IAS 38: Past exam questions

Intangible Assets: June 2017 Examination:

•On 1 April 2016, Epsilon purchased a brand from a competitor for an agreed price of $80 million. The directors of Epsilon believe that the useful life of the brand is indefinite. On 31 March 2017, no reliable estimate of its selling price was available but the directors of Epsilon estimated that the value in use of the brand was $85 million. The directors of Epsilon wish to use the fair value model for measuring intangible assets whenever permitted by International Financial Reporting Standards. (5 marks)

Proposed Solution: (Good answer)

Definition

Intangible assets are defined as “identifiable non-monetary asset without physical substance”

Treatment for initial recognition

Intangible assets should be initially recorded at cost for assets acquired separately.

So on 01.04.2016 it should be recognized at $ 80 Million Only

Subsequent recognition

For subsequent recognition IAS 38 have allowed two methods

1) Cost Method : in which cost is carried at its cost less accumulated amortization

2) Revaluation Method: in which asset is revalued & is carried at its Fair value reduced by

subsequent amortization.

But for adopting revaluation method fair value must be measured reliably in connection with an

active market.

In this case study it said that no reliable estimate of selling price of the brand is available which

indicates that there is no active market available for this brand. So directors can’t measure its

brand as per Fair Value Model. They need to continue with Cost Model instead.

Question: Dec 2016:

•As you know, in the year to September 2016 we spent considerable sums of money designing a new product. We spent the six months from October 2015 to March 2016 researching into the feasibility of the product. We charged these research costs to profit or loss. From April 2016, we were confident that the product would be commercially successful and we fully committed ourselves to financing its future development. We spent most of the rest of the year developing the product, which we will begin to sell in the next few months. These development costs have been recognised as intangible assets in our statement of financial position. How can this be right when all these research and development costs are design costs? Assume year ended 30 September 2016.

•Please justify this with reference to relevant reporting standards. (5 marks)

Oct 2015 to March 2016 :Research Phase.

April 2016 to September 2016 :Development phase

IAS 38 provides the treatment for internally generated intangible assets.

It says that cost for internally generated intangible assets need to be bifurcated in two phases

A- Research phase

B- Development Phase

If an entity can’t distinguish between two phases entity has to treat entire the expenses as if the same

were incurred in research phase only.

IAS 38 provides that cost incurred in research phase should be expensed out in profit & loss account

For recognition of expenses in development phase following criteria must be fulfilled

A. Intention to complete the intangible asset (IA) for use or sale

B. Technical feasibility for completing the IA

C. Availability of resources to complete the IA

D. Ability of IA to generate future economic benefits

E. Measurement of expenditure incurred in development phase reliably

IAS 38 provides that if all the above criterias are met, cost incurred incurred in development phase

should be recorded in statement of financial position.

In current scenario it can be observed that

Company is fully committed to finance future development cost – A fulfilled

Company spent first six month in researching the feasibility of product – B fulfilled

Company is confident about commercial success & sell in next few months : D fulfilled

Since above conditions are fulfilled it is correct to recognize the same as intangible assets in statement

of financial postion.

IAS 8: Past exam Question

June 2016

‘During a break-out session I heard someone talking about accounting policies and accounting estimates. He said that when there’s a change of these items sometimes the change is made retrospectively and sometimes it’s made prospectively. Please explain the difference between an accounting policy and an accounting estimate and give me an example of each.

Please also explain the difference between retrospective and prospective adjustments and how this applies to accounting policies and accounting estimates.’ (7 marks)

Proposed Solution I (Best answer)

Definitions/overview:

· Accounting policies are the specific principles, rules, bases, conventions and practices adopted by an entity for preparation and presentation of financial statements.

· The estimates relates to judgments made based on most up to date information available at the time of preparation and presentation of financials. So, estimates having inherent uncertainties.

When changes come under IAS 8:

The change in accounting policies should be made only if:

a) The change is required by IFRS standard

b) The changes will results into more appropriate presentation of financials. i.e. more reliable and relevant

· The changes in estimates are applicable if the changes will results into more reliable preparation and presentation of information.

Main difference between change in accounting policy and accounting estimates:

· Basis: Accounting policy is a principle or rule, or a measurement basis, accounting estimate is the amount determined based on selected basis or some pattern of future consumption of the asset.

· Application of Changes: Change accounting policy is accounted for retrospectively, but change in accounting estimate prospectively.

Example: Choice fair value vs. historical cost is a choice in accounting policy (measurement basis), but updating some provision based on fair value change is a change in accounting estimate.

Prospective Application: means adjustment in calculations of the current and future reporting periods through statement of change in income and no adjustments are required in comparatives and equity.

Proposed Solution II (Good answer)

Accounting policies are accounting principles, rules, practices used by an entity to record the transactions in books of accounts and in preparation and presentation of financial statements. e.g. Choosing straight line or written down value depreciation method is accounting policy choice. Change in accounting policies are accounted for retrospectively. Retrospective application means new/revised accounting policy shall be applied to transactions as if this new policy had always been implemented. Accounting estimate is judgement(s) made to record the transactions in books of accounts. e.g. Decision of useful life of depreciable property, plant and equipment assets is accounting estimate. Change in accounting estimates are accounted for prospectively.

Point to consider:

Method of depreciation is not an example of accounting policy - rather it is an accounting estimate. A common example would be inventory valuation.

Proposed Solution III (Good answer)

Diff b/w Accounting Policy & Accounting estimate

IAS 8 provides guidelines for capturing any changes in the accounting policy, estimate and errors.

Accounting Policies- are basically the principles, conventions, rules followed by any organization in preparing of their FS, disclosures, treatment of errors in books (if any) and is meant to be consistently followed. 1 mark

Accounting policies can be changed if:-

1. If required by IFRS – If the IFRS require changes in accounting policies, the entity is require to change those. Transitional provisions are given under the standard for applicability. for e.g IFRS 16 where in it was advised by IFRS that all the existing long term leases of any company to be recognized under ROU Asset & Liability-Jan19 onwards. Any changes initiated by IFRS can be applied PROSPECTIVELY. 1.5 marks

2. Voluntary change:

If such change results in more reliable, convenient presentation, more transparent. for eg if a company believes that obtaining FIFO criteria of Inventories gives a better representation and reliable picture than LIFO.

Any such changes in accounting policy –if VOLUNTARY- must be dealt with RESTROSPECTIVELY. 1.5 marks

If it is impracticable to apply those changes retrospectively, the changes must be done from the earliest date practicable. However, the entity is required to give appropriate disclosures. 1 mark

Accounting Estimates: These are monetary estimates and majorly based on best information available in the current scenario. It may change or revised due any unpredictable scenario. For eg. During the COVID-19 situation the Provision of bad debt increased for many companies.

1 mark

Any changes in accounting estimates is always Prospective. 1 mark

Derivatives as such

The very attribute of a derivative is that it has no value of its own. Yet, this instrument is expected to bring considerable volatility to an entity’s financial statements – specifically the balance sheet. The question arises as to what causes a derivative to create such an impact. Well, the point is that while a derivative does not have a value of its own, it derives its value from something else (underlying) – hence the name derivative. And, when that something else changes in its value, the value of derivative can be considerably higher or lower at different times.

Assume this, Co X identifies a share with a market value of $100. Co X has a reason to believe that the price of the share may decline in near future, and certainly not go above its current market price. It enters a promise to sell the share to another entity – Co Y for $105 say after 3 months, with a clause (option) to Co Y that if the share price is less than $105, Co Y does not need to buy the share.

Since Co X is taking a risk by allowing Co Y to buy the share at $105 only when the price will be more than $105 (option is with Co Y), the value of the agreement (option to sell) can be considerably high (assume that the price reaches to $140 – meaning thereby that Co X would be required to sell the share at $105 instead of the market price of $140), resulting into a liability for Co X. For Co Y, the value of the agreement will be positive, thereby resulting into the contract as an asset.

What we intend to bring on the table is the point that a derivative can be an asset or a liability, depending upon the value of the underlying, that is not controlled by either of the parties to the contract. And, this is likely to bring a huge volatility (upward and downward movements) to the balance sheet of the entity and income statement.

Hedge accounting is expected to manage the volatility at the incomes statement level, even though the balance sheet would remain unaffected – of course the counter value of the item that is hedged can match the balance sheet as well – however, the derivative shall be always separately recognized. This certainly results into a grossed-up balance sheet for a business as such.