions made by the company’s management or by its owners at the annual general meeting. Once we factor in the decision about dividend declaration, the ratio will no longer measure performance. Therefore, EPS measures the earnings for a full dividend payable to ordinary shareholders divided by the number of ordinary shares. In contrast to dividend calculations, it does not include profits carried forward but refers to actual earnings. IAS 33.10 defines the EPS calculations. Some items are to be deducted before earnings become distributable to ordinary shareholders: (a) preference dividends and (b) in Germany, additions to legal reserves, compare with IAS 33.14. IAS 33.12 rules the calculation of earnings: The amount that is distributable to the ordinary shareholders is divided by the number of ordinary shares based on IAS 33.19. Changes in the number of shares during the Accounting period with or without payment/ receipts are ruled by the calculation procedures following IAS 33.26 - IAS 33.29. CAPELIFT (Pty) Ltd. is based on 1,000,000 ordinary shares. Its earnings are 7,000,000 ZAR which results in Earnings per Share ratio of: 7,000,000 / 1,000,000 = 7 7 ZZAARR/ / ss. The Earnings per Share ratio is mostly known from the denominator for the Price-Earnings ratio that compares the market share price of shares to the earnings per share. For EPS calculations follow the link below. Link 5.B: EPS calculations <?page no="98"?> Berkau: Financial Statements 8e 5-98 Economic Value Added TM : The Economic Value Added is the increase of the company’s value due to its earnings. 71 For Economic Value Added (EVA) calculation, the net operating profit after taxes NOPAT is compared to the difference between assets and short-term liabilities, the latter one multiplied with the Weighted Average Cost of Capital WACC. 72 The WACC is a rate and is disclosed as percentage. The difference between assets and short-term liabilities represents the capital employed by the investors. Short-term liabilities are deducted to consider their financing by a company's creditors. By multiplying the capital employed with the WACC, we determine the profit that can be earned with an alternative investment under consideration of actual interest and cost of equity. This way, EVA compares net operating profits to opportunity costs. The result is a difference of how much the company’s value increases over an alternative investment. It is measured in a currency unit and applicable under consideration of a tax shield, which means for this textbook, it must be multiplied by the factor (1 - 30%). The tax shield considers that the alternative investment represents taxable income. For CAPELIFT (Pty) Ltd. the Weighted Average Costs of Capital require calculating the average bank loan’s rate of interest. The absolute interest payments are taken from the income statement and divided by the interest bearing liabilities 71 Economic Value Added is a trademark of Steward Stern Management Services. 72 Note, that in contrast to the ROSF we now refer to the NOPAT, which is based on operating to determine the interest rate. The payoff portion of the bank loan for the next Accounting period is disclosed as accounts payables but is subjected to interest payments, too. We assume the pay-off for the bank loans is 5 %/ a which matches with a useful life of 20 years for the aircrafts. We assume that the bank loan finances the aircraft over their entire useful life. Therefore, interest payments are divided by: (1 + 5%) × 50,000,000 = 5 522"550000"000000 ZZAARR. The rate of interest is: 2,950,000 / 52,500,000 = 5 5..6622%%/ / aa.. We expect a return to shareholders of 10 %/ a as a dividend and calculate WACC as: [10% × (7,500,000 + 6,000,000 + 7,000,000) + 5.62% × 52,500,000] / 73,000,000 = 6 6..8855%%/ / aa. The EVA compares the net operating profit with the interest income that could be earned on the capital market as opportunity costs. To compare the figures, we multiply the calculated WACC rate with the tax shield, which is: (1 - 30%) for this textbook. The tax shield considers our virtual interest income as taxable expenses. The Economic Value Added is: 7,000,000 - 6.85% × (1 - 30%) × (90,000,000 - 16,500,000 - 3,000,000) = 3 3"661199"552255 ZZAARR. The company increased its value by 3.62 million ZAR in comparison to an investment on the capital market based on the calculated WACC rate. 5.14 Liquidity Ratios - CAPELIFT (Pty) Ltd. Liquidity is the ability to transform assets into an easily convertible form, preferably cash. Liquidity ratios tell us profits, extraordinary income and expenses do not matter. <?page no="99"?> Berkau: Financial Statements 8e 5-98 Economic Value Added TM : The Economic Value Added is the increase of the company’s value due to its earnings. 71 For Economic Value Added (EVA) calculation, the net operating profit after taxes NOPAT is compared to the difference between assets and short-term liabilities, the latter one multiplied with the Weighted Average Cost of Capital WACC. 72 The WACC is a rate and is disclosed as percentage. The difference between assets and short-term liabilities represents the capital employed by the investors. Short-term liabilities are deducted to consider their financing by a company's creditors. By multiplying the capital employed with the WACC, we determine the profit that can be earned with an alternative investment under consideration of actual interest and cost of equity. This way, EVA compares net operating profits to opportunity costs. The result is a difference of how much the company’s value increases over an alternative investment. It is measured in a currency unit and applicable under consideration of a tax shield, which means for this textbook, it must be multiplied by the factor (1 - 30%). The tax shield considers that the alternative investment represents taxable income. For CAPELIFT (Pty) Ltd. the Weighted Average Costs of Capital require calculating the average bank loan’s rate of interest. The absolute interest payments are taken from the income statement and divided by the interest bearing liabilities 71 Economic Value Added is a trademark of Steward Stern Management Services. 72 Note, that in contrast to the ROSF we now refer to the NOPAT, which is based on operating to determine the interest rate. The payoff portion of the bank loan for the next Accounting period is disclosed as accounts payables but is subjected to interest payments, too. We assume the pay-off for the bank loans is 5 %/ a which matches with a useful life of 20 years for the aircrafts. We assume that the bank loan finances the aircraft over their entire useful life. Therefore, interest payments are divided by: (1 + 5%) × 50,000,000 = 5 522"550000"000000 ZZAARR. The rate of interest is: 2,950,000 / 52,500,000 = 55..6622%%/ / aa.. We expect a return to shareholders of 10 %/ a as a dividend and calculate WACC as: [10% × (7,500,000 + 6,000,000 + 7,000,000) + 5.62% × 52,500,000] / 73,000,000 = 6 6..8855%%/ / aa. The EVA compares the net operating profit with the interest income that could be earned on the capital market as opportunity costs. To compare the figures, we multiply the calculated WACC rate with the tax shield, which is: (1 - 30%) for this textbook. The tax shield considers our virtual interest income as taxable expenses. The Economic Value Added is: 7,000,000 - 6.85% × (1 - 30%) × (90,000,000 - 16,500,000 - 3,000,000) = 3 3"661199"552255 ZZAARR. The company increased its value by 3.62 million ZAR in comparison to an investment on the capital market based on the calculated WACC rate. 5.14 Liquidity Ratios - CAPELIFT (Pty) Ltd. Liquidity is the ability to transform assets into an easily convertible form, preferably cash. Liquidity ratios tell us profits, extraordinary income and expenses do not matter. Berkau: Financial Statements 8e 5-99 how quick a company’s assets can be “sold”. In general, long-term assets, like machinery or land is more difficult to exchange than cash or money in a bank account. If we liquidate a company, we transform all assets to cash used to retire the debts. 73 Liquidity ratios tell us how quick cash can be generated by selling assets to repay liabilities. We distinguish the liquidity ratios below: - Current Ratio. - Quick Ratio. - Cash Ratio. - Debtors’ Collection Days. Current Ratio: The Current Ratio is current assets divided by current liabilities. A current ratio of 100 % indicates that all current assets are financed by short-term liabilities. In that case, the financing of the business not risky as non-current assets are financed with long-term liabilities or equity and current assets by short-term liabilities. At CAPELIFT (Pty) Ltd., the Current Ratio is: 30,000,000 / 19,500,000 = 1 15533..8855%%. The Current Ratio proves that CAPELIFT (Pty) Ltd. has enough current assets to pay-off its short-term liabilities. As the value exceeds 100 %, we know that some current assets are financed longterm. However, the Current Ratio does not tell us about the Financing for longterm assets. 73 Study our textbook Basics of Accounting for liquidations and disposal, chapter (34) and (35). Quick Ratio: In contrast to the Current Ratio, the Quick Ratio only includes current assets that can be sold on short notice. We assume that inventories and prepayments are not easily convertible to cash and exclude (deduct) them from current assets in the nominator of the Quick Ratio. This gives us the current assets less inventories less prepayments divided by short-term liabilities. A Quick Ratio of 100 % means that the easily to liquidate assets cover short-term debts. A company then can repay its short-term liabilities without problems on short notice. At CAPELIFT (Pty) Ltd., the Quick Ratio is: 28,000,000 / 19,500,000 = 1 14433..5599%%. Hence, the quickly sellable current assets are sufficient for paying-off shortterm liabilities. Cash Ratio: The Cash Ratio is a further step into the direction of short-term liquidations. It tells us how much cash and cash equivalents can pay-off liabilities instantly, meaning within a few banking days. A Cash Ratio of 100 % means the company holds the short-term liabilities on cash or in a bank account. This indicates a high liquidity. At CAPELIFT (Pty) Ltd., the Cash Ratio is: 18,000,000 / 19,500,000 = 9 922..3311%%. The percentage is still high and indicates that CAPELIFT (Pty) Ltd. holds a sufficient portion of cash. Good liquidity is re- <?page no="100"?> Berkau: Financial Statements 8e 5-100 quired in Aviation to cover costs for labour, fuel, lay-overs and airport landing fees or before flights. A high liquidity is not per se a good indicator as it is a trade-off between liquidity and performance. Liquidity reserves are not available for financing business operations and therefore weaken the performance. Debtors’ Collection Days: The receivables are considered for liquidity, but they are difficult to collect on short notice. Therefore, the debtors’ collection days are relevant for liquidity. They consider the average time span for debt collection. The ratio Debtors’ collection Days divides the (total of receivables × 365) by credit sales. The Debtors’ Collection Days depend on the industry. We assume that at CAPELIFT (Pty) Ltd., half of the customers pay on cash and the remainder pays later. This gives Debtors’ Collection Days of: 10,000,000 × 365 / 25,000,000 = 1 14466 ddaayyss. In other words, it takes the debtors on average: 146/ 365 = 4 400 %% of the year to pay for their bills. This means that 40 % of sales on credit are currently carried as receivables on the balance sheet. This is not good in a country with a rate of interest of 9 %/ a, because CAPELIFT (Pty) Ltd. must finance the receivables for almost five months. 74 In comparison, the German HGB overrates liabilities. 5.15 Capital Structure Ratios - CAPELIFT (Pty) Ltd. We can derive the capital structure straight from the statement of financial position. On its credit side, we see where the company’s funds originate from: We see whether the company is financed by equity or liabilities. For liabilities, we further need to know the payment terms and strive for classification of debts as long-term and shortterm liabilities. In general, we prefer financing where long-term assets are financed by longterm debts and short-term assets are financed short-term. In contrast, it is risky to finance long-term assets you depend on by funds that are due on short notice. When we analyse debts for companies that report in accordance with IFRSs, we must consider that long-term liabilities are disclosed at fair values or at amortised costs. For amortised cost calculation we determine the liability’s value by the effective interest method based on IFRS 9.5.4.1., which smooths out volatilities. We can assume the values applied for disclosure on the balance sheet represent the true and fair values for debts. 74 Short-term liabilities are disclosed at settlement values. We discuss below only some ratios out of many gearing ratios they all provide with similar information about the capital structure. 75 We must understand why to analyse the capital structure. It is for the leverage effect and for financing decisions. 75 The capital structure is called gearing. This expression is related to the leverage effect. <?page no="101"?> Berkau: Financial Statements 8e 5-100 quired in Aviation to cover costs for labour, fuel, lay-overs and airport landing fees or before flights. A high liquidity is not per se a good indicator as it is a trade-off between liquidity and performance. Liquidity reserves are not available for financing business operations and therefore weaken the performance. Debtors’ Collection Days: The receivables are considered for liquidity, but they are difficult to collect on short notice. Therefore, the debtors’ collection days are relevant for liquidity. They consider the average time span for debt collection. The ratio Debtors’ collection Days divides the (total of receivables × 365) by credit sales. The Debtors’ Collection Days depend on the industry. We assume that at CAPELIFT (Pty) Ltd., half of the customers pay on cash and the remainder pays later. This gives Debtors’ Collection Days of: 10,000,000 × 365 / 25,000,000 = 1 14466 ddaayyss. In other words, it takes the debtors on average: 146/ 365 = 4 400 %% of the year to pay for their bills. This means that 40 % of sales on credit are currently carried as receivables on the balance sheet. This is not good in a country with a rate of interest of 9 %/ a, because CAPELIFT (Pty) Ltd. must finance the receivables for almost five months. 74 In comparison, the German HGB overrates liabilities. 5.15 Capital Structure Ratios - CAPELIFT (Pty) Ltd. We can derive the capital structure straight from the statement of financial position. On its credit side, we see where the company’s funds originate from: We see whether the company is financed by equity or liabilities. For liabilities, we further need to know the payment terms and strive for classification of debts as long-term and shortterm liabilities. In general, we prefer financing where long-term assets are financed by longterm debts and short-term assets are financed short-term. In contrast, it is risky to finance long-term assets you depend on by funds that are due on short notice. When we analyse debts for companies that report in accordance with IFRSs, we must consider that long-term liabilities are disclosed at fair values or at amortised costs. For amortised cost calculation we determine the liability’s value by the effective interest method based on IFRS 9.5.4.1., which smooths out volatilities. We can assume the values applied for disclosure on the balance sheet represent the true and fair values for debts. 74 Short-term liabilities are disclosed at settlement values. We discuss below only some ratios out of many gearing ratios they all provide with similar information about the capital structure. 75 We must understand why to analyse the capital structure. It is for the leverage effect and for financing decisions. 75 The capital structure is called gearing. This expression is related to the leverage effect. Berkau: Financial Statements 8e 5-101 We cover: - Debt to Equity ratio D2E. - Working Capital. - Interest Coverage. Debt to Equity Ratio: The Debt to Equity ratio is the relationship between liabilities and the total of equity. We divide the liabilities by the equity. At CAPELIFT (Pty) Ltd., the Debt-to-Equity D2E ratio is: (90,000,000 - 20,500,000) / 20,500,000 = 3 3..3399 or we say it is 339 %. This indicates that the company is highly indebted which is expectable in a capital-intensive industry. We check the coverage of long-term assets based on the debt structure. CAPELIFT (Pty) Ltd. has long-term funds which is part of its equity and long-term debts resulting from bank loans to the total extent of: 7,500,000 + 6,000,000 + 50,000,000 = 6 633"550000"000000 ZZAARR to finance property, plant and equipment carried at 60,000,000 ZAR. 76 We consider the coverage rate as sufficient to ensure continuance of its business operations. In Accounting and Finance, the leverage effect applies. 77 Based on the leverage effect the Return on Shareholders’ Funds can increase solely from excessive borrowing if the Return on Assets exceeds the capital costs. The effect focusses on the Return on Equity. Therefore, its formula describes the effect best if based on gearing: The formula for the ROE is: ROE = ROA + D2E × (ROA i); therein is: ROA Return on Assets, as EBIT divided by the 76 For our calculations, we do not consider retained earnings as they are subjected to claims of the owners. total of assets, D2E the Debt to Equity ratio and calculated as Liabilities over Equity and i is the (average) rate of interest for long-term debts. A company that is in debts can increase its Return on Equity by increase of gearing, given that the Return on Assets exceeds the rate of interest i on the capital market. The leverage effect works in both ways: It amplifies the Return on Equity in a positive as well as in a negative direction. The leverage effect is relevant for investment decisions if business growth is financed. We prepared the calculation of returns for CAPELIFT (Pty) Ltd. if the firm acquires a further aircraft to expand its fleet. Follow the QR-code below in Link 5.C for further considerations about the airline. Link 5.C: CAPELIFT (Pty) Ltd. Working Capital: Working Capital is an absolute asset metric and is measured in currency units. It originates from Finance and is the difference between short-term assets and short-term liabilities. In Finance, we need to know the Working Capital to decide about the funds required for running the business opera- 77 Find a detailed description of the leverage effect and the explanation of its formulas in our Management Accounting textbook, chapter (7). <?page no="102"?> Berkau: Financial Statements 8e 5-102 tions. Besides for investments, a company needs funds to start and keep the business going, e.g., inventories, spare parts or goods to sell, and for receivables in case customers are offered convenient payment terms. On the other side (of the balance sheet), if suppliers offer short-term borrowings, e.g., accept payments for goods later or after they have been sold, they reduce the financing. Therefore, we deduct shortterm liabilities for the calculation of the Working Capital. 78 CAPELIFT (Pty) Ltd. discloses a Working Capital that consists of receivables, prepaid expenses, cash/ bank less shortterm liabilities (without the long-term debts’ pay-off portion) and tax liabilities. As per 31.12.20X8, its Working Capital is: 10,000,000 + 2,000,000 + 18,000,000 - (16,500,000 - 2,500,000) - 3,000,000 = 1133"000000"000000 ZZAARR. In general, companies try to minimise their Working Capital. They strive for low inventories and holding as less cash as possible. As mentioned above, in Aviation a lot of payments are due at the time of and before flights. They cause high working capital needs. Interest Coverage: Interest Coverage measures how much the net profit before interest can cover interest expenses. The calculation is: EBIT divided by interest. 78 Running a consignment stock reduces Working Capital but it usually comes with higher purchase prices for the goods. The Interest Coverage at CAPELIFT (Pty) Ltd. is: 12,950,000 / 2,950,000 = 4 4..3399. The value is low and indicates that CAPELIFT (Pty) Ltd. is financed to a high extent. In contrast to the other metrics for gearing, Interest Coverage considers the costs for borrowing. If inverted and multiplied with 365 the Interest Coverage indicates how many days per year it takes to pay interest out of the profit. At CAPELIFT (Pty) Ltd. it takes: 365 / 4.39 = 8 833..1144 ddaayyss. This means, the company works from 1 st of January until 22 nd of March for its banks. 5.16 Market Value Ratios - CAPELIFT (Pty) Ltd. We only can calculate market value ratios for companies publicly listed. Then, the share market price is accessible to the public and can be compared to the valuation derived from the books. The below listed market value ratios apply: - Price/ Earnings Ratio. - Dividend Yield. - Market Book Ratio. No fair market value is available for CAPELIFT (Pty) Ltd. as its shares are not publicly traded. However, for teaching purpose, we pretend that its shares are traded at 15 ZAR/ s at the time of reporting (31.12.20X8). We also pretend that CAPELIFT (Pty) Ltd. declares a dividend of 50 % of earnings for 20X8. <?page no="103"?> Berkau: Financial Statements 8e 5-102 tions. Besides for investments, a company needs funds to start and keep the business going, e.g., inventories, spare parts or goods to sell, and for receivables in case customers are offered convenient payment terms. On the other side (of the balance sheet), if suppliers offer short-term borrowings, e.g., accept payments for goods later or after they have been sold, they reduce the financing. Therefore, we deduct shortterm liabilities for the calculation of the Working Capital. 78 CAPELIFT (Pty) Ltd. discloses a Working Capital that consists of receivables, prepaid expenses, cash/ bank less shortterm liabilities (without the long-term debts’ pay-off portion) and tax liabilities. As per 31.12.20X8, its Working Capital is: 10,000,000 + 2,000,000 + 18,000,000 - (16,500,000 - 2,500,000) - 3,000,000 = 1133"000000"000000 ZZAARR. In general, companies try to minimise their Working Capital. They strive for low inventories and holding as less cash as possible. As mentioned above, in Aviation a lot of payments are due at the time of and before flights. They cause high working capital needs. Interest Coverage: Interest Coverage measures how much the net profit before interest can cover interest expenses. The calculation is: EBIT divided by interest. 78 Running a consignment stock reduces Working Capital but it usually comes with higher purchase prices for the goods. The Interest Coverage at CAPELIFT (Pty) Ltd. is: 12,950,000 / 2,950,000 = 4 4..3399. The value is low and indicates that CAPELIFT (Pty) Ltd. is financed to a high extent. In contrast to the other metrics for gearing, Interest Coverage considers the costs for borrowing. If inverted and multiplied with 365 the Interest Coverage indicates how many days per year it takes to pay interest out of the profit. At CAPELIFT (Pty) Ltd. it takes: 365 / 4.39 = 8833..1144 ddaayyss. This means, the company works from 1 st of January until 22 nd of March for its banks. 5.16 Market Value Ratios - CAPELIFT (Pty) Ltd. We only can calculate market value ratios for companies publicly listed. Then, the share market price is accessible to the public and can be compared to the valuation derived from the books. The below listed market value ratios apply: - Price/ Earnings Ratio. - Dividend Yield. - Market Book Ratio. No fair market value is available for CAPELIFT (Pty) Ltd. as its shares are not publicly traded. However, for teaching purpose, we pretend that its shares are traded at 15 ZAR/ s at the time of reporting (31.12.20X8). We also pretend that CAPELIFT (Pty) Ltd. declares a dividend of 50 % of earnings for 20X8. Berkau: Financial Statements 8e 5-103 Price Earnings Ratio P/ E: The Price Earnings Ratio compares the fair market price of a share to the Earnings per Share. Hence, we calculate the market price paid for a share divided by its annual income. As we divide the market price by the EPS, the Price Earnings Ratio gives the number of periods it takes to break even - given that the company always declares a dividend of 100 %. At CAPELIFT (Pty) Ltd., the Price Earnings Ratio is: 25 / (7,000,000 / 1,000,000) = 33..5577. Hence, an investor must wait 4 years before she/ he breaks even with her/ his shares by dividends income. The Price-Earnings-Ratio is used for company comparisons and tells us about the confidence of the investors in the profitability of the company. Dividend Yield: The dividend yield is the dividend paid divided by the fair market price per share. It is an efficiency based metric that shows the return on investment from the investors’ perspective. We must weaken the above statement to the wording “it is a kind of efficiency ratio” as the payment for the shares only can be assumed to be at the actual share market price. At CAPELIFT (Pty) Ltd. the Dividend Yield is: (7,000,000 / 2) / (25 × 1,000,000) = 1144%%. Market Book Ratio: The Market Book Ratio of a share determines the fair market value as a percentage of its book value. The Market Book Value indicates confidence of potential investors in the company to increase the shareholders’ value as they are prepared to overpay the book value. The book value merely reflects a situation where a company is bought with the intention to be liquidated at fair values. We assume the Market Book Value normally is above 100 % as its benefits should exceed the proceeds from liquidation. At CAPELIFT (Pty) Ltd., the Market Book Value is: 25 / ((7,500,000 + 6,000,000 + 7,000,000) / 1,000,000) = 1 12211..9955%%. 5.17 Summary We introduced the basics of the Financial Statement Analysis for companies that prepare their financial statements in compliance with IFRSs. The Financial Statement Analysis should only be carried out if financial statements can be trusted, best after Auditing. The Financial Statement Analysis contains a horizontal analysis, a vertical analysis and a ratio analysis. Most common financial ratios are linked to performance, liquidity and gearing. For listed companies, market value ratios apply. A financial statement analysis requires profound knowledge about the industry the company operates in. We demonstrated a financial statement analysis for a small service provider in Aviation. The case is fictional and is discussed to prepare you for a real financial statement analysis of an existing airline. A link to a South African aviation business is provided in this chapter. <?page no="104"?> Berkau: Financial Statements 8e 5-104 5.18 Working Definitions Financial Statement Analysis: Evaluation of a company based on its financial statements. Liquidity: Ability of a company to retire its debts on short notice. For paying-off liabilities, assets are sold. Market Value Ratios: Ratios that compare the share price of a company with Accounting data derived from financial statements. A market value ratio tells the investor whether the share price is valuable. Performance: Ability of a company to be productive regarding goods manufacturing or rendering of services. Ratio: In Accounting, a ratio is a figure calculated from values taken from financial statements. 5.19 Question Bank (1) A company discloses a Return on Assets of 20 %. The equity is 100,000 EUR and the liabilities are 120,000 EUR. 1. The gross profit is 44,000 EUR. 2. The net profit is 44,000 EUR. 3. The net profit is 30,800 EUR. 4. The net profit is 20,000 EUR. (2) A company discloses inventories of 40,000 EUR, receivables of 10,000 EUR and a balancing figure of cash/ bank of 20,000 EUR. The short-term liabilities are amounting to 50,000 EUR. Which statement is correct? 1. The cash ratio is 29 %. 2. The current ratio is 60 %. 3. The quick ratio is 60 %. 4. The cash ratio is 40 %. (3) A company shows 40 % liabilities at an interest rate of 4 %/ a and 60 % of equity. Its shareholders expect a return of 10 %. How much are the weighted average cost of capital? 1. 7.0 % . 2. 7.6 % . 3. 4.0 % . 4. 6.4 % . (4) A company with 10,000 ordinary shareholders and 5,000 preference shareholders earns a pre-tax profit of 25,000 EUR. It declares a dividend of 50 % of the distributable amount to its ordinary shareholders. The preference dividend is 5,000 EUR. How much are its Earnings per Share if all shares have the same nominal value? 1. 1.50 EUR . 2. 1.25 EUR . 3. 0.70 EUR . 4. 0.63 EUR . (5) A company earns an operating profit before taxes of 100,000 EUR. The weighted average costs of capital are 5 %/ a. The assets are amounting to 1,000,000 EUR and the short-term liabilities are 400,000 EUR. How much is the Economic Value Added? 1. 70,000 EUR . 2. 49,000 EUR . 3. 40,000 EUR . 4. 50,000 EUR . 5.20 Solutions 1-2, 2-4, 3-2, 4-4, 5-3. <?page no="105"?> Berkau: Financial Statements 8e 5-104 5.18 Working Definitions Financial Statement Analysis: Evaluation of a company based on its financial statements. Liquidity: Ability of a company to retire its debts on short notice. For paying-off liabilities, assets are sold. Market Value Ratios: Ratios that compare the share price of a company with Accounting data derived from financial statements. A market value ratio tells the investor whether the share price is valuable. Performance: Ability of a company to be productive regarding goods manufacturing or rendering of services. Ratio: In Accounting, a ratio is a figure calculated from values taken from financial statements. 5.19 Question Bank (1) A company discloses a Return on Assets of 20 %. The equity is 100,000 EUR and the liabilities are 120,000 EUR. 1. The gross profit is 44,000 EUR. 2. The net profit is 44,000 EUR. 3. The net profit is 30,800 EUR. 4. The net profit is 20,000 EUR. (2) A company discloses inventories of 40,000 EUR, receivables of 10,000 EUR and a balancing figure of cash/ bank of 20,000 EUR. The short-term liabilities are amounting to 50,000 EUR. Which statement is correct? 1. The cash ratio is 29 %. 2. The current ratio is 60 %. 3. The quick ratio is 60 %. 4. The cash ratio is 40 %. (3) A company shows 40 % liabilities at an interest rate of 4 %/ a and 60 % of equity. Its shareholders expect a return of 10 %. How much are the weighted average cost of capital? 1. 7.0 % . 2. 7.6 % . 3. 4.0 % . 4. 6.4 % . (4) A company with 10,000 ordinary shareholders and 5,000 preference shareholders earns a pre-tax profit of 25,000 EUR. It declares a dividend of 50 % of the distributable amount to its ordinary shareholders. The preference dividend is 5,000 EUR. How much are its Earnings per Share if all shares have the same nominal value? 1. 1.50 EUR . 2. 1.25 EUR . 3. 0.70 EUR . 4. 0.63 EUR . (5) A company earns an operating profit before taxes of 100,000 EUR. The weighted average costs of capital are 5 %/ a. The assets are amounting to 1,000,000 EUR and the short-term liabilities are 400,000 EUR. How much is the Economic Value Added? 1. 70,000 EUR . 2. 49,000 EUR . 3. 40,000 EUR . 4. 50,000 EUR . 5.20 Solutions 1-2, 2-4, 3-2, 4-4, 5-3. Berkau: Financial Statements 8e 6-105 6 Formal Financial Statement Requirements 6.1 What is in the Chapter? This chapter discusses formal aspects of financial statements following IAS 1. We show how to present financial statements. We cover the notes, too. We use the case study BATHURST Ltd. in Australia for demonstration. The company is a car rental based on shares. BATHURST Ltd. prepares its financial statements in compliance with IFRSs. For the case study, a complete set of financial statements is prepared for its 2nd Accounting period after the company got established. We also introduce Bookkeeping entries following the effective interest method for the loan disclosure as covered in more detail in chapter (14). For teaching purpose, we consider that BATHURST Ltd. earns a loss in its first year and reports a negative cash flow. Its negative balancing figure of the Cash/ Bank account must be disclosed as short-term liability. To explain the difference of revenues to extraordinary income, we make BATHURST Ltd. buy bonds and earn interest income from the coupons which is obviously not its core business. The chapter starts with qualitative characteristics of IFRSs financial statements. 6.2 Learning Objectives In this chapter, you learn about formal requirements for the presentation of financial statements. After studying this chapter, you are familiarised with 79 Study legal aspects of Accounting in our textbook Basics of Accounting, chapter (4). IAS 1 and can prepare financial statements formally correct. 79 6.3 IFRSs Consistency IAS 1.16 requires that a company preparing financial statements following IFRSs makes an unreserved and explicit statement on its notes about its IFRS compliance. Check Figure 6.8 for our case study BATHURST Ltd. For general purpose financial statements, a company must at least annually prepare a full set of financial statements. General purpose financial statements are those statements a company usually prepares at the end of every year. No special occasions, like mergers or liquidations, trigger the reporting of general purpose financial statements. In accordance with our conventions in chapter (1), general purpose financial statements are prepared at yearends. Special circumstances can require reporting more frequently, e.g., a listing at the New York Stock Exchange requires companies to prepare financial statements quarterly. IAS 1.36 rules the frequency of reporting. It also says how to prepare financial statements in cases the Accounting period is shorter, e.g., if the establishment of the company takes place in the middle of a fiscal year. In compliance with IAS 1.10, a full set of financial statements comprises of a statement of financial position (balance sheet), a statement of profit or loss and other comprehensive income, a statement of changes in equity, a <?page no="106"?> Berkau: Financial Statements 8e 6-106 statement of cash flows and the notes. Notes describe applied Accounting policies and provide explanatory information about certain items on the financial statements. Based on IAS 1.38 and IAS 1.38A, financial statements must disclose comparative information about the preceding year. If a company change Accounting policies or parameters thereof, e.g., it alters depreciation method or its parameters, it must prepare a balance sheet for the balance sheet date two Accounting periods prior to the actual balance sheet day, which results in the company presenting in total three balances sheets, see IAS 1.40A. 6.4 Qualitative Characteristics of Financial Information IFRS Financial statements follow the Accounting principles as listed below: (a) Fair presentation (IAS 1.15). (b) Going concern principle (IAS 1.25). (c) Accrual basis of Accounting (IAS 1.27). (d) Materiality and aggregation (IAS 1.29). (e) Prohibition of offsetting (IAS 1.32). (f) Consistency of presentation (IAS 1.45). These principles are discussed below. Ad (a): Fair Presentation The dominant principle of international Accounting is fair presentation. IAS 1.9 defines that the objective of financial statements is to provide information useful to a wide range of users to support their economic decisions. No user group is prioritised. This is different to the status of creditors in the German HGB, compare chapter (2). Information provided by financial statements is financial position, profitability and cash flows of a company. To serve the needs of all users of financial statements, a company shall not bias information. IAS 1.15 states the fair presentation requires the faithful representation following the conceptual framework’s definitions and recognition criteria for assets, liabilities, income and expenses. F OC12 (conceptual framework for financial reporting) states that information must be complete, neutral and free from errors. Ad (b): Going Concern Based on the going concern principle of Accounting, the user of financial statements can trust the company to continue its operations for the foreseeable future. A company must be able to continue its business if not stated otherwise. If the management of the reporting company does not intend or cannot continue its business or sees significant uncertainties in doing so, it must disclose these circumstances and prepare its financial statements under the disclosure of liquidation values. Ad (c): Accrual Basis of Accounting Accounting theory sees the purpose of financial statements in informing users about the financial performance of the reporting company. This requires income and expenses to be allocated to <?page no="107"?> Berkau: Financial Statements 8e 6-106 statement of cash flows and the notes. Notes describe applied Accounting policies and provide explanatory information about certain items on the financial statements. Based on IAS 1.38 and IAS 1.38A, financial statements must disclose comparative information about the preceding year. If a company change Accounting policies or parameters thereof, e.g., it alters depreciation method or its parameters, it must prepare a balance sheet for the balance sheet date two Accounting periods prior to the actual balance sheet day, which results in the company presenting in total three balances sheets, see IAS 1.40A. 6.4 Qualitative Characteristics of Financial Information IFRS Financial statements follow the Accounting principles as listed below: (a) Fair presentation (IAS 1.15). (b) Going concern principle (IAS 1.25). (c) Accrual basis of Accounting (IAS 1.27). (d) Materiality and aggregation (IAS 1.29). (e) Prohibition of offsetting (IAS 1.32). (f) Consistency of presentation (IAS 1.45). These principles are discussed below. Ad (a): Fair Presentation The dominant principle of international Accounting is fair presentation. IAS 1.9 defines that the objective of financial statements is to provide information useful to a wide range of users to support their economic decisions. No user group is prioritised. This is different to the status of creditors in the German HGB, compare chapter (2). Information provided by financial statements is financial position, profitability and cash flows of a company. To serve the needs of all users of financial statements, a company shall not bias information. IAS 1.15 states the fair presentation requires the faithful representation following the conceptual framework’s definitions and recognition criteria for assets, liabilities, income and expenses. F OC12 (conceptual framework for financial reporting) states that information must be complete, neutral and free from errors. Ad (b): Going Concern Based on the going concern principle of Accounting, the user of financial statements can trust the company to continue its operations for the foreseeable future. A company must be able to continue its business if not stated otherwise. If the management of the reporting company does not intend or cannot continue its business or sees significant uncertainties in doing so, it must disclose these circumstances and prepare its financial statements under the disclosure of liquidation values. Ad (c): Accrual Basis of Accounting Accounting theory sees the purpose of financial statements in informing users about the financial performance of the reporting company. This requires income and expenses to be allocated to Berkau: Financial Statements 8e 6-107 the Accounting periods they belong to. The accrual basis of Accounting is required by F 44 (conceptual framework for financial reporting) and states that, under this principle, allocations are to be made towards the Accounting periods they are for and not as cash or its equivalent is paid or received. Therefore, a cash flow statement naturally cannot follow the accrual basis of Accounting. See IAS 1.27 and F OB17. In contrast to the statement of cash flows, the income statement always applies the accrual principle. This leads among other aspects to the disclosure of prepaid expenses and to the recording of depreciation on assets etc. Ad (d): Materiality and Aggregation Materiality in terms of Accounting refers to importance. IAS 1.29 requires important items to be presented separately unless the items are immaterial for the Accounting objectives. If items are not material the reporting company shall not omit them but can opt for a comprehensive disclosure, meaning the item is reported together with other items. Ad (e): Prohibition of Offsetting IAS 1.32 prohibits offsetting except it is permitted by a special standard. Offsetting refers to the deduction of negative amounts from positive ones and disclosing the remainder only. We do so when we consider depreciation on assets or pay-off amounts for liabilities. However, offsetting payables and receivables is unacceptable under the 80 An exception is in IAS 7.22. above-mentioned standard. 80 One exception is the disclosure of VAT receivables and payables based on inputand output-VAT entries as we apply one VAT account only. Ad (f): Consistency of Presentation IAS 1.45 requires continuing presentation formats, classifications of items and valuations over time. E.g., we cannot change the presentation or classification of items. The standard rules that changes are only accepted if the company needs items to be presented differently to provide better information which is more reliable and more relevant to users of the financial statements and if the revised structure is likely to be continued in the future. Financial statements must follow identification requirements in line with IAS 1.49. The standard determines a statement header and which information is disclosed thereon. Following IAS 1.51, the header must show the name of the reporting company, the date/ period of the statement, its reporting currency and the precision level (rounding). For single-entity financial statements, the name of the reporting company is disclosed together with its legal form, e.g., KIELING Taxi GmbH. The legal form disclosure indicates that the financial statements are no group statements. 6.5 C/ S BATHURST Ltd. Below, we study the car rental business BATHURST Ltd. in Melbourne. The company prepares a full set of financial statements which includes its notes for <?page no="108"?> Berkau: Financial Statements 8e 6-108 a two-year-Accounting period. The reporting period for the financial statements is 20X6; Therefore, we cover the period from 1.01.20X5 until 31.12.20X6. The statements from 20X5 are disclosed for comparison purpose. Data sheet for BATHURST Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((MMeellbboouurrnnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. AAccccoouunnttiinngg ppeerriiooddss: : 2200XX55 / / 2200XX66.. SShhaarree iissssuuee: : 5500"000000 ×× 66 AAUUDD/ / ss.. FFiinnaanncciinngg: : bbaannkk llooaann 115500"000000 AAUUDD; ; iinn-tteerreesstt 22..55 %%/ / aa.. AAsssseettss: : tthhrreeee ccaarrss ppuurrcchhaasseedd aatt 6655"000000 AAUUDD/ / ccaarr; ; aannnnuuaall ddeepprreecciiaattiioonn 1155"000000 AAUUDD/ / ccaarr; ; rreessiidduuaall vvaalluuee ppeerr ccaarr: : 55"000000 AAUUDD/ / ccaarr; ; ooffffiiccee: : 115500"000000 AAUUDD; ; ddeepprreecciiaa-ttiioonn oonn ooffffiiccee: : 1122"550000 AAUUDD/ / aa.. VVoolluummee ((oouuttppuutt)): : 885500 ddaayyss / / 998800 ddaayyss.. NNeett rreennttaall ffeeeess ((pprriiccee)) ppeerr ccaarr: : 115566 AAUUDD/ / dd / / 119955 AAUUDD/ / dd.. OOppeerraattiioonnaall eexxppeennsseess: : 4488"000000 AAUUDD / / 6655"000000 AAUUDD ((nnoott VVAATTaabbllee)).. BBoonnddss hheelldd ffrroomm ((22..0011..2200XX66)): : ffaaccee vvaalluuee: : 220000"000000 AAUUDD; ; ccoouuppoonn rraattee 44 %%/ / aa ((aann-nnuuaall ppaayymmeennttss)) VVAATT rraattee: : 2200 %%.. BATHURST Ltd. is based on 50,000 ordinary shares at 6 AUD/ s each. Its share capital is: 50,000 × 6 = 3 30000"000000 AAUUDD. BATHURST Ltd. is a car rental. The company was established on 1.01.20X4. At the beginning of 20X5 (one year later), BATHURST Ltd. owns three cars Mercedes-Benz C-class. Every car is one year old at that time. Depreciation is calculated following straight-line method over 4 years, the residual value at the end of the useful life is 5,000 AUD/ car. Costs of acquisition are 65,000 AUD/ car. From the cars’ acquisition, BATHURST Ltd. discloses an input VAT claim of: 3 × 20% × 65,000 = 3 399"000000 AAUUDD which is due in 20X5. The VAT receivables are disclosed on the balance sheet in Figure 6.1. BATHURST Ltd. runs its rental business from an office acquired at 150,000 AUD. No VAT applies for the acquisition. We further ignore acquisition tax. As per 1.01.20X5, the company has depreciated its office to the extent of: 150,000 / 12 = 1 122"550000 AAUUDD. To finance the office, BATHURST Ltd. took out a bank loan on 1.01.20X4 with a principal of 150,000 AUD. The annual rate of interest is 2.5 %/ a. Each year, BATHURST Ltd. repays a constant amount of 15,000 AUD/ a. On 1.01.20X5, the liabilities are: 150,000 - 15,000 = 1 13355"000000 AAUUDD. On the balance sheet, the bank loan is disclosed with 120,000 AUD interest bearing liabilities and 15,000 AUD short-term liabilities, the latter one is for the pay-off in the next year. IAS 1.60 applies. Figure 6.1 displays BATHURST Ltd.’s pro-forma balance sheet as per 1.01.20X5. BATHURST Ltd.'s operations commence on 1.01.20X5. In 20X4, the company only made acquisitions and discloses a loss of 61,250 AUD caused by depreciation on the office to the extent of 12,500 AUD, depreciation on the three cars 45,000 AUD and by interest for the bank loan. The latter one is: 2.5% × 150,000 = 3 3"775500 AAUUDD. Therefore, the loss is: 12,500 + 45,000 + 3,750 = 6 611"225500 AAUUDD and gets is carried forward to 20X5. Hence, it is the value of retained earnings shown on the balance sheet. Losses that are not compensated by dissolving reserves are disclosed as negative retained earnings. Detailed information about the calculation of the opening values on the balance sheet and the application of the effective interest method for the bank loan <?page no="109"?> Berkau: Financial Statements 8e 6-108 a two-year-Accounting period. The reporting period for the financial statements is 20X6; Therefore, we cover the period from 1.01.20X5 until 31.12.20X6. The statements from 20X5 are disclosed for comparison purpose. Data sheet for BATHURST Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((MMeellbboouurrnnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. AAccccoouunnttiinngg ppeerriiooddss: : 2200XX55 / / 2200XX66.. SShhaarree iissssuuee: : 5500"000000 ×× 66 AAUUDD/ / ss.. FFiinnaanncciinngg: : bbaannkk llooaann 115500"000000 AAUUDD; ; iinn-tteerreesstt 22..55 %%/ / aa.. AAsssseettss: : tthhrreeee ccaarrss ppuurrcchhaasseedd aatt 6655"000000 AAUUDD/ / ccaarr; ; aannnnuuaall ddeepprreecciiaattiioonn 1155"000000 AAUUDD/ / ccaarr; ; rreessiidduuaall vvaalluuee ppeerr ccaarr: : 55"000000 AAUUDD/ / ccaarr; ; ooffffiiccee: : 115500"000000 AAUUDD; ; ddeepprreecciiaa-ttiioonn oonn ooffffiiccee: : 1122"550000 AAUUDD/ / aa.. VVoolluummee ((oouuttppuutt)): : 885500 ddaayyss / / 998800 ddaayyss.. NNeett rreennttaall ffeeeess ((pprriiccee)) ppeerr ccaarr: : 115566 AAUUDD/ / dd / / 119955 AAUUDD/ / dd.. OOppeerraattiioonnaall eexxppeennsseess: : 4488"000000 AAUUDD / / 6655"000000 AAUUDD ((nnoott VVAATTaabbllee)).. BBoonnddss hheelldd ffrroomm ((22..0011..2200XX66)): : ffaaccee vvaalluuee: : 220000"000000 AAUUDD; ; ccoouuppoonn rraattee 44 %%/ / aa ((aann-nnuuaall ppaayymmeennttss)) VVAATT rraattee: : 2200 %%.. BATHURST Ltd. is based on 50,000 ordinary shares at 6 AUD/ s each. Its share capital is: 50,000 × 6 = 3 30000"000000 AAUUDD. BATHURST Ltd. is a car rental. The company was established on 1.01.20X4. At the beginning of 20X5 (one year later), BATHURST Ltd. owns three cars Mercedes-Benz C-class. Every car is one year old at that time. Depreciation is calculated following straight-line method over 4 years, the residual value at the end of the useful life is 5,000 AUD/ car. Costs of acquisition are 65,000 AUD/ car. From the cars’ acquisition, BATHURST Ltd. discloses an input VAT claim of: 3 × 20% × 65,000 = 3 399"000000 AAUUDD which is due in 20X5. The VAT receivables are disclosed on the balance sheet in Figure 6.1. BATHURST Ltd. runs its rental business from an office acquired at 150,000 AUD. No VAT applies for the acquisition. We further ignore acquisition tax. As per 1.01.20X5, the company has depreciated its office to the extent of: 150,000 / 12 = 1 122"550000 AAUUDD. To finance the office, BATHURST Ltd. took out a bank loan on 1.01.20X4 with a principal of 150,000 AUD. The annual rate of interest is 2.5 %/ a. Each year, BATHURST Ltd. repays a constant amount of 15,000 AUD/ a. On 1.01.20X5, the liabilities are: 150,000 - 15,000 = 1 13355"000000 AAUUDD. On the balance sheet, the bank loan is disclosed with 120,000 AUD interest bearing liabilities and 15,000 AUD short-term liabilities, the latter one is for the pay-off in the next year. IAS 1.60 applies. Figure 6.1 displays BATHURST Ltd.’s pro-forma balance sheet as per 1.01.20X5. BATHURST Ltd.'s operations commence on 1.01.20X5. In 20X4, the company only made acquisitions and discloses a loss of 61,250 AUD caused by depreciation on the office to the extent of 12,500 AUD, depreciation on the three cars 45,000 AUD and by interest for the bank loan. The latter one is: 2.5% × 150,000 = 3 3"775500 AAUUDD. Therefore, the loss is: 12,500 + 45,000 + 3,750 = 6 611"225500 AAUUDD and gets is carried forward to 20X5. Hence, it is the value of retained earnings shown on the balance sheet. Losses that are not compensated by dissolving reserves are disclosed as negative retained earnings. Detailed information about the calculation of the opening values on the balance sheet and the application of the effective interest method for the bank loan Berkau: Financial Statements 8e 6-109 disclosure can be downloaded through Link 6.A. At BATHURST Ltd., the effective rate of interest is 2.5 %/ a. The nominal rate of interest equals the effective rate as the loan is redeemed at its principal and annual interest payments apply. A simple method to determine the effective rate of interest is to calculate the internal rate of return for the loan vector. We use the MS-Excel function IRR() for the calculation. The payment vector for the loan is BL(t) = {150,000; (18,750); (18,375); (18,000); (17,625); (17,250); (16,875); (16,500); (16,125); (15,750); (15,375)}. It's internal rate of return gives: IRR(BL(t)) = 2 2..55%%/ / aa. Link 6.A: BATHURST Ltd. A C, L Non-current assets [AUD] Equity [AUD] P, P, E 287,500 Share capital 300,000 Intangibles Reserves Financial assets Retained earnings (61,250) Current assets Liabilities (liab.) Inventory Long-term liab. 120,000 Accounts receivables 39,000 Short-term liab. A/ P 15,000 Prepaid expenses Provisions Cash/ Bank 47,250 Income tax liab. Total assets 373,750 Total equity and liab. 373,750 Bathurst Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X5 Figure 6.1: BATHURST Ltd.’s balance sheet (20X4) Next, we discuss activities in 20X5: BATHURST Ltd. receives a VAT refund from the Australian revenue service of 39,000 AUD. This is recorded as Bookkeeping entry (1). BATHURST Ltd. rents out its cars at a rate of 156 AUD/ d (net value). During the Accounting period 20X5, its output measured as the number of car-daysrent-outs is 850. BATHURST Ltd.’s revenue is: 850 × 156 = 1 13322"660000 AAUUDD. The proceeds are paid in full and recorded as Bookkeeping entry (2). Proceeds is the gross value for the revenues and therefore represents receipts to be cashed in or claimed in the future. Operational expenses in 20X5 are 48,000 AUD and recorded as Bookkeeping entry (3). The costs for operations are non-VATable. Whether operational expenses are VATable depends on their nature. In general, services provided by third parties are VATable. If the operations are based on internal services, no VAT applies. BATHURST Ltd. pays for all operational expenses on cash and in full. <?page no="110"?> Berkau: Financial Statements 8e 6-110 The interest calculation for the bank loan is based on the value of the liabilities as per 1.01.20X5 because BATHURST Ltd. pays for interest and pay-off at the yearends. On 1.01.2025, the company owes: 120,000 + 15,000 = 113355"000000 AAUUDD. In accordance with IFRS 9 the effective interest method applies for interest calculations. Interest is: 2.5% × 135,000 = 3 3"337755 AAUUDD. We make a debit entry in the Interest account and credit cash/ bank. This gives Bookkeeping entry (4). The following paragraphs discuss the calculations and Bookkeeping entries for the effective interest method. The effective rate of interest is calculated for the comparison of loans and factors in all additional payments like fees and premiums as well as compound interest calculations for payments made during the year, e.g., monthly payments. The effective interest rate exceeds the nominal rate of interest. 81 In compliance with IFRSs, BATHURST Ltd. recognises the bank loan as liability and applies the effective interest method. This does not affect the need to separate short-term from long-term liabilities based on IAS 1.60. For BATHURST Ltd.’s loan the effective interest rate is 2.5 %/ a, which is equal to the nominal rate. In cases when effective interest differs from the nominal interest rate, interest recognised through profit and loss deviates from payment made for interest. Therefore, two separate Bookkeeping entries are required. At BATHURST Ltd. and for 20X5, the interest expense is: 135,000 × 2.5% = 3 3"337755 AAUUDD. The interest payment to the bank in 20X5 also is: (150,000 - 15,000) × 2.5% = 3 3"337755 AAUUDD (the same). For applying the effective interest method, we make two Bookkeeping entries for interest, the first one is for the interest expense and linked to the income statement and the second one refers to the payment and therefore is cash flow relevant. If both interest rates are the same, we can cut short recordings and only debit the Interest account and make a credit entry in cash/ bank. @ 31.12.20X5 Interest-20X5 INT 3,375 Interest Bearing Liabilities IBL 3,375 (interest recognition) Interst Bearing Liabilities IBL 3,375 Cash/ Bank C/ B 3,375 (recording interest payment) Next, we record adjustments. At BATHURST Ltd., they comprise of the repay of the bank loan and depreciation on the office and the three cars. 81 We discuss the effective interest method here as the bank loan must be carried at amortised costs. In chapter (14), we get back to the case The loan’s pay-off in the next following year again is 15,000 AUD/ a and must be classified as short-term liability. The payments then reduce short-term liabilities as we debit short-term liabilities study BATHURST Ltd. and calculate interest for alterations of the case. <?page no="111"?> Berkau: Financial Statements 8e 6-110 The interest calculation for the bank loan is based on the value of the liabilities as per 1.01.20X5 because BATHURST Ltd. pays for interest and pay-off at the yearends. On 1.01.2025, the company owes: 120,000 + 15,000 = 113355"000000 AAUUDD. In accordance with IFRS 9 the effective interest method applies for interest calculations. Interest is: 2.5% × 135,000 = 3 3"337755 AAUUDD. We make a debit entry in the Interest account and credit cash/ bank. This gives Bookkeeping entry (4). The following paragraphs discuss the calculations and Bookkeeping entries for the effective interest method. The effective rate of interest is calculated for the comparison of loans and factors in all additional payments like fees and premiums as well as compound interest calculations for payments made during the year, e.g., monthly payments. The effective interest rate exceeds the nominal rate of interest. 81 In compliance with IFRSs, BATHURST Ltd. recognises the bank loan as liability and applies the effective interest method. This does not affect the need to separate short-term from long-term liabilities based on IAS 1.60. For BATHURST Ltd.’s loan the effective interest rate is 2.5 %/ a, which is equal to the nominal rate. In cases when effective interest differs from the nominal interest rate, interest recognised through profit and loss deviates from payment made for interest. Therefore, two separate Bookkeeping entries are required. At BATHURST Ltd. and for 20X5, the interest expense is: 135,000 × 2.5% = 3 3"337755 AAUUDD. The interest payment to the bank in 20X5 also is: (150,000 - 15,000) × 2.5% = 3 3"337755 AAUUDD (the same). For applying the effective interest method, we make two Bookkeeping entries for interest, the first one is for the interest expense and linked to the income statement and the second one refers to the payment and therefore is cash flow relevant. If both interest rates are the same, we can cut short recordings and only debit the Interest account and make a credit entry in cash/ bank. @ 31.12.20X5 Interest-20X5 INT 3,375 Interest Bearing Liabilities IBL 3,375 (interest recognition) Interst Bearing Liabilities IBL 3,375 Cash/ Bank C/ B 3,375 (recording interest payment) Next, we record adjustments. At BATHURST Ltd., they comprise of the repay of the bank loan and depreciation on the office and the three cars. 81 We discuss the effective interest method here as the bank loan must be carried at amortised costs. In chapter (14), we get back to the case The loan’s pay-off in the next following year again is 15,000 AUD/ a and must be classified as short-term liability. The payments then reduce short-term liabilities as we debit short-term liabilities study BATHURST Ltd. and calculate interest for alterations of the case. Berkau: Financial Statements 8e 6-111 and credit cash/ bank. Observe the payoff Bookkeeping entry in 20X5 which is indicated by the three-letter-code linked to the contra accounts (C/ B and A/ P). After the payment, the loan’s pay-off for 20X6 is allocated to the Short-term Liabilities account by a Bookkeeping entry marked as (A/ P and IBL). As the pay-off payments at BATHURST Ltd. are constant a combination of the latter Bookkeeping entries is possible, however, for an annuity they would differ as the interest portion diminishes over the time and therefore, must be recorded separately. In business and management annuities are frequently in use as their calculation is easy due to the application of annuity factors and a liquidity planning becomes convenient once the same payments are made every year. Next, we discuss depreciation. In 20X5 and in 20X6, depreciation on the cars is 15,000 AUD/ (a × car). The cars’ total annual depreciation charge is: 3 × 15,000 = 4455"000000 AAUUDD/ / aa. Depreciation in 20X5 is recorded as Bookkeeping entries marked as (ACC and DPR). Depreciation on the office is 12,500 AUD/ a and is recorded as a further Bookkeeping entry in 20X5 which is marked again as (ACC and DPR). Note, that with an Asset Management in use a company will apply an Accumulated Depreciation on Car account and an Accumulated Depreciation on Office account. Hence, the ACC code applies for different accounts. Next, we calculate BATHURST Ltd.’s profit. The pre-tax profit marked as EBT for earnings before income taxation in 20X5 is: 132,600 - 45,000 - 12,500 - 3,375 - 48,000 = 2 233"772255 AAUUDD. After tax reduction a profit of: (1 - 30%) × 23,725 = 1 166"660077..5500 AAUUDD remains and is disclosed under annual surplus. Observe all accounts in Figure 6.2. D C D C OV 345,000 c/ d 345,000 OV 57,500 b/ d 345,000 DPR 45,000 c/ d 115,000 DPR 12,500 115,000 115,000 b/ d 115,000 Property, plant and equipment PPE Acc depr ACC D C D C A/ P 15,000 OV 120,000 C/ B 15,000 OV 15,000 c/ d 105,000 c/ d 15,000 IBL 15,000 120,000 120,000 30,000 30,000 b/ d 105,000 b/ d 15,000 Interest bearing liabilities IBL Short-term liabilities A/ P Figure 6.2: BATHURST Ltd.’s accounts (20X5) <?page no="112"?> Berkau: Financial Statements 8e 6-112 D C D C ACC 45,000 P5L 57,500 (4) 3,375 P5L 3,375 ACC 12,500 57,500 57,500 Depreciation-20X5 DPR Interest-20X5 INT D C D C P5L 132,600 (2) 132,600 OV 39,000 (1) 39,000 c/ d 26,520 (2) 26,520 65,520 65,520 b/ d 26,520 Revenue-20X5 REV Value added tax VAT D C D C OV 47,250 (3) 48,000 (3) 48,000 P5L 48,000 (1) 39,000 (4) 3,375 (2) 159,120 A/ P 15,000 c/ d 178,995 245,370 245,370 b/ d 178,995 Cash/ Bank C/ B Operational expenses-20X5 OEX D C D C DPR 57,500 REV 132,600 c/ d 7,118 ITL 7,118 INT 3,375 b/ d 7,118 OEX 48,000 EBT 23,725 132,600 132,600 ITL 7,118 b/ d 23,725 R/ E 16,608 23,725 23,725 Profit and Loss-20X5 P5L Income tax liabilities ITL D C D C OV 61,250 P5L 16,608 c/ d 300,000 OV 300,000 c/ d 44,643 b/ d 300,000 61,250 61,250 b/ d 44,643 Retained earnings R/ E Share capital ISS Figure 6.2: BATHURST Ltd.’s accounts (20X5) - continued Below, the recordings for 20X6 are discussed. BATHURST Ltd. pays income tax liabilities as recorded as Bookkeeping entry (A) and VAT liabilities as (B). <?page no="113"?> Berkau: Financial Statements 8e 6-112 D C D C ACC 45,000 P5L 57,500 (4) 3,375 P5L 3,375 ACC 12,500 57,500 57,500 Depreciation-20X5 DPR Interest-20X5 INT D C D C P5L 132,600 (2) 132,600 OV 39,000 (1) 39,000 c/ d 26,520 (2) 26,520 65,520 65,520 b/ d 26,520 Revenue-20X5 REV Value added tax VAT D C D C OV 47,250 (3) 48,000 (3) 48,000 P5L 48,000 (1) 39,000 (4) 3,375 (2) 159,120 A/ P 15,000 c/ d 178,995 245,370 245,370 b/ d 178,995 Cash/ Bank C/ B Operational expenses-20X5 OEX D C D C DPR 57,500 REV 132,600 c/ d 7,118 ITL 7,118 INT 3,375 b/ d 7,118 OEX 48,000 EBT 23,725 132,600 132,600 ITL 7,118 b/ d 23,725 R/ E 16,608 23,725 23,725 Profit and Loss-20X5 P5L Income tax liabilities ITL D C D C OV 61,250 P5L 16,608 c/ d 300,000 OV 300,000 c/ d 44,643 b/ d 300,000 61,250 61,250 b/ d 44,643 Retained earnings R/ E Share capital ISS Figure 6.2: BATHURST Ltd.’s accounts (20X5) - continued Below, the recordings for 20X6 are discussed. BATHURST Ltd. pays income tax liabilities as recorded as Bookkeeping entry (A) and VAT liabilities as (B). Berkau: Financial Statements 8e 6-113 The revenue from renting out cars for 980 days is recognised as: 980 × 195 = 119911"110000 AAUUDD. In 20X6, the price per daily rent increased to 195 AUD/ d. Only 55 % of the proceeds are received on cash - the remainder is expected to be collected in the next year. Observe Bookkeeping entry (C) which debits a portion of proceeds to receivables. Operational expenses in 20X6 increase too and now are amounting to 65,000 AUD/ a. They are recorded as Bookkeeping entry (D). BATHURST Ltd. pays all operational expenses instantly and on cash. To make cash reserves earn interest BATHURST Ltd. buys bonds for 200,000 AUD 82 with an annual coupon rate of 4 %/ a on 2.01.20X6 - recorded as Bookkeeping entry (E). BATHURST Ltd. is the bondholder. No transaction costs apply based on the conventions of this textbook. The bonds earn an interest income of: 200,000 × 4% = 8 8"000000 AAUUDD. We record the gain on the credit side of the Interest Income account (CPN for Coupon) as Bookkeeping entry (F). The bonds have been introduced to the case study for the demonstration of the difference between revenues and other income. The interest income generated by the bonds counts as other income as it is not linked to the core business of the company. As BATHURST Ltd.'s investment in the bonds causes an overdraft of its bank account, it must disclose the balancing figure of its Cash/ Bank account as short-term liability on the balance sheet to the extent of 3,516.50 AUD. 83 The interest expenses for the loan in 20X6 as paid to the bank are: (105,000 + 15,000) × 2.5% = 3 3"000000 AAUUDD. Interest is recorded as Bookkeeping entry (G). Next, we discuss the adjustments as recorded on 31.12.20X6. At BATHURST Ltd., the adjustments consider the pay-off of the bank loan and depreciation. The loan repayment is deducted from short-term liabilities to the extent of 15,000 AUD, see the Bookkeeping entry marked as (C/ B and A/ P). Again, the payoff for 20X7 is transferred from the Interest Bearing Liabilities account to short-term liabilities, see the Bookkeeping entry marked as (A/ P and IBL). Depreciation on cars remains 45,000 AUD/ a and depreciation on the office is 12,500 AUD/ a. Observe the profit calculation at BATHURST Ltd. in the Profit and Loss account shown in Figure 6.3. Based on the profit calculation, BATHURST Ltd.’s owners declare a dividend of 0.10 AUD/ share. Therefore, the financial statements are prepared under the appropriation of profits and disclose a dividend payable to shareholders of: 50,000 × 0.10 = 5 5"000000 AAUUDD as a shortterm liability. We show BATHURST Ltd.’s accounts as at 31.12.20X6 in Figure 6.3. 82 Learn about bonds in the case study KILDARE Ltd. and regarding the bond holder Bill Elmwood in our textbook Basics of Accounting, chapter (15). 83 Study our textbook Basics of Accounting, chapter (37). <?page no="114"?> Berkau: Financial Statements 8e 6-114 D C D C OV 345,000 c/ d 345,000 OV 57,500 b/ d 345,000 DPR 45,000 c/ d 115,000 DPR 12,500 115,000 115,000 b/ d 115,000 (D) 45,000 c/ d 172,500 (E) 12,500 172,500 172,500 b/ d 172,500 D C D C A/ P 15,000 OV 120,000 C/ B 15,000 OV 15,000 c/ d 105,000 c/ d 15,000 IBL 15,000 120,000 120,000 30,000 30,000 A/ P 15,000 b/ d 105,000 C/ B 15,000 b/ d 15,000 c/ d 90,000 c/ d 15,000 IBL 15,000 105,000 105,000 30,000 30,000 b/ d 90,000 b/ d 15,000 Interest bearing liabilities IBL Short-term liabilities A/ P Property, plant, equipment PPE Acc depr ACC D C D C ACC 45,000 P6L 57,500 (G) 3,000 P6L 3,000 ACC 12,500 57,500 57,500 Depreciation-20X6 DPR Interest-20X6 INT D C D C P6L 191,100 (C) 191,100 OV 39,000 (1) 39,000 c/ d 26,520 (2) 26,520 65,520 65,520 (B) 26,520 b/ d 26,520 c/ d 38,220 (C) 38,220 64,740 64,740 b/ d 38,220 Revenue-20X6 REV Value added tax VAT Figure 6.3: BATHURST Ltd.’s accounts (20X6) <?page no="115"?> Berkau: Financial Statements 8e 6-114 D C D C OV 345,000 c/ d 345,000 OV 57,500 b/ d 345,000 DPR 45,000 c/ d 115,000 DPR 12,500 115,000 115,000 b/ d 115,000 (D) 45,000 c/ d 172,500 (E) 12,500 172,500 172,500 b/ d 172,500 D C D C A/ P 15,000 OV 120,000 C/ B 15,000 OV 15,000 c/ d 105,000 c/ d 15,000 IBL 15,000 120,000 120,000 30,000 30,000 A/ P 15,000 b/ d 105,000 C/ B 15,000 b/ d 15,000 c/ d 90,000 c/ d 15,000 IBL 15,000 105,000 105,000 30,000 30,000 b/ d 90,000 b/ d 15,000 Interest bearing liabilities IBL Short-term liabilities A/ P Property, plant, equipment PPE Acc depr ACC D C D C ACC 45,000 P6L 57,500 (G) 3,000 P6L 3,000 ACC 12,500 57,500 57,500 Depreciation-20X6 DPR Interest-20X6 INT D C D C P6L 191,100 (C) 191,100 OV 39,000 (1) 39,000 c/ d 26,520 (2) 26,520 65,520 65,520 (B) 26,520 b/ d 26,520 c/ d 38,220 (C) 38,220 64,740 64,740 b/ d 38,220 Revenue-20X6 REV Value added tax VAT Figure 6.3: BATHURST Ltd.’s accounts (20X6) Berkau: Financial Statements 8e 6-115 D C D C OV 47,250 (3) 48,000 (D) 65,000 P6L 65,000 (1) 39,000 (4) 3,375 (2) 159,120 A/ P 15,000 c/ d 178,995 245,370 245,370 b/ d 178,995 (A) 7,118 (C) 126,126 (B) 26,520 (F) 8,000 (D) 65,000 (E) 200,000 (G) 3,000 ´c/ d 3,517 A/ P 15,000 316,638 316,638 b/ d 3,517 Cash/ Bank C/ B Operational expenses-20X6 OEX D C D C DPR 57,500 REV 191,100 c/ d 7,118 P5L 7,118 INT 3,000 CPN 8,000 (A) 7,118 b/ d 7,118 OEX 65,000 c/ d 22,080 P6L 22,080 EBT 73,600 29,198 29,198 199,100 199,100 b/ d 22,080 ITL 22,080 b/ d 73,600 R/ E 51,520 73,600 73,600 Profit and loss-20X6 P6L Income tax liabilities ITL D C D C OV 61,250 P5L 16,608 c/ d 5,000 R/ E 5,000 c/ d 44,643 b/ d 5,000 61,250 61,250 b/ d 44,643 P6L 51,520 DIV 5,000 c/ d 1,878 51,520 51,520 b/ d 1,878 Retained earnings R/ E Dividends/ p DIV Figure 6.3: BATHURST Ltd.’s accounts (20X6) continued <?page no="116"?> Berkau: Financial Statements 8e 6-116 D C D C (E) 200,000 c/ d 200,000 P6L 8,000 (F) 8,000 b/ d 200,000 D C D C (C) 103,194 c/ d 103,194 c/ d 300,000 OV 300,000 b/ d 103,194 b/ d 300,000 Financial instruments FIN Interest income-20X6 CPN Accounts receivables A/ R Share capital ISS Figure 6.3: BATHURST Ltd.’s accounts (20X6) continued Next, we prepare the annual financial statements for the reporting period 20X6. IAS 1.38 dictates to set-up financial statements that show a column for comparative figures (last period). 84 For BATHURST Ltd., all financial statements are discussed in detail: (1) Statement of financial position. (2) Statement of profit of loss and other comprehensive income. (3) Statement of changes in equity. (4) Statement of cash flows. (5) Notes. 6.6 Statement of Financial Position - BATHURST Ltd. The statement of financial position is the balance sheet. In F 4.4, the IASB defines the elements of financial position as assets, liabilities and equity. 84 BATHURST Ltd. reports annual financial statements at yearends. Annual reporting is a requirement resulting from IAS 1.36. Annual financial statements are general-purpose financial statements based on IAS 1.7. BATHURST Ltd.’s 20X6’s financial statements must disclose comparative information for 20X5 in line with the Framework F QC20 and IAS 1.38. 85 Read in the Conceptual Framework for Financial Reporting: F 4.8 - 4.14. 86 This is the reason, why we translate asset with Vermögenswert instead of Vermögensgegenstand. Definitions for the elements are given as: - An asset is a resource controlled by the company as result of past events. From assets future economic benefits are expected to flow to the company. 85 An asset differs from the German term Vermögensgegenstand on a German balance sheet 86 . - A liability is a present obligation of the company arising from past events the settlement of which is expected to result in an outflow of resources embodying economic benefits. 87 - Equity is the residual interest in assets after deduction of all liabilities. 88,89 87 Read in the Conceptual Framework for Financial Reporting: F 15 - F 19. 88 Read in the Conceptual Framework for Financial Reporting: F 20 - F 23. 89 The equity definition refers to the difference of assets and liabilities. We can easily verify the evaluation of equity when we think about a liquidation 89 . A company that liquidates all assets at fair values and retires its debts at fair values and without transaction costs, determines its equity as residual company value. This is called book value of the business as we derive it from the Bookkeeping records (books). <?page no="117"?> Berkau: Financial Statements 8e 6-116 D C D C (E) 200,000 c/ d 200,000 P6L 8,000 (F) 8,000 b/ d 200,000 D C D C (C) 103,194 c/ d 103,194 c/ d 300,000 OV 300,000 b/ d 103,194 b/ d 300,000 Financial instruments FIN Interest income-20X6 CPN Accounts receivables A/ R Share capital ISS Figure 6.3: BATHURST Ltd.’s accounts (20X6) continued Next, we prepare the annual financial statements for the reporting period 20X6. IAS 1.38 dictates to set-up financial statements that show a column for comparative figures (last period). 84 For BATHURST Ltd., all financial statements are discussed in detail: (1) Statement of financial position. (2) Statement of profit of loss and other comprehensive income. (3) Statement of changes in equity. (4) Statement of cash flows. (5) Notes. 6.6 Statement of Financial Position - BATHURST Ltd. The statement of financial position is the balance sheet. In F 4.4, the IASB defines the elements of financial position as assets, liabilities and equity. 84 BATHURST Ltd. reports annual financial statements at yearends. Annual reporting is a requirement resulting from IAS 1.36. Annual financial statements are general-purpose financial statements based on IAS 1.7. BATHURST Ltd.’s 20X6’s financial statements must disclose comparative information for 20X5 in line with the Framework F QC20 and IAS 1.38. 85 Read in the Conceptual Framework for Financial Reporting: F 4.8 - 4.14. 86 This is the reason, why we translate asset with Vermögenswert instead of Vermögensgegenstand. Definitions for the elements are given as: - An asset is a resource controlled by the company as result of past events. From assets future economic benefits are expected to flow to the company. 85 An asset differs from the German term Vermögensgegenstand on a German balance sheet 86 . - A liability is a present obligation of the company arising from past events the settlement of which is expected to result in an outflow of resources embodying economic benefits. 87 - Equity is the residual interest in assets after deduction of all liabilities. 88,89 87 Read in the Conceptual Framework for Financial Reporting: F 15 - F 19. 88 Read in the Conceptual Framework for Financial Reporting: F 20 - F 23. 89 The equity definition refers to the difference of assets and liabilities. We can easily verify the evaluation of equity when we think about a liquidation 89 . A company that liquidates all assets at fair values and retires its debts at fair values and without transaction costs, determines its equity as residual company value. This is called book value of the business as we derive it from the Bookkeeping records (books). Berkau: Financial Statements 8e 6-117 At BATHURST Ltd., the book value of the company is 301,877.50 AUD as per 31.12.20X6. This gives a share’s book value of: 301,877.50 / 50,000 = 6 6..0044 AAUUDD/ / ss. The book value only exceeds the face value of the shares at 0.08 AUD/ s; this is caused by not earning revenues in 20X4 (to keep the case study simple). Hence, BATHURST Ltd. carried a loss from the first year forward to 20X5. BATHURST Ltd. prepares the balance sheet as shown in Figure 6.4 for 20X6. A 20X6 20X5 20X6 20X5 C, L Non-current assets [AUD] [AUD] Equity [AUD] [AUD] P, P, E 172,500 230,000 Share capital 300,000 300,000 Intangibles Reserves Financial assets 200,000 Retained earnings 1,878 (44,643) Current assets Liabilities (liab.) Inventory Long-term liab. 90,000 105,000 Accounts receivables 103,194 Short-term liab. A/ P 61,737 41,520 Prepaid expenses Provisions Cash/ Bank 0 178,995 Income tax liab. 22,080 7,118 Total assets 475,694 408,995 Total equity and liab. 475,694 408,995 Bathurst Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X6 Figure 6.4: BATHURST Ltd.’s balance sheet (20X6) In line with IAS 1.51, BATHURST Ltd.’s must clearly identify its financial statements. The disclosure of the name (BATHURST Ltd.) indicates whether the balance sheet is a single-entity financial statement, a separate financial statement (IAS 27) or a group statement. The legal form (here: Ltd.) refers to a company, so the financial statement is for a single entity. The header also reveals the balance sheet-date (31.12.20X6), indicates the reporting currency (AUD for Australian Dollars) and marks the rounding level, here to the next full Australian Dollar. The requirements for the statement of financial position are laid out in IAS 1.54. BATHURST Ltd.’s financial statements disclose all required items of assets, liabilities and equity. IAS 1.60 requires reporting companies to disclose current and non-currents assets and liabilities separately. BATHURST Ltd. shows long-term assets under non-current assets. This applies for cars and property. Current assets are the items cash/ bank and receivables. No single values for items show on the balance sheet but are disclosed in the notes as a register of non-current assets (see below). Regarding liabilities, the separation is more difficult as the bank loan contains a short-term portion (the payoff for the next year) as well as a longterm portion. IAS 1.69 covers the distinction of liabilities. In contrast to shortterm liabilities, long-term debts must be disclosed at amortised costs following the effective interest method for recognition as required by IFRS 9.5.3.1 and <?page no="118"?> Berkau: Financial Statements 8e 6-118 IFRS 9.4.2.1. Bank loans are kept until settlement which supports a valuation at amortised costs. At amortised costs means the liability is compounded by the effective rate of interest and all payments made must be deducted. As per 31.12.20X6, BATHURST Ltd. discloses long-term liabilities resulting from the bank loan of 90,000 AUD and shortterm liabilities of 15,000 AUD; the latter ones are due on 31.12.20X7. Here, short-term liabilities are recorded as accounts payables (A/ P) and include the short-term bank loan’s pay-off payment, VAT liabilities and dividend claims. Also, the bank account overdraft counts as a short-term liability as BATHURST Ltd. does not finance its bonds by a loan. The income tax liabilities require extra disclosure following IAS 1.54 in combination with IAS 12. That item only shows liabilities from income taxes. No VAT liabilities are reported under this item. For VAT payables, we apply the item shortterm liabilities A/ P (see above). BATHURST Ltd.’s equity is determined by deduction of all liabilities from the total of assets and gives: 372,500 + 103,194 - 90,000 - 61,736.50 - 22,080 = 330011"888877..5500 AAUUDD. It includes ordinary shares and retained earnings. 6.7 Statement of Profit or Loss - BATHURST Ltd. The statement of profit or loss and other comprehensive income provides information about profit or loss and extraordinary items for gains and losses. 90 In general, extraordinary is what is not linked to the business model of the company. 91 BATHURST Ltd. discloses the statement of profit or loss and other comprehensive income as in Figure 6.5. 90 IAS 1.81A - IAS 1.105 specify the disclosure of profit or loss and other comprehensive income. 91 The F 4.24 specifies that the financial performance depends directly on income and expenses. In line with F 5.25, income is defined as increase in economic benefits during the Accounting period, e.g., as inflow and enhancement of assets or decrease of liabilities, other than equity changes linked to owners. Expenses are decreases of economic benefits, e.g., cash outflows or depletion of assets, resulting in a decrease of equity. (A payment of dividends is no expense.) Income can be revenue and gains - based on F 4.29, revenue is the funds received in exchange for business activities. F 4.31 does not define gains but gives examples. Along those, gains are extraordinary income, e.g., sales of non-current assets. Gains shall be disclosed separately from revenues and usually are reported net of expenses. <?page no="119"?> Berkau: Financial Statements 8e 6-118 IFRS 9.4.2.1. Bank loans are kept until settlement which supports a valuation at amortised costs. At amortised costs means the liability is compounded by the effective rate of interest and all payments made must be deducted. As per 31.12.20X6, BATHURST Ltd. discloses long-term liabilities resulting from the bank loan of 90,000 AUD and shortterm liabilities of 15,000 AUD; the latter ones are due on 31.12.20X7. Here, short-term liabilities are recorded as accounts payables (A/ P) and include the short-term bank loan’s pay-off payment, VAT liabilities and dividend claims. Also, the bank account overdraft counts as a short-term liability as BATHURST Ltd. does not finance its bonds by a loan. The income tax liabilities require extra disclosure following IAS 1.54 in combination with IAS 12. That item only shows liabilities from income taxes. No VAT liabilities are reported under this item. For VAT payables, we apply the item shortterm liabilities A/ P (see above). BATHURST Ltd.’s equity is determined by deduction of all liabilities from the total of assets and gives: 372,500 + 103,194 - 90,000 - 61,736.50 - 22,080 = 330011"888877..5500 AAUUDD. It includes ordinary shares and retained earnings. 6.7 Statement of Profit or Loss - BATHURST Ltd. The statement of profit or loss and other comprehensive income provides information about profit or loss and extraordinary items for gains and losses. 90 In general, extraordinary is what is not linked to the business model of the company. 91 BATHURST Ltd. discloses the statement of profit or loss and other comprehensive income as in Figure 6.5. 90 IAS 1.81A - IAS 1.105 specify the disclosure of profit or loss and other comprehensive income. 91 The F 4.24 specifies that the financial performance depends directly on income and expenses. In line with F 5.25, income is defined as increase in economic benefits during the Accounting period, e.g., as inflow and enhancement of assets or decrease of liabilities, other than equity changes linked to owners. Expenses are decreases of economic benefits, e.g., cash outflows or depletion of assets, resulting in a decrease of equity. (A payment of dividends is no expense.) Income can be revenue and gains - based on F 4.29, revenue is the funds received in exchange for business activities. F 4.31 does not define gains but gives examples. Along those, gains are extraordinary income, e.g., sales of non-current assets. Gains shall be disclosed separately from revenues and usually are reported net of expenses. Berkau: Financial Statements 8e 6-119 20X6 20X5 [AUD] [AUD] Revenue 191,100 132,600 Other income 8,000 0 199,100 132,600 Depreciation (57,500) (57,500) Other expenses (65,000) (48,000) Earnings before int. & taxes (EBIT) 76,600 27,100 Interest (3,000) (3,375) Earnings before taxes (EBT) 73,600 23,725 Income tax expenses (22,080) (7,118) Earnings after taxes (EAT) 51,520 16,608 Bathurst Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X6 Figure 6.5: BATHURST Ltd.’s income statement (20X6) It is common to show revenue and other income as positive figures and expenses as negative. The (DR)CR-format applies. BATHURST Ltd. discloses revenues from renting out cars separately to interest income from its bonds, based on IAS 1.82. BATHURST Ltd.’s income adds up to 199,100 AUD in 20X6. The expenses are depreciation and socalled other expenses, which are linked here to operations. An income statement does not show all single items of expenses, it follows IAS 1.82. The disclosure on the financial statements is less in the details as the Bookkeeping records. A company is free to prepare the income statement along the nature of expenses (IAS 1.102) or based on the cost of sales format (IAS 1.103). 92 Note, that special disclosure rules apply for the cost of sales format to provide the reader of fi- 92 Study our textbook Basics of Accounting, chapter (28). nancial statements with further information about the categories of expenses. E.g., by disclosing the cost of goods sold a company does not show cost categories like labour, materials or depreciation. Therefore, the company must give detailed information about its expense structure on its notes to enable users of financial statements to estimate the impact of e.g., salary increases on the profit. It is common practice to disclose earnings before interest and taxes EBIT as separate line item. This supports the calculation of return ratios. IAS 1.82 requires the explicit disclosure of finance costs which is shown for BATHURST Ltd. as interest item. It refers here to the financing through the bank loan. After deduction of income taxes as calculated based on national tax law and following <?page no="120"?> Berkau: Financial Statements 8e 6-120 the 30% assumption as textbook simplification, the annual surplus is disclosed on the bottom line under earnings after taxation EAT. 6.8 Statement of Changes in Equity - BATHURST Ltd. In compliance with IAS 1.106, equity changes either by profit or loss, by other comprehensive income or by transactions with the owners. The latter one refers to share issues/ redemptions or dividend declarations. The standard requires companies to prepare a statement of changes in equity, which shows columns for equity items and lines at the beginning and end of the year as well as for changes of equity during the Accounting period, see IAS 1.108 and IAS 1.109. In Figure 6.6, we present BATHURST Ltd.’s statement of changes in equity for 20X5 and 20X6. Share capital Reserves Retained earnings total [AUD] [AUD] [AUD] [AUD] as at 1.01.20X5 300,000 (61,250) 238,750 Profit 20X5 (EAT) 16,608 16,608 as at 31.12.20X5 300,000 0 (44,643) 255,358 Profit 20X6 (EAT) 51,520 51,520 Dividend 20X6 (5,000) (5,000) as at 31.12.20X6 300,000 0 1,878 301,878 Bathurst Ltd. STATEMENT of CHANGES in EQUITY as at 31.12.20X6 Figure 6.6: BATHURST Ltd.’s statement of changes in equity (20X6) BATHURST Ltd. equity depends on profits earned in 20X5 and 20X6 as well as on dividends declared for 20X6. The statement of changes in equity demonstrates how the book value of the company changes due to profit or loss and transactions with owners. As BATHURST Ltd. recorded other comprehensive income through profit and loss the statement of changes in equity also includes the interest income as an increase of retained earnings. 6.9 Statement of Cash Flows - BATHURST Ltd. Cash flow statements are required by IAS 1.10 and as laid out in IAS 1.111; IAS 7 covers the calculation thereof. <?page no="121"?> Berkau: Financial Statements 8e 6-120 the 30% assumption as textbook simplification, the annual surplus is disclosed on the bottom line under earnings after taxation EAT. 6.8 Statement of Changes in Equity - BATHURST Ltd. In compliance with IAS 1.106, equity changes either by profit or loss, by other comprehensive income or by transactions with the owners. The latter one refers to share issues/ redemptions or dividend declarations. The standard requires companies to prepare a statement of changes in equity, which shows columns for equity items and lines at the beginning and end of the year as well as for changes of equity during the Accounting period, see IAS 1.108 and IAS 1.109. In Figure 6.6, we present BATHURST Ltd.’s statement of changes in equity for 20X5 and 20X6. Share capital Reserves Retained earnings total [AUD] [AUD] [AUD] [AUD] as at 1.01.20X5 300,000 (61,250) 238,750 Profit 20X5 (EAT) 16,608 16,608 as at 31.12.20X5 300,000 0 (44,643) 255,358 Profit 20X6 (EAT) 51,520 51,520 Dividend 20X6 (5,000) (5,000) as at 31.12.20X6 300,000 0 1,878 301,878 Bathurst Ltd. STATEMENT of CHANGES in EQUITY as at 31.12.20X6 Figure 6.6: BATHURST Ltd.’s statement of changes in equity (20X6) BATHURST Ltd. equity depends on profits earned in 20X5 and 20X6 as well as on dividends declared for 20X6. The statement of changes in equity demonstrates how the book value of the company changes due to profit or loss and transactions with owners. As BATHURST Ltd. recorded other comprehensive income through profit and loss the statement of changes in equity also includes the interest income as an increase of retained earnings. 6.9 Statement of Cash Flows - BATHURST Ltd. Cash flow statements are required by IAS 1.10 and as laid out in IAS 1.111; IAS 7 covers the calculation thereof. Berkau: Financial Statements 8e 6-121 20X6 20X6 20X5 20X5 [AUD] [AUD] [AUD] [AUD] Cash flow from operating acitivities Proceeds 126,126 159,120 Payment for operations (65,000) (48,000) Income tax payment (7,118) VAT payment (26,520) 39,000 27,489 150,120 Cash flow from investing activities Bond investment (200,000) 0 (200,000) 0 Cash flow from financing activities Coupon received 8,000 Interest paid (3,000) (3,375) Pay-off bank loan (15,000) (15,000) (10,000) (18,375) Total cash flow (182,512) 131,745 Bathurst Ltd. STATEMENT of CASH FLOWS for the period ended 31.12.20X6 Figure 6.7: BATHURST Ltd.’s statement of cash flows (20X6) The statement of cash flows discloses comparative information from 20X5, too. The cash flow statement classifies cash flows in operating, investing and financing activities, based on IAS 7.10. 93 For the cash flows from operations, a company either applies the direct method or reconciles the operating cash flow from its earnings after taxes. Both methods comply with IAS 7.18. 94 For the sake of teaching, BATHURST Ltd. calculates its operating cash flow based on the direct method. Therefore, the company derives the operating cash flows from its Cash/ Bank account. 95 In- 93 IAS 7.14 gives examples of cash flows from operations. IAS 7.16 lists cash flows from investing activities and IAS 7.17 shows examples for financial cash flows. terest earned as well as paid are considered as cash flows from financing activities in accordance with IAS 7.33. Interest paid for the bank loan and received from the bonds are reported separately, see IAS 7.31. No offsetting is allowed. Dividend payments are classified as financial cash flow following IAS 7.34. The income tax payment counts as an operating cash flow which is consistent with IAS 7.35. 6.10 Notes - BATHURST Ltd. In contrast to German Accounting, notes are a more detailed description of Accounting policies. IAS 1.112 requires notes to provide information 94 Study our textbook Basics of Accounting, chapter (32). 95 The reconciliation method is discussed in chapter (10) in detail. We here only focus on the disclosure of the statement. <?page no="122"?> Berkau: Financial Statements 8e 6-122 about the basis of preparation of financial statements and the applied Accounting policies. Furthermore, notes show information required by IFRSs that is not disclosed in other financial statements, e.g., a register of non-current assets. IAS 1.113 states that notes must be presented in a systematic manner to make them understandable and comparable. Usually, the financial statements contain references to paragraphs in the notes - comparable to footnotes. All reporting companies must prepare notes under IFRSs. The notes are an element of a full set of financial statements. BATHURST Ltd. prepares its notes linked to the items below: (a) Accounting policies. (b) Equity. (c) Non-current interest bearing liabilities. (d) Tangible assets. (e) Inventory. (f) Tax liabilities. (g) Dividends. (h) Revenue. (i) Expenses. BATHURST Ltd.’s notes are following, linked to the financial statements as per 31.12.20X6 are depicted in Figure 6.8. BBaatthhuurrsstt LLttdd.. NNOOTTEESS ttoo FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS aass aatt 3311..1122..2200XX66 ((aa)) AAccccoouunnttiinngg PPoolliiccyy These annual financial statements are prepared in accordance with IFRSs and the Company’s Act in Australia. (IAS 1.16) The international standards below apply: - IAS 1, - IAS 7, - IAS 12, - IAS 16, - IAS 32, - IFRS 7, - IFRS 9, - IFRS 13, - IFRS 15. The company was established on 2.01.20X4 in the legal form of a limited company (Ltd.) under Australian law. Its balance sheet date is 31.12. BATHURST Ltd. is registered for VAT reduction. The board of directors as at 31.12.20X6 is: - Chief executive officer (CEO), chair: Peter Lansfield (holding 10,000 ordinary shares) <?page no="123"?> Berkau: Financial Statements 8e 6-122 about the basis of preparation of financial statements and the applied Accounting policies. Furthermore, notes show information required by IFRSs that is not disclosed in other financial statements, e.g., a register of non-current assets. IAS 1.113 states that notes must be presented in a systematic manner to make them understandable and comparable. Usually, the financial statements contain references to paragraphs in the notes - comparable to footnotes. All reporting companies must prepare notes under IFRSs. The notes are an element of a full set of financial statements. BATHURST Ltd. prepares its notes linked to the items below: (a) Accounting policies. (b) Equity. (c) Non-current interest bearing liabilities. (d) Tangible assets. (e) Inventory. (f) Tax liabilities. (g) Dividends. (h) Revenue. (i) Expenses. BATHURST Ltd.’s notes are following, linked to the financial statements as per 31.12.20X6 are depicted in Figure 6.8. BBaatthhuurrsstt LLttdd.. NNOOTTEESS ttoo FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS aass aatt 3311..1122..2200XX66 ((aa)) AAccccoouunnttiinngg PPoolliiccyy These annual financial statements are prepared in accordance with IFRSs and the Company’s Act in Australia. (IAS 1.16) The international standards below apply: - IAS 1, - IAS 7, - IAS 12, - IAS 16, - IAS 32, - IFRS 7, - IFRS 9, - IFRS 13, - IFRS 15. The company was established on 2.01.20X4 in the legal form of a limited company (Ltd.) under Australian law. Its balance sheet date is 31.12. BATHURST Ltd. is registered for VAT reduction. The board of directors as at 31.12.20X6 is: - Chief executive officer (CEO), chair: Peter Lansfield (holding 10,000 ordinary shares) Berkau: Financial Statements 8e 6-123 - Chief financial officer (CFO): Patricia Glenroy (holding 5,000 ordinary shares) - Chief operations officer (COO): Hank McKay (holding 6,000 ordinary shares) The independent Australian Auditing firm SAFETRUST Ltd. has audited the financial statements on 5.02.20X7. The statement of auditors discloses that in their opinion, the financial statements present fairly, in all material respects, the financial position of BATHURST Ltd. as of 31 December 20X6, and its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards and the requirements of the company’s act in Australia. The Accounting period 20X6 started on 1.01.20X6 and ended on 31.12.20X6. Comparative information is given for the fiscal year 20X5 as per 31.12.20X5. The financial statements are prepared on historical cost basis. Tangible assets are valued at cost less accumulated depreciation. Depreciation method is straight-line method for tangible assets. Liabilities are reported on amortised cost basis applying the effective interest method in compliance with IFRS 9. ((bb)) EEqquuiittyy Issued capital: BATHURST Ltd. was established on 2.01.20X3 by a par value share issue of 50,000 ordinary shares at 6 AUD/ s. - Authorised shares: 100,000 ordinary shares at 6 AUD/ s nominal amount - Issued shares: 50,000 ordinary shares at 6 AUD/ s nominal amount Reserves: - Capital reserves: n/ a. - Earnings reserves: n/ a. - Revaluation reserves: n/ a. Retained earnings: Retained earnings result from the valuation of liabilities and annual surplus of prior Accounting periods. ((cc)) IInntteerreesstt bbeeaarriinngg lliiaabbiilliittiieess The interest bearings liabilities result from a bank loan with COMMONWEALTH BANK. The bank loan is a mortgage with a nominal, annual rate of interest of 2.5 %/ a. The principal is 150,000 AUD. The annual pay-off amount is 15,000 AUD/ a. The bank loan is secured by the office building, as separate title property, located in 3141 Melbourne, 193 Toorak Rd. The bank loan recognition is based on amortised costs. The effective interest method applies. The present value of the loan is: 105,000 AUD. The short-term liability portion therein is 15,000 AUD. The settlement amount for the bank loan is: 105,000 AUD. <?page no="124"?> Berkau: Financial Statements 8e 6-124 There are no further bank loans. ((dd)) TTaannggiibbllee aasssseettss Tangible assets are one office, separate titled in an office block and three cars, type of Mercedes-Benz C-class. The office was conveyed into Bathurst Ltd.’s ownership on 5.01.20X4. The address is 193 Toorak Rd, 3141 Melbourne. The floor size of the office is 47 m 2 . The purchase price plus cost of conveyance (total costs of acquisition) are 150,000 AUD. The office is financed by a bank loan (mortgage) of 150,000 AUD. Depreciation on the building is based on straight line method and is amounting to 12,500 AUD/ a. The cars are disclosed on a register of non-current assets as a group of cars. The cars have been purchased at 65,000 AUD/ car on 2.01.20X4. The residual value of the cars is estimated to be: 3 × 5,000 = 1 155"000000 AAUUDD. Depreciation applies over a useful life period of four years based on straight-line method. Depreciation charges on motor vehicles are 15,000 AUD/ (a × car). Asset P, P, E @ cost / @ valuation Acc. depr. Acc. impairment loss Carrying amount Office (Toorak Rd, Melbourne) 150,000 (37,500) 0 112,500 Cars 3 Mercedes-Benz C-class 195,000 (135,000) 0 60,000 Total 172,500 Bathurst Ltd. REGISTER of NON-CURRENT ASSETS as at 31.12.20X6 The reconciliation of opening values with closing amounts is disclosed on asset group levels below: Cars Office total [AUD] [AUD] [AUD] Opening value 20X5 150,000 137,500 287,500 Additions 0 Disposal 0 Depreciation (45,000) (12,500) (57,500) Impairment loss 0 Revaluations 0 Closing value 20X5 105,000 125,000 230,000 Additions 0 Disposal 0 Depreciation (45,000) (12,500) (57,500) Impairment loss 0 Revaluations 0 Closing value 20X6 60,000 112,500 172,500 Bathurst Ltd. RECONCILIATION of OPENING VALUES with CLOSING VALUES as at 31.12.20X6 ((ee)) IInnvveennttoorryy Bathurst Ltd. does not carry inventories as per 31.12.20X6. <?page no="125"?> Berkau: Financial Statements 8e 6-124 There are no further bank loans. ((dd)) TTaannggiibbllee aasssseettss Tangible assets are one office, separate titled in an office block and three cars, type of Mercedes-Benz C-class. The office was conveyed into Bathurst Ltd.’s ownership on 5.01.20X4. The address is 193 Toorak Rd, 3141 Melbourne. The floor size of the office is 47 m 2 . The purchase price plus cost of conveyance (total costs of acquisition) are 150,000 AUD. The office is financed by a bank loan (mortgage) of 150,000 AUD. Depreciation on the building is based on straight line method and is amounting to 12,500 AUD/ a. The cars are disclosed on a register of non-current assets as a group of cars. The cars have been purchased at 65,000 AUD/ car on 2.01.20X4. The residual value of the cars is estimated to be: 3 × 5,000 = 1 155"000000 AAUUDD. Depreciation applies over a useful life period of four years based on straight-line method. Depreciation charges on motor vehicles are 15,000 AUD/ (a × car). Asset P, P, E @ cost / @ valuation Acc. depr. Acc. impairment loss Carrying amount Office (Toorak Rd, Melbourne) 150,000 (37,500) 0 112,500 Cars 3 Mercedes-Benz C-class 195,000 (135,000) 0 60,000 Total 172,500 Bathurst Ltd. REGISTER of NON-CURRENT ASSETS as at 31.12.20X6 The reconciliation of opening values with closing amounts is disclosed on asset group levels below: Cars Office total [AUD] [AUD] [AUD] Opening value 20X5 150,000 137,500 287,500 Additions 0 Disposal 0 Depreciation (45,000) (12,500) (57,500) Impairment loss 0 Revaluations 0 Closing value 20X5 105,000 125,000 230,000 Additions 0 Disposal 0 Depreciation (45,000) (12,500) (57,500) Impairment loss 0 Revaluations 0 Closing value 20X6 60,000 112,500 172,500 Bathurst Ltd. RECONCILIATION of OPENING VALUES with CLOSING VALUES as at 31.12.20X6 ((ee)) IInnvveennttoorryy Bathurst Ltd. does not carry inventories as per 31.12.20X6. Berkau: Financial Statements 8e 6-125 ((ff)) TTaaxx lliiaabbiilliittiieess Income taxes (IAS 12) All income tax liabilities along IAS 12 are resulting from income taxes. The income taxes are based on earnings from 20X6 and are amounting to 22,080 AUD. No prepayments for income taxes have been made. The amount for income tax is due on 15.01.20X7. Income taxes are disclosed as short-term liabilities on the balance sheet and under the income tax liability item. VAT payables The revenues earned by renting out motor vehicles are VATable at a VAT rate of 20 %. The VAT payables are: 38,220 AUD. The value is net of input-VAT claims. The amount is disclosed as short-term liability under the item accounts payables A/ P. VAT payables are due on 15.01.20X7. ((gg)) DDiivviiddeennddss BATHURST Ltd.’s owners declared a dividend to its registered shareholders to an extent of 0.10 AUD/ share. The total of dividends is: 50,000 × 0.10 = 5 5"000000 AAUUDD. The proposed payment of dividends needs approval at the annual meeting held on 30.05.20X7. The dividend is due on 15.06.20X7. The dividend will be paid to all shareholders registered on 1.06.20X6. ((hh)) RReevveennuuee Car rental (core business) BATHURST Ltd. earned a revenue of 191,100 AUD by renting out motor vehicles in Australia. No trade rebates/ discounts have been allowed. Receivables of 103,194 AUD result from business operations. Financial revenue An interest income of 8,000 AUD was earned from holding 2,000 bonds of Bank of Queensland. The bonds mature on 6.11.20Y9, and their nominal value is 100 AUD/ bond. The annual coupon rate is 4 %/ a. The bonds are traded at 100 AUD/ b as per 31.12.20X6. ((ii)) EExxppeennsseess Total expenses at BATHURST Ltd. are amounting to 125,125 AUD. The expense values are disclosed in detail below: - Depreciation on cars and office: 57,500 AUD. - Interest on bank loan: 3,000 AUD (effective rate of interest: 2.5 %/ a). - Operational expenses, such as: labour, maintenance, cleaning: 65,000 AUD. <?page no="126"?> Berkau: Financial Statements 8e 6-126 Melbourne, in January 20X7 PPeetteerr LLaannssffiieelldd ______________________ (CEO - BATHURST Ltd.) Figure 6.8: BATHURST Ltd.’s notes (20X6) The notes above are in line with IAS 1. The notes are signed by BATHURST Ltd.’s chief executive officer (CEO), Mr P. Lansfield. 6.11 ESG-Reporting ESG stands for Environment, social, and governance. BATHURST Ltd. is not obliged to prepare an ESG report yet. Companies increasingly report about their ESG performance in addition to their financial reports. Similar as financial statements that are prepared to disclose the responsibility for the funds provided by the owners, an ESG report discloses ESG targets and achievements to show a company’s impact on the environment, its contribution to social equality and proofs due diligence. Below we show a fictive ESG report for BATHURST Ltd. prepared for 20X6 as appendix to its notes. Thereafter we discuss standardisation for ESG reports. BBaatthhuurrsstt LLttdd.. EESSGG--RReeppoorrtt aass aatt 3311..1122..2200XX66 BATHURST Ltd. is a car rental in Melbourne, Australia, and voluntarily reports about its ESG performance and its objectives. It includes ESG aspects in its daily decisions. EE -- EEnnvviirroonnmmeenntt BATHURST Ltd. is a service provider and aims to become CO2 neutral by 20Y0. It strives for the introduction of carbon accounting to control its CO2 emissions. It strives for improvement of its greenhouse gas footprint with regard to scope (1) direct emissions: BATHURST Ltd. operates a paperless office where no invoices or other correspondence with its customers is printed out. The renting-out is based on a smart phone app. The car maintenance and cleaning are carried out in environmentally friendly and certified facilities and avoids waste of water and the use of aggressive cleaning chemicals. Scope (2) indirect emissions: BATHURST Ltd. will install a solar panel system and will heat from <?page no="127"?> Berkau: Financial Statements 8e 6-126 Melbourne, in January 20X7 PPeetteerr LLaannssffiieelldd ______________________ (CEO - BATHURST Ltd.) Figure 6.8: BATHURST Ltd.’s notes (20X6) The notes above are in line with IAS 1. The notes are signed by BATHURST Ltd.’s chief executive officer (CEO), Mr P. Lansfield. 6.11 ESG-Reporting ESG stands for Environment, social, and governance. BATHURST Ltd. is not obliged to prepare an ESG report yet. Companies increasingly report about their ESG performance in addition to their financial reports. Similar as financial statements that are prepared to disclose the responsibility for the funds provided by the owners, an ESG report discloses ESG targets and achievements to show a company’s impact on the environment, its contribution to social equality and proofs due diligence. Below we show a fictive ESG report for BATHURST Ltd. prepared for 20X6 as appendix to its notes. Thereafter we discuss standardisation for ESG reports. BBaatthhuurrsstt LLttdd.. EESSGG--RReeppoorrtt aass aatt 3311..1122..2200XX66 BATHURST Ltd. is a car rental in Melbourne, Australia, and voluntarily reports about its ESG performance and its objectives. It includes ESG aspects in its daily decisions. EE -- EEnnvviirroonnmmeenntt BATHURST Ltd. is a service provider and aims to become CO2 neutral by 20Y0. It strives for the introduction of carbon accounting to control its CO2 emissions. It strives for improvement of its greenhouse gas footprint with regard to scope (1) direct emissions: BATHURST Ltd. operates a paperless office where no invoices or other correspondence with its customers is printed out. The renting-out is based on a smart phone app. The car maintenance and cleaning are carried out in environmentally friendly and certified facilities and avoids waste of water and the use of aggressive cleaning chemicals. Scope (2) indirect emissions: BATHURST Ltd. will install a solar panel system and will heat from Berkau: Financial Statements 8e 6-127 20X8 onwards its office with solar energy produced by its own panels mounted on the roof. Scope (3) - other emissions: The fleet of the company is consequently changed to emission neutral cars. BATHURST Ltd. does not invest in piston engine driven motor vehicles in the future. After regular replacement of all cars, BATHURST Ltd. solely rents out electric cars which are charged on its own wall boxes and get fed with solar electricity. SS -- SSoocciiaall EEqquuaalliittyy BATHURST Ltd. is committed to social equality. At the time of reporting, its board members are 1/ 3 women. With its hiring procedures the company ensures that aspects of social equality and inclusion are considered when deciding about new employees joining the company. The safety and working place healthy of its offices is controlled regularly. BATHURST Ltd. assigned one board member (Mr McKay) with the task of working place security. GG -- GGoovveerrnnaannccee The corporate governance is based on risk management for the company (calculated on MonteCarloSimulations of identified and annually revised risk assessments) and the establishment of supply chains that guarantee the consideration of aspects of social equality and environmentally friendly production and service rendering. The rented-out cars are supporting e-mobility and are acquired from car manufacturers who report their ESG-performance themselves and in the future only with certified business partners. With national networking the company strives for building business cooperations with other rental companies to reduce the energy consumption on ferry rides for car returns. BATHURST Ltd. includes stakeholders by polls in their decision making procedures. BATHURST Ltd. invests in ESC education and reports voluntarily about its ESG achievements on social media and on its notes (as an appendix named ESG report). Melbourne, in January 20X7 PPeetteerr LLaannssffiieelldd ______________________ (CEO - BATHURST Ltd.) Figure 6.9: ESG report BATHURST Ltd.(20X6) Consumers are nowadays interested in the environmental and social impact of the products/ services they buy and consume. Also, investors and creditors check ESG reports to evaluate companies for their decision making. Companies like BATHURST Ltd. report on ESG nowadays voluntarily which frequently is used to advertise their own ESG activities to the public. It is also used as Marketing instrument <?page no="128"?> Berkau: Financial Statements 8e 6-128 which is not negative per se as it motivates the reporting companies to think about and reveal their contribution to environment friendly business models, to lessen social inequality and to improve their corporate governance. However, the actual form of reports bears a risk for greenwashing. With the standardisation of ESG reporting, more comparable valuations of companies become possible. ESG reports will be lifted to the level of financial reporting and become part of the management report which makes them subjected to auditing procedures. In the EU, about 50,000 companies will be required to formally prepare ESG reports. These are companies that exceed two out of three criteria for two following years: more than 250 employees, earning more than 50,000,000 EUR in revenues, and disclosing a total on the balance sheet of more than 25,000,000 EUR. For ESG reporting a double materiality counts: The impact of the company on environment is termed an inside-out materiality and the impact of the environment on its finance is referred to as outside-in materiality. ESG metrics are non-financial ratios and are either quantitative or qualitative. Quantitative metrics are e.g., (E) greenhouse gas emissions, usage of energy and water, waste reduction, carbon footprint; (S) employee turnover rates, accident statistics; (G) board diversity, etc. Qualitative metrics are more difficult to compare and are e.g., (E) the climate change strategy; (S) company’s commitment to diversity, social equality and inclusion, labour 96 ESRS = European Sustainability Reporting Standards practices, workplace health and safety; (G) building responsible supply chain partnerships, fair executive compensation, risk management, ethical business practice etc. Qualitative metrics give more room for interpretation and discussions. The standardisation is supported by different organisations. We only name the most important ones here: - Global Reporting Initiative’s GRI standards - SABS standards - IFRS Sustainability Disclosure Standards (developed by IFRS Foundation and its new established ISSB International Sustainability Standards Board) The board works together with EFRAG and GRI to ensure that the standards are compatible with local regulations. So far IFRS S1 and IFRS S2 have been released. - CSRD is the European “Corporate Sustainability Reporting Directive”. It is relevant for listed and large companies in Europe. The reporting requirements are based on numerous data points which provide readers of ESG-reports with comparable information, e.g., ESRS 96 E1 about climate change comes with 276 disclosure items. The ESRS are developed by EFRAG European Financial Reporting Advisory Group. We here focus on the ISSB that published two standards IFRS S1 and IFRS S2. The first one is about general <?page no="129"?> Berkau: Financial Statements 8e 6-128 which is not negative per se as it motivates the reporting companies to think about and reveal their contribution to environment friendly business models, to lessen social inequality and to improve their corporate governance. However, the actual form of reports bears a risk for greenwashing. With the standardisation of ESG reporting, more comparable valuations of companies become possible. ESG reports will be lifted to the level of financial reporting and become part of the management report which makes them subjected to auditing procedures. In the EU, about 50,000 companies will be required to formally prepare ESG reports. These are companies that exceed two out of three criteria for two following years: more than 250 employees, earning more than 50,000,000 EUR in revenues, and disclosing a total on the balance sheet of more than 25,000,000 EUR. For ESG reporting a double materiality counts: The impact of the company on environment is termed an inside-out materiality and the impact of the environment on its finance is referred to as outside-in materiality. ESG metrics are non-financial ratios and are either quantitative or qualitative. Quantitative metrics are e.g., (E) greenhouse gas emissions, usage of energy and water, waste reduction, carbon footprint; (S) employee turnover rates, accident statistics; (G) board diversity, etc. Qualitative metrics are more difficult to compare and are e.g., (E) the climate change strategy; (S) company’s commitment to diversity, social equality and inclusion, labour 96 ESRS = European Sustainability Reporting Standards practices, workplace health and safety; (G) building responsible supply chain partnerships, fair executive compensation, risk management, ethical business practice etc. Qualitative metrics give more room for interpretation and discussions. The standardisation is supported by different organisations. We only name the most important ones here: - Global Reporting Initiative’s GRI standards - SABS standards - IFRS Sustainability Disclosure Standards (developed by IFRS Foundation and its new established ISSB International Sustainability Standards Board) The board works together with EFRAG and GRI to ensure that the standards are compatible with local regulations. So far IFRS S1 and IFRS S2 have been released. - CSRD is the European “Corporate Sustainability Reporting Directive”. It is relevant for listed and large companies in Europe. The reporting requirements are based on numerous data points which provide readers of ESG-reports with comparable information, e.g., ESRS 96 E1 about climate change comes with 276 disclosure items. The ESRS are developed by EFRAG European Financial Reporting Advisory Group. We here focus on the ISSB that published two standards IFRS S1 and IFRS S2. The first one is about general Berkau: Financial Statements 8e 6-129 requirements for disclosure of sustainability related financial information and the second one about climate related disclosure. 6.12 Summary In this chapter, we covered the formal aspects of financial and ESG reporting. We mostly discussed implications resulting from the Framework, IAS 1 and IAS 7. We provided you with a full set of financial statements for the case study BATHURST Ltd., a car rental business in Melbourne. The financial statements include a statement of financial position, a statement of profit or loss and other comprehensive income, a statement of changes in equity, a statement of cash flows and the notes. Special disclosure aspects for loans, liabilities, depreciations, cash flows etc. have been discussed. 6.13 Working Definitions Accounting Period: The time span financial statements are prepared for. In this textbook, the Accounting period is always one year. Effective Interest Method: Valuation of a liability or financial instrument measured by a payment vector with revaluation of its elements based on internal rate of return. The effective rate of interest calculation is based on iteration procedures. Notes: Disclosure of Accounting policies and explanation of items on financial statements. 6.14 Question Bank (1) A Malaysian company is established on 15.03.20X4. Its balance sheet date is 31 st of December. How does the company disclose its first financial statements? 1. One 15 days period and 3 quarterly reports. 2. One 3.5 months long period and 1 half year report. 3. A shortened report for the period 15.03.-31.12.20X4. 4. A full Accounting period with zero amounts for the time between 1.01.-14.03.20X4. (2) On 4.07.20X3 a company takes out a bank loan (annuity) of 100,000 EUR. The rate of interest is 3 %/ a. The annuity is 10,000 EUR/ a. In the first year (20X3), the annuity is calculated per rate (consider the time of the loan issue). How much is the bank loan disclosure on the balance sheet as long-term liabilities (Interest Bearing Liabilities account); consider IAS 1.60? 1. 85,790 EUR . 2. 96,500 EUR . 3. 93,000 EUR . 4. 89,395 EUR . (3) A company reports on its notes: 1. The standards applied, the postal address of the company, the register of non-current assets and the remuneration of auditors. 2. All standards, the address of the company and all its subsidiaries, the register of current assets, the position of the board of directors, the total of assets. 3. All applied standards, the method of depreciation and the register of non-current assets, the reconciliation of opening and closing amounts for non-current assets, the <?page no="130"?> Berkau: Financial Statements 8e 6-130 valuation of inventory, dividends declared. 4. All applied standards, the method of depreciation and the register of current assets, the reconciliation of opening and closing amounts for current assets, the valuation of inventory, dividends declared. (4) The financial statements’ header shows: 1. The name of the reporting company, the time when the financial statements are prepared, the currency unit, the rounding of figures. 2. The name of the reporting company, its legal form, the balance sheet date or the reporting period’s ending, the currency unit, the rounding of figures. 3. The name of the reporting company and its legal form, the balance sheet date or the reporting period’s ending, the currency unit, the data format. 4. The name of the reporting company, an indication of group/ single entity statement, the time for which the financial statements are prepared, the currency unit, the rounding of figures, the international standards and paragraphs applicable. (5) Which standards apply for assets? 1. IAS 16, IAS 2, IFRS 9. 2. IAS 17, IAS 2, IFRS 18. 3. IAS 37, IAS 16, IFRS 9. 4. IAS 33, IAS 16, IAS 2. 6.15 Solutions 1-3, 2-4, 3-3, 4-2, 5-1. <?page no="131"?> Berkau: Financial Statements 8e 6-130 valuation of inventory, dividends declared. 4. All applied standards, the method of depreciation and the register of current assets, the reconciliation of opening and closing amounts for current assets, the valuation of inventory, dividends declared. (4) The financial statements’ header shows: 1. The name of the reporting company, the time when the financial statements are prepared, the currency unit, the rounding of figures. 2. The name of the reporting company, its legal form, the balance sheet date or the reporting period’s ending, the currency unit, the rounding of figures. 3. The name of the reporting company and its legal form, the balance sheet date or the reporting period’s ending, the currency unit, the data format. 4. The name of the reporting company, an indication of group/ single entity statement, the time for which the financial statements are prepared, the currency unit, the rounding of figures, the international standards and paragraphs applicable. (5) Which standards apply for assets? 1. IAS 16, IAS 2, IFRS 9. 2. IAS 17, IAS 2, IFRS 18. 3. IAS 37, IAS 16, IFRS 9. 4. IAS 33, IAS 16, IAS 2. 6.15 Solutions 1-3, 2-4, 3-3, 4-2, 5-1. Berkau: Financial Statements 8e 7-131 7 Non-current Assets on the Balance Sheet 7.1 What is in the Chapter? This chapter discusses recognition and measurement of non-current assets, e.g., machinery, business cars, restaurant interior etc. In general, non-current assets remain in the company for more than one Accounting period. Therefore, changes in valuation, e.g., depreciation, impairment loss and revaluation matter. The chapter structure follows a life cycle: we start off from the initial recognition, then cover subsequent valuations and finally discuss disposals. We focus on IAS 16 and IAS 36. IAS 16 deals with the recognition and measurement of property, plant and equipment, and IAS 36 contains regulations about impairment losses. This chapter also covers special assets, like intangible assets (IAS 38), investment property (IAS 40), leases (IFRS 16), financial instruments (IAS 32, IAS 39, IFRS 7 and IFRS 9) and capitalisation of borrowing costs (IAS 23). We discuss every aspect by case studies. 7.2 Learning Objectives After studying this chapter, you know how to recognise and measure noncurrent assets. You can record noncurrent assets at the time of initial valuation and know when and how to apply the cost model and revaluation model for subsequent valuations. You also understand the Bookkeeping entries for selling or disposals and are aware of special aspects based on IFRS 5 for assets held for sale. You understand Accounting for leases, investment property and financial instruments. You learn in this chapters about the topics below and in the given sequence: (1) Initial recognition. (2) Subsequent valuation. (3) Disposal of assets. (4) Investment property and assets held for sale. (5) Intangible assets. (6) Leases. (7) Financial instruments. 7.3 Initial Recognition Based on F 4.4 (conceptual for financial reporting), an asset is a resource controlled by a company as result of past events and from which future economic benefits are expected. The IFRSs focus on the economic benefit rather than legal possession. Therefore, recognition and valuation of assets depends on the expectation of economic benefit and the reliability of the measurement. F 4.8 defines a future economic benefit as the potential to contribute to the flow of cash or its equivalents into a company. This can be based on the asset’s potential to contribute to production, service rendering, administration or on its convertibility into cash. A reporting company must control its assets. If a company cannot control an asset, it cannot recognise it on its balance sheet. E.g., a doctor who considers his patient list as a potential for future economic benefit cannot disclosed it, as doctors do not control their patients’ decisions about which doctor they visit. Neither does a good reputation or a wellknown brand qualify for recognition as <?page no="132"?> Berkau: Financial Statements 8e 7-132 the reputation and the resulting customer behaviour are out of the owner’s control. The requirement about a past event defines how the reporting company obtained possession/ access of/ to the asset and determines its valuation, e.g., an asset can be added to the company by acquisition, donation, leasing etc. IAS 16 further determines how to recognise assets. An asset recognition (F 4.37) means to add an item to the asset side of the balance sheet. For recognition, a company needs to know the asset’s value. At the time of initial recognition, the reporting company must be able to measure an asset’s value reliably. This leads to the recognition requirements as stated in IAS 16.7: an economic benefit must be associated with the asset and its costs can be measured reliably. In some cases, assets are split for recognition into single parts. This applies if an asset includes major spare parts. Those assets are recognised separately based on IAS 16.8. An airliner is usually disclosed as a set of assets, e.g., fuselage, engines and interior even as these assets are physically mounted by bolts, rivets etc. Different depreciation parameters can apply for components, e.g., the fuselage or the power plants. IAS 16.14 also stipulates that regular maintenance (major part inspections, checks) must be added to the airliner’s costs 97 . 97 An example for an aircraft depreciation is discussed in out textbook Basics of Accounting, chapter (17). At first, we focus on the initial asset recognition. Technically, the recognition is a Bookkeeping entry which debits the Property, Plant, Equipment and VAT account and makes credit entries in cash/ bank and/ or payables. For the measurement, IAS 16.15 states: An item of property, plant and equipment that qualifies for recognition shall be measured at costs. At costs refers to the cost of acquisition. These are defined in IAS 16.16. The paragraph identifies three cost categories for the asset valuation. We must add them for the calculation of an asset's total value. (a) Acquisition price, including import duties, non-refundable VAT 98 , less trade discounts and rebates. (b) Directly attributable costs. (c) Cost of dismantling the asset. 7.4 C/ S GETEN (Pty) Ltd. Find below the case study GETEN (Pty) Ltd. to study acquisition cost. Data Sheet for GETEN (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((GGqqeebbeerrhhaa)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : MMaannuuffaaccttuurreerr.. AAccqquuiissiittiioonn ooff aa ssaaww: : 2244"000000 ZZAARR ggrroossss ppuurrcchhaassee pprriiccee.. TTrraaddee ddiissccoouunntt 55 %%.. VVAATT rraattee: : 2200 %%.. GETEN (Pty) Ltd. is a manufacturer and buys on 17.09.20X1 a saw at a price of 24,000 ZAR. The price is the gross value and includes 20 % input-VAT. GETEN (Pty) Ltd. is registered for VAT reduction. The seller of the saw offers GETEN (Pty) 98 VAT is non-refundable if no VAT registration applies. Following the conventions in chapter (1), those cases are not covered in this textbook. <?page no="133"?> Berkau: Financial Statements 8e 7-132 the reputation and the resulting customer behaviour are out of the owner’s control. The requirement about a past event defines how the reporting company obtained possession/ access of/ to the asset and determines its valuation, e.g., an asset can be added to the company by acquisition, donation, leasing etc. IAS 16 further determines how to recognise assets. An asset recognition (F 4.37) means to add an item to the asset side of the balance sheet. For recognition, a company needs to know the asset’s value. At the time of initial recognition, the reporting company must be able to measure an asset’s value reliably. This leads to the recognition requirements as stated in IAS 16.7: an economic benefit must be associated with the asset and its costs can be measured reliably. In some cases, assets are split for recognition into single parts. This applies if an asset includes major spare parts. Those assets are recognised separately based on IAS 16.8. An airliner is usually disclosed as a set of assets, e.g., fuselage, engines and interior even as these assets are physically mounted by bolts, rivets etc. Different depreciation parameters can apply for components, e.g., the fuselage or the power plants. IAS 16.14 also stipulates that regular maintenance (major part inspections, checks) must be added to the airliner’s costs 97 . 97 An example for an aircraft depreciation is discussed in out textbook Basics of Accounting, chapter (17). At first, we focus on the initial asset recognition. Technically, the recognition is a Bookkeeping entry which debits the Property, Plant, Equipment and VAT account and makes credit entries in cash/ bank and/ or payables. For the measurement, IAS 16.15 states: An item of property, plant and equipment that qualifies for recognition shall be measured at costs. At costs refers to the cost of acquisition. These are defined in IAS 16.16. The paragraph identifies three cost categories for the asset valuation. We must add them for the calculation of an asset's total value. (a) Acquisition price, including import duties, non-refundable VAT 98 , less trade discounts and rebates. (b) Directly attributable costs. (c) Cost of dismantling the asset. 7.4 C/ S GETEN (Pty) Ltd. Find below the case study GETEN (Pty) Ltd. to study acquisition cost. Data Sheet for GETEN (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((GGqqeebbeerrhhaa)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : MMaannuuffaaccttuurreerr.. AAccqquuiissiittiioonn ooff aa ssaaww: : 2244"000000 ZZAARR ggrroossss ppuurrcchhaassee pprriiccee.. TTrraaddee ddiissccoouunntt 55 %%.. VVAATT rraattee: : 2200 %%.. GETEN (Pty) Ltd. is a manufacturer and buys on 17.09.20X1 a saw at a price of 24,000 ZAR. The price is the gross value and includes 20 % input-VAT. GETEN (Pty) Ltd. is registered for VAT reduction. The seller of the saw offers GETEN (Pty) 98 VAT is non-refundable if no VAT registration applies. Following the conventions in chapter (1), those cases are not covered in this textbook. Berkau: Financial Statements 8e 7-133 Ltd. a trade discount of 5 % on the saw. A discount is a price reduction at the point of sale. If granted later, we call it a rebate. Here, the saw price is for GETEN (Pty) Ltd.: 95% × 24,000 = 2 222"880000 ZZAARR. The saw is an item of property, plant and equipment and falls under non-current assets. Future economic benefit is expected to flow to the buyer (GETEN (Pty) Ltd.) when it deploys the saw for its production. To recognise the saw, GETEN (Pty) Ltd. calculates its cost of acquisition as: (24,000/ 120%) × (1 - 5%) = 1199"000000 ZZAARR. The input-VAT is not included in the costs as GETEN (Pty) Ltd acts as VAT vendor and is entitled to receive a refund for input-VAT. Only nonrefundable taxes count as cost of acquisition. The discount must be deducted under IAS 16.16(a), too. The costs of the saw can be calculated reliably as they are derived from the price. We record the granted discount separately for teaching purposes as a received trade discount and make the Bookkeeping entries accordingly. @ 17.09.20X1 Property, Plant, Equipment PPE 20,000 Value Added Tax VAT 4,000 Cash/ Bank C/ B 24,000 (acquisition of a saw without consideration of discount granted) Cash/ Bank C/ B 1,200 Discount Received Account DRA 1,200 (recording discount received) Discount Received Account DRA 1,200 Value Added Tax VAT 200 Property, Plant, Equipment PPE 1,000 (closing-off the Discount Received account) The Bookkeeping entries can be recorded based on the reduced acquisition costs, too. 99 As the seller allows the discount at the point of sale, the Bookkeeping entry should be recorded as below: @ 17.09.20X1 Property, Plant, Equipment PPE 19,000 Value Added Tax VAT 3,800 Cash/ Bank C/ B 22,800 (acquisition of a saw under consideration of discount granted) After recording the Bookkeeping entry for the saw, its initial recognition is completed, and the value of the saw as disclosed in the Property, Plant and Equipment account is 19,000 ZAR. 99 Study the recording of discounts and rebates in out textbook Basics of Accounting, chapter (36). 7.5 Qualifying Assets If an asset still requires configurations, changes or further steps of manufacturing for its intended deployment, qualifying costs apply and must be <?page no="134"?> Berkau: Financial Statements 8e 7-134 added to the asset’s value in compliance with IAS 16.16(b). A taxi company buying a car and installing a distance meter configures the motor vehicle for its intended use as a (metered) taxi. The taxi appliance costs, e.g., the distance meter, markings, GPS, radio etc., are additional costs of acquisition and must be recorded as well as depreciated together with the taxi - instead of recognising them in the first Accounting period as expenses. They are no major spare parts either due to minor value. Adding expenses to the cost of acquisition can apply for interest spent on financing the asset’s qualifying, too. IAS 23.8 requires the reporting company to capitalise borrowing costs. Hence, a taxi company which takes a bank loan to finance the car’s alterations must add the interest to the costs of acquisition. IAS 23.10 defines requirements for the capitalisation of borrowing costs. In contrast, other (non-specific) interest or costs for repairs, e.g., exhauster replacement or tyre changes, fall under regular operations and are recorded through profit or loss when they occur. 7.6 C/ S LANGDAM Bhd. For the understanding of qualifying assets, we study the case of LANGDAM Bhd. in Kuala Lumpur: Data Sheet for LANGDAM Bhd. DDoommiicciillee: : MMaallaayyssiiaa ((KKuuaallaa LLuummppuurr)).. RReeppoorrttiinngg ccuurrrreennccyy: : MMYYRR.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. AAccqquuiissiittiioonn ooff ssooffttwwaarree: : 334400"000000 MMYYRR nneett ppuurrcchhaassee pprriiccee.. CCuussttoommiissiinngg ccoossttss: : 110000"000000 MMYYRR.. VVAATT rraattee 2200 %%.. LANGDAM Bhd. is a consultancy based on shares in Malaysia. On 24.11.20X6, the company buys the computer software ADMACC for its order management. The net purchase price for the ADMACC software is 340,000 MYR. In addition to the software purchase, a computer specialist customises LANGDAM Bhd.’s software. Customising a software is to make initial software settings and enter the master data. The software specialist charges 100,000 MYR (net value). The customising service costs are directly attributable costs under IAS 16.16(b). Therefore, the initial recognition of the software ADMACC is recorded as below: @ 24.11.20X6 Property, Plant, Equipment PPE 340,000 Value Added Tax VAT 68,000 Cash/ Bank C/ B 408,000 (acquisition of ADMACC software) Cash/ Bank C/ B 100,000 Value Added Tax VAT 20,000 Cash/ Bank C/ B 120,000 (recording customizing service under cost of acquisition) Now, the software ADMACC is measured at: 340,000 + 100,000 = 4 44400"000000 <?page no="135"?> Berkau: Financial Statements 8e 7-134 added to the asset’s value in compliance with IAS 16.16(b). A taxi company buying a car and installing a distance meter configures the motor vehicle for its intended use as a (metered) taxi. The taxi appliance costs, e.g., the distance meter, markings, GPS, radio etc., are additional costs of acquisition and must be recorded as well as depreciated together with the taxi - instead of recognising them in the first Accounting period as expenses. They are no major spare parts either due to minor value. Adding expenses to the cost of acquisition can apply for interest spent on financing the asset’s qualifying, too. IAS 23.8 requires the reporting company to capitalise borrowing costs. Hence, a taxi company which takes a bank loan to finance the car’s alterations must add the interest to the costs of acquisition. IAS 23.10 defines requirements for the capitalisation of borrowing costs. In contrast, other (non-specific) interest or costs for repairs, e.g., exhauster replacement or tyre changes, fall under regular operations and are recorded through profit or loss when they occur. 7.6 C/ S LANGDAM Bhd. For the understanding of qualifying assets, we study the case of LANGDAM Bhd. in Kuala Lumpur: Data Sheet for LANGDAM Bhd. DDoommiicciillee: : MMaallaayyssiiaa ((KKuuaallaa LLuummppuurr)).. RReeppoorrttiinngg ccuurrrreennccyy: : MMYYRR.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. AAccqquuiissiittiioonn ooff ssooffttwwaarree: : 334400"000000 MMYYRR nneett ppuurrcchhaassee pprriiccee.. CCuussttoommiissiinngg ccoossttss: : 110000"000000 MMYYRR.. VVAATT rraattee 2200 %%.. LANGDAM Bhd. is a consultancy based on shares in Malaysia. On 24.11.20X6, the company buys the computer software ADMACC for its order management. The net purchase price for the ADMACC software is 340,000 MYR. In addition to the software purchase, a computer specialist customises LANGDAM Bhd.’s software. Customising a software is to make initial software settings and enter the master data. The software specialist charges 100,000 MYR (net value). The customising service costs are directly attributable costs under IAS 16.16(b). Therefore, the initial recognition of the software ADMACC is recorded as below: @ 24.11.20X6 Property, Plant, Equipment PPE 340,000 Value Added Tax VAT 68,000 Cash/ Bank C/ B 408,000 (acquisition of ADMACC software) Cash/ Bank C/ B 100,000 Value Added Tax VAT 20,000 Cash/ Bank C/ B 120,000 (recording customizing service under cost of acquisition) Now, the software ADMACC is measured at: 340,000 + 100,000 = 4 44400"000000 Berkau: Financial Statements 8e 7-135 MMYYRR. This is the valuation for its initial recognition. 100 It includes the qualifying costs. Assets can also be acquired based on exchanges of goods and/ or can lead to delayed payments which add an interest portion to the cost of acquisition. We do not cover these cases in the textbook but prepared case study material for download. Study the special case studies accessible through Link 7.A and Link 7.B to enhance your knowledge about initial valuations. Link 7.A: RAVENWOOD GmbH Link 7.B: OTZE AG How it is Done (Initial Asset Recognition): (1) Determine the asset to be recognised. Check whether the recognition criteria are fulfilled. The asset must provide an economical benefit for its owner and its valuation must be reliable. (2) Apply the cost model. Based on the cost model, the costs of acquisition are calculated following IAS 16.16. (3) A company registered for VAT reduction must deduct input-VAT. (4) In case the company pays import duties, e.g., if importing the asset from a foreign country, add import duties to the net value. Calculate target country-specific input-VAT for the new gross value payable. Deduct VAT if the importing company is registered for VAT reduction at the time of its recognition. (5) Deduct rebates or trade discounts received from the supplier. (6) If the seller includes an interest portion in the price, disclose interest separately. If the company capitalises borrowing costs, no separation is necessary. (7) Make a debit entry in the Property, Plant and Equipment account for the cost of acquisition, another debit entry for the input-VAT in the VAT account and 100 See: IAS 16.15 - IAS 16.28. <?page no="136"?> Berkau: Financial Statements 8e 7-136 credit the Cash/ Bank account or the Accounts Payables account as required. (8) If an interest component applies, make a debit entry for interest. 7.7 Subsequent Valuation A subsequent valuation is any valuation following the initial one, e.g., depreciation, impairment loss, and revaluation. In general, a valuation determines the value an asset is carried at. That measurement is referred to as the carrying amount of an asset. Some assets’ value does not change, e.g., land, as land is not subjected to depreciation. Those assets are carried at cost. However, most assets change in value due to their deployment or because of increasing prices. For subsequent valuations, IAS 16.29 states that the reporting company must evaluate assets either based on the cost model or at valuation. A subsequent valuation based on the cost model in compliance with IAS 16.30 includes the initial costs of acquisition and all adjustments, such as: (a) Depreciation. (b) Impairment loss. (c) Reversal of an impairment loss. Depreciation reflects the regular deployment of an asset and the value reduction thereof. Bookkeeping entries for depreciation consider an expense on the debit side and the diminishment of the asset’s carrying value on the credit side. The best measurement for depreciation would be based on factors that directly reduce the asset’s value. E.g., depreciation on aircrafts is calculated based on the units of production method with a Hobbs meter measuring the flight time. However, as a practical expedient, the reporting company measures depreciation based on the time, e.g., following straight line method. Notice, that for this reason an asset which is not in use must be depreciated. An impairment loss is an extraordinary depreciation which can be caused by overuse of assets or accidents, e.g., tool breakage in a production machine. The requirement to record an impairment loss is indicated by a recoverable amount that falls below an asset’s carrying value (IAS 36.59). The difference between the recoverable amount (which is the lower of the fair value or the value in use) is recorded as an expense, termed impairment loss on the debit side and a credit entry in the Accumulated Impairment Loss account. Thereafter, depreciation for future periods must be adjusted following IAS 36.63. An impairment loss can be reversed based on IAS 36.110. In those cases, the (new) recoverable amount is capped to the asset’s value that would have been recorded if no impairment loss had been recognised. If the value is higher, a revaluation must be recorded for the portion the new valuation exceeds the carrying value based on regular depreciation. A subsequent valuation based on the revaluation model in line with IAS 16.31 refers to the fair value based on: (a) Current values. (b) Net realisable values. (c) Values in use. <?page no="137"?> Berkau: Financial Statements 8e 7-136 credit the Cash/ Bank account or the Accounts Payables account as required. (8) If an interest component applies, make a debit entry for interest. 7.7 Subsequent Valuation A subsequent valuation is any valuation following the initial one, e.g., depreciation, impairment loss, and revaluation. In general, a valuation determines the value an asset is carried at. That measurement is referred to as the carrying amount of an asset. Some assets’ value does not change, e.g., land, as land is not subjected to depreciation. Those assets are carried at cost. However, most assets change in value due to their deployment or because of increasing prices. For subsequent valuations, IAS 16.29 states that the reporting company must evaluate assets either based on the cost model or at valuation. A subsequent valuation based on the cost model in compliance with IAS 16.30 includes the initial costs of acquisition and all adjustments, such as: (a) Depreciation. (b) Impairment loss. (c) Reversal of an impairment loss. Depreciation reflects the regular deployment of an asset and the value reduction thereof. Bookkeeping entries for depreciation consider an expense on the debit side and the diminishment of the asset’s carrying value on the credit side. The best measurement for depreciation would be based on factors that directly reduce the asset’s value. E.g., depreciation on aircrafts is calculated based on the units of production method with a Hobbs meter measuring the flight time. However, as a practical expedient, the reporting company measures depreciation based on the time, e.g., following straight line method. Notice, that for this reason an asset which is not in use must be depreciated. An impairment loss is an extraordinary depreciation which can be caused by overuse of assets or accidents, e.g., tool breakage in a production machine. The requirement to record an impairment loss is indicated by a recoverable amount that falls below an asset’s carrying value (IAS 36.59). The difference between the recoverable amount (which is the lower of the fair value or the value in use) is recorded as an expense, termed impairment loss on the debit side and a credit entry in the Accumulated Impairment Loss account. Thereafter, depreciation for future periods must be adjusted following IAS 36.63. An impairment loss can be reversed based on IAS 36.110. In those cases, the (new) recoverable amount is capped to the asset’s value that would have been recorded if no impairment loss had been recognised. If the value is higher, a revaluation must be recorded for the portion the new valuation exceeds the carrying value based on regular depreciation. A subsequent valuation based on the revaluation model in line with IAS 16.31 refers to the fair value based on: (a) Current values. (b) Net realisable values. (c) Values in use. Berkau: Financial Statements 8e 7-137 In general, revaluations must be carried out for underrated assets. This means the fair value exceeds the carrying value. In this section, we cover case studies about: depreciation, impairment loss and revaluations (in this sequence). 7.8 C/ S GELLENDORFF LLC. We study depreciation and impairment loss for a business car. We consider an impairment loss caused by a car accident with is covered by GELLENDORFF LLC’s insurance company. Data Sheet for GELLENDORFF LLC. DDoommiicciillee: : SSoouutthh KKoorreeaa ((SSeeoouull)).. RReeppoorrttiinngg ccuurrrreennccyy: : KKRRWW ×× 1100 33 ((iinnddii-ccaatteedd aass ttKKRRWW)).. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. AAccqquuiissiittiioonn ooff aa mmoottoorr vveehhiiccllee aatt 8800"000000 ttKKRRWW wwiitthh aa 1100 %% rreebbaattee: : tthhuuss" 7722"000000 ttKKRRWW ggrroossss ppuurrcchhaassee pprriiccee.. DDaattee ooff aacc-qquuiissiittiioonn: : 22..0044..2200XX11.. AAccccoouunnttiinngg ppeerriiooddss: : 2200XX11 -- 2200XX55.. DDeepprreecciiaattiioonn: : ssttrraaiigghhtt--lliinnee mmeetthhoodd oovveerr ffiivvee yyeeaarrss" rreessiidduuaall vvaalluuee: : 1100"000000 ttKKRRWW.. OOnn 44..0044..2200XX44: : iimmppaaiirrmmeenntt lloossss dduuee ttoo aann aacccciiddeenntt ttoowwaarrddss" ccaassee ((ii)): : 2244"770000 ttKKRRWW; ; ccaassee ((iiii)): : 1188"440000 ttKKRRWW.. RReeppaaiirr: : 88"440000 ttKKRRWW ((ggrroossss aammoouunntt)).. EEvvaalluuaattiioonn aafftteerr rreeppaaiirrss: : ccaassee ((ii)) oonn 88..0044..2200XX44; ; iinn ccaassee ((iiii)): : tthhrreeee mmoonntthhss llaatteerr aatt 2222"440000 ttKKRRWW)) oonn 88..0077..2200XX44.. TThhee rreessiidduuaall vvaalluuee ddeeccrreeaasseess bbyy 22"000000 ttKKRRWW ((ccaassee ((iiii)) oonnllyy)).. IInn bbootthh ccaasseess tthhee iinnssuurraannccee ccoommppeenn-ssaatteess GGEELLLLEENNDDOORRFFFF LLLLCC ffoorr tthhee nneett vvaalluuee ooff tthhee rreeppaaiirr aanndd tthhee iimmppaaiirrmmeenntt lloossss.. VVAATT rraattee: : 2200 %%.. On 2.04.20X1, GELLENDORFF LLC buys a business car Kia Sorento and pays a gross purchase price of 80,000,000 KRW. KRW is the abbreviation for Korean Won. We work in 1,000s of Won, hence, our currency unit is: KRW × 10 3 = tKRW. The car fulfils the recognition criteria: It provides GELLENDORFF LLC with future economic benefit and the price can be measured reliably. Due to further acquisitions, the seller allows GELLENDORFF LLC a 10 % rebate one month later. The cost of acquisition is determined based on IAS 16.16 and requires a rebate deduction. 101 For the Kia Sorento, the cost of acquisition is: (1 - 10%) × 80,000 / 120% = 6 600"000000 ttKKRRWW. As GELLENDORFF LLC is acting as VAT vendor following the conventions in chapter (1), input-VAT is refundable and cannot be a cost. Therefore, the car’s net value after deduction of the rebate received is considered as cost of acquisition to the extent of 72,000 tKRW. If the seller allows the discount instantly, the acquisition is recorded based on the reduced price. As GELLENDORFF LLC receives the rebate one month later, we record the initial acquisition and the received rebate through a Rebate Received account, see the journal entries below. Notice, the Rebate Received account does not show in Figure 7.1 and Figure 7.2 as it is closed-off to the Property, Plant, Equipment account and Value added Tax account in 20X1. The accounts there are shown for 20X4 only. 101 Read chapter (36) about the recording of discounts received in our textbook Basics of Accounting. <?page no="138"?> Berkau: Financial Statements 8e 7-138 @ 2.04.20X1 Property, Plant, Equipment PPE 66,667 Value added Tax VAT 13,333 Cash/ Bank C/ B 80,000 (acquisition of the business car) @ 4.05.20X1 Cash/ Bank C/ B 8,000 Rebate Received Account RRA 8,000 (receipt of 10% rebate) Rebate Received Account RRA 8,000 Property, Plant, Equipment PPE 6,667 Value added Tax VAT 1,333 (PPE and VAT reduction according to a rebate allowed by the seller) Depreciation 102 is based on the cost of acquisition and follows here straightline method. After the useful life of 5 years the car is expected to be sold at 10,000 tKRW which is the best estimate for the future net selling price. 103 IAS 16.6 defines the residual value as the net value a company would currently obtain from an asset’s disposal. Disposal costs, e.g., car dealer commissions on sale, must be deducted. Currently obtainable refers to the selling price for a five year old car that could be obtained today. After the first year, the Kia Sorento is depreciated to an extent of 75% of its annual depreciation due to the acquisition in April. The depreciable value of an asset is the estimated loss in value over the entire useful life (5 years). Following IAS 16.6 this is the cost of an asset less its residual value. Applying straight-line method, we divide the depreciable amount by the useful life to calculate annual depreciation of: (60,000 - 10,000) / 5 = 1100"000000 ttKKRRWW/ / aa. The recorded depreciation for 20X1 is: 75% × 10,000 = 7 7"550000 ttKKRRWW. The journal entry for depreciation at GELLENDORFF LLC is shown below. For IFRS Accounting, we always make depreciation credit entries in the Accumulated Depreciation account: @ 31.12.20X1 Depreciation-20X1 DPR 7,500 Accumulated Depreciation ACC 7,500 (recording depreciation on the business car) The carrying value of the Kia Sorento as at 31.12.20X1 is: 60,000 - 7,500 = 5522"550000 ttKKRRWW. In 20X2 and 20X3, the car is depreciated by 10,000 tKRW/ a each. Its carrying 102 Study depreciation methods in our textbook Basics of Accounting, chapter (17). value at the beginning of 20X4 is: 52,500 - 10,000 - 10,000 = 3 322"550000 ttKKRRWW. 103 Remember, the AfA table of the German Minister of Finance is linked to German tax statements and does not apply here. <?page no="139"?> Berkau: Financial Statements 8e 7-138 @ 2.04.20X1 Property, Plant, Equipment PPE 66,667 Value added Tax VAT 13,333 Cash/ Bank C/ B 80,000 (acquisition of the business car) @ 4.05.20X1 Cash/ Bank C/ B 8,000 Rebate Received Account RRA 8,000 (receipt of 10% rebate) Rebate Received Account RRA 8,000 Property, Plant, Equipment PPE 6,667 Value added Tax VAT 1,333 (PPE and VAT reduction according to a rebate allowed by the seller) Depreciation 102 is based on the cost of acquisition and follows here straightline method. After the useful life of 5 years the car is expected to be sold at 10,000 tKRW which is the best estimate for the future net selling price. 103 IAS 16.6 defines the residual value as the net value a company would currently obtain from an asset’s disposal. Disposal costs, e.g., car dealer commissions on sale, must be deducted. Currently obtainable refers to the selling price for a five year old car that could be obtained today. After the first year, the Kia Sorento is depreciated to an extent of 75% of its annual depreciation due to the acquisition in April. The depreciable value of an asset is the estimated loss in value over the entire useful life (5 years). Following IAS 16.6 this is the cost of an asset less its residual value. Applying straight-line method, we divide the depreciable amount by the useful life to calculate annual depreciation of: (60,000 - 10,000) / 5 = 1100"000000 ttKKRRWW/ / aa. The recorded depreciation for 20X1 is: 75% × 10,000 = 7 7"550000 ttKKRRWW. The journal entry for depreciation at GELLENDORFF LLC is shown below. For IFRS Accounting, we always make depreciation credit entries in the Accumulated Depreciation account: @ 31.12.20X1 Depreciation-20X1 DPR 7,500 Accumulated Depreciation ACC 7,500 (recording depreciation on the business car) The carrying value of the Kia Sorento as at 31.12.20X1 is: 60,000 - 7,500 = 5522"550000 ttKKRRWW. In 20X2 and 20X3, the car is depreciated by 10,000 tKRW/ a each. Its carrying 102 Study depreciation methods in our textbook Basics of Accounting, chapter (17). value at the beginning of 20X4 is: 52,500 - 10,000 - 10,000 = 3 322"550000 ttKKRRWW. 103 Remember, the AfA table of the German Minister of Finance is linked to German tax statements and does not apply here. Berkau: Financial Statements 8e 7-139 7.9 Impairment Loss In addition to regular depreciation, an asset’s value can suddenly drop due to an extraordinary event. An unexpected loss in valuation is referred to as impairment loss. Any impairment loss must be recorded in the period when it occurs. The Bookkeeping entries for impairment losses are DR Impairment Loss - CR Accumulated Impairment Loss. It looks like the entries for depreciation. If the impairment loss recognised in prior Accounting periods does not exist anymore or has been decreased, a company must reverse the impairment loss. The Bookkeeping entry then is a debit entry in the Accumulated Impairment Loss account and the amount is credited to the Impairment Loss account (or the Reversal Impairment Loss account). Most of the companies insure assets against accidental loss in valuation. In the extended case study GELLENDORFF LLC, we demonstrate the recording of an impairment loss and an insurance refund. 7.10 Impairment Loss - GELLENDORFF LLC. Below, we study two alternative cases for GELLENDORFF LLC. In case (i), its Kia Sorento is crashed and repaired immediately. As GELLENDORFF LLC. expects the car’s value after repair to drop below the value before the accident, it asks an appraiser to estimate its value. Both, the repair and the impairment loss are covered by the insurance. In case (ii), the business car is crashed and is presented to an appraiser, too. The car is repaired 104 For case i, all Bookkeeping entries are indicated by ‘. three months later. Again, the company asks an appraiser to estimate the impairment loss which is covered by the insurance as well as the repair. The cases differ regarding the depreciation charge for the period between accident and repair as well as the recording of a reversal impairment loss after the repair has been carried out in case (ii). In general, a damaged asset, like a car or machinery, gets repaired without impairment loss. It is unlikely that an asset is appraised after repair, this only occurs if the owner expects a lasting damage. We here fabricated the case to demonstrate the recording of an impairment loss and its reversal for teaching purposes. Ad (i): Impairment Loss with Immediate Repair 104 On 4.04.20X4, GELLENDORFF LLC’s business car is involved in an accident. Before recording the damage, we calculate depreciation for a three-months period. Depreciation charge for the period January/ 20X4 - March/ 20X4 is recorded as Bookkeeping entry (1’). It is a quarter of the annual depreciation as we record depreciation accurate to a month. Therefore, the carrying value prior to the accident is: 60,000 - 7,500 - 2 × 10,000 - 2,500 = 3 300"000000 ttKKRRWW. As depreciation is considered for full months only, no depreciation is charged for the days in April prior to the accident. After the accident, the car is repaired. The repair costs are 8,400 tKRW (gross amount) and are recorded as Bookkeeping entry (2’) on 7.04.20X4. VAT applies, <?page no="140"?> Berkau: Financial Statements 8e 7-140 as the car repair shop is a company registered for VAT reduction. After the repair on 8.04.20X4, a qualified appraiser evaluates the car at 24,700 tKRW. 105 The difference between the carrying value before the accident and the new amount following the expertise must be recorded under impairment loss to the extent of: 30,000 - 24,700 = 5 5"330000 ttKKRRWW. 106 IAS 36.59 states that if the carrying value exceeds the recoverable amount, the carrying value shall be reduced to its recoverable amount. The recoverable amount is the lower of the value the asset can be sold at on an active market (fair value) and its value in use, which is the total of discounted cash flows resulting from deployment (IAS 36.6). A value in use is e.g., future and discounted rental income from property. If the carrying value exceeds the recoverable amount, an asset is overrated. For most tangible assets, we simply compare the carrying value in the books to the fair value (based on an appraiser’s estimate). The difference is then recorded as impairment loss. GELLENDORFF LLC's records an impairment loss of 5,300 tKRW as Bookkeeping entry (3’). See below the journalised entries recorded in March/ 20X4 and April/ 20X4 in GELLENDORFF LLC’s books. @ 31.03.20X4 Depreciation-20X4 DPR 2,500 Accumulated Depreciation ACC 2,500 (recording three months of depreciation) @ 7.04.20X4 Repair-20X4 REP 7,000 Value added Tax VAT 1,400 Cash/ Bank C/ B 8,400 (repair of the car) @ 8.04.20X4 Impairment Loss-20X4 I/ L 5,300 Accumulated I/ L account AIL 5,300 (impairment loss of the car based on the appraiser's estimate) IAS 36.63 rules depreciation after an impairment loss. Depreciation is adjusted to the asset’s revised valuation. A residual value must be considered for the calculation of the depreciable value if existent. 105 Here, we pretend that a lasting damage remains after repair to demonstrate the recording of an impairment loss. After the repair and recording of the impairment loss, depreciation on GELLENDORFF LLC's car is resumed. The residual value is not affected. Monthly depreciation now is: (24,700 - 10,000) / 21 = 770000 ttKKRRWW/ / mm. Depreciation for the rest of 20X4 is: 9 × 700 = 6 6"330000 ttKKRRWW and is recorded as Bookkeeping entry 106 The impairment loss is not linked to repair cost. <?page no="141"?> Berkau: Financial Statements 8e 7-140 as the car repair shop is a company registered for VAT reduction. After the repair on 8.04.20X4, a qualified appraiser evaluates the car at 24,700 tKRW. 105 The difference between the carrying value before the accident and the new amount following the expertise must be recorded under impairment loss to the extent of: 30,000 - 24,700 = 5 5"330000 ttKKRRWW. 106 IAS 36.59 states that if the carrying value exceeds the recoverable amount, the carrying value shall be reduced to its recoverable amount. The recoverable amount is the lower of the value the asset can be sold at on an active market (fair value) and its value in use, which is the total of discounted cash flows resulting from deployment (IAS 36.6). A value in use is e.g., future and discounted rental income from property. If the carrying value exceeds the recoverable amount, an asset is overrated. For most tangible assets, we simply compare the carrying value in the books to the fair value (based on an appraiser’s estimate). The difference is then recorded as impairment loss. GELLENDORFF LLC's records an impairment loss of 5,300 tKRW as Bookkeeping entry (3’). See below the journalised entries recorded in March/ 20X4 and April/ 20X4 in GELLENDORFF LLC’s books. @ 31.03.20X4 Depreciation-20X4 DPR 2,500 Accumulated Depreciation ACC 2,500 (recording three months of depreciation) @ 7.04.20X4 Repair-20X4 REP 7,000 Value added Tax VAT 1,400 Cash/ Bank C/ B 8,400 (repair of the car) @ 8.04.20X4 Impairment Loss-20X4 I/ L 5,300 Accumulated I/ L account AIL 5,300 (impairment loss of the car based on the appraiser's estimate) IAS 36.63 rules depreciation after an impairment loss. Depreciation is adjusted to the asset’s revised valuation. A residual value must be considered for the calculation of the depreciable value if existent. 105 Here, we pretend that a lasting damage remains after repair to demonstrate the recording of an impairment loss. After the repair and recording of the impairment loss, depreciation on GELLENDORFF LLC's car is resumed. The residual value is not affected. Monthly depreciation now is: (24,700 - 10,000) / 21 = 770000 ttKKRRWW/ / mm. Depreciation for the rest of 20X4 is: 9 × 700 = 6 6"330000 ttKKRRWW and is recorded as Bookkeeping entry 106 The impairment loss is not linked to repair cost. Berkau: Financial Statements 8e 7-141 (4’). Observe the journalised entry for the adjusted depreciation below. @ 31.12.20X4 Depreciation-20X4 DPR 6,300 Accumulated Depreciation ACC 6,300 (recording adjusted depreciation after the repair) GELLENDORFF LLC insured its Kia Sorento and confirms to the insurance company its VAT registration status. The insurance refunds the repair based on net amounts as GELLENDORFF LLC claims a VAT refund from the revenue service. Following IAS 16.65 the insurance refund for an item of property, plant, equipment is recorded once granted by the insurance company and not when payments are received. Therefore, we record two Bookkeeping entries at different dates. The compensation is amounting to: 7,000 + 5,300 = 1 122"330000 ttKKRRWW. This is recorded as Bookkeeping entry (5’). Observe the accounts in Figure 7.1. @ 30.08.20X4 Accounts Receivables A/ R 12,300 Insurance Refunds-20X4 IRA 12,300 (approval of the insurance refund) @ 2.09.20X4 Cash/ Bank C/ B 12,300 Accounts Receivables A/ R 12,300 (receipt of insurance compensation) The insurance refund is not recognised through profit or loss as it does not reflect ordinary revenue of the business. It must be recorded through other comprehensive income to indicate that the receipt is extraordinary. 107 D C D C OV 60,000 c/ d 60,000 OV 27,500 b/ d 60,000 (1') 2,500 c/ d 36,300 (4') 6,300 36,300 36,300 b/ d 36,300 Property, plant, equipment PPE Acc depr ACC Figure 7.1: GELLENDORFF LLC’s accounts (i) 107 See: Berkau, C.: Ausweis von Umsatzerlösen und sonstigen Erträgen/ Aufwendungen. In: KOR 24(2024)6. <?page no="142"?> Berkau: Financial Statements 8e 7-142 D C D C (3') 5,300 c/ d 5,300 c/ d 5,300 (3') 5,300 b/ d 5,300 b/ d 5,300 Impairment loss-20X4 I/ L Acc Impairment Loss AIL D C D C (1') 2,500 (2') 7,000 c/ d 7,000 (4') 6,300 c/ d 8,800 b/ d 7,000 8,800 8,800 b/ d 8,800 Depreciation-20X4 DPR Repair-20X4 REP D C D C (2') 1,400 c/ d 1,400 (5') 12,300 (2') 8,400 b/ d 1,400 c/ d 3,900 12,300 12,300 b/ d 3,900 Value added tax VAT Cash/ Bank C/ B D C c/ d 12,300 (5') 12,300 b/ d 12,300 Insurance refunds-20X4 IRA Figure 7.1: GELLENDORFF LLC’s accounts (i) continued How it is Done (Recording an Impairment Loss): (1) Check for overrating of the non-current asset (or group of assets) by comparison of the carrying value to its recoverable amount. (2) If the carrying value exceeds the recoverable amount, calculate the difference. It is the amount for the impairment loss. (3) Record an impairment loss as a debit entry in the Impairment Loss account and a credit entry in the Accumulated Impairment Loss account. (4) Resume depreciation with amounts based on the revised valuation. (You must divide the new carrying amount after deduction of its residual value by the remainder of the useful life.) Ad (ii): Impairment Loss, Delayed Repair and Partial Reversal of an Impairment Loss 108 108 We mark Bookkeeping entries now by ‘’. Next, we repeat the case of GELLENDORFF LLC but slightly alter the story. We now consider the Kia Sorento <?page no="143"?> Berkau: Financial Statements 8e 7-142 D C D C (3') 5,300 c/ d 5,300 c/ d 5,300 (3') 5,300 b/ d 5,300 b/ d 5,300 Impairment loss-20X4 I/ L Acc Impairment Loss AIL D C D C (1') 2,500 (2') 7,000 c/ d 7,000 (4') 6,300 c/ d 8,800 b/ d 7,000 8,800 8,800 b/ d 8,800 Depreciation-20X4 DPR Repair-20X4 REP D C D C (2') 1,400 c/ d 1,400 (5') 12,300 (2') 8,400 b/ d 1,400 c/ d 3,900 12,300 12,300 b/ d 3,900 Value added tax VAT Cash/ Bank C/ B D C c/ d 12,300 (5') 12,300 b/ d 12,300 Insurance refunds-20X4 IRA Figure 7.1: GELLENDORFF LLC’s accounts (i) continued How it is Done (Recording an Impairment Loss): (1) Check for overrating of the non-current asset (or group of assets) by comparison of the carrying value to its recoverable amount. (2) If the carrying value exceeds the recoverable amount, calculate the difference. It is the amount for the impairment loss. (3) Record an impairment loss as a debit entry in the Impairment Loss account and a credit entry in the Accumulated Impairment Loss account. (4) Resume depreciation with amounts based on the revised valuation. (You must divide the new carrying amount after deduction of its residual value by the remainder of the useful life.) Ad (ii): Impairment Loss, Delayed Repair and Partial Reversal of an Impairment Loss 108 108 We mark Bookkeeping entries now by ‘’. Next, we repeat the case of GELLENDORFF LLC but slightly alter the story. We now consider the Kia Sorento Berkau: Financial Statements 8e 7-143 is repaired three months after the accident. An appraiser estimates the value of the car directly after the accident and again after completion of the repair. The latter one leads to a reversal of the impairment loss. Furthermore, we demonstrate a change in residual value caused by the accident. A reporting company is obliged to check changes in asset valuations for assets subjected to impairment losses. An increase of the recoverable amount must reverse or change the impairment loss following IAS 36.114. A reversal of an impairment loss is the complete cancellation thereof whereas a change of the impairment loss only mitigates the value adjustment. Below, we rewind the case study to the day of the accident on 4.04.20X4. We alter the case study regarding to its timeline and car values: the car is repaired on 3.07.20X4 (three month later). Therefore, an adjusted depreciation applies for the time between the accident and the repair. The value directly after the accident is 18,400 tKRW as determined by a certified appraiser, and after repairing it is 22,400 tKRW. The residual value in case (ii) only is 8,000 tKRW as estimated by the appraiser, too. […] On 4.04.20X4, the business car is involved in an accident. Depreciation prior to the accident is recorded as Bookkeeping entry (1’’). The carrying value before the accident is: 60,000 - 7,500 - 2 × 10,000 - 2,500 = 3 300"000000 ttKKRRWW. After the accident, the car’s value is according to the expert’s estimate 18,400 tKRW 109 . The impairment loss as recorded under Bookkeeping entry (2’’) is: 30,000 - 18,400 = 1 111"660000 ttKKRRWW. The impairment loss is recorded on 6.04.20X4. The car’s residual value is not affected (yet). @ 31.03.20X4 Depreciation-20X4 DPR 2,500 Accumulated Depreciation ACC 2,500 (recording three months of depreciation) @ 6.04.20X4 Impairment Loss-20X4 I/ L 11,600 Accumulated I/ L account AIL 11,600 (impairment loss based on the appraiser's estimate) GELLENDORFF LLC takes the car to a car repair shop for repair on 3.07.20X4. Although the car is not in use for three months, depreciation must be recorded based on the valuation after impairment loss recognition. The adjusted depreciation charge for three months is: 3 × (18,400 - 10,000) / 21 = 1 1"220000 ttKKRRWW. See below the journal entries for the adjusted depreciation. 109 The damage value differs from the previous case (i). <?page no="144"?> Berkau: Financial Statements 8e 7-144 @ 30.06.20X4 Depreciation-20X4 DPR 1,200 Accumulated Depreciation ACC 1,200 (3 months depreciation after impairment loss recognition) On 3.07.20X4, GELLENDORFF LLC repairs the damaged Kia Sorento and pays the car repair shop 8,400 tKRW (gross amount). Check Bookkeeping entry (3’’). The repair is an expense and is recognised through profit or loss. After the repair (4’’) the appraiser estimated the new value of the car to 22,400 tKRW and confirms that its residual value decreases to 8,000 tKRW. The Accountant at GELLENDORFF LLC changes the impairment loss accordingly by recording Bookkeeping entry (5’’). This leads to an increase of the carrying value for the car to the extent of: 22,400 - (18,400 - 1,200) = 5 5"220000 ttKKRRWW. The reversal of the impairment loss is recorded as an inverse impairment loss Bookkeeping entry (5’’) with a debit entry made in the Accumulated Impairment Loss account and a credit entry in the (reversal) Impairment Loss account. The latter one is a negative expense recognition. IAS 36.117 caps the value for a reversal of an impairment loss to the value that would apply without any prior impairment loss recognitions. We calculate the maximum for GELLENDORFF LLC’s business car in line with IAS 36.117: Without accident, the Kia Sorento’s value on 3.07.20X4 would have been: 60,000 - (0.75 + 2 + 0.5) × (60,000 - 10,000) / 5 = 2 277"550000 ttKKRRWW. Hence, the change of the impairment loss is within the limits set by IAS 36.117. The value of 22,400 tKRW is below a valuation of 27,500 tKRW. @ 3.07.20X4 Repair-20X4 REP 7,000 Value added Tax VAT 1,400 Cash/ Bank C/ B 8,400 (repair of the car) @ 6.07.20X4 Accumulated I/ L Account AIL 5,200 Impairment Loss-20X4 I/ L 5,200 (changes made to the impairment loss recognised on 6. 04 .20X4) After the adjustment of the impairment loss, depreciation is resumed and recorded for the period July/ 20X4 until December/ 20X4. The adjusted depreciation for the second half of 20X4 considers the reduction of the residual value and is amounting to: 6 × (22,400 - 8,000) / 18 = 4 4"880000 ttKKRRWW. Find below the Bookkeeping entry (6’’). <?page no="145"?> Berkau: Financial Statements 8e 7-144 @ 30.06.20X4 Depreciation-20X4 DPR 1,200 Accumulated Depreciation ACC 1,200 (3 months depreciation after impairment loss recognition) On 3.07.20X4, GELLENDORFF LLC repairs the damaged Kia Sorento and pays the car repair shop 8,400 tKRW (gross amount). Check Bookkeeping entry (3’’). The repair is an expense and is recognised through profit or loss. After the repair (4’’) the appraiser estimated the new value of the car to 22,400 tKRW and confirms that its residual value decreases to 8,000 tKRW. The Accountant at GELLENDORFF LLC changes the impairment loss accordingly by recording Bookkeeping entry (5’’). This leads to an increase of the carrying value for the car to the extent of: 22,400 - (18,400 - 1,200) = 5 5"220000 ttKKRRWW. The reversal of the impairment loss is recorded as an inverse impairment loss Bookkeeping entry (5’’) with a debit entry made in the Accumulated Impairment Loss account and a credit entry in the (reversal) Impairment Loss account. The latter one is a negative expense recognition. IAS 36.117 caps the value for a reversal of an impairment loss to the value that would apply without any prior impairment loss recognitions. We calculate the maximum for GELLENDORFF LLC’s business car in line with IAS 36.117: Without accident, the Kia Sorento’s value on 3.07.20X4 would have been: 60,000 - (0.75 + 2 + 0.5) × (60,000 - 10,000) / 5 = 2 277"550000 ttKKRRWW. Hence, the change of the impairment loss is within the limits set by IAS 36.117. The value of 22,400 tKRW is below a valuation of 27,500 tKRW. @ 3.07.20X4 Repair-20X4 REP 7,000 Value added Tax VAT 1,400 Cash/ Bank C/ B 8,400 (repair of the car) @ 6.07.20X4 Accumulated I/ L Account AIL 5,200 Impairment Loss-20X4 I/ L 5,200 (changes made to the impairment loss recognised on 6. 04 .20X4) After the adjustment of the impairment loss, depreciation is resumed and recorded for the period July/ 20X4 until December/ 20X4. The adjusted depreciation for the second half of 20X4 considers the reduction of the residual value and is amounting to: 6 × (22,400 - 8,000) / 18 = 4 4"880000 ttKKRRWW. Find below the Bookkeeping entry (6’’). Berkau: Financial Statements 8e 7-145 @ 31.12.20X4 Depreciation-20X4 DPR 4,800 Accumulated Depreciation ACC 4,800 (6 months depreciation after recording of an impairment loss) Next, we consider the insurance compensation for GELLENDORFF LLC’s repair expenses and the impairment loss. The repair of 7,000 tKRW is fully covered. The insurance company pays the net amount. The loss in valuation is based on the recorded impairment loss which was partially reversed: 11,600 - 5,200 = 6 6"440000 ttKKRRWW. GELLENDORFF LLC receives a compensation of: 7,000 + 6,400 = 1 133"440000 ttKKRRWW from its insurance recorded as Bookkeeping entry (7’’). The Insurance Refund Account-20X4 account is closed-off to other comprehensive income (not shown). Study the accounts in Figure 7.2. D C D C OV 60,000 c/ d 60,000 OV 27,500 b/ d 60,000 (1'') 2,500 (4'') 1,200 c/ d 36,000 (6'') 4,800 36,000 36,000 b/ d 36,000 Property, plant, equipment PPE Acc depr ACC D C D C (1'') 2,500 (3'') 7,000 c/ d 7,000 (4'') 1,200 b/ d 7,000 (6'') 4,800 c/ d 8,500 8,500 8,500 b/ d 8,500 Depreciation-20X4 DPR Repair-20X4 REP D C D C (2'') 11,600 (5'') 5,200 (5'') 5,200 (2'') 13,400 c/ d 6,400 c/ d 8,200 11,600 11,600 13,400 13,400 b/ d 6,400 b/ d 8,200 Impairment loss-20X4 I/ L Acc Impairment Loss AIL Figure 7.2: GELLENDORFF LLC’s accounts (ii) <?page no="146"?> Berkau: Financial Statements 8e 7-146 D C D C (3'') 1,400 c/ d 1,400 (7'') 13,400 (3'') 8,400 b/ d 1,400 c/ d c/ d 5,000 13,400 13,400 b/ d 5,000 Value added tax VAT Cash/ Bank C/ B D C c/ d 13,400 (7'') 13,400 b/ d 13,400 Insurance refund-20X4 IRA Figure 7.2: GELLENDORFF LLC's accounts (ii) continued How it is Done (Reversal/ Change of an Impairment Loss): (1) After recording an impairment loss, monitor the value of the previously impaired asset. (2) Determine the fair value of the asset. (3) In case the asset is underrated, check how much the valuation of the asset would have been without impairment loss recognition. This value is the maximum for the asset valuation based on a reversal/ change of the impairment loss. If the fair value is below the maximum, continue with step (4a). Otherwise carry out step (4b)! (4a) Reverse/ change the impairment loss to its fair value without exceeding the maximum value. Record a debit entry in the Accumulated Impairment Loss account and a credit entry in the (reversal) Impairment Loss account. A reversal impairment loss or a change of an impairment loss is other comprehensive income. (4b) Reverse/ change the impairment loss to its capped value as in step (4a). Thereafter record a revaluation for the remainder of the value increase. A company must report in the notes about the valuation of its non-current assets. In general, a register of noncurrent assets and a reconciliation statement are prepared based on asset groups. Those statements are disclosed for GELLENDORFF LLC in Figure 7.3 and Figure 7.4 linked to case (ii) as at the yearend of 20X4: <?page no="147"?> Berkau: Financial Statements 8e 7-146 D C D C (3'') 1,400 c/ d 1,400 (7'') 13,400 (3'') 8,400 b/ d 1,400 c/ d c/ d 5,000 13,400 13,400 b/ d 5,000 Value added tax VAT Cash/ Bank C/ B D C c/ d 13,400 (7'') 13,400 b/ d 13,400 Insurance refund-20X4 IRA Figure 7.2: GELLENDORFF LLC's accounts (ii) continued How it is Done (Reversal/ Change of an Impairment Loss): (1) After recording an impairment loss, monitor the value of the previously impaired asset. (2) Determine the fair value of the asset. (3) In case the asset is underrated, check how much the valuation of the asset would have been without impairment loss recognition. This value is the maximum for the asset valuation based on a reversal/ change of the impairment loss. If the fair value is below the maximum, continue with step (4a). Otherwise carry out step (4b)! (4a) Reverse/ change the impairment loss to its fair value without exceeding the maximum value. Record a debit entry in the Accumulated Impairment Loss account and a credit entry in the (reversal) Impairment Loss account. A reversal impairment loss or a change of an impairment loss is other comprehensive income. (4b) Reverse/ change the impairment loss to its capped value as in step (4a). Thereafter record a revaluation for the remainder of the value increase. A company must report in the notes about the valuation of its non-current assets. In general, a register of noncurrent assets and a reconciliation statement are prepared based on asset groups. Those statements are disclosed for GELLENDORFF LLC in Figure 7.3 and Figure 7.4 linked to case (ii) as at the yearend of 20X4: Berkau: Financial Statements 8e 7-147 Asset P, P, E @ cost / @ valuation Acc. depr. Acc. impairment loss Carrying amount [tKRW] [tKRW] [tKRW] [tKRW] Kia Sorento 60,000 (36,000) (6,400) 17,600 . . . Gellendorff LLC REGISTER of NON-CURRENT ASSETS as at 31.12.20X4 Figure 7.3: GELLENDORFF LLC’s register of non-current assets 20X4 20X3 [tKRW] [tKRW] OV as per 1.01.20X4 32,500 42,500 Depreciation (2,500) (10,000) Adjusted depreciation (6,000) Impairment loss (11,600) Reversal impairment loss 5,200 Revaluation Value at per 31.12.20X4 17,600 32,500 Gellendorff LLC P, P, E-RECONCILIATION STATEMENT as at 31.12.20X4 Figure 7.4: GELLENDORFF LLC’s asset-reconciliation statement We recommend studying the case study OBSERVATRY Ltd. in task A7.40. 110 For the case study OBSERVATRY Ltd., knowledge about a disposal of a non-current assets is required. 111 If the diminishing balance method (= declining method) for depreciation applies and an impairment loss is reversed, an extra working is required to calculate the maximum value for the reversal of the impairment loss. IAS 36.117 applies. A change/ reversal of an impairment loss is recorded 110 You will find the task in the study material portal linked to this textbook. 111 Disposals are discussed in our textbook Basics of Accounting, chapter (35). An example for a through profit or loss. Any valuation that exceeds the maximum valuation results in a revaluation. Once a revaluation follows a prior recognised impairment loss, the reporting company must determine whether a portion thereof exceeds the maximum possible reversal of an impairment loss and is subjected to revaluation. The case GROOTVLEI Ltd. below covers declining method and the partial reversal of an impairment loss. Check case study GROOTVLEI Ltd. that is accessible online through Link 7.C. disposal of an asset after its revaluation can be found in chapter (7.16). <?page no="148"?> Berkau: Financial Statements 8e 7-148 Link 7.C: GROOTVLEI Ltd. If a reporting company changes depreciation parameters or the method of depreciation IAS 8.22 and IAS 1.10 require disclosing changes as if made one Accounting period prior to the reporting period to consider adjustments for comparative information (IAS 1.38). Study as an example for altered depreciation parameters case study TYGERVALLEY Ltd. IAS 8 applies. Link 7.D: TYGERVALLEY Ltd. 7.11 Revaluations Revaluations are recorded once a noncurrent asset’s fair value exceeds the carrying value. A fair value is what can be obtained as net selling price on the market. The situation of a revaluation is the opposite of an impairment loss. For revaluations, an asset must be underrated. Revaluations only can apply as subsequent valuations. Even if a company makes a lucky-buy 112 , it must recognise 112 A lucky-buy is to buy sth. at a price below its actual fair market value. the asset at costs. A subsequent valuation can be carried out on the next following balance sheet date. For the application of the revaluation model, we study below a welding machine at TINNEN Ltd. in Stellenbosch, SA. The company’s currency unit is South African Rand ZAR. An income tax rates applies at 30 %. Income taxes are relevant for revaluations, as deferred taxes result from carrying assets at different valuations for commercial and tax purposes. 7.12 C/ S TINNEN Ltd. In contrast to other case studies, we first describe the calculations, discuss the How-it-is-Done-paragraphs and explain the concept by referring to the calculations covered in the case study afterwards. As a short overview of revaluations, we describe its standard procedure: Once a non-current asset is underrated, its carrying value must be increased towards the actual fair market value. The value increase is added to the asset as well as to the equity section as revaluation reserve. No profit is realised as the asset remains in the company’s ownership. IAS 16.42 and IAS 12.18 require that a percentage to the extent the total income tax rate (here: 30 %) of the revaluation reserve must be accrued to deferred tax liabilities. The remaining 70 % stay in the Revaluation Reserves account. Once the asset gets sold, disposed of or depreciated, the full amount (sale/ disposal) or a portion (depreciation) of the de- <?page no="149"?> Berkau: Financial Statements 8e 7-148 Link 7.C: GROOTVLEI Ltd. If a reporting company changes depreciation parameters or the method of depreciation IAS 8.22 and IAS 1.10 require disclosing changes as if made one Accounting period prior to the reporting period to consider adjustments for comparative information (IAS 1.38). Study as an example for altered depreciation parameters case study TYGERVALLEY Ltd. IAS 8 applies. Link 7.D: TYGERVALLEY Ltd. 7.11 Revaluations Revaluations are recorded once a noncurrent asset’s fair value exceeds the carrying value. A fair value is what can be obtained as net selling price on the market. The situation of a revaluation is the opposite of an impairment loss. For revaluations, an asset must be underrated. Revaluations only can apply as subsequent valuations. Even if a company makes a lucky-buy 112 , it must recognise 112 A lucky-buy is to buy sth. at a price below its actual fair market value. the asset at costs. A subsequent valuation can be carried out on the next following balance sheet date. For the application of the revaluation model, we study below a welding machine at TINNEN Ltd. in Stellenbosch, SA. The company’s currency unit is South African Rand ZAR. An income tax rates applies at 30 %. Income taxes are relevant for revaluations, as deferred taxes result from carrying assets at different valuations for commercial and tax purposes. 7.12 C/ S TINNEN Ltd. In contrast to other case studies, we first describe the calculations, discuss the How-it-is-Done-paragraphs and explain the concept by referring to the calculations covered in the case study afterwards. As a short overview of revaluations, we describe its standard procedure: Once a non-current asset is underrated, its carrying value must be increased towards the actual fair market value. The value increase is added to the asset as well as to the equity section as revaluation reserve. No profit is realised as the asset remains in the company’s ownership. IAS 16.42 and IAS 12.18 require that a percentage to the extent the total income tax rate (here: 30 %) of the revaluation reserve must be accrued to deferred tax liabilities. The remaining 70 % stay in the Revaluation Reserves account. Once the asset gets sold, disposed of or depreciated, the full amount (sale/ disposal) or a portion (depreciation) of the de- Berkau: Financial Statements 8e 7-149 ferred taxes is transferred back to revaluation reserves and is accumulated to the Retained Earnings account thereafter. With transfer to retained earnings, revaluation reserves become distributable to shareholders because a profit realisation took place. Data Sheet for TINNEN Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((SStteelllleennbboosscchh)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : MMaannuuffaaccttuurriinngg.. AAccccoouunnttiinngg ppeerriiooddss: : 2200XX33 -- 2200XX44.. IItteemm ooff PPPPEE: : wweellddiinngg mmaacchhiinnee.. CCoosstt ooff aaccqquuiissiittiioonn: : 880000"000000 ZZAARR oonn 22..0011..2200XX33.. DDeepprreecciiaattiioonn: : ddeecclliinniinngg mmeetthhoodd aatt 11..6677 %%/ / mm.. RReevvaalluuaattiioonn oonn 11..0077..2200XX44: : 775500"000000 ZZAARR.. IInn bbootthh AAccccoouunnttiinngg ppeerriiooddss: : ootthheerr rreevvee-nnuuee: : 11"440000"000000 ZZAARR aanndd ootthheerr eexxppeennsseess: : 660000"000000 ZZAARR.. VVAATT rraattee: : 2200 %%.. On 2.01.20X3, TINNEN Ltd. buys a welding machine at 800,000 ZAR (net amount). The useful life of the welding machine is five years and declining method applies for depreciation. The depreciation rate is 1.67%/ m. 113 At first, TINNEN Ltd. records the acquisition and depreciation in 20X3. The paid price is the gross value of: 800,000 × 120% = 9 96600"000000 ZZAARR. TINNEN Ltd. pays the purchase price per bank transfer. Check Bookkeeping entry (1). @ 2.01.20X3 Property, Plant, Equipment PPE 800,000 Value Added TAX VAT 160,000 Cash/ Bank C/ B 960,000 (acquisition of the welding machine) Depreciation follows declining method 114 . At the end of 20X3, the welding machine’s carrying value is: 800,000 × (1 - 1.67%) 12 = 665533"661155..6677 ZZAARR. The difference between the carrying value on 31.12.20X4 and the cost of acquisition gives the annual depreciation in 20X3. It is: 800,000 - 653,615.67 = 114466"338844..3333 ZZAARR. The depreciation is recorded as Bookkeeping entry (2). @ 31.12.20X3 Depreciation-20X3 DPR 146,384 Accumulated Depreciation ACC 146,384 (recognition of depreciation for 20X3) How it is Done (Declining Method, Diminishing Balance Method): (1) Determine the depreciable amount. That is the cost of acquisition less residual value (if exists). (2) Calculate the applicable depreciation rate r, e.g., the monthly or annual depreciation rate (in general, it is given). 113 Study our textbook Basics of Accounting, chapter (17). 114 As an advice for exams: Calculate the carrying values and derive depreciation as the difference between opening and closing balance. <?page no="150"?> Berkau: Financial Statements 8e 7-150 (3) Determine the periods of depreciation, e.g., x months. (4) Calculate the carrying value as at the end of the depreciation period by multiplying the actual carrying value by the factor (1 r) x . (5) To calculate depreciation, deduct the new carrying value from the previous one. (6) Make a debit entry in the Depreciation account and credit accumulated depreciation. Besides of depreciation, TINNEN Ltd. recognises operational expenses (3) of 600,000 ZAR (non-VATable) and earns a revenue (4) of 1,400,000 ZAR (VATable). Observe the profit calculation in Figure 7.5. TINNEN Ltd. carries forward its profit to 20X4. @ 30.06.20X3 Operational Expenses-20X3 OEX 600,000 Cash/ Bank C/ B 600,000 (recognition of expenses for other operations) @ 1.07.20X3 Cash/ Bank C/ B 1,620,000 Value Added Tax VAT 280,000 Revenue-20X3 REV 1,400,000 (revenue recognition in 20X3) On 1.07.20X4, a qualified appraiser estimates the welding machine’s fair value to be 750,000 ZAR. At first, we calculate the welding machine’s book value as per 30.06.20X4 which is one day before its revaluation. TINNEN Ltd. must recognise depreciation for six months and calculates the book value as: 653,615.67 × (1 - 1.67%) 6 = 559900"779977..5566 ZZAARR. The fair value as estimated by the appraiser (= 750,000 ZAR) exceeds the carrying amount and thus requires a revaluation in compliance with IAS 16.31. The estimate from the qualified appraiser is a reliable measurement for the fair value. A Bookkeeping entry made for revaluations resembles replacement Bookkeeping entries. A replacement is the exchange of parts of an asset. If a truck engine is replaced, the carrying value of the old engine is credited to the Property, Plant, Equipment account and the value for the new one is recorded on the debit side. We call Bookkeeping entries made for revaluations replacement Bookkeeping entries because we replace virtually the asset by an asset of higher value instead of adding the difference in valuation. Follow our QR code for studying ordinary replacement Bookkeeping entries with the case study CORAL Ltd. <?page no="151"?> Berkau: Financial Statements 8e 7-150 (3) Determine the periods of depreciation, e.g., x months. (4) Calculate the carrying value as at the end of the depreciation period by multiplying the actual carrying value by the factor (1 r) x . (5) To calculate depreciation, deduct the new carrying value from the previous one. (6) Make a debit entry in the Depreciation account and credit accumulated depreciation. Besides of depreciation, TINNEN Ltd. recognises operational expenses (3) of 600,000 ZAR (non-VATable) and earns a revenue (4) of 1,400,000 ZAR (VATable). Observe the profit calculation in Figure 7.5. TINNEN Ltd. carries forward its profit to 20X4. @ 30.06.20X3 Operational Expenses-20X3 OEX 600,000 Cash/ Bank C/ B 600,000 (recognition of expenses for other operations) @ 1.07.20X3 Cash/ Bank C/ B 1,620,000 Value Added Tax VAT 280,000 Revenue-20X3 REV 1,400,000 (revenue recognition in 20X3) On 1.07.20X4, a qualified appraiser estimates the welding machine’s fair value to be 750,000 ZAR. At first, we calculate the welding machine’s book value as per 30.06.20X4 which is one day before its revaluation. TINNEN Ltd. must recognise depreciation for six months and calculates the book value as: 653,615.67 × (1 - 1.67%) 6 = 559900"779977..5566 ZZAARR. The fair value as estimated by the appraiser (= 750,000 ZAR) exceeds the carrying amount and thus requires a revaluation in compliance with IAS 16.31. The estimate from the qualified appraiser is a reliable measurement for the fair value. A Bookkeeping entry made for revaluations resembles replacement Bookkeeping entries. A replacement is the exchange of parts of an asset. If a truck engine is replaced, the carrying value of the old engine is credited to the Property, Plant, Equipment account and the value for the new one is recorded on the debit side. We call Bookkeeping entries made for revaluations replacement Bookkeeping entries because we replace virtually the asset by an asset of higher value instead of adding the difference in valuation. Follow our QR code for studying ordinary replacement Bookkeeping entries with the case study CORAL Ltd. Berkau: Financial Statements 8e 7-151 Link 7.E: CORAL Ltd. Revaluations only virtually replace the (entire) asset by its revaluated asset. Hence, we pretend to remove the asset carried at costs by the revalued one in our books. To indicate a revaluation, we add the suffix @VALUATION. We apply the P, P, E @COST account if following the cost model and a P, P, E @(RE)VALUATION account when an asset is carried at fair values based on the revaluation model. There are two alternative methods for revaluations: net replacement method and gross replacement method. In general, the net replacement method applies if the fair value is estimated by an appraiser. The revaluation is then recorded at the time of (re)valuation. In contrast, the gross replacement method applies for revaluations based on an increase of purchase costs for the same kind of assets. That method pulls the time of revaluation forward to the acquisition date. In the case study TINNEN Ltd., the net replacement method applies; however, we provide you with a QR code link to the gross replacement method at the end of the case study, for comparison of the methods. Before the revaluation of the welding machine, TINNEN Ltd. records depreciation for the period from January/ 20X4 until June/ 20X4: Depreciation is: 653,615.67 - 590,797.56 = 6 622"881188..1111 ZZAARR. We use capital letters for Bookkeeping entry identification as we now record the next year. Depreciation is shown as Bookkeeping entry (C) because (A) and (B) are used for payments of income tax and VAT liabilities. Check the accounts in Figure 7.5. @ 30.06.20X4 Depreciation-20X4 DPR 62,818 Accumulated Depreciation ACC 62,818 (depreciation recognition for 6 months) Next, we record the net replacement bookkeeping entry. The increase of the machine’s value is: 750,000 - 590,797.56 = 1 15599"220022..4444 ZZAARR. The Bookkeeping entry (R) 115 is shown below. The debit entry in the P, P, E @ VALUATION account adds the new value of the asset and the credit entry in the P, P, E @COST account cancels out the cost of acquisition. Accordingly, accumulated depreciation recorded so far must be deleted as the cost of acquisition less accumulated depreciation gives the book value of the welding machine. The difference in valuations is added to the revaluation reserves. 115 R for Revaluation. <?page no="152"?> Berkau: Financial Statements 8e 7-152 @ 1.07.20X4 (R) P, P, E @Valuation Account PPV 750,000 Accumulated Depreciation ACC 209,202 P, P, E @Cost Account PPC 800,000 Revaluation Reserves R-R 159,202 (net replacement Bookkeeping entry for revaluation) In most jurisdictions, revaluations are not accepted on tax statements. This results in a different asset valuation on the IFRS-balance sheet in comparison to the one for taxation. Therefore, an immediate sale of the welding machine at the fair market value 116 after its revaluation leads to a taxable profit of: 750,000 - 590,797.56 = 1 15599"220022..4444 ZZAARR as this is the difference between the fair value and the carrying value on the balance sheet for taxation. Based on our simplified income tax model, the profit from an immediate sale of the welding machine results in income taxes of: 159,202.44 × 30% = 4 477"776600..7733 ZZAARR. IAS 12 deals with income tax recognition. In compliance with IAS 12.20, TINNEN Ltd. must recognise the potential income taxes from a revaluation as deferred tax liability. As the Bookkeeping entry is directly linked to the revaluation, we indicate it by (R’). @ 1.07.20X4 (R') Revaluation Reserves R-R 47,761 Deferred Tax Liability DTL 47,761 (disclosure of deferred tax liability) For the full picture, study the accounts in Figure 7.5. When a revaluated asset is depreciated, the revaluation reserves and the deferred taxes get proportionally dissolved. We study TINNEN Ltd. during the second half of 20X4: TINNEN Ltd. depreciates the welding machine after revaluation. Depreciation is now based on the new carrying value of 750,000 ZAR. Hence, depreciation for the months July/ 20X4 until December/ 20X4 is: 750,000 - 750,000 × (1 - 1.67%) 6 = 7722"008811..4488 ZZAARR. Depreciation is recorded as Bookkeeping entry (D). The percentage of depreciation based on the entire depreciable amount is: 72,081.48 / 750,000 = 9 9..6611%%. Therefore, TINNEN Ltd. dissolves 9.61 % of the deferred tax liabilities: 9.61% × 47,760.73 = 44"558899..8811 ZZAARR and of the initially recorded revaluation reserves: 9.61% × 159,202.44 = 1 155"229999..3355 ZZAARR. The Bookkeeping entries (D) and (D’) follow IAS 16.41. 116 Remember, the fair market value is the value the machine is revalued at. <?page no="153"?> Berkau: Financial Statements 8e 7-152 @ 1.07.20X4 (R) P, P, E @Valuation Account PPV 750,000 Accumulated Depreciation ACC 209,202 P, P, E @Cost Account PPC 800,000 Revaluation Reserves R-R 159,202 (net replacement Bookkeeping entry for revaluation) In most jurisdictions, revaluations are not accepted on tax statements. This results in a different asset valuation on the IFRS-balance sheet in comparison to the one for taxation. Therefore, an immediate sale of the welding machine at the fair market value 116 after its revaluation leads to a taxable profit of: 750,000 - 590,797.56 = 1 15599"220022..4444 ZZAARR as this is the difference between the fair value and the carrying value on the balance sheet for taxation. Based on our simplified income tax model, the profit from an immediate sale of the welding machine results in income taxes of: 159,202.44 × 30% = 4477"776600..7733 ZZAARR. IAS 12 deals with income tax recognition. In compliance with IAS 12.20, TINNEN Ltd. must recognise the potential income taxes from a revaluation as deferred tax liability. As the Bookkeeping entry is directly linked to the revaluation, we indicate it by (R’). @ 1.07.20X4 (R') Revaluation Reserves R-R 47,761 Deferred Tax Liability DTL 47,761 (disclosure of deferred tax liability) For the full picture, study the accounts in Figure 7.5. When a revaluated asset is depreciated, the revaluation reserves and the deferred taxes get proportionally dissolved. We study TINNEN Ltd. during the second half of 20X4: TINNEN Ltd. depreciates the welding machine after revaluation. Depreciation is now based on the new carrying value of 750,000 ZAR. Hence, depreciation for the months July/ 20X4 until December/ 20X4 is: 750,000 - 750,000 × (1 - 1.67%) 6 = 7722"008811..4488 ZZAARR. Depreciation is recorded as Bookkeeping entry (D). The percentage of depreciation based on the entire depreciable amount is: 72,081.48 / 750,000 = 9 9..6611%%. Therefore, TINNEN Ltd. dissolves 9.61 % of the deferred tax liabilities: 9.61% × 47,760.73 = 44"558899..8811 ZZAARR and of the initially recorded revaluation reserves: 9.61% × 159,202.44 = 1 155"229999..3355 ZZAARR. The Bookkeeping entries (D) and (D’) follow IAS 16.41. 116 Remember, the fair market value is the value the machine is revalued at. Berkau: Financial Statements 8e 7-153 @ 31.12.20X4 (D') Deferred Tax Liability DTL 4,590 Revaluation Reserves R-R 4,590 (dissolving deferred tax liability) Revaluation Reserves R-R 15,299 Retained Earnings R/ E 15,299 (dissolving revaluation reserves due to depreciation) Next, we calculate the profit at TINNEN Ltd. In 20X4, the operating expenses and the revenue are the same as in 20X3. The net profit in 20X4 is: 1,400,000 - 134,899.59 - 600,000 = 6 65555"110000..4411 ZZAARR. It considers depreciation of the revalued welding machine as expenses to the extent of 62,818.11 + 72,081.48 = 1 13344"889999..5599 ZZAARR for the entire year. We here follow our simplified tax calculation based on the total income tax rate of 30 %. The tax calculation follows an asset valuation at costs and deviates from depreciation based on IFRSs. Once profit calculations differ, deferred tax must be disclosed. At TINNEN Ltd., the depreciation for taxation is: 653,615.67 - 653,615.67 × (1 - 1.67%) 12 = 111199"559988..8866 ZZAARR. The income tax calculation therefore gives: (1,400,000 - 119,598.86 - 600,000) × 30% = 2 20044"112200..3344 ZZAARR. The income taxes apply for the IFRSs financial statements. Technically, we copy them from the Tax-Profit and Loss-20X4 account into the IFRS-Profit and Loss -20X4 account. The copied income tax expenses exceed those following IFRS profit calculation. The difference in tax calculations is here caused by higher depreciation following IFRSs and is amounting to: 204,120.34 - 665,100.41 × 30% = 4 4"559900..2222 ZZAARR. It is disclosed as deferred tax income, which gets deducted from actual tax expenses on the income statement and is debited to the Retained Earnings account. Study Bookkeeping entry (G). Note, that the debit entry in the Retained Earnings account means that those income taxes are not refunded by the revenue service. D C D C (4) 1,680,000 (1) 960,000 (2) 146,384 P3L 146,384 (3) 600,000 c/ d 120,000 1,680,000 1,680,000 b/ d 120,000 (A) 196,085 (F) 1,680,000 (B) 120,000 (E) 600,000 c/ d 883,915 1,800,000 1,800,000 b/ d 883,915 Cash/ Bank C/ B Depreciation-20X3 DPR Figure 7.5: TINNEN Ltd.’s accounts (20X4) <?page no="154"?> Berkau: Financial Statements 8e 7-154 D C D C c/ d 146,384 (2) 146,384 (3) 600,000 P3L 600,000 (R) 209,202 b/ d 146,384 (C) 62,818 209,202 209,202 c/ d 72,081 (D) 72,081 b/ d 72,081 Acc depr ACC Operational expenses-20X3 OEX D C D C (1) 800,000 c/ d 800,000 (1) 160,000 (4) 280,000 b/ d 800,000 (R) 800,000 c/ d 120,000 280,000 280,000 (B) 120,000 b/ d 120,000 c/ d 280,000 (F) 280,000 400,000 400,000 b/ d 280,000 PPE @COST Value added tax VAT D C D C P3L 1,400,000 (4) 1,400,000 DPR 146,384 REV 1,400,000 OEP 600,000 NP3 653,616 1,400,000 1,400,000 ITL 196,085 b/ d 653,616 R/ E 457,531 653,616 653,616 Revenue-20X3 REV Profit and Loss-20X3 P3L D C D C c/ d 196,085 P3L 196,085 c/ d 457,531 P3L 457,531 (A) 196,085 b/ d 196,085 (G) 4,590 b/ d 457,531 c/ d 204,120 ITL 204,120 (D'') 15,299 400,205 400,205 c/ d 933,810 P4L 465,570 b/ d 204,205 938,400 938,400 b/ d 933,810 Income tax liabilities ITL Retained earnings R/ E Figure 7.5: TINNEN Ltd.’s accounts (20X4) continued <?page no="155"?> Berkau: Financial Statements 8e 7-154 D C D C c/ d 146,384 (2) 146,384 (3) 600,000 P3L 600,000 (R) 209,202 b/ d 146,384 (C) 62,818 209,202 209,202 c/ d 72,081 (D) 72,081 b/ d 72,081 Acc depr ACC Operational expenses-20X3 OEX D C D C (1) 800,000 c/ d 800,000 (1) 160,000 (4) 280,000 b/ d 800,000 (R) 800,000 c/ d 120,000 280,000 280,000 (B) 120,000 b/ d 120,000 c/ d 280,000 (F) 280,000 400,000 400,000 b/ d 280,000 PPE @COST Value added tax VAT D C D C P3L 1,400,000 (4) 1,400,000 DPR 146,384 REV 1,400,000 OEP 600,000 NP3 653,616 1,400,000 1,400,000 ITL 196,085 b/ d 653,616 R/ E 457,531 653,616 653,616 Revenue-20X3 REV Profit and Loss-20X3 P3L D C D C c/ d 196,085 P3L 196,085 c/ d 457,531 P3L 457,531 (A) 196,085 b/ d 196,085 (G) 4,590 b/ d 457,531 c/ d 204,120 ITL 204,120 (D'') 15,299 400,205 400,205 c/ d 933,810 P4L 465,570 b/ d 204,205 938,400 938,400 b/ d 933,810 Income tax liabilities ITL Retained earnings R/ E Figure 7.5: TINNEN Ltd.’s accounts (20X4) continued Berkau: Financial Statements 8e 7-155 D C D C (C) 62,818 (R) 750,000 c/ d 750,000 (D) 72,081 c/ d 134,900 b/ d 750,000 134,900 134,900 b/ d 134,900 P4L 134,900 Depreciation-20X4 DPR PPE @VALUATION D C D C (R') 47,761 (R) 159,202 (D') 4,590 (R') 47,761 (D'') 15,299 (D') 4,590 c/ d 43,171 c/ d 100,733 47,761 47,761 163,793 163,793 b/ d 43,171 b/ d 100,733 Revaluation reserves R-R Deferred tax liabilities DTL D C D C (E) 600,000 P4L 600,000 P4L 1,400,000 (F) 1,400,000 Operational expenses-20X4 OEX Revenue-20X4 REV D C D C DPR 134,900 REV 1,400,000 DPR 119,599 REV 1,400,000 OEX 600,000 OEX 600,000 NP4 665,100 NP4 680,401 1,400,000 1,400,000 1,400,000 1,400,000 ITL 204,120 b/ d 665,100 ITL 204,120 b/ d 680,401 R/ E 465,570 (G) 4,590 R/ E 476,281 669,691 669,691 680,401 680,401 Profit and Loss-20X4 P4L Tax-Profit and Loss-20X4 P4L Figure 7.5: TINNEN Ltd.’s accounts (20X4) continued We summarise revaluations by a Howit-is-Done paragraph. For the reference to Bookkeeping entries, we consider the application of one P, P, E account per asset. Carrying items of property, plant and equipment in separate accounts is called Asset Management. We refer to that procedure now in the How-it-is-Done paragraph below. How it is Done (Revaluations, Net Replacement Method): (1) Determine the fair value, e.g., by a valuation from a certified appraiser. (2) Create a new P, P, E @VALUATION account and enter the fair value on the debit side. <?page no="156"?> Berkau: Financial Statements 8e 7-156 (3) Make a credit entry in the previous P, P, E @COST account to close it off. (4) Close-off the Accumulated Depreciation account by making a debit entry. (5) If the revaluation follows an impairment loss close-off the Accumulated Impairment Loss account after reversing the impairment loss completely (to the maximum value) through profit or loss. (6) Record the difference in valuation on the credit side of the Revaluation Reserves account. (7) If the jurisdiction prohibits revaluations, deduct the tax portion from revaluations reserves and add them to the Deferred Tax Liabilities account. How it is Done (Depreciation of Revalued Assets): (1) Determine depreciation expenses based on IFRS valuations. (2) Make a debit entry in the Depreciation account and credit the Accumulated Depreciation account. (3) Calculate the percentage of depreciation based on the depreciable amount. (4) Dissolve the same percentage of the deferred tax liabilities by making a debit entry in the Deferred Tax Liability account and a credit entry in the Revaluation Reserves account. (5) Dissolve the same percentage of the ordinary revaluation reserves by debiting the Revaluation Reserves account and making a credit entry in the Retained Earnings account. (6) Calculate earnings before taxes following IFRSs. (7) Calculate earnings before taxes along national tax law and determine income tax expenses. (8) Copy the income tax expenses into the IFRS-Profit and Loss account. (9) The income taxes exceed the EBT IFRS × 30% tax calculation. Therefore, calculate the difference and deduct it from the income taxes in the Profit and Loss account. Credit retained earnings. (10) Calculate the annual surplus (EAT) and transfer it to retained earnings. So far, we only discussed the Bookkeeping entries for recording deferred taxes caused by revaluations in compliance with IAS 12. Next, we discuss the reason for recording and dissolving deferred tax liabilities and revaluation reserves. For this we refer to the case study TINNEN Ltd. Revaluations and deferred taxes are recorded on commercial financial <?page no="157"?> Berkau: Financial Statements 8e 7-156 (3) Make a credit entry in the previous P, P, E @COST account to close it off. (4) Close-off the Accumulated Depreciation account by making a debit entry. (5) If the revaluation follows an impairment loss close-off the Accumulated Impairment Loss account after reversing the impairment loss completely (to the maximum value) through profit or loss. (6) Record the difference in valuation on the credit side of the Revaluation Reserves account. (7) If the jurisdiction prohibits revaluations, deduct the tax portion from revaluations reserves and add them to the Deferred Tax Liabilities account. How it is Done (Depreciation of Revalued Assets): (1) Determine depreciation expenses based on IFRS valuations. (2) Make a debit entry in the Depreciation account and credit the Accumulated Depreciation account. (3) Calculate the percentage of depreciation based on the depreciable amount. (4) Dissolve the same percentage of the deferred tax liabilities by making a debit entry in the Deferred Tax Liability account and a credit entry in the Revaluation Reserves account. (5) Dissolve the same percentage of the ordinary revaluation reserves by debiting the Revaluation Reserves account and making a credit entry in the Retained Earnings account. (6) Calculate earnings before taxes following IFRSs. (7) Calculate earnings before taxes along national tax law and determine income tax expenses. (8) Copy the income tax expenses into the IFRS-Profit and Loss account. (9) The income taxes exceed the EBT IFRS × 30% tax calculation. Therefore, calculate the difference and deduct it from the income taxes in the Profit and Loss account. Credit retained earnings. (10) Calculate the annual surplus (EAT) and transfer it to retained earnings. So far, we only discussed the Bookkeeping entries for recording deferred taxes caused by revaluations in compliance with IAS 12. Next, we discuss the reason for recording and dissolving deferred tax liabilities and revaluation reserves. For this we refer to the case study TINNEN Ltd. Revaluations and deferred taxes are recorded on commercial financial Berkau: Financial Statements 8e 7-157 statements that follow IFRSs. A revaluation is never recorded through profit or loss as no profit realisation takes place. Therefore, a revaluation increases equity to the same extent as assets increase in value. Following IAS 12.15, a deferred tax liability is recognised for taxable, temporary differences. With a revaluation, taxable differences exist from the revaluation (deferred tax liabilities) and from higher depreciations recorded in periods after the revaluation (deferred tax income). The difference is temporary because revaluations are cancelled out by depreciations. 117 For the measurement of deferred taxes IAS 12.51 applies. When we revalue TINNEN Ltd.'s welding machine, both sides on the balance sheet increase by 159,202.22 ZAR. On the credit side, the increase is split at a 70 : 30 ratio between revaluations and deferred tax liability. The revaluation reserves are: 159,202.44 - 47,760.73 = 111111"444411..7711 ZZAARR and the deferred tax liabilities are: 159,202.44 × 30% = 4 477"776600..7733 ZZAARR. For a realisation of profit out of a revaluation, a company must either (1) sell/ dispose of the asset or (2) depreciate it. (1) Selling the welding machine immediately at its fair value (= 750,000 ZAR) results in a zero profit in the commercial financial statements and as a profit on disposal of: 750,000 - 590,797.56 = 1 15599"220022..4444 ZZAARR for taxation. The income taxes for the gain on disposal are: 30% × 159,202.44 = 4 477"776600..7733 ZZAARR. 117 For that reason, temporary differences do not result from revaluations of land, see the case study YSTERFONTEIN Ltd. in this chapter. As the company disclosed deferred taxes of 47,760.73 ZAR at the time of revaluation, it dissolves them due to the sale and accrues them to revaluation reserves. It further must dissolve the complete revaluation reserves because the revalued asset is disposed of: 111,441.71 + 47,760.73 = 1 15599"220022..4444 ZZAARR. This amount is added to retained earnings and becomes distributable to the owners. At the same time, a deferred tax income of 47,760.73 ZAR is added to the Retained Earnings account on the debit side. It results from the profit difference between the statement for taxation and the IFRS statement of: 159,202.44 × 30% = 4 477"776600..7733 ZZAARR. Remember, the IFRS gain on disposal is zero. Consequently, TINNEN Ltd.’s shareholders are entitled to receive a dividend of: 159,202.44 - 47,760.73 = 111111"444411..7711 ZZAARR in total, which is the gain on disposal after income tax. (2) If the company depreciates the asset to a certain extent - as TINNEN Ltd. did at 9.61 % of the new value, it dissolves deferred tax liabilities and revaluation reserves to the same percentage. This leads to 4,589.81 ZAR deferred taxes dissolved and added to the revaluation reserves and to dissolving 15,299.35 ZAR revaluation reserves. The latter amount is accrued to retained earnings. This way, 15,299.35 ZAR become distributable to shareholders. At the same time, a profit difference applies because the depreciation of a revalued machine exceeds depreciation for tax purposes where the asset is carried at cost. In case of TINNEN Ltd., we can take the difference from Figure 7.5 (DPR on the Profit and Loss accounts). It is: 134,899.59 - <?page no="158"?> Berkau: Financial Statements 8e 7-158 119,598.86 = 1 155"330000..7733 ZZAARR. The difference in depreciation results in a difference of profits which is: 680,401.14 - 665,100.41 = 1 155"330000..7733 ZZAARR and results in an income tax difference of: 15,300.73 × 30% = 4 4"559900..2222 ZZAARR. It is termed a deferred tax income as it is deducted from income tax expenses. As its contra entry is recorded on the debit side of the Retained Earnings account, it reduces the dissolved revaluation reserves for their tax portion towards: 15,299.35 - 4,589.81 = 1 100"770099..5544 ZZAARR. That is a partial (9.61 %) realisation of the revaluation of the welding machine after tax. To double-check our calculations, we multiply the distributable amount for TINNEN Ltd.’s owners as discussed for the sale (1) with the percentage of depreciation. This gives: 111,441.71 × 9.61 % = 1 100"770099..5555 ZZAARR. If an asset has a residual value, the above shown Bookkeeping entries will result a remainder of the revaluation reserves. They are dissolved once the company disposes of the revalued asset. Thus, the requirement for equality of retained earnings based on IFRSs and on national tax law only is fulfilled after the asset has been depreciated completely or after its final disposal. If the calculation of the percentage of depreciation is based on the depreciable amount revaluation reserves are completely dissolved together with the depreciation. We explain both alternatives below with the case study STEENBERG Ltd. In case (i) we dissolve revaluation reserves based on the depreciable amount. In case (ii), we calculate the percentage based on the complete fair value of the revalued asset. We can prove, that in case (ii) retained earnings will differ over the useful life. At the end, both cases give the same balancing figure in the Retained Earnings account. 7.13 C/ S STEENBERG Ltd. - Case (i) Data sheet for STEENBERG Ltd. DDoommiicciillee: : GGrreeaatt BBrriittiinn ((MMaanncchheesstteerr)).. RReeppoorrttiinngg ccuurrrreennccyy: : GGBBPP.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. AAccccoouunnttiinngg ppeerriiooddss: : 2200XX88 -- 2200XX99.. IItteemm ooff PPPPEE: : VVWW UUpp.. CCoosstt ooff aaccqquuiissiittiioonn: : 1122"000000 GGBBPP oonn 22..0011..2200XX33.. DDeepprreecciiaattiioonn: : ssttrraaiigghhtt--lliinnee mmeetthhoodd oovveerr 55 yyeeaarrss" rreessiidduuaall vvaalluuee: : 22"440000 GGBBPP.. RReevvaalluuaattiioonn oonn 11..0033..2200XX99: : 1111"550000 GGBBPP.. VVAATT iiggnnoorreedd.. STEENBERG Ltd. owns a business car VW Up. The car's cost of acquisition is 12,000 GBP on 1.07.20X8. Depreciation follows straight-line method over a useful life of 5 years. A residual value of 2,400 GBP applies. On 1.03.20X9, the car is revalued. Its fair value is then 11,500 GBP. Following IFRSs, depreciation in 20X9 is: 320 + 10 × (11,500 - 2,400)/ (60 - 6 - 2) = 22"007700 GGBBPP. The revaluation reserves are: 11,500 - (12,000 - 960 - 320) = 7 78800 GGBBPP. STEENBERG Ltd. transfers 30 % thereof to deferred tax liabilities, which is: 30% × 780 = 223344 GGBBPP. Excluding the residual value, the percentage of depreciation (after 1.03.20X9) is: 1,750 / (11,500 - 2,400) = 1199..2233%%. By depreciating its car, STEENBERG Ltd. dissolves 19.23 % of the <?page no="159"?> Berkau: Financial Statements 8e 7-158 119,598.86 = 1 155"330000..7733 ZZAARR. The difference in depreciation results in a difference of profits which is: 680,401.14 - 665,100.41 = 1 155"330000..7733 ZZAARR and results in an income tax difference of: 15,300.73 × 30% = 4 4"559900..2222 ZZAARR. It is termed a deferred tax income as it is deducted from income tax expenses. As its contra entry is recorded on the debit side of the Retained Earnings account, it reduces the dissolved revaluation reserves for their tax portion towards: 15,299.35 - 4,589.81 = 1 100"770099..5544 ZZAARR. That is a partial (9.61 %) realisation of the revaluation of the welding machine after tax. To double-check our calculations, we multiply the distributable amount for TINNEN Ltd.’s owners as discussed for the sale (1) with the percentage of depreciation. This gives: 111,441.71 × 9.61 % = 1 100"770099..5555 ZZAARR. If an asset has a residual value, the above shown Bookkeeping entries will result a remainder of the revaluation reserves. They are dissolved once the company disposes of the revalued asset. Thus, the requirement for equality of retained earnings based on IFRSs and on national tax law only is fulfilled after the asset has been depreciated completely or after its final disposal. If the calculation of the percentage of depreciation is based on the depreciable amount revaluation reserves are completely dissolved together with the depreciation. We explain both alternatives below with the case study STEENBERG Ltd. In case (i) we dissolve revaluation reserves based on the depreciable amount. In case (ii), we calculate the percentage based on the complete fair value of the revalued asset. We can prove, that in case (ii) retained earnings will differ over the useful life. At the end, both cases give the same balancing figure in the Retained Earnings account. 7.13 C/ S STEENBERG Ltd. - Case (i) Data sheet for STEENBERG Ltd. DDoommiicciillee: : GGrreeaatt BBrriittiinn ((MMaanncchheesstteerr)).. RReeppoorrttiinngg ccuurrrreennccyy: : GGBBPP.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. AAccccoouunnttiinngg ppeerriiooddss: : 2200XX88 -- 2200XX99.. IItteemm ooff PPPPEE: : VVWW UUpp.. CCoosstt ooff aaccqquuiissiittiioonn: : 1122"000000 GGBBPP oonn 22..0011..2200XX33.. DDeepprreecciiaattiioonn: : ssttrraaiigghhtt--lliinnee mmeetthhoodd oovveerr 55 yyeeaarrss" rreessiidduuaall vvaalluuee: : 22"440000 GGBBPP.. RReevvaalluuaattiioonn oonn 11..0033..2200XX99: : 1111"550000 GGBBPP.. VVAATT iiggnnoorreedd.. STEENBERG Ltd. owns a business car VW Up. The car's cost of acquisition is 12,000 GBP on 1.07.20X8. Depreciation follows straight-line method over a useful life of 5 years. A residual value of 2,400 GBP applies. On 1.03.20X9, the car is revalued. Its fair value is then 11,500 GBP. Following IFRSs, depreciation in 20X9 is: 320 + 10 × (11,500 - 2,400)/ (60 - 6 - 2) = 22"007700 GGBBPP. The revaluation reserves are: 11,500 - (12,000 - 960 - 320) = 7 78800 GGBBPP. STEENBERG Ltd. transfers 30 % thereof to deferred tax liabilities, which is: 30% × 780 = 223344 GGBBPP. Excluding the residual value, the percentage of depreciation (after 1.03.20X9) is: 1,750 / (11,500 - 2,400) = 1199..2233%%. By depreciating its car, STEENBERG Ltd. dissolves 19.23 % of the Berkau: Financial Statements 8e 7-159 revaluation reserves and deferred tax liability. Therefore, revaluation reserves of: 19.23% × 780 = 1 14499..9999 GGBBPP are dissolved. Check below the accounts for case (i) where the percentage of depreciation is based on the depreciable amount. D C D C OV 12,000 (R) 12,000 OV 960 c/ d 1,280 DPR 320 1,280 1,280 (R) 1,280 b/ d 1,280 P, P, E-Up @cost [1.07.20X8] PPC Accumulated depreciation ACC D C D C (R) 11,500 c/ d 11,500 (R2) 234 (R) 780 b/ d 11,500 c/ d 546 780 780 R/ E 150 b/ d 546 c/ d 441 DTL 45 591 591 b/ d 441 P, P, E-UP @ VALUATION PPV Revaluation reserves account RR D C D C c/ d 1,750 1,750 RR 45 (R2) 234 b/ d 1,750 c/ d 189 234 234 0 b/ d 189 Accumulated depreciation AC2 Deferred tax liabilities D C D C DTI 14 RR 150 DPR 320 REV 25,000 c/ d 16,156 P8L 16,020 DPR 1,750 16,170 16,170 EBT 22,930 b/ d 16,156 25,000 25,000 ITL 6,924 b/ d 22,930 R/ E 16,020 DTI 14 22,944 22,944 Retained earnings R/ E IFRS-Profit and Loss-20X8 P8L Figure 7.6: STEENBERG Ltd.’s accounts (i) <?page no="160"?> Berkau: Financial Statements 8e 7-160 D C D C DPR 1,920 REV 25,000 c/ d 6,924 PTL 6,924 EBT 23,080 b/ d 6,924 25,000 25,000 ITL 6,924 b/ d 23,080 R/ E 16,156 TAX-Profit and Loss-20X8 PTL Income tax liabilities ITL Figure 7.6: STEENBERG Ltd.’s accounts (i) continued In Figure 7.6, we calculate the deferred tax income: For the profit calculation, we randomly pick a cash revenue of 25,000 GBP. We calculate income tax expenses of: 30% × (25,000 - (12,000 - 2,400)/ 5) = 66"992244 GGBBPP. The deferred tax income is: 30% × (30% × (25,000 - 2,070) - 6,924) = 1133..5500 GGBBPP. The annual surplus is calculated in the IFRS-Profit and Loss account: (25,000 - 2,070) + 13.50 - 6,924 = 1166"001199..5500 GGBBPP. As retained earnings increase by annual surplus and dissolved revaluation reserves and decrease by deferred tax income, the increase in retained earnings on the IFRS balance sheet is: 16,019.50 + 150 - 13.50 = 1 166"115566 GGBBPP. The equity increase on the tax balance sheet is identical: (1 - 30%) × (25,000 - (12,000 - 2,400)/ 5) = 1 166"115566 GGBBPP. The equity increases are colour-marked in Figure 7.6. However, this does not work, if we calculate depreciation based on full values. We demonstrate the same case study as case (ii) below. 7.14 C/ S STEENBERG Ltd. - Case (ii) We now base the percentage of depreciation and for dissolving revaluation reserves on the entire asset value, instead of its depreciable value. The percentage in case (ii) is: 1,750 / 11,500 = 1 155..2222%% 118 . In case (ii), the dissolved deferred tax liabilities and the dissolved revaluations are less. The profit calculation does not change; therefore, the deferred tax income remains the same. The lower dissolved revaluation reserves show in the Retained Earnings account. Now, retained earnings following IFRSs are 16,125 GBP and retained earnings on the Profit and Loss account for taxes is still 16,156 GBP. Check the accounts in Figure 7.7. An equality of retained earnings will only show after complete depreciation and after the remainder of the revaluation reserves and deferred tax liabilities have been dissolved. This is, why it is recommended calculating the percentage for dissolving revaluation reserves and deferred tax income solely on the depreciable amount. However, in compliance with IFRSs, both cases (i) and (ii) are accepted. 118 For our calculations, we apply the fraction instead of the rounded percentage. <?page no="161"?> Berkau: Financial Statements 8e 7-160 D C D C DPR 1,920 REV 25,000 c/ d 6,924 PTL 6,924 EBT 23,080 b/ d 6,924 25,000 25,000 ITL 6,924 b/ d 23,080 R/ E 16,156 TAX-Profit and Loss-20X8 PTL Income tax liabilities ITL Figure 7.6: STEENBERG Ltd.’s accounts (i) continued In Figure 7.6, we calculate the deferred tax income: For the profit calculation, we randomly pick a cash revenue of 25,000 GBP. We calculate income tax expenses of: 30% × (25,000 - (12,000 - 2,400)/ 5) = 66"992244 GGBBPP. The deferred tax income is: 30% × (30% × (25,000 - 2,070) - 6,924) = 1133..5500 GGBBPP. The annual surplus is calculated in the IFRS-Profit and Loss account: (25,000 - 2,070) + 13.50 - 6,924 = 1166"001199..5500 GGBBPP. As retained earnings increase by annual surplus and dissolved revaluation reserves and decrease by deferred tax income, the increase in retained earnings on the IFRS balance sheet is: 16,019.50 + 150 - 13.50 = 1166"115566 GGBBPP. The equity increase on the tax balance sheet is identical: (1 - 30%) × (25,000 - (12,000 - 2,400)/ 5) = 1 166"115566 GGBBPP. The equity increases are colour-marked in Figure 7.6. However, this does not work, if we calculate depreciation based on full values. We demonstrate the same case study as case (ii) below. 7.14 C/ S STEENBERG Ltd. - Case (ii) We now base the percentage of depreciation and for dissolving revaluation reserves on the entire asset value, instead of its depreciable value. The percentage in case (ii) is: 1,750 / 11,500 = 1 155..2222%% 118 . In case (ii), the dissolved deferred tax liabilities and the dissolved revaluations are less. The profit calculation does not change; therefore, the deferred tax income remains the same. The lower dissolved revaluation reserves show in the Retained Earnings account. Now, retained earnings following IFRSs are 16,125 GBP and retained earnings on the Profit and Loss account for taxes is still 16,156 GBP. Check the accounts in Figure 7.7. An equality of retained earnings will only show after complete depreciation and after the remainder of the revaluation reserves and deferred tax liabilities have been dissolved. This is, why it is recommended calculating the percentage for dissolving revaluation reserves and deferred tax income solely on the depreciable amount. However, in compliance with IFRSs, both cases (i) and (ii) are accepted. 118 For our calculations, we apply the fraction instead of the rounded percentage. Berkau: Financial Statements 8e 7-161 D C D C OV 12,000 (R) 12,000 OV 960 c/ d 1,280 DPR 320 1,280 1,280 (R) 1,280 b/ d 1,280 P, P, E-Up @cost [1.07.20X8] PPC Accumulated depreciation ACC D C D C (R) 11,500 c/ d 11,500 (R2) 234 (R) 780 b/ d 11,500 c/ d 546 780 780 R/ E 119 b/ d 546 c/ d 463 DTL 36 582 582 b/ d 463 P, P, E-UP @ VALUATION PPV Revaluation reserves R-R D C D C c/ d 1,750 1,750 RR 36 (R2) 234 b/ d 1,750 c/ d 198 234 234 0 b/ d 198 Accumulated depreciation AC2 Deferred tax liabilities DTL D C D C DTI 14 RR 119 DPR 320 REV 25,000 c/ d 16,125 P8L 16,020 DPR 1,750 16,138 16,138 EBT 22,930 b/ d 16,125 25,000 25,000 ITL 6,924 b/ d 22,930 R/ E 16,020 DTI 14 22,944 22,944 Retained earnings R/ E IFRS-Profit and Loss-20X8 P8L D C D C DPR 1,920 REV 25,000 c/ d 6,924 PTL 6,924 EBT 23,080 b/ d 6,924 25,000 25,000 ITL 6,924 b/ d 23,080 R/ E 16,156 TAX-Profit and Loss-20X8 PTL Income tax liabilities ITL Figure 7.7: STEENBERG Ltd.'s accounts (ii) <?page no="162"?> Berkau: Financial Statements 8e 7-162 An alternative to the net replacement method is the gross replacement method. It applies in cases if the revaluation is caused by a price increase. Follow below the Link 7.F to the case study JANSSENS Ltd. Link 7.F: JANSSENS Ltd. 7.15 Disposal of Assets A disposal of an asset is best recorded through a Realisation account. 119 In case an item of property, plant and equipment is disposed of after prior revaluation, we must dissolve the revaluation reserves and deferred tax liabilities completely towards retained earnings. Only the disposal proceeds and the carrying value (Property, Plant and Equipment account, Accumulated Depreciation account and Accumulated Impairment Loss account) are closedoff to the Realisation account. The Realisation account is closed-off to the Profit and Loss account - we say is recorded through profit or loss although in case of disposals the expression other comprehensive income is more appropriate because the disposal of non-current assets is no revenue. IAS 16.67 states, that a de-recognition must be recorded for disposals or once no further benefits are expected from 119 Study our Basics of Accounting, chapters (34) and (35). 120 In South Africa, no acquisition tax for property applies. However, the SARS imposes a capital the asset. A profit (rather referred to as a gain) or loss on disposal are to be added to the Profit and Loss account or the Other Comprehensive Income account based on IAS 16.68. 7.16 C/ S YSTERFONTEIN Ltd. We study the case of YSTERFONTEIN Ltd. That is a construction company based in Johannesburg. Data Sheet for YSTERFONTEIN Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((JJoohhaannnneessbbuurrgg)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : CCoonnssttrruuccttiioonn.. AAccccoouunnttiinngg ppeerriioodd: : 2200XX11 -- 2200XX66.. PPlloott: : 330000 mm 22 ; ; ccoosstt ooff aaccqquuiissiittiioonn 222255"000000 ZZAARR pplluuss ccoonnvveeyyiinngg ffeeeess 5500"000000 ZZAARR.. RReevvaalluuaattiioonn ttoo 33"000000 ZZAARR/ / mm 22 .. SSaallee oonn 3300..1111..2200XX66 aatt 11"000000"000000 ZZAARR.. VVAATT nn/ / aa.. On 4.01.20X1, YSTERFONTEIN Ltd. buys a plot 300 m 2 in size intended for its use as parking lot for business cars and construction vehicles. The purchase price is 225,000 ZAR. For conveyance, YSTERFONTEIN Ltd. pays 50,000 ZAR. 120 The total costs of acquisition are: 225,000 + 50,000 = 2 27755"000000 ZZAARR. On 5.07.20X5, the municipality declares the land which includes YSTERFONTEIN Ltd.’s parking lot an industrial zone and, therefore, the property price increases to 3,000 ZAR/ m 2 . YSTERFONTEIN Ltd. must revalue its parking lot. The new value is: 300 × 3,000 + 50,000 = 9 95500"000000 ZZAARR. The costs for conveyance are still included in the property valuation. The Bookkeeping entry for the revaluation is gain tax on sales income exceeding the cost of acquisition. Various deductions and allowances apply. Check the South African tax law. <?page no="163"?> Berkau: Financial Statements 8e 7-162 An alternative to the net replacement method is the gross replacement method. It applies in cases if the revaluation is caused by a price increase. Follow below the Link 7.F to the case study JANSSENS Ltd. Link 7.F: JANSSENS Ltd. 7.15 Disposal of Assets A disposal of an asset is best recorded through a Realisation account. 119 In case an item of property, plant and equipment is disposed of after prior revaluation, we must dissolve the revaluation reserves and deferred tax liabilities completely towards retained earnings. Only the disposal proceeds and the carrying value (Property, Plant and Equipment account, Accumulated Depreciation account and Accumulated Impairment Loss account) are closedoff to the Realisation account. The Realisation account is closed-off to the Profit and Loss account - we say is recorded through profit or loss although in case of disposals the expression other comprehensive income is more appropriate because the disposal of non-current assets is no revenue. IAS 16.67 states, that a de-recognition must be recorded for disposals or once no further benefits are expected from 119 Study our Basics of Accounting, chapters (34) and (35). 120 In South Africa, no acquisition tax for property applies. However, the SARS imposes a capital the asset. A profit (rather referred to as a gain) or loss on disposal are to be added to the Profit and Loss account or the Other Comprehensive Income account based on IAS 16.68. 7.16 C/ S YSTERFONTEIN Ltd. We study the case of YSTERFONTEIN Ltd. That is a construction company based in Johannesburg. Data Sheet for YSTERFONTEIN Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((JJoohhaannnneessbbuurrgg)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : CCoonnssttrruuccttiioonn.. AAccccoouunnttiinngg ppeerriioodd: : 2200XX11 -- 2200XX66.. PPlloott: : 330000 mm 22 ; ; ccoosstt ooff aaccqquuiissiittiioonn 222255"000000 ZZAARR pplluuss ccoonnvveeyyiinngg ffeeeess 5500"000000 ZZAARR.. RReevvaalluuaattiioonn ttoo 33"000000 ZZAARR/ / mm 22 .. SSaallee oonn 3300..1111..2200XX66 aatt 11"000000"000000 ZZAARR.. VVAATT nn/ / aa.. On 4.01.20X1, YSTERFONTEIN Ltd. buys a plot 300 m 2 in size intended for its use as parking lot for business cars and construction vehicles. The purchase price is 225,000 ZAR. For conveyance, YSTERFONTEIN Ltd. pays 50,000 ZAR. 120 The total costs of acquisition are: 225,000 + 50,000 = 2 27755"000000 ZZAARR. On 5.07.20X5, the municipality declares the land which includes YSTERFONTEIN Ltd.’s parking lot an industrial zone and, therefore, the property price increases to 3,000 ZAR/ m 2 . YSTERFONTEIN Ltd. must revalue its parking lot. The new value is: 300 × 3,000 + 50,000 = 9 95500"000000 ZZAARR. The costs for conveyance are still included in the property valuation. The Bookkeeping entry for the revaluation is gain tax on sales income exceeding the cost of acquisition. Various deductions and allowances apply. Check the South African tax law. Berkau: Financial Statements 8e 7-163 disclosed below. Remember, that land is not subjected to depreciation. A portion of 30% (income tax rate) is accrued to the deferred tax liabilities as shown as Bookkeeping entry (2). @ 5.07.20X5 P, P, E @Valuation PPV 950,000 P, P, E @Cost PPC 275,000 Revaluation Reserves R-R 675,000 (revaluation of the plot) Revaluation Reserves R-R 202,500 Deferred Tax Liabilities DTL 202,500 (transfer of tax liabilities to the extent of 30%) On 30.11.20X6, YSTERFONTEIN Ltd. sells the plot at 1,000,000 ZAR on cash. The Bookkeeping entries are made through the Realisation account after deferred tax and revaluation reserves are closedoff to retained earnings. @ 30.11.20X6 Deferred Tax Liabilities DTL 202,500 Revaluation Reserves R-R 202,500 (dissolving deferred taxes) Revaluation Reserves R-R 675,000 Retained Earnings R/ E 675,000 (dissolving revaluation reserves which makes them distributable) Cash/ Bank C/ B 1,000,000 Realisation-20X6 REA 1,000,000 (cash receipt from buyer) Realisation-20X6 REA 950,000 P, P, E @Valuation PPV 950,000 (closing-off of the PPE account) In South Africa a capital gain tax exists. The capital gain is calculated by deduction of the cost of acquisition from the income from the sale. Here, the capital gain is amounting to: 1,000,000 - 275,000 = 7 72255"000000 ZZAARR. No deduction and allowances are discussed here for the sake of simplification. The rate for the capital gain tax is the total income tax rate of 30 %. See below the journal entry for the capital gain tax recording. 121 121 The capital gain tax recording is not part of the syllabus of international Accounting. It has been added here to make the case study look more real and would be taught in an International Taxation class. <?page no="164"?> Berkau: Financial Statements 8e 7-164 @ 31.12.20X6 Capital Gain Tax CGT 217,500 Accounts Payables A/ P 217,500 (disclosure of capital gain tax as short-term liabilities) Check YSTERFONTEIN Ltd.’s accounts which only contain business activities regarding the plot (simplification). D C D C OV 950,000 (D) 950,000 OV 472,500 (B) 675,000 (A) 202,500 675,000 675,000 PPE @VALUATION Revaluation Reserves R-R D C D C (A) 202,500 OV 202,500 DTI 202,500 (B) 675,000 c/ d 507,500 OCI 35,000 710,000 710,000 b/ d 507,500 Deferred tax liabilities DTL Retained earnings R/ E D C D C (D) 950,000 (C) 1,000,000 (C) 1,000,000 . . . GoD 50,000 1,000,000 1,000,000 Realisation-20X6 REA Cash/ Bank C/ B D C D C OCI 50,000 (5) 50,000 EBT 50,000 GoD 50,000 ITL 217,500 b/ d 50,000 R/ E 35,000 DTI 202,500 252,500 252,500 Gain on disposal-20X6 GoD Other comprehensive income-20X6 OCI D C D C c/ d 217,500 PLT 217,500 EBT 725,000 GoD 725,000 b/ d 217,500 A/ P 217,500 b/ d 725,000 R/ E 507,500 725,000 725,000 Accounts payables A/ P Profit and Loss for Taxation PLT Figure 7.8: YSTERFONTEIN Ltd.’s accounts <?page no="165"?> Berkau: Financial Statements 8e 7-164 @ 31.12.20X6 Capital Gain Tax CGT 217,500 Accounts Payables A/ P 217,500 (disclosure of capital gain tax as short-term liabilities) Check YSTERFONTEIN Ltd.’s accounts which only contain business activities regarding the plot (simplification). D C D C OV 950,000 (D) 950,000 OV 472,500 (B) 675,000 (A) 202,500 675,000 675,000 PPE @VALUATION Revaluation Reserves R-R D C D C (A) 202,500 OV 202,500 DTI 202,500 (B) 675,000 c/ d 507,500 OCI 35,000 710,000 710,000 b/ d 507,500 Deferred tax liabilities DTL Retained earnings R/ E D C D C (D) 950,000 (C) 1,000,000 (C) 1,000,000 . . . GoD 50,000 1,000,000 1,000,000 Realisation-20X6 REA Cash/ Bank C/ B D C D C OCI 50,000 (5) 50,000 EBT 50,000 GoD 50,000 ITL 217,500 b/ d 50,000 R/ E 35,000 DTI 202,500 252,500 252,500 Gain on disposal-20X6 GoD Other comprehensive income-20X6 OCI D C D C c/ d 217,500 PLT 217,500 EBT 725,000 GoD 725,000 b/ d 217,500 A/ P 217,500 b/ d 725,000 R/ E 507,500 725,000 725,000 Accounts payables A/ P Profit and Loss for Taxation PLT Figure 7.8: YSTERFONTEIN Ltd.’s accounts Berkau: Financial Statements 8e 7-165 The Profit and Loss for Taxation account is colour-marked in Figure 7.8 to indicate that it is not part of the books for IFRSs financial statement preparation. How it is Done (Disposal of an Asset): (1) Record all depreciation or impairment losses before the asset is disposed of. If the asset is carried at revaluation values, dissolve revaluation reserves and deferred tax liabilities. (2) Prepare a Realisation account for the disposal. (3) Record receipts for the proceeds as a debit entry in the Cash/ Bank account and a credit entry in the Realisation account. For sales on credit record receivables accordingly. (4) Record output-VAT collected with the disposal as a debit entry in the Realisation account and a credit entry in the VAT account - if VAT applies. (5) Close-off the P, P, E account to the Realisation account. (6) Close-off the Accumulated Depreciation account and, if existing, the Accumulated Impairment Loss account, to the Realisation account. (7) Determine the balancing figure of the Realisation account. If the Realisation account is debit balanced the balancing figure is a loss on disposal. If the Realisation account is credit balanced the balancing figure is a gain/ profit on disposal. (8) Close-off the Realisation account to the Profit and Loss account or the Other Comprehensive Income account. YSTERFONTEIN Ltd. applies a Realisation account to calculate the gain on disposal for the land. It is: 1,000,000 - 950,000 = 5500"000000 ZZAARR. From the point of view of taxation, the profit on disposal is: 1,000,000 - 275,000 = 772255"000000 ZZAARR. Therefore, the capital gain taxes are: 725,000 × 30% = 2 21177"550000 ZZAARR. These taxes do not fall under income tax liabilities and must be recorded as short-term payables. As we compare the tax to expected income tax from a gain of 50,000 ZAR, the capital gain tax exceeds the taxes on other comprehensive income by: 217,500 - 15,000 = 220022"550000 ZZAARR. YSTERFONTEIN Ltd. records deferred tax income to the same extent as the dissolved deferred tax liabilities. Hence, YSTERFONTEIN Ltd.’s equity increases as if no revaluation has been recorded. YSTERFONTEIN Ltd. case study is simple as plots are not depreciable. Furthermore, no VAT applies for property sales. <?page no="166"?> Berkau: Financial Statements 8e 7-166 We recommend working on task A7.55 PAROW Ltd., which is about the revaluation of a plot, too. 122 7.17 Investment Property and Assets Held for Sale Investment property is land and buildings held for earning a rental income or for capital appreciation. IAS 40 applies. IAS 40.5 states that investment property is never land and buildings that are used for goods production, service rendering or administration. In those cases, IAS 16 applies. IAS 40.5 states further that investment property does not apply for assets held for sale. A company that buys land/ buildings as a property dealer does not apply IAS 40 but IFRS 5 instead. IAS 40.7 states that investment property is in general independent from other ordinary business of the company. IAS 40.10 allows property to be separated in owner occupied portions and items of investment property. Owner occupation also applies for hotels. The service character dominates and makes the whole hotel fall under property, plant and equipment as ruled by IAS 16. 7.18 C/ S MERSEBURG Ltd. Below, we study an office block partly used by MERSEBURG Ltd.: Data Sheet for MERSEBURG Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((GGrraahhaammssttoowwnn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. IInnvveessttmmeenntt pprrooppeerrttyy: : 2211"002211"000000 ZZAARR; ; ooffffiiccee bblloocckk wwiitthh 4422 ooffffiicceess" bboouugghhtt oonn 22..0011..2200XX77.. DDeepprreecciiaattiioonn: : 442200"442200 ZZAARR.. RReevvaalluuaattiioonn ttoowwaarrddss 2255"220000"000000 ZZAARR oonn 22..0011..2200XX88.. VVAATT nn/ / aa.. On 2.01.20X7, MERSEBURG Ltd. buys an office block with 42 single offices in Grahamstown, South Africa. The costs of acquisition are 21,000,000 ZAR. Additional costs for the transfer apply. Those are 21,000 ZAR. One of the offices is used for the administration of the other 41 offices. The offices are separable as laid out in IAS 40.10. For the sake of simplicity, we pretend, all offices have the same size and value. Due to different use, MERSEBURG Ltd. must account for the offices separately. The owner occupied office is classified as property, plant and equipment and falls under IAS 16 whereas the other 41 offices are investment property as defined in IAS 40.5. At the time of acquisition, MERSEBURG Ltd. records the office block by the Bookkeeping entry below with partial allocated conveyance costs: @ 2.01.20X7 Investment Property IVP 20,520,500 P, P, E @cost PPC 500,500 Cash/ Bank C/ B 21,021,000 (acquisition of offices for renting out and self occupation purposes) 122 Find the task in the study material portal. <?page no="167"?> Berkau: Financial Statements 8e 7-166 We recommend working on task A7.55 PAROW Ltd., which is about the revaluation of a plot, too. 122 7.17 Investment Property and Assets Held for Sale Investment property is land and buildings held for earning a rental income or for capital appreciation. IAS 40 applies. IAS 40.5 states that investment property is never land and buildings that are used for goods production, service rendering or administration. In those cases, IAS 16 applies. IAS 40.5 states further that investment property does not apply for assets held for sale. A company that buys land/ buildings as a property dealer does not apply IAS 40 but IFRS 5 instead. IAS 40.7 states that investment property is in general independent from other ordinary business of the company. IAS 40.10 allows property to be separated in owner occupied portions and items of investment property. Owner occupation also applies for hotels. The service character dominates and makes the whole hotel fall under property, plant and equipment as ruled by IAS 16. 7.18 C/ S MERSEBURG Ltd. Below, we study an office block partly used by MERSEBURG Ltd.: Data Sheet for MERSEBURG Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((GGrraahhaammssttoowwnn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. IInnvveessttmmeenntt pprrooppeerrttyy: : 2211"002211"000000 ZZAARR; ; ooffffiiccee bblloocckk wwiitthh 4422 ooffffiicceess" bboouugghhtt oonn 22..0011..2200XX77.. DDeepprreecciiaattiioonn: : 442200"442200 ZZAARR.. RReevvaalluuaattiioonn ttoowwaarrddss 2255"220000"000000 ZZAARR oonn 22..0011..2200XX88.. VVAATT nn/ / aa.. On 2.01.20X7, MERSEBURG Ltd. buys an office block with 42 single offices in Grahamstown, South Africa. The costs of acquisition are 21,000,000 ZAR. Additional costs for the transfer apply. Those are 21,000 ZAR. One of the offices is used for the administration of the other 41 offices. The offices are separable as laid out in IAS 40.10. For the sake of simplicity, we pretend, all offices have the same size and value. Due to different use, MERSEBURG Ltd. must account for the offices separately. The owner occupied office is classified as property, plant and equipment and falls under IAS 16 whereas the other 41 offices are investment property as defined in IAS 40.5. At the time of acquisition, MERSEBURG Ltd. records the office block by the Bookkeeping entry below with partial allocated conveyance costs: @ 2.01.20X7 Investment Property IVP 20,520,500 P, P, E @cost PPC 500,500 Cash/ Bank C/ B 21,021,000 (acquisition of offices for renting out and self occupation purposes) 122 Find the task in the study material portal. Berkau: Financial Statements 8e 7-167 MERSEBURG Ltd. rents out 41 offices and receives a monthly rental income therefrom. In case the offices' fair value changes, IAS 40.35 requires recording the valuation differences as gain or loss in the Accounting period when the changes take place. This is different to revaluations along IAS 16.39. We show the two alternative valuations for MERSEBURG Ltd.’s offices: In 20X7, MERSEBURG Ltd. applies the cost model and depreciates the 42 offices to an extent of 420,420 ZAR (all together). The offices are carried then at a value of: 21,021,000 - 420,420 = 2200"660000"558800 ZZAARR at the end of the Accounting period 20X7. On 2.01.20X8, MERSEBURG Ltd. acknowledges that the office values increased from 20,600,580 ZAR to 25,200,000 ZAR. The self-occupied office requires a revaluation based on IAS 16. The carrying value was 490,490 ZAR and the new value is 600,000 ZAR. The revaluation is recorded as the Bookkeeping entries below: @ 2.01.20X8 P, P, E @valuation PPV 600,000 Accumulated Depreciation ACC 10,010 P, P, E @cost PPC 500,500 Revaluation Reserves R/ R 109,510 (revaluation of the self occupied office, net replacement Bookkeeping entry) Revaluation Reserves R-R 32,853 Deferred Tax Liabilities DTL 32,853 (allocation of the tax portion to deferred tax liabilities) In contrast to the self-occupied office, the value increase for the investment property (41 offices) is recorded through profit or loss and disclosed as a gain on revaluation of investment property. It is: 41 × (600,000 - 490,490) = 4 4"448899"991100 ZZAARR see the Bookkeeping entry below: @ 2.01.20X8 Investment Property IVP 4,489,910 Gain on Revaluation of IVP GOR 4,489,910 (recording revaluation gain on investment property) 7.19 Assets Held for Sale IFRS 5 applies for non-current assets held for sale. According to IFRS 5.8, a requirement for non-current assets to be classified as held for sale is that a plan exists to sell the asset. Non-current assets held for sale shall be valued at the lower of carrying costs and fair value less cost to sell (IFRS 5.15.). Assets along IFRS 5 are no inventories. They merely represent non-current assets of the company that are to be disposed of due to discontinued operations or they have no economic benefit left and will be discarded. This applies also for replaced assets, like a taxi company that bought a new car and intends <?page no="168"?> Berkau: Financial Statements 8e 7-168 to sell its old one. A company shall not depreciate a non-current asset while it is classified as held for sale based on IFRS 5.25. IFRS 5.38 requires separate disclosure of non-current assets held for sale. 7.20 C/ S OVERBERG (Pty) Ltd. We explain the concept of IFRS 5 by the case study OVERBERG (Pty) Ltd., a surf shop on the Atlantic Ocean beach in Cape Town. Data Sheet for OVERBERG (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((CCaappee TToowwnn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. AAsssseettss ffoorr ssaallee: : 1155 kkiittee ssuurrffiinngg uunniittss" ccoosstt ooff aaccqquuiissiittiioonn: : 2200"000000 ZZAARR/ / KKSSUU oonn 22..0011..2200XX44; ; uusseeffuull lliiffee: : 44 yyeeaarrss; ; rreessiidduuaall vvaalluuee: : 88"000000 ZZAARR/ / KKSSUU.. IInntteennttiioonn ttoo sseellll ffrroomm 11..1100..2200XX55 dduuee ttoo ddiissccoonnttiinnuueedd ooppeerraattiioonnss; ; sseelllliinngg pprriiccee 1100"000000 ZZAARR/ / KKSSUU.. OOnn 3311..1122..2200XX66" 1100 kkiittee ssuurrffiinngg uunniitteess aarree lleefftt.. VVAATT rraattee: : 2200 %%.. OVERBERG (Pty) Ltd. is a surf shop in the Western Cape of South Africa. The business sells surf equipment in Cape Town and runs a kite surfing training centre in Camps Bay. For the kite surfing training centre, OVERBERG (Pty) Ltd. bought 15 kites and surfboards we refer to as KSU (kite surfing unit). The KSUs are acquired at unit costs of 20,000 ZAR/ u on 2.01.20X4. Depreciation on the KSUs follows straight-line method over a useful life of four years. The residual value per KSU is 8,000 ZAR/ KSU. On 1.10.20X6, OVERBERG (Pty) Ltd. intends to close its kite surfing training centre and to turn it into a surf shop instead. Therefore, the training centre activities become discontinued operations. No training classes are offered after 1.11.20X6. OVERBERG (Pty) Ltd. plans to sell the KSUs at 10,000 ZAR/ u (ex VAT). No additional selling costs are relevant, as OVERBERG (Pty) Ltd. sells the KSUs in its own shop. At the beginning of 20X6, the KSUs are carried at 14,000 ZAR/ u each. Depreciation for the period January/ 20X6 until October/ 20X6 is: 10 × (14,000 - 8,000) / 24 = 2 2"550000 ZZAARR/ / KKSSUU. When OVERBERG (Pty) Ltd. ceases its kite surfing training on 1.11.20X6, it carries each KSU at: 14,000 - 2,500 = 1111"550000 ZZAARR/ / KKSSUU. IFRS 5.15 requires the valuation of the KSUs at the lower of the carrying value and the fair value less costs to sell. OVERBERG (Pty) Ltd.’s intention to sell the KSUs at 10,000 ZAR/ u determines their fair values. Hence, the KSUs are held for sale and written down in accordance with IFRS 5.20 from 11,500 ZAR/ KSU to 10,000 ZAR/ KSU. OVERBERG (Pty) Ltd. makes the Bookkeeping entry below. We call the account for assets held for sale Disposal Assets account DAA: @ 1.11.20X6 Disposal Assets Account DAA 150,000 Accumulated Depreciation ACC 127,500 IL on Discontinued Ops ILD 22,500 P, P, E - KSU 300,000 (writing-off KSU due to discontinuation of training centre activities) <?page no="169"?> Berkau: Financial Statements 8e 7-168 to sell its old one. A company shall not depreciate a non-current asset while it is classified as held for sale based on IFRS 5.25. IFRS 5.38 requires separate disclosure of non-current assets held for sale. 7.20 C/ S OVERBERG (Pty) Ltd. We explain the concept of IFRS 5 by the case study OVERBERG (Pty) Ltd., a surf shop on the Atlantic Ocean beach in Cape Town. Data Sheet for OVERBERG (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((CCaappee TToowwnn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : SSeerrvviiccee pprroovviiddeerr.. AAsssseettss ffoorr ssaallee: : 1155 kkiittee ssuurrffiinngg uunniittss" ccoosstt ooff aaccqquuiissiittiioonn: : 2200"000000 ZZAARR/ / KKSSUU oonn 22..0011..2200XX44; ; uusseeffuull lliiffee: : 44 yyeeaarrss; ; rreessiidduuaall vvaalluuee: : 88"000000 ZZAARR/ / KKSSUU.. IInntteennttiioonn ttoo sseellll ffrroomm 11..1100..2200XX55 dduuee ttoo ddiissccoonnttiinnuueedd ooppeerraattiioonnss; ; sseelllliinngg pprriiccee 1100"000000 ZZAARR/ / KKSSUU.. OOnn 3311..1122..2200XX66" 1100 kkiittee ssuurrffiinngg uunniitteess aarree lleefftt.. VVAATT rraattee: : 2200 %%.. OVERBERG (Pty) Ltd. is a surf shop in the Western Cape of South Africa. The business sells surf equipment in Cape Town and runs a kite surfing training centre in Camps Bay. For the kite surfing training centre, OVERBERG (Pty) Ltd. bought 15 kites and surfboards we refer to as KSU (kite surfing unit). The KSUs are acquired at unit costs of 20,000 ZAR/ u on 2.01.20X4. Depreciation on the KSUs follows straight-line method over a useful life of four years. The residual value per KSU is 8,000 ZAR/ KSU. On 1.10.20X6, OVERBERG (Pty) Ltd. intends to close its kite surfing training centre and to turn it into a surf shop instead. Therefore, the training centre activities become discontinued operations. No training classes are offered after 1.11.20X6. OVERBERG (Pty) Ltd. plans to sell the KSUs at 10,000 ZAR/ u (ex VAT). No additional selling costs are relevant, as OVERBERG (Pty) Ltd. sells the KSUs in its own shop. At the beginning of 20X6, the KSUs are carried at 14,000 ZAR/ u each. Depreciation for the period January/ 20X6 until October/ 20X6 is: 10 × (14,000 - 8,000) / 24 = 2 2"550000 ZZAARR/ / KKSSUU. When OVERBERG (Pty) Ltd. ceases its kite surfing training on 1.11.20X6, it carries each KSU at: 14,000 - 2,500 = 1111"550000 ZZAARR/ / KKSSUU. IFRS 5.15 requires the valuation of the KSUs at the lower of the carrying value and the fair value less costs to sell. OVERBERG (Pty) Ltd.’s intention to sell the KSUs at 10,000 ZAR/ u determines their fair values. Hence, the KSUs are held for sale and written down in accordance with IFRS 5.20 from 11,500 ZAR/ KSU to 10,000 ZAR/ KSU. OVERBERG (Pty) Ltd. makes the Bookkeeping entry below. We call the account for assets held for sale Disposal Assets account DAA: @ 1.11.20X6 Disposal Assets Account DAA 150,000 Accumulated Depreciation ACC 127,500 IL on Discontinued Ops ILD 22,500 P, P, E - KSU 300,000 (writing-off KSU due to discontinuation of training centre activities) Berkau: Financial Statements 8e 7-169 After classifying the KSUs as assets held for sale, OVERBERG (Pty) Ltd. stops depreciation. At the end of 20X6, OVERBERG (Pty) Ltd. sells five of the KSUs at a net selling price of 10,000 ZAR/ u. See Bookkeeping entry (3). The remaining KSUs are still in the shop on 31.12.20X6. Observe in Figure 7.9 the accounts as at 31.12.20X6. D C D C OV 300,000 (2) 300,000 (2) 127,500 OV 90,000 (1) 37,500 127,500 127,500 P, P, E (KSU) Acc depr ACC D C D C (1) 37,500 P&L 37,500 (2) 150,000 (3) 50,000 c/ d 100,000 150,000 150,000 b/ d 100,000 Depreciation-20X6 DPR Disposal assets account DAA D C D C (2) 22,500 P&L 22,500 (3) 60,000 c/ d 60,000 b/ d 60,000 Impairment Loss on discontinued ops ILD Cash/ Bank C/ B D C D C c/ d 10,000 (6) 10,000 DPR 37,500 b/ d 10,000 ILD 22,500 NL 60,000 60,000 60,000 b/ d 60,000 R/ E 60,000 Value added tax VAT Profit and Loss-20X6 P&L D C P&L 60,000 c/ d 60,000 b/ d 60,000 Retained earnings R/ E Figure 7.9: OVERBERG (Pty) Ltd.’s accounts 7.21 Intangible Assets Intangible assets are assets without physical substance, e.g., licenses, rights, warranties, patents, design costs, goodwill etc. IAS 38 rules intangible assets. IAS 38.4 states that in some cases, intangible assets are linked to assets with physical substance, e.g., software comes with an installation-CD and a printed manual. We then must assess <?page no="170"?> Berkau: Financial Statements 8e 7-170 which component of the asset is dominant. In the case of software, the intangible portion is the major part, hence, we classify software as intangible asset. Although cash and its equivalents may be regarded as intangible, it is always recorded as non-current asset under cash/ bank or as financial instruments. IAS 38.12 requires intangible assets to be identifiable which means they must be separable and exchangeable between individuals, or they must result from contractual or legal rights. Following IAS 38.13, intangible assets shall be in the control of the reporting company. 7.22 C/ S Dentist PAARDEBERG We discuss our next case PAARDEBERG, who is a dentist: Data Sheet for Dr. Paardeberg. DDoommiicciillee: : GGeerrmmaannyy ((HHaammbbuurrgg)) RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : DDooccttoorr’’ss cclliinniicc.. CCoosstt ooff aaccqquuiissiittiioonn: : 775500"000000 EEUURR.. AAsssseettss’’ vvaalluuee: : 8800"000000 EEUURR VVAATT nn/ / aa.. Dr Paardeberg is a dentist and plans the acquisition of a clinic in Hamburg. He buys the clinic from a doctor who wants to relocate to Asia. The value of the clinic is significantly higher than the assets linked thereto, such as the surgery room, the waiting area equipment, computer systems etc. The main value that determines the selling price for the clinic is the patient base. Although, there is a material economic benefit when taking over the clinic, the patients are not controlled by the business. Therefore, the acquisition of the clinic cannot be based on the recognition of goodwill for the patient list. In case Dr. Paardeberg pays a price for the clinic that exceeds the tangible assets’ total, the difference between cost of acquisition and the sum of tangible assets is regarded as goodwill. Goodwill results from the clinic’s acquisition and thus, becomes an identifiable intangible asset because it is derived from contractual rights. The acquisition of the clinic is in exchange of 750,000 EUR, 80,000 EUR thereof is linked to tangible equipment. PAARDEBERG makes the Bookkeeping entry on 4.03.20X7 as below: @ 4.03.20X7 Property, Plant, Equipment PPE 80,000 Goodwill G/ W 670,000 Cash/ Bank C/ B 750,000 (acquisition of a dentist clinic with goodwill consideration) After initial recognition of intangible assets at cost, the subsequent valuation is based on depreciation over the useful life or on valuations, the latter one requires a regular impairment/ revaluation test. In the case of the dentist’s clinic PAARDEBERG, the goodwill resulting from the reputation and the future patients’ visits depends on the doctor’s performance and his friendliness. Therefore, the goodwill is subjected to changes. PAARDEBERG must check the <?page no="171"?> Berkau: Financial Statements 8e 7-170 which component of the asset is dominant. In the case of software, the intangible portion is the major part, hence, we classify software as intangible asset. Although cash and its equivalents may be regarded as intangible, it is always recorded as non-current asset under cash/ bank or as financial instruments. IAS 38.12 requires intangible assets to be identifiable which means they must be separable and exchangeable between individuals, or they must result from contractual or legal rights. Following IAS 38.13, intangible assets shall be in the control of the reporting company. 7.22 C/ S Dentist PAARDEBERG We discuss our next case PAARDEBERG, who is a dentist: Data Sheet for Dr. Paardeberg. DDoommiicciillee: : GGeerrmmaannyy ((HHaammbbuurrgg)) RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : DDooccttoorr’’ss cclliinniicc.. CCoosstt ooff aaccqquuiissiittiioonn: : 775500"000000 EEUURR.. AAsssseettss’’ vvaalluuee: : 8800"000000 EEUURR VVAATT nn/ / aa.. Dr Paardeberg is a dentist and plans the acquisition of a clinic in Hamburg. He buys the clinic from a doctor who wants to relocate to Asia. The value of the clinic is significantly higher than the assets linked thereto, such as the surgery room, the waiting area equipment, computer systems etc. The main value that determines the selling price for the clinic is the patient base. Although, there is a material economic benefit when taking over the clinic, the patients are not controlled by the business. Therefore, the acquisition of the clinic cannot be based on the recognition of goodwill for the patient list. In case Dr. Paardeberg pays a price for the clinic that exceeds the tangible assets’ total, the difference between cost of acquisition and the sum of tangible assets is regarded as goodwill. Goodwill results from the clinic’s acquisition and thus, becomes an identifiable intangible asset because it is derived from contractual rights. The acquisition of the clinic is in exchange of 750,000 EUR, 80,000 EUR thereof is linked to tangible equipment. PAARDEBERG makes the Bookkeeping entry on 4.03.20X7 as below: @ 4.03.20X7 Property, Plant, Equipment PPE 80,000 Goodwill G/ W 670,000 Cash/ Bank C/ B 750,000 (acquisition of a dentist clinic with goodwill consideration) After initial recognition of intangible assets at cost, the subsequent valuation is based on depreciation over the useful life or on valuations, the latter one requires a regular impairment/ revaluation test. In the case of the dentist’s clinic PAARDEBERG, the goodwill resulting from the reputation and the future patients’ visits depends on the doctor’s performance and his friendliness. Therefore, the goodwill is subjected to changes. PAARDEBERG must check the Berkau: Financial Statements 8e 7-171 economic benefits resulting from the goodwill regularly. If patients refrain from coming back, an impairment loss must be recorded towards the derived goodwill. For the situation that the patient base increases due to the competence of Dr Pardeberg, an increase of the goodwill is not possible. 7.23 Design and Research Costs The costs for development and product design are intangible assets, too. Their costs are based on cost calculations and are depreciated over the periods, in which the goods are produced. Special requirements apply to consider design costs as cost of development based on IAS 38.54 - 38.64. Special recognition criteria for the classification as development costs are laid out below: The first phase of the product design process when new knowledge is obtained, is seen as “research”. Its costs cannot be recorded as intangible assets but shall be recognised through profit or loss for the year of the research. Once the design process transitions to its next phase “development”, the reporting company should demonstrate that it fulfils the criteria laid out in IAS 38.57, e.g., feasibility, intention and ability of marketing the product, the potential of producing the goods etc. 123 7.24 C/ S WESPOORT Ltd. As a case study about the recording of design costs we discuss the case of WESPOORT Ltd. in East London. 123 Study IAS 38.57 for the details. Data Sheet for WESPOORT Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((EEaasstt LLoonnddoonn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : MMaannuuffaaccttuurriinngg.. DDeessiiggnn ccoossttss: : 660000"000000 ZZAARR.. FFuullffiillmmeenntt ooff ccrriitteerriiaa aalloonngg IIAASS 3388..5577 oonn 33..0033..2200XX44.. PPrroodduuccttiioonn ccoommmmeenncceess oonn 3311..0055..2200XX44.. PPrroodduuccttiioonn vvoolluummee: : 9966"000000 llaawwnn mmoowweerrss oovveerr ttwwoo yyeeaarrss.. VVAATT nn/ / aa.. WESPOORT Ltd. is a company that produces lawn mowers in the Eastern Cape Province. For the next season, WESPOORT Ltd. designs a new cordless lawn mower. It carries out a Marketing Research and runs tests with rechargeable batteries. Thereafter, on 3.03.20X4, WESPOORT Ltd. starts to design the new lawn mower model and spends 600,000 ZAR for engineering. During the development phase, WESPOORT Ltd. records labour, depreciation on the design software system (CAD system) and expenses for product tests. WESPOORT Ltd. demonstrates the fulfilment of the requirements in IAS 38.57 on 3.03.20X4. WESPOORT Ltd. intends to produce 96,000 units of the new lawn mower during the period June/ 20X4 until May/ 20X6. The development phase is completed on 31.05.20X4 and production commences right thereafter. WESPOORT Ltd. records development costs to the extent of 600,000 ZAR as intangible asset and depreciates them at the yearend proportionate to the production volume of lawn mowers. The production volume of lawn mowers is evenly distributed over the entire pro- <?page no="172"?> Berkau: Financial Statements 8e 7-172 duction period. Hence, the partial development cost depreciation for the production period of seven months in 20X4 is: 7 × 600,000 / 24 = 1 17755"000000 ZZAARR. Observe below the Bookkeeping entries for the recognition and depreciation of development expenses as intangible assets: @ 31.05.20X4 Intangible Assets ITA 600,000 Depreciation-20X4 100,000 Labour-20X4 LAB 350,000 Other Expenses (testing) OTH 150,000 (recognition of development costs) @ 31.12.20X4 Depreciation-20X4 DPR 175,000 Accumulated Depreciation ACC 175,000 (recording depreciation on intangible assets: development costs) 7.25 Leases Following IFRS 16.9, a lease is a contract between a lessee and a lessor about an identified asset’s use for a period in exchange for a consideration (payment). The asset is in the ownership of the lessor. 124 With the lease contract, the asset gets in control of the lessee. The legal conveyance of the asset is an essential factor regarding the lease contract and results in the recognition thereof. The fact, that the lessee controls the asset distinguishes it from other services, where - in contrast the supplier still decides about the asset’s use, like a car rental. The lessee recognises the leased asset as a right-of-control-the-use of an asset (also termed right-of-use-asset RUA) and a lease liability, both at their present values. The right-of-use-asset can either be disclosed as item of property, plant and equipment or as a special item on the balance sheet, e.g., as a 124 Study leases with the case COSSAL Ltd. in our textbook Basics of Accounting, chapter (15). right. Lease liabilities are recorded and disclosed like other financial liabilities. In accordance with IFRS 16.22, the lessee discloses all leased assets on the financial statements. This affects performance ratios, e.g., the Return on Assets. Very short-term leases and leases of minor importance/ valuation are exempted from recognition and are recorded as expenses, see IFRS 16.5. A lease is recorded in the lessee’s books at the time of the asset transfer. For the lessee a lease contract is like an agreement about renting an asset. It must pay for the asset’s use. Later, it returns the asset to the lessor. IFRS 16.9 requires at the commencement of a lease the reporting company to assess whether the contract is, or contains, a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period in exchange for consideration. […]. <?page no="173"?> Berkau: Financial Statements 8e 7-172 duction period. Hence, the partial development cost depreciation for the production period of seven months in 20X4 is: 7 × 600,000 / 24 = 1 17755"000000 ZZAARR. Observe below the Bookkeeping entries for the recognition and depreciation of development expenses as intangible assets: @ 31.05.20X4 Intangible Assets ITA 600,000 Depreciation-20X4 100,000 Labour-20X4 LAB 350,000 Other Expenses (testing) OTH 150,000 (recognition of development costs) @ 31.12.20X4 Depreciation-20X4 DPR 175,000 Accumulated Depreciation ACC 175,000 (recording depreciation on intangible assets: development costs) 7.25 Leases Following IFRS 16.9, a lease is a contract between a lessee and a lessor about an identified asset’s use for a period in exchange for a consideration (payment). The asset is in the ownership of the lessor. 124 With the lease contract, the asset gets in control of the lessee. The legal conveyance of the asset is an essential factor regarding the lease contract and results in the recognition thereof. The fact, that the lessee controls the asset distinguishes it from other services, where - in contrast the supplier still decides about the asset’s use, like a car rental. The lessee recognises the leased asset as a right-of-control-the-use of an asset (also termed right-of-use-asset RUA) and a lease liability, both at their present values. The right-of-use-asset can either be disclosed as item of property, plant and equipment or as a special item on the balance sheet, e.g., as a 124 Study leases with the case COSSAL Ltd. in our textbook Basics of Accounting, chapter (15). right. Lease liabilities are recorded and disclosed like other financial liabilities. In accordance with IFRS 16.22, the lessee discloses all leased assets on the financial statements. This affects performance ratios, e.g., the Return on Assets. Very short-term leases and leases of minor importance/ valuation are exempted from recognition and are recorded as expenses, see IFRS 16.5. A lease is recorded in the lessee’s books at the time of the asset transfer. For the lessee a lease contract is like an agreement about renting an asset. It must pay for the asset’s use. Later, it returns the asset to the lessor. IFRS 16.9 requires at the commencement of a lease the reporting company to assess whether the contract is, or contains, a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period in exchange for consideration. […]. Berkau: Financial Statements 8e 7-173 The costs of the right-of-use-asset contain the lease instalments, plus prior payments, other direct costs and estimated restoring costs, as required by IFRS 16.24. For the recognition of the lease liability following IFRS 16.26 their disclosure at present values is mandated. The discount rate for the present value calculation is either the interest rate implicit in the lease or the incremental borrowing rate of the lessee. Next, we cover the lease recognition in the lessor’s books. For the lessor, a lease is a financial service. The lessor finances the lessee’s use of the asset. Therefore, the revenue is interest income. Only if the lessor is a retailer, a sales revenue is recorded in its books, as demonstrated in the case study RICHTERVELD Ltd. In general, the lessor is in the possession of the asset already. Ownership results from prior purchase or manufacturing. The lessor allocates the lease object to receivables by a Bookkeeping entry like DR Lease Receivables account and credits the asset. Here, we discuss the lessee at first. A case study about lessors follows. 7.26 C/ S KRIGE (Pty) Ltd. For the basics of leasing, we discuss the case study KRIGE (Pty) Ltd.: 125 The lessor decides about the interest in the lease. We calculate here with a new car costing 600,000 ZAR and leased out for five years at 120,000 ZAR/ a. When dissolving the equation: 600,000 = 120,000 × ((1+r) 5 -1)/ (r × (1 + r) 5 ) for r we get 4.88%/ a and round to up 5 %/ a for the sake of simplification. 126 The vector is about three payments. Its first element is for the beginning of 20X3, but we pull it Data Sheet for KRIGE (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((JJoohhaannnneessbbuurrgg)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : TTrraannssppoorrttaattiioonn" UUBBEERR.. LLeeaassiinngg oobbjjeecctt: : TTooyyoottaa ccaarr ffoorr 22 yyeeaarrss.. LLeeaassiinngg rraatteess: : 112200"000000 ZZAARR/ / aa.. RReessttoorriinngg ccoossttss: : 5500"000000 ZZAARR.. VVAATT iiggnnoorreedd.. Mr Krige is an UBER driver in Johannesburg. He establishes the company KRIGE (Pty) Ltd. which prepares financial statements following IFRSs. KRIGE (Pty) Ltd. enters in a lease contract over a taxi with a Toyota dealer for a two year period, commencing on 2.01.20X3 and ending 31.12.20X4. The lease comes with an interest rate of 5 %/ a. 125 The rate is used for present value calculations. KRIGE (Pty) Ltd. pays annually 120,000 ZAR/ a in lease instalments. Furthermore, KRIGE (Pty) Ltd. estimates the restoring costs for minor repairs, e.g., scratches and dents, to be 50,000 ZAR at the end of the lease. The payment vector 126 for the taxi is: TC(t) = {0; -120,000; (-120,000 - 50,000)} = { {00; ; --112200"000000; ; -- 117700"000000}}. The total lease liability 127 is the vector’s present value of: 120,000/ 1.05 + 170,000/ 1.05 2 = 226688"448800..7733 ZZAARR. KRIGE (Pty) Ltd. does not know the real price for the taxi as the dealer does not tell him the fair market value. KRIGE (Pty) Ltd. recognises the right-of-use-asset at the present value (as per 2.01.20X3) of all lease payments which includes the restoring costs at the forward one day to the 31.12.20X2, the next one is on 31.12.20X3 and the last payment at the end of the lease contract on 31.12.20X4. 127 The account for the lease liability is Lease Liabilities IBL. Its three-letter-code refers to longterm liabilities as it stands for interest bearing liabilities. <?page no="174"?> Berkau: Financial Statements 8e 7-174 end: 268,480.73 ZAR. The Bookkeeping entry (1) is made on 2.01.20X3: @ 2.01.20X3 Right-of-Use-Asset RUA 268,481 Lease Liabilitiy IBL 268,481 (recognition of the lease) Next, we record the lease liability to the same extent. For its disclosure on 31.12.20X3, interest is to be considered as an expense in 20X3 of: 268,480.73 × 5% = 1 133"442244..0044 ZZAARR. At the time of recognition on the balance sheet, the lease payment for 20X3 has been made and the next payment falls under shortterm liabilities. We record the payment as Bookkeeping entry (3). In compliance with IAS 1.60, we disclose the payments for 20X4 as short-term liabilities. We do not unwind of the discount and take the short-term liabilities as balancing figure from the Short-term Liabilities account. To double-check the amount, we can discount the next year’s settlement value by 5 % which gives: 170,000 / 1.05 = 116611"990044..7766 ZZAARR. One year later, on 31.12.20X4, KRIGE (Pty) Ltd. retires the remaining lease liability, now disclosed under short-term liabilities. Therefore, it is not disclosed on the balance sheet per 31.12.20X4. Observe the Bookkeeping entries (2) to (4) below which are recorded in 20X3. @ 31.12.20X3 Interest-20X3 INT 13,424 Lease Liabilitiy IBL 13,424 (recording interest expenses for 20X3) Lease Liability IBL 120,000 Cash/ Bank C/ B 120,000 (recording the lease payment at the yearend) Lease Liability IBL 161,905 Short-term Liabilities A/ P 161,905 (separation of short-term liabilities) IFRS 16.23 requires carrying the rightof-use-asset at cost. As the costs usually are unknown by the lessee, IFRS 16.26 applies. It states that the initial costs are the present value of all lease payments. For subsequent valuation on the debit side, the right-of-use-asset is depreciated based on an appropriate depreciation method and its parameters. In general, straight-line method applies. Here, depreciation on the right-of-useasset is based on straight-line method without residual value consideration. Depreciation in both years is: 268,480.73 / 2 = 1 13344"224400..3377 ZZAARR. The first one is recorded as Bookkeeping entry (5). <?page no="175"?> Berkau: Financial Statements 8e 7-174 end: 268,480.73 ZAR. The Bookkeeping entry (1) is made on 2.01.20X3: @ 2.01.20X3 Right-of-Use-Asset RUA 268,481 Lease Liabilitiy IBL 268,481 (recognition of the lease) Next, we record the lease liability to the same extent. For its disclosure on 31.12.20X3, interest is to be considered as an expense in 20X3 of: 268,480.73 × 5% = 1 133"442244..0044 ZZAARR. At the time of recognition on the balance sheet, the lease payment for 20X3 has been made and the next payment falls under shortterm liabilities. We record the payment as Bookkeeping entry (3). In compliance with IAS 1.60, we disclose the payments for 20X4 as short-term liabilities. We do not unwind of the discount and take the short-term liabilities as balancing figure from the Short-term Liabilities account. To double-check the amount, we can discount the next year’s settlement value by 5 % which gives: 170,000 / 1.05 = 116611"990044..7766 ZZAARR. One year later, on 31.12.20X4, KRIGE (Pty) Ltd. retires the remaining lease liability, now disclosed under short-term liabilities. Therefore, it is not disclosed on the balance sheet per 31.12.20X4. Observe the Bookkeeping entries (2) to (4) below which are recorded in 20X3. @ 31.12.20X3 Interest-20X3 INT 13,424 Lease Liabilitiy IBL 13,424 (recording interest expenses for 20X3) Lease Liability IBL 120,000 Cash/ Bank C/ B 120,000 (recording the lease payment at the yearend) Lease Liability IBL 161,905 Short-term Liabilities A/ P 161,905 (separation of short-term liabilities) IFRS 16.23 requires carrying the rightof-use-asset at cost. As the costs usually are unknown by the lessee, IFRS 16.26 applies. It states that the initial costs are the present value of all lease payments. For subsequent valuation on the debit side, the right-of-use-asset is depreciated based on an appropriate depreciation method and its parameters. In general, straight-line method applies. Here, depreciation on the right-of-useasset is based on straight-line method without residual value consideration. Depreciation in both years is: 268,480.73 / 2 = 1 13344"224400..3377 ZZAARR. The first one is recorded as Bookkeeping entry (5). Berkau: Financial Statements 8e 7-175 @ 31.12.20X3 Depreciation-20X3 DPR 134,240 Accumulated Depreciation ACC 134,240 (recognition of depreciation on the right of use asset) Study the accounts in Figure 7.10. D C D C (1) 268,481 c/ d 268,481 (3) 120,000 (1) 268,481 b/ d 268,481 (4) 161,905 (2) 13,424 281,905 281,905 Right-of-use-asset RUA Lease liability IBL D C D C c/ d 120,000 (3) 120,000 c/ d 161,905 (4) 161,905 b/ d 120,000 b/ d 161,905 Cash/ Bank C/ B Short-term liabilities A/ P D C D C (5) 134,240 P3L 134,240 c/ d 134,240 (5) 134,240 b/ d 134,240 Depreciation-20X3 DPR Accumulated depreciation ACC C D C DPR 134,240 NL 147,664 P3L 147,664 c/ d 147,664 INT 13,424 b/ d 147,664 b/ d 147,664 R/ E 147,664 C (2) 13,424 P3L 13,424 Profit and Loss-20X3 P3L Retained earnings R/ E Interest-20X3 INT Figure 7.10: KRIGE (Pty) Ltd.’s accounts (20X3) In 20X4, KRIGE (Pty) Ltd. depreciates the right-of-use-asset by Bookkeeping entry (A) and pays the agreed 170,000 ZAR. The payment is recorded as Bookkeeping entry (B) and includes the lease instalment and the given value guarantee payment: 120,000 + 50,000 = 1 17700"000000 ZZAARR. Bookkeeping entry (C) calculates the interest on the short-term liabilities. It is: 161,904.76 × 5% = 8 8"009955..2244 ZZAARR. In general, the separate disclosure of short-term liabilities and long-term liabilities is combined with a different measurement of the liability categories. However, lease liabilities are usually held at present values which applies <?page no="176"?> Berkau: Financial Statements 8e 7-176 for their long-term as well as for their short-term portion. Interest is capitalised towards the shortterm liabilities. Therefore, the Shortterm Liability account discloses the unwinding of the discount at a rate of 5 %. As a result, the short-term liabilities increase before payment to a value of 161,904.76 + 8,095.24 = 1 17700"000000 ZZAARR. For the disposal of the car, we apply a Realisation account. The disposal of the car is recorded as Bookkeeping entries (D’) and (D’’). @ 31.12.20X4 Depreciation-20X4 DPR 134,240 Accumulated Depreciation ACC 134,240 (recording depreciation on the right of use asset) Short-term Liabilities A/ P 170,000 Cash/ Bank C/ B 170,000 (recording the lease payment at the yearend) Interest-20X4 INT 8,095 Short-term Liabilities A/ P 8,095 (unwinding of the disount for last instalment) Realisation-20X4 REA 268,481 Right-of-Use-Asset RUA 268,481 (disposal of the right of use asset) Accumulated Depreciation ACC 268,481 Realisation-20X4 REA 268,481 (derecognition of accumulated depreciation) In Figure 7.11, the Realisation account is zero-balanced. The total expenses are depreciation, interest and restoring costs. D C D C (1) 268,481 c/ d 268,481 P3L 147,664 c/ d 147,664 b/ d 268,481 (D') 268,481 b/ d 147,664 P4L 142,336 c/ d 290,000 290,000 290,000 b/ d 290,000 Right-of-use-asset RUA Retained earnings R/ E Figure 7.11: KRIGE (Pty) Ltd.’s accounts (20X4) <?page no="177"?> Berkau: Financial Statements 8e 7-176 for their long-term as well as for their short-term portion. Interest is capitalised towards the shortterm liabilities. Therefore, the Shortterm Liability account discloses the unwinding of the discount at a rate of 5 %. As a result, the short-term liabilities increase before payment to a value of 161,904.76 + 8,095.24 = 1 17700"000000 ZZAARR. For the disposal of the car, we apply a Realisation account. The disposal of the car is recorded as Bookkeeping entries (D’) and (D’’). @ 31.12.20X4 Depreciation-20X4 DPR 134,240 Accumulated Depreciation ACC 134,240 (recording depreciation on the right of use asset) Short-term Liabilities A/ P 170,000 Cash/ Bank C/ B 170,000 (recording the lease payment at the yearend) Interest-20X4 INT 8,095 Short-term Liabilities A/ P 8,095 (unwinding of the disount for last instalment) Realisation-20X4 REA 268,481 Right-of-Use-Asset RUA 268,481 (disposal of the right of use asset) Accumulated Depreciation ACC 268,481 Realisation-20X4 REA 268,481 (derecognition of accumulated depreciation) In Figure 7.11, the Realisation account is zero-balanced. The total expenses are depreciation, interest and restoring costs. D C D C (1) 268,481 c/ d 268,481 P3L 147,664 c/ d 147,664 b/ d 268,481 (D') 268,481 b/ d 147,664 P4L 142,336 c/ d 290,000 290,000 290,000 b/ d 290,000 Right-of-use-asset RUA Retained earnings R/ E Figure 7.11: KRIGE (Pty) Ltd.’s accounts (20X4) Berkau: Financial Statements 8e 7-177 D C D C c/ d 120,000 (3) 120,000 c/ d 161,905 (4) 161,905 b/ d 120,000 (B) 170,000 b/ d 161,905 c/ d 290,000 (B) 170,000 (C) 8,095 290,000 290,000 170,000 170,000 b/ d 290,000 Cash/ Bank C/ B Short-term liabilities A/ P D C D C (A) 134,240 P4L 134,240 c/ d 134,240 (5) 134,240 b/ d 134,240 (D'') 268,481 (A) 134,240 268,481 268,481 Depreciation-20X4 DPR Acc depr ACC D C D C (3) 120,000 (1) 268,481 (C) 8,095 P4L 8,095 (4) 161,905 (2) 13,424 281,905 281,905 Lease liabilities IBL Interest-20X4 INT D C D C DPR 134,240 NL 142,336 (D') 268,481 (D'') 268,481 INT 8,095 142,336 142,336 Profit and Loss-20X4 P4L Realisation REA Figure 7.11: KRIGE (Pty) Ltd.’s accounts (20X4) - continued How it is Done (Recording Leases): (1) Examine whether a lease applies. (2) Determine the value of the lease object or the right-of-use-asset. It is the asset’s fair value or if unknown the present value of all lease payments. For present value calculation apply the discount rate implicit in the lease or the lessee’s incremental borrowing rate. (3) Adjust the asset calculation for all lease payments linked to the lease. Those payments are rates and further payments, e.g., for restoring the leased asset. (4) Record the leased asset as a right-of-use-asset and as a lease liability at the same time. (5) Record depreciation on the right-of-use-asset. <?page no="178"?> Berkau: Financial Statements 8e 7-178 (6) Record the lease liability changes based on the lease valuation based on present value calculations. You must compound the lease liability with the interest rate applicable. (7) The carrying value of the right-of-use-asset and the lease liability can differ due to their measurement methods. (8) At the end of the lease term, record a disposal of the right-of-use-asset in a Realisation account and the retirement of the lease liabilities. Consider all payments made at the end of the lease contract. 7.27 C/ S RICHTERSVELD (Pty) Ltd. - Lessee For a finance lease the Bookkeeping entries look similar. Under a finance lease the lessee does not return the asset but keeps it. We discuss the case study RICHTERSVELD (Pty) Ltd. which is a bakery. It leases a kneading machine from the retailer BOULOUNGER Ltd. Data Sheet for RICHTERSVELD (Pty) Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((MMeellbboouurrnnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : FFoooodd IInndduussttrryy ((bbaakkeerryy)).. LLeeaassiinngg oobbjjeecctt: : kknneeaaddiinngg mmaacchhiinnee ffoorr 22 yyeeaarrss.. GGrroossss ppuurrcchhaassee pprriiccee: : 110088"000000 AAUUDD.. IInniittiiaall ppaayymmeenntt: : 1100"000000 AAUUDD.. LLeeaassee rraatteess: : 2244"000000 AAUUDD/ / aa.. LLeeaassee ppeerriioodd: : 2200XX44" 2200XX55.. IInntteerreesstt rraattee ((bboorrrroowweerr)): : 88 %%/ / aa TTyyppee ooff lleeaassee: : FFiinnaannccee lleeaassee.. PPuurrcchhaassee ooff tthhee kknneeaaddiinngg mmaacchhiinnee aatt 4455"000000 AAUUDD aatt tthhee eenndd ooff tthhee lleeaassee.. VVAATT rraattee == 2200%%.. RICHTERSVELD (Pty) Ltd. is a bakery in Melbourne. For its bread unit, the company enters in a lease with 128 If the lessee is reasonably certain to exercise the purchase option, the purchase price must be included in the vector: {0; 24,000; 69,000} for BOULOUNGER Ltd. over a kneading machine. RICHTERSVELD (Pty) Ltd. intends to lease the machine for two years and can buy it thereafter. At the commencement of the lease a payment of 10,000 AUD is due. The lease instalments are 24,000 AUD/ a. After the leasing period the lease contract includes the option to buy the machine at 45,000 AUD. RICHTERSVELD (Pty) Ltd. guarantees the value of the machine to be 45,000 AUD after its two years of deployment. Due to intensive usage of the machine with high volumes, it expects the machine to be worth only 43,000 AUD at the end of the lease term. Therefore, a payment of 2,000 AUD is expected to be made to fulfil the given value guarantee at the end of the lease contract. Under IFRS 16.27 the payment becomes part of the right-of-use-asset. RICHTERSVELD (Pty) Ltd. intends to exercise the purchase option but is not sure yet. 128 RICHTERSVELD (Pty) Ltd. applies the calculation of the lease liability. It then becomes 81,378.60 AUD. <?page no="179"?> Berkau: Financial Statements 8e 7-178 (6) Record the lease liability changes based on the lease valuation based on present value calculations. You must compound the lease liability with the interest rate applicable. (7) The carrying value of the right-of-use-asset and the lease liability can differ due to their measurement methods. (8) At the end of the lease term, record a disposal of the right-of-use-asset in a Realisation account and the retirement of the lease liabilities. Consider all payments made at the end of the lease contract. 7.27 C/ S RICHTERSVELD (Pty) Ltd. - Lessee For a finance lease the Bookkeeping entries look similar. Under a finance lease the lessee does not return the asset but keeps it. We discuss the case study RICHTERSVELD (Pty) Ltd. which is a bakery. It leases a kneading machine from the retailer BOULOUNGER Ltd. Data Sheet for RICHTERSVELD (Pty) Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((MMeellbboouurrnnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : FFoooodd IInndduussttrryy ((bbaakkeerryy)).. LLeeaassiinngg oobbjjeecctt: : kknneeaaddiinngg mmaacchhiinnee ffoorr 22 yyeeaarrss.. GGrroossss ppuurrcchhaassee pprriiccee: : 110088"000000 AAUUDD.. IInniittiiaall ppaayymmeenntt: : 1100"000000 AAUUDD.. LLeeaassee rraatteess: : 2244"000000 AAUUDD/ / aa.. LLeeaassee ppeerriioodd: : 2200XX44" 2200XX55.. IInntteerreesstt rraattee ((bboorrrroowweerr)): : 88 %%/ / aa TTyyppee ooff lleeaassee: : FFiinnaannccee lleeaassee.. PPuurrcchhaassee ooff tthhee kknneeaaddiinngg mmaacchhiinnee aatt 4455"000000 AAUUDD aatt tthhee eenndd ooff tthhee lleeaassee.. VVAATT rraattee == 2200%%.. RICHTERSVELD (Pty) Ltd. is a bakery in Melbourne. For its bread unit, the company enters in a lease with 128 If the lessee is reasonably certain to exercise the purchase option, the purchase price must be included in the vector: {0; 24,000; 69,000} for BOULOUNGER Ltd. over a kneading machine. RICHTERSVELD (Pty) Ltd. intends to lease the machine for two years and can buy it thereafter. At the commencement of the lease a payment of 10,000 AUD is due. The lease instalments are 24,000 AUD/ a. After the leasing period the lease contract includes the option to buy the machine at 45,000 AUD. RICHTERSVELD (Pty) Ltd. guarantees the value of the machine to be 45,000 AUD after its two years of deployment. Due to intensive usage of the machine with high volumes, it expects the machine to be worth only 43,000 AUD at the end of the lease term. Therefore, a payment of 2,000 AUD is expected to be made to fulfil the given value guarantee at the end of the lease contract. Under IFRS 16.27 the payment becomes part of the right-of-use-asset. RICHTERSVELD (Pty) Ltd. intends to exercise the purchase option but is not sure yet. 128 RICHTERSVELD (Pty) Ltd. applies the calculation of the lease liability. It then becomes 81,378.60 AUD. Berkau: Financial Statements 8e 7-179 for its calculation its incremental borrowing interest rate of 8 %/ a. 129 The right-of-use-asset is the present value of all payments for the lease. The vector for the lease is: R(t) = {10,000, 24,000, (24,000 + 2,000)} = { {1100"000000; ; 2244"000000; ; 2266"000000}}. Its present value based on a discount rate of 8 % is: 10,000 + 24,000/ (1 + 8%) + 26,000/ (1 + 8%) 2 = 5544"551133..0033 AAUUDD. The right-of-use-asset exceeds the lease liability by 10,000 AUD, as the initial payment has been made and therefore, it is no liability. RICHTERSVELD (Pty) Ltd. recognises the lease on 2.01.20X4 as Bookkeeping entry (1). @ 2.01.20X4 Right-of-Use-Asset RUA 54,513 Lease Liabilitiy IBL 44,513 Cash/ Bank C/ B 10,000 (recognition of the lease of the kneading machine) At the end of 20X4, RICHTERSVELD (Pty) Ltd. records interest of: 44,513.03 × 8% = 33"556611..0044 AAUUDD and depreciation of: 54,513.03/ 2 = 2 277"225566..5522 AAUUDD. Furthermore, the lease payment of 24,000 AUD is paid to the lessor. Observe the Bookkeeping entries (2) - (4). 130 @ 31.12.20X4 Depreciation-20X4 DPR 27,257 Accumulated Depreciation ACC 27,257 (recording depreciation on the right of use asset) Lease Liabilities IBL 24,000 Cash/ Bank C/ B 24,000 (recording the lease payment at the yearend) Interest-20X4 INT 3,561 Lease Liabilitiy IBL 3,561 (recording interest expenses for 20X4) Study the accounts as per 31.12.20X4 in Figure 7.12. 129 The interest rate implicit in the lease is unknown for RICHTERSVELD (Pty) Ltd. 130 We ignore here the separate disclosure of shortterm and long-term liabilities along IAS 1.60. That aspect is covered by the case study KRIGE (Pty) Ltd. already. <?page no="180"?> Berkau: Financial Statements 8e 7-180 D C D C (1) 54,513 c/ d 54,513 OV . . . (1) 10,000 b/ d 54,513 c/ d 34,000 (3) 24,000 34,000 34,000 b/ d 34,000 D C D C (3) 24,000 (1) 44,513 (2) 3,561 P4L 3,561 c/ d 24,074 (2) 3,561 48,074 48,074 b/ d 24,074 Right of use asset RUA Cash/ Bank C/ B Lease liability IBL Interst-20X4 INT D C D C (4) 27,257 P4L 27,257 c/ d 27,257 (4) 27,257 b/ d 27,257 D C D C DPR 27,257 R/ E 30,818 P4L 30,818 c/ d 30,818 INT 3,561 b/ d 30,818 30,818 30,818 Depreciation-20X4 DPR Accumulated depreciation ACC Profit and Loss-20X4 P4L Retained earnings R/ E Figure 7.12: RICHTERSVELD (Pty) Ltd.’s accounts (20X4) In 20X5, RICHTERSVELD (Pty) Ltd. recognises interest expenses of: (44,513.03 × 1.08 - 24,000) × 8% = 1 1"992255..9933 AAUUDD and depreciation again to the extent of 27,256.52 AUD. Observe the accounts after recording expenses and making payments to the lessor in Figure 7.13. D C D C (1) 54,513 c/ d 54,513 OV . . . (1) 10,000 b/ d 54,513 REA 54,513 c/ d 34,000 (3) 24,000 34,000 34,000 b/ d 34,000 c/ d 60,000 (B) 26,000 60,000 60,000 b/ d 60,000 Right-of-use-asset RUA Cash/ Bank C/ B Figure 7.13: RICHTERSVELD (Pty) Ltd.’s accounts (20X5) <?page no="181"?> Berkau: Financial Statements 8e 7-180 D C D C (1) 54,513 c/ d 54,513 OV . . . (1) 10,000 b/ d 54,513 c/ d 34,000 (3) 24,000 34,000 34,000 b/ d 34,000 D C D C (3) 24,000 (1) 44,513 (2) 3,561 P4L 3,561 c/ d 24,074 (2) 3,561 48,074 48,074 b/ d 24,074 Right of use asset RUA Cash/ Bank C/ B Lease liability IBL Interst-20X4 INT D C D C (4) 27,257 P4L 27,257 c/ d 27,257 (4) 27,257 b/ d 27,257 D C D C DPR 27,257 R/ E 30,818 P4L 30,818 c/ d 30,818 INT 3,561 b/ d 30,818 30,818 30,818 Depreciation-20X4 DPR Accumulated depreciation ACC Profit and Loss-20X4 P4L Retained earnings R/ E Figure 7.12: RICHTERSVELD (Pty) Ltd.’s accounts (20X4) In 20X5, RICHTERSVELD (Pty) Ltd. recognises interest expenses of: (44,513.03 × 1.08 - 24,000) × 8% = 1 1"992255..9933 AAUUDD and depreciation again to the extent of 27,256.52 AUD. Observe the accounts after recording expenses and making payments to the lessor in Figure 7.13. D C D C (1) 54,513 c/ d 54,513 OV . . . (1) 10,000 b/ d 54,513 REA 54,513 c/ d 34,000 (3) 24,000 34,000 34,000 b/ d 34,000 c/ d 60,000 (B) 26,000 60,000 60,000 b/ d 60,000 Right-of-use-asset RUA Cash/ Bank C/ B Figure 7.13: RICHTERSVELD (Pty) Ltd.’s accounts (20X5) Berkau: Financial Statements 8e 7-181 D C D C (3) 24,000 (1) 44,513 (2) 3,561 P4L 3,561 c/ d 24,074 (2) 3,561 48,074 48,074 (B) 26,000 b/ d 24,074 (C) 1,926 26,000 26,000 Lease liability IBL Interst-20X4 INT D C D C (4) 27,257 P4L 27,257 c/ d 27,257 (4) 27,257 b/ d 27,257 c/ d 54,513 (A) 27,257 54,513 54,513 REA 54,513 b/ d 54,513 Depreciation-20X4 DPR Accumulated depreciation ACC D C D C DPR 27,257 R/ E 30,818 P4L 30,818 c/ d 30,818 INT 3,561 b/ d 30,818 30,818 30,818 P5L 29,182 c/ d 60,000 60,000 60,000 b/ d 60,000 Profit and Loss-20X4 P4L Retained earnings R/ E D C D C (A) 27,257 P5L 27,257 (C) 1,926 P5L 1,926 D C D C DPR 27,257 R/ E 29,182 RUA 54,513 ACC 54,513 INT 1,926 29,182 29,182 Profit and Loss-20X5 P5L Realisiation-20X5 REA Depreciation-20X5 DPR Interest-20X5 INT Figure 7.13: RICHTERSVELD (Pty) Ltd.’s accounts (20X5 continued 7.28 C/ S RICHTERSVELD (Pty) Ltd. - Lessor Next, we discuss the lease of the kneading machine in the lessor’s books. The lessor is BOULANGER Ltd. which is a retailer for industrial kitchen appliances. The business model is to buy the machinery from the manufacturer and sell them on with adding a sales margin of 25 % to the cost of acquisition. In the case of the kneading machine, the company buys it a gross purchase price of 86,400 AUD. The cost of acquisition is: 86,400/ 120% = 7 722"000000 AAUUDD. The fair market value of the kneading machine is 90,000 AUD (net selling price). Accordingly, the margin for <?page no="182"?> Berkau: Financial Statements 8e 7-182 BOULANGER Ltd. from the sale of the machinery is: 90,000 - 72,000 = 1 188"000000 AAUUDD. On 2.01.20X4, we record the acquisition of the kneading machine at BOULANGER Ltd. as Bookkeeping entry (1) VAT applies at a VAT rate of 20 %. @ 2.01.20X4 Asset Held for Lease A4L 72,000 Value Added Tax VAT 14,400 Cash/ Bank C/ B 86,400 (recognition of the kneading machine) For the calculation of the interest rate implicit in the lease, we determine the payment vector of the lease which is based on the fair market value of the kneading machine 131 and the payments expected from RICHTERSVELD (Pty) Ltd. B(t) = {(-90,000 + 10,000); 24,000; (24,000 + 45,000)} = { {--8800"000000; ; 2244"000000; ; 6699"000000}}. The vector considers the purchase of the machine or its return at the agreed and guaranteed value. Its internal rate of return is: IRR(B(t)) = 99..0077 4444 %%/ / aa. As BOULANGER Ltd. receives the initial payment from RICHTERSVELD (Pty) Ltd., the receivables are the present value of the future payments: 24,000/ (1 + 9.07 44 %) + 69,000 / (1 + 9.07 44 %) 2 = 8800"000000..0055 AAUUDD. By the Bookkeeping entries (2) and (3), BOULANGER Ltd. recognises its revenue and the cost of sale. The difference gives the sales profit. Bookkeeping entry (4) records the interest income for 20X4, and Bookkeeping entry (5) records the receipt from the lessee to the extent of 24,000 AUD. Find below the Bookkeeping entries as recorded in the lessor’s books for 20X4. @ 31.12.20X4 Cash/ Bank C/ B 10,000 Accounts Receivables A/ R 80,000 Revenue-20X4 REV 90,000 (sales revenue recognition of the kneading machine) Cost of Sale-20X4 COS 72,000 Asset Held for Lease A4L 72,000 (recording the cost of sale) Accounts Receivables A/ R 7,260 Interest Income-20X4 I4I 7,260 (recording interest income for 20X4 based on the rate implicit in the lease) Cash/ Bank C/ B 24,000 Accounts Receivables A/ R 24,000 (cash receipt from the lessee RICHTERSVELD (Pty) Ltd.) 131 IFRS 16.71 applies. <?page no="183"?> Berkau: Financial Statements 8e 7-182 BOULANGER Ltd. from the sale of the machinery is: 90,000 - 72,000 = 1 188"000000 AAUUDD. On 2.01.20X4, we record the acquisition of the kneading machine at BOULANGER Ltd. as Bookkeeping entry (1) VAT applies at a VAT rate of 20 %. @ 2.01.20X4 Asset Held for Lease A4L 72,000 Value Added Tax VAT 14,400 Cash/ Bank C/ B 86,400 (recognition of the kneading machine) For the calculation of the interest rate implicit in the lease, we determine the payment vector of the lease which is based on the fair market value of the kneading machine 131 and the payments expected from RICHTERSVELD (Pty) Ltd. B(t) = {(-90,000 + 10,000); 24,000; (24,000 + 45,000)} = { {--8800"000000; ; 2244"000000; ; 6699"000000}}. The vector considers the purchase of the machine or its return at the agreed and guaranteed value. Its internal rate of return is: IRR(B(t)) = 99..0077 4444 %%/ / aa. As BOULANGER Ltd. receives the initial payment from RICHTERSVELD (Pty) Ltd., the receivables are the present value of the future payments: 24,000/ (1 + 9.07 44 %) + 69,000 / (1 + 9.07 44 %) 2 = 8800"000000..0055 AAUUDD. By the Bookkeeping entries (2) and (3), BOULANGER Ltd. recognises its revenue and the cost of sale. The difference gives the sales profit. Bookkeeping entry (4) records the interest income for 20X4, and Bookkeeping entry (5) records the receipt from the lessee to the extent of 24,000 AUD. Find below the Bookkeeping entries as recorded in the lessor’s books for 20X4. @ 31.12.20X4 Cash/ Bank C/ B 10,000 Accounts Receivables A/ R 80,000 Revenue-20X4 REV 90,000 (sales revenue recognition of the kneading machine) Cost of Sale-20X4 COS 72,000 Asset Held for Lease A4L 72,000 (recording the cost of sale) Accounts Receivables A/ R 7,260 Interest Income-20X4 I4I 7,260 (recording interest income for 20X4 based on the rate implicit in the lease) Cash/ Bank C/ B 24,000 Accounts Receivables A/ R 24,000 (cash receipt from the lessee RICHTERSVELD (Pty) Ltd.) 131 IFRS 16.71 applies. Berkau: Financial Statements 8e 7-183 In Figure 7.14 all relevant accounts for BOULANGER Ltd. are shown. Calculations have been made based on the rate implicit in the lease which has been determined by the IRR() function in MS- Excel. 132 D C D C (1) 72,000 (3) 72,000 (1) 14,400 c/ d 14,400 b/ d 14,400 (B) 14,400 Asset held for lease A4L Value added tax VAT D C D C OV . . . (1) 86,400 (2) 80,000 (5) 24,000 (2) 10,000 (4) 7,260 c/ d 63,260 (5) 24,000 87,260 87,260 c/ d 52,400 b/ d 63,260 (D) 69,000 86,400 86,400 (C) 5,740 (B) 14,400 b/ d 52,400 69,000 69,000 (D) 69,000 (A) 7,578 c/ d 23,422 83,400 83,400 b/ d 23,422 D C D C P4L 90,000 (2) 90,000 (3) 72,000 P4L 72,000 D C D C COS 72,000 REV 90,000 P4L 7,260 (4) 7,260 EBT 25,260 I4I 7,260 97,260 97,260 ITL 7,578 b/ d 25,260 R/ E 17,682 D C D C c/ d 17,682 P4L 17,682 c/ d 7,578 P4L 7,578 b/ d 17,682 (A) 7,578 b/ d 7,578 c/ d 21,700 P5L 4,018 c/ d 1,722 P5L 1,722 21,700 21,700 9,300 9,300 b/ d 21,700 b/ d 1,722 Cash/ Bank C/ B Accounts receivables A/ R Revenue-20X4 REV Cost of sale-20X4 COS Profit and Loss-20X4 P4L Interest income-20X4 I4I Retained earnings R/ E Income tax liabilities ITL Figure 7.14: BOULANGER Ltd.’s accounts 132 Examples about lease modifications can be found in: Berkau/ Neethling/ Msiza: Case Study FIUMICINO (Pty) Ltd.: Lease Modifications in the Lessors' Books - IFRS 16. in: KOR 24(2024)7/ 8. <?page no="184"?> Berkau: Financial Statements 8e 7-184 D C D P5L 5,740 (C) 5,740 EBT 5,740 I5I 5,740 ITL 1,722 b/ d 5,740 R/ E 4,018 Interest income-20X5 I5I Profit and Loss-20X5 P5L Figure 7.14: BOULANGER Ltd.’s accounts continued 7.29 Short-term Leases Leases can also be short-term and then must be recorded as expense. See below the case study JONKERS GmbH, a consultancy based in Osnabrück. 7.30 C/ S JONKERS GmbH The company regularly visits its clients and bills travel expenses directly without adding further surcharges to them. At JONKERS GmbH, only short-term leases apply which are considered as an expense and recorded through profit or loss. Data Sheet for JONKERS GmbH: DDoommiicciillee: : GGeerrmmaannyy ((OOssnnaabbrrüücckk)).. RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : CCoonnssuullttaannccyy.. RReenntt ooff aann AAuuddii AA44 ccaarr oonn 66..0066..2200XX77 ffoorr 44 ddaayyss.. LLeeaassee rraatteess: : 113355 EEUURR/ / dd.. IInnssuurraannccee rraattee: : 4400 EEUURR/ / dd.. VVAATT iiggnnoorreedd.. On 6.06.20X7, JONKERS GmbH visits a client in Saarbrücken. From the car rental, JONKERS GmbH hires an Audi A4. It returns the car on 9.06.20X7, which results in a rental expense for 4 days of: 4 × 135 = 5 54400 EEUURR. Although the risk of accident is transferred to JONKERS GmbH, no lease contract applies following IFRS 16. JONKERS GmbH insures the car and accrues insurance fees to its Travel Expense account. Insurance is: 4 × 40 = 1 16600 EEUURR. JONKERS GmbH charges its client the total travel costs of: 540 + 160 = 7 70000 EEUURR. The refund is not recorded as revenue but as a credit entry in the Travel Expense account as it represents an income from external expense coverage. Short-term rent of the car does not fall under leases. It is a service of the car rental although JONKERS GmbH has the full use of the car and can decide where to go. However, it cannot sell the car. In case of JONKERS GmbH, IFRS 16.5 applies as the lease is short-term and of minor value. JONKERS GmbH records the cost by two Bookkeeping entries: (1) for the car rental and (2) for the receipt of the refund from its client. <?page no="185"?> Berkau: Financial Statements 8e 7-184 D C D P5L 5,740 (C) 5,740 EBT 5,740 I5I 5,740 ITL 1,722 b/ d 5,740 R/ E 4,018 Interest income-20X5 I5I Profit and Loss-20X5 P5L Figure 7.14: BOULANGER Ltd.’s accounts continued 7.29 Short-term Leases Leases can also be short-term and then must be recorded as expense. See below the case study JONKERS GmbH, a consultancy based in Osnabrück. 7.30 C/ S JONKERS GmbH The company regularly visits its clients and bills travel expenses directly without adding further surcharges to them. At JONKERS GmbH, only short-term leases apply which are considered as an expense and recorded through profit or loss. Data Sheet for JONKERS GmbH: DDoommiicciillee: : GGeerrmmaannyy ((OOssnnaabbrrüücckk)).. RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : CCoonnssuullttaannccyy.. RReenntt ooff aann AAuuddii AA44 ccaarr oonn 66..0066..2200XX77 ffoorr 44 ddaayyss.. LLeeaassee rraatteess: : 113355 EEUURR/ / dd.. IInnssuurraannccee rraattee: : 4400 EEUURR/ / dd.. VVAATT iiggnnoorreedd.. On 6.06.20X7, JONKERS GmbH visits a client in Saarbrücken. From the car rental, JONKERS GmbH hires an Audi A4. It returns the car on 9.06.20X7, which results in a rental expense for 4 days of: 4 × 135 = 5 54400 EEUURR. Although the risk of accident is transferred to JONKERS GmbH, no lease contract applies following IFRS 16. JONKERS GmbH insures the car and accrues insurance fees to its Travel Expense account. Insurance is: 4 × 40 = 1 16600 EEUURR. JONKERS GmbH charges its client the total travel costs of: 540 + 160 = 7 70000 EEUURR. The refund is not recorded as revenue but as a credit entry in the Travel Expense account as it represents an income from external expense coverage. Short-term rent of the car does not fall under leases. It is a service of the car rental although JONKERS GmbH has the full use of the car and can decide where to go. However, it cannot sell the car. In case of JONKERS GmbH, IFRS 16.5 applies as the lease is short-term and of minor value. JONKERS GmbH records the cost by two Bookkeeping entries: (1) for the car rental and (2) for the receipt of the refund from its client. Berkau: Financial Statements 8e 7-185 @ 9.06.20X7 Travel Expenses-20X7 TEX 700 Cash/ Bank C/ B 700 (recognition of travel expenses billed by the car rental) @ 1.07.20X7 Cash/ Bank C/ B 700 Travel Expenses-20X7 TEX 700 (recording the receipt of the refund) 7.31 Financial Instruments For financial instruments, we refer to IAS 32, (Financial Instruments, Presentation), IFRS 7: (Financial Instruments, Disclosure) and IFRS 9: (Financial Instruments). IAS 32.11 defines financial instruments. A financial instrument is any contract that gives rise to a financial asset at one company and a financial liability or equity instrument at another one. E.g., if a company invests in fresh shares, it will disclose them as non-current assets and the emitting corporation discloses the shares as issued capital and most probably under capital reserves, as well (for the premium). IAS 32.11 defines the details of financial assets and financial liabilities. A financial asset is e.g., a right to receive cash whereas a financial liability can be a contractual obligation to deliver cash. In this textbook, long-term financial instruments are covered in this chapter (7). In chapter (14) we discuss financial liabilities. Their measurements are based on the same IFRS standards. We cover various financial assets to provide you with a wide range of knowledge of how to recognise and measure financial instruments. We list 133 IAS 39 also rules the measurement of financial instruments, so reporting companies can still choose whether to follow IAS 39 or IFRS 9. We below the discussed financial asset categories together with the case study names: (a) Cross-border investment in another company, based on ordinary shares - HAWKINS Ltd. / STEYN GmbH. (b) Bonds traded at a bond market - HAVENGA Ltd. (c) Bonds held to maturity - NATBERGEN (Pty) Ltd. (d) Preference Shares, held at FVTOCI and later Sold - DORRINGTON Ltd. / ROTTMAN Ltd. (e) Derivatives, call option to buy copper - MOLLENBERG Ltd. IAS 32 defines financial instruments but does not rule their recognition or measurement. However, IFRS 7 and IFRS 9 do. All aspects of how to disclose financial instruments have been moved to IFRS 7: Financial Instruments, Disclosure. Measurement can now be found in IFRS 9. 133 In this chapter, we focus on the owners' side. Financial assets are investments, ownership of shares, bonds, receivables, currency futures, call opfocus on IFRS 9 as IAS 39 will be superseded shortly. <?page no="186"?> Berkau: Financial Statements 8e 7-186 tions etc. We cover here only a selection of cases to show how owners record and measure financial assets. The main rule for the disclosure of financial instruments is to study the business model of the holding company. Business model is a technical term in Accounting which refers to what the owner intends to do with her/ his financial assets. We distinguish financial assets held until maturity from those held for trading purpose. If e.g., a company holds bonds 134 until redemption (until they mature), it must disclose them at amortised costs 135 . If a shareholder intends to sell her/ his stock whenever a good price can be obtained, we allocate the shares to the current asset section. The valuation is then based on fair market values. Note, as shares do not mature, this is the default case. We focus on current financial assets in chapter (9). We discuss below the case of HAWKINS Ltd., a South African company that reports in accordance with IFRSs and holds an investment in a German company. 7.32 C/ S HAWKINS Ltd. / STEYN GmbH - Cross-Border Investments Below, we provide an overview of the case study: Data Sheet for HAWKINS Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((UUppiinnggttoonn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. 134 Study bonds in our textbook Basics of Accounting, chapter (15). 135 Check for the Bookkeeping entries of a loan held at amortised costs the case study BATHURST Ltd. in chapter (6). IInnvveessttmmeenntt: : 88 %% iinn SSTTEEYYNN GGmmbbHH" iissssuueedd ccaappiittaall 110000"000000 EEUURR; ; bbooookk vvaalluuee: : 224455"000000EEUURR.. CCuurrrreennccyy eexxcchhaannggee rraattee 1155 ZZAARR : : 11 EEUURR" llaatteerr: : 1155..5500 ZZAARR : : 11 EEUURR.. SSTTEEYYNN GGmmbbHH''ss pprrooffiitt: : 2255"000000 EEUURR" ddiivvii-ddeenndd 5500 %% tthheerreeooff.. VVAATT iiggnnoorreedd.. HAWKINS Ltd. holds 8 % of STEYN GmbH in Germany. STEYN GmbH is an online retailer for tyres in Hamburg and based on an issued capital of 100,000 EUR. The company’s book value is 245,000 EUR at the time when HAWKINS Ltd. buys 8 % of the German firm at 19,600 EUR. The share price is justified by the book value of STEYN GmbH which is 245 % of its issued capital. 136 The book value of the acquired shares with a nominal value of 8,000 EUR is: 8,000 × 245% = 1 199"660000 EEUURR. No fresh shares are issued for HAWKINS Ltd. buying its investment in STEYN GmbH. The currency exchange rate at the time of acquisition on 2.07.20X3 is: 15 ZAR : 1 EUR. HAWKINS Ltd. pays in South African Rand: 15 × 19,600 = 2 29944"000000 ZZAARR. We ignore transaction costs based on our conventions. Following IAS 32.11, a financial asset applies for HAWKINS Ltd., as stock of another company falls under equity instruments. As the German company is in the legal form of a GmbH, we do not use the term shareholder but (partial) owner. HAWKINS Ltd.'s business model implies that the investment is timely unlimited. This supports the disclosure of the investment under non-current financial assets on the balance sheet. IFRS 9.5.1.1 requires the initial recognition at 136 Equity increases as a result or earnings added to reserves and/ or profits carried forward from prior Accounting periods. <?page no="187"?> Berkau: Financial Statements 8e 7-186 tions etc. We cover here only a selection of cases to show how owners record and measure financial assets. The main rule for the disclosure of financial instruments is to study the business model of the holding company. Business model is a technical term in Accounting which refers to what the owner intends to do with her/ his financial assets. We distinguish financial assets held until maturity from those held for trading purpose. If e.g., a company holds bonds 134 until redemption (until they mature), it must disclose them at amortised costs 135 . If a shareholder intends to sell her/ his stock whenever a good price can be obtained, we allocate the shares to the current asset section. The valuation is then based on fair market values. Note, as shares do not mature, this is the default case. We focus on current financial assets in chapter (9). We discuss below the case of HAWKINS Ltd., a South African company that reports in accordance with IFRSs and holds an investment in a German company. 7.32 C/ S HAWKINS Ltd. / STEYN GmbH - Cross-Border Investments Below, we provide an overview of the case study: Data Sheet for HAWKINS Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((UUppiinnggttoonn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. 134 Study bonds in our textbook Basics of Accounting, chapter (15). 135 Check for the Bookkeeping entries of a loan held at amortised costs the case study BATHURST Ltd. in chapter (6). IInnvveessttmmeenntt: : 88 %% iinn SSTTEEYYNN GGmmbbHH" iissssuueedd ccaappiittaall 110000"000000 EEUURR; ; bbooookk vvaalluuee: : 224455"000000EEUURR.. CCuurrrreennccyy eexxcchhaannggee rraattee 1155 ZZAARR : : 11 EEUURR" llaatteerr: : 1155..5500 ZZAARR : : 11 EEUURR.. SSTTEEYYNN GGmmbbHH''ss pprrooffiitt: : 2255"000000 EEUURR" ddiivvii-ddeenndd 5500 %% tthheerreeooff.. VVAATT iiggnnoorreedd.. HAWKINS Ltd. holds 8 % of STEYN GmbH in Germany. STEYN GmbH is an online retailer for tyres in Hamburg and based on an issued capital of 100,000 EUR. The company’s book value is 245,000 EUR at the time when HAWKINS Ltd. buys 8 % of the German firm at 19,600 EUR. The share price is justified by the book value of STEYN GmbH which is 245 % of its issued capital. 136 The book value of the acquired shares with a nominal value of 8,000 EUR is: 8,000 × 245% = 1 199"660000 EEUURR. No fresh shares are issued for HAWKINS Ltd. buying its investment in STEYN GmbH. The currency exchange rate at the time of acquisition on 2.07.20X3 is: 15 ZAR : 1 EUR. HAWKINS Ltd. pays in South African Rand: 15 × 19,600 = 2 29944"000000 ZZAARR. We ignore transaction costs based on our conventions. Following IAS 32.11, a financial asset applies for HAWKINS Ltd., as stock of another company falls under equity instruments. As the German company is in the legal form of a GmbH, we do not use the term shareholder but (partial) owner. HAWKINS Ltd.'s business model implies that the investment is timely unlimited. This supports the disclosure of the investment under non-current financial assets on the balance sheet. IFRS 9.5.1.1 requires the initial recognition at 136 Equity increases as a result or earnings added to reserves and/ or profits carried forward from prior Accounting periods. Berkau: Financial Statements 8e 7-187 294,000 ZAR which is the costs of acquisition. HAWKINS Ltd. records Bookkeeping entry (1), see below: @ 2.07.20X3 Financial Assets STEYN FNA 294,000 Cash/ Bank C/ B 294,000 (recognition of investment in STEYN GmbH) HAWKINS Ltd. does not record its shares in STEYN GmbH as an investment as it is below 20 % of STEYN GmbH’s total issued capital. 137 HAWKINS Ltd. discloses its shares as a financial asset following IFRS 9. The initial valuation is at cost (see above). The subsequent valuation of the shares in STEYN GmbH depends on their EUR value and the exchange rate to the South African Rand. We assume that on the balance sheet date of 31.12.20X3 the currency exchange rate has changed in HAWKINS Ltd.’s favour due to a weak South African Rand ZAR. The exchange rate is now: 15.50 ZAR : 1 EUR. As the financial asset’s valuation is based on EUR values, HAWKINS Ltd. shares increase towards a value of: 19,600 × 15.50 = 3 30033"880000 ZZAARR. The question for HAWKINS Ltd. is whether it must adjust the valuation on the balance sheet? Yes, it must. Despite the intention to keep the shares, HAWKINS Ltd. must apply a fair value presentation, here: through other comprehensive income. HAWKINS Ltd. considers the increase in share values as gain due to the favourable currency exchange rate changes to the extent of: 19,600 × 15.50 - 294,000 = 99"880000 ZZAARR. HAWKINS Ltd. records the currency exchange gain together with a profit share as discussed below. In 137 Accounting for business combinations is covered in chapter (8). Bookkeeping entry (3), the increase of the share value based on equity increase is considered, which causes the difference resulting from the exchange rate to exceed 9,800 ZAR towards 10,150 ZAR. The shares increase because STEYN GmbH added profit to earnings reserves. This is relevant, because we apply a valuation at equity further below. Next, we check the dividends. STEYN GmbH earned a pre-tax profit 25,000 EUR during the Accounting period 20X3. The company distributes half of the earnings (after taxes) to owners and adds the other half to earnings reserves. Hence, the profit share HAWKINS Ltd. receives is: 8% × 25,000 × (1 - 30%) / 2 = 770000 EEUURR which is in South African Rand: 700 × 15.50 = 1 100"885500 ZZAARR. STEYN GmbH adds: 25,000 × (1 - 30%) / 2 = 88"775500 EEUURR to its earnings reserves account which results in an equity increase. The shares are not traded publicly. So, we do not have any other indication for the valuation of shares than the company’s equity. Therefore, the fair value of the financial asset at HAWKINS Ltd. is adjusted through other comprehensive income and now is: 8% × (245,000 + 8,750) × 15.50 = 3 31144"665500 ZZAARR. This measurement is referred to as ad-equity-valuation. It is the default measurement for associated companies <?page no="188"?> Berkau: Financial Statements 8e 7-188 and ruled by IAS 28. We apply the method due to the lack of an active market for the shares in STEYN GmbH. HAWKINS Ltd. records the value adjustment of: 314,650 - 294,000 = 2 200"665500 ZZAARR through other comprehensive income. The amount contains the equity increase from the addition to reserves as well as the value increase caused by the favourable currency exchange. The profit share (portion of the profit appropriation) as paid to HAWKINS Ltd. is: 700 × 15.50 = 1 100"885500 ZZAARR. As STEYN GmbH is no company based on shares, we do not call this a dividend. In total, HAWKINS Ltd.’s gain is: 10,850 + 20,650 = 3 311"550000 ZZAARR. Observe the Bookkeeping entries (2) and (3). Due to IFRS 9.5.7.10, HAWKINS Ltd. records the currency gain separately. It is: 8% × (245,000 + 8,750) × (15.50 - 15) = 1100"115500 ZZAARR. The gain due to equity increase (addition to reserves) is: 20,650 - 10,150 = 1 100"550000 ZZAARR. @ 31.12.20X3 Cash/ Bank C/ B 10,850 Other Comprehensive Income-20X3 OCI 10,850 (receipt of appropriation of profit from investment) Financial Assets STEYN FNA 20,650 Gain on Currency Exchange-20X3 GCE 10,150 Other Comprehensive Income-20X3 OCI 10,500 (value increase of the shares in STEYN GmbH) On HAWKINS Ltd.’s balance sheet, the financial asset is now disclosed at 314,650 ZAR. Other comprehensive income is disclosed on the income statement at: 10,850 + 20,650 = 3 311"550000 ZZAARR. Special reporting requirements apply for HAWKINS Ltd. due to IFRS 7, like credit and market risk disclosure. Permanent changes in the valuation of financial assets cause volatility on the balance sheet and gains/ expenses on the income statement of the holder/ owner of financial assets. IFRSs allow a valuation at amortised cost to prevent the balance sheet from oscillating asset valuations. IFRS 9.4.1.2 requires carrying financial assets at amortised costs if the company’s business model is keeping the assets and receiving regular cash flows on specific dates. Those cash flows can result from interest, pay-off and redemption payments, but not from capital appreciation. A valuation at amortised costs means a systematic approximation of the initial valuation to the final value. Technically, the effective interest method applies. A company that holds bonds until maturity discloses them at amortised costs. 7.33 C/ S HAVENGA Ltd. - Bonds HAVENGA Ltd. buys bonds which are traded on the bond market. Data Sheet for HAVENGA Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((PPrreettoorriiaa)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. OOnn 22..0011..2200XX22" bboonnddss iissssuuee aatt 11 ZZAARR/ / bb.. CCoouuppoonn rraattee 1111 %%.. TTiimmee ttoo mmaattuurriittyy: : 2255 yyeeaarrss.. VVAATT nn/ / aa.. <?page no="189"?> Berkau: Financial Statements 8e 7-188 and ruled by IAS 28. We apply the method due to the lack of an active market for the shares in STEYN GmbH. HAWKINS Ltd. records the value adjustment of: 314,650 - 294,000 = 2 200"665500 ZZAARR through other comprehensive income. The amount contains the equity increase from the addition to reserves as well as the value increase caused by the favourable currency exchange. The profit share (portion of the profit appropriation) as paid to HAWKINS Ltd. is: 700 × 15.50 = 1 100"885500 ZZAARR. As STEYN GmbH is no company based on shares, we do not call this a dividend. In total, HAWKINS Ltd.’s gain is: 10,850 + 20,650 = 3 311"550000 ZZAARR. Observe the Bookkeeping entries (2) and (3). Due to IFRS 9.5.7.10, HAWKINS Ltd. records the currency gain separately. It is: 8% × (245,000 + 8,750) × (15.50 - 15) = 1100"115500 ZZAARR. The gain due to equity increase (addition to reserves) is: 20,650 - 10,150 = 1 100"550000 ZZAARR. @ 31.12.20X3 Cash/ Bank C/ B 10,850 Other Comprehensive Income-20X3 OCI 10,850 (receipt of appropriation of profit from investment) Financial Assets STEYN FNA 20,650 Gain on Currency Exchange-20X3 GCE 10,150 Other Comprehensive Income-20X3 OCI 10,500 (value increase of the shares in STEYN GmbH) On HAWKINS Ltd.’s balance sheet, the financial asset is now disclosed at 314,650 ZAR. Other comprehensive income is disclosed on the income statement at: 10,850 + 20,650 = 3 311"550000 ZZAARR. Special reporting requirements apply for HAWKINS Ltd. due to IFRS 7, like credit and market risk disclosure. Permanent changes in the valuation of financial assets cause volatility on the balance sheet and gains/ expenses on the income statement of the holder/ owner of financial assets. IFRSs allow a valuation at amortised cost to prevent the balance sheet from oscillating asset valuations. IFRS 9.4.1.2 requires carrying financial assets at amortised costs if the company’s business model is keeping the assets and receiving regular cash flows on specific dates. Those cash flows can result from interest, pay-off and redemption payments, but not from capital appreciation. A valuation at amortised costs means a systematic approximation of the initial valuation to the final value. Technically, the effective interest method applies. A company that holds bonds until maturity discloses them at amortised costs. 7.33 C/ S HAVENGA Ltd. - Bonds HAVENGA Ltd. buys bonds which are traded on the bond market. Data Sheet for HAVENGA Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((PPrreettoorriiaa)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. OOnn 22..0011..2200XX22" bboonnddss iissssuuee aatt 11 ZZAARR/ / bb.. CCoouuppoonn rraattee 1111 %%.. TTiimmee ttoo mmaattuurriittyy: : 2255 yyeeaarrss.. VVAATT nn/ / aa.. Berkau: Financial Statements 8e 7-189 The bonds’ face value is 5,000,000 ZAR (nominal value) and repayment is in 25 years. They are issued on 2.01.20X2. This is when HAVENGA Ltd. buys them. The coupon rate of the bonds is 11 %/ a. Coupons are paid annually at yearends. Observe the Bookkeeping entry (1) at the time of acquisition following the cost model: @ 2.01.20X2 Financial Assets (Bonds) FNA 5,000,000 Cash/ Bank C/ B 5,000,000 (recognition of bonds) On 31.12.20X3, HAVENGA Ltd. receives the coupon which is: 5,000,000 × 11% = 555500"000000 ZZAARR. The Bookkeeping entry (2) for the coupon receipt shows the bonds’ income assigned to other comprehensive income: @ 31.12.20X2 Cash/ Bank C/ B 550,000 Bond Income-20X2 OCI 550,000 (receipt of coupon) For further information about HAVENGA Ltd.’s bond valuation, check the link below: Link 7.G: Bond valuation During the next years, the bonds’ value fluctuates and on balance sheet dates, the fair market values are: - 20X3: 6,306,624.27 ZAR - 20X4: 6,164,191.10 ZAR - 20X5: 5,961,479.99 ZAR - 20X6: 5,095,205.27 ZAR - 20X7: 5,000,000.00 ZAR Following IFRS 9.4.1.2, HAVENGA Ltd. records its bonds at amortised costs. Therefore, HAVENGA Ltd. ignores bond market values. HAVENGA Ltd.’s bonds are disclosed constantly at 5,000,000 ZAR which results in temporarily underrating. HAVENGA Ltd.’s business model is to keep the bonds until maturity. At the date of redemption, it will receive 5,000,000 ZAR regardless of what the bond price was in between. The valuation at HAVENGA Ltd. was constantly at the cost of acquisition because the company bought the bonds at face values and the redemption takes place at face values, too. Therefore, the measurement at amortised costs is simple. In case a holder buys bonds with a premium or discount and holds them until maturity, the effective interest method applies in line with IFRS 9.4.1.2 and IFRS 9.5.4.1., which will approximate the bond valuation consequently towards its redemption value. <?page no="190"?> Berkau: Financial Statements 8e 7-190 We demonstrate the measurement at amortised costs by the next case study NATBERGEN (Pty) Ltd. 7.34 C/ S NATBERGEN (Pty) Ltd. - Bonds held to Maturity Data Sheet for NATBERGEN (Pty) Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((BBrriissbbaannee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. BBoonnddss aatt 440000"000000 AAUUDD" ccoosstt ooff aaccqquuiissii-ttiioonn: : 335500"000000 oonn 33..0011..2200XX33.. BBoonnddss mmaattuurree oonn 3311..1122..2200XX77.. CCoouuppoonn rraattee: : 88 %%/ / aa" 3322"000000 AAUUDD/ / aa.. VVAATT iiggnnoorreedd.. On 3.01.20X3, NATBERGEN (Pty) Ltd. buys bonds five years before they mature at 350,000 AUD. Their face value is 400,000 AUD. We say the acquisition was at a discount (below-par). A listing of bonds below their principal results either from an interest market rate that exceeds the coupon rate or from the investors mistrusting the issuer’s capability to pay coupons and for redemption. The coupon rate of NATBERGEN (Pty) Ltd.’s bonds is 8 %/ a which makes the holder receive an annual coupon of: 8% × 400,000 = 3 322"000000 AAUUDD/ / aa. Dividend and interest depend on the nominal value and must in general be recorded through profit or loss or other comprehensive income. NATBERGEN (Pty) Ltd. initially recognises the bonds at 350,000 AUD (cost of acquisition). Check the Bookkeeping entry below: @ 3.01.20X3 Financial Assets (Bonds) FNA 350,000 Cash/ Bank C/ B 350,000 (recognition of bonds) NATBERGEN (Pty) Ltd. keeps the bonds until maturity and benefits only from bond related payments. The bond payments are linked to interest (coupon) and repayment. 138 Measurement at amortised costs applies. The calculation of the amortised costs ignores all fluctuations of the bonds’ fair market values. The effective interest method follows opening and closing values and payments made or received in between. Here, NATBERGEN (Pty) Ltd. buys the bonds at 350,000 AUD (opening value) and receives at the time of redemption (on 31.12.20X7) 400,000 AUD. In between and in the last year, coupons are 138 Payments like this are called solely payments of principal and interest SPPI. received. The payment vector is: B(t) = {(350,000); 32,000; 32,000; 32,000; 32,000; 432,000}. Amortised costs reflect the increase in valuation of the bonds by regular adjustments. Therefore, the current value is compounded at the effective rate of interest. All payments for coupons and redemption must be deducted for the bond valuation. Check the valuation of NATBERGEN (Pty) Ltd.’s bonds in Figure 7.16. and in the How-it-is-Done paragraph below. It results in a valuation of zero after redemption. <?page no="191"?> Berkau: Financial Statements 8e 7-190 We demonstrate the measurement at amortised costs by the next case study NATBERGEN (Pty) Ltd. 7.34 C/ S NATBERGEN (Pty) Ltd. - Bonds held to Maturity Data Sheet for NATBERGEN (Pty) Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((BBrriissbbaannee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. BBoonnddss aatt 440000"000000 AAUUDD" ccoosstt ooff aaccqquuiissii-ttiioonn: : 335500"000000 oonn 33..0011..2200XX33.. BBoonnddss mmaattuurree oonn 3311..1122..2200XX77.. CCoouuppoonn rraattee: : 88 %%/ / aa" 3322"000000 AAUUDD/ / aa.. VVAATT iiggnnoorreedd.. On 3.01.20X3, NATBERGEN (Pty) Ltd. buys bonds five years before they mature at 350,000 AUD. Their face value is 400,000 AUD. We say the acquisition was at a discount (below-par). A listing of bonds below their principal results either from an interest market rate that exceeds the coupon rate or from the investors mistrusting the issuer’s capability to pay coupons and for redemption. The coupon rate of NATBERGEN (Pty) Ltd.’s bonds is 8 %/ a which makes the holder receive an annual coupon of: 8% × 400,000 = 3 322"000000 AAUUDD/ / aa. Dividend and interest depend on the nominal value and must in general be recorded through profit or loss or other comprehensive income. NATBERGEN (Pty) Ltd. initially recognises the bonds at 350,000 AUD (cost of acquisition). Check the Bookkeeping entry below: @ 3.01.20X3 Financial Assets (Bonds) FNA 350,000 Cash/ Bank C/ B 350,000 (recognition of bonds) NATBERGEN (Pty) Ltd. keeps the bonds until maturity and benefits only from bond related payments. The bond payments are linked to interest (coupon) and repayment. 138 Measurement at amortised costs applies. The calculation of the amortised costs ignores all fluctuations of the bonds’ fair market values. The effective interest method follows opening and closing values and payments made or received in between. Here, NATBERGEN (Pty) Ltd. buys the bonds at 350,000 AUD (opening value) and receives at the time of redemption (on 31.12.20X7) 400,000 AUD. In between and in the last year, coupons are 138 Payments like this are called solely payments of principal and interest SPPI. received. The payment vector is: B(t) = {(350,000); 32,000; 32,000; 32,000; 32,000; 432,000}. Amortised costs reflect the increase in valuation of the bonds by regular adjustments. Therefore, the current value is compounded at the effective rate of interest. All payments for coupons and redemption must be deducted for the bond valuation. Check the valuation of NATBERGEN (Pty) Ltd.’s bonds in Figure 7.16. and in the How-it-is-Done paragraph below. It results in a valuation of zero after redemption. Berkau: Financial Statements 8e 7-191 How it is Done (Effective Interest Method for Bonds on the Holder’s side) (1) Prepare the payment vector for the financial asset (bond). (2) Determine the effective rate of interest by the internal rate of return function in MS Excel. (3) Compound the actual value of the financial asset (bond) with the effective rate of interest. (4) Deduct all payments for coupons and/ or redemption (5) The result is the final value of the financial asset (bond). We calculate the effective rate of interest as the internal rate of return of the vector B(t). It is 11.41 77 %/ a. An alternative approach to calculate the effective rate of interest is to prepare a financial schedule and use the goal seek function, as demonstrated in Link 7.H. Link 7.H: NATBERGEN (Pty) Ltd. Period Opening amount Eff. interest Coupon received/ redemption Carrying amount 20X3 350,000.00 39,962.10 32,000.00 357,962.10 20X4 357,962.10 40,871.19 32,000.00 366,833.29 20X5 366,833.29 41,884.08 32,000.00 376,717.37 20X6 376,717.37 43,012.62 32,000.00 387,729.99 20X7 387,729.99 44,270.01 432,000.00 (0.00) Natbergen (Pty) Ltd. BOND VALUATION PLAN (20X3 - 20X7) Figure 7.15: Bond measurement at effective interest <?page no="192"?> Berkau: Financial Statements 8e 7-192 Until the time of maturity, NATBERGEN (Pty) Ltd. increased the bonds incrementally to a valuation of 400,000 AUD which is the settlement value at redemption. We discuss below a further case study DORRINGTON Ltd. about redeemable preference shares. 7.35 C/ S DORRINGTON Ltd. / ROTTMAN Ltd. - Pref. Shares Preference shares come without voting rights, but the dividend is based on a percentage of their nominal value. This is an advantage as the dividend does not depend on the performance of the issuer and, therefore, is free of risks. In case of a liquidation of the company, preference shareholders rank between creditors and ordinary shareholders. This counts as a further advantage; however, it is only relevant if something is left for distribution. If a liquidation is caused by Accounting insolvency (liabilities exceed the assets) nothing can be shared. By default, preference shares are cumulative, meaning a pending (not declared) preference dividend from previous years must be paid before further dividends (to ordinary shareholders) can be declared. Next, we focus on the company that issues preference shares, which is DORRINGTON Ltd. Later, we discuss the shareholders’ side (ROTTMAN Ltd.) where the preference shares are recognised as financial assets and carried at their fair values with adjustments made through other 139 In Germany, redeemable preference shares are not accepted to be disclosed under equity because they are regarded as liabilities. comprehensive income. The ROTTMAN Ltd. view is relevant for this chapter (7) as the company carries the preference shares as financial instruments on its balance sheet. Data Sheet for DORRINGTON Ltd. and ROTTMAN Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((KKiimmbbeerrllyy)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. IIssssuueedd ccaappiittaall: : 110000"000000 oorrddiinnaarryy sshhaarreess aatt 1100 ZZAARR/ / ss.. IIssssuuee ooff 1100"000000 pprreeffeerreennccee sshhaarreess" ddiivvii-ddeenndd: : 1122 %%/ / aa bbaasseedd oonn pprriinncciippaall" iissssuuee pprriiccee 1111..2233 ZZAARR/ / ss oonn 22..0011..2200XX77.. RROOTTTTMMAANN LLttdd.. hhoollddss 11"000000 pprreeffeerreennccee sshhaarreess.. SShhaarree pprriiccee oonn 3311..1122..2200XX77: : 1100..9900 ZZAARR/ / ss.. RROOTTTTMMAANN LLttdd.. sseellllss 11"000000 pprreeffeerreennccee sshhaarreess oonn 3300..0033..2200XX88 aatt tthhee mmaarrkkeett pprriiccee ooff 1111 ZZAARR/ / ss.. VVAATT iiggnnoorreedd.. DORRINGTON Ltd. issues preference shares. The preference shares’ dividend is 12 %/ a based on the nominal value of 10 ZAR/ s. DORRINGTON Ltd.'s preference shares are redeemable. 139 Redeemable preference shares are bought back when they mature. The fair market price applies for redemption. According to international policy, DORRINGTON Ltd. discloses its preference shares under issued capital and capital reserves on the equity section of its balance sheet. The premium is recorded under capital reserves. DORRINGTON Ltd. is based on 100,000 ordinary shares at 10 ZAR/ s. The issued capital is: 100,000 × 10 = 1 1"000000"000000 ZZAARR before the issue of preference shares. <?page no="193"?> Berkau: Financial Statements 8e 7-192 Until the time of maturity, NATBERGEN (Pty) Ltd. increased the bonds incrementally to a valuation of 400,000 AUD which is the settlement value at redemption. We discuss below a further case study DORRINGTON Ltd. about redeemable preference shares. 7.35 C/ S DORRINGTON Ltd. / ROTTMAN Ltd. - Pref. Shares Preference shares come without voting rights, but the dividend is based on a percentage of their nominal value. This is an advantage as the dividend does not depend on the performance of the issuer and, therefore, is free of risks. In case of a liquidation of the company, preference shareholders rank between creditors and ordinary shareholders. This counts as a further advantage; however, it is only relevant if something is left for distribution. If a liquidation is caused by Accounting insolvency (liabilities exceed the assets) nothing can be shared. By default, preference shares are cumulative, meaning a pending (not declared) preference dividend from previous years must be paid before further dividends (to ordinary shareholders) can be declared. Next, we focus on the company that issues preference shares, which is DORRINGTON Ltd. Later, we discuss the shareholders’ side (ROTTMAN Ltd.) where the preference shares are recognised as financial assets and carried at their fair values with adjustments made through other 139 In Germany, redeemable preference shares are not accepted to be disclosed under equity because they are regarded as liabilities. comprehensive income. The ROTTMAN Ltd. view is relevant for this chapter (7) as the company carries the preference shares as financial instruments on its balance sheet. Data Sheet for DORRINGTON Ltd. and ROTTMAN Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((KKiimmbbeerrllyy)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. IIssssuueedd ccaappiittaall: : 110000"000000 oorrddiinnaarryy sshhaarreess aatt 1100 ZZAARR/ / ss.. IIssssuuee ooff 1100"000000 pprreeffeerreennccee sshhaarreess" ddiivvii-ddeenndd: : 1122 %%/ / aa bbaasseedd oonn pprriinncciippaall" iissssuuee pprriiccee 1111..2233 ZZAARR/ / ss oonn 22..0011..2200XX77.. RROOTTTTMMAANN LLttdd.. hhoollddss 11"000000 pprreeffeerreennccee sshhaarreess.. SShhaarree pprriiccee oonn 3311..1122..2200XX77: : 1100..9900 ZZAARR/ / ss.. RROOTTTTMMAANN LLttdd.. sseellllss 11"000000 pprreeffeerreennccee sshhaarreess oonn 3300..0033..2200XX88 aatt tthhee mmaarrkkeett pprriiccee ooff 1111 ZZAARR/ / ss.. VVAATT iiggnnoorreedd.. DORRINGTON Ltd. issues preference shares. The preference shares’ dividend is 12 %/ a based on the nominal value of 10 ZAR/ s. DORRINGTON Ltd.'s preference shares are redeemable. 139 Redeemable preference shares are bought back when they mature. The fair market price applies for redemption. According to international policy, DORRINGTON Ltd. discloses its preference shares under issued capital and capital reserves on the equity section of its balance sheet. The premium is recorded under capital reserves. DORRINGTON Ltd. is based on 100,000 ordinary shares at 10 ZAR/ s. The issued capital is: 100,000 × 10 = 1 1"000000"000000 ZZAARR before the issue of preference shares. Berkau: Financial Statements 8e 7-193 On 2.01.20X7, DORRINGTON Ltd. issues 10,000 preference shares at 11.23 ZAR/ s (issue price). The face value of the preference shares is 10 ZAR/ s. For the recording of the preference shares, we apply IAS 32.15. At DORRINGTON Ltd., the preference shares are recorded as equity instruments at nominal values. The premium of: 11.23 - 10 = 1 1..2233 ZZAARR/ / ss is multiplied with the number of shares and added to capital reserves. It gives a credit entry of: 10,000 × 1.23 = 1 122"330000 ZZAARR. Now, we change the perspective towards the shareholders. We analyse one preference shareholder, ROTTMAN Ltd. that owns 1,000 preference shares bought at 11.23 ZAR/ s on 2.01.20X7. ROTTMAN Ltd.’s intention is not to keep the preference shares until redemption but to sell them in the nearby future - however, not during the first year. Therefore, the preference shares are initially recorded at a cost of: 1,000 × 11.23 = 1111"223300 ZZAARR in the non-current asset section. Observe Bookkeeping entry (I) recorded in ROTTMAN Ltd.’s books. @ 2.01.20X7 Financial Asset (pref shares) FNA 11,230 Cash/ Bank C/ B 11,230 (recognition of DORRINGTON preference shares ) At the end of the fiscal year 20X7, the preference shares are traded at 10.90 ZAR/ s at the Johannesburg Stock Exchange JSE. As ROTTMAN Ltd. classifies its preference shares to be carried at fair values (FVTOCI), the valuation is at fair market prices which results in an impairment loss of: (11.23 - 10.90) × 1,000 = 333300 ZZAARR which is deducted from other comprehensive income. ROTTMAN Ltd. must record the impairment loss through other comprehensive income, as share trading is not its core business. The preference dividend received by ROTTMAN Ltd. is based on the face value of the shares of: 12% × 10,000 = 11"220000 ZZAARR. It is a dividend income recorded through other comprehensive income, observe Bookkeeping entries (II), (III) at the preference shareholder’s side below: @ 31.12.20X7 Impairment Loss on Shares-20X7 I/ L 330 Financial Asset (pref shares) FNA 330 (impairment loss recognition on preference shares) Cash/ Bank C/ B 1,200 Other Comprehensive Income-20X7 OCI 1,200 (receipt of preference dividend) ROTTMAN Ltd., sells its 1,000 preference shares on 30.03.20X8 at 11 ZAR/ s. After the fair value disclosure on 31.12.20X7, the selling price results in a gain on disposal through other comprehensive income of: (11 - 10.90) × 1,000 = 1 10000 ZZAARR. Observe Bookkeeping entry (A): To keep the case study simple, we do not consider that the preference shares earned <?page no="194"?> Berkau: Financial Statements 8e 7-194 an interest claim of: 25% × 12% × 1,000 × 10 = 3 30000 ZZAARR from January/ 20X8 until March/ 20X8. With a cum-interest sale the earned preference dividend claim would be added to the price at which shares are sold at. We here assume, that the selling price of 11 ZAR/ s considers the interest income already as the dividend is paid out in December/ 20X8 to the buyer. @ 30.03.20X8 Cash/ Bank C/ B 11,000 Financial Asset (pref shares) FNA 10,900 Other Comprehensive Income-20X8 OCI 100 (sale of preference shares) In line with IFRS 9.5.2.1, the following rule applies: A preference shareholder who keeps shares carries them at amortised costs but can opt for recognition at fair values through other comprehensive income FVTOCI. If the intention is holding shares for trading purposes, the valuation is based on fair values through profit or loss FVTPL. Preference dividends received are recorded through profit or loss or other comprehensive income. We discuss another case study in the online materials which contains a financial liability resulting from writing a call option for a specific amount of ordinary shares. That leads to the recognition of an equity instrument. See the case study HELWAN AIRWAYS Ltd. which buys the rights for a route in return of a call option linked to its own shares. You reach the case through Link 7.I. Link 7.I: HELWAN AIRWAYS Ltd. 7.36 Derivatives A special form of financial instruments are derivatives. They are often acquired for hedging. Derivatives are financial instruments where the financial obligation of the issuer depends on a particular value, e.g., the price of commodities. Derivatives are futures, swaps and options. The valuation of derivatives is based on fair values through profit or loss. We discuss the case of electro manufacturer MOLLENBERG Ltd. who buys a call option for copper to secure its production costs at a volatile market for commodities. A call option is a contract where the option holder receives a contractual right to buy commodities or financial instruments at a certain time or within a certain period for a fixed strike price by paying a premium (fee). Options can be sold on. As the option holder got more alternatives as the seller (the option writer), we describe her/ his situation as long. Accordingly, the option writer is in the short position. If the market price falls below the strike price when the option can be exercised the option becomes futile, we say, "out of the money" and the option <?page no="195"?> Berkau: Financial Statements 8e 7-194 an interest claim of: 25% × 12% × 1,000 × 10 = 3 30000 ZZAARR from January/ 20X8 until March/ 20X8. With a cum-interest sale the earned preference dividend claim would be added to the price at which shares are sold at. We here assume, that the selling price of 11 ZAR/ s considers the interest income already as the dividend is paid out in December/ 20X8 to the buyer. @ 30.03.20X8 Cash/ Bank C/ B 11,000 Financial Asset (pref shares) FNA 10,900 Other Comprehensive Income-20X8 OCI 100 (sale of preference shares) In line with IFRS 9.5.2.1, the following rule applies: A preference shareholder who keeps shares carries them at amortised costs but can opt for recognition at fair values through other comprehensive income FVTOCI. If the intention is holding shares for trading purposes, the valuation is based on fair values through profit or loss FVTPL. Preference dividends received are recorded through profit or loss or other comprehensive income. We discuss another case study in the online materials which contains a financial liability resulting from writing a call option for a specific amount of ordinary shares. That leads to the recognition of an equity instrument. See the case study HELWAN AIRWAYS Ltd. which buys the rights for a route in return of a call option linked to its own shares. You reach the case through Link 7.I. Link 7.I: HELWAN AIRWAYS Ltd. 7.36 Derivatives A special form of financial instruments are derivatives. They are often acquired for hedging. Derivatives are financial instruments where the financial obligation of the issuer depends on a particular value, e.g., the price of commodities. Derivatives are futures, swaps and options. The valuation of derivatives is based on fair values through profit or loss. We discuss the case of electro manufacturer MOLLENBERG Ltd. who buys a call option for copper to secure its production costs at a volatile market for commodities. A call option is a contract where the option holder receives a contractual right to buy commodities or financial instruments at a certain time or within a certain period for a fixed strike price by paying a premium (fee). Options can be sold on. As the option holder got more alternatives as the seller (the option writer), we describe her/ his situation as long. Accordingly, the option writer is in the short position. If the market price falls below the strike price when the option can be exercised the option becomes futile, we say, "out of the money" and the option Berkau: Financial Statements 8e 7-195 holder paid the expenses for the option (premium) in vain. No obligation to exercise the option applies. If the market price exceeds the strike price “in the money”, the option holder benefits from the price difference. However, the profit made is reduced for the premium previously paid. Call options make sense if their holder expects the market prices to increase. Options can be linked to purchases (calls) or sales (puts). In the case of MOLLENBERG Ltd. the company takes a long call position. 7.37 MOLLENBERG Ltd. - Call Option MOLLENBERG Ltd. buys a call option on copper at a premium of 10,000 AUD. Data Sheet for MOLLENBERG Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((PPeerrtthh)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : MMaannuuffaaccttuurriinngg.. CCaallll ooppttiioonn: : 110000"000000 llbbss.. ccooppppeerr aatt 336600"000000 AAUUDD.. CCooppppeerr pprriicceess: : 22..5500 UUSSDD/ / llbb; ; 22..6655 UUSSDD/ / llbb.. CCuurrrreennccyy eexxcchhaannggee rraatteess: : 6699 UUSSDD == 110000 AAUUDD; ; 7722 UUSSDD == 110000 AAUUDD.. PPrreemmiiuumm: : 1100"000000 AAUUDD.. VVAATT nn/ / aa.. MOLLENBERG Ltd. needs copper as material for its products. The copper price fluctuates and MOLLENBERG Ltd. expects the purchase prises to increase in the nearby future. It buys a call option which allows the purchase of copper at 3.60 AUD/ lb 140 on 31.12.20X9. The option is purchased on 14.05.20X5 when the copper price is 2.50 USD/ lb. The currency exchange rate to the US-Dollar was at that time: 69 USD : 100 AUD. MOLLENBERG Ltd. pays for the premium 10,000 AUD. The quantity is 100,000 lbs. The initial valuation takes place on 14.05.20X5. MOLLENBERG Ltd. records the option as financial asset. Check below the Bookkeeping entry (1) which is recorded at cost of acquisition and represents the paid fees: @ 14.05.20X5 Financial Asset (call option) FNA 10,000 Cash/ Bank C/ B 10,000 (recognition of the call option for copper at costs (fee)) If on 31.12.20X5, the copper price is below 3.60 AUD/ lb the option becomes (temporarily) void as MOLLENBERG Ltd. could rather buy copper without exercising the call option. However, a drop in copper price will not impair the call option as MOLLENBERG Ltd. does not know the price on 31.12.20X9 yet (four years later). 140 Copper usually is traded in pounds (lbs.) The valuation of the call option as per 31.12.20X5 is at fair value through other comprehensive income. The reason is that there is still a chance to sell on the call option. We assume, on 31.12.20X5, the copper price is 2.65 USD/ lb, and the exchange rate is: 72 USD : 100 AUD. For the fair value calculation of the call option, we calculate the temporary gain related to <?page no="196"?> Berkau: Financial Statements 8e 7-196 the purchase price. On 31.12.20X5, 100,000 lbs copper cost: 100,000 × 2.65 / 0.72 = 3 36688"005555..5566 AAUUDD. Due to the call option, MOLLENBERG Ltd. can buy the copper at 360,000 AUD. Hence, the fair value of the option is: 368,055.56 - 360,000 = 8 8"005555..5566 AAUUDD. This results in a decrease in valuation compared to the cost of acquisition of: 10,000 - 8,055.56 = 11"994444..4444 AAUUDD. MOLLENBERG Ltd. who measures the call option at fair values through other comprehensive income adjusts its valuation by making Bookkeeping entry (2). The valuation considers that the advantage of buying cheap is reduced for the premium. @ 31.12.20X5 Other Expenses-20X5 OTH 1,944 Financial Asset (call option) FNA 1,944 (loss recognition on call option) In the next years, MOLLENBERG Ltd. continues with the adjustment of its option based on copper prices and the exchange rates to the USD again. The valuation reflects its profit under consideration of the premium. If the price is below 360,000 AUD on 31.12.20X9, the call option is out of the money and MOLLENBERG Ltd. records an impairment loss for the (remaining) premium as the call option becomes useless. If the call option is processed for the purchase of copper, the option is expensed and will be added to the cost of purchase for MOLLENBERG Ltd.’s copper. To keep the case study short, we assume that the valuation of 8,055.56 AUD from 20X5 stays (no further copper price changes) and the price for the desired copper quantity is 365,000 AUD on 31.12.20X9. The costs of purchase now are: 360,000 + 8,055.56 = 3 36688"005555..5566 AAUUDD. Consider that we recorded in 20X5 expenses to the extent of 1,944.44 AUD which are accumulated towards 20X5 as impairment loss. Therefore, the total purchase costs are 370,000 AUD. The above shown value applies for all copper prices exceeding 360,000 AUD. We now assume (as an alternative scenario) the copper price is 355,000 AUD on 31.12.20X9. MOLLENBERG Ltd. forfeits the call option, buys copper at 355,000 AUD and records an impairment loss on the call option. Thus, the costs of purchase are: 355,000 AUD and the impairment loss is 8,055.56 AUD. We also must consider the impairment loss from 20X5 to an extent of 1,944.44 AUD. In comparison to not buying the call option, the expenses increase by: 8,055.56 + 1,944.44 = 1 100"000000 AAUUDD. These are the costs for the premium. So far, we discussed financial instruments held for longer periods. If companies hold shares or bonds or other financial instruments short-term, we allocate them to securities in the current asset section of the balance sheet. We discuss those instruments in chapter (9). <?page no="197"?> Berkau: Financial Statements 8e 7-196 the purchase price. On 31.12.20X5, 100,000 lbs copper cost: 100,000 × 2.65 / 0.72 = 3 36688"005555..5566 AAUUDD. Due to the call option, MOLLENBERG Ltd. can buy the copper at 360,000 AUD. Hence, the fair value of the option is: 368,055.56 - 360,000 = 8 8"005555..5566 AAUUDD. This results in a decrease in valuation compared to the cost of acquisition of: 10,000 - 8,055.56 = 11"994444..4444 AAUUDD. MOLLENBERG Ltd. who measures the call option at fair values through other comprehensive income adjusts its valuation by making Bookkeeping entry (2). The valuation considers that the advantage of buying cheap is reduced for the premium. @ 31.12.20X5 Other Expenses-20X5 OTH 1,944 Financial Asset (call option) FNA 1,944 (loss recognition on call option) In the next years, MOLLENBERG Ltd. continues with the adjustment of its option based on copper prices and the exchange rates to the USD again. The valuation reflects its profit under consideration of the premium. If the price is below 360,000 AUD on 31.12.20X9, the call option is out of the money and MOLLENBERG Ltd. records an impairment loss for the (remaining) premium as the call option becomes useless. If the call option is processed for the purchase of copper, the option is expensed and will be added to the cost of purchase for MOLLENBERG Ltd.’s copper. To keep the case study short, we assume that the valuation of 8,055.56 AUD from 20X5 stays (no further copper price changes) and the price for the desired copper quantity is 365,000 AUD on 31.12.20X9. The costs of purchase now are: 360,000 + 8,055.56 = 3 36688"005555..5566 AAUUDD. Consider that we recorded in 20X5 expenses to the extent of 1,944.44 AUD which are accumulated towards 20X5 as impairment loss. Therefore, the total purchase costs are 370,000 AUD. The above shown value applies for all copper prices exceeding 360,000 AUD. We now assume (as an alternative scenario) the copper price is 355,000 AUD on 31.12.20X9. MOLLENBERG Ltd. forfeits the call option, buys copper at 355,000 AUD and records an impairment loss on the call option. Thus, the costs of purchase are: 355,000 AUD and the impairment loss is 8,055.56 AUD. We also must consider the impairment loss from 20X5 to an extent of 1,944.44 AUD. In comparison to not buying the call option, the expenses increase by: 8,055.56 + 1,944.44 = 1 100"000000 AAUUDD. These are the costs for the premium. So far, we discussed financial instruments held for longer periods. If companies hold shares or bonds or other financial instruments short-term, we allocate them to securities in the current asset section of the balance sheet. We discuss those instruments in chapter (9). Berkau: Financial Statements 8e 7-197 How it is Done (Recording Financial Assets as non-Current Assets): (1) Determine whether the financial asset is held short-term or long-term. For short-term recognition check chapter (9) in this textbook. (2) If the financial asset is held for long-term periods, we recognise the financial asset at its costs as a non-current asset. (3) For subsequent valuation check the business model of the company holding. It determines the valuation of the financial asset. (4) If the financial asset is held to maturity apply the effective interest method. If the financial asset is held ready to sell apply fair value presentation through either profit or loss or through other comprehensive income. (5) For the disposal of financial assets apply the Realisation account. (6) Record a gain or loss on disposal through either profit or loss or through other comprehensive income. 7.38 Summary Non-current assets are property, plant and equipment or intangible assets or financial instruments. A special recognition is required for leases which is based on a right-of-use-asset that falls under intangible non-current assets and a lease liability at the same time. As non-current assets are held for a longer period than a fiscal year, changes in valuation matter. Examples for subsequent measurement are depreciation, impairment loss and revaluations. In contrast, financial instruments are measured at amortised costs or following the fair value model. Carrying assets at amortised costs requires applying the effective interest method. De-recognitions of non-current assets are either recorded in profit or loss or other comprehensive income. 7.39 Working Definitions Amortised Costs: To keep an asset or liabilities at amortised costs is a simplification of its measurement accepted for financial instruments that are intended to keep until maturity. It replaces a fair value presentation. The calculation of amortised costs is based on the effective interest method. Call Option: Right but not an obligation to buy assets at an agreed price in the future. Carrying Value: Measurement of an asset at which it is disclosed on the financial statements. Cost of Acquisition: Based on the conventions of this textbook in chapter (1) about VAT reduction: the net price for buying an asset less all discounts/ rebates and including all attributable costs. Fair Value: Measurement of an asset/ liability as it is transferred at on an active market, e.g., a bond price. <?page no="198"?> Berkau: Financial Statements 8e 7-198 Financial Asset: Shares, bonds, options etc., bought to keep them for more than one Accounting period. Gross Replacement Method: Method of recording a valuation based most probably on a change of cost of acquisition for new assets. Adjustments are recorded as if the asset was bought at the increased price. Impairment Loss: Difference between a carrying value and a subsequent, lower valuation that is regarded as extraordinary. Intangible Asset: Asset without physical nature. Investment: Ownership of a portion of another business, e.g., holding more than 20 % or its shares. In general, investments are subsidiaries, partial ownership in associated companies or result from joint ventures. Investment Property: Land or buildings held for renting out or capital appreciation. Lease: Contract to use an asset and taking control by paying its owner a certain consideration for an agreed time span. The duration of the lease must be material. Lessee: Party that leases an asset from its owner. Lessor: Party that leases out an asset. Net Replacement Bookkeeping Entries: Method to record a revaluation based on most probably an expertise at the time of adjustment of measurement. Put Option: Right but no obligation to sell an asset at an agreed price in the future. Realisation Account: Account to record the disposal of assets. The Realisation account is closed-off to the profit or loss or to other comprehensive income. Recoverable Amount: Obtainable selling price or value in use - whichever is higher. Revaluation: Assigning a value to an asset that exceeds the carrying value. Value in Use: Valuation of an asset based on received cash flows. 7.40 Questions Bank (1) A Retailer in Australia enters for its salesperson in a lease over an electric driven business car for three years beginning with 2.01.20X1. The lease payments are 25,000.00 AUD/ a in arrears. No VAT applies. No restoring costs apply either. Determine the lease liabilities in the lessee’s books for the 1 st Accounting period if the interest rate implicit in the lease is 7.21 %/ a. 1. 75,000 AUD . 2. 65,357 AUD . 3. 70,069 AUD . 4. 50,000 AUD . (2) A car is acquired at a price of 78,000 EUR (gross amount) and is fetched from Stuttgart for 1,200 EUR gross amount. The dealership offers a trade discount of 10 % for the car. How much are the resulting cost of acquisition? 1. 71,400 EUR . 2. 59,500 EUR . 3. 59,400 EUR . 4. 58,500 EUR . (3) A company is registered for VAT reduction. It acquires a business car at a gross purchase price of 62,400 EUR on 3.07.20X4. The car is to be depreciated over five years <?page no="199"?> Berkau: Financial Statements 8e 7-198 Financial Asset: Shares, bonds, options etc., bought to keep them for more than one Accounting period. Gross Replacement Method: Method of recording a valuation based most probably on a change of cost of acquisition for new assets. Adjustments are recorded as if the asset was bought at the increased price. Impairment Loss: Difference between a carrying value and a subsequent, lower valuation that is regarded as extraordinary. Intangible Asset: Asset without physical nature. Investment: Ownership of a portion of another business, e.g., holding more than 20 % or its shares. In general, investments are subsidiaries, partial ownership in associated companies or result from joint ventures. Investment Property: Land or buildings held for renting out or capital appreciation. Lease: Contract to use an asset and taking control by paying its owner a certain consideration for an agreed time span. The duration of the lease must be material. Lessee: Party that leases an asset from its owner. Lessor: Party that leases out an asset. Net Replacement Bookkeeping Entries: Method to record a revaluation based on most probably an expertise at the time of adjustment of measurement. Put Option: Right but no obligation to sell an asset at an agreed price in the future. Realisation Account: Account to record the disposal of assets. The Realisation account is closed-off to the profit or loss or to other comprehensive income. Recoverable Amount: Obtainable selling price or value in use - whichever is higher. Revaluation: Assigning a value to an asset that exceeds the carrying value. Value in Use: Valuation of an asset based on received cash flows. 7.40 Questions Bank (1) A Retailer in Australia enters for its salesperson in a lease over an electric driven business car for three years beginning with 2.01.20X1. The lease payments are 25,000.00 AUD/ a in arrears. No VAT applies. No restoring costs apply either. Determine the lease liabilities in the lessee’s books for the 1 st Accounting period if the interest rate implicit in the lease is 7.21 %/ a. 1. 75,000 AUD . 2. 65,357 AUD . 3. 70,069 AUD . 4. 50,000 AUD . (2) A car is acquired at a price of 78,000 EUR (gross amount) and is fetched from Stuttgart for 1,200 EUR gross amount. The dealership offers a trade discount of 10 % for the car. How much are the resulting cost of acquisition? 1. 71,400 EUR . 2. 59,500 EUR . 3. 59,400 EUR . 4. 58,500 EUR . (3) A company is registered for VAT reduction. It acquires a business car at a gross purchase price of 62,400 EUR on 3.07.20X4. The car is to be depreciated over five years Berkau: Financial Statements 8e 7-199 following straight-line method under consideration of a residual value of 12,000 EUR. After an accident and a repair of 10,200 EUR (gross value, paid by the company) on 1.10.20X4 the business car is worth 38,000 EUR. The insurance company covers the repair costs and the impairment loss. How much is the compensation receivable from the insurance? 1. 20,500 EUR . 2. 22,200 EUR . 3. 30,380 EUR . 4. 12,000 EUR . (4) On 1.07.20X3, a company buys a machine at cost of acquisition of 300,000.00 EUR which is depreciated over 5 years without residual value following straight-line method. 2.5 years later, on 29.12.20X5, the machine is revalued and is disclosed at a fair value of 200,000.00 EUR. How much are the revaluation reserves as disclosed on the balance sheet on 31.12.20X5? 1. 50,000 EUR . 2. 56,000 EUR . 3. 80,000 EUR . 4. 35,000 EUR . (5) A company buys a machine on 2.03.20X3 at 5,000 EUR net amount. The useful life is 5 years and, depreciation follows declining method at 2%/ m. How much is the carrying value of the machine as per 31.12.20X4? 1. 4,085.36 EUR . 2. 3,205.85 EUR . 3. 3,000.00 EUR . 4. 3,078.90 EUR . 7.41 Solutions 1-2; 2-2; 3-1; 4-4; 5-2. <?page no="200"?> Berkau: Financial Statements 8e 8-200 8 Business Combinations 8.1 What is in the Chapter? Group Accounting is required for the disclosure of investments in separate financial statements following IAS 27 as well as for the presentation of financial statements for business combinations, like groups or joint ventures. Business combinations following IFRS 3 require consolidations. A group is a set of companies that are linked to each other by control relationships, meaning one company usually holds the majority of voting rights. If company A owns companies B and C, all three companies form a group in terms of Accounting. A joint venture is a company that is controlled by other companies together. If the companies X and Y control Z together, then Z is the joint venture and X and Y are investors. This chapter covers one case study for separate financial statements, three case studies about Group Accounting and two joint venture examples. 8.2 Learning Objectives After studying this chapter, you understand the basics of consolidations and know how to prepare financial statements for business combinations. You know and understand the major regulations for Group Accounting. You can prepare group statements on case study level and apply a consolidation worksheet as provided by our CH5file. 141 141 Study the instructions for that file in our textbook Basics of Accounting, chapter (5). 8.3 Group Accounting A group consists of a parent and subsidiary. A parent is the company exercising control power, a subsidiary is the dependent company. Groups must prepare financial statements for the entire group in addition to single-entity financial statements. A single-entity financial statement is a set of financial statements for a single company. A group of three companies with one parent and two subsidiaries prepares four sets of financial statements, three single-entity financial statements and one for the group. Consolidation is an Accounting technical term for calculations made on group statements to remove double or multiple considerations of items which are caused by the process of adding financial statements in preparation of the group statements. Group Accounting does not require recording real Bookkeeping entries. “Making consolidation Bookkeeping entries” does not fall under a general Bookkeeping definition. It is a common term in use for the preparation of consolidated financial statements. However, group statements are derived from single-entity financial statements. Relevant standards for business combinations are IAS 27: Separate Financial Statements, IAS 28: Investments in Associates and Joint ventures, IFRS 3: Business Combinations, IFRS 10: Consolidated Financial Statements, IFRS 11: Joint Arrangements and <?page no="201"?> Berkau: Financial Statements 8e 8-200 8 Business Combinations 8.1 What is in the Chapter? Group Accounting is required for the disclosure of investments in separate financial statements following IAS 27 as well as for the presentation of financial statements for business combinations, like groups or joint ventures. Business combinations following IFRS 3 require consolidations. A group is a set of companies that are linked to each other by control relationships, meaning one company usually holds the majority of voting rights. If company A owns companies B and C, all three companies form a group in terms of Accounting. A joint venture is a company that is controlled by other companies together. If the companies X and Y control Z together, then Z is the joint venture and X and Y are investors. This chapter covers one case study for separate financial statements, three case studies about Group Accounting and two joint venture examples. 8.2 Learning Objectives After studying this chapter, you understand the basics of consolidations and know how to prepare financial statements for business combinations. You know and understand the major regulations for Group Accounting. You can prepare group statements on case study level and apply a consolidation worksheet as provided by our CH5file. 141 141 Study the instructions for that file in our textbook Basics of Accounting, chapter (5). 8.3 Group Accounting A group consists of a parent and subsidiary. A parent is the company exercising control power, a subsidiary is the dependent company. Groups must prepare financial statements for the entire group in addition to single-entity financial statements. A single-entity financial statement is a set of financial statements for a single company. A group of three companies with one parent and two subsidiaries prepares four sets of financial statements, three single-entity financial statements and one for the group. Consolidation is an Accounting technical term for calculations made on group statements to remove double or multiple considerations of items which are caused by the process of adding financial statements in preparation of the group statements. Group Accounting does not require recording real Bookkeeping entries. “Making consolidation Bookkeeping entries” does not fall under a general Bookkeeping definition. It is a common term in use for the preparation of consolidated financial statements. However, group statements are derived from single-entity financial statements. Relevant standards for business combinations are IAS 27: Separate Financial Statements, IAS 28: Investments in Associates and Joint ventures, IFRS 3: Business Combinations, IFRS 10: Consolidated Financial Statements, IFRS 11: Joint Arrangements and Berkau: Financial Statements 8e 8-201 IFRS 12: Disclosure of Interest in other Entities. IAS 27 rules the Accounting for separate financial statements. 142 A separate financial statement is a statement of a parent or a joint venture investor that covers investments either at costs or fair values in accordance with IFRS 9 or based on Equity Accounting as ruled in IAS 28 (IAS 27.10). A company not holding investments does not prepare separate financial statements, check IAS 27.7. IAS 28 refers to associated companies and to joint ventures. In particular, the equity method is subjected to regulations in IAS 28.10 and the following paragraphs. In short, the equity method states, that investments in controlled companies increase/ decrease with equity changes in the dependent company (to the same extent/ percentage). 143 IFRS 3 contains regulations about business combinations based on the acquisition method. A business combination applies once the acquired assets and liabilities constitute a business. This applies for subsidiaries, associated companies and joint ventures. E.g., someone buying all buses of a travel service company will not constitute a group, see IFRS 3.3. IFRS 10 covers consolidated financial statements. Consolidated financial statements are prepared for groups. A group comprises of a parent and all its subsidiaries. In consolidated financial statements, the assets, liabilities, equity, income, expenses and cash flows 142 Same as the IASB states in IAS 27.3, we do not discuss reasons for the preparation of separate financial statements in case they are required we show only how to do it. of the parent and all subsidiaries are presented as those of a single economic entity. IFRS 11 regulates joint arrangements which mostly is a company controlled collectively by more than one investor (joint venture), or a joint operation. Joint control of operations requires regulations about how to jointly make decisions. IFRS 12 requires companies to disclose information about nature, risks and interest in other companies. It helps the reader of financial statements to evaluate the impacts on the financial position, financial performance and on cash flows of business combinations. A business combination exists if one company dominates another one by taking over control. This usually refers to the rights of ownership. Two threshold percentages are relevant, 20 % and 50 %. Commonly, (1) < 20 % of control does not imply any influence on the (partially) owned company. The owner discloses the investment as financial instrument under IFRS 9 which is initially at cost and for subsequent measurement at fair values through profit or loss or through other comprehensive income. 144 As expedient for fair values the book value of a company can be used. (2) 20 % … 50 % of control defines an investment in an associated company with substantial influence exercised by the owner of the 143 Check the case study STEYN/ HAWKINS in chapter (7) where we applied the equity method. 144 We cover these cases in chapter (7) and (9). <?page no="202"?> Berkau: Financial Statements 8e 8-202 shares. For the valuation of an associated company, the equity method applies. Owners of associate companies prepare separate financial statements in line with IAS 27. (3) > 50% of control requires the preparation of group statements. Group statements are financial statements of the entire group which cover all group members. It also includes subsidiaries of subsidiaries in a multiple-level group structure. The percentages of control can differ from the legal portion of ownership. They are based on control criteria. Control refers to the power to govern the financial and operating policies of a company to obtain benefits from its operations (IFRS 10, appendix A). Criteria of control are defined by IFRS 10.7. In general, the percentage of ownership is easy to determine. However, in a multiple-level group, companies are subsidiary and parent at the same time. The calculation of influence is then based on the control power. If company A owns 60 % of B, whereas B owns 55 % of C, A is in control of both companies B and C, even as the legal ownership for C only is: 60% × 55% = 33%. It only matters that A controls B which defines full control power, to be considered as 100 % of control power. Next, B fully controls C because it holds 55 % of its shares. Hence, B controls C completely, and we consider the percentage of control to be 100 %, too. Therefore, A prepares consolidated financial statements that cover the companies A, B and C. Company B does not prepare consolidated financial statements for B and C, as this is covered by A’s Group Accounting. Here, IFRS 10.31 applies: Company B is an investment and evaluates its subsidiary C for separate financial statements following IFRS 9 initially at cost and later at fair values through profit or loss. For business combinations the following three principles apply: Regarding the control hierarchy in the group the highest parent shields all lower members from preparing separate group statements. In Accounting slang this is referred to as the Christmas tree principle, because a Christmas tree’s upper branches shield the lower ones against rain. Based on the principle of full consolidation, only one superordinated company exercises control. It is the one which holds more than 50 % of voting rights. A subsidiary is therefore considered in group statement to an extent of 100 %. E.g., if two companies hold another one at 70 % and 30 % only the one has absolute (70 %) power over the company and includes it completely in its group statements. The other holder is considered as non-controlling interest holder. In Group Accounting, control is never shared in contrast to Joint Venture Accounting where partial control is considered for disclosure. Group Accounting refers to all subsidiaries regardless of where they are domiciled (global consolidation principle). Hence, Group Accounting ig- <?page no="203"?> Berkau: Financial Statements 8e 8-202 shares. For the valuation of an associated company, the equity method applies. Owners of associate companies prepare separate financial statements in line with IAS 27. (3) > 50% of control requires the preparation of group statements. Group statements are financial statements of the entire group which cover all group members. It also includes subsidiaries of subsidiaries in a multiple-level group structure. The percentages of control can differ from the legal portion of ownership. They are based on control criteria. Control refers to the power to govern the financial and operating policies of a company to obtain benefits from its operations (IFRS 10, appendix A). Criteria of control are defined by IFRS 10.7. In general, the percentage of ownership is easy to determine. However, in a multiple-level group, companies are subsidiary and parent at the same time. The calculation of influence is then based on the control power. If company A owns 60 % of B, whereas B owns 55 % of C, A is in control of both companies B and C, even as the legal ownership for C only is: 60% × 55% = 33%. It only matters that A controls B which defines full control power, to be considered as 100 % of control power. Next, B fully controls C because it holds 55 % of its shares. Hence, B controls C completely, and we consider the percentage of control to be 100 %, too. Therefore, A prepares consolidated financial statements that cover the companies A, B and C. Company B does not prepare consolidated financial statements for B and C, as this is covered by A’s Group Accounting. Here, IFRS 10.31 applies: Company B is an investment and evaluates its subsidiary C for separate financial statements following IFRS 9 initially at cost and later at fair values through profit or loss. For business combinations the following three principles apply: Regarding the control hierarchy in the group the highest parent shields all lower members from preparing separate group statements. In Accounting slang this is referred to as the Christmas tree principle, because a Christmas tree’s upper branches shield the lower ones against rain. Based on the principle of full consolidation, only one superordinated company exercises control. It is the one which holds more than 50 % of voting rights. A subsidiary is therefore considered in group statement to an extent of 100 %. E.g., if two companies hold another one at 70 % and 30 % only the one has absolute (70 %) power over the company and includes it completely in its group statements. The other holder is considered as non-controlling interest holder. In Group Accounting, control is never shared in contrast to Joint Venture Accounting where partial control is considered for disclosure. Group Accounting refers to all subsidiaries regardless of where they are domiciled (global consolidation principle). Hence, Group Accounting ig- Berkau: Financial Statements 8e 8-203 nores geographical borders. Accounting rules apply following the parent's jurisdiction. 145 We cover Accounting for business combinations in three subordinated sections: (1) Separate financial statements. (2) Consolidated financial statements. (3) Joint Venture Accounting. 8.4 Separate Financial Statements IAS 27 IAS 27 rules separate financial statements. Separate financial statements are prepared by parents as well as by investors. The major difference to group statements is that no consolidations apply. Investments are measured based on their portion of ownership. Separate financial statements are only prepared for a single company (and disclose their investments as assets). 8.5 C/ S BRENO Ltd. We discuss separate financial statements for the case study BRENO Ltd. that holds a financial interest in another company as well as an investment in an associated company. Data Sheet for BRENO Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((BBllooeemmffoonntteeiinn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. IInnvveessttmmeennttss: : 3366..55 %% ooff SSAABBOONNAA LLttdd..; ; 99 %% ooff SSUUUURREENNBBEERRGG LLttdd.. PPrrooffiittss ((EEAATT)): : BBRREENNOO LLttdd..: : 228800"000000 ZZAARR / / SSUUUURREENNBBEERRGG LLttdd..: : 3344"000000 ZZAARR / / SSAABBOONNAA LLttdd..: : 2244"000000 ZZAARR.. DDiivviiddeennddss: : 4400 %% / / 2255 %% / / 1155 %%.. SShhaarree pprriiccee SSUUUURREENNBBEERRGG LLttdd..: : aatt aaccqquuii-ssiittiioonn 33 ZZAARR/ / ss" llaatteerr iinnccrreeaassee 66 %%.. VVAATT iiggnnoorreedd.. BRENO Ltd. owns 36.5 % of SABONA Ltd. and 9 % of SUURENBERG Ltd. Hence, SABONA Ltd. is an associated company and the investment in SUURENBERG Ltd. is a financial asset. The characteristics for holding an associated company (SABONA Ltd.) are significance of influence and are fulfilled. In line with IAS 28.5, a company has significant influence, once holding 20 % or more of the voting power. BRENO Ltd. does not prepare group statements, nor does it consolidate its separate financial statements. It prepares them with disclosure of SUURENBERG Ltd. as a financial asset and SABONA Ltd. as an associated company (investment) thereon. See in Figure 8.1 the statement of financial position for BRENO Ltd. as at the beginning of 20X5. Check the non-current asset section where the investment and the financial asset are disclosed. 145 For simplification, we assume all companies prepare single entity-financial statements and Group Accounting following IFRSs. <?page no="204"?> Berkau: Financial Statements 8e 8-204 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 800,000 Share capital 500,000 Investments 73,000 Reserves 300,000 Financial assets 27,000 Retained earnings 140,000 Current assets Liabilities (liab.) Inventory 34,000 Long-term liab. Accounts receivables Short-term liab. A/ P Prepaid expenses Provisions Cash/ Bank 66,000 Income tax liab. 60,000 Total assets 1,000,000 Total equity and liab. 1,000,000 Breno Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X5 Figure 8.1: BRENO Ltd.’s balance sheet (1.01.20X5) IAS 28 applies for the valuation of the share in SABONA Ltd.; for the valuation of the financial instrument SUURENBERG Ltd., it follows IFRS 9. During the Accounting period 20X5, the three companies earn the below listed profits and make payments to their owners. No profit/ loss is carried forward. - BRENO Ltd.: profit before taxes (and before dividends): 280,000 ZAR, dividend: 40 % of the profit after taxes and after revaluation of investments in associates and financial assets. - SUURENBERG Ltd.: profit after taxes 34,000 ZAR, dividend 25 % thereof. - SABONA Ltd.: profit after taxes: 24,000 ZAR, dividend 15 % thereof. The dividend receipts from investments are not yet included on the income statement and balance sheet for BRENO Ltd. No appropriation of profits has been considered yet. Observe BRENO Ltd.’s income statement as shown in Figure 8.2 below: <?page no="205"?> Berkau: Financial Statements 8e 8-204 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 800,000 Share capital 500,000 Investments 73,000 Reserves 300,000 Financial assets 27,000 Retained earnings 140,000 Current assets Liabilities (liab.) Inventory 34,000 Long-term liab. Accounts receivables Short-term liab. A/ P Prepaid expenses Provisions Cash/ Bank 66,000 Income tax liab. 60,000 Total assets 1,000,000 Total equity and liab. 1,000,000 Breno Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X5 Figure 8.1: BRENO Ltd.’s balance sheet (1.01.20X5) IAS 28 applies for the valuation of the share in SABONA Ltd.; for the valuation of the financial instrument SUURENBERG Ltd., it follows IFRS 9. During the Accounting period 20X5, the three companies earn the below listed profits and make payments to their owners. No profit/ loss is carried forward. - BRENO Ltd.: profit before taxes (and before dividends): 280,000 ZAR, dividend: 40 % of the profit after taxes and after revaluation of investments in associates and financial assets. - SUURENBERG Ltd.: profit after taxes 34,000 ZAR, dividend 25 % thereof. - SABONA Ltd.: profit after taxes: 24,000 ZAR, dividend 15 % thereof. The dividend receipts from investments are not yet included on the income statement and balance sheet for BRENO Ltd. No appropriation of profits has been considered yet. Observe BRENO Ltd.’s income statement as shown in Figure 8.2 below: Berkau: Financial Statements 8e 8-205 [ZAR] Revenue 750,000 Other income 0 750,000 Materials (10,000) Labour (120,000) Depreciation (80,000) Other expenses (250,000) Earnings before int. & taxes (EBIT) 290,000 Interest (10,000) Earnings before taxes (EBT) 280,000 Income tax expenses (84,000) Deferred taxes 0 Earnings after taxes (EAT) 196,000 Breno Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X5 Figure 8.2: BRENO Ltd.’s income statement (20X5) In this case study, all dividends are paid during the Accounting period they are for. This means BRENO Ltd. receives dividend payments in 20X5 from SABONA Ltd. and SUURENBERG Ltd. The shares of SUURENBERG Ltd. are disclosed as financial asset following IFRS 9 on BRENO Ltd.’s balance sheet. SUURENBERG Ltd. is listed at the Johannesburg Stock exchange JSE. At the time of acquisition by BRENO Ltd., its share price per 1 ZAR/ s ordinary share was 3 ZAR/ s. BRENO Ltd. holds 9,000 shares. The costs of acquisition of the shares are: 3 × 9,000 = 2 277"000000 ZZAARR. This is the value shown on the balance sheet in Figure 8.1. BRENO Ltd. initially recorded the shares at costs in compliance with IFRS 9.5.1.1. The share price of 3 ZAR/ s is the cost of acquisition. With the profit earned during 20X5, the share price for SUURENBERG Ltd. increases on 31.12.20X5 by 0.18 ZAR/ s as traded at Johannesburg Stock Exchange (given). The fair market value per share is 3.18 ZAR/ s. This results in an increase of: 0.18 / 3 = 6 6%%. Therefore, BRENO Ltd. increases the value of its shares, too. It carries the shares at their fair value through other comprehensive income based on IFRS 9.5.2.1. The increase of the shares is: 6% × 27,000 = 1 1"662200 ZZAARR. BRENO Ltd. makes the Bookkeeping entry below in its books: @ 31.12.20X5 Financial Asset (SUURENB.) FNA 1,620 Other Compreh. Income-20X5 OCI 1,620 (value increase through other compreh. income for shares in SUURENBERG) <?page no="206"?> Berkau: Financial Statements 8e 8-206 BRENO Ltd.’s share of the dividends declared by SUURENBERG Ltd. (25 %) is linked to 9 % of ownership and is: 9% × 34,000 × 25% = 7 76655 ZZAARR. BRENO Ltd. records the dividend received as other comprehensive income. @ 31.12.20X5 Cash/ Bank C/ B 765 Other Comprehensive Income-20X5 OCI 765 (recording dividend receipt from SUURENBERG Ltd.) For the investment in the associated company SABONA Ltd., BRENO Ltd. applies the equity method following IAS 28.10. The equity method increases/ decreases the value of an investment based on the book value of the associated company. 146 IAS 27.12 requires recording dividends through profit or loss unless the entity elects to use the equity method. SABONA Ltd. earned an annual surplus of 24,000 ZAR in 20X5. Linked to the total of its issued capital, this is a portion of: 24,000 / (73,000/ 36.5%) = 1 122%%. The denominator calculates SABONA Ltd.’s equity based on the disclosure on BRENO Ltd.'s balance sheet. The share issue was par value. SABONA Ltd. is disclosed at 73,000 ZAR which is 36.5 % of all shares. Accordingly, SABONA Ltd.’s issued capital is: 73,000 / 36.5% = 220000"000000 ZZAARR. The dividend paid to SABONA Ltd.’s owners is 15 % of the profit of 24,000 ZAR and is to be deducted following IAS 28.10 and IAS 27.12. The reason is, that the book value of SABONA Ltd. decreases with the dividend payment. Hence, the increase in equity is based on the portion which is not distributed to owners: 12% × (1 - 15%) = 1 100..22%%. The value of the associated company SABONA Ltd. increases by: 73,000 × 10.2% = 7 7"444466 ZZAARR. Furthermore, a dividend of: 15% × 24,000 × 36.5% = 1 1"331144 ZZAARR is received and recorded through other comprehensive income. Observe the Bookkeeping entries below: @ 31.12.20X5 Cash/ Bank C/ B 1,314 Other Comprehensive Income-20X5 OCI 1,314 (recording dividend receipt from SABONA Ltd.) Investment @Equit (SABONA) INV 7,446 Other Compreh. Income-20X5 OCI 7,446 (investment increase by measurment @ equity for SABONA interest) 146 In many jurisdictions, e.g., Germany, the disclosure of an equity instrument increasing/ decreasing due to price fluctuations and the application of the equity method are prohibited for singleentity financial statements as relate to unrealised profits. <?page no="207"?> Berkau: Financial Statements 8e 8-206 BRENO Ltd.’s share of the dividends declared by SUURENBERG Ltd. (25 %) is linked to 9 % of ownership and is: 9% × 34,000 × 25% = 7 76655 ZZAARR. BRENO Ltd. records the dividend received as other comprehensive income. @ 31.12.20X5 Cash/ Bank C/ B 765 Other Comprehensive Income-20X5 OCI 765 (recording dividend receipt from SUURENBERG Ltd.) For the investment in the associated company SABONA Ltd., BRENO Ltd. applies the equity method following IAS 28.10. The equity method increases/ decreases the value of an investment based on the book value of the associated company. 146 IAS 27.12 requires recording dividends through profit or loss unless the entity elects to use the equity method. SABONA Ltd. earned an annual surplus of 24,000 ZAR in 20X5. Linked to the total of its issued capital, this is a portion of: 24,000 / (73,000/ 36.5%) = 1 122%%. The denominator calculates SABONA Ltd.’s equity based on the disclosure on BRENO Ltd.'s balance sheet. The share issue was par value. SABONA Ltd. is disclosed at 73,000 ZAR which is 36.5 % of all shares. Accordingly, SABONA Ltd.’s issued capital is: 73,000 / 36.5% = 220000"000000 ZZAARR. The dividend paid to SABONA Ltd.’s owners is 15 % of the profit of 24,000 ZAR and is to be deducted following IAS 28.10 and IAS 27.12. The reason is, that the book value of SABONA Ltd. decreases with the dividend payment. Hence, the increase in equity is based on the portion which is not distributed to owners: 12% × (1 - 15%) = 1 100..22%%. The value of the associated company SABONA Ltd. increases by: 73,000 × 10.2% = 7 7"444466 ZZAARR. Furthermore, a dividend of: 15% × 24,000 × 36.5% = 1 1"331144 ZZAARR is received and recorded through other comprehensive income. Observe the Bookkeeping entries below: @ 31.12.20X5 Cash/ Bank C/ B 1,314 Other Comprehensive Income-20X5 OCI 1,314 (recording dividend receipt from SABONA Ltd.) Investment @Equit (SABONA) INV 7,446 Other Compreh. Income-20X5 OCI 7,446 (investment increase by measurment @ equity for SABONA interest) 146 In many jurisdictions, e.g., Germany, the disclosure of an equity instrument increasing/ decreasing due to price fluctuations and the application of the equity method are prohibited for singleentity financial statements as relate to unrealised profits. Berkau: Financial Statements 8e 8-207 IAS 27.12 requires the deduction of dividends from the investment value because it is an equity decrease. We considered the dividend deduction already when we calculated an investment increase of 7,446 ZAR because we multiplied with 10.2 % instead of with 12 %. Regarding the other comprehensive income, dividends result in a zero-sumgame as the associate’s value decreases to the same extent as dividend income is received. Therefore, with the equity method, dividend payments do not matter for the valuation. As BRENO Ltd. is a company based on shares, no dividend tax applies. We show the financial statements of BRENO Ltd. after the appropriation of profits in Figure 8.3 and Figure 8.4. The profit before taxes is 291,145 ZAR. See the income statement in Figure 8.3. The dividend portion is: 40% × 291,145 × (1 - 30%) = 8811"552200..6600 ZZAARR. It is recorded as a liability to shareholders and disclosed as short-term debt on the balance sheet. Dividends are paid in 20X6. The value for retained earnings is: 140,000 + 203,802 - 81,520.60 = 2 26622"228811..4400 ZZAARR. The other income on BRENO Ltd.’s statement of profit or loss and other comprehensive income consists of the dividends from SUURENBERG Ltd. and from SABONA Ltd. and their increase in valuation of: 765 + 1,620 + 7,446 + 1,314 = 1 111"114455 ZZAARR. ANon-current assets [ZAR] Equity [ZAR] P, P, E 720,000 Share capital 500,000 Investments 80,446 Reserves 300,000 Financial assets 28,620 Retained earnings 262,281 Current assets Liabilities (liab.) Inventory 34,000 Long-term liab. Accounts receivables Short-term liab. A/ P 81,521 Prepaid expenses Provisions Cash/ Bank 368,079 Income tax liab. 87,344 Total assets 1,231,145 Total equity and liab. 1,231,145 Breno Ltd. SEPARATE STATEMENT of FINANCIAL POSITION as at 31.12.20X5 Figure 8.3: BRENO Ltd.’s balance sheet (separate F/ S) <?page no="208"?> Berkau: Financial Statements 8e 8-208 [ZAR] Revenue 750,000 Other income 11,145 761,145 Materials (10,000) Labour (120,000) Depreciation (80,000) Other expenses (250,000) Earnings before int. & taxes (EBIT) 301,145 Interest (10,000) Earnings before taxes (EBT) 291,145 Income tax expenses (87,344) Deferred taxes 0 Earnings after taxes (EAT) 203,802 Breno Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X5 Figure 8.4: BRENO Ltd.’s income statement (separate F/ S) How it is Done (Separate Financial Statements): (1) Determine whether separate financial statements must be prepared (IAS 27). National law applies (Company’s Act). (2) If separate financial statements apply, prepare them for the holder of the investment. (3) Recognise financial assets at cost or at fair values through either profit or loss or through other comprehensive income based on IFRS 9. (4) Disclose investments in associates or joint ventures following the equity method as laid out in IAS 28. (5) Record an investment in subsidiaries initially at costs and later at fair values through other comprehensive income. (6) Record dividends received from investments through either profit or loss or through other comprehensive income. (7) If applying the equity method, a dividend paid by the associate or joint venture reduces the investment’s valuation. Record a deduction of assets accordingly. <?page no="209"?> Berkau: Financial Statements 8e 8-208 [ZAR] Revenue 750,000 Other income 11,145 761,145 Materials (10,000) Labour (120,000) Depreciation (80,000) Other expenses (250,000) Earnings before int. & taxes (EBIT) 301,145 Interest (10,000) Earnings before taxes (EBT) 291,145 Income tax expenses (87,344) Deferred taxes 0 Earnings after taxes (EAT) 203,802 Breno Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X5 Figure 8.4: BRENO Ltd.’s income statement (separate F/ S) How it is Done (Separate Financial Statements): (1) Determine whether separate financial statements must be prepared (IAS 27). National law applies (Company’s Act). (2) If separate financial statements apply, prepare them for the holder of the investment. (3) Recognise financial assets at cost or at fair values through either profit or loss or through other comprehensive income based on IFRS 9. (4) Disclose investments in associates or joint ventures following the equity method as laid out in IAS 28. (5) Record an investment in subsidiaries initially at costs and later at fair values through other comprehensive income. (6) Record dividends received from investments through either profit or loss or through other comprehensive income. (7) If applying the equity method, a dividend paid by the associate or joint venture reduces the investment’s valuation. Record a deduction of assets accordingly. Berkau: Financial Statements 8e 8-209 8.6 Consolidated Financial Statements Consolidated financial statements are referred to as derived financial statements because a group itself does not keep Bookkeeping records. Group statements are based on single-entity financial statements. This gives us some extra work regarding the preparation of subsequent group statements as we must maintain the initial consolidations. This technically means, we must repeat the initial capital consolidation every year. With an application of Accounting software, this should not become a problem. However, in an exam it gives us extra work. In contrast to financial statements along IAS 27, Group Accounting requires consolidations. We start our discussion with consolidations and prepare group statements for three case studies. For the consolidated financial statements, all single-entity financial statements of group members are “addedup” item-wise. For the calculations, financial statements must be uniform regarding formal aspects. The same as fraction adding, e.g., 1/ 3 + 1/ 2 = 5/ 6, requires finding a common denominator, the addition of financial statements requires the application of the same GAAPS, reporting in the same currency, referencing to the same balance sheet date etc. E.g., a group of a Dutch and South African company with the parent based in South Africa, must transfer the financial statements prepared in the Netherlands and applying the Dutch Woertbook van Koophandel into IFRSs. Furthermore, it must re-value its items towards the reporting currency, the South African Rand ZAR. Once financial statements are conformed, we add them. Addition by item means, we add every item separately, e.g., PPE Dutch + PPE SAn = PPE Group . Adding financial statements causes items counting double, like the interest in the subsidiary and its assets. To avoid multiple considerations, consolidations eliminate intra-group balances, transactions, income and expenses. 8.7 C/ S GAMKA/ SWARTBERG Group - Initial Consolidation We study the case of the GAMKA/ SWARTBERG group below and introduce the acquisition method following IFRS 3.4. It requires identifying the acquirer (GAMKA Ltd.), to determine the acquisition date (1.01.20X4), to recognise and measure all assets, liabilities and non-controlling interest (see below) and to measure and recognise goodwill. With the next following case studies, we discuss PORTERSVILLE Ltd. and its subsidiary HENDERSON Ltd. to study profit consolidations. With the case study PATTEN/ SPYKER we cover group member transactions and the consolidation of intra-group profits. Data Sheet for GAMKA/ SWARTBERG DDoommiicciillee: : SSoouutthh AAffrriiccaa ((CCaappee TToowwnn)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. IInnvveessttmmeenntt: : GGAAMMKKAA LLttdd.. hhoollddss 8800 %% ooff SSWWAARRTTBBEERRGG LLttdd.. AAccqquuiissiittiioonn ddaattee: : 11..0011..2200XX44.. AAccqquuiissiittiioonn mmeetthhoodd aapppplliieess.. VVAATT iiggnnoorreedd.. <?page no="210"?> Berkau: Financial Statements 8e 8-210 On 1.01.20X4, GAMKA Ltd. buys 80 % of the ordinary shares of SWARTBERG Ltd. With the acquisition, the companies form a group. GAMKA Ltd. is the owner of 80 % of the ordinary shares of SWARTBERG Ltd. and takes over control of SWARTBERG Ltd. By gaining control power, GAMKA Ltd. becomes the parent; SWARTBERG Ltd. is the subsidiary. GAMKA Ltd. and SWARTBERG Ltd. both prepare single-entity financial statements and one set of financial statements for the group. The group statements contain a full set of financial statements which consider all group members as “departments” of a single company (= the group). This means that all assets of GAMKA Ltd. and SWARTBERG Ltd. are disclosed on the balance sheet of GAMKA Group. Note, that the group name does not carry a legal form. This helps us to distinguish group statements from single-entity financial statements. 147 A full set of financial statement comprises in general of a statement of financial position, a statement of profit or loss and other comprehensive income, a statement of cash flows, a statement of changes in equity and the notes. IAS 1.10 applies for group statements, too. To determine the items on the GAMKA Group’s statement of financial position we add all balance sheet items for the group members. For recognition and measurement, fair values as on acquisition date apply (IFRS 3.18). E.g., PPE GAMKA + PPE SWARTBERG = 230,000 + 40,000 = 2 27700"000000 ZZAARR. The above values are derived from the balance sheets shown in Figure 8.5 and Figure 8.6. 147 See e.g., Figure 8.10. For the group’s balance sheet, a capital consolidation must be carried out because some items count twice: GAMKA Ltd.’s investment in SWARTBERG Ltd. is an asset. Also, the assets of SWARTBERG Ltd. are considered as group assets. This results in a double recognition of the subsidiary’s asset. To keep Group Accounting free from the above-mentioned multiple considerations, the group statements require capital consolidation by which the investment and the total subsidiary’s equity are cancelled out. In general, consolidations consist of capital consolidation, a consolidation of intra-group receivables/ payables and an intra-group profit consolidation on the balance sheet as well as on the income statement. The objective is to eliminate multiple considerations of items or to delete effects of intergroup transactions, like internal profits. A capital consolidation is a calculation to eliminate the investment in subsidiaries and their equity on group statements. As the subsidiary valuation is based on the acquisition method and equity valuations are based on nominal values, a difference can result which either is a goodwill or a negative goodwill. If only a percentage of a subsidiary is acquired, the equity portion linked to ownership is cancelled out against its cost of acquisition. The equity portion that does not belong to the group is disclosed as non-controlling interest in the equity section of the group statement of financial position (extra item). This is the portion of owners who are no group members, <?page no="211"?> Berkau: Financial Statements 8e 8-210 On 1.01.20X4, GAMKA Ltd. buys 80 % of the ordinary shares of SWARTBERG Ltd. With the acquisition, the companies form a group. GAMKA Ltd. is the owner of 80 % of the ordinary shares of SWARTBERG Ltd. and takes over control of SWARTBERG Ltd. By gaining control power, GAMKA Ltd. becomes the parent; SWARTBERG Ltd. is the subsidiary. GAMKA Ltd. and SWARTBERG Ltd. both prepare single-entity financial statements and one set of financial statements for the group. The group statements contain a full set of financial statements which consider all group members as “departments” of a single company (= the group). This means that all assets of GAMKA Ltd. and SWARTBERG Ltd. are disclosed on the balance sheet of GAMKA Group. Note, that the group name does not carry a legal form. This helps us to distinguish group statements from single-entity financial statements. 147 A full set of financial statement comprises in general of a statement of financial position, a statement of profit or loss and other comprehensive income, a statement of cash flows, a statement of changes in equity and the notes. IAS 1.10 applies for group statements, too. To determine the items on the GAMKA Group’s statement of financial position we add all balance sheet items for the group members. For recognition and measurement, fair values as on acquisition date apply (IFRS 3.18). E.g., PPE GAMKA + PPE SWARTBERG = 230,000 + 40,000 = 2 27700"000000 ZZAARR. The above values are derived from the balance sheets shown in Figure 8.5 and Figure 8.6. 147 See e.g., Figure 8.10. For the group’s balance sheet, a capital consolidation must be carried out because some items count twice: GAMKA Ltd.’s investment in SWARTBERG Ltd. is an asset. Also, the assets of SWARTBERG Ltd. are considered as group assets. This results in a double recognition of the subsidiary’s asset. To keep Group Accounting free from the above-mentioned multiple considerations, the group statements require capital consolidation by which the investment and the total subsidiary’s equity are cancelled out. In general, consolidations consist of capital consolidation, a consolidation of intra-group receivables/ payables and an intra-group profit consolidation on the balance sheet as well as on the income statement. The objective is to eliminate multiple considerations of items or to delete effects of intergroup transactions, like internal profits. A capital consolidation is a calculation to eliminate the investment in subsidiaries and their equity on group statements. As the subsidiary valuation is based on the acquisition method and equity valuations are based on nominal values, a difference can result which either is a goodwill or a negative goodwill. If only a percentage of a subsidiary is acquired, the equity portion linked to ownership is cancelled out against its cost of acquisition. The equity portion that does not belong to the group is disclosed as non-controlling interest in the equity section of the group statement of financial position (extra item). This is the portion of owners who are no group members, Berkau: Financial Statements 8e 8-211 e.g., for an investor holding 30 % of a subsidiary. Due to a full consolidation, group statements cover the entire subsidiary including the portion held by others. Therefore, group statements must disclose the portion belonging to owners who do not control a subsidiary. In the old days, this portion was called minority interest. A consolidation of receivables and payables removes all mutual debts and receivables between group members. A profit consolidation results in the deduction of intra-group profits on the group’s income statement and the equity section of the group’s balance sheet. A profit consolidation can also change asset measurements, if e.g., one group member sells goods to another one and earns a profit. Together with the profit elimination a goods valuation adjustment becomes necessary. About consolidations, we distinguish initial consolidation and subsequent ones. An initial consolidation is recorded at acquisition date in general when the group is defined by the parent gaining control power over the subsidiary. Any subsequent consolidation is recorded after the initial one. Accountants refer to those calculations as “consolidation Bookkeeping entries” because adjustments are made on the debit and credit sides together. Consolidated financial statements do not cause nor do they affect payments. No tax payments nor dividends depend on the group statements. The only purpose of Group Accounting is providing information. Below, we study consolidations for the GAMKA GROUP. The two group members provide the financial statements on 31.12.20X3 as below. This is one day before the acquisition (1.01.20X4): A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 230,000 Share capital 300,000 Intangibles Reserves Financial assets Retained earnings 70,000 Current assets Liabilities (liab.) Inventory 170,000 Long-term liab. 50,000 Accounts receivables Short-term liab. A/ P 50,000 Prepaid expenses Provisions Cash/ Bank 100,000 Income tax liab. 30,000 Total assets 500,000 Total equity and liab. 500,000 Gamka Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X3 Figure 8.5: GAMKA Ltd.’s statement of financial position <?page no="212"?> Berkau: Financial Statements 8e 8-212 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 40,000 Share capital 50,000 Intangibles Reserves Financial assets Retained earnings 28,000 Current assets Liabilities (liab.) Inventory 30,000 Long-term liab. Accounts receivables Short-term liab. A/ P 10,000 Prepaid expenses Provisions Cash/ Bank 30,000 Income tax liab. 12,000 Total assets 100,000 Total equity and liab. 100,000 Swartberg Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X3 Figure 8.6: SWARTBERG Ltd.’s statement of financial position The single-entity financial statements in Figure 8.5 and Figure 8.6 show the names of the group members together with their legal form. All items on the balance sheets are measured at fair values and have been prepared under IFRSs regulations. The reporting currency is the South African Rand ZAR. The financial statements of both group members are prepared without consideration of profit appropriation, because all profits are carried forward to 20X4. We prepare group statements as per 31.12.20X4 (one year later). At first, we prepare the capital consolidation: When GAMKA Ltd. buys 80 % of SWARTBERG Ltd. on 1.01.20X4, its book value is: 50,000 + 28,000 = 7 788"000000 ZZAARR. The book value of GAMKA Ltd.’s investment is 80 % thereof: 80% × (50,000 + 28,000) = 6 622"440000 ZZAARR. GAMKA Ltd. pays the (previous) owners 65,000 ZAR in exchange of 80 % of SWARTBERG Ltd.’s ordinary shares. The payment exceeds the book value of the acquired share in SWARTBERG Ltd. Due to the acquisition, the statement of financial position now discloses a value for the investment of 65,000 ZAR and a lower cash/ bank item. Cash/ bank now is: 100,000 - 65,000 = 3 355"000000 ZZAARR. GAMKA Ltd. bought the subsidiary at a price above its book value, probably for strategic intentions, e.g., regarding the present market position of SWARTBERG Ltd., or the acquirer expects a high potential of the business in the future etc. 148 GAMKA Ltd. makes the Bookkeeping entry below which indicates that the subsidiary is recorded at cost. 149 See in Figure 8.7 the balance sheet for GAMKA Ltd. on 1.01.20X4 after the acquisition. 148 Study our textbook Management Accounting, chapter (11). 149 We refrain from applying the journal entry format for consolidations to indicate that no real Bookkeeping entries are carried out. <?page no="213"?> Berkau: Financial Statements 8e 8-212 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 40,000 Share capital 50,000 Intangibles Reserves Financial assets Retained earnings 28,000 Current assets Liabilities (liab.) Inventory 30,000 Long-term liab. Accounts receivables Short-term liab. A/ P 10,000 Prepaid expenses Provisions Cash/ Bank 30,000 Income tax liab. 12,000 Total assets 100,000 Total equity and liab. 100,000 Swartberg Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X3 Figure 8.6: SWARTBERG Ltd.’s statement of financial position The single-entity financial statements in Figure 8.5 and Figure 8.6 show the names of the group members together with their legal form. All items on the balance sheets are measured at fair values and have been prepared under IFRSs regulations. The reporting currency is the South African Rand ZAR. The financial statements of both group members are prepared without consideration of profit appropriation, because all profits are carried forward to 20X4. We prepare group statements as per 31.12.20X4 (one year later). At first, we prepare the capital consolidation: When GAMKA Ltd. buys 80 % of SWARTBERG Ltd. on 1.01.20X4, its book value is: 50,000 + 28,000 = 7 788"000000 ZZAARR. The book value of GAMKA Ltd.’s investment is 80 % thereof: 80% × (50,000 + 28,000) = 6 622"440000 ZZAARR. GAMKA Ltd. pays the (previous) owners 65,000 ZAR in exchange of 80 % of SWARTBERG Ltd.’s ordinary shares. The payment exceeds the book value of the acquired share in SWARTBERG Ltd. Due to the acquisition, the statement of financial position now discloses a value for the investment of 65,000 ZAR and a lower cash/ bank item. Cash/ bank now is: 100,000 - 65,000 = 3 355"000000 ZZAARR. GAMKA Ltd. bought the subsidiary at a price above its book value, probably for strategic intentions, e.g., regarding the present market position of SWARTBERG Ltd., or the acquirer expects a high potential of the business in the future etc. 148 GAMKA Ltd. makes the Bookkeeping entry below which indicates that the subsidiary is recorded at cost. 149 See in Figure 8.7 the balance sheet for GAMKA Ltd. on 1.01.20X4 after the acquisition. 148 Study our textbook Management Accounting, chapter (11). 149 We refrain from applying the journal entry format for consolidations to indicate that no real Bookkeeping entries are carried out. Berkau: Financial Statements 8e 8-213 DR Investment Subsidiary........ 65,000 ZAR CR Cash/ Bank.................... 65,000 ZAR A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 230,000 Share capital 300,000 Intangibles Reserves Investment 65,000 Retained earnings 70,000 Current assets Liabilities (liab.) Inventory 170,000 Long-term liab. 50,000 Accounts receivables Short-term liab. A/ P 50,000 Prepaid expenses Provisions Cash/ Bank 35,000 Income tax liab. 30,000 Total assets 500,000 Total equity and liab. 500,000 Gamka Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X4 Figure 8.7: GAMKA Ltd.’s balance sheet after acquisition On the single-entity financial statements, GAMKA Ltd.’s investment in the subsidiary is disclosed at its cost of acquisition of 65,000 ZAR. This is the value of transferred consideration, here the price paid (IFRS 3.37). For the group statements, we “add” the items on both balance sheets. Note, that the balance sheet for SWARTBERG Ltd. did not change with the transfer of ownership. It only shows now the balance sheet date 1.01.20X4 (we do not disclose the balance sheet again but refer to Figure 8.6). With the acquisition of 80 % of SWARTBERG Ltd., GAMKA Ltd. becomes the parent and SWARTBERG Ltd. the subsidiary. Both companies still must prepare single-entity financial statements. We next prepare the group statements. They are indicated as GAMKA GROUP statements. Adding the financial statements is supported by a consolidation worksheet as shown in Figure 8.8. <?page no="214"?> Berkau: Financial Statements 8e 8-214 PARENT SUBSIDIARY AGGR. CONS. F/ S N-cur Assets P,P,E 230,000 40,000 270,000 270,000 Investments 65,000 65,000 65,000 Goodwill 0 0 cur Assets Inventory 170,000 30,000 200,000 200,000 Cash/ Bank 35,000 30,000 65,000 65,000 500,000 100,000 600,000 600,000 SH's capital Issued capital (300,000) (50,000) (350,000) (350,000) Reserves 0 0 Reval. Reserves 0 0 Retained ear. (70,000) (28,000) (98,000) (98,000) Non-ctrl int 0 0 Liabilities Int. bear. liab. (50,000) (50,000) (50,000) Payables (50,000) (10,000) (60,000) (60,000) Tax liabilities (30,000) (12,000) (42,000) (42,000) (500,000) (100,000) (600,000) (600,000) Figure 8.8: GAMKA Group’s consolidation worksheet (20X3.1) The consolidation worksheet adds the single-entity financial statements for GAMKA Ltd. and SWARTBERG Ltd. per item. The sum is shown as aggregated balance sheet (AGGR) which is the group balance sheet before consolidations. E.g., the item for property, plant and equipment on the aggregated financial statements gives: 230,000 + 40,000 = 227700"000000 ZZAARR. By adding financial statements, the investment of 65,000 ZAR and all its assets get disclosed on the debit side. Remember, the book value of the acquired company is the total of its assets less its liabilities: 100,000 - (10,000 + 12,000) = 7 788"000000 ZZAARR. 150 This means SWARTBERG Ltd. now counts more than 180 % on the group statements. "More" refers to the goodwill not yet disclosed but included in the amount of 65,000 ZAR. 100 % is 150 Compare to Figure 8.6. the result of a full consolidation although, only 80 % is the percentage of ownership. The multiple consideration of the subsidiary is misleading. To avoid multiple considerations of subsidiaries, we carry out a capital consolidation. The aim is to cancel out the investment and the partial book value of SWARTBERG Ltd. and to disclose the excess of payment as a goodwill. 80 % of SWARTBERG Ltd.’s value is: 80% × 78,000 = 6 622"440000 ZZAARR. The overpayment is: 65,000 - 62,400 = 2 2"660000 ZZAARR. We make a Bookkeeping entry as shown in the column for capital consolidation (CAP.CONS). This is ruled by IFRS 3.32. Observe the capital consolidation as shown in the next consolidation chart in Figure 8.9 under CAP.CONS. <?page no="215"?> Berkau: Financial Statements 8e 8-214 PARENT SUBSIDIARY AGGR. CONS. F/ S N-cur Assets P,P,E 230,000 40,000 270,000 270,000 Investments 65,000 65,000 65,000 Goodwill 0 0 cur Assets Inventory 170,000 30,000 200,000 200,000 Cash/ Bank 35,000 30,000 65,000 65,000 500,000 100,000 600,000 600,000 SH's capital Issued capital (300,000) (50,000) (350,000) (350,000) Reserves 0 0 Reval. Reserves 0 0 Retained ear. (70,000) (28,000) (98,000) (98,000) Non-ctrl int 0 0 Liabilities Int. bear. liab. (50,000) (50,000) (50,000) Payables (50,000) (10,000) (60,000) (60,000) Tax liabilities (30,000) (12,000) (42,000) (42,000) (500,000) (100,000) (600,000) (600,000) Figure 8.8: GAMKA Group’s consolidation worksheet (20X3.1) The consolidation worksheet adds the single-entity financial statements for GAMKA Ltd. and SWARTBERG Ltd. per item. The sum is shown as aggregated balance sheet (AGGR) which is the group balance sheet before consolidations. E.g., the item for property, plant and equipment on the aggregated financial statements gives: 230,000 + 40,000 = 227700"000000 ZZAARR. By adding financial statements, the investment of 65,000 ZAR and all its assets get disclosed on the debit side. Remember, the book value of the acquired company is the total of its assets less its liabilities: 100,000 - (10,000 + 12,000) = 7788"000000 ZZAARR. 150 This means SWARTBERG Ltd. now counts more than 180 % on the group statements. "More" refers to the goodwill not yet disclosed but included in the amount of 65,000 ZAR. 100 % is 150 Compare to Figure 8.6. the result of a full consolidation although, only 80 % is the percentage of ownership. The multiple consideration of the subsidiary is misleading. To avoid multiple considerations of subsidiaries, we carry out a capital consolidation. The aim is to cancel out the investment and the partial book value of SWARTBERG Ltd. and to disclose the excess of payment as a goodwill. 80 % of SWARTBERG Ltd.’s value is: 80% × 78,000 = 6 622"440000 ZZAARR. The overpayment is: 65,000 - 62,400 = 2 2"660000 ZZAARR. We make a Bookkeeping entry as shown in the column for capital consolidation (CAP.CONS). This is ruled by IFRS 3.32. Observe the capital consolidation as shown in the next consolidation chart in Figure 8.9 under CAP.CONS. Berkau: Financial Statements 8e 8-215 PARENT SUBSIDIARY AGGR. CAP. CONS CAP. CONS CAP. CONS CONS. F/ S N-cur Assets P,P,E 230,000 40,000 270,000 270,000 Investments 65,000 65,000 (65,000) 0 Goodwill 0 2,600 2,600 cur Assets Inventory 170,000 30,000 200,000 200,000 Cash/ Bank 35,000 30,000 65,000 65,000 500,000 100,000 600,000 (62,400) 0 0 537,600 SH's capital Issued capital (300,000) (50,000) (350,000) 40,000 10,000 (300,000) Reserves 0 0 Reval. Reserves 0 0 Retained ear. (70,000) (28,000) (98,000) 22,400 5,600 (70,000) Non-ctrl int 0 (10,000) (5,600) (15,600) Liabilities Int. bear. liab. (50,000) (50,000) (50,000) Payables (50,000) (10,000) (60,000) (60,000) Tax liabilities (30,000) (12,000) (42,000) (42,000) (500,000) (100,000) (600,000) 62,400 0 0 (537,600) Figure 8.9: GAMKA Group’s consolidation worksheet (20X3.2) The capital consolidation procedure contains two steps. The first one eliminates the acquisition costs of the investment and its partial (= 80 %) book value (issued capital and retained earnings) and discloses the goodwill of: 2,600 + 40,000 + 22,400 = 6 655"000000 ZZAARR. The second step allocates the portion of 20 % of the shares’ nominal value and retained earnings to the other owners of SWARTBERG Ltd. (not GAMKA Ltd.). We refer to them as non-controlling interest holders. Therefore, the equity section of a consolidated balance sheet contains an extra item called non-controlling interest. For the GAMKA Group, this item contains 20 % of the shares at nominal values and 20 % of the retained earnings at the time of acquisition. This gives: 20% × 50,000 = 1 100"000000 ZZAARR and: 20% × 28,000 = 5 5"660000 ZZAARR. These initial capital consolidation bookkeeping entries are maintained for subsequent consolidations. The consolidated statement of financial position for GAMKA GROUP is displayed in Figure 8.10. It is derived from the right column in the consolidation worksheet. <?page no="216"?> Berkau: Financial Statements 8e 8-216 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 270,000 Share capital 300,000 Intangibles Reserves Investment Retained earnings 70,000 Goodwill 2,600 Non-ctrl interest 15,600 Current assets Liabilities (liab.) Inventory 200,000 Long-term liab. 50,000 Accounts receivables Short-term liab. A/ P 60,000 Prepaid expenses Provisions Cash/ Bank 65,000 Income tax liab. 42,000 Total assets 537,600 Total equity and liab. 537,600 Gamka Group consolidated STATEMENT of FINANCIAL POSITION as at 1.01.20X4 Figure 8.10: Consolidated balance sheet For further considerations (subsequent consolidations), we combine the initial consolidation Bookkeeping entries. That way, we can disclose them in one column on the (next) consolidation chart. The consolidation bookkeeping entry is: DR Goodwill..................... 2,600 ZAR DR Issued Capital............... 50,000 ZAR DR Retained Earnings............ 28,000 ZAR CR Investments.................. 65,000 ZAR CR Non-ctrl. Interest........... 15,600 ZAR For the initial consolidation of GAMKA/ SWATBERG group, no consolidation of receivables/ payables nor for intra-group profit applies. 8.8 C/ S GAMKA/ SWARTBERG Group - Subsequent Consolidations We study the consolidated financial statements for GAMKA Ltd. and SWARTBERG Ltd. one year later: The companies disclose their income statements as below in Figure 8.11 and Figure 8.13 for the period ended on 31.12.20X4: <?page no="217"?> Berkau: Financial Statements 8e 8-216 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 270,000 Share capital 300,000 Intangibles Reserves Investment Retained earnings 70,000 Goodwill 2,600 Non-ctrl interest 15,600 Current assets Liabilities (liab.) Inventory 200,000 Long-term liab. 50,000 Accounts receivables Short-term liab. A/ P 60,000 Prepaid expenses Provisions Cash/ Bank 65,000 Income tax liab. 42,000 Total assets 537,600 Total equity and liab. 537,600 Gamka Group consolidated STATEMENT of FINANCIAL POSITION as at 1.01.20X4 Figure 8.10: Consolidated balance sheet For further considerations (subsequent consolidations), we combine the initial consolidation Bookkeeping entries. That way, we can disclose them in one column on the (next) consolidation chart. The consolidation bookkeeping entry is: DR Goodwill..................... 2,600 ZAR DR Issued Capital............... 50,000 ZAR DR Retained Earnings............ 28,000 ZAR CR Investments.................. 65,000 ZAR CR Non-ctrl. Interest........... 15,600 ZAR For the initial consolidation of GAMKA/ SWATBERG group, no consolidation of receivables/ payables nor for intra-group profit applies. 8.8 C/ S GAMKA/ SWARTBERG Group - Subsequent Consolidations We study the consolidated financial statements for GAMKA Ltd. and SWARTBERG Ltd. one year later: The companies disclose their income statements as below in Figure 8.11 and Figure 8.13 for the period ended on 31.12.20X4: Berkau: Financial Statements 8e 8-217 [ZAR] Revenue 200,000 Other income (10,000) 190,000 Materials (14,000) Labour (100,000) Depreciation (16,000) Other expenses 0 Earnings before int. & taxes (EBIT) 60,000 Interest 0 Earnings before taxes (EBT) 60,000 Income tax expenses (18,000) Deferred taxes 0 Earnings after taxes (EAT) 42,000 Gamka Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X4 Figure 8.11: GAMKA Ltd.’s income statement (20X4) A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 214,000 Share capital 300,000 Intangibles Reserves Investment 65,000 Retained earnings 112,000 Current assets Liabilities (liab.) Inventory 160,000 Long-term liab. 50,000 Accounts receivables Short-term liab. A/ P 50,000 Prepaid expenses Provisions Cash/ Bank 91,000 Income tax liab. 18,000 Total assets 530,000 Total equity and liab. 530,000 Gamka Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X4 Figure 8.12: GAMKA Ltd.’s balance sheet (20X4) For the understanding of the statement of financial position, we provide background information about the business operations which is not relevant for consolidations. You can skip these explanations if happy with the given balance sheet and continue reading where the * is. The item property, plant and equipment is reduced for depreciation and is amounting to: 230,000 - 16,000 = 221144"000000 ZZAARR. Goods have been released from stock which leads to a reduction of 10,000 ZAR in the Inventory account: 170,000 - 10,000 = 1 16600"000000 ZZAARR. We assume all business activities - except of depreciation are on cash. GAMKA Ltd. <?page no="218"?> Berkau: Financial Statements 8e 8-218 pays 30,000 ZAR to the revenue service for income tax liabilities from 20X3. A cash revenue of 200,000 ZAR is deducted for labour and materials. Hence, the item cash/ bank is: 35,000 + 200,000 - 14,000 - 100,000 - 30,000 = 9 911"000000 ZZAARR. On the credit side, there is no change in issued capital and the earnings after tax are added to retained earnings: 70,000 + 42,000 = 1 11122"000000 ZZAARR. In the liability section, the only change is made in the Income Tax Liability account: 30,000 - 30,000 + 18,000 = 1 188"000000 ZZAARR. We now study the subsidiary, SWARTBERG Ltd. in Figure 8.13 and Figure 8.14. [ZAR] Revenue 35,000 Other income 0 35,000 Materials (15,000) Labour 0 Depreciation (10,000) Other expenses 0 Earnings before int. & taxes (EBIT) 10,000 Interest 0 Earnings before taxes (EBT) 10,000 Income tax expenses (3,000) Deferred taxes 0 Earnings after taxes (EAT) 7,000 Swartberg Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X4 Figure 8.13: SWARTBERG Ltd.’s income statement (20X4) A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 30,000 Share capital 50,000 Intangibles Reserves Financial assets Retained earnings 35,000 Current assets Liabilities (liab.) Inventory 30,000 Long-term liab. Accounts receivables Short-term liab. A/ P 10,000 Prepaid expenses Provisions Cash/ Bank 38,000 Income tax liab. 3,000 Total assets 98,000 Total equity and liab. 98,000 Swartberg Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X4 Figure 8.14: SWARTBERG Ltd.’s balance sheet (20X4) <?page no="219"?> Berkau: Financial Statements 8e 8-218 pays 30,000 ZAR to the revenue service for income tax liabilities from 20X3. A cash revenue of 200,000 ZAR is deducted for labour and materials. Hence, the item cash/ bank is: 35,000 + 200,000 - 14,000 - 100,000 - 30,000 = 9 911"000000 ZZAARR. On the credit side, there is no change in issued capital and the earnings after tax are added to retained earnings: 70,000 + 42,000 = 1 11122"000000 ZZAARR. In the liability section, the only change is made in the Income Tax Liability account: 30,000 - 30,000 + 18,000 = 1188"000000 ZZAARR. We now study the subsidiary, SWARTBERG Ltd. in Figure 8.13 and Figure 8.14. [ZAR] Revenue 35,000 Other income 0 35,000 Materials (15,000) Labour 0 Depreciation (10,000) Other expenses 0 Earnings before int. & taxes (EBIT) 10,000 Interest 0 Earnings before taxes (EBT) 10,000 Income tax expenses (3,000) Deferred taxes 0 Earnings after taxes (EAT) 7,000 Swartberg Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X4 Figure 8.13: SWARTBERG Ltd.’s income statement (20X4) A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 30,000 Share capital 50,000 Intangibles Reserves Financial assets Retained earnings 35,000 Current assets Liabilities (liab.) Inventory 30,000 Long-term liab. Accounts receivables Short-term liab. A/ P 10,000 Prepaid expenses Provisions Cash/ Bank 38,000 Income tax liab. 3,000 Total assets 98,000 Total equity and liab. 98,000 Swartberg Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X4 Figure 8.14: SWARTBERG Ltd.’s balance sheet (20X4) Berkau: Financial Statements 8e 8-219 We repeat the explanation of the single-entity financial statements for SWARTBERG Ltd. Again: if you are happy with the financial statements without further explanation, you can skip this paragraph and continue reading at the *. The value for property, plant and equipment on SWARTBERG Ltd.’s statement of financial position results from the previous value less depreciation, no acquisition nor revaluation takes place: 40,000 - 10,000 = 3 300"000000 ZZAARR. Inventories do not change. For the value of cash/ bank, we consider that all business activities - depreciation exempted are on a cash basis. They include income tax payment, revenue and material payments. The item cash/ bank is: 30,000 + 35,000 - 15,000 - 12,000 = 3 388"000000 ZZAARR. There are no changes in issued capital and the item retained earnings is: 28,000 + 7,000 = 3 355"000000 ZZAARR. Short-term liabilities remain unchanged, and the income tax liabilities are based on the payment of 20X3’s debts. The item tax liabilities are: 12,000 - 12,000 + 3,000 = 3 3"000000 ZZAARR. * The consolidation procedures are based on the consolidation worksheet again. Once we enter the figures for the singleentity balance sheets we see the aggregated balance sheet. On the consolidation worksheet, the initial consolidation Bookkeeping entries are given. We apply the comprehensive Bookkeeping entry for capital consolidation as calculated above. Observe the consolidation worksheet in Figure 8.15. PARENT SUBSIDIARY AGGR. CAP. CONS CONS. F/ S N-cur Assets P,P,E 214,000 30,000 244,000 244,000 Investments 65,000 65,000 (65,000) 0 Goodwill 0 2,600 2,600 cur Assets Inventory 160,000 30,000 190,000 190,000 Cash/ Bank 91,000 38,000 129,000 129,000 530,000 98,000 628,000 (62,400) 565,600 SH's capital Issued capital (300,000) (50,000) (350,000) 50,000 (300,000) Reserves 0 0 Reval. Reserves 0 0 Retained ear. (112,000) (35,000) (147,000) 28,000 (119,000) Non-ctrl int 0 (15,600) (15,600) Liabilities Int. bear. liab. (50,000) (50,000) (50,000) Payables (50,000) (10,000) (60,000) (60,000) Tax liabilities (18,000) (3,000) (21,000) (21,000) (530,000) (98,000) (628,000) 62,400 (565,600) Figure 8.15: GAMKA Group’s consolidation worksheet (20X4.1) <?page no="220"?> Berkau: Financial Statements 8e 8-220 No changes regarding investment valuation nor for the percentage of ownership apply. The only adjustment required is for the profit and the portion belonging to the non-controlling interest holders thereof. No inter-group profits took place. The profit of the subsidiary is 7,000 ZAR as disclosed on the income statement. A portion of 80 % belongs to the group and the remaining 20 % are assigned to noncontrolling interest holders. Hence, we allocate: 80% × 7,000 = 5 5"660000 ZZAARR to the group and: 7,000 - 5,600 = 1 1"440000 ZZAARR to the non-controlling interest holders. This is also disclosed at the bottom of the income statement, see Figure 8.16. [ZAR] Revenue 35,000 Other income 0 35,000 Materials (15,000) Labour 0 Depreciation (10,000) Other expenses 0 Earnings before int. & taxes (EBIT) 10,000 Interest 0 Earnings before taxes (EBT) 10,000 Income tax expenses (3,000) Deferred taxes 0 Earnings after taxes (EAT) 7,000 EAT controlling interest holders (5,600) EAT non-ctrl interest holders (1,400) 0 Swartberg Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X4 Figure 8.16: Extended income statement for SWARTBERG Ltd. (20X4) The next step of consolidations is to allocate the profit to the group and noncontrolling-interest holders on the balance sheet. We make the consolidation Bookkeeping entry as below: DR Retained Earnings............ 1,400 ZAR CR Non-ctrl Interest............ 1,400 ZAR Observe the Bookkeeping entry made on the consolidation worksheet and check the derived consolidated balance sheet in Figure 8.17 and Figure 8.18. <?page no="221"?> Berkau: Financial Statements 8e 8-220 No changes regarding investment valuation nor for the percentage of ownership apply. The only adjustment required is for the profit and the portion belonging to the non-controlling interest holders thereof. No inter-group profits took place. The profit of the subsidiary is 7,000 ZAR as disclosed on the income statement. A portion of 80 % belongs to the group and the remaining 20 % are assigned to noncontrolling interest holders. Hence, we allocate: 80% × 7,000 = 5 5"660000 ZZAARR to the group and: 7,000 - 5,600 = 1 1"440000 ZZAARR to the non-controlling interest holders. This is also disclosed at the bottom of the income statement, see Figure 8.16. [ZAR] Revenue 35,000 Other income 0 35,000 Materials (15,000) Labour 0 Depreciation (10,000) Other expenses 0 Earnings before int. & taxes (EBIT) 10,000 Interest 0 Earnings before taxes (EBT) 10,000 Income tax expenses (3,000) Deferred taxes 0 Earnings after taxes (EAT) 7,000 EAT controlling interest holders (5,600) EAT non-ctrl interest holders (1,400) 0 Swartberg Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X4 Figure 8.16: Extended income statement for SWARTBERG Ltd. (20X4) The next step of consolidations is to allocate the profit to the group and noncontrolling-interest holders on the balance sheet. We make the consolidation Bookkeeping entry as below: DR Retained Earnings............ 1,400 ZAR CR Non-ctrl Interest............ 1,400 ZAR Observe the Bookkeeping entry made on the consolidation worksheet and check the derived consolidated balance sheet in Figure 8.17 and Figure 8.18. Berkau: Financial Statements 8e 8-221 PARENT SUBSIDIARY AGGR. CAP. CONS non-ctrl Int CONS. F/ S N-cur Assets P,P,E 214,000 30,000 244,000 244,000 Investments 65,000 65,000 (65,000) 0 Goodwill 0 2,600 2,600 cur Assets Inventory 160,000 30,000 190,000 190,000 Cash/ Bank 91,000 38,000 129,000 129,000 530,000 98,000 628,000 (62,400) 0 565,600 SH's capital Issued capital (300,000) (50,000) (350,000) 50,000 (300,000) Reserves 0 0 Reval. Reserves 0 0 Retained ear. (112,000) (35,000) (147,000) 28,000 1,400 (117,600) Non-ctrl Int 0 (15,600) (1,400) (17,000) Liabilities Int. bear. liab. (50,000) (50,000) (50,000) Payables (50,000) (10,000) (60,000) (60,000) Tax liabilities (18,000) (3,000) (21,000) (21,000) (530,000) (98,000) (628,000) 62,400 0 (565,600) Figure 8.17: GAMKA Group’s consolidation worksheet (20X4.2) A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 244,000 Share capital 300,000 Intangibles Reserves Investment Retained earnings 117,600 Goodwill 2,600 Non-ctrl interest 17,000 Current assets Liabilities (liab.) Inventory 190,000 Long-term liab. 50,000 Accounts receivables Short-term liab. A/ P 60,000 Prepaid expenses Provisions Cash/ Bank 129,000 Income tax liab. 21,000 Total assets 565,600 Total equity and liab. 565,600 GAMKA GROUP consolidated STATEMENT of FINANCIAL POSITION as at 31.12.20X3 Figure 8.18: GAMKA Group’s consolidated balance sheet (20X4) The consolidated income statement is straight forward because no intra-group profit applies. Therefore, we can add the income statements for the group members. See the result in Figure 8.19. We must split the subsidiary’s profit between the group and the non-controlling interest holders. The profit assigned to the group also contains the parent’s profit and is: 42,000 + 80% × 7,000 = 4477"660000 ZZAARR. The value is disclosed negative on the income statement as it is allocated towards retained earnings. The <?page no="222"?> Berkau: Financial Statements 8e 8-222 portion of the subsidiary’s profit allocated to non-controlling interest holders is based on the percentage they hold: 20% × 7,000 = 1 1"440000 ZZAARR. It is a negative figure on the income statement, too. It represents the debit entry in the Profit and Loss account made for the transfer to the non-controlling interest holders item on the group balance sheet. [ZAR] Revenue 235,000 Other income (10,000) 225,000 Materials (29,000) Labour (100,000) Depreciation (26,000) Other expenses 0 Earnings before int. & taxes (EBIT) 70,000 Interest 0 Earnings before taxes (EBT) 70,000 Income tax expenses (21,000) Deferred taxes 0 Earnings after taxes (EAT) 49,000 EAT controlling interest holders (47,600) EAT non-ctrl interest holders (1,400) 0 Gamka Group STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X4 Figure 8.19: GAMKA Group’s consolidated income statement (20X4) The statement of changes in equity requires additions for the profit distribution between controlling interest and non-controlling interest holders. See below the statement of changes in equity for the group as at 31.12.20X4 in Figure 8.20. Therein the profit allocation is only linked to the split of the subsidiary because the parent’s profit belongs to the group completely. We deduct the noncontrolling interest holders’ share of the profit from the group’s profit before the split which is 49,000 ZAR. <?page no="223"?> Berkau: Financial Statements 8e 8-222 portion of the subsidiary’s profit allocated to non-controlling interest holders is based on the percentage they hold: 20% × 7,000 = 1 1"440000 ZZAARR. It is a negative figure on the income statement, too. It represents the debit entry in the Profit and Loss account made for the transfer to the non-controlling interest holders item on the group balance sheet. [ZAR] Revenue 235,000 Other income (10,000) 225,000 Materials (29,000) Labour (100,000) Depreciation (26,000) Other expenses 0 Earnings before int. & taxes (EBIT) 70,000 Interest 0 Earnings before taxes (EBT) 70,000 Income tax expenses (21,000) Deferred taxes 0 Earnings after taxes (EAT) 49,000 EAT controlling interest holders (47,600) EAT non-ctrl interest holders (1,400) 0 Gamka Group STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X4 Figure 8.19: GAMKA Group’s consolidated income statement (20X4) The statement of changes in equity requires additions for the profit distribution between controlling interest and non-controlling interest holders. See below the statement of changes in equity for the group as at 31.12.20X4 in Figure 8.20. Therein the profit allocation is only linked to the split of the subsidiary because the parent’s profit belongs to the group completely. We deduct the noncontrolling interest holders’ share of the profit from the group’s profit before the split which is 49,000 ZAR. Berkau: Financial Statements 8e 8-223 Share capital Non-ctrl interest Retained earnings total [ZAR] [ZAR] [ZAR] [ZAR] as at 1.01.20X4 300,000 15,600 70,000 385,600 Profit 20X4 49,000 49,000 Profit allocation 1,400 (1,400) 0 as at 31.12.20X4 300,000 17,000 117,600 434,600 Gamka Group STATEMENT of CHANGES in EQUITY as at 31.12.20X4 Figure 8.20: Consolidated statement of changes in equity (20X4) Group statements include a statement of cash flows, too: We assume that all activities of the case study are based on cash - depreciation exempted. The statement of cash flows for the group follows the reconciliation method as discussed in detail in chapter (10). The cash flow statement for the group is depicted in Figure 8.21. Cash flow from operating acitivities [ZAR] [ZAR] EBT 70,000 add Interest paid 0 add Depreciation 26,000 96,000 changes in working capital changes in A/ R 0 changes in inventory 10,000 changes in A/ P (42,000) changes in VAT/ r only materials 0 changes in VAT/ p 0 64,000 Cash flow from investing activities Investments 0 0 Cash flow from financing activities Financial activities 0 0 Total cash flow 64,000 Gamka Group STATEMENT of CASH FLOWS for the period ended 31.12.20X4 Figure 8.21: GAMKA Group’s consolidated SCF (20X4) The value of total cash flows equals the aggregated cash flows as we can derive from the single balance sheets of the group members: 91,000 + 38,000 - 30,000 - 35,000 = 6 644"000000 ZZAARR. <?page no="224"?> Berkau: Financial Statements 8e 8-224 How it is Done (Consolidated Financial Statements): (1) Determine whether consolidated financial statements apply. (2) Determine the companies to be considered for consolidated financial statements. A company is included to consolidated financial statements once the parent executes the control power. (3) Copy single-entity financial statements for preparation of Group Accounting. If needed, adjust the reporting currency, the reporting balance sheet date etc. Make further adjustments to align the copies with IFRSs if they have been prepared following other GAAPs. (4) Add the financial statements item-wise. Refer to the resulting financial statement as the aggregated financial statements. (5) Prepare a capital consolidation based on the acquisition method. Make the consolidation Bookkeeping entries in the consolidation worksheet. The capital consolidation is at the time of acquisition. (6) Run a profit consolidation. Cancel out any intragroup profits and adjust assets dependent on intragroup profits, e.g., the measurement of goods that have been traded between group members. (7) Consolidate internal receivables/ payables. Cancel out any intra-group receivables and liabilities. (8) In case dividends are considered, cancel out intragroup dividend payment/ receipt portions. (9) Prepare consolidated financial statements based on the figures on the consolidation worksheet (right column). 8.9 C/ S PORTERSVILLE/ HENDERSON Group Below, we discuss a profit consolidation and its impact on the valuation of inventories as well as dividends. PORTERSVILLE Ltd. buys on 3.01.20X2 a share of 80 % of its supplier HENDERSON Ltd. HENDERSON Ltd. is a retailer. All shares of PORTERSVILLE Ltd. as well as of HENDERSON Ltd. have a face value of 1 AUD/ s. Data Sheet for PORTERSVILLE/ HENDERSON DDoommiicciillee: : AAuussttrraalliiaa ((SSyyddnneeyy)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. IInnvveessttmmeenntt: : PPOORRTTEERRSSVVIILLLLEE LLttdd.. hhoollddss 8800 %% ooff HHEENNDDEERRSSOONN LLttdd.. AAccqquuiissiittiioonn ddaattee: : 33..0011..2200XX22" aaccqquuiissiittiioonn ccoossttss 552200"000000 AAUUDD ffoorr 440000"000000 oorrddiinnaarryy sshhaarreess.. BBooookk vvaalluuee ooff HHEENNDDEERRSSOONN LLttdd.. aatt ttiimmee ooff aaccqquuiissiittiioonn: : 660000"000000 AAUUDD.. AAccqquuiissiittiioonn mmeetthhoodd aapppplliieess.. AAccttuuaall AAccccoouunnttiinngg ppeerriioodd: : 2200XX55 DDiivviiddeenndd aatt HHEENNDDEERRSSOONN LLttdd..: : 00..1155 AAUUDD/ / ss.. <?page no="225"?> Berkau: Financial Statements 8e 8-224 How it is Done (Consolidated Financial Statements): (1) Determine whether consolidated financial statements apply. (2) Determine the companies to be considered for consolidated financial statements. A company is included to consolidated financial statements once the parent executes the control power. (3) Copy single-entity financial statements for preparation of Group Accounting. If needed, adjust the reporting currency, the reporting balance sheet date etc. Make further adjustments to align the copies with IFRSs if they have been prepared following other GAAPs. (4) Add the financial statements item-wise. Refer to the resulting financial statement as the aggregated financial statements. (5) Prepare a capital consolidation based on the acquisition method. Make the consolidation Bookkeeping entries in the consolidation worksheet. The capital consolidation is at the time of acquisition. (6) Run a profit consolidation. Cancel out any intragroup profits and adjust assets dependent on intragroup profits, e.g., the measurement of goods that have been traded between group members. (7) Consolidate internal receivables/ payables. Cancel out any intra-group receivables and liabilities. (8) In case dividends are considered, cancel out intragroup dividend payment/ receipt portions. (9) Prepare consolidated financial statements based on the figures on the consolidation worksheet (right column). 8.9 C/ S PORTERSVILLE/ HENDERSON Group Below, we discuss a profit consolidation and its impact on the valuation of inventories as well as dividends. PORTERSVILLE Ltd. buys on 3.01.20X2 a share of 80 % of its supplier HENDERSON Ltd. HENDERSON Ltd. is a retailer. All shares of PORTERSVILLE Ltd. as well as of HENDERSON Ltd. have a face value of 1 AUD/ s. Data Sheet for PORTERSVILLE/ HENDERSON DDoommiicciillee: : AAuussttrraalliiaa ((SSyyddnneeyy)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. IInnvveessttmmeenntt: : PPOORRTTEERRSSVVIILLLLEE LLttdd.. hhoollddss 8800 %% ooff HHEENNDDEERRSSOONN LLttdd.. AAccqquuiissiittiioonn ddaattee: : 33..0011..2200XX22" aaccqquuiissiittiioonn ccoossttss 552200"000000 AAUUDD ffoorr 440000"000000 oorrddiinnaarryy sshhaarreess.. BBooookk vvaalluuee ooff HHEENNDDEERRSSOONN LLttdd.. aatt ttiimmee ooff aaccqquuiissiittiioonn: : 660000"000000 AAUUDD.. AAccqquuiissiittiioonn mmeetthhoodd aapppplliieess.. AAccttuuaall AAccccoouunnttiinngg ppeerriioodd: : 2200XX55 DDiivviiddeenndd aatt HHEENNDDEERRSSOONN LLttdd..: : 00..1155 AAUUDD/ / ss.. Berkau: Financial Statements 8e 8-225 IInnvveennttoorriieess aatt PPOORRTTEERRSSVVIILLLLEE LLttdd..: : ggooooddss ffoorr 110000"000000 AAUUDD bboouugghhtt ffrroomm HHEENNDDEERRSSOONN LLttdd.. CCoosstt ooff aaccqquuiissiittiioonn aatt HHEENNDDEERRSSOONN LLttdd..: : 6655"000000 AAUUDD.. VVAATT iiggnnoorreedd.. On 3.01.20X2, PORTERSVILLE Ltd. buys an 80 % share in HENDERSON Ltd. when its retained earnings are 100,000 AUD. No reserves were disclosed on HENDERSON Ltd.’s balance sheet at that time. Find below the balance sheets of both companies as at 31.12.20X5 - three years later. PORTERSVILLE Ltd.'s inventories include goods for 100,000 AUD, bought from HENDERSON Ltd. This is the price paid to HENDERSON Ltd. on purchase. HENDERSON Ltd. bought the goods itself for 65,000 AUD from a supplier. HENDERSON Ltd. pays a dividend of 0.15 AUD/ s for 20X5. The dividend is not considered in the financial statements as disclosed in Figure 8.22 and Figure 8.23 (before appropriation of profits). No profit/ loss carried forward applies for the financial statements or PORTERSVILLE Ltd. nor HENDERSON Ltd. A C, L Non-current assets [AUD] Equity [AUD] P, P, E 2,300,000 Share capital 1,000,000 Intangibles Reserves 300,000 Investments 520,000 Retained earnings 700,000 Non-ctrl interest Current assets Liabilities (liab.) Inventory 260,000 Long-term liab. 1,000,000 Accounts receivables Short-term liab. A/ P 220,000 Prepaid expenses Provisions Cash/ Bank 440,000 Income tax liab. 300,000 Total assets 3,520,000 Total equity and liab. 3,520,000 Portersville Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X5 Figure 8.22: PORTERSVILLE Ltd.’s balance sheet (parent) <?page no="226"?> Berkau: Financial Statements 8e 8-226 A C, L Non-current assets [AUD] Equity [AUD] P, P, E 1,300,000 Share capital 500,000 Intangibles Reserves 300,000 Investments Retained earnings 210,000 Non-ctrl interest Current assets Liabilities (liab.) Inventory 300,000 Long-term liab. 800,000 Accounts receivables Short-term liab. A/ P 300,000 Prepaid expenses Provisions Cash/ Bank 600,000 Income tax liab. 90,000 Total assets 2,200,000 Total equity and liab. 2,200,000 Henderson Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X5 Figure 8.23: HENDERSON Ltd.’s balance sheet (subsidiary) We start with the repetition of the capital consolidations: The capital consolidation as per 3.01.20X2 considers the acquisition of 400,000 ordinary shares of HENDERSON Ltd. at a price of 520,000 AUD. The total equity of HENDERSON Ltd. at that time was: 500,000 + 100,000 = 6 60000"000000 AAUUDD. The book value of the shares at the time of acquisition was: 80% × 600,000 = 4 48800"000000 AAUUDD. See the consolidation Bookkeeping entry below: DR Goodwill..................... 40,000 AUD DR Issued Shares................ 500,000 AUD DR Retained Earnings............ 100,000 AUD CR Non-ctrl. Interest........... 120,000 AUD CR Investment................... 520,000 AUD The capital consolidation remains unchanged. We enter the figures into the consolidation worksheet below. The only alteration is for the allocation of retained earnings to earnings reserves. Hence, the above debit entry is no longer in the Retained Earnings account but in the Earnings Reserves account. This follows the appropriation of profits in the year of the acquisition. No profit/ loss are carried forward for this case study. <?page no="227"?> Berkau: Financial Statements 8e 8-226 A C, L Non-current assets [AUD] Equity [AUD] P, P, E 1,300,000 Share capital 500,000 Intangibles Reserves 300,000 Investments Retained earnings 210,000 Non-ctrl interest Current assets Liabilities (liab.) Inventory 300,000 Long-term liab. 800,000 Accounts receivables Short-term liab. A/ P 300,000 Prepaid expenses Provisions Cash/ Bank 600,000 Income tax liab. 90,000 Total assets 2,200,000 Total equity and liab. 2,200,000 Henderson Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X5 Figure 8.23: HENDERSON Ltd.’s balance sheet (subsidiary) We start with the repetition of the capital consolidations: The capital consolidation as per 3.01.20X2 considers the acquisition of 400,000 ordinary shares of HENDERSON Ltd. at a price of 520,000 AUD. The total equity of HENDERSON Ltd. at that time was: 500,000 + 100,000 = 6 60000"000000 AAUUDD. The book value of the shares at the time of acquisition was: 80% × 600,000 = 448800"000000 AAUUDD. See the consolidation Bookkeeping entry below: DR Goodwill..................... 40,000 AUD DR Issued Shares................ 500,000 AUD DR Retained Earnings............ 100,000 AUD CR Non-ctrl. Interest........... 120,000 AUD CR Investment................... 520,000 AUD The capital consolidation remains unchanged. We enter the figures into the consolidation worksheet below. The only alteration is for the allocation of retained earnings to earnings reserves. Hence, the above debit entry is no longer in the Retained Earnings account but in the Earnings Reserves account. This follows the appropriation of profits in the year of the acquisition. No profit/ loss are carried forward for this case study. Berkau: Financial Statements 8e 8-227 PARENT SUBSIDIARY AGGR. CAP. CONS CONS. F/ S N-cur Assets P,P,E 2,300,000 1,300,000 3,600,000 3,600,000 Investments 520,000 520,000 (520,000) 0 Goodwill 0 40,000 40,000 cur Assets Inventory 260,000 300,000 560,000 560,000 Cash/ Bank 440,000 600,000 1,040,000 1,040,000 3,520,000 2,200,000 5,720,000 (480,000) 0 5,240,000 SH's capital Issued capital (1,000,000) (500,000) (1,500,000) 500,000 (1,000,000) Reserves (300,000) (300,000) (600,000) 100,000 (500,000) Retained ear. (700,000) (210,000) (910,000) (910,000) Non-ctrl. int 0 (120,000) (120,000) Liabilities Int. bear. liab. (1,000,000) (800,000) (1,800,000) (1,800,000) Payables (220,000) (300,000) (520,000) (520,000) Tax liabilities (300,000) (90,000) (390,000) (390,000) (3,520,000) (2,200,000) (5,720,000) 480,000 0 (5,240,000) Figure 8.24: Consolidation worksheet for PORTERSVILLE Group (1) As the after-tax profit from 20X3 is added to reserves, we know that between 3.01.20X2 and 31.12.20X4, HENDERSON Ltd. increased its reserves by: 300,000 - 100,000 = 2 20000"000000 AAUUDD. The value is allocated to the group and the non-controlling interest holders at a 4 : 1 ratio and gives us the next column in the Consolidation worksheet. We split those earnings reserves at a 4 : 1 ratio which gives 160,000 : 40,000. We then accrue 40,000 AUD for non-controlling interest holders to their account. For layout reasons, we hide the single company columns in Figure 8.25. AGGR. CAP. CONS non-CTRL CONS. F/ S N-cur Assets P,P,E 3,600,000 3,600,000 Investments 520,000 (520,000) 0 Goodwill 0 40,000 40,000 cur Assets Inventory 560,000 560,000 Cash/ Bank 1,040,000 1,040,000 5,720,000 (480,000) 0 0 0 5,240,000 SH's capital Issued capital (1,500,000) 500,000 (1,000,000) Reserves (600,000) 100,000 40,000 (460,000) Retained ear. (910,000) (910,000) Non-ctrl. int 0 (120,000) (40,000) (160,000) Liabilities Int. bear. liab. (1,800,000) (1,800,000) Payables (520,000) (520,000) Tax liabilities (390,000) (390,000) (5,720,000) 480,000 0 0 0 (5,240,000) Figure 8.25: Consolidation worksheet for PORTERSVILLE Group (2) <?page no="228"?> Berkau: Financial Statements 8e 8-228 The inventories disclosed on PORTERSVILLE Ltd.’s balance sheet contain an intra-group profit which was correctly disclosed on the single-entity financial statements. PORTERSVILLE Ltd. bought the goods at 100,000 AUD from HENDERSON Ltd. and discloses them at these costs. In contrast, the group statements must follow an asset valuation at cost of acquisition for the group. These are the purchase costs for HENDERSON Ltd. amounting to 65,000 AUD. This is: 100,000 - 65,000 = 3 355"000000 AAUUDD less than disclosed on the balance sheet of PORTERSVILLE Ltd. At the same time, the sales profit recorded by HENDERSON Ltd. becomes an unrealised profit from the viewpoint of Group Accounting. The goods have been exchanged between group companies. Hence, we deduct HENDERSON Ltd.’s profit in the Retained Earnings account as well as in the Income Tax Liabilities account by a total of 35,000 AUD. This gives: 35,000 × (1 - 30%) = 2244"550000 AAUUDD deductions from retained earnings and: 35,000 × 30% = 1 100"550000 AAUUDD from income taxes. Although Group Accounting has no impact on taxation we record a deduction of income tax liabilities. Below, the next consolidation step for the PORTERSVILLE Group is recorded in Figure 8.26. AGGR. CAP. CONS non-CTRL Profit.CONS CONS. F/ S N-cur Assets P,P,E 3,600,000 3,600,000 Investments 520,000 (520,000) 0 Goodwill 0 40,000 40,000 cur Assets Inventory 560,000 (35,000) 525,000 Cash/ Bank 1,040,000 1,040,000 5,720,000 (480,000) 0 (35,000) 0 5,205,000 SH's capital Issued capital (1,500,000) 500,000 (1,000,000) Reserves (600,000) 100,000 40,000 (460,000) Retained ear. (910,000) 24,500 (885,500) Non-ctrl. int 0 (120,000) (40,000) (160,000) Liabilities Int. bear. liab. (1,800,000) (1,800,000) Payables (520,000) (520,000) Tax liabilities (390,000) 10,500 (379,500) (5,720,000) 480,000 0 35,000 0 (5,205,000) Figure 8.26: Consolidation worksheet for PORTERSVILLE Group (3) Next, we discuss the profit appropriation of the subsidiary HENDERSON Ltd. The company pays a dividend of 0.15 AUD/ s. The total dividend is: 0.15 × 500,000 = 7755"000000 AAUUDD. A portion of: 80% × 75,000 = 6600"000000 AAUUDD is an intra-group dividend and does not require consideration on consolidated financial statements. The other portion of: 75,000 - 60,000 = 1155"000000 AAUUDD is a payment to non-controlling interest holders which are regarded as group-outsiders. Hence, a dividend payment is recorded as a cash reduction of 15,000 AUD for the group. <?page no="229"?> Berkau: Financial Statements 8e 8-228 The inventories disclosed on PORTERSVILLE Ltd.’s balance sheet contain an intra-group profit which was correctly disclosed on the single-entity financial statements. PORTERSVILLE Ltd. bought the goods at 100,000 AUD from HENDERSON Ltd. and discloses them at these costs. In contrast, the group statements must follow an asset valuation at cost of acquisition for the group. These are the purchase costs for HENDERSON Ltd. amounting to 65,000 AUD. This is: 100,000 - 65,000 = 3 355"000000 AAUUDD less than disclosed on the balance sheet of PORTERSVILLE Ltd. At the same time, the sales profit recorded by HENDERSON Ltd. becomes an unrealised profit from the viewpoint of Group Accounting. The goods have been exchanged between group companies. Hence, we deduct HENDERSON Ltd.’s profit in the Retained Earnings account as well as in the Income Tax Liabilities account by a total of 35,000 AUD. This gives: 35,000 × (1 - 30%) = 2244"550000 AAUUDD deductions from retained earnings and: 35,000 × 30% = 1100"550000 AAUUDD from income taxes. Although Group Accounting has no impact on taxation we record a deduction of income tax liabilities. Below, the next consolidation step for the PORTERSVILLE Group is recorded in Figure 8.26. AGGR. CAP. CONS non-CTRL Profit.CONS CONS. F/ S N-cur Assets P,P,E 3,600,000 3,600,000 Investments 520,000 (520,000) 0 Goodwill 0 40,000 40,000 cur Assets Inventory 560,000 (35,000) 525,000 Cash/ Bank 1,040,000 1,040,000 5,720,000 (480,000) 0 (35,000) 0 5,205,000 SH's capital Issued capital (1,500,000) 500,000 (1,000,000) Reserves (600,000) 100,000 40,000 (460,000) Retained ear. (910,000) 24,500 (885,500) Non-ctrl. int 0 (120,000) (40,000) (160,000) Liabilities Int. bear. liab. (1,800,000) (1,800,000) Payables (520,000) (520,000) Tax liabilities (390,000) 10,500 (379,500) (5,720,000) 480,000 0 35,000 0 (5,205,000) Figure 8.26: Consolidation worksheet for PORTERSVILLE Group (3) Next, we discuss the profit appropriation of the subsidiary HENDERSON Ltd. The company pays a dividend of 0.15 AUD/ s. The total dividend is: 0.15 × 500,000 = 7755"000000 AAUUDD. A portion of: 80% × 75,000 = 6600"000000 AAUUDD is an intra-group dividend and does not require consideration on consolidated financial statements. The other portion of: 75,000 - 60,000 = 1155"000000 AAUUDD is a payment to non-controlling interest holders which are regarded as group-outsiders. Hence, a dividend payment is recorded as a cash reduction of 15,000 AUD for the group. Berkau: Financial Statements 8e 8-229 The dividend is paid in 20X5 already to simplify the case study. We also consider how much of the retained earnings is left as a profit carried forward and allocate a 20 % portion thereof to non-controlling interest holders. The retained earnings of HENDERSON Ltd. were 210,000 AUD on the single-entity-balance sheet. Remember, that no profit is carried forward. Hence, the retained earnings result from profits earned in 20X5. We deducted 24,500 AUD for intra-group profits and another 75,000 AUD for dividends. Hence, the remaining retained earnings are: 210,000 - 24,500 - 75,000 = 1 11100"550000 AAUUDD. A 20 % portion of this amount is assigned to the non-controlling interest holders. It results in a transfer of: 110,500 × 20% = 2222"110000 AAUUDD to non-controlling interest holders for the profit in 20X5. The amount of 37,100 AUD deducted from the group retained earnings is for the dividend paid to non-controlling interest holders and the non-controlling interest holders’ share of profits: 15,000 + 22,100 = 3 377"110000 AAUUDD. See below in Figure 8.27 the last column filled in the consolidation worksheet for the PORTERSVILLE Group and in Figure 8.28 its consolidated balance sheet. AGGR. CAP. CONS non-CTRL Profit.CONS Dividends CONS. F/ S N-cur Assets P,P,E 3,600,000 3,600,000 Int. assets 0 0 Investments 520,000 (520,000) 0 Goodwill 0 40,000 40,000 cur Assets Inventory 560,000 (35,000) 525,000 Cash/ Bank 1,040,000 1,040,000 5,720,000 (480,000) 0 (35,000) 0 5,205,000 SH's capital Issued capital (1,500,000) 500,000 (1,000,000) Reserves (600,000) 100,000 40,000 (460,000) Retained ear. (910,000) 24,500 37,100 (848,400) Non-ctrl. int 0 (120,000) (40,000) (37,100) (197,100) Liabilities Int. bear. liab. (1,800,000) (1,800,000) Payables (520,000) (520,000) Tax liabilities (390,000) 10,500 (379,500) (5,720,000) 480,000 0 35,000 0 (5,205,000) Figure 8.27: Consolidation worksheet for PORTERSVILLE Group (4) <?page no="230"?> Berkau: Financial Statements 8e 8-230 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 3,600,000 Share capital 1,000,000 Intangibles Reserves 460,000 Investment Retained earnings 848,400 Goodwill 40,000 Non-ctrl interest 197,100 Current assets Liabilities (liab.) Inventory 525,000 Long-term liab. 1,800,000 Accounts receivables Short-term liab. A/ P 520,000 Prepaid expenses Provisions Cash/ Bank 1,040,000 Income tax liab. 379,500 Total assets 5,205,000 Total equity and liab. 5,205,000 Portersville GROUP CONSOLIDATED STATEMENT of FINANCIAL POSITION as at 31.12.20X5 Figure 8.28: PORTERSVILLE Group’s balance sheet 8.10 Intra-Group Profit Consolidation If we consolidate an intra-group profit, the allocation of retained earnings to the parent and to the non-controlling interest holders are affected. The elimination of the intra-group profit increases the subsidiary’s profit, if the parent earned the intra-group profit. In this case study, the subsidiary HENDERSON Ltd.’s profit on selling goods to the parent PORTERSVILLE Ltd. was deleted and we adjusted its retained earnings and the non-controlling interest portion thereof. If the subsidiary's profit increases due to intra-group profit consolidation, we must consider an increase of non-controlling interest. Examples are the receipt and payment of service from the parent, buying non-current assets from the parent with value adjustment for lower depreciation, taking a loan from the parent etc. In the next case study, we cover a group where the parent provides a consultancy service to its subsidiary which is partly paid for on credit. We must consolidate the intra-group profit and consider an increase of the subsidiary's equity, which we allocate partly to the non-controlling interest holders. 8.11 C/ S PATTEN/ SPYKER PATTEN Ltd. is a consultancy and bought 60 % of the production firm SPYKER (Pty) Ltd. on 1.01.20X0 at 700,000 AUD. See below in Figure 8.29 and in Figure 8.30 the balance sheet of the group companies. <?page no="231"?> Berkau: Financial Statements 8e 8-230 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 3,600,000 Share capital 1,000,000 Intangibles Reserves 460,000 Investment Retained earnings 848,400 Goodwill 40,000 Non-ctrl interest 197,100 Current assets Liabilities (liab.) Inventory 525,000 Long-term liab. 1,800,000 Accounts receivables Short-term liab. A/ P 520,000 Prepaid expenses Provisions Cash/ Bank 1,040,000 Income tax liab. 379,500 Total assets 5,205,000 Total equity and liab. 5,205,000 Portersville GROUP CONSOLIDATED STATEMENT of FINANCIAL POSITION as at 31.12.20X5 Figure 8.28: PORTERSVILLE Group’s balance sheet 8.10 Intra-Group Profit Consolidation If we consolidate an intra-group profit, the allocation of retained earnings to the parent and to the non-controlling interest holders are affected. The elimination of the intra-group profit increases the subsidiary’s profit, if the parent earned the intra-group profit. In this case study, the subsidiary HENDERSON Ltd.’s profit on selling goods to the parent PORTERSVILLE Ltd. was deleted and we adjusted its retained earnings and the non-controlling interest portion thereof. If the subsidiary's profit increases due to intra-group profit consolidation, we must consider an increase of non-controlling interest. Examples are the receipt and payment of service from the parent, buying non-current assets from the parent with value adjustment for lower depreciation, taking a loan from the parent etc. In the next case study, we cover a group where the parent provides a consultancy service to its subsidiary which is partly paid for on credit. We must consolidate the intra-group profit and consider an increase of the subsidiary's equity, which we allocate partly to the non-controlling interest holders. 8.11 C/ S PATTEN/ SPYKER PATTEN Ltd. is a consultancy and bought 60 % of the production firm SPYKER (Pty) Ltd. on 1.01.20X0 at 700,000 AUD. See below in Figure 8.29 and in Figure 8.30 the balance sheet of the group companies. Berkau: Financial Statements 8e 8-231 A C, L Non-current assets [AUD] Equity [AUD] P, P, E 600,000 Share capital 1,000,000 Intangibles Reserves 400,000 Investment 700,000 Retained earnings Current assets Liabilities (liab.) Inventory 350,000 Long-term liab. 500,000 Acc. receivables A/ R Short-term liab. A/ P 100,000 Prepaid expenses Provisions Cash/ Bank 350,000 Income tax liab. Total assets 2,000,000 Total equity and liab. 2,000,000 Patten Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X0 Figure 8.29: PATTEN Ltd.'s balance sheet after acquisition A C, L Non-current assets [AUD] Equity [AUD] P, P, E 350,000 Share capital 500,000 Intangibles Reserves 178,500 Investment Retained earnings 321,500 Current assets Liabilities (liab.) Inventory 200,000 Long-term liab. 100,000 Acc. receivables A/ R 300,000 Short-term liab. A/ P 50,000 Prepaid expenses Provisions Cash/ Bank 300,000 Income tax liab. Total assets 1,150,000 Total equity and liab. 1,150,000 Spyker (Pty) Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X0 Figure 8.30: SPYKER (Pty) Ltd.'s balance sheet We explain the figures on the balance sheets as per 31.12.20X0, when we prepare the first consolidated financial statements. We start with the parent PATTEN Ltd. During the fiscal year 20X0, the consultancy PATTEN Ltd. depreciates its items of property, plant, and equipment to an extent of 15 %. It records labour at 200,000 AUD. PATTEN Ltd. records a consulting revenue of 450,000 AUD, 30 % of the revenue results from consulting its subsidiary SPYKER (Pty) Ltd. SPYKER (Pty) Ltd. only pays half of the price, the other portion is due on 31.03.20X1. The costs for the consultancy service are labour to an extent of 200,000 AUD and depreciation. These costs are evenly allocated to consultancy jobs. During the fiscal year 20X0, the production firm SPYKER (Pty) Ltd. depreciates its machinery by 50,000 AUD. It purchases materials for 500,000 AUD and records a closing stock of raw materials of 70,000 AUD. The opening value of raw materials to an extent of 200,000 <?page no="232"?> Berkau: Financial Statements 8e 8-232 AUD (see its balance sheet) are consumed in production. At the end of the year, no finished goods are on stock. Labour is 400,000 AUD, 75 % thereof is for production. This information is needed for product calculation as their net selling price depends therefrom. SPYKER (Pty) Ltd. receives from its parent consultation service and gets charged 135,000 AUD. The consultation is about the marketing of its products. Therefore, the consultancy costs are not included in the calculation of its products. The revenue in 20X0 equals 150 % of the costs of manufacturing. The total costs of manufacturing comprise of labour, depreciation, and materials. They are amounting to: 50,000 + 630,000 + 300,000 = 998800"000000 AAUUDD. Based on the price calculation, the revenue is: 150% × 980,000 = 1 1"447700"000000 AAUUDD. At the end of the fiscal year 20X0, both companies declare and pay a dividend of 10 % of their distributable amounts. The distributable amount also contains other comprehensive income earned during 20X0. Dividends received by a company are not subjected to tax on capital returns nor are they relevant for the income tax calculation of the recipient, hence, the full dividends are added to the distributable amounts in both companies. 151 The companies prepare the balance sheets and income statements as below: A C, L Non-current assets [AUD] Equity [AUD] P, P, E 510,000 Share capital 1,000,000 Intangibles Reserves 400,000 Investment 700,000 Retained earnings 127,800 Current assets Liabilities (liab.) Inventory 350,000 Long-term liab. 500,000 Acc. receivables A/ R 67,500 Short-term liab. A/ P 100,000 Prepaid expenses Provisions Cash/ Bank 548,300 Income tax liab. 48,000 Total assets 2,175,800 Total equity and liab. 2,175,800 Patten Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X0 Figure 8.31: PATTEN Ltd.'s balance sheet (20X0) 151 The regulations are based on national tax law. We here adhere to our conventions. <?page no="233"?> Berkau: Financial Statements 8e 8-232 AUD (see its balance sheet) are consumed in production. At the end of the year, no finished goods are on stock. Labour is 400,000 AUD, 75 % thereof is for production. This information is needed for product calculation as their net selling price depends therefrom. SPYKER (Pty) Ltd. receives from its parent consultation service and gets charged 135,000 AUD. The consultation is about the marketing of its products. Therefore, the consultancy costs are not included in the calculation of its products. The revenue in 20X0 equals 150 % of the costs of manufacturing. The total costs of manufacturing comprise of labour, depreciation, and materials. They are amounting to: 50,000 + 630,000 + 300,000 = 998800"000000 AAUUDD. Based on the price calculation, the revenue is: 150% × 980,000 = 11"447700"000000 AAUUDD. At the end of the fiscal year 20X0, both companies declare and pay a dividend of 10 % of their distributable amounts. The distributable amount also contains other comprehensive income earned during 20X0. Dividends received by a company are not subjected to tax on capital returns nor are they relevant for the income tax calculation of the recipient, hence, the full dividends are added to the distributable amounts in both companies. 151 The companies prepare the balance sheets and income statements as below: A C, L Non-current assets [AUD] Equity [AUD] P, P, E 510,000 Share capital 1,000,000 Intangibles Reserves 400,000 Investment 700,000 Retained earnings 127,800 Current assets Liabilities (liab.) Inventory 350,000 Long-term liab. 500,000 Acc. receivables A/ R 67,500 Short-term liab. A/ P 100,000 Prepaid expenses Provisions Cash/ Bank 548,300 Income tax liab. 48,000 Total assets 2,175,800 Total equity and liab. 2,175,800 Patten Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X0 Figure 8.31: PATTEN Ltd.'s balance sheet (20X0) 151 The regulations are based on national tax law. We here adhere to our conventions. Berkau: Financial Statements 8e 8-233 [AUD] Revenue 450,000 Other income 30,000 480,000 Materials 0 Labour (200,000) Depreciation (90,000) Other expenses 0 Earnings before int. & taxes (EBIT) 190,000 Interest 0 Earnings before taxes (EBT) 190,000 Income tax expenses (48,000) Deferred taxes 0 Earnings after taxes (EAT) 142,000 Patten Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X0 Figure 8.32: PATTEN Ltd.'s income statement (20X0) 152 We explain PATTEN Ltd.'s financial statements at the end of the first year. Depreciation is 15 % of the items of property, plant and equipment: 15% × 600,000 = 9 900"000000 AAUUDD. The figures for labour and revenue are given. The revenue from the consultation of SPYKER (Pty) Ltd. is: 30% × 450,000 = 1 13355"000000 AAUUDD. The payment received is 50 % thereof: 135,000 / 2 = 6 677"550000 AAUUDD. PATTEN Ltd. receives 30,000 AUD in dividends from its subsidiary as other comprehensive income. The distributable amount is the profit after taxes including the received dividends 142,000 AUD. Therefore, PATTEN Ltd.’s dividend is: 10% × 142,000 = 1 144"220000 AAUUDD which is paid in 20X0 153 already. The income taxes at PATTERN do not depend on the dividends received from SPYKER (Pty) Ltd.: 30% × (190,000 - 30,000) = 4 488"000000 AAUUDD. The item cash/ bank considers all payments including the receipt and payment of dividends: 350,000 + 450,000 - 67,500 - 200,000 + 30,000 - 14,200 = 554488"330000 AAUUDD. The retained earnings are disclosed after the appropriation of profits: (1 - 10%) × 142,000 = 1 12277"880000 AAUUDD. The subsidiary SPYKER (Pty) Ltd. prepares its financial statements as disclosed in Figure 8.33 and Figure 8.34. 152 The income tax calculation does not consider the other income from dividends. 153 To simplify the case study, dividends are paid in the Accounting period they are for. <?page no="234"?> Berkau: Financial Statements 8e 8-234 A C, L Non-current assets [AUD] Equity [AUD] P, P, E 300,000 Share capital 500,000 Intangibles Reserves 178,500 Investment Retained earnings 450,000 Current assets Liabilities (liab.) Inventory 70,000 Long-term liab. 100,000 Acc. receivables A/ R 300,000 Short-term liab. A/ P 117,500 Prepaid expenses Provisions Cash/ Bank 752,500 Income tax liab. 76,500 Total assets 1,422,500 Total equity and liab. 1,422,500 Spyker (Pty) Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X0 Figure 8.33: SPYKER (Pty) Ltd.'s balance sheet (20X0) [AUD] Revenue 1,470,000 Other income 0 1,470,000 Materials (630,000) Labour (400,000) Depreciation (50,000) Other expenses (135,000) Earnings before int. & taxes (EBIT) 255,000 Interest 0 Earnings before taxes (EBT) 255,000 Income tax expenses (76,500) Deferred taxes 0 Earnings after taxes (EAT) 178,500 Spyker (Pty) Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X0 Figure 8.34: SPYKER (Pty) Ltd.'s income statement (20X0) We discuss the figures on the financial statements of SPYKER (Pty) Ltd. below: Depreciation is 50,000 AUD (given). The material expenses are calculated based on a periodic inventory system. They are: 200,000 + 500,000 - 70,000 = 663300"000000 AAUUDD. Labour is 400,000 AUD; 300,000 AUD thereof is for production. The revenue is calculated as 150 % of the cost of manufacturing: (50,000 + 630,000 + 300,000) × 150% = 1 1"447700"000000 AAUUDD. SPYKER (Pty) Ltd. received non- <?page no="235"?> Berkau: Financial Statements 8e 8-234 A C, L Non-current assets [AUD] Equity [AUD] P, P, E 300,000 Share capital 500,000 Intangibles Reserves 178,500 Investment Retained earnings 450,000 Current assets Liabilities (liab.) Inventory 70,000 Long-term liab. 100,000 Acc. receivables A/ R 300,000 Short-term liab. A/ P 117,500 Prepaid expenses Provisions Cash/ Bank 752,500 Income tax liab. 76,500 Total assets 1,422,500 Total equity and liab. 1,422,500 Spyker (Pty) Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X0 Figure 8.33: SPYKER (Pty) Ltd.'s balance sheet (20X0) [AUD] Revenue 1,470,000 Other income 0 1,470,000 Materials (630,000) Labour (400,000) Depreciation (50,000) Other expenses (135,000) Earnings before int. & taxes (EBIT) 255,000 Interest 0 Earnings before taxes (EBT) 255,000 Income tax expenses (76,500) Deferred taxes 0 Earnings after taxes (EAT) 178,500 Spyker (Pty) Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X0 Figure 8.34: SPYKER (Pty) Ltd.'s income statement (20X0) We discuss the figures on the financial statements of SPYKER (Pty) Ltd. below: Depreciation is 50,000 AUD (given). The material expenses are calculated based on a periodic inventory system. They are: 200,000 + 500,000 - 70,000 = 663300"000000 AAUUDD. Labour is 400,000 AUD; 300,000 AUD thereof is for production. The revenue is calculated as 150 % of the cost of manufacturing: (50,000 + 630,000 + 300,000) × 150% = 1 1"447700"000000 AAUUDD. SPYKER (Pty) Ltd. received non- Berkau: Financial Statements 8e 8-235 manufacturing related 154 consultancy of: 135,000 AUD and paid half of the amount instantly: 135,000 / 2 = 6 677"550000 AAUUDD. The dividends paid by SPYKER (Pty) Ltd. are 10 % of the distributable amount. The retained earnings from the previous year 321,500 AUD can be paid to owners and contribute to the distributable amount. The payment to owners is: 10% × (321,500 + 178,500) = 5 500"000000 AAUUDD; as the parent holds 60 % of the subsidiary, 60% × 50,000 = 3 300"000000 AAUUDD thereof is paid to PATTEN Ltd. The other portion of 20,000 AUD is accrued to noncontrolling interest holders of SPYKER (Pty) Ltd. According to the case study, dividends are paid in 20X0 already. To explain the item retained earnings, we calculate its value after payment of dividends: 321,500 + 178,500 - 50,000 = 445500"000000 AAUUDD. For the capital consolidation, we prepare the worksheet below. In the first step, the costs of acquisition are consolidated towards 60 % of equity (issued capital, reserves and retained earnings) of SPYKER (Pty) Ltd. A goodwill of: 700,000 - 60% × (500,000 + 178,500 + 321,500) = 1 10000"000000 AAUUDD remains. Furthermore, 40 % of equity is allocated to non-controlling interest holders: 40% × (500,000 + 178,500 + 321,500) = 200,000 + 71,400 + 128,600 = 4 40000"000000 AAUUDD. We combine the Bookkeeping entries for capital consolidation as below. DR Goodwill..................... 100,000 AUD DR Issued Capital............... 500,000 AUD DR Reserves..................... 178,500 AUD DR Retained earnings............ 321,500 AUD CR Investments.................. 700,000 AUD CR Non-Ctrl. Interest........... 400,000 AUD Check the worksheet for capital consolidation in Figure 8.35. 154 The consultancy fees do not count for the calculation of the cost of manufacturing. <?page no="236"?> Berkau: Financial Statements 8e 8-236 PARENT SUBSIDIARY AGGR. CAP. CONS CONS. F/ S N-cur Assets P,P,E 600,000 350,000 950,000 950,000 Int. assets 0 0 Investments 700,000 700,000 (700,000) 0 Goodwill 0 100,000 100,000 cur Assets Inventory 350,000 200,000 550,000 550,000 Receivables 300,000 300,000 300,000 Cash/ Bank 350,000 300,000 650,000 650,000 2,000,000 1,150,000 3,150,000 (600,000) 0 2,550,000 SH's capital Issued capital (1,000,000) (500,000) (1,500,000) 300,000 200,000 (1,000,000) Reserves (400,000) (178,500) (578,500) 107,100 71,400 (400,000) Retained ear. (321,500) (321,500) 192,900 128,600 0 Non-ctrl. Int 0 (400,000) (400,000) Liabilities Int. bear. liab. (500,000) (100,000) (600,000) (600,000) Payables (100,000) (50,000) (150,000) (150,000) Tax liabilities 0 0 (2,000,000) (1,150,000) (3,150,000) 600,000 0 (2,550,000) Figure 8.35: Worksheet for capital consolidation (PATTEN/ SPYKER) The next steps of consolidation are (1) the elimination of the intra-group profit, (2) consolidation of the intra-profit’s receivables and payables, (3) the allocation of non-controlling interest and (4) the consolidation of the dividends. (1) The service must be eliminated from the consolidation sheet. As both parties recorded expense/ revenue and cash/ bank, the intra-group profit is neutral to the group statements already. No adjustments are required for its elimination. However, the intra-group profit affects the subsidiary’s profit calculation and matters for the non-controlling interest holders. Without the inter-group profit, SPYKER (Pty) Ltd.'s profit after taxes would be: (1 - 30%) × 135,000 = 9944"550000 AAUUDD higher. The profit of the parent would be lower to the same extent. As the difference affects the subsidiary, we adjust the non-controlling-interest. On the consolidation worksheet, we allocate the higher profit of the subsidiary to an extent of 40 % to the noncontrolling interest holders: 40% × 94,500 = 3 377"880000 AAUUDD. Check the column Service on the consolidation worksheet in Figure 8.36. (2) As the intra group consultation service was only paid to an extent of 50 %, the liabilities at the subsidiary and the receivables at the parent PATTEN Ltd. are cancelled out. The value is: 135,000 / 2 = 6677"550000 AAUUDD. Check the column Debts on the consolidation worksheet in Figure 8.36. (3) Before elimination of the intra-group service, the profit in 20X0 of SKYPER (Pty) Ltd. is: 178,500 - 50,000 = 1 12288"550000 AAUUDD after taxation and deduction of dividends. It must be split between noncontrolling interest holders and the group at a 40 : 60 ratio: The allocation to non-controlling interest holders is: 40% × 128,500 = 5 511"440000 AAUUDD. Check the <?page no="237"?> Berkau: Financial Statements 8e 8-236 PARENT SUBSIDIARY AGGR. CAP. CONS CONS. F/ S N-cur Assets P,P,E 600,000 350,000 950,000 950,000 Int. assets 0 0 Investments 700,000 700,000 (700,000) 0 Goodwill 0 100,000 100,000 cur Assets Inventory 350,000 200,000 550,000 550,000 Receivables 300,000 300,000 300,000 Cash/ Bank 350,000 300,000 650,000 650,000 2,000,000 1,150,000 3,150,000 (600,000) 0 2,550,000 SH's capital Issued capital (1,000,000) (500,000) (1,500,000) 300,000 200,000 (1,000,000) Reserves (400,000) (178,500) (578,500) 107,100 71,400 (400,000) Retained ear. (321,500) (321,500) 192,900 128,600 0 Non-ctrl. Int 0 (400,000) (400,000) Liabilities Int. bear. liab. (500,000) (100,000) (600,000) (600,000) Payables (100,000) (50,000) (150,000) (150,000) Tax liabilities 0 0 (2,000,000) (1,150,000) (3,150,000) 600,000 0 (2,550,000) Figure 8.35: Worksheet for capital consolidation (PATTEN/ SPYKER) The next steps of consolidation are (1) the elimination of the intra-group profit, (2) consolidation of the intra-profit’s receivables and payables, (3) the allocation of non-controlling interest and (4) the consolidation of the dividends. (1) The service must be eliminated from the consolidation sheet. As both parties recorded expense/ revenue and cash/ bank, the intra-group profit is neutral to the group statements already. No adjustments are required for its elimination. However, the intra-group profit affects the subsidiary’s profit calculation and matters for the non-controlling interest holders. Without the inter-group profit, SPYKER (Pty) Ltd.'s profit after taxes would be: (1 - 30%) × 135,000 = 9944"550000 AAUUDD higher. The profit of the parent would be lower to the same extent. As the difference affects the subsidiary, we adjust the non-controlling-interest. On the consolidation worksheet, we allocate the higher profit of the subsidiary to an extent of 40 % to the noncontrolling interest holders: 40% × 94,500 = 3 377"880000 AAUUDD. Check the column Service on the consolidation worksheet in Figure 8.36. (2) As the intra group consultation service was only paid to an extent of 50 %, the liabilities at the subsidiary and the receivables at the parent PATTEN Ltd. are cancelled out. The value is: 135,000 / 2 = 6677"550000 AAUUDD. Check the column Debts on the consolidation worksheet in Figure 8.36. (3) Before elimination of the intra-group service, the profit in 20X0 of SKYPER (Pty) Ltd. is: 178,500 - 50,000 = 1 12288"550000 AAUUDD after taxation and deduction of dividends. It must be split between noncontrolling interest holders and the group at a 40 : 60 ratio: The allocation to non-controlling interest holders is: 40% × 128,500 = 5 511"440000 AAUUDD. Check the Berkau: Financial Statements 8e 8-237 column non-ctrl on the consolidation worksheet in Figure 8.36. (4) For the dividends of the subsidiary, we acknowledge that payments have already been made. SPYKER (Pty) Ltd.’s dividends paid towards the group are considered. However, the dividend portion to the non-controlling interest holders must be deducted from retained earnings and accumulated towards the non-controlling interest item: 40% × 50,000 = 2 200"000000 AAUUDD. Check the column non-ctrl on the consolidation worksheet in Figure 8.36. AGGR. CAP. CONS Service Debts Div non-ctrl CONS. F/ S N-cur Assets P,P,E 810,000 810,000 Int. assets 0 0 Investments 700,000 (700,000) 0 Goodwill 0 100,000 100,000 cur Assets Inventory 420,000 420,000 Receivables 367,500 (67,500) 300,000 Cash/ Bank 1,300,800 1,300,800 3,598,300 (600,000) 0 (67,500) 0 0 2,930,800 SH's capital Issued capital (1,500,000) 500,000 (1,000,000) Reserves (578,500) 178,500 (400,000) Retained ear. (577,800) 321,500 37,800 20,000 51,400 (147,100) Non-ctrl int. 0 (400,000) (37,800) (20,000) (51,400) (509,200) Liabilities Int. bear. liab. (600,000) (600,000) Payables (217,500) 67,500 (150,000) Tax liabilities (124,500) (124,500) (3,598,300) 600,000 0 67,500 0 0 (2,930,800) Figure 8.36: Consolidation worksheet (PATTEN/ SPYKER) Below, we disclose the consolidated statement of financial position for the PATTEN/ SPYKER Group in Figure 8.37 and the consolidated income statement in Figure 8.38. A C, L Non-current assets [AUD] Equity [AUD] P, P, E 810,000 Share capital 1,000,000 Intangibles Reserves 400,000 Investment Retained earnings 147,100 Goodwill 100,000 Non-ctrl. Int. 509,200 Current assets Liabilities (liab.) Inventory 420,000 Long-term liab. 600,000 Acc. receivables A/ R 300,000 Short-term liab. A/ P 150,000 Prepaid expenses Provisions Cash/ Bank 1,300,800 Income tax liab. 124,500 Total assets 2,930,800 Total equity and liab. 2,930,800 Patten/ Spyker Group STATEMENT of FINANCIAL POSITION as at 31.12.20X0 Figure 8.37: Consolidated SFP for PATTEN/ SPYKER <?page no="238"?> Berkau: Financial Statements 8e 8-238 [AUD] Revenue 1,785,000 Other income 30,000 1,815,000 Materials (630,000) Labour (600,000) Depreciation (140,000) Other expenses 0 Earnings before int. & taxes (EBIT) 445,000 Interest 0 Earnings before taxes (EBT) 445,000 Income tax expenses (124,500) Deferred taxes 0 Earnings after taxes (EAT) 320,500 Patten/ Spyker Group STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X0 Figure 8.38: Consolidated income statement (PATTEN/ SPYKER) 155 8.12 Joint Venture Accounting Joint Venture Accounting requires a joint arrangement to exist. IFRS 11.4 defines a joint arrangement as an agreement where two or more parties jointly control another one. With joint control unanimous consent is required for all decisions as laid out by IFRS 11.7. One or more companies exercising control power over another one, requires Equity Accounting based on IAS 28 or an investment disclosure following IFRS 9 based on IFRS 11.24 and IFRS 11.25. The IASB distinguishes between joint operations and joint ventures. Follow- 155 The dividends are irrelevant for the income tax calculation. 156 The expression arrangement is abstract. Think of a joint project, although some characteristics of Project Management are not met here. ing IFRS 11.14, the investor must determine which type of joint arrangement applies. In line with IFRS 11.15, a joint operation is a joint arrangement 156 where the controlling parties keep the rights on their own assets and an obligation for their own liabilities. The companies allocate profit and costs proportionally to their shares. No extra company is established. In line with IFRS 11.16, a joint venture is a joint arrangement where the controlling parties have the rights to the assets of the joint arrangement. In general, this leads to the establishment of a limited company which is accounted for with Equity Accounting on the financial statements of the investors. <?page no="239"?> Berkau: Financial Statements 8e 8-238 [AUD] Revenue 1,785,000 Other income 30,000 1,815,000 Materials (630,000) Labour (600,000) Depreciation (140,000) Other expenses 0 Earnings before int. & taxes (EBIT) 445,000 Interest 0 Earnings before taxes (EBT) 445,000 Income tax expenses (124,500) Deferred taxes 0 Earnings after taxes (EAT) 320,500 Patten/ Spyker Group STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X0 Figure 8.38: Consolidated income statement (PATTEN/ SPYKER) 155 8.12 Joint Venture Accounting Joint Venture Accounting requires a joint arrangement to exist. IFRS 11.4 defines a joint arrangement as an agreement where two or more parties jointly control another one. With joint control unanimous consent is required for all decisions as laid out by IFRS 11.7. One or more companies exercising control power over another one, requires Equity Accounting based on IAS 28 or an investment disclosure following IFRS 9 based on IFRS 11.24 and IFRS 11.25. The IASB distinguishes between joint operations and joint ventures. Follow- 155 The dividends are irrelevant for the income tax calculation. 156 The expression arrangement is abstract. Think of a joint project, although some characteristics of Project Management are not met here. ing IFRS 11.14, the investor must determine which type of joint arrangement applies. In line with IFRS 11.15, a joint operation is a joint arrangement 156 where the controlling parties keep the rights on their own assets and an obligation for their own liabilities. The companies allocate profit and costs proportionally to their shares. No extra company is established. In line with IFRS 11.16, a joint venture is a joint arrangement where the controlling parties have the rights to the assets of the joint arrangement. In general, this leads to the establishment of a limited company which is accounted for with Equity Accounting on the financial statements of the investors. Berkau: Financial Statements 8e 8-239 Based on IFRS 11.20 and IFRS 11.24, a joint operator recognises its assets, liabilities, profits, gain portions and expenses based on its share in interest. An investor in a joint venture recognises its arrangement as investment. Below, we demonstrate both joint arrangements based on comparable case studies: (1) Joint operation. (2) Joint venture. 8.13 C/ S QUICKARMS- RESPONSE-FIRE Joint Operations On 1.01.20X7, the security firms QUICKARMS Ltd. and RESPONSE (Pty) Ltd. decide to run a suburb patrol service together. There is a third partner involved: FIRE Ltd. which contributes 10 %. Data Sheet for QUICKARMS- RESONSE-FIRE operations DDoommiicciillee: : SSoouutthh AAffrriiccaa ((JJoohhaannnneessbbuurrgg)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : SSeeccuurriittyy SSeerrvviiccee.. PPaarrttnneerrss: : QQUUIICCKKAARRMMSS LLttdd" RREESSPPOONNSSEE ((PPttyy)) LLttdd" FFIIRREE LLttdd.. PPoorrttiioonnss: : 4455 %% / / 4455 %% / / 1100 %%.. AAsssseettss aallll ttooggeetthheerr: : 115500"000000 ZZAARR.. JJooiinntt rreevveennuuee: : 770000"000000 ZZAARR.. JJooiinntt ccoossttss: : mmaatteerriiaallss: : 8800"000000 ZZAARR; ; llaa-bboouurr: : 550000"000000 ZZAARR.. VVAATT iiggnnoorreedd.. The contract states that only unanimous decisions of the three parties can be made. Therefore, FIRE Ltd. can block a motion even with its 10 % of holdings. In a joint arrangement every partner can execute a veto control. The joint arrangement about the joint patrol service is classified as joint operation following IFRS 11.15. The investors have joint responsibility for the deployed assets and for the liabilities. In their financial statements, QUICKARMS Ltd., RESPONSE (Pty) Ltd. as well as FIRE Ltd. consider the assets (cars, weapons) for the joint patrol service to the extent of 150,000 ZAR as asset portions calculated proportionally to their holdings: QUICKARMS Ltd. and RESPONSE (Pty) Ltd. to an extend of 45 % each and FIRE Ltd. of 10 %. Hence, e.g., QUICKARMS Ltd. discloses: 45% × 150,000 = 6 677"550000 ZZAARR of the deployed assets. The partners pay for the acquisition of joint assets based on their share. The disclosure requirements based on IFRS 11.20 apply. Depreciation applies based on straight-line method over three years. It is agreed that RESPONSE (Pty) Ltd. collects all revenues and pays for all operations of the joint patrol service. At yearend, RESPONSE (Pty) Ltd. transfers the share of profits to the other operators. Study the balance sheet of QUICKARMS Ltd. in Figure 8.39. It discloses the assets for the joint control as share in joint assets. They are: 45 % × 150,000 = 6 677"550000 ZZAARR. <?page no="240"?> Berkau: Financial Statements 8e 8-240 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 300,000 Share capital 400,000 Intangibles Reserves 100,000 Share in joint assets 67,500 Retained earnings Current assets Liabilities (liab.) Inventory Long-term liab. 115,000 Accounts receivables Short-term liab. A/ P Prepaid expenses Provisions Cash/ Bank 247,500 Income tax liab. Total assets 615,000 Total equity and liab. 615,000 QuickArms Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X7 Figure 8.39: QUICKARMS Ltd.’s balance sheet (20X6) In 20X7, the revenue for the joint patrol service is 700,000 ZAR. The consumption of materials is 80,000 ZAR and labour is 500,000 ZAR, all paid on cash. The profit of the joint patrol service is: 700,000 - 80,000 - 500,000 = 1 12200"000000 ZZAARR. At the end of 20X7, QUICKARMS Ltd. is entitled to receive a profit share of: 45% × 120,000 = 5 544"000000 EEUURR from its partner RESPONSE (Pty) Ltd. QUICKARMS Ltd. must add depreciation on its assets that were deployed in the joint patrol service operations to the extent of: 45% × (150,000 / 3) = 2 222"550000 ZZAARR. As QUICKARMS Ltd. discloses the joint assets on its financial statements, it must depreciate them itself. We prepare the income statement for QUICKARMS Ltd. It does not include any items linked to the joint patrol service yet. Observe the income statement in Figure 8.40. See below also the balance sheet without consideration of the joint patrol service. It is shown in Figure 8.41. <?page no="241"?> Berkau: Financial Statements 8e 8-240 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 300,000 Share capital 400,000 Intangibles Reserves 100,000 Share in joint assets 67,500 Retained earnings Current assets Liabilities (liab.) Inventory Long-term liab. 115,000 Accounts receivables Short-term liab. A/ P Prepaid expenses Provisions Cash/ Bank 247,500 Income tax liab. Total assets 615,000 Total equity and liab. 615,000 QuickArms Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X7 Figure 8.39: QUICKARMS Ltd.’s balance sheet (20X6) In 20X7, the revenue for the joint patrol service is 700,000 ZAR. The consumption of materials is 80,000 ZAR and labour is 500,000 ZAR, all paid on cash. The profit of the joint patrol service is: 700,000 - 80,000 - 500,000 = 1 12200"000000 ZZAARR. At the end of 20X7, QUICKARMS Ltd. is entitled to receive a profit share of: 45% × 120,000 = 5 544"000000 EEUURR from its partner RESPONSE (Pty) Ltd. QUICKARMS Ltd. must add depreciation on its assets that were deployed in the joint patrol service operations to the extent of: 45% × (150,000 / 3) = 2 222"550000 ZZAARR. As QUICKARMS Ltd. discloses the joint assets on its financial statements, it must depreciate them itself. We prepare the income statement for QUICKARMS Ltd. It does not include any items linked to the joint patrol service yet. Observe the income statement in Figure 8.40. See below also the balance sheet without consideration of the joint patrol service. It is shown in Figure 8.41. Berkau: Financial Statements 8e 8-241 [ZAR] Revenue 1,300,000 Other income 0 1,300,000 Materials (35,000) Labour (500,000) Depreciation (50,000) Other expenses (43,000) Earnings before int. & taxes (EBIT) 672,000 Interest 0 Earnings before taxes (EBT) 672,000 Income tax expenses (201,600) Deferred taxes 0 Earnings after taxes (EAT) 470,400 QuickArms Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X7 Figure 8.40: QUICKARMS Ltd.’s income statement A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 250,000 Share capital 400,000 Intangibles Reserves 100,000 Share in joint assets 67,500 Retained earnings 470,400 Current assets Liabilities (liab.) Inventory Long-term liab. 115,000 Accounts receivables Short-term liab. A/ P Prepaid expenses Provisions Cash/ Bank 969,500 Income tax liab. 201,600 Total assets 1,287,000 Total equity and liab. 1,287,000 QuickArms Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X7 Figure 8.41: QUICKARMS Ltd.’s balance sheet (20X7) For QUICKARMS Ltd.’s financial statements, we consider the share of the profit of the joint patrol service as receivables. We further add the depreciation on the assets for the joint patrol service to the expenses. We record Bookkeeping entries as below for the profit share of 54,000 ZAR and for the depreciation on the deployed assets to the extent of: 22,500 ZAR: <?page no="242"?> Berkau: Financial Statements 8e 8-242 @ 31.12.20X7 Depreciation-20X7 DPR 22,500 Accumulated Depreciation ACC 22,500 (recording depreciation on joined assets) Accounts Receivables A/ R 54,000 Other Compreh. Income-20X7 OCI 54,000 (other income recognition from joint operations) After recording the above Bookkeeping entries and considering an income tax increase of: (54,000 - 22,500) × 30% = 99"445500 ZZAARR, the financial statements look as below: [ZAR] Revenue 1,300,000 Other income (joint) 54,000 1,354,000 Materials (35,000) Labour (500,000) Depreciation (50,000) Depreciation (joint) (22,500) Other expenses (43,000) Earnings before int. & taxes (EBIT) 703,500 Interest 0 Earnings before taxes (EBT) 703,500 Income tax expenses (211,050) Deferred taxes 0 Earnings after taxes (EAT) 492,450 QuickArms Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X7 Figure 8.42: QUICKARMS Ltd.’s income statement 157 157 The other income received is no dividend. It is subjected to income tax. <?page no="243"?> Berkau: Financial Statements 8e 8-242 @ 31.12.20X7 Depreciation-20X7 DPR 22,500 Accumulated Depreciation ACC 22,500 (recording depreciation on joined assets) Accounts Receivables A/ R 54,000 Other Compreh. Income-20X7 OCI 54,000 (other income recognition from joint operations) After recording the above Bookkeeping entries and considering an income tax increase of: (54,000 - 22,500) × 30% = 99"445500 ZZAARR, the financial statements look as below: [ZAR] Revenue 1,300,000 Other income (joint) 54,000 1,354,000 Materials (35,000) Labour (500,000) Depreciation (50,000) Depreciation (joint) (22,500) Other expenses (43,000) Earnings before int. & taxes (EBIT) 703,500 Interest 0 Earnings before taxes (EBT) 703,500 Income tax expenses (211,050) Deferred taxes 0 Earnings after taxes (EAT) 492,450 QuickArms Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X7 Figure 8.42: QUICKARMS Ltd.’s income statement 157 157 The other income received is no dividend. It is subjected to income tax. Berkau: Financial Statements 8e 8-243 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 250,000 Share capital 400,000 Intangibles Reserves 100,000 Share in joint assets 45,000 Retained earnings 492,450 Current assets Liabilities (liab.) Inventory Long-term liab. 115,000 Accounts receivables 54,000 Short-term liab. A/ P Prepaid expenses Provisions Cash/ Bank 969,500 Income tax liab. 211,050 Total assets 1,318,500 Total equity and liab. 1,318,500 QuickArms Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X7 Figure 8.43: QUICKARMS Ltd.’s balance sheet (20X7) How it is Done (Accounting for Joint Operations): (1) Mark assets assigned for the joint operations on the balance sheet for extra disclosure. (2) Calculate the profit of the joint operations before taxation. (3) Transfer the pre-tax profit to the other joint operator(s) or receive it from the other joint operator(s) and consider it as other comprehensive income. (4) Disclose depreciation and other expenses linked to joint operations separately on the income statement. (5) Prepare single-entity financial statements. The case study is repeated below for a joint arrangement classified as joint venture. This requires the establishment of a new company CLOSE-WATCH (Pty) Ltd. The content of the case study below is slightly different to the previous one. We do not intend to compare the figures for an evaluation of joint arrangement types. We only demonstrate the Accounting work and omit tax related or legal aspects. 8.14 C/ S CLOSEWATCH - Joint Venture If the three companies agree in a joint venture, a separate company is established. The three investors jointly control the new company CLOSE-WATCH (Pty) Ltd. IFRS 11.24 requires the proportional disclosure of the joint venture on the balance sheet of the investor’s financial statement as investment. Data Sheet for CLOSE-WATCH (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((JJoohhaannnneessbbuurrgg)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : SSeeccuurriittyy SSeerrvviiccee.. EEssttaabblliisshheedd: : 11..0011..2200XX77.. OOwwnneerrss: : QQUUIICCKKAARRMMSS LLttdd" RREESSPPOONNSSEE ((PPttyy)) LLttdd" FFIIRREE LLttdd.. SShhaarree: : 4455 %% / / 4455 %% / / 1100 %%.. IIssssuueedd ccaappiittaall: : 220000"000000 ZZAARR.. <?page no="244"?> Berkau: Financial Statements 8e 8-244 BBoorrrroowwiinngg 2255"000000 ZZAARR ffrroomm QQUUIICCKKAARRMM LLttdd.. PPrrooppeerrttyy" ppllaanntt aanndd eeqquuiippmmeenntt: : 115500"000000 ZZAARR.. RReevveennuuee: : 770000"000000 ZZAARR.. MMaatteerriiaallss: : 8800"000000 ZZAARR; ; llaabboouurr: : 550000"000000 ZZAARR.. VVAATT iiggnnoorreedd.. The balance sheet of CLOSE-WATCH (Pty) Ltd. shows in Figure 8.44. The company CLOSE-WATCH (Pty) Ltd. is established with 200,000 ZAR. 150,000 ZAR therefrom is invested in assets, like cars and weapons. The company further borrows from QUICKARMS Ltd. 25,000 ZAR as disclosed under short-term liabilities. A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 150,000 Share capital 200,000 Intangibles Reserves Financial assets Retained earnings Current assets Liabilities (liab.) Inventory Long-term liab. Accounts receivables Short-term liab. A/ P 25,000 Prepaid expenses Provisions Cash/ Bank 75,000 Income tax liab. Total assets 225,000 Total equity and liab. 225,000 Close-Watch (Pty) Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X7 Figure 8.44: CLOSE-WATCH (Pty) Ltd.’s opening balance sheet In 20X7, CLOSE-WATCH (Pty) Ltd. records a profit of 49,000 ZAR after taxes. No dividend has been declared. The short-term liabilities of 25,000 ZAR are paid back by then. <?page no="245"?> Berkau: Financial Statements 8e 8-244 BBoorrrroowwiinngg 2255"000000 ZZAARR ffrroomm QQUUIICCKKAARRMM LLttdd.. PPrrooppeerrttyy" ppllaanntt aanndd eeqquuiippmmeenntt: : 115500"000000 ZZAARR.. RReevveennuuee: : 770000"000000 ZZAARR.. MMaatteerriiaallss: : 8800"000000 ZZAARR; ; llaabboouurr: : 550000"000000 ZZAARR.. VVAATT iiggnnoorreedd.. The balance sheet of CLOSE-WATCH (Pty) Ltd. shows in Figure 8.44. The company CLOSE-WATCH (Pty) Ltd. is established with 200,000 ZAR. 150,000 ZAR therefrom is invested in assets, like cars and weapons. The company further borrows from QUICKARMS Ltd. 25,000 ZAR as disclosed under short-term liabilities. A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 150,000 Share capital 200,000 Intangibles Reserves Financial assets Retained earnings Current assets Liabilities (liab.) Inventory Long-term liab. Accounts receivables Short-term liab. A/ P 25,000 Prepaid expenses Provisions Cash/ Bank 75,000 Income tax liab. Total assets 225,000 Total equity and liab. 225,000 Close-Watch (Pty) Ltd. STATEMENT of FINANCIAL POSITION as at 1.01.20X7 Figure 8.44: CLOSE-WATCH (Pty) Ltd.’s opening balance sheet In 20X7, CLOSE-WATCH (Pty) Ltd. records a profit of 49,000 ZAR after taxes. No dividend has been declared. The short-term liabilities of 25,000 ZAR are paid back by then. Berkau: Financial Statements 8e 8-245 [ZAR] Revenue 700,000 Other income 0 700,000 Materials (80,000) Labour (500,000) Depreciation (50,000) Other expenses 0 Earnings before int. & taxes (EBIT) 70,000 Interest 0 Earnings before taxes (EBT) 70,000 Income tax expenses (21,000) Deferred taxes 0 Earnings after taxes (EAT) 49,000 Close-Watch (Pty) Ltd. STATEMENT of PROFIT & LOSS and OTHER COMPREHENSIVE INCOME for the year ended 31.12.20X7 Figure 8.45: CLOSE-WATCH (Pty) Ltd.’s income statement A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 100,000 Share capital 200,000 Intangibles Reserves Financial assets Retained earnings 49,000 Current assets Liabilities (liab.) Inventory Long-term liab. Accounts receivables Short-term liab. A/ P 0 Prepaid expenses Provisions Cash/ Bank 170,000 Income tax liab. 21,000 Total assets 270,000 Total equity and liab. 270,000 Close-Watch (Pty) Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X7 Figure 8.46: CLOSE-WATCH (Pty) Ltd.’s balance sheet (20X7) QUICKARM Ltd. and RESPONSE (Pty) Ltd. show the investment at: 45% × 200,000 = 9 900"000000 ZZAARR. FIRE Ltd. discloses a financial asset of 20,000 ZAR. At the time of acquisition, QUICKARMS Ltd. discloses separate financial statements which show its share in the joint venture at cost based on the equity method. For the major investors, Equity Accounting along IAS 28.10 applies. QUICKARMS Ltd.’s separate financial statements as at 1.01.20X7 are shown below in Figure 8.47. Therein, receivables from lending 25,000 ZAR are disclosed, too. <?page no="246"?> Berkau: Financial Statements 8e 8-246 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 300,000 Share capital 400,000 Intangibles Reserves 100,000 Investment (joint) 90,000 Retained earnings Current assets Liabilities Inventory Interest bear liab 115,000 Accounts receivables 25,000 Accounts payables Prepaid expenses Provisions Cash/ Bank 200,000 Tax liabilities Total assets 615,000 Total equity and liab. 615,000 QuickArms / Close-Watch JOINT VENTURE SEPARATE STATEMENT of FINANCIAL POSITION as at 1.01.20X7 Figure 8.47: QUICKARMS/ CLOSE-WATCH (JV)’s balance sheet (IAS 27) At the end of 20X7, the value of CLOSE- WATCH (Pty) Ltd. increased by: (249,000 - 200,000) / 200,000 = 2 244..55%%. As no dividend has been declared, the investments on the balance sheet at QUICKARM Ltd. and RESPONSE (Pty) Ltd. increase by 24.5 %, too. The new valuation is: (1 + 24.5%) × 90,000 = 1 11122"005500 ZZAARR. The contra entry for the increase in valuation is made in the Investment Income account which is omitted for the calculation of income tax. 158 Hence, retained earnings are: 1,300,000 + 22,050 - 35,000 - 500,000 - 50,000 - 43,000 - 201,600 = 4 49922"445500 ZZAARR. The income taxes of 201,600 ZAR remain unchanged. Below, the balance sheet for the investor QUICKARMS Ltd. is displayed in Figure 8.48 as separate financial statement. The profit and loss calculation, as reported in Figure 8.40 without consideration of the joint venture, applies and is adjusted for the investment income to disclose separate financial statements. 158 It represents an unrealised profit. <?page no="247"?> Berkau: Financial Statements 8e 8-246 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 300,000 Share capital 400,000 Intangibles Reserves 100,000 Investment (joint) 90,000 Retained earnings Current assets Liabilities Inventory Interest bear liab 115,000 Accounts receivables 25,000 Accounts payables Prepaid expenses Provisions Cash/ Bank 200,000 Tax liabilities Total assets 615,000 Total equity and liab. 615,000 QuickArms / Close-Watch JOINT VENTURE SEPARATE STATEMENT of FINANCIAL POSITION as at 1.01.20X7 Figure 8.47: QUICKARMS/ CLOSE-WATCH (JV)’s balance sheet (IAS 27) At the end of 20X7, the value of CLOSE- WATCH (Pty) Ltd. increased by: (249,000 - 200,000) / 200,000 = 2 244..55%%. As no dividend has been declared, the investments on the balance sheet at QUICKARM Ltd. and RESPONSE (Pty) Ltd. increase by 24.5 %, too. The new valuation is: (1 + 24.5%) × 90,000 = 1 11122"005500 ZZAARR. The contra entry for the increase in valuation is made in the Investment Income account which is omitted for the calculation of income tax. 158 Hence, retained earnings are: 1,300,000 + 22,050 - 35,000 - 500,000 - 50,000 - 43,000 - 201,600 = 4 49922"445500 ZZAARR. The income taxes of 201,600 ZAR remain unchanged. Below, the balance sheet for the investor QUICKARMS Ltd. is displayed in Figure 8.48 as separate financial statement. The profit and loss calculation, as reported in Figure 8.40 without consideration of the joint venture, applies and is adjusted for the investment income to disclose separate financial statements. 158 It represents an unrealised profit. Berkau: Financial Statements 8e 8-247 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 250,000 Share capital 400,000 Intangibles Reserves 100,000 Investment (joint) 112,050 Retained earnings 492,450 Current assets Liabilities Inventory Interest bear liab 115,000 Accounts receivables Accounts payables Prepaid expenses Provisions Cash/ Bank 947,000 Tax liabilities 201,600 Total assets 1,309,050 Total equity and liab. 1,309,050 QuickArms Ltd. SEPARATE STATEMENT of FINANCIAL POSITION as at 31.12.20X7 Figure 8.48: QUICKARM/ CLOSE-WATCH joint venture balance sheet As no indication for an increase in valuation exists for the financial asset at FIRE Ltd., the valuation remains 20,000 ZAR. Note, due to the application of the equity method based on IAS 28.10, the borrowing between the joint venture and one of its investors does not affect the valuation as no consolidation is carried out. How it is Done (Joint Venture Accounting): (1) Prepare financial statements for the joint venture and the investors. Check whether the joint venture is a financial asset or requires Equity Accounting. (2a) If the joint venture is recorded as financial asset, apply valuation at cost or subsequently at fair values through profit or loss or through other comprehensive income. (2b) If the joint venture requires Equity Accounting, check whether separate financial statements are required. (3a) If the separate financial statements are initially required, recognise the joint venture proportionally and at costs. (3b) If the separate financial statements are subsequently required, disclose the joint venture proportionally based on the equity method. (4b) Record dividends received through profit or loss or through other comprehensive income. Deduct dividends paid from the valuation of the joint venture. (5) Prepare separate financial statements for the investors and the joint venture. <?page no="248"?> Berkau: Financial Statements 8e 8-248 8.15 Summary Group Accounting is linked to the preparation of separate financial statements along IAS 27, to consolidated financial statements along IFRS 3 or to joint arrangements along IFRS 11. Minor investments are disclosed as financial instruments following IFRS 9. Investments with significant influence are measured based on the equity method based on IAS 28. Group Accounting aims to provide the user of financial statements with additional information. It has no impact on the need and the way how single companies prepare and present their single-entity financial statements. No payments depend on Group Accounting. In Europe, Group Accounting based on IFRSs is required if one group member participates actively on the public capital market. 8.16 Working Definitions Acquisition Method: Method of Group Accounting. The items of the acquired company are valued as at the time of gaining ownership. Associated Company: An associated company is a company the investor holds between 20 and 50 % from. A significance of influence is characteristic. Capital Consolidation: A calculation that cancels out the double count for the acquisition of a subsidiary. Consolidated Financial Statements: Statements of a group in which items are shown as those of a single entity. Control: Power to determine the strategy and operating decisions of another company. To exercise control power over another company, ownership is assumed to exceed 50 %. Equity Method: Measurement of associates and joint ventures based on the changes of the book value. IAS 28.10 rules the equity method. Group Accounting: Preparation of financial statements for business combinations. Joint Arrangements: Joint operations or joint ventures. Profit Consolidation: Cancelation of intra-group profits and adjustment of valuations for assets linked thereto. Separate Financial Statements: Statements prepared by a parent/ investor that show the proportionate share in subsidiaries, associates and joint operations based on IAS 27. 8.17 Question Bank (1) A Ltd. buys 210 shares of B Ltd. which is based on 300 shares at 10 EUR/ s. At the time of acquisition, the Retained Earnings Account at B Ltd. is 1,000 EUR. The costs of the investment are 2,900 EUR. How much is the goodwill? 1. Nil . 2. 100 EUR . 3. 200 EUR . 4. (120 EUR) . (2) L Ltd. buys 550 shares of S Ltd. which is based on 1,000 shares at 5 EUR/ s. At the time of acquisition, the Retained Earnings account is 1,500 EUR. At the beginning of the fiscal year, the opening balance for S Ltd.’s Retained Earnings account is 5,000 EUR. How much is the non-controlling interest disclosed on the consolidated balance sheet? <?page no="249"?> Berkau: Financial Statements 8e 8-248 8.15 Summary Group Accounting is linked to the preparation of separate financial statements along IAS 27, to consolidated financial statements along IFRS 3 or to joint arrangements along IFRS 11. Minor investments are disclosed as financial instruments following IFRS 9. Investments with significant influence are measured based on the equity method based on IAS 28. Group Accounting aims to provide the user of financial statements with additional information. It has no impact on the need and the way how single companies prepare and present their single-entity financial statements. No payments depend on Group Accounting. In Europe, Group Accounting based on IFRSs is required if one group member participates actively on the public capital market. 8.16 Working Definitions Acquisition Method: Method of Group Accounting. The items of the acquired company are valued as at the time of gaining ownership. Associated Company: An associated company is a company the investor holds between 20 and 50 % from. A significance of influence is characteristic. Capital Consolidation: A calculation that cancels out the double count for the acquisition of a subsidiary. Consolidated Financial Statements: Statements of a group in which items are shown as those of a single entity. Control: Power to determine the strategy and operating decisions of another company. To exercise control power over another company, ownership is assumed to exceed 50 %. Equity Method: Measurement of associates and joint ventures based on the changes of the book value. IAS 28.10 rules the equity method. Group Accounting: Preparation of financial statements for business combinations. Joint Arrangements: Joint operations or joint ventures. Profit Consolidation: Cancelation of intra-group profits and adjustment of valuations for assets linked thereto. Separate Financial Statements: Statements prepared by a parent/ investor that show the proportionate share in subsidiaries, associates and joint operations based on IAS 27. 8.17 Question Bank (1) A Ltd. buys 210 shares of B Ltd. which is based on 300 shares at 10 EUR/ s. At the time of acquisition, the Retained Earnings Account at B Ltd. is 1,000 EUR. The costs of the investment are 2,900 EUR. How much is the goodwill? 1. Nil . 2. 100 EUR . 3. 200 EUR . 4. (120 EUR) . (2) L Ltd. buys 550 shares of S Ltd. which is based on 1,000 shares at 5 EUR/ s. At the time of acquisition, the Retained Earnings account is 1,500 EUR. At the beginning of the fiscal year, the opening balance for S Ltd.’s Retained Earnings account is 5,000 EUR. How much is the non-controlling interest disclosed on the consolidated balance sheet? Berkau: Financial Statements 8e 8-249 1. 5,175 EUR . 2. 5,000 EUR . 3. 6,325 EUR . 4. 4,500 EUR . (3) Which statement is correct? 1. An investment in an associate is one that is below 20 % of ownership and is initially disclosed at cost. The subsequent valuation is based on the equity method along IAS 28. 2. An investment in an associate is one that is more than 20 % of ownership and is initially disclosed at cost. The subsequent valuation is based on the equity method along IAS 28. 3. An investment in an associate is one that is more than 20% of ownership and is initially disclosed at cost. The subsequent valuation is based on the equity method along IAS 27. 4. An investment in an associate is one that is more than 25% of ownership and is initially disclosed at cost. The subsequent valuation is based on the equity method along IAS 27. (4) On 1.01.20X2, Y Ltd. buys 50 shares of C Ltd. which is based on 200 ordinary shares at 10 EUR/ s. The total costs of acquisition are 500 EUR. At the time of acquisition, the Retained Earnings account of C Ltd. is zero balanced. On 31.12.20X7, the closing balance of Y Ltd.’s Retained Earnings account is 2,000 EUR and C Ltd.’s one equals 1,000 EUR. What is the disclosure of the investment in C Ltd. on Y Ltd.’s single entity statement of financial position? 1. 1,250 EUR . 2. 1,000 EUR . 3. 750 EUR . 4. 500 EUR . (5) On 1.01.20X2, A (Pty) Ltd. buys 60 % of the shares of P Ltd. The opening balance of P Ltd.’s Retained Earnings account is 1,000 EUR. The subsidiary declares a dividend of 600 EUR. The closing balance of the Retained Earnings account (after appropriation of profits) is 1,500 EUR on the single entity financial statements. How much is the increase of P Ltd.’s equity due to profit/ dividend on the consolidated financial statements (non-controlling portion)? 1. 660 EUR . 2. 200 EUR . 3. 360 EUR . 4. 900 EUR . 8.18 Solutions 1-2, 2-4, 3-2, 4-3, 5-2. <?page no="250"?> Berkau: Financial Statements 8e 9-250 9 Current Assets on the Balance Sheet 9.1 What is in the Chapter? Current assets usually stay in a company for less than a year. They comprise of inventories, receivables, securities, and cash/ bank. IRFSs also regard prepaid expenses as current assets, because they meet the characteristics for assets set by the conceptual framework for financial reporting F 4.8 - F 4.13. In this chapter, we teach recognition and measurement of current assets. As inventories include raw materials, work-in-process as well as finished goods, we cover Manufacturing Accounting 159 for the calculation of finished goods in production firms. We introduce the perpetual system for inventory movements and show its differences to the periodic system as discussed in chapter (4). As financial instruments can also be held for shortterm periods, this chapter considers their recognition and measurement as securities. This chapter contains the case study GREENACRES Ltd. to show different inventory movement systems. With the case study ROSEFIELD Ltd. we explain stock releases at different prices, and we introduce the cost formulas first-in-first-out and weighted average method. The case study HEISTEL (Pty) Ltd. discusses inventory measurement at values below the cost of purchase (at net realisable values). Manufacturing Accounting is discussed with the case study RIEBEEK- 159 Study for Manufacturing Accounting our textbook Basics of Accounting, chapter (25) and for the difference between Job Order Costing and KASTEEL (Pty) Ltd. which is a printing company (manufacturer). Besides of the cost flow in production firms, we cover aspects of idle costs following IAS 2.13. Furthermore, four minor case studies are discussed for the valuation of short-term financial assets as securities and one for cash and its equivalents’ disclosure at the end of this chapter. 9.2 Learning Objectives In this chapter, you learn the recognition and measurement of short-term assets as ruled by IAS 2. You also get familiarised with the calculation of finished goods applying Work-in-Process Accounts and the Manufacturing Overheads Accounts. You learn about Accounting for receivables and securities. After studying this chapter, you can disclose and evaluate current assets in compliance with IAS 2 and financial instruments based on IFRS 9. 9.3 Current and non-Current Assets Current assets are disclosed separately from long-term ones based on IAS 1.60. IAS 1.61 states that items should be classified based on a 12-month rule. IAS 1.66 defines current assets as assets that are realised, sold or consumed within a normal operating cycle, merchandise goods, or cash/ bank. All other items are classified as non-current assets. Process Costing our textbook Management Accounting, chapter (18) and (19) respectively. <?page no="251"?> Berkau: Financial Statements 8e 9-250 9 Current Assets on the Balance Sheet 9.1 What is in the Chapter? Current assets usually stay in a company for less than a year. They comprise of inventories, receivables, securities, and cash/ bank. IRFSs also regard prepaid expenses as current assets, because they meet the characteristics for assets set by the conceptual framework for financial reporting F 4.8 - F 4.13. In this chapter, we teach recognition and measurement of current assets. As inventories include raw materials, work-in-process as well as finished goods, we cover Manufacturing Accounting 159 for the calculation of finished goods in production firms. We introduce the perpetual system for inventory movements and show its differences to the periodic system as discussed in chapter (4). As financial instruments can also be held for shortterm periods, this chapter considers their recognition and measurement as securities. This chapter contains the case study GREENACRES Ltd. to show different inventory movement systems. With the case study ROSEFIELD Ltd. we explain stock releases at different prices, and we introduce the cost formulas first-in-first-out and weighted average method. The case study HEISTEL (Pty) Ltd. discusses inventory measurement at values below the cost of purchase (at net realisable values). Manufacturing Accounting is discussed with the case study RIEBEEK- 159 Study for Manufacturing Accounting our textbook Basics of Accounting, chapter (25) and for the difference between Job Order Costing and KASTEEL (Pty) Ltd. which is a printing company (manufacturer). Besides of the cost flow in production firms, we cover aspects of idle costs following IAS 2.13. Furthermore, four minor case studies are discussed for the valuation of short-term financial assets as securities and one for cash and its equivalents’ disclosure at the end of this chapter. 9.2 Learning Objectives In this chapter, you learn the recognition and measurement of short-term assets as ruled by IAS 2. You also get familiarised with the calculation of finished goods applying Work-in-Process Accounts and the Manufacturing Overheads Accounts. You learn about Accounting for receivables and securities. After studying this chapter, you can disclose and evaluate current assets in compliance with IAS 2 and financial instruments based on IFRS 9. 9.3 Current and non-Current Assets Current assets are disclosed separately from long-term ones based on IAS 1.60. IAS 1.61 states that items should be classified based on a 12-month rule. IAS 1.66 defines current assets as assets that are realised, sold or consumed within a normal operating cycle, merchandise goods, or cash/ bank. All other items are classified as non-current assets. Process Costing our textbook Management Accounting, chapter (18) and (19) respectively. Berkau: Financial Statements 8e 9-251 The above classification applies not strictly for every single item of inventory. E.g., a production firm that manufactures gear boxes and has one gear box on stock that has been produced based on a customer’s specifications for two years does not change its classification. The general classification as inventory stays. As inventories are held for shorter periods than one year, no depreciation applies. However, value decreases can occur because inventory is measured at the lower of cost of purchase and net realisable value. Similar rules apply for bad debts. Bad debts are receivables a company considers irrecoverable. They are transferred to the Bad Debts account which is an expense account. 160 Recording bad debts means to write-off receivables by recording an expense and making a credit entry in the Accounts Receivables account. Current assets are: (1) Inventories. (2) Receivables. (3) Securities. (4) Prepaid expenses. (5) Cash/ bank. 9.4 Inventories IAS 2.6 defines inventories: They are assets a company trades with or assets needed for its operations, e.g., for production or service rendering. They can be considerably high, e.g., in the retailing industry or production firms. In contrast, service rendering companies, 160 Study the case study MOSSEL SPORTS in our textbook Basics of Accounting, chapter (34). e.g., consultancies, law firms or software developers, hold low levels of inventories. We start-off from the case study of the retailer GREENACRES Ltd. For traders, inventories are merely merchandise goods purchased and sold on to their customers. The case study GREENACRES Ltd. is about two alternative inventory systems 161 , the periodic and the perpetual system. We explain the Bookkeeping entries for both systems with an identical case. At first, we explain the already applied periodic system followed by the introduction of the perpetual system. A periodic system has been covered for the case study RYNEVELD Ltd. already. For retailers, the Trading account applies for gross profit calculations when a periodic inventory system is in use. With a periodic inventory system, a company takes stock once per Accounting period, in general on 31.12.20XX. The inventory levels are known at the beginning and end of an Accounting period, but not in between. Stocking inventories is recorded in the Purchase account as debit entry. No Bookkeeping entries for stock releases are made. A company determines its inventory consumption by calculating the difference between opening value and purchases and deducts closing stock. Nowadays, a periodic system seldom applies and only if inventory is of lower interest. In contrast, a perpetual inventory system records inputs as well as outputs of stock. The Inventory accounts apply: we make debit entries for inputs 161 Study our textbook Basics of Accounting, chapter (26). <?page no="252"?> Berkau: Financial Statements 8e 9-252 and record stock releases as credit entries. Under a perpetual inventory system, a company always knows its inventory levels. Observing its stock levels supports retailers with data for their order management. In the paragraphs below, returns that have been introduced in chapter (4) are discussed with the case study GREENACRES Ltd. Four cases are covered: returns outwards and returns inwards for periodic and perpetual systems. The valuation of inventory is based on net values for companies registered for VAT reduction. IAS 2.11 defines costs of purchase. They are the net purchase price less trade discounts and rebates. Also, attributable costs, e.g., for transportation and goods handling, are added to costs. For subsequent valuations, either the cost of purchase or the net realisable value applies, whichever is lower. See IAS 2.9: Inventories shall be measured at the lower of cost and net realisable value which is the estimated selling price less cost of completion and less costs to make the deal (IAS 2.6). The regulations for valuation are strict; this means the reporting company cannot choose between the valuation methods: Once values decrease, the lower value applies. For increasing inventory values (after purchase), the purchase price marks the maximum. No revaluations, as for non-current assets, are allowed for inventory. IAS 2.6 defines the net realisable value as the fair value of inventories which is defined by IFRS 13.6 as the price obtained by selling the asset/ inventory in an orderly transaction. Writing-down inventories from purchase costs to net realisable values ensures that inventory is carried at fair values obtainable from their sale or use (IAS 2.28). 9.5 C/ S GREENACRES Ltd. With the case study GREENACRES Ltd. we demonstrate the recording of inventories following alternative inventory systems. The company sells lamps. For the sake of simplicity, only one type of lamp is traded, and its costs of purchase are constant. See below the data sheet for GREENACRES Ltd.: Data sheet for GREENACRES Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((GGqqeebbeerrhhaa)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : RReettaaiilleerr.. OOppeenniinngg vvaalluuee: : 116688"000000 ZZAARR; ; PPuurrcchhaassee 11"220000"000000 ZZAARR; ; uunniitt ccoossttss: : 11"220000 ZZAARR/ / uu; ; nneett sseelllliinngg pprriiccee: : 22"000000 ZZAARR/ / uu.. SSaalleess aammoouunntt: : 880000 uunniittss ((440000 ++ 225500 ++ 115500)).. VVAATT rraattee: : 2200 %%.. At the beginning of 20X5, GREENACRES Ltd. discloses an opening value for its lamps of 168,000 ZAR which results from 140 lamps purchased at 1,200 ZAR/ u each in the past. During the Accounting period 20X5, GREENACRES Ltd. orders 1,000 lamps at 1,200 ZAR/ u. The lamps are of the same type as those on stock at the beginning of 20X5. At first, we apply a periodic system. The lamps valuation is at their constant cost of purchase. The Bookkeeping entry (1) for the purchase of lamps is shown below. <?page no="253"?> Berkau: Financial Statements 8e 9-252 and record stock releases as credit entries. Under a perpetual inventory system, a company always knows its inventory levels. Observing its stock levels supports retailers with data for their order management. In the paragraphs below, returns that have been introduced in chapter (4) are discussed with the case study GREENACRES Ltd. Four cases are covered: returns outwards and returns inwards for periodic and perpetual systems. The valuation of inventory is based on net values for companies registered for VAT reduction. IAS 2.11 defines costs of purchase. They are the net purchase price less trade discounts and rebates. Also, attributable costs, e.g., for transportation and goods handling, are added to costs. For subsequent valuations, either the cost of purchase or the net realisable value applies, whichever is lower. See IAS 2.9: Inventories shall be measured at the lower of cost and net realisable value which is the estimated selling price less cost of completion and less costs to make the deal (IAS 2.6). The regulations for valuation are strict; this means the reporting company cannot choose between the valuation methods: Once values decrease, the lower value applies. For increasing inventory values (after purchase), the purchase price marks the maximum. No revaluations, as for non-current assets, are allowed for inventory. IAS 2.6 defines the net realisable value as the fair value of inventories which is defined by IFRS 13.6 as the price obtained by selling the asset/ inventory in an orderly transaction. Writing-down inventories from purchase costs to net realisable values ensures that inventory is carried at fair values obtainable from their sale or use (IAS 2.28). 9.5 C/ S GREENACRES Ltd. With the case study GREENACRES Ltd. we demonstrate the recording of inventories following alternative inventory systems. The company sells lamps. For the sake of simplicity, only one type of lamp is traded, and its costs of purchase are constant. See below the data sheet for GREENACRES Ltd.: Data sheet for GREENACRES Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((GGqqeebbeerrhhaa)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : RReettaaiilleerr.. OOppeenniinngg vvaalluuee: : 116688"000000 ZZAARR; ; PPuurrcchhaassee 11"220000"000000 ZZAARR; ; uunniitt ccoossttss: : 11"220000 ZZAARR/ / uu; ; nneett sseelllliinngg pprriiccee: : 22"000000 ZZAARR/ / uu.. SSaalleess aammoouunntt: : 880000 uunniittss ((440000 ++ 225500 ++ 115500)).. VVAATT rraattee: : 2200 %%.. At the beginning of 20X5, GREENACRES Ltd. discloses an opening value for its lamps of 168,000 ZAR which results from 140 lamps purchased at 1,200 ZAR/ u each in the past. During the Accounting period 20X5, GREENACRES Ltd. orders 1,000 lamps at 1,200 ZAR/ u. The lamps are of the same type as those on stock at the beginning of 20X5. At first, we apply a periodic system. The lamps valuation is at their constant cost of purchase. The Bookkeeping entry (1) for the purchase of lamps is shown below. Berkau: Financial Statements 8e 9-253 @ 30.06.20X5 Purchase-20X5 PUR 1,200,000 Value Added Tax VAT 240,000 Cash/ Bank C/ B 1,440,000 (purchase of 1,000 goods) In 20X5, GREENACRES Ltd. sells 800 lamps at a net selling price of 2,000 ZAR/ u. The Bookkeeping entry (2) for the revenue recognition is recorded on 1.07.20X5. We record separate sales of 400, of 250 and of 150 lamps by one Bookkeeping entry. @ 1.07.20X5 Cash/ Bank C/ B 1,920,000 Value Added Tax VAT 320,000 Revenue-20X5 REV 1,600,000 (revenue recognition for 800 sold goods) At the end of 20X5, GREENACRES Ltd. takes stock and has 340 lamps in storage. Their value is: 340 × 1,200 = 440088"000000 ZZAARR. GREENACRES Ltd. transfers the closing stock with reference (three-digit-code T/ A) to its Trading account under Bookkeeping entry (3). The valuation is based on the costs of purchase. In the Trading Account, GREENACRES Ltd. calculates the cost of goods sold by deduction of the closing stock from the total of opening value and purchases: 168,000 + 1,200,000 - 408,000 = 9 96600"000000 ZZAARR. The cost of goods sold are disclosed on the income statement. Observe the Bookkeeping entry below and the gross profit calculation following in Figure 9.1. @ 31.12.20X5 Inventories INV 408,000 Trading Account-20X5 T/ A 408,000 (recording inventories after stock taking) D C D C OV 168,000 T/ A 168,000 OV . . . (1) 1,440,000 (3) 408,000 c/ d 408,000 (2) 1,920,000 c/ d 480,000 576,000 576,000 1,920,000 1,920,000 b/ d 408,000 b/ d 480,000 Inventories (lamps) INV Cash/ Bank C/ B Figure 9.1: GREENACRES Ltd.’s accounts (periodic system) <?page no="254"?> Berkau: Financial Statements 8e 9-254 D C D C (1) 1,200,000 T/ A 1,200,000 (1) 240,000 (2) 320,000 c/ d 80,000 320,000 320,000 b/ d 80,000 Purchase-20X5 PUR Value added tax VAT D C D C T/ A 1,600,000 (2) 1,600,000 INV 168,000 REV 1,600,000 PUR 1,200,000 (3) 408,000 GP 640,000 2,008,000 2,008,000 b/ d 640,000 Revenue-20X5 REV Trading account-20X5 T/ A Figure 9.1: GREENACRES Ltd.’s accounts (periodic system) continued 9.6 Perpetual Inventory System We repeat the case study GREENACRES Ltd., but now apply a perpetual system for the inventory movements. Under the perpetual system, a company adds purchases to the Inventory account directly (no Purchase account applies) and records stock releases on time. The contra account is the Cost of Goods Sold account. This enables the company to determine its stock level by balancingoff its Inventory account. To demonstrate how a company obtains stock level information during the year, we alter the Bookkeeping entries. Instead of one sale of 800 lamps we consider three single sales and stock releases at 400, 250, and then 150 units. The cost of goods sold are now calculated in an extra account which is closed-off to the Trading account to facilitate the gross profit calculation by deduction of cost of goods sold from revenues. 9.7 C/ S GREENACRES Ltd. - Perpetual Inventory System In the case study the same opening value for lamps applies: 160,000 ZAR. GREENACRES Ltd. buys 1,000 lamps and records Bookkeeping entry (A). With that Bookkeeping entry, the lamps increase the inventory level. @ 30.06.20X5 Inventories INV 1,200,000 Value Added Tax VAT 240,000 Cash/ Bank C/ B 1,400,000 (adding the purchases to inventories) <?page no="255"?> Berkau: Financial Statements 8e 9-254 D C D C (1) 1,200,000 T/ A 1,200,000 (1) 240,000 (2) 320,000 c/ d 80,000 320,000 320,000 b/ d 80,000 Purchase-20X5 PUR Value added tax VAT D C D C T/ A 1,600,000 (2) 1,600,000 INV 168,000 REV 1,600,000 PUR 1,200,000 (3) 408,000 GP 640,000 2,008,000 2,008,000 b/ d 640,000 Revenue-20X5 REV Trading account-20X5 T/ A Figure 9.1: GREENACRES Ltd.’s accounts (periodic system) continued 9.6 Perpetual Inventory System We repeat the case study GREENACRES Ltd., but now apply a perpetual system for the inventory movements. Under the perpetual system, a company adds purchases to the Inventory account directly (no Purchase account applies) and records stock releases on time. The contra account is the Cost of Goods Sold account. This enables the company to determine its stock level by balancingoff its Inventory account. To demonstrate how a company obtains stock level information during the year, we alter the Bookkeeping entries. Instead of one sale of 800 lamps we consider three single sales and stock releases at 400, 250, and then 150 units. The cost of goods sold are now calculated in an extra account which is closed-off to the Trading account to facilitate the gross profit calculation by deduction of cost of goods sold from revenues. 9.7 C/ S GREENACRES Ltd. - Perpetual Inventory System In the case study the same opening value for lamps applies: 160,000 ZAR. GREENACRES Ltd. buys 1,000 lamps and records Bookkeeping entry (A). With that Bookkeeping entry, the lamps increase the inventory level. @ 30.06.20X5 Inventories INV 1,200,000 Value Added Tax VAT 240,000 Cash/ Bank C/ B 1,400,000 (adding the purchases to inventories) Berkau: Financial Statements 8e 9-255 Based on the 3 sales, revenue is recorded in three Bookkeeping entries, with 400 lamps, then with 250 lamps and eventually with 150 lamps. All lamps are sold at a net selling price of 2,000 ZAR/ u. The total number of lamps sold is: 400 + 250 + 150 = 8 80000 llaammppss. The revenue (C 1 ) is: 400 × 2,000 = 8 80000"000000 ZZAARR, revenue (C 2 ) is: 250 × 2,000 = 5 50000"000000 ZZAARR and revenue (C 3 ) is: 150 × 2,000 = 3 30000"000000 ZZAARR. GREENACRES Ltd. records also three Bookkeeping entries (B 1 … B 3 ) for the stock releases on 1.07.20X5, on 1.08.20X5, and on 1.09.20X5. The expense account for retailers is not termed Material Expense account but Cost of Goods Sold account. The expenses and revenue recognition are recorded in the Accounting period of the sales. All Bookkeeping entries for inventory movements are based on the unit cost of purchase which are constantly 1,200 ZAR/ u. Observe the Bookkeeping entries (B 1 ) - (C 3 ) below: @ 1.07.20X5 Cash/ Bank C/ B 960,000 Value Added Tax VAT 160,000 Revenue-20X5 REV 800,000 (revenue recognition for 400 goods sold) Cost of Goods Sold-20X5 COS 480,000 Inventories INV 480,000 (stock release for 400 goods) @ 1.08.20X5 Cash/ Bank C/ B 600,000 Value Added Tax VAT 100,000 Revenue-20X5 REV 500,000 (revenue recognition for 250 goods sold) Cost of Goods Sold-20X5 COS 300,000 Inventories INV 300,000 (stock release for 250 goods) @ 1.09.20X5 Cash/ Bank C/ B 360,000 Value Added Tax VAT 60,000 Revenue-20X5 REV 300,000 (revenue recognition for 150 goods sold) Cost of Goods Sold-20X5 COS 180,000 Inventories INV 180,000 (stock release for 150 goods) With a perpetual system, GREENACRES Ltd. always knows stock levels, e.g., after the 2 nd sale: 168,000 + 1,200,000 - 480,000 - 300,000 = 5 58888"000000 ZZAARR. Study the accounts at GREENACRES Ltd. in Figure 9.2. <?page no="256"?> Berkau: Financial Statements 8e 9-256 D C D C OV 168,000 (B 1 ) 480,000 OV . . . (A) 1,440,000 (A) 1,200,000 (B 2 ) 300,000 (C 1 ) 960,000 (B 3 ) 180,000 (C 2 ) 600,000 c/ d 408,000 (C 3 ) 360,000 c/ d 480,000 1,368,000 1,368,000 1,920,000 1,920,000 b/ d 408,000 b/ d 480,000 Inventories (lamps) INV Cash/ Bank C/ B D C D C T/ A 1,600,000 (C 1 ) 800,000 (B 1 ) 480,000 T/ A 960,000 (C 2 ) 500,000 (B 2 ) 300,000 (C 3 ) 300,000 (B 3 ) 180,000 1,600,000 1,600,000 960,000 960,000 Revenue-20X5 REV Cost of goods sold-20X5 COS D C D C COS 960,000 REV 1,600,000 (A) 240,000 (C 1 ) 160,000 G/ P 640,000 (C 2 ) 100,000 1,600,000 1,600,000 c/ d 80,000 (C 3 ) 60,000 b/ d 640,000 320,000 320,000 b/ d 80,000 Trading account-20X5 T/ A Value added tax VAT Figure 9.2: GREENACRES Ltd.’s accounts (perpetual system) How it is Done (Recording Under a Perpetual Inventory System): (1) Record purchases in the Inventory account. Apply separate Inventory accounts for different goods. (2) When selling goods, make entries for the revenue recognition based on the selling price. (3) Make debit entries in the Cost of Goods Sold account for stock releases. Measure inventory movements at the lower of cost of purchase and net realisable values. (4) When required, calculate the inventory level(s) by balancing-off the Inventory account(s). (5) At the yearend, apply a Trading account for the gross profit calculation. Close-off the Cost of Goods Sold account to the Trading account. Do not make entries for opening values nor closing stock of inventories in the Trading account! Close-off the Revenue account to the Trading account too. (6) In case of returns, make entries in the Inventory account according to the case. <?page no="257"?> Berkau: Financial Statements 8e 9-256 D C D C OV 168,000 (B 1 ) 480,000 OV . . . (A) 1,440,000 (A) 1,200,000 (B 2 ) 300,000 (C 1 ) 960,000 (B 3 ) 180,000 (C 2 ) 600,000 c/ d 408,000 (C 3 ) 360,000 c/ d 480,000 1,368,000 1,368,000 1,920,000 1,920,000 b/ d 408,000 b/ d 480,000 Inventories (lamps) INV Cash/ Bank C/ B D C D C T/ A 1,600,000 (C 1 ) 800,000 (B 1 ) 480,000 T/ A 960,000 (C 2 ) 500,000 (B 2 ) 300,000 (C 3 ) 300,000 (B 3 ) 180,000 1,600,000 1,600,000 960,000 960,000 Revenue-20X5 REV Cost of goods sold-20X5 COS D C D C COS 960,000 REV 1,600,000 (A) 240,000 (C 1 ) 160,000 G/ P 640,000 (C 2 ) 100,000 1,600,000 1,600,000 c/ d 80,000 (C 3 ) 60,000 b/ d 640,000 320,000 320,000 b/ d 80,000 Trading account-20X5 T/ A Value added tax VAT Figure 9.2: GREENACRES Ltd.’s accounts (perpetual system) How it is Done (Recording Under a Perpetual Inventory System): (1) Record purchases in the Inventory account. Apply separate Inventory accounts for different goods. (2) When selling goods, make entries for the revenue recognition based on the selling price. (3) Make debit entries in the Cost of Goods Sold account for stock releases. Measure inventory movements at the lower of cost of purchase and net realisable values. (4) When required, calculate the inventory level(s) by balancing-off the Inventory account(s). (5) At the yearend, apply a Trading account for the gross profit calculation. Close-off the Cost of Goods Sold account to the Trading account. Do not make entries for opening values nor closing stock of inventories in the Trading account! Close-off the Revenue account to the Trading account too. (6) In case of returns, make entries in the Inventory account according to the case. Berkau: Financial Statements 8e 9-257 (7) Calculate the gross profit and close-off the Trading account to profit or loss. 9.8 Returns Returns are recorded when a company sends back purchased goods to its supplier or when customers bring back goods they bought. The first ones are termed returns outwards, and the latter ones returns inwards. Recording returns is a Bookkeeping topic 162 ; however, it is covered here as their journal entries depend on the inventory system. Below, we discuss the case study GREENACRES Ltd. again but now consider 50 lamps returned to the supplier and 15 lamps brought back by customers. The cost of purchase is 1,200 ZAR/ u and net selling price is 2,000 ZAR/ u. (a) Returns outwards under the periodic inventory system. (b) Returns outwards under the perpetual inventory system. (c) Returns inwards under the periodic inventory system. (d) Returns inwards under the perpetual inventory system. For all cases, entries can be made in the accounts already in use or in separate Returns Outwards and Returns Inwards account. Hence, a return outward can also be recorded as a negative purchase on the credit side of the Purchase account. The same applies for returns inwards. They can be recognised as negative sale on the debit side of the Revenue account or on the debit side of the Returns Inwards account. Preferred is a recording through returns accounts as it is easier. (a) Return of 50 lamps to the supplier under a periodic system: After the purchase of 1,000 lamps, GREENACRES Ltd. detects 50 faulty lamps and sends them back to the supplier on 5.07.20X5. The unit purchase cost is 1,200 ZAR/ u. For the return, the Returns Outwards account applies which must be credited. Like purchases, returns outwards are recorded at the cost of purchase which is the net value. At the time of return and refund, the input-VAT claim is adjusted (reduced) by making a credit entry in the Value Added Tax account. The Cash/ Bank account is debited for the refund (gross value) if the supplier makes a payment. As an alternative, suppliers can reduce the invoice which results in a debit entry in the payables or issue a voucher which gives a debit entry in receivables. Here, the supplier refunds GREENACRES Ltd. on cash. See below the Bookkeeping entries: 162 Study chapters (20 - 23) in our textbook Basics of Accounting. <?page no="258"?> Berkau: Financial Statements 8e 9-258 @ 5.07.20X5 Cash/ Bank C/ B 72,000 Value Added Tax VAT 12,000 Returns Outwards-20X5 R.O. 60,000 (recognition of a return outwards - 50 goods) @ 31.12.20X5 Returns Outwards-20X5 R.O. 60,000 Trading Account-20X5 T/ A 60,000 (closing-off the Returns Outwards account to profit or loss) The above journal entries show that the Returns Outwards account is closed-off to the Trading Account or to profit or loss. Retailers will close it off to the Trading Account and manufacturers will apply the Profit and Loss account respectively. In a periodic system, returns outwards are deducted from purchases for the calculation of the cost of goods sold. At GREENACRES Ltd., the cost of goods sold is: 168,000 + 1,200,000 - 348,000 - 60,000 = 9 96600"000000 ZZAARR. 163 A return outward does not affect the cost of goods sold. Therefore, returns outwards do not matter for profit calculations. (b) Return of 50 lamps to the supplier under a perpetual system: A return outwards results in a stock release which is combined with the input- VAT claim adjustment and the recording of a cash receipt/ invoice reduction/ voucher issue. The Returns Outwards account is closed-off to inventories. @ 5.07.20X5 Cash/ Bank C/ B 72,000 Value Added Tax VAT 12,000 Returns Outwards-20X5 R.O. 60,000 (recognition of a return outwards - 50 goods) Returns Outwards-20X5 R.O. 60,000 Inventories INV 60,000 (closing-off the Returns Outwards account to inventories) No further Bookkeeping entry is required, and profit calculation is as disclosed in Figure 7.2. (c) Returns inwards of 15 lamps under the periodic system: On 12.10.20X5, GREENACRES Ltd.’s customers return 15 lamps they previously bought at a net selling price of 2,000 163 Note, that the figure 348,000 ZAR results from inventory decrease caused by return. 408,000 - 60,000 = 348,000 ZAR. ZAR/ u. This is recorded as a return inward. The value is: 15 × 2,000 = 3 300"000000 ZZAARR. A return inward reverses a sale. Therefore, returns inwards are recognised on the debit side and are measured at net selling prices of the goods brought back. At the same time, a return inward requires a reduction of the out- <?page no="259"?> Berkau: Financial Statements 8e 9-258 @ 5.07.20X5 Cash/ Bank C/ B 72,000 Value Added Tax VAT 12,000 Returns Outwards-20X5 R.O. 60,000 (recognition of a return outwards - 50 goods) @ 31.12.20X5 Returns Outwards-20X5 R.O. 60,000 Trading Account-20X5 T/ A 60,000 (closing-off the Returns Outwards account to profit or loss) The above journal entries show that the Returns Outwards account is closed-off to the Trading Account or to profit or loss. Retailers will close it off to the Trading Account and manufacturers will apply the Profit and Loss account respectively. In a periodic system, returns outwards are deducted from purchases for the calculation of the cost of goods sold. At GREENACRES Ltd., the cost of goods sold is: 168,000 + 1,200,000 - 348,000 - 60,000 = 9 96600"000000 ZZAARR. 163 A return outward does not affect the cost of goods sold. Therefore, returns outwards do not matter for profit calculations. (b) Return of 50 lamps to the supplier under a perpetual system: A return outwards results in a stock release which is combined with the input- VAT claim adjustment and the recording of a cash receipt/ invoice reduction/ voucher issue. The Returns Outwards account is closed-off to inventories. @ 5.07.20X5 Cash/ Bank C/ B 72,000 Value Added Tax VAT 12,000 Returns Outwards-20X5 R.O. 60,000 (recognition of a return outwards - 50 goods) Returns Outwards-20X5 R.O. 60,000 Inventories INV 60,000 (closing-off the Returns Outwards account to inventories) No further Bookkeeping entry is required, and profit calculation is as disclosed in Figure 7.2. (c) Returns inwards of 15 lamps under the periodic system: On 12.10.20X5, GREENACRES Ltd.’s customers return 15 lamps they previously bought at a net selling price of 2,000 163 Note, that the figure 348,000 ZAR results from inventory decrease caused by return. 408,000 - 60,000 = 348,000 ZAR. ZAR/ u. This is recorded as a return inward. The value is: 15 × 2,000 = 3 300"000000 ZZAARR. A return inward reverses a sale. Therefore, returns inwards are recognised on the debit side and are measured at net selling prices of the goods brought back. At the same time, a return inward requires a reduction of the out- Berkau: Financial Statements 8e 9-259 put-VAT liabilities. No output-VAT applies for the returned goods and a debit entry is recorded in the Value Added Tax account. The credit entry is either in cash/ bank for a payment, in payables for a voucher, or in receivables if the invoice sent out to the customer is adjusted. The Bookkeeping entries for a return inward are recorded as shown below: @ 12.10.20X5 Returns Inwards-20X5 R.I. 30,000 Value Added Tax VAT 6,000 Cash/ Bank C/ B 36,000 (recognition of a cash return of 15 goods) @ 31.12.20X5 Trading Account-20X5 T/ A 30,000 Returns Inwards-20X5 R.I. 30,000 (closing-off of the Returns Inwards account to profit or loss) Under a periodic inventory system, no further action is required. If returned goods are not faulty, the seller puts them in stock. If the goods are faulty and are not repaired, they are disposed of. The outcome is considered once the company takes stock. Usually, a return inward is combined with a return outward when the seller takes back the goods from its customers and passes them on to its supplier. (d) Return of 15 lamps under a perpetual system. When GREENACRES Ltd. takes back the 15 lamps from its customers on 12.10.20X5 two options are considered: (d1) the customers return the lamps because of an unintentional purchase and the goods are intact. Goods are then added to inventories. In this case, the return inwards requires two entries. One for the reverse of the sale and the second one for the stock increase. The first one gives a debit entry in the Returns Inwards account based on the net selling price and adjusts the output-VAT by debiting the VAT account. A credit entry is made for the compensation (gross amount) either in cash/ bank, payables or receivables. The second Bookkeeping entry reflects that goods are put in stock. This requires an adjustment of the Cost of Goods Sold account on the credit side as those goods are no expenses anymore and a debit entry is made in the Inventory account. The value of the returned lamps is: 15 × 1,200 = 1 188"000000 ZZAARR. At the yearend, the Returns Inwards account is closed-off to either profit or loss or to the Revenue account. At GREENACRES Ltd. the value for the cost of goods sold under the assumption of returned goods being stocked gives: 480,000 + 300,000 + 180,000 - 15 × 1,200 = 9 94422"000000 ZZAARR. Therefore, the gross profit is: 1,600,000 - 30,000 - 942,000 = 6 62288"000000 ZZAARR. Observe the journalised entries below: <?page no="260"?> Berkau: Financial Statements 8e 9-260 @ 12.10.20X5 Returns Inwards-20X5 R.I. 30,000 Value Added Tax VAT 6,000 Cash/ Bank C/ B 36,000 (recognition of a cash return of 15 goods) Inventories INV 18,000 Cost of Goods Sold-20X5 COS 18,000 (closing-off of the Returns Inwards account to profit or loss) @ 31.12.20X5 Trading Account-20X5 T/ A 30,000 Returns Inwards-20X5 R.I. 30,000 (closing-off of the Returns Inwards account to profit or loss) For the case (d2), GREENACRES Ltd. simply omits the second Bookkeeping entry as goods are discarded. The cost of goods sold in 20X5 are: 480,000 + 300,000 + 180,000 = 9 96600"000000 ZZAARR. At the same time the revenue is reduced for the returns: 1,600,000 - 30,000 = 1 1"557700"000000 ZZAARR. The company’s gross profit is: 1,570,000 - 960,000 = 6 61100"000000 ZZAARR. The difference in gross profit calculations for case (d1) and case (d2) is: 15 × 1,200 = 1 188"000000 ZZAARR. If purchases and sales are based on different values and selling prices, the return calculation becomes more demanding and requires individual order tracking or the application of cost formulas to determine the sequence of stock releases. 164 9.9 Differences in Inventory Valuation So far, we discussed inventories with constant measurement. However, values of items of inventory differ due to two effects: (1a) Differences of purchase prices. 164 Check the case MONTAGUE (Pty) Ltd. in chapter (28) of our textbook Basics of Accounting. (1b) Loss in valuation: Inventory valuation can decrease while goods are on stock, e.g., loss due to deterioration, damage etc. 9.10 Different Purchase Price Application Following the principle of specific identification, a company that bought inventories at different prices must carried them at individual costs, see IAS 2.23. An exception of individual inventory valuation applies if goods are interchangeable. Interchangeability means that it is not possible to distinguish goods from each other due to technical restrictions or a high quantity, e.g., for fluids, such as gasoline in a tank or screws in a box. Sometimes, if the units’ value is too low to justify the effort for inventory tracking. Ordinary interchangeability is also fulfilled for packages of specified groceries, e.g. chicken wings where the package carries a label with different BB-dates 165 printed thereon. For ordinarily interchangeable goods, cost formulas apply. With reference to IAS 2.25, they follow the first-in-first- 165 BB stands for best before. <?page no="261"?> Berkau: Financial Statements 8e 9-260 @ 12.10.20X5 Returns Inwards-20X5 R.I. 30,000 Value Added Tax VAT 6,000 Cash/ Bank C/ B 36,000 (recognition of a cash return of 15 goods) Inventories INV 18,000 Cost of Goods Sold-20X5 COS 18,000 (closing-off of the Returns Inwards account to profit or loss) @ 31.12.20X5 Trading Account-20X5 T/ A 30,000 Returns Inwards-20X5 R.I. 30,000 (closing-off of the Returns Inwards account to profit or loss) For the case (d2), GREENACRES Ltd. simply omits the second Bookkeeping entry as goods are discarded. The cost of goods sold in 20X5 are: 480,000 + 300,000 + 180,000 = 9 96600"000000 ZZAARR. At the same time the revenue is reduced for the returns: 1,600,000 - 30,000 = 11"557700"000000 ZZAARR. The company’s gross profit is: 1,570,000 - 960,000 = 6 61100"000000 ZZAARR. The difference in gross profit calculations for case (d1) and case (d2) is: 15 × 1,200 = 1 188"000000 ZZAARR. If purchases and sales are based on different values and selling prices, the return calculation becomes more demanding and requires individual order tracking or the application of cost formulas to determine the sequence of stock releases. 164 9.9 Differences in Inventory Valuation So far, we discussed inventories with constant measurement. However, values of items of inventory differ due to two effects: (1a) Differences of purchase prices. 164 Check the case MONTAGUE (Pty) Ltd. in chapter (28) of our textbook Basics of Accounting. (1b) Loss in valuation: Inventory valuation can decrease while goods are on stock, e.g., loss due to deterioration, damage etc. 9.10 Different Purchase Price Application Following the principle of specific identification, a company that bought inventories at different prices must carried them at individual costs, see IAS 2.23. An exception of individual inventory valuation applies if goods are interchangeable. Interchangeability means that it is not possible to distinguish goods from each other due to technical restrictions or a high quantity, e.g., for fluids, such as gasoline in a tank or screws in a box. Sometimes, if the units’ value is too low to justify the effort for inventory tracking. Ordinary interchangeability is also fulfilled for packages of specified groceries, e.g. chicken wings where the package carries a label with different BB-dates 165 printed thereon. For ordinarily interchangeable goods, cost formulas apply. With reference to IAS 2.25, they follow the first-in-first- 165 BB stands for best before. Berkau: Financial Statements 8e 9-261 out (FIFO) principle or the weighted average cost calculation. 166 We cover losses in valuations after the case study ROSEFIELD Ltd. under 9.12. 9.11 C/ S ROSEFIELD Ltd. ROSEFIELD Ltd. is a toy shop. It applies a perpetual system for its inventory movements. In the first case (i), ROSEFIELD Ltd. applies the first-infirst-out formula, below (ii), we cover the identical case but then apply the weighted average cost formula. First-in-First-out - Case (i): ROSEFIELD Ltd. is a retailer for game consoles in Melbourne. Data Sheet for ROSEFIELD Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((MMeellbboouurrnnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : RReettaaiilleerr.. OOppeenniinngg vvaalluuee: : zzeerroo.. PPuurrcchhaasseess: : sseeee FFiigguurree 99..33.. SSaalleess: : II--VVII/ / 2200XX00: : 110000 ×× GGaammee CCoonnssoolleess-- 440000; ; VVIIII--XXIIII/ / 2200XX00: : 114488 ×× GGaammee CCoonnssoolleess-- 440000; ; 112266 ×× GGaammee CCoonnssoolleess--550000.. NNeett sseelllliinngg pprriicceess: : GGaammee CCoonnssoollee--440000 aatt 220000 AAUUDD/ / uu; ; GGaammee CCoonnssoollee--550000 aatt 335500 AAUUDD/ / uu.. VVAATT rraattee: : 2200 %%.. ROSEFIELD Ltd. purchases the game consoles from a local supplier at different prices. It’s purchase journal is disclosed in Figure 9.3 below. Game consoles of the same type are ordinarily interchangeable; therefore, ROSEFIELD Ltd.’s inventory valuation does not follow individual identification but is based on cost formulas, here: first-in-first-out. All game consoles carry a type identifier label. ROSEFIELD Ltd. applies two separate inventory accounts: one for Game Consoles-400 and the other one for Game Consoles-500. At the beginning of 20X0, no game consoles are on stock. See below the Purchase Journal as recorded in 20X0. Date Item Amount Purchase price [AUD] 5.01.20X0 Game Console-400 80 120 5.01.20X0 Game Console-500 50 200 1.04.20X0 Game Console-400 100 125 1.04.20X0 Game Console-500 100 210 1.07.20X0 Game Console-400 75 130 1.07.20X0 Game Console-500 100 215 1.10.20X0 Game Console-400 100 130 Rosefield Ltd. PURCHASE JOURNAL for the period ended 31.12.20X0 Figure 9.3: ROSEFIELD Ltd.’s purchases 166 Cost formulas are covered in our textbook Basics of Accounting, chapter (27). <?page no="262"?> Berkau: Financial Statements 8e 9-262 In 20X0, ROSEFIELD Ltd. sells 100 Game Consoles-400 in the first half of the year and another 148 Game Consoles-400 in the second half. The net selling price per Game Console-400 is 200 AUD/ u. No Game Console-500 is sold during the first half of 20X0. During the second half of the year, ROSEFIELD Ltd. sells 126 Game Consoles-500 at a net selling price of 350 AUD/ u. To keep the case simple, we pretend sales take place either on 30.06.20X0 or 31.12.20X0. The first sale of 100 Game Consoles-400 causes stock releases of: 80 × 120 + 20 × 125 = 1122"110000 AAUUDD. Thereafter, 80 Game Consoles-400 are left on stock at 125 AUD/ u. The revenue earned by selling 100 Game Consoles-400 is: 100 × 200 = 2 200"000000 AAUUDD. ROSEFIELD Ltd. records the sale of Game Consoles-400 as Bookkeeping entries (8) and (9i) on 30.06.20X0: @ 30.06.20X0 Cash/ Bank C/ B 24,000 Value Added Tax VAT 4,000 Revenue-20X0 REV 20,000 (revenue recognition of 100 Game Consoles-400 sold) Cost of Goods Sold-20X0 COS 12,100 Inventories IN4 12,100 (stock release of 100 Game Consoles-400) In the second half of 20X0, ROSEFIELD Ltd. sells 148 Game Consoles-400 at 200 AUD/ u and earns a revenue of: 148 × 200 = 2 299"660000 AAUUDD. The costs of goods sold are: (100 - 20) × 125 + (148 - 80) × 130 = 1188"884400 AAUUDD. Observe Bookkeeping entries (10) and (11i) which ROSEFIELD Ltd. records on 31.12.20X0. @ 31.12.20X0 Cash/ Bank C/ B 35,520 Value Added Tax VAT 5,920 Revenue-20X0 REV 29,600 (revenue recognition of 148 Game Consoles-400 sold) Cost of Goods Sold-20X0 COS 18,840 Inventories IN4 18,840 (stock release of 148 Game Consoles-400) With the sale of the Game Consoles-500 ROSEFIELD Ltd. earns a revenue of: 126 × 350 = 4 444"110000 AAUUDD. The cost of goods sold are: 50 × 200 + (126 - 50) × 210 = 2255"996600 AAUUDD. Check Bookkeeping entries (12) and (13i) recorded both on 31.12.20X0. <?page no="263"?> Berkau: Financial Statements 8e 9-262 In 20X0, ROSEFIELD Ltd. sells 100 Game Consoles-400 in the first half of the year and another 148 Game Consoles-400 in the second half. The net selling price per Game Console-400 is 200 AUD/ u. No Game Console-500 is sold during the first half of 20X0. During the second half of the year, ROSEFIELD Ltd. sells 126 Game Consoles-500 at a net selling price of 350 AUD/ u. To keep the case simple, we pretend sales take place either on 30.06.20X0 or 31.12.20X0. The first sale of 100 Game Consoles-400 causes stock releases of: 80 × 120 + 20 × 125 = 1122"110000 AAUUDD. Thereafter, 80 Game Consoles-400 are left on stock at 125 AUD/ u. The revenue earned by selling 100 Game Consoles-400 is: 100 × 200 = 2200"000000 AAUUDD. ROSEFIELD Ltd. records the sale of Game Consoles-400 as Bookkeeping entries (8) and (9i) on 30.06.20X0: @ 30.06.20X0 Cash/ Bank C/ B 24,000 Value Added Tax VAT 4,000 Revenue-20X0 REV 20,000 (revenue recognition of 100 Game Consoles-400 sold) Cost of Goods Sold-20X0 COS 12,100 Inventories IN4 12,100 (stock release of 100 Game Consoles-400) In the second half of 20X0, ROSEFIELD Ltd. sells 148 Game Consoles-400 at 200 AUD/ u and earns a revenue of: 148 × 200 = 2 299"660000 AAUUDD. The costs of goods sold are: (100 - 20) × 125 + (148 - 80) × 130 = 1188"884400 AAUUDD. Observe Bookkeeping entries (10) and (11i) which ROSEFIELD Ltd. records on 31.12.20X0. @ 31.12.20X0 Cash/ Bank C/ B 35,520 Value Added Tax VAT 5,920 Revenue-20X0 REV 29,600 (revenue recognition of 148 Game Consoles-400 sold) Cost of Goods Sold-20X0 COS 18,840 Inventories IN4 18,840 (stock release of 148 Game Consoles-400) With the sale of the Game Consoles-500 ROSEFIELD Ltd. earns a revenue of: 126 × 350 = 4 444"110000 AAUUDD. The cost of goods sold are: 50 × 200 + (126 - 50) × 210 = 2255"996600 AAUUDD. Check Bookkeeping entries (12) and (13i) recorded both on 31.12.20X0. Berkau: Financial Statements 8e 9-263 @ 31.12.20X0 Cash/ Bank C/ B 52,920 Value Added Tax VAT 8,820 Revenue-20X0 REV 44,100 (revenue recognition of 126 Game Consoles-500 sold) Cost of Goods Sold-20X0 COS 25,960 Inventories IN5 25,960 (stock release of 126 Game Consoles-500) Study the accounts in Figure 9.4. The gross profit calculation is in the Trading account. In contrast to the application of a periodic inventory movement system, the Trading account only shows revenues and the cost of goods sold (COS). D C D C (1) 9,600 (9i) 12,100 (2) 10,000 (13i) 25,960 (3) 12,500 (11i) 18,840 (4) 21,000 (5) 9,750 (6) 21,500 c/ d 26,540 (7) 13,000 c/ d 13,910 52,500 52,500 44,850 44,850 b/ d 26,540 b/ d 13,910 Inventory Game Console-400 IN4 Inventory Game Console-500 IN5 D C D C (1) 1,920 (8) 4,000 (8) 24,000 (1) 11,520 (2) 2,000 (10) 5,920 (10) 35,520 (2) 12,000 (3) 2,500 (12) 8,820 (12) 52,920 (3) 15,000 (4) 4,200 (4) 25,200 (5) 1,950 (5) 11,700 (6) 4,300 (6) 25,800 (7) 2,600 c/ d 730 c/ d 4,380 (7) 15,600 19,470 19,470 116,820 116,820 b/ d 730 b/ d 4,380 Value added tax VAT Cash/ Bank C/ B D C D C (8) 20,000 (9i) 12,100 (10) 29,600 (11i) 18,840 c/ d 93,700 (12) 44,100 (13i) 25,960 c/ d 56,900 93,700 93,700 56,900 56,900 T/ A 93,700 b/ d 93,700 b/ d 56,900 T/ A 56,900 Revenue-20X0 REV Cost of goods sold-20X0 COS Figure 9.4: ROSEFIELD Ltd.’s accounts (i: FIFO) <?page no="264"?> Berkau: Financial Statements 8e 9-264 D C COS 56,900 REV 93,700 G/ P 36,800 93,700 93,700 b/ d 36,800 Trading account-20X0 T/ A Figure 9.4: ROSEFIELD Ltd.’s accounts (i: FIFO) continued Weighted Average - Case (ii): If ROSEFIELD Ltd. applies the weighted average cost formula, it must calculate for every stock release the average value of game consoles under consideration of their actual numbers. The sales taking place either on 30.06.20X0 or 31.12.20X0 affects the game console valuations. The average value calculation solely considers the number and the costs for game consoles that have been purchased until then. For studying the differences, we only replace Bookkeeping entries (9i), (11i) and (13i) made for stock releases. Bookkeeping entry (9ii) replaces Bookkeeping entry (9i). In contrast to the FIFO cost formula, ROSEFIELD Ltd. now calculates the weighted average costs for the Game Consoles-400 on 30.06.20X0 as: (80 × 120 + 100 × 125) / 180 = 1 12222..7788 AAUUDD/ / uu. Hence, the inventory movement is: 100 × 122.78 = 1 122"227788 AAUUDD. The Bookkeeping entry (9ii) is recorded on 30.06.20X0 as below: @ 30.06.20X0 Cost of Goods Sold-20X0 COS 12,278 Inventories IN4 12,278 (stock release of 100 Game Consoles-400) The Bookkeeping entry (11ii) replaces Bookkeeping entry (11i). The valuation of Game Consoles-400 at weighted average cost on 31.12.20X0 is: ((180 - 100) × 122.78 + 75 × 130 + 100 × 130) / (80 + 75 + 100) = 1 12277..7733 AAUUDD/ / uu. Hence, the cost of goods sold are: 148 × 127.73 = 1188"990044..7766 AAUUDD. The calculation is based on the exact value for the weighted average costs. No rounding of the value of 127.73 AUD/ u is considered. For the Bookkeeping entry (11ii), we consider 18,905 AUD: @ 31.12.20X0 Cost of Goods Sold-20X0 COS 18,905 Inventories IN4 18,905 (stock release of 148 Game Consoles-400) The Bookkeeping entry (13ii) replaces Bookkeeping entry (13i). The valuation of the Game Consoles-500 at weighted average on 31.12.20X0 is: (50 × 200 + 100 × 210 + 100 × 215) / (50 + 100 + 100) = 221100 AAUUDD/ / uu. Therefore, the cost of <?page no="265"?> Berkau: Financial Statements 8e 9-264 D C COS 56,900 REV 93,700 G/ P 36,800 93,700 93,700 b/ d 36,800 Trading account-20X0 T/ A Figure 9.4: ROSEFIELD Ltd.’s accounts (i: FIFO) continued Weighted Average - Case (ii): If ROSEFIELD Ltd. applies the weighted average cost formula, it must calculate for every stock release the average value of game consoles under consideration of their actual numbers. The sales taking place either on 30.06.20X0 or 31.12.20X0 affects the game console valuations. The average value calculation solely considers the number and the costs for game consoles that have been purchased until then. For studying the differences, we only replace Bookkeeping entries (9i), (11i) and (13i) made for stock releases. Bookkeeping entry (9ii) replaces Bookkeeping entry (9i). In contrast to the FIFO cost formula, ROSEFIELD Ltd. now calculates the weighted average costs for the Game Consoles-400 on 30.06.20X0 as: (80 × 120 + 100 × 125) / 180 = 1 12222..7788 AAUUDD/ / uu. Hence, the inventory movement is: 100 × 122.78 = 1122"227788 AAUUDD. The Bookkeeping entry (9ii) is recorded on 30.06.20X0 as below: @ 30.06.20X0 Cost of Goods Sold-20X0 COS 12,278 Inventories IN4 12,278 (stock release of 100 Game Consoles-400) The Bookkeeping entry (11ii) replaces Bookkeeping entry (11i). The valuation of Game Consoles-400 at weighted average cost on 31.12.20X0 is: ((180 - 100) × 122.78 + 75 × 130 + 100 × 130) / (80 + 75 + 100) = 1 12277..7733 AAUUDD/ / uu. Hence, the cost of goods sold are: 148 × 127.73 = 1188"990044..7766 AAUUDD. The calculation is based on the exact value for the weighted average costs. No rounding of the value of 127.73 AUD/ u is considered. For the Bookkeeping entry (11ii), we consider 18,905 AUD: @ 31.12.20X0 Cost of Goods Sold-20X0 COS 18,905 Inventories IN4 18,905 (stock release of 148 Game Consoles-400) The Bookkeeping entry (13ii) replaces Bookkeeping entry (13i). The valuation of the Game Consoles-500 at weighted average on 31.12.20X0 is: (50 × 200 + 100 × 210 + 100 × 215) / (50 + 100 + 100) = 221100 AAUUDD/ / uu. Therefore, the cost of Berkau: Financial Statements 8e 9-265 sales for the Game Consoles-500 is: 126 x 210 = 2266"446600 AAUUDD. The Bookkeeping entry (13ii) is recorded on 31.12.20X0. Observe the gross profit calculation in Figure 9.5: @ 31.12.20X0 Cost of Goods Sold-20X0 COS 26,460 Inventories IN5 26,460 (stock release of 126 Game Consoles-500) D C D C (1) 9,600 (9ii) 12,278 (2) 10,000 (13ii) 26,460 (3) 12,500 (11ii) 18,905 (4) 21,000 (5) 9,750 (6) 21,500 c/ d 26,040 (7) 13,000 c/ d 13,668 52,500 52,500 44,850 44,850 b/ d 26,040 b/ d 13,668 Inventory Game Console-400 IN4 Inventory Game Console-500 IN5 D C D C (1) 1,920 (8) 4,000 (8) 24,000 (1) 11,520 (2) 2,000 (10) 5,920 (10) 35,520 (2) 12,000 (3) 2,500 (12) 8,820 (12) 52,920 (3) 15,000 (4) 4,200 (4) 25,200 (5) 1,950 (5) 11,700 (6) 4,300 (6) 25,800 (7) 2,600 c/ d 730 c/ d 4,380 (7) 15,600 19,470 19,470 116,820 116,820 b/ d 730 b/ d 4,380 Value added tax VAT Cash/ Bank C/ B D C D C (8) 20,000 (9ii) 12,278 (10) 29,600 (11ii) 18,905 c/ d 93,700 (12) 44,100 (13ii) 26,460 c/ d 57,642 93,700 93,700 57,642 57,642 b/ d 93,700 b/ d 93,700 b/ d 57,642 T/ A 57,642 Revenue-20X0 REV Cost of goods sold-20X0 COS D C COS 57,642 REV 93,700 G/ P 36,058 93,700 93,700 b/ d 36,058 Trading account-20X0 T/ A Figure 9.5: ROSEFIELD Ltd.’s accounts (ii: weighted average) <?page no="266"?> Berkau: Financial Statements 8e 9-266 How it is Done (Inventory Calculations based on Weighted Average Cost Formula): (1) Determine the unit costs and quantity of the opening value of inventory. (For inventory value calculations prepare extra workings.) (2) When you add items to the Inventory account determine their value and amount. (3) Calculate the weighted average unit costs by the formula c = (a × x + b × y)/ (a + b). a is the number of prior stock; x is the unit costs of prior stock; b is the number of goods put in stock and y is the cost of purchase for inputs. c is the unit costs of the current stock. Enhance the formula for multiple inputs. (4) When you release goods from stock, multiply their number with the unit costs c. (5) Continue by step (2) and (3) for inputs or (4) for outputs. You can study the extended ROSEFILED Ltd. case study with consideration of returns and trade discounts and more purchases and sales of game consoles. Download the case study through the QR code below, shown in Link 9.A. Link 9.A: ROSEFIELD Ltd. 9.12 Loss on Valuation Inventory valuation can decrease due to deterioration, damage or declining of selling prices, too. Stock is written down to their net realisable values, as required by IAS 2.28. The routine to mark down inventory resembles an impairment loss Bookkeeping entry; however, the technical term is writing inventory down or off - the latter one for destroyed items of inventory. The down/ off-writing is recorded as expense. IAS 2.30 requires calculating the net realisable value based on best evidence available. 9.13 C/ S HEISTEL (Pty) Ltd. Below we study the case of HEISTEL (Pty) Ltd. for inventory decreases in valuation. Data Sheet for HEISTEL (Pty) Ltd. DDoommiicciillee: : GGeerrmmaannyy ((SSaaaarrbbrrüücckkeenn)).. RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : RReettaaiilleerr.. OOppeenniinngg vvaalluuee: : 3388"225500 EEUURR ((4455 llaappttooppss aatt 885500 EEUURR/ / uu.. NNeett sseelllliinngg pprriiccee: : 11"220000 EEUURR/ / uu.. NNeeww ggrroossss sseelllliinngg pprriiccee ((oonn ssppeecciiaall)): : 999999 EEUURR/ / uu.. VVAATT rraattee: : 2200 %%.. The laptop retailer HEISTEL (Pty) Ltd. recently bought 200 laptops from its supplier SUNNY AG at unit costs of 850 EUR/ u. The net selling price is 1,200 EUR/ u. At the end of 20X4, there are 45 <?page no="267"?> Berkau: Financial Statements 8e 9-266 How it is Done (Inventory Calculations based on Weighted Average Cost Formula): (1) Determine the unit costs and quantity of the opening value of inventory. (For inventory value calculations prepare extra workings.) (2) When you add items to the Inventory account determine their value and amount. (3) Calculate the weighted average unit costs by the formula c = (a × x + b × y)/ (a + b). a is the number of prior stock; x is the unit costs of prior stock; b is the number of goods put in stock and y is the cost of purchase for inputs. c is the unit costs of the current stock. Enhance the formula for multiple inputs. (4) When you release goods from stock, multiply their number with the unit costs c. (5) Continue by step (2) and (3) for inputs or (4) for outputs. You can study the extended ROSEFILED Ltd. case study with consideration of returns and trade discounts and more purchases and sales of game consoles. Download the case study through the QR code below, shown in Link 9.A. Link 9.A: ROSEFIELD Ltd. 9.12 Loss on Valuation Inventory valuation can decrease due to deterioration, damage or declining of selling prices, too. Stock is written down to their net realisable values, as required by IAS 2.28. The routine to mark down inventory resembles an impairment loss Bookkeeping entry; however, the technical term is writing inventory down or off - the latter one for destroyed items of inventory. The down/ off-writing is recorded as expense. IAS 2.30 requires calculating the net realisable value based on best evidence available. 9.13 C/ S HEISTEL (Pty) Ltd. Below we study the case of HEISTEL (Pty) Ltd. for inventory decreases in valuation. Data Sheet for HEISTEL (Pty) Ltd. DDoommiicciillee: : GGeerrmmaannyy ((SSaaaarrbbrrüücckkeenn)).. RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : RReettaaiilleerr.. OOppeenniinngg vvaalluuee: : 3388"225500 EEUURR ((4455 llaappttooppss aatt 885500 EEUURR/ / uu.. NNeett sseelllliinngg pprriiccee: : 11"220000 EEUURR/ / uu.. NNeeww ggrroossss sseelllliinngg pprriiccee ((oonn ssppeecciiaall)): : 999999 EEUURR/ / uu.. VVAATT rraattee: : 2200 %%.. The laptop retailer HEISTEL (Pty) Ltd. recently bought 200 laptops from its supplier SUNNY AG at unit costs of 850 EUR/ u. The net selling price is 1,200 EUR/ u. At the end of 20X4, there are 45 Berkau: Financial Statements 8e 9-267 laptops left. SUNNY AG started already with the production of a new laptop model. To clear stock, HEISTEL (Pty) Ltd. intends to sell the laptops at 999 EUR/ u gross selling price in January/ 20X5. The net selling price per unit is: 999 / 120% = 883322..5500 EEUURR/ / uu. The planned (future) sale is sufficient evidence for writing-down inventories on 31.12.20X4. The valuation decreases by: 45 × (850 - 832.50) = 778877..5500 EEUURR. The Bookkeeping entry below records the inventory writing-down. The Loss on Write-down Inventory account is closed-off to profit or loss. @ 31.12.20X4 Loss on Write-down-20X4 LWD 788 Inventories INV 788 (value adjustment for laptops on stock due to stock clearance) Profit and Loss-20X4 P4L 788 Loss on Write-down-20X4 LWD 788 (closing-off the Loss on Write Down account) The new valuation of the 45 laptops on the statement of financial position is: 45 × 832.50 = 3 377"446622..5500 EEUURR . How it is Done (Writing-down Inventories): (1) Determine the carrying value and valuation of inventories as well as the fair value (net realisable value). (2) If the fair value is the same or above the carrying value, nothing needs to be done. (3) If the fair value is below the carrying value, determine the difference on valuation. (4) Record the difference on valuation as a debit entry in the Loss on Write-down Inventory account (expense). Make the contra entry in the Inventory account. (5) At the end of the Accounting period, close-off the Loss on Write-down Inventory account to the Profit and Loss account. An alternative inventory measurement method based on IAS 2.22 is the retail method. It is based on selling prices and a known percentage sales margin. It only applies for cases if it is impracticable to apply other costing methods. The retail method is appropriate for large volumes of fast turning goods. 167 Find the task in the study material portal. We recommend studying task A4.41 RIVERGATE (Pty) Ltd., which is an online trader for laptops. The task is about different laptop types and increasing purchase prices as well as a drop in inventory values due to discontinuation of one laptop model. 167 <?page no="268"?> Berkau: Financial Statements 8e 9-268 9.14 Manufacturing Accounting Manufacturing Accounting is about the calculation of finished goods. The cost of manufacturing are the costs for production. They comprise of direct materials and costs of conversion. IAS 2.12 defines cost of conversion. They comprise of direct labour costs plus systematically allocated manufacturing overheads, e.g., depreciation on production facilities, indirect labour etc. For the calculation of finished goods, the Work-in-Process account applies. We focus on Job Order Costing as it is the most common method in Manufacturing Accounting and is always applicable. If similar or equal products are manufactured, e.g., in a brewery or in Pharmaceutical industry, Process Costing can apply, too. 168 With a Job Order Costing system, direct costs, e.g., purchase costs for materials and direct labour, are accumulated towards job orders, represented by the Work-in-Process account. The Work-in-Process account shows the cost of the goods produced per batch. A job order is an internal order for parts production or assembling. In contrast, a customer order is an order assigned to one client and about a final product or spare parts if sold to customers. Manufacturing Accounting requires the recording of overheads in the factory and their allocation to finished goods. At first, manufacturing costs are recorded in expense accounts linked to 168 Process Costing is covered in our textbook Management Accounting for the case study EDEWECHT (Pty) Ltd. in chapter (19). cost categories, like depreciation, supervisors’ salary etc. Thereafter, manufacturing overheads are allocated to departments/ cost centres. For now, a cost centre is just a small production department. All cost centres get discharged by the application of overheads. Overhead application means to charge the job orders for the service they use in the cost centre. Therefore, manufacturing overheads are allocated to job orders. The Work-in-Process account is debited, and a credit entry is made in the Manufacturing Overheads account of the cost centre that renders the service. All overheads which are not linked to production are recorded in non-Manufacturing accounts, e.g., Administration, Other Expenses account etc., and closed-off to the Profit and Loss account directly. We summarise: In manufacturing companies and production firms, there are three different kinds of accounts: - Work-in-Process account: representing single job orders. - Manufacturing Overheads accounts: linked to cost centres or cost centre groups in production. - Non-manufacturing accounts: linked to departments not involved in production. They are usually named following their function, e.g., Administration account, Marketing account etc. The Work-in-Process account supports the calculation of finished goods. Once all costs are added to the Workin-Process account including applied <?page no="269"?> Berkau: Financial Statements 8e 9-268 9.14 Manufacturing Accounting Manufacturing Accounting is about the calculation of finished goods. The cost of manufacturing are the costs for production. They comprise of direct materials and costs of conversion. IAS 2.12 defines cost of conversion. They comprise of direct labour costs plus systematically allocated manufacturing overheads, e.g., depreciation on production facilities, indirect labour etc. For the calculation of finished goods, the Work-in-Process account applies. We focus on Job Order Costing as it is the most common method in Manufacturing Accounting and is always applicable. If similar or equal products are manufactured, e.g., in a brewery or in Pharmaceutical industry, Process Costing can apply, too. 168 With a Job Order Costing system, direct costs, e.g., purchase costs for materials and direct labour, are accumulated towards job orders, represented by the Work-in-Process account. The Work-in-Process account shows the cost of the goods produced per batch. A job order is an internal order for parts production or assembling. In contrast, a customer order is an order assigned to one client and about a final product or spare parts if sold to customers. Manufacturing Accounting requires the recording of overheads in the factory and their allocation to finished goods. At first, manufacturing costs are recorded in expense accounts linked to 168 Process Costing is covered in our textbook Management Accounting for the case study EDEWECHT (Pty) Ltd. in chapter (19). cost categories, like depreciation, supervisors’ salary etc. Thereafter, manufacturing overheads are allocated to departments/ cost centres. For now, a cost centre is just a small production department. All cost centres get discharged by the application of overheads. Overhead application means to charge the job orders for the service they use in the cost centre. Therefore, manufacturing overheads are allocated to job orders. The Work-in-Process account is debited, and a credit entry is made in the Manufacturing Overheads account of the cost centre that renders the service. All overheads which are not linked to production are recorded in non-Manufacturing accounts, e.g., Administration, Other Expenses account etc., and closed-off to the Profit and Loss account directly. We summarise: In manufacturing companies and production firms, there are three different kinds of accounts: - Work-in-Process account: representing single job orders. - Manufacturing Overheads accounts: linked to cost centres or cost centre groups in production. - Non-manufacturing accounts: linked to departments not involved in production. They are usually named following their function, e.g., Administration account, Marketing account etc. The Work-in-Process account supports the calculation of finished goods. Once all costs are added to the Workin-Process account including applied Berkau: Financial Statements 8e 9-269 overheads from manufacturing cost centres their total costs are allocated to the Finished Goods Inventory account. If you divide the cost of manufacturing by the lot size the result is the unit costs of manufacturing. 9.15 Overhead Application The allocation of manufacturing overheads to job orders (debit entry Workin-Process account - credit entry Manufacturing Overheads) is called overhead application. In Financial Accounting, the application of overheads follows a Full Cost Accounting system. Therefore, variable and fixed manufacturing overheads are transferred together. 169 This is relevant as with a full costs application the unit costs increase because of low volumes. IAS 2.12 requires the application of overheads. For the facilitation of applying overheads, we must multiply the performance of the cost centre by a predetermined overhead allocation rate, e.g., 150 EUR/ MH (per machinehour). A job order for which the cost centre rendered 3 hours of service is charged with: 3 × 150 = 450 EUR of the manufacturing overheads therein. These are accrued to the Work-in-Process account on its debit side. The most accurate calculation is achieved if all calculations are based on actual costs. However, during production, the actual data are not available (yet). Therefore, the overhead application follows budgeted values at normal capacity. An overhead allocation rate is 169 In Management Accounting, we apply marginal Cost Accounting systems to avoid miscalculations induced by over-capacity. calculated as budgeted costs over normal volume (capacity). The use of predetermined cost rates is likely to cause applied overheads to differ from actual ones. This results either in overor underapplication of overheads. Underapplication of manufacturing overheads often is referred to as idle costs. IAS 2.13 requires applying manufacturing overheads based on normal capacity. Normal capacity is the average capacity in the past with consideration of usual interruptions caused by maintenance and impairments. All Manufacturing Overheads accounts are closed-off to the Profit and Loss account after completion of overhead applications. You could say the closing difference (“the rest”) is transferred to profit or loss. 9.16 C/ S RIEBEECK-KASTEEL (Pty) Ltd. Below, we study an under-application of overheads for RIEBEECK- KASTEEL (Pty) Ltd., a production firm for maps in South Africa. Data Sheet for RIEBEECK-KASTEEL (Pty) Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((LLaannggeebbaaaann)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : MMaannuuffaaccttuurreerr.. PPeerriiooddss: : 2200XX66 bbuuddggeetteedd / / 2200XX66 aaccttuuaall.. OOvveerrhheeaaddss: : ddeepprreecciiaattiioonn: : 225500"000000 ZZAARR/ / mm; ; ssuuppeerrvviissoorrss’’ ssaallaarryy: : 111100"000000 ZZAARR/ / mm; ; aaddmmiinniissttrraattiioonn: : 112244"000000 ZZAARR/ / mm.. PPrroodduuccttiioonn aammoouunntt: : 660000"000000 mmaappss iinn 116600 hhrrss / / 445500"000000 mmaappss iinn 112244 hhrrss.. DDiirreecctt mmaatteerriiaallss: : ppaappeerr 11..2200 ZZAARR/ / uu; ; iinnkk 00..8800 ZZAARR/ / uu.. <?page no="270"?> Berkau: Financial Statements 8e 9-270 NNeett sseelllliinngg pprriiccee: : 77 ZZAARR/ / uu.. IInn 2200XX66" RRIIEEBBEEEECCKK--KKAASSTTEEEELL ((PPttyy)) LLttdd.. sseellllss 338855"000000 mmaappss.. VVAATT rraattee: : 2200 %%.. The company’s expenses comprise of direct costs, which are direct materials for paper and ink, and of overheads, which are indirect labour, depreciation and administrative costs. Materials are purchases based on the budgeted values; no safety stock applies. Stock releases depend on the actual volume. If the company prints less maps than budgeted for, a closing stock of materials is left. For the sake of simplicity, the opening values for both materials are zero in the case study. For the map printing, RIEBEECK-KASTEEL (Pty) Ltd. uses a printer with an annual depreciation of 250,000 ZAR/ a. Further manufacturing overheads are the supervisors’ salary in the printing department at 110,000 ZAR/ a. Administration costs of 124,000 ZAR/ a apply, too but are not linked to production. In 20X6, RIEBEECK-KASTEEL (Pty) Ltd. intends to print 600,000 maps. The scheduled production time is 160 hours, which gives an output rate of: 600,000 / 160 = 33"775500 uu/ / hhoouurr. RIEBEECK-KASTEEL (Pty) Ltd. measures its printing volume in hours. The calculation of the predetermined overhead allocation rate is discussed further down. Its reference unit is ZAR/ h as it also refers to the printing hours. Paper costs per map are 1.20 ZAR/ u and for ink 0.80 ZAR/ u. For the intended map volume, RIEBEECK-KASTEEL (Pty) Ltd. purchases paper at: 1.20 × 600,000 = 772200"000000 ZZAARR. Ink is purchased for: 0.80 × 600,000 = 4 48800"000000 ZZAARR. At the time of material purchases RIEBEECK-KASTEEL (Pty) Ltd. does not know its production volume yet. After production is completed, all maps are added to the Finished Goods Inventory account. When sold, the costs of maps are recorded as expenses in the Cost of Goods Sold account. The net selling price per map is 7 ZAR/ u. RIEBEECK- KASTEEL (Pty) Ltd. intends selling all 600,000 maps in 20X6. A revenue of: 7 × 600,000 = 4 4"220000"000000 ZZAARR is expected. In Figure 9.6, we show Manufacturing Accounting based on the budgeted volumes. We calculate the predetermined overhead allocation rate which considers normal capacity (= 160 hours for 600,000 maps). The rate allocates printer depreciation and the supervisors’ salary of the printing department to the job order. The predetermined overhead allocation rate is: (250,000 + 110,000) / 160 = 22"225500 ZZAARR/ / hh. It is referred to as predetermined as it is based on budgeted volume and expenses. Below, we disclose all accounts with planned values. Remember, that the accounts in Figure 9.6 are no records of the actual production. They are used for product calculation and profit planning. 170 170 For a calculation of planned cash flows (not discussed in this textbook) we consider VAT and prepare a Cash/ Bank account. <?page no="271"?> Berkau: Financial Statements 8e 9-270 NNeett sseelllliinngg pprriiccee: : 77 ZZAARR/ / uu.. IInn 2200XX66" RRIIEEBBEEEECCKK--KKAASSTTEEEELL ((PPttyy)) LLttdd.. sseellllss 338855"000000 mmaappss.. VVAATT rraattee: : 2200 %%.. The company’s expenses comprise of direct costs, which are direct materials for paper and ink, and of overheads, which are indirect labour, depreciation and administrative costs. Materials are purchases based on the budgeted values; no safety stock applies. Stock releases depend on the actual volume. If the company prints less maps than budgeted for, a closing stock of materials is left. For the sake of simplicity, the opening values for both materials are zero in the case study. For the map printing, RIEBEECK-KASTEEL (Pty) Ltd. uses a printer with an annual depreciation of 250,000 ZAR/ a. Further manufacturing overheads are the supervisors’ salary in the printing department at 110,000 ZAR/ a. Administration costs of 124,000 ZAR/ a apply, too but are not linked to production. In 20X6, RIEBEECK-KASTEEL (Pty) Ltd. intends to print 600,000 maps. The scheduled production time is 160 hours, which gives an output rate of: 600,000 / 160 = 33"775500 uu/ / hhoouurr. RIEBEECK-KASTEEL (Pty) Ltd. measures its printing volume in hours. The calculation of the predetermined overhead allocation rate is discussed further down. Its reference unit is ZAR/ h as it also refers to the printing hours. Paper costs per map are 1.20 ZAR/ u and for ink 0.80 ZAR/ u. For the intended map volume, RIEBEECK-KASTEEL (Pty) Ltd. purchases paper at: 1.20 × 600,000 = 772200"000000 ZZAARR. Ink is purchased for: 0.80 × 600,000 = 4 48800"000000 ZZAARR. At the time of material purchases RIEBEECK-KASTEEL (Pty) Ltd. does not know its production volume yet. After production is completed, all maps are added to the Finished Goods Inventory account. When sold, the costs of maps are recorded as expenses in the Cost of Goods Sold account. The net selling price per map is 7 ZAR/ u. RIEBEECK- KASTEEL (Pty) Ltd. intends selling all 600,000 maps in 20X6. A revenue of: 7 × 600,000 = 4 4"220000"000000 ZZAARR is expected. In Figure 9.6, we show Manufacturing Accounting based on the budgeted volumes. We calculate the predetermined overhead allocation rate which considers normal capacity (= 160 hours for 600,000 maps). The rate allocates printer depreciation and the supervisors’ salary of the printing department to the job order. The predetermined overhead allocation rate is: (250,000 + 110,000) / 160 = 22"225500 ZZAARR/ / hh. It is referred to as predetermined as it is based on budgeted volume and expenses. Below, we disclose all accounts with planned values. Remember, that the accounts in Figure 9.6 are no records of the actual production. They are used for product calculation and profit planning. 170 170 For a calculation of planned cash flows (not discussed in this textbook) we consider VAT and prepare a Cash/ Bank account. Berkau: Financial Statements 8e 9-271 D C D C OV . . . (1) 864,000 (1) 144,000 (12) 840,000 (12) 5,040,000 (2) 576,000 (2) 96,000 (4) 110,000 c/ d 600,000 (5) 124,000 840,000 840,000 c/ d 3,366,000 b/ d 600,000 5,040,000 5,040,000 b/ d 3,366,000 Cash/ Bank C/ B Value added tax VAT D C D C (1) 720,000 (6) 720,000 (2) 480,000 (7) 480,000 Inventory (paper) INP Inventory (ink) INI D C D C (3) 250,000 (8) 250,000 c/ d 250,000 (3) 250,000 b/ d 250,000 Depreciation on printer-20X6 DPR Accumulated depreciation ACC D C D C (4) 110,000 (9) 110,000 (5) 124,000 P&L 124,000 Supervisors' salary-20X6 LAB Administration-20X6 ADM D C D C (6) 720,000 (10) 1,560,000 (8) 250,000 WIP 360,000 (7) 480,000 (9) 110,000 MOH 360,000 360,000 360,000 1,560,000 1,560,000 Work-in-Process-20X6 WIP Manufacturing overheads-20X6 MOH D C D C (10) 1,560,000 (11) 1,560,000 (11) 1,560,000 P&L 1,560,000 Finished goods inventory FGI Cost of goods sold-20X6 COS Figure 9.6: RIEBEECK-KASTEEL (Pty) Ltd.’s budgeted accounts <?page no="272"?> Berkau: Financial Statements 8e 9-272 D C D C P&L 4,200,000 (12) 4,200,000 COS 1,560,000 REV 4,200,000 ADM 124,000 EBT 2,516,000 4,200,000 4,200,000 b/ d 2,516,000 Revenue-20X6 REV Profit and Loss-20X6 P&L Figure 9.6: RIEBEECK-KASTEEL (Pty) Ltd.’s budgeted accounts continued The overhead allocation in Figure 9.6 does not overnor underapply overheads. No one plans idle costs, except the capacities cannot be used to their full extent. As IFRSs require applying a Full Cost Accounting system, unit costs increase with underapplication of manufacturing overheads. Therefore, we carefully observe the actual unit costs: They are calculated by dividing the cost of manufacturing (direct costs plus applied overheads) by the lot size: 1.560,000 / 600,000 = 2 2..6600 ZZAARR/ / uu. The budget is based on normal capacity and a complete sale of maps. Below, we demonstrate underperformance. We repeat the calculation; now it is based on actual volumes. RIEBEECK- KASTEEL (Pty) Ltd. only prints 450,000 maps in 124 hours. Note, that the production process is less efficient than planned; the output rate dropped from 3,750 u/ hour to: 450,000 / 124 = 3 3"662299..0033 uu/ / hhoouurr. The allocation of overheads for manufacturing is based on the performance in the printing department in hours, not on its output (maps) to check efficiency. RIEBEECK-KASTEEL (Pty) Ltd. produces 75 % of the planned volume in: 124/ 160 = 7777..5500 %% of the budgeted time. The lower map production results in a closing stock of raw materials, for paper as well as for ink. The paper left is worth: (600,000 - 450,000) × 1.20 = 1 18800"000000 ZZAARR and the ink: (600,000 - 450,000) × 0.80 = 1 12200"000000 ZZAARR. RIEBEECK-KASTEEL (Pty) Ltd. sells 385,000 maps at 7 ZAR/ u in 20X6. Therefore, it puts: 450,000 - 385,000 = 6 655"000000 mmaappss in stock (finished goods inventory). The calculation of finished goods follows actual volume but refers to the predetermined overhead allocation rate. We demonstrate below two alternative calculations, (i) under the assumption that the lower map volume represents the normal capacity situation and we do not separate idle costs, and (ii) following IAS 2.13. The latter one applies if the deviation in product volume is considerable. The reason to separate idle costs following IAS 2.13 is to avoid an application of overheads for unused capacity to units of production. This would increase their unit costs in low volume situations. Therefore, the paragraph states that idle costs should not be allocated to products but recognised separately through profit or loss. Idle costs are <?page no="273"?> Berkau: Financial Statements 8e 9-272 D C D C P&L 4,200,000 (12) 4,200,000 COS 1,560,000 REV 4,200,000 ADM 124,000 EBT 2,516,000 4,200,000 4,200,000 b/ d 2,516,000 Revenue-20X6 REV Profit and Loss-20X6 P&L Figure 9.6: RIEBEECK-KASTEEL (Pty) Ltd.’s budgeted accounts continued The overhead allocation in Figure 9.6 does not overnor underapply overheads. No one plans idle costs, except the capacities cannot be used to their full extent. As IFRSs require applying a Full Cost Accounting system, unit costs increase with underapplication of manufacturing overheads. Therefore, we carefully observe the actual unit costs: They are calculated by dividing the cost of manufacturing (direct costs plus applied overheads) by the lot size: 1.560,000 / 600,000 = 2 2..6600 ZZAARR/ / uu. The budget is based on normal capacity and a complete sale of maps. Below, we demonstrate underperformance. We repeat the calculation; now it is based on actual volumes. RIEBEECK- KASTEEL (Pty) Ltd. only prints 450,000 maps in 124 hours. Note, that the production process is less efficient than planned; the output rate dropped from 3,750 u/ hour to: 450,000 / 124 = 33"662299..0033 uu/ / hhoouurr. The allocation of overheads for manufacturing is based on the performance in the printing department in hours, not on its output (maps) to check efficiency. RIEBEECK-KASTEEL (Pty) Ltd. produces 75 % of the planned volume in: 124/ 160 = 7777..5500 %% of the budgeted time. The lower map production results in a closing stock of raw materials, for paper as well as for ink. The paper left is worth: (600,000 - 450,000) × 1.20 = 1 18800"000000 ZZAARR and the ink: (600,000 - 450,000) × 0.80 = 1 12200"000000 ZZAARR. RIEBEECK-KASTEEL (Pty) Ltd. sells 385,000 maps at 7 ZAR/ u in 20X6. Therefore, it puts: 450,000 - 385,000 = 6655"000000 mmaappss in stock (finished goods inventory). The calculation of finished goods follows actual volume but refers to the predetermined overhead allocation rate. We demonstrate below two alternative calculations, (i) under the assumption that the lower map volume represents the normal capacity situation and we do not separate idle costs, and (ii) following IAS 2.13. The latter one applies if the deviation in product volume is considerable. The reason to separate idle costs following IAS 2.13 is to avoid an application of overheads for unused capacity to units of production. This would increase their unit costs in low volume situations. Therefore, the paragraph states that idle costs should not be allocated to products but recognised separately through profit or loss. Idle costs are Berkau: Financial Statements 8e 9-273 transferred to the Profit and Loss account if capacity deviates significantly from normal situations. The answer to the question what normal capacity is and what indicates overcapacity, is subjected to judgement. IAS 2.13 names the criteria. Here, a decrease in map volume by 25 % marks a substantial underperformance. Later, we cover as case (iii) the same calculations as for (ii) but apply a Manufacturing Summary Account for teaching purpose. 9.17 C/ S RIEBEECK-KASTEEL (Pty) Ltd. (i) A Full Cost Accounting system considers all manufacturing overheads for the finished goods calculation; hence 360,000 ZAR are allocated to the Work-in-Process account. Those manufacturing overheads include idle costs. RIEBEECK- KASTEEL (Pty) Ltd. has recorded: 160 - 124 = 3366 hhoouurrss idle time. RIEBEECK- KASTEEL (Pty) Ltd. cannot reduce depreciation and must pay for its supervisor as agreed per employment contract. The supervisor is not employed on a piecework contract 171 . Under a full cost Accounting system, the unit costs increase (in comparison to budgeted values) to: (450,000 × (1.20 + 0.80) + 360,000) / 450,000 = 2 2..8800 ZZAARR/ / uu. The profit is: 385,000 × (7 - 2.80) - 124,000 = 1 1"449933"000000 ZZAARR. 9.18 C/ S RIEBEECK-KASTEEL (Pty) Ltd. - IAS 2.13 (ii) For the application of IAS 2.13, we refer to the accounts in Figure 9.7. With recognition of idle time for the printer and the supervisor, the manufacturing overheads are applied based on the actual performance (measured in hours) multiplied with the predetermined overhead allocation rate. At RIEBEECK-KASTEEL (Pty) Ltd., the predetermined overhead allocation rate is: 360,000 / 160 = 2 2"225500 ZZAARR/ / hh. Hence, RIEBEECK-KASTEEL (Pty) Ltd.’s applied overheads of: 124 × 2,250 = 2 27799"000000 ZZAARR. The remainder of the manufacturing overheads is idle cost of: 360,000 - 279,000 = 8 811"000000 ZZAARR. They represent costs of the period and are recognised through profit or loss. Observe the profit calculation in Figure 9.7 as discussed above. We transfer idle costs of 81,000 ZAR into the Profit and Loss account. On the income statement, idle costs are disclosed under cost of goods sold or as other expenses. 172 With an over-application of manufacturing overheads, the Bookkeeping entries would be inverted and give a reduction of the cost of goods sold item on the income statement. Due to technical reasons an over-application is more seldom in production firms. 171 For Accounting for labour, study chapter (19) in our textbook Basics of Accounting. 172 The preference is a disclosure together with cost of goods sold. <?page no="274"?> Berkau: Financial Statements 8e 9-274 D C D C OV . . . (1) 864,000 (1) 144,000 (12) 539,000 (12) 3,234,000 (2) 576,000 (2) 96,000 (4) 110,000 c/ d 299,000 (5) 124,000 539,000 539,000 c/ d 1,560,000 b/ d 299,000 3,234,000 3,234,000 b/ d 1,560,000 Cash/ Bank C/ B Value added tax VAT D C D C (1) 720,000 (6) 540,000 (2) 480,000 (7) 360,000 c/ d 180,000 c/ d 120,000 720,000 720,000 480,000 480,000 b/ d 180,000 b/ d 120,000 Inventory (paper) INP Inventory (ink) INI D C D C (3) 250,000 (8) 250,000 c/ d 250,000 (3) 250,000 b/ d 250,000 Depreciation on printer-20X6 DPR Accumulated depreciation ACC D C D C (4) 110,000 (9) 110,000 (5) 124,000 P&L 124,000 Supervisors' salary-20X6 LAB Administration-20X6 ADM D C D C (6) 540,000 (10) 1,179,000 (8) 250,000 WIP 279,000 (7) 360,000 (9) 110,000 c/ d 81,000 MOH 279,000 360,000 360,000 1,179,000 1,179,000 b/ d 81,000 COS 81,000 Work-in-Process-20X6 WIP Manufacturing overheads-20X6 MOH D C D C (10) 1,179,000 (11) 1,008,700 (11) 1,008,700 P&L 1,089,700 c/ d 170,300 MOH 81,000 1,179,000 1,179,000 1,089,700 1,089,700 b/ d 170,300 Finished goods inventory FGI Cost of goods sold-20X6 COS Figure 9.7: RIEBEECK-KASTEEL (Pty) Ltd.’s actual accounts (IAS 2.13) <?page no="275"?> Berkau: Financial Statements 8e 9-274 D C D C OV . . . (1) 864,000 (1) 144,000 (12) 539,000 (12) 3,234,000 (2) 576,000 (2) 96,000 (4) 110,000 c/ d 299,000 (5) 124,000 539,000 539,000 c/ d 1,560,000 b/ d 299,000 3,234,000 3,234,000 b/ d 1,560,000 Cash/ Bank C/ B Value added tax VAT D C D C (1) 720,000 (6) 540,000 (2) 480,000 (7) 360,000 c/ d 180,000 c/ d 120,000 720,000 720,000 480,000 480,000 b/ d 180,000 b/ d 120,000 Inventory (paper) INP Inventory (ink) INI D C D C (3) 250,000 (8) 250,000 c/ d 250,000 (3) 250,000 b/ d 250,000 Depreciation on printer-20X6 DPR Accumulated depreciation ACC D C D C (4) 110,000 (9) 110,000 (5) 124,000 P&L 124,000 Supervisors' salary-20X6 LAB Administration-20X6 ADM D C D C (6) 540,000 (10) 1,179,000 (8) 250,000 WIP 279,000 (7) 360,000 (9) 110,000 c/ d 81,000 MOH 279,000 360,000 360,000 1,179,000 1,179,000 b/ d 81,000 COS 81,000 Work-in-Process-20X6 WIP Manufacturing overheads-20X6 MOH D C D C (10) 1,179,000 (11) 1,008,700 (11) 1,008,700 P&L 1,089,700 c/ d 170,300 MOH 81,000 1,179,000 1,179,000 1,089,700 1,089,700 b/ d 170,300 Finished goods inventory FGI Cost of goods sold-20X6 COS Figure 9.7: RIEBEECK-KASTEEL (Pty) Ltd.’s actual accounts (IAS 2.13) Berkau: Financial Statements 8e 9-275 D C D C P&L 2,695,000 (12) 2,695,000 COS 1,089,700 REV 2,695,000 ADM 124,000 EBT 1,481,300 2,695,000 2,695,000 b/ d 1,481,300 Revenue-20X6 REV Profit and Loss-20X6 P&L Figure 9.7: RIEBEECK-KASTEEL (Pty) Ltd.’s actual accounts (IAS 2.13) Due to a longer production time per map in comparison to the budgeted time, the unit costs per map slightly increase to: 1,179,000 / 450,000 = 2 2..6622 ZZAARR/ / uu. However, those unit costs are clearly below the ones for case (i) which are 2.80 ZAR/ u. Consider that direct materials for paper and ink of 2 ZAR/ u are included. The increase in unit costs is caused by allocating idle costs to products in case (i). How it is Done (Manufacturing Accounting): (1) Record standard Bookkeeping entries for purchases (apply perpetual system) and for expenses, revenues and other comprehensive income. (2) Define Work-in-Process accounts for job orders, Manufacturing Overhead accounts for cost centres and Administration account(s). (3) Record stock releases of materials as direct materials to the Work-in-Process accounts or as manufacturing overheads to cost centres. (4) Transfer direct labour to Work-in-Process accounts or as manufacturing overheads to cost centres. (5) Transfer other manufacturing overheads to cost centres or as administrative expenses if not production related. (6) Do not transfer interest if not linked to production. (7) Add up all manufacturing overheads in a cost centre. (8) Determine the predetermined overhead allocation rate for cost centres by dividing the total budgeted costs by the planned performance as measured in reference units. (9) Allocate manufacturing overheads to job orders by multiplying the actual performance with the predetermined overhead allocation rate. (10) Transfer overor underapplied overheads of the cost centres to profit or loss. Underapplied overheads <?page no="276"?> Berkau: Financial Statements 8e 9-276 lead to a debit entry in the Profit and Loss account and overapplied overheads give credit entries therein. (11) Add up all costs of a job order. These are direct materials and cost of conversion. The cost of conversion are direct labour and applied manufacturing overheads. (12) Transfer job order costs to the Finished Goods account once production is completed. (13) When finished goods are sold record stock releases in the Cost of Goods Sold account. Make Bookkeeping entries for revenues/ other comprehensive income. (14) Close-off the Cost of Goods Sold account(s), the Administration Expenses account(s), the Interest account(s) and the Revenue account(s) to profit or loss and calculate earnings before taxation. (15) Close off the Profit and Loss account to income tax liabilities and retained earnings. How it is Done (Recording Idle Plant Costs): (1) Follow the procedures of Manufacturing as described above: (1.1) Add direct costs to job orders (WIP account). (1.2) Add manufacturing overheads to cost centres (MOH account). (1.3) Add non-manufacturing overheads to expense accounts and later close them off to the Profit and Loss account. (2) For each cost centre compare actual manufacturing overheads to those calculated based on normal capacity (use predetermined overhead allocation rate POR). Check whether actual and normal capacity significantly deviate. (3a) If actual and normal capacity are close, apply actual overhead calculation by closing-off the Manufacturing Overheads account to the Work-in-Process accounts. Record inventory movements towards the Finished Goods Inventory account. (5b) If actual and normal capacity differ significantly, allocate overheads based on normal capacity and debit remaining idle costs as expenses in profit or loss. 9.19 Manufacturing Summary Account A Manufacturing Summary Account is a reconciliation account for manufacturing overheads and work-in-process. It applies for periodic inventory movement system and if the Work-in-Process account and the Manufacturing Overhead account are linked to the <?page no="277"?> Berkau: Financial Statements 8e 9-276 lead to a debit entry in the Profit and Loss account and overapplied overheads give credit entries therein. (11) Add up all costs of a job order. These are direct materials and cost of conversion. The cost of conversion are direct labour and applied manufacturing overheads. (12) Transfer job order costs to the Finished Goods account once production is completed. (13) When finished goods are sold record stock releases in the Cost of Goods Sold account. Make Bookkeeping entries for revenues/ other comprehensive income. (14) Close-off the Cost of Goods Sold account(s), the Administration Expenses account(s), the Interest account(s) and the Revenue account(s) to profit or loss and calculate earnings before taxation. (15) Close off the Profit and Loss account to income tax liabilities and retained earnings. How it is Done (Recording Idle Plant Costs): (1) Follow the procedures of Manufacturing as described above: (1.1) Add direct costs to job orders (WIP account). (1.2) Add manufacturing overheads to cost centres (MOH account). (1.3) Add non-manufacturing overheads to expense accounts and later close them off to the Profit and Loss account. (2) For each cost centre compare actual manufacturing overheads to those calculated based on normal capacity (use predetermined overhead allocation rate POR). Check whether actual and normal capacity significantly deviate. (3a) If actual and normal capacity are close, apply actual overhead calculation by closing-off the Manufacturing Overheads account to the Work-in-Process accounts. Record inventory movements towards the Finished Goods Inventory account. (5b) If actual and normal capacity differ significantly, allocate overheads based on normal capacity and debit remaining idle costs as expenses in profit or loss. 9.19 Manufacturing Summary Account A Manufacturing Summary Account is a reconciliation account for manufacturing overheads and work-in-process. It applies for periodic inventory movement system and if the Work-in-Process account and the Manufacturing Overhead account are linked to the Berkau: Financial Statements 8e 9-277 same cost centres. This situation is seldom and can be observed where a Process Costing applies. For the case study RIEBEECK-KASTEEL (Pty) Ltd., a Manufacturing Summary account can be applied as shown below. 9.20 C/ S RIEBEECK-KASTEEL (Pty) Ltd. (iii) For the case study RIEBEECK-KASTEEL (Pty) Ltd. following IAS 2.13 we apply a Manufacturing Summary Account. We need to know the inventory valuations which we copy from the previous calculations. The calculation of finished goods requires excluding the idle costs. The below listed unit costs apply for the calculation. - Paper: 1.20 ZAR/ u. - Ink: 0.80 ZAR/ u. - Maps: 2.62 ZAR/ u. At RIEBEECK-KASTEEL (Pty) Ltd. we only have one Work-in-Process account and one Manufacturing Overhead account in use which is now replaced by their reconciliation account. D C D C OV.P 720,000 FGI 1,179,000 FGI 1,008,700 P&L 1,008,700 OV.I 480,000 INP 180,000 DPR 250,000 INI 120,000 LAB 110,000 c/ d 81,000 1,560,000 1,560,000 b/ d 81,000 P&L 81,000 D C D C MSA 1,179,000 COS 1,008,700 COS 1,008,700 REV 2,695,000 c/ d 170,300 MSA 81,000 1,179,000 1,179,000 ADM 124,000 b/ d 170,300 EBT 1,481,300 2,695,000 2,695,000 b/ d 1,481,300 Manuf. summary account-20X6 MSA Cost of goods sold-20X6 COS Finished goods inventory FGI Profit and Loss-20X6 P&L Figure 9.8: RIEBEECK-KASTEEL (Pty) Ltd.'s Manufacturing Summary Account (iii) In the Manufacturing Summary account, we see the opening values for the paper (OV.P) and for ink (OV.I). Furthermore, all expenses at RIEBEECK-KASTEEL (Pty) Ltd. are added, which here is depreciation (DPR) and the supervisor's salary (LAB). After production, the closing stocks for paper (INP) and ink (INI) as well as for the maps (FGI) are determined. The balancing figure in the Manufacturing Summary account represents the idle costs which are added to profit or loss. A Manufacturing Summary Account is only applicable in special situations and requires calculating the unit cost of manufacturing in an extra working. <?page no="278"?> Berkau: Financial Statements 8e 9-278 We recommend working on the case study HEUNING Ltd. which is a manufacturer for garden tools. Task A9.49a follows the weighted average method and task A9.49b is the same case study but based on the cost formula first-in-first-out. The case HEUNING Ltd. comes with 4 Job Order accounts (WIP) and 2 Manufacturing Overheads accounts. 173 9.21 Receivables Receivables are recorded in the current-asset section of the balance sheet and reflect future receipts. Receivables from customers in arrears frequently contain a VAT portion which matters for bad debts recognition (writing-off receivables). Besides of trade receivables, there are input-VAT receivables that represent claims against the revenue service and receivables resulting from granted loans to other parties. In general, the latter ones do not include VAT. Receivables fall under financial instruments and are contracts ruled by IAS 32.11. Companies must report credit risks following IFRS 7.9, too. Trade receivables are risky to the extent that the owing party fails its payment obligations (bankruptcy). IFRS 9.3.1.2 requires a fair value measurement of all financial assets through either the profit or loss or other comprehensive income. 9.22 C/ S CHELMSFORD Below, we study trade receivables from an Australian car dealer. 173 Find the task HEUNING Ltd. in the study material portal linked. Data Sheet for CHELMSFORD Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((SSyyddnneeyy)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : ddeeaalleerrsshhiipp.. PPeerriiooddss: : 2200XX33 / / 2200XX44.. SSaallee ooff ccaarr: : 6655"000000 AAUUDD ((nneett aammoouunntt)) oonn 55..0044..2200XX33 ppaayyaabbllee oonn 44..0044..2200XX44 IInntteerreesstt: : 33"000000 AAUUDD ((nneett aammoouunntt)) VVAATT rraattee: : 2200 %%.. CHELMSFORD Ltd. records trade receivables from the sale of a VW T-ROC to the extent of 81,600 AUD. The company accepted a sale where the customer buys the car on 5.04.20X3 and pays the complete price one year later (4.04.20X4). An Interest portion of 3,000 AUD (net value) is included in the settlement value. The agreement between CHELMSFORD Ltd. and the buyer is about a car delivery and the receipt of: (65,000 + 3,000) × 120% = 8 811"660000 AAUUDD in 20X4. 65,000 AUD is the car’s regular net selling price. The Bookkeeping entry (1) shows the recording of a financial asset in CHELMSFORD Ltd.’s books. On the customer’s side, a financial liability is disclosed under short-term liabilities (A/ P). At CHELMSFORD Ltd., a deferred interest income linked to the next Accounting period is recorded, too. The interest income is for the period April/ 20X3 until March/ 20X4. Hence, it is relevant for 20X3 to an extent of nine months. The actual interest income is: 3,000 × 9/ 12 = 22"225500 AAUUDD in 20X3. The remainder is deferred interest income of: 3,000 - 2,250 = 775500 AAUUDD. <?page no="279"?> Berkau: Financial Statements 8e 9-278 We recommend working on the case study HEUNING Ltd. which is a manufacturer for garden tools. Task A9.49a follows the weighted average method and task A9.49b is the same case study but based on the cost formula first-in-first-out. The case HEUNING Ltd. comes with 4 Job Order accounts (WIP) and 2 Manufacturing Overheads accounts. 173 9.21 Receivables Receivables are recorded in the current-asset section of the balance sheet and reflect future receipts. Receivables from customers in arrears frequently contain a VAT portion which matters for bad debts recognition (writing-off receivables). Besides of trade receivables, there are input-VAT receivables that represent claims against the revenue service and receivables resulting from granted loans to other parties. In general, the latter ones do not include VAT. Receivables fall under financial instruments and are contracts ruled by IAS 32.11. Companies must report credit risks following IFRS 7.9, too. Trade receivables are risky to the extent that the owing party fails its payment obligations (bankruptcy). IFRS 9.3.1.2 requires a fair value measurement of all financial assets through either the profit or loss or other comprehensive income. 9.22 C/ S CHELMSFORD Below, we study trade receivables from an Australian car dealer. 173 Find the task HEUNING Ltd. in the study material portal linked. Data Sheet for CHELMSFORD Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((SSyyddnneeyy)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : ddeeaalleerrsshhiipp.. PPeerriiooddss: : 2200XX33 / / 2200XX44.. SSaallee ooff ccaarr: : 6655"000000 AAUUDD ((nneett aammoouunntt)) oonn 55..0044..2200XX33 ppaayyaabbllee oonn 44..0044..2200XX44 IInntteerreesstt: : 33"000000 AAUUDD ((nneett aammoouunntt)) VVAATT rraattee: : 2200 %%.. CHELMSFORD Ltd. records trade receivables from the sale of a VW T-ROC to the extent of 81,600 AUD. The company accepted a sale where the customer buys the car on 5.04.20X3 and pays the complete price one year later (4.04.20X4). An Interest portion of 3,000 AUD (net value) is included in the settlement value. The agreement between CHELMSFORD Ltd. and the buyer is about a car delivery and the receipt of: (65,000 + 3,000) × 120% = 8 811"660000 AAUUDD in 20X4. 65,000 AUD is the car’s regular net selling price. The Bookkeeping entry (1) shows the recording of a financial asset in CHELMSFORD Ltd.’s books. On the customer’s side, a financial liability is disclosed under short-term liabilities (A/ P). At CHELMSFORD Ltd., a deferred interest income linked to the next Accounting period is recorded, too. The interest income is for the period April/ 20X3 until March/ 20X4. Hence, it is relevant for 20X3 to an extent of nine months. The actual interest income is: 3,000 × 9/ 12 = 22"225500 AAUUDD in 20X3. The remainder is deferred interest income of: 3,000 - 2,250 = 775500 AAUUDD. Berkau: Financial Statements 8e 9-279 @ 5.04.20X3 Accounts Receivables A/ R 81,600 Interest Income-20X3 I3I 2,250 Deferred Interest Income DII 750 Value Added Tax VAT 13,600 Revenue-20X3 REV 65,000 (recognition of the car sale) The valuation of the financial asset is based on the settlement value. From experience, CHELMSFORD Ltd.’s credit risk regarding its customers’ payment failure is 10 % of the debts. On average 10 % of receivables are written-off as bad debts because they do not get paid and are not collectable either. Hence, CHELMSFORD Ltd. calculates the fair value of its receivables based on the estimated credit risks. The bad debt portion resulting from the car sale is: 10% × 81,600 = 8 8"116600 AAUUDD. At the end of 20X3, CHELMSFORD Ltd. records the risk as Bookkeeping entry (2). The recording of bad debts is here a precautious consideration of a potential payment failure and is reversed upon complete receipt of the 81,600 AUD. If the receivables are not received the bad debts are extended to the full amount. @ 6.04.20X3 Bad Debts Account-20X3 BDA 6,800 Value Added Tax VAT 1,360 Accounts Receivables A/ R 8,160 (precautious recording of bad debts based on credit risk) The recording of bad debts resulting from trade receivables includes a debit entry in the VAT account for the reduction of CHELMSFORD Ltd.’s output-VAT obligation. The revenue recognition at the time of the deal made CHELMSFORD Ltd. record the full output-VAT. The interest income as well as the bad debts are closed-off to the Profit or Loss- 20X3 account (not shown). The buyer of the van pays the agreed price of 81,600 AUD on time (in 20X4). The payment changes the fair value of the receivables, as the cash receipt voids the previously recorded credit risk. Therefore, we record the payment in two steps, the first one is for a reversal of the written-down receivables and the second one is made for the settlement of the receivables in full. Observe Bookkeeping entries (a) and (b). <?page no="280"?> Berkau: Financial Statements 8e 9-280 @ 5.04.20X4 Accounts Receivables A/ R 8,160 Value Added Tax VAT 1,360 Bad Debts Account-20X4 BDA 6,800 (bad debts reversal) Cash Bank C/ B 81,600 Accounts Receivables A/ R 81,600 (receipt of payment from the buyer as agreed) For a correct allocation of the interest portion, CHELMSFORD Ltd. accrues deferred interest to its Interest Income account. How it is Done (Valuation of Receivables): (1) Determine the settlement value SMV, in general, it is the gross value if resulting from selling goods or services. In case the receivables result from pure lending, no VAT applies. (2) If the settlement value contains an interest portion add it to receivables. (3) Determine credit risks, preferably as a percentage (rr). (4) Calculate the fair value of receivables under consideration of credit risks by multiplying the settlement value with the factor: (1 - rr). (5) Record the written-down receivables as bad debts, make a debit entry in the Bad Debts account to the extent of the net amount of the settlement value multiplied with the risk percentage: (1/ 120%) × SMV × rr. Make a debit entry in the VAT account for value added tax linked to the credit risk: (20%/ 120%) × SMV × rr and a credit entry in the Accounts Receivables account to the extent of: SMV × rr. (6) Check the solvency of the debtor regularly. (7a) If the debtor is insolvent write-off the remaining receivables as bad debts, too. Make a debit entry in the Bad Debts account and in the VAT account and cancel out the remaining receivables to the extent of SMV × (1 - rr) in the Receivables account A/ R. Later, close-off the Bad Debts account to the Profit and Loss account. (7b) If the debtor pays the outstanding receivables and if receivables were previously written down for a credit risk consideration, make a debit entry in the Accounts Receivables account to the extent of: SMV × rr and in the VAT account to the extent of: (20%/ 120%) × SMV × rr. Credit (1/ 120%) × SMV × rr to bad debts. <?page no="281"?> Berkau: Financial Statements 8e 9-280 @ 5.04.20X4 Accounts Receivables A/ R 8,160 Value Added Tax VAT 1,360 Bad Debts Account-20X4 BDA 6,800 (bad debts reversal) Cash Bank C/ B 81,600 Accounts Receivables A/ R 81,600 (receipt of payment from the buyer as agreed) For a correct allocation of the interest portion, CHELMSFORD Ltd. accrues deferred interest to its Interest Income account. How it is Done (Valuation of Receivables): (1) Determine the settlement value SMV, in general, it is the gross value if resulting from selling goods or services. In case the receivables result from pure lending, no VAT applies. (2) If the settlement value contains an interest portion add it to receivables. (3) Determine credit risks, preferably as a percentage (rr). (4) Calculate the fair value of receivables under consideration of credit risks by multiplying the settlement value with the factor: (1 - rr). (5) Record the written-down receivables as bad debts, make a debit entry in the Bad Debts account to the extent of the net amount of the settlement value multiplied with the risk percentage: (1/ 120%) × SMV × rr. Make a debit entry in the VAT account for value added tax linked to the credit risk: (20%/ 120%) × SMV × rr and a credit entry in the Accounts Receivables account to the extent of: SMV × rr. (6) Check the solvency of the debtor regularly. (7a) If the debtor is insolvent write-off the remaining receivables as bad debts, too. Make a debit entry in the Bad Debts account and in the VAT account and cancel out the remaining receivables to the extent of SMV × (1 - rr) in the Receivables account A/ R. Later, close-off the Bad Debts account to the Profit and Loss account. (7b) If the debtor pays the outstanding receivables and if receivables were previously written down for a credit risk consideration, make a debit entry in the Accounts Receivables account to the extent of: SMV × rr and in the VAT account to the extent of: (20%/ 120%) × SMV × rr. Credit (1/ 120%) × SMV × rr to bad debts. Berkau: Financial Statements 8e 9-281 (8b) Make a debit entry in the Cash/ Bank account and a credit entry in the Accounts Receivables account for the full cash receipt. 9.23 Securities Securities are financial instruments and are ruled by IFRS 9. They can be shares, bonds etc. We use the technical term securities, because they are held in a way which allows easy liquidations. Securities earn interest or gains from capital appreciation. In rainy days, their owner can sell securities quickly for an increase of liquidity. As the benefit is the option to sell them on short notice, they are disclosed under current assets and IFRS 9 requires their measurement at fair values. The classification of financial instrument in line with IFRS 9.4.1.2 depends on the holders’ business model. Securities held for sale are kept at fair values through profit or loss (FVTPL) or fair values through other comprehensive income (FVTOCI). The “T” for “through” refers to where adjustments from valuation changes are recorded. Securities in the current asset section usually fall under this classification (FVTPL or FVTOCI). In contrast, financial assets which solely are held for the receipt of contractual cash flows must be carried at amortised costs following IFRS 9.4.1.2 and are covered in chapter (7). Shares always are carried at FVTPL/ FVTOCI. In compliance with IFRS 9.5.1.1, we measure securities initially at costs and subsequently at fair values (IFRS 9.5.7). Fair market values of publicly traded securities are prices as traded at a stock exchange or bond market. Next, we discuss three case studies about securities. 9.24 C/ S NOKOX (Pty) Ltd. At first, the case study NOKOX (Pty) Ltd. that is related to shares is discussed: Data Sheet for NOKOX (Pty) Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((MMeellbboouurrnnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. PPeerriioodd: : 2200XX88.. PPuurrcchhaassee ooff 3300"000000 sshhaarreess ooff MMCCDD aatt 115500 AAUUDD/ / ss oonn 3300..0044..2200XX88.. DDiivviiddeenndd: : 11 UUSSDD/ / ss.. CCuurrrreennccyy eexxcchhaannggee rraattee 11 UUSSDD : : 11..5500 AAUUDD / / 11 UUSSDD : : 11..4400 AAUUDD.. SShhaarree pprriiccee aatt NNSSEE: : 110055 UUSSDD/ / ss oonn 3311..1122..2200XX88.. VVAATT nn/ / aa.. ** CCaallll ooppttiioonn: : 22"770000"000000 UUSSDD aatt 44"000000"000000 AAUUDD oonn 3311..1122..2200XX88.. AAccqquuiissiittiioonn: : 44..0044..2200XX88.. BBaannkkiinngg ffeeee: : 2255"000000 AAUUDD.. CCuurrrreennccyy eexxcchhaannggee rraattee 11 UUSSDD : : 11..4488 AAUUDD.. On 30.04.20X8, NOKOX (Pty) Ltd. buys 30,000 shares of McDonald’s corporation at 150 AUD/ s each. The shares are traded at 100 USD/ s. At the time of acquisition, the currency exchange rate is: 1 USD = 1.50 AUD. The costs of purchase are: 30,000 × 150 = 4 4"550000"000000 AAUUDD. We ignore transaction costs. NOKOX (Pty) Ltd. intends to sell the shares in 20X9. It classifies its shares as securities. On 31.12.20X8, NOKOX (Pty) Ltd. receives <?page no="282"?> Berkau: Financial Statements 8e 9-282 the 20X8-dividend of 42,000 AUD. The dividend is amounting to 1 USD/ s. By then, the Australian Dollar depreciated against the US-Dollar and is traded at: 1 USD : 1.40 AUD. Therefore, the dividend income in Australian Dollar is: 30,000 × 1.40 = 4 422"000000 AAUUDD. It is recorded as a gain because for NOKOX (Pty) Ltd. dividend income is extraordinary. The account carries the three-letter-code OCI for other comprehensive income. At the same time, the shares of McDonald’s Corporation are traded at the New York Stock Exchange NYSE at 105 USD/ s. The shares’ Australian Dollar value is: 30,000 × 105 × 1.40 = 4 4"441100"000000 AAUUDD. Due to the weak Australian Dollar, NOKOX (Pty) Ltd. lost: 4,500,000 - 4,410,000 = 9 900"000000 AAUUDD. The loss in valuation exceeds the dividend income. We deduct the loss in valuation from dividend income and calculate a net loss of: 90,000 - 42,000 = 4 488"000000 AAUUDD. NOKOX (Pty) Ltd. records the dividend income and the share price loss in compliance with IFRS 9.4.1.2A. The latter one is classified as other expenses (OTH). @ 31.012.20X8 Cash Bank C/ B 42,000 Dividend Income-20X8 OCI 42,000 (recognition of dividend income in reporting currency as gain) Loss in Valuation-20X8 OTH 90,000 Securities SEC 90,000 (value adjustment of shares in reporting currency) We continue the case study NOKOX (Pty) Ltd. further below and then cover Hedging, too. Hedging is to compensate a loss from currency exchange rates by investing in “opposite” financial instruments. Before we continue with the case NOKOX (Pty) Ltd., we cover bonds and options. NOKOX (Pty) Ltd. is continued at the *. There, we demonstrate the hedging of its shares by a call option. Next, we continue with bonds. 9.25 C/ S TRAGER GmbH In the case study below, TRAGER GmbH buys bonds and holds them under securities: Data Sheet for TRAGER GmbH DDoommiicciillee: : GGeerrmmaannyy ((MMüünnsstteerr)).. RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. PPeerriioodd: : 2200XX88.. PPuurrcchhaassee ooff 330000 BBoonnddss aatt 7788 EEUURR/ / bb.. NNoommiinnaall aammoouunntt: : 110000 EEUURR/ / bb.. CCoouuppoonn: : 44 %%/ / 66mm.. BBoonndd lliissttiinngg oonn 3311..1122..2200XX44 aatt 8844 ((%%)).. VVAATT nn/ / aa.. On 3.04.20X8, TRAGER GmbH buys 300 bonds at 78 EUR/ b each (fair bond market value). The bonds’ principal is 100 EUR/ b. This is the value the bonds mature at on settlement date and the coupon is based on. The bonds pay semi-annually a coupon of 4%/ 6m, which is on 30.06. and on 31.12. each year. Therefore, the effective rate of interest is: (1 + 4%/ 2) 2 - 1 = 44..0044%%/ / aa. As TRAGER GmbH plans to sell its bonds in January/ 20X9, no recognition at amortised costs applies therefore, we can ignore the effec- <?page no="283"?> Berkau: Financial Statements 8e 9-282 the 20X8-dividend of 42,000 AUD. The dividend is amounting to 1 USD/ s. By then, the Australian Dollar depreciated against the US-Dollar and is traded at: 1 USD : 1.40 AUD. Therefore, the dividend income in Australian Dollar is: 30,000 × 1.40 = 4 422"000000 AAUUDD. It is recorded as a gain because for NOKOX (Pty) Ltd. dividend income is extraordinary. The account carries the three-letter-code OCI for other comprehensive income. At the same time, the shares of McDonald’s Corporation are traded at the New York Stock Exchange NYSE at 105 USD/ s. The shares’ Australian Dollar value is: 30,000 × 105 × 1.40 = 4 4"441100"000000 AAUUDD. Due to the weak Australian Dollar, NOKOX (Pty) Ltd. lost: 4,500,000 - 4,410,000 = 9 900"000000 AAUUDD. The loss in valuation exceeds the dividend income. We deduct the loss in valuation from dividend income and calculate a net loss of: 90,000 - 42,000 = 4 488"000000 AAUUDD. NOKOX (Pty) Ltd. records the dividend income and the share price loss in compliance with IFRS 9.4.1.2A. The latter one is classified as other expenses (OTH). @ 31.012.20X8 Cash Bank C/ B 42,000 Dividend Income-20X8 OCI 42,000 (recognition of dividend income in reporting currency as gain) Loss in Valuation-20X8 OTH 90,000 Securities SEC 90,000 (value adjustment of shares in reporting currency) We continue the case study NOKOX (Pty) Ltd. further below and then cover Hedging, too. Hedging is to compensate a loss from currency exchange rates by investing in “opposite” financial instruments. Before we continue with the case NOKOX (Pty) Ltd., we cover bonds and options. NOKOX (Pty) Ltd. is continued at the *. There, we demonstrate the hedging of its shares by a call option. Next, we continue with bonds. 9.25 C/ S TRAGER GmbH In the case study below, TRAGER GmbH buys bonds and holds them under securities: Data Sheet for TRAGER GmbH DDoommiicciillee: : GGeerrmmaannyy ((MMüünnsstteerr)).. RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. PPeerriioodd: : 2200XX88.. PPuurrcchhaassee ooff 330000 BBoonnddss aatt 7788 EEUURR/ / bb.. NNoommiinnaall aammoouunntt: : 110000 EEUURR/ / bb.. CCoouuppoonn: : 44 %%/ / 66mm.. BBoonndd lliissttiinngg oonn 3311..1122..2200XX44 aatt 8844 ((%%)).. VVAATT nn/ / aa.. On 3.04.20X8, TRAGER GmbH buys 300 bonds at 78 EUR/ b each (fair bond market value). The bonds’ principal is 100 EUR/ b. This is the value the bonds mature at on settlement date and the coupon is based on. The bonds pay semi-annually a coupon of 4%/ 6m, which is on 30.06. and on 31.12. each year. Therefore, the effective rate of interest is: (1 + 4%/ 2) 2 - 1 = 44..0044%%/ / aa. As TRAGER GmbH plans to sell its bonds in January/ 20X9, no recognition at amortised costs applies therefore, we can ignore the effec- Berkau: Financial Statements 8e 9-283 tive rate of interest for the bond disclosure here. Due to its business model, TRAGER GmbH holds the bonds at fair values through other comprehensive income. At the time of purchase, TRAGER GmbH measures its bonds as purchased with a discount at: 300 × 78 = 2 233"440000 EEUURR. @ 3.04.20X8 Securities SEC 23,400 Cash/ Bank C/ B 23,400 (bond recognition at cost of acquisition) On 30.06.20X8 as well as on 31.12.20X8, TRAGER GmbH receives interest income (coupons) of: 300 × 4 = 1 1"220000 EEUURR. The company records the receipts as interest income which is disclosed as other comprehensive income (twice). @ 30.06.20X8 Cash Bank C/ B 1,200 Interest Income-20X8 OCI 1,200 (coupon receipt and accumulation towards other comprehensive income) @ 31.12.20X8 Cash Bank C/ B 1,200 Interest Income-20X8 OCI 1,200 (coupon receipt and accumulation towards other comprehensive income) On 31.12.20X8, TRAGER GmbH must disclose its bonds at fair market values. At that date, the bonds are traded at 84 EUR/ b. We say the bonds are listed at 84 (percent). On the financial statements, the bonds show at: 300 × 84 = 2 255"220000 EEUURR. The difference in valuation is: 25,200 - 23,400 = 1 1"880000 EEUURR. TRAGER GmbH records the gain as other comprehensive income: @ 31.12.20X8 Securities SEC 1,800 Gain on Valuation-20X8 OCI 1,800 (recognition of the bonds' valuation gain as other comprehensive income) 9.26 C/ S GRENVILLE AG Future contracts are recorded under securities, too. Study the case of GRENVILLE AG: Data Sheet for GRENVILLE AG DDoommiicciillee: : GGeerrmmaannyy ((EEsssseenn)).. RReeppoorrttiinngg ccuurrrreennccyy: : EEUURR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. PPeerriioodd: : 2200XX55.. EExxcchhaannggee ooff 1100"000000 UUSSDD ttoowwaarrddss 99"000000 EEUURR oonn 3311..1122..2200XX55.. CCuurrrreennccyy eexxcchhaannggee rraattee: : oonn 22..0011..2200XX55: : 11..1100 UUSSDD == 11 EEUURR / / oonn 3311..1122..2200XX55: : 11..2255 UUSSDD == 11 EEUURR.. VVAATT nn/ / aa.. <?page no="284"?> Berkau: Financial Statements 8e 9-284 On 2.01.20X5, GRENVILLE AG that trades goods with an US based customer enters in a contract (forward exchange contract) with Deutsche Bank to exchange 10,000 USD to 9,000 EUR on 31.12.20X5. No payment is made yet. The bank's transaction fees (commission) are included in the exchange price. The forward exchange contract is to secure an expected receipt of 10,000 USD from GRENVILLE AG’s overseas customer. On 2.01.20X5, the currency exchange rate is: 1.10 USD : 1 EUR. Based on that rate, the expected receipt is worth: 10,000 / 1.1 = 9 9"009900..9911 EEUURR. The transaction costs (fees) are: 9,090.91 - 9,000 = 9 900..9911 EEUURR. We record Bookkeeping entry (1) upon recognition (2.01.20X5): @ 2.01.20X5 Accounts Receivables A/ R 9,000 Fees-20X5 FEE 91 Accounts Payables A/ P 9,091 (recognition of the forward currency exchange contract in reporting currency) The contract is recognised as a future receipt and a present obligation to pay 10,000 USD and the fees at the yearend. In contrast to a call option, this contract is binding and leads to the agreed receipt and payment at the specified date 31.12.20X5. We pretend that on 31.12.20X5, the currency exchange rate has changed to: 1.25 USD : 1 EUR. Hence, the actual valuation of 10,000 USD declines to: 10,000 / 1.25 = 8 8"000000 EEUURR. Therefore, GRENVILLE AG earns a currency gain from the future exchange contract of: 9,091.91 - 8,000 = 1 1"009911..9911 EEUURR. Consider the bank fees as expenses. GRENVILLE AG receives: 9,000 - 8,000 = 11"000000 EEUURR in cash. Note, the 8,000 EUR are paid in USD. On 31.12.20X5, the financial asset is derecognised because Deutsche Bank pays the agreed EUR amount in exchange for 10,000 USD received. Observe Bookkeeping entry (2): @ 31.12.20X5 Cash Bank C/ B 1,000 Accounts Payables A/ P 9,091 Securities SEC 9,000 Gain on Valuation-20X5 OCI 1,091 (receipt from future currency contract) For the case study GRENVILLE AG, a recognition of the forward exchange contract on the balance sheet is not required because as at 31.12.20X5, the currency contract has been settled already. As the case study GRENVILLE AG shows, short-term financial assets can secure a currency exchange risk. This falls under Hedging. Hedging allows based on IFRS 9.5.7.1 (a) the disclosure under special rules to simplify Accounting. <?page no="285"?> Berkau: Financial Statements 8e 9-284 On 2.01.20X5, GRENVILLE AG that trades goods with an US based customer enters in a contract (forward exchange contract) with Deutsche Bank to exchange 10,000 USD to 9,000 EUR on 31.12.20X5. No payment is made yet. The bank's transaction fees (commission) are included in the exchange price. The forward exchange contract is to secure an expected receipt of 10,000 USD from GRENVILLE AG’s overseas customer. On 2.01.20X5, the currency exchange rate is: 1.10 USD : 1 EUR. Based on that rate, the expected receipt is worth: 10,000 / 1.1 = 9 9"009900..9911 EEUURR. The transaction costs (fees) are: 9,090.91 - 9,000 = 9 900..9911 EEUURR. We record Bookkeeping entry (1) upon recognition (2.01.20X5): @ 2.01.20X5 Accounts Receivables A/ R 9,000 Fees-20X5 FEE 91 Accounts Payables A/ P 9,091 (recognition of the forward currency exchange contract in reporting currency) The contract is recognised as a future receipt and a present obligation to pay 10,000 USD and the fees at the yearend. In contrast to a call option, this contract is binding and leads to the agreed receipt and payment at the specified date 31.12.20X5. We pretend that on 31.12.20X5, the currency exchange rate has changed to: 1.25 USD : 1 EUR. Hence, the actual valuation of 10,000 USD declines to: 10,000 / 1.25 = 8 8"000000 EEUURR. Therefore, GRENVILLE AG earns a currency gain from the future exchange contract of: 9,091.91 - 8,000 = 1 1"009911..9911 EEUURR. Consider the bank fees as expenses. GRENVILLE AG receives: 9,000 - 8,000 = 11"000000 EEUURR in cash. Note, the 8,000 EUR are paid in USD. On 31.12.20X5, the financial asset is derecognised because Deutsche Bank pays the agreed EUR amount in exchange for 10,000 USD received. Observe Bookkeeping entry (2): @ 31.12.20X5 Cash Bank C/ B 1,000 Accounts Payables A/ P 9,091 Securities SEC 9,000 Gain on Valuation-20X5 OCI 1,091 (receipt from future currency contract) For the case study GRENVILLE AG, a recognition of the forward exchange contract on the balance sheet is not required because as at 31.12.20X5, the currency contract has been settled already. As the case study GRENVILLE AG shows, short-term financial assets can secure a currency exchange risk. This falls under Hedging. Hedging allows based on IFRS 9.5.7.1 (a) the disclosure under special rules to simplify Accounting. Berkau: Financial Statements 8e 9-285 We call the currency future in the prior case study a hedging instrument and the receivables expected from the overseas customer the hedged item. IFRS 9.6 allows to recognise losses and gains of both items together, which is referred to as matching concept. Instead of recording both items (hedged item and hedging instrument) separately, IFRS 9.6 requires a combined presentation. Technically this would fall under offsetting which is why an extra standard is necessary to legalise this procedure. *9.27 C/ S NOKOX (Pty) Ltd. continued After studying Hedging, we continue the case study NOKOX (Pty) Ltd. which is the Australian investor who bought 30,000 MCD shares in 20X8. The situation is now altered as we consider that NOKOX (Pty) Ltd. secures its profit in USD by the purchase of a call option for USD. The USD profit is the increase in share valuation from 100 USD/ s to 105 USD/ s plus the dividend income. Hence, NOKOX (Pty) Ltd. earns: 30,000 × (105 - 100) + 30,000 × 1 = 1 18800"000000 UUSSDD. Without currency exchange rate decrease, the dividend gain in AUD would have been: 180,000 × 1.50 = 2 27700"000000 AAUUDD. Due to the depreciation of the AUD against the USD, NOKOX (Pty) Ltd. loses: (3,000,000 + 180,000) × (1.50 - 1.40) = 3 31188"000000 AAUUDD. The difference is a loss of: 270,000 - 318,000 = - -4488"000000 AAUUDD, once disclosed in reporting currency. To hedge its profit, NOKOX (Pty) Ltd. buys on 4.04.20X8 at costs of 25,000 AUD an option to exchange 2,700,000 USD on 31.12.20X8 to 4,000,000 AUD. The exchange rate on 4.04.20X8 is: 1 USD : 1.48 AUD. At first, we record the option separately from the shares. We refer to this recognition as case (i). Later, we discuss a combined presentation under case (ii). The latter one is in line with IFRS 9.6. (i): Separate Positions The option is bought at 25,000 AUD and is recorded as a single item at cost. At the time of purchasing the MCD shares, the option is not helping as the exchange rate is: 1 AUD : 1.50 USD. Using the option would even result in a loss of: 2,700,000 × 1.50 - 4,000,000 = 5500"000000 AAUUDD. On the 31.12.20X8, the option’s value is higher. Based on the currency exchange rate, 2,700,000 USD are worth: 2,700,000 × 1.40 = 3 3"778800"000000 AAUUDD. The value of the option is: 4,000,000 - 3,780,000 = 2 22200"000000 AAUUDD. We still must deduct the fees. This gives: 220,000 - 25,000 = 1 19955"000000 AAUUDD. We deduct NOKOX (Pty) Ltd.’s currency loss from the realised gain of the call option, which gives a profit of: 195,000 - 48,000 = 1 14477"000000 AAUUDD. Observe the Bookkeeping entries below for the initial and subsequent valuation of the call option. <?page no="286"?> Berkau: Financial Statements 8e 9-286 @ 4.04.20X8 Securities (Call Option) SEC 25,000 Cash/ Bank C/ B 25,000 (recognition of the call option at cost) @ 31.12.20X8 Securities (Call Option) SEC 195,000 Gain on Valuation-20X8 OCI 195,000 (recognition of gain from call option with fees deducted) NOKOX (Pty) Ltd. records the gain from the call option and the loss from the shares as other comprehensive income. On 31.12.20X8, NOKOX (Pty) Ltd. exercises the option and exchanges 2,700,000 USD worth: 2,700,000 × 1.40 = 33"778800"000000 AAUUDD into 4,000,000 AUD. The latter transaction is shown as Bookkeeping entry (i3). See the accounts in Figure 9.9. @ 31.12.20X8 Cash Bank (in AUD) C/ B 4,000,000 Cash/ Bank (in USD) C/ B 3,780,000 Securities SEC 220,000 (option exercise) D C D C (3) 90,000 (2) 42,000 (1) 4,500,000 (3) 90,000 c/ d 147,000 (i2) 195,000 c/ d 4,410,000 237,000 237,000 4,500,000 4,500,000 b/ d 147,000 b/ d 4,410,000 Other comprehensive income-20X8 OCI Securities SEC D C D C (i1) 25,000 (i3) 220,000 (2) 42,000 (1) 4,500,000 (i2) 195,000 (i3) 4,000,000 (i1) 25,000 220,000 220,000 c/ d 4,263,000 (i3) 3,780,000 8,305,000 8,305,000 b/ d 4,263,000 Option FA Cash/ Bank C/ B Figure 9.9: NOKOX (Pty) Ltd.’s accounts (ii): Hedging In compliance with IFRS 9.6.1.2, NOKOX (Pty) Ltd. combines the hedged item (shares) with the hedge instrument (call option). On its balance sheet, NOKOX (Pty) Ltd. discloses an item of current assets that combines the two financial instruments. Its initial valuation is based on the shares and the call option, both valued at cost: 30,000 × 100 × 1.50 + 25,000 = <?page no="287"?> Berkau: Financial Statements 8e 9-286 @ 4.04.20X8 Securities (Call Option) SEC 25,000 Cash/ Bank C/ B 25,000 (recognition of the call option at cost) @ 31.12.20X8 Securities (Call Option) SEC 195,000 Gain on Valuation-20X8 OCI 195,000 (recognition of gain from call option with fees deducted) NOKOX (Pty) Ltd. records the gain from the call option and the loss from the shares as other comprehensive income. On 31.12.20X8, NOKOX (Pty) Ltd. exercises the option and exchanges 2,700,000 USD worth: 2,700,000 × 1.40 = 33"778800"000000 AAUUDD into 4,000,000 AUD. The latter transaction is shown as Bookkeeping entry (i3). See the accounts in Figure 9.9. @ 31.12.20X8 Cash Bank (in AUD) C/ B 4,000,000 Cash/ Bank (in USD) C/ B 3,780,000 Securities SEC 220,000 (option exercise) D C D C (3) 90,000 (2) 42,000 (1) 4,500,000 (3) 90,000 c/ d 147,000 (i2) 195,000 c/ d 4,410,000 237,000 237,000 4,500,000 4,500,000 b/ d 147,000 b/ d 4,410,000 Other comprehensive income-20X8 OCI Securities SEC D C D C (i1) 25,000 (i3) 220,000 (2) 42,000 (1) 4,500,000 (i2) 195,000 (i3) 4,000,000 (i1) 25,000 220,000 220,000 c/ d 4,263,000 (i3) 3,780,000 8,305,000 8,305,000 b/ d 4,263,000 Option FA Cash/ Bank C/ B Figure 9.9: NOKOX (Pty) Ltd.’s accounts (ii): Hedging In compliance with IFRS 9.6.1.2, NOKOX (Pty) Ltd. combines the hedged item (shares) with the hedge instrument (call option). On its balance sheet, NOKOX (Pty) Ltd. discloses an item of current assets that combines the two financial instruments. Its initial valuation is based on the shares and the call option, both valued at cost: 30,000 × 100 × 1.50 + 25,000 = Berkau: Financial Statements 8e 9-287 44"552255"000000 AAUUDD. On 31.12.20X8, the shares’ value decreases to: 30,000 × 105 × 1.40 = 4 4"441100"000000 AAUUDD. The valuation of the call option is derived from the cost of acquisition and the gain of: 25,000 + 195,000 = 2 22200"000000 AAUUDD, see above. The total item’s value is: 4,410,000 + 220,000 = 4 4"663300"000000 AAUUDD. The residual gain on valuation gives: 4,630,000 - 4,525,000 = 1 10055"000000 AAUUDD. We add this amount to the dividend income of: 30,000 × 1 × 1.40 = 4 422"000000 AAUUDD, which is a gain outside of the combined item. Hence, the total gain is: 105,000 + 42,000 = 1 14477"000000 AAUUDD. In contrast to case (i) we disclose a gain from the combined item of 105,000 AUD and a dividend income to the extent of 42,000 AUD. How it is Done (Accounting for Securities): (1) Check the business model and the intention of holding securities. If they fall under current assets continue below with step (2), otherwise consider financial assets as in chapter (7). (2) Record the securities at cost of acquisition. Do not depreciate securities. (3) Monitor the securities’ fair value; this is usually the fair market price on the bond market. In case the value of securities changes, record changes either through profit or loss or through other comprehensive income. Make the contra entry in the Securities account. (4) For selling securities apply a Realisation account. In case a security is used, like executing a call option, record an expense to the extent of the security and make the contra entry in the Securities account for the invalidation of the security. 9.28 Prepaid Expenses Prepaid expenses are payments, e.g., for labour, rent, insurance etc., allocated to certain future periods that have been paid for already. The characteristics of prepaid expenses resemble those of receivables. The difference is that prepaid expenses are settled by services and receivables on cash. In contrast to German HGB, the IASB regards prepaid expenses as current assets. They fulfil the criteria of assets recognition. In contrast, German HGB shows an extra item outside of the current asset section, referred to as Rechnungsabgrenzungsposten (accrual as separate item). 9.29 Cash and its Equivalents We disclose cash and its equivalents in the Cash/ Bank account. It is cash, like coins and bills on hand, and money in the bank. Investments that are as liquid as cash and convertible to known amounts of cash fall under cash equivalents (IAS 7.6) and we record them in the bank account, too <?page no="288"?> Berkau: Financial Statements 8e 9-288 In general, companies keep separate records for each bank account for bank reconciliation purposes. 174 The measurement of cash/ bank does not change except of when cash is held in a foreign currency. In those cases, the valuation is based on the currency exchange rate that applies on the transaction date for initial valuation and on the currency exchange rate on the balance sheet date for revaluations. Differences are recorded through profit or loss or other comprehensive income. 9.30 C/ S BAKENSKOP PLC See the case study BAKENSKOP PLC below. Data Sheet for BAKENSKOP PLC DDoommiicciillee: : BBoottsswwaannaa ((GGaabboorroonnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : BBWWPP.. CCllaassssiiffiiccaattiioonn: : ttrraaddeerr.. PPeerriioodd: : 2200XX55.. OOppeenniinngg vvaalluuee: : 550000"000000 BBWWPP.. AAddddiittiioonn: : 2200"000000 EEUURR.. CCuurrrreennccyy eexxcchhaannggee rraattee 11 BBWWPP : : 00..0099 EEUURR / / 11 BBWWPP : : 00..0077 EEUURR.. VVAATT nn/ / aa.. BAKENSKOP PLC is a Botswanan retailer. It reports in Botswanan Pula BWP. For the import of goods from Europe, BAKENSKOP PLC applies an extra bank account in EUR. For disclosure on its balance sheet, BAKENSKOP PLC must transfer its balance to the reporting currency BWP. At the beginning of fiscal year 20X5, BAKENSKOP PLC’s EUR-bank account’s 174 Study our textbook Basics of Accounting, chapter (37). opening value is 40,000 EUR. The currency exchange rate is: 1 BWP : 0.08 EUR. Hence, the opening value in the reporting currency is: 40,000 / 0.08 = 550000"000000 BBWWPP. This is disclosed on the balance sheet as per 1.01.20X5. On 1.10.20X5, BAKENSKOP PLC buys 20,000 EUR at an exchange rate of: 1 BWP : 0.09 EUR which is accrued to its EUR-bank account. On 31.12.20X5, the currency exchange rate is: 1 BWP : 0.07 EUR. BAKENSKOP PLC discloses a balancing figure of 60,000 EUR on its bank account. The value of the EUR bank account in Botswanan Pula is: 60,000 / 0.07 = 8 85577"114422..8866 BBWWPP. After we calculated the fair value of the bank account’s balancing figure, we record the impact of the currency exchange rate. The first 40,000 EUR make BAKENSKOP PLC earn: 40,000 × (0.07 -1 - 0.08 -1 ) = 7 711"442288..5577 BBWWPP. The receipt from October 20X5 results in another gain of: 20,000 × (0.07 -1 - 0.09 -1 ) = 6633"449922..0066 BBWWPP. The resulting income from currency exchanges is: 71,428.57 + 63,492.06 == 113344"992200..6633 BBWWPP. BAKENSKOP PLC does not convert every Bookkeeping entry to the reporting currency as the bank account is based on EUR. Therefore, prior Bookkeeping entries have been made in EUR. There is only a revaluation Bookkeeping entry required at yearends which is shown below. Observe the accounts in Figure 9.10: <?page no="289"?> Berkau: Financial Statements 8e 9-288 In general, companies keep separate records for each bank account for bank reconciliation purposes. 174 The measurement of cash/ bank does not change except of when cash is held in a foreign currency. In those cases, the valuation is based on the currency exchange rate that applies on the transaction date for initial valuation and on the currency exchange rate on the balance sheet date for revaluations. Differences are recorded through profit or loss or other comprehensive income. 9.30 C/ S BAKENSKOP PLC See the case study BAKENSKOP PLC below. Data Sheet for BAKENSKOP PLC DDoommiicciillee: : BBoottsswwaannaa ((GGaabboorroonnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : BBWWPP.. CCllaassssiiffiiccaattiioonn: : ttrraaddeerr.. PPeerriioodd: : 2200XX55.. OOppeenniinngg vvaalluuee: : 550000"000000 BBWWPP.. AAddddiittiioonn: : 2200"000000 EEUURR.. CCuurrrreennccyy eexxcchhaannggee rraattee 11 BBWWPP : : 00..0099 EEUURR / / 11 BBWWPP : : 00..0077 EEUURR.. VVAATT nn/ / aa.. BAKENSKOP PLC is a Botswanan retailer. It reports in Botswanan Pula BWP. For the import of goods from Europe, BAKENSKOP PLC applies an extra bank account in EUR. For disclosure on its balance sheet, BAKENSKOP PLC must transfer its balance to the reporting currency BWP. At the beginning of fiscal year 20X5, BAKENSKOP PLC’s EUR-bank account’s 174 Study our textbook Basics of Accounting, chapter (37). opening value is 40,000 EUR. The currency exchange rate is: 1 BWP : 0.08 EUR. Hence, the opening value in the reporting currency is: 40,000 / 0.08 = 550000"000000 BBWWPP. This is disclosed on the balance sheet as per 1.01.20X5. On 1.10.20X5, BAKENSKOP PLC buys 20,000 EUR at an exchange rate of: 1 BWP : 0.09 EUR which is accrued to its EUR-bank account. On 31.12.20X5, the currency exchange rate is: 1 BWP : 0.07 EUR. BAKENSKOP PLC discloses a balancing figure of 60,000 EUR on its bank account. The value of the EUR bank account in Botswanan Pula is: 60,000 / 0.07 = 8 85577"114422..8866 BBWWPP. After we calculated the fair value of the bank account’s balancing figure, we record the impact of the currency exchange rate. The first 40,000 EUR make BAKENSKOP PLC earn: 40,000 × (0.07 -1 - 0.08 -1 ) = 7 711"442288..5577 BBWWPP. The receipt from October 20X5 results in another gain of: 20,000 × (0.07 -1 - 0.09 -1 ) = 6633"449922..0066 BBWWPP. The resulting income from currency exchanges is: 71,428.57 + 63,492.06 == 113344"992200..6633 BBWWPP. BAKENSKOP PLC does not convert every Bookkeeping entry to the reporting currency as the bank account is based on EUR. Therefore, prior Bookkeeping entries have been made in EUR. There is only a revaluation Bookkeeping entry required at yearends which is shown below. Observe the accounts in Figure 9.10: Berkau: Financial Statements 8e 9-289 @ 31.12.20X5 Cash Bank (in BWP) C/ B 134,921 Gain on Valuation-20X5 OCI 134,921 (recognition of an currency valuation gain in reporting currency) D C D C [EUR] [EUR] [BWP] [BWP] OV 40,000 OV 500,000 (1) 20,000 c/ d 60,000 (1) 222,222 60,000 60,000 OCI 134,921 c/ d 857,143 b/ d 60,000 857,143 857,143 b/ d 857,143 Cash/ Bank EUR Cash/ Bank BWP D C [BWP] [BWP] c/ d 134,921 BWP 134,921 b/ d 134,921 Other comprehensive income-20X5 OCI Figure 9.10: BAKENSKOP PLC’s foreign currency bank accounts 9.31 Summary On the current asset section, we disclose inventories, receivables, securities, prepaid expenses and cash/ bank. The valuation of inventories is at the lower of cost and net realisable values. For the valuation of finished goods in production firms, Manufacturing Accounting applies. Receivables are measured at settlement values but an adjustment for potential credit risks applies. Those adjustments as well as a complete payment failure of the debtor is recorded as bad debts. Securities are short-term financial instruments held at fair values through profit and loss or through other comprehensive income as by default. IFRS 9 applies for their valuation. In contrast to the German Handelsgesetzbuch, prepaid expenses are considered as current assets. 9.32 Working Definitions Bad Debts: Expense account for irrecoverable receivables. Hedging: Carrying two financial instruments with opposite risks, such as a receivable in USD and a future in USD. Idle Costs: Expenses for unused production facilities. Inventories: Asset held for sale or for support of production or for service rendering. Work-in-Process Account: Account in Manufacturing Accounting that represents a job order. The Work-in-Pro- <?page no="290"?> Berkau: Financial Statements 8e 9-290 cess account is the reconciliation account for Job Order accounts. See also the conventions in chapter (1). Manufacturing Accounting: Accounting for finished goods valuation in manufacturing companies and production firms. Manufacturing Accounting is based on Work-in-Process accounts and Manufacturing Overheads accounts. Manufacturing Overheads Account: An account to gather all overheads linked to production. Net Realisable Value: Measurement at fair value at which an asset can be sold among knowledgeable, willing and independent parties (orderly transaction). Overhead Application: Allocation of manufacturing overheads to job orders by making a debit entry in the Workin-Process account and a credit entry in the Manufacturing Overheads account. Securities: Short-term financial instruments. 9.33 Question Bank (1) A company records as manufacturing overheads: 30,000 EUR depreciation, 55,000 EUR indirect labour and 6,000 EUR factory insurance expenses. The planned output is 100,000 kg. The predetermined overhead allocation rate is 0.86 EUR/ kg. The actual performance is only 60,000 kg. How much are the applied overheads following IAS 2.13, if normal capacity applies and idle costs are recorded? 1. 51,600 EUR . 2. 54,600 EUR . 3. 86,000 EUR . 4. 91,000 EUR . (2) A company records the following stockings. 100 at 34 EUR, 200 at 33 EUR, 150 at 35 EUR. Based on a weighted average cost formula, how much is a stock release of 25 units? 1. 842 EUR . 2. 850 EUR . 3. 848 EUR . 4. 875 EUR . (3) A production firm calculates the predetermined overhead allocation rate based on its manufacturing overheads budget 60,000 EUR and a planned performance of 400 machine hours. During the actual period, there are actual costs of 61,000 EUR and the recorded machine hours are 390 hours in the manufacturing department. (MOH- Account). How much are underapplied manufacturing overheads? 1. (1,500 EUR) . 2. 2,500 EUR . 3. 1,538 EUR . 4. Nil . (4) A company carries a note receivable from selling goods to the extent of 1,500 EUR. The customer is most probably (80 % probability) insolvent. How much are the recorded bad debts? 1. 0 EUR . 2. 1,000 EUR . 3. 1,250 EUR . 4. 1,500 EUR . (5) On 4.05.20X5, a company buys 50 bonds that mature in the next Accounting period (30.06.20X6). The purchase price is 246 EUR/ b, and the principal of the bond is 250 <?page no="291"?> Berkau: Financial Statements 8e 9-290 cess account is the reconciliation account for Job Order accounts. See also the conventions in chapter (1). Manufacturing Accounting: Accounting for finished goods valuation in manufacturing companies and production firms. Manufacturing Accounting is based on Work-in-Process accounts and Manufacturing Overheads accounts. Manufacturing Overheads Account: An account to gather all overheads linked to production. Net Realisable Value: Measurement at fair value at which an asset can be sold among knowledgeable, willing and independent parties (orderly transaction). Overhead Application: Allocation of manufacturing overheads to job orders by making a debit entry in the Workin-Process account and a credit entry in the Manufacturing Overheads account. Securities: Short-term financial instruments. 9.33 Question Bank (1) A company records as manufacturing overheads: 30,000 EUR depreciation, 55,000 EUR indirect labour and 6,000 EUR factory insurance expenses. The planned output is 100,000 kg. The predetermined overhead allocation rate is 0.86 EUR/ kg. The actual performance is only 60,000 kg. How much are the applied overheads following IAS 2.13, if normal capacity applies and idle costs are recorded? 1. 51,600 EUR . 2. 54,600 EUR . 3. 86,000 EUR . 4. 91,000 EUR . (2) A company records the following stockings. 100 at 34 EUR, 200 at 33 EUR, 150 at 35 EUR. Based on a weighted average cost formula, how much is a stock release of 25 units? 1. 842 EUR . 2. 850 EUR . 3. 848 EUR . 4. 875 EUR . (3) A production firm calculates the predetermined overhead allocation rate based on its manufacturing overheads budget 60,000 EUR and a planned performance of 400 machine hours. During the actual period, there are actual costs of 61,000 EUR and the recorded machine hours are 390 hours in the manufacturing department. (MOH- Account). How much are underapplied manufacturing overheads? 1. (1,500 EUR) . 2. 2,500 EUR . 3. 1,538 EUR . 4. Nil . (4) A company carries a note receivable from selling goods to the extent of 1,500 EUR. The customer is most probably (80 % probability) insolvent. How much are the recorded bad debts? 1. 0 EUR . 2. 1,000 EUR . 3. 1,250 EUR . 4. 1,500 EUR . (5) On 4.05.20X5, a company buys 50 bonds that mature in the next Accounting period (30.06.20X6). The purchase price is 246 EUR/ b, and the principal of the bond is 250 Berkau: Financial Statements 8e 9-291 EUR/ b. On 31.12.20X5, the coupon at 5.4 %/ a is paid. At which value are the bonds disclosed on the balance sheet as per 31.12.20X5? 1. 12,964 EUR . 2. 12,171 EUR . 3. 12,500 EUR . 4. 12,300 EUR . 9.34 Solutions 1-1, 2-3, 3-2, 4-2, 5-4. <?page no="292"?> Berkau: Financial Statements 8e 10-292 10 Statement of Cash Flows 10.1 What is in the Chapter? This chapter covers how to prepare cash flow statements in compliance with IFRSs. There are three methods for cash flow calculation: the direct method, as applied for KENILWORTH METERED TAXI Ltd. in chapter (3), the reconciliation of profits with the operating cash flows, as we prepared BATHURST Ltd.’s cash flow statement with, in chapter (6) and the derivative method 175 . Usually, the reconciliation method applies. We start this chapter with the profit calculation, preparation of the Cash/ Bank account and the direct method for a cash flow statement. Thereafter we prepare a cash flow statement based on the reconciliation method for operating cash flows in detail. We follow in this chapter the How-itis-Done paragraph for the reconciliation of profits with operating cash flows. We explain all steps in detail and thereafter apply them for the case study EIMKE Ltd. 10.2 Learning Objectives After studying cash flows in this chapter, you understand the need of reporting cash flows in categories of cash flows from operations, investments and finance. You can apply the direct method for a full statement of cash flows and the reconciliation method 175 Find the derivative method in the study material portal accessible via QR code link. for its cash flows from operations. You understand the steps for the reconciliation of profits with cash flows from operations and can calculate a cash flow from operations by the reconciliation method. 10.3 Cash Flow Statement Obligation Cash flows change cash/ bank during an Accounting period. In IAS 1.10, a statement of cash flows is required as part of a full set of financial statements. Users of financial statements can assess a company’s liquidity situation by analysing the cash/ bank item on the balance sheet in combination with the statement of cash flows. They strive for forecasting future liquidity and cash flow developments to support their economic decisions about the reporting company. Formally, a statement of cash flows resembles a liquidity plan (cash budget) 176 . In comparison to a cash flow statement, there are four major formal differences: (1) A liquidity plan starts-off from the opening value of cash/ bank and ends with the closing balance of the cash/ bank item (liquidity) whereas the statement of cash flows discloses the changes. (2) On a cash flow statement cash flows are classified in categories to support estimates of future receipts/ payments. Cash flows resulting from operating activities are usually repetitive whereas 176 Study our textbook Management Accounting, chapter (6). <?page no="293"?> Berkau: Financial Statements 8e 10-292 10 Statement of Cash Flows 10.1 What is in the Chapter? This chapter covers how to prepare cash flow statements in compliance with IFRSs. There are three methods for cash flow calculation: the direct method, as applied for KENILWORTH METERED TAXI Ltd. in chapter (3), the reconciliation of profits with the operating cash flows, as we prepared BATHURST Ltd.’s cash flow statement with, in chapter (6) and the derivative method 175 . Usually, the reconciliation method applies. We start this chapter with the profit calculation, preparation of the Cash/ Bank account and the direct method for a cash flow statement. Thereafter we prepare a cash flow statement based on the reconciliation method for operating cash flows in detail. We follow in this chapter the How-itis-Done paragraph for the reconciliation of profits with operating cash flows. We explain all steps in detail and thereafter apply them for the case study EIMKE Ltd. 10.2 Learning Objectives After studying cash flows in this chapter, you understand the need of reporting cash flows in categories of cash flows from operations, investments and finance. You can apply the direct method for a full statement of cash flows and the reconciliation method 175 Find the derivative method in the study material portal accessible via QR code link. for its cash flows from operations. You understand the steps for the reconciliation of profits with cash flows from operations and can calculate a cash flow from operations by the reconciliation method. 10.3 Cash Flow Statement Obligation Cash flows change cash/ bank during an Accounting period. In IAS 1.10, a statement of cash flows is required as part of a full set of financial statements. Users of financial statements can assess a company’s liquidity situation by analysing the cash/ bank item on the balance sheet in combination with the statement of cash flows. They strive for forecasting future liquidity and cash flow developments to support their economic decisions about the reporting company. Formally, a statement of cash flows resembles a liquidity plan (cash budget) 176 . In comparison to a cash flow statement, there are four major formal differences: (1) A liquidity plan starts-off from the opening value of cash/ bank and ends with the closing balance of the cash/ bank item (liquidity) whereas the statement of cash flows discloses the changes. (2) On a cash flow statement cash flows are classified in categories to support estimates of future receipts/ payments. Cash flows resulting from operating activities are usually repetitive whereas 176 Study our textbook Management Accounting, chapter (6). Berkau: Financial Statements 8e 10-293 a cash flow from financing or investing activities is seen as once-off payment/ receipt. (3) A cash flow statement refers to the past and the liquidity plan is for budgeting. (4) In contrast to a cash flow statement, the calculated liquidity is adjusted for bank loans and overdraft options. All reporting companies that apply IFRSs prepare and disclose a statement of cash flows. The total cash flow can already be read from the difference of the cash/ bank item on balance sheets for two following Accounting periods. On a statement of cash flows, the cash flow is disclosed following a classification as: - Cash flows from operations. - Cash flows from investing activities. - Cash flows from financing activities. The major challenge of a cash flow statement preparation is the cash flow separation and the allocation of cash flows to categories. 10.4 C/ S EIMKE Ltd. We discuss the case study EIMKE Ltd. in Melbourne. At first, we prepare its income statement and a Cash/ Bank account. Data Sheet for EIMKE Ltd. DDoommiicciillee: : AAuussttrraalliiaa ((MMeellbboouurrnnee)).. RReeppoorrttiinngg ccuurrrreennccyy: : AAUUDD.. CCllaassssiiffiiccaattiioonn: : pprroodduuccttiioonn ffiirrmm.. PPeerriioodd: : 2200XX88.. OOppeenniinngg vvaalluueess: : sseeee bbaallaannccee sshheeeett aass aa 3311..1122..2200XX77.. AAccttiivviittiieess iinn 2200XX88: : ppaayyiinngg iinnccoommee ttaaxx 3300"000000 AAUUDD" bbuuyyiinngg ggooooddss 6600"000000 AAUUDD ((ggrroossss aammoouunntt" ddeepprreecciiaattiioonn 2200"000000 AAUUDD" ccoolllleeccttiinngg rreecceeiivvaabblleess 22"550000 AAUUDD" bbaannkk llooaann ppaayymmeenntt 33"000000 AAUUDD" rreevveennuuee 112200"000000 AAUUDD" mmaatteerriiaallss 6600"000000 AAUUDD.. VVAATT rraattee: : 2200 %%.. EIMKE Ltd. is a production firm in Australia. Its statement of financial position at the end of the previous Accounting period is shown in Figure 10.1. A C, L Non-current assets [AUD] Equity [AUD] P, P, E 75,000 Share capital 30,000 Intangibles Reserves Financial assets Retained earnings 70,000 Current assets Liabilities (liab.) Inventory 20,000 Long-term liab. 18,000 Accounts receivables 5,000 Short-term liab. A/ P 2,000 Prepaid expenses Provisions Cash/ Bank 50,000 Income tax liab. 30,000 Total assets 150,000 Total equity and liab. 150,000 Eimke Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X7 Figure 10.1: EIMKE Ltd.’s balance sheet (20X7) EIMKE Ltd. discloses a bank loan with a value of 20,000 AUD. Following IAS 1.60, <?page no="294"?> Berkau: Financial Statements 8e 10-294 the pay-off portion of 2,000 AUD is classified and disclosed as a short-term liability. The pay-off amount of EIMKE Ltd.’s bank loan is constant in this case study (given). Retained earnings of 70,000 AUD are based on last year’s profit and do not contain profits/ losses carried forward. The income tax liabilities result from the profit earned during 20X7 and are due in 20X8. The receivables reflect future receipts from customers for goods purchased in the past. EIMKE Ltd. records the below business activities in 20X8: (1) Payment of income tax liabilities to an extent of 30,000 AUD. (2) Purchase and payment of materials at cost of purchase of 50,000 AUD (gross amount: 60,000 AUD). (3) Depreciation to the extent of 20,000 AUD. (4) Collection of half of the receivables disclosed on the balance sheet in Figure 10.1. 177 (5) Payment of interest of 1,000 AUD and pay-off of 2,000 AUD for its bank loan deducted from its shortterm Liabilities account (IAS 1.60 applies). (6) Earning a revenue of 120,000 AUD. From the proceeds (gross value) 90 % are paid by the customers, the remainder proceeds are collected in the next Accounting periods. (7) Material consumption of 60,000 AUD in production. We show the Bookkeeping entries (1) - (7). For the sake of simplification, revenues and stock releases are recorded on 1.07.20X8 and debt collection and materials on 30.06.20X8. Recordings for the bank loan are split into three separate Bookkeeping entries (5a) - (5c) made at the yearend. @ 1.01.20X8 (1) Income Tax Liabilities ITL 30,000 Cash/ Bank C/ B 30,000 (paying income tax liabilities resulting from 20X7) @ 30.06.20X8 (2) Inventories INV 50,000 Value Added Tax VAT 10,000 Cash/ Bank C/ B 60,000 (purchase of materials) @ 31.12.20X8 (3) Depreciation-20X8 DPR 20,000 Accumulated Depreciation ACC 20,000 (recording depreciation) 177 EIMKE Ltd. carries the remainder in accounts receivables as no indication for recoverability issues is present. Alternatively, the company must write them off as bad debts. <?page no="295"?> Berkau: Financial Statements 8e 10-294 the pay-off portion of 2,000 AUD is classified and disclosed as a short-term liability. The pay-off amount of EIMKE Ltd.’s bank loan is constant in this case study (given). Retained earnings of 70,000 AUD are based on last year’s profit and do not contain profits/ losses carried forward. The income tax liabilities result from the profit earned during 20X7 and are due in 20X8. The receivables reflect future receipts from customers for goods purchased in the past. EIMKE Ltd. records the below business activities in 20X8: (1) Payment of income tax liabilities to an extent of 30,000 AUD. (2) Purchase and payment of materials at cost of purchase of 50,000 AUD (gross amount: 60,000 AUD). (3) Depreciation to the extent of 20,000 AUD. (4) Collection of half of the receivables disclosed on the balance sheet in Figure 10.1. 177 (5) Payment of interest of 1,000 AUD and pay-off of 2,000 AUD for its bank loan deducted from its shortterm Liabilities account (IAS 1.60 applies). (6) Earning a revenue of 120,000 AUD. From the proceeds (gross value) 90 % are paid by the customers, the remainder proceeds are collected in the next Accounting periods. (7) Material consumption of 60,000 AUD in production. We show the Bookkeeping entries (1) - (7). For the sake of simplification, revenues and stock releases are recorded on 1.07.20X8 and debt collection and materials on 30.06.20X8. Recordings for the bank loan are split into three separate Bookkeeping entries (5a) - (5c) made at the yearend. @ 1.01.20X8 (1) Income Tax Liabilities ITL 30,000 Cash/ Bank C/ B 30,000 (paying income tax liabilities resulting from 20X7) @ 30.06.20X8 (2) Inventories INV 50,000 Value Added Tax VAT 10,000 Cash/ Bank C/ B 60,000 (purchase of materials) @ 31.12.20X8 (3) Depreciation-20X8 DPR 20,000 Accumulated Depreciation ACC 20,000 (recording depreciation) 177 EIMKE Ltd. carries the remainder in accounts receivables as no indication for recoverability issues is present. Alternatively, the company must write them off as bad debts. Berkau: Financial Statements 8e 10-295 @ 30.06.20X8 (4) Cash Bank C/ B 2,500 Accounts Receivables A/ R 2,500 (debts collection) @ 31.12.20X8 (5) Interest-20X8 INT 1,000 Cash/ Bank C/ B 1,000 (recognition of interest expenses) Accounts Payables A/ P 2,000 Cash/ Bank C/ B 2,000 (pay-off of the bank loan from short-term liabilities following IAS 1.60) Interest Bearing Liabilities IBL 2,000 Accounts Payables A/ P 2,000 (reclassification of next year's pay-off of the bank loan following IAS 1.60) @ 1.07.20X8 (6) Cash Bank C/ B 129,600 Accounts Receivables A/ R 14,400 Value Added Tax VAT 14,000 Revenue-20X8 REV 120,000 (revenue recognition) @ 30.06.20X8 (7) Material Expenses-20X8 MAT 60,000 Inventories INV 60,000 (recording material expenses) From the above business activities, only (1), (2), (4), (5) and (6) are relevant for cash flows. The Profit and Loss account is shown in Figure 10.2. You find the balance sheet as per 31.12.20X8 in Figure 10.5. D C DPR 20,000 REV 120,000 INT 1,000 MAT 60,000 EBT 39,000 120,000 120,000 ITL 11,700 b/ d 39,000 R/ E 27,300 Profit and Loss-20X8 P8L Figure 10.2: EIMKE Ltd.’s Profit and Loss-20X8 account From a comparison of cash/ bank, we learn that EIMKE Ltd.'s liquidity increased. Cash/ bank on the balance sheet as per 31.12.20X7 was 50,000 AUD (Figure 10.1) and one year later it is 89,100 AUD. Check Figure 10.5. Therefore, its total cash flow is: 89,100 - 50,000 = 3 399"110000 AAUUDD. <?page no="296"?> Berkau: Financial Statements 8e 10-296 Next, we classify cash flows. Operating activities at EIMKE Ltd. are the tax payment (1), the purchase (2), the collection of receivables (4) and the proceeds (6). Cash flows from financing activities include the pay-off payment of the bank loan (5b) and the payment of interest (5a). 178 No investments took place at EIMKE Ltd. in 20X8. Observe below the statement of cash flows in Figure 10.3. Cash flow from operating acitivities [AUD] [AUD] Proceeds 129,600 Purchase payment (60,000) Collection of receivables 2,500 Tax payment (30,000) 42,100 Cash flow from investing activities Investments 0 0 Cash flow from financing activities Interest payment (1,000) Pay-off payment (2,000) (3,000) Total cash flow 39,100 Eimke Ltd. STATEMENT of CASH FLOWS for the period ended 31.12.20X8 Figure 10.3: EIMKE Ltd.’s statement of cash flows (20X8) How it is Done (Cash Flow Statement - Direct Method): (1) Determine all payments relevant for the Accounting period from the Cash/ Bank account. (2) Classify cash flows into categories: operating, investing and financing cash flows. (3) Operating cash flows result from the normal operations of the business, e.g., payments for purchases, labour payments, rent payments, tax payments, sales etc. (4) Investing cash flows are caused by acquisitions and sales of non-current assets like buying machinery or their disposal. (5) Financing cash flows are linked to the financing of the business and usually change debt or equity items on the balance sheet. Examples are bank loans taken out, share and bond issues as well as paying/ receiving dividends, interest, coupons and payments to retire debts. Our conventions in chapter (1) apply. 178 In line with IAS 7.33, interest can be classified as operating or financial cash flow. We follow our conventions and consider interest as financing activities by default. <?page no="297"?> Berkau: Financial Statements 8e 10-296 Next, we classify cash flows. Operating activities at EIMKE Ltd. are the tax payment (1), the purchase (2), the collection of receivables (4) and the proceeds (6). Cash flows from financing activities include the pay-off payment of the bank loan (5b) and the payment of interest (5a). 178 No investments took place at EIMKE Ltd. in 20X8. Observe below the statement of cash flows in Figure 10.3. Cash flow from operating acitivities [AUD] [AUD] Proceeds 129,600 Purchase payment (60,000) Collection of receivables 2,500 Tax payment (30,000) 42,100 Cash flow from investing activities Investments 0 0 Cash flow from financing activities Interest payment (1,000) Pay-off payment (2,000) (3,000) Total cash flow 39,100 Eimke Ltd. STATEMENT of CASH FLOWS for the period ended 31.12.20X8 Figure 10.3: EIMKE Ltd.’s statement of cash flows (20X8) How it is Done (Cash Flow Statement - Direct Method): (1) Determine all payments relevant for the Accounting period from the Cash/ Bank account. (2) Classify cash flows into categories: operating, investing and financing cash flows. (3) Operating cash flows result from the normal operations of the business, e.g., payments for purchases, labour payments, rent payments, tax payments, sales etc. (4) Investing cash flows are caused by acquisitions and sales of non-current assets like buying machinery or their disposal. (5) Financing cash flows are linked to the financing of the business and usually change debt or equity items on the balance sheet. Examples are bank loans taken out, share and bond issues as well as paying/ receiving dividends, interest, coupons and payments to retire debts. Our conventions in chapter (1) apply. 178 In line with IAS 7.33, interest can be classified as operating or financial cash flow. We follow our conventions and consider interest as financing activities by default. Berkau: Financial Statements 8e 10-297 (6) Calculate operating, investing and financing cash flow by adding receipts and deducting payments. (7) Add all cash flow categories for total cash flow calculation. A cash flow statement can be prepared by three methods. - Direct method. - Indirect method (reconciliation of profits with operating cash flows and calculating investing and financing cash flows directly). - Derivative method. This method derives cash flows from two balance sheets, the income statement, the register of non-current assets and the profit appropriation. It allows a cash flow statement preparation from “outside of the company”. For EIMKE Ltd., we applied the direct method above. IAS 7.18 focusses on the operating cash flow and refers to the direct method based on cash receipts and payments. In contrast, the indirect method reconciles profits with operating cash flows. The investing and financing cash flows must always be determined directly. 10.5 Direct Method The direct method follows the Cash/ Bank account and classifies all entries therein in operating, investing and financing payments/ receipts. The cash flow categories are defined in IAS 7.6. Operating activities of a company aim to earn revenues and are not linked to investing nor financing of the business. Examples for operating cash flows can be found in IAS 7.14. Investing activities are the acquisition and disposal of non-current assets. Examples are mentioned in IAS 7.16. Financing activities change equity and/ or long-term liabilities. Find examples in IAS 7.17. We also consider all payments linked to the latter ones, e.g., interest payments and repayments of liabilities as financing activities. IAS 7.33 applies. The application of the direct method is simple. With a high volume of entries in the Cash/ Bank account, the cash flow statement preparation gets extensive. 10.6 C/ S EIMKE Ltd. - Direct Method EIMKE Ltd.’s Cash/ Bank and Accounts Receivables account for 20X8 are displayed in Figure 10.4. D C D C OV 50,000.00 (1) 30,000.00 OV 5,000.00 (4) 2,500.00 (4) 2,500.00 (2) 60,000.00 (6) 14,400.00 c/ d 16,900.00 (6) 129,600.00 (5) 3,000.00 19,400.00 19,400.00 c/ d 89,100.00 16,900.00 182,100.00 182,100.00 b/ d 89,100.00 Cash/ Bank C/ B Accounts receivables A/ R Figure 10.4: EIMKE Ltd.’s accounts (20X8) <?page no="298"?> Berkau: Financial Statements 8e 10-298 We classify cash flows as follows: (1), (2), (4) and (6) are operative cash flows, (5a) and (5b) are financing cash flows. 10.7 Reconciliation of Profits with Operating Cash Flows For the indirect method, we reconcile profits with operating cash flows. For profit and loss calculations, we record business activities solely on a revenue and expense base. A statement of (operating) cash flows requires the recording of the same activities again, now based on payments and receipts. To avoid extra Accounting work, we adjust profits for activities that (1) are relevant for profitability but do not affect cash and (2) vice versa. Business activities that fall under (1) are e.g., depreciation, additions to provisions etc. Business activities that fall under (2) are e.g., purchases and payments for materials which are not consumed and result in a stock increase, payments in connection to receivables/ payables, prepaid expenses, VAT receivables/ payables etc. For the adjustments (1) and (2), we reconcile the profit with cash flows. The advantage of the reconciliation method is that calculations are not based on business activities recorded by single Bookkeeping entries but on profit adjustments under consideration of balance sheet items. It cuts short the workload for the cash flow statement preparation significantly. The following How-it-is-Done paragraph shows the steps for the reconciliation procedure. How it is Done (Reconciliation of Profits with Operating Cash Flows): (1) Calculate profit for the period as earnings after taxes. (2) Add expenses for operations with no payments, e.g., depreciations, expenses for additions to provisions, interest payments etc. (3) Deduct interest income as it is a financing cash flow. (4) Add debt collections, deduct increases of receivables. (5) Add decreases of prepaid expenses, deduct increases thereof. (6) Add decreases of inventory, deduct increases thereof. (7) Add increases of short-term liabilities and provisions, deduct decreases thereof. (8) Add increases of income tax liabilities, deduct decreases thereof. (9) Add decreases of VAT receivables (input-VAT refund receipt), deduct increases thereof (input-VAT paid to suppliers). <?page no="299"?> Berkau: Financial Statements 8e 10-298 We classify cash flows as follows: (1), (2), (4) and (6) are operative cash flows, (5a) and (5b) are financing cash flows. 10.7 Reconciliation of Profits with Operating Cash Flows For the indirect method, we reconcile profits with operating cash flows. For profit and loss calculations, we record business activities solely on a revenue and expense base. A statement of (operating) cash flows requires the recording of the same activities again, now based on payments and receipts. To avoid extra Accounting work, we adjust profits for activities that (1) are relevant for profitability but do not affect cash and (2) vice versa. Business activities that fall under (1) are e.g., depreciation, additions to provisions etc. Business activities that fall under (2) are e.g., purchases and payments for materials which are not consumed and result in a stock increase, payments in connection to receivables/ payables, prepaid expenses, VAT receivables/ payables etc. For the adjustments (1) and (2), we reconcile the profit with cash flows. The advantage of the reconciliation method is that calculations are not based on business activities recorded by single Bookkeeping entries but on profit adjustments under consideration of balance sheet items. It cuts short the workload for the cash flow statement preparation significantly. The following How-it-is-Done paragraph shows the steps for the reconciliation procedure. How it is Done (Reconciliation of Profits with Operating Cash Flows): (1) Calculate profit for the period as earnings after taxes. (2) Add expenses for operations with no payments, e.g., depreciations, expenses for additions to provisions, interest payments etc. (3) Deduct interest income as it is a financing cash flow. (4) Add debt collections, deduct increases of receivables. (5) Add decreases of prepaid expenses, deduct increases thereof. (6) Add decreases of inventory, deduct increases thereof. (7) Add increases of short-term liabilities and provisions, deduct decreases thereof. (8) Add increases of income tax liabilities, deduct decreases thereof. (9) Add decreases of VAT receivables (input-VAT refund receipt), deduct increases thereof (input-VAT paid to suppliers). Berkau: Financial Statements 8e 10-299 (10) Add increases of VAT payables (output-VAT collected from customers), deduct decreases thereof (output-VAT paid to revenue service). (11) Add earnings after taxes and adjustments thereto from steps (2) to (10). The total is the operating cash flow. (12) Calculate investing and financing cash flow based on singular receipts and payments. (13) Add all cash flow categories for the total cash flow calculation. We explain the above steps in detail. Remember that for target to determine cash flows based on changes on the income statement and linked to balance sheet items. Therefore, the above How-it-is-Done paragraph use the wording increases and decreases. 10.8 Why Step (1)? The annual profit results from items on the income statement regardless of their payments/ receipts. It is the start for the cash flow reconciliation method. 10.9 Why step (2)? Expenses without payments in the same Accounting period do not affect cash. For the cash flow statement preparation, these expenses are irrelevant but have been considered for the profit or loss calculation. Therefore, we must cancel them out. E.g., depreciation is not cash relevant as its Bookkeeping entry is a debit entry for depreciation charge and a credit entry in the Accumulated Depreciation account. Another example is an expense recorded together with additions to provisions. Those expenses are relevant 179 Check step (7), too. for the profit in the actual Accounting period, but payments are made in the future. Therefore, we deduct those expenses. 179 Interest results in payments but they are classified as financing cash flows. We add interest payments to the profit and avoid a double consideration for the cash flow statement as they appear as financial cash flow already on the cash flow statement. 10.10 Why Step (3)? An interest income is classified as financing cash flow. The receipt is deleted for operating cash flow calculations and added to financing cash flows by step (12). Step (3) reclassifies cash flows from interest expenses and income. 10.11 Why Step (4)? We analyse step (4) regardless of individual Bookkeeping entries. Any decrease of receivables is considered a receipt for debt collection. In the opposite case if receivables increase, we consider a payment made to the debtor, which she/ he is obliged to repay in the future. <?page no="300"?> Berkau: Financial Statements 8e 10-300 10.12 Why Step (5)? For cash flow calculations, we do not distinguish between receivables and prepaid expenses. A note receivable is a (paid) claim which are repaid in the future and prepaid expenses is a (paid) claim for a service receipt, e.g., for rent, insurance, work etc. We focus on the initial payment: Increases of prepaid expenses and receivables are payments and decreases are receipts. 10.13 Why Step (6)? Inventories represent current assets for which payments have been made. It does not matter whether inventories are raw materials, supplies or finished goods. We count an increase of inventories as a negative cash flow. An inventory decrease is a cash receipt in exchange for delivered goods. All changes in inventories are valued based on cost of acquisition or cost of manufacturing, because we consider VAT in an extra step. 10.14 Why Step (7)? Changes in short-term payables and provisions are not linked to financial cash flows. If payables to suppliers are recorded, the expense has been considered either in the income statement or by other cash flows already. E.g., when materials are purchased the increase of inventory is recorded as a negative cash flow in step (6). If the buyer does not pay, we compensate the deduction in step (6) by adding cash to short-term liabilities (step (7)) for a granted supplier loan. Therefore, a purchase-on-credit-transaction is divided into a paid purchase and a granted cash-loan. A company retiring short-term debts, does not disclose this on the income statement because repayments do not affect profitability. On the reconciliation statement, we must disclose this cash outflow as a negative cash flow caused by a reduction of short-term liabilities. In contrast, changes of longterm liabilities are financing cash flows. IAS 1.60 requires recording an increase of short-term liabilities and a decrease of interest bearing liabilities for the separation of long-term liabilities and short-term liabilities. If a company pays for an annuity, interest is considered on the income statement. Following IAS 1.60, we disclose the pay-off portion of the loan one year before its settlement under short-term liabilities and pay them off at the yearend. The pay-off of a short-term liability becomes then a cash flow from financing activities. In contrast, the previous increase of the short-term liabilities is no cash flow but a liability swop without cash flow relevance. Therefore, the preparation of a cash flow statement via reconciliation statement requires a thorough analysis of shortterm liabilities. Dissolving provisions results in negative expenses which compensates the ordinary recorded expenses (at the time of recognition) on the income statement. When a provision is dissolved, we debit provisions and make a credit entry in the expense account. Therefore, dissolving a provision does not give an expense on the income statement. However, when a provision is dissolved, payments are made and <?page no="301"?> Berkau: Financial Statements 8e 10-300 10.12 Why Step (5)? For cash flow calculations, we do not distinguish between receivables and prepaid expenses. A note receivable is a (paid) claim which are repaid in the future and prepaid expenses is a (paid) claim for a service receipt, e.g., for rent, insurance, work etc. We focus on the initial payment: Increases of prepaid expenses and receivables are payments and decreases are receipts. 10.13 Why Step (6)? Inventories represent current assets for which payments have been made. It does not matter whether inventories are raw materials, supplies or finished goods. We count an increase of inventories as a negative cash flow. An inventory decrease is a cash receipt in exchange for delivered goods. All changes in inventories are valued based on cost of acquisition or cost of manufacturing, because we consider VAT in an extra step. 10.14 Why Step (7)? Changes in short-term payables and provisions are not linked to financial cash flows. If payables to suppliers are recorded, the expense has been considered either in the income statement or by other cash flows already. E.g., when materials are purchased the increase of inventory is recorded as a negative cash flow in step (6). If the buyer does not pay, we compensate the deduction in step (6) by adding cash to short-term liabilities (step (7)) for a granted supplier loan. Therefore, a purchase-on-credit-transaction is divided into a paid purchase and a granted cash-loan. A company retiring short-term debts, does not disclose this on the income statement because repayments do not affect profitability. On the reconciliation statement, we must disclose this cash outflow as a negative cash flow caused by a reduction of short-term liabilities. In contrast, changes of longterm liabilities are financing cash flows. IAS 1.60 requires recording an increase of short-term liabilities and a decrease of interest bearing liabilities for the separation of long-term liabilities and short-term liabilities. If a company pays for an annuity, interest is considered on the income statement. Following IAS 1.60, we disclose the pay-off portion of the loan one year before its settlement under short-term liabilities and pay them off at the yearend. The pay-off of a short-term liability becomes then a cash flow from financing activities. In contrast, the previous increase of the short-term liabilities is no cash flow but a liability swop without cash flow relevance. Therefore, the preparation of a cash flow statement via reconciliation statement requires a thorough analysis of shortterm liabilities. Dissolving provisions results in negative expenses which compensates the ordinary recorded expenses (at the time of recognition) on the income statement. When a provision is dissolved, we debit provisions and make a credit entry in the expense account. Therefore, dissolving a provision does not give an expense on the income statement. However, when a provision is dissolved, payments are made and Berkau: Financial Statements 8e 10-301 must be considered on the cash flow statement for the period, when the payment takes place. As an example, we observe a company that dissolves a provision for rework: When the provision is recorded in 20X1, the expenses for rework are recognised on the income statement. We make Bookkeeping entry (1) as below. Consider that as pulling forward an expense without making a payment. @ 31.12.20X1 Rework-20X1 Provisions PRO (recognition of a provision for rework in 20X1) In the period of dissolving the provision (20X2), we record a cash relevant Bookkeeping (A) for the rework carried out. However, that Bookkeeping entry does not change the provisions yet. As the expenses have been considered in the previous Accounting period on the income statement, dissolving the provision cancels out the actual expenses (20X2). It is recorded as Bookkeeping entry (B). 180 @ 30.06.20X2 (A) Rework-20X2 REW Cash/ Bank C/ B (recognition of rework carried out in 20X2) @ 30.06.20X2 (B) Provision PRO Rework-20X2 REW (provision for rework dissolved) Dissolving a provision is not recorded as an expense through profit or loss, but its payment falls into the period when the provision is dissolved. For reconciliation, keep in mind: rising a provision is covered by step (1) and (2) and its dissolving by step (7). The reason for this inequality in procedure is that the consideration depends on what you see on the financial statements: Recording a provision is shown as an expense on the income statement. In contrast, dissolving a provision is derived from the balance sheet, where it is visible. 180 Check chapter (14) for the recording of differences between expenses in 20X1 and 20X2. Dissolving provisions usually gives a negative cash flow. 10.15 Why Step (8)? Increases in income taxes are shortterm liabilities due in the next following Accounting period. Therefore, they are recorded as positive cash flows. If a company makes prepayments or pays income taxes from prior Accounting periods, the item income tax liabilities can decrease on the balance sheet which is due to a payment to the revenue service which exceeds <?page no="302"?> Berkau: Financial Statements 8e 10-302 the income tax expenses of the actual period. 10.16 Why Step (9)? The step can be combined with step (4) as VAT receivables fall under receivables. A company usually records VAT receivables for purchases and acquisitions in one account which can make it difficult to segregate input-VAT payments for investments later. Input- VAT for investments should be considered as cash flow from investing activities. As an expedient, we can assume that companies only run one VAT account and do not distinguish what input-VAT is paid for. If we record investing cash flows based on gross amounts, we must ignore their input-VAT entry on the VAT account for step (9). In contrast, we consider all VAT refunds as operating cash flows, no matter whether the refund is linked to an investment or to operations. 10.17 Why Step (10)? Output-VAT is collected from customers and buyers on behalf of the revenue service and results in receipts. Therefore, output-VAT gives a positive cash flow at the time of collection and a negative cash flow when paid to the revenue service. We consider for the cash flow statement preparation the difference of output-VAT payment and receipts. Same as for step (9) applies to major disposals of non-current assets. The following steps (11) to (13) are standard procedure and do not require our further attention. 10.18 C/ S EIMKE Ltd. - Reconciliation Method Below, we study the reconciliation method for EIMKE Ltd. The reconciliation is calculated on the statement of cash flows as shown in Figure 10.7. The calculations refer to the figures disclosed on its balance sheet and the income statement as they can be found in Figure 10.5 and Figure 10.6 respectively. <?page no="303"?> Berkau: Financial Statements 8e 10-302 the income tax expenses of the actual period. 10.16 Why Step (9)? The step can be combined with step (4) as VAT receivables fall under receivables. A company usually records VAT receivables for purchases and acquisitions in one account which can make it difficult to segregate input-VAT payments for investments later. Input- VAT for investments should be considered as cash flow from investing activities. As an expedient, we can assume that companies only run one VAT account and do not distinguish what input-VAT is paid for. If we record investing cash flows based on gross amounts, we must ignore their input-VAT entry on the VAT account for step (9). In contrast, we consider all VAT refunds as operating cash flows, no matter whether the refund is linked to an investment or to operations. 10.17 Why Step (10)? Output-VAT is collected from customers and buyers on behalf of the revenue service and results in receipts. Therefore, output-VAT gives a positive cash flow at the time of collection and a negative cash flow when paid to the revenue service. We consider for the cash flow statement preparation the difference of output-VAT payment and receipts. Same as for step (9) applies to major disposals of non-current assets. The following steps (11) to (13) are standard procedure and do not require our further attention. 10.18 C/ S EIMKE Ltd. - Reconciliation Method Below, we study the reconciliation method for EIMKE Ltd. The reconciliation is calculated on the statement of cash flows as shown in Figure 10.7. The calculations refer to the figures disclosed on its balance sheet and the income statement as they can be found in Figure 10.5 and Figure 10.6 respectively. Berkau: Financial Statements 8e 10-303 A C, L Non-current assets [AUD] Equity [AUD] P, P, E 55,000 Share capital 30,000 Intangibles Reserves Financial assets Retained earnings 97,300 Current assets Liabilities (liab.) Inventory 10,000 Long-term liab. 16,000 Accounts receivables 16,900 Short-term liab. A/ P 16,000 Prepaid expenses Provisions Cash/ Bank 89,100 Income tax liab. 11,700 Total assets 171,000 Total equity and liab. 171,000 Eimke Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X8 Figure 10.5: EIMKE Ltd.’s balance sheet (20X8) [AUD] Revenue 120,000 Other income 0 120,000 Materials (60,000) Labour 0 Depreciation (20,000) Other expenses 0 Earnings before int. & taxes (EBIT) 40,000 Interest (1,000) Earnings before taxes (EBT) 39,000 Income tax expenses (11,700) Deferred taxes 0 Earnings after taxes (EAT) 27,300 Eimke Ltd. STATEMENT of PROFIT & LOSS and other COMPREHENSIVE INCOME for the year ended 31.12.20X8 Figure 10.6: EIMKE Ltd.’s income statement (20X8) The cash flow reconciliation starts from the earnings after taxes which are 27,300 AUD. At first, we add interest, as interest is a financing cash flow. The operating cash flow so far is: 27,300 + 1,000 = 2 288"330000 AAUUDD. The adjustments for activities that are expenses/ revenue but are irrelevant for cash apply for depreciation only. As depreciation was deducted on the income <?page no="304"?> Berkau: Financial Statements 8e 10-304 statement, we add it on the reconciliation statement. The operating cash flow after adjustment for depreciation is: 28,300 + 20,000 = 4 488"330000 AAUUDD. This completes step (2) in the How-it-is-Done paragraph sequence. The next adjustment is for activities that are cash/ bank-relevant but are not recorded on the income statement. The first item is the Accounts Receivables account. Receivables increase by: 16,900 - 5,000 = 1 111"990000 AAUUDD. An increase of receivables is seen as payment that results in a claim. Note, that the consideration of receivables is linked here to the debts collection as well as to the proceeds to be received in the next year. The operating cash flow so far is: 48,300 - 11,900 = 3 366"440000 AAUUDD. Step (4) is completed. At EIMKE Ltd., inventories decrease by: 10,000 - 20,000 = -1 100"000000 AAUUDD. A decrease of inventories is considered for the cash flow reconciliation method as cash sale, hence, it is a positive cash flow of 10,000 AUD. Our operating cash flow calculation so far gives: 36,400 + 10,000 = 4 466"440000 AAUUDD. Step (6) is now completed. Next, we check changes in payables. There are only changes in income tax liabilities and VAT payables which are considered in step (8) and step (9). Income tax liabilities are disclosed as payables. The changes in income tax liabilities are: 11,700 - 30,000 = - -1188"330000 AAUUDD. As the payment for income taxes from the last period exceeds the actual income taxes expenses, the balance sheet item for income tax liability on the balance sheet decreases. A reduction of liabilities is considered as a payment for the cash flow calculation: 46,400 - 18,300 = 2 288"110000 AAUUDD. We completed step (8). Output-VAT liabilities increase by 24,000 -10,000 = 1 144"000000 AAUUDD. The figure is the total of payables and receivables as disclosed on the balance sheet. However, we show extra items for VAT receivables and payables on the reconciliation statement. Any increase of payables is considered as a receipt. Decreases of VAT liabilities count as payments. We add the amount to our cash flow calculation: 28,100 + 14,000 = 4 422"110000 AAUUDD. This completes step (9) and (10). The financing cash flow can be derived from the changes in the Interest Bearing Liabilities account. The change of interest bearing liabilities is: 18,000 - 16,000 = 22"000000 AAUUDD. The reduction of liabilities indicates a payment and is a negative cash flow. Furthermore, we deduct paid interest. The total cash flow for EIMKE Ltd. is: 42,100 - 2,000 - 1,000 = 3 399"110000 AAUUDD. The step (12) is completed. Observe the cash flow statement based on the indirect method (= reconciliation method for cash flows from operations) in Figure 10.7. <?page no="305"?> Berkau: Financial Statements 8e 10-304 statement, we add it on the reconciliation statement. The operating cash flow after adjustment for depreciation is: 28,300 + 20,000 = 4 488"330000 AAUUDD. This completes step (2) in the How-it-is-Done paragraph sequence. The next adjustment is for activities that are cash/ bank-relevant but are not recorded on the income statement. The first item is the Accounts Receivables account. Receivables increase by: 16,900 - 5,000 = 1 111"990000 AAUUDD. An increase of receivables is seen as payment that results in a claim. Note, that the consideration of receivables is linked here to the debts collection as well as to the proceeds to be received in the next year. The operating cash flow so far is: 48,300 - 11,900 = 3 366"440000 AAUUDD. Step (4) is completed. At EIMKE Ltd., inventories decrease by: 10,000 - 20,000 = -1 100"000000 AAUUDD. A decrease of inventories is considered for the cash flow reconciliation method as cash sale, hence, it is a positive cash flow of 10,000 AUD. Our operating cash flow calculation so far gives: 36,400 + 10,000 = 4 466"440000 AAUUDD. Step (6) is now completed. Next, we check changes in payables. There are only changes in income tax liabilities and VAT payables which are considered in step (8) and step (9). Income tax liabilities are disclosed as payables. The changes in income tax liabilities are: 11,700 - 30,000 = - -1188"330000 AAUUDD. As the payment for income taxes from the last period exceeds the actual income taxes expenses, the balance sheet item for income tax liability on the balance sheet decreases. A reduction of liabilities is considered as a payment for the cash flow calculation: 46,400 - 18,300 = 2 288"110000 AAUUDD. We completed step (8). Output-VAT liabilities increase by 24,000 -10,000 = 1 144"000000 AAUUDD. The figure is the total of payables and receivables as disclosed on the balance sheet. However, we show extra items for VAT receivables and payables on the reconciliation statement. Any increase of payables is considered as a receipt. Decreases of VAT liabilities count as payments. We add the amount to our cash flow calculation: 28,100 + 14,000 = 4 422"110000 AAUUDD. This completes step (9) and (10). The financing cash flow can be derived from the changes in the Interest Bearing Liabilities account. The change of interest bearing liabilities is: 18,000 - 16,000 = 22"000000 AAUUDD. The reduction of liabilities indicates a payment and is a negative cash flow. Furthermore, we deduct paid interest. The total cash flow for EIMKE Ltd. is: 42,100 - 2,000 - 1,000 = 3 399"110000 AAUUDD. The step (12) is completed. Observe the cash flow statement based on the indirect method (= reconciliation method for cash flows from operations) in Figure 10.7. Berkau: Financial Statements 8e 10-305 [AUD] [AUD] Cash flow from operating acitivities Earnings after taxes EAT 27,300 add Interest 1,000 add Depreciation 20,000 48,300 changes in working capital changes in inventory 10,000 changes in A/ R (11,900) changes in prepaid expenses 0 changes in A/ P, not ITL 0 changes in income tax liabilities ITL (18,300) changes in VAT/ r only materials (10,000) changes in VAT/ p 24,000 42,100 Cash flow from investing activities Investments 0 0 Cash flow from financing activities Interest (1,000) Pay-off (2,000) (3,000) Total cash flow 39,100 Eimke Ltd. STATEMENT of CASH FLOWS for the period ended 31.12.20X8 Figure 10.7: EIMKE Ltd.’s cash flow statement (20X8) To see the application of the indirect method for the RYNEVELD Ltd. case study as covered in chapter (4), follow Link 10.A below. Link 10.A: RYNEVELD Ltd. 181 Find the task in the study material portal. We recommend studying the case KATERNBERG (Pty) Ltd. in task A10.23. 181 The task also contains a solution prepared following the derivative method which we refer to below: 10.19 Derivative Method A higher sophisticated method in cash flow calculation is the derivative method which can be applied even if no Bookkeeping records are available. Download the explanation and cash <?page no="306"?> Berkau: Financial Statements 8e 10-306 flow calculation based on the derivative method for the case EIMKE Ltd. below through Link 10.B: Link 10.B: EIMKE Ltd. 10.20 Summary Statements of cash flows belong to financial statements. The cash flow statements show changes in the cash/ bank item on the balance sheet and classifies the total cash flow as single cash flow categories resulting from operations, investing and financing activities. For cash flow calculations, the direct method and indirect method apply. The latter one is recommended as it avoids the analysis of single Bookkeeping entries but can be prepared based on figures taken from the income statement and the balance sheet. 10.21 Working Definitions Cash Equivalent: Short-term assets that are as liquid as cash and which are certain in terms of valuation. Cash Flow: Changes in the Cash/ Bank account. Reconciliation Method: Calculation of operating cash flows by adjusting the profit after taxes regarding revenue/ expenses without payments/ receipts and payments/ receipts irrelevant for profit or loss calculation. 10.22 Question Bank (1) How is an increase of a shortterm liability resulting from supplies considered in the cash flow statement based on the reconciliation of profits with the cash flows from operations? 1. Not at all. 2. As a cash inflow. 3. As a cash outflow to its full extent. 4. As a partial cash outflow based on the portion of payment. (2) Which are financial cash flows? 1. Bank loan repayment, trade discount, interest. 2. Bond issue, interest, bond redemption. 3. Bank loan principle, bank overdraft, VAT. 4. Interest, coupon, insurance fees. (3) Which statement about the reconciliation statement is incorrect? 1. Depreciation is added to earnings after taxes. 2. Interest earned is added to earnings before taxes. 3. Increases of VAT payables are added to earnings after taxes. 4. Prepaid expenses are deducted from earnings before taxes. (4) A company earns a profit after taxes of 381,500 AUD. Depreciation is 60,000 AUD. Interest income is 45,000 AUD. How much is the operating cash flow? <?page no="307"?> Berkau: Financial Statements 8e 10-306 flow calculation based on the derivative method for the case EIMKE Ltd. below through Link 10.B: Link 10.B: EIMKE Ltd. 10.20 Summary Statements of cash flows belong to financial statements. The cash flow statements show changes in the cash/ bank item on the balance sheet and classifies the total cash flow as single cash flow categories resulting from operations, investing and financing activities. For cash flow calculations, the direct method and indirect method apply. The latter one is recommended as it avoids the analysis of single Bookkeeping entries but can be prepared based on figures taken from the income statement and the balance sheet. 10.21 Working Definitions Cash Equivalent: Short-term assets that are as liquid as cash and which are certain in terms of valuation. Cash Flow: Changes in the Cash/ Bank account. Reconciliation Method: Calculation of operating cash flows by adjusting the profit after taxes regarding revenue/ expenses without payments/ receipts and payments/ receipts irrelevant for profit or loss calculation. 10.22 Question Bank (1) How is an increase of a shortterm liability resulting from supplies considered in the cash flow statement based on the reconciliation of profits with the cash flows from operations? 1. Not at all. 2. As a cash inflow. 3. As a cash outflow to its full extent. 4. As a partial cash outflow based on the portion of payment. (2) Which are financial cash flows? 1. Bank loan repayment, trade discount, interest. 2. Bond issue, interest, bond redemption. 3. Bank loan principle, bank overdraft, VAT. 4. Interest, coupon, insurance fees. (3) Which statement about the reconciliation statement is incorrect? 1. Depreciation is added to earnings after taxes. 2. Interest earned is added to earnings before taxes. 3. Increases of VAT payables are added to earnings after taxes. 4. Prepaid expenses are deducted from earnings before taxes. (4) A company earns a profit after taxes of 381,500 AUD. Depreciation is 60,000 AUD. Interest income is 45,000 AUD. How much is the operating cash flow? Berkau: Financial Statements 8e 10-307 1. 510,950 AUD . 2. 560,000 AUD . 3. 530,000 AUD . 4. 396,500 AUD . (5) A company earns a profit after tax of 500,000 EUR. The profit calculation considers depreciation of 100,000 EUR and an interest income of 50,000 EUR. How much is the cash flow from operations? 1. 650,000 EUR . 2. 764,286 EUR . 3. 550,000 EUR . 4. 564,286 EUR . 10.23 Solutions 1-2, 2-2, 3-2, 4-2, 5-2. <?page no="308"?> Berkau: Financial Statements 8e 11-308 11 Equity on the Balance Sheet 11.1 What is in the Chapter? Equity is funds provided by the owners of a company. We cover the equity section on the balance sheet that comprises of the issued capital, reserves and retained earnings. With the case study YARRA Ltd., we explain the major aspects of equity. The chapter follows the sequence of equity items on the balance sheet: (1) Issued capital. (2) Reserves. (3) Retained earnings. The case study YARRA Ltd. covers equity changes over three years, like the issue and redemption of ordinary and preference shares and the appropriation of profits. We also explain a share issue based on rights from the viewpoint of one shareholder. For share buy-backs we cover the Treasury Stock account and its disclosure on the balance sheet. 11.2 Learnings Objectives After studying this chapter, you are familiarised with the equity section and can measure and disclose equity items on the balance sheet following IFRSs. You also understand how special transactions with owners work. You learn about the profit appropriation and can determine the book value of a company. 182 Study our textbook Basics of Accounting, chapter (33). 183 If the issue price exceeds the face value, the premium is added to capital reserves. We get 11.3 Equity Equity refers to regulations based on national Company's Acts more than on international Accounting standards. The equity disclosure follows the legal form of a company. 182 11.4 Issued Capital We start-off from a short discussion about legal company forms. We distinguish between private companies with a limited liability, e.g., limited liability companies LLC (in the US), limited liability corporations LLC (UK), companies with limited liability GmbH (Germany), proprietary limited companies (Pty) Ltd. (in the Commonwealth and South Africa) and public companies based on shares. The latter ones can go public by an initial public offering IPO and usually are listed at a stock exchange. Legal forms for companies based on shares are corporations Corp., Inc. (in the US), public limited companies PLC, Ltd (UK), Stock companies AG (Germany), and public companies Ltd. (Commonwealth, South Africa). With a share issue a company receives funds from its owners, which are added to the Cash/ Bank account and get credited to the Issued Capital account. 183 In this textbook, we call all portions of issued capital “shares”. A share issue conveys a partial ownership of the company to its investor. Trading of shares does not affect equity of the back to the disclosure later in the chapter but focus on issued capital for now. <?page no="309"?> Berkau: Financial Statements 8e 11-308 11 Equity on the Balance Sheet 11.1 What is in the Chapter? Equity is funds provided by the owners of a company. We cover the equity section on the balance sheet that comprises of the issued capital, reserves and retained earnings. With the case study YARRA Ltd., we explain the major aspects of equity. The chapter follows the sequence of equity items on the balance sheet: (1) Issued capital. (2) Reserves. (3) Retained earnings. The case study YARRA Ltd. covers equity changes over three years, like the issue and redemption of ordinary and preference shares and the appropriation of profits. We also explain a share issue based on rights from the viewpoint of one shareholder. For share buy-backs we cover the Treasury Stock account and its disclosure on the balance sheet. 11.2 Learnings Objectives After studying this chapter, you are familiarised with the equity section and can measure and disclose equity items on the balance sheet following IFRSs. You also understand how special transactions with owners work. You learn about the profit appropriation and can determine the book value of a company. 182 Study our textbook Basics of Accounting, chapter (33). 183 If the issue price exceeds the face value, the premium is added to capital reserves. We get 11.3 Equity Equity refers to regulations based on national Company's Acts more than on international Accounting standards. The equity disclosure follows the legal form of a company. 182 11.4 Issued Capital We start-off from a short discussion about legal company forms. We distinguish between private companies with a limited liability, e.g., limited liability companies LLC (in the US), limited liability corporations LLC (UK), companies with limited liability GmbH (Germany), proprietary limited companies (Pty) Ltd. (in the Commonwealth and South Africa) and public companies based on shares. The latter ones can go public by an initial public offering IPO and usually are listed at a stock exchange. Legal forms for companies based on shares are corporations Corp., Inc. (in the US), public limited companies PLC, Ltd (UK), Stock companies AG (Germany), and public companies Ltd. (Commonwealth, South Africa). With a share issue a company receives funds from its owners, which are added to the Cash/ Bank account and get credited to the Issued Capital account. 183 In this textbook, we call all portions of issued capital “shares”. A share issue conveys a partial ownership of the company to its investor. Trading of shares does not affect equity of the back to the disclosure later in the chapter but focus on issued capital for now. Berkau: Financial Statements 8e 11-309 company which shares are subjected to the trading. Shares can be ordinary shares or preference shares. Ordinary shares come with the common rights of ownership, e.g., a claim on dividends, and with voting rights. In contrast, preference shares offer their holders the privilege of a preference dividend but excludes them from their right to vote. 184 Companies cannot declare a dividend on ordinary shares without preference dividends to be declared. However, they can decide to not declare dividends at all. If preference shares are cumulative, the company must make up for omitted preference dividends before a declaration of dividends for the actual year. The procedure of a share issue includes an Allotment account. 185 To keep our case in this chapter simple, we follow a simplified recording routine: We pretend that share issues are not overnor undersubscribed and only record a debit entry in cash/ bank and make credit entries directly in the Issued Capital and Capital Reserves accounts. The nominal value is accrued to the Issued Capital account and the premium is added to capital reserves. 11.5 C/ S YARRA Ltd. YARRA Ltd. is a company based on shares in Durban, South Africa. The case study covers a period of three years. Data Sheet for YARRA Ltd. DDoommiicciillee: : SSoouutthh AAffrriiccaa ((DDuurrbbaann)).. RReeppoorrttiinngg ccuurrrreennccyy: : ZZAARR.. CCllaassssiiffiiccaattiioonn: : nn/ / aa.. OOrrddiinnaarryy sshhaarreess: : 11"000000"000000 sshhaarreess" nnoomm-iinnaall vvaalluuee 11 ZZAARR/ / ss.. PPeerriiooddss ccoonnssiiddeerreedd: : 2200XX00 / / 2200XX11 / / 2200XX22.. PPrree--ttaaxx pprrooffiittss: : 220000"000000 ZZAARR / / nniill / / 227755"000000 ZZAARR.. IInnvveessttmmeenntt iinn pprrooppeerrttyy" ppllaanntt" eeqquuiipp-mmeenntt: : 550000"000000 ZZAARR.. ((nnoonn--ddeepprreecciiaabbllee)) PPrrooffiitt bbeeffoorree ttaaxxaattiioonn ((2200XX00)): : 220000"000000 ZZAARR.. PPrreeffeerreennccee sshhaarree ccaappiittaall: : 550000"000000 ZZAARR; ; ccuummuullaattiivvee pprreeffeerreennccee sshhaarreess; ; ddiivviiddeenndd ccllaaiimm: : 55 %%/ / aa; ; iissssuueedd oonn 3300..0066..2200XX00.. PPrreeffeerreennccee ddiivviiddeennddss: : 1122"550000 ZZAARR / / nniill / / ((22 ×× 2255"000000 ZZAARR)).. SShhaarreehhoollddeerr AA.. VViisssseerrhhookk: : 9900"000000 oorrddii-nnaarryy sshhaarreess.. SShhaarree iissssuuee 550000"000000 oorrddiinnaarryy sshhaarreess oonn 11..0077..2200XX11 aatt 11..2244 ZZAARR/ / ss.. SShhaarree pprriiccee oonn 11..0077..2200XX11: : 11..6600 ZZAARR/ / ss.. SShhaarree pprriiccee oonn 11..1100..2200XX11: : 11..0033 ZZAARR/ / ss.. SShhaarree rreeddeemmppttiioonn: : 220000"000000 sshhaarreess.. SShhaarree pprriiccee oonn 11..1111..2200XX11: : 11 ZZAARR/ / ss.. SShhaarree rreeddeemmppttiioonn: : 110000"000000 sshhaarreess.. AApppprroopprriiaattiioonn ooff pprrooffiittss ((2200XX22)): : 220000"000000 ZZAARR ttoo eeaarrnniinnggss rreesseerrvveess" oorrddiinnaarryy ddiivvii-ddeenndd: : 00..0044 ZZAARR/ / ss" pprreeffeerreennccee ddiivviiddeenndd 22 ×× 2255"000000 ZZAARR.. VVAATT iiggnnoorreedd.. On 2.01.20X0, YARRA Ltd. issues 1,000,000 ordinary shares at 1 ZAR/ s each. The share issue is a par-value-issue which is a share issue at nominal values. No premium applies and therefore, no credit entry is recorded in the Capital Reserves account. The Bookkeeping entry is as below: 184 Preference shares have been introduced in chapter (7) with the case DORRINGTON/ ROTTMAN. 185 Study our textbook Basics of Accounting, chapter (33) for the details of recording share issues. <?page no="310"?> Berkau: Financial Statements 8e 11-310 @ 2.01.20X0 Cash Bank C/ B 1,000,000 Issued Capital Ord. ISO 1,000,000 (issue of 1,000,000 ordinary shares at 1 ZAR/ s) Later, on 30.06.20X0, YARRA Ltd. issues 500,000 preference shares at 1 ZAR/ s, again: par-value. The preference shares come with a dividend claim of 5 %/ a based on nominal values and proportionate to the time they are outstanding. As YARRA Ltd. issues its preference shares in the middle of 20X0, only 50 % of the preference dividend claim is due in 20X0. The preference shareholders receive a dividend of: 50% × 500,000 × 1 × 5% = 1122"550000 ZZAARR. YARRA Ltd.'s preference shares are cumulative and recorded separately from ordinary shares in the Issued Capital Pref account. @ 30.06.20X0 Cash Bank C/ B 500,000 Issued Capital Pref. ISP 500,000 (issue of 500,000 preference shares par value at 1 ZAR/ s) 11.6 Reserves Building reserves in a company is comparable to what private households do when they save money for rainy days. They put money aside which was previously earned. The reserves on the balance sheet are: - Capital reserves. - Earnings reserves. - Revaluation reserves. The account names indicate the origin of the funds. Capital reserves result from share issues (premiums), earnings reserves are recorded by appropriations of profits and revaluation reserves apply for companies revaluing items of property, plant and equipment following IAS 16.31. 186 11.7 C/ S YARRA Ltd. - 20X0 continued In 20X0, YARRA Ltd. buys non-current assets at 500,000 ZAR 187 and earns a profit after taxation of: 200,000 × (1 - 30%) = 1 14400"000000 ZZAARR. The company prepares a balance sheet as depicted in Figure 11.1. On its annual general meeting, the shareholders declare a preference dividend of 12,500 ZAR. No dividends to ordinary shareholders are declared. The remainder of the profit is carried forward to 20X1. The balance sheet is prepared under the consideration of the appropriation of profits which reduces retained earnings to: 140,000 - 12,500 = 112277"550000 ZZAARR. The preference dividends are disclosed under short-term liabilities; observe below in Figure 11.1. At the end of the chapter, Figure 11.6 shows all accounts for the period 20X0 - 20X2. 186 Repeat the case study GELLENDORFF LLC in chapter (7) 187 For the sake of simplification, no depreciation applies in this case study. Hence, profits are to the same values as cash is received. <?page no="311"?> Berkau: Financial Statements 8e 11-310 @ 2.01.20X0 Cash Bank C/ B 1,000,000 Issued Capital Ord. ISO 1,000,000 (issue of 1,000,000 ordinary shares at 1 ZAR/ s) Later, on 30.06.20X0, YARRA Ltd. issues 500,000 preference shares at 1 ZAR/ s, again: par-value. The preference shares come with a dividend claim of 5 %/ a based on nominal values and proportionate to the time they are outstanding. As YARRA Ltd. issues its preference shares in the middle of 20X0, only 50 % of the preference dividend claim is due in 20X0. The preference shareholders receive a dividend of: 50% × 500,000 × 1 × 5% = 1122"550000 ZZAARR. YARRA Ltd.'s preference shares are cumulative and recorded separately from ordinary shares in the Issued Capital Pref account. @ 30.06.20X0 Cash Bank C/ B 500,000 Issued Capital Pref. ISP 500,000 (issue of 500,000 preference shares par value at 1 ZAR/ s) 11.6 Reserves Building reserves in a company is comparable to what private households do when they save money for rainy days. They put money aside which was previously earned. The reserves on the balance sheet are: - Capital reserves. - Earnings reserves. - Revaluation reserves. The account names indicate the origin of the funds. Capital reserves result from share issues (premiums), earnings reserves are recorded by appropriations of profits and revaluation reserves apply for companies revaluing items of property, plant and equipment following IAS 16.31. 186 11.7 C/ S YARRA Ltd. - 20X0 continued In 20X0, YARRA Ltd. buys non-current assets at 500,000 ZAR 187 and earns a profit after taxation of: 200,000 × (1 - 30%) = 114400"000000 ZZAARR. The company prepares a balance sheet as depicted in Figure 11.1. On its annual general meeting, the shareholders declare a preference dividend of 12,500 ZAR. No dividends to ordinary shareholders are declared. The remainder of the profit is carried forward to 20X1. The balance sheet is prepared under the consideration of the appropriation of profits which reduces retained earnings to: 140,000 - 12,500 = 112277"550000 ZZAARR. The preference dividends are disclosed under short-term liabilities; observe below in Figure 11.1. At the end of the chapter, Figure 11.6 shows all accounts for the period 20X0 - 20X2. 186 Repeat the case study GELLENDORFF LLC in chapter (7) 187 For the sake of simplification, no depreciation applies in this case study. Hence, profits are to the same values as cash is received. Berkau: Financial Statements 8e 11-311 A C, L Non-current assets [ZAR] Equity [ZAR] P, P, E 500,000 Share capital 1,500,000 Intangibles Reserves Financial assets Retained earnings 127,500 Current assets Liabilities (liab.) Inventory Long-term liab. Accounts receivables Short-term liab. 12,500 Prepaid expenses Provisions Cash/ Bank 1,200,000 Income tax liab. 60,000 Total assets 1,700,000 Total equity and liab. 1,700,000 Yarra Ltd. STATEMENT of FINANCIAL POSITION as at 31.12.20X0 Figure 11.1: YARRA Ltd.’s balance sheet (20X0) The balance sheet shows YARRA Ltd.’s book as per 31.12.20X0: 1,700,000 - 60,000 - 12,500 = 1 1"662277"550000 ZZAARR. For the case study, we pretend that ordinary and preference shares are traded at the same prices. Therefore, we calculation equity metrics without differentiation between ordinary and preference shares. The book value per (ordinary or preference) share is: 1,627,500 / 1,500,000 = 1 1..0099 ZZAARR/ / ss. A book value is derived from the Bookkeeping entries and does not reflect the fair market value at which shares are traded. Here we divided the total equity by the number of outstanding shares as per 31.12.20X0. 11.8 C/ S YARRA Ltd. - 20X1 On 2.05.20X1, YARRA Ltd.’s shareholders decide at their annual general meeting the issue of another 500,000 ordinary shares. The fresh shares are issued on 1.07.20X1 at an issue price of 1.24 ZAR/ s. Their nominal value again is 1 ZAR/ s. Therefore, their premium is: 1.24 - 1 = 00..2244 ZZAARR/ / ss. We discuss below how to determine an appropriate issue price: With a company adding profits to equity its book value exceeds the nominal value. It can sink due to a loss, too. E.g., if a German GmbH established with 25,000 EUR records a loss of 3,000 EUR in its first period, its book value becomes: 25,000 - 3,000 = 22,000 EUR. If shares are traded publicly its share price is determined by supply and demand. This results in a fair market value. In total, we have three share prices: the nominal value, the book value and the fair market value. An issue price for fresh shares should exceed the book value but must stay under the fair market value to not jeopardise the share issue. Existing shareholders suffer from share issue prices below the fair market value as the fresh shares reduce the average share valuation. We follow the considerations above and discuss the case of YARRA Ltd. <?page no="312"?> Berkau: Financial Statements 8e 11-312 On 1.07.20X1, YARRA Ltd.’s shares are traded at 1.60 ZAR/ s. Hence, the issue price of 1.24 ZAR/ s is below the fair market value but exceeds the book value of 1.09 ZAR/ s (as per 31.12.20X0). The weighted average share price for all shares after the share issue is: (1,500,000 × 1.60 + 500,000 × 1.24) / 2,000,000 = 1 1..5511 ZZAARR/ / ss. An existing shareholder loses: 1.60 - 1.51 = 0 0..0099 ZZAARR/ / ss whereas the buyer of fresh shares wins: 1.51 - 1.24 = 0 0..2277 ZZAARR/ / ss. To avoid losses in share valuation due to fresh share issues YARRA Ltd. makes a rights issue. With an issue of rights, all owners of the existing shares receive a purchase right which is tradable and compensates for the losses expected from share valuation. The rights received motivate existing shareholders to accept share issues and facilitates a preselection of future investors. On 1.07.20X1, YARRA Ltd. issues 500,000 fresh shares at a 1: 3 ratio, meaning: per three existing shares one fresh share is issued. The difference between fair market value and the average share price after the issue is: 1.60 - 1.51 = 0 0..0099 ZZAARR/ / ss. YARRA Ltd. compensates its existing ordinary and preference shareholders by one purchase right per three shares holding. Therefore, the fair right's value is calculated as 0.27 ZAR/ right. We study shareholder Anna Visserhok holding 90,000 shares of YARRA Ltd. She receives 30,000 purchase rights at: 3 × 0.09 = 0 0..2277 ZZAARR/ / rriigghhtt. Now, Ms Visserhok has two options: - Selling on the rights results in a gain of: 30,000 × 0.27 = 8 8"110000 ZZAARR. Her fortune thereafter is: 8,100 + 90,000 × 1.51 = 1 14444"000000 ZZAARR. - Investing in fresh shares requires her to buy fresh shares at the issue price of 1.24 ZAR/ s and using her purchase rights. Ms Visserhok’s fortune becomes also: 120,000 × 1.51 - 30,000 × 1.24 = 1 14444"000000 ZZAARR. To confirm, we check the valuation of Ms Visserhok’s shares before the share issue. It was: 90,000 × 1.60 = 1 14444"000000 ZZAARR. We study the Bookkeeping entries for share issues with a premium at YARRA Ltd. YARRA Ltd.’s shareholders pick up all shares. We record the share issue at an issue price of 1.24 ZAR/ s which exceeds the nominal value of 1 ZAR/ s by 0.24 ZAR/ s. The nominal portion of the share price is accrued to the issued capital. The premium is: (1.24 - 1) × 500,000 = 1 12200"000000 ZZAARR and is recorded as credit entry in the Capital Reserves account. @ 1.07.20X1 Cash Bank C/ B 620,000 Issued Capital Ord. ISO 500,000 Capital Reserves C-R 120,000 (issue of 500,000 ordinary shares at an issue price of 1.24 ZAR/ s) <?page no="313"?> Berkau: Financial Statements 8e 11-312 On 1.07.20X1, YARRA Ltd.’s shares are traded at 1.60 ZAR/ s. Hence, the issue price of 1.24 ZAR/ s is below the fair market value but exceeds the book value of 1.09 ZAR/ s (as per 31.12.20X0). The weighted average share price for all shares after the share issue is: (1,500,000 × 1.60 + 500,000 × 1.24) / 2,000,000 = 1 1..5511 ZZAARR/ / ss. An existing shareholder loses: 1.60 - 1.51 = 0 0..0099 ZZAARR/ / ss whereas the buyer of fresh shares wins: 1.51 - 1.24 = 0 0..2277 ZZAARR/ / ss. To avoid losses in share valuation due to fresh share issues YARRA Ltd. makes a rights issue. With an issue of rights, all owners of the existing shares receive a purchase right which is tradable and compensates for the losses expected from share valuation. The rights received motivate existing shareholders to accept share issues and facilitates a preselection of future investors. On 1.07.20X1, YARRA Ltd. issues 500,000 fresh shares at a 1: 3 ratio, meaning: per three existing shares one fresh share is issued. The difference between fair market value and the average share price after the issue is: 1.60 - 1.51 = 0 0..0099 ZZAARR/ / ss. YARRA Ltd. compensates its existing ordinary and preference shareholders by one purchase right per three shares holding. Therefore, the fair right's value is calculated as 0.27 ZAR/ right. We study shareholder Anna Visserhok holding 90,000 shares of YARRA Ltd. She receives 30,000 purchase rights at: 3 × 0.09 = 0 0..2277 ZZAARR/ / rriigghhtt. Now, Ms Visserhok has two options: - Selling on the rights results in a gain of: 30,000 × 0.27 = 8 8"110000 ZZAARR. Her fortune thereafter is: 8,100 + 90,000 × 1.51 = 1 14444"000000 ZZAARR. - Investing in fresh shares requires her to buy fresh shares at the issue price of 1.24 ZAR/ s and using her purchase rights. Ms Visserhok’s fortune becomes also: 120,000 × 1.51 - 30,000 × 1.24 = 1 14444"000000 ZZAARR. To confirm, we check the valuation of Ms Visserhok’s shares before the share issue. It was: 90,000 × 1.60 = 1 14444"000000 ZZAARR. We study the Bookkeeping entries for share issues with a premium at YARRA Ltd. YARRA Ltd.’s shareholders pick up all shares. We record the share issue at an issue price of 1.24 ZAR/ s which exceeds the nominal value of 1 ZAR/ s by 0.24 ZAR/ s. The nominal portion of the share price is accrued to the issued capital. The premium is: (1.24 - 1) × 500,000 = 1 12200"000000 ZZAARR and is recorded as credit entry in the Capital Rese