KC-01 Corporate Financial Reporting

STUDY TEXT
CA SRI LANKA CURRICULUM 2015
First edition 2015

ISBN 9781 4727 1050 5
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2015
ii
Contents
Page
Introduction
iv
Chapter features
vi
Learning outcomes
vii
Action verbs checklist
xiii
KC1 Corporate Financial Reporting

1
The Regulatory and Conceptual Framework
Non-financial reporting
39
Presentation of financial statements
71
Non-current assets
101
Intangible assets
135
Impairment of assets
155
Leases
181
Other standards related to assets
209
Provisions and Events after the reporting period
241
10
Revenue
267
11
Income taxes
297
12
Financial Instruments
331
13
Employee Benefits
389
14
Disclosure Standards 1
439
15
Disclosure Standards 2
467
16
Principles of consolidation
497
17
Step acquisitions and disposals
557
18
Complex groups and group reorganisations
593
19
Statements of cash flows
627
20
Foreign exchange issues
667
21
Small company reporting and first time adoption
701
22
Financial statement analysis
727
Index
757
Introduction
iii
Introduction
At the Corporate Level a student should have achieved comprehensive knowledge on accounting and
financial reporting, and built on the analytical skills acquired at the Business Level. One should also
have developed advisory capacity on financial reporting, impact of accounting standards, various
accounting options and their implications to management. One should be able to critically analyse
different types of reports produced by an organisation in communicating its results to the stakeholders
and deal with ethical issues arising from financial reporting. The ability to integrate with other
functions of the business is a rounding off skill that is also expected at this level.
Syllabus structure
Main syllabus areas
Weightings
1. Interpretation & Application of Sri Lanka Accounting Standards

(SLFRS/LKAS/IFRIC/SIC)
35%
2. Preparation & Presentation of Consolidated Financial Statements
30%
3. Analysis, Interpretations & Communication of Financial Results
25%
4. Corporate Governance & Recent Developments in Financial Reporting
5%
5. Ethical Issues in Financial Reporting and the Regulatory Framework
5%
One of the key elements in examination success is practice. It is important that not only you fully
understand the topics by reading carefully the information contained in this Study Text, but it is also
vital that you practise the techniques and apply the principles that you have learned.
In order to do this, you should:
Work through all the examples provided within the chapters and review the solutions, ensuring
that you understand them;
Complete the progress test for each chapter.
In addition, you should use the Practice & Revision Kit. These questions will provide you with excellent
examination practice when you are in the revision phase of your studies.
iv
Pillar structure
The Curriculum 2015 is structured around three pillars, namely, Knowledge, Skills and Personal.
The Pillars are subdivided into specific subject areas or sub pillars and content is delivered to meet the
requirements of three progressively ascending levels of competency, namely, Executive, Business and
Corporate.
The Corporate Level aims to produce a CA professional fully equipped with the required knowledge,
skills and personality to be a corporate leader.
The Knowledge Pillar focuses on imparting sound technical knowledge required of a competent CA,
and comprises five sub pillars that focus on the following subject areas:
Sub pillar 1: Financial Accounting and Reporting (FA&R)
Sub pillar 2: Management Accounting and Finance (MA&F)
Sub pillar 3: Taxation and Law (T&L)
Sub pillar 4: Assurance and Ethics (A&E)
Sub pillar 5: Management and Contemporary Issues (M&C)
Introduction
Chapter features
Each chapter contains a number of helpful features to guide you through each topic.
vi
Topic list
This tells you what you will be studying in the chapter. The topic items form
the numbered headings within the chapter.
Chapter
introduction
The introduction puts the chapter topic into perspective and explains why it is
important, both within your studies and within your practical working life.
Learning
Outcomes
The learning outcomes issued for the module by CA Sri Lanka are listed at the
beginning of the chapter, with reference to the chapter section within which
coverage will be found.
Key terms
These are definitions of important concepts that you really need to know and
understand before the exam.
Examples
These are illustrations of particular techniques or concepts with a worked

solution or explanation provided immediately afterwards.
Case study
Often based on real world scenarios and contemporary issues, these examples
or illustrations are designed to enrich your understanding of a topic and add
practical emphasis.
Questions
These are questions that enable you to practise a technique or test your
understanding. You will find the answer underneath the question.
Formula to
learn
These are the formula that you are required to learn for the exam.
Section
introduction
This summarises the key points to remember from each section.
Chapter
roundup
This provides a recap of the key areas covered in the chapter.
Progress
Test
Progress tests at the end of each chapter are designed to test your memory.
Bold text
Throughout the Study Text you will see that some of the text is in bold type.
This is to add emphasis and to help you to grasp the key elements within a
sentence or paragraph.
Evaluation/
Synthesis
Metacognitive
1.1 Level A
It may require the analysis, application

and evaluation of relevant standard/s.
(Refer Appendix 3)
A complicated matter includes

transactions and/or events which
require thorough analysis of the matter
and evaluation of standards.
Where:
Thorough knowledge and comprehension of

the standard to identify significant
complicated issues and any potential
implications to the financial statements, and
to exercise professional judgment in the
evaluation and application of standards in
resolving a complicated matter related to
financial reporting.
Knowledge
Process
Knowledge
Dimension
Knowledge Component
(Syllabus Weighting 35%)
1.1.7 Design the appropriate disclosures to be made in

the financial statements.
1.1.6 Advise appropriate application and selection of

accounting/reporting options given under
standards.
1.1.5 Evaluate the impact of the use of different expert

inputs to financial reporting.
1.1.4 Propose appropriate accounting policies to be

selected in different circumstances.
1.1.3 Evaluate the outcomes of the application of

different accounting treatments.
1.1.2 Recommend the appropriate accounting

treatment to be used in complicated
circumstances in accordance with Sri Lanka
Accounting Standards.
1, 3, 4, 5,
6,7,8,9, 10,
11, 12, 13,
14, 15, 16,
17, 18, 19,
20, 21
Chapter
Learning outcomes
1.1.1 Advise on the application of Sri Lanka Accounting

Standards in solving complicated matters.
Learning Outcome
1. Interpretation and Application of Sri Lanka Accounting Standards (SLFRS/LKAS/IFRIC/SIC)
CA Sri Lankas Learning outcomes for the Module are set out on the following pages. They are cross-referenced to the chapter in the Study Text where they are
covered.
Learning outcomes
vii
viii
Application/
Analysis/
Evaluate
Conceptual/
Procedural
1.2 Level B
(Refer Appendix 3)
A moderately complicated matter includes

transactions and/or events which require an
analysis of a matter and evaluation of such
matter with the related standard/s.
Where:
Good knowledge and comprehension of the

standard to identify moderately complicated
issues and any potential implications to the
financial statements, and to exercise
professional judgment in the analysis and
application of standards in resolving a
moderately complicated matter related to
Knowledge
Process
Knowledge
Dimension
Knowledge Component
9, 12, 13,
20
1.2.1 Apply Sri Lanka Accounting Standards in solving

moderately complicated matters.
1.2.5 Outline the disclosures to be made in the financial

statements.
1.2.4 Demonstrate the appropriate application and

selection of accounting/reporting options given
under standards.
1.2.3 Demonstrate a thorough knowledge of Sri Lanka

Accounting standards in the selection and
application of accounting policies.
1.2.2 Recommend the appropriate accounting

treatment to be used in complicated
circumstances in accordance with Sri Lanka
Chapter
Learning Outcome
(Refer Appendix 3)
A simple transaction or event includes

transactions or events which require direct
and conceptual application of standards.
Where:
Conceptual knowledge and understanding of

the standard to identify simple issues, to
exercise reasonable professional judgment in
the application of standards in resolving a
simple (straightforward) matter related to
1.3 Level C
Knowledge Component

Knowledge
Process
Remember/
Comprehension/
Application
Knowledge
Dimension
Conceptual
1.3.3 List the disclosures to be made in the financial

statements.
8, 11, 12,
20
Chapter
Learning outcomes
1.3.2 Apply the concepts/principals of the standards to

resolve a simple/straight forward matter.
1.3.1 Explain the concepts/principals of Sri Lanka

Learning Outcome
ix
Metacognitive
Metacognitive
Procedural/
Metacognitive
2.1 Consolidated financial statements
2.2 Joint ventures
2.3 Investments in associates
Knowledge
Dimension
Knowledge Component
Evaluate/
Synthesis
Evaluate/
Synthesis
Synthesis
Knowledge
Process
2. Preparation and Presentation of Consolidated Financial Statements
2.3.2 Compile financial statements when there is an

investment in an associate.
2.3.1 Advise appropriate accounting treatment to be

used when there is an investment in an associate.
2.2.2 Compile financial statements for joint ventures.
2.2.1 Evaluate the information provided and identify

the existence of joint ventures.
2.1.2 Recompile a consolidated set of financial

statements, post acquisition, merger or
divestment.
2.1.1 Compile consolidated financial statements for a

group with more than two subsidiaries, subsubsidiaries or foreign subsidiaries.
Learning Outcome
16
16
16, 17, 18
Chapter
Trend analysis
Evaluate
Evaluate
Knowledge
Process
3.2.2
3.2.1
3.1.1
Knowledge
Process
Evaluate/
Synthesis
Knowledge
Dimension
Metacognitive
Knowledge Component
4.1 Corporate governance and sustainability

reports including integrated reporting
Criticise an annual report of a company in a

given scenario, on the basis of adequacy of
disclosures.
Compile an integrated report along with a
sustainability report for a given entity.
Evaluate integrated/sustainability reports in
accordance with the triple bottom line
principle and GRI guidelines.
4.1.1
4.1.2
4.1.3
Learning Outcome
Chapter
22
22
Chapter
Learning outcomes
Criticise external financial statements, on the

basis of relevant and rational conclusions drawn
from the financial statements analysis.
Evaluate external financial statements.
Evaluate the reasonableness of financial

statements relative to the actual financial status
of an entity.
Learning Outcome
4. Corporate Governance and Recent Developments in Financial Reporting
Common size analysis
Procedural
3.2 External financial statements analysis
Procedural
Knowledge
Dimension
3.1 Internal financial statement analysis
Knowledge Component
3. Analysis, Interpretations and Communication of Financial Results
xi
xii
Procedural
Knowledge
Dimension
Evaluate
Knowledge
Process
Metacognitive
5.1 Recent ethical issues
Knowledge
Dimension
Knowledge Component
Evaluate
Knowledge
Process
5. Ethical Issues in Financial Reporting and the Regulatory Framework
4.2 New exposure drafts
Knowledge Component
Evaluate the possible impact of new exposure

drafts on financial statements.
5.1.1 Advise on accurate presentation of financial

statements for a given set of circumstances, with
reference to global examples.
Learning Outcome
4.2.1
Learning Outcome
4. Corporate Governance and Recent Developments in Financial Reporting
Chapter
Chapter

Knowledge Process
Verb List
Verb Definitions
Tier 1 Remember
Define
Describe exactly the nature, scope or meaning
Recall important information
Draw
Produce (a picture or diagram)
Identify
Recognise, establish or select after

consideration
List
Write the connected items one below the other
Relate
To establish logical or causal connections
State
Express something definitely or clearly
Calculate/
Compute
Make a mathematical computation
Discuss
Examine in detail by argument showing

different aspects, for the purpose of arriving at
a conclusion
Explain
Make a clear description in detail revealing

relevant facts
Interpret
Present in understandable terms or to translate
Recognise
To show validity or otherwise, using knowledge

or contextual experience
Record
Enter relevant entries in detail
Summarise
Give a brief statement of the main points (in

facts or figures)
Tier 2 Comprehension
Explain important
information
xiii
Knowledge Process
Verb List
Verb Definitions
Tier 3 Application
Apply
Put to practical use
Use knowledge in a setting

other than the one in which it
was learned/solve closeended problems
Assess
Determine the value, nature, ability or quality
Demonstrate
Prove, especially with examples
Graph
Represent by means of a graph
Prepare
Make ready for a particular purpose
Prioritise
Arrange or do in order of importance
Reconcile
Make consistent with another
Solve
To find a solution through calculations and/or

explanations
Analyse
Examine in detail in order to determine the

solution or outcome
Compare
Examine for the purpose of discovering

similarities
Contrast
Examine in order to show unlikeness or

differences
Differentiate
Constitute a difference that distinguishes

something
Outline
Make a summary of significant features
Tier 4 Analysis
Draw relations among ideas
and to compare and
contrast/solve open-ended
problems
xiv
Knowledge Process
Verb List
Verb Definitions
Tier 5 Evaluate
Advise
Offer suggestions about the best course of

action in a manner suited to the recipient
Convince
To persuade others to believe something using

evidence and/or argument
Criticise
Form and express a judgment
Evaluate
To determine the significance by careful

appraisal
Recommend
A suggestion or proposal as to the best course

of action
Resolve
Settle or find a solution to a problem or

contentious matter
Validate
Check or prove the accuracy
Compile
Produce by assembling information collected

from various sources
Design
Devise the form or structure according to a plan
Develop
To disclose, discover, perfect or unfold a plan or

idea
Propose
To form or declare a plan or intention for

consideration or adoption
Formation of judgments and

decisions about the value of
methods, ideas, people or
products
Tier 6 Synthesis
Solve unfamiliar problems by
combining different aspects
to form a unique or novel
solution
xv
xvi
CHAPTER
INTRODUCTION
This chapter revises the regulatory and conceptual frameworks studied at KB1 together with SLFRS
13 Fair Value Measurement. The chapter also considers current developments in financial reporting.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
Advise on the application of Sri Lanka Accounting Standards in solving

complicated matters.
Recommend the appropriate accounting treatment to be used in complicated
circumstances in accordance with Sri Lanka Accounting Standards.
Evaluate the outcomes of the application of different accounting treatments.
Propose appropriate accounting policies to be selected in different
circumstances.
Evaluate the impact of the use of different expert inputs to financial reporting.
Advise appropriate application and selection of accounting/reporting options
given under standards.
Design the appropriate disclosures to be made in the financial statements.
Corporate Governance and Recent Developments in Financial Reporting
4.2
New exposure
drafts
Ethical Issues in Financial Reporting and the Regulatory Framework
5.1
Recent ethical
issues
4.2.1
5.1.1
Evaluate the possible impact of new exposure drafts on financial statements
Advise on accurate presentation of financial statements for a given set of

circumstances, with reference to global examples.
KC1 | Chapter 1: The Regulatory and Conceptual Framework
CHAPTER CONTENTS
1 The regulatory framework
2 Ethics
3 The Conceptual Framework
4 SLFRS 13 Fair Value Measurement
SLFRS 13 Learning objectives

Advise on the fair value measurement in relation to non-financial assets,
liabilities, entitys own equity instruments, financial assets and financial
liabilities.
Discuss valuation techniques, input to valuation techniques and fair value
hierarchy.
Advise on accounting treatment to be used at fair value measurement at initial
recognition.
Evaluate the impact of fair value adjustments on financial statements.
Apply the requirements in preparation of disclosures.
1 The Regulatory Framework

The regulatory framework of financial reporting refers to the many sources of
regulation, including accounting standards, company law and stock exchange
rules.
1.1 Sri Lankan GAAP

Sri Lankan GAAP (Generally Accepted Accounting Practice) includes the following
mandatory sources:
1.
The Companies Act
2.
SEC Regulations and rulings (applicable only for listed companies)
3.
Accounting standards as issued by the Institute of Chartered Accountants of

Sri Lanka (CA Sri Lanka).
CA Sri Lanka
1.1.1 The Companies Act

Companies Act No 07 of 2007 regulates the affairs of limited liability companies.
The relevant sections are as follows:
Section 56
When a company makes any distribution to any shareholder, it is

required to maintain a solvent position and a certificate of
solvency should be provided by the auditors.
Section 69
Shares must be redeemed on the specified date where a

company has an obligation to do so. Otherwise shareholders are
ranked as unsecured creditors.
Section 148
Every company should keep accounting records that correctly

record and explain the companys transactions.
Section 171
A company must have a reporting date in each calendar year; an

exception is after incorporation when the first reporting date
must be within 15 months of incorporation. No accounting
period can exceed 15 months.
Section 192
Directors' interests in transactions must be entered in the

interest register and disclosed to other Board members.
For further details of the content of these sections, refer to your KB1 study text.
1.1.2 SEC Regulations
SEC Rules govern the listing of Securities on the Exchange and continuing listing
requirements in order to ensure the creation and maintenance of a market in
which Securities can be issued and traded in an orderly and fair manner and
which secures efficiency and confidence of all stakeholders in the operation and
conduct of the market. The rules are summarised below:
CA Sri Lanka
Initial listing
A company applying to list must comply with the Rules and

enter into a listing undertaking (a binding contract) with the
Exchange.
Listing of
shares and
debentures
An offer for subscription or offer for sale of shares or debt is

issued for cash only. In the case of a listing by introduction,
shares or debt must have been allotted at least 6 months
previously. In order to be listed, debt securities must be fully
paid and freely transferable.
Prospectus
and
introductory
documents
The Rules set out the basic requirements for the contents of a
prospectus. The Exchange is within its rights to require
additional information to be disclosed.
Further issue
Further shares of the same class as shares already listed may
of securities of not be issued until approved by the Exchange.
a listed entity In the case of an application to issue another class of shares, the
total value of all the other classes of shares issued at any given
time (as set out in the latest statement of financial position of
the Entity), must not exceed fifteen percent of the entitys
shareholders funds (ie stated capital and reserves).
A rights issue or issue through public subscription is for cash
only.
Articles of
Must contain the following provisions:
association/
Shares must be freely transferable and registration not
other
subject to restriction
corresponding Notices must be published in Sinhala, Tamil and English
documents
newspapers
More than 3 persons may not be registered as joint holders of
shares other than in relation to a deceased member
The company must comply with the Rules.
Continuing
listing
requirements
It is the duty of the board of directors of every listed entity to

ensure that all the Rules of the Exchange are met on a
continuing basis as long as the entity remains listed.
Corporate
disclosure
A listed entity must make immediate disclosure of price

sensitive information to the Exchange in order to ensure the
maintenance of a fair and orderly securities market.
Related party
transactions
The Rules provide certain measures to prevent directors, chief

executive officers or substantial shareholders taking advantage
of their positions.
Enforcement
Non-compliance with the Rules or failure to pay interest on

listed debt securities will result in the transfer of listed
securities to the Default Board.
For further details of the content of the rules, refer to your KB1 study text.
CA Sri Lanka
1.1.3 Accounting standards

The Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka) issues
accounting standards in Sri Lanka. In 2011 it decided to converge fully with all
pronouncements made by the International Accounting Standards Board (IASB)
and thereafter to adopt all new pronouncements of the IASB.
The IASB issues IFRS, which are adopted by CA Sri Lanka as SLFRS. Previously
issued IASs have been adopted in Sri Lanka as LKAS. The following SLFRS and
LKAS are examinable at KC1:
Title
CA Sri Lanka
LKAS 1
Presentation of financial statements
LKAS 2
Inventories
LKAS 7
Statement of cash flows
LKAS 8
Accounting policies, changes in accounting estimates and errors
LKAS 10
Events after the reporting period
LKAS 11
Construction Contracts
LKAS 12
Income taxes
LKAS 16
Property, plant and equipment
LKAS 17
Leases
LKAS 18
Revenue
LKAS 19
Employee benefits
LKAS 20
Accounting for government grants and disclosure of government

assistance
LKAS 21
The effects of changes in foreign exchange rates
LKAS 23
Borrowing costs
LKAS 24
Related party disclosures
LKAS 26
Accounting and Reporting by Retirement Benefit Plans
LKAS 27
Separate financial statements
LKAS 28
Investments in associates and joint ventures
LKAS 29
Financial Reporting in Hyperinflationary Economies
LKAS 32
Financial Instruments: presentation
LKAS 33
Earnings per share
Title
LKAS 34
Interim financial reporting
LKAS 36
LKAS 37
Provisions, contingent liabilities and contingent assets
LKAS 38
Intangible assets
LKAS 39
Financial Instruments: recognition and measurement
LKAS 40
Investment property
LKAS 41
Agriculture
SLFRS 1
First time adoption of SLFRS
SLFRS 2
Share-based payment
SLFRS 3
Business combinations
SLFRS 4
Insurance Contracts
SLFRS 5
Non-current assets held for sale and discontinued operations
SLFRS 6
Exploration for and Evaluation of Mineral Resources
SLFRS 7
Financial instruments: disclosures
SLFRS 8
Operating segments
SLFRS 9*
Financial instruments
SLFRS 10
Consolidated financial statements
SLFRS 11
Joint arrangements
SLFRS 12
Disclosure of interests in other entities
SLFRS 13
Fair value measurement
SLFRS 15*
Revenue from contracts with customers
SLFRS
For Small and Medium-sized Entities
*SLFRS 9 and SLFRS 15 are not yet effective; therefore they are examinable as
current developments rather than in full detail.
The Sri Lanka Accounting and Auditing Standards Act No 15 of 1995 requires all
special business enterprises to comply with accounting standards established by
CA Sri Lanka. Therefore full SLFRS must be applied by:
All companies with debt or equity securities traded in a public market in Sri
Lanka (in both separate and consolidated financial statements), and
CA Sri Lanka
Specified Business Enterprises (SBEs), including banks, insurance companies

and other financial institutions.
Other companies may apply either full SLFRS or the SLFRS for SMEs.
1.1.4 Interpretations
Interpretations, referred to as IFRICs (or previously SICs) are issued by the IFRS
Interpretations Committee as necessary to:
Interpret the application of IFRS
Provide timely guidance on financial reporting issues not specifically addressed
in IFRS
They are therefore of limited scope in nature, dealing with specific issues only. The
Interpretations that are examinable at KC 1 are:
Title
CA Sri Lanka
IFRIC 1
Changes in Existing Decommissioning, Restoration and Similar

Liabilities
IFRIC 2
Members Share in Cooperative Entities and Similar Instruments
IFRIC 4
Determining whether an Arrangement contains a Lease
IFRIC 5
Rights to Interests arising from Decommissioning, Restoration

and Environmental Rehabilitation Funds
IFRIC 6
Liabilities arising from Participating in a Specific Market Waste

Electrical and Electronic Equipment
IFRIC 7
Applying the Restatement Approach under IAS 29 Financial

Reporting in Hyperinflationary Economies
IFRIC 9
Reassessment of Embedded Derivatives
IFRIC 10
Interim Reporting and Impairment
IFRIC 12
Service Concession Arrangements
IFRIC 13
Customer Loyalty Programmes
IFRIC 14
IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding

Requirements and their Interaction
IFRIC 15
Agreements for the Construction of Real Estate
IFRIC 16
Hedge of a Net Investment in a Foreign Operation
IFRIC 17
Distributions of Non-cash Assets to Owners
Title
IFRIC 18
Transfers of Assets from Customers
IFRIC 19
Extinguishing Financial Liabilities with Equity Instruments
IFRIC 20
Stripping Costs in the Production Phase of a Surface Mine
SIC 15
Operating Leases Incentives
SIC 25
Income Taxes Change in the Tax Status of an Entity or its

Shareholder
SIC 27
Evaluating the Substance of Transactions in the Legal Form of a

Lease
SIC 29
Disclosure Service Concession Arrangements
SIC 31
Revenue Barter Transactions Involving Advertising Services
SIC 32
Intangible Assets Website Costs
Interpretations form part of full SLFRS and are therefore applicable by those
companies that apply full SLFRS.
1.2 The development of accounting standards

1.2.1 Development of new and revised accounting standards by the IASB
The IASB has a six-step due process to develop new standards or revise existing
standards. The steps are as follows:
1.
Setting the agenda involves identifying an item and adding it to the IASBs
work agenda.
2.
Planning the project involves the IASB deciding whether to conduct a project
alone or jointly with a national standard-setter.
3.
Developing and publishing the discussion paper (a non-mandatory step). A

discussion paper includes an overview of the issue being addressed and
possible approaches to addressing it. It is published and interested parties
are invited to comment.
4.
Developing and publishing the exposure draft (a mandatory step). An

exposure draft (ED) is a proposed standard, and is the IASBs main vehicle
for consulting the public about proposals.
5.
Developing and publishing the standard. A standard is published after

comments received on the ED are considered. In the light of these a topic
may be re-exposed (ie a second ED is published) prior to the finalisation of
the standard.
CA Sri Lanka
6.
After the standard is issued the IASB monitors its use and application in order
to identify whether further amendments are required. A post-implementation
review, being a formal review, normally takes place in respect of major new
standards and amendments, usually after they have been applied for two
years (which is normally 30-36 months after their effective date).
CA Sri Lanka has input into step 4 as follows:

1.
IASB exposure drafts and draft interpretations are exposed for public
comment by CA Sri Lanka.
2.
At the same time CA Sri Lanka conducts round table discussions to identify
the impact of the proposed standard in Sri Lanka.
3.
Sri Lanka forwards its views to the IASB.
1.2.2 Adoption of new and revised standards by CA Sri Lanka

The process by which CA Sri Lanka adopts finalised IFRS as SLFRS is as follows:
1.
CA Sri Lanka reviews the IFRS and related technical materials. This may
result in modification of the standard for use in Sri Lanka, or deferral of a
standards adoption.
2.
The standard is translated into Sinhala and Tamil and published in the Extra
Ordinary Gazette as required by the Accounting and Auditing Standards Act
No: 15 of 1995 in Sri Lanka.
Once gazetted, the standard becomes legally authoritative.
1.3 Current developments

The IASB has a detailed work plan with a number of projects on-going at any given
time. In this section we consider a number of these projects. The status of the
projects is as at 20 December 2014.
1.3.1 Early stage projects
There are a number of projects that have been added to the IASBs work agenda,
but as yet no discussion paper or exposure draft has been issued. Most of these
projects are narrow-scope, however there is one major early stage project, dealing
with the principles of disclosure. The objective of this project is to identify and
develop a set of principles for disclosure in IFRS.
CA Sri Lanka
1.3.2 Discussion papers in issue

Discussion papers on the following topics are currently in issue:
A Portfolio Revaluation approach to Macro Hedging a project related to
financial instruments that aims to develop an approach to better reflect the
dynamic risk management activities of entities in their financial statements.
Rate Regulated Activities rate-regulated activities are those activities that an
entity provides but subject to government regulation in respect of supply and
pricing eg gas, electricity and water. The discussion paper explores possible
approaches to reporting the financial effects of this type of regulation. This
project aims to provide a long-term solution to the issue of accounting for rateregulated activities; in the meantime an interim standard (IFRS 14) was issued
in 2012 to provide short-term guidance (see section 1.4).
1.3.3 Exposure drafts in issue
Exposure drafts in issue relate to major projects and narrow-scope amendments.
Major projects
Leases A project to replace IAS 17 Leases has been on the IASBs work plan for
a number of years. An exposure draft was issued in 2010 and a revised
exposure draft in 2013. The proposed amendments are considered in more
detail in Chapter 7 Leases.
Insurance Contracts This major project to undertake a comprehensive review
of accounting for insurance contracts was added to the IASBs agenda in 2001.
A first ED was issued in 2010 and a second in 2013. The proposed amendments
are considered in more detail in Chapter 12 Financial Instruments.
Narrow-scope amendments
Measuring quoted investments in subsidiaries, joint ventures and associates at
fair value (proposed amendments to IFRS 10, IFRS 12, IFRS 13, IAS 27, IAS 28
and IAS 36). The proposed amendments clarify that the fair value of an
investment in the financial instruments of a subsidiary, joint venture or
associate quoted in an active market is calculated based on the quoted price
without adjustment for the level of shareholding.
Recognition of Deferred Tax Assets for Unrealised Losses (proposed
amendments to IAS 12) clarifies how to account for deferred tax assets related
to debt instruments measured at fair value. For further detail see Chapter 11
Income Taxes.
Disclosure initiative (proposed amendments to IAS 7). The proposed
amendments are to improve the information provided in financial statements
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CA Sri Lanka
about an entitys financing activities and provide disclosures that help users to
understand the liquidity of an entity. Further detail is provided in Chapter 19
Statements of Cash Flows.
Classification and measurement of Share-based payment transactions
(proposed amendment to IFRS 2). The proposed amendments clarify
accounting where there is a performance vesting condition or a modification
and classification where there is a net settlement feature. The proposed
amendments are considered in more detail in Chapter 13 Employee benefits.
1.3.4 Recently issued standards
Two major standards were issued in 2014 but are not examinable within this
edition of the KC1 study text. They are:
IFRS 9 Financial Instruments (effective 1 January 2018), and
IFRS 15 Revenue from Contracts with Customers (effective 1 January 2017).
The full detail of the impact of these standards is discussed in the relevant
chapters (Chapter 12 Financial Instruments and Chapter 10 Revenue).
IFRS 14 Regulatory Deferral Accounts was also issued in 2014. This standard is an
interim standard applicable whilst the IASB works on its rate-regulated activities
project. The new standard permits an entity adopting IFRS for the first time to
continue to account for regulatory deferral account balances in accordance with
its previous GAAP.
Amended standards
In addition to the new standards detailed above, the following amended standards
have been issued by the IASB.
CA Sri Lanka
Clarification of acceptable methods of

depreciation and amortisation
amendments to IAS 16 and IAS 38
(effective 1 January 2016)
The amendment clarifies that a revenuebased depreciation/amortisation method

is not appropriate because it reflects a
pattern of economic benefits being
generated from the asset rather than the
expected pattern of consumption of future
economic benefits embodied in the asset.
Accounting for acquisitions of

interests in joint operations
amendments to IFRS 11 (effective 1
January 2016)
The amendments require that where an

entity acquires an interest in a joint
operation that constitutes a business, IFRS
3 principles should be applied and
therefore goodwill may be recognised.
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Agriculture: Bearer plants

amendments to IAS 16 and IAS 41
A bearer plant (a plant held solely to grow

produce over its productive life) is
brought within the scope of IAS 16 rather
than IAS 41.
Equity method in Separate Financial

Statements amendments to IAS 27
The amendments allow an entity to apply

the equity method when accounting for
investments in subsidiaries, joint ventures
and associates in its separate financial
statements.
Sale or contribution of assets

between an investor and its associate
or joint venture amendments to
IFRS 10 and IAS 28 (effective 1
January 2016)
The amendments clarify that in a

transaction involving an associate or joint
venture, the extent of gain or loss
recognition depends on whether the
assets sold or contributed constitute a
business
Disclosure initiative amendments

to IAS 1 (effective 1 January 2016)
Narrow focus amendments to IAS 1 in

order to alleviate problems with over
disclosure and
aggregation/disaggregation
Investment Entities applying the

Consolidation Exception
amendments to IFRS 10, IFRS 12 and
IAS 28 (effective 1 January 2016)
The amendments clarify certain issues in

accounting for investment entities.
1.3.5 Post-implementation reviews

The following post-implementation reviews are currently underway:
(1)
IFRS for SMEs

When the IFRS for SMEs was first issued, the IASB committed to undertake
an initial comprehensive review of it after the first two full years of
application in order to assess whether amendments were necessary.
This review process began in 2012 and an exposure draft of proposed
amendments was issued in 2013. The majority of the proposed changes
concern clarifications to the current text and will not result in a change in the
way that entities account for certain transactions and events. The one
exception to this is a change to the section on income taxes in order to align
its requirements with those of IAS 12.
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(2)
IFRS 3 Business Combinations

IFRS 3 was revised in 2008, with the new requirements taking effect on
1 July 2009. A post-implementation review therefore began in January 2014
with a request for information on experience with, and the effects of,
implementing the standard.
1.4 Annual Improvements

The annual improvements programme is a vehicle through which the IASB makes
non-urgent, but necessary amendments to IFRS. The amendments made through
this process are clarifications of guidance and wording or corrections of minor
unintended consequences, conflicts or oversights.
Each annual improvements cycle lasts for two years from the identification of
issues to the final amendments; an omnibus exposure draft is issued midway
through the process, which contains proposed amendments to all standards under
consideration.
Annual improvements from the 2012-2014 cycle were issued in September 2014,
and the IASB is now working on the 2014-2016 cycle, having discontinued the
2013-2015 cycle in July 2014 in the light of there only being one proposed
amendment.
2 Ethics
Accountants must behave ethically and abide by ethical codes in order to apply
accounting standards correctly and achieve a fair presentation of financial
statements.
As we have seen, a regulatory framework of financial reporting exists, which
includes company law and accounting standards. Such a regulatory framework is
necessary in order to ensure that a companys financial position and performance
is fairly presented in its financial statements. This is turn is important because the
financial statements are relied on by investors, lenders and other users in order to
make economic decisions.
A regulatory framework can, however, only go so far in achieving an
outcome of fair presentation. In addition, the individuals who prepare the
financial statements must ensure that they adhere to the regulatory
framework. This raises the issue of professional ethics and ethical
behaviour.
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2.1 Professional ethics

Professional ethics are the principles and standards that underlie the
responsibilities and conduct of a person in performing their function in a
particular field of expertise.
Chartered accountants of Sri Lanka are bound by the Code of Ethics for
Professional Accountants issued by CA Sri Lanka. This is based on the Code of
Ethics for Professional Accountants published by the International Federation of
Accountants. The fundamental principles contained within this Code are:
Integrity. Members should be straightforward and honest in all professional
and business relationships.
Objectivity. Members should not allow bias, conflict of interest or undue
influence of others to override professional or business judgements.
Professional Competence and Due Care. Members have a continuing duty to
maintain professional knowledge and skill at a level required to ensure that a
client or employer receives the advantage of competent professional service
based on current developments in practice, legislation and techniques.
Members should act diligently and in accordance with applicable technical and
professional standards when providing professional services.
Confidentiality. Members should respect the confidentiality of information
acquired as a result of professional or business relationships and should not
disclose any such information to third parties without proper and specific
authority unless there is a legal or professional right or duty to disclose.
Confidential information acquired as a result of professional and business
relationships should not be used for the personal advantage of the professional
accountant or third parties.
Professional Behaviour. Members should comply with relevant laws and
regulations and should avoid any action that discredits the profession.
In the context of the preparation of accurate financial statements for a given set of
circumstances, the principles can be applied as follows:
Accountants should follow the requirements of relevant law and accounting
standards.
They should ensure that they know and understand accounting standards,
including recent revisions and amendments, and apply these.
They should remain objective and not be biased to overstate profits or assets
for the purposes of personal (or other) gain.
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They should not succumb to pressure from others to deviate from the
requirements of law and accounting standards and guidance.
They should raise concerns with the relevant individuals of bodies (such as an
audit committee) where they are subject to pressure from other individuals to
deviate from the requirements of law and accounting standards and guidance.
This is referred to as whistleblowing.
2.1.1 Example: Professional ethics
A Chartered Accountant joined a manufacturing company as its Finance Director.
The company had acquired land on which it built industrial units. The Finance
Director discovered that, before he began work at the company, one of the units
had been sold and the selling price was significantly higher than the amount that
appeared in the company's records. The difference had been siphoned off to
another company one in which his boss, the Managing Director, was a major
shareholder. Furthermore, the Managing Director had kept his relationship with
the second company a secret from the rest of the board.
The Managing Director acted unethically and not in the best interests of the
company. Having identified this, the Finance Director was obliged by CA Sri
Lankas Code of Ethics to pursue the matter.
The Finance Director confronted the Managing Director and asked him to reveal
his position to the board. However, the Managing Director refused to disclose his
position to anyone else. The secret profits on the sale of the unit had been used, he
said, to reward the people who had secured the sale. Without their help, he added,
the company would be in a worse position financially.
The Finance Director then told the Managing Director that unless he reported to
the board he would have to inform the board members himself. The Managing
Director still refused. The Finance Director disclosed the full position to the board.
The Finance Director therefore displayed integrity and objectivity and did not
succumb to pressure from the Managing Director to keep quiet. In disclosing the
position to the board, the Finance Director took a whistleblowing approach to
remedying the situation.
QUESTION
Ethics and accounting standards
Draft financial statements for World Tea Plc for the year ended 31 March 20X2
have been prepared, and the statement of profit or loss shows a sharp drop in
operating profits compared to the previous year. This has a knock on effect on
operating cash flow in the statement of cash flows. The directors of World Tea Plc
are of the opinion that this is the result of a major customer suffering financial
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15
difficulties together with a general reduction in the level of trade in the second
half of 20X1. They are, however, sure that this was a temporary problem and
believe that trading has improved significantly in the final two months of the
reporting period.
The directors are concerned that the fall in operating cash flow may result in the
breach of loan covenants and a drop in market confidence. They are also aware
that a drop in operating profits will adversely affect the performance related pay
awarded to directors and senior management of World Tea. They therefore
believe that it is in the best interests of the company and its long-term health to
make some adjustments to the draft financial statements. They have suggested to
the financial controller, a Chartered Accountant, that she:
1.
Include a proportion of operating expenses as extraordinary items in the

statement of profit or loss, stated after operating profit.
2.
Include a proportion of the proceeds generated from the sale of property,

plant and equipment as cash generated from operations in the statement of
cash flows. All property, plant and equipment is used in World Tea
operations.
Required
Explain the ethical responsibility of the financial controller in respect of the
directors suggestion.
ANSWER
The financial controller is a Chartered Accountant and as such:
1.
Should be aware of the requirements of SLFRS and should apply those

requirements in order to achieve fairly presented financial statements.
2.
Is bound by the CA Sri Lanka Code of Ethics.
Requirements of SLFRS
LKAS 1 is clear that no items of income or expense can be presented as
extraordinary. Therefore to make the adjustment requested by the directors
would result in an unfair presentation of profit.
LKAS 7 states that cash flows associated with the sale of an item of owner-used
plant are cash flows from investing activities. They are only cash flows from
operating activities if the plant was held to be rented out to others. This is not the
case here.
The requirements of SLFRS can be departed from, however only where
compliance would be so misleading that it would conflict with the objectives of
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financial statements set out in the Conceptual Framework. This is not the case
here.
Code of Ethics
If the financial controller were to accept the directors suggestion to manipulate
the accounts this would be a clear breach of integrity ie that the financial
controller is honest in her professional conduct.
Acceptance of the suggestion by the financial controller also displays a lack of
objectivity ie the requirement that an accountant should not allow bias, conflict of
interest or the influence of others to override professional judgment. It is unclear
whether the financial controller is senior management and therefore benefits
from performance related pay, but if this is the case, objectivity becomes even
more relevant since the financial controller herself would benefit from adjustment
of the normalised profit figure. It is also unclear to what extent the directors are
exerting pressure on the financial controller. Allowing herself to be influenced to
act wrongly would display a lack of objectivity on her part.
The requirements to behave professionally and display professional
competence and due care mean that the financial controller must comply with
applicable professional standards and regulations and avoid any act that
discredits the profession. The inclusion of proceeds from the sale of non-current
assets in operating cash flow and classification of normal operating expenses as
extraordinary would display a lack of professional behaviour.
The financial controller should explain to the directors the requirements of
accounting standards and principles in respect of the suggested amendments to
the financial statements. She should attempt to persuade the directors to refrain
from amending the financial statements.
If the directors insist on the suggested adjustments being made, the financial
controller should consider her position and identify the misstated amounts to the
companys internal or external auditors.
2.2 Business ethics

An individuals approach to professional ethics is to some extent determined by
the business ethics of the organisation that they work for. Business ethics set the
tone for the culture and behaviour of management and employees; they are clearly
linked to corporate governance. Some companies have an ethical code that sets
out their ethical objectives, for example to be honest in all business transactions
and to treat employees well.
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17
In other companies, it may be the norm to deviate from the rules in order to
achieve a particular outcome. In the next section we consider examples of
companies throughout the world that have not behaved ethically and as a result
have issued misleading financial statements, sometimes leading to their downfall.
In many cases it was not a single individual at these companies that resulted in
problems, but an underlying unethical culture.
2.3 Global examples

In recent years there have been a number of examples of companies collapsing or
suffering financial loss as a result of adopting misleading accounting practices.
Some are explained below:
Enron (2001)
Enron was the first of a series of large accounting scandals that have arisen over
the last 15 years. The company was formed in 1985 and provided the first
nationwide gas pipeline network in the USA. It later branched into other areas
including Enron Online, a website for trading commodities.
At the end of the 1990s, the CEO developed a staff of executives who used
accounting loopholes and poor financial reporting practices to overstate revenue
and hide billions of dollars of deals from failed deals and projects. Furthermore
they pressured their accountants, Arthur Andersen, to ignore these practices. The
main accounting issues were:
The companys reported revenue increased by more than 750% between 1996
and 2000, largely as a result of reporting the entire value of trades in which it
was an agent as revenue, rather than just the agency fee, as other companies
did.
The recognition of unrealised profits which then failed to materialise. For
example in a contract with Blockbuster Video to introduce an on demand
entertainment network to US cities, Enron recognised an estimated $110
million profit after pilot projects were run. This was despite analysts
questioning the technical viability and commercial demand for the service. The
network failed to work, Blockbuster withdrew from the contract, but Enron
continued to recognise future profits.
Enron used special purpose entities partnerships created for a temporary or
specific purpose. It did not consolidate these entities and used them to hide its
debt, meaning that net assets in the Enron financial statements were
overstated.
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Investors confidence in the company began to decline in 2000, the CEO left the
company in 2001, and after a period of rapidly falling share prices, Enron
announced, in 2001, that it had to restate its financial statements for 1997 2000
as a result of accounting violations. These restatements reduced earnings for the
period by $613 million (a reduction of 23%) and in December 2001, Enron filed
for bankruptcy protection.
As a result of the dubious accounting practices at Enron and its subsequent
collapse:
Several executives were jailed.
The companys auditor was convicted of criminal obstruction of justice charges
and subsequently collapsed.
21,000 jobs were lost.
Xerox (2002)
In 2002 a complaint was made by the US regulator alleging that Xerox deceived
the public between 1997 and 2000 by using several accounting manoeuvres, the
most significant involving recording revenue in the period a lease contract was
signed, rather than spreading it over the length of the contract.
The regulator identified that the accounting irregularities increased fiscal year
1997 pre-tax profits by $405 million, 1998 pre-tax earnings by $655 million and
1999 pre tax earnings by $511 million.
Xerox restated its income for each of the years 1997 2001 and paid a civil
penalty of $10 million.
WorldCom (2002)
From 1999 2002, senior management at WorldCom used fraudulent accounting
practices to hide the companys poor financial position and report better
profitability and growth than actually existed. This was achieved by capitalising
costs that should have been expensed, and inflating revenues with entries from
bogus accounts. By the end of 2003 it was estimated that the companys assets had
been inflated by about $11 billion.
The fraud was discovered by a routine assessment of capital expenditure by the
companys internal audit function.
As a result of the fraud, shareholders lost $180 billion, 20,000 employees lost their
jobs and the CEO was sentenced to 25 years in prison.
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Parmalat (2003)
Parmalat was an Italian dairy group that collapsed in 2003 in Europes biggest
bankruptcy. The companys 2003 financial reports were found to misrepresent
the underlying situation; in particular:
4 billion funds in a Bank of America account were found to be non-existent.
The company was found to owe 14.3 billion, being 8 times the amount
reported.
As a result the company was declared insolvent in December 2003 and the CEO
was charged with financial fraud and money laundering and imprisoned. Several
other Parmalat executives were also convicted and the Deloitte partners involved
in the Parmalat audit were banned from practising for 2 years.
Olympus (2011)
In 2011 Olympus, the Japanese electronics company, employed a new CEO. He was
dismissed from the post within a fortnight, after challenging the Board over
suspiciously large payments relating to acquisitions. As a result of the challenge,
an investigation was launched which revealed a cover up of losses dating back to
the 1990s. This was described by the Wall Street Journal as one of the longestrunning loss-hiding arrangements in Japanese corporate history.
In December 2011, Olympus offices were raided by the Japanese authorities and
in February 2012, 7 executives were arrested; three were subsequently given jail
sentences. The company lost 80% of its value in the aftermath of the scandal,
however it subsequently returned to profit and its shares regained most of their
losses.
3 The Conceptual Framework

The Conceptual Framework for Financial Reporting includes chapters on the
objective of general purpose financial reporting, qualitative characteristics of
financial information, underlying assumption, definition, recognition and
measurement of elements of the financial statements and capital maintenance.
3.1 Revision
The IASBs Conceptual Framework for Financial Reporting (Conceptual
Framework), as adopted by CA Sri Lanka, was explained in detail in the KB1 study
text. The following is a summary of its main contents; you should go back and
review your KB1 notes for further detail.
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CA Sri Lanka
The Conceptual Framework is not a Sri Lanka Accounting Standard and so does
not define standards for any particular measurement or disclosure issue.
Nothing in the Conceptual Framework overrides any specific Sri Lanka
Accounting Standard.
The objective of general purpose financial reporting is to provide information
about the reporting entity that is useful to existing and potential investors,
lenders and other creditors in making decisions about providing resources to
the entity.
These users need information about the economic resources of the entity; the
claims against the entity; and changes in the entitys economic resources and
claims.
The Conceptual Framework makes it clear that financial information should be
prepared on an accruals basis (with the exception of the statement of cash
flows).
Going concern is the underlying assumption in preparing financial statements.
Qualitative characteristics are the attributes that make financial information
useful to users.
The fundamental qualitative characteristics are relevance and faithful
representation. A faithful representation is complete, neutral and free from
error.
The enhancing qualitative characteristics are comparability, verifiability,
timeliness and understandability.
The elements of financial position are assets, liabilities and equity:
An asset is a resource controlled by an entity as a result of past events and
from which future economic benefits are expected to flow to the entity.
A liability is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of
resources embodying economic benefits.
Equity is the residual interest in the assets of the entity after deducting all of
its liabilities.
The elements of financial performance are income and expenses:
Income is increases in economic benefits in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in
equity other than those relating to contributions from equity participants.
Expenses are decreases in economic benefits during the accounting period in
the form of outflows or depletions of assets or incurrences of liabilities that
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21
result in decreases in equity, other than those relating to distributions to

equity participants.
Elements of the financial statements are recognised if:
It is probable that any future economic benefit associated with the item will
flow to or from the entity, and
The item has a cost or value that can be measured with reliability.
Elements of the financial statements may be measured using bases including
historical cost, current cost, realisable value, settlement value and present
value.
Historical cost is the most commonly adopted measurement basis, but this is
usually combined with other bases, eg inventory is carried at the lower of cost
and net realisable value.
Capital maintenance refers to the concept that profits can only be made when
the capital of an organisation is restored to, or maintained at the level that it
was at the start of an accounting period.
Under the physical capital maintenance concept, a profit is earned only when
the operating capability of an organisation at the end of a period exceeds the
operating capability at the start of the period.
Under the financial capital maintenance concept, a profit is earned when the
money value of net assets at the end of a period exceeds their money value at
the start of the period after excluding capital injections and dividends paid
during the period.
3.2 Development of the Conceptual Framework

The current Conceptual Framework is the part-complete output of a project to
replace the 1989 Framework for the Preparation and Presentation of Financial
Statements. It includes revised chapters on the objective of general purpose
financial reporting and the qualitative characteristics of useful information, but
the remaining text is the 1989 Framework. The current Conceptual Framework
was issued in 2010 and remains incomplete because the IASB suspended work in
order to concentrate on more urgent projects arising from the global financial
crisis.
The project has now restarted and a discussion paper on the review of the
Conceptual Framework was issued in 2013. The discussion paper aims to solicit
feedback on the main areas that the IASB will consider when it starts to develop
complete proposals, including:
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Definitions of assets and liabilities

Recognition and derecognition of assets and liabilities
Measurement
Equity
Profit or loss and other comprehensive income
Presentation and disclosure.
The IASB is currently expecting to issue an exposure draft in 2015.
QUESTION
Conceptual Framework
Explain how the Conceptual Framework is related to SLFRS.
ANSWER
The Conceptual Framework is not itself an SLFRS and it does not override any
specific SLFRS.
It is used as a basis in the development of accounting standards, and therefore
several standards reflect its content exactly. For example, the Conceptual
Frameworks definition of an asset is reproduced in standards relating to assets,
such as IAS 16 Property, Plant and Equipment and IAS 38 Intangible assets. Equally
the definition of a liability is reproduced in standards including IAS 37 Provisions,
Contingent Liabilities and Contingent Assets.
It is also the case that the recognition criteria given within the Conceptual
Framework are reproduced in a number of standards, and in some cases expanded
to become more relevant to a particular topic. For example the recognition criteria
relevant to a liability are reflected in IAS 37 on provisions, however additional
detail is added to reflect the fact that the application of these criteria where there
is uncertainty may be difficult.
In the rare case that there is a conflict between an accounting standard and the
Conceptual Framework, the requirements of the accounting standard prevail.
Cases of conflict will, however, reduce as older accounting standards are revised
and amended and brought into line with the general principles presented in the
Conceptual Framework.
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4 SLFRS 13 Fair Value Measurement

SLFRS 13 Fair Value Measurement provides guidance on determining fair value
where other standards require an item to be measured at fair value.
SLFRS 13 was introduced at KB1 level; in this section we revise the requirements
of the standard.
4.1 Introduction and scope

SLFRS 13 sets out to define fair value and set out in a single accounting standard a
framework for measuring fair value where it is required by another standard.
SLFRS 13 does not, however, apply to the measurement of fair value in respect of
the following:
(a)
Share-based payment transactions within the scope of SLFRS 2 Share-based

payment;
(b)
Leasing transactions within the scope of LKAS 17 Leases; and
(c)
Net realisable value as in LKAS 2 Inventories or value in use as in LKAS 36

Impairment of assets.
In each of these cases, the relevant standard provides the required guidance.
4.2 Fair value

Fair value is defined as:
'the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement
date'
This is an exit price ie the price that an entity disposing of an asset or liability
would achieve rather than the price that an entity acquiring an asset or liability
would have to pay.
4.3 Measurement
Fair value is a market-based measurement, not an entity-specific measurement.
Therefore, fair value is measured using the assumptions that market participants
would use when pricing the asset under current market conditions, taking into
account any relevant characteristics of the asset. Whether an entity actually
intends to hold an asset or settle a liability is irrelevant when measuring fair value.
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A fair value measurement requires an entity to determine:

(i)
The item being measured
(ii)
For a non-financial asset, the highest and best use of the asset and whether
the asset is used in combination with other assets;
(iii) The market in which an orderly transaction would take place for the asset or
liability, and
(iv) The appropriate valuation technique to use when measuring fair value.
4.4 Unit of account

The item for which fair value is determined is referred to in SLFRS 13 as the unit
of account. It is defined as the level at which an asset or liability is aggregated or
disaggregated in an SLFRS for accounting purposes.
In most cases, the unit of account is an individual asset or liability (eg an
individual property), but in some instances it may be a group of assets or liabilities
(eg the assets and liabilities of an SLFRS 5 disposal group).
4.5 Highest and best use

In the case of non-financial assets, fair value is determined based on the highest
and best use of the asset from the perspective of a market participant.
The highest and best use should be:
Physically possible
Legally permissible
Financially feasible.
In many cases it can be assumed that the current use of an asset is its highest and
best use.
4.5.1 Example: Highest and best use
Company A owns vacant land that is measured at fair value. Although it has
permission to do so, Company A is unable to secure funding for the development
of the land and expects this situation to continue. Although Company A has
insufficient funds to develop the land, other market participants may have
sufficient funds and therefore future development is considered in determining
fair value of the land.
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4.6 The market

It is assumed that the transaction to sell an asset or transfer a liability takes
place either in the principal market for the asset or liability or in the absence of
a principal market, in the most advantageous market for the asset or liability.
The principal market is the market with the greatest volume and level of
activity for that asset or liability.
The most advantageous market is the market that maximises the amount that
would be received to sell the asset or minimises the amount that would be paid
to transfer the liability after taking into account transaction and transport
costs.
In most cases the principal market and the most advantageous market will be
the same.
It is presumed that the market in which an entity normally transacts is the
principal or most advantageous market unless there is evidence to the contrary.
QUESTION
Fair value measurement
You work in the accounting department at Mannar Machines Ltd. As you have
recently studied SLFRS 13, the financial controller has asked you to review her
workings to establish the fair value of inventory held by a subsidiary that Mannar
Machines has recently acquired:
Product line 1 (100,000 units)
Market
Sales volume in previous 12 months
Selling price per unit
Transaction costs
Transport to market costs
Net price received
Product line 2 (500 units)
Sales volume in previous 12 months
Selling price per unit
Transaction costs
Transport to market costs
Net price received
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Asia
240,300
Rs.
350
10
5
335
10,000
Rs.
2,300
100
60
2,140
Europe
180,300
Rs.
390
20
30
340
Africa
90,200
Rs.
325
15
20
290
10,000
Rs.
2,450
120
90
2,240
CA Sri Lanka
Therefore:
Product line 1: 100,000 Rs 340
Product line 2: 500 Rs 2,240
Fair value of inventory acquired
Rs.
34,000,000
1,120,000
35,120,000
Required
Prepare notes explaining how the fair value of the above inventory acquired
should be determined in accordance with SLFRS 13.
ANSWER
Product line 1
Product line 1 is sold in three markets Asia, Europe and Africa.
Asia is the principal market as it has the greatest sales volume.
If a principal market exists then the price in that market must be used to
establish fair value.
Fair value takes into account transport costs but not transaction costs.
The selling price of product line 1 is Rs. 350 and transport costs are Rs. 5.
Therefore the fair value of one unit is Rs. 345.
The fair value of inventory held is therefore 100,000 Rs. 345 = Rs. 34,500,000.
Product line 2
Product line 2 is sold in equal volumes in Asia and Africa. Therefore there is no
principal market.
The most advantageous market is Africa as each sale in this market results in
greater net proceeds (Rs. 2,240) than each sale in Asia.
Although transaction costs are taken into account when determining the most
advantageous market, fair value once determined is not adjusted for these
costs.
Fair value is the selling price Rs. 2,450 less transport costs of Rs. 90 = Rs. 2,360.
The fair value of inventory held is therefore 500 Rs. 2,360 = Rs. 1,180,000.
The total fair value of inventory is Rs. 34,500,000 + Rs. 1,180,000 = Rs. 35,680,000
CA Sri Lanka
27
4.7 Valuation techniques

SLFRS 13 requires use of a valuation technique that is appropriate in the
circumstances and that maximises the use of relevant observable inputs and
minimises the use of unobservable inputs.
The standard discusses three widely used valuation approaches:
Approach
Techniques
Market approach
A valuation technique that uses prices and other relevant

information generated by market transactions involving
identical or comparable assets and liabilities.
Cost approach
A valuation technique that reflects the amount that would be

required currently to replace the service capacity of an
asset.
Income approach
A valuation technique that converts future amounts (eg cash

flows or income) to a single discounted amount. The fair
value measurement is determined on the basis of the value
indicated by current market expectations about those future
amounts.
Whichever valuation technique is selected should be applied consistently from

period to period.
To increase consistency and comparability in fair value measurements and related
disclosures, SLFRS 13 establishes a fair value hierarchy that categorises into three
levels the inputs to valuation techniques used to measure fair value. The fair value
hierarchy gives the highest priority to quoted prices (unadjusted) in active
markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to
unobservable inputs (Level 3 inputs).
Level 1 inputs quoted prices (unadjusted) in active markets for identical
assets or liabilities that the entity can access at the measurement date.
Level 2 inputs are inputs other than quoted prices included within Level 1 that
are observable for the asset or liability, either directly or indirectly.
Level 3 inputs are unobservable inputs for the asset or liability.
An items fair value is categorised according to the lowest level input. Therefore a
fair value measurement of quoted shares based on the unadjusted share price is a
level 1 measurement, whereas a fair value measurement of an unquoted
investment using a valuation technique based on discounted cash flows is a level 3
measurement.
28
CA Sri Lanka
4.8 Measurement of financial instruments

4.8.1 Financial assets
The following should be considered where a financial asset is being fair valued:
If a quoted item has a bid price (the price that buyers are willing to pay) and an
ask price (the price that sellers are willing to achieve), the price within the bidask spread that is most representative of fair value is used to measure fair
value. The use of bid prices for financial assets and the use of ask prices for
financial liabilities is permitted but not required. SLFRS 13 does not preclude
the use of mid-market pricing.
In the case of equity shares, a control premium is considered when measuring
the fair value of a controlling interest. Similarly, any non-controlling interest
discount is considered where measuring a non-controlling interest.
The valuation of unlisted equity investments involves significant judgment and
different valuation techniques are likely to result in different fair values,
however this does not mean that any of the techniques are incorrect. Certain
techniques are better suited to particular types of business, for example an
asset based approach is relevant to property companies whilst an income
approach is more relevant to service businesses. It is likely that valuation will
be based on some unobservable inputs and as a result the overall fair value will
be classified as a level 3 measurement.
4.8.2 Liabilities and own equity instruments
Liabilities and own equity instruments must be measured on the assumption that
the liability or equity is transferred to a market participant at the measurement
date and therefore:
A liability would remain outstanding and the market participant would be
required to fulfill the obligation
An entitys own equity instrument would remain outstanding and the market
participant would take on the rights and responsibilities associated with the
instrument.
This differs (sometimes significantly so) from a measurement that is based on the
assumption of settlement of a liability or cancellation of an entitys own equity
instrument.
SLFRS 13 further requires that the fair value of a liability must factor in nonperformance risk. Anything that could influence the likelihood of an obligation
being fulfilled is considered a non-performance risk. This could include the risk of
physically extracting or transporting an asset or the entitys own credit risk.
CA Sri Lanka
29
The specific approach to fair value liabilities and an entitys own equity
instruments sometimes differs from the concepts to fair value an asset and is
summarised in the following flowchart:
Is there a quoted price for
the transfer of an
identical or a similar
liability or entitys own
equity instrument?
Yes
Use quoted
price
No
Yes
Is there an identical item

held by another entity as
an asset?
Measure fair value of the

liability or equity
instrument from the
perspective of market
participant that holds the
identical item as an asset
at the measurement date.
No
Measure the fair value of

the liability or equity
instrument using a
valuation technique from
the perspective of a
market participant that
owes the liability or has
issued the equity.
4.9 Fair value at initial recognition

When an asset is acquired or a liability assumed, the price paid to acquire the
asset or paid to assume the liability is an entry price.
The SLFRS that is applicable to the acquired asset or assumed liability may,
however, require that it is initially measured at fair value. This is not necessarily
the same as the entry price and where it differs, any gain or loss is recognised in
profit or loss unless the specific SLFRS requires otherwise. This is commonly
known as a day one gain or loss. Day one gains or losses may be recognised for
assets or liabilities within the scope of SLFRS 3 Business Combinations (the gain on
a bargain purchase), LKAS 41 Agriculture and LKAS 39 Financial Instruments:
Recognition and Measurement.
30
CA Sri Lanka
4.10 Disclosure
An entity should disclose information that helps users of the financial statements
assess both of the following:
(a)
For assets and liabilities that are measured at fair value on a recurring or
non-recurring basis in the statement of financial position after initial
recognition, the valuation techniques and inputs used to develop those
measurements.
(b)
For recurring fair value measurements using significant unobservable inputs

(Level 3), the effect of the measurements on profit or loss or other
comprehensive income for the period.
4.10.1 Example: Fair value measurement disclosure note

The following table sets out the companys assets and liabilities that are measured
and recognised at fair value at 31 December 20X4:
At 31.12.X4
Recurring fair value
measurements
Available-for-sale equity shares
Investment properties
Non-recurring fair value
measurements
Land held for sale
Level 1
Rs'000
Level 2
Rs'000
Level 3
Rs'000
Total
Rs'000
30,000
30,000
7,000
25,000
32,000
37,000
25,000
62,000
4,500
4,500
4,500
4,500
The company has measured land held for sale at fair value on a non-recurring
basis as a result of its classification as held for sale.
There have been no transfers between levels 1 and 2 during the year.
Company policy is to recognise transfers into and out of the different fair value
hierarchy levels at the date the event or change in circumstances causing the
transfer occurred.
Valuation processes for level 3 fair values
The company engages qualified valuers to determine the fair value of the groups
financial instruments that are in level 3 of the fair value hierarchy every 6 months.
The fair value of investment property is determined at the end of each reporting
period.
CA Sri Lanka
31
The following table sets out the amount of total gains or losses for the period
included in profit or loss in relation to assets measured on a recurring basis using
level 3 of the fair value hierarchy:
Unrealised gains
and losses
recognised in profit
or loss
Available-for-sale
equity shares
Rs'000
(1,200)
Investment
properties
Rs'000
3,400
Total
Rs'000
2,200
Valuation techniques
The following valuation techniques are used:
Level 1
Quoted share prices.
Level 2
Land held for sale
Sale comparison approach: sale prices

of comparable land in similar location
are adjusted for differences in key
attributes such as land size. The
valuation model is based on price per
square metre.
Level 3
32
Discounted cash flow method. Key

unobservable inputs are: weighted
average cost of capital, revenue growth
rate, discount for lack of marketability
and control premium.
Investment properties
Income approach based on estimated

rental values. Key unobservable inputs
are discount rate, expected vacancy
rate and rental growth rate.
CA Sri Lanka
QUESTION
After a company's year end 31 March 20X7, but before its financial statements
were authorised for issue, some non-current assets were put on the market and
classified as held for sale.
Explain the appropriate accounting treatment in the financial statements for the
year ended 31 March 20X7, and evaluate this treatment in the context of the
Conceptual Framework for Financial Reporting.
ANSWER
At the year end, it was not the intention of management to sell the assets. This is a
situation that has arisen after the end of the reporting period.
Consequently, SLFRS 5 Non-current assets held for sale and discontinued
operations, confirmed by LKAS 10 Events After the Reporting Period does not
permit classification as held for sale at the end of the reporting period unless it is
'highly probable' that the assets will be sold at the time, supported by a number of
rules which establish whether this is the case.
The Conceptual Framework for Financial Reporting is principally concerned with
recognition of assets and liabilities, and changes in those assets and liabilities.
Whether the non-current asset is classified as held for sale or not, it still meets the
Conceptual Framework definition of an asset, 'a resource controlled by the entity
as a result of past events and from which future economic benefits are expected to
flow to the entity'. Those economic benefits can be realised by use or by sale.
Conceptual Framework requires an asset's recognition when it is probable that it
will generate future economic benefits and they can be measured with reliability.
Again whether the asset is held for sale or not, it is probable that economic
benefits will be generated, and a decision to sell provides another way to measure
those benefits.
SLFRS 5 only allows classification as held for sale when the sale is 'highly'
probable, a concept not addressed by the Conceptual Framework. However, this is
not a recognition issue, which requires merely 'probability', but a classification
issue, an area not covered in detail by the Conceptual Framework.
Consequently, the accounting treatment is consistent with the relevant
requirements of the Conceptual Framework.
CA Sri Lanka
33
QUESTION
ABC Ltd acquired a property by way of a finance lease in the year ended
31 December 20X3. It sublets the property to small businesses. The lease
stipulates that the property must be used for commercial rather than residential
purposes. This restriction is not imposed by the planning authorities and
therefore at a future date the property could be used for residential purposes. The
owner has established that were the property to be sold at 31 December 20X3, it
would raise Rs. 29 Mn if sold as a residential apartment block, or Rs. 25 Mn if sold
as offices. In either case, legal fees of 1% of the sale price would be incurred.
Explain how the fair value of the property is determined.
ANSWER
The fair value is determined in accordance with SLFRS 13 by reference to exit
(selling) prices. It is assumed that the property will be sold to a market participant
that will use the property in its highest and best use. In this case the higher value
is Rs. 29 Mn for residential purposes.
Where there is a restriction in use of an asset, as is the case here, SLFRS 13
considers whether that restriction would be passed on to a purchaser in a future
sale. That is not the case here the property could be used on a residential basis in
the future. Therefore the current restriction in use is not relevant when
determining fair value.
Transaction costs are not taken into account when determining fair value and
therefore the 1% legal fees are not relevant.
Fair value is therefore Rs. 29 Mn.
34
CA Sri Lanka
CHAPTER ROUNDUP
The regulatory framework of financial reporting refers to the many sources of

regulation, including accounting standards, company law and stock exchange
rules.
The IASB issues IFRS and Interpretations that are adopted by CA Sri Lanka as
SLFRS and Interpretations.
The IASB has a work plan for the development of new and revised IFRS. There are
several on-going projects at various stages of development.
Accountants must behave ethically and abide by ethical codes in order to apply
accounting standards correctly and achieve a fair presentation of financial
statements.
The Conceptual Framework for Financial Reporting includes chapters on the

objective of general purpose financial reporting, qualitative characteristics of
financial information, underlying assumption, definition, recognition and
measurement of elements of the financial statements and capital maintenance.
The Conceptual Framework is a work in progress and the IASB expects to issue an
exposure draft in relation to outstanding sections in 2015.
SLFRS 13 Fair Value Measurement provides guidance on determining fair value

where other standards require an item to be measured at fair value.
CA Sri Lanka
35
PROGRESS TEST
36
What topics are the subject of the two major IASB exposure drafts currently in
issue?
IFRS 9 and IFRS 15 were issued in 2014, what financial reporting topics do they
cover?
What is the final step in the IASBs due process?
The Conceptual Framework is currently a work in progress; which parts of it are

from the 1989 Framework?
If an asset is sold in several markets, which market is relevant when determining

fair value?
What are level 2 inputs in the fair value hierarchy of SLFRS 13?
What valuation approaches may be taken in line with SLFRS 13?
CA Sri Lanka
ANSWERS TO PROGRESS TEST
Leases and Insurance Contracts
Revenue (IFRS 15) and Financial Instruments (IFRS 9)
Monitoring the use of a new standard (including conducting a postimplementation review).
Sections on the elements of financial statements, recognition and measurement of

elements and capital maintenance are all from the 1989 Framework.
The principal market; where there is no principal market the most advantageous
market.
Inputs other than quoted prices included within Level 1 that are observable for
the asset or liability, either directly or indirectly.
Market, cost and income approaches
CA Sri Lanka
37
38
CA Sri Lanka
CHAPTER
INTRODUCTION
The concept of non-financial reporting was introduced at KB1. This
chapter revises and expands on that knowledge and explains the
relevance of professional ethics to financial reporting.
Knowledge Component
4
Corporate Governance and Recent Developments in Financial Reporting
4.1
Corporate governance and

sustainability reports
including integrated
reporting
4.1.1
4.1.2
4.1.3
Criticise an annual report of a company in a given scenario on the basis

of adequacy of disclosures.
Compile an integrated report along with a sustainability report for a
given entity.
Evaluate integrated/sustainability reports in accordance with the triple
bottom line principle and GRI guidelines.
39
KC1 | Chapter 2: Non-financial reporting
CHAPTER CONTENTS
1 Introduction to non-financial reporting
2 Corporate governance reporting
3 Sustainability and integrated reporting
1 Introduction to non-financial reporting

Non-financial reporting refers to narrative reports presented within or
alongside the annual report. These may include a directors report, corporate
governance reports and sustainability reports.
The term non-financial reporting includes those narrative reports that may be
(and in some cases must be) included in, or presented alongside, an annual report.
These reports may include:
A directors report as required by company law
Corporate governance reports
Social/environmental/sustainability reports
1.1 Directors report

In Sri Lanka, a Directors Report is presented within the Annual report of a
company. It should include declarations to the effect that:
The company has not engaged in any activity that contravenes laws and
regulations;
The Directors have declared all material interests in contracts involving the
Company and refrained from voting on matters in which they were materially
interested;
The Company has made all endeavours to ensure the equitable treatment of
shareholders;
The business is a going concern (with supporting assumptions or qualifications
as necessary);
40
CA Sri Lanka
Directors have conducted a review of the internal controls covering financial,

operational and compliance controls and risk management and have obtained
reasonable assurance of their effectiveness and successful adherence
therewith.
If any of these declarations cannot be made, an explanation should be provided of
why this is the case.
1.2 Corporate governance reports

Corporate governance is the system by which companies and other entities are
directed and controlled. The trigger for developments in corporate governance
was the collapse of major international companies during the 1980s as a result of
dubious and sometimes fraudulent activities on the part of owners and managers.
It is now accepted that a strong structure and diligent practice of corporate
governance is vital to inspire investor confidence, expand the private sector,
stimulate economic growth and reduce opportunity for fraud, so creating a
healthy and robust investment climate.
Developments in governance have resulted in increased need to report
governance structures and activities to stakeholders.
This type of reporting is discussed in more detail in the next section of the chapter.
1.3 Social/environmental/sustainability reports

Environmental reporting is the disclosure of information in the published annual
report (or elsewhere) of the effect that an entitys operations have on the natural
environment. Social reporting is the disclosure of information on the impacts that
operations have on communities and individuals.
In some cases social and environmental items affect the financial statements, for
example where an environmental provision is made. Here, the form of reporting is
governed by the relevant accounting standards and is mandatory. Additional
information may, however be given on a voluntary basis. In other cases, items do
not affect the financial statements, for example efforts to reduce pollution or
create employment. These activities are the focus of environmental and social
reports.
At the end of the 1980s there were perhaps only two or three companies in the
world issuing social and environmental reports. Now most listed companies
produce them and worldwide there are around 20 award schemes for
environmental reporting. Such reports may be included within the annual report,
CA Sri Lanka
41
or they may be presented as a separate document, which may be printed and

distributed or posted on the entitys website.
The next step beyond social and environmental reports is sustainability reporting,
which links these issues to economic performance. This, together with integrated
reporting - the newest development in non-financial reporting is discussed in
more detail in section 3 of this chapter.
2 Corporate governance reporting

Corporate governance involves a set of relationships between a companys
management, its board, its shareholders and other stakeholders.
Corporate governance guidance is continually evolving in the light of changes to
the economic, commercial and regulatory environments; governance practice and
guidance must keep pace.
Most countries develop their own codes of governance that must be adopted by
specified companies within that jurisdiction. Most often, they are applicable to
listed companies. There is also a global movement to improve corporate
governance and the reporting of governance activities, driven by various
international bodies.
2.1 Global developments

A number of organisations have been involved in the development of globally
accepted corporate governance practice. These include the United Nations
Conference on Trade and Development (UNCTAD) and the International
Corporate Governance Network (ICGN).
Both bodies have developed guidance on the reporting of corporate governance
activities.
2.1.1 UNCTAD
UNCTAD first published a report Transparency and Disclosure Requirements for
Corporate Governance in 2002 with the goal of achieving better corporate
transparency and accountability in order to facilitate investment flows and
mobilise financial resources for economic development. This report was updated
in 2006 as Guidance on Good Practices in Corporate Governance Disclosure. It is
aimed in particular at regulators and companies in developing countries and
transition economies. The Guidance divides disclosures between financial and
42
CA Sri Lanka
non-financial, with financial disclosures being based on IFRS. Non-financial

disclosures are recommended in the areas of:
Company objectives
Ownership and shareholder rights
Changes in control and transactions involving significant assets
Governance structures and policies
Members of the board and key executives
Material issues regarding stakeholders and environmental and social
stewardship
Material foreseeable risk factors
Independence of external auditors
Internal audit function
2.1.2 International Corporate Governance Network
The ICGN was founded in 1995 in the USA; today it is a global organisation of
leaders in corporate governance from over 50 countries. Its mission is to inspire
and promote effective standards of corporate governance to advance efficient
markets and economies worldwide.
In 2014 the ICGN issued the fourth edition of its Global Governance Principles,
which describe the responsibilities of boards and shareholders and aim to
enhance dialogue between the parties. These Principles apply predominantly to
listed companies but also to unlisted companies that aspire to high standards of
corporate governance practice.
A section of the Principles deals with reporting and audit. It promotes the use of
an integrated report (see section 3.2) and requires disclosure of internal controls
systems, external audit and inclusion of a report from the audit committee within
the annual report.
2.2 Corporate governance reporting in Sri Lanka

2.2.1 Guidance on corporate governance reporting
CA Sri Lanka published a Code of Best Practice on matters related to financial
aspects of Corporate Governance in 1997. The fourth edition of the publication
Code of Best Practice on Corporate Governance was issued jointly with the
Securities and Exchange Commission of Sri Lanka in 2014.
CA Sri Lanka
43
This Code states that directors should include in a companys annual report a
corporate governance report that sets out the manner and extent to which the
company has complied with the principles and provisions of the Code:
Directors
(in respect of each director)
Name, qualifications and profile
Nature of expertise in relevant areas
Immediate family and/or material business relationships with other Directors
of the company
Whether the Director is executive/non-executive/independent
Names of listed companies in Sri Lanka for which the Director serves as a
Director
Names of other companies in Sri Lanka for which the Director serves as a
Director (other than those in the same Group as the reporting company)
Number/percentage of Board meetings of the company attended in the year
Total number of Board seats held (and an indication of whether the company is
listed/unlisted and the directorship is executive/non-executive)
Names of Board Committees in which the Director serves as Chairman/a
member
Number/percentage of committee meetings attended in the year.
Directors remuneration
The names of Directors who serve on the remuneration committee
A statement of remuneration policy and
Aggregate remuneration paid to executive and non-executive directors.
Relations with shareholders
The policy and methodology for communication with shareholders and how
this is implemented
The process for responding to shareholder matters.
Major and material transactions
All proposed material transactions which, if entered into, would materially alter
the Companys (or Groups) net asset base.
44
CA Sri Lanka
The material facts of a substantial proposed related party transaction (with a

value of more than one third of the value of company assets) and obtain
approval for the transaction.
Accountability and audit
The annual report should contain:
A Directors report (see section 1.1)
A statement setting out the responsibilities of the Board for preparing and
presenting financial statements and a report on internal control
A management discussion and analysis including discussion of:
Industry structure and developments
Opportunities and threats
Risks and concerns
Internal control systems and their adequacy
Social and environmental protection activities carried out by the company
Financial performance
Material developments in human resources/industrial relations, and
Prospects for the future.
Related party transactions
Audit committee
The names of Directors in the Audit Committee
A determination of the independence of the auditors
A report by the audit committee which sets out the manner of compliance with
the Codes guidelines on audit committee activities.
Code of Business Conduct and Ethics
Existence of such a code within a company to address topics including conflict
of interest, bribery and corruption, entertainment and gifts, accounting and
record keeping, corporate opportunities, confidentiality, fair dealing, use of
company assets, compliance with laws and regulations and reporting of illegal /
unethical behaviour.
Statement of compliance with the code by Directors and key management
personnel
The Code also promotes sustainability reporting in the annual report (see section
3.1).
CA Sri Lanka
45
2.2.2 CASE STUDY: Corporate Governance report

The following is a one-page extract from the 30 page corporate governance report
within the John Keells Holdings PLC Annual Report for 2012/2013. This page
explains how the Company complies with some of the requirements of the Code of
Best Practice on Corporate Governance:
Corporate Governance
Code of Best practice of Corporate Governance jointly issued by the Securities and
Exchange Commission of Sri Lanka (SEC) and the Institute of Chartered
Accountants of Sri Lanka (CA Sri Lanka)
(Issued on 1st July 2008)
A. Directors
Rule
Compliance
Status
JKH Action
A.1 Company to be
headed by an
effective Board to
direct and control the
company
The JKH Group is headed by an

effective Board of Directors who are
responsible and accountable for the
stewardship function of the Group.
A.1.1 Regular Board

meetings
The Board of JKH meets at least

once a quarter.
A.1 The Board
46
CA Sri Lanka
Rule
A.1.2 Board should be
responsible for
matters including
implementation of
business strategy,
skills and succession
of the management
team, integrity of
information, internal
controls and risk
management,
compliance with
laws and ethical
standards,
stakeholder
interests, adopting
appropriate
accounting policies
and fostering
compliance with
financial regulations
and fulfilling other
Board functions
Compliance
Status
JKH Action
Powers specifically vested in the
Board to execute their
responsibility include:
Providing direction and
guidance to the Company in the
formulation of its strategies,
with emphasis on the medium
and long term, in the purchase of
its operational and financial
goals.
Reviewing and approving annual
budget plans.
Reviewing HR process with
emphasis on top management
succession planning.
Appointing and reviewing the
performance of the ChairmanCEO.
Monitoring systems of
governance and compliance.
Overseeing systems of internal
control and risk management.
Determining
CA Sri Lanka
47
Rule
A.1.3 Act in accordance
with the laws of the
country and obtain
professional advice
as and when
required
48
Compliance
Status
JKH Action
The Board seeks independent

professional advice when deemed
nevessary.
During the year under review,
professional advice as a result of the
current and future economic, geopolitical shifts.
Impacts on JKH's business
operations as a result of the
current and future economic, geopolitical shifts.
Employee satisfaction survey and
participation in employee
compensation and benefits
surveys done to ensure that JKH
is "More than just a work place".
Legal, tax and accounting aspects,
particularly where independent
external advice was deemed
necessary in ensuring the
integrity of the subject decision.
Market surveys, architectural and
engineering advisory services as
necessary for business
operations.
Actuarial valuation of retirement
benefits and valuation of property
including that of investment
property.
Information technology
consultancy services pertaining to
version upgrades of the Groupwide enterprise resource
planning system.
Specific technical know-how and
domain knowledge required for
identified project feasibilities and
evaluations.
CA Sri Lanka
Rule
Compliance
Status
JKH Action
To ensure robust deliberation and

optimum decision making, the
Directors have access to the
services of the company secretaries
whose appointment and/or
removal is the responsibility of the
Board.
A.1.4 Access to advice and

services of the
Company Secretary
Source: John Keells Holdings Plc Annual Report 2013/2014
3 Sustainability and integrated reporting

Sustainability reports integrate environmental, social and economic data and
performance measures. Integrated reporting is concerned with reporting on the
value created by an organisations resources.
3.1 Sustainability reporting

Sustainability is the ability for something to last for a long time, or indefinitely.
Increasingly companies wish to make their operations sustainable and contribute
to sustainable development and a sustainable global economy ie one that
combines long term profits with ethical behaviour, environmental and social care.
3.1.1 A sustainability report
A sustainability report is a report published by a company about the economic,
environmental and social impacts caused by its everyday activities. The report
also presents the entitys values and governance model and demonstrates the link
between its strategy and its commitment to a sustainable global economy.
By producing a sustainability report, a company is better able to measure its
impacts, set goals and manage change. The production of this type of report
requires a company to set up a reporting cycle to collect data, communicate it and
respond to it. As a result, sustainability performance is monitored on an on-going
basis and management can use this knowledge to contribute to shaping the
companys strategy and policies.
CA Sri Lanka
49
3.1.2 The Global Reporting Initiative (GRI)

The Global Reporting Initiative is a leading organisation in the field of
sustainability. It promotes the use of sustainability reporting and has issued
guidelines that set out the framework of a sustainability report.
The GRI states that when a company considers sustainability it must consider four
key areas of performance and impact: economic, environmental, social and
governance.
3.1.3 The GRI Guidelines
The GRIs guidelines on sustainability reporting are the most widely used in the
world. The first guidelines were issued in 2000 and more recently the G4
guidelines were issued in May 2013. These guidelines set out the framework of a
sustainability report to include general standard disclosures and specific standard
disclosures:
General standard disclosures
50
Strategy and analysis
Includes a statement from the CEO on sustainability

and a description of the key impacts, risks and
opportunities.
Organisational profile
The organisation's structure including brands, location

of operations, geographical markets served and size of
operations.
Identified material
aspects and
boundaries
Details entities included in the financial statements but

not in the report and the parameters of the report
including materiality.
Stakeholder
engagement
A list of stakeholder groups, approaches to stakeholder

engagement and key topics and concerns raised
through stakeholder engagement.
Report profile
The reporting period and cycle and policy / practice as

regards seeking external assurance for the report.
Governance
Governance structure of the organisation, details of

governance processes.
Ethics and Integrity
Details of the organisations values, principles,

standards and norms of behaviour and the
mechanisms for seeking advice on unlawful/unethical
behaviour such as helplines.
CA Sri Lanka
Specific standard disclosures

Economic
Economic performance
Market presence
Indirect economic impacts
Procurement practices
Environmental
Materials
Energy
Water
Biodiversity
Emissions, effluents, and waste
Products and services
Compliance
Transport
Overall
Supplier environmental assessment
Environmental grievance mechanisms
Social: Labour
Practices and Decent
Work
Employment
Labour/management relations
Occupational health and safety
Training and education
Diversity and equal opportunity
Equal remuneration for men and women
Supplier assessment for labour practices
Labour practices grievance mechanisms
Social: Human Rights
Investment
Non-discrimination
Freedom of association and collective bargaining
Child labour
Forced or compulsory labour
Security practices
Indigenous rights
Assessment
Supplier human rights
Human Rights grievance mechanisms
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51
Social: Society
Local communities
Anti-corruption
Public policy
Anti-competitive behaviour
Compliance
Supplier assessment for impacts on society
Grievance mechanisms for impacts on society
Social: Product
Responsibility
Customer health and safety

Product and service labelling
Marketing communications
Customer privacy
Compliance
3.1.4 CASE STUDY: Sustainability report

BHP Billiton is a mining company with operations throughout the world. Its 2013
Sustainability Report complies with an earlier (but similar) version of the Global
Reporting Initiative Guidelines. To give an overview of the companys
sustainability performance, the report selects a number of non-financial targets
and measured its performance against them. They include the following:
TARGET
PERFORMANCE
Year on year improvement of total

recordable injury frequency (TRIF).
TRIF performance in FY2013 was a

2% improvement compared with
FY2012.
In addition to the use of personal

protective equipment which
safeguards our workforce, we will
reduce potential occupational
exposure to carcinogens and airborne
contaminants by 10%.
A 5.7% reduction in potential

employee exposures compared with
FY2012.
No significant environmental incidents No significant environmental incidents

resulting from our controlled
resulted from our controlled
operations.
operations.
We will maintain total greenhouse gas
emissions below FY2006 levels while
we continue to grow our business.
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FY2013 greenhouse gas emissions

were lower than the FY 2006 baseline.
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TARGET
PERFORMANCE
We will finance the conservation and

continuing management of areas of
high biodiversity and ecosystem value
that are of national or international
conservation significance.
Two projects of international

conservation significance were
established the Five Rivers
Conservation Project in Australia and
the Valdivian Coastal Reserve Project
in Chile.
No significant community incidents

resulting from our controlled
operations.
No significant community incidents

resulted from our controlled
operations.
1% of pre-tax profits invested in

community programs, including cash,
in-kind support and administration,
calculated on the average of the
previous three years pre-tax profit.
US$245.8 million invested in

community programs, including
US$106 million to the BHP Billiton
Foundation.
3.1.5 CA Sri Lankas Guidance

In its Code of Best Practice on Corporate Governance issued in 2014, CA Sri Lanka
promotes the use of sustainability reporting, which it describes as the practice of
recognising, measuring, disclosing and being accountable to internal and external
stakeholders for organisational performance towards the goals of sustainable
development in the context of the overall business activities and strategy of the
entity. It goes on to state that the following principles underlie the development
of a sustainable business environment and sustainability disclosure:
CA Sri Lanka
Economic sustainability
This principle recognises how organisations

take responsibility for the economic impacts of
their strategies, decisions and activities and
how this is integrated throughout the
organisation.
The environment
Environmental governance should take into

account the direct and indirect economic, social,
health and environmental implications of
decisions and activities.
Labour practice
This encompasses all policies and practices

relating to work performed by or on behalf of
an organisation.
53
Society
An entity should build a relationship with the

community and strive for sustainable
development including responsible public
policy participation, fair competition and
responsible community involvement.
Product responsibility
A company should manufacture quality

products and ensure that they are safe for
consumers and the environment.
Stakeholder identification,
engagement and effective
communication
Internal and external stakeholders should be

identified; communication should be proactive
and transparent. It should include reporting on
social, environmental and economic issues and
be relevant, material, comparable and focus on
substance over form.
Sustainable reporting and

disclosure
Should be formalised and take place regularly;

this is a Board responsibility and should link
sustainable issues more closely to strategy.
Sustainable reporting may be built on
guidelines such as the GRI guidelines (see
above).
3.2 Integrated reporting

Integrated reporting is a further development in non-financial reporting beyond
environmental/social and sustainability reporting. Essentially it
links
sustainability to a companys strategy and the creation of value on the basis that a
business cannot develop an effective sustainable strategy unless it clearly
understands and records the relationship between strategy, governance and
financial performance and the social, environmental and economic context within
which it operates.
An integrated report can therefore be described as
a concise communication about how an organisations strategy, governance,
performance and prospects, in the context of its external environment, lead to the
creation of value in the short, medium and long term
(www.theiirc.org)
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CA Sri Lanka
3.2.1 The International Integrated Reporting Council (IIRC)

The IIRC was formed in 2010 and aims to create a globally accepted framework
for a process that results in corporate communication about value creation over
time.
In 2013, the International Integrated Reporting Council introduced the integrated
reporting framework (<IR> Framework). The framework refers to an
organisations resources as 'capitals'. Capitals are used to assess value creation.
Increases or decreases in these capitals indicate the level of value created or lost
over a period. Capitals cover various types of resources found in a standard
organisation. These may include financial capitals, such as the entity's financial
reserves through to its intellectual capital which is concerned with intellectual
property and staff knowledge.
3.2.2 Types of capital
The integrated reporting framework classifies the capitals as:
Capital
Comment
Financial capital
The pool of funds that is:

Available to an organisation for use in the production of
goods or the provision of services
Obtained through financing, such as debt, equity or
grants, or generated through operations or investments
Manufactured
capital
Manufactured physical objects (as distinct from natural

physical objects) that are available to an organisation for
use in the production of goods or the provision of services,
including:
Buildings
Equipment
Infrastructure (such as roads, ports, bridges and waste and
water treatment plants)
Manufactured capital is often created by other
organisations, but includes assets manufactured by the
reporting organisation for sale or when they are retained for
its own use.
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Capital
Comment
Intellectual capital
Organisational knowledge-based intangibles, including:

Intellectual property, such as patents, copyrights,
software, rights and licences
'Organisational capital' such as tacit knowledge, systems,
procedures and protocols
Human capital
People's competencies, capabilities and experience, and

their motivations to innovate, including their:
Alignment with and support for an organisation's
governance framework, risk management approach and
ethical values
Ability to understand, develop and implement an
organisation's strategy
Loyalties and motivations for improving processes,
goods and services, including their ability to lead,
manage and collaborate
Natural
Input to goods and services and what activities impact:

Water, land, minerals and forests
Biodiversity and eco-system health
Social and
relationship capital
The institutions and the relationships within and between

communities, groups of stakeholders and other networks,
and the ability to share information to enhance individual
and collective well-being.
Social and relationship capital includes:
Shared norms and common values and behaviours
Key stakeholder relationships and the trust and
willingness to engage that an organisation developed and
strives to build and protect with external stakeholders
Intangibles associated with the brand and reputation
that an organisation has developed
An organisations social licence to operate
Source: The International Integrated Reporting Framework, www.theiirc.org

3.2.3 Interaction of capitals
Capitals continually interact with one another, an increase in one can result in a
decrease another. For example, a decision to purchase a new IT system would
56
CA Sri Lanka
improve an entity's 'manufactured' capital while decreasing its financial capital in

the form of its cash reserves.
At present adopting integrated reporting is voluntary, as a result organisations are
free to report only on those 'capitals' felt to be most relevant in communicating
performance.
3.2.4 Short term versus long term
Integrated reporting forces management to balance the organisation's short term
objectives against its longer term plans. Business decisions which are solely
dedicated to the pursuit of increasing profit (financial capital) at the expense of
building good relations with key stakeholders such as customers (social capital)
are likely to hinder value creation in the longer term. It is thought that by
producing a holistic view of organisational performance that this will lead to
improved management decision making, ensuring that decisions are not taken in
isolation.
3.2.5 Monetary values
Integrated reporting is not aimed at attaching a monetary value to every aspect of
the organisation's operations. It is fundamentally concerned with evaluating value
creation through the communication of qualitative and quantitative performance
measures. Key performance indicators are effective in communicating
performance.
For example when providing detail on customer satisfaction this can be
communicated as the number of customers retained compared to the previous
year. Best practice in integrated reporting requires organisations to report on
both positive and negative movements in 'capital' to avoid only providing half the
story.
3.2.6 Materiality
When preparing an integrated report management should disclose matters which
are likely to impact on an organisations ability to create value. The inclusion of
both internal and external threats regarded as being materially important is
evaluated and quantified. This provides users with an indication of how
management intend to combat risks should they materialise.
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3.2.7 Guiding principles

The second part of the <IR> Framework discusses the guiding principles that
underlie the preparation and presentation of an integrated report and the content
elements of such a report.
The guiding principles are:
Strategic focus and future orientation: An integrated report should provide
insight into the organisations strategy and how it relates to the organisations
ability to create value in the short, medium and long term and to its use of and
effects on the capitals.
Connectivity of information: An integrated report should show an holistic
picture of the combination, interrelatedness and dependencies between the
factors that affect the organisations ability to create value over time.
Stakeholder relationships: An integrated report should provide insight into
the nature and quality of the organisations relationships with its key
stakeholders, including how and to what extent the organisation understands,
takes into account and responds to their legitimate needs and interests.
Materiality: An integrated report should disclose information about matters
that substantively affect the organisations ability to create value over the short,
medium and long term.
Conciseness: An integrated report should be concise.
Reliability and completeness: An integrated report should include all
material matters, both positive and negative, in a balanced way and without
material error.
Consistency and comparability: The information in an integrated report
should be presented:
on a basis that is consistent over time
in a way that enables comparison with other organisations to the
extent it is material to the organisations own ability to create value
over time.
An integrated report must include the following eight key content elements:
58
1.
Organisational overview and external environment the report should

explain what the organisation does and the circumstances under which it
operates.
2.
Governance the report should explain how the organisations governance

structure supports its ability to create value in the short, medium and long
term.
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3.
Business model the organisations business model should be explained.
4.
Risks and opportunities specific risks to the organisations ability to

create value should be identified and an explanation of the organisations
risk management approach should be provided.
5.
Strategy and resource allocation an explanation should be provided of

the organisation's strategy and how it intends to achieve its strategic
objectives.
6.
Performance the report should explain to what extent the organisation

has achieved its strategic objectives for the period and what its outcomes are
in terms of effects on the capitals.
7.
Outlook - the report should identify the challenges and uncertainties that
the organisation is likely to encounter in pursuing its strategy; it should
explain the potential implications for the business model and future
performance.
8.
Basis of preparation and presentation within the report an entity should

explain how it determines what matters to include in the report and how
these matters are quantified or evaluated.
3.2.8 Implications of the introduction of integrated reporting

Implications
Comment
IT costs
The introduction of integrated reporting will most likely

require significant upgrades to be made to the
organisation's IT and information system infrastructure.
Such developments will be needed to capture KPI data.
Due to the broad range of business activities reported on
using integrated reporting (customer, supplier relations,
finance and human resources) it is highly likely the costs
of improving the infrastructure will be significant.
Time/ staff costs
The process of gathering and collating the data for

inclusion in the report is likely to require a significant
amount of staff time. This may serve to decrease staff
morale if they are expected to undertake this work in
addition to existing duties.
This may require additional staff to be employed.
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59
Implications
Comment
Consultancy costs
Organisations producing their first integrated report may

seek external guidance from an organisation which
provides specialist consultancy on integrated reporting.
Consultancy fees are likely to be significant.
Disclosure
There is a danger that organisations may volunteer more

information about their operational performance than
intended. Disclosure of planned strategies and key
performance measures are likely to be picked up by
competitors.
3.2.9 CASE STUDY: Integrated report

John Keells Holdings PLC is the largest company listed on the Colombo Stock
Exchange. Its 2012/2013 Annual Report was its second integrated report, and it
introduced the report as follows:
This 2012/2013 Annual Report is a reflection of the integrated approach of
management, encompassing a Triple Bottom Line performance for the period 1st
April 2012 to 31st March 2013. This Report is the Groups second integrated
Annual Report, covering not only the financials, but also the economic,
environmental and social performance, as well as the overall corporate
governance framework, the risk management process, the risks and opportunities
identified by the company and an overview of the Groups strategic direction.
The first 178 pages of the report are given to integrated narrative reports,
including reports on:
Governance
Sustainability integration including sustainability reporting highlights,

sustainability policy and framework and the sustainability agenda.
Risk management
Management discussion and analysis including triple bottom line

discussion and analysis focussing on investors, people, environment, ethics,
products and community.
The report is too big to reproduce in this study text, however you can access it
online at http://www.keells.com/annual-reports.html.
The IIRC maintains a database of emerging practice in integrated reporting; in that
database it singles out the John Keells Holdings PLC 2012/2013 Annual Report
review of stakeholder engagement as demonstrating the IR Guiding Principles of
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CA Sri Lanka
Stakeholder relationships, Materiality and Conciseness. An extract from the John

Keells Holdings PLC Annual Report is reproduced below together with
commentary from the IIRC:
Sustainability Integration
The John Keells Holdings PLC Annual Report: Stakeholder Engagement Process
The John Keells Group carries out its stakeholder engagement by first identifying
the perceived issues faced by the stakeholders of the Group and its operating
companies.
These issues are subsequently validated and any further issues are identified
through an independent stakeholder engagement process carried out in
accordance with the AA 1000 Stakeholder Engagement Standard. The Group
carries out its stakeholder engagement process for its internal and external
stakeholders separately, with the staffs concerns being assessed through a Voice
of Employee (VOE) Survey on a randomly selected sample of employees through
an e-platform, with survey results being shared with all employees.
Engagement of Significant Stakeholders
The Groups significant stakeholders are customers, employees, communities,
investors, governments, legal and regulatory bodies, business partners, suppliers
or principals, society, pressure groups and media, and industry peers or
competitors who have the ability to influence its outcomes or to be substantially
impacted by the Companys operations.
Engagement with stakeholders encompasses a range of activities and interactions
that include formal and informal consultations, participation, negotiations,
communication, mandatory and voluntary disclosures, certification, and
accreditation. The mode and frequency used for each stakeholder group is as
follows.
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61
Customers Individual & Corporate B2B

Method of engagement:
Personal meetings, discussion forums, surveys, field visits, conference calls,
progress reviews, information dissemination through printed reports,
telephone, SMS and corporate websites, workshops, business development
activities, road shows and trade fairs
Frequency of engagement:
Quarterly through Customer Satisfaction Surveys
On-going basis through information dissemination through printed reports,
telephone, SMS, e-mail and corporate website
Bi-annually through personal meetings
Annually through road shows and trade fairs
Employees Directors, Executives, Non-Executives

Direct reporting, intranet communication, employee satisfaction surveys,
collective bargaining, open door policy at all management levels, annual
events, professional training and development activities, team building
activities
Intranet communications through JK Connect and My Portal on a daily basis
Bi-annual performance review and skip level meetings
Employee satisfaction surveys and dip stick surveys, such as VOE (Voice Of
Employee) conducted annually
Professional training, development activities and team building through
internal as well as external sources conducted at least annually
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CA Sri Lanka
Community Neighbours, Community, Community Leaders

Corporate Social Responsibility programmes and activities, community
educational and information dissemination programmes, one-to-one
meetings, workshops, forums
Engagement with the community is carried out prior to entry into the
community area
Engagement is then carried out on a monthly basis while operating
Community engagement is also carried out on exit
Investors Institutional, Fund Managers/Analysts, Lenders, Multilateral

Lenders
Periodic disclosures through annual reviews and quarterly reports, one-toone meetings, investor road shows, phone calls and corporate websites
Annual disclosures
Quarterly reports
Regular Investor road shows
On-going through phone calls, e-mail, written communication and websites
Government, Government Institutions and Departments

Meetings, discussions, newsletters and circulars, presentations and briefings,
advisory meetings, membership on national committees, lobbying activities
via chambers of commerce
Engagement with the Government is carried out on an on-going basis
through meetings, business forums, newsletters and circulars. The senior
management are members of bodies such as the Chamber of Commerce who
meet on a monthly basis
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63
Legal & Regulatory Bodies

Regular meetings, periodic disclosures, correspondence, representation
through chambers of commerce and trade associations with bodies such as
local authorities, municipal councils and other institutions such as the
Consumer Affairs Authority, Department of Inland Revenue, Customs
Department, Securities & Exchange Commission, Colombo Stock Exchange
and Tourist Board of Sri Lanka
Engagement with the legal and regulatory bodies is carried out on an ongoing basis as the senior management are members of chambers and
industry associations that meet at least on a quarterly basis
Business Partners, Principals and Suppliers
Regular meetings, distributor conferences, correspondence, monthly market
reports, engagement as part of the transparent and well established sourcing
mechanism for all high value items sourced by Group, conference calls and emails, circulars, membership in industry associations
Regular market reports at minimum on a monthly basis

Annually through distributor conferences
Annually through contract renegotiations
On-going through conference calls, e-mails and circulars
Commentary from the IIRC:

IR Guiding Principles this extract demonstrates:
Stakeholder relationships
Materiality
Conciseness
Key observations:
John Keells presents a thorough review of stakeholder engagement and material
issues as a component of demonstrating how the capitals are integrated into the
business.
64
CA Sri Lanka
Initially, John Keells outlines the engagement process which the business
undertakes to determine the material issues of the business as determined by the
companys stakeholders, which is followed by an explanation of who the business
considers to be their key stakeholders. Interestingly, for each of these key
stakeholder groups, John Keells outlines the methods of engagement and the
frequency of engagement which provides the reader with an understanding of the
scope and scale of activities which the business undertakes to ensure the business
is engaged with key stakeholders.
This section of the Report is concluded by summarising the key concerns
identified from the engagement process. Through a graphic representation, the
Groups stakeholder concerns are mapped demonstrating the impact each issue
has on the company against the impact it has on key stakeholders by four main
categories social, economic, labour and environment. This presentation provides
the reader with a good sense of how the stakeholder and company concerns
compare.
Finally, these material issues are mapped to the performance indicators of the
business, demonstrating the link between the material issues and the strategic
progress of the business.
QUESTION
Explain the benefits of the adoption of integrated reporting in Sri Lanka.
ANSWER
Integrated reporting has a number of benefits for reporting organisations, for
stakeholders in those organisations and for Sri Lanka as a capital market.
As far as reporting organisations are concerned, the benefits of integrated
reporting include the following:
Lower operational and strategic risk
New business opportunities and increased sales
Improved decision making
Greater customer loyalty
Better stakeholder relations
Improved access to capital at a lower cost as a result of increased confidence in
the organisation
Improved reputation and a stronger brand
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65
Reduced regulatory intervention

Alliances with new business partners.
Stakeholders in Sri Lankan companies that adopt integrated reporting will benefit
as they will receive more relevant and complete information that allows them to
make better quality decisions.
Sri Lanka as a capital market will benefit in the following ways:
Greater availability of more transparent information, meaning improved capital
market efficiency.
Business opportunities for Sri Lankan service organisations. As integrated
reporting expands, these organisations will develop a knowledge and
understanding of it and can later penetrate other markets as those markets
develop this type of reporting.
QUESTION
The financial controller of Lankasport, a Colombo-based based manufacturer and
retailer of sporting goods, prepares quarterly accounts for the Finance Director. At
the end of the first quarter of 20X4 the financial controller identified that net
assets were below the level required by a bank covenant and alerted the Finance
Director to this. The following week the financial controller identified that
amended quarterly accounts had been sent to the bank, in which the inventory
figure had been increased.
The same issue arose at the end of the second quarter of 20X4, and again the
financial controller noted that the accounts sent to the bank included a different
inventory figure from those that he had prepared the previous week.
The financial controller is sure that cut-off procedures and valuation were
correctly adhered to and so has asked the Finance Director to explain the
adjustments.
Her response was as follows:
The adjustment is just for some goods held at one of our customers retail
premises we missed it out from the stock count. Dont worry Ive got it all in
hand!
The financial controller has reviewed the contract with the customer in question
and notes that it clearly states that the customer will be supplied with goods as
ordered and has no right of return in the case of unsold goods. He also notes that
Lankasport has sold goods to this customer for a number of years on the same
terms, and no adjustment has ever been made before.
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CA Sri Lanka
Both the financial controller and finance director are chartered accountants.
Required
Explain why the inventory adjustment suggests an ethical issue.
ANSWER
In accordance with LKAS 18, goods held at a customer's premises remain the
inventory of the selling entity if the risks and rewards of ownership have not
transferred to the customer.
In this case, the customer has no right of return of unsold goods. This would
suggest that the risks and rewards of ownership have transferred to the customer
and that Lankasport should have recognised a sale when the goods were delivered
to the customer.
The fact that no such adjustment has taken place previously, even though sales
have taken place on the same terms would appear to support this assertion.
If this is the case, the finance director is incorrect to increase closing inventory by
the goods held at the customer's premises.
It would appear that the finance director might be trying to manipulate the net
assets figure in order to meet bank covenants.
If these were breached, the bank could take action and Lankasport's funding
package could be withdrawn and the company could be put out of business.
In this case shareholders, employees and the public would all be affected. The fact
that the finance director may be trying to protect these parties does not, however,
make her actions acceptable.
Adjustment to the closing inventory figure will also result in an overstated profit
figure as cost of sales is reduced by the adjustment.
If Lankasport gives its employees profit related bonuses, this may also result in a
personal gain being made by the finance director.
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67
CHAPTER ROUNDUP
68
Non-financial reporting refers to narrative reports presented within or

alongside the annual report. These may include a directors report, management
commentary, corporate governance reports and sustainability reports.
Corporate governance involves a set of relationships between a companys

management, its board, its shareholders and other stakeholders.
Sustainability reports include environmental, social and economic data and

performance measures.
Integrated reporting is concerned with reporting on the value created by an

organisations resources.
Resources are referred to as capitals; value is created or lost when capitals

interact with one another.
Integrated reporting leads to an holistic view when assessing organisational

performance.
CA Sri Lanka
PROGRESS TEST
What is corporate governance?
What four key areas of performance and impact does a sustainability report deal
with?
What guidance provides the framework for a sustainability report?
What is an integrated report?
What are the guiding principles of the <IR> Framework?
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70
The system by which companies and other entities are directed and controlled
Economic, environmental, social and governance
The GRI G4 guidelines.
A concise communication about how an organisations strategy, governance,

performance and prospects, in the context of its external environment, lead to the
creation of value in the short, medium and long term
Strategic focus and future orientation, connectivity of information, stakeholder

relationships, materiality, conciseness, reliability and completeness and
consistency and comparability.
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises the LKAS 1 presentation requirements in respect
of financial statements, the LKAS 8 requirements for the selection of
accounting policies and LKAS 21 requirements for accounting for
transactions denominated in a foreign currency. It also expands on the
topic of interim reports that was introduced at KB1.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

Recommend the appropriate accounting treatment to be used in
complicated circumstances in accordance with Sri Lanka Accounting
Standards.
Evaluate the outcomes of the application of different accounting
treatments.
circumstances.
Evaluate the impact of the use of different expert inputs to financial
reporting.
Advise appropriate application and selection of accounting/reporting
options given under standards.
Design the appropriate disclosures to be made in the financial
statements.
71
KC1 | Chapter 3: Presentation of financial statements
CHAPTER CONTENTS
1 LKAS 1 Presentation of Financial Statements
2 LKAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors
3 LKAS 21 The Effects of Changes in Foreign Exchange Rates
4 LKAS 34 Interim Financial Reporting
LKAS 1 Learning objectives

Criticise general features of financial statements.
Compile complete set of financial statements in compliance with the standard.
Advise on appropriate classification of current & non-current assets/ liabilities.
Recommend the items to be recognised in Profit or Loss and other
comprehensive income items.
Assess the appropriateness of going concern assumption in preparation of
financial statements.
Recommend on minimum and additional comparative information to be
disclosed.
Advise on consistency of presentation requirements.
Recommend the appropriate accounting policies to be selected in given
circumstances.
Advise impact of change in accounting policies and change in accounting
estimates.
Design appropriate disclosures to be made in respect of change in accounting
policies, estimates and errors.
Outline and apply the translation of foreign currency amounts and transactions
into the functional currency and the presentation currency.
Advise when to prepare interim financial statements.
Recommend the minimum components and form and content of interim
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CA Sri Lanka
Recommend periods for which interim financial periods are required to be

presented.
Advise how to decide materiality for interim financial statements.
Advise how to consider seasonal revenue, costs incurred unevenly and
accounting estimates in preparing interim financial statements.
Recommend how to restate previously reported interim periods.
1 LKAS 1 Presentation of Financial Statements

LKAS 1 contains general requirements for the presentation of financial
statements together with suggested formats and disclosure requirements.
This section of the chapter summarises the requirements of LKAS 1 Presentation
of Financial Statements. It was covered in detail at KE1 and KB1 and you should go
back to your previous notes for further detail.
1.1 General requirements

A complete set of financial statements includes a statement of financial
position, a statement of profit or loss and other comprehensive income (as one
or two statements), a statement of changes in equity, a statement of cash flows
and notes to the accounts.
Comparative information should be provided for all amounts in the financial
statements and notes.
Comparative information for narrative and descriptive information should also
be provided if it is relevant to understanding the current periods financial
statements.
Additional comparative information may also be provided as long as it is
prepared in accordance with SLFRS. Where a particular statement is provided
for an additional comparative period, the related notes should also be provided
for that additional comparative period. A full set of financial statements is not
required for an additional comparative period.
A third statement of financial position at the start of the comparative period is
presented when retrospective adjustment has been made.
Financial statements must present a true and fair view of financial position,
performance and cash flows; compliance with SLFRS is presumed to achieve
fair presentation.
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73
If compliance with an SLFRS conflicts with the objective of financial statements

in the Conceptual Framework an entity may depart from that specific
requirement; departure must be disclosed.
Financial statements are prepared on a going concern basis unless management
intends to liquidate an entity or has no realistic alternative but to do so; if
material uncertainties exist with regard to going concern, these should be
disclosed.
Financial statements other than the statement of cash flows are prepared on
the accrual basis.
Each material class of similar items must be presented separately; if a line item
is not individually material it is aggregated with other items.
Assets and liabilities and income and expenses are not offset unless required or
permitted by another SLFRS.
A complete set of financial statements should be presented at least annually.
Presentation and classification of items should be consistent from one period to
another unless change is required by a new SLFRS or would be appropriate
after a change in an entitys operations.
QUESTION
Going concern
Pretoran Ltd manufactures components for electrical devices. You work for the
companys audit firm and have recently received the following email from the
Financial Controller of The Pretoran Group:
To:
Preena Da Silva
From:
James Perera
Subject:
Problem subsidiary
Dear Preena,
I hope that you are well. I am currently preparing the statutory accounts for the
2014 year-end for some of the Groups subsidiaries and Im a little worried that
one of them may not be trading for very much longer. The company produces a
single high tech component, but is being sued for copyright violation by a much
bigger player in the market. Theres a chance that our subsidiary will lose the case.
What should I do about the preparation of the statutory accounts for the
subsidiary?
I look forward to hearing from you,
James
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CA Sri Lanka
(a)
(b)
Advise the Financial Controller of Pretoran Ltd.

Identify factors that may indicate that a company is not a going concern.
ANSWER
(a)
The subsidiary makes a single component and is being sued by a larger

competitor for copyright violation.
If the subsidiary loses the case it is probable that it will go out of business as
it will no longer have a product. The management must therefore assess the
situation in order to assess the likelihood of losing the case.
If the subsidiary is expected to lose the case then the financial statements
should not be prepared on the going concern basis. Instead a break-up basis
should be used. This is not described by LKAS 1 but will result in a different
presentation and measurement of items in the financial statements. LKAS 1
does require that disclosure is made of the fact that the financial statements
are not prepared on a going concern basis and the basis on which they are
prepared. The reason why the entity is not a going concern should also be
disclosed.
If the subsidiary is expected to win the case then the financial statements
should be prepared on the going concern basis, however disclosure should
be made of the material uncertainties that cast doubt on the companys
ability to continue as a going concern.
(b)
In assessing going concern, management should take into account all

available information including that about the future (at least 12 months
beyond the reporting date). The following factors may indicate that a
company is not a going concern:
Low levels of current and expected profitability
Negative operating cash flows (historic or budgeted)
Adverse key financial ratios
Inability to pay dividends
Expected inability to meet debt repayment schedules
A growth in levels of competition
A decline for demand for products / failure to reinvest in new products
An inability to agree suitable financing with the bank / withdrawal of
financial support from bank
Financing long-term assets through short-term finance such as an
overdraft
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Withdrawal of supplier credit

Pending legal or regulatory proceedings against the entity.
1.2 Statement of financial position

A suggested format is:
ABC CO
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X2
20X2
20X1
Rs'000 Rs'000 Rs'000 Rs'000
Assets
Non-current assets:
X
X
Goodwill
X
X
Other intangible assets
X
X
X
X
Current assets:
X
X
Inventories
X
X
Trade receivables
X
X
Other current assets
X
X
Cash and cash equivalents
X
X
X
X
Total assets
Equity and liabilities
Equity:
X
X
Stated capital
X
X
Retained earnings
Other components of equity
X
X
X
X
Non-current liabilities:
X
X
Long-term borrowings
X
X
Long-term provisions
X
X
Current liabilities:
X
X
Trade and other payables
X
X
Short-term borrowings
X
X
Current portion of long-term
borrowings
X
X
Current tax payable
X
X
Short-term provisions
X
X
X
X
Total equity and liabilities
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CA Sri Lanka
LKAS 1 requires that certain line items are disclosed as a minimum. These are
detailed in your KB1 study text.
Current and non-current assets and liabilities should be presented separately in
the statement of financial position other than where a presentation based on
liquidity provides more relevant and reliable information.
QUESTION
Current and non-current distinction
The following are assets and liabilities of a boat and ship building company at
31 December 20X4:
(a)
Specialist steel that is used in the construction of warships. The steel is left
over from a recently completed order; it is unlikely to be used within
12 months as the company has no current orders for warships.
(b)
Two completed small fishing boats that are available for sale to the general
public.
(c)
An amount of Rs. 6 million due from a customer that has contracted the
company to build a tugboat. Rs. 3.7 million of the Rs. 6 million has been
billed to the customer.
(d)
A part complete tourist boat that the company intends to offer for sale to
local river cruise companies when complete. The boat is likely to take
14 months to complete.
(e)
The company has an outstanding bank loan of Rs. 60 million. The maturity
date attached to the loan was 20Y0, however the company has breached a
covenant during 20X4 making it repayable on demand. The bank has stated
that it will not demand repayment.
Required
Explain how these assets should be presented in the statement of financial
position of the boat and shipbuilding company at 31 December 20X4.
ANSWER
CA Sri Lanka
(a)
The specialist steel is raw material inventory. It will be used within the
normal operating cycle of the company and therefore it is classified as a
current asset. As there are currently no orders for warships the company
should assess whether the inventory might be impaired.
(b)
The completed fishing boats are finished goods inventory. They are held for
the purpose of being traded and are expected to be sold in the normal
operating cycle of the company. Therefore they are classified as current
assets even if a sale is not expected within 12 months.
77
(c)
The amount due from a customer forms part of trade and other receivables.
It is expected to be realised in the normal operating cycle of the company
and is therefore classified as current. It is irrelevant to classification and
recognition that part of the Rs. 6 Mn has been billed and part has not. These
parts are, however separately disclosed as a trade receivable (the billed
element) and an amount due from customers in respect of construction
contracts in accordance with LKAS 11 (the unbilled element).
(d)
The part complete boat is work-in-progress inventory. Even though it will

take 14 months to complete, and possibly even longer to sell, it is classified
as a current asset. This is because the inventory is subject to a sale in the
ordinary course of business.
(e)
The loan is repayable on demand and is therefore classified as current; this is

regardless of the banks statement that it will not demand repayment.
1.3 Statement of profit or loss and other comprehensive income

A suggested format is:
ABC CO
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOMEFOR
THE YEAR ENDED 31 DECEMBER 20X2
20X2
20X1
Rs'000
Rs'000
X
X
Revenue
(X)
(X)
Cost of sales
X
X
Gross profit
X
X
Other income
(X)
(X)
Distribution costs
(X)
(X)
Administrative expenses
(X)
(X)
Other expenses
(X)
(X)
Finance cost
X
X
Share of profit of associates
X
X
Profit before tax
(X)
(X)
Income tax expense
X
X
Profit for the year
Other comprehensive income:
Items that will not be reclassified to profit or loss:
X
X
Gains on property revaluation
Remeasurements of defined benefit pension plans
(X)
X
Share of gain on property revaluation of associates
X
Income tax relating to items that will not be

(X)
(X)
reclassified
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CA Sri Lanka
Items that may be reclassified to profit or loss

Exchange differences on translating foreign
operations
Available-for-sale financial assets
Cash flow hedges
Income tax relating to items that may be reclassified
Total comprehensive income for the year
(X)
X
(X)
(X)
X
X
X
(X)
X
X
X
The format provided:

(i)
Illustrates the one statement approach. LKAS 1 allows a two statement

approach to be taken whereby a statement of profit or loss is provided
alongside a statement in which profit is presented and other
comprehensive income is detailed.
(ii)
Illustrates the classification of expenses by function.

expenses to be classified by nature rather than function.
LKAS 1 allows
LKAS 1 requires that certain line items are disclosed as a minimum. These are
detailed in your KB1 study text.
Other comprehensive income comprises income and expense items that are not
recognised in profit or loss. It includes reclassification adjustments where an
item is reclassified to profit or loss.
Other comprehensive income:
Must be classified according to whether it will not or may be reclassified to
profit or loss.
May be stated net of related tax effects or before related tax effects with one
aggregate tax amount disclosed.
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79
1.4 Statement of changes in equity

The statement of changes in equity shows movements in an entitys equity for the
period. A suggested format is:
ABC CO
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 DECEMBER 20X2
Balance at 1.1.X2
Changes in accounting policy
Restated balance
Changes in equity for 20X2
Issue of shares
Dividends
Total comprehensive income
or the year
Issue of stated capital
Balance at 31.12.X2
NonStated Revaluation Retained controlling

capital
surplus earnings interest Total
X
X
X
X
X
(X)
(X)
X
X
X
X
X
X
(X)
X
(X)
X
X
(X)
X
X
X
X
X
Dividends paid during the year are not shown on the statement of profit or loss;
they are shown in the statement of changes in equity.
Total comprehensive income attributable to owners of the parent and the noncontrolling interest are disclosed separately.
The effects of retrospective application or retrospective restatement (LKAS 8)
are disclosed for each component of equity.
For each component of equity, a reconciliation is disclosed between the
carrying amount at the beginning and the end of the period, separately
disclosing changes resulting from:
(i)
profit or loss;
(ii)
other comprehensive income; and
(iii) transactions with owners in their capacity as owners, showing separately

contributions by and distributions to owners, and changes in ownership
interests in subsidiaries that do not result in a loss of control.
1.4.1 IFRIC 17 Distributions of Non-cash Assets to Owners
Dividends are recognised in the statement of changes in equity, as discussed
above. When dividends are not payable in cash. IFRIC 17 applies. It states that:
80
CA Sri Lanka
A dividend payable is recognised only when the dividend is authorised and no

longer at the discretion of the management.
The dividend is measured at the fair value of the net assets to be distributed.
The liability is remeasured at each reporting date and settlement, with changes
recognised directly in equity.
The difference between the dividend paid and the carrying amount of the net
assets distributed is recognised in profit or loss and disclosed separately.
Additional disclosures are required if the net assets held for distribution meet
the definition of a discontinued operation.
Note that IFRIC 17 applies only when all shareholders of the same class of equity
instruments are treated in the same way.
2 LKAS 8 Accounting Policies, Changes in Accounting

Estimates and Errors
LKAS 8 requires that a change in accounting policy or correction of error is dealt
with retrospectively so that the financial statements appear as if the new policy
had always been in place or the error had never occurred; a change in
accounting estimate is dealt with prospectively.
2.1 Accounting policies

Accounting policies are the specific principles, bases, conventions, rules and
practices adopted by an entity in preparing and presenting financial statements.
An accounting policy is selected based on the relevant SLFRS.
In the absence of an SLFRS management should use judgement and consider:
SLFRS and interpretations dealing with similar issues
The Conceptual Framework
Pronouncements of other standards setters.
Policies must be selected consistently for similar transactions / items.
An accounting policy is only changed where required by an SLFRS or for more
relevant and reliable presentation.
Transitional provisions of a new standard detail the required treatment for the
change in policy.
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81
Otherwise a change in policy is applied retrospectively (with the exception of a

change between LKAS 16 measurement models).
Disclosure must be made where a change in accounting policy has a material
effect on any period presented in the financial statements or may have a
material effect in subsequent periods.
Retrospective application is applying a new accounting policy to transactions,
other events and conditions as if that policy had always been applied.
QUESTION
Change in accounting policy
AB Trading Ltd acquired a small office block on 1 January 20X4 for Rs. 35 Mn
which it immediately leased to tenants. The company has no other investment
properties and applied the cost model to the office block, depreciating it over 50
years. At 31 December 20X6, the directors of AB Trading decided that the LKAS 40
fair value model should be applied to the property and this would result in more
relevant and reliable information in the financial statements.
Fair values of the office block were:
31 December 20X4
31 December 20X5
31 December 20X6
Rs. 36.3 million

Rs. 37.5 million
Rs. 37.9 million
Information from the companys draft accounts was as follows:

31 December 20X6
31 December 20X5
Rs'000
Rs'000
Net profit for the year
65,500
53,000
Opening retained
242,000
189,000
earnings
Required
82
(a)
Provide extracts from the statement of financial position, statement of profit

or loss and other comprehensive income and statement of changes in equity
for the year ended 31 December 20X6 together with 20X5 comparatives.
(b)
Draft the required disclosure note in respect of the change in accounting

policy.
CA Sri Lanka
ANSWER
Extracts from the statement of financial position at
31 December
20X6
Rs'000
Investment property
37,900
31 December
20X5
Rs'000
37,500
Extracts from the statement of profit or loss and other comprehensive income for
the year ended
31 December
31 December
20X6
20X5
Rs'000
Rs'000
Gain on re-measurement of investment
400
1,200
property
Extracts from the statement of changes in equity
Retained earnings
Rs'000
189,000
2,000
191,000
54,900
245,900
65,900
311,800
At 1.1.X5
Prior period adjustment (W2)
As restated
Profit for year ended 31.12.X5 (restated W1)
At 31.12.X5
Profit for year ended 31.12.X6 (W1)
At 31.12.X6
W1 Adjustments to draft profit
Year ended
Draft profit for the year

Investment property (W2)
Revised profit
31 December
20X6
Rs'000
65,500
400
65,900
31 December
20X5
Rs'000
53,000
1,900
54,900
W2 Investment property
1.1.X4
Profit or loss y/e 31.12.X4
31.12.X4
31.12.X5
31.12.X6
CA Sri Lanka
Cost model
Rs'000
35,000
(700)
34,300
(700)
33,600
Depreciation not
yet accounted for
Fair value model

Rs'000
35,000
1,300
36,300
1,200
37,500
400
Adjustment
Rs'000
2,000
1,900
400
37,900
83
(b)
Disclosure change in accounting policy note

At 31 December 20X6 the Directors of AB Trading Ltd elected to adopt the
LKAS 40 fair value model. The cost model was used until this date, however
the fair value model is believed to result in more reliable and relevant
information.
Comparative information has been restated in order to apply the new
accounting policy retrospectively. The change in accounting policy has resulted
in an increase of Rs. 1.9 million to profit in the year ended 31 December 20X5
and an increase of Rs. 2 million in prior years. The Rs. 2 million increase in
respect of prior years is reported as a prior period adjustment in the statement
of changes in equity.
2.2 Accounting estimates

An accounting estimate is an area where judgement is required in order to
apply an accounting policy.
A change in accounting estimate is an adjustment of the carrying amount of an
asset or a liability or the amount of the periodic consumption of an asset, that
results from the assessment of the present status of, and expected future benefits
and obligations associated with, assets and liabilities. Changes in accounting
estimates result from new information or new developments and, accordingly, are
not corrections of errors.
A change in accounting estimate is applied prospectively.
The effect of a change is included in the same expense classification as was used
for the previous estimate.
Prospective application of a change in accounting policy and of recognising the
effect of a change in an accounting estimate, respectively, are:
Applying the new accounting policy to transactions, other events and
conditions occurring after the date as at which the policy is changed; and
Recognising the effect of the change in the accounting estimate in the current
and future periods affected by the change.
Disclosure should be made of the nature and amount of a change in an
accounting estimate that has a material effect. If it is not possible to quantify
the amount this fact should be disclosed.
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CA Sri Lanka
2.3 Errors
Prior period errors are omissions from, and misstatements in the financial
statements for one or more prior periods arising from a failure to use, or a misuse
of, reliable information that:
Was available when financial statements for those periods were authorised for
issue, and
Could reasonably be expected to have been obtained and taken into account in
the preparation and presentation of those financial statements.
Such errors include the effects of mathematical mistakes, mistakes in applying
accounting policies, oversights or misinterpretations of facts, and fraud.
Errors arising in the current period are dealt with through profit or loss.
Material prior period errors are corrected retrospectively by restating
comparative amounts and where relevant restating opening balances of the
earliest period presented.
Retrospective restatement is correcting the recognition, measurement and
disclosure of amounts of elements of financial statements as if a prior period error
had never occurred.
Disclosure is made of:
The nature of the error
For each prior period, to the extent practicable, the amount of the correction.
(i)
(ii)
For each financial statement line item affected

If LKAS 33 applies, for basic and diluted earnings per share
The amount of the correction at the beginning of the earliest prior
period presented.
2.4 Impracticability
Retrospective adjustment is required in respect of both a change in accounting
policy and the correction of an error that occurred before the earliest comparative
period.
Where it is impracticable to apply this requirement:
The new policy is applied prospectively from the start of the earliest period
practicable
The error is corrected prospectively from the earliest date practicable.
CA Sri Lanka
85
Impracticable. Applying a requirement is impracticable when the entity cannot

apply it after making every reasonable effort to do so. It is impracticable to apply a
change in an accounting policy retrospectively or to make a retrospective
restatement to correct an error if one of the following apply:
The effects of the retrospective application or retrospective restatement are not
determinable.
The retrospective application or retrospective restatement requires
assumptions about what management's intent would have been in that period.
The retrospective application or retrospective restatement requires significant
estimates of amounts and it is impossible to distinguish objectively information
about those estimates that: provides evidence of circumstances that existed on
the date(s) at which those amounts are to be recognised, measured or
disclosed; and would have been available when the financial statements for that
prior period were authorised for issue, from other information.

A company records a foreign currency transaction at the spot exchange rate on
the date of the transaction. Subsequent retranslation of the foreign balance in
the statement of financial position results in exchange gains or losses.
LKAS 21 deals with two situations:
a single company transacting in a foreign currency, and
the translation of a foreign operations financial statements for inclusion in the
consolidated financial statements.
In this chapter we consider the first situation only; the second situation is
considered in chapter 20.
3.1 Functional and presentation currency

Each entity should determine its functional currency and measure its results
and financial position in that currency.
The functional currency is the currency of the primary economic environment
in which the entity operates. This is normally the currency of the country in
which an entity is located.
The presentation currency is the currency in which an entity presents its
financial statements. This can be any currency but is normally the functional
currency.
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CA Sri Lanka
3.2 Foreign currency transactions

A foreign currency transaction is initially recorded in the functional currency,
by applying the spot exchange rate (the exchange rate on the date of the
transaction).
An average rate for a period may be used if exchange rates do not fluctuate
significantly.
At the reporting date any monetary items are retranslated using the closing
(year end) exchange rate.
Monetary items are units of currency held and assets and liabilities to be
received or paid in a fixed or determinable number of units of currency.
The cash settlement of monetary items is translated at the spot rate on the
settlement date.
Non-monetary items carried at historical cost are not retranslated subsequent
to initial recognition; non-monetary items carried at fair value are retranslated
each time that an up to date fair value is established, using the spot rate on the
date of valuation.
Exchange differences arising on retranslation at the reporting date and on
settlement are normally recognised in profit or loss in the period in which they
arise.
Where a gain or loss on a non-monetary item is recognised in other
comprehensive income any related exchange differences are also recognised in
other comprehensive income.
4 LKAS 34 Interim Financial Reporting

LKAS 34 does not prescribe which entities should produce interim financial
reports however for those that do it lays down principles and guidelines for their
production, including recognition and measurement guidelines.
4.1 Introduction
An interim period is a financial reporting period shorter than a full financial year.
An interim financial report is a financial report containing either a complete set
of financial statements (as described in LKAS 1) or set of condensed financial
statements (as described in LKAS 34) for an interim period.
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87
LKAS 34 does not prescribe whether an entity should present interim statements,
nor how often. It does, however provide guidance on contents for those entities
that do present interim statements.
LKAS 34 encourages publicly traded companies to prepare interim financial
statements at least at the end of the first half of the financial year and make them
available within 60 days.
4.2 Minimum components

The standard specifies the minimum component elements of an interim financial
report.
Condensed statement of financial position

Condensed statement of profit or loss and other comprehensive income
Condensed statement of changes in equity
Condensed statement of cash flows
Selected note disclosures
The rationale for requiring only condensed statements and selected note
disclosures is that entities need not duplicate information in their interim report
that is contained in their report for the previous financial year. Interim statements
should focus more on new events, activities and circumstances.
4.3 Form and content

Where full financial statements are given as interim financial statements, LKAS 1
should be used as a guide, otherwise LKAS 34 specifies minimum contents.
The condensed statement of financial position should include, as a minimum, each
of the major components of assets, liabilities and equity as were in the statement
of financial position at the end of the previous financial year, thus providing a
summary of the economic resources of the entity and its financial structure.
The condensed statement of profit or loss and other comprehensive income
should include, as a minimum, each of the component items of income and
expense as are shown in profit or loss for the previous financial year, together
with the earnings per share and diluted earnings per share.
The condensed statement of cash flows should show, as a minimum, the three
major sub-totals of cash flow as required in statements of cash flows by LKAS 7,
namely: cash flows from operating activities, cash flows from investing activities
and cash flow from financing activities.
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CA Sri Lanka
The condensed statement of changes in equity should include, as a minimum, each

of the major components of equity as were contained in the statement of changes
in equity for the previous financial year of the entity.
4.3.1 Selected explanatory notes
LKAS 34 states that relatively minor changes from the most recent annual
financial statements need not be included in an interim report. However, the notes
to an interim report should include the following (unless the information is
contained elsewhere in the report).
CA Sri Lanka
(a)
A statement that the same accounting policies and methods of

computation have been used for the interim statements as were used for
the most recent annual financial statements. If not, the nature of the
differences and their effect should be described. (The accounting policies for
preparing the interim report should only differ from those used for the
previous annual accounts in a situation where there has been a change in
accounting policy since the end of the previous financial year, and the new
policy will be applied for the annual accounts of the current financial
period.)
(b)
Explanatory comments on the seasonality or 'cyclicality' of operations in

the interim period. For example, if a company earns most of its annual
profits in the first half of the year, because sales are much higher in the first
six months, the interim report for the first half of the year should explain this
fact.
(c)
The nature and amount of items during the interim period affecting assets,
liabilities, capital, net income or cash flows, that are unusual, due to their
nature, incidence or size.
(d)
The issue or repurchase of equity or debt securities
(e)
Nature and amount of any changes in estimates of amounts reported in an

earlier interim report during the financial year, or in prior financial years if
these affect the current interim period
(f)
Dividends paid on ordinary shares and the dividends paid on other shares
(g)
Segmental results for the business segments or geographical segments of

the entity (see SLFRS 8)
(h)
Any significant events since the end of the interim period
(i)
Effect of the acquisition or disposal of subsidiaries during the interim period
(j)
Any significant change in a contingent liability or a contingent asset since

the date of the last annual statement of financial position
89
The entity should also disclose the fact that the interim report has been produced
in compliance with LKAS 34 on interim financial reporting.
QUESTION
Disclosures
Identify examples of the type of disclosures required according to the above list of
explanatory notes.
ANSWER
The following are examples:
(a)
Write-down of inventories to net realisable value and the reversal of such a

write-down
(b)
Recognition of a loss from the impairment of property, plant and equipment,

intangible assets, or other assets, and the reversal of such an impairment
loss
(c)
Reversal of any provisions for the costs of restructuring
(d)
Acquisitions and disposals of items of property, plant and equipment
(e)
Commitments for the purchase of property, plant and equipment
(f)
Litigation settlements
(g)
Corrections of fundamental errors in previously reported financial data
(h)
Any debt default or any breach of a debt covenant that has not been
corrected subsequently
(i)
4.4 Periods covered

The standard requires that interim financial reports should provide financial
information for the following periods or as at the following dates.
90
(a)
Statement of financial position data as at the end of the current interim

period, and comparative data as at the end of the most recent financial year
(b)
Statement of comprehensive income data for the current interim period

and cumulative data for the current year to date, together with comparative
data for the corresponding interim period and cumulative figures for the
previous financial year
CA Sri Lanka
(c)
Statement of cash flows data should be cumulative for the current year to
date, with comparative cumulative data for the corresponding interim
period in the previous financial year
(d)
Data for the statement of changes in equity should be for both the current
interim period and for the year to date, together with comparative data for
the corresponding interim period, and cumulative figures, for the previous
financial year
4.5 Materiality
Materiality should be assessed in relation to the interim period financial data. It
should be recognised that interim measurements rely to a greater extent on
estimates than annual financial data.
4.6 Recognition and measurement principles

A large part of LKAS 34 deals with recognition and measurement principles, and
guidelines as to their practical application. The guiding principle is that an entity
should use the same recognition and measurement principles in its interim
statements as it does in its annual financial statements.
This means, for example, that a cost that would not be regarded as an asset in the
year-end statement of financial position should not be regarded as an asset in the
statement of financial position for an interim period. Similarly, an accrual for an
item of income or expense for a transaction that has not yet occurred (or a
deferral of an item of income or expense for a transaction that has already
occurred) is inappropriate for interim reporting, just as it is for year-end
reporting.
Applying this principle of recognition and measurement may result, in a
subsequent interim period or at the year-end, in a remeasurement of amounts
that were reported in a financial statement for a previous interim period. The
nature and amount of any significant remeasurements should be disclosed.
4.6.1 Revenues received occasionally, seasonally or cyclically
Revenue that is received as an occasional item, or within a seasonal or cyclical
pattern, should not be anticipated or deferred in interim financial statements, if it
would be inappropriate to anticipate or defer the revenue for the annual financial
statements. In other words, the principles of revenue recognition should be
applied consistently to the interim reports and year-end reports.
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91
4.6.2 Costs incurred unevenly during the financial year

These should only be anticipated or deferred (ie treated as accruals or
prepayments) if it would be appropriate to anticipate or defer the expense in the
annual financial statements. For example, it would be appropriate to anticipate a
cost for property rental where the rental is paid in arrears, but it would be
inappropriate to anticipate part of the cost of a major advertising campaign later
in the year, for which no expenses have yet been incurred.
The standard goes on, in an appendix, to deal with specific applications of the
recognition and measurement principle. Some of these examples are explained
below, by way of explanation and illustration.
4.6.3 Payroll taxes or insurance contributions paid by employers
In some countries these are assessed on an annual basis, but paid at an uneven
rate during the course of the year, with a large proportion of the taxes being paid
in the early part of the year, and a much smaller proportion paid later on in the
year. In this situation, it would be appropriate to use an estimated average annual
tax rate for the year in an interim statement, not the actual tax paid. This
treatment is appropriate because it reflects the fact that the taxes are assessed on
an annual basis, even though the payment pattern is uneven.
4.6.4 Cost of a planned major periodic maintenance or overhaul
The cost of such an event later in the year must not be anticipated in an interim
financial statement unless there is a legal or constructive obligation to carry out
this work. The fact that a maintenance or overhaul is planned and is carried out
annually is not of itself sufficient to justify anticipating the cost in an interim
financial report.
4.6.5 Other planned but irregularly-occurring costs
Similarly, these costs such as charitable donations or employee training costs,
should not be accrued in an interim report. These costs, even if they occur
regularly and are planned, are nevertheless discretionary.
4.6.6 Year-end bonus
A year-end bonus should not be provided for in an interim financial statement
unless there is a constructive obligation to pay a year-end bonus (eg a contractual
obligation, or a regular past practice) and the size of the bonus can be reliably
measured.
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4.6.7 Holiday pay

The same principle applies here. If holiday pay is an enforceable obligation on the
employer, then any unpaid accumulated holiday pay may be accrued in the
interim financial report.
4.6.8 Non-monetary intangible assets
The entity might incur expenses during an interim period on items that might or
will generate non-monetary intangible assets. LKAS 38 Intangible assets requires
that costs to generate non-monetary intangible assets (eg development expenses)
should be recognised as an expense when incurred unless the costs form part of
an identifiable intangible asset. Costs that were initially recognised as an expense
cannot subsequently be treated instead as part of the cost of an intangible asset.
LKAS 34 states that interim financial statements should adopt the same approach.
This means that it would be inappropriate in an interim financial statement to
'defer' a cost in the expectation that it will eventually be part of a non-monetary
intangible asset that has not yet been recognised: such costs should be treated as
an expense in the interim statement.
4.6.9 Depreciation
Depreciation should only be charged in an interim statement on non-current
assets that have been acquired, not on non-current assets that will be acquired
later in the financial year.
4.6.10 Foreign currency translation gains and losses
These should be calculated by the same principles as at the financial year end, in
accordance with LKAS 21.
4.6.11 Tax on income
An entity will include an expense for income tax (tax on profits) in its interim
statements. The tax rate to use should be the estimated average annual tax rate
for the year. For example, suppose that in a particular jurisdiction, the rate of tax
on company profits is 30% on the first Rs. 200,000 of profit and 40% on profits
above Rs. 200,000. Now suppose that a company makes a profit of Rs. 200,000 in
its first half year, and expects to make Rs. 200,000 in the second half year. The rate
of tax to be applied in the interim financial report should be 35%, not 30%, ie the
expected average rate of tax for the year as a whole. This approach is appropriate
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93
because income tax on company profits is charged on an annual basis, and an

effective annual rate should therefore be applied to each interim period.
As another illustration, suppose a company earns pre-tax income in the first
quarter of the year of Rs. 300,000, but expects to make a loss of Rs. 100,000 in
each of the next three quarters, so that net income before tax for the year is zero.
Suppose also that the rate of tax is 30%. In this case, it would be inappropriate to
anticipate the losses, and the tax charge should be Rs. 90,000 for the first quarter
of the year (30% of Rs. 300,000) and a negative tax charge of Rs. 30,000 for each
of the next three quarters, if actual losses are the same as anticipated.
Where the tax year for a company does not coincide with its financial year, a
separate estimated weighted average tax rate should be applied for each tax year,
to the interim periods that fall within that tax year.
Some countries give entities tax credits against the tax payable, based on amounts
of capital expenditure or research and development, and so on. Under most tax
regimes, these credits are calculated and granted on an annual basis; therefore it
is appropriate to include anticipated tax credits within the calculation of the
estimated average tax rate for the year, and apply this rate to calculate the tax on
income for interim periods. However, if a tax benefit relates to a specific one-time
event, it should be recognised within the tax expense for the interim period in
which the event occurs.
4.6.12 Inventory valuations
Within interim reports, inventories should be valued in the same way as for yearend accounts. It is recognised, however, that it will be necessary to rely more
heavily on estimates for interim reporting than for year-end reporting.
In addition, it will normally be the case that the net realisable value of inventories
should be estimated from selling prices and related costs to complete and dispose
at interim dates.
4.7 Use of estimates

Although accounting information must be reliable and free from material error, it
may be necessary to sacrifice some accuracy and reliability for the sake of
timeliness and cost-benefits. This is particularly the case with interim financial
reporting, where there will be much less time to produce reports than at the
financial year end. The standard therefore recognises that estimates will have to
be used to a greater extent in interim reporting, to assess values or even some
costs, than in year-end reporting.
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An appendix to LKAS 34 gives some examples of the use of estimates.

(a)
Inventories. An entity might not need to carry out a full inventory count at
the end of each interim period. Instead, it may be sufficient to estimate
inventory values using sales margins.
(b)
Provisions. An entity might employ outside experts or consultants to advise

on the appropriate amount of a provision, as at the year end. It will probably
be inappropriate to employ an expert to make a similar assessment at each
interim date. Similarly, an entity might employ a professional valuer to
revalue non-current assets at the year end, whereas at the interim date(s)
the entity will not rely on such experts.
(c)
Income taxes. The rate of income tax (tax on profits) will be calculated at
the year end by applying the tax rate in each country/jurisdiction to the
profits earned there. At the interim stage, it may be sufficient to estimate the
rate of income tax by applying the same 'blended' estimated weighted
average tax rate to the income earned in all countries/jurisdictions.
The principle of materiality applies to interim financial reporting, as it does to

year-end reporting. In assessing materiality, it needs to be recognised that interim
financial reports will rely more heavily on estimates than year-end reports.
Materiality should be assessed in relation to the interim financial statements
themselves, and should be independent of 'annual materiality' considerations.
4.8 IFRIC 10 Interim Reporting and Impairment

IFRIC 10 addresses a conflict between the requirements of LKAS 34 and those in
other standards on the recognition and reversal of impairment losses.
IFRIC 10 concludes that an impairment loss recognised in a previous interim
period in respect of goodwill or an investment in an equity instrument or financial
asset carried at cost may not be reversed.
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QUESTION
SL Vehicles is a Sri Lanka based manufacturer of passenger vehicles. The company
has experienced low levels of profitability throughout 20X4 as a result of
increasing raw materials prices and pressure to lower prices in line with emerging
competitors. The companys latest cash flow budgets indicate that the company
will generate negative operating cash flows from the middle of 20X5 and as a
result the company is unlikely to be able to meet its mandatory debt repayments
that fall due in 20X5. The government of Sri Lanka, recognising the importance of
SL Vehicles to the economy, has committed to make a cash injection to the
company in January 20X5 in return for redeemable preference shares with a
20 year term. It has also guaranteed the companys bank debt.
Required
Discuss whether it is appropriate that the 20X4 financial statements of SL
Vehicles are prepared on the going concern basis.
ANSWER
In assessing going concern, management must assess all available information.
There are several indicators that suggest that SL Vehicles may not be a going
concern and may cease to trade within 12 months:
The company has suffered low levels of profitability

Raw materials prices are increasing
There is emerging competition
Negative operating cash flows are expected in 20X5
The company is likely to be unable to meet mandatory debt repayments
Based on these factors alone it would not be appropriate to prepare the companys
financial statements on the going concern basis.
It is however relevant that the Sri Lankan Government has committed to support
the company, both in terms of a bailout and providing a bank guarantee. This
support means that the company is likely to continue to trade for the foreseeable
future (12 months) and therefore the going concern basis is appropriate.
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QUESTION
Colombo Textiles Ltd purchased a weaving machine from an overseas supplier on
1 July 20X6 at a cost of TY 19.6 million. The cost of the machine was incorrectly
treated as a cost of sales. The prevailing exchange rate on the date of the
transaction was Rs. 1: TY 4.9. The exchange rate was Rs. 1: TY 5 at 30 June 20X7
and Rs. 1: TY 4.8 on 30 June 20X7. Colombo Textiles Ltd depreciated weaving
machines at a rate of 15% on cost until 1 July 20X8 when it revised its estimates
and adopted a rate of 20%.
Required
Explain what adjustments are required to the financial statements of Colombo
Textiles Ltd in the year ended 30 June 20X8 in respect of the error.
ANSWER
The printing machine is incorrectly accounted for at 1 July 20X6. This is a prior
period error and LKAS 8 requires that it is corrected retrospectively ie as if the
error had not occurred.
The machine should have been recognised as a non-current asset at 1 July 20X6
measured at Rs. 4 million (TY 19.6 million /4.9).
This is a non-monetary asset and is not therefore subsequently re-measured in
line with changing exchange rates.
The machine should have been depreciated in the year ended 30 June 20X7 by
15% of cost ie Rs. 600,000. The carrying amount of the machine at 30 June 20X7 is
therefore Rs. 3.4 million (4 million 600,000).
The machine should be depreciated in the year ended 30 June 20X8 by 20% of
cost ie Rs. 800,000. The carrying amount of the machine at 30 June 20X8 is
therefore Rs. 2.6 million (4 million 600,000 800,000).
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CHAPTER ROUNDUP
98
LKAS 1 contains general requirements for the presentation of financial

statements together with suggested formats and disclosure requirements.
LKAS 8 requires that a change in accounting policy or correction of error is dealt

with retrospectively so that the financial statements appear as if the new policy
had always been in place or the error had never occurred; a change in
accounting estimate is dealt with prospectively.
A company records a foreign currency transaction at the spot exchange rate on

the date of the transaction. Subsequent retranslation of the foreign balance in
the statement of financial position results in exchange gains or losses.
LKAS 34 does not prescribe which entities should produce interim financial
reports however for those that do it lays down principles and guidelines for their
production including recognition and measurement guidelines.
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PROGRESS TEST
When is a third statement of financial position at the start of the comparative

period required in a set of financial statements?
When should a liability be classified as current?
What items of other comprehensive income may be reclassified to profit or loss?
How is a change in accounting policy required by the issue of a new standard

applied?
What provision does LKAS 8 make if retrospective adjustment or restatement is

impracticable?
What is the functional currency of an entity?
What periods are covered by interim financial statements?
How is seasonal revenue dealt with in interim financial statements?
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100
When an accounting policy is applied retrospectively or other retrospective

restatement is made and this has a material affect on information in the statement
of financial position at the start of the comparative period.
When it is:
(a)
expected to be settled in the normal operating cycle of the entity
(b)
due to be settled within 12 months of the reporting date held primarily for
the purposes of being traded.
Exchange differences on retranslation of foreign operations, gains or losses on

available-for-sale financial assets and cash flow hedges.
In accordance with the transitional provisions of that standard.
The new policy is applied prospectively from the start of the earliest period
practicable
The error is corrected prospectively from the earliest date practicable.
The currency of the primary economic environment in which the entity operates.
See section 4.3
Seasonal revenue is not anticipated (or deferred); revenue is recognised when the
recognition criteria of LKAS 18 are met.
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CHAPTER
INTRODUCTION
Non-current assets may be tangible or intangible and held for an entitys
own use or for long term investment purposes. In this chapter we cover
the requirements of LKAS 16 Property, Plant and Equipment and LKAS 40
Investment Property.
Much of the technical contents of the chapter is revision, however the
scenarios to which the standards requirements are applied are more
complex than those seen at KB1 level.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

Standards.
treatments.
circumstances.
reporting.
statements.
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KC1 | Chapter 4: Non-current assets
CHAPTER CONTENTS
1 Property, Plant and Equipment
2 LKAS 40 Investment Property

Analyse the criteria that must be satisfied in order to recognise an item as PPE
Analyse the accounting treatment for initial measurement and subsequent
measurement of PPE
Recommend appropriate
measurement
accounting
policy
selection
of
subsequent
Critically analyse the amounts to be capitalised

Assess useful life, residual value and depreciation for given complex scenarios
Design the disclosures to be made in respect of PPE.
Advise suitable accounting treatment on capitalisation of borrowing cost on
qualifying assets.
Recommend appropriate accounting treatment for recognition of borrowing
cost.
Evaluate the accounting requirements for commencement of capitalisation,
suspension of capitalisation and cessation of capitalisation.
Outline the disclosure requirements.
Assess the cost of investment property
Advise the adjustments to be made in the financial statements in respect of
transfers and disposals of investment property
Develop the disclosures to be made in respect of investment properties.
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1 Property, plant and equipment

Two standards are relevant to property, plant and equipment; both have been
covered in detail at KB1 and KE1 levels. The standards are LKAS 16 Property,
Plant and Equipment and LKAS 23 Borrowing Costs.
1.1 LKAS 16 scope and definitions

LKAS 16 Property, Plant and Equipment applies to all property, plant and
equipment other than:
PPE classified as held for sale (SLFRS 5)
Biological assets related to agricultural activity (LKAS 41)
The recognition and measurement of exploration and evaluation assets
(SLFRS 6)
Mineral rights and mineral reserves such as oil, gas and similar nonregenerative resources.
The standard provides the following definitions:
Property, plant and equipment are tangible assets that:
Are held by an entity for use in the production or supply of goods or services,
for rental to others, or for administrative purposes; and
Are expected to be used during more than one period.
Cost is the amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire an asset at the time of its acquisition or
construction.
Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.
Carrying amount is the amount at which an asset is recognised after deducting
any accumulated depreciation and impairment losses.
Depreciation is the systematic allocation of the depreciable amount of an asset
over its useful life.
Depreciable amount is the cost of an asset, or other amount substituted for cost,
less its residual value.
Residual value is the estimated amount that an entity would currently obtain
from disposal of the asset, after deducting costs of disposal, if the asset were
already of the age and in the condition expected at the end of its useful life.
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Useful life is
(a)
the period over which an asset is expected to be available for use by an

entity, or
(b)
the number of production or similar units expected to be obtained from the

asset by the entity
(LKAS 16)
1.2 Recognition and initial measurement

An item of PPE is recognised when:
(a)
It is probable that future economic benefits associated with the asset will
flow to the entity, and
(b)
The cost of the asset to the entity can be measured reliably.
These recognition criteria mirror those of the Conceptual Framework.

Individually insignificant assets such as tools and moulds may be aggregated
for recognition as PPE.
Expenditure on health and safety equipment is recognised as an asset when it
enables an entity to obtain future economic benefits from related assets in
excess of those benefits it could earn otherwise.
Major inspections and overhauls that are required for an asset to operate are
capitalised as part of the cost of the asset to which they relate.
1.2.1 Initial measurement
Initial measurement is at cost. This includes:
Purchase price
Includes import duties

Excludes trade discounts and recoverable purchase tax
Deemed to be fair value in an exchange transaction unless
the transaction lacks commercial substance or the fair
value of the asset acquired and that given up arent
reliably measurable. In that case deemed to be the
carrying amount of the asset given up.
Directly
attributable
costs of bringing
the asset into
working
condition for its
104
Include:
Costs of site preparation
Initial delivery and handling costs
Installation and assembly costs
Professional fees
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intended use
Testing costs (after deducting net proceeds from selling

samples produced during testing)
Staff costs directly related to the
construction/acquisition of the asset.
Exclude:
Costs of opening a new facility / introducing a new
product or service / conducting business in new
location or with new class of customer
Staff training costs
Administration and general overhead costs
Costs to relocate entitys operations
Initial operating losses
Costs incurred when the asset can operate as intended
but is yet to be brought into use.
Dismantling /
Where there is a present obligation (at the time of purchase /
removal and
construction) to dismantle and remove an asset at the end of
restoration costs its useful life or to put right land affected by the operation of
the asset
DEBIT
PPE
CREDIT Provision
Eligible
borrowing costs
Discounted costs
Discounted costs
Eligible borrowing costs on qualifying assets must be

capitalised. Rules are provided by LKAS 23; see below.
1.2.2 LKAS 23 Borrowing costs

Borrowing costs are interest and other costs that an entity incurs in connection
with the borrowing of funds.
A qualifying asset is an asset that necessarily takes a substantial period of time to
get ready for its intended use or sale.
A qualifying asset may include PPE, intangible assets, investment properties or
inventory.
Capitalisation begins when:
Expenditure on the asset is being incurred
Borrowing costs are being incurred, and
Activities necessary to prepare the asset for intended use or sale are
underway.
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Capitalisation is suspended when active development of an asset is

unexpectedly suspended for an extended period.
Capitalisation ceases when substantially all of the activities necessary to
prepare an asset for intended use or sale are complete. This is usually when
physical construction of the asset is complete.
In terms of specific borrowings, the borrowing costs capitalised are the actual
costs incurred less investment income on the temporary investment of the
borrowed funds.
In terms of general borrowings, borrowing costs eligible for capitalisation are
calculated by applying a capitalisation rate to expenditure on the qualifying
asset.
The capitalisation rate is the weighted average of the borrowing costs
applicable to the borrowings of the entity that are outstanding during the
period.
QUESTION
Koala Construction
Koala Construction Ltd builds office blocks and retail units on a speculative basis,
selling them to customers when complete. On 1 February 20X1, the company
began a project to build an office block in Kandy. The first stage of the build was
financed using the companys cash reserves; on 1 June 20X1, the project manager
drew down Rs. 15 million from general borrowings to finance the second stage. A
further Rs. 20 million was drawn down on 1 November to finance the third and
final stage of the build. The office block was completed on 30 November other
than final decoration in line with the purchasers specification. A purchaser was
identified immediately and between 1 December and 31 December, Koala
Construction Ltd finalised the decorating of the complex. The sale of the office
complex was completed in January 20X2.
Koala Constructions general borrowings are as follows:
Rs. 50 million bank loan with an interest rate of 4% per annum was arranged
on 1 May 20X1 and is due for repayment in 20X4.
Rs. 20 million bank loan with an interest rate of 6% per annum was arranged
on 1 August 20X1 and is due for repayment in 20X8.
Required
Explain what amount of borrowing costs should be capitalised and how the office
block is recognised in Koala Constructions statement of financial position at
31 December 20X1.
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ANSWER
Borrowing costs are capitalised when all of the following conditions are met:
1.
Expenditure on the asset is being incurred
2.
Borrowing costs are being incurred
3.
Activities necessary to prepare the asset for intended use or sale are
underway.
Activities necessary to prepare the office block for intended use or sale
commenced on 1 February 20X1, and from this date it is assumed that
expenditure is being incurred; borrowing costs in relation to borrowings used to
fund the build of the complex are incurred from 1 June 20X1 (when the first
drawdown occurs). Therefore the date of commencement is 1 June 20X1.
Borrowing costs cease to be capitalised when the activities to prepare the
qualifying asset for intended use or sale are substantially complete. LKAS 23
clarifies that an asset is normally ready for intended use or sale when the physical
construction of the asset is complete. If minor modifications (such as the
decoration of a property to the purchasers specification) are outstanding, this
indicates that substantially all activities to prepare the qualifying asset for
intended use or sale are substantially complete. Therefore the date on which
capitalisation ceases is 30 November 20X1.
Koala funds the construction using general borrowing costs.
The first draw down of funds on 1 June 20X1 is from the Rs. 50 Mn 4% loan (as the
6% loan had not been arranged at this date).
Borrowing costs to be capitalised in respect of this draw down are:
Rs 15 Mn 4% 6/12 months
Rs.
300,000
The second draw down of funds on 1 November is from borrowings which include
both the 4% and the 6% loan. A weighted average cost of borrowing applicable to
these general borrowings must be calculated:
(50/(50+20) 4%) + 20/(50 + 20) 6%) = 4.59%
This rate is applied to the draw down on 1 November 20X3 from the date of draw
down to the date on which activities to complete the build are substantially
complete (30 November). Borrowing costs to be capitalised are therefore:
Rs 20 Mn 4.59% 1/12months
Rs.
76,167
Total borrowing costs to be capitalised are therefore Rs. 376,167.
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1.3 Subsequent costs

Subsequent expenditure is added to the carrying amount of the asset when it is
probable that future economic benefits, in excess of the originally assessed
standard of performance of the existing asset, will flow to the entity.
1.4 Depreciation
Depreciation is charged on all assets with the exception of land. Expenditure on
repairs and maintenance does not negate the need to charge depreciation.
Depreciation commences when an asset is in the location and condition
necessary for it to be used in the manner intended by management.
Depreciation ceases when an asset is classified as held for sale or is disposed of.
Determination of useful life should take into account expected usage of the
asset, expected physical wear and tear, obsolescence, legal or other limits on
use of the asset.
Where residual value exceeds carrying amount the depreciation charge is zero.
The depreciation method used should reflect the pattern in which the assets
future economic benefits are expected to be consumed by the entity.
Residual value, useful life and depreciation method are reviewed at least at
each year end. Any change is accounted for as a change in accounting estimate.
Complex assets with several component parts with different useful lives are
treated as separate assets for depreciation purposes.
1.5 Subsequent measurement

LKAS 16 allows assets to be measured after initial recognition using either the cost
model or the revaluation model.
Where the cost model is applied, assets are measured at cost less accumulated
depreciation less impairment losses.
Where the revaluation model is applied, assets are measured at revalued
amount less subsequent accumulated depreciation less subsequent impairment
losses.
Where the revaluation model is adopted, it must be applied to an entire class of
assets.
Revaluations must be kept up to date such that the carrying amount of an asset
does not differ significantly from its fair value.
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Revaluations are accounted for as follows:

Upwards revaluation
Downwards revaluation
Not previously
revalued
DEBIT
DEBIT
Profit or loss
CREDIT OCI (revaluation

reserve)
CREDIT
PPE
Previously
revalued
downwards /
upwards
DEBIT
DEBIT
OCI (revaluation
reserve)
CREDIT OCI (revaluation

reserve)
DEBIT
Profit or loss
CREDIT
PPE
The credit to profit or loss is

equal to the downward
revaluation previously
recognised in profit or loss.
The debit to OCI is equal to the

balance on the revaluation
reserve in respect of the asset.
PPE
PPE
CREDIT Profit or loss
A revalued asset is depreciated in the same way as an asset held under the cost
model, with depreciation spreading the revalued amount over the assets
remaining useful life.
In the case of an upwards revaluation, LKAS 16 allows entities to transfer an
amount equal to the increase in depreciation charge from the revaluation
reserve to retained earnings in the equity section of the statement of financial
position, if they wish to do so.
When a revalued asset is disposed of, the revaluation reserve in respect of that
asset becomes realised and is transferred to retained earnings.
1.5.1 Determining fair value where the revaluation model is applied
Fair value is determined in accordance with SLFRS 13 Fair Value Measurement.
This standard is discussed in detail in Section 4 of Chapter 1. You should
remember that:
Fair value is an exit (selling) price.
It is based on the highest and best use of a non-financial asset.
It is assumed to take place in the principal or most advantageous market.
1.5.2 Advantages and disadvantages of each model
The main advantage of the revaluation model is the impact on the statement of
financial position: a companys net assets are instantly increased and that
company appears to be financially healthier than previously. It is also true that
adoption of the revaluation model results in a more relevant statement of financial
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position, based on up-to-date values. This is useful to investors aiming to fully

understand their investment and creditors looking for assets on which to secure
loans. It also means that assets are measured using more comparable bases, since
current assets will be also measured in current terms.
The disadvantages of adopting the revaluation model manifest themselves in
practical terms and in terms of increased expenses in profit or loss:
In practical terms a company that adopts the revaluation model must apply that
model to all assets of the same class and it must keep valuations up to date.
Depending on the number of assets in the class and the volatility of fair values,
these requirements may be onerous and their implementation time-consuming
and labour intensive. Fair value must be measured by reference to SLFRS 13,
and may not be straightforward.
These practical considerations have a knock on effect on profit or loss as costs
associated with applying the revaluation model may be significant eg internal
labour costs, external surveyor fees and so on. This may result in management
choosing not to adopt the revaluation model, for example, where a profitrelated pay scheme is in place.
A further effect on profit or loss is seen in terms of an increased depreciation
charge (assuming upwards revaluation). Although the difference between
historic depreciation and that based on revalued amount can be transferred
within reserves, the depreciation charge based on revalued amount must be
recognised in profit or loss for the year.
1.5.3 Effect of measurement models on the financial statements
The effect of the cost and revaluation model on the financial statements is
summarised in the table below. Note that where the fair value of an asset is
decreased below cost this is recognised regardless of which model is applied (as
an impairment or downwards revaluation). Therefore the effect in the statement
of financial position and the subsequent depreciation charge is the same under
both models. The table therefore concentrates on the effect of upwards
revaluations.
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Revaluation model
Cost model
Carrying amount of net

assets is up to date.
Carrying amount of net

assets may be out of date.
Carrying amounts of
revalued assets are on
comparable terms with
current assets.
Carrying amounts of old

items of PPE are not
comparable with other
items.
Increased net assets

value.
Depressed net assets

value.
Statement of profit or
loss
Increased expenses as a
result of higher
depreciation and costs of
revaluation.
Lower expenses.
Other comprehensive
income
Revaluation surplus
recognised in OCI (unless
reverses a previous
impairment loss).
No effect.
Statement of changes in
equity
Reserves movement to
transfer excess
depreciation to retained
earnings.
No effect.
Statement of financial
position
1.6 Disclosures
For each class of property, plant and equipment, the following must be disclosed:
(a)
Measurement bases for determining the gross carrying amount (if more
than one, the gross carrying amount for that basis in each category).
(b)
Depreciation methods used.
(c)
Useful lives or depreciation rates used.
(d)
Gross carrying amount and accumulated depreciation (aggregated with

accumulated impairment losses) at the beginning and end of the period.
(e)
Reconciliation of the carrying amount at the beginning and end of the

period showing:
(i)
Additions
(ii)
Disposals/assets classified as held for sale
(iii) Acquisitions through business combinations (see Chapter 16)

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111
(iv) Increases/decreases during the period from revaluations and from

impairment losses recognised in OCI
(v)
Impairment losses recognised in profit or loss
(vi) Impairment losses reversed in profit or loss

(vii) Depreciation
(viii) Net exchange differences (from translation of statements of foreign
entity)
(ix) Any other movements.
The financial statements should also disclose:
(a)
Existence and amounts of restrictions on title, and items pledged as

security for liabilities.
(b)
Amount of expenditures in the carrying amounts of items in the course of

construction.
(c)
Amount of commitments to acquire PPE.
(d)
The amount of compensation from third parties for PPE that was impaired,
lost or given up that is included in profit or loss.
Additional disclosures are required in respect of revalued assets. These are:
112
(a)
Effective date of the revaluation.
(b)
Whether an independent valuer was involved.
(d)
Carrying amount of each class of property, plant and equipment that would
have been included in the financial statements had the assets been carried at
cost less accumulated depreciation and accumulated impairment losses.
(e)
Revaluation surplus, indicating the movement for the period and any
restrictions on the distribution of the balance to shareholders.
CA Sri Lanka
1.6.1 CASE STUDY: PPE Disclosure

The following is an example PPE disclosure note for Cargills (Ceylon) PLC, taken
from its 2013-2014 annual report.
PROPERTY, PLANT AND EQUIPMENT
Group
Cost/
revaluation
As at 1 April
Additions
Revaluation
Transfers
Disposals
Impairment
As at 31
March
Depreciation
/Impairment
As at 1 April
Charge for
the year
Disposals
Impairment
As at 31
March
Carrying
value
Capital work
in progress
Carrying
value
as at 31
March
Freehold
land
Freehold
building
Plant,
machinery
and
Other
Rs'000
Motor
vehicles
Total
2014
Total
2013
Rs'000
Expenditure
incurred on
leasehold
building
Rs'000
Rs'000
Rs'000
Rs'000
Rs. '000
8,162,101
68,440
121,000
8,351,541
2,048,686
308,364
43,000
2,400,050
3,175,739
892,626
4,068,365
10,294,565
1,905,365
(228,335)
(2,481)
733,644
160,504
(15,716)
878,432
24,414,735
3,335,299
164,000
(244,051)
(2,481)
27,667,502
17,639,692
3,540,035
3,556,295
(234,000)
(87,287)
24,414,735
360,951
69,933
1,443,130
392,660
4,833,921
1,094,793
440,767
117,594
7,078,769
1,674,980
5,804,901
1,331,017
430,884
1,835,790
(116,559)
719
5,812,874
(13,713)
544,648
(130,272)
719
8,624,196
(57,149)
7,078,769
8,351,541
1,969,166
2,232,575
6,156,240
333,784
19,043,306
17,335,966
3,077,485
3,301,601
8,351,541
1,969,166
2,232,575
6,156,240
333,784
22,120,791
20,637,567
Expenditure incurred on leasehold building represent the cost incurred in setting

up new outlets.
Free hold land and buildings owned by the Group are revalued once in three years
by an independent professional valuer. The latest revaluation was carried out and
accounted for as at 31 March 2013.
Those revaluations had been carried out in conformity with the requirements of
LKAS 16 "Property, plant and equipment". The surplus on revaluation was
credited to the revaluation reserve account.
Due to change in the nature of use, Freehold land at Nittambuwa, was reclassified
as Investment Property. This property was revalued as at 31 March 2014 by
Messrs. Mr. T Weeratne (FIV), an independent professional valuer. The Property
was valued at its open market value/fair value.
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113
The details of assets mortgaged for banking facilities obtained have been given in
note 23.2 to the financial statements.
1.6.2 LKAS 23 Disclosures

LKAS 23 requires that the following information is disclosed in respect of
borrowing costs:
(a)
the amount of borrowing costs capitalised during the period
(b)
the capitalisation rate used to determine the amount of borrowing costs

eligible for capitalisation.
QUESTION
Pacific Consumables Ltd
Pacific Consumables Ltd is a distributor of food and beverages in Sri Lanka.

The company runs its operations from a head office In Colombo which it has
owned for several years. The carrying amount of the property at 30 April 20X3
was Rs. 8,740,000 and at that date it had a remaining useful life of 28 years.
Depreciation has not yet been calculated for the year ended 30 April 20X4.
The Managing Director of Pacific Consumables Ltd believes that the property has
plenty of life left in it yet and has therefore proposed to the Finance Director that
the remaining useful life of the property is extended to 40 years as at 1 May
20X3.The Finance Director has made an alternative suggestion that the property is
revalued at 30 April 20X4. She has taken professional advice and has been told
that at this date in its current use as an office, the property has a market value of
Rs. 14.2 million. If the property were sold on the basis of conversion to a hotel, it
would have a fair value of Rs. 15.5 million and if it were sold for conversion to a
residential block, the fair value would be Rs. 15.2 million. There are no planning
restrictions on the use of the property. Any sale would incur legal costs of
Rs. 500,000.
As part of a plan to diversify product range, Pacific Consumables Ltd began
construction of a new distribution warehouse near to Bandaranaike Airport on
1 November 20X3. This was financed by the proceeds of a share issue. The costs
incurred in respect of this property were as follows:
Rs'000
Site selection
260
Legal costs of acquiring site
340
Site preparation
1,320
Architects fees
450
Construction materials
2,720
Construction labour
2,400
Proportion of administrative costs allocated to project
190
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The amount billed by the architects includes Rs. 125,000 in relation to original
blueprints drawn up. These blueprints were scrapped when the directors of
Pacific Consumables Ltd instructed the architects to revise their plans in order to
make the building as environmentally friendly as possible.
In line with the green credentials of the new building, Pacific Consumables Ltd
have installed solar panels on the roof of the warehouse at a cost of Rs. 350,000. A
further Rs. 20,000 was spent on having the building certified as eco-friendly by the
Sri Lanka Green Building Council (SLGBC). The directors of Pacific Consumables
Ltd decided to obtain this certification in order to boost their credentials as a
sustainable company and so that they could refer to it within their sustainability
report.
The solar panels are expected to last 20 years before they will require
replacement; the SLGBC certificate must be renewed every 5 years. The property
was completed on 12 March 20X4 and brought into use on 1 April 20X4.
Pacific Consumables Ltd depreciates property over a 50 year useful life.
Required
(a)
In the context of property, plant and equipment and with reference to the
relevant accounting standard, explain the difference between an accounting
policy and accounting estimate, and calculate the carrying amount of the
head office at 30 April 20X4 assuming that the Managing Directors
suggestion is accepted.
(b)
Assuming that the Finance Directors suggestion is accepted, identify the fair
value of the head office at 30 April 20X4 and accounting entries required to
revalue the property.
(c)
Calculate and explain the initial measurement of the new distribution

warehouse.
ANSWER
(a)
Head office: Managing Director's suggested accounting

An accounting policy is defined by LKAS 8 as the specific principles, bases,
conventions, rules and practices applied by an entity in preparing and
presenting financial statements. Accounting policies in the context of
property, plant and equipment may include:
A policy to recognise as property, plant and equipment any items meeting
the definition of a non-current asset and the recognition criteria of
LKAS 16
A policy to depreciate assets
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A policy to revalue assets (or hold them at historical cost)

Many policies are required by accounting standards (as are the first two
listed above), whereas others are a matter of choice (as is the third one listed
above). In practice, a change in accounting policy is a change in:
Where an item is presented in the financial statements (eg depreciation
expense is included in administrative expenses whereas previously it was
included in cost of sales)
How an item is recognised in the financial statements (eg a cost
previously recognised as an expense is now recognised as an asset)
The measurement basis used in the financial statements (eg the
revaluation model is adopted rather than the historical cost model)
Most accounting policies require the use of judgment in their application.
This judgment is an accounting estimate. For example an accounting policy is
to depreciate property; accounting estimates are the residual value, useful
life and method of depreciation.
If the Managing Directors suggestion to revise the remaining useful life is
accepted, this would be a change in an accounting estimate. LKAS 8 requires
that a change in accounting estimate is recognised prospectively in profit or
loss. Therefore the new useful life is applied to the calculation of
depreciation from the date of change (1 May 20X3). The carrying amount at
30 April 20X4 is therefore:
Rs.
8,740,000
Carrying amount at 1 May 20X3
(218,500)
Depreciation in year ended 30 April 20X4 (8.74/40)
8,521,500
Carrying amount at 30 April 20X4
(b)
Head office: Finance Director's suggested solution

If a revaluation policy is adopted, as permitted by LKAS 16, the property is
revalued to fair value.
Fair value is established in line with SLFRS 13 Fair Value Measurement.
This defines fair value as the price that would be received to sell an asset in
an orderly transaction between market participants at the measurement
date. This price assumes the highest and best use of a non-financial asset
based on use which is physically possible, legally permissible and financially
feasible.
In this case there is no planning restriction on the use of the property and
therefore the highest and best use of the head office is as a hotel. The fair
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value of the property as a hotel is Rs. 15.5 Mn, however the question remains
as to whether this is reduced to take account of legal costs on sale.
SLFRS 13 classifies such costs as transaction costs and is clear that these are
not taken into account in establishing fair value. Therefore fair value is
Rs. 15.5 Mn at 30 April 20X4.
The carrying amount of the property at this date is Rs. 8,427,857 (8.74
27/28 years)
The revaluation increase is therefore Rs. 7,072,143.
This is recognised by:
(c)
DEBIT
Property
Rs. 7,072,143
CREDIT
Other comprehensive income

(revaluation surplus)
Rs. 7,072,143
New warehouse
The initial cost of an item of PPE includes its purchase price plus any costs
directly attributable to bringing the asset to the location and condition
necessary for it to operate in the normal manner intended by management.
Site selection costs are not directly attributable costs and do not therefore
form part of the cost of the new warehouse; these are instead recognised in
profit or loss as incurred. Site preparation costs are, however, directly
attributable to the completion of the warehouse and these do form part of its
cost.
LKAS 16 is clear that professional fees are part of the cost of an item of PPE
and therefore both legal costs and architects fees are included in the initial
measurement. The architects fees include Rs. 125,000 relating to scrapped
blueprints. This came about as a result of the directors decision to make the
building environmentally friendly. These fees relate to wasted resources,
and as such LKAS 16 does not permit their inclusion in the initial
measurement of the property.
Both construction materials and labour are directly attributable to the
completion of the warehouse and are included in the initial cost of the
property. LKAS 16 does not allow the inclusion of a proportion of general
and administrative overheads in the cost of an asset; Rs. 190,000 is therefore
The solar panels are an item of property, plant and equipment and their cost
is capitalised as part of the cost of the property. The cost of obtaining SLGBC
certification is not a cost attributable to bringing the warehouse into
working condition. The warehouse would operate in the manner in which it
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117
was intended to without this certification. Therefore this cost is recognised

in profit or loss.
The initial measurement of the property is therefore:
Site preparation
Legal costs of acquiring site
Architects Fees (450 125)
Construction materials
Construction labour
Solar panels
Rs'000
1,320
340
325
2,720
2,400
350
7,455
2 LKAS 40 Investment Property

Investment property is property held to earn rentals or for capital
appreciation or for both; it is initially measured at cost and subsequently an
entity may choose to apply either the cost or the fair value model.
2.1 Definitions
LKAS 40 includes a number of definitions, the most important of which is the
definition of investment property.
Investment property is property (land or a building or part of a building or
both) held (by the owner or by the lessee under a finance lease) to earn rentals or
for capital appreciation or both, rather than for:
(a)
(b)
Use in the production or supply of goods or services or for administrative

purposes, or
Sale in the ordinary course of business
Owner-occupied property is property held by the owner (or by the lessee under
a finance lease) for use in the production or supply of goods or services or for
administrative purposes.
measurement date.
Cost is the amount of cash or cash equivalents paid or the fair value of other
consideration given to acquire an asset at the time of its acquisition or
construction.
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Carrying amount is the amount at which an asset is recognised in the statement

of financial position.
2.2 Definition of investment property

LKAS 40 provides examples of how the definition of investment property is
applied:
Investment property
Not investment property
Land held for long-term capital

appreciation rather than for short-term
sale in the ordinary course of business.
Property which is complete or under

construction and intended for sale in the
ordinary course of business (LKAS 2)
Land held for a currently undetermined

use.
Property under construction on behalf of

third parties (LKAS 11).
A building owned by the reporting

entity (or held by the entity under a
finance lease) and leased out under an
operating lease.
Owner-occupied property, property held

or under development for future owner
occupation, owner-occupied property
awaiting disposal (LKAS 16)
A building that is vacant but is held to

be leased out under one or more
operating leases.
Property that is leased to another entity

under a finance lease (LKAS 17)
Property that is being constructed or

developed for future use as investment
property.
2.2.1 Property held under an operating lease

LKAS 40 states that a property interest that is held by a lessee under an operating
lease may be classified and accounted for as an investment property, if and only
if the property would otherwise meet the definition of an investment property and
the lessee uses the LKAS 40 fair value model. This classification is available on a
property-by-property basis
2.2.2 Investment property in a group scenario
Where a property is owned by one group company and rented to another it is only
investment property in the owners individual financial statements; in the
consolidated financial statements it is owner-occupied.
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119
2.2.3 Investment property with mixed use

In some cases part of a property is held to earn rentals or for capital appreciation
and part is owner occupied. The following treatment is applied in this instance:
If the investment property and owner-occupied portions could be sold or
leased out separately, the portions are accounted for separately under LKAS 40
and LKAS 16 respectively.
If the portions could not be sold or leased out separately:
The whole property is investment property under LKAS 40 if an insignificant
portion is owner-occupied.
The whole property is owner-occupied under LKAS 16 if a significant portion
is owner-occupied.
2.2.4 Investment property where ancillary services are provided
An entity may provide ancillary services to the occupants of a property that it
holds:
The property is an investment property where the ancillary services are
insignificant to the arrangement as a whole.
The property is owner-occupied where the ancillary services are significant.
2.2.5 Use of judgement
LKAS 40 appreciates that it may be difficult to determine whether a property is
investment property, for example because it is unclear whether ancillary services
are significant or whether a significant portion of a property which cannot be split
for sale is owner-occupied.
In the light of this difficulty, the standard requires an entity to disclose when
classification is difficult (see section 2.8)
QUESTION
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Investment property
1.
Pacific Towers, an office building divided into small units which is owned by
Asia Property PLC and let out to several small businesses. Asia Property PLC
provides security and maintenance services for its tenants.
2.
Aparthotel Colombo, an apartment-hotel designed for business people and

run by Asiatel PLC. Asiatel operates a reception and concierge service in the
property together with a gym for residents. A maid service is provided every
day and meals are available in the on site restaurant.
CA Sri Lanka
3.
The Jaffna Building is a twenty storey property owned by Jaffna Enterprises

PLC. Nineteen of the floors are rented out to tenants for office use, whilst the
sales department of Jaffna Enterprises occupies the top floor.
Required
State whether each of the above properties is classified as an investment
property.
ANSWER
1.
Pacific Towers is classified as an investment property. The ancillary services

provided are insignificant to the lease arrangement as a whole.
2.
Apart hotel Colombo is an owner-occupied property run as a hotel. The

ancillary services provided are significant to the sale of a hotel
room/apartment.
3.
The Jaffna Property is a mixed use building. It is evident from the existing
arrangement that the twenty floors can be, and are, let separately and
therefore separate accounting is appropriate. 1/20th of the property is
accounted for as owner-occupied under LKAS 16 whilst the remaining
19/20ths are accounted for as investment property under LKAS 40.
2.3 Recognition
Investment property should be recognised as an asset when:
(a)
It is probable that the future economic benefits that are associated with the
investment property will flow to the entity, and
(b)
The cost of the investment property can be measured reliably.
2.4 Initial measurement

An investment property is initially measured at cost (being purchase price plus
directly attributable expenditure), including transaction costs. If payment is
deferred the cost is the cash price equivalent with any difference between this and
the total payments recognised as a finance cost over the credit period.
The cost of an investment property does not include start-up costs, operating
losses before the investment property is fully occupied or any abnormal costs of
wasted material, labour or other resources incurred in the construction or
development of the property.
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121
2.4.1 Property acquired under a lease

The initial cost of an investment property held under a lease isthe lower of the fair
value of the property and the present value of the minimum lease payments. An
equivalent amount is recognised as a liability.
2.4.2 Property acquired in an exchange transaction
Where an investment property is acquired in exchange for other non-monetary
assets, the cost of the investment property is equal to its fair value unless:
(a)
(b)
the exchange transaction lacks commercial substance, or

the fair value of neither asset received nor given up is reliably measurable.
If the property is not measured at fair value its cost is equal to the carrying
amount of the asset given up.

LKAS 40 requires an entity to choose between two models.
The fair value model
The cost model
The selected policy should be applied to all of its investment property.
Where an entity chooses to classify a property held under an operating lease as an
investment property, there is no choice. The fair value model must be used for all
the entity's investment property, regardless of whether it is owned or leased.
2.5.1 Fair value model
Where the fair value model is applied, an entity should re-measure all of its
investment property to fair value at each reporting date and recognise any gains
or losses on re-measurement in profit or loss.
Fair value is established in accordance with SLFRS 13 Fair Value Measurement,
and should reflect rental income from current leases and other assumptions
that market participants would use when pricing investment property under
current market conditions.
In determining fair value an entity should not double count assets. For example,
elevators or air conditioning are often an integral part of a building and should
be included in the investment property, rather than recognised separately.
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CA Sri Lanka
If an investment property is measured at fair value, the property must continue

to be measured at fair value until disposal, even if information to ascertain fair
value becomes less readily available.
2.5.2 Inability to measure fair value reliably
There is a rebuttable presumption that the fair value of an investment property
can be measured reliably on a continuing basis. If, however, the market for
comparable properties is inactive then the fair value may not be reliably
measurable on a continuing basis.
The presumption may only be rebutted at initial recognition as an investment
property;
Where this is the case the LKAS 16 cost model should be applied to the
individual property and a residual value of nil is assumed.
2.5.3 Investment property under construction and the fair value model
If the fair value of an investment property under construction is not reliably
measurable but it is expected that it will be measurable when complete, the
property is carried at cost until the earlier of the completion of construction or the
ability to measure fair value.
Any difference between the carrying amount of the property under construction
and the fair value on the date of completion is recognised in profit or loss.
If an entity measures an investment property under construction at fair value it
must continue to apply the fair value model to the complete property.
2.5.4 Cost model
An entity that applies the cost model should measure its investment property
using the cost model in LKAS 16 ie at depreciated cost, less any accumulated
impairment losses.
Entities that choose the cost model are required to measure the fair value of
investment properties for disclosure purposes even though this is not the value at
which investment property is measured in the financial statements.
2.5.5 Changing models
An entity should not change from one model to the other unless the change will
result in a more appropriate presentation.
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123
LKAS 40 states that it is highly unlikely that a change from the fair value model to
the cost model will result in a more appropriate presentation.
2.6 Transfers
Transfers to or from investment property are made when there is a change in use.
An investment property may be transferred to owner-occupied property or
inventories or vice versa.
Where the cost model is applied, the carrying amount of the property does not
change on the transfer. Where the fair value model is applied the following rules
apply:
Investment property is transferred to owner-occupied property or inventories:
the deemed cost of the property is the fair value at the date of transfer;
Owner-occupied property is transferred to investment property: an LKAS 16
revaluation is recognised at the point of transfer and the property is
transferred at fair value.
Inventories are transferred to investment property: on transfer the difference
between the previous carrying amount and fair value is recognised in profit or
loss.
2.7 Disposals
An investment property is derecognised on disposal or when it is permanently
withdrawn from use and no future economic benefits are expected from its
disposal.
Disposal may be achieved by a sale or by entering into a finance lease.
Any gain or loss on disposal is the difference between the net disposal proceeds
and the carrying amount of the asset; it is recognised in profit or loss.
Compensation from third parties for investment property that was impaired, lost
or given up is recognised in profit or loss when the compensation becomes
receivable.
QUESTION
1.
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Transfers and disposals
Puttalam Place is owned by Puttalam Property PLC, a property development

company, and classified as an investment property measured under the fair
value model. At 31 October 20X4 it has a carrying amount of Rs. 13.4 million.
On this date Puttalam Property decided to dispose of the property in its
existing state.
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2.
Trincomalee Tower is owned and occupied by Trincomalee Trading PLC. It is

recognised and measured in the financial statements in accordance with the
revaluation model of LKAS 16. At the last revaluation on 31 December 20X3
the property was remeasured to Rs. 16 million and had a remaining useful
life of 20 years. On 1 July 20X4 Trincomalee Trading moved to a new site and
the property was immediately let out to tenants under operating leases. At
this date the fair value of the property had fallen to Rs. 15.5 million.
Required
Advise the adjustments required to the financial statements in respect of the
above transfers of investment properties.
ANSWER
1.
Although Puttalam Property is a property development company and

Puttalam Place is to be sold, the property remains investment property and
is not transferred to inventories. Such a transfer only takes place according
to LKAS 40 where development takes place before the sale. The provisions of
LKFRS 5 in respect of assets held-for-sale may apply.
2.
Trincomalee Tower is transferred from owner-occupied property to

investment property on 1 July 20X4. At this date the property must be
revalued in accordance with LKAS 16 prior to being transferred at fair value.
The carrying amount of the property at the date of transfer is Rs. 15.6 million
(Rs. 16 Mn 234/240 months). Therefore a revaluation loss of Rs. 100,000 is
recognised prior to the transfer. This is recognised in accordance with LKAS
16 in other comprehensive income, provided that a revaluation surplus in
respect of the property exists at the date of transfer; if a surplus does not
exist, it is recognised in profit or loss.
2.8 Disclosure
2.8.1 General disclosures
An entity with investment properties must disclose the following:
CA Sri Lanka
(a)
Whether it applies the fair value or the cost model;
(b)
The criteria used to distinguish between investment property, owneroccupied property and inventory where classification is difficult;
(c)
The extent that the fair value of investment property (as measured or
disclosed in the financial statements) is based on valuation by an
independent, qualified and experienced valuer;
125
(d)
Amounts recognised in profit or loss in respect of:

Rental income from investment property
Direct operating expenses of investment property which did and did not
generate rental income in the period
(e)
Details of restrictions on the realisability of investment property or the

remittance of income or the proceeds of disposal,
(f)
Contractual obligations to purchase, construct or develop investment

property or for repairs, maintenance or enhancements.
2.8.2 Fair value model disclosures

Where the fair value model is applied, the following must be disclosed in addition
to the general disclosures listed above:
(a)
Whether, and in what circumstances, property interests held under

operating leases are classified as investment property; and
(b)
A reconciliation between the carrying amounts of investment property at the

start and end of the period which details:
Additions (from acquisitions, subsequent expenditure and business
combinations)
Assets classified as held-for-sale
Net gains or losses from fair value adjustments
Net exchange differences arising on translation of financial statements
into a presentation currency
Transfers to and from inventories and owner-occupied property
Other changes.
Where the fair value model is applied but an investment property is measured
using the cost model because its fair value cannot be measured reliably, a
description of the property must be provided together with an explanation of why
the fair value cant be measured reliably and if possible a range of estimates
within which the fair value is highly likely to lie.
2.8.3 Cost model disclosures
Where the cost model is applied, the following must be disclosed in addition to the
general disclosures listed above:
(a)
126
The depreciation methods used and useful lives or depreciation rates; and
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(b)
The gross carrying amount and the accumulated depreciation at the

beginning and end of the period; and
(c)
A reconciliation between the carrying amounts of investment property at the

start and end of the period which details:
Additions (from acquisitions, subsequent expenditure and business
combinations)
Assets classified as held-for-sale
Depreciation
Impairment losses recognised and reversed
Net exchange differences arising on translation of financial statements
into a presentation currency
Transfers to and from inventories and owner-occupied property
Other changes.
(d)
The fair value of the investment property, or if this cannot be reliably

measured, a description of the property, an explanation of why the fair value
cant be measured reliably and if possible a range of estimates within which
the fair value is highly likely to lie.
QUESTION
Investment property disclosure
Matara Developments PLC owns 2 properties within the city of Matara which are
let out to tenants under operating leases. The company has classified these
properties as investment properties and has elected to apply the LKAS 40 fair
value model. The following information is relevant to the year ended
31 December 20X3:
The properties generated rental income of Rs. 2 million during the year;
repairs, maintenance and other operating expenses amounted to Rs. 250,000.
One of the properties was transferred from owner-occupied property part way
through the year. At the date of the transfer the fair value of the property was
Rs. 13 million. At the end of the year the fair value of the property was
Rs. 13.8 million.
The other property has been investment property for a number of years. At the
start of the year it had a fair value of Rs. 16 million and this had increased to
Rs. 17.4 million by the end of the year.
All fair values are determined by an external company, Valuation Experts (Pte)
Ltd.
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127
Both investment properties are held as security by Matara Developments bank

in respect of general borrowings.
Required
Develop draft investment property disclosures for the financial statements of
Matara Developments PLC.
ANSWER
Accounting policies
Investment property, which is property held to earn rentals and/or for capital
appreciation (including property under construction for such purposes) is stated
at its fair value at the reporting date. Gains or losses arising from changes in the
fair value of investment property are included in profit or loss for the period in
which they arise.
Investment property
Fair value
At 1 January 20X3
Increase in fair value in the year (0.8 Mn + 1.4 Mn)
Transferred from property, plant and equipment
At 31 December 20X3
Rs'000
16,000
2,200
13,000
31,200
The fair value of the companys investment property at 31 December 20X3 has
been arrived at on the basis of a valuation carried out by Valuation Experts (Pte)
Ltd., independent valuers not connected with the Company. The valuation was
arrived at by reference to market evidence of transactions for similar properties.
The Company has pledged all of its investment property to secure general banking
facilities granted to the Company.
The property rental income earned by the Company from its investment property,
all of which is leased out under operating leases amounted to Rs. 2 million. Direct
operating expenses arising on the investment property in the period amounted to
Rs. 250,000.
QUESTION
Mandalay Plantations (Pvt) Ltd owns significant amounts of land, much of which
has been held for more than 20 years. The company applies the cost model of
LKAS 16 to account for the land. The management of Mandalay Plantations (Pvt)
Ltd is currently developing an expansion strategy and wants to borrow funds from
a number of banks to fund this. In order to make Mandalay Plantations seem a
128
CA Sri Lanka
more attractive proposition to lenders, the management is considering adopting

the revaluation model.
Required
(a)
Explain why adopting the revaluation model may not be a good decision for
the company
(b)
Advise why an upwards revaluation is recognised as other comprehensive

income.
ANSWER
(a)
The company owns land purchased several years ago and held at cost; it is
therefore likely to be the case that the carrying amount of land is
significantly less than its current market value.
By adopting the revaluation model for land, management will immediately
boost net assets, which may make the company a more attractive
proposition to lenders. In particular the level of security available (in the
form of land) will be immediately obvious to lenders.
It is however important to remember that regardless of whether an
accounting revaluation is recognised, land is worth its market value. Most
lenders understand this and will perform their own valuation exercise for
the purposes of identifying the level of security available.
The management should also realise that by adopting the revaluation model,
they are committing the company to the requirements of LKAS 16, namely
that:
the revaluation model is applied to all assets in the same class (ie there is
no option to apply the model only to assets that have increased
significantly in value)
revaluations must be kept up to date such that carrying amount is not
significantly different from fair value.
These requirements make the revaluation model a costly and time
consuming accounting option. There is also the possibility that some more
recently acquired land may have fallen in value since purchase. In this case
there would be a requirement to recognise an impairment in profit or loss.
(b)
CA Sri Lanka
A revaluation surplus is recognised as other comprehensive income and

accumulated in a revaluation reserve. The only exception to this rule is
where an upwards revaluation reverses a previous downwards revaluation
(impairment) recognised in profit or loss. In this case the surplus is first
129
recognised in profit or loss to the extent that a downwards revaluation was

recognised.
A revaluation surplus is generally recognised in other comprehensive
income because it is an unrealised gain ie a gain that is not the result of a
completed transaction. It would therefore mislead users of the financial
statements to recognise the gain in profit; this may lead investors to believe
that additional profits were available for distribution.
QUESTION
JB Investments PLC acquired a retail park in Colombo on 1 January 20X3 for
Rs. 190 Mn and immediately leased it to tenants. The property is held under the
LKAS 40 cost model and depreciated over 40 years. At 31 December 20X5, the
management of JB Investments PLC decided that application of the LKAS 40 fair
value model would result in more reliable and relevant information in the
financial statements. The fair value of the property at each year end since
acquisition was:
31.12.X3 Rs. 198 Mn
31.12.X4 Rs. 204 Mn
31.12.X5 Rs. 205 Mn
Reported profit for the year in 20X4 was Rs. 110 Mn and draft profit for 20X5 was
Rs. 117 Mn.
Required
Draft extracts from the financial statements of JB Investments PLC for the year
ended 31 December 20X5 in respect of the property. Your answer should reflect
the LKAS 1 requirements in respect of comparative figures.
ANSWER
A change from the cost model to the fair value model is a change in accounting
policy. LKAS 8 requires that this is accounted for retrospectively (as if the fair
value model had always been applied).
130
CA Sri Lanka
Adjustments are calculated as follows:

Year ended
Cost model
Rs'000
190,000
Cost
(4,750)
Depreciation /
FV gain or loss
185,250
31.12.X3
(4,750)
Depreciation /
FV gain or loss
180,500
31.12.X4
(4,750)
Depreciation /
FV gain or loss
175,750
31.12.X5
Fair value model

Rs'000
190,000
8,000
Adjustment
Rs'000
12,750
198,000
6,000
10,750
204,000
1,000
5,750
205,000
Statement of financial position (extracts) at
Investment property
31.12.X5
Rs'000
205,000
31.12.X4
Rs'000
204,000
Statement of profit or loss (extracts) for the year ended
Gain on remeasurement of investment

property
31.12.X5
Rs'000
1,000
31.12.X4
Rs'000
6,000
Statement of changes in equity (extracts)
At 1.1.X4
Prior period adjustment
As restated
20X4 profit (110 + 10.75)
At 1.1.X5
20X5 profit (117 + 5.75)
At 31.12.X5
CA Sri Lanka
Retained earnings
Rs'000
X
12,750
X
120,750
X
122,750
X
131
CHAPTER ROUNDUP
Two standards are relevant to property, plant and equipment; both have been
covered in detail at KB1 and KE1 levels. The standards are LKAS 16 Property,
Plant and Equipment and LKAS 23 Borrowing Costs.
LKAS 16 requires that PPE is initially measured at cost and subsequently using
the revaluation or the cost model.
LKAS 23 requires that eligible borrowing costs are capitalised within the cost
of qualifying assets.
PPE with the exception of land is depreciated over its useful life.
Investment property
132
Investment property is property that is held to earn rentals/for capital

appreciation rather than for use or sale in the ordinary course of business.
Initial measurement is at cost including transaction costs; subsequently an

entity may choose to apply either the cost model or the fair value model with
the same model applied to all investment property.
Under the cost model investment property is measured at depreciated cost less
impairment losses; under the fair value model investment property is remeasured to fair value at each reporting date with gains and losses
Where investment property is measured at fair value transfers in from

PPE/inventories are remeasured to fair value on transfer.
An investment property is derecognised on disposal or when it is permanently

withdrawn from use and no future economic benefits are expected from its
disposal. The difference between carrying amount and proceeds is recognised in
profit or loss
LKAS 40 requires a number of general disclosures together with additional

disclosures depending on whether the fair value model or cost model is applied.
CA Sri Lanka
PROGRESS TEST
Where a property is part owner-occupied and part let out under operating leases,
what accounting standard applies?
What adjustment is required on the transfer of an item of inventory to investment

property under the fair value model?
CA Sri Lanka
133
134
If the parts are separable, LKAS 16 applies to the owner-occupied portion and
LKAS 40 applies to the portion that is rented out. If the parts are not separable,
LKAS 40 is applied to the whole property only where the owner-occupied portion
is insignificant.
The property is remeasured to fair value on the transfer with any gain or loss
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises LKAS 38 Intangible Assets and SIC 32 Intangible
Assets Website Costs. You have studied both of these at KB1 level.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

Standards.
treatments.
circumstances.
reporting.
statements.
135
KC1 | Chapter 5: Intangible assets
CHAPTER CONTENTS
1 LKAS 38 Intangible Assets
2 SIC 32 Intangible Assets Website Costs

Advise the conditions to be satisfied to recognise an intangible asset.
Evaluate given set of information to ascertain whether an intangible asset could
be recognised.
Assess cost of an internally generated intangible asset.
Develop the disclosures to be made in respect of intangible assets.
1 LKAS 38 Intangible Assets

Intangible assets are non-monetary assets without physical substance; they
are recognised if this definition and the LKAS 38 recognition criteria are met.
They are initially measured at cost and subsequently under the cost or rarely
This section revises a standard that you studied at KB1, LKAS 38 Intangible Assets.
LKAS 38 defines intangible assets and provides the recognition criteria,
measurement bases and disclosure requirements for these assets. It applies to
intangible assets other than:
(a)
those within the scope of another standard (such as deferred tax assets,
lease receivable assets, employee benefits assets and goodwill acquired in a
business combination)
(b)
financial assets
(c)
exploration and evaluation assets
(d)
expenditure on the development and extraction of minerals, oil, natural gas.
1.1 Definition
An intangible asset is an identifiable non-monetary asset without physical
substance.
An asset is a resource:
(a)
136
controlled by the entity as a result of events in the past, and

CA Sri Lanka
(b)
something from which the entity expects future economic benefits to flow.
Monetary assets are money held and assets to be received in fixed or

determinable amounts of money.
1.2 Recognition
An intangible asset is recognised if, and only if it meets the definition of an
intangible asset given above and both of the following criteria are met:
(a)
It is probable that the future economic benefits that are attributable to the
asset will flow to the entity, and
(b)
The cost can be measured reliably.
The following table summarises the criteria that must be met before an item is
capitalised as an intangible:
Identifiable
An asset is identifiable if:

It is separable (capable of sale/transfer either alone
or with a related contract or asset/liability) OR
It arises from contractual or other legal rights.
CA Sri Lanka
Controlled by entity
The asset is under the control of the entity as a result of

a past event; the entity can enjoy the economic benefits
of the asset and prevent others from accessing those
benefits.
Future economic
benefits
The asset must result in expected future economic

benefits for example from the sale of products or
services or a reduction in expenditure.
Probable economic
benefits
The expected future economic benefits must be

probable. Such an assessment requires judgement and
external evidence should be sought. This criterion is
always considered to be satisfied for intangible assets
acquired in a business combination.
Reliable
measurement
The cost of the asset must be able to be measured

reliably.
137
QUESTION
Recognition of intangible assets
The new financial controller of Gin Traders Ltd is from a country where IFRS as
converged with SLFRS are not applied. She is unsure of the requirements of LKAS
38 and has asked for your advice as to whether an intangible asset should be
recognised in each of the following cases:
(a)
Gin Traders has an extensive customer list that it has built up for a new
product line over the last year. Employee timesheets reveal that the staff cost
of contacting new potential customers and compiling the list amounts to
Rs. 68,000.
(b)
The financial controller feels that the name Gin Traders is sufficiently well
known and respected that an element of goodwill should be capitalised in
the statement of financial position. She has suggested an amount of
Rs. 150,000, being the amount recognised when a large conglomerate
acquired one of Gin Traders competitors recently.
(c)
Gin Traders has acquired a brand, Supastick from a competitor at a cost of

Rs. 80,000. SupaStick is an extra strong glue formula that can be used instead
of nails. The brand has strong sales and the formula is patent-protected. The
acquisition cost includes transfer of the patent protection.
Required
Advise the new financial controller whether the items of expenditure listed may
be recognised as an intangible asset in accordance with LKAS 38.
ANSWER
138
(a)
The customer list is an internally generated item rather than a purchased

item. It is likely to meet the requirement to be identifiable as such a list may
be sold to a competitor. The benefit of the list is, however, unlikely to be
controlled by Gin Traders. This is because an entity cannot control the
actions of its customers; those customers may choose to transfer their
custom elsewhere. Rs. 68,000 is not recognised as an intangible; instead it is
recognised in profit or loss. This conclusion is in line with LKAS 38 which
specifically prohibits the recognition of a customer list as an asset.
(b)
LKAS 38 prohibits the recognition of internally generated goodwill. Goodwill

is not an identifiable asset, nor is it controlled by an entity as a result of a
past event. In addition, internally generated goodwill is not capable of
reliable measurement; Gin Traders is a different company to its competitor
and therefore the Rs. 150,000 recognised in that case is not appropriate
here.
CA Sri Lanka
(c)
The brand is an acquired intangible asset. Where an intangible asset is

acquired separately it is, by definition, identifiable. Such an asset is also
within the control of the acquiring entity as a result of a past event. The
acquisition of the asset is normally because there is an expectation of future
economic benefits. Cost can be measured reliably as the purchase price.
Therefore the brand SupaStick is recognised in Gin Traders' statement of
financial position initially at its cost of Rs. 80,000.
1.3 Measurement
LKAS 38 provides guidance on the initial and subsequent measurement of
intangible assets. Subsequent measurement is based on the cost or revaluation
model.
1.3.1 Initial measurement
An intangible asset that meets the recognition criteria is initially measured at cost:
Separately acquired in
cash transaction
Cost includes purchase price and the directly

attributable costs of preparing the asset for its
intended use, including:
Costs of employee benefits arising directly from
bringing the asset to its working condition
Professional fees arising directly from bringing the
asset to working condition, and
Costs of testing whether the asset is functioning
properly.
Cost does not include the costs of introducing a new
product or service, the costs of conducting business in
a new location or with a new customer or
administration and general overhead costs.
Separately acquired in
exchange transaction
CA Sri Lanka
Cost is the fair value of the intangible asset acquired

unless the exchange transaction lacks commercial
substance or the fair value of the assets in the
exchange transaction cannot be measured reliably. In
this case cost is the carrying amount of the asset given
up.
139
Acquired in business
combination
Cost is the fair value of the asset at the acquisition

date.
Internally generated
Cost includes those costs incurred after the

recognition criteria are met (see section 1.4).
An asset may be acquired free of charge or for a nominal amount by way of

government grant. Examples of intangible assets acquired by way of a government
grant are airport-landing rights, licences to operate radio stations and import
licences. In this case an entity may choose to recognise the intangible asset and the
grant at fair value initially. If the entity does not choose to do this, it recognises the
asset initially at its nominal amount plus any expenditure that is directly
attributable to preparing the asset for its intended use.
1.3.2 Subsequent measurement: the cost model
The cost model requires that an intangible asset is carried at its cost, less any
accumulated amortisation and less any accumulated impairment losses.
The useful life of an intangible asset may be finite or indefinite.
The useful life of an intangible asset is determined by taking into account
factors such as product life cycles, obsolescence and expected competitor
actions. It should be reviewed at each reporting date.
The useful life of an asset arising from contractual or other legal rights should
not exceed the period of the rights.
Amortisation starts when the asset is available for use and ceases at the earlier
of classification as held for sale or derecognition.
The amortisation pattern should reflect the pattern in which the assets future
economic benefits are consumed. The straight line basis can be used where
such a pattern cant be predicted reliably. Amortisation method should be
reviewed at each reporting date.
The residual value of an intangible asset is assumed to be zero unless a third
party is committed to buying the intangible asset at the end of its useful life or
unless there is an active market for that type of asset (so that its expected
residual value can be measured) and it is probable that there will be a market
for the asset at the end of its useful life.
Where the life is indefinite the asset is not amortised but the useful life is
reviewed annually and the asset is tested for impairment annually.
140
CA Sri Lanka
1.3.3 Subsequent measurement: the fair value model

The revaluation model allows an intangible asset to be carried at a revalued
amount, which is its fair value at the date of revaluation, less any subsequent
accumulated amortisation and any subsequent accumulated impairment losses.
The revaluation model can only be applied to assets for which fair value can be
measured reliably by reference to an active market in that type of asset.
An active market is a market in which transactions for the asset take place with
sufficient frequency and volume to provide pricing information on an on-going
basis.
The entire class of intangible assets of that type must be revalued at the same
time.
If an intangible asset in a class of revalued intangible assets cannot be revalued
because there is no active market for this asset, the asset should be carried at
its cost less any accumulated amortisation and impairment losses.
Revaluations should be made with such regularity that the carrying amount
does not differ from that which would be determined using fair value at the end
of the reporting period.
Where an intangible asset is revalued upwards to a fair value, the amount of the
revaluation should be credited to other comprehensive income and
accumulated in a revaluation reserve in equity (unless it is a reversal of a
revaluation decrease that was previously charged against income, in which case
the increase can be recognised as income).
The amortisation charge per annum will increase after an upwards revaluation,
and the excess over historical cost amortisation can be transferred annually
from the revaluation reserve to retained earnings.
Where the carrying amount of an intangible asset is revalued downwards, the
amount of the downwardrevaluation should be charged as an expense against
income (unless the asset has previously been revalued upwards in which case
the decrease is first recognised as other comprehensive income and charged
against any previous revaluation surplus in respect of that asset).
1.4 Research and development

LKAS 38 assesses all internally generated intangible assets by classifying them as
either research or development.
Research is original and planned investigation undertaken with the prospect of
gaining new scientific or technical knowledge and understanding.
CA Sri Lanka
141
Research costs do not meet the criteria for recognition as the research phase of
a project is too distant from an inflow of economic benefits. They are written off
as an expense as incurred.
Development is the application of research findings or other knowledge to a
plan or design for the production of new or substantially improved materials,
devices, products, processes, systems or services before the start of commercial
production or use.
Development costs are capitalised as an intangible asset if all of the following
criteria are met:
(a) The technical feasibility of completing the intangible asset so that it will be
available for use or sale.
(b) Its intention to complete the intangible asset and use or sell it.
(c) Its ability to use or sell the intangible asset.
(d) How the intangible asset will generate probable future economic benefits.
Among other things, the entity should demonstrate the existence of a
market for the output of the intangible asset or the intangible asset itself or,
if it is to be used internally, the usefulness of the intangible asset.
(e) Its ability to measure the expenditure attributable to the intangible asset
during its development reliably:
An internally generated intangible asset (development) is initially
recognised at cost being the costs that can be directly attributed or
allocated on a reasonable and consistent basis to creating, producing or
preparing the asset for its intended use.
Only those costs incurred after all recognition criteria are met are
capitalised.
Earlier expenditure is not retrospectively recognised.
Subsequently an internally generated intangible asset is measured using
the cost or revaluation model as discussed in the previous section.
QUESTION
Measurement of intangible assets
SL Foods Ltd owns and operates a number of food outlets, half of which are
operated by SL Foods under franchise from a global company Pizza Pie Co. The
other outlets operate under the name Fresh, which SL Foods Ltd started a
number of years ago.
142
CA Sri Lanka
SL Foods Ltd has incurred the following expenses in the year ended 31 December
20X4 and wishes to know which can be recognised as intangible assets in the
statement of financial position:
1.
Franchise fees paid to Pizza Pie Co for the use of the trading name Pizza Pie
Co for a new outlet.
2.
Training costs for staff at the new Pizza Pie outlet.
3.
Advertising costs incurred prior to the opening of the new Pizza Pie outlet.
4.
The cost of a new accounting software package.
5.
Costs incurred in developing a chiller process to ensure that the salads sold
at Fresh outlets remain crisp. This process is expected to be implemented by
20X6. Testing indicates that it will cut wastage as salads will last longer.
6.
The costs of testing the chiller process.
7.
The salaries of staff involved in the chiller process development project.
8.
A share of the general overheads (eg rent and depreciation) of the

Innovation department as an allocation to the chiller process development
project.
9.
A share of administrative overheads as an allocation to the chiller process

development project.
Required
Advise the management of SL Foods Ltd which costs can be capitalised as an
intangible asset.
ANSWER
CA Sri Lanka
1.
Franchise fees meet the definition of an intangible asset as they are

identifiable (evidenced by their separate acquisition) and result in a benefit
(a revenue stream) that is controlled by SL Foods as a result of a past event
(the acquisition). It is assumed that SL Foods would not have paid the fees if
economic benefit were not probable; the fee provides evidence of reliable
measurement.
2.
Training costs must be expensed. The benefit of training costs is not

controlled by SL Foods as the staff that it has trained may leave the company.
3.
Advertising costs are the costs of introducing a new product or service; LKAS
38 specifically prohibits these costs forming part of an intangible asset.
4.
Accounting software is a separately acquired intangible asset. All recognition

criteria are met and it is capitalised at cost.
143
5.
This is a project in development phase; based on the information provided,

the project is technically feasible, SL Foods can and does intend to complete
the project and the project will result in cost savings. Therefore provided
that the related costs can be measured reliably they should be capitalised.
Capitalisation of costs is not allowed before all recognition criteria are met.
6.
Testing costs are an example of development costs and these should be

capitalised as described above.
7.
Staff costs are also part of the development costs and should be capitalised
as described above.
8.
An allocation of the overheads of the Innovation department do form part of

the development costs to be capitalised, as these are directly attributable
costs.
9.
General overheads are not directly attributable costs and should be

expensed.
1.5 Disclosure
LKAS 38 requires a number of general disclosures together with additional
disclosures about research and development expenditure and intangible assets
measured using the revaluation model.
1.5.1 General disclosures
An entity must disclose the following for each class of intangible assets,
distinguishing between those that are internally generated and those that are not:
144
(a)
Whether useful lives are indefinite, and where this is not the case, the
amortisation rates and methods used.
(b)
The gross carrying amount and accumulated amortisation at the start and
end of the period.
(c)
The line item in the statement of profit or loss in which amortisation is

included.
(d)
A reconciliation of the carrying amount at the start and end of the period
showing additions, assets classified as held for sale, revaluation increases
and decreases, impairment losses recognised and reversed, amortisation,
exchange differences and other changes.
CA Sri Lanka
In addition the following must be disclosed:

(a)
The carrying amount of any intangible asset with an indefinite useful life and
the reasons supporting the assessment of an indefinite life.
(b)
A description, the carrying amount and remaining amortisation period of

any material intangible asset.
(c)
For intangible assets acquired by way of government grant and recognised

initially at fair value:
The fair value initially recognised
Their carrying amount
Whether the cost or revaluation model is applied
(d)
The existence and carrying amounts of intangible assets with restricted title
/ pledged as security for liabilities.
(e)
The amount of contractual commitments for the acquisition of intangible

assets.
1.5.2 Research and development expenditure

An entity should disclose the aggregate amount of research and development
expenditure recognised as an expense in the period.
1.5.3 Revaluation model disclosures
If intangible assets are accounted for at revalued amounts, the following must be
disclosed:
(a)
By class of intangible assets:

(i)
the effective date of the revaluation
(ii)
the carrying amount of revalued intangible assets
(iii) the carrying amount that would have been recognised if the cost model
were applied.
(b)
CA Sri Lanka
The amount of the revaluation surplus that relates to intangible assets at the
start and end of the period indicating changes in the period and restrictions
on the distribution of the balance to shareholders.
145
1.5.4 CASE STUDY: Intangible assets disclosure note

The following is an extract from the accounting policies note and intangible assets
note of the DCSL Group Annual Report of 2012/2013.
3 Significant Accounting Policies (contd.)
3.5 Intangible Asset
An intangible asset is recognised if it is probable that future economic benefits will
flow to the entity and the cost of the asset can be measured reliably in accordance
with LKAS 38 on Intangible Assets.
Intangible assets with finite useful lives are measured at cost less accumulated
amortisation and accumulated impairment losses.
3.5.1 Goodwill
Goodwill represents the excess of the cost of acquisition over the fair value of
Groups share of the net identifiable assets of the acquired Subsidiary at the date
of acquisition. Goodwill acquired in a business combination is tested annually for
impairment or more frequently if events or changes in circumstance indicate that
it might be impaired and carried at cost less accumulated impairment losses.
Impairment losses on goodwill are not reversed.
Goodwill is allocated to cash generating units for the purpose of impairment
testing. The allocation is made to those cash generating units or groups of loan
generating units that are expected to benefit from the business combination in
which goodwill arose.
3.16.2 Intangible Assets
3.16.2.1 License Fees and Access Rights
Separately acquired licences and access rights are shown at historical cost.
Expenditures on license fees and access rights that is deemed to benefit or relate
to more than one financial year is classified as intangible assets and is being
amortised over the agreement period on a straight line basis.
3.16.2.2 Amortisation
Amortisation is recognised in profit or loss on a straight line basis over the
estimated useful lives of intangible assets from the date that they are available for
use. The estimated useful lives for the current and comparative periods are as
follows:
Computer software
FLAG access rights
Licenses
146
3 5 years
15 years
10 years
CA Sri Lanka
15 Intangible Assets
GROUP
As at 31 March,
License Fees
FLAG Cable
Software Cost &
Implementation
Total
Notes
COMPANY
2013
2012
Rs'000
215,895
2,113,785
33,647
As at
1 April
2011
Rs'000
79,248
2,300,302
25,866
Rs'000
17,277
Rs'000
16,061
2,405,416
17,277
16,061
16,061
2013
2012
15.1
15.2
15.3
Rs'000
353,225
1,927,268
35,813
2,316,306
2,363,327
As at
1 April
2011
Rs'000
16,061
15.2 Flag Cable
Cost
Balance at the beginning
of the year
Additions during the year
Balance at the end of the
year
Accumulated
Amortisation
Balance at the beginning
of the year
Amortised during the year
Balance at the end of the
year
Net book value
2013
Rs'000
GROUP
2012
Rs'000
2011
Rs'000
2,797,761
2,797,761
2,797,761
2,797,761
2,797,761
2,797,761
683,976
497,459
310,942
186,517
870,493
186,517
683,976
186,517
497,459
1,927,268
2,113,785
2,300,302
2 SIC 32 Intangible Assets Website Costs

SIC 32 Intangible Assets Website Costs is related to intangible assets.
SIC 32 Intangible Assets Website Costs addresses the issue of how to account for
the internal costs of developing and operating a website and in particular whether
the website is an intangible asset.
Note that certain associated costs are outside the scope of the Interpretation:
Hardware such as web servers are property, plant and equipment within the
scope of LKAS 16.
Hosting costs are an expense accounted for as service is received.
CA Sri Lanka
147
2.1 Recognition criteria

SIC 32 states that a website is recognised as an intangible asset if:
1.
It is probable that future economic benefits will flow to the entity, and
2.
The cost of the asset can be measured reliably, and
3.
The recognition criteria associated with development costs are met, ie:
Completion of the intangible asset is technically feasible
The entity intends to complete the website and use it
The entity can use the website
The entity can demonstrate how the website will generate economic
benefits
There are adequate resources to complete the website
Expenditure attributable to the website during development can be
measured reliably.
In respect of the requirement to demonstrate how the website will generate

economic benefits, SIC 32 states:
1.
The requirement is met when a website is capable of generating revenue by

allowing on line orders to be placed
2.
The requirement is not met when a website is developed solely as an

advertising or promotional tool.
Therefore the costs of developing a website that is not capable of taking orders
and is simply an advertising tool are recognised as an expense.
2.2 Application of recognition criteria

SIC 32 states that the development of a website can be split into 4 stages; a fifth
stage is the operating stage when the website is complete. The recognition criteria
apply to each of these stages as follows:
Planning stage
Expenditure recognised as an expense when

incurred.
Application and
infrastructure development
stage
Where content is developed for purposes other than

to advertise products or services, expenditure is
recognised as an intangible when the expenditure
can be attributed to preparing the website for its
intended use.
Graphical design stage

Content development stage
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To the extent that content is developed to advertise

products or services (eg photographing products),
associated costs are expensed when services are
received.
Operating stage
Expenditure recognised as an expense unless it

meets the LKAS 38 definition and recognition
criteria for an intangible asset.
After initial recognition, a website intangible asset is measured in accordance with

LKAS 38. The useful life of the asset should be short.
QUESTION
1
Speak is a telecommunications company that incurred the following

expenditure during the year to 31 December 20X0.
1.1.X0
Acquired a patent for Rs 1.2 Mn. The patent has ten years left
to run at the date of acquisition.
31.3.X0
Spent Rs. 2.5 Mn on an advertising campaign to maintain the

value of the company's main brand, Connect-U-Up.
31.12.X0
Paid Rs. 6.5 Mn to acquire a licence to supply broad band

communications support to off-shore oil platforms. This
licence was acquired in open competition and is readily
marketable.
31.12.X0
The company has spent significant amounts of money in

training its workforce and building a customer base. The
directors estimate that this has generated goodwill in the
business of Rs. 9.5 Mn.
Required
Assess the carrying amount of intangible assets to be recognised in the
statement of financial position at 31 December 20X0.
2
HeadsApp Ltd develops apps for smartphones and tablet devices. At

31 December 20X4, 64% of HeadsApps total assets are represented by the
capitalised costs of the internal development and production of such apps.
These assets are measured at historical cost. They are not amortised as they
are considered to have an indefinite useful life, but they are tested for
impairment when indicators of impairment are identified.
Periodically HeadsApp is required to update its apps to improve their
performance, fix problems and ensure continued compatibility with
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operating systems. The costs of doing this are expensed to profit or loss for
the year.
Required
Discuss the accounting treatment applied by HeadsApp Ltd.
ANSWER
1
Patent
The patent is a purchased intangible and therefore the recognition criteria
are met. It is capitalised at its cost of Rs. 1.2 Mn. At 31 December 20X0 one
year's amortisation should be provided giving a carrying amount of
Rs. 1.08 Mn.
Advertising
Advertising expenditure is purchased, however the question arises as to
whether it meets the definition of an intangible asset. LKAS 38 is clear that
although future economic benefits are provided, no intangible asset is
created. Therefore this expenditure is recognised as an expense when
incurred.
Licence
The licence is a separately acquired intangible asset and as such is
capitalised at its cost of Rs. 6.5 Mn. As the licence is readily marketable it
may have an active market. Therefore there may be scope to apply the
revaluation model to this asset.
Training and goodwill
The costs of training cannot be capitalised as an intangible asset as they do
not meet the definition of an asset; specifically the benefit is not controlled
by the entity as employees may leave their employment at any time.
Additionally, LKAS 38 is clear that internally generated goodwill cannot be
recognised as an asset.
Therefore the carrying amount of intangible assets at the reporting date is
Rs. 7.58 Mn.
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LKAS 38 Intangible assets allows internally developed intangibles such as the

apps to be capitalised provided certain criteria (technological feasibility,
probable future benefits, intent and ability to use or sell the software,
resources to complete the software, and ability to measure cost) are met. It is
assumed, in the absence of information to the contrary, that they have;
accordingly HeadsApps treatment is correct in this respect.
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As regards subsequent measurement, LKAS 38 requires that an entity must

choose either the cost model or the revaluation model for each class of
intangible asset. HeadsApp has chosen cost, and this is acceptable as an
accounting policy. It is unlikely that the revaluation model would be
available in this case as each app will be unique ie there is not an active
market in apps that could be used as reference to establish revalued
amounts.
Intangible assets may have a finite or an indefinite useful life. LKAS 38 states
that an entity may treat an intangible asset as having an indefinite useful life,
when, having regard to all relevant factors there is no foreseeable limit to the
period over which the asset is expected to generate net cash inflows for the
entity. Indefinite is not the same as infinite. Computer software is
mentioned in LKAS 38 as an intangible that is prone to technological
obsolescence and whose life may therefore be short. Its useful life should be
reviewed each reporting period to determine whether events and
circumstances continue to support an indefinite useful life assessment for
that asset. If they do not, the change in the useful life assessment from
indefinite to finite should be accounted for as a change in an accounting
estimate.
The asset should also be assessed for impairment using the guidance in LKAS
36 Impairment of assets. Specifically, LKAS 38 requires that an entity must
test an intangible asset with an indefinite life for impairment annually, and
whenever there is an indication that the asset may be impaired. HeadsApp is
currently only testing for impairment when there are indications of
impairment; this is incorrect. The asset is tested for impairment by
comparing its recoverable amount with its carrying amount.
HeadsApp is correct to expense the maintenance costs. These should not be
capitalised as they do not enhance the value of the asset over and above the
original benefits.
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CHAPTER ROUNDUP
152
Intangible assets are non-monetary assets without physical substance.
They are recognised if this definition and the LKAS 38 recognition criteria are
met.
They are initially measured at cost and subsequently under the cost or rarely
Internally generated intangible assets are classified as either research or

development.
Research costs are expensed as incurred; development costs are capitalised if

the LKAS 38 criteria are met.
SIC 32 requires that the LKAS 38 recognition criteria for development costs are
applied to the costs of developing a website.
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PROGRESS TEST
What are the three elements of the definition of an intangible asset?
What are the LKAS 38 recognition criteria applicable to an intangible asset?
Over what period is an intangible asset amortised?
The costs of developing a website that is not capable of generating on line sales
may be capitalised if certain criteria are met. True or false?
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154
It must be Identifiable, Controlled by the entity as a result of a past event and

result in expected future economic benefits.
In order to be recognised the intangible must result in probable future economic

benefits and be capable of reliable measurement.
Over its useful life if that useful life is finite; otherwise it is not amortised.
False. Only the costs of developing a website that can generate revenue may be
capitalised (if the relevant criteria are met).
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CHAPTER
INTRODUCTION
In this chapter we revise the requirements of LKAS 36 Impairment of
Assets. This standard is relevant to a number of types of assets including
property, plant and equipment and intangible assets. It is not relevant to
financial assets; LKAS 39 provides detailed impairment rules for these
assets
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

Standards.
treatments.
circumstances.
reporting.
statements.
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KC1 | Chapter 6: Impairment of assets
CHAPTER CONTENTS
1 LKAS 36 Impairment of Assets
2 Cash-generating units
3 Disclosure
LKAS 16 Learning objective

Critically analyse impairment indicators and impairment of property, plant and
equipment.
LKAS 38 Learning objective
Assess whether an intangible asset is impaired.
Advise on the criteria to be considered when identifying CGUs.
Recommend the accounting treatment to be used in allocating goodwill amount
to assets included in CGU.
Assess the impairment loss of individual asset and CGU.
Evaluate a given situation and determine the impairment status of an asset.
Design appropriate disclosures to be made with respect to impairment.
Recommend how to reverse an impairment loss of an individual asset, goodwill
and a CGU.
Assess the impairment loss to be reversed for an individual asset, goodwill and
a CGU.
1 LKAS 36 Impairment of Assets

Assets should not be carried above their recoverable amount. An impairment
loss is recognised in profit or loss where carrying amount exceeds recoverable
amount.
1.1 Scope of LKAS 36 Impairment of Assets

LKAS 36 applies to all tangible, intangible and financial assets except for:
Inventories
Assets arising from construction contracts
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Deferred tax assets

Assets arising under LKAS 19 Employee benefits
Financial assets within the scope of LKAS 32 Financial instruments: presentation
Investment property measured at fair value (LKAS 40)
Biological assets measured at fair value less costs to sell (LKAS 41)
Non-current assets held for sale, which are dealt with under SLFRS 5 Noncurrent assets held for sale and discontinued operations
1.2 Definitions
LKAS 36 provides the following definitions:
An impairment loss is the amount by which the carrying amount of an asset or
cash-generating unit exceeds its recoverable amount.
Carrying amount is the amount at which an asset is recognised after deducting
any accumulated depreciation (amortisation) and accumulated impairment losses
thereon.
Recoverable amount is the higher of an assets fair value less costs of disposal
and its value in use.
measurement date.
Costs of disposal are incremental costs directly attributable to the disposal of an
asset or cash-generating unit excluding finance costs and income tax expense.
Value in use is the present value of the future cash flows expected to be derived
from an asset or cash-generating unit.
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1.3 Approach to impairment testing

The following flowchart provides an overview of LKAS 36 and the approach to
impairment:
Does the asset require
annual impairment
testing?
No
Are there indicators of

impairment?
(section 1.4)
Yes
Yes *
No
Can recoverable amount

be determined for the
individual asset (is it
capable of generating
cash flows alone
No impairment test
required
No
Yes
Perform impairment test

for the single asset.
Perform impairment test

for the cash generating
unit (CGU) to which the
asset belongs.
(section 1.5)
(section 2)
Recognise any
impairment loss
Recognise any
impairment loss against
assets of the CGU per
LKAS 36 (section 2.3)
(section 1.6)
Disclosure
(section 3)
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*Annual impairment tests are required for:

(a)
(b)
(c)
An intangible asset with an indefinite useful life.

An intangible asset that is not yet available for use.
Goodwill acquired in a business combination.
These assets are first tested at the end of the year in which they were initially
recognised. Thereafter they are tested at the same time every year, however this
need not be at the end of the year. Different intangibles may be tested at different
times.
1.4 Indications of impairment

LKAS 36 states that an entity should assess whether there are indications of
impairment to any of its assets at the end of each reporting period. Indications
may be internal or external and include:
Internal indicators
External indicators
Obsolescence /physical damage to

asset.
Fall in assets market value that

exceeds the fall that would be
expected as a result of normal use /
passage of time.
Adverse changes to the way the asset

is used (eg plans to discontinue the
part of the business that it is used
for).
Worse than expected economic
performance of the asset.
Significant change in the

environment in which the asset is
used (technological, market, legal,
economic).
Worse than budgeted net cash flows

/ operating profit (loss).
Increase in market interest rates

/market rates of return on
investments that is likely to affect the
discount rate used to calculate value
in use.
Significant decline in budgeted net

cash flows / operating profit from
the asset.
The carrying amount of the entitys

net assets exceeding its market
capitalisation.
Higher than budgeted cash flows to

operate / maintain asset.
Operating losses / net cash outflows

when current periods aggregated
with budgeted future periods.
These lists are not exhaustive.
Where there are indications of impairment, an impairment test is carried out.
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1.4.1 Indications of impairment of an investment in a group entity

An investment in a subsidiary, joint venture or associate may be impaired where
the investor recognises a dividend from the investment and there is evidence that:
(a)
The carrying amount of the investment in the separate financial statements

exceeds the carrying amounts of the investees net assets and goodwill in the
consolidated financial statements, or
(b)
The dividend exceeds the total comprehensive income of the investee in the
period in which the dividend is declared.
1.5 The impairment test (single asset)

Testing for impairment involves establishing recoverable amount and comparing
this with carrying amount.
Recoverable amount is the higher of value in use and fair value less costs of
disposal.
Where either value in use or fair value exceeds carrying amount, an asset is not
impaired and there is no need to determine the other amount.
If there is no basis for making a reliable estimate of the fair value of an asset,
value in use is used as recoverable amount.
If there is no reason to expect that value in use materially exceeds fair value
less costs of disposal, fair value less costs of disposal is used as recoverable
amount (eg where an asset is held for disposal).
Where carrying amount exceeds recoverable amount, it is written down to
recoverable amount and an impairment loss is recognised in profit or loss.
1.5.1 Value in use
Value in use is the present value of the future cash flows expected to be generated
by an asset. It must reflect:
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(a)
An estimate of the future cash flows the entity expects to derive from the
asset.
(b)
Expectations about possible variations in the amount and timing of future

cash flows.
(c)
The time value of money.
(d)
The price for bearing the uncertainty inherent in the asset.
(e)
Other factors that would be reflected in pricing future cash flows from the
asset.
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Value in use is calculated by:

1. Estimating cash flows to be derived from use and disposal of the asset.
The standard requires that:
(a)
Cash flow projections are based on reasonable and supportable

assumptions.
(b)
Projections of cash flows, normally up to a maximum period of five years, are

based on the most recent budgets or financial forecasts.
(c)
A steady or declining growth rate for each subsequent year (unless a rising
growth rate can be justified) is used in extrapolating short-term projections
of cash flows beyond this period. Unless a higher growth rate can be justified,
the long-term growth rate employed should not be higher than the average
long-term growth rate for the product, market, industry or country.
Include:
Exclude:
Projected cash inflows from

continuing use of the asset.
Cash flows associated with a

future restructuring to which an
entity is not committed.
Projected cash outflows necessary

to generate these cash inflows eg
servicing.
Net cash flows from the disposal
of the asset at the end of its life.
Cash flows associated with

improving the assets
performance.
Cash flows from financing
activities.
Income tax receipts or payments.
2. Discounting these cash flows using an appropriate discount rate

The discount rate should be a current pre-tax rate (or rates) that reflects:
The current assessment of the time value of money, and
The risks specific to the asset.
A rate that reflects current market assessments of the time value of money and the
risks specific to the asset is the return that investors would require if they were to
choose an investment that would generate cash flows of amounts, timing and risk
profile equivalent to those that the entity expects to derive from the asset. This
rate is estimated from:
The rate implicit in current market transactions for similar assets, or
The weighted average cost of capital of a listed entity that has a single asset
which is similar to that under review in terms of service potential and risks.
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161
The discount rate should not include a risk weighting if the underlying cash flows
have already been adjusted for risk. For example, if the discount rate includes the
effect of price increases due to general inflation, future cash flows are estimated in
nominal terms; if the discount rate excludes the effect of price increases due to
general inflation, future cash flows are estimated in real terms.
Foreign currency future cash flows are initially prepared in the currency in
which they will arise and are then discounted using an appropriate rate.
Translation of the resulting figure into the reporting currency should be based on
the spot rate at the year end.
1.5.2 Fair value less costs of disposal
Fair value is established in accordance with the requirements of SLFRS 13 Fair
Value Measurement.
It is the price that would be received to sell an asset or paid to transfer a
measurement date.
LKAS 36 clarifies that costs of disposal may include legal costs, stamp duty and
similar transaction taxes, costs of removing the asset, and direct incremental
costs to bring an asset into condition for its sale. They do not, however, include
termination benefits, nor costs associated with reducing or reorganising a
business following the disposal of an asset.
1.5.3 Intangible assets with an indefinite useful life
These assets are tested annually for impairment.
LKAS 36 allows the most recent detailed calculation of recoverable amount (for a
previous period) to be used where:
The most recently calculated recoverable amount exceeded the assets carrying
amount by a substantial margin, and
Events and circumstances that have occurred since the most recent recoverable
amount calculation have been analysed and there is only a remote likelihood
that recoverable amount if determined now would be less than the assets
carrying amount, and
If the asset is part of a cash generating unit (section 2), the assets and liabilities
making up that unit have not changed significantly since the most recent
recoverable amount calculation.
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1.6 Recognition of impairment loss

Impairment losses are normally recognised in profit or loss as they arise, however
where an impairment loss arises on a revalued asset, the impairment is treated as
a revaluation decrease and first recognised in other comprehensive income and
charged against the revaluation surplus in respect of that asset.
Where the amount of impairment loss exceeds the carrying amount of the asset, a
liability is recognised only if it is required by another standard.
QUESTION
Recognition of impairment loss
Abekoon Traders Ltd acquired its head office on 1 January 20W8 at a cost of
Rs. 5.0 million (excluding land). Abekoon Traders' policy is to depreciate property
on a straight-line basis over 50 years with a zero residual value.
On 31 December 20X2 (after five years of ownership) Abekoon Traders revalued
the non-land element of its head office to Rs. 8.0 million. The company does not
transfer annual amounts out of revaluation reserves as assets are used: this is in
accordance with the permitted treatment in LKAS 16 Property, plant and
equipment.
In January 20X8 localised flooding occurred and the recoverable amount of the
non-land element of the head office property fell to Rs. 2.9 million.
Required
What impairment charge should be recognised in the profit or loss of Abekoon
Traders Ltd arising from the impairment review in January 20X8 according to
LKAS 36 Impairment of assets?
ANSWER
Rs. 700,000
LKAS 36.60 and 61 (also LKAS 16.40) require that an impairment that reverses a
previous revaluation should be recognised through other comprehensive income
to the extent of the amount in the revaluation surplus for that same asset. Any
remaining amount is recognised through profit or loss. Therefore:
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(a)
The carrying amount at 31 December 20X2 is 45/50 Rs. 5.0 Mn = Rs. 4.5 Mn
(b)
The revaluation reserve created is Rs3.5m (ie Rs. 8.0 Mn Rs. 4.5 Mn)
(c)
The carrying amount at 31 December 20X7 is 40/45 Rs. 8.0 Mn = Rs. 7.1 Mn
(d)
The recoverable amount at 31 December 20X7 is Rs. 2.9 Mn
(e)
The total impairment charge is Rs. 4.2 Mn (ie Rs. 7.1 Mn Rs. 2.9 Mn)
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(f)
Of this, Rs. 3.5 million is a reversal of the revaluation reserve, so only Rs. 0.7
million is recognised through profit or loss.
1.7 Subsequent accounting for an impaired asset

The impaired asset continues to be depreciated, with the recoverable amount
written off over the remaining useful life.
Further impairment tests are carried out at any later date where there are
indications of impairment.
1.8 Reversals of impairment losses

A reversal of a previous impairment loss is recognised where:
1.
Recoverable amount of the asset exceeds carrying amount, and
2.
There has been a change in the estimates used to determine the assets
recoverable amount since the last impairment loss was recognised.
The reversal of an impairment loss is recognised by:

DEBIT
CREDIT
Assets carrying amount

Profit or loss
Where the asset is carried at a revalued amount, the reversal of the impairment
loss is treated as a revaluation increase.
The new carrying amount after the reversal cannot be higher than the carrying
amount would have been (after the relevant depreciation) if the original
impairment had not occurred.
Subsequent depreciation is based on the new carrying amount, estimated residual
value and estimated useful life.
2 Cash-generating units
Where the recoverable amount of an individual asset cannot be determined, it
should be tested for impairment as part of the cash-generating unit to which
it belongs.
LKAS 36 provides the following definitions relevant to cash-generating units
(CGUs):
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A cash-generating unit is the smallest identifiable group of assets that generates

cash inflows that are largely independent of the cash inflows from other assets or
groups of assets.
Corporate assets are assets other than goodwill that contribute to the future cash
flows of both the cash-generating unit under review and other cash-generating
units.
2.1 Identifying a cash-generating unit (CGU)

should be tested for impairment as part of the cash-generating unit (CGU) to
which it belongs.
When identifying CGUs, management may consider:
How the entitys operations are managed eg by product line, business or
location
How decisions are made about continuing or disposing of the entitys
operations and assets.
A group of assets is identified as a CGU when an active market exists for the output
produced by the group; this is the case even where some of the output is used
internally.
There are two instances where the CGU of an asset does not have to be considered
in order to determine whether that asset is impaired:
Where the assets fair value less costs of disposal exceeds its carrying amount
(ie there is no impairment), or
Where the assets value in use can be estimated to be close to its fair value less
costs of disposal and fair value less costs of disposal can be measured
A CGU should be identified consistently from period to period for the same asset
unless a change is justified.
QUESTION
Cash generating units 1
Lanka Bus Company provides services under contract with a municipality that
requires a minimum service on each of five routes. Assets devoted to each bus
route and cash flows arising from each route can be identified separately; one of
the routes operates at a significant loss.
The management of the Lanka Bus Company has designated each of the five routes
as a separate CGU for the purposes of impairment testing.
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Required
Comment on the management decision to designate each route as a CGU.
ANSWER
The Lanka Bus Company does not have the option to curtail only one bus route as
the contract with the municipality requires a minimum service on all five routes.
Therefore the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets is
the bus company as a whole.
The management is therefore incorrect to designate each route as a separate CGU.
QUESTION
Cash generating unit 2
Minimart belongs to a retail store chain Maximart. Minimart makes all its retail
purchases through Maximart's purchasing centre. Pricing, marketing, advertising
and human resources policies (except for hiring Minimart's cashiers and
salesmen) are decided by Maximart. Maximart also owns five other stores in the
same city as Minimart (although in different neighbourhoods) and 20 other stores
in other cities. All stores are managed in the same way as Minimart. Minimart and
four other stores were purchased five years ago and goodwill was recognised.
Required
What is the cash-generating unit for Minimart?
ANSWER
In identifying Minimart's cash-generating unit, an entity considers whether, for
example:
(a)
Internal management reporting is organised to measure performance on a

store-by-store basis.
(b)
The business is run on a store-by-store profit basis or on a region/city basis.
All Maximart's stores are in different neighbourhoods and probably have different
customer bases. So, although Minimart is managed at a corporate level, Minimart
generates cash inflows that are largely independent from those of Maximart's
other stores. Therefore, it is likely that Minimart is a cash-generating unit.
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2.2 Allocating assets to a CGU

An impairment loss in a CGU arises where its carrying amount exceeds its
recoverable amount.
The recoverable amount of a CGU is determined in the same way as the
recoverable amount of an individual asset.
The carrying amount of a CGU is determined on a basis consistent with the way in
which the recoverable amount of the CGU is determined ie it includes those assets
that will generate cash flows that are used in determining the CGUs value in use.
2.2.1 Corporate assets
A portion of corporate assets should be allocated to the CGUs on a reasonable and
consistent basis when determining the CGUs carrying amount eg on the basis of
the carrying amounts of the other non-current assets of each CGU.
Where corporate assets can be allocated on a reasonable and consistent basis, an
impairment test is conducted by comparing the carrying amount of a CGU
(including its allocation of corporate asset) with its recoverable amount.
Where corporate assets cannot be allocated on a reasonable and consistent
basis, an impairment test is conducted by:
(a)
comparing the carrying amount of the CGU excluding the corporate asset
with its recoverable amount.
(b)
Allocating a portion of the assets carrying amount on a reasonable and

consistent basis by identifying the smallest group of CGUs that includes the
CGU to which the asset belongs.
(c)
Comparing the carrying amount of that group of CGUs (including the portion
of allocated asset) with the recoverable amount of the group of units.
2.2.2 Goodwill
Goodwill acquired in a business combination does not generate cash flows
independently of other assets. It must be allocated to each of the acquirer's cashgenerating units (or groups of cash-generating units) that are expected to benefit
from the synergies of the combination.
Each unit to which the goodwill is so allocated should:
(a)
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Represent the lowest level within the entity at which the goodwill is
monitored for internal management purposes
167
(b)
Not be larger than a reporting segment determined in accordance with

SLFRS 8 Operating segments.
It may be impracticable to complete the allocation of goodwill before the first

reporting date after a business combination, particularly if the acquirer is
accounting for the combination for the first time using provisional values. The
initial allocation of goodwill must be completed before the end of the first
reporting period after the acquisition date.
Impairment testing where goodwill allocated to a single CGU
In this case an impairment test is conducted by comparing the carrying amount of
the CGU including goodwill with its recoverable amount.
Impairment testing where goodwill allocated to a group of CGUs
In this case an impairment test is conducted for each CGU by comparing the
carrying amount of the CGU excluding goodwill with its recoverable amount.
Goodwill is tested for impairment by comparing the carrying amount of all CGUs
in the group (including goodwill) with their recoverable amount.
Where there is a non-controlling interest in a CGU to which goodwill is allocated,
and the non-controlling interest is measured as a proportion of the net assets of
the acquiree, adjustment is required to the carrying amount of goodwill before the
impairment test is carried out. This ensures that full goodwill is included in the
carrying amount of the CGU before it is compared with recoverable amount.
2.2.3 Example: Non-controlling interest
P acquired an 80% interest in a subsidiary for Rs. 16 million in 20X5 when the
identifiable net assets of the subsidiary amounted to Rs. 18 million. The noncontrolling interest is measured as a proportion of net assets and the subsidiary is
a CGU.
At 31 December 20X5, Ps year end, the recoverable amount of the subsidiary is
Rs. 19.1 Mn and the carrying amount of its identifiable net assets is Rs. 18.4 million.
Required
Calculate the impairment loss at 31 December 20X5.
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Solution
Recognised goodwill is initially measured at Rs. 1.6 million (16m + (20% x 18 Mn)
18 Mn). At 31 December 20X therefore:
Goodwill
Net assets
Total
Rs'000
Rs'000
Rs'000
1,600
18,400
20,000
Carrying amount
400
400
Notional NCI goodwill
(20%/80% Rs 1.6 Mn)
2,000
18,400
20,400
(19,100)
Recoverable amount
1,300
Impairment loss
2.3 Impairment losses in a CGU

When an impairment loss is recognised for a cash-generating unit, the loss should
be allocated between the assets in the unit in the following order.
(a)
(b)
(c)
First, to any assets that are obviously damaged or destroyed

Next, to the goodwill allocated to the cash-generating unit
Then to all other assets in the cash-generating unit, on a pro rata basis
In allocating an impairment loss, the carrying amount of an asset should not be

reduced below the highest of:
(a)
(b)
(c)
Its fair value less costs of disposal

Its value in use (if determinable)
Zero
2.3.1 Example: Allocation of impairment loss

Continuing from the example in section 2.2, the Rs. 1.3 million loss is allocated to
goodwill in the first instance. In this case the amount of goodwill exceeds the
impairment loss; it is therefore allocated between the notional and recognised
goodwill on the same basis that profit or loss is allocated between the ownership
interests:
Carrying
Impairment Revised carrying
amount
loss
amount
Rs'000
Rs'000
Rs'000
400
(260)
140
Notional goodwill (1,300 20%)
1,600
(1,040)
560
Recognised goodwill (1,300 80%)
18,400
18,400
Net assets
20,000
18,960
Recognised amount
An impairment loss of Rs. 1,040,000 is recognised in profit or loss and recognised
goodwill written down to Rs. 560,000.
CA Sri Lanka
169
2.4 Reversal of impairment losses in a CGU

The reversal of an impairment loss for a CGU is allocated to the assets of the unit,
except for goodwill, pro rata with the carrying amounts of those assets.
These increases in carrying amounts are treated as reversals of impairment losses
for individual assets (see Section 1.7.1)
An impairment loss for goodwill is not reversed subsequent to recognition.
QUESTION
Impairment loss and goodwill 1
The Dias Company is testing for impairment two subsidiaries, which have been
identified as separate cash-generating units.
Some years ago Dias acquired 80% of The Horas Company for Rs. 600,000 when
the fair value of Horas identifiable assets was Rs. 400,000. As Horas policy is to
distribute all profits by way of dividend, the fair value of its identifiable net assets
remained at Rs. 400,000 on 31 December 20X7. The impairment review indicated
Horas recoverable amount at 31 December 20X7 to be Rs. 520,000.
Some years ago Dias acquired 85% of The Meses Company for Rs. 800,000 when
the fair value of Meses identifiable net assets was Rs. 700,000. Goodwill of
Rs. 205,000 (Rs. 800,000 (Rs. 700,000 85%)) was recognised. As Meses policy
is to distribute all profits by way of dividend, the fair value of its identifiable net
assets remained at Rs. 700,000 on 31 December 20X7. The impairment review
indicated Meses recoverable amount at 31 December 20X7 to be Rs. 660,000.
It is Dias group policy to measure the non-controlling interest using the
proportion of net assets method.
Required
Determine the following amounts in respect of Dias consolidated financial
statements at 31 December 20X7 according to LKAS 36 Impairment of assets.
170
(a)
The carrying amount of Horas assets to be compared with its recoverable

amount for impairment testing purposes
(b)
The carrying amount of goodwill in respect of Horas after the recognition of

any impairment loss
(c)
The carrying amount of the non-controlling interest in Meses after

recognition of any impairment loss
CA Sri Lanka
ANSWER
(a)
(b)
(c)
Rs. 750,000
Rs. 96,000
Rs. 99,000
Workings
(a)
Book value of Horas net assets
Goodwill recognised on acquisition
Rs 600,000 (80% Rs 400,000)
Notional goodwill (Rs. 280,000 20/80)
Rs.
400,000
280,000
70,000
750,000
(b)
The impairment loss is the total Rs. 750,000 less the recoverable amount of
Rs. 520,000 = Rs. 230,000. Under LKAS 36 this is firstly allocated against the
Rs. 350,000 goodwill. (As the impairment loss is less than the goodwill, none
is allocated against identifiable net assets.) As only the goodwill relating to
Horas is recognised, only its 80% share of the impairment loss is recognised:
Rs.
280,000
Carrying value of goodwill
(184,000)
Impairment (80% Rs 230,000)
96,000
Revised carrying amount of goodwill
(c)
Rs.
700,000
205,000
36,176
941,176
(660,000)
281,176
Carrying amount of Meses net assets

Recognised goodwill
Notional goodwill (15/85 Rs 205,000)
Recoverable amount
Impairment loss
Allocated to:
Recognised and notional goodwill
Other net assets
241,176
40,000
Therefore the non-controlling interest is (Rs. 700,000 Rs. 40,000) 15% =

Rs. 99,000.
As the non-controlling interest does not include goodwill, only the
impairment allocated to other net assets is included here.
CA Sri Lanka
171
QUESTION
Impairment loss and goodwill 2
Assume that the facts relating to the acquisition of Horas are the same as above,
except that The Dias Group chooses to measure the non-controlling interest on the
acquisition of Horas at fair value. The fair value of the non-controlling interest in
Horas at acquisition was Rs. 100,000.
Required
Determine the following amounts in respect of The Dias Groups consolidated
financial statements at 31 December 20X7 according to LKAS 36 Impairment of
assets.
(a)
The carrying amount of Horas assets to be compared with its recoverable

amount for impairment testing purposes
(b)
The carrying amount of goodwill in respect of Horas after the recognition of

any impairment loss
ANSWER
(a)
(b)
Rs. 700,000
Rs. 120,000
Workings
(a)
Consideration transferred
Fair value of NCI
Fair value of net assets acquired
Goodwill
Book value of Horas' net assets

Goodwill recognised on acquisition
(b)
172
Rs.
600,000
100,000
700,000
400,000
300,000
Rs.
400,000
300,000
700,000
The impairment loss is the total Rs. 700,000 less the recoverable amount of
Rs. 520,000 = Rs. 180,000. Under LKAS 36 this is first allocated against the
Rs. 300,000 goodwill. (As the impairment loss is less than the goodwill, none
is allocated against identifiable net assets.)
Rs.
300,000
Carrying value of goodwill
(180,000)
Impairment
120,000
Revised carrying amount of goodwill
CA Sri Lanka
In the equity of the group statement of financial position, the retained

earnings will be reduced by the parent's share of the impairment loss on the
full goodwill, ie Rs. 144,000 (80% Rs. 180,000) and the NCI reduced by the
NCI's share, ie Rs. 36,000 (20% Rs. 180,000).
In the statement of profit or loss and other comprehensive income, the
impairment loss of Rs. 180,000 will be charged as an extra operating
expense. As the impairment loss relates to the full goodwill of the subsidiary,
so it will reduce the NCI in the subsidiary's profit for the year by Rs. 36,000
(20% Rs. 180,000).
3 Disclosure
LKAS 36 has extensive disclosure requirements.
LKAS 36 requires that the following is disclosed for each class of assets:
(a)
The amount of impairment losses and reversals recognised in profit or loss

in the period and the line item where they are recognised.
(b)
The amount of impairment losses and reversals recognised in other

comprehensive income in the period.
Where an entity reports segment information in accordance with SLFRS 8, the

following is disclosed for each reportable segment:
(a)
The amount of impairment losses recognised in profit or loss and in other

comprehensive income during the period, and
(b)
The amount of reversals of impairment losses recognised in profit or loss

and in other comprehensive income in the period.
In addition the following is disclosed for individual assets or CGUs for which a
material impairment loss is recognised or reversed in the period:
(a)
(b)
(c)
CA Sri Lanka
Events and circumstances leading to recognition of the loss or reversal

The amount of loss or reversal recognised
Details of the individual asset or CGU:
173
Asset
CGU
Nature of the asset
Description of the CGU
Reportable segment to which the

asset belongs (where SLFRS 8
applicable).
Amount of impairment loss

recognised / reversed by class of
assets and reportable segment
(where SLFRS 8 applicable).
Where the aggregation of assets in
the CGU has changed since previous
estimate of recoverable amount, a
description of the current and former
way of aggregating assets and
reasons for the change.
(d)
The recoverable amount and whether that is value in use or fair value less
costs of disposal.
(e)
Details of how fair value is determined (where fair value less costs of
disposal is recoverable amount);
The level of the SLFRS 13 fair value hierarchy within which the fair value
measurement is categorised.
For level 2/3 fair value measurements, a description of the valuation
techniques used and details of any change in valuation techniques.
For level 2/3 fair value measurements, each key assumption on which
management has based its determination of fair value less costs of
disposal.
(f)
Details of the discount rate used in value in use (where that is recoverable
amount).
For the aggregate impairment losses and the aggregate reversals of impairment
losses recognised during the period that are not material:
(a)
The main classes of assets affected by impairment losses and reversals.
(b)
The main events and circumstances that led to the recognition of these
impairment losses and reversals.
In addition detailed disclosure is required in respect of estimates used to measure

recoverable amounts of CGUs containing goodwill or intangible assets with
indefinite useful lives.
174
CA Sri Lanka
QUESTION
Sports Reports Ltd owns 150 magazine titles of which 70 were purchased and 80
were created by the company. The following information is relevant:
The price of each purchased title is recognised as an intangible asset.
The costs of creating new titles together with the costs of maintaining existing
titles are expensed as incurred.
Cash inflows from sales and advertising are identifiable for each magazine title.
Titles are managed by sport (eg football, cricket, cycling and so on).
The level of advertising income for each title depends on the range of titles
relevant to a particular sport.
Management has a policy of abandoning old titles before the end of their
economic lives and replacing them immediately with new titles relevant to the
same sport.
Required
Advise on the criteria to be considered to identify the cash generating unit(s) of
Sports Reports Ltd.
ANSWER
A CGU is the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets.
It is likely that the recoverable amount of each magazine title can be assessed. The
level of advertising income for a title is influenced to some extent by the number
of titles relevant to the same sport, however cash inflows from direct sales and
advertising are identifiable. In addition, although magazine titles are managed by
sport, decisions to abandon titles are made on an individual basis.
Therefore it is likely that individual magazine titles generate cash inflows that are
largely independent of one another and that each magazine title is a separate CGU.
CA Sri Lanka
175
QUESTION
Kalu Ltd has a number of cash-generating units and recognised an impairment
loss in two of them in the year ended 31 December 20X6. The recoverable amount
of the CGUs in both cases was value in use. Specific discount rates for the
calculation of value in use are not directly available from the market, and Kalu
management estimates the discount rates using its weighted average cost of
capital. In calculating the cost of debt as an input to the determination of the
discount rate, Kalu management used the risk-free rate adjusted by the company
specific average credit spread of its outstanding debt, which had been raised two
years previously. As Kalu did not have any need for additional financing and did
not need to repay any of the existing loans before 20X9, its management did not
see any reason for using a different discount rate.
Kalu has made no disclosure in relation to the impairment losses as it felt that
such disclosure may be prejudicial to its core business.
Required
Discuss the validity of the accounting treatments in Kalus financial statements for
the year ended 31 December 20X6.
ANSWER
While the cash flows used in testing for impairment are specific to the entity, the
discount rate is supposed to appropriately reflect the current market assessment
of the time value of money and the risks specific to the asset or cash generating
unit. When a specific rate for an asset or cash-generating unit is not directly
available from the market, which is usually the case, the discount rate to be used is
a surrogate. An estimate should be made of a pre-tax rate that reflects the current
market assessment of the time value of money and the risks specific to the asset
that have not been adjusted for in the estimate of future cash flows. According to
LKAS 36, this rate is the return that the investors would require if they chose an
investment that would generate cash flows of amounts, timing and risk profile
equivalent to those that the entity expects to derive from the assets.
Rates that should be considered are the entitys weighted average cost of capital,
the entitys incremental borrowing rate or other market rates. The objective must
be to obtain a rate that is sensible and justifiable. Kalu should not use the risk free
rate adjusted by the company specific average credit spread of outstanding debt
raised two years ago. Instead the credit spread input applied should reflect the
current market assessment of the credit spread at the time of impairment testing,
even though Kalu does not intend raising any more finance.
176
CA Sri Lanka
Disclosures
With regard to the impairment loss recognised in respect of each cash generating
unit, assuming the loss is material, LKAS 36 requires disclosure:
The amount of the loss
The events and circumstances that led to the loss
A description of the impairment loss by class of asset
Kalu cannot avoid making the disclosures on the basis of the effect on its core
business.
CA Sri Lanka
177
CHAPTER ROUNDUP
178
Assets are tested for impairment when there are indicators of impairment;
certain assets are tested annually.
Assets should not be carried above their recoverable amount. An impairment

loss is recognised in profit or loss where carrying amount exceeds recoverable
amount.
Recoverable amount is the higher of value in use and fair value less costs of
disposal.

should be tested for impairment as part of the cash-generating unit to which
it belongs.
LKAS 36 has extensive disclosure requirements.
CA Sri Lanka
PROGRESS TEST
Which assets are tested for impairment annually?
Are the following cash flows included or excluded from a value in use calculation?
Projected cash inflows from continuing use of the asset
Net cash flows from the disposal of the asset at the end of its life
Cash flows associated with improving the assets performance
Costs to service and maintain the asset
Interest costs associated with acquisition of the asset
Where an impairment loss is reversed, the new carrying amount of the relevant
asset is capped at what amount?
Where goodwill cannot be allocated to individual CGUs, how is it tested for

impairment?
When is notional goodwill calculated?
In what order is an impairment loss allocated to the assets of a CGU?
CA Sri Lanka
179
180
Intangible assets that are not yet available for use, intangible assets with an
indefinite useful life and goodwill, arising on a business combination.
2
Projected cash inflows from continuing use of the asset.
Net cash flows from the disposal of the asset at the end of its life.
Cash flows associated with improving the assets performance
Costs to service and maintain the asset
Interest costs associated with acquisition of the asset
Include
Include
Exclude
Include
Exclude
The new carrying amount after the reversal cannot be higher than the carrying
amount would have been (after the relevant depreciation) if the original
impairment had not occurred.
Based on the carrying amount vs recoverable amount of the smallest group of

CGUs to which it can be allocated.
Where goodwill is part of a CGU, there is a non-controlling interest and the noncontrolling interest is measured as a proportion of net assets at acquisition
(meaning that no NCI goodwill is recognised).
(a)
(b)
(c)
First, to any assets that are obviously damaged or destroyed

Next, to the goodwill allocated to the cash generating unit
Then to all other assets in the cash-generating unit, on a pro rata basis
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises the topic of leasing. Lease arrangements are a
common way of financing the purchase of assets; you should be able to
account for such a transaction from both the lessor and the lessees
perspective. The chapter also introduces a new topic, also covered by
LKAS 17, being sale and leaseback.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

Standards.
treatments.
circumstances.
reporting.
statements.
181
KC1 | Chapter 7: Leases
CHAPTER CONTENTS
1 Introduction
2 Operating leases
3 Finance leases
4 Sale and leaseback transactions
5 Related Interpretations
6 Current developments

Analyse the conditions to be satisfied to recognise a lease as a finance lease.
Contrast classification of leases.
Analyse the initial measurement, subsequent measurement and disclosures of
finance leases in the financial statements of lessors and lessees.
Evaluate as to how to record sale and leaseback transactions.
Design the disclosures required to be made in respect of leases.
1 Introduction
Leases are classified as finance or operating leases; substance over form is
important in distinguishing between them.
1.1 Types of lease

LKAS 17 defines a lease and identifies two types:
A lease is an agreement whereby the lessor conveys to the lessee in return for
rent the right to use an asset for an agreed period of time.
A finance lease is a lease that transfers substantially all the risks and rewards
incident to ownership of an asset. Title may or may not eventually be transferred.
An operating lease is a lease other than a finance lease.
Lease classification is made at the inception of the lease, being the earlier of the
date of the lease agreement and the date of commitment by the parties to the
principal provisions of the lease.
182
CA Sri Lanka
QUESTION
Classification as a finance lease
Explain under what circumstances a lease might be classified as a finance lease.
ANSWER
LKAS 17 defines a finance lease as a lease that transfers substantially all risks and
rewards incident to ownership of an asset to the lessee.
Risks include the possibility of losses from idle capacity, technological
obsolescence and falls in returns due to varying economic conditions. Rewards of
ownership include the profitable use of the asset during its economic life.
An assessment of risks and rewards is subjective and there may not be a clear
conclusion. Therefore LKAS 17 provides examples of situations that normally
result in a lease being classified as a finance lease. They are:
Ownership of the asset is transferred to the lessee by the end of the lease term;
The lessee has the option to purchase the asset at a price that makes the option
reasonably certain to be exercised;
The lease term is for the major part of the economic life of the asset;
At the inception of the lease, the present value of the minimum lease payments
(discounted at the interest rate implicit in the lease) amounts to at least
substantially all of the fair value of the leased asset;
The leased asset is of such a specialised nature that only the lessee could use it
without major modifications.
All of these situations point to the lessor acquiring the asset and using the lease
arrangement as a form of finance for the acquisition.
The standard also provides indicators of situations that could also lead to a lease
being classified as a finance lease:
If the lessee can cancel the lease, the lessors losses associated with the
cancellation are borne by the lessee;
Gains or losses from the fluctuation in the fair value of the residual accrue to
the lessee;
The lessee has the ability to continue the lease for a secondary period at a rent
that is substantially lower than market rent.
CA Sri Lanka
183
QUESTION
Land and buildings
A business has taken out a new lease on a factory building and surrounding land.
The fair value of the building is Rs. 7 Mn and the fair value of the land is Rs. 10 Mn.
The lease is for 20 years with annual payments in arrears of Rs. 1,100,000. After
20 years, the business can extend the lease for a further 20 years for an annual
payment of Rs. 50,000.
Required
Explain how the lease is classified in accordance with LKAS 17?
ANSWER
Land and buildings leased together are considered separately for the purposes of
lease classification.
A lease of land is normally treated as an operating lease, unless title is expected
to pass at the end of the lease term.
A lease of buildings will be treated as a finance lease if it satisfies the
requirements of LKAS 17.
There is no indication that title will pass in respect of the land and therefore the
lease in respect of the land is classified as an operating lease. The ability to extend
the lease for a secondary period for below market rent suggests that the lease in
respect of the building is a finance lease.
Therefore the lease payments will be split in line with the fair values of the land
and the building. Rs. 647,059 (1,100,000 10/17) will be treated as payment on
an operating lease for the land and Rs. 452,941 will be treated as payment on a
finance lease for the building.
1.2 Further definitions

In addition to definitions related to types of leases, LKAS 17 provides a number of
further definitions that are relevant to the accounting treatment of leases as
described in the next two sections of the chapter:
The lease term is the non-cancellable period for which the lessee has contracted
to lease the asset together with any further terms for which the lessee has the
option to continue to lease the asset, with or without further payment, when at the
inception of the lease it is reasonably certain that the lessee will exercise the
option.
184
CA Sri Lanka
The inception of the lease is the earlier of the date of the lease agreement and
the date of commitment by the parties to the principal provisions of the lease. As
at that date:
The lease is classified either as an operating or finance lease, and
In the case of a finance lease the amounts to be recognised at the
commencement of the lease are determined.
The commencement of the lease term is the date from which the lessee is
entitled to exercise its right to use the leased asset. It is the date of the initial
recognition of the lease.
Minimum lease payments are the payments over the lease term that the lessee is
or can be required to make, excluding contingent rent, costs for services and taxes
to be paid and reimbursed to the lessor, together with:
(a)
For a lessee, any amounts guaranteed by the lessee or by a party related to

the lessee; or
(b)
For a lessor, any residual value guaranteed to the lessor by:

(i)
The lessee;
(ii)
A party related to the lessee
(iii) A third party unrelated to the lessor that is financially capable of

discharging the obligations under the guarantee.
Guaranteed residual value is:
(a)
For a lessee, that part of the residual value that is guaranteed by the lessee or
by a party related to the lessee (the amount of the guarantee being the
maximum amount that could, in any event, become payable), and
(b)
For a lessor, that part of the residual value that is guaranteed by the lessee or
by a third party unrelated to the lessor that is financially capable of
discharging the obligations under the guarantee.
Unguaranteed residual value is that portion of the residual value of the leased
asset, the realisation of which by the lessor is not assured or is guaranteed solely
by a party related to the lessor.
Fair value is the amount for which an asset could be exchanged or a liability
settled between knowledgeable, willing parties in an arms length transaction.
The interest rate implicit in the lease is the discount rate that, at the inception
of the lease, causes the aggregate present value of:
(a)
(b)
CA Sri Lanka
The minimum lease payments, and

The unguaranteed residual value
185
to be equal to the sum of

(a)
(b)
The fair value of the leased asset, and

Any initial direct costs.
(LKAS 17)
2 Operating leases
An operating lease expense is recognised in profit or loss on a straight-line
basis over the lease term in the lessees financial statements.
The lessor recognises income in profit or loss on a straight line basis over the
lease term.
2.1 Operating leases: lessee accounting

LKAS 17 requires that lease payments under an operating lease are recognised as
an expense on a straight line basis over the lease term unless another systematic
basis is more representative of the time pattern of the users benefit.
SIC 15 requires that incentives provided by a lessor to enter into an operating
lease agreement are recognised as a reduction of rental expenses over the lease
term.
2.1.1 Disclosure
Lessees should disclose the following in respect of operating leases:
1.
A general description of significant leasing arrangements
2.
The total lease payments recognised as an expense in the period.
3.
The total of future minimum lease payments under non-cancellable

operating leases for each of the following periods:
(a)
(b)
(c)
Not later than one year

Later than one year and not later than five years
Later than five years
QUESTION
Operating leases: lessee accounting
Beira Baskets (Pvt) Ltd entered into a non-cancellable agreement with PV Leasing
Ltd to lease a property for 3 years from 1 July 20X7. PV Leasing incurred costs
associated with arranging the lease of Rs. 40,000. The property has an expected
remaining useful life of 40 years at this date and a carrying amount of
186
CA Sri Lanka
Rs. 3.4 million. The terms of the lease agreement require an initial non-refundable
deposit of Rs 12,000 and then monthly rentals of Rs. 3,000 paid in arrears.
Beira Baskets rents a number of properties under similar terms; the average lease
term is 5 years.
Required
Prepare extracts from the financial statements of Beira Baskets (Pvt) Ltd for the
year ended 31 December 20X7 in respect of the lease.
ANSWER
Statement of profit or loss for the year ended 31 December 20X7 (extract)
Operating lease expense
Rs.
20,000
Statement of financial position at 31 December 20X7 (extract)

Prepayment
Rs.
10,000
Note Operating lease arrangements

Minimum lease payments recognised as an expense in the year
Rs.
20,000
At the reporting date the company had outstanding commitments for future
minimum lease payments under non-cancellable operating leases which fall due
as follows:
Within one year (12m 3,000)
In the second to fifth years (18m 3,000)
After five years
Rs.
36,000
54,000
90,000
Operating lease payments represent rentals payable by the company in respect of

properties. Leases are negotiated for an average term of five years and rentals are
fixed for this term.
Workings
Total lease payments (3 yrs 12m 3,000) + 12,000
Annual charge therefore 120,000/3years
Expense in the year 40,000 6/12m
Cash paid in the year (6m 3,000) + 12,000
Therefore prepayment
CA Sri Lanka
Rs.
120,000
40,000
20,000
30,000
10,000
187
2.2 Operating leases: lessor accounting

LKAS 17 requires that operating leases are recognised in the financial statements
of a lessor as follows:
1.
The underlying asset is presented according to the nature of the asset, with
depreciation recognised in profit or loss. Any initial direct costs incurred in
negotiating and arranging an operating lease are added to the carrying
amount of the asset and recognised as an expense over the lease term.
2.
Lease income is recognised in profit or loss on a straight-line basis over the

lease term unless another systematic basis is more representative of the
pattern in which benefits derived from the asset diminish.
SIC 15 requires that incentives provided by a lessor to enter into an operating

lease agreement are recognised as a reduction of rental income over the lease
term.
2.2.1 Disclosure
Lessors should disclose the following in respect of operating leases:
1.
A general description of the lessors leasing arrangements
2.
The future minimum lease payments under non-cancellable operating leases

in aggregate and for each of the following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years;
(iii) Later than five years.
QUESTION
Operating leases: lessor accounting
Using the information in the question in section 1.1, prepare extracts from the
financial statements of PV Leasing Ltd for the year ended 31 December 20X7 in
respect of the lease.
ANSWER
Statement of profit or loss for the year ended 31 December 20X7 (extract)
Depreciation
Operating lease income
188
Rs.
(43,000)
20,000
CA Sri Lanka

Property
Non-current liabilities
Deferred income
Current liabilities
Deferred income
Rs.
3,397,000
6,000
4,000
Note Operating lease arrangements

The company rents property out under arrangements classified as operating
leases. Property rental income earned in the year was Rs. 20,000. Direct operating
expenses arising on the arrangement of operating leases are added to the carrying
amount of the underlying property and amortised over the remaining useful life of
the asset. The lessee does not have an option to purchase the property at the
expiry of the lease period.
At the reporting date the company had contracted with tenants for the following
future minimum lease payments:
Within one year (12m 3,000)
In the second to fifth years (18m 3,000)
After five years
Rs.
36,000
54,000
90,000
Workings
Income
Total lease receipts (3 yrs 12m 3,000) + 12,000
Annual credit to income therefore 120,000/3years
Income in the year 40,000 6/12m
Deferred income
Income in the year
Cash received (6m 3,000) + 12,000
Deferred income
Deferred income within one year (40,000 (12 3,000))
Deferred income in more than one year (balance)
Non-current asset
Property carrying amount at commencement of lease
Initial direct costs
Depreciation (3,440,000 / 40 years) 6/12m
Carrying amount at reporting date
CA Sri Lanka
Rs.
120,000
40,000
20,000
Rs.
20,000
30,000
10,000
4,000
6,000
Rs.
3,400,000
40,000
3,440,000
(43,000)
3,397,000
189
3 Finance leases
Lessees should recognise an asset and corresponding lease obligation in
respect of assets acquired under a finance lease. A lessor derecognises an asset
that is leased out under a finance lease and instead recognises the amount
due from the lessee.
3.1 Finance leases: lessee accounting

A lessee recognises a finance lease arrangement as follows:
1.
Recognise an asset and corresponding DEBIT

lease liability at the lower of fair value CREDIT
and the present value of minimum lease
payments.
Asset
Lease liability
2.
Any initial deposit is deducted from the DEBIT

liability immediately.
CREDIT
Lease liability
Cash
3.
Depreciate the asset over the shorter of DEBIT

the lease term and the assets useful life. CREDIT
Useful life is used where there is
reasonable certainty that the lessee will
gain ownership of the asset.
Depreciation expense
Asset (accumulated
depreciation)
4.
Recognise interest accruing to the lease DEBIT

liability using the actuarial method ie at CREDIT
the interest rate implicit in the lease.
Finance costs
Lease liability
5.
Recognise lease payments.
Lease liability
Cash
DEBIT
CREDIT
A finance lease liability working should be used to calculate amounts outstanding

at the reporting date:
Y/e
20XX
B/f obligation
at 1 January
Rs.
X
Interest
charge (15%)
Rs.
X
Finance cost
in P/L
190
Payment
Rs.
(X)
C/f obligation at
31 December
Rs.
X
Total lease
liability at
reporting date
CA Sri Lanka
The table above shows payments in arrears; where payments are in advance
the table is rearranged so that interest is charged on the outstanding obligation
after the payment is recognised.
The table should include a row for each interest bearing period; therefore if
payments are made quarterly, 4 rows per annum are required.
3.1.1 Splitting the lease liability
In the statement of financial position the lease liability is split between the current
and non-current obligation:
The current obligation at the end of one reporting period is the payments to be
made in the next reporting period less any interest that has not yet accrued.
The non-current obligation is the lease liability less the current obligation.
3.1.2 Disclosure
LKAS 17 requires the following disclosures by lessees in respect of finance leases:
1.
A general description of the lessees material leasing arrangements,

including but not limited to:
The basis on which contingent rents are determined.
The existence and terms of renewal or purchase options and escalation
clauses.
Restrictions imposed by lease arrangements, such as those concerning
dividends or additional debt.
2.
The net carrying amount at the end of the reporting period for each class of
asset
3.
A reconciliation between the total of minimum lease payments at the end of

the reporting period, and their present value. In addition, an entity should
disclose the total of minimum lease payments at the end of the reporting
period, and their present value, for each of the following periods:
(i) Not later than one year
(ii) Later than one year and not later than five years
(iii) Later than five years
CA Sri Lanka
4.
Contingent rents recognised as an expense for the period.
5.
The total of future minimum sublease payments expected to be received

under non-cancellable subleases at the end of the reporting period.
191
QUESTION
Puttalam Plantations Ltd leases an asset on 1 January 20X4 and incurs Rs. 40,000
costs to set up the agreement. The leased asset has a fair value of Rs. 1.6 million on
1 January 20X4; this is equivalent to the present value of minimum lease
payments. Its useful life at that date is 5 years. The terms of the lease are:
A non-refundable deposit of Rs. 116,000 is payable at the commencement of the
lease.
Six annual instalments of Rs. 320,000 are payable in arrears.
Puttalam Plantations guarantees a sales value of at least Rs. 160,000 when the
lessor sells the asset in the general market at the end of the lease term.
The interest rate implicit in the lease is 10%.
Required
(a)
Prepare numerical extracts from the financial statements of Puttalam

Plantations Ltd for the year ended 31 December 20X4 in respect of the lease.
(b)
Explain what would happen at the end of the lease if the asset could be sold
by the lessor:
(i)
(ii)
For Rs. 160,000

For Rs. 130,000.
ANSWER
(a)
Statement of profit or loss for the year ended 31 December 20X4

(extract)
Rs.
Depreciation [(1,600,000 + 40,000 160,000)/5)]
296,000
Finance costs (W)
148,400
Rs.
Non-current assets
Leased asset [(1,600,000 + 40,000) 296,000]
192
1,344,000
Finance lease liability over one year (W) (1,312,400
188,760)
1,123,640
Current liabilities
Finance lease liability within one year (W) (320,000
131,240)
188,760
CA Sri Lanka
Note Obligations under finance leases
Amounts payable under finance leases:

Within one year
In the second to fifth years
After five years
Less future finance charges (balance)
Minimum
lease
payments
Rs.
320,000
1,280,000
1,600,000
(287,600)
1,312,400
PV of
minimum
lease
payments
Rs.
188,760
1,123,640
1,312,400
Working
Bal b/f
Rs.
1,600,000
(116,000)
1,484,000
1,312,400
20X4
20X5
(b)
Interest accrued at
10%
Rs.
Payment
31 Dec
Rs.
Bal c/f
31 Dec
Rs.
148,400
131,240
(320,000)
(320,000)
1,312,400
1,123,640
At the end of the lease term, Puttalam Plantations will have an asset at a
residual value of Rs. 160,000 and a finance lease liability of the same amount,
representing the guaranteed residual value.
(i)
If the lessor can sell the asset for Rs. 160,000, Puttalam Plantations has
no further liability and derecognises asset and finance lease liability by:
DEBIT
CREDIT
(ii)
Finance lease liability

Asset
Rs. 160,000
Rs. 160,000
If the lessor can only sell the asset for Rs. 130,000, Puttalam
Plantations must make up the difference of Rs. 30,000. It must first
recognise the impairment in the asset by:
DEBIT
CREDIT
Profit or loss
Asset
Rs. 30,000
Rs. 30,000
The asset and lease liability are derecognised by:

DEBIT
CREDIT
CREDIT
CA Sri Lanka
Finance lease liability

Cash
Asset
Rs. 160,000
Rs. 30,000
Rs. 130,000
193
3.2 Finance leases: lessor accounting

A lessor does not recognise the asset in a finance lease arrangement, but instead
recognises a receivable measured as the net investment in the lease plus direct
costs to negotiate the lease (eg commissions and legal fees).
The net investment in the lease is the gross investment in the lease discounted at
the interest rate implicit in the lease.
The gross investment in the lease is the aggregate of:
The minimum lease payments receivable by the lessor under a finance lease,
and
Any unguaranteed residual value accruing to the lessor.
An unguaranteed residual value is that portion of the residual value of a leased
asset that the lessor is not assured.
Unearned finance income is the difference between the net investment in the
lease and the gross investment in the lease.
The accounting treatment applied to the receivable is similar to that applied to the
lease liability by the lessee:
1.
Recognise finance income to give a DEBIT

constant periodic rate of return on the CREDIT
receivable.
Receivable
Finance income
2.
Recognise lease payments by the lessee.
Cash
Receivable
DEBIT
CREDIT
The estimated unguaranteed residual value accruing to the lessor must be

reviewed regularly and if there is a reduction in the value the income allocation
over the lease term must be revised.
3.1.3 Disclosure
In respect of finance leases, lessors should disclose:
194
1.
A general description of the lessors material leasing arrangements
2.
A reconciliation between the gross investment in the lease at the end of the
reporting period and the present value of minimum lease payments
receivable at the end of the reporting period.
3.
The gross investment in the lease and present value of minimum lease
payments receivable at the end of the reporting period for each of the
following periods:
CA Sri Lanka
(i) Not later than one year

(ii) Later than one year and not later than five years
(iii) Later than five years
4.
Unearned finance income
5.
Unguaranteed residual values accruing to the benefit of the lessor.
QUESTION
SL Equipment Ltd leased an asset to a customer from 1 June 20X1. The fair value
of the asset on this date was Rs. 178,500 and legal fees payable by SL Equipment
amounted to Rs. 1,500. The terms of the lease were:
Eight annual rentals of Rs. 33,000 payable in advance
Implicit interest rate of 12.8%.
Required
Prepare numerical extracts from the financial statements of SL Equipment Ltd for
the year ended 31 May 20X2 in respect of the lease.
ANSWER
Statement of profit or loss for the year ended 31 May 20X2 (extract)
Rs.
Finance income
18,816
Statement of financial position at 31 May 20X2 (extract)
Rs.
Non-current assets
Net investment in finance lease (165,816 33,000)
Current asset
Net investment in finance lease
132,816
33,000
Note Finance lease receivables

Minimum
lease
payments
Amounts receivable under finance leases:
Within one year
In the second to fifth years
After five years
Less unearned finance income (balance)
PV of minimum lease payments receivable
CA Sri Lanka
Rs.
33,000
198,000
231,000
(65,184)
165,816
PV of
minimum
lease
payments
Rs.
33,000
132,816
165,816
195
Workings
The net investment in the lease is calculated as:
Rs.
178,500
1,500
180,000
Amount due from lessee (fair value of the asset)

Direct costs
31 May 20X2
Bal b/f
Instalment
c/f
Rs.
180,000
Rs.
(33,000)
Rs.
147,000
Interest at
12.8%
Rs.
18,816
Bal c/f
31 Dec
Rs.
165,816
3.1.4 Manufacturer and dealer leases

A manufacturing company may make an asset and then lease it out under a finance
lease. In this case the cost of the asset to the lessor is the manufacturing cost
rather than a market price. Therefore the manufacturer makes two types of
income on leasing the asset:
1.
2.
A profit or loss (being fair value less manufacturing cost), and

Finance income from the leasing arrangement.
A similar situation applies to dealers, who normally acquire assets at a discount

before leasing them out.
LKAS 17 requires the following treatment:
The selling profit or loss is recognised immediately as if an outright sale had
taken place:
Revenue is the lower of fair value or present value of minimum lease
payments using a market rate of interest.
Cost of sales is the cost of the asset (or carrying amount) less the present
value of any unguaranteed residual value.
If interest rates are artificially low, the selling profit is restricted to that
which would apply had a commercial rate been applied.
Costs incurred in connection with arranging the lease are recognised as an
expense when the selling profit is recognised.
196
CA Sri Lanka
4 Sale and leaseback transactions

In a sale and leaseback transaction, an asset is sold by a vendor and then the
same asset is leased back to the same vendor. The accounting treatment
depends on whether the transaction involves an operating or finance lease and
whether proceeds are at fair value.
Sale and leaseback transactions are a common way for companies to raise cash
whilst retaining use of their assets. The lease payment and sale price are normally
interdependent because they are negotiated as part of the same package.
The accounting treatment for the lessee (the seller) depends on the type of lease
involved.
4.1 Sale and finance leaseback

In a sale and leaseback transaction which results in a finance lease:
The disposal of the asset is recognised in the normal way, however any
apparent profit or loss (that is, the difference between the sale price and the
previous carrying amount) is deferred and amortised in the financial
statements of the seller/lessee over the lease term. It is not recognised as
income immediately.
The finance lease is recognised as described in Section 3.1 of this Chapter.
4.2 Sale and operating leaseback

In a sale and leaseback transaction which results in an operating lease:
The disposal of the asset is recognised in the normal way, however the
resulting profit or loss is recognised as follows.
(i)
Any profit or loss should be recognised immediately, provided it is clear

that the transaction is established at a fair value.
(ii)
Where the sale price is below fair value, any profit or loss should be
recognised immediately except that if the apparent loss is compensated
by future lease payments at below market price it should to that extent be
deferred and amortised over the period for which the asset is expected to
be used.
(iii) If the sale price is above fair value, the excess over fair value should be
deferred and amortised over the period over which the asset is expected
to be used.
CA Sri Lanka
197
In addition, for an operating lease where the fair value of the asset at the time
of the sale is less than the carrying amount, the loss (carrying value less fair
value) should be recognised immediately.
The operating lease is recognised as described in Section 2.1 of this Chapter.
4.3 Disclosure
The disclosure requirements seen earlier for operating and finance leases apply
equally to such leases as a result of sale and leaseback transactions.
QUESTION
Kelani Industries Ltd sold an asset to LankaBank for Rs. 5,200,000 on 1 July 20X3.
On this date the asset had a carrying amount of Rs. 3,100,000. Kelani Industries
entered into an agreement on the same date to lease the asset back under a 20
year lease for annual rentals of Rs. 280,000. The lease arrangement has been
determined to be a finance lease.
Required
How is the transaction accounted for by Kelani Industries on 1 July 20X3 and
subsequently?
ANSWER
The Rs. 3,100,000 carrying amount of the asset is derecognised and proceeds of
Rs. 5,200,000 are recognised.
The Rs. 2,100,000 difference between these amounts is recognised as deferred
income. This amount will be recognised in profit or loss over the 20 year lease
term at a rate of Rs. 105,000 per annum.
An asset and corresponding lease obligation of Rs. 5,200,000 are recognised.
The asset will be depreciated over the lease term (assuming this is less than the
useful life) giving a depreciation charge of Rs. 260,000 per annum.
Interest will accrue to the finance lease obligation over the year to 30 June
20X4. The payment of Rs. 280,000 on 30 June 20X4 will pay this accrued
interest together with an amount of the capital outstanding. This pattern will
be repeated in each year of the lease.
198
CA Sri Lanka
SIC 27 Evaluating the Substance of Transactions in the Legal form of a Lease and
IFRIC 4 Determining whether an Arrangement contains a Lease are relevant to
lease accounting.
SIC-15 Operating lease incentives is considered in section 2; it confirms that
operating lease expenses / income should be recognised on a straight-line basis
where the lessor provides incentives for the lessee to enter into the agreement.
Other relevant interpretations are SIC 27 and IFRIC 4.
5.1 SIC-27 Evaluating the Substance of Transactions in the Legal

Form of a Lease
SIC-27 addresses issues that may arise when an arrangement between an entity
and an investor involves the legal form of a lease. It contains the following
provisions:
(a)
Accounting for arrangements between an entity and an investor should

reflect the substance of the arrangement. All aspects of an arrangement
should be evaluated to determine its substance, with weight given to those
aspects and implications that have an economic effect.
In this respect, SIC-27 includes a list of indicators that individually
demonstrate that an arrangement may not, in substance, involve a lease
under LKAS 17 Leases:
(i)
An entity retains all of the risks and rewards of ownership of an

underlying asset and enjoys substantially the same rights to its use as
before the arrangement.
(ii)
The primary reason for the arrangement is to achieve a particular tax

result.
(iii) An option is included on terms that make its exercise almost certain.
These indicators are particularly relevant in the case of sale and leaseback
transactions, where the substance of the transaction may be a secured loan.
(b)
CA Sri Lanka
If an arrangement does not meet the definition of a lease, and is therefore

outside the scope of LKAS 17, SIC-27 considers:
(i)
Whether a separate investment account and lease payment obligation

that might exist represent assets and liabilities of the entity.
(ii)
How the entity should account for other obligations resulting from the
arrangement.
199
(iii) How the entity should account for a fee it might receive from an
investor.
SIC-27 includes a list of indicators that collectively demonstrate that, in
substance, a separate investment account and lease payment obligation do
not meet the definitions of an asset and a liability and should not be
recognised by the entity.
Other obligations of an arrangement, including any guarantees provided and
obligations incurred upon early termination, should be accounted for under
LKAS 37 or LKAS 39, depending on the terms. Further, the criteria in LKAS
18.20 should be applied to the facts and circumstances of each arrangement
in determining when to recognise a fee as income that an entity might
receive.
(c)
A series of transactions that involve the legal form of a lease is linked, and
therefore should be accounted for as one transaction, when the overall
economic effect cannot be understood without reference to the series of
transactions as a whole.
5.2 IFRIC 4 Determining whether an Arrangement contains a

Lease
IFRIC 4 deals with arrangements that do not take the legal form of a lease but
which convey rights to use assets in return for a payment or series of payments.
Such arrangements may include:
(a)
Outsourcing arrangements.
(b)
Telecommunication contracts that provide rights to capacity.
(c)
Take-or-pay and similar contracts, in which purchasers must make specified

payments regardless of whether they take delivery of the contracted
products or services.
IFRIC 4 specifies that an arrangement that meets both of the following criteria is a
lease, or contains a lease and so should be accounted for in accordance with LKAS
17 Leases:
200
1.
Fulfilment of the arrangement depends upon a specific asset. The asset need
not be explicitly identified by the contractual provisions of the arrangement.
Rather, it may be implicitly specified because it is not economically feasible
or practical for the supplier to fulfil the arrangement by providing use of
alternative assets.
2.
The arrangement conveys a right to control the use of the underlying asset.
This is the case if any of the following conditions are met:
CA Sri Lanka
The purchaser in the arrangement has the ability or right to operate the
asset or direct others to operate the asset (while obtaining more than an
insignificant amount of the output of the asset),
The purchaser has the ability or right to control physical access to the
asset (while obtaining more than an insignificant amount of the output of
the asset), or
There is only a remote possibility that parties other than the purchaser
will take more than an insignificant amount of the output of the asset and
the price that the purchaser will pay is neither fixed per unit of output nor
equal to the current market price at the time of delivery.
5.2.1 Example: IFRIC 4
A manufacturing company enters into an arrangement with a utilities company to
supply a minimum amount of gas for a specified period of time. The utilities
company builds a facility next to the manufacturing company to produce the gas
as it is not practical to rely on one of its existing facilities. The utilities company
maintains ownership and control over the facility. The utilities company charges
the manufacturing company a fixed capacity charge plus a variable amount based
on the costs incurred in generating the gas supplied.
This arrangement contains a lease since:
1.
Fulfilment of the gas supply is dependent on the specific facility.
2.
The price the manufacturing company will pay is neither fixed per unit of
output nor equal to the current market price per unit of output.
The IASB are in the process of developing a new standard to replace IAS 17
(LKAS 17). The new standard will not distinguish between finance and
operating leases.
LKAS 17 has not been without its critics. The original standard closed many
loopholes in the treatment of leases, but it has been open to abuse and
manipulation. For example companies may structure a lease specifically so that it
is classified as an operating lease and so the company avoids reporting a liability
in its statement of financial position. Whilst analysts frequently adjust the
statement of financial position to capitalise operating leases, other users of
financial statements do not have sufficient knowledge to do this.
CA Sri Lanka
201
The IASB has been engaged in a project to replace IAS 17 Leases for a number of
years, with the aim of replacing its many shortcomings and a new standard is
likely to be issued in 2015. The proposed approach would require all leases to be
reported in the statement of financial position, so providing more complete and
useful information to users of the financial statements.
6.1 Main changes

The proposed new approach to lease accounting will require a lessee to recognise
assets and liabilities for the rights and obligations created by leases.
There is no distinction between an operating and finance lease; all leases are
treated in the same way.
Lessee accounting
A lessee will be required to recognise a right-of-use asset and a lease liability
for all leases of more than 12 months.
A lessee will be able to choose whether to recognise a right of use asset and
lease liability for all leases of 12 months or less. Short leases include
cancellable leases where the initial cancellable period is 12 months or less.
Where an asset and liability are recognised, both would initially be recognised
at the present value of lease payments and the right of use asset would also
include the direct costs of entering into the lease.
Recognition of lease expenses will depend on whether a lease is classified as
type A or type B:
Type A leases are those related to assets such as equipment where the lessee
consumes part of the leased asset. The right of use asset in relation to type A
leases is amortised through profit or loss and an interest expense on the
liability is recognised.
Type B leases are those related to assets such as property where the lessee
uses the underlying asset but doesnt consume any more than an
insignificant part of it. The expense recognised in profit or loss for a type B
lease is a single lease expense.
Lessor accounting
Leases are also classified as type A or type B for lessors:
In respect of type A leases (eg plant and equipment) the underlying asset is
derecognised; a lease receivable and residual asset ( a retained interest in the
underlying asset) are recognised. Interest income is recognised in profit or loss.
202
CA Sri Lanka
In respect of type B leases (eg property) the asset being leased continues to be
recognised in the statement of financial position. Rental income is recognised in
profit or loss.
Practically, there are few changes proposed to the accounting treatment applied
by lessors in respect of finance leases or operating leases in respect of property.
The proposed changes in respect of operating lease agreements for plant and
equipment are more significant.
QUESTION
A lessee enters into a 10-year operating lease on an office building. The developer
offers a 2-year rent free period, providing the tenant signs for 10 years. Lease
payments are Rs80m per annum payable in years 3-10.
Required
Recommend, showing the double entry, how the lease should be accounted for
over the ten years.
ANSWER
SIC 15 Operating Lease Incentives requires that where the lessor provides
incentives for the lessee to enter into the agreement, the benefit should be spread
over the lease term.
Consequently, the entity recognises an expense in each of the 10 years of
Rs. 64 Mn [(Rs. 80 Mn 8)/ 10 years]. In the first and second years this is shown
as an accrual which is reduced by Rs. 16 Mn per annum over years 3 to 10 as the
payments of Rs. 80 Mn are made, exceeding the profit or loss charge of Rs. 64 Mn
as follows:
In each of years 1 and 2:
DEBIT
CREDIT
Operating lease rental expense

Accruals
Rs. 64 Mn
Rs. 64 Mn
In each of years 3-10:

DEBIT
DEBIT
CREDIT
CA Sri Lanka
Operating lease rental expense

Accruals/deferred income
Cash
Rs. 64 Mn
Rs. 16 Mn
Rs. 80 Mn
203
QUESTION
Pacific Ltd owns an asset with a carrying amount of Rs. 40,000 and a fair value of
Rs. 45,000. It has negotiated a number of possible agreements to sell the asset and
lease it back under an operating lease for 7 years starting on 1 January 20X8. The
agreements are:
A
B
C
D
Sell for Rs. 45,000; annual future lease payments at a market rate of
Rs. 7,500.
Sell for Rs. 37,500; annual future lease payments Rs. 7,500
Required
State how each of these agreements would be accounted for in Pacific Ltds
financial statements?
ANSWER
204
Sale at fair value
A profit of Rs. 5,000 is recognised immediately
Sale for less than The loss is not compensated for by low future
fair value
rentals therefore the loss of Rs. 2,500 is
recognised immediately
Sale for less than The loss is compensated for by low future
fair value
rentals therefore the loss of Rs. 15,000 is
recognised in the statement of financial position
and released to profit or loss over the lease
term.
Sale for more than A profit of Rs. 5,000 (the profit based on sale at
fair value
fair value) is recognised immediately; the excess
profit of Rs. 10,000 is recognised in the
statement of financial position and released to
profit or loss over the lease term.
CA Sri Lanka
CHAPTER ROUNDUP
Leases are classified as finance or operating leases; substance over form is

important in distinguishing between them.
An operating lease expense is recognised in profit or loss on a straight-line

basis over the lease term in the lessees financial statements. The lessor
recognises income in profit or loss on a straight line basis over the lease term.
Lessees should recognise an asset and corresponding lease obligation in

respect of assets acquired under a finance lease.
A lessor derecognises an asset that is leased out under a finance lease and
instead recognises the amount due from the lessee.
In a sale and leaseback transaction, a vendor sells an asset and then the same
asset is leased back to the same vendor. The accounting treatment depends on
whether the transaction involves an operating or finance lease and whether
proceeds are at fair value.
SIC 27 Evaluating the Substance of Transactions in the Legal form of a Lease and
IFRIC 4 Determining whether an Arrangement contains a Lease are relevant to
lease accounting.
The IASB are in the process of developing a new standard to replace IAS 17
(LKAS 17). The new standard will not distinguish between finance and
operating leases.
CA Sri Lanka
205
PROGRESS TEST
206
Distinguish between a finance lease and an operating lease.
How is a deposit paid by the lessee to the lessor at the start of an operating lease
accounted for?
Over what term is an asset acquired under a finance lease depreciated?
How should manufacturer or dealer lessors account for finance leases?
What is the proposed new accounting treatment to be applied to a lease of

equipment by a lessee?
CA Sri Lanka
A finance lease transfers substantially all the risks and rewards incident to
ownership of an asset. Title may or may not be transferred eventually.
An operating lease is a lease other than a finance lease.
The payment is spread across the lease term and recognised as income by the
lessor and an expense by the lessee, alongside the lease payments.
The shorter of useful life and lease term; if title passes at the end of the lease term,
use useful life.
(a)
Recognise the selling profit/loss in income for the period as if it were an

outright sale.
(b)
If interest rates are artificially low, restrict the selling price to that applying
on a commercial rate of interest.
(c)
Recognise indirect costs as an expense at the lease's start.
CA Sri Lanka
A right of use asset and a lease liability would be recognised, initially at the
present value of lease payments. Two related expenses are recognised in profit or
loss, being the amortisation of the right of use asset and an interest expense on the
liability.
207
208
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter deals with a number of standards relating to assets. Most of these should
be familiar to you from your previous studies, although SLFRS 6 Exploration for and
Evaluation of Mineral Resources is new at the KC1 level. The requirements of standards
that you have previously studied are summarised in this chapter; you should go back to
your previous material to refresh your knowledge if necessary.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
1.3
Level C
1.3.1
1.3.2
1.3.3
Advise on the application of Sri Lanka Accounting Standards in solving complicated

matters.
Propose appropriate accounting policies to be selected in different circumstances.
Advise appropriate application and selection of accounting/reporting options given
under standards.
Explain the concepts/principles of Sri Lanka Accounting Standards.
Apply the concepts/principles of the standards to resolve a simple/straight forward
matter.
List the disclosures to be made in the financial statements.
209
KC1 | Chapter 8: Other standards related to assets
CHAPTER CONTENTS
1 LKAS 2 Inventories
2 LKAS 11 Construction contracts
3 LKAS 20 Government Grants
4 LKAS 41 Agriculture
5 SLFRS 6 Exploration for and Evaluation of Mineral Resources
Advise the basis of measurement of inventories.

Evaluate the composition of cost of inventories.
Assess cost and NRV of inventories.
Design disclosure to be made in respect of inventories.
Advise appropriate accounting policy for inventories.

Criticise the identification of a contract as a construction contract.
Evaluate the criteria to be satisfied to recognise the contract revenue and
contract cost.
Assess revenue from construction contract.
Assess how to recognise expected losses.
Assess expected losses from construction contract.
Evaluate the impact of change in estimate of contract revenue or contract cost.
Develop the disclosures to be made in respect of construction contracts.
Analyse the recognition criteria of government grants.
Evaluate the presentation of grants relating to assets and income.
Compile the financial statements applying the requirements for grants related
to income and grants related to assets.
Design the disclosure requirements with regard to accounting for government
grants as per the standard.
Differentiate agriculture, agricultural produce, biological asset and biological
transformation.
210
CA Sri Lanka
Recommend when a biological asset can be recognised.

Evaluate given set of information to assess whether biological asset could be
recognised.
Assess the cost of biological asset at initial measurement.
Assess gains and losses on initial recognition and subsequent measurement of
biological assets.
Recommend the adjustments to be made in relation to government grants
recovered in respect of biological assets.
Outline the disclosures to be made in respect of biological assets.
1 LKAS 2 Inventories
Inventories are measured at the lower of cost and net realisable value. Cost
includes costs of purchase and costs of conversion. Where items are
interchangeable cost is estimated using a cost formula. An inventory write
down to NRV is recognised in profit or loss.
Inventories are assets:
held for sale in the ordinary course of business;
in the process of production for such sale; or
in the form of materials or supplies to be consumed in the production process
or in the rendering of services.
Inventories can include goods purchased and held for resale, finished goods, work
in progress and raw materials.
In most businesses the measurement of inventory is an important factor in the
determination of profit. Inventory measurement is a highly subjective exercise
and consequently there is a wide variety of different methods used in practice.
1.1 Scope of LKAS 2

The following items are excluded from the scope of the standard.
Work in progress under construction contracts (covered by LKAS 11
Construction contracts, see Section 2)
Financial instruments (eg shares, bonds)
Biological assets (covered by LKAS 41 Agriculture, see Section 4)
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Certain inventories are exempt from the standard's measurement rules, ie those
held by:
Producers of agricultural and forest products
Commodity broker-traders
1.2 Measurement
Inventories are measured at the lower of cost and net realisable value (NRV).
Where NRV is less than cost, the carrying amount of inventories is written down.
Cost
The cost of inventories includes costs of purchase, costs of conversion and any
other costs in bringing the inventories to their present location and condition.
Cost does not include abnormal amounts (eg wasted materials or labour),
storage costs, administrative overheads or selling costs.
For individual items (ie non-interchangeable items) and specific projects, actual
costs can be established.
In the case of interchangeable items a cost formula should be used, being FIFO
or AVCO.
The same cost formula is applied to all inventories with a similar nature and
use.
Net realisable value
Net realisable value is the estimated selling price in the ordinary course of
business less the estimated costs of completion and the estimated costs
necessary to make the sale.
The reason why inventory is held should be considered eg some inventory is
held to satisfy a contract and the NRV is therefore the contract price.
The assessment of NRV should take place at the same time as estimates are
made of selling price, using the most reliable information available.
Fluctuations of price or cost should be taken into account if they relate directly
to events after the reporting period, which confirm conditions existing at the
end of the period.
Write downs to NRV
A write down of inventories normally takes place on an item by item basis but
similar items may be grouped.
On occasion a write down to NRV may be of such size, incidence or nature that
it must be disclosed separately.
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The amount of any write-down of inventories to NRV and all losses of

inventories are recognised as an expense in the period the write-down or loss
occurs.
Reversals of write downs
NRV must be reassessed at the end of each period and compared again with
cost. If the NRV has risen for inventories held over the end of more than one
period, then the previous write down is reversed to the extent that the
inventory is then valued at the lower of cost and the new NRV. This may be
possible when selling prices have fallen in the past and then risen again.
The amount of any reversal of any write-down of inventories, arising from an
increase in NRV, is recognised as a reduction in the amount of inventories
recognised as an expense in the period in which the reversal occurs.
1.3 Disclosure
The financial statements should disclose the following.
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(a)
Accounting policies adopted in measuring inventories, including the cost

formula used
(b)
Total carrying amount of inventories and the carrying amount in

classifications appropriate to the entity
(c)
Carrying amount of inventories carried at NRV.
(d)
The amount of inventories recognised as an expense in the period.
(e)
The amount of any write down of inventories recognised as an expense in

the period.
(f)
The amount of any reversal of write down recognised in profit or loss in the
period.
(g)
The circumstances that led to the reversal of a write down of inventories,

and
(h)
The carrying amount of inventories pledged as security for liabilities.
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1.3.1 Disclosure notes relating to inventories

CASE STUDY
The following disclosure note relating to inventories is taken from the 2013/2014
Lion Brewery (Ceylon) PLC Annual Report
10 INVENTORIES
Raw and packing materials
Work in progress
Finished goods
Maintenance spares & others
576,712
145,249
1,795,380
220,632
372,640
97,672
1,763,434
284,785
Provision for inventory (Note 10.1)
2,737,973
(42,952)
2,518,531
(111,816)
2,695,021
2,406,715
Provision for inventory

Balance as at beginning of the year
Provisions made during the year
Reversals during the year
Balance as at end of the year
111,816
74,719
(143,583)
90,891
71,836
(50,911)
42,952
111,816
QUESTION
Based on the types of inventory listed in the above disclosure note, draft a suitable
accounting policy note for Lion Brewery (Ceylon) PLC.
ANSWER
The following accounting policy note is taken from the 2013/2014 Annual Report:
Inventories
Inventories are stated at the lower of cost and net realisable value. Net realisable
value is the estimated selling price in the ordinary course of business less the
estimated costs.
The cost of inventories includes expenditure incurred in acquiring the inventories
and other costs incurred in bringing them to their existing location and condition.
Accordingly the costs of inventories are accounted as follows:
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Raw materials and packing

materials
Work in progress
Finished goods
Maintenance stock
Cost of purchase together with any incidental

cost
Raw material cost and a proportion of
manufacturing expenses
Raw material cost and manufacturing
expenses
At weighted average cost
Appropriate provisions will be made for the value of any stocks that are obsolete.
1.4 IFRIC 20 Stripping Cost in the Production Phase of a Mine

Entities engaged in surface mining operations often need to strip mine waste
materials in order to gain access to mineral ore deposits. Two benefits are
associated with such stripping:
1.
Usable ore which produces inventory, and
2.
Improved access to ore, which will be mined in the future.
IFRIC 20 requires that:

Costs of stripping which provide benefit in the form of inventory are accounted
for under LKAS 2, and
Costs of stripping which provide benefit in the form of improved access to ore
are recognised as a non-current asset when certain criteria are met.Such an
asset is initially measured at cost and subsequently carried at cost or revalued
amount less depreciation / amortisation and impairment losses.
2 LKAS 11 Construction Contracts

A construction contract is a contract that usually spans a year-end; revenue and
costs are recognised depending on the stage of completion.
2.1 Construction contracts

A construction contract is a contract specifically negotiated for the construction
of an asset or a combination of assets that are closely interrelated or
interdependent in terms of their design, technology, function, or ultimate use.
A fixed price contract is a construction contract in which the contractor agrees to
a fixed contract price, which is sometimes subject to cost escalation clauses.
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215
A cost plus contract is a construction contract in which the contractor is

reimbursed for allowable or otherwise defined costs, plus a percentage of these
costs or a fixed fee.
Construction contracts may involve the building of one asset, eg a bridge, or a
series of interrelated assets eg an oil refinery. They may also include rendering of
services (eg architects) or restoring or demolishing an asset.
A single construction contract for a series of assets is accounted for as a number of
separate contracts when:
Separate proposals are submitted for each asset
Separate negotiations are undertaken for each asset; the customer can
accept/reject each individually
Identifiable costs and revenues can be separated for each asset
Multiple construction contracts are combined for accounting purposes when:
The group of contracts are negotiated as a single package
Contracts are closely interrelated, with an overall profit margin
The contracts are performed concurrently or in a single sequence
2.2 Contract revenue and costs

Total revenue and costs must be determined before considering amounts to be
recognised in a given accounting period:
Contract
revenue
As specified in contract plus additional amounts that are probable

and can be reliably measured including variations, claims and
incentive payments.
Reduced by penalties charged to contractor due to delays that are
probable and can be reliably measured.
May vary throughout life of contract
Contract
costs
Relating directly to the contract

Attributable to general contract activity and can be allocated to
the specific contract systematically and rationally based on
normal levels of construction activity.
Other costs that can be charged to the customer under the
contract.
NOT general administrative costs, selling costs, R&D or
depreciation of idle plant (unless reimbursement specified in
contract).
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The effect of any change in the estimate of contract revenue or costs or the
outcome of a contract should be accounted for as a change in accounting estimate
under LKAS 8 Accounting policies, changes in accounting estimates and errors.
Therefore it is dealt with prospectively from the date of change.
2.3 Accounting for construction contracts

The accounting treatment applied to a construction contract depends on whether
the outcome of the activity can be estimated reliably. The outcome can be
estimated reliably when:
Fixed price contracts
It is probable that economic benefits of the contract will flow to the entity
Total contract revenue can be reliably measured
Stage of completion at the period end and costs to complete the contract can be
reliably measured (using the costs basis, sales basis or physical completion
basis)
Costs attributable to the contract can be identified clearly and be reliably
measured (actual costs can be compared to previous estimates)
Cost plus contracts
It is probable that economic benefits of the contract will flow to the entity
Costs attributable to the contract (whether or not reimbursable) can be
identified clearly and be reliably measured
The following flow chart summarises the accounting treatment applicable to
contracts for which the outcome can and cannot be reliably estimated:
Outcome can be reliably estimated
Expected profit
Expected loss
Revenue / costs /
profit recognised by
reference to stage of
completion
Loss is recognised
in full immediately
Outcome cannot be
reliably estimated
Revenue is recognised
to the extent that
contract costs incurred
are recoverable.
Contract costs are an
expense in the period
in which they are
incurred.
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217
2.4 Disclosure
Where payments to suppliers for raw materials and progress billings to customers
are not in line with amounts recognised in the statement of profit or loss, a gross
amount due to or from customers is reported in the statement of financial
position. This is calculated as:
Costs incurred to date
Recognised profits/(losses) to date
Progress billings to date
Amount due from / (to)customers
Rs.
X
(X)
X
(X)
X (X)
In addition a receivable amount for unpaid progress billings may be recognised.

In the notes to the financial statements, LKAS 11 requires the following to be
disclosed in respect of construction contracts:
The amount of revenue recognised in the period;

The methods used to determine revenue recognised in the period;
The methods used to determine stage of completion;
The gross amount due to or from customers at the reporting date.

The IASB has issued IFRS 15 Revenue from Contracts with Customers, which will be
adopted in Sri Lanka as SLFRS 15. This new standard will replace both LKAS 11
and LKAS 18; it is explained in more detail in Chapter 10.
QUESTION
Comprehensive question
Negombo Contracts PLC has a fixed price contract to build a commercial centre.
The initial amount of revenue agreed is Rs. 650 Mn. At the beginning of the
contract on 1 January 20X3 the initial estimate of the contract costs is Rs. 490 Mn.
At the end of 20X3 the estimate of the total costs has risen to Rs. 505 Mn.
During 20X4 the customer agrees to a variation that increases expected revenue
from the contract by Rs. 20 Mn and causes additional costs of Rs. 15 Mn. At the end
of 20X4 there are materials stored on site for use during the following period that
cost Rs. 10 Mn.
Negombo Contracts PLC has decided to determine the stage of completion of the
contract by calculating the proportion that contract costs incurred for work to
date bear to the latest estimated total contract costs. The contract costs incurred
at the end of each year were 20X3: Rs. 131.3 Mn, 20X4: Rs. 379.2 Mn (including
materials in store), 20X5: Rs. 520 Mn.
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Amounts billed to the customer by the end of each year were 20X3: Rs. 150 Mn,
20X4: Rs. 490 Mn, 20X5: Rs. 670 Mn and amounts received from the customer
were 20X3: Rs. 150 Mn, 20X4: Rs. 475 Mn and 20X5: Rs. 620 Mn.
Required
Prepare extracts from the financial statements of Negombo Contracts for each
year of the contract. Notes are not required.
ANSWER
Statement of profit or loss for the year ended 31 December
Revenue (W2)
Cost of sales (W2)
Profit (W2)
20X3
Rs'000
169,000
(131,300)
37,700
20X4
Rs'000
306,700
(237,900)
68,800
20X5
Rs'000
194,300
(150,800)
43,500
20X4
Rs'000
20X5
Rs'000
Statement of financial position at 31 December

20X3
Rs'000
Current assets
Inventory
Amounts due from customers (W3)
Trade receivables (W4)
Current liabilities
Amounts due to customers (W3)
10,000
19,000
15,000
50,000
14,300
Workings:
W1 Stage of completion
Initial amount of revenue agreed in the

contract
Variation
Total contract revenue
20X3
Rs'000
650,000
20X4
Rs'000
650,000
20X5
Rs'000
650,000
650,000
20,000
670,000
20,000
670,000
Contract costs incurred to date

Contract costs to complete
Total estimated contract costs
131,300
373,700
505,000
379,200
140,800
520,000
520,000
520,000
Estimated profit
145,000
150,000
150,000
26%
71%
100%
Stage of completion
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The stage of completion in 20X4 is calculated by deducting the Rs. 10 Mn of

materials held for the following period from the costs incurred up to that year end,
ie Rs. 369.2 Mn/Rs. 520 Mn = 71%.
Revenue, expenses and profit will be recognised in profit or loss as follows.
W2 Amounts recognised in profit or loss
20X3 Revenue (Rs 650 Mn 26%)

Costs (Rs 505 Mn 26%)
To date
Rs'000
169,000
131,300
37,700
Recognised
in
prior years
Rs'000
Recognised
in
current year
Rs'000

475,700
369,200
106,500
169,000
131,300
37,700
306,700
237,900
68,800

670,000
520,000
150,000
475,700
369,200
106,500
194,300
150,800
43,500
20X3
Rs'000
131,300
37,700
(150,000)
19,000
20X4
Rs'000
369,200
106,500
(490,000)
(14,300)
20X5
Rs'000
520,000
150,000
(670,000)
-
20X3
Rs'000
150,000
(150,000)
-
20X4
Rs'000
490,000
(475,000)
15,000
20X5
Rs'000
670,000
(620,000)
50,000
W3 Amounts due to /from customers
Costs incurred to date

Recognised profit to date
Progress billings
Amounts due (to) / from customers
W4 Trade receivables
Progress billings
Cash received
Receivables
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3 LKAS 20 Government Grants

Government grants are recognised in profit or loss to match the costs that they
are intended to compensate.
3.1 Scope
LKAS 20 does not cover the following situations.
Accounting for government grants in financial statements reflecting the effects
of changing prices
Government assistance given in the form of 'tax breaks'
Government acting as part-owner of the entity
3.2 Definitions
These definitions are given by the standard.
Government. Government, government agencies and similar bodies whether
local, national or international.
Government assistance. Action by government designed to provide an economic
benefit specific to an entity or range of entities qualifying under certain criteria.
Government grants. Assistance by government in the form of transfers of
resources to an entity in return for past or future compliance with certain
conditions relating to the operating activities of the entity. They exclude those
forms of government assistance which cannot reasonably have a value placed
upon them and transactions with government which cannot be distinguished from
the normal trading transactions of the entity.
Grants related to assets. Government grants whose primary condition is that an
entity qualifying for them should purchase, construct or otherwise acquire noncurrent assets. Subsidiary conditions may also be attached restricting the type or
location of the assets or the periods during which they are to be acquired or held.
Grants related to income. Government grants other than those related to assets.
Forgivable loans. Loans which the lender undertakes to waive repayment of
under certain prescribed conditions.
Fair value. The price that would be received to sell an asset or paid to transfer a
measurement date.
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3.3 Accounting for government grants

Recognition
criteria
Recognise when there is reasonable assurance that:

The entity will comply with conditions attached to the
grant;
The grant will be received.
(in the case of a forgivable loan, the terms for
forgiveness will be met)
Recognition in
profit or loss
Recognise grant as income over a period to match it to

the costs for which it compensates
Presentation in
statement of
financial position
Recognise as deferred income (liability), OR
Presentation in
statement of profit
or loss
Present as separate credit under general heading such as

other income, OR
Deduct from carrying amount of related asset
Deduct from related expense
3.3.1 Repayment of government grants

The repayment of a grant is accounted for as a revision of an accounting estimate
(see LKAS 8).
(a)
Repayment of a grant related to income: apply first against any unamortised

deferred income set up in respect of the grant; any excess should be
recognised immediately as an expense.
(b)
Repayment of a grant related to an asset: increase the carrying amount of the

asset or reduce the deferred income balance by the amount repayable. The
cumulative additional depreciation that would have been recognised to date
in the absence of the grant should be immediately recognised as an expense.
It is possible that the circumstances surrounding repayment may require a review

of the asset value and an impairment of the new carrying amount of the asset.
QUESTION
Recognition and presentation of government grants
Explain how the following should be accounted for insofar as the information
provided permits:
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1.
Company A receives a grant to subsidise specific expenditure that arises in

the year that the grant is received.
2.
Company B receives a grant to help it achieve export targets. The company

expects to achieve the targets 5 years after receipt of the grant.
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3.
Company C receives a grant for the purchase of a specialised piece of

machinery.
4.
Company D receives a grant for the purchase of land. A condition of the grant
is that the Company must build a property on the land.
ANSWER
1.
The grant is recognised in profit or loss in the period in which the specific
expenditure is recognised ie the period of receipt.
2.
The grant is initially recognised as deferred income. It is released to profit as

the costs of meeting the export targets are recognised. This is likely to be
over the 5 year period stated.
3.
The grant is recognised in profit or loss as the machine is depreciated and in

the same proportion. The grant is either netted off against the carrying
amount of the machine so reducing the subsequent depreciation charge or it
is recognised as a separate liability in the statement of financial position and
released to profit as income.
4.
The grant is recognised in profit or loss over the life of the property.
3.4 Government assistance

Some forms of government assistance cannot reasonably have a value placed on
them, eg free technical or marketing advice, provision of guarantees. In addition,
some transactions with government cannot be distinguished from the entity's
normal trading transactions, eg government procurement policy resulting in a
portion of the entity's sales.
Disclosure of such assistance may be necessary because of its significance; its
nature, extent and duration should be disclosed.
3.5 Disclosure
Disclosure is required of the following.
Accounting policy adopted, including method of presentation
Nature and extent of government grants recognised and other forms of
assistance received
Unfulfilled conditions and other contingencies attached to recognised
government assistance
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223
QUESTION
Government grant disclosure
Draft a suitable accounting policy note for a company that has:

Received a government loan with a preferential interest rate.
Received a grant towards staff training costs.
Received a grant towards the purchase of PPE.
The company in question adopts presentation requirements resulting in the fullest
disclosure.
ANSWER
Government grants are not recognised until there is reasonable assurance that the
company will comply with the conditions attached to them and that the grants will
be received.
The benefit of a government loan at a below-market rate of interest is treated as a
government grant measured as the difference between proceeds received and the
fair value of the loan based on prevailing market interest rates.
Government grants towards staff training costs are recognised as income over the
periods necessary to match them with the related costs and are deducted in
reporting the related expense.
Government grants relating to property, plant and equipment are treated as
deferred income and released to profit or loss over the expected useful lives of the
assets concerned.
4 LKAS 41 Agriculture
Biological assets are measured at fair value less costs to sell with changes in
fair value recognised in profit or loss.
LKAS 41 Agriculture is relevant to entities that are engaged in agricultural activity
and deals with biological assets, agricultural produce at the point of harvest and
government grants related to biological assets.
It does not apply to land used for agricultural activities or intangible assets related
to agricultural activities.
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4.1 Definitions
LKAS 41 provides the following definitions relevant to agriculture:
Agricultural activity is the management by an entity of the biological
transformation and harvest of biological assets for sale or conversion into
agricultural produce or into additional biological assets.
Agriculture produce is the harvested product of an entitys biological assets.
A biological asset is a living plant or animal, for example sheep, pigs, beef cattle,
dairy cows, fish trees in a forest, plants for harvest (eg wheat) and plants from
which produce is harvested (eg fruit trees).
Biological transformation is the processes of growth, degeneration, production
and procreation that cause qualitative or quantitative changes in a biological asset.
Harvest is the detachment of produce from a biological asset or the cessation of a
biological assets life process.
4.2 Accounting for a biological asset

Recognition
A biological asset is recognised when, and only when:

The entity controls the asset as a result of past events;
It is probable that future economic benefits associated
with the asset will flow to the entity; and
The fair value or cost of the asset can be measured
reliably.
Initial
measurement
Fair value less costs to sell.
Subsequent
measurement
Re-measure to fair value less costs to sell
The difference between cost and initial measurement is

Gain or loss recognised in profit or loss immediately
4.3 Measurement at fair value less costs to sell

measurement date.
Costs to sell are the incremental costs directly attributable to the disposal of an
asset, excluding finance costs and income taxes. They include commissions paid to
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225
dealers, transfer taxes and duties and fees. They do not include income taxes or
finance costs.
LKAS 41 makes the following additional points about fair value:
Measurement at fair value may be facilitated by grouping assets according to
their age, quality or similar attributes used in the market as a basis for pricing.
Where a sales contract for a future date exists, the contract price is not
necessarily relevant in measuring fair value since it does not necessarily reflect
current market conditions.
Cost may approximate fair value, particularly when:
Little biological transformation has taken place since purchase, or
The impact of biological transformation is not expected to be material
Where biological assets are attached to land (eg trees in a plantation forest),
there may be no separate market for the biological assets. Here the fair value of
the biological assets should be measured using information about the combined
assets.
4.3.1 Inability to measure fair value reliably
There is a rebuttable presumption that the fair value of a biological asset can be
measured reliably. This presumption can be rebutted only on initial recognition
and only if quoted market prices are not available and alternative fair value
measurements are determined to be unreliable. If the presumption is rebutted, a
biological asset should be measured at cost less accumulated depreciation and
accumulated impairment losses.
4.4 Government grants and biological assets

Government grants related to biological assets measured at fair value less costs to
sell may be conditional (ie require the recipient to meet certain criteria, such as
not engaging in specified agricultural activity) or be unconditional.
An unconditional government grant is recognised in profit or loss when it is
receivable.
A conditional government grant is recognised only when the conditions
attached to the grant are met.
Where biological assets are measured at depreciated cost, government grants are
recognised in accordance with LKAS 20 (see section 3).
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4.5 Disclosure of biological assets

In respect of biological assets, an entity must disclose:
(a)
The aggregate gain or loss in the period on initial recognition of biological

assets and from the change in fair value less costs to sell of biological assets;
(b)
A description of each group of biological assets;
(c)
A description of the nature of activities involving each group of biological

assets;
(d)
Non-financial measures or estimates of physical quantities of each group of

biological assets at the end of the period;
(e)
Details of biological assets whose title is restricted and commitments for the
acquisition of biological assets.
(f)
A reconciliation of changes in the carrying amount of biological assets

between the beginning and end of the current period.
4.5.1 Consumer Biological Assets

The following biological assets disclosure is taken from the 2013/2014 Annual
Report of Distilleries Company of Sri Lanka (DCSL) PLC:
17.2 Consumer Biological Assets
Group
For the year ended 31 March
Balance as at the Beginning of the Year
Gain/(Loss) Arising from Changes in
Fair Value Less Cost to Sell
Increase Due to Development
Balance as at the end of the year
2014
Rs'000
1,475,236
74,293
2013
Rs'000
1,422,786
42,685
10,236
1,559,765
9,765
1,475,236
Managed timber plantations include commercial timber plantations cultivated in

estates. The timber plantations are recorded at fair value other than young trees
which are recorded at cost as the significant biological transformation has not
taken place.

For accounting periods starting on or after 1 January 2016, LKAS 41 will no longer
apply to bearer plants, which will instead fall within the scope of LKAS 16.
A bearer plant is defined as a living plant that:
(i)
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is used in the production or supply of agricultural produce,
227
(ii)
is expected to bear produce for more than one period, and
(iii) has a remote likelihood of being sold as agricultural produce except for
incidental scrap sales.
An example of a bearer plant is therefore a fruit tree. Annual crops such as wheat
or maize and plants cultivated to be themselves harvested (eg trees for lumber)
are not bearer plants.
QUESTION
Agriculture
Dias Dairy Ltd acquired a herd of 200 dairy cattle on 31 December 20X3 at a cost
of Rs. 1,000 each. The market value of a dairy cow on 31 December 20X4 was
Rs. 1,200 and at 31 December 20X5 was Rs. 1,250. Sellers auction costs for
livestock amount to 3% of the selling price.
Extracts from the Dias Dairy Ltd financial statements for the year ended
31 December 20X5 were as follows:
Statement of financial position
Biological assets (dairy herd)
20X5
Rs.
160,000
20X4
Rs.
180,000
20X5
Rs.
20,000
20X4
Rs.
20,000
Statement of profit or loss

Depreciation
Accounting policy Biological assets
The Company owns a herd of dairy cattle. The herd is measured at depreciated
cost in accordance with LKAS 41.
Required
Comment on the accounting treatment adopted by Dias Dairy Ltd for the herd of
cattle and redraft the numerical extracts from the financial statements in order
that they comply with LKAS 41.
ANSWER
The herd of dairy cattle meets the LKAS 41 definition of a biological asset, being a
living plant or animal.
LKAS 41 requires that a biological asset is recognised by an entity when the entity
controls the asset as a result of a past event, it is probable that future economic
benefits will flow to the entity and the fair value or cost of the asset can be
measured reliably.
Based on the information provided these criteria are met and the company is
correct to capitalise the dairy cattle.
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A biological asset is initially measured at fair value less costs to sell and the
difference between cost and this amount is recognised in profit or loss. In this case
fair value less costs to sell at 31 December 20X3 is Rs. 194,000 (200 Rs. 1,000
97%). The acquisition is therefore recognised by:
DEBIT
DEBIT
CREDIT
Biological assets
Profit/loss
Cash
194,000
6,000
200,000
A biological asset is subsequently measured at fair value less costs to sell with any
resulting gain or loss recognised in profit or loss. At 31 December 20X4 fair value
less costs to sell is Rs. 232,800 (200 Rs. 1,200 97%) and a gain of Rs. 38,800
(232,800 194,000) is recognised in profit or loss. At 31 December 20X5 fair
value less costs to sell is Rs. 242,500 (200 Rs. 1,250 97%) and a gain of
Rs. 9,700 (242,500 232,800) is recognised in profit or loss.
There is a presumption that the fair value of a biological asset can be measured
reliably. This presumption is rebutted only if quoted market prices for the asset
are not available and other fair value measurements are deemed unreliable. In
this case a biological asset is measured at depreciated cost.
Dias Dairy Ltd has measured its herd at depreciated cost. The extracts of financial
statements provided suggests that the herd was initially measured at its cost of
Rs. 200,000 (200 Rs. 1,000) and is being depreciated over a 10 year period. As
explained above this treatment is only allowed if quoted prices are unavailable. In
this case they clearly are and therefore the treatment applied by Dias Dairy Ltd is
incorrect.
Biological assets (dairy herd)
Gain on remeasurement to fair value
CA Sri Lanka
20X5
Rs.
242,500
20X4
Rs.
232,800
20X5
Rs.
9,700
20X4
Rs.
38,800
229
5 SLFRS 6 Exploration for and Evaluation of Mineral

Resources
SLFRS 6 requires that exploration and evaluation expenditure in relation to
mineral resources is capitalised as an asset when it can be associated with
finding specific mineral resources. It is measured using either the cost model or
the revaluation model (LKAS 16).
Exploration for and evaluation of mineral resources is defined by SLFRS 6 as
The search for mineral resources, including minerals, oil, natural gas and similar
non-regenerative resources after an entity has obtained legal rights to explore in a
specific area, as well as the determination of the technical feasibility and
commercial viability of extracting the mineral resource.
The standard specifies the accounting treatment applied to exploration and
evaluation expenditure and identifies the required disclosures in respect of this.
5.1 Scope
SLFRS 6 applies only to exploration and evaluation expenditures, defined as:
Expenditures incurred by an entity in connection with the exploration for and
evaluation of mineral resources before the technical feasibility and commercial
viability of extracting a mineral resource are demonstrable.
It does not apply to:
Expenditure incurred before an entity has obtained legal rights to explore a
specific area, or
Expenditure incurred after the technical feasibility and commercial viability of
extracting a mineral resource are demonstrable.
5.2 Recognition as an asset

Exploration and evaluation assets are the result of the capitalisation of exploration
and evaluation expenditure.
This expenditure is capitalised (at cost) when it can be associated with finding
specific mineral resources. SLFRS 6 states that the following are examples of
expenditure that might be capitalised as part of an exploration and evaluation
asset:
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CA Sri Lanka
(a)
acquisition of rights to explore
(b)
topological and geological studies
(c)
exploratory drilling
(d)
trenching
(e)
sampling and
(f)
activities in relation to evaluating the feasibility and viability of extracting a

mineral resource.

After initial recognition as an asset, exploration and evaluation assets are
measured using either:
The cost model or
The revaluation model (LKAS 16)
They are assessed for impairment when facts and circumstances suggest that their
carrying amount may exceed recoverable amount. Impairment losses are
measured, presented and disclosed in accordance with LKAS 36.
5.4 Presentation
Exploration and evaluation assets are classified as either tangible or intangible
according to their nature.
Tangible assets might include vehicles and drilling rigs; intangible might include
drilling rights.
When the feasibility and viability of extracting a mineral resource are
demonstrable, exploration and evaluation assets are no longer classified as such.
5.5 Disclosure
Information must be disclosed that identifies and explains the amounts recognised
in the financial statements from the exploration for and evaluation of mineral
resources.
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231
QUESTION
As part of its year end processes Adikari Textiles Ltd held its annual inventory
count on 31 August 20X4.
Materials included in work-in-progress at 31 August 20X4 have been costed at
Rs. 450,000, and the inventory sheets state that 1,000 labour hours have been
worked on these items. Labour was paid Rs. 180 per hour in 20X4.
The following working sheet has been prepared by a member of the accounts team
in order to assist with the measurement of work in progress.
WORKING SHEET ANNUAL OVERHEADS FOR Y/E 31.08.X4
Rs.
Factory rent, rates and insurance
Administration expenses
Factory floor supervisors salaries
Factory heat, light and power*
Sales commissions and selling costs*
Depreciation of production machinery*
Depreciation of delivery vehicles***
Storage of finished goods*
2,930,000
3,800,000
2,200,000
6,000,000
2,400,000
4,000,000
1,520,000
1,900,000
* The Adikari Textiles accountant considers these to be variable costs.

** Delivery vehicles are used to deliver finished goods to customers
Hours worked by production staff in the year ended 31.08.X4
Normal hours worked by production staff in a year
160,000
190,000
Overheads are absorbed on the basis of labour hours.

Required
Explain how Adikari Textiles Ltds work in progress is measured at 31 August
20X4.
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CA Sri Lanka
ANSWER
Inventories are measured at the lower of cost and net realisable value. Net
realisable value is selling price less costs to completion and incurred in achieving a
sale.
In the case of Adikari Textiles Ltds work-in-progress, the direct costs to be
included in the measurement of inventories are:
Rs.
450,000
Direct materials
180,000
Direct labour (1,000 180)
630,000
Certain overheads are not included in the measurement of work-in-progress, as
they do not relate to bringing the inventory to its current location and condition.
In this case it is unclear whether the administrative costs are relevant to bringing
the inventory to its current location and condition. This is assumed not to be the
case. The costs to be recognised in profit or loss in the year are therefore:
ales commission and selling costs
Depreciation of delivery vehicles
Storage of finished goods
Rs.
3,800,000
2,400,000
1,520,000
1,900,000
9,620,000
The remaining overheads are included in the measurement of work-in-progress as

they are relevant to bringing the inventory to its current location and condition.
Certain overheads are fixed and these are absorbed based on the normal level of
production:
Rs.
2,930,000
Factory rent, rates and insurance
2,200,000
Factory floor supervisors salaries
5,130,000
Normal level of activity
Recovery rate per hour 5,130,000/190,000
190,000
Rs 27/hour
Fixed overheads to be included in the valuation of work-in-progress are therefore

1,000 hours 27 = 27,000
Actual hours worked by production staff in the year are 160,000. Therefore
160,000 27 = Rs. 4,320,000 of the fixed production overheads are absorbed into
CA Sri Lanka
233
inventories. The remaining Rs. 5,130,000 Rs. 4,320,000 = Rs. 810,000 are
Variable overheads are absorbed based on the actual level of production:
Rs.
6,000,000
Factory heat , light and power
4,000,000
Depreciation of production machinery
10,000,000
Actual level of activity
Recovery rate per hour 10,000,000/160,000
160,000
Rs 62.50/hour
Variable production overheads to be included in the valuation of work-in-progress

are therefore 1,000 hours 62.50 = Rs. 62,500
Work-in-progress is therefore measured at:
Direct costs
Fixed production overheads
Variable production overheads
Rs.
630,000
27,000
62,500
719,500
QUESTION
Perera Industries Ltd received a grant of Rs. 1 million on 1 October 20X4 on
condition that the money was used towards the purchase of a machine costing
Rs. 4 million. The company acquired the machine on 1 December 20X4 and
immediately started to depreciate it based on a 25% reducing balance. The
machine is expected to be used for 10 years at which time it will have a residual
value of Rs. 225,250.
Perera Industries recognises grants separately from related assets in the
statement of financial position.
Required
Explain how the asset and related grant are accounted for and prepare the
relevant extracts from the statement of financial position and statement of profit
or loss for the year ended 31 December 20X4 and 31 December 20X5.
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CA Sri Lanka
ANSWER
The machine is initially recognised at cost of Rs. 4 million by:
DEBIT
CREDIT
PPE
Cash
Rs. 4 million
Rs. 4 million
The machine is subsequently depreciated using a 25% reducing balance:

Rs.
4,000,000
Cost 1.12.X4
(83,333)
Depreciation 20X4 (4m 25% 1/12)
3,916,667
Carrying amount 31.12.X4
(979,167)
Depreciation 20X5 (3,916,667 25%)
2,937,500
The grant is recognised at proceeds of Rs. 1 million. The credit entry is made to a
deferred income balance in accordance with the Companys policy for
presentation of asset related grants:
DEBIT
CREDIT
Cash
Deferred income
Rs. 1 million
Rs. 1 million
The deferred income is released to profit to match the depreciation of the

machine. Therefore it is released from 1 December 20X4 and in proportion to the
depreciation of the machine:
Rs.
1,000,000
Proceeds
(20,833)
Release to profit 20X4 (1m 25% 1/12)
979,167
(244,792)
Release to profit 20X5 (979,167 25%)
734,375
(183,594)
Release to profit 20X6 (734,375 25%)
550,781
Statement of financial position at 31 December
Non-current assets
PPE
Deferred grant income
Current liabilities
Deferred grant income
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20X4
Rs.
20X5
Rs.
3,916,667
2,937,500
734,375
550,781
244,792
183,594
235
Statement of profit or loss for the year ended 31 December
Depreciation
Grant income
236
20X4
Rs.
83,333
(20,833)
20X5
Rs.
979,167
(244,792)
CA Sri Lanka
CHAPTER ROUNDUP
Inventories are measured at the lower of cost and net realisable value.
Cost includes costs of purchase and costs of conversion.
Where items are interchangeable cost is estimated using a cost formula.
An inventory write down to NRV is recognised in profit or loss.
A construction contract is a contract that usually spans a year-end
Where the outcome can be reliably estimated and the contract is profitable,
revenue and costs are recognised depending on the stage of completion.
Where the outcome can be reliably estimated and the contract is loss making
the loss is recognised in full.
Where the outcome cannot be reliably estimated revenue is recognised to the

extent that costs incurred are recoverable.
Government grants are recognised in profit or loss to match the costs that they
are intended to compensate.
Biological assets are measured at fair value less costs to sell with changes in
fair value recognised in profit or loss.
SLFRS 6 requires that exploration and evaluation expenditure in relation to

mineral resources is capitalised as an asset when it can be associated with
finding specific mineral resources. It is measured using either the cost model or
the revaluation model (LKAS 16).
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237
PROGRESS TEST
238
IFRIC 20 states that there are two assets arising from stripping mine waste
materials. What are they?
What may cause contract revenue to change as a construction contract

progresses?
What information is required in the accounting policy note in respect of

construction contracts?
How is a government loan at below the market rate of interest accounted for in the
recipients accounts?
How is a biological asset initially measured?
SLFRS 6 requires that all expenditure after the technical feasibility and
commercial viability of extracting mineral resource are demonstrable is
capitalised. True or false?
CA Sri Lanka
Inventory (usable ore) and a non-current asset (improved access to ore to be

mined in the future).
Variations in contract work as instructed by the customer, reimbursement claims

for unforeseen costs, incentive payments based on performance and penalties
charged to the contractor by the customer.
The methods used to determine revenue in the period and the methods used to
determine stage of completion.
This is a government grant. The benefit is the difference between the initial
carrying amount of the loan in accordance with LKAS 39 and the proceeds
received.
At fair value less costs to sell. Any difference between this and cost is recognised
in profit or loss.
False. Expenditure after the technical feasibility and commercial viability of

extracting a mineral resource are demonstrable is not within the scope of SLFRS 6.
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239
240
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CHAPTER
INTRODUCTION
Both LKAS 37 and LKAS 10 are standards that you have already met in detail at KE1 and KB1. At KC1
level you may have to identify incorrect accounting treatment or comment on treatment applied in a
given scenario.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.2
Level B
1.1.7
1.2.1
1.2.2
1.2.3
1.2.4
1.2.5

matters.
Advise appropriate application and selection of accounting/reporting options given under
standards.
Apply Sri Lanka Accounting Standards in solving moderately complicated matters.
Demonstrate a thorough knowledge of Sri Lanka Accounting standards in the selection and
Demonstrate the appropriate application and selection of accounting/reporting options
Outline the disclosures to be made in the financial statements.
241
KC1 | Chapter 9: Provisions and events after the reporting period
CHAPTER CONTENTS
1 LKAS 37 Provisions, Contingent Liabilities and Contingent Assets
3 LKAS 10 Events after the Reporting Period

Differentiate provisions and liabilities.
Advise the conditions to be satisfied to recognise a provision in the financial
statements.
Evaluate given information to identify whether provision need to be made in
the FS.
Differentiate contingent liabilities and contingent assets.
Analyse the factors to be considered in measurement of provisions.
Advise how to record reimbursement, changes in provisions and use of
provisions.
Assess restructuring provisions to be made in the financial statements.
Develop the disclosures to be made in respect of provisions, contingent
liabilities and contingent assets.
Analyse events after the reporting period for reporting purposes.
Develop disclosures for post balance sheet events.
1 LKAS 37 Provisions, Contingent Liabilities and Contingent

Assets
A provision is made where the LKAS 37 criteria are met. It is measured at the
best estimate of expenditure required to settle the present obligation.
Contingent liabilities and probable contingent assets are disclosed in the
LKAS 37 addresses the issue of accounting for uncertainty, limiting opportunities
for the manipulation of profit figures through the creation and release of
provisions. The objective of the standard is to ensure that appropriate recognition
criteria and measurement bases are applied to provisions, contingent liabilities
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CA Sri Lanka
and contingent assets and that sufficient information is disclosed in the notes to
enable users to understand their nature, timing and amount.
1.1 Definitions
A provision is a liability of uncertain timing or amount.
A liability is an obligation of an entity to transfer economic benefits as a result of
past transactions or events.
An onerous contract is a contract in which the unavoidable costs of meeting the
obligations under the contract exceed the economic benefits expected to be
received under it.
A restructuring is a programme that is planned and controlled by management
and materially changes either:
(a)
(b)
The scope of a business undertaken by an entity, or

The manner in which that business is conducted.
A contingent liability is:

A possible obligation that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain
future events not wholly within the entity's control; or
A present obligation that arises from past events but is not recognised because:
It is not probable that a transfer of economic benefits will be required to
settle the obligation; or
The amount of the obligation cannot be measured with sufficient reliability.
A contingent asset is a possible asset that arises from past events and whose
existence will be confirmed by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the control of the entity.
(LKAS 37)
LKAS 37 distinguishes provisions from other liabilities such as trade payables and
accruals. This is on the basis that for a provision, there is uncertainty about the
timing or amount of the future payment.
1.2 Recognition of provisions

A provision is recognised in the financial statements when all of the following
criteria are met:
(a)
CA Sri Lanka
There is a present obligation as a result of a past event.
243
(b)
It is probable that a transfer of economic benefits will be required to settle

the obligation.
(c)
A reliable estimate can be made of the obligation.
Present obligation as
result of past event
Legal obligation (contract, legislation, operation of

law), or
Constructive obligation (derives from an entitys
actions)
Must relate to a past event (provision cannot be for
future intentions)
Probable transfer of
economic benefits
More likely than not
Reliable estimate
Can be made in all but rarest cases
Consider population as a whole where there are a

number of similar obligations
Disclose contingent liability if estimate cannot be

made
1.3 Measurement of provisions

A provision is measured at the best estimate of the expenditure required to settle
the present obligation at the end of the reporting period.
Single obligation
Best estimate is usually the most likely outcome,

however if other possible outcomes are mostly
higher, the best estimate will be higher and if other
possible outcomes are mostly lower, the best
estimate will be lower.
Large population of items
Use expected values approach ie take each possible

outcome and weight it according the probability of
that outcome happening.
A provision is measured at the present value of the amount required to settle

an obligation where the time value of money is material. The discount rate
should be a pre-tax rate that reflects current market assessments of the time
value of money. The rate should not reflect risks for which cash flow estimates
have been adjusted.
Future events that are reasonably expected to occur and may affect the amount
required to settle an obligation are taken into account when measuring a
provision.
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CA Sri Lanka
Gains from the expected disposal of assets are not taken into account when
measuring a provision.
QUESTION
Subsequent events
The following scenarios relate to different companies:

1.
On 12 October 20X3 the Board of Adikari Ltd decided to close one of its
operating divisions. The decision was publicly announced at a press
conference on 15 November 20X3, the day after a staff meeting was held to
inform employees of the decision. In its statement of financial position at
31 October 20X3, the financial controller of Adikari Ltd recognised a
provision of Rs. 25 million in respect of expected operating losses of the
division to its closure date and staff retraining costs.
2.
On 18 August 20X4 an ex-employee of Mannar (Pvt) Ltd commenced a legal

action against the company for unfair dismissal. At the year-end of
30 September 20X4, Mannar (Pvt) Ltds lawyers advised the company that
based on the available evidence the ex-employee had a 55% chance of
winning their case. If the ex-employee won, he would probably be awarded
damages of Rs. 5 million but it might be Rs. 5.5 million. The financial
controller of Mannar (Pvt) Ltd has not provided for the cost of damages,
however has accrued for unbilled legal costs.
Required
Comment on the accounting treatment applied in each of the above scenarios.
ANSWER
1.
Adikari Ltd
The decision to close was made on 12 October 20X3 and this was first
announced to affected parties (staff members) on 14 November 20X3. At the
year-end of 31 October 20X3 a past event has occurred (the decision to
close), however there is no legal or constructive obligation. A constructive
obligation does not arise until 14 November 20X3. Therefore the financial
controller is incorrect to recognise a provision at 31 October 20X3.
Furthermore LKAS 37 only allows a provision to be made for the direct costs
of a closure or restructuring. The standard specifically prohibits provisions
for operating losses or provisions that reflect the future intentions of an
entity. Staff retraining is not a direct cost of closure it is related to future
intentions. Therefore even if the decision to close had been announced the
provision for Rs. 25 million should not be recognised.
CA Sri Lanka
245
2.
Mannar (Pvt) Ltd

The recognition criteria of LKAS 37 must be applied:
A past event (the dismissal of the employee) has created a legal

obligation for Mannar (Pvt) Ltd (since legal action has been brought).
The likelihood of an outflow of economic benefits is assessed by

experts as being 55%. This is probable as defined by LKAS 37 ie more
likely than not.
Damages have been estimated at between Rs. 5 million and Rs. 5.5 million.
This is a single obligation and LKAS 37 requires that the best estimate of
outflow is the most likely outcome. In this case that is Rs. 5 million.
Therefore all recognition criteria are met and a provision should have been
made for Rs. 5 million.
The financial controller is correct to record an accrual in respect of unbilled
legal costs. These meet the definition of a liability ie they form a present
obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying
economic benefits.
1.4 Accounting entries

The following table summarises the accounting entries made in respect of
provisions:
Increase in / recognition of provision
DEBIT
CREDIT
Expense
Provision
Decrease in / release of provision
DEBIT
CREDIT
Provision
Expense
Use of a provision
DEBIT
CREDIT
Provision
Cash
Provisions should be reviewed at the end of each reporting period and adjusted
to reflect the current best estimate.
A provision should only be used for the purpose for which it was recognised.
1.5 Reimbursements
Some or all of the expenditure needed to settle a provision may be expected to be
recovered from a third party. If so, the reimbursement should be recognised only
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CA Sri Lanka
when it is virtually certain that reimbursement will be received if the entity settles
the obligation.
The reimbursement should be treated as a separate asset, and the amount
recognised should not be greater than the provision itself.
The provision and the amount recognised for reimbursement may be netted off
inprofit or loss.
QUESTION
A corporate customer launched a legal case against Mattala Machinery PLC on
2 December 20X4 on the basis that a machine supplied by the company was faulty
and as a result goods produced by it were substandard, resulting in lost contracts
and wasted materials.
Mattala Machinerys legal team has advised that the company has a 75% chance of
losing the case and as a result would have to pay Rs. 15,000,000 in damages.
Mattala Machinery is covered by insurance for such an eventuality and if it loses
the case against the customer it is virtually certain that it can claim for the full
amount of the loss net of a 5% excess.
Required
How is the above situation reflected in the financial statements of Mattala
Machinery PLC at 31 December 20X4?
ANSWER
Mattala Machinery should recognise:
A provision for Rs. 15 million in respect of the customer claim
An asset for 95% 15 million = Rs. 14.25 million in respect of the insurance
claim
A net expense of Rs. 750,000 in profit or loss.
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247
1.6 Common scenarios

LKAS 37 includes guidance on whether a provision should be made in certain
situations:
Future operating
losses
Recognition criteria not met; provision should not be

made.
Onerous contracts (see

definitions, section
1.1)
The present obligation under the contract is

recognised as a provision.
Restructuring (see
definitions, section
1.1)
Includes:
Sale or termination of line of business
Closure of business locations in a geographical area
or relocation of business activities from one area to
another
Changes in management structure
Fundamental reorganisations that have a material
effect on the nature and focus of an entitys
operations.
A provision is made when there is a constructive
obligation ie
The entity has a detailed formal plan for
restructuring and
The entity has raised a valid expectation in those
affected that it will carry out the restructuring.
In the case of a sale of an operation there is only an
obligation when there is a binding sale agreement.
A restructuring provision includes only direct
expenditure arising from the restructuring.
1.7 Disclosure
Disclosures required in the financial statements for provisions fall into two parts:
For each class of provision:
248
(a)
The carrying amount at the beginning and end of the period
(b)
Additional provisions made in the period, including increases to existing

provisions
(c)
Amounts used during the period
CA Sri Lanka
(d)
Unused amounts reversed during the period
(e)
The increase during the period in the discounted amount arising from the
passage of time and the effect of any change in the discount rate.
For each class of provision, disclosure of the background to the making of the
provision and the uncertainties affecting its outcome, including:
(a) A brief description of the nature of the provision and the expected timing of
any resulting outflows relating to the provision.
(b) An indication of the uncertainties about the amount or timing of those
outflows and, where necessary, to provide adequate information, the major
assumptions made concerning future events.
(c) The amount of any expected reimbursement relating to the provision and
whether any asset that has been recognised for that expected
reimbursement.
1.7.1 Non-disclosure
LKAS 37 permits reporting entities to avoid disclosure requirements relating to
provisions (and contingent liabilities and contingent assets) if they would be
expected to seriously prejudice the position of the entity in dispute with other
parties. However, this should only be employed in extremely rare cases. Details
of the general nature of the provision/contingencies must still be provided,
together with an explanation of why it has not been disclosed.
1.7.2 Example: Provisions disclosure note
Restructuring Litigation
Rs Mn
630
1,245
At 1 January 20X4
92
210
Provisions made in the
year
(180)
(450)
Amounts used
(25)
(165)
Unused amounts
reversed
(5)
4
Exchange difference
521
835
At 31 December 20X4
Other
390
60
Total
2,265
362
(30)
(85)
(660)
(275)
335
(1)
1,691
Restructuring
Restructuring provisions arose from a number of projects across the Group. These
include plans to close the Indian manufacturing division. Restructuring provisions
are expected to result in future cash outflows when implementing the plans
(usually over the following two to three years).
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249
Litigation
Litigation provisions have been set up to cover tax, legal and administrative
proceedings that arise in the ordinary course of business. These provisions cover
several cases whose detailed disclosure could be detrimental to the Group. The
Group does not believe that any of these litigation cases will have a material
adverse impact on its financial position. The timing of cash outflows depends on
the outcome of proceedings.
Other
Other provisions are mainly in respect of onerous leases. These result from
unfavourable leases, breach of contracts or supply agreements above market
prices in which the unavoidable costs of meeting the obligations under the
contracts exceed the economic benefits expected to be received or for which no
benefits are expected to be received.
1.8 Contingent liabilities

A contingent liability is defined in section 1.1. Contingent liabilities should not be
recognised in financial statements but they should be disclosed in the notes.
Unless the possibility of an outflow of economic benefits is remote, disclose for

each contingent liability:
(a)
A brief description of its nature; and where practicable
(b)
An estimate of the financial effect
(c)
An indication of the uncertainties relating to the amount or timing of any

outflow; and
(d)
The possibility of any reimbursement.
1.8.1 Example: Contingent liabilities disclosure note

During the reporting period, a customer of the Company instigated proceedings
against it for alleged defects in an electronic product which, it is claimed, were the
cause of a major fire at the customers premises on 5 November 20X3. Total losses
to the customer have been estimated at Rs. 10 Mn and this amount is being
claimed from the Company.
The Companys legal advisers have stated that they do not consider that the suit
has merit, and they have recommended that it is contested. No provision has been
made in these financial statements as the Companys management do not consider
there to be a probable loss.
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1.9 Contingent assets

A contingent asset is defined in section 1.1. A contingent asset must not be
recognised in the accounts, but should be disclosed if it is probable that the
economic benefits associated with the asset will flow to the entity.
If the flow of economic benefits associated with the contingent asset becomes
virtually certain, it should then be recognised as an asset in the statement of
financial position, as it is no longer a contingent asset.
Where an inflow of economic benefits is probable, an entity should disclose:
(a)
(b)
A brief description of its nature; and where practicable

An estimate of the financial effect.
QUESTION
Settawa Plant Ltd operates in the mining and excavation industries. The following
issues are relevant to the company in the year ended 31 December 20X3:
1.
The company constructed a mine shaft during the year that was ready for
use on 31 December 20X3. Governmental planning permission was granted
for the mine shaft on condition that Settawa Plant dismantles the mine shaft
and restores the site on which it is located at the end of the mines useful life
(30 years). Settawa estimates that the cost of this in 30 years will be
Rs. 35 million and the present value of this amount is Rs. 10 million. The
accountant of Settawa Plant has created a provision for Rs. 35 million and
charged this as an exceptional expense in profit or loss.
2.
In December 20X2 the former purchasing director of the company was

dismissed. She brought an unfair dismissal claim against Settawa Plant in
February 20X3 and is seeking damages of Rs. 7 million. As the Companys
legal team advised that the ex-employee had just a 55% chance of winning
her case the accountant has made no provision but disclosed a contingent
liability.
Required
CA Sri Lanka
(a)
Comment on the accounting treatment applied by the Company accountant,

suggesting the correct treatment where necessary.
(b)
Prepare the necessary numerical disclosures to be reported in the financial

statements in the year ended 31 December 20X3.
251
ANSWER
(a)
Mine shaft
The planning permission for the mine shaft requires that at the end of its
useful life the mine shaft is removed and site restored.
The granting of the planning permission means that the company has a
legal obligation to incur restoration costs in the future. The past event is
the construction of the mine shaft. Therefore the company has a legal
obligation as a result of a past event at the reporting date.
The costs to be incurred in the future are a probable outflow of benefit.
Settawa Plant has estimated the restoration costs at Rs. 35 million.
Therefore the LKAS 37 provision recognition criteria are met and the
company accountant is correct to make a provision.
The provision should be measured at the full cost of restoration as estimated
at the time of construction (ie it should not gradually accrue over the mine
shafts life). LKAS 37 requires that provisions are measured at present value
where the time value of money is significant. This is the case here and so the
provision is measured at Rs. 10 million rather than Rs. 35 million.
Restoration costs form part of the cost of the mine shaft. Therefore the
provision should not be recognised in profit or loss but capitalised as part of
PPE:
DEBIT
CREDIT
PPE
Provision
Rs. 10 million
Rs. 10 million
Unfair dismissal case

The recognition criteria of LKAS 37 should be applied:
Settawa Plant has received a claim in the year for damages arising from an
event that happened in the previous year. Therefore a legal obligation
exists as a result of a past event.
The Company legal team consider there is a 55% chance of Settawa losing
the court case. This is more likely than not and therefore results in a
probable outflow of benefits.
The amount of damages claimed is Rs. 7 million; this is a reliable estimate
of the outflow to settle the obligation.
Therefore a provision should be made for Rs. 7 million by:
DEBIT
CREDIT
252
Profit/loss
Provision
Rs. 7 million
Rs. 7 million
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(b)
Settawa Plant
Extract from statement of financial position at 31 December 20X3
Rs'000
Non-current assets
10,000
Provisions
10,000
Current liabilities
Provisions
7,000
Extract from statement of profit or loss for year ended 31 December
20X3
Rs'000
Operating expenses
7,000
Note - Provisions
At 1 January 20X3
Provided in year
At 31 December 20X3
Restoration
Rs'000
10,000
10,000
Legal
Rs'000
7,000
7,000
Total
Rs'000
17,000
17,000
IFRIC 6, IFRIC 1, IFRIC 5 and IFRIC 21 deal with provisions arising as a result of
specific circumstances.
2.1 IFRIC 6 Liabilities Arising from Participating in a Specific

Market Waste Electrical and Electronic equipment
IFRIC 6 applies to the manufacturers of certain electrical goods when those
manufacturers have to contribute towards the cost of the waste management of
decommissioned electronic and electrical equipment supplied to private
households.
The interpretation deals in particular with identifying the event that gives rise to a
decommissioning liability. It concludes that the event that triggers liability
recognition is participation in the market during the measurement period (eg in a
given calendar year) rather than the incurrence of costs or the initial sale of the
electrical goods.
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253
2.1.1 Example: Obligation for the costs of waste management

Kandy Electricals PLC sells electrical equipment and has a 4% market share in
20X4. It subsequently discontinues operations and is therefore no longer in the
market when the waste management costs for its products are allocated to those
entities with market share in 20X7. As a result its obligation in 20X7 is nil.
Beira Electricals PLC starts to sell electrical equipment in 20X7 and achieves a
market share of 2% in that period. Therefore the companys obligation for the
costs of waste management from earlier periods is 2% of total costs of waste
management allocated to 20X7. This is the case even though Beira Electricals was
not in the market in the earlier periods and has not produced any of the goods for
which waste management costs are allocated in 20X7.
2.2 IFRIC 1 Changes in Existing Decommissioning, Restoring and

Similar Liabilities
Where an entity acquires or builds an item of PPE, there may be an obligation to
dismantle and remove the asset and rectify damage caused by the asset at the end
of its useful life. Where this is the case, the entity should make a provision for the
present value of the dismantling or rectification costs.
IFRIC 1 deals with accounting for changes to such a provision as a result of
A change to the estimated cash flows required to settle the obligation (timing
and amount), and
A change in the discount rate applied to the cash flows
The interpretation concludes that:
1.
Where the related asset is measured using the cost model these changes
should be capitalised as part of the cost of the asset and depreciated over the
remaining useful life of the item.
2.
Where the related asset is measured using the revaluation model, a change
in the value of the liability does not affect the carrying amount of the item,
but instead affects the revaluation surplus or deficit on the item. The effect of
the change is treated consistently with other revaluation surpluses or
deficits ie a surplus is credited to equity and a deficit recognised in profit or
loss.
The interpretation also states that the unwinding of the discount is recognised in
profit or loss as a finance cost.
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2.3 IFRIC 5 Rights to Interests arising from Decommissioning,

Restoration and Environmental Rehabilitation Funds
Entities may contribute to a fund to reimburse decommissioning, restoration or
rehabilitation costs when they are incurred. Such a fund may be set up for the
benefit of just one or many contributors.
IFRIC 5 deals with how a contributor should account for its interest in a fund and
how an obligation to make additional contributions should be accounted for. It
states:
If an entity recognises a decommissioning obligation and contributes to a fund
to pay for the obligation, it should apply SLFRSs to determine whether the fund
should be consolidated or equity accounted (see Chapters 16-19)
When a fund is not consolidated or equity accounted, and the fund does not
relieve the contributor of the requirement to pay decommissioning costs, the
contributor should recognise its obligation to pay such costs as a liability and
its right to receive reimbursement from the fund as a reimbursement under
LKAS 37 (see Section 1.5).
A right to reimbursement is measured at the lower of the decommissioning
obligation recognised and the contributors share of the fair value of the net
assets of the fund.
When a contributor has an obligation to make potential additional
contributions to the fund, that obligation is a contingent liability within the
scope of LKAS 37.
2.4 IFRIC 21 Levies

A levy is an amount imposed on an entity by the government in accordance with
laws and/or regulations. For the purposes of IFRCI 21, it is not:
An amount that is within the scope of another standard eg income taxes, or
A fine or penalty imposed for a breach of legislation.
For example, in Sri Lanka, the government requires certain entities to pay a
Tourism Development Levy based on their turnover. The government uses money
raised through the levy to develop and promote tourism in Sri Lanka.
2.4.1 The accounting issue
IFRIC 21 provides guidance on when a liability should be recognised for a levy. It
addresses both:
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255
Levies that fall within the scope of LKAS 37 because their timing / amount is
uncertain, and
Levies for which the timing / amount is certain.
2.4.2 Obligating event
A liability is recognised when an obligating event occurs. IFRIC 21 confirms that
the obligating event in the case of a levy is the activity that triggers the payment of
the levy in accordance with the relevant legislation.
2.4.3 Example: Obligating event
Elephant Co is required to pay a levy on the last day of each calendar year as a
result of the generation of revenue in that year. The amount of levy payable is
calculated as 1.5% of the level of revenue generated in the previous year.
Therefore as a result of generating revenue throughout 20X2, Elephant must pay a
levy on 31 December 20X2 measured as 1.5% of revenue generated in 20X1.
In this case, the obligating event is the generation of revenue in 20X2, even though
the amount of levy payable is related to the level of revenue in 20X1.
The levy payable on 31 December 20X3 is not recognised until revenue is actually
generated in 20X3, even though as at 31 December 20X2, Elephant Co is
economically compelled to continue to operate in 20X3 and its financial
statements are prepared on the going concern basis, so indicating that it is
expected to continue to operate.
2.4.4 Recognition
If an obligation is triggered when a minimum threshold is reached, the liability is
recognised at that time.
If an obligating event occurs over a period of time, the liability is recognised
progressively.
2.4.5 Example: Progressive recognition
Iguana Co is required to pay a levy to the government on 31 December 20X3,
triggered by the generation of profits in 20X3. The amount of levy is related to the
level of profits generated in the year.
Iguana Co must recognise a liability progressively during 20X3. This reflects the
fact that at any point in 20X3, Iguana Co has a present obligation to pay a levy on
revenue generated to date.
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CA Sri Lanka
2.4.6 Example: Minimum threshold

Impala Co is required to pay a levy to the government when its revenue reaches Rs.
15 million. The levy is calculated as 0.5% of all revenue generated in the year. In the
year ended 31 December 20X4, Impala Co achieves revenue of Rs. 15 million on
8 April.
Impala Co does not recognise a liability for the levy until 8 April 20X4, when the
minimum threshold is met. On this date it recognises a liability of Rs. 75,000. The
liability is increased progressively over the period 8 April to 31 December 20X4 as
Impala Co generates further revenue.
2.4.7 Interim financial statements
The recognition principles described above are also applied to interim financial
statements. Therefore:
A liability is not recognised at the end of the interim period if there is no
present obligation to pay the levy at that date;
A liability is recognised at the end of the interim period if there is a present
obligation to pay the levy at that date.
3 LKAS 10 Events after the Reporting Period

The financial statements are significant indicators of the success of a company
or its failure. It is therefore important that they include all the information
necessary for an understanding of financial position. Therefore they are adjusted
for events after the reporting period that provide evidence of year end
conditions.
LKAS 10 is concerned with events that arise after the reporting period, and
addresses the issue of whether significant events should in fact be reflected in the
financial statements, even though they occurred after the period end.
3.1 Definition
LKAS 10 provides the following definition.
Events after the reporting period are those events, both favourable and
unfavourable, that occur between the reporting date and the date on which the
financial statements are authorised for issue. Two types of events can be
identified:
Those that provide further evidence of conditions that existed at the reporting
date; and
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257
Those that are indicative of conditions that arose subsequent to the reporting
date
(LKAS 10)
The date on which the financial statements are authorised for issue may not be
clear. For the avoidance of doubt, LKAS 10 clarifies when the date is in three
specific circumstances:
If an entity is required to submit its financial statements to its shareholders for
approval after the financial statements have been issued, the financial
statements are authorised for issue on the date of issue, not the date when the
shareholders approve the financial statements.
If the management of an entity is required to issue its financial statements to a
supervisory board for approval, the financial statements are authorised for
issue when the management authorises them for issue to the supervisory
board.
The date on which the financial statements are authorised for issue is not
brought forward as a result of a public announcement of profit or other
selected financial information.
3.2 Adjusting events

Adjusting events are those events that provide further evidence of conditions that
existed at the reporting date. The financial statements are adjusted to reflect these
events.
3.3 Non-adjusting events

Non-adjusting events are those events that are indicative of conditions that arose
subsequent to the reporting date. The financial statements are not adjusted to
reflect these events.
Although the financial statements are not adjusted to reflect these events, material
non-adjusting events should be disclosed.
LKAS 10 provides examples of both adjusting and non-adjusting events.
QUESTION
The following events are taken from LKAS 10. Identify whether they are adjusting
or non adjusting:
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CA Sri Lanka
Adjusting
CA Sri Lanka
1.
The settlement after the reporting period of a

court case that confirms that the entity had a
present obligation at the end of the reporting
period.
2.
The destruction of a property by fire.
3.
The determination after the reporting period of

the cost of assets purchased before the end of
the reporting period.
4.
Announcing a plan to discontinue an operation.
5.
The bankruptcy of a customer that occurs after

the reporting period
6.
The receipt of information after the reporting

period indicating that a non-current asset was
impaired at the end of the reporting period.
7.
A major business combination after the

reporting period or disposing of a major
subsidiary.
8.
Abnormally large changes after the reporting

period in asset prices.
9.
The determination after the reporting period of

the amount of bonus or profit-sharing payments
(if the entity had a present legal or constructive
obligation to make such payments at the period
end as a result of events before that date)
10.
The discovery of fraud or errors showing that

the financial statements are incorrect.
11.
Changes in tax rates or tax laws enacted or

announced after the reporting period that have a
significant effect on current and deferred tax
amounts in the financial statements.
12.
Entering into significant

contingent liabilities.
commitments
Nonadjusting
or
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ANSWER
Adjusting events are numbers 1, 3,5,6,9 and 10.
Non-adjusting events are numbers 2,4,7,8, 11 and 12.
3.4 Dividends
The declaration of an ordinary dividend, in the period between the reporting date
and date on which the financial statements are authorised for issue, is a nonadjusting event, and no liability should be recognised.
The dividend should, however, be disclosed in accordance with LKAS 1
Presentation of Financial Statements.
3.4 Going concern

If the management of a company determine after the reporting period that it
intends to liquidate the company or to cease trading, or that it has no realistic
alternative but to do so, this is classified as an adjusting event.
In this case, the basis of accounting should be changed and the financial
statements should not be prepared on the going concern basis.
3.5 Disclosure
LKAS 10 requires disclosure in respect of:
The date on which the financial statements were authorised for issue and who
gave that authorisation;
Material non-adjusting events.
The standard also requires that where a company receives information after the
reporting period about conditions that existed at the end of the reporting period,
it must update disclosures that relate to those conditions in the light of the new
information.
3.5.1 Material non-adjusting event disclosure
For each material category of non-adjusting event after the reporting period, the
following should be disclosed:
260
(a)
the nature of the event, and
(b)
an estimate of its financial effect, or a statement that such an estimate cannot

be made.
CA Sri Lanka
3.5.2 Example: Events after the reporting period disclosure

On 13 January 20X5 part of the premises of AB Ltd were seriously damaged by
fire. Insurance claims have been put in hand but the cost of refurbishment is
currently expected to exceed these by Rs. 2 Mn.
QUESTION
Abercrombie Processing Ltd is planning to close one of its business divisions due
to declining customer demand. Closure is expected to take place in April 20X4 and
the facts of the closure have been included in a detailed formal plan. The plan was
approved at a Board meeting on 12 December 20X3 and a press release was
issued on the following day. The Company accountant has made a provision at the
year end of 31 December 20X3 for the following costs of closure:
Consultancy fees re corporate strategy
Voluntary redundancy costs
Identifiable losses until closure
Retraining of staff
Rs. 40 million
Rs. 80 million
Rs. 45 million
Rs. 25 million
Required
Comment on the validity of the accounting treatment applied by the company
accountant.
ANSWER
The closure of a division is a restructuring activity as defined by LKAS 37 (sale or
termination of a line of business).
A restructuring provision is recognised if there is a detailed formal plan in place
and a valid expectation of the closure has been created by the reporting date.
Abercrombie Processing does have a formal plan in place; it has been approved by
the directors and announced before the year-end. Therefore a provision for the
costs of closure can be recognised in the statement of financial position at
31 December 20X3.
The provision can include only direct costs that are necessarily entailed by the
restructuring and are not associated with the ongoing activities of the company.
Consultancy fees cannot be provided for as these are associated with ongoing
activities. These are expensed as incurred
Voluntary redundancy costs are necessarily entailed by the restructuring and
are included in the provision
Future losses cannot be provided for as they do not relate to a past event
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261
Retraining costs are associated with ongoing activities and so cannot be

provided for. These are expensed as incurred.
Therefore the provision should be for Rs. 80 Mn only.
QUESTION
Gigg Leisure Ltd operates a chain of health clubs throughout Sri Lanka. In the year
ended 31 December 20X5 it was sued by a customer who alleges that they were
injured whilst using a faulty machine at a Company owned gym in Colombo. At the
year end the accountant of Gigg Leisure Ltd has made a provision for damages of
Rs1.5million, based on legal advice that the Company had an expected 75% chance
of losing the case at that date. The court case was heard in February 20X6 and
damages were settled at Rs. 1.75 million. Gigg Leisure Ltds financial statements
were approved for distribution in March 20X6.
Required
Explain the correct accounting treatment for the claim for damages.
ANSWER
Gigg Leisure Ltd has made a provision for damages at 31 December 20X5. This is
correct as the LKAS 37 recognition criteria are met:
1.
There is a present obligation as a result of a past event (the past event is the
injury and resulting claim and the obligation is legal)
2.
An outflow of economic benefits is 75% likely ie it is probable
3.
At the reporting date a reliable estimate of damages can be made.
The subsequent settlement of the court case in February 20X6 is an event after the
reporting period. It is adjusting as it adds information about conditions that
existed at the period end.
Therefore the measurement of the provision should reflect the settlement amount
and the recognised provision should be remeasured to Rs. 1.75 million. This will
result in an extra charge to profit or loss of Rs. 250,000.
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CHAPTER ROUNDUP
A provision is made where the LKAS 37 criteria are met:

a present obligation exists as a result of a past event
an outflow of economic benefits is probable
the outflow can be measured reliably
A provision is measured at the best estimate of expenditure required to settle

the present obligation.
Expected values are used to measure a provision where there is a large

population of items.
Contingent liabilities and probable contingent assets are disclosed in the

IFRIC 6, IFRIC 1 and IFRIC 5 deal with provisions arising as a result of specific
circumstances.
The financial statements are significant indicators of the success of a company

or its failure. It is therefore important that they include all the information
necessary for an understanding of financial position. Therefore they are adjusted
for events after the reporting period that provide evidence of year end
conditions.
Non-adjusting events are disclosed if material.
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263
PROGRESS TEST
264
A company wishes to make a provision for warranty costs. It provides a warranty

for a 12 month period after sale and sold 100,000 items in 20X3. It is estimated
that 10% of these items will need major repairs at an average of Rs. 3,000 and
25% will need minor repairs at an average of Rs. 2,000. The remainder will be
defect free. What provision is required at the end of 20X3?
What is the best estimate of the expenditure expected to settle a single present
obligation?
A company is virtually certain to receive a reimbursement for an amount provided

for. How is this reflected in the financial statements?
Under what circumstances does LKAS 37 allow non-disclosure of provisions and

contingencies?
What is IFRIC 1 concerned with?
Give three examples of adjusting events after the reporting period.
CA Sri Lanka
(10% 100,000 Rs. 3,000) + (25% 100,000 Rs. 2,000) = Rs. 80 Mn
Best estimate is usually the most likely outcome, however if other possible
outcomes are mostly higher, the best estimate will be higher and if other possible
outcomes are mostly lower, the best estimate will be lower.
The reimbursement should be treated as a separate asset, and the amount

recognised should not be greater than the provision itself. The provision and the
amount recognised for reimbursement may be netted off in profit or loss.
If disclosure would be expected to seriously prejudice the position of the entity in

dispute with other parties.
Accounting for changes in decommissioning and restoration provisions.
Any of:
The settlement after the reporting period of a court case that confirms that the
entity had a present obligation at the end of the reporting period.
The receipt of information after the reporting period indicating that a noncurrent asset was impaired at the end of the reporting period.
The bankruptcy of a customer that occurs after the reporting period.
The determination after the reporting period of the cost of assets purchased
before the end of the reporting period.
The determination after the reporting period of the amount of bonus or profitsharing payments (if the entity had a present legal or constructive obligation to
make such payments at the period end as a result of events before that date)
The discovery of fraud or errors showing that the financial statements are
incorrect.
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266
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CHAPTER
INTRODUCTION
Revenue is often the single largest number in a set of financial
statements. It drives profit and is a key part of many financial ratios used
for appraisal. The relevance of revenue to the financial statements as a
whole means that consistent and reliable recognition policies are vital.
LKAS 18 and a number of related interpretations provides the current
accounting guidance, however SLFRS 15 will replace LKAS 18 with effect
from 2017.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

matters.
under standards.
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KC1 | Chapter 10: Revenue
CHAPTER CONTENTS
1 LKAS 18 Revenue

Analyse revenue and the criteria to be satisfied to recognise revenue from sale
of goods & rendering of services.
Evaluate basis used to measure revenue.
Compute revenue from sale of goods and rendering of services.
Design the disclosures to be made in respect of revenue.
1 LKAS 18 Revenue
LKAS 18 provides guidance on the measurement of revenue and when it should
be recognised in the case of sale of goods and rendering of services. It is
measured at the fair value of consideration received.
1.1 Scope
LKAS 18 covers the revenue from specific types of transaction or events.
Sale of goods (manufactured products and items purchased for resale)
Rendering of services
Use by others of entity assets yielding interest, royalties and dividends
Interest, royalties and dividends are included as income because they arise from
the use of an entity's assets by other parties.
The Standard specifically excludes various types of revenue arising from leases,
insurance contracts, changes in value of financial instruments or other current
assets, natural increases in agricultural assets and mineral ore extraction.
1.2 Definitions
Revenue is the gross inflow of economic benefits during the period arising in the
course of the ordinary activities of an entity when those inflows result in increases
in equity, other than increases relating to contributions from equity participants.
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CA Sri Lanka
Interest is the charge for the use of cash or cash equivalents or amounts due to
the entity.
Royalties are charges for the use of non-current assets of the entity, eg patents,
computer software and trademarks.
Dividends are distributions of profit to holders of equity investments, in
proportion with their holdings, of each relevant class of capital.
Revenue does not include sales taxes, value added taxes or goods and service
taxes which are only collected for third parties, because these do not represent an
economic benefit flowing to the entity. The same is true for revenues collected by
an agent on behalf of a principal. Revenue for the agent is only the commission
received for acting as agent.
1.3 Measurement
Revenue is measured as the fair value of the consideration received, taking
account of any trade discounts and volume rebates.
When the inflow of cash or cash equivalents is deferred and the arrangement
constitutes a financing transaction, the fair value of the consideration is
determined by discounting all future receipts using an imputed rate of interest.
The difference between the fair value of the consideration and the nominal
amount of the consideration is recognised as interest revenue.
1.3.1 Exchange transactions
The measurement of revenue where goods or services are exchanged depends
upon the nature of the goods or services:
Where goods or services are exchanged for similar goods or services (in nature
and value), the exchange is not regarded as a revenue-generating transaction.
Where goods or services are exchanged for dissimilar goods or services,
revenue is measured at the fair value of the goods or services received, adjusted
by any cash or cash equivalents transferred.
1.4 Recognition
LKAS 18 contains separate recognition criteria for the sale of goods and the
rendering of services:
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269
Sale of goods
Significant risks and rewards of

ownership transferred to buyer
Amount of revenue can be measured

reliably
Seller has no continuing managerial

involvement / effective control over
goods
Probable economic benefits will flow

to the seller
Amount of revenue can be measured

reliably
Probable economic benefits will flow
to the seller
Costs can be measured reliably.
The stage of completion of the

transaction at the end of the
reporting period can be measured
reliably
Costs incurred and costs to
completion can be measured reliably.
QUESTION
Revenue 1
1.
A Ltd sells goods to Z Ltd on a sale or return basis. The goods are transferred
on 1 September 20X3 and Z Ltd will pay A Ltd as and when it sells the goods
to its own customers. Any goods remaining unsold at 30 November 20X3 will
be returned to A Ltd.
2.
B Ltd sells a machine to X Ltd on 1 August 20X3, transferring it immediately.

X Ltd paid a 20% deposit on 15 July 20X3 and have a credit period of
3 months until 31 October to pay the balance. Until the balance is received
B Ltd retains legal title of the machine.
4.
C Ltd sells a computerised accountancy package with one years after sales
support. The cost of providing support to one customer for one year is
calculated to be Rs. 10,000 and the product is sold for Rs. 100,000. D Ltd has
an expected return of 15%.
5.
D Ltd sells goods to Y Ltd on 1 June 20X4. Legal title is transferred to Y Ltd
on this date and D Ltd issues an invoice. Y Ltd requests that delivery is
delayed until August when its new warehouse facility is available.
Required
Explain when revenue should be recognised in each case.
ANSWER
1.
270
The risks and rewards of ownership are not transferred on 1 September

20X3 as Z Ltd has the right of return and at this stage there is no probability
that economic benefits will flow to A Ltd. Revenue should be recognised
when goods are sold on to third parties. At this stage there is no longer the
risk of the goods being returned / economic benefits not arising for A Ltd.
CA Sri Lanka
2.
On 15 July 20X3 B Ltd should record the 20% deposit received as deferred
revenue rather than a sale. The sale is made and revenue recognised on
1 August 20X3 as B Ltd retains only an insignificant risk of ownership at this
date.
3.
Rs. 11,500 (10,000 1.15) is recognised as deferred income when a package

is sold and recognised over the course of the following year. The remaining
Rs. 88,500 (100,000 11,500) is recognised immediately as revenue.
4.
This is a bill and hold sale. Revenue is recognised at 1 June 20X4 provided
that it is probable delivery will be made, the goods are available for delivery,
Y Ltd has acknowledged delayed delivery and normal payment terms apply.
QUESTION
Revenue 2
You work in the Finance Department of Pacific World Ltd, a multinational

conglomerate based in Sri Lanka. You have been asked by the Finance Director to
review the following email received from the Managing Director of one of the
operating divisions:
To:
From:
Re:
Finance Department
Raj da Silva, MD South East Asia
Income recognition
Since moving to head up the companys operations in South East Asia Ive been
reviewing the performance of the division. There are a few things Im not clear on
and Id like your advice before discussing these issues with the divisional financial
controller.
1.
CA Sri Lanka
We sell components to a large car manufacturer in Korea and in order to

support what is one of our biggest customers, we have an arrangement
whereby we set a selling price of 5% below our regular price and then
provide 2 years interest free credit. The divisional accountant is currently
recording the equivalent of the regular price as revenue on despatch of the
components and then recording the difference between this and the cash to
be received as a finance cost spread equally across the credit period. This
doesnt seem quite right to me, but Im not sure what the solution is or what
the effect might be on the financial statements!
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2.
One of the businesses in my area contracts to provide property repairs to

customers over a given period, normally 24 months. During that time a fixed
fee is paid by the customer and we then attend customer premises as
required to attend to repairs. Sometimes we attend 4 times a year,
sometimes 10 and sometimes never, depending on variables outside our
control, such as the weather. We set the fixed fee for existing customers
based on the level of callouts in the previous period. The accountant is
currently recording the fixed fee on a given contract as equal amounts of
revenue every month. I think it needs to be more exact and relate to the
number of call outs. What do you think?
Thanks,
Raj
Pacific Worlds imputed interest rate is 6%.
Required
Prepare notes in response to the email. You may assume that the MD has an
understanding of debit and credit entries.
ANSWER
Components
There are two issues to consider here:
1.
2.
Goods sold at a discount, and

The extended period of credit.
Where a trade discount is provided to a customer, as appears to be the case here,

revenue is recognised net of the discount.
Where extended credit is given, in effect the arrangement constitutes a financing
transaction. Therefore revenue is initially recognised when goods are provided at
an amount equal to the future cash receipts discounted at an imputed rate of
interest. This is 6% in the case of Pacific World. The receivable balance is then
wound up over the credit period to be equal to the actual amount of cash
receivable and this is recognised as finance income.
The divisional accountant is incorrect in initially recognising revenue of the
regular price and then recognising the difference between this and the cash
amount receivable as a finance cost.
272
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The following illustration will help to explain the effect on the financial
statements:
Assuming a transaction with the Korean Car manufacturer of Rs. 1 Mn taking place
on the first day of an accounting year, the current accounting treatment is:
1.
At despatch recognise revenue of Rs. 1 Mn and an equivalent receivable

balance:
DEBIT
CREDIT
2.
Receivable
Revenue
Rs. 1 Mn
Rs. 1 Mn
In years 1 and 2 recognise Rs. 25,000 (5% Rs. 1 Mn 1/2years) as a

reduction in the receivable and finance cost:
DEBIT
CREDIT
Finance cost
Receivable
Rs. 25,000
Rs. 25,000
The correct accounting treatment would be:

1.
At despatch recognise revenue of Rs. 845,496 (950,000 1/1.062) and an

equivalent receivable balance:
DEBIT
CREDIT
2.
Rs. 845,496
Rs. 845,496
In year 1 unwind the discounted receivable by Rs. 50,730 (845,496 6%)

and recognise finance income:
DEBIT
CREDIT
3.
Receivable
Revenue
Receivable
Finance income
Rs. 50,730
Rs. 50,730
In year 2 again unwind the discounted receivable by Rs. 53,774 (845,496 +

50,730) 6% and recognise finance income:
DEBIT
CREDIT
Receivable
Finance income
Rs. 53,774
Rs. 53,774
The net income recognised over the two years is Rs. 950,000 in both cases,
however the revenue recognised in the first case is Rs. 154,504 greater. Therefore
revenue is currently overstated due to incorrect accounting treatment.
Property repairs
The contract is for services that are performed by an indeterminate number of
acts over (usually) a two-year period.
In this case LKAS 18 requires that for practical purposes revenue is recognised on
a straight-line basis over the period, unless there is evidence for the use of another
method that better reflects the stage of completion.
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273
As the number of call outs may vary significantly from year to year, it is unlikely
that this is the case. In particular it is impossible to identify what proportion of
total call outs over the two year period have occurred in any given accounting
period before the two year period is complete.
Therefore it would appear that the divisional accountant is correct in his / her
approach.
1.4.1 Interest, dividends and royalties
The revenue is recognised on the following bases.
(a)
Interest is recognised on a time proportion basis that takes into account the
effective yield on the asset
(b)
Royalties are recognised on an accruals basis in accordance with the

substance of the relevant agreement
(c)
Dividends are recognised when the shareholder's right to receive payment is

established
The effective yield on an asset mentioned above is the rate of interest required to
discount the stream of future cash receipts expected over the life of the asset to
equate to the initial carrying amount of the asset.
Royalties are usually recognised on the same basis that they accrue under the
relevant agreement. Sometimes the true substance of the agreement may require
some other systematic and rational method of recognition.
1.5 Disclosure
The following items should be disclosed.
(a)
The accounting policies adopted for the recognition of revenue, including the
methods used to determine the stage of completion of transactions involving
the rendering of services
(b)
The amount of each significant category of revenue recognised during the

period including revenue arising from:
(i)
(ii)
(iii)
(iv)
(v)
(c)
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The sale of goods

The rendering of services
Interest
Royalties
Dividends
The amount of revenue arising from exchanges of goods or services included

in each significant category of revenue
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Any contingent gains or losses, such as those relating to warranty costs, claims or
penalties should be treated according to LKAS 37 Provisions, contingent liabilities
and contingent assets.
1.6 Substance over form

Accounting standards require that commercial substance is reflected rather than
legal form in order that transactions are represented faithfully in the financial
statements. This concept is particularly relevant in a number of transactions
where goods or services are provided to another party but the commercial
substance of the transaction is not necessarily that of a sale.
The following features of a transaction might indicate that substance differs from
form:
1.
It is linked to a number of other transactions and should be viewed as part of

those rather than individually; and
2.
The legal title of an asset is separated from the risks and rewards of that
asset.
1.6.1 Sale and repurchase

A company may sell an asset to a financial institution such as a bank and agree to
repurchase the asset at a later date. The purpose of such a transaction is for the
company to raise funds. This type of transaction may involve the sale of property,
or inventory that takes an extended period of time to mature eg whisky.
The commercial substance of this type of transaction may be a true sale, however
often it is, in substance, a loan secured on the sold asset. If that is the case, the
sale proceeds are recognised as a loan rather than revenue.
The risks and rewards of a sale and repurchase transaction should be assessed to
identify the commercial substance of the transaction. Indicators may include:
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275
Risks and rewards transferred

(and so sale recorded)
Risks and rewards not transferred (and

so loan recorded)
There is no contractual
requirement for the seller to
repurchase the asset
The sale price is not equal to the fair

value of the asset at the sale date
The seller has no rights over the

asset after the sale
There are indications that the

repurchase will occur (this may be
through the seller having a call option
and the financial institution a put
option)
The financial institution benefits

from increases in the market
value of the asset (ie the
repurchase price is linked to
market value)
The seller retains rights to use the asset
The repurchase price is not related to

the fair value of the asset but represents
the initial sale price plus interest.
1.6.2 Example: Sale and repurchase transaction

The Colombo Beverage Company Ltd (CBC) sells maturing stock to the SLC Bank on
1 January 20X3 for Rs. 8 million when the market value of the stock was
Rs. 14 million. CBC has the option to repurchase the inventory on 1 January 20X8 for
Rs. 12 million when the market value of the stock is expected to be Rs. 16 million. The
stock will remain at CBC premises throughout the 5 year period. CBCs credit rating
means that it would pay 8.447% per annum on borrowings.
Required
Illustrate how the sale and repurchase transaction is accounted for
Solution
CBC retains the risks and rewards of ownership of the stock and retains
managerial involvement (through the stock being retained at CBCs premises).
Therefore the sales proceeds are recognised as a loan with an annual finance cost
of 8.447%:
B/f
Finance cost
C/f
Rs.
Rs.
Rs.
20X3
8,000,000
675,760
8,675,760
20X4
8,675,760
732,841
9,408,601
20X5
9,408,601
794,745
10,203,346
20X6
10,203,346
861,877
11,065,223
20X7
11,065,223
934,777*
12,000,000
*rounding difference of Rs. 98
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1.6.3 Consignment inventory

It is common in certain industries for a manufacturer to enter into an arrangement
for a retailer to take and display items of inventory with a view to selling them to a
customer. This is common practice in the motor industry, for example. Legal title
remains with the manufacturer until such time as the onward sale to a customer is
made.
The issue in this case is whether the manufacturer or the dealer owns the
inventory whilst they are displayed in the retailers showroom and therefore
when the manufacturer should recognise revenue from a sale.
The risks and rewards of ownership must be assessed in order to conclude:
if the risks and rewards are retained by the manufacturer then no sale has been
made and revenue is not recognised when the goods are transferred to the
retailer.
If the risks and rewards are passed to the retailer then a sale has been made
and the manufacturer should recognise the sale when the goods are transferred
to the retailer.
Indicators that risks and rewards have or have not been transferred may include
the following:
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Risks and rewards transferred (sale

recognised when goods transferred)
Risks and rewards not transferred

(sale not recognised when goods
transferred)
The manufacturer cannot require

dealer to return the goods
The manufacturer can require the

retailer to return goods without
compensation
The price charged is fixed and

doesnt vary with the length of time
the goods are held
The price charged to the retailer

increases the longer the goods are
held
The price charged to the retailer is

based on the list price on the
delivery date
The price charged to the retailer is

based on the list price on the date of
sale to the customer
The retailer is unable to return

vehicles to the manufacturer without
penalty
The retailer can return goods to the

manufacturer without penalty
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QUESTION
You are the accountant of Hippala, a listed company that prepares consolidated
financial statements. The year end of Hippala is 31 August.
On 1 March 20X1, Hippala sold a property to a bank for Rs. 50 million. The market
value of the property at the date of the sale was Rs. 100 Mn. Hippala continues to
occupy the property rent-free. Hippala has the option to buy the property back
from the bank at the end of every month from 31 March 20X1 until
28 February 20X6. Hippala has not yet exercised this option. The repurchase price
will be Rs. 50 million plus Rs. 500,000 for every complete month that has elapsed
from the date of sale to the date of repurchase. The bank cannot require Hippala to
repurchase the property and the facility lapses after 28 February 20X6. The
directors of Hippala expect property prices to rise at around 5% each year for the
foreseeable future.
Required
Explain how the transaction described above will be dealt with in the
consolidated financial statements (statement of financial position and statement
of profit or loss and other comprehensive income) of Hippala for the year ended
31 August 20X1.
ANSWER
The key issue here is whether Hippala has retained the risks inherent in owning
the property. This depends on whether Hippala is likely to exercise its option to
repurchase the property in practice.
(i)
Hippala can repurchase the property at any time until 28 February 20X6, but
the bank cannot require repurchase. This means that Hippala is protected
against any fall in the value of the property below Rs. 50 million. This
suggests that some risk has been transferred to the bank.
(ii)
In practice, the value of the property is expected to rise by 5% each year for
the foreseeable future. Therefore it is extremely unlikely that the value of the
property will fall below Rs. 50 million.
(iii) Hippala can benefit from the expected rise in the value of the property by
buying it back at a price that is well below its anticipated market value.
In conclusion, Hippala is likely to exercise the option and therefore has retained
the risk of changes in the property's market value. Other important aspects of the
transaction are:
(a)
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The 'sale' price of the property was only 50% of its market value.
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(b)
Hippala occupies the property rent-free (a reward of ownership).
(c)
The repurchase price depends on the length of time that elapses between the
date of the agreement and the date of repurchase, rather than on the market
value of the property.
Therefore, the transaction is essentially a loan secured on the property, rather

than an outright sale. The Rs. 500,000 payable for each month that the bank holds
the property is interest on the loan.
The property remains in the consolidated statement of financial position at its cost
or market value (depending on the accounting policy adopted by Hippala). The
loan of Rs. 50 million and accrued interest of Rs. 3,000,000 (6 500,000) are
reported under non-current liabilities. Interest of Rs. 3,000,000 is recognised in
consolidated profit or loss.
Interpretations related to revenue deal with specific aspects of revenue
recognition such as customer loyalty programmes and the sale of real estate
off plan.
2.1 IFRIC 12 Service Concession Arrangements

A service concession arrangement is an arrangement whereby a government or
other body grants contracts for the supply of public services such as roads,
energy distribution, prisons or hospitals to private operators.
Two types of service concession agreement exist:
1.
One in which the operator has a contractual right to receive cash or another
asset from the government
2.
One in which the operator has the right to charge for access to the public
sector asset that it constructs or upgrades.
2.1.1 Accounting for service concession arrangements

In the first type of arrangement, the operator should recognise a financial asset
measured at fair value to the extent that it has an unconditional contractual right
to receive cash or another financial asset from (or at the discretion of) the
government/grantor.
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279
This is the case where the government / grantor contractually guarantees to pay
the operator:
(a)
specified or determinable amounts, or
(b)
the shortfall (if any) between the amount received from users of the public
service and a specified or determinable amount, even if the payment is
contingent on the operator ensuring that the infrastructure meets specified
quality or efficiency requirements.
In the second type of arrangement, the operator should recognise an intangible

asset measured at fair value to the extent it receives a licence to charge users of
the public service.
2.1.2 Operating revenue
The service concession arrangement operator should recognise and measure
revenue in accordance with LKAS 11 and 18 for the service it performs.
2.1.3 Example: SLMS Ltd
On 1 January 20X1 a government contracts with SLMS Ltd to build a scanner to be
used in public health services. The construction of the scanner will be completed
on 31 December 20X1 and from 1 January 20X2, SLMS will make the scanner
available to the public health facility until 31 December 20X6 and provide
maintenance services during this period. On 31 December 20X6 the scanner is
given to the government for no additional consideration. Each time the scanner is
used Rs. 10,000 is payable to SLMS Ltd. The government guarantees annual
income of Rs. 6 million to SLMS Ltd to be paid in arrears.
SLMS Ltd also sells similar equipment in the ordinary course of business and
estimates that the fair value of services provided in building the scanner is
Rs. 35 million. The estimated average interest rate of lending to the government is
5%.
Required
How is the arrangement accounted for?
Solution
SLMS Ltd should recognise revenue of Rs. 35 million, being the fair value of the
services provided to build the scanner, on 31 December 20X1.
In return for building the scanner, SLMS Ltd receives:
1.
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A financial asset: a fixed and determinable amount of cash, being Rs. 6 million
per annum for 5 years, and
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2.
An intangible asset: the right to charge patents for the use of the scanner and
retain any amounts collected over Rs. 6 Mn per annum.
The correct accounting entry is therefore:

DEBIT
DEBIT
CREDIT
Financial asset
Intangible asset
Revenue
Rs. 35,000,000
Rs. 35,000,000
Rs. 35,000,000
The question is how to split the revenue between the financial and intangible
asset?
Initial recognition
The financial asset is a receivable and should be recognised in accordance with
LKAS 39. It is initially measured at 31 December 20X1 (ie when the scanners
construction is complete) at fair value, being the discounted future cash flows:
31.12.X2
31.12.X3
31.12.X4
31.12.X5
31.12.X6
Rs.
5,714,286
5,442,177
5,183,026
4,936,215
4,701,157
25,976,861
6,000,000 1/1.05
6,000,000 1/1.052
6,000,000 1/1.053
6,000,000 1/1.054
6,000,000 1/1.055
The intangible asset is therefore the balance of Rs. 9,023,139.

Subsequent measurement
The financial asset is measured at amortised cost:
B/f
20X2
20X3
20X4
20X5
20X6
Rs.
25,976,861
21,275,704
16,339,489
11,156,463
5,714,286
Finance
income 5%
Rs.
1,298,843
1,063,785
816,974
557,823
285,714
Payment
received
Rs.
(6,000,000)
(6,000,000)
(6,000,000)
(6,000,000)
(6,000,000)
C/f
Rs.
21,275,704
16,339,489
11,156,463
5,714,286
-
Each year the minimum Rs. 6 Mn payment is allocated against the receivable
balance; any excess is recognised as revenue.
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281
The intangible asset is amortised:

B/f
Rs.
9,023,139
7,218,511
5,413,883
3,609,255
1,804,627
20X2
20X3
20X4
20X5
20X6
Amortisation
expense
Rs.
(1,804,628)
(1,804,628)
(1,804,628)
(1,804,628)
(1,804,627)
C/f
Rs.
7,218,511
5,413,883
3,609,255
1,804,627
2.2 SIC 29 Disclosure Service Concession Arrangements

SIC 29 is related to IFRIC 12 and addresses the issue of what information should
be disclosed in respect of a service concession arrangement in the financial
statements of an operator and a grantor.
It concludes that an operator and a grantor should disclose:
(a)
A description of the arrangement
(b)
Significant terms of the arrangement that may affect the amount, timing and
certainty of future cash flows (eg the period of the concession, re-pricing
dates and the basis upon which repricing or renegotiation is determined)
(c)
The nature and extent (eg quantity, time period or amount as appropriate)
of:
(i)
Rights to use specified assets
(ii)
Obligations to provide or rights to expect provision of services
(iii) Obligations to acquire or build items of PPE

(iv) Obligations to deliver or rights to receive specified assets at the end of
the concession period
(v)
Renewal and termination options, and
(vi) Other rights and obligations eg major overhauls

(d)
Changes in the arrangement occurring in the period
(e)
How the service arrangement has been classified.
An operator shall disclose the amount of revenue and profits or losses recognised
in the period on exchanging construction services for a financial asset or
intangible asset.
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2.3 IFRIC 13Customer Loyalty Programmes

A customer loyalty programme is a programme whereby customers who buy
goods or services are awarded credits. These may be reward points or travel
miles, for example, and can be redeemed in the future for free / discounted goods
and services.
IFRIC 13 deals with the accounting treatment applied to customer loyalty
programmes. It requires that the proceeds of a sale in which reward points /
credits are awarded are split into:
1.
2.
Revenue, and
Deferred revenue associated with the reward points/credits.
The proceeds recognised as deferred revenue are measured by reference to the

fair value of the rewards/credits awarded, taking into account:
The discounts or incentives that would be offered to customers who have not
earned reward points / credits from an initial sale, and
The proportion of reward points / credits that are not expected to be redeemed
by customers
If customers can choose their award, the fair values of the range of available
awards weighted in proportion to the frequency with which each award is
expected to be selected.
The deferred revenue is recognised as revenue when the issuing entity has
fulfilled its obligations by supplying the awards or paying another party to do so.
QUESTION
SuperMart Ltd is a supermarket chain operating in Sri Lanka. It awards customers
SuperPoints for every Rs. 200 spent in store. Customers can redeem these for
vouchers, which can be used at restaurants, cinemas and sports facilities.
Required
Prepare an extract of the accounting policy note which details SuperMart Ltds
policy for recognising revenue from the sale of goods in accordance with LKAS 18
/ IFRIC 13.
ANSWER
Accounting policy note Revenue recognition
Revenue from the sale of goods is recognised when all of the following conditions
are satisfied:
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283
1.
The Company has transferred to the buyer the significant risks and rewards
of ownership of the goods.
2.
The Company retains neither continuing managerial involvement to the

degree usually associated with ownership nor effective control over the
goods sold.
3.
The amount of revenue can be measured reliably.
4.
It is probable that the economic benefits associated with the transaction will
flow to the entity, and
5.
The costs incurred or to be incurred in respect of the transaction can be

measured reliably.
Sales of goods that result in award credits for customers under the Companys
SuperPoint Scheme are accounted for as multiple element revenue transactions
and the fair value of the consideration received is allocated between the goods
supplied and the award credits granted. The consideration allocated to the award
credits is measured by reference to their fair value ie the amount for which the
award credits could be sold separately. Such consideration is not recognised as
revenue at the time of the initial sale transaction, but is deferred and recognised
as revenue when the award credits are redeemed and the Companys obligations
have been fulfilled.
2.4 IFRIC 15 Agreements for the Construction of Real Estate

IFRIC 15 addresses:
1.
Whether an agreement for the construction of real estate is within the scope
of LKAS 11 or LKAS 18
2.
When revenue from the construction of real estate is recognised.
In particular the interpretation standardises how real estate developers account

for revenue arising from sales of units before construction is complete ie 'off plan'.
2.4.1 LKAS 11 or LKAS 18?
IFRIC 15 states that LKAS 11 is applied when the definition of a construction
contract is met. This is the case when the buyer can specify:
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1.
The major structural elements of the design of the real estate before
construction commences
2.
Major structural changes once construction is in progress.
CA Sri Lanka
If construction could take place independently of the agreement and buyers only
have limited ability to influence the design of the real estate, the agreement is
within the scope of LKAS 18.
2.4.2 Accounting treatment
LKAS 11
When a contract is within the scope of LKAS 11, the requirements of LKAS 11 are
followed ie revenue is recognised by reference to stage of completion provided
that the outcome of the contract can be estimated reliably.
LKAS 18
When a contract is within the scope of LKAS 18, it may be for the rendering of
services or provision of goods.
The contract is for the rendering of services where, for example, the customer
enters into several agreements with different entities relating to different aspects
of the construction, and the entity is responsible only for assembling materials
supplied by others. In this case, revenue is recognised by reference to stage of
completion.
When a contract is within the scope of LKAS 18 and for the sale of goods (ie the
provision of services together with the construction materials), the sale of goods
recognition criteria in LKAS 18 apply. IFRIC 15 focuses on the transfer of risks and
rewards and distinguishes between whether this transfer occurs at one point in
time or over a period of time.
Where it occurs at one point in time, revenue is recognised only when all of the
LKAS 18 criteria are met.
Where it occurs over a period of time (as construction progresses) the
percentage of completion method is applied.
2.4.2.1 Example: Accounting treatment of construction agreement

AsiaBuild Ltd buys a plot of land for the construction of commercial property. It
designs an office block to build on the land and obtains planning permission. The
office block is marketed to potential buyers and the company signs an agreement
with one of them for the sale of the land and construction of the office block. The
buyer cannot put the land or part built office block back to AsiaBuild. AsiaBuild
then commences construction of the office block.
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285
Accounting treatment
The agreement should be split into two components:
1.
2.
The sale of the land, and

The construction of the office block.
The sale of the land is a sale of goods within the scope of LKAS 18.
In terms of the office block, the major structural decisions were made by AsiaBuild
and included in the designs submitted to the planning authorities before the buyer
signed the purchase agreement. It is therefore assumed that no major design
changes will happen after the build has commenced. Therefore the sale of the
office block is within the scope of LKAS 18 rather than LKAS 11.
The construction takes place on land owned by the buyer and the buyer cannot
put the office block back to AsiaBuild. This indicates that AsiaBuild transfers the
significant risks and rewards of ownership to the buyer as construction
progresses. Therefore if the revenue recognition criteria of LKAS 18 are met
continuously as construction progresses, AsiaBuild should recognise revenue from
the construction of the office block by reference to the stage of completion.
2.5 IFRIC 18 Transfers of Assets from Customers

2.5.1 The situation
IFRIC 18 deals with the situation in which an entity receives an item of PPE which
it must then use to either connect the customer to a network or to provide the
customer with ongoing access to a supply of goods or services (eg water or gas). In
some cases the customer transfers cash to the entity in order to buy or build the
necessary item of PPE.
For example, a house builder may construct multiple houses and install a pipe on
the commonly owned land to connect the houses to the water main. The house
builder transfers ownership of the pipe to the water company that will be
responsible for its maintenance.
2.5.2 The accounting treatment
The basic principle of IFRIC 18 is that when an item of PPE is transferred from a
customer, provided that the definition of an asset is met from the recipients
perspective, it must recognise the asset in its accounts.
The deemed cost of the asset is its fair value on the transfer date.
If services are received by the customer in return for the transfer, then the
recipient should split the transaction into separate components in accordance
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CA Sri Lanka
with LKAS 18. If only one component is identified then revenue is recognised
when the service is performed (eg when access to a utility network is provided).
2.6 SIC 31 Barter Transactions involving Advertising Services

LKAS 18 states that in order to be recognised, revenue must be capable of reliable
measurement. SIC 31 deals with the situation where a seller can reliably measure
revenue at the fair value of advertising services received or provided in a barter
transaction.
SIC 31 states that :
Revenue from a barter transaction involving advertising cannot be measured
reliably at the fair value of advertising services received.
Revenue from a barter transaction involving advertising can be measured
reliably at the fair value of advertising services provided by reference to nonbarter transactions that:
Involve advertising similar to the advertising in the barter transaction
Occur frequently
Represent a predominant number of transactions and amount when
compared to all transactions to provide advertising that is similar to the
advertising in the barter transaction
Involve cash and/or another form of consideration (such as marketable
securities or non-monetary assets) that has a reliably measurable fair value
Do not involve the same counterparty as in the barter transaction.
IFRS 15 (SLFRS 15) Revenue from Contracts with Customers was issued by the
IASB in May 2014 and becomes effective in 2017. It replaces IAS 18 (LKAS 18)
and IAS 11 (LKAS 11). The new standard requires that revenue is recognised
when performance obligations are met.
IFRS 15 Revenue from Contracts with Customers was issued by the IASB in May
2014 and when it becomes effective, on 1 January 2017, will replace both IAS 11
Construction Contracts and IAS 18 Revenue. The standard was developed in
conjunction with the American standard-setter, FASB, and an almost fully
converged US standard has also been issued. IFRS 15 has been adopted in Sri
Lanka as SLFRS 15 Revenue from Contracts with Customers.
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287
The standard provides a single, principles-based five step model to be applied to

all contracts with customers.
3.1 Objective of the standard

The objective of SLFRS 15 is to establish the principles that an entity must apply in
order to report useful information about the nature, amount, timing and
uncertainty of revenue and cash flows arising from a contract with a customer.
3.2 Scope
The standard applies to all contracts with customers with the exception of:
Lease contracts within the scope of LKAS 17
Insurance contracts within the scope of SLFRS 4
Financial instruments and other contractual rights or obligations within the
scope of LKAS 39, SLFRS 10, SLFRS 11, LKAS 27 or LKAS 28, and
Non-monetary exchanges between entities in the same line of business to
facilitate sales to customers (eg a contract between two oil companies to
exchange oil in order to fulfil demand from customers in different locations on
a timely basis).
3.3 Definitions in the standard

Definitions provided in the standard include:
Revenue income arising in the course of an entitys ordinary activities.
Contract an agreement between two or more parties that creates enforceable
rights and obligations.
Performance obligation a promise in a contract with a customer to transfer to
the customer either:
(a)
A good or service (or a bundle of goods or services) that is distinct, or
(b)
A series of distinct goods or services that are substantially the same and that
have the same pattern of transfer to the customer.
Transaction price the amount of consideration to which an entity expects to be

entitled in exchange for transferring promised goods or services to a customer,
excluding amounts collected on behalf of third parties.
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3.4 Five step process

The following steps are applied in order to account for revenue in accordance with
SLFRS 15:
1.
Identify the contract with a customer

A contract can be written, verbal or implied but the following criteria must
be met:
The parties involved must have committed to perform their respective
obligations
Each party's rights regarding goods or services to be transferred can be
identified
Payment terms for the goods or services to be transferred can be
identified
The contract has commercial substance
It is probable that the selling entity will collect the consideration to which
it will be entitled in return for providing goods or services
In some circumstances related contracts may be combined.
2.
Identify the performance obligations in the contract

A contract will include one or more promises to provide goods or services;
these are separated into distinct performance obligations at the inception of
a contract.
3.
Determine the transaction price

The transaction price may be fixed or variable (due to discounts, incentives
etc). It is estimated by considering the effect of variable consideration, the
time value of money (if significant), non-cash consideration and
consideration payable to the customer. It should be estimated using either
an expected value approach or an approach based on the single most likely
amount.
4.
Allocate the transaction price to the performance obligations

The transaction price is allocated to each performance obligation on the
basis of the relative standalone selling price.
5.
Recognise revenue when the entity satisfies a performance obligation

A performance obligation is satisfied when control of the underlying goods
or services is transferred to the customer.
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A performance obligation is satisfied and revenue recognised over time

when at least one of the following criteria is met:
The customer receives and consumes the benefit of the entity's
performance as the entity performs
The entity's performance creates or enhances an asset that the customer
controls as the asset is created or enhanced
The entity's performance does not create an asset with an alternative use
to the entity and the entity has a right to payment for performance
completed to date.
If none of these criteria are met, the following indicators are considered
when deciding the time when control of the asset is transferred to the
customer:
The entity has transferred physical possession of the asset
The entity has a present right to demand payment for the asset
The customer has accepted the asset
The customer has the significant risks and rewards of ownership of the
asset
The customer has legal title to the asset.
3.4.1 Costs relating to a contract
SLFRS 15 contains criteria for establishing which costs relating to a contract
should be capitalised.
The costs of obtaining a contact are capitalised only when they are incremental
eg sales commissions and expected to be recovered.
The costs of fulfilling a contract are capitalised when they relate directly to a
contract, generate or enhance resources that will be used to satisfy
performance obligations and are expected to be recovered (unless they are
within the scope of another SLFRS).
In both cases, capitalised costs are amortised in a manner consistent with the
pattern of transfer of the goods or services to which the capitalised costs relate.
3.5 Disclosure
The disclosure requirements of SLFRS 15 aim to provide sufficient information to
allow users to understand the nature, amount timing and uncertainty of revenue
and cash flows arising from a contract with a customer.
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To achieve this, qualitative and quantitative information is required about:

Contracts with customers
Significant judgements and changes in judgements made in applying the
standard to those contracts
Any assets recognised from the costs to obtain or fulfil a contract with a
customer.
3.6 Expected effects of the new standard

The new standard contains far more prescriptive guidance than is included in
LKAS 18. The effects of the new requirement will vary from entity to entity and
industry to industry. It is unlikely that the timing and amount of revenue
recognised will change for simple contracts, however most complex arrangements
will be affected to some extent.
For example in the telecoms industry multiple deliverables are common and
current practice is mixed. Mobile phone businesses that account for a free
handset as a marketing cost will have to instead allocate revenue based on
standalone selling prices. Equally in professional services where performancebased fees are commonplace, the new model requires variable payments to be
accounted for on a best estimate basis.
QUESTION
Wave, a listed company, sells top of the range surfboards to professional surfers.
Wave requires its customers to pay a 10% deposit when placing an order for a
surfboard. If the customer cancels the order the deposit is non refundable.
However if Wave is not able to fulfil the order the deposit is returned. The balance
becomes payable when the board is delivered.
Required
Advise the directors of Wave how the revenue should be recognised in their
financial statements (detailing the relevant key principles of LKAS 18 Revenue).
ANSWER
LKAS 18 Revenue states that revenue from sale of goods should not be recognised
unless the following conditions have been met:
(1)
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Significant risks and rewards of ownership have been transferred to the

buyer
291
(2)
No continuing managerial involvement is retained, nor effective control over

the goods sold
(3)
Revenue and costs can be reliably measured
(4)
It is probable that economic benefits will flow to the seller.
The receipt of the 10% deposit does not meet the above conditions. If Wave is not
able to fulfil the contract the deposit will be returned.
Where a deposit is received in advance of delivery, the revenue should only be
recognised when the goods are delivered to the customer and accepted. (Risks
and rewards transferred and no further managerial involvement).
The deposit should be shown as a liability until delivery. If the customer cancels
the order the liability can be transferred to profit or loss and recognised as
revenue.
QUESTION
Kaffir Co entered into the following transactions in December 20X5.
1.12.20X5
15.12.20X5
21.12.20X5
31.12.20X5
Goods sold on a consignment basis. The customer

has confirmed that 50% of these goods were sold
on to a third party during December
Goods sold for Rs 100,000 including servicing fees
of Rs 20,000 for 4 months from 16 December
Advertising commissions earned. The
advertisement will appear before the public from
February to March 20X6
Goods sold, payable in three equal instalments of
Rs 100,000 on 1 January, 1 February and 1 March
20X6
Rs.
355,000
100,000
142,260
300,000
897,260
An appropriate discount rate, where appropriate is 1% per month. Other than the
amounts payable in instalments all debts have been paid.
The new Financial Controller is unsure of how to account for these transactions
and specifically what revenue to recognise. The Managing Director has suggested
that its always good to maximise profits and therefore to record Rs. 897,260 as
revenue.
Required
Advise the Financial Controller and Managing Director what amount should be
recognised as revenue in the year ended 31 December 20X5, referencing relevant
accounting standards.
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ANSWER
LKAS 18 has different criteria for the recognition of revenue in respect of goods
and services. The appendix to the standard gives examples of the application of
these criteria to specific scenarios.
Revenue from goods sold on a consignment basis is recognised only when the
goods are sold on to a third party. Therefore in respect of the transaction dated
1.12.X5, revenue of 50% Rs. 355,000 = Rs. 177,500 is recognised.
Where a sale transaction includes goods and an associated service, these are
unbundled and accounted for separately. Therefore in respect of the transaction
on 15.12.X5, Rs. 80,000 revenue from the sale of goods is recognised immediately.
The Rs. 20,000 revenue from servicing fees is recognised as the service is
provided. By the year end 1/8 of the service has been provided (1/2 month out of
4 months) and therefore 1/8 of Rs. 20,000 = Rs. 2,500 is recognised as revenue.
In respect of advertising commissions, the appendix to LKAS 18 states that
revenue is recognised when the advert appears before the public. Therefore no
revenue is recognised in 20X5.
Where goods are sold but payment is deferred, the deferred consideration is
discounted to present value to be recognised as revenue. As the associated
receivable balance is wound up over the period until payment, interest income is
recognised. Therefore revenue recognised on 31.12.20X5 is Rs. 100,000 +
Rs. 100,000/1.01 + Rs. 100,000/1.012 = Rs. 297,040
1.12.20X5
Consignment sales
15.12.20X5
Goods and servicing
21.12.20X5
Advertising commission
31.12.20X5
Goods
Total revenue recognised in the year
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Rs.
177,500
82,500
0
297,040
557,040
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CHAPTER ROUNDUP
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LKAS 18 provides guidance on the measurement of revenue and when it should

be recognised in the case of sale of goods and rendering of services.
It is measured at the fair value of consideration received.
Interpretations related to revenue deal with specific aspects of revenue

recognition such as customer loyalty programmes and the sale of real estate
off plan.
IFRS 15 (SLFRS 15) Revenue from Contracts with Customers was issued by the
IASB in May 2014 and becomes effective in 2017. It replaces IAS 18 (LKAS 18)
and IAS 11 (LKAS 11).
The new standard requires that revenue is recognised when performance

obligations are met.
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PROGRESS TEST
What conditions must be met to recognise revenue from a sale of goods?
How is revenue from the sale of an item with a service plan recognised?
A property is sold to a bank for half of its market value. The seller has a call option
to repurchase the property at a 10% premium over proceeds received at a later
date. How should this transaction be accounted for?
Where property is sold off plan and the purchaser can specify structural elements
of the plan and change these when construction is underway, how is the sale
accounted for by the seller?
Revenue from a barter transaction involving advertising ____________ be measured

reliably at the fair value of advertising services received. (Can or cannot?)
SLFRS 15 requires that revenue is recognised when __________________________________.

(Fill in the blank.)
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296
See section 1.4
The amount of revenue related to the service plan is deferred and recognised as
revenue over the period during which the service is performed. The amount
deferred must cover the cost of the services together with a reasonable profit on
those services.
This is a sale and repurchase transaction that is, in substance a loan secured on
the property. It is accounted for as a loan balance, initially at proceeds, and wound
up to redemption value.
IFRIC 15 requires it is accounted for in accordance with LKAS 11.
Revenue from a barter transaction involving advertising cannot be measured

reliably at the fair value of advertising services received.
SLFRS 15 requires that revenue is recognised when a performance obligation is

met.
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CHAPTER
INTRODUCTION
In this chapter we revise the principles of current and deferred tax that
you met at KB1. The chapter then progresses to deal with the more
advanced topic of deferred tax arising in group scenarios.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
1.3
Level C
1.3.1
1.3.2
1.3.3

matters.
under standards.
Explain the concepts/principals of Sri Lanka Accounting Standards.
Apply the concepts/principals of the standards to resolve a simple/straight forward
matter.
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KC1 | Chapter 11: Income taxes
CHAPTER CONTENTS
1 Current tax
2 Deferred tax
3 Deferred tax and groups

Analyse the criteria for recognising deferred tax assets arising from the carry
forward of unused tax losses and tax credits.
Outline the different circumstances that the temporary differences arise when
the amount of investments in subsidiaries, branches and associates or interests
in JVs become different from the tax base of the investment or interest.
Design the disclosures to be made in respect of income tax.
1 Current tax
Current tax is payable in respect of the trading activities of the period. The tax
charge is adjusted for any under or overprovision of a prior period.
This section revises in brief the accounting treatment applied to current tax. For
additional detail and examples you should refer to your KB1 study text.
1.1 Definitions
Current tax is the amount of income taxes payable (recoverable) in respect of the
taxable profit (tax loss) for a period.
Taxable profit (tax loss) is the profit (loss) for a period, determined in
accordance with the rules established by the taxation authorities, upon which
income taxes are payable (recoverable).
Accounting profit is profit or loss for a period before deducting tax expense.
Tax expense (tax income) is the aggregate amount included in the determination
of profit or loss for the period in respect of current tax and deferred tax.
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1.2 Recognition, measurement and presentation of current tax

Tax on the profits of a reporting period is measured at the amount expected to
be paid to the authorities.
It is recognised as a liability at the reporting date to the extent that it remains
unpaid.
The tax liability at the reporting date also includes any unpaid tax in respect of
previous reporting periods.
The tax charge for the year is usually recognised in profit or loss for the period.
The charge to profit or loss is increased by the amount of an underprovision
from the previous accounting period; it is decreased by the amount of an
overprovision from the previous accounting period.
Where an item is recognised directly in equity or in other comprehensive
income, the related tax charge is also recognised directly in equity or in other
comprehensive income.
Current tax assets and liabilities must be shown separately from other tax
assets and liabilities in the statement of financial position. They may be offset
only where:
The entity has a legally enforceable right to set off the recognised amounts.
The entity intends to settle the amounts on a net basis or to realise the asset
and settle the liability at the same time.
2 Deferred tax
Deferred tax is an accounting adjustment relating to temporary differences.
Taxable temporary differences result in deferred tax liabilities and deductible
temporary differences result in deferred tax assets.
Again this section of the chapter revises in brief material that you should be
familiar with. You should refer to your KB1 study text for additional examples and
explanations.
Deferred tax compensates for temporary differences between taxable and
accounting profits and attempts to match the tax impact of a transaction to the
accounting impact for the purposes of financial reporting, so that both are
reported in the same period.
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2.1 Definitions
Deferred tax liabilities are the amounts of income taxes payable in future
periods in respect of taxable temporary differences.
Deferred tax assets are the amounts of income taxes recoverable in future
periods in respect of:
(a)
(b)
(c)
Deductible temporary differences

The carry forward of unused losses and
The carry forward of unused tax credits.
Temporary differences are differences between the carrying amount of an asset

or liability in the statement of financial position and its tax base. Temporary
differences may be either:
(a)
Taxable temporary differences which are temporary differences that will

result in taxable amounts in determining taxable profit (tax loss) of future
periods when the carrying amount of the asset or liability is recovered or
settled.
(b)
Deductible temporary differences, which are temporary differences that

will result in amounts that are deductible in determining taxable profit (tax
loss) of future periods when the carrying amount of the asset or liability is
recovered or settled.
The tax base of an asset or liability is the amount attributed to that asset or
liability for tax purposes.
2.2 Approach to deferred tax

LKAS 12 requires a 'balance sheet' approach to deferred tax whereby temporary
differences are calculated as the difference between the carrying amount of an
item for accounting purposes and its tax base.
1. Calculate tax base of
asset or liability
The tax base of an asset is the amount that will

be deductible for tax purposes against any
taxable economic benefits that will flow to the
entity when it recovers the carrying amount of
the asset.
Where those benefits are not taxable, the tax
base is the same as the assets carrying amount.
The tax base of a liability is its carrying amount
less any amount that is deducted for tax purposes
in relation to the liability in future periods.
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For revenue received in advance, the tax base of

the liability is its carrying amount less any
revenue that will not be taxable in future periods.
In some cases tax base will be equal to carrying
amount:
Accrued expenses that have already been
given tax relief;
A loan payable measured at the amount
originally received where this amount is the
amount repayable at maturity;
Accrued expenses that will never benefit from
tax relief; and
Accrued income that will never be taxable.
2. Calculate temporary
difference
Where carrying amount exceeds tax base the

difference is a taxable temporary difference.
Common examples giving rise
temporary differences include:
to
taxable
Revenue included in accounting profit but

taxed on a cash basis and so not included in
taxable profit.
Accelerated capital allowances whereby tax
capital allowances exceed depreciation on a
cumulative basis.
Development costs capitalised for accounting
purposes but given immediate tax relief.
A loan where transaction costs are amortised
over the loan term for accounting purposes
but given immediate tax relief.
Items carried at fair value (which exceeds
cost) for accounting purposes but at cost for
tax purposes.
A taxable temporary difference does not result in
a deferred tax liability where
It arises from the initial recognition of
goodwill
It arises from the initial recognition of an item
which isnt part of a business combination and
does not at the time of the transaction affect
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301
accounting or taxable profit.

Where tax base exceeds carrying amount the
difference is a deductible temporary difference.
Common examples giving rise to deductible
temporary differences include:
Pension costs expensed for accounting
purposes as service is provided but not given
tax relief until an entity pays retirement
benefits or pays into a pension fund.
Depreciation exceeds tax capital allowances on
a cumulative basis.
Impairment losses are recognised in
accounting profit but no tax adjustment is
made.
Research costs are expensed for accounting
purposes but do not receive tax relief until a
later date.
Income is deferred in the SOFP but is included
in taxable profits.
Tax losses are carried forward.
A deferred tax asset in respect of tax losses is
only calculated where it is expected that profits
will be available in the future to absorb tax
losses.
A deductible temporary difference does not
result in a deferred tax asset where it arises from
the initial recognition of an item which isnt part
of a business combination and does not at the
time of the transaction affect accounting or
taxable profit.
3. Apply relevant tax rate
to temporary difference
The tax rate is that which is expected to apply to

the period when the underlying item is
realised/settled based on rates enacted or
substantively enacted by the end of the reporting
period.
Where different tax rates apply to different levels
of income average rates expected to apply are
used.
The tax rate used should reflect the expected
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manner of recovery (income tax rate for

use/capital gains tax rate for sale).
Taxable temporary difference tax rate =
deferred tax liability
Deductible temporary difference tax rate =
deferred tax asset.
LKAS 12 prohibits the discounting of deferred tax
assets and liabilities.
4. Record overall deferred
tax asset/liability
A deferred tax liability is recognised for all

taxable temporary differences.
A deferred tax asset is recognised for deductible
temporary differences to the extent that future
taxable profits will probably be available against
which it can be utilised. This is assumed where
sufficient taxable temporary differences exist
relating to the same tax authority and same
entity.
Unrecognised deferred tax assets are reassessed
at each reporting date.
Deferred tax assets and liabilities are offset and
presented as a single amount in the SOFP
provided that:
There is a legally enforceable right to set off
current tax assets and liabilities, and
Deferred taxes relate to income taxes levied by
the same tax authority on the same taxable
entity or different taxable entities that intend
to settle current assets/liabilities on a net
basis or simultaneously.
A change in carrying amount is recognised in
profit or loss, OCI or equity depending on where
the underlying transaction is recognised.
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QUESTION
Revaluation
A company revalued its premises to Rs. 65,000,000 on 31 December 20X9. The

property originally cost Rs. 35,000,000 on 1 January 20X4 and was being
depreciated over 50 years on a straight line basis. The property has not suffered
any impairment losses. Capital allowances were provided on the property at
6.67% of cost. The applicable tax rate is 28%.
(a)
Explain the deferred tax implications of the revaluation.
(b)
Explain how your answer would differ if the property had been impaired by
Rs 5.014 Mn at the end of 20X7.
ANSWER
(a)
The carrying amount of the factory before the revaluation was Rs. 30.8 Mn
(Rs. 35 Mn 44/50years).
A revaluation gain of Rs. 34.2 Mn (Rs. 65 Mn Rs. 30.8 Mn) is recognised on
31 December 20X9. This is a taxable temporary difference and results in a
deferred tax liability of Rs. 9,576,000 (Rs. 34.2 Mn 28%).
Both the revaluation gain and deferred tax liability are recognised in other
comprehensive income and accumulated in a revaluation reserve in equity.
The net amount recognised in OCI is Rs. 24,624,000 (Rs. 34.2 Mn
Rs. 9.576 Mn).
(b)
If the property had been impaired in 20X7 the carrying amount at

31 December 20X9 would be:
Rs'000
35,000
Cost (1.1.X4)
(2,800)
Depreciation (35m/50 4 years)
32,200
(5,014)
Impairment loss
27,186
Carrying amount post impairment
(1,182)
Depreciation (27.186/46 2 years)
26,004
A surplus of Rs. 38,996,000 (Rs. 65 Mn Rs. 26.004 Mn) arises on
revaluation, giving rise to a deferred tax liability of Rs. 10,918,880
(Rs. 38,996,000 28%).
Rs. 5,014,000 of the revaluation gain reverses the impairment loss and is
recognised in profit or loss. The related tax of Rs. 1,403,920 (Rs. 5,014,000
28%) is also recognised in profit or loss.
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The remaining Rs. 33,982,000 of the revaluation gain is recognised in OCI.

The related tax of Rs. 9,514,960 (Rs. 33,982,000 28%) is also recognised in
OCI.
QUESTION
Tax rates
A company has an asset with a carrying amount of Rs. 250,000 and a tax base of
Rs. 150,000. The company operates in Wunderland where the income tax rate is
20% and the capital gains rate is 30%. Explain the deferred tax implications of the
company owning the asset.
ANSWER
The deferred tax implication depends on whether the company sells the asset
without further use or recovers its carrying amount through use.
In either case there is a taxable temporary difference of Rs. 100,000.
If the intention is to sell the asset without further use a deferred tax liability of
Rs. 30,000 (30% Rs. 100,000) arises.
If the intention is to use the asset then a deferred tax liability of Rs. 20,000 (20%
Rs. 100,000) arises.
QUESTION
Deferred tax comprehensive question
Lanka Machinery Makers Ltd (LMM) manufactures and sells commercial food
preparation machinery throughout the world. Its administration and distribution
functions operate from a small head office property in central Columbo owned by
LMM, whilst its manufacturing base is a rented factory on the outskirts of the city.
The finance department of LMM is currently preparing the companys financial
statements for the year ended 31 December 20X4, and the deferred tax treatment
of a number of items remains outstanding:
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1.
At 31 December 20X4 it was decided to increase the general provision for

doubtful debts from Rs. 720,000 to Rs. 1,150,000. At the same time,
management noted that a particular customer was experiencing trading
difficulties, and as a result a specific provision was created for 50% of that
customers Rs. 560,000 outstanding balance. These provisions have been
accounted for correctly and appear in the year-end statement of financial
position.
2.
LMM has been required to pay a penalty fee of Rs. 80,000 in respect of the a
breach of health and safety regulations. This amount has been charged as an
expense within Administration expenses in the statement of profit or loss.
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3.
LMMs head office cost Rs. 16.5 million to construct four years ago (excluding
land). It is being depreciated over 50 years and has a carrying amount at
31 December 20X4 of Rs. 15.18 million.
4.
LMM own approximately half of the machines used on its production line
and lease the remainder under operating leases. The owned machines cost
Rs. 1,958,000 when purchased (including Rs. 182,000 for machinery
purchased in the year ended 31 December 20X4) and have a carrying
amount at 31 December 20X4 of Rs. 1,734,900.
5.
LMM contributes to a defined contribution pension scheme on behalf of

employees. At 31 December 20X4 an accrual for contributions of Rs. 940,000
was made.
The tax treatment of these items is as follows:

Tax relief is given on the expense associated with a general provision for
doubtful debts only when a debt becomes bad; tax relief is given on the expense
associated with a specific provision for doubtful debts when the provision is
made.
Fines and penalties are never allowable for tax purposes.
Commercial buildings benefit from a 6.66% annual tax allowance on the nonland element of the cost.
Plant and machinery benefits from an allowance of 12.5% on cost.
Pension contributions benefit from tax relief on a cash basis.
The deferred tax liability at 31 December 20X3 was Rs. 371,300.
The tax computation prepared by LMMs tax department is provided below:
Tax computation LMM year ended 31 December 20X4 DRAFT
Rs.
Rs.
8,340,000
Accounting profit before tax
Disallowable expenditure
330,000
Depreciation Head office property
105,100
Depreciation plant and machinery
430,000
Increase in general provision for doubtful
debts
80,000
Penalty fee
945,100
Capital allowances (see below)
(1,100,000)
Head office
(244,750)
Machinery
7,940,350
Taxable profits
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Rs.
Taxed at 28%
Capital allowances head office
TWDV b/f
Annual allowance (6.66% 16.5 Mn)
TWDV c/f
Qualifying cost b/f and c/f
Rs.
2,223,298
Rs.
13,200,000
(1,100,000)
12,100,000
16,500,000
Capital allowances machinery
TWDV b/f
Additions
Annual allowance (12.5% 1,958,000)
TWDV c/f
Rs.
1,153,000
182,000
(244,750)
1,090,250
Allowances
Rs.
244,750
244,750
Required
What deferred tax position should be reflected in the statement of financial
position at the 30 September 20X4 year end, and what is the tax charge in profit or
loss for the year then ended? You should explain your calculations.
ANSWER
Statement of financial position for LMM as at 31 December
20X4
Rs.
Deferred tax liability
457,702
20X3
Rs.
371,300
Statement of profit or loss and other comprehensive income for LMM for the
year ended 31 December 20X4
Rs.
Income tax charge
Tax on profits for the year
Deferred tax
2,223,298
86,402
2,309,700
Workings
(1)
General provision for doubtful debts

The question states that tax relief is not provided on the expense associated
with an increase in the general provision for doubtful debts when that
provision is made. Therefore the tax base of the general provision is nil.
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307
Rs.
Tax base
Carrying amount
Temporary difference
Nil
(1,150,000)
1,150,000
As the carrying amount is less than the tax base, this is a deductible
temporary difference and results in a deferred tax asset of Rs. 322,000 (28%
Rs. 1,150,000).
(2)
Specific provision for doubtful debts

The question states that tax relief is provided on the expense associated with
an increase in the specific provision for doubtful debts when the provision is
made. Therefore the tax and accounting treatment of this item are the same
and there is no deferred tax impact.
(3)
Penalty fee
The penalty fee will never be an allowable expense for tax purposes, and it is
therefore treated as a permanent difference. There is no deferred tax impact
of permanent differences.
(4)
Head office
Deferred tax arises on the construction cost of the head office. The
temporary difference at 31 December 20X4 is calculated as:
Rs.
12,100,000
Tax base (tax computation)
15,180,000
Carrying amount
3,080,000
As the carrying amount is more than the tax base, this is a taxable temporary
difference and results in a deferred tax liability of Rs. 862,400 (28%
Rs. 3,080,000).
(5)
Machinery
Again the temporary difference is calculated as the difference between the
tax base and carrying amount of the machinery:
Carrying amount
Rs.
1,090,250
1,734,900
644,650
As the carrying amount is more than the tax base, this is a taxable temporary
difference and results in a deferred tax liability of Rs. 180,502 (28%
Rs. 644,650).
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(6)
Pension contributions
Rs.
Carrying amount
nil
(940,000)
940,000
As the carrying amount is less than the tax base, this is a deductible
temporary difference and results in a deferred tax asset of Rs. 263,200
(28% Rs. 940,000).
(7)
Summary
All of the elements of deferred tax relate to the same jurisdiction (Sri Lanka),
and it is assumed that there is a right to set off the asset and liability.
Therefore the net deferred tax liability at the year end is:
Rs.
(322,000)
General provision for doubtful debts
862,400
Head office
180,502
Machinery
(263,200)
Pension contributions
457,702
The net provision has therefore increased by Rs. 86,402 (457,702
371,300). This is recognised in profit or loss for the period.
2.3 Disclosure
The following must be disclosed in relation to income taxes:
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(a)
the major components of tax expense in profit or loss including the current
tax expense, adjustments in relation to the tax of previous periods and
deferred tax expense/income amounts relating to the origination and
reversal of temporary differences and changes in tax rates.
(b)
The aggregate current and deferrred tax relating to items that are charged or
credited directly to equity.
(c)
The amount of income tax relating to each component of other

(d)
An explanation of the relationship between tax expense and accounting

profit in either or both of the following forms:
i.
a numerical reconciliation between tax expense (income) and the

product of accounting profit multiplied by the applicable tax rate, or
ii.
a numerical reconciliation between the average effective tax rate and

the applicable tax rate.
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(e)
An explanation of changes in the applicable tax rates compared to the

previous period.
(f)
The amount of any deductible temporary differences, unused tax losses and
unused tax credits for which no deferred tax asset is recognised.
(g)
The aggregate amount of temporary differences associated with investments

in subsidiaries, branches and associates and interests in joint arrangements
for which deferred tax liabilities have not been recognised.
(h)
In respect of each type of temporary difference:
(i)
i.
The amount of deferred tax assets and liabilities recognised in the

statement of finanicial position
ii.
The amount of deferred tax income or expense recognised in profit or

loss.
In respect of discontinued operations the tax expense relating to:

i.
The gain or loss on discontinuance, and
ii.
The profit or loss from the ordinary activities of the discontinued

operation for the period and corresponding amounts for each prior
period presented.
(j)
The amount of income tax consequences of dividends to shareholders of the

entity that were proposed or declared before the financial statements were
authorised for issue but are not recognised as a financial liability in the
(k)
The amount of a deferred tax asset and the nature of evidence supporting its
recognition when:
i.
The utilisation of the deferred tax asset is dependent on future taxable

profits in excess of the profits arising from the reversal of existing
taxable temporary differences, and
ii.
The entity has suffered a loss in either the current or preceding period
in the tax jurisdiction to which the deferred tax asset relates.
2.3.1 Example: Reconciliation

LKAS 12 requires a reconciliation between tax expense and accounting profit in
one of two forms. The two possible forms are illustrated below.
Elephant Co makes an accounting profit before tax of Rs. 23,890,000 in the year
ended 31 December 20X4 and recognises a tax expense of Rs. 6,913,400. Included
in the companys statement of profit or loss are:
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CA Sri Lanka
Disallowable political donations of Rs. 1 million

Disallowable fines for pollution of Rs. 400,000
A gain on the disposal of a property of Rs. 760,000
The tax rate is 28%; it was 27% in 20X3.
Net taxable temporary differences at the start of the accounting period were
Rs. 4,500,000.
Reconciliation form 1
The first form allowed reconciles between the product of accounting profit
multiplied by the applicable tax rate(s) and tax expense:
Rs'000
Rs'000
Profit before tax
23,890
Tax at applicable rate of 28%
6,689.2
Tax effect of expenses that are not deductible in
determining taxable profit:
Political donations (28% 1,000,000)
280
Fines (28% 400,000)
112
392
Tax effect of income that is not taxable in
determining taxable profit:
Gain on disposal of property (28% 760,000)
(212.8)
Increase in opening deferred tax resulting from an
45
increase in tax rate (4,500,000 1%)
Tax expense
6,913.4
Reconciliation form 2
This reconciles the applicable tax rate to the average effective tax rate.
Applicable tax rate
Tax effect of expenses that are not deductible for tax purposes:
Political donations (280/23,890 100%)
Fines for environmental pollution (112/23,890 100%)
Tax effect of income that is not taxable in determining taxable profit:
Gain on disposal of property (212.8/23,890 100%)
Effect on opening deferred taxes of increase in tax rate (45/23,890
100%)
Average effective tax rate (6,913.4/23,890 100%)
CA Sri Lanka
%
28.0
1.17
0.47
(0.89)
0.19
28.94
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2.3.2 CASE STUDY: Deferred tax disclosure

The following disclosure notes are taken from Ceylon Tea Brokers plc Annual
Report 2013/2014:
8 TAXATION
For the year ended 31st March

Current Income Tax Expense (Note 8.1)
Under Provision
Provision on Deferred Taxation (Note 16)
2014
Rs.
20,421,066
612,934
21,034,000
2013
Rs.
15,149,748
(151,637)
1,658,705
16,656,816
The provision for income tax is based on the elements of income and expenditure
as reported in the Financial Statements and computed in accordance with the
provision of the Inland Revenue Act No.10 of 2006 and subsequent amendments
thereto. In terms of the Fifth schedule (section 43) of the Inland Revenue Act
No.10 of 2006 newly introduced by the Inland Revenue (Amendment) Act No.22 of
2011, the Company is liable for income tax at the concessionary rate of 10% on its
storage income, and 28% on other revenue sources and other income.
8.1 Current Income Tax Expense

Accounting Profit Before Taxation
Aggregate Disallowable Items
Aggregate Allowable Items
Total Statutory Income
Other Source of Income
Taxable Income
Tax at 10% (on Storage Income)
Tax at 28%
Less : Tax Credits
2014
Rs.
77,234,190
10,295,779
(6,361,302)
81,168,667
81,168,667
1,281,200
19,139,866
20,421,066
2013
Rs.
56,434,242
19,375,974
(18,923,596)
56,886,620
157,896
57,044,516
444,758
14,727,143
(22,153)
15,149,748
2014
Rs.
(348,798)
(612,934)
(961,732)
2013
Rs.
1,309,907
(1,658,705)
(348,798)
16 DEFERRED TAXATION
As at 31st March
Balance at the beginning of the Year
Charge/(Reversal) for the Year
Balance at the end of the Year
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CA Sri Lanka
Deferred tax is provided using the liability method in respect of temporary

difference between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for taxation purposes. Deferred Tax has
been computed taking into consideration the effective tax rate of 28%. The
deferred tax provision as at the year end made up as follows:
On Property, Plant
and Equipment
On Retirement
Benefit Obligations
2014
Temporary
Tax
Difference
Effect
Rs.
Rs.
2013
Temporary
Tax
Difference
Effect
Rs.
Rs.
(13,520,840) (3,785,835)
(9,506,463)
(2,661,810)
8,260,757
(1,245,706)
2,313,012
(348,798)8
10,086,081
(3,434,759)
2,824,103
(961,732)
3 Deferred tax and groups

Deferred tax may arise in respect of fair value adjustments on business
combinations, unrealised losses, retained earnings of investees and changes
in exchange rates. The recognition of deferred tax on a business combination
may affect the measurement of goodwill.
3.1 Temporary differences

When investments in group companies are held, temporary differences arise
because the carrying amount of the investment (ie the parent's share of the net
assets including goodwill) becomes different from the tax base (often the cost) of
the investment. Why do these differences arise? These are some examples.
There are undistributed profits held by subsidiaries, branches, associates and
joint ventures.
There are changes in foreign exchange rates when a parent and its subsidiary
are based in different countries.
There is a reduction in the carrying amount of an investment in an associate
to its recoverable amount.
The temporary difference in the consolidated financial statements may be

different from the temporary difference associated with that investment in the
parent's separate financial statements when the parent carries the investment in
its separate financial statements at cost or revalued amount.
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313
3.1.1 Circumstances giving rise to taxable temporary differences
In a business combination, the cost of the acquisition must be allocated to the fair
values of the identifiable assets and liabilities acquired as at the date of the
transaction. Temporary differences will arise when the tax bases of the
identifiable assets and liabilities acquired are not affected by the business
combination or are affected differently. For example, if the carrying amount of an
asset is increased to fair value but the tax base of the asset remains at cost to the
previous owner, a taxable temporary difference arises which results in a deferred
tax liability and this will also affect goodwill.
The following are provided by LKAS 12 as other examples of group situations that
would result in a taxable temporary difference:
Unrealised losses resulting from intragroup transactions are eliminated
from the carrying amount of inventory or property, plant and equipment
however the tax bases of the assets are not adjusted to eliminate the URP.
Retained earnings of subsidiaries, branches, associates and joint ventures are
included in consolidated retained earnings, but income taxes will be payable if
the profits are distributed to the reporting parent.
Investments in foreign subsidiaries, branches or associates or interests in
foreign joint ventures are affected by changes in foreign exchange rates.
There may be either a taxable temporary difference or a deductible temporary
difference in this situation.
An entity accounts in its own currency for the cost of the non-monetary assets
of a foreign operation that is integral to the reporting entity's operations but
the taxable profit or tax loss of the foreign operation is determined in the
foreign currency.
3.1.2 Circumstances that give rise to deductible temporary differences
In a business combination, when a liability is recognised on acquisition but the

related costs are not deducted in determining taxable profits until a later period, a
deductible temporary difference arises resulting in a deferred tax asset. A
deferred tax asset will also arise when the fair value of an identifiable asset
acquired is less than its tax base. In both these cases goodwill is affected. The
following examples of deductible temporary differences are also provided by the
standard:
Unrealised profits resulting from intragroup transactions are eliminated
from the carrying amount of assets, such as inventory or property, plant or
equipment, but no equivalent adjustment is made for tax purposes.
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CA Sri Lanka
Investments in foreign subsidiaries, branches or associates or interests in

foreign joint ventures are affected by changes in foreign exchange rates.
A foreign operation accounts for its non-monetary assets in its own (functional)
currency. If its taxable profit or loss is determined in a different currency
(under the presentation currency method) changes in the exchange rate result
in temporary differences.
3.2 Recognition
3.2.1 Deferred tax liability
LKAS 12 requires entities to recognise a deferred tax liability for all taxable
temporary differences associated with investments in subsidiaries, branches and
associates, and interests in joint ventures, except to the extent that both of these
conditions are satisfied:
(a)
The parent/investor/venturer is able to control the timing of the reversal of

the temporary difference
(b)
It is probable that the temporary difference will not reverse in the

foreseeable future.
3.2.2 Deferred tax asset
LKAS 12 states that a deferred tax asset should be recognised for all deductible
temporary differences arising from investments in subsidiaries, branches and
associates, and interests in joint ventures, to the extent that (and only to the extent
that) both these are probable:
(a)
That the temporary difference will reverse in the foreseeable future, and
(b)
That taxable profit will be available against which the temporary difference
can be utilised.
3.2.3 Application of recognition criteria

Undistributed profits
Where a parent company controls the dividend policy of a subsidiary, it can

control the timing of the reversal of temporary differences. Therefore when the
parent has determined that those profits will not be distributed in the foreseeable
future, the parent does not recognise a deferred tax liability. The same applies to
investments in branches.
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315
Foreign exchange
Where a foreign operation's taxable profit or tax loss (and therefore the tax base
of its non-monetary assets and liabilities) is determined in a foreign currency,
changes in the exchange rate give rise to temporary differences. These relate to
the foreign entity's own assets and liabilities, rather than to the reporting entity's
investment in that foreign operation, and so the reporting entity should recognise
the resulting deferred tax liability or asset. The resulting deferred tax is charged
or credited to profit or loss.
Associates
An investor in an associate does not control that entity and so cannot determine
its dividend policy. Without an agreement requiring that the profits of the
associate should not be distributed in the foreseeable future, therefore, an
investor should recognise a deferred tax liability arising from taxable temporary
differences associated with its investment in the associate. Where an investor
cannot determine the exact amount of tax, but only a minimum amount, then the
deferred tax liability should be that amount.
Joint ventures
In a joint venture, the agreement between the parties usually deals with profit
sharing. When a venturer can control the sharing of profits and it is probable that
the profits will not be distributed in the foreseeable future, a deferred liability is
not recognised.
3.3 Deferred tax assets of an acquired subsidiary

Deferred tax assets of a subsidiary may not satisfy the criteria for recognition
when a business combination is initially accounted for but may be realised
subsequently.
These should be recognised as follows:
If recognised within 12 months of the acquisition date and resulting from new
information about circumstances existing at the acquisition date, the credit
entry should be made to goodwill. If the carrying amount of goodwill is reduced
to zero, any further amounts should be recognised in profit or loss.
If recognised outside the 12 months 'measurement period' or not resulting
from new information about circumstances existing at the acquisition date, the
credit entry should be made to profit or loss.
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CA Sri Lanka
QUESTION
Deferred tax assets of an acquired subsidiary
In 20X2 Sky Ltd acquired a subsidiary, Ocean Ltd, which had deductible temporary
differences of Rs. 3 Mn. The tax rate at the date of acquisition was 30%. The
resulting deferred tax asset of Rs. 0.9 Mn was not recognised as an identifiable
asset in determining the goodwill of Rs. 5 Mn resulting from the business
combination. Two years after the acquisition, Sky Ltd decided that future taxable
profit would probably be sufficient for the entity to recover the benefit of all the
deductible temporary differences.
Required
(a)
Consider the accounting treatment of the subsequent recognition of the

deferred tax asset in 20X4.
(b)
What would happen if the tax rate had risen to 40% by 20X4 or decreased to
20%?
ANSWER
(a)
The entity recognises a deferred tax asset of Rs 0.9 Mn (Rs. 3 Mn 30%) and,
in profit or loss, deferred tax income of Rs. 0.9 Mn. Goodwill is not adjusted
as the recognition does not arise within the measurement period (ie within
the 12 months following the acquisition).
(b)
If the tax rate rises to 40%, the entity should recognise a deferred tax asset
of Rs. 1.2 Mn (Rs. 3 Mn 40%) and, in profit or loss, deferred tax income of
Rs. 1.2 Mn.
If the tax rate falls to 20%, the entity should recognise a deferred tax asset of
Rs. 0.6 Mn (Rs. 3 Mn 20%) and deferred tax income of Rs. 0.6 Mn.
In both cases, the entity will also reduce the cost of goodwill by Rs 0.9 Mn
and recognise an expense for that amount in profit or loss.
QUESTION
Deferred tax and groups 1
Red is a private limited liability company and has two 100% owned subsidiaries,
Blue and Green, both themselves private limited liability companies. Red acquired
Green on 1 January 20X2 for Rs. 5 Mn when the fair value of the net assets was
Rs. 4 Mn, and the tax base of the net assets was Rs. 3.5 Mn. The acquisition of
Green and Blue was part of a business strategy whereby Red would build up the
'value' of the group over a three-year period and then list its existing share capital
on the stock exchange.
(a)
CA Sri Lanka
The following details relate to the acquisition of Green, which manufactures

electronic goods.
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(i)
Part of the purchase price has been allocated to intangible assets

because it relates to the acquisition of a database of key customers
from Green. The recognition and measurement criteria for an
intangible asset under IFRS 3 Business combinations/IAS 38 Intangible
assets do not appear to have been met but the directors feel that the
intangible asset of Rs. 0.5 Mn will be allowed for tax purposes and
have computed the tax provision accordingly. However, the tax
authorities could possibly challenge this opinion.
(ii)
Green has sold goods worth Rs. 3 Mn to Red since acquisition and made
a profit of Rs. 1 Mn on the transaction. The inventory of these goods
recorded in Red's statement of financial position at the year-end of
31 May 20X2 was Rs. 1.8 Mn.
(iii) The balance on the retained earnings of Green at acquisition was

Rs. 2 million. The directors of Red have decided that, during the three
years to the date that they intend to list the shares of the company, they
will realise earnings through future dividend payments from the
subsidiary amounting to Rs. 500,000 per year. Tax is payable on any
remittance or dividends and no dividends have been declared for the
current year.
(b)
Blue was acquired on 1 June 20X1 and is a company which undertakes

various projects ranging from debt factoring to investing in property and
commodities. The following details relate to Blue for the year ending 31 May
20X2.
(i)
Blue has a portfolio of readily marketable government securities that

are held as current assets. These investments are stated at fair value in
the statement of financial position with any gain or loss recognised in
profit or loss for the year. These gains and losses are taxed when the
investments are sold. Currently the accumulated unrealised gains are
Rs. 4 million.
(ii)
Blue has calculated that it requires a specific allowance of Rs. 2 million

against loans in its portfolio. Tax relief is available when the specific
loan is written off.
(iii) When Red acquired Blue it had unused tax losses brought forward. At
1 June 20X1, it appeared that Blue would have sufficient taxable profit
to realise the deferred tax asset created by these losses but subsequent
events have proven that the future taxable profit will not be sufficient
to realise all of the unused tax loss.
The current tax rate for Red is 30% and for public companies is 35%.
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CA Sri Lanka
Required
Discuss the accounting of Green and Blue in the consolidated financial statements
of Red.
ANSWER
Acquisition of the subsidiaries general
Fair value adjustments have been made for consolidation purposes in both cases
and these will affect the deferred tax charge for the year. This is because the
deferred tax position is viewed from the perspective of the group as a whole. For
example, it may be possible to recognise deferred tax assets that previously could
not be recognised by individual companies, because there are now sufficient tax
profits available within the group to utilise unused tax losses. Therefore a
provision should be made for temporary differences between fair values of the
identifiable net assets acquired and their carrying amounts(Rs. 4 million less
Rs. 3.5 million in respect of Green). No provision should be made for the
temporary difference of Rs. 1 million arising on goodwill recognised as a result of
the combination with Green.
Future listing
Red plans to seek a listing in three years' time. Therefore it will become a public
company and will be subject to a higher rate of tax. LKAS 12 states that deferred
tax should be measured at the average tax rates expected to apply in the periods
in which the temporary differences are expected to reverse, based on current
enacted tax rates and laws. This means that Red may be paying tax at the higher
rate when some of its temporary differences reverse and this should be taken into
account in the calculation.
Acquisition of Green
CA Sri Lanka
(i)
The directors have calculated the tax provision on the assumption that the
intangible asset of Rs. 0.5 Mn will be allowed for tax purposes. However, this
is not certain and the directors may eventually have to pay the additional
tax. If the directors cannot be persuaded to adjust their calculations a
liability for the additional tax should be recognised.
(ii)
The intra-group transaction has resulted in an unrealised profit in the group

accounts and this will be eliminated on consolidation. The tax charge in the
group statement of profit or loss and other comprehensive income includes
the tax on this profit, for which the group will not become liable to tax until
the following period. From the perspective of the group, there is a temporary
difference. Because the temporary difference arises in the financial
319
statements of Red, deferred tax should be provided on this difference (an

asset) using the rate of tax payable by Red.
(iii) Deferred tax should be recognised on the unremitted earnings of
subsidiaries unless the parent is able to control the timing of dividend
payments or it is unlikely that dividends will be paid for the foreseeable
future. Red controls the dividend policy of Green and this means that there
would normally be no need to make a provision in respect of unremitted
profits. However, the profits of Green will be distributed to Red over the next
few years and tax will be payable on the dividends received. Therefore a
deferred tax liability should be shown.
Acquisition of Blue
(i)
A temporary difference arises where non-monetary assets are revalued

upwards and the tax treatment of the surplus is different from the
accounting treatment. In this case the carrying amount of the securities is
increased to fair value but no corresponding adjustment has been made to
the tax base of the investments because the gains will be taxed in future
periods. Therefore the company should recognise a deferred tax liability on
the temporary difference of Rs. 4 Mn.
(ii)
A temporary difference arises when the provision for the loss on the loan
portfolio is first recognised. The general allowance is expected to increase
and therefore it is unlikely that the temporary difference will reverse in the
near future. However, a deferred tax liability should still be recognised. The
temporary difference gives rise to a deferred tax asset. LKAS 12 states that
deferred tax assets should not be recognised unless it is probable that
taxable profits will be available against which the taxable profits can be
utilised. This is affected by the situation in point (c) below.
(iii) In theory, unused tax losses give rise to a deferred tax asset. However, LKAS
12 states that deferred tax assets should only be recognised to the extent
that they are regarded as recoverable. They should be regarded as
recoverable to the extent that on the basis of all the evidence available it is
probable that there will be suitable taxable profits against which the losses
can be recovered. The future taxable profit of Blue will not be sufficient to
realise all the unused tax loss. Therefore the deferred tax asset is reduced to
the amount that is expected to be recovered.
This reduction in the deferred tax asset implies that it was overstated at
1 June 20X1, when it was acquired by the group. As these are the first postacquisition financial statements, goodwill should also be adjusted.
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QUESTION
Deferred tax and groups 2
You are the accountant of Payit. Your assistant is preparing the consolidated
financial statements of the year ended 31 March 20X2. However, he is unsure how
to account for the deferred tax effects of certain transactions as he has not studied
LKAS 12. These transactions are given below.
Transaction 1
During the year, Payit sold goods to a subsidiary for Rs. 10 Mn, making a profit of
20% on selling price. 25% of these goods were still in the inventories of the
subsidiary at 31 March 20X2. The subsidiary and Pay it are in the same tax
jurisdiction and pay tax on profits at 30%.
Transaction 2
An overseas subsidiary made a loss adjusted for tax purposes of Rs. 8 million
(Rs equivalent). The only relief available for this tax loss is to carry it forward for
offset against future taxable profits of the overseas subsidiary. Taxable profits of
the oversees subsidiary suffer tax at a rate of 25%.
Required
Compute the effect of both the above transactions on the deferred tax amounts in
the consolidated statement of financial position of Payit at 31 March 20X2. You
should provide a full explanation for your calculations and indicate any
assumptions you make in formulating your answer.
ANSWER
Transaction 1
This intra-group sale will give rise to a provision for unrealised profit on the
unsold inventory of Rs. 10,000,000 20% 25% = Rs. 500,000. This provision
must be made in the consolidated accounts. However, this profit has already been
taxed in the financial statements of Payit. In other words there is a timing
difference. In the following year when the stock is sold outside the group, the
provision will be released, but the profit will not be taxed. The timing difference
therefore gives rise to a deferred tax asset. The asset is 30% Rs. 500,000 =
Rs. 150,000.
Deferred tax assets are recognised to the extent that they are recoverable. This
will be the case if it is more likely than not that suitable tax profits will exist from
which the reversal of the timing difference giving rise to the asset can be deducted.
The asset is carried forward on this assumption.
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321
Transaction 2
An unrelieved tax loss gives rise to a temporary difference because the loss is
recognised in the financial statements but not yet allowed for tax purposes. When
the overseas subsidiary generates sufficient taxable profits, the loss will be offset
against these in arriving at taxable profits.
The amount of the deferred tax asset to be carried forward is 25% Rs. 8 Mn =
Rs. 2 Mn.
As with Transaction 1, deferred tax assets are recognised to the extent that they
are recoverable. This will be the case if it is more likely than not that suitable tax
profits will exist from which the reversal of the temporary difference giving rise to
the asset can be deducted
4 Related Interpretation
SIC 25 deals with changes in the tax status of an entity or its shareholders. The
effects of a change in tax status are normally recognised in profit or loss.
4.1 SIC 25 Income Taxes Changes in the Tax Status of an Entity

or its Shareholders
A change in the tax status of an entity or its shareholders may have consequences
for an entity by increasing or decreasing its tax liabilities or assets.
This may, for example, occur upon:
The public listing of an entity's equity instruments
The restructuring of an entity's equity
A controlling shareholder's move to a foreign country.
As a result of such an event, an entity may be taxed differently; it may for example
gain or lose tax incentives or become subject to a different rate of tax in the future.
A change in the tax status of an entity or its shareholders may have an immediate
effect on the entity's current tax liabilities or assets. The change may also increase
or decrease the deferred tax liabilities and assets recognised by the entity,
depending on the effect the change in tax status has on the tax consequences that
will arise from recovering or settling the carrying amount of the entity's assets
and liabilities.
A change in the tax status of an entity or its shareholders does not give rise to
increases or decreases in amounts recognised directly in equity. The current and
deferred tax consequences of a change in tax status shall be included in net profit
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CA Sri Lanka
or loss for the period, unless those consequences relate to transactions and events
that result, in the same or a different period, in a direct credit or charge to the
recognised amount of equity. Those tax consequences that relate to changes in the
recognised amount of equity, in the same or a different period (not included in net
profit or loss) shall be charged or credited directly to equity.
QUESTION
Nikatenna Holdings, a private company purchased 1% of the shares in a public
company for Rs. 350 Mn on 15 March 20X4.
Nikatenna Holdings intends to keep the shares for several years. At the reporting
date the shares have a fair value of Rs. 400 Mn. Gains are taxed when the
investments are sold.
Required
(a)
Discuss the tax implications of the scenario above for the year ended
31 December 20X4. Assume a tax rate of 28%.
(b)
Explain the implications if Nikatenna intended to list in the future assuming

listed companies have a current tax rate of 33%.
ANSWER
(a)
A temporary difference arises when the shares are revalued as the tax
treatment is different from the accounting treatment. The fair value gain of
Rs. 50 Mn is recognised in other comprehensive income (as this investment
must be classified as available-for-sale).
The gain is a taxable temporary difference and the company should
recognise a deferred tax liability of Rs. 14 Mn (Rs. 50 Mn 28%),
representing the future tax to pay on the gain recognised, payable when the
investments are sold.
It should be charged to other comprehensive income, ie the same section of
the statement of profit or loss and other comprehensive income as the gain
recognised.
(b)
CA Sri Lanka
If the company plans to list it will become subject to a higher tax rate. LKAS
12 states that deferred tax should be measured at the average tax rates
expected to apply in the periods in which the temporary differences are
expected to reverse (ie when the tax becomes payable), based on tax rates
enacted or substantively enacted by the year end date. This will need to be
taken into account in the calculation and any changes in opening balances
should also be disclosed separately.
323
QUESTION
The Kandy Group headed by Kandy Co operates in a number of diverse industries
throughout Asia. It has recently appointed a new Managing Director from a
country where IFRS are not applied. The Managing Director has approached you,
the financial controller and asked you to explain how the provision for deferred
taxation would be calculated in the following situations under LKAS 12 Income
taxes:
(i)
A wholly owned overseas subsidiary, Sol, a limited liability company, sold

goods costing Rs. 7 million to Kandy Co on 1 September 20X5, and these
goods had not been sold by Kandy Co before the year end. Kandy Co had paid
Rs. 9 million for these goods. The Managing Director does not understand
how this transaction should be dealt with in the financial statements of the
subsidiary and the group for taxation purposes. Sol pays tax locally at 30%.
(ii)
Karri, a limited liability company, is a wholly owned subsidiary of Kandy, and

is a cash generating unit in its own right. The value of the property, plant and
equipment of Karri at 31 October 20X5 was Rs. 6 million and purchased
goodwill was Rs. 1 million before any impairment loss. The company had no
other assets or liabilities. An impairment loss of Rs. 1.8 million had occurred
at 31 October 20X5. The tax base of the property, plant and equipment of
Karri was Rs. 4 million as at 31 October 20X5. The directors wish to know
how the impairment loss will affect the deferred tax liability for the year.
Impairment losses are not an allowable expense for taxation purposes.
Assume a tax rate of 28%.

Required
Prepare notes for a discussion with the Managing Director which detail, with
suitable computations, how the situations (i) and (ii) above will impact on the
accounting for deferred tax under LKAS 12 Income taxes in the group financial
statements of the Kandy Group.
ANSWER
Intra-group sale
Sol has made a profit of Rs. 2 Mn on its sale to Kandy. Tax is payable on the profits
of individual companies. Sol is liable for tax on this profit in the current year and
will have provided for the related tax in its individual financial statements.
However, from the viewpoint of the group the profit will not be realised until the
following year, when the goods are sold to a third party. The profit must therefore
be eliminated from the consolidated financial statements. Because the group pays
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CA Sri Lanka
tax before the profit is realised there is a temporary difference of Rs. 2 million and
a deferred tax asset of Rs. 600,000 (30% Rs. 2 million).
Impairment loss
The impairment loss in the financial statements of Karri reduces the carrying
amount of property, plant and equipment, but is not allowable for tax. Therefore
the tax base of the property, plant and equipment is different from its carrying
amount and there is a temporary difference.
Under LKAS 36 Impairment of assets the impairment loss is allocated first to
goodwill and then to other assets:
Property,
plant and
Goodwill
equipment
Total
Rs Mn
Rs Mn
Rs Mn
1
6.0
7.0
Carrying amount at 31 October 20X5
(1)
(0.8)
(1.8)
Impairment loss
5.2
5.2
LKAS 12 states that no deferred tax should be recognised on goodwill and

therefore only the impairment loss relating to the property, plant and equipment
affects the deferred tax position.
The effect of the impairment loss is as follows:
Before
impairment
Rs Mn
6
Carrying amount
(4)
Tax base
2
Tax liability (28%)
0.56
After
impairment
Rs Mn
5.2
(4)
1.2
Difference
0.34
0.22
Rs Mn
0.8
Therefore the impairment loss reduces the deferred tax liability by Rs. 220,000.
The IASB has proposed narrow scope amendments to IAS 12 which will in turn
affect LKAS 12
ED/2014/3 Recognition of Deferred Tax Assets for Unrealised Losses was issued in
June 2014. It proposed to amend IAS 12 (LKAS 12 ) to clarify that:
Unrealised losses on debt instruments measured at fair value for accounting
purposes and at cost for tax purposes can give rise to deductible temporary
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325
differences. This is regardless of whether the holder expects to recover the

carrying amount of the debt instrument by holding it until maturity or by
through sale.
Taxable profit against which an entity assesses a deferred tax asset for
recognition is the amount before any reversal of deductible temporary
differences.
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CHAPTER ROUNDUP
Current tax is payable in respect of the trading activities of the period. The tax
charge is adjusted for any under or overprovision of a prior period.
Deferred tax is an accounting adjustment relating to temporary differences.

Taxable temporary differences result in deferred tax liabilities and deductible
temporary differences result in deferred tax assets.
Deferred tax may arise in respect of fair value adjustments on business

combinations, unrealised losses, retained earnings of investees and changes
in exchange rates. The recognition of deferred tax on a business combination
may affect the measurement of goodwill.
SIC 25 deals with changes in the tax status of an entity or its shareholders. The
effects of a change in tax status are normally recognised in profit or loss.
The IASB has proposed narrow scope amendments to IAS 12 which will in turn
affect LKAS 12.
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327
PROGRESS TEST
328
The current tax liability in the statement of financial position is not usually equal
to the tax charge to profits. Why?
What is the tax base of an asset?
Current liabilities include revenue received in advance with a carrying amount of

Rs. 3,500. The revenue is taxed on an accruals basis. What is its tax base?
What tax rate is used to calculated deferred tax amounts?
Why is there a deferred tax implication in the consolidated accounts of an

unrealised profit on sale of inventory from a parent to its subsidiary?
How do temporary differences arise when investments are held in subsidiaries,

associates and so on?
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The difference may be due to a combination of:

Some of the current year tax charge having been paid such that the liability at
the year end represents only part of the tax charge for the year.
The current liability may include outstanding tax from previous years.
The tax expense is usually subject to adjustment in respect of under or over
provision in the previous year.
Elements of the tax charge are recognised in equity/ OCI if the underlying item
is also recognised in equity /OCI.
The tax charge includes deferred tax.
The tax base of an asset is the amount that will be deductible for tax purposes
against any taxable economic benefits that will flow to the entity when it recovers
the carrying amount of the asset. Where those benefits are not taxable, the tax
base is the same as the assets carrying amount.
Rs. 3,500.
The tax rate which is expected to apply to the period when the underlying item is
realised/settled based on rates enacted or substantively enacted by the end of the
reporting period. Where different tax rates apply to different levels of income
average rates expected to apply are used. The tax rate used should reflect the
expected manner of recovery (income tax rate for use/capital gain tax rate for
sale).
The carrying amount of the inventory in the consolidated statement of financial

position is the original cost of the inventory to the parent company (ie the
unrealised profit is deducted from the carrying amount in the subsidiarys books).
There is no group tax; tax is based on individual entity status and therefore the tax
base is the cost of the inventory to the subsidiary.
When the carrying amounts of the investment become different to the tax base of
the investment.
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329
330
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CHAPTER
INTRODUCTION
This chapter revises KB1 material and introduces new, more advanced financial
instruments topics such as hedge accounting. You should go back and review your KB1
material for additional examples relating to topics that we revise at this level.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS
/ LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.2
Level B
1.1.7
1.2.1
1.2.2
1.2.3
1.2.4
1.3
Level C
1.2.5
1.3.1
1.3.2
1.3.3

matters.
under standards.
Demonstrate a thorough knowledge of Sri Lanka Accounting standards in the selection
and application of accounting policies.
Demonstrate the appropriate application and selection of accounting/reporting
Apply the concepts/principals of the standards to resolve a simple/straight forward
matter.
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KC1 | Chapter 12: Financial Instruments
CHAPTER CONTENTS
1 LKAS 32 Financial Instruments: Presentation
2 LKAS 39 Financial Instruments: Recognition and Measurement
3 Derivatives
4 Hedge accounting
5 SLFRS 9 Financial Instruments
6 SLFRS 4 Insurance Contracts
7 SLFRS 7 Financial Instruments: Disclosures
8 IFRIC 19 Extinguishing Financial Liabilities with Equity
Instruments

Advise on appropriate classification of financial assets.
Assess the value of financial assets and liabilities at initial recognition and
subsequent measurement.
Advise when to derecognise financial assets and financial liabilities.
Advise fair value measurement considerations of financial assets.
Assess the gains and losses arising on subsequent measurement of financial
assets.
Advise on reclassifications, gains or losses on impairment and uncollectability
of financial assets.
Outline disclosures to be made in respect of financial assets and liabilities.
Outline the principle of hedge accounting.
Explain insurance contracts.
Differentiate an insurance contract from a financial instrument.
Evaluate significance of financial instruments for financial position and
performance.
Discuss other disclosures pertaining to accounting policies hedge accounting
and fair value.
Discuss nature and extent of risk arising from financial instruments.
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1 LKAS 32 Financial Instruments: Presentation

LKAS 32 Financial Instruments: Presentation and LKAS 39 Financial
Instruments: Recognition and Measurement are the main standards that
prescribe the accounting treatment for financial instruments. These are
supplemented by SLFRS 7 Financial Instruments: Disclosures that provides
disclosure requirements. SLFRS 9 Financial Instruments has been issued and
will replace LKAS 39 in 2018.
If you read the financial press you will probably be aware of rapid international
expansion in the use of financial instruments. These vary from straightforward,
traditional instruments, eg bonds, through to various forms of so-called 'derivative
instruments'.
1.1 Definitions
Financial instrument. Any contract that gives rise to both a financial asset of one
entity, and a financial liability or equity instrument of another entity.
Financial asset. Any asset that is:
(a)
Cash;
(b)
An equity instrument of another entity;
(c)
A contractual right to receive cash or another financial asset from another

entity; or to exchange financial instruments with another entity under
conditions that are potentially favourable to the entity; or
(d)
A contract that will or may be settled in the entity's own equity instruments
and is:
(i)
A non-derivative for which the entity is or may be obliged to receive a

variable number of the entity's own equity instruments; or
(ii)
A derivative that will or may be settled other than by the exchange of a

fixed amount of cash or another financial asset for a fixed number of
the entity's own equity instruments.
Financial liability. Any liability that is:

(a)
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A contractual obligation:
(i)
To deliver cash or another financial asset to another entity; or
(ii)
To exchange financial instruments with another entity under

conditions that are potentially unfavourable, or
333
(b)
A contract that will or may be settled in the entitys own equity instruments
and is:
(i)
Anon-derivative for which the entity is or may be obliged to deliver a

variable number of the entity's own equity instruments; or
(ii)
A derivative that will or may be settled other than by the exchange of a

fixed amount of cash or another financial asset for a fixed number of
the entity's own equity instruments.
Equity instrument. Any contract that evidences a residual interest in the assets of
an entity after deducting all of its liabilities.
Derivative. A financial instrument or other contract with all three of the following
characteristics:
(a)
Its value changes in response to the change in a specified interest rate,

financial instrument price, commodity price, foreign exchange rate, index of
prices or rates, credit rating or credit index, or other variable (sometimes
called the 'underlying');
(b)
It requires no initial net investment or an initial net investment that is

smaller than would be required for other types of contracts that would be
expected to have a similar response to changes in market factors; and
(c)
It is settled at a future date.

(LKAS 32 and LKAS 39)
The following are points to note in relation to the definition of a financial

instrument above:
The contract giving rise to a financial asset and liability need not be in writing.
An entity involved in the contract could be an individual, partnership,
company or government agency.
The following are not financial instruments: physical assets, prepaid expenses,
deferred income, most warranty obligations and liabilities or assets that are not
contractual.
Financial instruments include both primary instruments and derivative
instruments. Derivative instruments are discussed in section 3 of this chapter.
1.2 LKAS 32 objective and scope

The objective of LKAS 32 Financial Instruments: Presentation is: 'to establish
principles for presenting financial instruments as liabilities or equity and for
offsetting financial assets and financial liabilities.
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LKAS 32 should be applied in the presentation of all types of financial instruments,

whether recognised or unrecognised, with the exception of the following:
Interests in subsidiaries (SLFRS 10)
Interests in associates (LKAS 28)
Interests in joint ventures (SLFRS 11/LKAS 28)
Pensions and other post-retirement benefits (LKAS 19)
Insurance contracts (SLFRS 4)
Contracts that require a payment based on climatic, geological or other physical
variables
Financial instruments, contracts and obligations under share-based payment
transactions (SLFRS 2)
1.3 The distinction between a financial liability and equity

The classification of a financial instrument as a liability or as equity depends on
the following.
The substance of the contractual arrangement on initial recognition
The definitions of a financial liability and an equity instrument.
A financial instrument is a financial liability if there is a contractual obligation to
transfer economic benefit ie deliver either cash or another financial asset to the
holder or to exchange another financial instrument with the holder under
potentially unfavourable conditions to the issuer.
If there is no contractual obligation to deliver cash or another financial asset to the
holder, the financial instrument is an equity instrument eg ordinary shares are an
equity instrument as the issuer has no obligation to pay a dividend.
Note that commercial substance takes precedence over legal form; although
substance and legal form are often consistent with each other, this is not always
the case.
QUESTION
Redeemable preference shares
During the financial year ended 31 December 20X5, Moora Co issued the financial
instrument described below. Identify whether it should be classified as liability or
equity, explaining in not more than 40 words the reason for your choice. You
should refer to the relevant SLFRS.
Redeemable preference shares with a coupon rate 5%. The shares are redeemable
on 31December 20X9 at premium of 20%.
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335
ANSWER
Liability. The preference shares require regular distributions to the holders but
more importantly have the debt characteristic of being redeemable. Therefore,
according to LKAS 32 Financial Instruments: Presentation they must be classified
as liability.
1.3.1 Compound instruments

Some financial instruments contain both a liability and an equity element. In such
cases, LKAS 32 requires the component parts of the instrument to be classified
separately, according to the substance of the contractual arrangement and the
definitions of a financial liability and an equity instrument.
Convertible debt
One of the most common types of compound instrument is convertible debt
where conversion is at the holders option. This creates a primary financial
liability of the issuer and grants an option to the holder of the instrument to
convert it into an equity instrument (usually ordinary shares) of the issuer. This is
the economic equivalent of the issue of conventional debt plus a warrant to
acquire shares in the future.
Although in theory there are several possible ways of calculating the split, the
following method is recommended.
(a)
Calculate the value for the liability component as the future cash flows
associated with the instrument (assuming redemption) discounted at a
market interest rate for similar bonds having no conversion rights
(b)
Deduct this from the instrument as a whole to leave a residual value for the
equity component.
The reasoning behind this approach is that an entity's equity is its residual
interest in its assets amount after deducting all its liabilities. The sum of the
carrying amounts assigned to liability and equity will always be equal to the
carrying amount that would be ascribed to the instrument as a whole.
1.3.2 Contingent settlement provisions
An entity may issue a financial instrument where the way in which it is settled
depends on:
(a)
(b)
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The occurrence or non-occurrence of uncertain future events, or

The outcome of uncertain circumstances,
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that are beyond the control of both the holder and the issuer of the instrument.
For example, an entity might have to deliver cash instead of issuing equity shares.
In this situation it is not immediately clear whether the entity has an equity
instrument or a financial liability.
Such financial instruments should be classified as financial liabilities unless the
possibility of settlement is remote.
1.3.3 Settlement options
When a derivative financial instrument gives one party a choice over how it is
settled (eg, the issuer can choose whether to settle in cash or by issuing shares)
the instrument is a financial asset or a financial liability unless all the
alternative choices would result in it being an equity instrument.
1.3.4 Treasury shares
If an entity reacquires its own equity instruments, those instruments ('treasury
shares') must be deducted from equity. No gain or loss may be recognised in profit
or loss on the purchase, sale, issue or cancellation of an entity's own equity
instruments. Consideration paid or received shall be recognised directly in equity.
1.3.5 Puttable instruments
A puttable instrument is a financial instrument that gives the holder the right to
put the instrument back to the issuer (ie redeem it) for cash or another financial
asset.
LKAS 32 historically required such instruments to be classified as liabilities,
however a 2008 amendment to the standard requires entities to classify such
instruments as equity, so long as they meet certain conditions. The amendment
further requires that instruments imposing an obligation on an entity to deliver to
another party a pro rata share of the net assets only on liquidation should be
classified as equity.
1.4 Interest, dividends, losses and gains

Interest, dividends, losses and gains relating to a financial instrument classified
as a financial liability are recognised as income or expense in profit or loss.
Dividends to equity shareholders are charged directly to equity by the issuer.
These will appear in the statement of changes in equity.
Transaction costs of an equity transaction are accounted for as a deduction
from equity.
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337
1.5 Offsetting a financial asset and a financial liability

A financial asset and financial liability should only be offset, with the net amount
reported in the statement of financial position, when an entity:
(a)
Has a legally enforceable right of set off, and
(b)
Intends to settle on a net basis, or to realise the asset and settle the liability
simultaneously, ie at the same moment.
This will reflect the expected future cash flows of the entity in these specific
circumstances. In all other cases, financial assets and financial liabilities are
presented separately.
QUESTION
Debt or equity?
During the financial year ended 28 February 20X5, MN issued the two financial
instruments described below. For each of the instruments, identify whether it
should be classified as debt or equity, explaining in not more than 40 words each
the reason for your choice. In each case you should refer to LKAS 32.
(i)
Redeemable preferred shares with a coupon rate 8%. The shares are
redeemable on 28 February 20X9 at premium of 10%.
(ii)
A grant of share options to senior executives. The options may be exercised

from 28 February 20X8.
ANSWER
338
(i)
Debt. The preference shares require regular distributions to the holders but
more importantly have the debt characteristic of being redeemable.
Therefore according to LKAS 32 Financial instruments: presentation they
must be classified as debt.
(ii)
Equity. According to SLFRS 2 Share-based payment the grant of share options

must be recorded as equity in the statement of financial position. It is an
alternative method of payment to cash for the provision of the services of the
directors.
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QUESTION
Compound instrument
On 1 January 20X1, EFG issued 10,000 5% convertible bonds at their par value of
Rs. 500 each. The bonds will be redeemed on 1 January 20X6. Each bond is
convertible at the option of the holder at any time during the five year period.
Interest on the bond will be paid annually in arrears.
The prevailing market interest rate for similar debt without conversion options at
the date of issue was 6%.
At what value should the equity element of the hybrid financial instrument be
recognised in the financial statements of EFG at the date of issue?
ANSWER
Working in Rs'000, find the present value of the principal value of the bond,
Rs. 5,000,000 (10,000 500) and the interest payments of Rs. 250,000 annually
(5% 5 Mn) at the market rate for non-convertible bonds of 6%, using the
discount factor tables. The difference between this total and the principal amount
of Rs5m is the equity element.
Rs.
3,735,000
Present value of principal 5 Mn 0.747
1,053,000
Present value of interest 250,000 4.212
4,788,000
Liability value
5,000,000
Principal amount
212,000
Equity element
1.6 IFRIC 2 Members Shares in Co-operative Entities and Similar

Instruments
IFRIC 2 provides guidance in applying the requirements of LKAS 32 to members
shares in co-operatives and similar entities. These shares have some
characteristics of equity and, subject to some limitations, give the holder the right
to request redemption for cash. IFRIC 2 considers how those redemption terms
are evaluated when determining whether shares are financial liabilities or equity.
The interpretation concludes that shares for which the member has the right to
request redemption are normally liabilities. They are equity if:
The entity has an unconditional right to refuse redemption
Local law, regulation or the entitys governing charter can unconditionally
prohibit redemption.
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2 LKAS 39 Financial Instruments: Recognition and

Measurement
All financial assets and liabilities should be recognised in the statement of
financial position, including derivatives. They are initially recognised at fair
value; subsequent measurement depends on their classification.
Financial assets should be derecognised when the rights to the cash flows from
the asset expire or where substantially all the risks and rewards of ownership
are transferred to another party.
Financial liabilities should be derecognised when they are extinguished.
2.1 Scope
LKAS 39 applies to all entities and to all types of financial instruments except
those specifically excluded, as listed below.
(a)
Investments in subsidiaries, associates, and joint ventures that are

accounted for under SLFRS 10, LKAS 28 and SLFRS 11
(b)
Leases covered in LKAS 17
(c)
Employee benefit plans covered in LKAS 19
(d)
Insurance contracts
(e)
Equity instruments issued by the entity eg ordinary shares issued, or options

and warrants
(f)
Financial guarantee contracts
(g)
A forward contract between an acquirer and selling shareholder that will

result in a business combination within the scope of SLFRS 3
(h)
Loan commitments that cannot be settled net in cash or another financial

instrument
(i)
Financial instruments, contracts and obligations under share-based payment

transactions, covered in SLFRS 2
(j)
Rights to payments to reimburse the entity for expenditure to settle a

provision made in accordance with LKAS 37
2.2 Recognition
A financial asset or financial liability is recognised in the statement of financial
position when the reporting entity becomes a party to the contractual
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provisions of the instrument. An important consequence of this is that all

derivatives should be recognised in the statement of financial position (see
section 3).
This is different from the recognition criteria in the Conceptual Framework and in
most other standards. Items are normally recognised when there is a probable
inflow or outflow of resources and the item has a cost or value that can be
measured reliably.
QUESTION
Recognition
An entity has entered into two separate contracts.

(a)
A firm commitment (an order) to buy a specific quantity of iron.
(b)
A forward contract to buy a specific quantity of iron at a specified price on a

specified date, provided delivery of the iron is not taken.
Required
Discuss whether a financial instrument should be recognised in each of these
cases.
ANSWER
Contract (a) is a normal trading contract. The entity does not recognise a liability
for the iron until the goods have actually been delivered. (Note that this contract
is not a financial instrument because it involves a physical asset, rather than a
financial asset.)
Contract (b) is a financial instrument. Under LKAS 39, the entity recognises a
financial liability (an obligation to deliver cash) on the commitment date, rather
than waiting for the closing date on which the exchange takes place.
Note that planned future transactions, no matter how likely, are not assets and
liabilities of an entity the entity has not yet become a party to the contract.
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341
2.3 Derecognition
Derecognition is the removal of a financial instrument from the statement of
financial position. The following table revises KB1 knowledge:
Derecognition of
financial assets
When:
(a)
The contractual rights to the cash flows

from the financial asset expire or
(b)
An entity transfers substantially all the

risks and rewards of ownership to another
party.
Derecognition of
financial liabilities
When it is extinguished ie when the obligation

specified in the contract is discharged, cancelled
or expires.
Partial derecognition
Part of a financial instrument can be

derecognised if that part comprises:
Gain or loss on
derecognition
(a)
Only specifically identified cash flows, or
(b)
Only a fully proportionate share of the cash

flows.
The gain or loss recognised in profit or loss on

derecognition is the difference between the
carrying amount of the financial instrument and
the proceeds.
In the case of a partial disposal the carrying
amount is pro-rated between that part disposed
of and that part retained on the basis of fair
values.
Accumulated gains or losses on AFS assets are
also reclassified to profit or loss.
QUESTION
Derecognition
Discuss whether the following financial instruments should be derecognised:
342
(a)
Co enters into a stocklending agreement where an investment is lent to a

third party for a finite period of time in exchange for payment of a fee.
(b)
Co sells title to some of its receivables to a debt factor in exchange for an

immediate cash payment of 92% of their value. The terms of the agreement
are that B Co has to compensate the factor for any amounts not recovered
after 6 months.
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(c)
Co sells an investment in shares but retains a call option to repurchase those

shares at any time at a price equal to their current market value at the date
of repurchase.
ANSWER
(a)
A Co should not derecognise the investment as it has retained substantially

all risks and rewards of ownership. The stock is retained in its books even
though legal title is temporarily transferred.
(b)
B Co has received 92% of its transferred receivables in cash, but whether it

can retain this amount permanently is dependent on the performance of the
factor in recovering all of the receivables. B Co may have to repay some of it
and therefore retains the risks and rewards of 100% of the receivables
amount. The receivables should not be derecognised. The cash received
should be treated as a loan.
The 8% of the receivables that B Co will never receive in cash should be
treated as interest over the six-month period; it should be recognised as an
expense in profit or loss and increase the carrying amount of the loan.
At the end of the six months, the receivables should be derecognised by
netting them against the amount of the loan that does not need to be repaid
to the factor. The amount remaining is bad debts which should be recognised
as an expense in profit or loss.
(c)
C Co should derecognise the asset as its option to repurchase is at the

prevailing market value.
2.4 Financial assets

2.4.1 Classification
LKAS 39 requires that financial assets are classified as one of the following types
upon initial recognition:
Financial assets at fair
value through profit or
loss (FVTPL)
Financial assets that are:

(a)
Held for trading, ie it is:

Acquired principally for the purpose of sale
in the short-term
Part of a portfolio of financial instruments
that are managed together and for which
there is evidence of a recent pattern of shortterm profit taking, or
A derivative.
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343
(b)
Designated as such. This is only allowed where:

It eliminates or significantly reduces an
accounting mismatch
A group of assets is managed and its
performance evaluated on a fair value basis.
Held to maturity
financial assets (HTM)
Financial assets with fixed or determinable payments

and fixed maturity that:
A company has the intention and ability to hold to
maturity
Do not meet the definition of loans and receivables
Are not designated as fair value through profit or
loss or available-for-sale.
Loans and receivables
Non-derivative financial assets with fixed or

determinable payments that are not quoted in an
active market, other than:
Those that the entity intends to sell immediately or
in the near term, which should be classified as held
for trading and those that the entity upon initial
recognition designates as at fair value through
profit or loss
Those that the entity upon initial recognition
designates as available-for-sale, or
Those for which the holder may not recover
substantially all of the initial investment, other
than because of credit deterioration, which shall be
classified as available-for-sale.
Available-for-sale
financial assets (AFS)
344
Non-derivative financial assets designated as

available-for-sale or not classified under any of the
other three headings.
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2.4.2 Measurement
The following table summarises the initial and subsequent measurement of
financial assets:
Classification
Initial
Transaction
measurement costs
Subsequent
measurement
Gains and
losses
recognised in:
FVTPL
Fair value
Expense
Fair value
Profit or loss
HTM
Fair value
Add to initial Amortised cost Profit or loss

measurement
Loans and
receivables
Fair value
Add to initial Amortised cost Profit or loss

measurement
AFS
Fair value
Add to initial Fair value

measurement
Other
comprehensive
income
FVTPL and AFS financial assets are remeasured to fair value at each reporting
date. Fair value is determined in accordance with SLFRS 13 Fair Value
Measurement (see chapter 1).
HTM financial assets and loans and receivables are measured at amortised cost,
defined as follows:
Amortised cost is the amount at which a financial asset or liability is measured at
initial recognition minus principal repayments, plus or minus the cumulative
amortisation using the effective interest method of any difference between that
initial amount and the maturity amount.
The effective interest method is a method of calculating the amortised cost of a
financial instrument and of allocating the interest income or interest expense over
the relevant period.
The effective interest rate is the rate that exactly discounts estimated future cash
payments or receipts through the expected life of the financial instrument to the
net carrying amount of the financial asset or liability.
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345
QUESTION
Financial assets
Atlantic Trading Ltd purchased a Rs. 20 million 6% debenture at par on 1 January

20X2 when the market rate of interest was 6%. Interest is paid annually on
31 December. The debenture is redeemable at par on 31 December 20X3.
The market rate of interest on debentures of equivalent term and risk changed to
7% on 31 December 20X2.
Required
Show the charge or credit to profit or loss for each of the two years to
31 December 20X3 if the debentures are classified as:
(a)
(b)
Held to maturity financial assets.

Financial assets at fair value through profit or loss
Fair value is to be calculated using discounted cash flow techniques.
ANSWER
(a) HTM
20X2
20X3
Rs'000
Rs'000
Profit or loss
Interest income (W1)/(W2)
Gain/(loss) due to change in
FV (W2)
position
Financial asset (W1)/(W2)
(b) FVTPL
20X2
20X3
Rs'000
Rs'000
1,200
1,200
1,200
1,387
1,200
1,200
(187)
1,013
1,387
20,000
19,813
WORKINGS
1
Amortised cost
Cash 1.1.20X2
Effective interest at 6% (same as nominal as no discount on
issue/premium on redemption)
Coupon received (nominal interest 6% 20 Mn)
At 31.12.20X2
Effective interest at 6%
Coupon and capital received ((6% 20 Mn) + 20 Mn)
At 31.12.20X3
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Rs'000
20,000
1,200
(1,200)
20,000
1,200
(21,200)
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Fair value
Cash
Effective interest (as above)
Coupon received (as above)
Fair value loss (balancing figure)
At 31.12.20X2 (W3)
Interest at 7% (7% 19,813)
Coupon and capital received ((6% 20 Mn) + 20 Mn)
At 31.12.20X3
Rs'000
20,000
1,200
(1,200)
(187)
19,813
1,387
(21,200)
Fair value at 31.12.20X2

Interest and capital due on 31.12.20X3 at new market rate
(21.2m/1.07)
Rs'000
19,813
2.4.3 Reclassification of financial assets

In limited circumstances non-derivative financial assets may be reclassified.
Reclassification out of the HTM category
If an entity no longer has the ability or intention to hold a held-to-maturity
financial asset to maturity it is reclassified to the available for sale category.
On reclassification:
It is remeasured to fair value
Any gain or loss is recognised in other comprehensive income.
Such a reclassification, or the sale of a held-to-maturity asset before the maturity
date triggers a penalty in accordance with the LKAS 39 tainting rules. The heldto-maturity category is now deemed to be tainted and as a result:
(1)
All remaining held-to-maturity financial assets are reclassified as available

for sale and remeasured to fair value, and
(2)
The held-to-maturity category is unavailable to the entity for the remainder

of the financial year and the two subsequent financial years.
This penalty is avoided only where the financial asset sold or reclassified is
insignificant compared to the total amount of held-to-maturity assets or the
reclassification was:
Within three months of maturity, or
After the entity has collected substantially all amounts of principal, or
Outside the entitys control.
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Reclassification out of the FVTPL and AFS categories

Reclassification out of the fair value through profit or loss and available for sale
categories is allowed in limited circumstances. It is not allowed for:
Derivatives
Financial assets that are designated as fair value through profit or loss on initial
recognition.
The criteria for reclassification are as follows.
(a)
If a debt instrument would have met the definition of loans and receivables,
had it not been required to be classified as held for trading at initial
recognition, it may be reclassified out of fair value through profit or loss
provided the entity has the intention and ability to hold the asset for the
foreseeable future or until maturity.
(b)
If a debt instrument was classified as available for sale, but would have met
the definition of loans and receivables if it had not been designated as
available for sale, it may be reclassified to the loans and receivables category
provided the entity has the intention and ability to hold the asset for the
foreseeable future or until maturity.
(c)
Other debt instruments or any equity instruments may be reclassified from

fair value through profit or loss to available for sale or, in the case of debt
instruments only from fair value through profit or loss to held to maturity if
the asset is no longer held for selling in the short term. Such cases will be
rare.
Reclassified assets must be measured at fair value at the date of reclassification

and this becomes the new cost, or amortised cost of the financial asset. Previously
recognised gains and losses cannot be reversed.
For assets reclassified out of AFS, amounts previously recognised in other
comprehensive income must be reclassified to profit or loss.
Accounting subsequent to reclassification
After the reclassification date, the normal LKAS 39 requirements apply. For
example, in the case of financial assets measured at amortised cost, a new effective
interest rate will be determined. If a fixed rate debt instrument is reclassified as
loans and receivables and held to maturity, this effective interest rate will be used
as the discount rate for future impairment calculations.
Reclassified debt instruments are treated differently. If, after the instrument has
been reclassified, an entity increases its estimate of recoverability of future cash
flows, the carrying amount is not adjusted upwards (in accordance with existing
LKAS 39 rules). Instead, a new effective interest rate must be applied from that
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date on. This enables the increase in recoverability of cash flows to be recognised
over the expected life of the financial asset.
2.4.4 Impairment of financial assets
At each reporting date, an entity should assess whether there is objective evidence
that a financial asset or group of assets is impaired. Note that this is not necessary
for FVTPL financial assets since they are measured at fair value with changes
recognised in profit or loss in any case.
QUESTION
Indicators of impairment
List examples of indications that a financial asset may be impaired
ANSWER
Significant financial difficulty of the issuer
A breach of contract such as a default in interest or principal payments
The lender granting a concession, that it would not otherwise consider, to the
borrower as a result of the borrowers financial difficulty
It becomes probable that the borrower will enter bankruptcy
An active market for the financial asset disappears due to financial difficulties
Observable data that indicates there is a measurable decrease in the estimated
future cash flows from a group of financial assets.
An impairment loss is measured and recognised as follows:
Financial assets carried at amortised cost
The impairment loss is the difference between the asset's carrying amount and its
recoverable amount. The asset's recoverable amount is the present value of
estimated future cash flows, discounted at the financial instrument's original
effective interest rate.
The amount of the loss should be recognised in profit or loss.
If the impairment loss decreases at a later date (and the decrease relates to an
event occurring after the impairment was recognised) the reversal is recognised
in profit or loss. The carrying amount of the asset must not exceed what the
amortised cost would have been had there been no impairment.
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Financial assets carried at cost

Unquoted equity instruments are carried at cost if their fair value cannot be
reliably measured. The impairment loss is the difference between the asset's
carrying amount and the present value of estimated future cash flows, discounted
at the current market rate of return for a similar financial instrument. Such
impairment losses cannot be reversed.
Available for sale financial assets are carried at fair value and gains and losses are
recognised in other comprehensive income. Any impairment loss on an available
for sale financial asset should be removed from equity and recognised in net profit
or loss for the period even though the financial asset has not been derecognised.
The impairment loss is the difference between its acquisition cost (net of any
principal repayment and amortisation) and current fair value less any impairment
loss on that asset previously recognised in profit or loss.
Impairment losses relating to equity instruments cannot be reversed. Impairment
losses relating to debt instruments may be reversed if, in a later period, the fair
value of the instrument increases and the increase can be objectively related to an
event occurring after the loss was recognised.
QUESTION
Impairment
Aruba Co purchased 5% loan stock in Tobago Co on 1 January 20X3 (its issue

date) for Rs. 100,000. The term of the loan stock was 5 years and the maturity
value is Rs. 130,525. The effective rate of interest on the loan stock is 10% and the
company has classified it as a held-to-maturity financial asset.
At the end of 20X4 Tobago Co went into liquidation. All interest had been paid
until that date. On 31 December 20X4 the liquidator of Tobago Co announced that
no further interest would be paid and only 80% of the maturity value would be
repaid, on the original repayment date.
The market interest rate on similar bonds is 8% on that date.
Required
350
(a)
What value should the loan stock have been stated at just before the
impairment became apparent?
(b)
At what value should the loan stock be stated at 31 December 20X4, after the
impairment?
(c)
How will the impairment be reported in the financial statements for the year
ended 31 December 20X4?
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ANSWER
(a)
The loan stock is classified as a held-to-maturity financial asset and so it

would have been stated at amortised cost:
Rs.
100,000
Initial cost
10,000
Interest at 10%
(5,000)
Cash at 5%
105,000
At 31 December 20X3
10,500
Interest at 10%
(5,000)
Cash at 5%
110,500
At 31 December 20X4
(b)
After the impairment, the loan stock is stated at its recoverable amount
(using the original effective interest rate of 10%):
80% Rs. 130,525 0.751 = Rs. 78,419
(c)
The impairment of Rs. 32,081 (110,500 78,419) should be recorded:

DEBIT Profit or loss
CREDIT Financial asset
Rs. 32,081
Rs. 32,081
2.5 Financial liabilities

2.5.1 Classification of financial liabilities
Financial liabilities are classified at initial recognition either as fair value through
profit or loss (FVTPL) or other liabilities. They are classified as FVTPL when they
are:
(a)
Held for trading, ie:

Incurred principally for the purpose of repurchase in the short-term
Part of a portfolio of financial instruments that are managed together and
for which there is evidence of a recent pattern of short-term profit taking,
or
A derivative (see section 3).
(b)
Designated as such. This is only allowed where:

It eliminates or significantly reduces an accounting mismatch
A group of liabilities is managed and its performance evaluated on a fair
value basis.
After initial classification financial liabilities may not be reclassified.

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2.5.2 Measurement of financial liabilities

The following table summarises the initial and subsequent measurement of
financial liabilities:
Classification
Initial
Transaction
measurement costs
Subsequent
measurement
Gains and
losses
recognised
in:
FVTPL
Fair value
Expense
Fair value
Profit or loss
Other financial
liabilities
Fair value
Deduct from Amortised cost

initial
measurement
Profit or loss
Fair value is determined in accordance with SLFRS 13 Fair Value Measurements

discussed before.
QUESTION
FINANCIAL LIABILITIES
Adikari Co issues a bond for Rs. 503,778, on 1 January 20X2. No interest is payable
on the bond, but it will be held to maturity and redeemed on 31 December 20X4
for Rs. 600,000. The bond has not been designated as at fair value through profit
or loss.
Required
Calculate the charge to profit or loss of Adikari Co for the year ended
31 December 20X2 and the balance outstanding at 31 December 20X2.
ANSWER
The bond is a 'deep discount' bond and is a financial liability of Adikari Co. It is
measured at amortised cost. Although there is no interest as such, the difference
between the initial cost of the bond and the price at which it will be redeemed is a
finance cost. This must be allocated over the term of the bond at a constant rate on
the carrying amount.
To calculate amortised cost we need to calculate the effective interest rate of the
bond: 600,000/503,778 = 1.191 over three years.
To calculate an annual rate, we take the cube root, (1.191)1/3 = 1.06, so the annual
interest rate is 6%.
The charge to the statement of profit or loss is Rs. 30,227 (503,778 6%)
The balance outstanding at 31 December 20X2 is Rs. 534,005 (503,778 + 30,227)
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QUESTION
FINANCIAL LIABILITIES 2
On 1 January 20X3 Beehive Co issued Rs. 600,000 loan notes. Issue costs were
Rs. 200. The loan notes do not carry interest, but are redeemable at a premium of
Rs. 152,389 on 31 December 20X4. The effective finance cost of the debentures is
12%. The loan notes have not been designated as at fair value through profit or
loss.
Required
Calculate is the finance cost in respect of the loan notes for the year ended
31 December 20X4?
ANSWER
The premium on redemption of the loan notes represents a finance cost. The
effective rate of interest must be applied so that the debt is measured at amortised
cost (LKAS 39).
At the time of issue, the loan notes are recognised at their net proceeds of Rs.
599,800 (600,000 200).
The finance cost for the year ended 31 December 20X4 is calculated as follows.
B/f
Interest @ 12%
C/f
Rs'000
Rs'000
Rs'000
20X3
599,800
71,976
671,776
20X4
671,776
80,613
752,389
3 Derivatives
A derivative is a financial instrument that derives its value from the price or rate
of an underlying item. Embedded derivatives may require separation from
their host contract for accounting purposes.
of an underlying item. Common examples of derivatives include:
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(a)
Forward contracts: agreements to buy or sell an asset at a fixed price at a

fixed future date
(b)
Futures contracts: similar to forward contracts except that contracts are

standardised and traded on an exchange
(c)
Options: rights (but not obligations) for the option holder to exercise at a
pre-determined price; the option writer loses out if the option is exercised
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(d)
Swaps: agreements to swap one set of cash flows for another (normally
interest rate or currency swaps).
The nature of derivatives often gives rise to particular problems. The value of a
derivative (and the amount at which it is eventually settled) depends on
movements in an underlying item (such as an exchange rate). This means that
settlement of a derivative can lead to a very different result from the one
originally envisaged. A company which has derivatives is exposed to uncertainty
and risk (potential for gain or loss) and this can have a very material effect on its
financial performance, financial position and cash flows.
Yet because a derivative contract normally has little or no initial cost, under
traditional accounting it may not be recognised in the financial statements at all.
Alternatively it may be recognised at an amount which bears no relation to its
current value. This is clearly misleading and leaves users of the financial
statements unaware of the level of risk that the company faces. LKASs 32 and 39
were developed in order to correct this situation.
A derivative may be a financial asset or liability depending on the movement in
the underlying variable.
3.1 Accounting treatment

A derivative is classified as FVTPL whether it is an asset or a liability. Therefore it
is initially measured at its fair value (normally zero) and subsequently at its fair
value with changes recognised in profit or loss.
QUESTION
Orchid Co entered into a three-year interest rate swap with another company for
speculative purposes on 1 April 20X6.
The swap requires Orchid to pay interest at a fixed rate of 6% per annum and
receive interest at an annual variable rate equivalent to SLIBOR + 1%, reset at sixmonthly intervals. Interest is determined on a notional amount of Rs. 200 Mn,
however Orchid and the other company do not exchange this principal amount at
the inception of the agreement.
Settlement is on a net basis and paid six monthly in arrears.
SLIBOR is:
1 April 20X6
30 September 20X6
31 March 20X7
30 September 20X7
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5%
5%
6%
6.5%
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The fair value of the swap is:

30 September 20X6
30 September 20X7
Rs. 5.85 Mn
Rs. 5.15 Mn
Required
(a)
Explain how the arrangement is accounted for by Orchid
(b)
Prepare extracts from the financial statements of Orchid for the year ended
30 September 20X7, explaining the amounts calculated.
ANSWER
(a)
The interest rate swap meets the definition of a derivative because:

its value changes in response to changes in SLIBOR
there is no initial net investment
settlements occur at future dates
In accordance with LKAS 39 the swap is measured at fair value through
profit or loss. It may be a financial asset or a financial liability depending on
whether it is in the money or not.
(b)
Recognition and measurement of swap

Orchid Co enters into the swap arrangement on 1 April 20X6, however at
this date the swap had no value and therefore it is not recognised.
At the year end, 30 September 20X6, the swap is measured at its fair value of
Rs. 5.75 Mn by:
DEBIT
Financial asset
Rs. 5.85 Mn
CREDIT
Profit or loss
Rs. 5.85 Mn
At 30 September 20X7 the swap is remeasured to its new fair value of

Rs. 5.25 Mn by:
DEBIT
Profit or loss
Rs. 700,000
CREDIT
Financial asset
Rs. 700,000
Recognition and measurement of interest income

SLIBOR has increased since the swap was entered into and therefore interest
income will be recognised every 6 months as follows:
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6 m/e:
30.9.X6
30.3.X7
Interest paid
(6% 200 Mn
6/12m)
6m
6m
30.9.X7
6m
Interest received
at SLIBOR + 1%
Net settlement
6m
7% 200 Mn
6/12m
7m
7.5% 200 Mn
6/12m
7.5m
1m
1.5m
The interest income is recognised by:

31 March 20X7
DEBIT
Cash
Rs. 1 Mn
CREDIT
Finance income
Rs. 1 Mn
30 September 20X7
DEBIT
Cash
Rs. 1.5 Mn
CREDIT
Finance income
Rs. 1.5 Mn
Therefore extracts from the financial statements for the year ended
30 September 20X7 are as follows:
Non-current assets
Financial asset: interest rate swap
2014
Rs'000
2013
Rs'000
5,150
5,850
Statement of profit or loss and other comprehensive income

2014
2013
Rs'000
Rs'000
(Increase)/Decrease in fair value of
700
(5,850)
financial assets
Interest income
(2,500)
-
3.2 Embedded derivatives

An embedded derivative is a derivative instrument that is embedded within a host
contract that may or may not be a financial instrument. Host contracts may
include a debt instrument, an equity instrument, insurance contracts, construction
contracts, leases and sale contracts.
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Possible examples of embedded derivatives include:

(a)
A term in a lease of retail premises that provides for contingent rentals

based on sales:
'Host'
contract
Lease
Embedded Contingent
derivative
rentals
Accounted for as normal
Treat as derivative, ie remeasured to FV with changes

recognised in P/L
(b)
A bond which is redeemable in five years' time with part of the redemption
price being based on the increase in the Colombo Stock Exchange All Share
Index.
(c)
Construction contract priced in a foreign currency. The construction contract

is a non-derivative contract, but the changes in foreign exchange rate
provide the embedded derivative.

When an entity becomes party to a host contract with an embedded derivative, it
must assess whether the embedded derivative should be separated from its host
contract and accounted for as a derivative. It must separate the embedded
derivative if:
(a)
The economic characteristics and risks of the embedded derivative are not
closely related to those of the host contract, and
(b)
A separate instrument with the same terms as the embedded derivative

would meet the definition of a derivative, and
(c)
The hybrid instrument is not measured at fair value with changes recognised
in profit or loss (in which case there is no benefit to separating the
embedded derivative).
3.3 IFRIC 9 Reassessment of Embedded Derivatives

As discussed above, LKAS 39 requires that an entity assesses whether embedded
derivatives are separate from the host contract and accounted for separately
when it initially becomes party to a hybrid contract.
IFRIC 9 clarifies that reassessment of the hybrid contract is not allowed unless the
terms of the hybrid contract change such that cash flows are modified.
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4 Hedge Accounting
A hedge arises where the change in fair value of one item is offset by the change in
fair value or cash flows of another item. Hedge accounting is permitted in certain
circumstances, provided that the hedging relationship is clearly defined,
measureable and actually effective.
There are three types of hedge: fair value hedge, cash flow hedge and hedge of a
net investment in a foreign operation. The accounting treatment depends on
the type of hedge.
Introduction
LKAS 39 requires hedge accounting where there is a designated hedging
relationship between a hedging instrument and a hedged item. It is prohibited
otherwise. The following definitions relate to hedging:
Hedging, for accounting purposes, means designating one or more hedging
instruments so that their change in fair value is an offset, in whole or in part, to the
change in fair value or cash flows of a hedged item.
A hedged item is an asset, liability, firm commitment, or forecasted future
transaction that:
(a)
exposes the entity to risk of changes in fair value or changes in future cash
flows, and that
(b)
is designated as being hedged.
A hedging instrument is a designated derivative or (in limited circumstances)

another financial asset or liability whose fair value or cash flows are expected to
offset changes in the fair value or cash flows of a designated hedged item. (A nonderivative financial asset or liability may be designated as a hedging instrument
for hedge accounting purposes only if it hedges the risk of changes in foreign
currency exchange rates.)
Hedge effectiveness is the degree to which changes in the fair value or cash flows
of the hedged item attributable to a hedged risk are offset by changes in the fair
value or cash flows of the hedging instrument.
(LKAS 39)
In simple terms, entities hedge to reduce their exposure to risk and uncertainty,
such as changes in prices, interest rates or foreign exchange rates. Hedge
accounting recognises hedging relationships by allowing (for example) losses on a
hedged item to be offset against gains on a hedging instrument.
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Generally only assets, liabilities etc that involve external parties can be designated
as hedged items. The foreign currency risk of an intragroup monetary item (eg
payable/receivable between two subsidiaries) may qualify as a hedged item in the
group financial statements if it results in an exposure to foreign exchange rate
gains or losses that are not fully eliminated on consolidation. This can happen (per
LKAS 21) when the transaction is between entities with different functional
currencies.
In addition the foreign currency risk of a highly probable group transaction may
qualify as a hedged item if it is in a currency other than the functional currency of
the entity and the foreign currency risk will affect profit or loss.
4.1 Conditions for hedge accounting

Before a hedging relationship qualifies for hedge accounting, all of the following
conditions must be met.
(a)
The hedging relationship must be designated at its inception as a hedge

based on the entity's risk management objective and strategy. There must be
formal documentation (including identification of the hedged item, the
hedging instrument, the nature of the risk that is to be hedged and how the
entity will assess the hedging instrument's effectiveness in offsetting the
exposure to changes in the hedged item's fair value or cash flows
attributable to the hedged risk).
(b)
The hedge is expected to be highly effective in achieving offsetting changes

in fair value or cash flows attributable to the hedged risk. This means that
the ratio of the gain or loss on the hedging instrument compared to the loss
or gain on item being hedged is within the ratio 80% to 125%. (Note: the
hedge need not necessarily be fully effective.)
(c)
For cash flow hedges, a forecast transaction that is the subject of the hedge
must be highly probable and must present an exposure to variations in cash
flows that could ultimately affect profit or loss.
(d)
The effectiveness of the hedge can be measured reliably.
(e)
The hedge is assessed on an on-going basis (annually) and has been effective
during the reporting period.
4.1.1 Example: Hedging

A company owns inventories of 2,000 gallons of oil which cost Rs. 400,000 on
1 December 20X3.
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In order to hedge the fluctuation in the market value of the oil the company signs a
futures contract to deliver 20,000 gallons of oil on 31 March 20X4 at the futures
price of Rs. 220 per gallon.
The market price of oil on 31 December 20X3 is Rs. 230 per gallon and the futures
price for delivery on 31 March 20X4 is Rs. 240 per gallon.
Required
Explain the impact of the transactions on the financial statements of the company:
(a)
(b)
Without hedge accounting

With hedge accounting.
Solution
The futures contract was intended to protect the company from a fall in oil prices
(which would have reduced the profit when the oil was eventually sold). However,
oil prices have actually risen, so that the company has made a loss on the contract.
Without hedge accounting:
The futures contract is a derivative and therefore must be remeasured to fair
value under LKAS 39. The loss on the futures contract is recognised in profit or
loss:
DEBIT
CREDIT
Profit or loss (2,000 (240 220))

Financial liability
Rs. 40,000
Rs. 40,000
With hedge accounting:

The loss on the futures contract is recognised in the profit or loss as before.
The inventories are revalued to fair value:
Rs.
460,000
(400,000)
60,000
Fair value at 31 December 20X3 (2,000 230)

Cost
Gain
The gain is also recognised in profit or loss:
DEBIT
CREDIT
Inventory
Profit or loss
Rs. 60,000
Rs. 60,000
The net effect on the profit or loss is a gain of Rs. 20,000 compared with a loss of
Rs. 40,000 without hedging.
The standard identifies three types of hedging relationship.
Fair value hedge: a hedge of the exposure to changes in the fair value of a
recognised asset or liability, or an identified portion of such an asset or liability,
that is attributable to a particular risk and could affect profit or loss.
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Cash flow hedge: a hedge of the exposure to variability in cash flows that
(a)
Is attributable to a particular risk associated with a recognised asset or

liability (such as all or some future interest payments on variable rate debt)
or a highly probable forecast transaction (such as an anticipated purchase or
sale), and that
(b)
Could affect profit or loss.
Hedge of a net investment in a foreign operation: LKAS 21 defines a net

investment in a foreign operation as the amount of the reporting entity's interest
in the net assets of that operation.
(LKAS 39)
The hedge in the example above is a fair value hedge (it hedges exposure to
changes in the fair value of a recognised asset: the oil).

4.2.1 Fair value hedges
The gain or loss resulting from re-measuring the hedging instrument at fair value
is recognised in profit or loss.
The gain or loss on the hedged item attributable to the hedged risk should adjust
the carrying amount of the hedged item and be recognised in profit or loss.
4.2.2 Example: Fair value hedge
On 1 July 20X6 Kaylon Co acquired 10,000 ounces of a material which it held in its
inventory. This cost Rs. 200 per ounce, so a total of Rs. 2 million. The directors of
Kaylon Co were concerned that the price of this inventory would fall, so on
1 July 20X6 they sold 10,000 ounces in the futures market for Rs. 210 per ounce
for delivery on 30 June 20X7. On 1 July 20X6 the conditions for hedge accounting
were all met.
At 31 December 20X6, the end of Kaylons reporting period, the fair value of the
inventory was Rs. 220 per ounce while the futures price for 30 June 20X7 delivery
was Rs. 227 per ounce. On 30 June 20X7 the trader sold the inventory and closed
out the futures position at the then spot price of Rs. 230 per ounce.
Required
Set out the accounting entries in respect of the above transactions.
Solution
At 31 December 20X6 the increase in the fair value of the inventory was
Rs. 200,000 (10,000 (Rs. 220 Rs. 200)) and the increase in the forward
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contract liability was Rs. 170,000 (10,000 (Rs. 227 Rs. 210)). Hedge
effectiveness was 85% (170,000 as a % of 200,000), so hedge accounting was still
permitted.
Debit
Credit
31 December 20X6
Rs.
Rs.
Profit or loss
Financial liability
(To record the loss on the forward contract)
170,000
Inventories
Profit or loss
(To record the increase in the fair value of the
inventories)
200,000
170,000
200,000
At 30 June 20X7 the increase in the fair value of the inventory was another
Rs. 100,000 (10,000 (Rs. 230 Rs. 220)) and the increase in the forward
contract liability was another Rs. 30,000 (10,000 (Rs. 230 Rs. 227)).
Debit
Credit
Rs.
Rs.
30 June 20X7
Profit or loss
30,000
Financial liability
30,000
(To record the loss on the forward contract)
Inventories
Profit or loss
(To record the increase in the fair value of the
inventories)
100,000
100,000
Profit or loss
Inventories
(To record the inventories now sold)
2,300,000
Cash
Profit or loss revenue
(To record the revenue from the sale of inventories)
2,300,000
Financial liability
Cash
2,300,000
2,300,000
200,000
200,000
(To record the settlement of the net balance due on closing the financial liability)
4.2.3 Cash flow hedges
The portion of the gain or loss on the hedging instrument that is determined to be
an effective hedge is recognised as other comprehensive income.
The ineffective portion of the gain or loss on the hedging instrument is recognised
in profit or loss.
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When a hedging transaction results in the recognition of an asset or liability,

changes in the value of the hedging instrument recognised in equity either:
(a)
Are adjusted against the carrying amount of the asset or liability, or
(b)
Affect the profit or loss at the same time as the hedged item (for example,
through depreciation or sale).
4.2.4 Example: Cash flow hedge

Mountain Co signs a contract on 1 November 20X1 to purchase an asset on
1 November 20X2 for Z60,000,000. Mountain reports in Rs and hedges this
transaction by entering into a forward contract to buy Z60,000,000 on
1 November 20X2 at Rs 1: Z1.5.
Spot and forward exchange rates at the following dates are:
Spot
Forward (for delivery on 1.11.X2)
1.11.X1
Rs 1: Z1.45
Rs 1: Z1.5
31.12.X1
Rs 1: Z1.20
Rs 1: Z1.24
1.11.X2
Rs 1: Z1.0
Rs 1: Z1.0 (actual)
Required
Show the double entries relating to these transactions at 1 November 20X1,
31 December 20X1 and 1 November 20X2.
Solution
Entries at 1 November 20X1
The value of the forward contract at inception is zero so no entries recorded
(other than any transaction costs), but risk disclosures will be made.
The contractual commitment to buy the asset would be disclosed if material (LKAS
16).
Entries at 31 December 20X1
Gain on forward contract:
Value of contract at 31.12.X1 (Z60,000,000/1.24)
Gain on contract
Rs.
48,387,096
40,000,000
8,387,096
Compare to movement in value of asset (unrecognised):

Increase in Rs cost of asset
(Z60,000,000/1.20 Z60,000,000/1.45)
Rs. 8,620,690
As this is higher, the hedge is deemed fully effective at this point:
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DEBIT Financial asset (Forward a/c)

CREDIT Other comprehensive income
Rs. 8,387,096
Rs. 8,387,096
Entries at 1 November 20X2

Additional gain on forward contract
Rs.
60,000,000
48,387,096
11,612,904

Gain on contract
Compare to movement in value of asset (unrecognised):
Increase in Rs cost of asset
(Z60,000,000/1.0 Z60,000,000/1.2)
Rs. 10,000,000
Therefore, the hedge is not fully effective during this period, but is still highly
effective (and hence hedge accounting can be used):
10,000,000/11,612,904 = 86% which is within the 80% 125% bandings.
DEBIT Financial asset (Forward a/c)
CREDIT Other comprehensive income
CREDIT Profit or loss
Rs. 11,612,904
Rs. 10,000,000
Rs. 1,612,904
Purchase of asset at market price

DEBIT Asset (Z60,000,000/1.0)
CREDIT Cash
Rs. 60,000,000
Rs. 60,000,000
Settlement of forward contract

DEBIT Cash
CREDIT Financial asset (Forward a/c)
Rs. 20,000,000
Rs. 20,000,000
Realisation of gain on hedging instrument

The cumulative gain of Rs. 18,387,096 recognised in other comprehensive income
and held in equity:
Is reclassified to profit or loss as the asset is used, ie over the asset's useful life;
or
Adjusts the initial cost of the asset (reducing future depreciation).
4.2.5 Hedges of a Net Investment

Hedges of a net investment arise in the consolidated accounts where a parent
company takes a foreign currency loan in order to buy shares in a foreign
subsidiary. The loan and the investment need not be denominated in the same
currency, however assuming that the currencies perform similarly against the
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parent company's own currency, it should be the case that fluctuations in the
exchange rate affect the asset (the net assets of the subsidiary) and the liability
(the loan) in opposite ways, hence gains and losses are hedged.
In this type of accounting hedge, the hedging instrument is the foreign currency
loan rather than a derivative.
You may understand this type of hedge better after studying Chapter 20, but in a
simple sense, without applying hedging rules:
(a)
The loan would be retranslated to the parent's own currency at the year end
using the spot exchange rate; any resultant gain or loss would be recognised
in profit or loss.
(b)
Prior to consolidation, the subsidiary's accounts would be translated into the

parent's own currency with any gain or loss recognised in other
(c)
On consolidation, the gain or loss on the loan would affect consolidated

profit or loss and the loss or gain on the translation of the subsidiary's net
assets would affect consolidated reserves.
The net investment hedge ensures that the gains and losses are both recognised in
other comprehensive income and accumulated in reserves by:
Recognising the portion of the gain or loss on the hedging instrument that is
determined to be effective in other comprehensive income
Recognising the ineffective portion in profit or loss
Any gain or loss recognised in other comprehensive income is reclassified to profit
or loss on the disposal or partial disposal of the foreign operation.
QUESTION
Hedge accounting
Elephant Co manufactures and retails jewellery. On 31 December 20X3 the cost of

Elephants finished pieces of jewellery amounted to Rs. 5.6 Mn and they contained
18,000 troy ounces of gold. At that date the sales value of finished pieces was
Rs. 6.1 Mn.
The selling price of jewellery is dependent on the market price of gold and
therefore Elephants management wish to reduce their business risk by hedging
the value of the gold content of their jewellery. This has, to date, proved to be an
effective strategy.
The company therefore sold futures contracts for 18,000 troy ounces of gold at
Rs. 335 per troy ounce at 31 December 20X3. The contracts mature on
31 December 20X4.
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Elephant has a reporting date of 30 September and at 30 September 20X4, the fair
value of the jewellery was Rs. 5.95 Mn and the forward price of gold per troy
ounce for delivery on 31 December 20X4 was Rs. 320.
Required
Advise how the transactions are reflected in Elephants financial statements in the
year ended 30 September 20X4.
ANSWER
1)
Change in forward value of contract:

At 31 December 20X3 (12,000 Rs 335)
At 30 September 20X4 (12,000 Rs 320)
Gain on contract
Rs.
4,020,000
3,840,000
180,000
(2)
Change in fair value of expected future cash flows on the hedged item
(not recognised):
Rs.
6,100,000
At 31 December 20X3
5,950,000
At 30 September 20X4
150,000
Reduction in expected future cash flows
(3)
Hedge effectiveness
Change in hedging instrument 180,000
=
= 120% therefore the hedge is effective
Change in hedged item
150,000
(4)
Accounting treatment
The hedge is highly effective and therefore hedge accounting can be applied.
As the change in the fair value of the gold is less than the change in the value
of the forward contract, only Rs. 150,000 of the gain on the contract is
recognised in other comprehensive income. The remainder is recognised in
profit or loss
Statement of financial position at 30 September 20X4
Current assets: derivative financial assets
Rs.
180,000
Statement of profit or loss and other comprehensive income for the

year ended 30 September 20X4
Rs.
Gain on forward contract
30,000
Cash flow hedge
150,000
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5 SLFRS 9 Financial Instruments

The complete version of SLFRS 9 Financial Instruments was issued in 2014. It is
the same as IFRS 9, which was the culmination of a long-term project by the IASB
and FASB to improve and simplify accounting for financial instruments. The
standard becomes effective on 1 January 2018, and from this date replaces
LKAS 39.
Certain elements of the standard are the same as LKAS 39; other elements are
different. The remainder of this section concentrates on the differences.
5.1 Scope and definitions

The scope of SLFRS 9 is the same as that of LKAS 39; in addition, several
definitions including those of a financial instrument, a financial asset and a
financial liability are the same.
5.2 Classification of financial assets

On recognition, SLFRS 9 requires that financial assets are classified as measured at
either:
Amortised cost, or
Fair value through other comprehensive income, or
Fair value through profit or loss
The SLFRS 9 classification is made on the basis of both:
(a)
(b)
The entity's business model for managing the financial asset, and
The contractual cash flow characteristics of the financial asset.
A financial asset is classified as measured at amortised cost where:

(a)
The objective of the business model within which the asset is held is to hold
assets in order to collect contractual cash flows, and
(b)
The contractual terms of the financial asset give rise on specified dates to
cash flows that are solely payments of principal and interest on the principal
outstanding.
A financial asset is classified as measured at fair value through other

comprehensive income where:
(a)
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The financial asset is held within a business model whose objective is

achieved by both collecting contractual cash flows and selling financial
assets, and
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(b)
The contractual terms of the financial asset give rise on specified dates to
cash flows that are solely payments of principal and interest on the principal
outstanding.
Other financial assets that do not meet these criteria are measured at fair value
through profit or loss.
5.2.1 Application of classification criteria
An application of these rules means that:
Equity investments are classified as measured at fair value through profit or
loss. This is because contractual cash flows on specified dates are not a
characteristic of equity instruments. An entity may make an irrevocable
election at initial recognition to measure an equity instrument at fair value
through other comprehensive income. This is allowed where the instrument is
not held for trading.
Derivatives are measured at fair value
Debt instruments may be classified as measured at either amortised cost or
fair value depending on whether they meet the criteria above. Even where
the criteria are met at initial recognition, a debt instrument may be classified as
measured at fair value through profit or loss if doing so eliminates or
significantly reduces a measurement or recognition inconsistency (sometimes
referred to as an 'accounting mismatch') that would otherwise arise from
measuring assets or liabilities or recognising the gains and losses on them on
different bases.
5.2.2 Reclassification of financial assets
SLFRS 9 requires that where an entity changes its business model for managing
financial assets, it should reclassify all affected financial assets. This
reclassification applies only to debt instruments as equity instruments must be
measured at fair value.
Financial liabilities may not be reclassified.
QUESTION
Classification
Would an investment in a convertible loan qualify to be measured at amortised

cost under SLFRS 9?
ANSWER
No, because of the inclusion of the conversion option, which is not deemed to
represent payments of principal and interest
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5.3 Classification of financial liabilities

On recognition, SLFRS 9 requires that financial liabilities are classified as
measured at either:
(a)
(b)
Fair value through profit or loss, or

Amortised cost.
A financial liability is classified at fair value through profit or loss if:

(a)
(b)
It is held for trading, or

Upon initial recognition it is designated at fair value through profit or loss.
Derivatives are always measured at fair value through profit or loss.

These classification rules are unchanged from those previously contained within
LKAS 39.
5.4 Initial measurement

Financial instruments are initially measured at the transaction price, that is the
fair value of the consideration given.
Transaction costs are added to the initial measurement of a financial asset not at
fair value through profit or loss and deducted from the initial measurement of a
financial liability not at fair value through profit or loss.

Subsequently financial assets and liabilities are measured at fair value with
changes recognised in profit or loss or other comprehensive income or at
amortised cost in accordance with their classification.
The effective interest method is applied to financial instruments measured at
amortised cost. This method is the same as that described by LKAS 39.
5.5.1 Financial liabilities measured at fair value
Where a financial liability is designated as measured at fair value through profit
or loss, the gain or loss is split into:
The gain or loss arising as a result of credit risk
Other gain or loss
The gain or loss arising as a result of credit risk is recognised in other
comprehensive income; the other gain or loss is recognised in profit or loss. On
derecognition, amounts recognised in other comprehensive income are not
reclassified to profit or loss.
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Example: Asset measurement

On 8 February 20X8 ABC Co acquires an investment in the shares of XYZ Co with
the intention of holding it in the long term. The investment cost Rs. 85 Mn. At ABC
Co's year end of 31 March 20X8, the market price of the investment is Rs. 90 Mn.
ABC Co has elected to recognise changes in the fair value of the equity investment
in other comprehensive income.
Required
How is the asset initially and subsequently measured?
Answer
The asset is initially recognised at the fair value of the consideration, being
Rs. 85 Mn.
At the period end it is remeasured to Rs. 90 Mn.
This results in the recognition of Rs. 5 Mn in other comprehensive income.
5.6 Impairments and credit losses

The impairment requirements of SLFRS 9 are applied to financial assets measured
at amortised cost or fair value through other comprehensive income.
LKAS 39 uses an 'incurred loss' model for the impairment of financial assets. This
model assumes that all loans will be repaid until evidence to the contrary, that is
until the occurrence of an event that triggers an impairment indicator. Only at this
point is the impaired loan written down to a lower value.
The SLFRS 9 approach differs from this in that an expected loss model is applied.
Under this approach, expected credit losses are accounted for from the date when
financial instruments are first recognised. Entities must recognise 12 month
expected credit losses, or where credit risk has increased significantly since initial
recognition, lifetime expected credit losses.
Expected credit losses are measured in a way that reflects:
An unbiased and probability weighted amount that is determined by evaluating
a range of possible outcomes;
The time value of money; and
Reasonable and supportable information that is available without undue cost or
effort at the reporting date about past events, current conditions and forecasts
of future economic conditions.
Impairment losses are recognised in profit or loss.
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5.7 Embedded derivatives

The LKAS 39 rules for embedded derivatives are simplified as follows.
Where the host contract is a financial asset within the scope of SLFRS 9, the
classification and measurement rules of the standard are applied to the whole
hybrid contract.
The accounting rules where the host contract is not a financial asset within the
scope of SLFRS 9 remain the same as those within LKAS 39.
5.8 Hedge accounting

The new model for hedge accounting aligns the accounting treatment more closely
with the risk management activities of an entity. This combines the following.
(a)
A management view, that aims to use information produced internally for

risk management purposes, and
(b)
An accounting view that seeks to address the risk management issue of the
timing of recognition of gains and losses.
Although the categories of hedge remain the same as those under LKAS 39 and the
accounting treatment of each is largely unchanged, SLFRS 9 introduces new rules
as to which relationships qualify for hedge accounting.
5.8.1 Qualifying for hedge accounting
SLFRS 9 permits hedge accounting only if:
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(1)
The hedging relationship consists only of eligible hedging instruments and

eligible hedged items, and
(2)
At the inception of the hedging relationship there is formal designation and

documentation of the relationship, and
(3)
The following hedge effectiveness criteria are met.

(a)
There is an economic relationship between the hedged item and the

hedging instrument, ie the hedging instrument and the hedged item
have values that generally move in the opposite direction because of
the same risk, which is the hedged risk.
(b)
The effect of credit risk does not dominate the value changes that
result from that economic relationship, ie the gain or loss from credit
risk does not frustrate the effect of changes in the underlyings on the
value of the hedging instrument or the hedged item, even if those
changes were significant.
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(c)
The hedge ratio of the hedging relationship (quantity of hedging

instrument vs quantity of hedged item) is the same as that resulting
from the quantity of the hedged item that the entity actually hedges
and the quantity of the hedging instrument that the entity actually
uses to hedge that quantity of hedged item.
Therefore under SLFRS 9 the LKAS 39 80%125% test of whether a hedging

relationship qualifies for hedge accounting is replaced by an objective-based
assessment. This allows genuine hedging relationships to be accounted for as such
whereas the LKAS 39 rules sometimes prevented management from accounting
for an actual hedging transaction as a hedge.
5.8.2 Rebalancing and discontinuing hedging relationships
Rebalancing refers to adjustments to the designated quantities of the hedged item
or the hedging instrument of an already existing hedging relationship for the
purpose of maintaining a hedge ratio that complies with the hedge.
The standard requires rebalancing to be undertaken if the risk management
objective remains the same, but the hedge effectiveness requirements are no
longer met. Where the risk management objective for a hedging relationship has
changed, rebalancing does not apply and the hedging relationship must be
discontinued.
Unlike under LKAS 39, an entity cannot voluntarily discontinue hedge accounting.
Under SLFRS 9, an entity is not allowed to discontinue hedge accounting where
the hedging relationship still meets the risk management objective and continues
to meet all other qualifying criteria.
5.8.3 Types of hedge and hedge accounting
The three types of hedge identified by LKAS 39 remain the same under SLFRS 9.
The accounting treatment applied to these is unchanged with the following
exceptions:
In a fair value hedge, if the hedged item is an investment in an equity
instrument measured at fair value through other comprehensive income, the
gains and losses on the hedged investment and hedging instrument are
recognised in other comprehensive income.
In a cash flow hedge of a forecast transaction, if a non-financial asset or liability
is recognised, the entity must remove the effective portion of the hedge
recognised in other comprehensive income and include it in the initial cost or
carrying amount of the non-financial item. The LKAS 39 option to reclassify the
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effective portion to profit or loss when the hedged item affects earnings is
removed.
5.9 Section summary

The final version of SLFRS 9 was issued in 2014 and becomes effective in 2018.
The standard classifies financial assets as measured at amortised cost or fair value
depending on the business model for managing them and the cash flow
characteristics of the assets.
The SLFRS 9 impairment model takes an expected loss approach rather than the
incurred loss approach of LKAS 39.
The categories of hedging relationships remain the same as those in LKAS 39,
however the accounting treatment becomes more closely aligned with risk
management activities.
6 SLFRS 4 Insurance Contracts

SLFRS 4 Insurance Contracts applies to insurance and reinsurance contracts that
an entity issues and reinsurance contracts that an entity holds. It does not address
accounting for an insurance contract held by an entity. The definition of an
insurance contract sets it apart from a financial instrument.
SLFRS 4 specifies the financial reporting for insurance contracts by an entity that
issues such contracts. It is an interim financial standard until the IASB complete
their comprehensive project on insurance contracts.
6.1 Scope and definition

SLFRS 4 applies to the majority of
Insurance and reinsurance contracts that an entity issues
Reinsurance contracts that it holds
The standard does not apply to financial assets and liabilities within the scope of
LKAS 39.
An insurance contract is a contract under which one party (the insurer) accepts
significant insurance risk from another party (the policyholder) by agreeing to
compensate the policyholder if a specified uncertain future event adversely affects
the policyholder.
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A reinsurance contract is an insurance contract issued by one insurer (the

reinsurer) to compensate another insurer for losses on one or more contracts
issued by that insurer.
Insurance risk is risk, other than financial risk, transferred from the holder of a
contract to the issuer.
Reinsurer
compensates for
losses
Insurer
compensates for
losses
Policyholder
The following are examples of insurance contracts if the transfer of insurance risk
is significant:
(a)
(b)
(c)
(d)
(e)
(f)
Insurance against theft or damage to property;

Insurance against product or professional liability;
Disability and medical cover;
Product warranties;
Compensation for losses whilst travelling;
Catastrophe insurance.
6.1.1 Insurance contract vs financial instrument

We have already seen the definition of an insurance contract (above). A financial
instrument is any contract that gives rise to both a financial asset of one entity,
and a financial liability or equity instrument of another entity.
In some cases it may be unclear whether a contract is an insurance contract or a
contract resulting in a financial instrument. It should be remembered that any
contract that exposes the issuer to financial risk without significant insurance risk
is not an insurance contract.
6.1.2 Financial guarantee contracts
Some contracts meet the definition of an insurance contract and also meet the
definition of a financial guarantee contract in LKAS 32/LKAS 39. These contracts
provide credit insurance that provides for specified payments to be made to
reimburse for losses incurred as a result of non-payment of amounts by debtors.
They may be referred to as:
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Guarantees
Letters of credit
Credit derivative default contracts or
Insurance contracts.
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These contracts are within the scope of LKAS 32/39 and not within the scope of
SLFRS 4, however if an issuer of such a contract has previously explicitly asserted
that it regards the contract as an insurance contract and has used accounting
applicable to insurance contracts, it may elect to continue to do so.

The SLFRS:
Prohibits an insurer or reinsurer from making a provision for possible claims
under contracts not in existence at the reporting date;
Requires that insurers and reinsurers test for the adequacy of recognised
insurance liabilities;
Requires that insurers conduct an impairment test for reinsurance assets;
Requires an insurer or reinsurer to keep insurance liabilities in its statement of
financial position until they are discharged, cancelled or expire
Prohibits the offsetting of insurance liabilities against related reinsurance
assets in an insurers statement of financial position.

The IASB is currently engaged in a project to undertake a comprehensive review
of accounting for insurance contracts. It will result in a standard to replace IFRS 4
(and so SLFRS 4). The objectives of the IASB are to:
Improve comparability by having a coherent, principles-based framework for
all types of insurance contracts together with one accounting model applicable
to all insurance contracts.
Increase transparency by:
Providing information about how much risk and uncertainty exists

Highlighting information about what drives performance
Explaining what an insurer expects to pay to fulfil its insurance contracts
Expose the hidden values of embedded options and guarantees
To date the IASB has issued two exposure drafts, one in 2010 and another in 2013.
The IASB is currently redeliberating the proposals and a final standard is expected
at the end of 2015 at the earliest.
6.3.1 Proposals
The ED issued in 2013 builds on the proposals of the earlier ED. It proposes that
insurance contracts are reflected in the financial statements in the following ways:
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Reflects the expected contract profit from the insurance contract and a current
estimate of the amount of future cash flows from the insurance contract adjusted
to reflect the timing and uncertainty relating to those cash flows.
Reports an operating result that reflects underwriting experience, the change in
uncertainty and the profit from services in the period.
A cost-based view of the cost of financing the insurance contract would be
reflected through the interest and discount rate changes.
7 SLFRS 7 Financial Instruments: Disclosures

SLFRS 7 specifies the disclosures required for financial instruments. The standard
requires qualitative and quantitative disclosures about exposure to risks
arising from financial instruments and specifies minimum disclosures about credit
risk, liquidity risk and market risk.
7.1 Objective
The objective of the SLFRS is to require entities to provide disclosures in their
financial statements that enable users to evaluate:
(a)
The significance of financial instruments for the entity's financial position

and performance
(b)
The nature and extent of risks arising from financial instruments to which
the entity is exposed during the period and at the reporting date, and how
the entity manages those risks
The principles in SLFRS 7 complement the principles for recognising, measuring

and presenting financial assets and financial liabilities in LKAS 32 Financial
instruments: Presentation and LKAS 39 Financial instruments: Recognition and
measurement.
7.2 Classes of financial instruments and levels of disclosure

The entity must group financial instruments into classes appropriate to the nature
of the information disclosed. An entity must decide in the light of its circumstances
how much detail it provides. Sufficient information must be provided to permit
reconciliation to the line items presented in the statement of financial position.
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7.2.1 Statement of financial position

The following must be disclosed.
(a)
Carrying amount of financial assets and liabilities by LKAS 39 category
(b)
Reason for any reclassification between fair value and amortised cost (and
vice versa)
(c)
Details of the assets and exposure to risk where the entity has made a
transfer such that part or all of the financial assets do not qualify for
derecognition.
(d)
The carrying amount of financial assets the entity has pledged as

collateral for liabilities or contingent liabilities and the associated terms and
conditions.
(e)
When financial assets are impaired by credit losses and the entity records
the impairment in a separate account (eg an allowance account used to
record individual impairments or a similar account used to record a
collective impairment of assets) rather than directly reducing the carrying
amount of the asset, it must disclose a reconciliation of changes in that
account during the period for each class of financial assets.
(f)
The existence of multiple embedded derivatives, where compound

instruments contain these.
(g)
Defaults and breaches
7.2.2 Statement of profit or loss and other comprehensive income

The entity must disclose the following items of income, expense, gains or
losses, either on the face of the financial statements or in the notes.
(a)
Net gains/losses by LKAS 39 category (broken down as appropriate: eg

interest, fair value changes, dividend income)
(b)
Interest income/expense
(c)
Impairment losses by class of financial asset
7.2.3 Other disclosures

Entities must disclose in the summary of significant accounting policies the
measurement basis used in preparing the financial statements and the other
accounting policies that are relevant to an understanding of the financial
statements.
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Hedge Accounting
Disclosures must be made relating to hedge accounting, as follows:
(a)
Description of hedge
(b)
Description of financial instruments designated as hedging instruments

and their fair value at the reporting date
(c)
The nature of the risks being hedged
(d)
For cash flow hedges, periods when the cash flows will occur and when
will affect profit or loss
(e)
For fair value hedges, gains or losses on the hedging instrument and the
hedged item
(f)
The ineffectiveness recognised in profit or loss arising from cash flow

hedges and net investments in foreign operations.
Fair values
SLFRS 7 retains the following general requirements in relation to the disclosure of
fair value for those financial instruments measured at amortised cost:
(a)
For each class of financial assets and financial liabilities an entity should
disclose the fair value of that class of assets and liabilities in a way that
permits it to be compared with its carrying amount.
(b)
In disclosing fair values, an entity should group financial assets and financial
liabilities into classes, but should offset them only to the extent that their
carrying amounts are offset in the statement of financial position.
It also states that disclosure of fair value is not required where:
Carrying amount is a reasonable approximation of fair value
For investments in equity instruments that do not have a quoted market

price in an active market for an identical instrument, or derivatives linked to
such equity instruments
SLFRS 13 (see Chapter 1) provides disclosure requirements in respect of the fair

value of financial instruments measured at fair values. It requires that
information is disclosed to help users assess:
(a)
For assets and liabilities measured at fair value after initial recognition, the
valuation techniques and inputs used to develop those measurements.
(b)
For recurring fair value measurements (ie those measured at each period
end) using significant unobservable (Level 3) inputs, the effect of the
measurements on profit or loss or other comprehensive income for the
period.
In order to achieve this, the following should be disclosed as a minimum
for each class of financial assets and liabilities measured at fair value.
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(c)
The fair value measurement at the end of the period.
(d)
The level of the fair value hierarchy within which the fair value
measurements are categorised in their entirety.
(e)
For assets and liabilities measured at fair value at each reporting date
(recurring fair value measurements), the amounts of any transfers between
Level 1 and Level 2 of the fair value hierarchy and reasons for the transfers.
(f)
For fair value measurements categorised within Levels 2 and 3 of the

hierarchy, a description of the valuation techniques and inputs used in the
fair value measurement, plus details of any changes in valuation techniques.
(g)
For recurring fair value measurements categorised within Level 3 of the fair
value hierarchy:
(i)
A reconciliation from the opening to closing balances
(ii)
The amount of unrealised gains or losses recognised in profit or loss in

the period and the line item in which they are recognised
(iii) A narrative description of the sensitivity of the fair value measurement

to changes in unobservable inputs
(h)
For recurring and non-recurring fair value measurements categorised within

Level 3 of the fair value hierarchy, a description of the valuation processes
used by the entity.
An entity should also disclose its policy for determining when transfers between
levels of the fair value hierarchy are deemed to have occurred.
7.2.4 Example: Fair value disclosures
For assets and liabilities measured at fair value at the end of the reporting period,
the SLFRS requires quantitative disclosures about the fair value measurements for
each class of assets and liabilities. An entity might disclose the following for assets:
Rs Mn
Description
Trading equity securities
Non-trading equity securities
Corporate securities
Derivatives interest rate
contracts
Total recurring fair value
measurements
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31.12.X9
45
32
90
78
245
Fair value measurements at the end of

the reporting period using
Level 1
Level 2
Level 3
inputs
inputs
inputs
45
32
9
81
78
54
159
32
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7.3 Nature and extent of risks arising from financial instruments

In undertaking transactions in financial instruments, an entity may assume or
transfer to another party one or more of different types of financial risk as
defined below. The disclosures required by the standard show the extent to which
an entity is exposed to these different types of risk, relating to both recognised
and unrecognised financial instruments.
Credit risk
The risk that one party to a financial instrument will cause a

financial loss for the other party by failing to discharge an
obligation.
Currency
risk
The risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in foreign exchange
rates.
Interest rate
risk
instrument will fluctuate because of changes in market interest
rates.
Liquidity
risk
The risk that an entity will encounter difficulty in meeting

obligations associated with financial liabilities.
Loans
payable
Loans payable are financial liabilities, other than short-term trade

payables on normal credit terms.
Market risk
instrument will fluctuate because of changes in market prices.
Market risk comprises three types of risk: currency risk, interest
rate risk and other price risk.
Other price
risk
instrument will fluctuate because of changes in market prices
(other than those arising from interest rate risk or currency
risk), whether those changes are caused by factors specific to the
individual financial instrument or its issuer, or factors affecting all
similar financial instruments traded in the market.
Past due
A financial asset is past due when a counterparty has failed to

make a payment when contractually due.
7.3.1 Qualitative disclosures

For each type of risk arising from financial instruments, an entity must disclose:
(a)
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The exposures to risk and how they arise
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(b)
Its objectives, policies and processes for managing the risk and the methods
used to measure the risk
(c)
Any changes in (a) or (b) from the previous period
7.3.2 Quantitative disclosures

For each financial instrument risk, summary quantitative data about risk
exposure must be disclosed. This should be based on the information provided
internally to key management personnel. More information should be provided if
this is unrepresentative.
Information about credit risk must be disclosed by class of financial instrument:
(a)
Maximum exposure at the yearend
(b)
Any collateral pledged as security
(c)
In respect of the amount disclosed in (b), a description of collateral held as

security and other credit enhancements
(d)
Information about the credit quality of financial assets that are neither past
due nor impaired
(e)
Financial assets that are past due or impaired, giving an age analysis and a
description of collateral held by the entity as security
(f)
Collateral and other credit enhancements obtained, including the nature and
carrying amount of the assets and policy for disposing of assets not readily
convertible into cash
For liquidity risk entities must disclose:

(a)
(b)
A maturity analysis of financial liabilities

A description of the way risk is managed
Disclosures required in connection with market risk are:

(a)
Sensitivity analysis, showing the effects on profit or loss of changes in each

market risk
(b)
If the sensitivity analysis reflects interdependencies between risk variables,

such as interest rates and exchange rates the method, assumptions and
limitations must be disclosed
7.4 Capital disclosures

Certain disclosures about capital are required. An entity's capital does not relate
solely to financial instruments, but has more general relevance. Accordingly, those
disclosures are included in LKAS 1, rather than in SLFRS 7.
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8 IFRIC 19 Extinguishing Financial Liabilities with Equity

Instruments
IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments deals with
debt for equity swaps.
8.1 IFRIC 19 Extinguishing Financial Liabilities with Equity

Instruments
IFRIC 19 deals with debt for equity swaps ie where the terms of a financial liability
are renegotiated with the result that a debtor extinguishes a liability by issuing
equity instruments to a creditor.
The Interpretation concludes that the issue of equity instruments to extinguish a
liability is consideration paid.
The equity instruments are initially measured at their fair value unless the fair
value cannot be reliably measured. In this case the equity instruments are
measured at the fair value of the financial liability extinguished.
The difference between the carrying amount of the financial liability and the
consideration paid is recognised in profit or loss.
QUESTION
Wijekoon Supplies (Pvt) Ltd purchased 0.5% of the shares in a listed company for
Rs. 180 Mn on 15 March 20X7. Transaction costs were Rs. 500,000. Wijekoon
Supplies intends to hold the shares for several years. At the year-end the shares
have a fair value of Rs. 200 Mn.
Required
382
(a)
Analyse the implications of the scenario above for the financial statements
of Wijekoon Supplies for the year ended 31 December 20X7. Give suitable
calculations where possible.
(b)
Advise how the change in value would be accounted for if, at the following
year end 31 December 20X8, the company issuing the shares experienced
financial difficulties and the shares were only worth Rs60m?
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ANSWER
(a)
The shares are a financial asset in the books of Wijekoon Supplies. LKAS 39
Financial Instruments: Recognition and Measurement sets out four categories
of financial assets for accounting purposes:
Financial assets at fair value through profit or loss

Held-to maturity financial assets
Loans and receivables
Shares cannot be classified as either held-to-maturity or loans and

receivables as a characteristic of each of these categories is fixed or
determinable payments.
Investments in shares are therefore classified as fair value through profit or
loss (where they are held for trading or are designated as such) or as
available-for-sale otherwise. The intention of Wijekoon Supplies is to hold
the shares for several years and therefore they are not held for trading. They
must be classified as available-for-sale.
Initially the shares should be measured at fair value plus transaction costs,
ie at Rs. 180.5 Mn.
On subsequent measurement, the shares are measured at their fair value at
the year end. Therefore at 31 December 20X7 the shares are re-measured to
Rs 200 Mn. A gain of Rs 19.5 Mn misrecognised in other comprehensive
income.
(b)
Financial difficulties of the issuer is an indicator of an impairment. The

shares should be shown in the statement of financial position at Rs. 60 Mn.
This is a fall of Rs. 140 Mn from the previous carrying amount. This is
recognised in other comprehensive income by:
DEBIT
Rs. 140 Mn
CREDIT
AFS financial assets
Rs. 140 Mn
The impairment element of this fall in value is the difference between

original cost of Rs180m and impaired amount of Rs. 60 Mn ie Rs. 120 Mn.
This is immediately reclassified to profit or loss by:
CA Sri Lanka
DEBIT
Profit or loss
Rs. 120 Mn
CREDIT
Rs. 120 Mn
383
QUESTION
At 1 January 20X4 Oceanic Co acquired a debt instrument with a principal amount
of Rs. 10 Mn at a fixed interest rate of 6% per annum. This is classified as a FVTPL
financial asset and the fair value of the instrument at the acquisition date is
Rs. 10 Mn.
On the same date Oceanic Co enters into an interest rate swap exchanging the
fixed interest rate payments on the debt instrument for floating interest rate
payments in order to offset the risk of a fall in the fair value of the instrument. On
1 January 20X4, Oceanic designates and documents the swap as a hedging
instrument and the hedge as a fair value hedge. On this date the swap has a fair
value of zero.
At 31 December 20X4, market interest rates have increased to 7% and the fair
value of the debt instrument has decreased to Rs. 9.62 Mn. The fair value of the
swap at this date has increased by Rs. 450,000 Mn.
Required
Illustrate the impact of these transactions on the financial statements of Oceanic Co.
ANSWER
Hedge effectiveness =
Change in hedging instrument

Change in hedge item
= Rs. 450,000/Rs. 380,000

= 118.4%
Hedge effectiveness of 118.4% is within the window of 80% 125%. Therefore
hedge accounting may be applied.
STATEMENT OF FINANCIAL POSITION
1 January
Debt instrument (hedged item)

Derivative asset (hedging instrument)
20X3
Rs'000
10,000
Rs'000
(380)
450
31
December
20X3
Rs'000
9,620
450
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Loss on debt instrument
Gain on derivative
Ineffective hedge
(380)
450
70
This results in an ineffective hedge of Rs. 70,000 gain recognised in profit or loss.
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CHAPTER ROUNDUP
LKAS 32 Financial Instruments: presentation and LKAS 39 Financial

Instruments: Recognition and Measurement are the main standards that
prescribe the accounting treatment for financial instruments. These are
supplemented by SLFRS 7 Financial Instruments: Disclosures that provides
disclosure requirements. SLFRS 9 Financial Instruments has been issued and will
replace LKAS 39 in 2018.
All financial assets and liabilities should be recognised in the statement of

financial position, including derivatives. They are initially recognised at fair value;
subsequent measurement depends on their classification.
Financial assets should be derecognised when the rights to the cash flows from
the asset expire or where substantially all the risks and rewards of ownership
are transferred to another party.
Financial liabilities should be derecognised when they are extinguished.
of an underlying item. Embedded derivatives may require separation from
their host contract for accounting purposes.
A hedge arises where the change in fair value of one item is offset by the change in
fair value or cash flows of another item. Hedge accounting is permitted in certain
circumstances, provided that the hedging relationship is clearly defined,
measureable and actually effective.
There are three types of hedge: fair value hedge, cash flow hedge and hedge of a
net investment in a foreign operation. The accounting treatment depends on the
type of hedge.
The complete version of SLFRS 9 Financial Instruments was issued in 2014. It is the
same as IFRS 9, which was the culmination of a long-term project by the IASB and
FASB to improve and simplify accounting for financial instruments. The standard
becomes effective on 1 January 2018, and from this date replaces LKAS 39.
SLFRS 4 Insurance Contracts applies to insurance and reinsurance contracts that

an entity issues and reinsurance contracts that an entity holds. It does not address
accounting for an insurance contract held by an entity. The definition of an
insurance contract sets it apart from a financial instrument.
SLFRS 7 specifies the disclosures required for financial instruments. The standard
requires qualitative and quantitative disclosures about exposure to risks
arising from financial instruments and specifies minimum disclosures about credit
risk, liquidity risk and market risk.
IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments deals with

debt for equity swaps.
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385
PROGRESS TEST
386
What are treasury shares and how are they accounted for?
What is the conclusion of IFRIC 2?
How are available for sale financial assets initially and subsequently measured?
What are the held to maturity tainting rules?
How is an impairment loss calculated for a financial asset carried at amortised

cost?
When is an embedded derivative separate from its host contract for accounting
purposes?
How is highly effective defined for hedge accounting purposes?
How does a fair value hedge operate?
Under SLFRS 9 what classifications of financial asset are available?
10
How are equity instruments measured under SLFRS 9?
11
What is a key difference between the LKAS 39 and the SLFRS 9 impairment
model?
12
The objective of SLFRS 7 is to provide disclosures that allow the user to evaluate
what?
CA Sri Lanka
Treasury shares arise when an entity reacquires its own equity instruments; they
are deducted from equity and no gain or loss is recognised in profit or loss.
IFRIC 2 deals with members shares in cooperative entities and similar

instruments. It concludes that if the member has the right to request redemption
of such shares they are normally liabilities.
Initially at fair value plus transaction costs and subsequently at fair value with
changes in value recognised in other comprehensive income.
If an entity sells or reclassifies held to maturity financial assets before the

maturity date, all remaining HTM assets are reclassified as AFS and measured
accordingly. The HTM category is not available for the remainder of the financial
year and a further two financial years.
The impairment loss is the difference between the asset's carrying amount and its
recoverable amount. The asset's recoverable amount is the present value of
estimated future cash flows, discounted at the financial instrument's original
effective interest rate.
When:
(a)
The economic characteristics and risks of the embedded derivative are not
closely related to those of the host contract, and
(b)
A separate instrument with the same terms as the embedded derivative

would meet the definition of a derivative, and
(c)
The hybrid instrument is not measured at fair value with changes recognised
in profit or loss (in which case there is no benefit to separating the
embedded derivative).
Between 80% 125% effective (ie the ratio of the gain or loss on the hedging
instrument compared to the gain or loss on the hedged item is 80%-125%)
Changes in the fair value of the hedging instrument are recognised in profit or
loss; changes in the fair value of the hedged item are also recognised in profit or
loss so that the gains / losses on the hedged item and instrument are matched.
Amortised cost, fair value through other comprehensive income (FVTOCI) and fair
value through profit or loss (FVTPL).
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388
10
Equity instruments are always measured at fair value. An irrevocable election may
be made at initial recognition to measure an equity instrument at FVTOCI rather
than FVTPL.
11
The LKAS 39 model is an incurred loss model (ie losses that have arisen are
recognised) whereas the SLFRS 9 model is an expected loss model (ie losses are
recognised before they arise).
12
(a)
The significance of financial instruments for the entity's financial position

and performance
(b)
The nature and extent of risks arising from financial instruments to which
the entity is exposed during the period and at the reporting date, and how
the entity manages those risks
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CHAPTER
INTRODUCTION
Many companies reward their employees by way of short and long term benefits
including holiday pay and pension plans. An increasing number of companies
also provide employees with share-based payments including share options and
share appreciation rights schemes. LKAS 19 Employee Benefits deals with short
and long term benefits, whilst SLFRS 2 deals with share-based payments.
This chapter expands the knowledge acquired at the KB1 level in respect of
these two standards. It also introduces LKAS 26 Accounting and Reporting by
Retirement Benefit Plans.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.2
Level B
1.1.7
1.2.1
1.2.2
1.2.3
1.2.4
1.2.5

matters.
standards.
Demonstrate a thorough knowledge of Sri Lanka Accounting standards in the selection
and application of accounting policies.
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KC1 | Chapter 13: Employee Benefits
CHAPTER CONTENTS
1 LKAS 19 Employee Benefits
2 SLFRS 2 Share-based Payment
3 LKAS 26 Accounting and Reporting by Retirement Benefit Plans

Evaluate short-term benefits and recognition and measurement of short-term
benefits.
Compare and contrast the difference between defined contribution plans and
defined benefit plans.
Analyse the recognition and measurement of defined benefit plans and defined
contribution plans.
Analyse recognition and measurement of other long term employee benefits.
Design presentation and disclosures pertaining to defined contribution plans
and defined benefit plans
Differentiate defined benefit plans and defined contribution plans.
Discuss the concepts of actuarial present value of promised retirement benefits
and frequency of valuation.
Explain the valuation of assets.
Discuss the information to be presented on financial statements in respect of
defined benefit plans and defined contribution plans.
Outline the disclosure requirements pertaining to retirement benefit plans.
Explain the recognition criteria of share-based payments.
Explain equity settled share-based payment and cash-settled share-based
payment transactions.
Explain vesting conditions and non-vesting conditions.
Assess amounts to be included in the financial statements in respect of sharebased payments.
Advise on the methodology to be followed in identifying, measuring, recording
and presenting a given share-based payment transaction in the financial
statements for a given set of circumstances.
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1 LKAS 19 Employee Benefits

LKAS 19 Employee Benefits deals with the benefits awarded to employees as part
of their remuneration package. It focuses in particular on accounting for pension
plans, with an expense equivalent to the contribution due being recognised in
respect of defined contribution plans. A pension surplus or deficit is
recognised in respect of defined benefit plans and components of the movement
in the surplus or deficit are recognised in profit or loss or other
1.1 Introduction
Employee benefits are all forms of consideration given by an entity in exchange for
services performed by employees. LKAS 19 recognises 4 types:
1
Short-term benefits eg salaries, sick leave, maternity leave and annual leave
Post-employment benefits, eg pensions and post-employment medical care

and post-employment insurance
Other long-term benefits, eg sabbatical leave and disability benefits
Termination benefits, eg early retirement payments and redundancy

payments
Benefits may be paid to the employees themselves, to their dependants (spouses,

children, etc) or to third parties.
1.2 Definitions
Definitions within the standard include the following:
Types of employee benefit
Short-term employee benefits are employee benefits (other than termination
benefits) that are expected to be settled wholly before twelve months after the
end of the annual reporting period in which the employees render the related
service.
Post-employment benefits are employee benefits (other than termination
benefits and short-term employee benefits) that are payable after the completion
of employment.
Other long-term employee benefits are all employee benefits other than shortterm employee benefits, post-employment benefits and termination benefits.
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Termination benefits are employee benefits provided in exchange for the

termination of an employees employment as a result of either:
(a)
A company decision to terminate an employee's employment before the

normal retirement date; or
(b)
An employee's decision to accept an offer of benefits in exchange for

termination.
Types of plan
Post-employment benefit plans are arrangements under which an entity
provides post-employment benefits for one or more employees.
Defined contribution plans are post-employment benefit plans under which an
entity pays fixed contributions into a separate entity (a fund) and will have no
legal or constructive obligation to pay further contributions if the fund does not
hold sufficient assets to pay all employee benefits relating to employee service in
the current and prior periods.
Defined benefit plans are post-employment benefit plans other than defined
contribution plans.
Multi-employer plans are plans that
(a)
Pool the assets contributed by various entities that are not under common
control, and
(b)
Use those assets to provide benefits to employees of more than one entity on
the basis that contribution and benefit levels are determined without regard
to the identity of the entity that employs the employees.
Defined Benefit Plans

The net defined benefit liability (asset) is the deficit or surplus adjusted for any
effect of limiting a net defined benefit asset to the asset ceiling.
The deficit or surplus is
(a)
(b)
The present value of the defined benefit obligation less

The fair value of plan assets (if any).
The asset ceiling is the present value of any economic benefits available in the
form of refunds from the plan or reductions in future contributions to the plan.
The present value of a defined benefit obligation is the present value, without
deducting any plan assets, of expected future payments required to settle the
obligation from employee service in the current and prior periods.
Plan assets comprise:
(a)
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Assets held by a long-term employee benefit fund, and

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(b)
Qualifying insurance policies.
measurement date.
Service cost comprises:
(a)
Current service cost, which is the increase in the present value of the defined
benefit obligation resulting from employee service in the current period
(b)
Past service cost, which is the change in the present value of the defined
benefit obligation for employee service in prior periods, resulting from a
plan amendment or a curtailment, and
(c)
Any gain or loss on settlement.
Net interest on the net defined benefit liability (asset) is the change during the
period in the net defined benefit liability (asset) that arises from the passage of
time.
Remeasurements of the net defined benefit liability (asset) comprise:
(a)
Actuarial gains and losses;
(b)
The return on plan assets, excluding amounts included in net interest on the
net defined benefit liability (asset), and
(c)
Any change in the effect of the asset ceiling, excluding amounts included in
net interest on the net defined benefit liability (asset).
Actuarial gains and losses are changes in the present value of the defined benefit
obligation resulting from:
(a)
Experience adjustments (the effects of differences between the previous

actuarial assumptions and what has actually occurred), and
(b)
The effects of changes in actuarial assumptions.
The return on plan assets is interest, dividends and other income derived from
the plan assets together with realised and unrealised gains or losses on the plan
assets less any costs of managing plan assets and any tax payable by the plan other
than that included in actuarial assumptions.
A settlement is a transaction that eliminates all further legal or constructive
obligations for part or all of the benefits provided under a defined benefit plan,
other than a payment of benefits to or on behalf of employees as set out in the
terms of the plan and included in actuarial assumptions.
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1.3 Short-term employee benefits

Short-term employee benefit costs are recognised as employee costs in the period
in which employee service is given (unless these costs can be capitalised, for
example as part of a non-current asset).
In the statement of financial position:
An accrual is recognised to the extent that benefits are unpaid at the period
end;
A prepayment is recognised to the extent that benefits are paid in advance
1.3.1 Short-term absences
Short-term paid absences may be non-accumulating or accumulating:
Non-accumulating paid absences (eg sick pay) do not carry forward if unused in
the current period. An expense is recognised when the absence occurs.
Accumulating paid absences (eg some holiday pay) carry forward to the next
period if unused in the current period. An expense is recognised when an
employee provides service which increases their entitlement to paid absences
and a liability is recognised for any unused entitlement. The liability is
recognised regardless of whether the accumulating paid absence is vesting (ie
employees are entitled to a cash payment on leaving the entity) or non-vesting
(ie employees are not paid for unused entitlement in cash). Whether an
absence is vesting or not will, however affect the measurement of the liability
recognised.
1.3.2 Profit sharing or bonus plans
Profit shares or bonuses payable within 12 months after the end of the accounting
period are recognised as an expense and a liability when they can be measured
reliably and the entity has a present obligation to pay them. This is usually
when the employer recognises the profit or other performance achievement to
which the profit share or bonus relates. The measurement of the liability reflects
the possibility that some employees may leave without receiving a bonus.
QUESTION
Holiday leave
The accountant of Asia Traders (Pvt) Ltd has prepared draft financial statements
at 31 December 20X3 including the following amounts:
Liability for paternity pay
Liability for holiday pay
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Rs. 20,000
Rs. 290,000
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The liability for paternity pay is in respect of an employee who was permitted to
take 2 weeks of leave within 3 months of the birth of his child. The child was born
in August 20X3 and no leave has been taken.
The liability for holiday pay was calculated based on 100 days of holiday carried
forward to 20X4 and an average daily wage of Rs. 2,900. Any employees who leave
Asia Traders are not entitled to a cash payment in respect of unused holiday
entitlement; staff turnover is 10% per annum on average.
Required
Comment on the validity of the amounts recognised in the financial statements of
Asia Traders at 31 December 20X3.
ANSWER
Paternity pay
Paternity pay is a short-term employee benefit.
It is non-accumulating in that any entitlement not used within the specified
period may not be carried forward.
Therefore no liability should be recognised for the paternity pay.
The liability and associated expense entry should be reversed in the financial
statements.
Had the leave been taken by the employee during the specified time, an expense
would have been recognised at that time.
Holiday pay
Holiday pay is also a short-term benefit.
It is clear from the information that it is an accumulating paid absence ie
unused entitlement is carried forward.
It is also clear that the accumulating paid absence is non-vesting ie it is not paid
in cash at such time as an employee leaves Asia Traders.
Therefore measurement of the liability should take into account the unused
entitlement that is expected to be used in the future, but ignore that entitlement
relating to employees who are expected to leave.
Based on the information given and an average staff turnover of 10%, a more
accurate estimation of the liability may be Rs. 261,000 (Rs. 2,900 100 days
90%).
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1.4 Post-employment benefits

Post-employment benefit schemes are often referred to as plans.
The plan receives regular contributions from the employer (and sometimes from
current employees as well) and the money is invested in assets, such as stocks and
shares and other investments.
The post-employment benefits are paid out of the income from the plan assets
(dividends, interest) or from money from the sale of some plan assets. Benefits
may take the form of pensions, post-employment life assurance or medical care.
Plans may be defined contribution or defined benefit plans
Defined contribution plans
Fixed
contributions
PENSION
PLAN
Variable
benefits
depending on
how well plan
performs
The entitys legal or constructive obligation is limited to the amount that it agrees
to contribute to the fund (the fixed contribution); the risk lies with the employee
who may receive lower benefits than expected.
Defined benefit plans
Variable
contributions
depending on
how well plan
performs
PENSION
PLAN
Fixed benefits
The entitys obligation is to provide the agreed benefits; the risk lies with the
entity as they may be obliged to increase contributions.
1.4.1 Multi-employer plans
Multi-employer plans are run for the benefit of several entities: various entities
contribute to the pool and the employees of those entities benefit on retirement.
Multi-employer plans may be defined contribution plans or defined benefit plans.
A multi-employer defined contribution plan is accounted for in the normal way; a
multi-employer defined benefit plan is also accounted for in the normal way, but
only to the extent to which an entity participates in it (ie a proportion of the
surplus / deficit and related costs are recognised). If the extent to which an entity
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participates cant be established then the plan is accounted for as if it were a

defined contribution plan and additional disclosures must be made.
1.5 Defined contribution plans

Contributions to a defined contribution plan are recognised as an expense in
the period in which they are payable (unless labour costs are included in the
cost of assets such as property under construction).
Unpaid contributions that are due at the end of a period are recognised as an
accrued expense (liability).
Excess contributions are recognised as a prepaid expense (asset) to the extent
that the prepayment will result in a reduction in future payments or a refund.
LKAs 19 requires that the following disclosures are made in respect of defined
contribution plans:
(a)
(b)
A description of the plan

The amount recognised as an expense in the period
QUESTION
Defined contribution plan
Grand Designs Ltd contributes 7% of all employees salaries into a postemployment plan each period. The assets of the plan are held separately from
those of the company under the control of trustees. Salaries amounted to
Rs. 29 Mn in the year ended 31 December 20X4 and the company had paid
Rs. 1.9 Mn into the plan by the reporting date.
Required
Provide extracts from the financial statements of Grand Designs Ltd for the year
ended 31 December 20X4 together with relevant disclosure notes.
ANSWER
Rs'000
Staff costs (29m 1.07)
31,030

Pension plan accrual ((29m 7%) 1.9m)
130
Notes to the accounts

The company operates a defined contribution retirement benefit plan for all
employees. The assets of the plan are held separately from those of the company
in funds under the control of trustees.
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The total cost charged to profit or loss of Rs. 2,030,000 represents contributions
payable to this plan at rates specified in the rules. At 31 December 20X4,
contributions of Rs. 130,000 due in respect of the current reporting period had not
been paid to the plan.
1.6 Defined benefit plans

LKAs 19 requires that a net defined benefit plan asset or liability is recognised in
the statement of financial position at each reporting date and movements in this
net amount from year to year are recognised in the statement of profit or loss and
The net defined benefit asset or liability (surplus or deficit) is calculated as
Rs.
Present value of defined benefit obligation
(obligation to pay future benefits to employees)
Fair value of plan assets

Net defined benefit liability / (asset)
(X)
X/(X)
Where a net defined benefit asset arises, this is recognised in the financial
statements subject to the asset ceiling.
Note that the defined benefit obligation refers not only to the legal obligation
under the formal terms of a defined benefit plan that an entity must account for,
but also for any constructive obligation that it may have. A constructive
obligation, which will arise from the entity's informal practices, exists when the
entity has no realistic alternative but to pay employee benefits, for example if any
change in the informal practices would cause unacceptable damage to employee
relationships.
LKAS 19 advocates a 4-step approach to accounting for a defined benefit plan:
1.
2.
3.
4.
Measure the deficit or surplus

Determine the amount of the net defined benefit liability or asset
Determine amounts to be recognised in profit or loss
Determine amounts to be recognised as other comprehensive income
1.6.1 Measure the deficit or surplus

The present value of the defined benefit obligation and the fair value of plan
assets are usually measured by an actuary (although this is not required by
LKAS 19).
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This process should take place with sufficient regularity that reported amounts
are not materially different from the actual value at the reporting date.
Measurement involves three steps:
The cost of providing future benefits is estimated using the projected unit
credit method. This method assumes that each period of employee service
results in an additional unit of future benefit. These are measured separately
and then added together to measure the total obligation. The actuary will
employ a number of assumptions in this process, both demographic eg
mortality rates and employee turnover rates and financial eg the discount
rate and benefit levels.
The total obligation is discounted to present values using a rate determined
by reference to market yields at the end of the reporting period on high
quality corporate bonds.
Plan assets are measured at fair value (excluding unpaid contributions due
from an employer and less any liabilities of the fund that do not relate to
employee benefits).
1.6.2 Determine the amount of the net defined benefit liability or asset
The net defined benefit liability or asset is measured as the present value of the
defined benefit obligation at the reporting date minus the fair value of the plan
assets at the reporting date.
Where the resulting net amount is a surplus (the fair value of the assets exceeds
the present value of the obligation), the amount of the surplus that is recognised
may be limited by the asset ceiling (section 1.6.8).
1.6.3 Determine the amounts to be recognised in profit or loss
Service costs and the net interest on the defined benefit asset or liability are
Service costs include current service cost, past service cost and gains or losses on
settlement of a defined benefit plan.
Current service cost is the increase in the present value of the defined benefit
obligation as a result of employees rendering service in the current period.
This is charged to operating expenses
Past service cost is the change in the present value of the defined benefit
obligation as a result of amendments or curtailments to the pension plan.
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The net interest on the defined benefit asset or liability includes the return on plan
assets and the unwinding of the discount on the obligation. It is calculated as:
Discount rate
Net defined benefit liability

(asset)
Determined by reference
to year end market yields
on high quality fixed-rate
corporate bonds.
Determined at the start of the

accounting period, taking account
of changes in the period as a
result of cash paid into and out of
the plan.
1.6.4 Determine remeasurements to be recognised in other comprehensive

income
Remeasurements may be positive (a gain) or negative (a loss) and include:
1.
Actuarial gains and losses which arise as a result of changes in actuarial

assumptions and experience adjustments;
2.
The return on plan assets (excluding amounts included in net interest on the
net defined benefit liability)
3.
Any change in the effect of the asset ceiling (again excluding amounts
included in net interest on the net defined benefit liability).
Practically actuarial gains and losses is the difference between the obligation as
brought forward and adjusted for amounts paid out, service costs and interest and
the obligation at the end of the period as measured by the actuary.
The return on plan assets is the difference between the plan assets brought
forward and adjusted for amounts paid out, contributions paid in and interest and
plan assets at the end of the period as measured by the actuary.
Remeasurements are recognised in other comprehensive income and are never
reclassified to profit or loss.
1.6.5 Summary of reconciling items defined benefit plans
The following table shows the main items which reconcile the balance of a defined
benefit asset or liability at the start and end of a period. It does not include past
service costs, gains or losses on settlement or the effect of the asset ceiling.
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Balance at start of
year
Contributions in
Benefits paid
Current service
cost
Interest (5%)
As measured
Remeasurements
As advised by
actuary at end of
year
Fair value of plan

assets
Rs'000
10,000
PV of DB obligation
Rs'000
13,000
1,000
(900)
(900)
1,200
500
10,600
(100)
10,500
QUESTION
650
13,950
50
14,000
Net deficit
Rs'000
(3,000)
1,000
(1,200)
(150)
(3,350)
(150)
(3,500)
Defined benefit plan
The financial controller of Trincomalee Motors Ltd has sent you the following
email to ask for your advice in the preparation of the financial statements for the
year ended 31 December 20X4:
EMAIL
To: Chaturi de Silva
From: Asanka Weerasinghe
Re: Pension scheme accounting
Chaturi,
As you know I have recently returned from an extended leave, during which I
believe the accounting rules with regard to defined benefit pensions have
changed. I am therefore a little unsure as to what amounts should be recognised
in our financial statements. I have prepared a draft working and I would be
grateful if you would review it and report back to me whether it adheres to the
new rules.
Kind regards,
Asanka
CA Sri Lanka
401
Draft working
B/f
Contributions
paid (31.12.X4)
Benefits paid out
(31.12.X4)
Interest income at
5%
Interest cost at
6%
Actuarial
difference
Advised by
actuary
Asset
Rs'000
8,900
1,000
(300)
Obligation
Rs'000
10,100
Recognised in
profit or loss:
Rs 1 Mn expense
(300)
9,600
480
9,800
588
10,080
(100)
10,388
502
9,980
10,890
Rs 480,000
income
Rs588,000
expense
Rs 402,000
income
Required
Prepare notes for a meeting with Asanka which explain whether the draft working
conforms to the requirements of LKAS 19.
ANSWER
Notes for meeting
Contributions paid are not an expense; this accounting treatment is relevant to
defined contribution schemes where contributions due in a year are recognised
as an expense.
In the case of a defined benefit scheme, the correct accounting entry for cash
contributions to a scheme is:
DEBIT
CREDIT
Fair value of plan assets

Cash
You have correctly reduced both the asset and obligation by the benefits paid
out in the year.
Interest must be calculated on the net defined benefit asset or liability.
Although practically interest can be calculated separately on the asset and
liability, the same discount rate should be applied to both. This should be
determined by reference to year-end market yields on high quality fixed-rate
corporate bonds.
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CA Sri Lanka
Interest should also be calculated on the asset/obligation outstanding

throughout the year (as adjusted for mid year amounts paid in or out). You
appear to have incorrectly calculated interest based on the balance at the end of
the year (after the contribution in and benefits paid out on 31 December).
You are correct to recognise interest in profit or loss, however the amount
recognised should be a net amount rather than a separate item of income and
expense.
You have not included a current service cost in your reconciliation. This is an
amount advised by the actuary and represents the extra benefits payable as a
result of employees working for an extra year. This omission would appear to
explain why the actuarial difference that you note in respect of the obligation is
so high.
The differences between the asset and obligation value as calculated and those
as measured by the actuary are referred to by LKAS 19 as remeasurements.
These include actuarial differences and the difference between actual return on
plan assets and that included in the net interest amount. Remeasurements are
recognised in other comprehensive income rather than in profit or loss.
You should also note that the remeasurement of the obligation does not
represent a gain as you have suggested, but a loss since it increases the
obligation.
1.6.6 Past service costs

Past service costs arise where a defined benefit plan:
1.
Is amended eg a new plan is introduced, an existing plan is withdrawn or

benefits payable are changed.
2.
Is curtailed such that the number of employees covered by a plan is reduced.
The past service cost is the change in the present value of the defined benefit plan
as a result of the amendment or curtailment. It may be positive (where additional
benefits are introduced) or negative (where existing benefits are withdrawn).
Past service costs are recognised in profit or loss as the earlier of
CA Sri Lanka
(a)
when the amendment or curtailment occurs
(b)
when related restructuring costs are recognised in accordance with LKAS 37

or termination benefits in accordance with LKAS 19.
403
1.6.7 Gains and losses on settlements

A settlement arises when all or part of a post-employment benefit obligation is
eliminated by an employer.
The gain or loss on settlement is calculated as the difference between
(a)
the present value of the defined benefit obligation being settled, valued at
the date of settlement, and
(b)
the settlement price including any plan assets transferred and any payments
made directly by the entity in connection with the settlement.
Resulting gains and losses are recognised immediately in profit or loss.

1.6.8 Asset ceiling
The asset ceiling limits the amount of a net defined benefit surplus recognised in
the statement of financial position. LKAS 19 defines it as the present value of any
economic benefits available in the form of refunds from the plan or reductions in
future contributions to the plan. Therefore if a calculated defined benefit surplus
were Rs. 3 Mn but the asset ceiling were Rs 2.9 Mn then the surplus would be
written down to Rs. 2.9 Mn. Changes in the effect of the asset ceiling are
recognised as remeasurements in other comprehensive income.
IFRIC 14 IAS 19 The Limit on a Defined Benefit Asset, Minimum Funding
Requirements and their Interaction provides additional guidance on the
determination of the asset ceiling, and in particular whether refunds or reductions
in future contributions are available where local legislation stipulates a minimum
funding requirement (ie that entities must contribute a minimum amount to
pension plans).
The interpretation states:
Economic benefits available to entities in the form of refunds or reductions in
future contributions are measured at the maximum amount that is consistent
with the terms and conditions of the plan and any statutory requirements in the
jurisdiction of the plan.
The entity's intentions on how to use a surplus are disregarded.
An economic benefit in the form of a refund or reduction in contributions is
regarded as available if the entity has an unconditional right to realise it at
some point during the life of the plan or when the plan liabilities are settled.
Where economic benefits are available as unconditional right to a refund, the
economic benefits are measured as the amount of the surplus at the end of the
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CA Sri Lanka
reporting period that the entity has a right to receive as a refund less associated
costs.
Where economic benefits are available as a reduction in contributions, the
economic benefits are measured as the future service cost to the entity for each
period over the shorter of the expected life of the plan and the expected life of
the entity.
If minimum funding requirements exist, these are split into contributions
required to cover any existing shortfall for past service and contributions to
cover future service. The economic benefit available as a reduction in future
contributions is the sum of:
Any amount that reduces future minimum funding requirement
contributions for future service because the entity made a prepayment, and
The estimated future service cost in each period less the estimated minimum
funding requirement contributions that would be required for future service
in those periods if there were no prepayment.
1.6.9 Disclosure
A reporting entity with a defined benefit pension plan should disclose information
that:
(a)
explains the characteristics of its defined benefit plans and risks associated
with them;
(b)
identifies and explains the amounts in its financial statements arising from
defined benefit plans, and
(c)
describes how defined benefit plans may affect the amount, timing and
uncertainty of the entitys future cash flows.
Characteristics and risks

Characteristics of the plan should be disclosed including the nature of benefits
provided, a description of the regulatory framework in which the plan operates
and a description of any other entitys responsibilities for the governance of the
plan.
A description of the risks to which the plan exposes the entity should be
provided with a focus on unusual, entity or plan-specific risks and
concentrations of risk.
A description of plan amendments, curtailments and settlements should be
disclosed.
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405
Explanation of amounts in financial statements

In the statement of financial position the net defined benefit liability/asset is
recognised, subject to the asset ceiling if it is an asset.
A reconciliation should be provided in the notes to the accounts for each of:
Plan assets
The present value of the defined benefit obligation
The effect of the asset ceiling.
In addition:
The fair value of plan assets should be separated into classes that distinguish
the nature and risks of those classes of assets.
Significant actuarial assumption used to determine the present value of the
defined obligation should be disclosed.
Amount, timing and uncertainty of cash flows
A sensitivity analysis for each significant actuarial assumption at the end of the
reporting period should be disclosed with a description of methods and
assumptions used to prepare it and changes in these methods and assumptions
from the previous period.
An indication of the effect of the plan on future cash flows is provided by
disclosing a description of funding arrangements, expected contributions to the
plan in the next period and information about the maturity profile of the defined
benefit obligation.
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CA Sri Lanka
1.6.10 CASE STUDY: Defined benefit disclosure

The following is the employee benefits disclosure note taken from the John Keells
Holdings PLC Annual Report 2013/2014
36 Employee benefit liabilities
As at 31st March
In LKR'000s
At the beginning of
the year
Current service cost
Acquisitions
Transfers
Disposals
Interest cost on
benefit obligation
Payments
(Gain)/Loss arising
from changes in
assumptions
Exchange translation
difference
At the end of the year
Group
Group
2014
2013
2014
2013
1,385,072
121,138
(5,108)
1,372,161
110,096
(7,423)
134,075
8,434
(4,034)
126,864
7,796
(7,516)
152,358
(163,362)
137,216
(117,217)
14,748
(5,047)
12,686
(4,148)
51,981
(109,726)
(1,314)
(1,607)
(295)
1,541,784
(35)
1,385,072
146,862
134,075
The expenses are recognised in the income statement in the following line
items;
Cost of sales
Distribution expenses
Administrative
expenses
131,633
17,463
93,332
13,702
9,932
8,092
124,400
273,496
140,278
247,312
13,250
23,182
12,390
20,482
The employee benefit liability of the Group is based on the actuarial valuations
carried out by Messrs. Actuarial & Management Consultants (Pvt) Ltd., actuaries.
The principal assumptions used in determining the cost of employee benefits
were:
2014
2013
Discount rate
11%
11%
Future salary increases
6% - 10%
6% - 10%
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407
36.1 Sensitivity of assumptions used

If a one percentage point change in the assumptions, would have the following
effects:
In LKR'000s
Discount rate
2014
2013
Group
Company
Group
Company
Effect on the
defined benefit
obligation liability
Increase by one
percentage point
Decrease by on
percentage point
Salary increment
2014
Group
Company
(55,037)
(6,961)
(86,845)
(5,337)
78,563
7,234
45,754
7,615
58,619
5,690
(86,613)
(7,650)
36.2 Maturity analysis of the payments

The following payments are expected on employee benefit liabilities in future
years
As at 31st March
In LKR'000s
Within the next 12 months
Between 1 and 5 years
Beyond 10 years
Total expected payments
2014
Group
247,404
338,509
420,425
341,282
194,164
1,541,784
Company
4,702
20,856
84,771
18,748
17,785
146,862
The Group and Companys weighted average duration of defined benefit obligation
is 5.80 years and 5.50 years respectively.
[Extracted from http://www.keells.com/annual-report-flash-2014/sources/indexPop.htm]
1.7 Other long-term benefits

Long-term employee benefits are all employee benefits other than short-term
employee benefits, post-employment benefits and termination benefits if not
expected to be settled wholly before twelve months after the end of the annual
reporting period in which the employees render the related service eg longservice leave, sabbatical leave, long-term profit sharing and deferred
remuneration.
In common with defined benefit plans, a surplus or deficit is recognised in relation
to other long-term benefits. However, since there is normally far less uncertainty
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CA Sri Lanka
relating to the measurement of these benefits, LKAS 19 requires a simpler method

of accounting for them, with all of the following recognised in profit or loss:
(a)
(b)
(c)
Service cost
Net interest on the defined benefit liability (asset)
Re-measurement of the defined benefit liability (asset)
1.8 Termination of benefit

Termination benefits are accounted for according to their nature, as an
enhancement of other post-employment benefits, or as short-term benefit or other
long-term benefit.
2 SLFRS 2 Share-based payments

SLFRS 2 requires that share-based payment transactions are recognised in profit
or loss in order to be consistent with the recognition of similar transactions for
cash. The corresponding entry is to equity in the case of equity-settled
transactions and a liability account in the case of cash-settled transactions.
SLFRS 2 applies to all share-based payment transactions. There are three types.
(a)
Equity-settled share-based payment transactions, in which the entity

receives goods or services in exchange for equity instruments of the entity
(including shares or share options)
(b)
Cash-settled share-based payment transactions, in which the entity

receives goods or services in exchange for amounts of cash that are based on
the price (or value) of the entity's shares or other equity instruments of the
entity
(c)
Transactions in which the entity receives or acquires goods or services and

either the entity or the supplier has a choice as to whether the entity settles
the transaction in cash (or other assets) or by issuing equity instruments
2.1 Definitions
A number of definitions are provided by SLFRS2:
A share-based payment arrangement is an agreement between the entity (or
another group entity) and another party that entitles the other party to receive:
CA Sri Lanka
(a)
Cash or other assets of the entity for amounts that are based on the price (or
value) of equity instruments of the entity or another group entity, or
(b)
Equity instruments of the entity or another group entity.
409
An equity-settled share-based payment is a share-based payment transaction in

which an entity:
(a)
Receives goods or services as consideration for its own equity instruments

(including shares or share options), or
(b)
Receives goods or services but has no obligation to settle the transaction

with the supplier.
A cash-settled share-based payment is a share-based payment transaction in

which the entity acquires goods or services by incurring a liability to transfer cash
or other assets to the supplier of those goods or services for amounts that are
based on the price (or value) of equity instruments (including shares or share
options) of the entity or another group entity.
A share option is a contract that gives the holder the right, but not the obligation,
to subscribe to the entitys shares at a fixed or determinable price for a specified
period of time.
Fair value is the amount for which an asset could be exchanged, a liability settled
or an equity instrument granted could be exchanged, between knowledgeable,
willing parties in an arms length transaction.
The grant date is the date at which the entity and another party (including an
employee) agree to a share-based payment arrangement. At this date the entity
confers on the counterparty the right to cash, other assets or equity instruments of
the entity, provided the specific vesting conditions are met.
Intrinsic value is the difference between the fair value of the shares to which the
counterparty has the right to subscribe or receive and the price (if any) the
counterparty is required to pay for those shares. For example a share option with
an exercise price of Rs. 15 on a share with a fair value of Rs. 20 has an intrinsic
value of Rs. 5.
Vest is to become an entitlement. Under a share-based payment arrangement, a
counterpartys right to receive cash, other assets or equity instruments of the
entity vests when the counterpartys entitlement is no longer conditional on the
satisfaction of any vesting conditions.
Vesting conditions are the conditions that determine whether the entity receives
the services that entitle the counterparty to receive cash, other assets or equity
instruments of the entity, under a share-based payment arrangement.
The vesting period is the period during which all the specified vesting conditions
of a share based payment arrangement are to be satisfied.
A service condition is a vesting condition that requires the counterparty to
complete a specified period of service during which services are provided to the
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CA Sri Lanka
entity. If the counterparty, regardless of the reason, ceases to provide service

during the vesting period, it has failed to satisfy the condition. A service condition
does not require a performance target to be met.
A performance condition is a vesting condition that requires
(a)
The counterparty to complete a specified period of service (a service

condition), and
(b)
Specified performance targets to be met while the counterparty is rendering

the service required in (a)
The period of achieving the performance target(s):

(a)
Shall not extend beyond the end of the service period; and
(b)
May start before the service period on the condition that the commencement
date of the performance target is not substantially before the
commencement of the service period.
A performance target is defined by reference to:

(a)
The entitys own operations (or activities) or the operations or activities of

another entity in the same group (ie a non-market condition); or
(b)
The price (or value) of the entitys equity instruments or the equity
instruments of another entity in the same group, including shares and share
options (ie a market condition).
A market condition is a performance condition upon which the exercise price,

vesting or exercisability of an equity instrument depends, that is related to the
market price of an entitys equity instruments.
2.2 Equity-settled share-based payments

2.2.1 Recognition principle
An entity should recognise goods or services received or acquired in an equitysettled share-based payment transaction when it obtains the goods or as the
services are received by:
DEBIT
CREDIT
Expense (or asset if recognition criteria met)

Equity
2.2.2 Measurement and recognition

In a transaction with employees the transaction is measured at the fair value of
the equity instruments granted at the grant date.
CA Sri Lanka
411
In a transaction with a party other than an employee, the transaction is

measured:
At the fair value of the goods/services received where this can be estimated
reliably, or
At the fair value of the equity instruments granted at the grant date
otherwise.
Where equity instruments vest immediately (ie the counterparty is entitled to
them immediately), the transaction is recognised on the grant date.
Where equity instruments do not vest immediately and the counterparty has to
meet specified vesting conditions, the transaction is recognised over the vesting
period.
The expense recognised in each year of a vesting period is based on the best
available estimate of the number of equity instruments expected to vest. That
estimate is revised at each reporting date in the vesting period.
On the vesting date, the entity should revise the estimate to equal the number
of equity instruments that actually vest.
Note that where there are multiple vesting dates, the options relating to each
vesting date are accounted for separately.
2.2.3 Vesting and non-vesting conditions
Vesting conditions are taken into account when estimating the number of equity
instruments that are expected to vest for the purpose of measuring equity-settled
share based payments.
Vesting conditions can be subdivided into service conditions and performance
conditions:
Service conditions require the counterparty to complete a specified period of
service , and
Performance conditions require the counterparty to complete a specified
period of service and specified performance targets to be met (such as a
specified increase in the entitys profit over a specified period of time).
Performance conditions that are linked to the share price of an entity are known
as market conditions and are not taken into account when estimating how many
shares will vest. Instead, market conditions are taken into account when
measuring the fair value of an equity instrument at the grant date.
Non-vesting conditions are all conditions other than service or performance
conditions eg the requirement that an employee must contribute towards the
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CA Sri Lanka
price of an equity instrument issued. These are taken into account when
estimating the fair value of equity instruments granted. They are not, however,
taken into account when estimating how many equity instruments will vest for the
purposes of measuring equity-settled share-based payments.
In summary therefore:
Relevant when determining:
the fair value of
instruments granted
the number of
instruments expected to
vest
Service conditions
Market performance
conditions
Non-market performance
conditions
Non-vesting conditions
QUESTION
Equity-settled share-based payments
You are the new Financial Controller at Liyanage Supplies PLC. The Board of
Directors have suggested that a new share option scheme is introduced in order to
reward the companys 400 employees. You have received the following email from
the Chief Operating Officers assistant:
To:
From:
Date:
Subject:
Financial Controller
PA to Athula Da Silva
13 December 20X0
Share option scheme
Hi Chandrika
Athula has asked me to contact you to ask for advice about the proposed new
share option scheme.
The plan is to introduce the scheme on 1 January 20X1, and on this date 100 share
options will be granted to each of our 400 employees. The options become
available to the employees only if they still work for the company on 31 December
20X3.
Athula says that for the purpose of providing illustrative calculations you should
assume the following:
the fair value of each option will be Rs. 20 on 1 January 20X1 and then Rs. 25,
Rs. 30 and Rs. 35 on 31 December 20X1, 20X2 and 20X3 respectively.
CA Sri Lanka
413
20 employees will leave the firm in 20X1, 25 in 20X2 and 10 in 20X3

Athula says that the Board are worried about the new scheme creating a large
liability that will grow every year as the fair value of the options increases. She is
convinced that this is not the case but is not sure what the correct treatment
would be. Please could you make an appointment with me to see Athula so that
you can provide advice.
Kind regards
Saminda
Required
Prepare notes for use in your upcoming meeting with Athula.
ANSWER
This is an equity-settled share-based payment option.
SLFRS 2 requires the company to recognise an expense in respect of the scheme
in each of 20X1, 20X2 and 20X3 as the employees provide service.
The corresponding entry is to equity, therefore the Board should not be
concerned about the recognition of a liability.
The total amount to be recognised as an expense and as equity is based on the
number of options expected to vest ie the number of options that employees
will be entitled to on 31 December 20X3.
As 55 of the 400 employees are expected to leave over the 3 years of the
scheme, only 345 employees options will vest.
Therefore the total expense/equity to be recognised over the three year period
would be Rs. 690,000 (345 employees 100 options Rs. 20).
This is based on the fair value of the options at the grant date. The fair value of
the options at subsequent dates is irrelevant and calculations should not be
adjusted for this.
The Rs. 690,000 is spread over the three years of the vesting period ie until the
date on which employees are entitled to the options.
Therefore, based on our illustrative figures, each year an expense of
Rs. 230,000 is recognised and a similar amount accumulated in equity.
Note, however that if the estimated number of employees still employed at the
vesting date changes throughout the 3 year vesting period, this must be taken
into account in the calculations.
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CA Sri Lanka
For example, if at 31 December 20X1 a total 55 employees are expected to leave

before the vesting date, an expense of Rs. 230,000 (as previously calculated) is
recognised in 20X1. If, however, at 31 December 20X2 this estimate has been
revised to 60 employees in total expected to have left before 31 December
20X3, the cumulative expense to be recognised at the end of 20X1 and 20X2
would be Rs. 453,333 (340 employees 100 options Rs. 20 2/3 years). As
Rs. 230,000 was recognised in 20X1, the remaining Rs. 223,333 would be
recognised in 20X2.
At the vesting date, the final expense amount recognised is adjusted to take into
account the number of options that actually do vest.
2.2.4 Cancellations
An entity may cancel (or settle) equity instruments that it has previously granted.
Where this occurs:
The cancellation / settlement is treated as an acceleration of vesting and any
amount of the fair value of instruments at the grant date that has not yet been
recognised is recognised immediately.
Any payment made to an employee is accounted for as a deduction from equity
up to the repurchase date fair value of equity instruments granted. Any excess
is recognised as an expense.
If new equity instruments are granted to the employee as replacement for
cancelled equity instruments, this is treated as a modification of the original
instruments (see next section). The incremental fair value is the fair value of
the cancelled instruments immediately before cancellation less any payment
made to an employee on cancellation that is treated as a deduction in equity.
If new equity instruments are granted to the employee but not identified as a
replacement, they are accounted for as a new grant of instruments.
2.2.5 Example: Cancellations
Meepitiya Exports PLC granted 5,000 share options to each of its 10 managers on
1 January 20X5. The terms and conditions attached to the options required
continued employment until 31 December 20X7 in order for the options to vest.
At 1 January 20X5 the options had a fair value of Rs. 50 and it was expected that 8
managers would remain in employment until the vesting date.
On 30 June 20X6, the Board of Meepitiya cancelled the share option scheme,
deciding instead to reward management through a bonus scheme. On the
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415
cancellation date the fair value of the options was Rs. 60 and the market price of a
Company share was Rs. 96. Of the original 10 managers, 9 remained in
employment at this date and each was paid Rs. 64 per share option in
compensation.
Required
How is the cancellation recognised?
Solution
The original cost to Meepitiya Exports for the scheme was Rs. 2 Mn (5,000 8
Rs. 50).
An expense of Rs. 666,667 (Rs. 2 Mn/3years) was therefore recognised in 20X5
At the cancellation date the cost based on the number of options vested at that
date is Rs. 2.25 Mn (5,000 9 Rs. 50).
The charge to profit or loss in 20X6 is therefore Rs. 1,583,333 (Rs. 2.25 Mn
Rs. 666,667).
Compensation paid amounts to Rs 2.88 Mn (5,000 9 Rs. 64)
The amount of this attributable to the fair value of the options cancelled is
Rs 2.7 Mn (5,000 9 Rs. 60).
This is deducted from equity as a share buy back; the remaining Rs. 180,000 is
charged to profit or loss.
2.2.6 Modifications
An entity may modify the terms and conditions on which equity instruments are
granted. For example the exercise price may be changed, so affecting the fair value
of the instrument, additional instruments may be granted, or vesting conditions
may be changed.
SLFRS 2 requires that, in the case of a modification:
1.
Services/goods received are measured at a minimum at the grant date fair

value of instruments granted that are expected to vest.
2.
The effect of modifications that increase the fair value of the share-based
payment arrangement or otherwise benefit the employee are recognised in
addition.
Changes to fair value

Where a modification decreases the fair value of the equity instruments
granted, the share-based payment continues to be accounted for based on fair
value of the instruments at the grant date.
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CA Sri Lanka
Where a modification increases the fair value of the equity instruments

granted, the additional amount is accounted for as well as amounts based on
the fair value of the instruments at the grant date. The additional amount is
calculated as the difference between the fair value of the instruments granted
measured immediately before and after the modification. It is recognised:
Immediately if modification takes place after the vesting date
Over the remainder of the vesting period if modification takes place before
the vesting date.
Number of instruments granted
Where a modification decreases the number of instruments, the decrease is
accounted for as a cancellation (see previous section).
Where a modification increases the number of instruments granted, the fair
value of the additional instruments granted as at the modification date is
recognised:
Immediately if modification takes place after the vesting date
Over the remainder of the vesting period if modification takes place before
the vesting date.
Change to vesting conditions
Where vesting conditions are changed in a manner that is detrimental to the
employee, the modified vesting conditions are not taken into account when
considering the number of instruments expected to vest.
Where vesting conditions are changed to the benefit of employees, the modified
vesting conditions are taken into account when considering the number of
instruments expected to vest.
2.3 Cash-settled share-based payments

A cash-settled share-based payment involves paying the counterparty to the
transaction an amount of cash that is determined by reference to share price on a
given date eg share appreciation rights (SARs).
2.3.1 Recognition principle
An entity should recognise goods or services received or acquired in a cash-settled
share-based payment transaction when it obtains the goods or as the services are
received by:
DEBIT
CREDIT
CA Sri Lanka
Expense (or asset if recognition criteria met)

Liability
417
2.3.2 Measurement and recognition

A company measures the goods or services acquired and the liability incurred
at the fair value of the liability.
The fair value of the liability is re-measured at each reporting date until the
liability is settled and again at the date of settlement.
Any changes in fair value are recognised in profit or loss for the period.
The entity should recognise the services received, and a liability to pay for
those services, as the employees render service. For example, if share
appreciation rights do not vest until the employees have completed a specified
period of service, the entity should recognise the services received and the
related liability, over that period.
As with equity-settled payments, service and non-market performance vesting
conditions should be taken into account when estimating the amount of the
liability.
QUESTION
Cash-settled share-based payments
On 1 January 20X2Asia Imports PLC grants 200 cash share appreciation rights
(SARs) to each of its 800 employees, on condition that the employees continue to
work for the entity until 31 December 20X4.
During 20X2 55 employees leave. The company estimates that a further 70 will
leave during 20X3 and 20X4.
During 20X3 36 employees leave and the company estimates that a further 25 will
leave during 20X4.
During 20X4 27 employees leave.
At 31 December 20X4 250 employees exercise their SARs. Another 190 employees
exercise their SARs at 31 December 20X5 and the remaining employees exercise
their SARs at the end of 20X6.
The fair values of the SARs for each year in which a liability exists are shown
below, together with the intrinsic values (equal to the cash paid out) at the dates
of exercise.
Fair value
Intrinsic
value
Rs.
Rs.
20X2
18.50
20X3
19.50
20X4
20.00
18.00
20X5
21.40
19.00
20X6
25.00
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CA Sri Lanka
Required
Calculate the amount to be recognised in the profit or loss for each of the five
years ended 31 December 20X6 and the liability to be recognised in the statement
of financial position at 31 December for each of the five years.
ANSWER
For the three years to the vesting date of 31 December 20X4 the expense is based
on the entity's estimate of the number of SARs that will actually vest. The fair
value of the liability is re-measured at each year-end.
The intrinsic value of the SARs at the date of exercise is the amount of cash
actually paid.
Liability
Expense
Expense
at
for
year-end
year
Rs.
Rs.
Rs.
20X2
Expected to vest (800 125):
675 200 18.50 1/3
832,500
832,500
20X3
Expected to vest (800 116):
684 200 19.50 2/3
1,778,400
945,900
20X4
Exercised:
250 200 18.00
900,000
Not yet exercised (800 118 250)
432 200 20.00
1,728,000
(50,400)
849,600
20X5
Exercised:
190 200 19.00
722,000
Not yet exercised (253 140):
242 200 21.40
1,035,760
(692,240)
29,760
20X6
Exercised:
242 200 25.00
1,210,000
Nil
(1,035,760)
174,240
2,832,000
2.4 Share-based payments with a choice of settlement

The terms of some share-based payments allow for a choice of settlement in either
cash or equity instruments. Where the issuing entity has the choice, the whole
transaction is treated as either cash-settled or equity-settled. Where the
counterparty has the choice, the transaction is treated as the granting of a
compound instrument and a liability and equity component are recognised.
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2.4.1 Entity has choice of settlement

In this case the transaction is treated as a cash-settled transaction and a liability is
recognised to the extent that the entity has a present obligation to deliver cash. A
present obligation exists where, for example:
The entity is prohibited from issuing shares
The entity has a stated policy to settle in cash
The entity has a past practice of settling in cash rather than shares.
Where there is no present obligation, the entity treats the transaction as an
equity-settled share-based transaction. If, in this case, the transaction is ultimately
settled in cash, this is treated as a repurchase of the equity instrument by a
deduction against equity.
2.4.2 Counterparty has choice of settlement
In this case, the transaction is treated as the granting of a compound instrument
and a debt and equity element are recognised.
In a transaction with employees, the fair value of the compound instrument is
estimated as a whole and debt and equity components are then valued
separately. Such a transaction is usually structured so that debt and equity
components are equal.
In a transaction with other counterparties, the equity component is the
difference between the fair value of the goods or services received and the fair
value of the debt component on the date when the goods or services are
received.
Subsequently, the debt component is treated as a cash-settled share-based
payment and the equity element as an equity-settled share-based payment.
QUESTION
Choice of settlement
On 1 March 20X3, Colombo Crate Company (CCC) grants a director a right to

receive either 100,000 shares or cash to the value of 95,000 shares on
28 February 20X6, provided that she is still employed on that date. The market
price of a CCC share at various dates is:
1 March 20X3
28 February 20X4
28 February 20X5
28 February 20X6
Rs. 90.00
Rs. 95.00
Rs. 110.00
Rs. 125.00
On 28 February 20X6, the director opts to receive the shares. The fair value of the
share route is estimated to be Rs. 86.00 per share.
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Required
Advise CCC how this transaction should be accounted for in each relevant year.
ANSWER
At the grant date:
The fair value of the cash route is Rs. 8,550,000 (95,000 Rs. 90.00)
The fair value of the share route is Rs. 8,600,000 (100,000 Rs. 86.00)
The fair value of the equity component is therefore Rs. 50,000 (Rs. 8.6 Mn
Rs. 8.55 Mn)
The transaction is therefore recognised as:
Liability
Rs.
28 February 20X4
95,000 Rs 95.00 1/3
3,008,333
Rs 50,000 1/3
28 February 20X5
95,000 Rs 110.00 2/3
6,966,667
Rs 50,000 1/3
28 February 20X6
95,000 Rs 125.00
11,875,000
Rs 50,000 1/3
Equity
Rs.
Expense
Rs.
16,667
3,008,333
16,667
16,667
3,958,334
16,667
16,667
4,908,333
16,667
On 28 February 20X6, since the director opts to receive shares rather than cash,
Rs. 11,875,000 is transferred from liabilities to equity, so resulting in an equity
balance of Rs. 11,925,000 (Rs. 11,875,000 + Rs. 50,000).
2.5 Group share-based payment transactions

When an entity enters a share-based payment transaction, it must apply SLFRS 2
regardless of whether it or another group entity will settle the transaction.
Whether the transaction is classified as cash-settled or equity-settled depends on
which entity will settle the transaction and how:
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421
Entity
Obligation to Settlement
settle
in
receiving
goods/services
Subsidiarys
individual
financial
statements
Consolidated
financial
statements
Subsidiary
Subsidiary
Equity of the
subsidiary
Equitysettled
Equitysettled
Subsidiary
Subsidiary
Cash
Cash-settled
Cash-settled
Subsidiary
Subsidiary
Equity of
parent
Cash-settled
Equitysettled
Subsidiary
Parent
Equity of
parent
Equitysettled
Equitysettled
Subsidiary
Parent
Cash
Equitysettled
Cash-settled
2.6 Share-based payments and deferred tax

The accounting treatment and tax treatment of share-based payments is generally
different. For example the treatment of share options usually differs in two
respects:
1.
The accounting expense is recognised over the vesting period, however the
related tax deduction is not available until the options granted are exercised.
2.
The accounting expense is based on the fair value of the options at the grant
date whereas the tax allowance is based on the share price at the exercise
date.
A deductible temporary difference resulting in a deferred tax asset therefore

arises. This is measured as:
Carrying amount of share-based payment expense
Tax base of share-based payment expense
X
(X)
X
The tax base is the estimated amount that the tax authorities will allow as a
deduction in the future based on information at the reporting date.
If the estimated future tax deduction exceeds the amount of the cumulative
expense, this indicates that the tax deduction also relates to an equity item and
therefore the excess is recognised directly in equity.
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2.6.1 Example: Share-based payments and deferred tax

Pacific Properties PLC issued an employee, Ronald Chatterjee, with 20,000 share
options on 1 January 20X0, on which date each option had a fair value of Rs. 25.00.
The options vest on 31 December 20X1 provided that Ronald remains in
employment, and have an exercise price of Rs. 37.50.
The share price of Pacific Properties was Rs. 75.00 on 31 December 20X0. Ronald
remained employed at this date.
In accordance with SLFRS 2, an expense of Rs. 250,000 was recognised in profit or
loss in respect of the options in 20X0.
Tax allowances are given when the options are exercised and the tax allowance is
based on the options intrinsic value at exercise.
Tax is charged at 28%.
Required
What are the deferred tax implications of the share options granted?
Solution
31.12.X0
Fair value (20,000 Rs.75.00 )
Exercise price (20,000 Rs 37.50 )
Intrinsic value (tax deduction)
Tax at 28%
Rs.
750,000
(375,000)
375,000
105,000
At 31 December 20X0, the cumulative remuneration expense is Rs. 250,000, which

is less than the estimated tax deduction of Rs. 375,000. Therefore:
1.
A deferred tax asset of Rs. 105,000 is recognised in the statement of financial

position
2.
There is deferred tax income of Rs. 70,000 (Rs. 250,000 x 28%)
3.
The excess of Rs. 35,000 is recognised in equity.
2.7 Disclosures
SLFRS 2 requires that information should be disclosed that enables users of the
financial statements to:
CA Sri Lanka
1.
Understand the nature and extent of share-based payments that existed

during the accounting period.
2.
Understand how the fair value of the goods or services received or the fair
value of the equity instruments granted during the period was determined.
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3.
Understand the effect of share-based payment transactions on a companys

profit or loss for a period and its financial position.
2.7.1 Nature and extent of share-based payments

In order to enable users to understand the nature and extent of share-based
payments, a company should disclose the following. Illustrative examples are
provided for each disclosure:
(a)
A description of each type of share-based payment arrangement that existed

during the period. Example:
The Company has a share option scheme for all employees. Options are
exercisable at a price equal to the average quoted market price of the
Companys shares on the date of the grant. The vesting period is three years.
If the options remain exercised after a period of five years from the date of
grant, the options expire. Options are forfeited if the employee leaves the
Company before the options vest.
(b)
The number and weighted average exercise prices of share options

outstanding at the start of the period, granted during the period, forfeited
during the period, exercised during the period, expired during the period,
outstanding at the end of the period and exercisable at the end of the period.
Example:
Number of share
Weighted average
exercise price (Rs)
options
X
X
Outstanding at start of period
X
X
Granted during period
Forfeited during period
Exercised during the period
Expired during the period
X
X
Outstanding at end of period
X
X
Exercisable at end of period
(c)
The weighted average share price of share options exercised during the
period as at the date of exercise. Example:
The weighted average share price at the date of exercise for share options
exercised during the period was Rs X.
(d)
The range of exercise prices and weighted average remaining contractual life
for share options outstanding at the end of the period. Example:
The options outstanding at the end of the year had a weighted average
exercise price of RsX and a weighted average remaining contractual life of X
years.
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2.7.2 Determination of fair value

In order to enable users to understand how fair value was determined, a company
should disclose:
(a)
For share options granted during the period, the weighted average fair value
of those options at the measurement date and information on how the fair
value was measured. Example:
In 20XX, options were granted on 1 August. The aggregate of the estimated
fair values of the options granted on that date is Rs X. The fair value of the
options was measured using the Black Scholes model and the following
inputs:
Weighted average share price
Rs X
Weighted average exercise price
Rs X
Expected volatility
Expected life
X years
Risk free rate
X%
Expected dividend yields
X%
(b)
For other equity instruments granted in the period, the number and
weighted average fair value of those instruments at the measurement date
and information on how fair value was measured.
(c)
Details of share-based payment arrangements that were modified during the

period including explanation of the modifications, incremental fair value
granted and information on how the incremental fair value was measured.
Example:
During 20XX the Company re-priced certain outstanding options. The strike
price was reduced from RsX to the then current market price of RsX. The
increase in fair value will be expensed over the remaining vesting period of
two years. The Company used the inputs noted above to measure the fair
value of the old and new options.
If the entity has measured directly the fair value of goods or services
received in the period, it should disclose how that fair value was determined
eg whether fair value was measured at market price for those goods or
services.
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425
2.7.3 Effect of share-based payments

In order to enable users to understand the effect of share-based payments on
performance and position, a company should disclose:
(a)
The total expense recognised in the period in respect of share-based

payment transactions. Example:
The company recognised a total expense of RsX related to equity-settled
share-based payment transactions in 20XX.
(b)
For liabilities arising from share-based payment transactions:

(i)
the total carrying amount at the end of the period, and
(ii)
the total intrinsic value at the end of the period of liabilities for which
the right to cash had vested. Example:
The company has issued to certain employees share appreciation rights

(SAR) that require the company to pay the intrinsic value of the SAR to the
employee at the date of exercise. The company has recorded a liability of Rs
X in 20XX. The total expense was RsX in 20XX and the total intrinsic value at
the reporting date was RsX.

The IASB issued its narrow scope amendments to IFRS 2 (and so SLFRS 2) in
November 2014. The proposed amendments address requests to clarify certain
classification and measurement issues, in particular:
How to account for cash-settled share-based payment transactions with an
attached performance condition.
How to classify share-based payment transactions with a net settlement
feature, and
How to account for modifications of share-based payment transactions from
cash-settled to equity settled.
Cash-settled share-based
performance condition
payment
transactions
with
an
attached
IFRS 2 (SLFRS 2) does not currently address the effect of vesting conditions on the
fair value of a cash-settled share-based payment. The amendments proposed to
IFRS 2 (SLFRS 2) clarify that the accounting treatment should adopt the same
approach as that applied to equity-settled share-based payment transactions.
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Share-based payment transactions with a net settlement feature

In some jurisdictions, when an employee is awarded share-based payments, these
are taxed and the awarding entity is required to withhold the relevant tax amount
and transfer it to the authorities.
The terms of the employee share-based payment arrangement may allow or
require the entity to meet this obligation by deducting equity instruments that
would otherwise be issued to the employee on exercise or vesting of a share-based
payment. This is a net settlement feature.
The proposed amendments clarify that where there is a net settlement feature, the
transaction is classified as equity-settled in its entirety providing that it would
have been classified as such had the net settlement feature not existed.
Modifications of share-based payment transactions for cash-settled to
equity-settled
The proposed amendment clarifies the accounting for two situations that IFRS 2
(SLFRS 2) does not currently address:
1.
Modifications to the terms and conditions of a share-based payment

transaction that result in it changing from a cash-settled to an equity-settled
transaction.
2.
Transactions in which a cash-settled share-based payment is settled and

replaced by a new equity-settled share-based transaction.
The amendments propose that:
The liability recognised in respect of the original cash-settled share-based
transaction is derecognised on modification.
The equity-settled share-based payment transaction is measured by
reference to the modification date fair value of the equity instruments
granted as a result of the modification.
The equity-settled share-based transaction is recognised to the extent
that services have been rendered up to the modification date.
The difference between the carrying amount of the liability derecognised
and the amount recognised in equity at the same date is recognised in
profit or loss immediately.
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3 LKAS 26 Accounting and Reporting by Retirement Benefit

Plans
LKAS 26 outlines the requirements for the preparation of financial statements of
retirement benefit plans.
So far in this chapter we have dealt with accounting for a pension plan by an entity
that pays contributions into the plan for the benefit of its employees.
LKAS 26 deals with the preparation of the financial statements for the pension
plan itself.
3.1 Definitions
The definitions of different types of plan in LKAS 26 are similar to those in LKAS
19:
A defined contribution plan is a retirement benefit plan under which amounts to
be paid as retirement benefits are determined by contributions to a fund together
with investment earnings thereon.
A defined benefit plan is a retirement benefit plan under which amounts to be
paid as retirement benefits are determined by reference to a formula usually
based on employees earnings and / or years of service.
3.2 Defined contribution plans

The financial statements of a defined contribution plan include:
1.
2.
A statement of net assets available for benefits, and

A description of the funding policy.
3.2.1 Valuation of plan assets

Retirement benefit plan investments are carried at fair value. In the case of
marketable securities, this is market value.
Where an estimate of the fair value of plan investments is not possible, disclosure
must be made of the reason why fair value is not used.
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3.3 Defined benefit plans

The financial statements of a defined benefit plan may take one of two forms:
A statement showing the net assets available for benefits and the actuarial
present value of promised retirement benefits and the resulting excess or
deficit, or
A statement of net assets available for benefits and either a note disclosing the
actuarial present value of promised retirement benefits or reference to this
information in an accompanying actuarial report.
3.3.1 Valuation of plan assets
As in the case of defined contribution plans, defined benefit plan investments are
carried at fair value, and again, in the case of marketable securities, this is market
value.
3.3.2 Actuarial present value of promised retirement benefits
The actuarial present value of promised retirement benefits is based on the
benefits promised under the terms of the plan on service rendered to date using
either current salary levels or projected salary levels.
It is common for actuarial valuations to be prepared only every three years; where
an actuarial valuation has not been prepared at the date of the financial
statements, the most recent valuation is used as a base and the date of the
valuation is disclosed.
The salary levels used should be disclosed together with any changes in actuarial
assumptions that have had a significant effect on the actuarial present value of
promised retirement benefits.
3.4 Disclosure requirements

The following disclosures must be made in respect of both a defined contribution
plan and a defined benefit plan:
1.
A statement of net assets available for benefits, disclosing:

Assets at the end of the period, suitably classified
The basis of valuation of assets
Details of any single investment exceeding either 5% of the net assets
available for benefits or 5% of any class or type of security
Details of any investment in the employer, and
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429
Liabilities other than the actuarial present value of promised retirement

benefits
2.
A statement of changes in net assets available for benefits, disclosing:

Employer contributions
Employee contributions
Investment income (interest and dividends)
Other income
Benefits paid or payable
Other expenses
Taxes on income
Profits and losses on disposal of investments and changes in value of
investments
Transfers to and from other plans
3.
A summary of significant accounting policies
4.
A description of the plan and the effect of any changes in the plan during
the period, including:
The names of the employers and employee groups covered
The number of participants receiving benefits and the number of other
participants classified as appropriate
The type of plan (defined contribution or defined benefit)
A note as to whether participants contribute to the plan
A description of the retirement benefits promised to participants
A description of any plan termination terms
Changes in any of the above.
In addition, for defined benefit plans, the following must be disclosed:

The actuarial present value of promised retirement benefits
A description of the significant actuarial assumptions made and the method
used to calculate the actuarial present value of promised retirement benefits.
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QUESTION
A company is considering setting up a pension plan for its employees. The
directors have heard of two types of plan, defined contribution and defined benefit
plans. They are unsure of the differences between the two.
Required
Compare and contrast the two types of plan for the purpose of advising the
directors.
ANSWER
Defined contribution plans are pension plans under which an entity pays fixed
pension contributions into a separate entity (a fund) and has no legal or
constructive obligation to pay further contributions.
If the fund performs well the employee will have a greater fund and pension.
However if the fund performs badly the employee bears the risk and will receive a
lower pension.
Accounting is on an accruals basis for employer contributions and the entries for
contributions relating to the plan for the period are:
DEBIT
CREDIT
Staff costs
Cash/accruals.
Therefore if the company is risk adverse or if the company wishes to be able to

control its cash flows a defined contribution plan would be a good consideration.
Defined benefit plans are similar to defined contribution plans in that an entity
pays contributions to a separate fund on behalf of employees and ultimately the
fund pays a pension to the employee.
They differ, however in that:
Contributions are not fixed, but variable. They are advised by an actuary in
order to ensure that the pension has sufficient funds to pay the pension.
Pensions are not dependent upon how the fund has performed; they are
guaranteed based upon a proportion of the employees final salary when
working for the company.
The accounting for defined benefit plans is also distinct from the accounting for
defined contribution plans: a net defined benefit asset or liability is shown in the
statement of financial position. Where the fair value of plan assets exceeds the
present value of the defined benefit obligation, an asset is shown. Where the
obligation exceeds the plan assets, it is a liability. Certain changes in the net
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431
amount from year to year are recognised in profit or loss and others in other
Accounting for a defined benefit plan is much more complex than a defined
contribution plan.
To conclude:
A defined contribution plan has a fixed input and a variable output (risk is with
the employee).
A defined benefit plan has a variable input and fixed output (risk is with the
employer).
QUESTION
Kagalle Co-operative PLC granted 100,000 share appreciation rights to each of its
five directors on 1 July 20X5.
The rights vest on 30 June 20X8 provided that the directors are still employed.
The fair value of each share appreciation right at 31 December 20X5 was Rs. 500
and at 31 December 20X6, Rs. 700.
At 31 December 20X5 it was expected that 4 directors would remain employed
after the three years and at 31 December 20X6 it is expected that all five directors
will be employed throughout the vesting period.
Required
Discuss the accounting treatment for the share appreciation rights for the years
ended 31 December 20X5 and 31 December 20X6, and assess amounts to be
recognised in the financial statements.
ANSWER
The granting of share appreciation rights is cash-settled share based payment per
SLFRS 2 Share-based Payment. These need to be measured at the fair value at each
year-end. An expense and a liability is recognised over the three year vesting period.
The company should estimate the number of directors that are expected to be
employed at the vesting date which in this case is 30 June 20X8.
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CA Sri Lanka
Amounts to be included in the financial statements are:

Year ended 31 December 20X5
Four directors are expected to be employed at the vesting date and therefore an
expense of 100,000 4 directors Rs. 500 6/36months = Rs. 33,333,333 is
recognised by:
DEBIT
CREDIT
Expense Rs. 33,333,333

Liability Rs. 33,333,333
Amounts in the financial statements are:

Expense of Rs. 33,333,333
Liability of Rs. 33,333,333
Year ended 31 December 20X6
All five directors are now expected to be employed. This will be adjusted
prospectively as a change in accounting estimate (LKAS 8) in the current year.
The year end liability is 100,000 5 directors Rs. 700 18/36months =
Rs. 175,000,000.
This is an increase of Rs. 141,666,667 and this is recognised by:
DEBIT
CREDIT
Expense
Liability
Rs. 141,666,667
Rs. 141,666,667
Amounts in the financial statements are:

Expense of Rs. 141,666,667
Liability of Rs. 175,000,000
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CHAPTER ROUNDUP
434
LKAS 19 Employee benefits covers short-term, long-term and post employment

benefits as well as termination benefits.
Short-term benefits are recognised as an expense when employee service is

given. There are no specific disclosure requirements for short-term employee
benefits in the Standard.
There are two types of post-employment benefit plan:

Defined contribution plans
Defined benefit plans
Contributions made to defined contribution plans are recognised as an expense

when an employee renders service; amounts are recognised in the statement of
financial position only to the extent that contributions due have not been paid or
have been overpaid.
A defined benefit plan is recognised in the statement of financial position as

either an asset or liability. The recognised amount is the net of the fair value of
plan assets and the present value of the defined benefit obligation. In the
case of an asset, the asset ceiling may limit the recognised amount.
Service costs, gains or losses on settlement and net interest on the net
defined benefit asset / liability are recognised in profit or loss.
Remeasurements including actuarial gains and losses, the return on plan assets
not included in net interest and changes in the asset ceiling are recognised in
Other long-term benefits include disability benefit and sabbatical leave; they
are accounted for in a similar way to defined benefit plans, although no amounts
are recognised in other comprehensive income. There are no specific
disclosure requirements for other long-term employee benefits in the Standard.
SLFRS 2 requires that share-based payment transactions are recognised in

profit or loss in order to be consistent with the recognition of similar transactions
for cash.
Share-based payment transactions may be equity-settled, cash-settled or

there may be a choice of settlement.
Equity-settled share-based payments are recognised as an expense or asset

with a corresponding increase to equity.
Non-vesting conditions and market-based performance vesting conditions

are not taken into account when estimating the number of equity instruments
expected to vest.
CA Sri Lanka
Cancellations result in an acceleration of vesting.
The effect of modifications that increase the fair value of the share-based
payment arrangement or otherwise benefit the employee are recognised; the
effect of modifications that decrease the fair value or are detrimental to
employees are not.
Cash-settled share-based payments are recognised as an expense or asset

together with a corresponding liability. The liability is remeasured at each
reporting date.
Where the entity can choose the form of settlement the transaction is cashsettled if there is an obligation to deliver cash, otherwise it is treated as equitysettled.
Where the counterparty can choose the form of settlement the transaction is
treated as the granting of a compound instrument.
There is normally a deferred tax impact of share options since tax relief is given
at a different time from the recognition of an expense and normally for a different
amount.
LKAS 26 outlines the requirements for the preparation of financial statements of

retirement benefit plans.
It outlines the financial statements required and the measurement of various line
items.
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435
PROGRESS TEST
436
What are defined benefit pension plan service costs and how are they recognised?
What are remeasurements and how are they recognised?
How does accounting for a cash-settled share-based payment differ from

accounting for an equity-settled share-based payment?
How is a modification that increases the fair value of share options accounted for?
CA Sri Lanka
Service costs include current service cost (the increase in the present value of the
defined benefit obligation resulting from employee service in the current period),
past service cost (the change in the present value of the defined benefit obligation
for employee service in prior periods, resulting from a plan amendment or a
curtailment) and gains or losses on settlement. These are recognised in profit or
loss.
Remeasurements include actuarial gains and losses (arising from changes in

assumptions and experience adjustments), the difference between the actual
return on plan assets and amount included in net interest and any change in the
effect of the asset ceiling excluding amounts included in net interest. These are
recognised in other comprehensive income.
The credit entry for a cash-settled transaction is a liability rather than equity, and
unlike an equity-settled transaction, the amount is remeasured at each reporting
date.
The difference between the fair value of the instruments granted measured
immediately before and after the modification is recognised in profit or loss. It is
recognised:
Immediately if modification takes place after the vesting date.
Over the remainder of the vesting period if modification takes place before the
vesting date.
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438
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter is the first of two dealing with disclosure standards.
It concentrates on two standards:
SLFRS 5 Non-current Assets Held for Sale and Discontinued

Operations, and
LKAS 24 Related Party Disclosures
These are both standards that were covered at KB1, and

therefore much of the technical content of this chapter will be
revision.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards
(SLFRS / LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

matters.
under standards.
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KC1 | Chapter 14: Disclosure Standards 1
CHAPTER CONTENTS
1 SLFRS 5 Non-Current Assets Held for Sale and Discontinued
Operations
2 LKAS 24 Related Party Disclosures

Explain recognition of impairment losses, reversals and changes to a plan of
sale.
Advise the appropriate classification of non-current assets as held for sale or as
held for distribution to owners.
Assess the value of non-current assets held for sale.
Design the disclosures to be made in respect of non-current assets held for sale
and discontinued operations.
Advise on how to identify related party transactions.
Evaluate information provided to identify whether a related party transaction
exists.
Advise on the disclosures to be made in respect of related parties.
1 SLFRS 5 Non-Current Assets Held for Sale and

Discontinued Operations
SLFRS 5 requires non-current assets 'held for sale' to be presented
separately in the statement of financial position and discontinued operations to
be presented separately in the statement of profit or loss and other
1.1 Introduction
SLFRS 5 requires separate disclosure of non-current assets held for sale and
discontinued operations so that users of financial statements will be better able to
make projections about the financial position, profits and cash flows of the entity. If
an asset (or group of assets) is to be sold or distributed to owners, then it will not
contribute to future revenues; equally if part of a business is to be discontinued then
its results will not contribute to overall results in the future. By reporting these
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CA Sri Lanka
amounts separately, SLFRS 5 provides users of financial statements with better and
more relevant information for decision-making purposes.
1.2 Non-current assets held for sale/distribution

SLFRS 5 refers to individual assets as well as disposal groups in the context of
being held for sale or held for distribution to owners.
A disposal group is a group of assets to be disposed of, by sale or otherwise,
together as a group in a single transaction, and liabilities directly associated with
those assets that will be transferred in the transaction. (In practice a disposal
group could be a subsidiary, an LKAS 36 cash-generating unit or a single operation
within an entity.)
An asset or disposal group is classified as held for sale/distribution if
(a)
(b)
The asset is available for immediate sale/distribution in its present condition.

Its sale/distribution is highly probable:
Highly probable sale
Highly probable distribution
Management committed to plan to

sell the asset.
Actions to complete distribution

have been initiated.
Active programme to locate a

buyer.
Marketed for sale at a reasonable

price.
Distribution expected to be
completed within one year of date
of classification.
Sale expected to take place within

one year from the date of
classification.
Unlikely that significant changes

to plan will be made or
distribution will be withdrawn.
May require consideration of the

probability of shareholder
approval.
Unlikely that significant changes

to plan will be made or plan will
be withdrawn.
If the sale has not actually taken place within one year an asset can still be
classified as held for sale provided that the delay has been caused by events or
circumstances beyond the entity's control and there is sufficient evidence that the
entity is still committed to sell the asset.
If an entity acquires an asset exclusively with a view to its subsequent disposal,
the asset is classified as held for sale only if the sale is expected to take place
within one year and it is highly probable that all the other criteria will be met
within a short time (normally three months).
CA Sri Lanka
441
An asset that is to be abandoned cannot be classified as held for sale as its carrying
amount is recovered through use rather than sale.
QUESTION
Classification as held for sale
A company plans to renovate a property in order to increase its value prior

to selling it to a third party. The company is already working to locate a
buyer at current market values.
A company is committed to a plan to sell a factory and its operations and had
started work to identify a buyer. At the date on which the company becomes
committed to the sale plan there is a backlog of orders.
A company is committed to a plan to sell a machine and has classified it as

held for sale. During the initial one-year period market conditions
deteriorated and as a result the asset has not been sold. During the year the
company actively marketed the machine but did not receive any reasonable
offers and so reduced the price. The asset continues to be marketed at a
reasonable price 14 months after classification as held for sale.
Required
Advise the appropriate classification of each of the assets above.
ANSWER
1
The property is not available for sale as a result of the delay in timing of the
transfer imposed by the selling company. This is not classified as held for sale.
The company is selling both factory and operations and therefore any
incomplete orders at the sale date will be transferred to the buyer. Therefore
the factory is available for immediate sale in its present condition and is
classified as held for sale on the date on which the company becomes
committed to the plan.
The machine should remain classified as held for sale at the end of the one
year period as the deterioration in market conditions is beyond the control
of the company and all other conditions to classify the machine as held for
sale are met.
1.3 Measurement of assets held for sale or distribution

Certain assets are scoped out of the SLFRS 5 measurement requirements although
the classification and presentation requirements still apply:
Deferred tax assets (LKAS 12)
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CA Sri Lanka
Assets arising from employee benefits (LKAS 19)

Financial assets (LKAS 39/SLFRS 9)
Investment properties accounted for in accordance with the fair value model
(LKAS 40)
Agricultural and biological assets (LKAS 41)
Insurance contracts (SLFRS 4)
1.3.1 Initial measurement on transfer
Immediately prior to classification as held for sale or distribution, the carrying
amount of an asset (or the assets and liabilities of a disposal group) is measured
according to the previously applicable accounting standard.
On transfer to the held for sale/distribution category the asset / disposal group is
measured at the lower of carrying amount and fair value less costs to
sell/distribute.
The following definitions provided in SLFRS 5 are relevant to measurement:
Fair value: the price that would be received to sell an asset or paid to transfer a
measurement date (SLFRS 13).
Costs to sell: the incremental costs directly attributable to the disposal of an asset
(or disposal group), excluding finance costs and income tax expense.
SLFRS 5 requires that costs to sell are discounted to present value where a sale is
expected to occur beyond one year. In practice this is only necessary where a sales
transaction is delayed beyond a year as described in section 1.2.
1.3.2 Impairment losses
Any impairment losses arising on classification as held for sale/distribution are
charged to profit or loss.
An impairment loss recognised on a disposal group is allocated to the non-current
assets of the disposal group that are within the measurement requirements of
SLFRS 5 in the following order:
CA Sri Lanka
(a)
to reduce the carrying amount of any goodwill, and then
(b)
to the other assets of the disposal group on a pro rata basis related to
carrying amounts.
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1.3.3 Subsequent measurement

Non-current assets held for sale should not be depreciated, even if they are still
being used by the entity.
At the period end, if an asset or disposal group previously classified as held for
sale or for distribution remains unsold/distributed, it is remeasured:
If fair value less costs to sell has fallen, then a further impairment loss is
recognised;
If the fair value less costs to sell of an asset held for sale has increased, it is
recognised only to the extent that cumulative impairment losses (LKAS 36 or
SLFRS 5) have previously been recognised in respect of the asset.
If the fair value less costs to sell of a disposal group has increased, it is
recognised only to the extent that cumulative impairment losses have
previously been recognised in respect of the non-current assets within the
scope of SLFRS 5. The carrying amounts of assets outside the measurement
scope of SLFRS 5 are not affected by the reversal. A previous write down of
goodwill is not reversed.
Where previous impairment losses are reversed, a gain is recognised in profit or
loss.
QUESTION
Reversal of impairment losses
Mannar Manufacturing PLC has owned a piece of equipment for a number of years.
The equipment has a carrying amount of Rs. 3.25 Mn at 1 July 20X3, on which date it
was classified as held for sale. The market value of the machine at 1 July 20X3 is
Rs. 3.1 Mn and Mannar Manufacturing expect transaction costs to amount to
Rs100,000. At the year-end of 31 December 20X3 the equipment remains unsold
although the criteria to classify it as held for sale are still met. At this date the
market value of the asset is Rs. 3.2 Mn.
Required
Calculate at what value should the equipment be included in the statement of
financial position at 31 December 20X3 and what amounts are recognised in profit
or loss during the year in respect of it (insofar as the information allows)?
ANSWER
At 1 July 20X3 the equipment is classified as held for sale. At this date it is
measured at the lower of carrying amount and fair value less costs to sell.
Carrying amount is Rs. 3.25 Mn
Fair value less costs to sell is Rs. 3 Mn (Rs. 3.1 Mn Rs. 100,000)
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CA Sri Lanka
Therefore the asset is initially recognised as an asset held for sale at Rs. 3 Mn and
an impairment loss of Rs. 250,000 is recognised in profit or loss.
The asset is no longer depreciated.
At the period end the fair value less costs to sell has increased to Rs. 3.1 Mn
(Rs. 3.2 Mn Rs. 100,000). Therefore Rs. 100,000 of the impairment loss can be
reversed.
Summary amounts recognised in financial statements
Statement of financial position at 31 December 20X3
Non-current asset held for sale
Rs. 3.1 Mn
Income statement for the year ended 31 December 20X3

Impairment loss on transfer to AHFS
Subsequent reversal
Rs. 250,000
(Rs. 100,000)
1.4 Changes to a plan of sale

Where non-current assets (or disposal groups) are no longer classified as held for
sale (for example, because the sale has not taken place within one year):
1
They are reclassified out of the held for sale category based on the normal
SLFRS classification.
Assets within the measurement scope of SLFRS 5 are remeasured to the

lower of:
(a)
Carrying amount before classification as held for sale, adjusted for any
depreciation, amortisation or revaluations that would have been
recognised had the asset not been held for sale, and
(b)
Recoverable amount at the date of the decision not to sell.
Recoverable amount is the higher of an assets fair value less costs to sell and its
value in use.
Value in use is the present value of estimated future cash flows expected to arise
from the continuing use of an asset and from its disposal at the end of its useful
life.
Any adjustments to the measurement of assets no longer classified as held for sale
are recognised in the profit or loss from continuing operations in the period in
which the held for sale classification is no longer met.
CA Sri Lanka
445
1.5 Presentation and disclosure of assets and disposal groups

held for sale
Non-current assets and the assets of disposal groups classified as held for sale
or distribution are presented separately from other assets in the statement of
financial position.
The liabilities of a disposal group classified as held for sale are presented
separately from other liabilities in the statement of financial position.
Assets and liabilities held for sale/distribution are not offset and presented as a
single amount.
The major classes of assets and liabilities held for sale are separately disclosed
either on the face of the statement of financial position or in the notes unless a
disposal group is a newly acquired subsidiary.
SLFRS 5 requires non-current assets or disposal groups held for sale to be
shown as a separate component of current assets/current liabilities.
For example (taken from standard)
ASSETS
Non-current assets
AAA
Current assets
BBB
CCC
Total assets
X
X
X
X
X
X
EQUITY AND LIABILITIES

Equity
DDD
EEE
Non-current assets classified as held for sale
Current liabilities
FFF
GGG
Liabilities directly associated with non-current assets
classified as held for sale
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X
X
X
X
X
CA Sri Lanka
Note that assets held for sale and the assets and liabilities of disposal groups are
not reclassified in the comparative statement of financial position presented
within a set of financial statements.
1.5.1 Additional disclosures
The following should be disclosed in the notes to the financial statements in the
period in which a non-current asset or disposal group has been classified as held
for sale or sold:
(a)
A description of the non-current asset or disposal group;
(b)
A description of the facts and circumstances of the sale or leading to the

expected disposal and the expected timing and manner of disposal;
(c)
The loss recognised on transfer to held for sale and the caption in the
statement of profit or loss and other comprehensive income that includes
that amount;
(d)
If applicable, the reporting segment in which the asset or disposal group is

presented in accordance with SLFRS 8 Operating Segments.
In addition if there has been a change to a plan for sale, a description of the facts
and circumstances leading to the decision to change the plan and the effect of the
decision on the results of the operations for the period and any prior periods
presented should be disclosed.
1.6 Discontinued operations

A discontinued operation is a component of an entity that has either been
disposed of, or is classified as held for sale, and:
(a)
Represents a separate major line of business or geographical area of

operations,
(b)
Is part of a single co-ordinated plan to dispose of a separate major line of

business or geographical area of operations, or
(c)
Is a subsidiary acquired exclusively with a view to resale.
A component of an entity comprises operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the rest of
the entity.
1.7 Presentation of discontinued operations

An entity should present and disclose information that enables users of the
financial statements to evaluate the financial effects of discontinued operations.
CA Sri Lanka
447

An entity should disclose a single amount in the statement of profit or loss and
other comprehensive income comprising the total of:
(a)
The post-tax profit or loss of discontinued operations and
(b)
The post-tax gain or loss recognised on the measurement to fair value less
costs of disposal or on the disposal of the assets or disposal group(s)
constituting the discontinued operation.
An entity should also disclose an analysis of this single amount into:

(a)
The revenue, expenses and pre-tax profit or loss of discontinued operations
(b)
The related income tax expense
(c)
The gain or loss recognised on the measurement to fair value less costs of
disposal or on the disposal of the assets of the discontinued operation
(d)
The related income tax expense
This may be presented either in the statement of profit or loss and other
comprehensive income or in the notes. If it is presented in the statement of profit
or loss and other comprehensive income, it should be presented in a section
identified as relating to discontinued operations, ie separately from continuing
operations. Gains and losses on the remeasurement of a disposal group that is not
a discontinued operation but is held for sale should be included in profit or loss
from continuing operations.
This analysis is not required where the discontinued operation is a newly
acquired subsidiary that has been classified as held for sale.
1.7.2 Statement of cash flows
An entity should disclose the net cash flows attributable to the operating,
investing and financing activities of discontinued operations. These disclosures
may be presented either on the face of the statement of cash flows or in the notes.
Again, this analysis is not required where the discontinued operation is a newly
acquired subsidiary that has been classified as held for sale.
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CA Sri Lanka
1.8 CASE STUDY : Illustration

The following illustration is taken from the Richard Pieris & Company PLC Annual
Report 2012/2013.
Income statement
Notes
Continuing operations
Revenue
3
Cost of sales
Gross profit
Other operating income
4.1
Selling and distribution
expenses
Administrative Expenses 4.3
Other operating expenses 4.2
Operating profit
Finance costs
5
Finance Income
6
Share of profit of an
associate
7
Profit before tax from
continuing operations
Income tax expense
8
Profit for the year from
Discontinued operations
Loss after tax for the year
from discontinued
operations
9
Profit for the year
Group
2013
2012
Rs'000
Rs'000
34,690,340
32,005,182
(26,216,569)
(24,628,455)
8,473,771
7,376,727
550,194
1,225,105
(1,454,437)
(3,783,849)
(64,470)
3,721,209
(1,058,464)
328,997
63,765
(1,306,746)
(3,249,903)
(92,545)
3,952,638
(798,277)
301,991
Company
2013
2012
Rs'000
Rs'000
1,164,265
1,542,190
1,164,265
1,542,190
515,832
(366,425)
797,840
(436,705)
28,475
62,436
Attributable to:
Equity holders of the
parent
Non-controlling interests
Earnings per share
Basic
Diluted
Earnings per share for
Basic
Diluted
Dividend per share
CA Sri Lanka
3,055,507
(770,237)
3,518,788
(644,540)
389,610
(11,314)
1,524,058
(19,683)
2,285,270
2,874,248
378,296
1,504,375
(581)
2,284,689
(4,374)
2,869,874
378,296
1,504,375
Group
Notes
(327,492)
1,730,530
(217,202)
10,730
2013
Company
2012
1,902,724
381,965
2,284,689
2,575,061
294,813
2,869,874
10
10
Rs. 0.98
Rs. 0.95
Rs. 1.33
Rs. 1.27
10
10
11
Rs. 0.98
Rs. 0.95
Rs. 0.20
Rs. 1.33
Rs. 1.27
Rs. 0.70
2013
2012
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2 LKAS 24 Related Party Disclosures

LKAS 24 requires that related parties are identified and any transactions with
them in the reporting period are disclosed. This enables users to assess the impact
of transactions that may not have taken place at arms length.
2.1 Objective of LKAS 24

LKAS 24 ensures that financial statements contain the disclosures necessary to
draw attention to the possibility that the reported financial position and results
may have been affected by the existence of related parties and by material
transactions with them.
2.2 Scope of LKAS 24

The standard requires disclosure of related party transactions and outstanding
balances in the separate financial statements of a parent, venturer or investor
presented in accordance with LKAS 27 as well as in consolidated financial
statements.
An entity's financial statements disclose related party transactions and
outstanding balances with other entities in a group. Intragroup transactions and
balances are eliminated in the preparation of consolidated financial statements.
2.3 Definitions
The following important definitions are given by the standard. The definitions of
control, joint control and significant influence within SLFRS 10, SLFRS 11 and
LKAS 28 are also relevant:
Related party. A related party is a person or entity that is related to the entity
that is preparing its financial statements.
(a)
A person or a close member of that person's family is related to a reporting

entity if that person:
(i)
Has control or joint control over the reporting entity;
(ii)
Has significant influence over the reporting entity; or
(iii) Is a member of the key management personnel of the reporting entity

or of a parent of the reporting entity.
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CA Sri Lanka
(b)
An entity is related to a reporting entity if any of the following conditions

applies:
(i)
The entity and the reporting entity are members of the same group
(which means that each parent, subsidiary and fellow subsidiary is
related to the others).
(ii)
One entity is an associate or joint venture of the other entity (or an

associate or joint venture of a member of a group of which the other
entity is a member).
(iii) Both entities are joint ventures of the same third party.
(iv) One entity is a joint venture of a third entity and the other entity is an
associate of the third entity.
(v)
The entity is a post-employment defined benefit plan for the benefit of

employees of either the reporting entity or an entity related to the
reporting entity. If the reporting entity is itself such a plan, the
sponsoring employers are also related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in

(a).
(vii) A person identified in (a)(i) has significant influence over the entity or
is a member of the key management personnel of the entity (or of a
parent of the entity).
Related party transaction. A transfer of resources, services or obligations
between related parties, regardless of whether a price is charged.
Key management personnel are those persons having authority and
responsibility for planning, directing and controlling the activities of the entity,
directly or indirectly, including any director (whether executive or otherwise) of
that entity.
Close members of the family of an individual are those family members who
may be expected to influence, or be influenced by, that individual in their dealings
with the entity. They may include:
(a)
(b)
(c)
the individual's domestic partner and children;

children of the domestic partner; and
dependants of the individual or the domestic partner.
Compensation is all employee benefits including those to which SLFRS 2 applies.

Employee benefits are all forms of consideration paid, payable or provided by the
entity or on behalf of the entity in exchange for services rendered to the entity.
CA Sri Lanka
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2.4 Application of the definition

LKAS 24 lists the following, which are not necessarily related parties.
(a)
Two entities simply because they have a director or other key management
in common (notwithstanding the definition of related party above, although
it is necessary to consider how that director would affect both entities)
(b)
Two venturers, simply because they share joint control over a joint venture.
(c)
Certain other bodies, simply as a result of their role in normal business

dealings with the entity
(i)
(ii)
(iii)
(iv)
(d)
Providers of finance
Trade unions
Public utilities
Government departments and agencies
Any single customer, supplier, franchisor, distributor, or general agent with

whom the entity transacts a significant amount of business, simply by virtue
of the resulting economic dependence.
QUESTION
Identification of related parties
Capital Contracts (Pvt) Ltd is a building contractor based in Colombo. Its directors
are Fathima Perera, Kasun Dias and Udari Da Silva. Udari is married to Chamath,
the Procurement Manager at SLF Supermarkets PLC. Kasuns brother Gayan owns
55% of the shares in Asia Bathrooms (Pvt) Ltd.
Capital Contracts has the following shareholdings:
10% of the shares in a supplier, Pacific Pipes (Pvt) Ltd

35% of the shares in Basin Builders (Pvt) Ltd
A further 35% of the shares in Basin Builders (Pvt) Ltd are owned by Rathnayake
Construction (Pvt) Ltd.
Required
Explain which of the above are related parties to Capital Contracts (Pvt) Ltd?
ANSWER
452
Fathima Perera, Kasun Dias and Udari Da Silva are all directors of Capital
Contracts (Pvt) Ltd and so are related by virtue of being key management
personnel.
Chamath Da Silva is related by virtue of being a close family member of Udari

Da Silva.
CA Sri Lanka
SLF Supermarkets PLC is not related to Capital Contracts (Pvt) Ltd. The two
companies would only be related if Chamath Da Silva controlled or jointly
controlled SLF Supermarkets PLC [(b)(vi) of the definition of a related party]
or if Udari Da Silva controlled or jointly controlled Capital Contracts (Pvt)
Ltd [(b)(vii) of the definition of a related party].
Gayan Dias is related to Capital Contracts (Pvt) Ltd only if he is classified as a

close family member of Kasun. Application of the definition of a close family
member requires judgement and therefore without further information this
is unclear.
If Gayan Dias is deemed to be a related party of Capital Contracts (Pvt) Ltd,

then Asia Bathrooms (Pvt) Ltd is also a related party of Capital Contracts
(Pvt) Ltd.
Capital Contracts (Pvt) Ltd is not related to Pacific Pipes (Pvt) Ltd as Pacific
Pipes (Pvt) Ltd is (based on a 10% shareholding) not a subsidiary, joint
venture or associate of Capital Contracts (Pvt) Ltd. This status is not changed
by the fact that Pacific Pipes (Pvt) Ltd is a supplier of Capital Contracts (Pvt)
Ltd.
Based on the information provided, Basin Builders (Pvt) Ltd is a joint venture
of Capital Contracts (Pvt) Ltd. The two companies are therefore related.
Rathnayake Construction (Pvt) Ltd and Capital Contracts (Pvt) Ltd are not
related simply by virtue of the fact that both are joint venturers in Basin
Builders (Pvt) Ltd. Therefore unless any other relationship exists, they are
not related.
2.5 Related party transactions

The standard lists some examples of transactions that are disclosed if they are
with a related party:
CA Sri Lanka
Purchases or sales of goods (finished or unfinished)
Purchases or sales of property and other assets
Rendering or receiving of services
Leases
Transfer of research and development
Transfers under licence agreements
Provision of finance (including loans and equity contributions in cash or in

kind)
Provision of guarantees and collateral security

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Settlement of liabilities on behalf of the entity or by the entity on behalf of

another party.
2.6 Disclosures
Disclosure is required in respect of the controlling party and parent-subsidiary
relationships, transactions with key management personnel and other related
party transactions.
2.6.1 Controlling party disclosures
Relationships between parents and subsidiaries must be disclosed irrespective of
whether any transactions have taken place between the related parties. An entity
must disclose the name of its parent and, if different, the ultimate controlling
party. This will enable a reader of the financial statements to be able to form a
view about the effects of a related party relationship on the reporting entity.
If neither the parent nor the ultimate controlling party produces financial
statements available for public use, the name of the next most senior parent that
does so shall also be disclosed.
2.6.2 Key management personnel disclosures
An entity should disclose key management personnel compensation in total and
for each of the following categories:
(a)
(b)
(c)
(d)
(e)
Short-term employee benefits

Post-employment benefits
Other long-term benefits
Termination benefits, and
Share-based payment
2.6.3 Other related party transaction disclosures

If there are transactions between related parties, the nature of the related party
relationship should be disclosed as well as information about the transactions and
outstanding balances necessary for an understanding of the potential effect of the
relationship on the financial statements. At a minimum, disclosures should
include:
454
(a)
The amount of transactions
(b)
The amount of outstanding balances and their terms and conditions and
details of guarantees given or received
CA Sri Lanka
(c)
Provisions for doubtful debts related to outstanding balances, and
(d)
The expense recognised in the period in respect of bad or doubtful debts due
from related parties.
These disclosures should be made separately for each of the following categories:
The parent
Entities with joint control / significant influence over the entity
Subsidiaries
Associates
Joint ventures in which the entity is a venture
Key management personnel of the entity or its parent, and
Other related parties.
Items of a similar nature may be disclosed in aggregate unless separate disclosure

is necessary for an understanding of the effect on the financial statements.
Disclosures that related party transactions were made on terms equivalent to
those that prevail in arm's length transactions are made only if such disclosures
can be substantiated.
2.6.4 Government-related entities
The disclosures in section 2.6.3 are not required in respect of transactions with;
A government that has control or joint control of or significant influence over

the reporting entity
Another entity that is a related party because the same government has
control or joint control of or significant influence over the reporting entity
and the other entity.
In this case, the following information is instead disclosed:
CA Sri Lanka
(a)
The name of the government and nature of its relationship with the
reporting entity.
(b)
The following information in sufficient detail to allow an understanding of

the effect of related party transactions on the financial statements:
The nature and amount of each individually significant transaction
For other transactions that are collectively significant, a qualitative or

quantitative indication of their extent.
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2.7 Question practice

At KC1 level you may be required to draft or critique a related party disclosure.
The first of the following questions involves drafting part of a disclosure note. It is
taken from the KB1 material; the second question involves critiquing a disclosure
note that has been prepared.
QUESTION
Related party disclosure
The following information relates to the Columbo Group companies and

transactions with other parties:
Mrs C, a director of Kandy, a 90% subsidiary of Columbo has borrowed

Rs. 1,000,000 from Columbo
Mrs B, one of the directors of Columbo is paid by Moratuwa, a 75%

subsidiary Kandy to act as an independent consultant. She is paid an annual
sum of Rs. 400,000
Galle, a company controlled by the brother of a director of Columbo is a

customer of Kandy. During the year ended 31 December 20X4, Galle
purchased Rs. 100,000 goods from Kandy; at the year end, Rs. 60,000 is
outstanding. Rs. 10,000 of this amount is 6 months overdue and the directors
of Kandy have decided to provide for this amount in full.
Kandy has provided a bank guarantee to its main customer in order to

ensure continuing trading.
Directors of group companies are remunerated as follows:

Columbo
Salary Rs
Bonus Rs
Pension Rs
Mr A
1,200,000
300,000
500,000
Mrs B
780,000
260,000
500,000
Mrs C
890,000
400,000
440,000
Mrs D
880,000
380,000
530,000
Mr E
820,000
370,000
420,000
Mr F
790,000
370,000
420,000
Kandy
Moratuwa
Required
Prepare the related party disclosure note for the Columbo Group financial
statements for the year ended 31 December 20X4.
456
CA Sri Lanka
ANSWER
Identification of related parties
Columbo, Kandy and Moratuwa are related to each other as group

companies
The three companies are also related to Galle (assuming that the brother is a
close family member of the director of Columbo)
Columbo is related to Mr A and Mrs B
Kandy is related to Mr A, Mrs B, Mrs C and Mrs D
Moratuwa is related to Mr A, Mrs B, Mr E and Mr F
Kandy is not related to its main customer simply by virtue of economic

dependence.
The loan from Columbo to Mrs C is not a related party transaction as Mrs C
cannot influence Columbo
Mrs Bs work as independent consultant for Moratuwa is a related party

transaction
The transactions between Kandy and Galle are related party transactions
The bank guarantee is not a related party transaction.
Related Parties Disclosure Note

The Columbo Group includes the following companies:
Columbo
Kandy
Moratuwa
90% owned by Columbo

75% owned by Kandy
Balances and transactions between Columbo and its subsidiaries, which are
related parties, have been eliminated on consolidation and are not disclosed in
this note.
Trading transactions
During the year, group companies entered into the following transactions with
related parties that are not members of the group:
Rs.
Sale of goods to other related parties
Receipt of services from key management personnel other than
In their capacity as key management personnel
CA Sri Lanka
1,500,000
400,000
457
The following amounts were outstanding at the reporting date:

Amounts owed
by related parties
Rs.
60,000
(10,000)
Other related parties

Less provision for doubtful debt
50,000
Compensation of key management personnel
The compensation of the directors, who are the key management personnel of the
group is set out below in aggregate for each of the categories specified in LKAS 24
Related Party Disclosures.
Rs'000
Short term employee benefits
2,540
1,000
Post employment benefits
3,540
QUESTION
Disclosure of related party transactions
Galle PLC is the parent company of the Galle Group, which operates in the tourism
industry in Sri Lanka. As part of its internal reporting system, Galle PLC records all
transactions with other Group and associated companies. The output of the system
at 31 December 20X3 in respect of the year ended on that date was as follows:
Company
Matara Ltd
Puttalam Ltd
Jaffna Ltd
Badulla Ltd
Vavuniya Ltd
Kagalle Ltd
Relationship
100% subsidiary
80% subsidiary
40% associate
25% associate
30% joint
venture
10% investment
Purchases
Owed to
Sales by
by Galle
Galle PLC
Galle PLC
PLC
at year end
Rs'000
Rs'000
Rs'000
225,000
50,000
160,000
23,000
- 320,000
- 190,000
90,000
5,000
180,000
Owed by
Galle PLC
at year end
Rs'000
65,000
20,000
-
16,000
All transactions with subsidiaries were at group set transfer prices; no such prices
were set for transactions with other companies and the management of the Galle
Group believes that they took place at market prices.
Galle PLC has provided a guarantee to Vavuniya Ltd that remains in place at the
year end.
458
CA Sri Lanka
The Group Finance Director intends to present this output as the related party
disclosure in the Group financial statements for the year ended
31 December 20X3.
Required
Comment on the suggested form of the related party disclosure and redraft for
the Galle Group in accordance with LKAS 24 insofar as you can based on the
information provided.
ANSWER
Although not mandatory, it is usual to group together transactions with

similar types of related party (eg associates) rather than list them separately.
Items of a similar nature may be disclosed in aggregate unless separate
disclosure is necessary for an understanding of the effect on the financial
statements.
In the group financial statements, transactions between the parent company

and subsidiaries should not be disclosed since these are eliminated on
consolidation.
The 10% investment in Kagalle is unlikely to constitute a related party and

therefore no disclosure is required of transactions between this company
and Galle PLC.
Disclosure that transactions took place at market prices may only be made
where this claim can be substantiated. This does not appear to be the case
here.
Comparatives should be provided (however in this case there is insufficient

information in the question to do so).
The terms and conditions of outstanding balances should be disclosed

including whether they are secured and the form of consideration to be
provided.
In respect of the guarantee, details should be provided including the Groups

maximum exposure.
Related Parties redrafted note

Balances between Galle PLC and its subsidiaries, which are related parties, have
been eliminated on consolidation and are not disclosed in this note. Transactions
between Galle PLC and other related parties are disclosed below.
During the year, group companies entered into the following transactions with
related parties that are not members of the group.
CA Sri Lanka
459
Relationship
Associates
Joint ventures
Sale of goods
Rs'000
90,000
Purchases of goods
Rs'000
510,000
-
The following amounts were outstanding at the reporting date:

Relationship
Associates
Joint ventures
Owed by related parties

Rs'000
5,000
Owed to related parties

Rs'000
85,000
-
The amounts outstanding are unsecured and will be settled in cash.
QUESTION
On 1 July 20X9, the board of directors of Batara PLC agreed to sell a division of the
business. The division currently has work planned until the end of September
20X9 so the board have agreed to complete the work and then discontinue the
operations of the division. There is an interested buyer for the division but Batara
PLC have stated that the purchase cannot take place until after the work has been
completed and realistically anticipate that a transfer of the division cannot occur
until 31 October 20X9.
Required
Analyse whether the division should be classified as 'held for sale' at 1 July 20X9?
ANSWER
In order to be held for sale an asset must be available for immediate sale in its
present condition and a sale must be highly probable.
At 1 July 20X9 the division is not available for immediate sale in its present
condition and therefore it does not meet the criteria specified in SLFRS 5 as being
held for sale.
The division will only be available for immediate sale in its present condition
when the planned work has been completed. It may meet the criteria on 31
October when the work has been completed.
460
CA Sri Lanka
QUESTION
Timbuktu PLC disposed of its retail division on 31 August 20X9. The results of the
division for the period to disposal are shown below:
Rs Mn
140,655
Revenue
(130,248)
Cost of sales
10,407
Gross profit
(20,059)
Expenses
(9,652)
Loss before tax
(180)
Tax
(9,832)
Loss for the period
The gain on disposal of the retail division amounted to Rs. 24 Mn with a related
tax expense of Rs. 2 Mn.
Required
Advise what amount(s) in respect of discontinued operations should be disclosed
in the statement of profit or loss and other comprehensive income according to
SLFRS 5
ANSWER
A single amount must be presented in the statement of profit or loss and other
comprehensive income comprising the post-tax profit or loss of discontinued
operations and the post-tax gain or loss recognised on the disposal of the
operations. This is calculated as:
Rs Mn
(9,832)
Loss for the period
22,000
Gain on disposal after tax (24-2)
12,168
Profit from discontinued operations
This amount must be further analysed, however this analysis can take place in the
notes to the accounts.
QUESTION
Advise whether the parties mentioned below are related to X, a public limited
company, for the purposes of LKAS 24 Related Party Disclosures:
CA Sri Lanka
(a)
Children of the former wife of the finance director with her new husband
(b)
X's sole supplier
(c)
Co B. X's marketing director is the managing director of Company B.

461
(d)
The ex wife of a 24% shareholder in X to whom the shareholder pays

maintenance.
ANSWER
462
(a)
The former wife of the finance director would be considered a related party
if she were financially dependent on the finance director (and so influenced
by him), who is key management personnel of the company, but her children
with her new husband are not, as she is not the finance director's domestic
partner.
(b)
X's sole supplier is not automatically considered a related party, simply due
to X's economic dependence on it.
(c)
Companies are not automatically related simply because they have a director
in common. However, if X's marketing director uses his influence to
encourage trading with B, any transactions would need to be disclosed.
(d)
The shareholder is considered a related party as, with 24% of the votes,
significant influence over X would be possible. As the ex wife to whom the
shareholder pays maintenance is financially dependent on the shareholder
she is considered close family and therefore a related party.
CA Sri Lanka
CHAPTER ROUNDUP
SLFRS 5 requires non-current assets 'held for sale' to be presented separately

in the statement of financial position.
They are measured at the lower of carrying amount and fair value less costs to
sell / distribute.
SLFRS 5 also requires discontinued operations to be presented separately in

the statement of profit or loss and other comprehensive income.
LKAS 24 requires that related parties are identified and any transactions with
them in the reporting period are disclosed.
This enables users to assess the impact of transactions that may not have taken
place at arms length.
Disclosures are required in respect of the controlling party and parentsubsidiary relationships, transactions with key management personnel and
other related party transactions.
CA Sri Lanka
463
PROGRESS TEST
464
When can a non-current asset be classified as held for sale?
How should an asset held for sale or distribution be measured?
What single amount is disclosed in the statement of profit or loss and other
comprehensive income in respect of discontinued operations?
What individuals may be considered to be a related party of a company?
A company provides its subsidiary with management services without charge. Is

this a related party transaction?
What categories should key management personnel compensation be disclosed

under?
CA Sri Lanka
(a)
(b)
At the lower of carrying amount and fair value less costs to sell or distribute.
The post-tax profit or loss of discontinued operations and the post-tax gain or loss
recognised on the measurement to fair value less costs of disposal or on the
disposal of the assets or disposal group(s) constituting the discontinued
operation.
An individual that has control or joint control of or significant influence over the
company a member of the key management personnel of the company, or a close
member of the family of the above.
Yes the parent and subsidiary are related parties; the provision of services is a
related party transaction. The fact that a price is not charged is not relevant.
CA Sri Lanka
The asset must be available for immediate sale in its present condition
Its sale must be highly probable (ie significantly more likely than not).
Short-term employee benefits

Post-employment benefits
Other long-term benefits
Termination benefits, and
Share-based payment
465
466
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter continues from the previous chapter and deals
with two more standards that concentrate on disclosure:
SLFRS 8 Operating Segments
LKAS 33 Earnings per Share
Both of these standards are relevant only to listed companies.

Again, both of these standards were covered at KB1, and
therefore much of the technical content of this chapter will be
revision.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

matters.
under standards.
467
CHAPTER CONTENTS
1 SLFRS 8 Operating Segments
2 LKAS 33 Earnings Per Share

Explain operating segments.
Outline the quantitative thresholds and entity shall report separately
information about an operating segment.
Outline the disclosure requirements with regard to operating segments as per
the standard.
Recommend appropriate segments to be used in financial reporting.
Design suitable disclosure requirements under operating segments.
Evaluate the impact of potential ordinary shares, options, warrants and their
equivalents on earnings per share and diluted earnings per share.
Advise the impact of contracts that may be settled in ordinary shares or cash on
the earnings per share.
Assess the value of a share when there is potential ordinary shares, options,
warrants etc.
Advise the appropriate presentation of EPS.
Design the disclosures pertaining to EPS.
1 SLFRS 8 Operating Segments

SLFRS 8 requires that the results of reportable operating segments are
disclosed separately.
You have already met the requirements of SLFRS 8 at KB1. This section revises the
technical requirements of the standard in brief before concentrating on their
application through examples and questions.
468
CA Sri Lanka
1.1 Purpose of segment reporting

Many large entities have a number of lines of business and may also operate in
more than one distinct geographical area. Each of these lines of business or
geographical areas is likely to be subject to differing levels of risk and reward,
with different levels of profitability and opportunities for growth. The purpose of
SLFRS 8 is to require companies to provide separate financial information about
each significant segment in order to allow interested parties to gain a better
understanding of the business.
1.2 Scope
The standard is only applicable to entities whose equity or debt securities are
traded on a stock exchange or who are in the process of filing financial statements
for the purpose of issuing instruments.
In group accounts, only consolidated segmental information must be disclosed.
1.3 Operating segments

An operating segment is a component of an entity:
(a)
That engages in business activities from which it may earn revenues and
incur expenses (including revenues and expenses relating to transactions
with other items of the same entity)
(b)
Whose operating results are regularly reviewed by the entity's chief

operating decision maker to make decisions about resources to be allocated
to the segment and assess its performance, and
(c)
For which discrete financial information is available.
The term 'chief operating decision maker' identifies the function which
allocates resources and assesses the performance of the entity's operating
segments. It does not necessarily refer to an individual.
An operating segment normally has a segment manager who maintains direct
contact with the chief operating decision maker. The segment manager may be
a function rather than an individual.
An entity may have a matrix structure of operations whereby some managers
are responsible for different product and service lines and other managers are
responsible for separate geographical areas. In this case the entity should
determine whether product /service lines or geographical areas are the
operating segments. This decision is based on the core principle that the
purpose of segment disclosures is to allow users to evaluate the nature and
financial effects of the activities in which an entity engages and the economic
environments in which it operates.
CA Sri Lanka
469
Two or more operating segments may be aggregated if the segments have

similar economic characteristics, and the segments are similar in all of the
following respects:
The nature of the products or services

The nature of the production process
The type or class of customer for their products or services
The methods used to distribute their products or provide their services
If applicable, the nature of the regulatory environment
1.4 Reportable segments

In order for an identified operating segment to be reportable, the segment total
should be 10% or more of the total:
(a)
(b)
(c)
Revenue (internal and external), or

All segments not reporting a loss (or all segments in loss if greater), or
Assets
If those segments that meet the quantitative threshold do not represent at least
75% of total external revenue, additional segments must be identified (even if
they do not meet the 10% thresholds).
Two or more operating segments below the thresholds may be aggregated to
produce a reportable segment if the segments have similar economic characteristics,
and the segments are similar in a majority of the aggregation criteria above.
Operating segments that do not meet any of the quantitative thresholds may be
reported separately if management believes that information about the segment
would be useful to users of the financial statements.
Operating segments that are not separately reported are combined and their
results disclosed in an all other segments category.
QUESTION
Reportable operating segments
The operating segments of a diversified professional services company, AB

Professional PLC are:
Operating segment
Tax services
Accounting
Legal
Risk consultancy
Corporate finance
PR and marketing
Secretarial services
470
Revenue
%
55
8
7
9
8
6
7
100
Profit
%
65
6
8
5
8
6
2
100
Assets
%
58
9
7
7
6
8
5
100
CA Sri Lanka
No two operating segments share all of the SLFRS 8 aggregation criteria. All sales
are made to external customers with the exception of the Secretarial Services
division which makes all of its sales to other internal segments.
Required
Advise how the principles in SLFRS 8 Operating segments for the determination
of a companys reportable operating segments would be applied using the
information given above.
ANSWER
Only the Tax services segment meets the 10% quantitative threshold for a
reportable segment.
This segment only provides 55% of total revenue generated by the Company and
59% (55/93 100%) of external revenue. Therefore additional operating
segments must be identified as reportable.
It may be the case that certain other segments have similar economic
characteristics and meet a majority of the SLFRS 8 aggregation criteria in which
case they may be joined to form a reportable segment.
It may also be the case that the management of AB Professional wish to report the
results of particular segments that dont qualify as reportable in order to provide
useful information to users.
If this is not the case then other operating segments must be designated as
reportable in order to achieve the required 75% of external revenue in reportable
segments.
The logical way to achieve this would be to designate the next largest segments in
terms of revenue until the 75% threshold were achieved.
Risk consultancy provides (9/93 100%) = 10% of external revenue; if this is
reported separately, total external revenue reported becomes 59% + 10% = 69%.
A further segment must be reported. This could be any of Accounting, Legal,
Corporate Finance and PR and Marketing, all of which contribute more than 6%
external revenues.
1.5 Disclosure
1.5.1 General information
CA Sri Lanka
Factors used to identify the entity's reportable segments
Judgements made by management in applying the aggregation criteria.
Types of products and services from which each reportable segment

derives its revenues
471
1.5.2 Information about profit or loss, assets and liabilities

The following information is disclosed for each reportable segment:
A measure of profit or loss
A measure of total assets and

liabilities (assuming this is reported to
the chief operating decision maker)
And
And
Provided that the following amounts

are provided to the chief operating
decision maker or are included in the
measure of segment profit or loss
Provided that the following amounts

are provided to the chief operating
decision maker or are included in the
measure of segment assets
External revenues
Internal revenues
Interest revenue
Interest expense
Depreciation and amortisation
Material items of income and
expense
Interest in the profit or loss of
associates / joint ventures under
the equity method
Income tax expense or income
Material non-cash items (other
than depreciation and
amortisation)
Investment in associates / joint

ventures under the equity method
Amounts of additions to noncurrent assets (other than
financial instruments, deferred tax
assets, pension assets and rights
under insurance contracts).
1.5.3 Example: Information about profit, loss, assets and liabilities

The following illustrative disclosure is taken from the Implementation Guidance
provided alongside SLFRS 8.
The hypothetical company does not allocate tax expense (tax income) or nonrecurring gains and losses to reportable segments. In addition, not all reportable
segments have material non-cash items other than depreciation and amortisation
in profit or loss. The amounts in this illustration are assumed to be the amounts in
reports used by the chief operating decision maker.
472
CA Sri Lanka
Car
parts
Rs'000
Motor
vessel
Rs'000
Software
Rs'000
Electronics
Rs'000
Finance
Rs'000
All
other
Rs'000
Revenues from external

customers
3,000
5,000
9,500
12,000
5,000
1,000(a)
Intersegment revenues
3,000
1,500
4,500
Totals
Rs'000
35,500
Interest revenue
450
800
1,000
1,500
3,750
Interest expense
350
600
700
1,100
2,750
1,000
1,000
Depreciation and
amortisation
200
100
50
1,500
1,100
2,950
Reportable segment profit
200
70
900
2,300
500
100
4,070
200
200
2,000
5,000
3,000
12,000
57,000
2,000
81,000
300
700
500
800
600
2,900
1,050
3,000
1,800
8,000
30,000
43,850
Net interest revenue(b)
Other material non-cash items:

Reportable segment assets
Expenditure for reportable
segment non-current assets
Reportable segment liabilities
(a)
Revenues from segments below the quantitative thresholds are attributable

to four operating segments of the company. Those segments include a small
property business, an electronics equipment rental business, a software
consulting practice and a warehouse leasing operation. None of those
segments has ever met any of the quantitative thresholds for determining
reportable segments.
(b)
The finance segment derives a majority of its revenue from interest.

Management primarily relies on net interest revenue, not the gross revenue
and expense amounts, in managing that segment. Therefore, as permitted by
SLFRS 8, only the net amount is disclosed.
1.5.4 Reconciliations
The total reportable segment amount of the following must be reconciled to the
equivalent entity amount:
CA Sri Lanka
Revenue
Profit or loss
Assets
Liabilities
Other material items of information.
473
1.5.5 Example: Reconciliations

To continue with the illustration above, selected reconciliations may be presented
as follows:
Revenues
Total revenues for reportable segments
Other revenues
Elimination of intersegment revenues
Entity revenues
Rs'000
39,000
1,000
(4,500)
35,500
Assets
Total assets for reportable segments
Other assets
Elimination of receivable from corporate HQ
Other unallocated amounts
Entity revenues
Rs'000
79,000
2,000
(1,000)
1,500
81,500
1.5.6 Information about products and services

An entity should report the revenues from external customers for each product
and service unless the necessary information is not available and costs to develop
it would be excessive.
1.5.7 Information about geographical areas
The following geographical information is disclosed unless the necessary
information is not available and costs to develop it would be excessive:
Revenue from external customers
In country of domicile
Abroad
Non-current assets (other than financial instruments, deferred tax assets,
pension assets and rights under insurance contracts)
Located in country of domicile
Located abroad.
474
CA Sri Lanka
1.5.8 Example: information about geographical areas

To continue with the example in sections 1.5.3 and 1.5.6 the following provides
example of a geographical disclosure:
Revenue
Non-current assets
Rs'000
Rs'000
19,000
11,000
Sri Lanka
India
4,200
China
3,400
6,500
Japan
2,900
3,500
Other countries
6,000
3,000
35,500
24,000
Total
1.5.9 Information about major customers

Information about reliance on major customers (ie those who represent more
than 10% of external revenue) should be provided.
1.5.10 CASE STUDY: information about major customers
Revenues from one customer of XYZs software and electronics segment represent
approximately Rs5m of the Companys total revenues.
The following is an extract from the 2013/14 Annual Report of Indo-Malay PLC, a
company with just two operating segments, both of which are reportable and a
relatively simple segment reporting note.
18 Segmental Reporting
For management purpose, the company is organised into the following two
business segments:
CA Sri Lanka
475
(A)
Industry
Revenue
External revenue
Result
Segment result
Taxation
Other information
Segment assets
Segment liabilities
Capital expenditure
Depreciation
Retirement benefits
charge
(B)
Geographical
Revenue
Non-current assets
Oil Palm
2014
2013
Rs. '000
Rs. '000
165,702
193,366
165,702
193,366
Investments
2014
2013
Rs. '000
Rs. '000
104,939
51,000
104,939
51,080
Company
2014
2013
Rs. '000
Rs. '000
270,641
244,446
270,641
244,446
109,000
(25,979)
83,021
101,386
(259)
101,127
210,386
(26,238)
184,148
143,036
(34,546)
100,490
44,679
(478)
44201
187,715
(35,024)
152,691
1,707,191 1,697,800 3,670,385 3,880,482 5,377,576 5,578,290

72,200
49,642
38,469
22,194
110,669
71,836
8,888
1,172
8,888
1,172
747
576
747
576
291
236
291
236
Malaysia
Sri Lanka
Company
2014
2013
2014
2013
2014
2013
Rs. '000
Rs. '000
Rs. '000
Rs. '000
Rs. '000
Rs. '000
166,405
193,366
104,236
51,000
270,641
244,446
1,646,563 1,657,701 3,650,307 3,876,347 5,296,870 5,534,048
2 LKAS 33 Earnings per Share

Earnings per share is widely used by investors as a measure of a companys
performance. LKAS 33 deals with the calculation and presentation of
earnings per share (EPS) and diluted earnings per share (DEPS).
Again, much of LKAS 33 Earnings per Share is assumed knowledge from KB1. In
addition to revising this material, some new aspects of the standard are
introduced at KC1 level.
Remember that like SLFRS 8, LKAS 33 is only applicable to companies that are
listed, ie:
Whose ordinary shares are traded in a public market, or
That are in the process of being listed.
It is also applicable to groups with a parent company whose shares are traded in a
public market.
Where an entity prepares both separate and consolidated financial statements,
earnings per share is only required to be presented on the basis of the
consolidated information.
476
CA Sri Lanka
2.1 Definitions
The following definitions are included in LKAS 33 and are relevant to the
calculation of basic and diluted earnings per share:
An ordinary share is an equity instrument that is subordinate to all other classes
of equity instruments.
A potential ordinary share is a financial instrument or other contract that may
entitle its holder to ordinary shares.
Dilution is a reduction in earnings per share or an increase in loss per share
resulting from the assumption that convertible instruments are converted, that
options or warrants are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.
Antidilution is an increase in earnings per share or a reduction in loss per share
resulting from the assumption that convertible instruments are converted, that
options or warrants are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.
Options, warrants and their equivalents are financial instruments that give the
holder the right to purchase ordinary shares.
2.2 Calculation of basic earnings per share

The following formula is applied in the calculation of basic EPS:
FORMULA TO LEARN
Basic EPS =
Net profit/(loss) attributable to ordinary shareholders

Weighted average number of ordinary shares outstanding during the period
2.2.1 Profit attributable to ordinary shareholders

This is calculated as:
Profit after tax for the year
Profit attributable to the NCI
Profit attributable to preference shareholders not already
recognised in profit or loss
Profit attributable to ordinary shareholders
Rs.
X
(X)
(X)
X
Profit attributable to preference shareholders includes:

Dividends
CA Sri Lanka
477
The excess that arises where an entity purchases its own preference shares for
more than their carrying amount
Where discontinued operations are presented, basic earnings per share must also
be disclosed for continuing operations. To calculate profits attributable to
ordinary shareholders for this purpose, profits of the discontinued operation must
be deducted from the above calculation.
QUESTION
Pacific Power PLC reported retained profits of Rs. 120 Mn in the year ended
31 December 20X6. The company has the following shares in issue at that date:
50 million ordinary shares
6 million 3% redeemable preference shares
10 million 5% irredeemable cumulative preference shares
Rs. 700,000,000
Rs. 9,000,000
Rs. 60,000,000
Fixed dividends are paid on the preference shares at the relevant coupon rate on
carrying amount.
There have been no issues of shares during the year.
Required
(a)
Calculate the profit attributable to ordinary shareholders for the year ended
31 December 20X6?
(b)
State how might your answer differ if the irredeemable preference shares
were non-cumulative?
ANSWER
(a)
Irredeemable preference share dividend (5% 60,000,000)
Rs'000
120,000
(3,000)
117,000
Profit after tax
Note: the redeemable preference share dividend is already charged against

profit for the year as part of finance costs.
(b)
If the irredeemable preference shares were non-cumulative, profit would

only be adjusted for the dividend if it were declared.
2.2.2 Weighted average number of ordinary shares

The weighted average number of ordinary shares during the period is calculated
by applying a time-weighting factor to shares in issue throughout the year. The
478
CA Sri Lanka
date on which shares are deemed to be issued for the purposes of the calculation
of the weighted average number of ordinary shares is as follows:
Consideration for share issue
Inclusion date
Cash
When cash receivable
Voluntary reinvestment of dividends
Dividend payment date
Conversion of debt instrument to

ordinary shares
Date interest ceases accruing
In place of principal or interest on other

financial instruments
Date interest ceases accruing
In exchange for settlement of a liability
Settlement date
Acquisition of an asset
Date on which acquisition recognised
As services are rendered.
If a company has 100,000 shares in issue from 1 January 20X4 to 31 March 20X4
and then issues 50,000 further shares in exchange for an immediate payment of
cash, then the weighted average number of shares is:
1 January 31 March
100,000 3/12 months
1 April 31 December
150,000 9/12 months
25,000
112,500
137,500
Weighted average number of shares
This figure is adjusted for events that have changed the number of shares
outstanding without a corresponding change in resources:
Event
Adjustment factor applied to ordinary shares

before the event
Bonus issue
Number of shares in issue post bonus issue

Number of shares in issue pre bonus issue
Rights issue
Pre-rights issue price of shares

Theoretical ex-rights price (TERP)
In both cases, the reciprocal of the adjustment factor can be used to re-calculate
the comparative EPS for the previous year.
QUESTION
Earnings per share
Typhoon Tea PLC had a profit after tax of Rs. 81 Mn in the year ended
31 December 20X3. This increased to Rs. 83 Mn in the year ended 31 December
20X4. The company had 100 million ordinary shares in issue at 1 January 20X3
and 20X4 and made the following issues in 20X4:
CA Sri Lanka
479
A bonus issue of 1 for 10 on 1 March 20X4
A 1 for 5 rights issue on 1 July 20X4. The market price of one share
immediately before the rights issue was Rs. 16.20; the exercise price was
Rs. 12.50.
Required
What is the basic earnings per share for the year ended 31 December 20X3
and 20X4?
ANSWER
y/e 31 December 20X3 as initially reported
Earnings
Weighted average number of shares
Rs. 81 million
100 million
81,000,000
100,000,000
Therefore basic EPS
Rs. 0.81
y/e 31 December 20X4
Earnings
Weighted average number of shares (see below)
83,000,000
Therefore basic EPS
123,188,703
Weighted average number of shares:
Time factor
100 Mn
1.1.X4 28.2.X4
2/12m
10 Mn
Bonus issue
110 Mn
1.3.X4 30.6.X4
4/12m
22 Mn
Rights issue
132 Mn
1.7.X4 31.12.X4
6/12m
Rs. 83 million
123,188,703
Rs. 0.67
Adj 1
11/10
Adj 2
16.20/15.58
No. shares
19,062,901
16.20/15.58
38,125,802
66,000,000
123,188,703
Adjustment 1: Bonus issue

Number of shares in issue post bonus issue
Number of share in issue pre bonus issue
Adjustment 2: Rights issue
Pre-rights issue price of shares
Theoretical ex-rights price (TERP)
TERP: 5 existing shares @ 16.20
1 new share @ 12.50
6
480
11
10
16.20
15.58
81.00
12.50
93.50
CA Sri Lanka
Therefore 93.50/6
15.58
y/e 31 December 20X3 adjusted EPS

Rs 0.81 10/11 15.58/16.20
Rs 0.71
2.3 Calculation of diluted earnings per share

The diluted EPS figure is a worst case scenario earnings per share figure which
provides the EPS that would have been obtained in the current financial period if
current dilutive potential ordinary shares had been in issue as ordinary shares.
Dilutive potential ordinary shares
Will decrease EPS on issue because

the number of shares will increase
but profits will not increase
proportionately.
Include:
Convertible loan stock or
convertible preferred shares
Options or warrants
Shares that would be issued on the
satisfaction of conditions resulting
from contractual arrangements such
as the purchase of a business.
Remember that antidilutive potential ordinary shares (ie those that increase
profits more than they increase the number of shares in issue) are not taken into
account in the calculation of diluted EPS.
Diluted earnings per share is calculated as:
FORMULA TO LEARN
Diluted EPS =
profits in basic EPS + effect on profit of dilutive potential ordinary shares

Number of shares in basic EPS dilutive potential ordinary shares
The calculation should be performed in steps with each group of dilutive potential
ordinary shares added in turn, starting with the most dilutive.
After each addition, diluted EPS is calculated and the diluted earnings per share
figure is that which is the lowest calculated at any stage.
2.3.1 Profits
The earnings used in diluted EPS are those calculated for basic EPS, adjusted by
the post-tax effect of:
(a)
CA Sri Lanka
Any dividends on dilutive potential ordinary shares that were deducted to

arrive at earnings for basic EPS
481
(b)
Interest recognised in the period for the dilutive potential ordinary shares
(convertible debt)
(c)
Any other changes in income or expenses (fees or discount) that would

result from the conversion of the dilutive potential ordinary shares
2.3.2 Number of shares
The number of ordinary shares is the weighted average number of ordinary

shares calculated for basic EPS plus the weighted average number of ordinary
shares that would be issued on the conversion of the dilutive potential ordinary
shares into ordinary shares.
It should be assumed that dilutive ordinary shares were converted into ordinary
shares at the beginning of the period or, if later, at the actual date of issue.
The computation assumes the most advantageous conversion rate or exercise rate
from the standpoint of the holder of the potential ordinary shares.
2.3.3 Contracts that may be settled in ordinary shares or cash
An entity may issue a contract that may be settled in either cash or its own
ordinary shares.
Where the method of settlement is at the entitys option, it is assumed that the
contract will be settled in ordinary shares and therefore the resulting potential
ordinary shares are included in the calculation of diluted earnings per share if
they are dilutive.
Where the method of settlement is at the counterpartys option, the more
dilutive of cash settlement and share settlement is used in calculating diluted
EPS.
2.3.4 Question practice
The following questions will refresh your memory as to how different types of
potential ordinary shares are dealt with.
QUESTION
Share options
Adanti PLC has the following results for the year ended 31 December 20X2.
Net profit for year
Weighted average number of ordinary shares
outstanding during year
Average fair value of one ordinary share during year
482
Rs. 30,500,000
10,500,000 shares
Rs. 25
CA Sri Lanka
Weighted average number of shares under option

during year
Exercise price for shares under option during year
500,000 shares
Rs. 14
Required
Calculate both basic and diluted earnings per share.
ANSWER
Basic earnings per share

= 30,500,000 = Rs. 2.90
Weighted average number of ordinary shares 10,500,000
Diluted earnings per share
Profit per EPS + effect of options

30,500,000 0
=
= Rs. 2.85
No shares per EPS effect of options 10,500,000 220,000
Effect of options on number of shares:
Total funds raised from exercise of options (500,000 Rs. 14)

Number of shares issued at full market price to raise
Equivalent funds (Rs. 7 Mn/Rs. 25)
Therefore shares deemed free (500,000 280,000)
QUESTION
Rs. 7,000,000
280,000
220,000
Convertible loan stock
Alahakoon PLC has 100,000,000 ordinary shares in issue, and also had in issue in
20X4:
(a)
Rs. 20,000,000 of 18% convertible loan stock, convertible in three years'

time at the rate of 9 shares per Rs. 100 of stock;
(b)
Rs. 35,000,000 of 12% convertible loan stock, convertible in one year's time
at the rate of 12 shares per Rs. 100 of stock.
The total earnings in 20X4 were Rs. 175,000,000.

The rate of income tax is 28%.
Required
Calculate the basic EPS and diluted EPS.
ANSWER
1
2
CA Sri Lanka
Calculate basic EPS:

175,000,000/100,000,000 =
Rs. 1.75
Consider whether the loan stock is dilutive or antidilutive:
483
18% loan stock:

Incremental earnings =
=
20,000,000 18% (1-28%)

Rs. 2,592,000
Incremental shares
=
=
20,000,000/100 9
1,800,000
Therefore EPS
=
=
Rs. 2,592,000/1,800,000
Rs. 1.44 so dilutive
12% loan stock:

Incremental earnings =
=
35,000,000 12% (1-28%)

Rs. 3,024,000
Incremental shares
=
=
35,000,000/100 12
4,200,000
Therefore EPS
=
=
Rs. 3,024,000/4,200,000
Rs. 0.72, so dilutive
Calculate Diluted EPS:

(a)
add in most dilutive loan stock (12%)

(175,000,000 3,024,000)
= Rs. 1.71
(100,000,000 4,200,000)
(b)
add in 18% loan stock as well as 12%
(175,000,000 3,024,000 2,592,000)

= Rs. 1.70
(100,000,000 4,200,000 1,800,000)
Therefore diluted EPS is Rs. 1.70, being the lowest diluted EPS calculated.
Note that if, on addition of the 18% loan stock, diluted EPS had risen above
Rs. 1.71, then Rs. 1.71 would be diluted EPS.
QUESTION
Contingently issuable shares
Explain whether each of these groups of potential ordinary shares should be

taken into account in the calculation of diluted earnings per share.
P Co acquired 75% of the shares in S Co on 1 March 20X4 in exchange for cash

consideration and 200,000 of its own shares that will be issued only if S Co
achieves revenue of Rs. 60 Mn in the first year of ownership. At 31 December
20X4 revenue is Rs. 51 Mn.
P Co also acquired 80% of C Co in May 20X4. Part of the consideration for
business combination is shares in P Co that will be issued only if the share price
of P Co reaches Rs. 20 by the anniversary of the acquisition date. The share
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CA Sri Lanka
price has fluctuated significantly since the acquisition date, recording a low of
Rs. 8.70 and a high at the year-end of Rs. 21.
ANSWER
Where ordinary shares are issuable contingent upon a future event occurring,
these shares are included in the calculation of diluted EPS based on the number of
shares that would be issuable if the end of the period were the end of the
contingency period.
1
The specified level of earnings to be achieved by 1 March 20X5 has not been
achieved by the year end and so the contingently issuable shares are not
included in the calculation of diluted EPS.
The required market price has been achieved at the period end and
therefore the contingently issuable shares are included in the calculation of
diluted EPS.
2.4 Presentation of earnings per share

Basic and diluted EPS should be presented by an entity in the statement of profit
or loss and other comprehensive income for each class of ordinary share that has a
different right to share in the net profit for the period. If an entity presents items
of profit or loss in a separate statement in accordance with LKAS 1, it should
present earnings per share only in that statement.
The basic and diluted EPS should be presented with equal prominence for all
periods presented.
Disclosure must still be made where the EPS figures (basic and/or diluted) are
negative (ie a loss per share).
2.4.1 Disclosure
An entity should disclose the following.
CA Sri Lanka
(a)
The amounts used as the numerators in calculating basic and diluted EPS,
and a reconciliation of those amounts to the net profit or loss for the period
(b)
The weighted average number of ordinary shares used as the denominator

in calculating basic and diluted EPS, and a reconciliation of these
denominators to each other.
485
2.4.2 Alternative EPS figures
An entity may present alternative EPS figures if it wishes. However, LKAS 33 lays
out certain rules where this takes place.
(a)
The weighted average number of shares as calculated under LKAS33 must be

used.
(b)
A reconciliation must be given if necessary between the component of profit

used in the alternative EPS and the line item for profit reported in the
statement of comprehensive income.
(c)
Basic and diluted EPS must be shown with equal prominence.
2.4.3 CASE STUDY: Alternative EPS figures
The following earnings per share disclosure note is taken from the Citrus Leisure
PLC Annual Report 2012/13.
25 EARNINGS PER SHARE
Basic earnings per share is calculated by dividing the net profit for the year
attributable to equity holders of the parent by the weighted average number of
ordinary shares outstanding during the year. The weighted average number of
ordinary shares outstanding during the year and the previous year are adjusted
for events that have changed the number of ordinary shares outstanding, without
a corresponding change in the resources such as a bonus issue.
Diluted earrings per share is calculated by dividing the net profit attributable to
ordinary share holders by the weighted average number of ordinary shares of
outstanding during the year adjusted for the effects all dilutive potential ordinary
shares.
Group
2013
Rs.
Amounts used as the Numerator
Net Profit attributable to Equity Holders of the
Parent for Basic and Diluted Earnings Per Share
Number of Ordinary Shares Used as the

Denominator
Weighted Average Number of Ordinary Shares in
issue applicable to Basic Earnings Per Share
Weighted Average Number of Ordinary Shares
adjusted for the effect of dilution
(48,476,717)
2013
Number
2012
Rs.
(6,562,151)
2012
Number
85,150,970
57,679,054
85,150,970
94,183,432
Notice that:
486
CA Sri Lanka
The 2013 loss and weighted average number of shares is the same for both
basic and diluted earnings per share. Therefore there are no dilutive potential
ordinary shares at the 2013 year end. The basic and diluted earnings per share
reported in the financial statements is the same figure.
The 2014 loss for both basic and diluted earnings per share is the same figure,
however the weighted average number of shares is different. This suggests that
the potential ordinary shares may be options or warrants.
QUESTION
Business decisions and EPS
You are the financial controller of PD Plantations PLC and have received the
following email from the CEO:
To:
From:
Subject:
Nihinsa Balendran
Vidu Dias
Transactions and earnings per share
Dear Nihinsa
The Board has recently been discussing some financing and other options
available to the company in the future. We are very aware of the importance of
earnings per share to investors and analysts and wed really like to make decisions
that wont affect EPS negatively. With that in mind, please could you advise me of
the impact of the following:
1
We would like to raise cash to fund expansion into a new market. This will
be through some form of debt, possibly convertible debt or possibly
redeemable debt structured as redeemable preference shares.
We are considering rewarding our highest performing staff with a profitrelated bonus scheme. The bonus would be paid in cash.
Our shares are currently trading at a relatively high market price, which
makes them less accessible to individual shareholders. In order to dilute the
market value of a share, we are considering making a bonus issue of shares
to existing shareholders.
Many thanks
Kind regards
Vidu Dias
Required
Draft a reply to Vidu Dias.
CA Sri Lanka
487
ANSWER
To: Vidu Dias
From: Nihinsa Balendran
Re: Transactions and earnings per share
Dear Vidu
Thank you for your email. In reply to your queries about the impact of various
issues on earnings per share, I trust that you will find the details below useful.
I have referred to both basic and diluted earnings per share.
Basic earnings per share is a current measure of how much profit is

attributable to each existing ordinary share. It is therefore affected by any
transaction that affects either profit or the number of shares in existence, or
both.
Diluted earnings per share is a worst case scenario the earnings per share
that would be reported if all potential ordinary shares that would reduce
EPS had been issued in the year.
Financing options
Redeemable debt will result in interest payments increasing and so profits

decreasing. There is no effect on the number of ordinary shares in issue so overall
this will reduce earnings per share. As diluted earnings per share is based on
basic earnings per share , this will also be reduced. What you should, however,
remember is that although this negative effect will be evident in the short term, in
the long term the debt-funded expansion should result in substantially increased
profits and so earnings per share.
The effects of convertible debt on basic earnings per share are the same as those
described above. In this case, however, diluted earnings per share may also fall
due to the existence of potential ordinary shares. The calculation of diluted
earnings per share only takes into account dilutive potential ordinary shares it is
impossible to say whether convertible debt is dilutive or not without
understanding the amounts involved and interest rate attached. If the convertible
debt were dilutive this would decrease diluted earnings per share.
Redeemable preference shares pay a legal dividend, however for accounting
purposes this is treated as a finance cost and the shares are treated as debt.
Therefore the effect of these shares on earnings per share is exactly the same as
redeemable debt.
488
CA Sri Lanka
Profit-related bonus scheme
A bonus is recognised as an expense, and therefore reduces profits available to

shareholders, so reducing both basic and diluted earnings per share. Assuming
that such a scheme would remain in place, this would be a long-term effect and,
unlike in the case of the debt issue, would not result in a longer term increase in
profits (and so EPS).
Bonus share issue
A bonus share issue has no effect on profit, however it does increase the number
of shares in existence, so reducing both basic and in turn diluted earnings per
share. This reduction is however superficial the companys performance is no
worse simply as a result of the bonus issue. To reflect this, the effect of a bonus
issue also adjusts the comparative figures, so making them comparable with
current year figures.
I hope that you find this information useful, please do contact me if I can be of any
further help,
Kind Regards
Nihinsa
Tutorial note
Regarding a bonus issue of shares, the following illustration explains why the
reduction in EPS is superficial.
A company makes profits of Rs. 100 Mn in year 1 and year 2. It has 100m shares
outstanding throughout year 1 and at the start of year 2 it makes a 1 for 5 bonus
issue. It therefore has 120m shares outstanding throughout year 2.
The performance of the company is identical in both years it makes the same
profits and has the same level of capital available to it.
Basic EPS in year 1 is Rs. 100 Mn/100 Mn shares = Rs. 1
Basic EPS in year 2 is Rs. 100 Mn/120 Mn shares = Rs. 0.83
This doesnt reflect the fact that the performance of the company is identical.
Therefore we adjust the year 1 comparative:
Rs. 1 5/6 (reciprocal of the bonus fraction) = Rs. 0.83.
The same EPS is now reported for both years so demonstrating a comparable
performance.
CA Sri Lanka
489
QUESTION
The Finance Director of Vadugas Industries PLC, a recently listed company, is
applying SLFRS 8 for the first time and has compiled the following information
about operating segments. She has explained that other segments is comprised
of several small diverse businesses, the results of which are deemed so
individually insignificant that the Board does not review them on a regular basis.
The FD is unsure whether the results of all segments need to be reported and has
been told by the CEO that he believes that only Segment B needs to be reported, as
the largest segment.
Revenue
internal
external
Profit before tax
Total assets
Segment
A
Rs Mn
Segment
B
Rs Mn
Segment
C
Rs Mn
60
45
7
16
0
200
8
128
14
20
6
4
Segment Other segments

D
Rs Mn
Rs Mn
145
70
74
12
26
34
14
8
Required
Advise the Finance Director of Vadugas Industries which of the segments are
reportable and explain why SLFRS 8 does not only apply to the largest segment.
ANSWER
SLFRS 8 requires that operating segments are identified and the results of
reportable operating segments disclosed separately.
An operating segment is a segment that engages in business activities to earn
revenues and incur expenses, whose operating results are regularly reviewed by
the chief decision maker and for which discrete financial information is available.
It is assumed that the segments listed meet the definition of operating segments.
Although SLFRS 8 allows for the aggregation of segments with similar
characteristics for the purposes of applying the standard, the other segments are
described as diverse and their results are not regularly reviewed by the Board,
which is assumed to be the chief decision maker. Therefore these other segments
are ignored.
With regard to segments A-D, an operating segment is reportable where its
segment total is 10% or more of total revenue or all segments reporting a profit
(or loss if greater) or assets.
490
CA Sri Lanka
The relevant quantitative thresholds for Vadugas Industries PLC are:

Total
10%
Rs Mn
Rs Mn
Revenue (total)
614
61.4
Profit before tax
109
10.9
Total assets
168
16.8
Therefore:
Segment A meets the revenue test with segment revenue of Rs. 105 Mn
Segment B meets the revenue and asset tests with segment revenue of
Rs. 200 Mn and segment assets of Rs. 128 Mn
Segment C does not meet any of the tests.
Segment D meets the revenue and profit before tax tests with segment
revenue of Rs. 215 Mn and profit before tax of Rs. 74 Mn.
Therefore the results of Segments A, B and D should be reported separately in

accordance with SLFRS 8.
If the company were only to report the results of the largest segment, this would
be of limited use to users of the financial statements. The purpose of SLFRS 8 is to
allow interested parties to understand the risks and rewards attached to different
products and services and different geographical locations. By disclosing only the
results of the largest segment, this information is not evident.
QUESTION
Question name
Jaffna Property PLC reported basic and diluted earnings per share in the year
ended 31 December 20X3 of Rs. 1.23 based on 750,000,000 shares outstanding
throughout the period. In the year ended 31 December 20X4, the company made a
profit of Rs. 950 Mn. At the start of January 20X4, by way of a bonus for
performance in 20X3, the company issued 30,000,000 share options to staff. These
have an exercise price of Rs. 10.00. It also made a 3 for 20 bonus issue of shares on
1 October 20X4.
The average price of a Jaffna Property PLC share in 20X4 was Rs. 12.50.
Required
Advise the appropriate presentation of earnings per share and design the
required disclosures for Jaffna Property PLC in respect of earnings per share.
CA Sri Lanka
491
ANSWER
Both basic and diluted earnings per share are disclosed on the face of the
statement of profit or loss and other comprehensive income with equal
prominence:
Profit for the year (1.23 x 750m)
20X4
Rs'000
950,000
20X3
Rs'000
922,500
Basic earnings per share (W1/W3)
Rs 1.10
Rs 1.07
Diluted earnings per share (W2/W3)
Rs 1.09
Rs 1.07
Note: Earnings per share
The following reflects the income and share data used in the earnings per share
computations
20X4
20X3
Amounts used as numerator
Rs'000
Rs'000
Net profit attributable to the equity holders of
950,000
922,500
the company for basic and diluted earnings per
share
Number of ordinary shares used as denominator
No.
No.
862,500,000
750,000,000
Weighted average number of shares in issue
(Basic EPS)
6,000,000
Potential ordinary shares

868,500,000
750,000,000
Weighted average number of shares in issue
(Diluted EPS)
Workings
Basic earnings per share

Profit attributable to ordinary shareholders (Rs)
950,000,000
Weighted average number of shares:

1 Jan 20X4 30 Sept 20X4
750 Mn 9/12m 23/20 646,875,000
Bonus issue 750m/20 3
112.5 Mn
1 Oct 20X4 -31 Dec 20X4
862.5 Mn 3/12m
215,625,000
862,500,000
Basic EPS therefore

2
950,000,000/862,500,000
Diluted earnings per share

Profit for diluted EPS (unchanged)
492
Rs 1.10
Rs 950,000,000
CA Sri Lanka
Weighted average number of shares for diluted EPS:

For basic EPS
Options
862,500,000
6,000,000
868,500,000
Diluted EPS therefore 950,000,000/868,500,000
Rs 1.09
Options
Funds raised through exercise of options (10.00 30m)

Rs 300,000,000
Number of full price shares (Rs 300,000,000/Rs 12.50)
Number of free shares
3
24,000,000
6,000,000
Restated comparatives
The comparatives are restated by multiplying by the reciprocal of the
bonus fraction:
Rs. 1.23 20/23 = Rs. 1.07
CA Sri Lanka
493
CHAPTER ROUNDUP
494
SLFRS 8 requires that the results of reportable operating segments are

disclosed separately.
Operating segments are reportable when they meet the quantitative threshold
being 10% or more of total entity revenue, profit (or loss if greater) or
assets.
Disclosure is required of operating segment profit or loss, segment assets,

segment liabilities and certain income and expense items together with a
reconciliation of segment totals for these amounts to entity total.
Other disclosures relate to major customers and geographical information.
Earnings per share is widely used by investors as a measure of a companys

performance. LKAS 33 deals with the calculation and presentation of earnings
per share (EPS) and diluted earnings per share (DEPS).
EPS is calculated by dividing the net profit or loss for the period attributable
to ordinary shareholders by the weighted average number of ordinary
shares outstanding during the period.
Diluted EPS is calculated by adjusting the net profit attributable to ordinary

shareholders and the weighted average number of shares outstanding for the
effects of all dilutive potential ordinary shares.
Basic and diluted EPS are presented in the statement of profit or loss and other
comprehensive income with equal prominence.
CA Sri Lanka
PROGRESS TEST
What 3 criteria form the definition of an operating segment?
What proportion of external revenue must be generated by separately reported

operating segments?
About which customers does SLFRS 8 require disclosure?
How does a bonus issue affect the calculation of weighted average number of
shares for the purpose of calculating EPS?
What is the process to calculate diluted earnings per share?
Where in the financial statements is diluted earnings per share disclosed?
CA Sri Lanka
495
(a)
(b)
(c)
75%
Those who represent more than 10% of external revenue.
Shares in issue before the bonus issue are multiplied by the bonus fraction which
is number of shares after the issue/number of shares before the issue.
1.
Calculate basic earnings per share
2.
Calculate the individual earnings per share for each group of potential
ordinary shares in order to identify those that are dilutive and those that are
anti-dilutive.
3.
Ignore the anti-dilutive potential ordinary shares.
4.
Add the dilutive potential ordinary shares into the DEPS calculation one by
one, starting with the most dilutive.
5.
DEPS is the lowest figure calculated for DEPS after each addition of potential
ordinary shares.
496
The segment engages in activities to earn revenue and incur expenses.

Its financial information is reviewed by the chief operating decision maker.
Discrete financial information is available.
On the face of the statement of profit or loss and other comprehensive income (or
statement of profit or loss if presented separately), given equal prominence as
basic EPS.
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises the principles of group accounting including
accounting for subsidiaries, associates and joint arrangements.
Subsequent chapters build on these basics and cover more advanced
group accounting topics.
Knowledge Component
1 Interpretation and Application of Sri Lanka Accounting Standards
1.1 Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

matters.
under standards.
2 Preparation and presentation of Consolidated Financial Statements

2.1 Consolidated
financial
statements
2.1.1
2.2 Joint ventures
2.2.1
2.2.2
Evaluate the information provided and identify the existence of joint ventures.
Compile financial statements for joint ventures.
2.3 Investments in
associates
2.3.1
Advise appropriate accounting treatment to be used when there is an investment in an

associate.
Compile financial statements when there is an investment in an associate.
2.1.2
2.3.2
Compile consolidated financial statements for a group with more than two
subsidiaries, sub subsidiaries and foreign subsidiaries.
Recompile a consolidated set of financial statements post acquisition / merger /
divestment
497
KC1 | Chapter 16: Principles of consolidation
CHAPTER CONTENTS
1 Introduction
2 Principles of consolidation
3 SLFRS 3 Business Combinations
4 Preparation of consolidated financial statements
5 Associates and joint arrangements
6 SLFRS 12 Disclosure of Interests in Other Entities

Evaluate the information provided and recommend which entities require
consolidation.
Advise on recognising and measuring the identifiable assets, acquired, the
liabilities assumed and non-controlling interest in the acquiree.
Assess goodwill/gain from bargain purchase.
Advise on the subsequent measurement and accounting in relation to reaquired
rights and contingent liabilities recognised as of the acquisition date,
indemnification assets and contingent consideration.
Group Accounting Learning objectives
Apply the method of accounting for business combinations including complex
group structures.
Apply the recognition and measurement criteria for identifiable acquired assets
and liabilities and goodwill including step acquisitions.
Outline the circumstances in which a group is required to prepare consolidated
Outline the circumstances when a group may claim an exemption from the
preparation of consolidated financial statements.
Outline why directors may not wish to consolidate a subsidiary and where this
is permitted.
Outline and apply the key definitions and accounting methods which relate to
interests in joint arrangements.
498
CA Sri Lanka
Investments in Associates and Joint Ventures Learning objectives

Outline the different joint arrangements.
Apply the equity method of accounting for associates and joint arrangements.
Advise on assessment of joint control and significant influence.
Contrast the principles of control, joint control and significant influence.
Advise when to discontinue the equity method of accounting.
Analyse impairment conditions and apply the methodology for accounting for
impairment.
Prepare disclosures on information about significant judgements and
assumptions in determining control, joint control and significant influence.
List disclosure requirements:
Subsidiaries
Non-controlling interest
Nature and extent of significant restrictions
Nature of risk associated with entitys interest in consolidated structured
entities
Interest in joint arrangements and associates
Interest in unconsolidated structured entities.
1 Introduction
A parent company prepares consolidated financial statements to include its
subsidiaries. Associates and joint ventures are accounted for using the equity
method. Other investments are financial assets accounted for under LKAS 39.
A group of companies includes a parent company and one or more subsidiaries. It
may also include one or more associates. Five accounting standards are relevant
to group accounting; they are:
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LKAS 27 Separate Financial Statements

LKAS 28 Investments in Associates
SLFRS 3 Business Combinations
SLFRS 10 Consolidated Financial Statements
SLFRS 11 Joint Arrangements
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These standards are all concerned with different aspects of group accounts, but
there is some overlap between them.
1.1 Definitions
The following definitions are drawn from the standards listed above:
A group is a parent and its subsidiaries. (SLFRS 10)
A parent is an entity that controls one or more entities. (SLFRS 10)
A subsidiary is an entity that is controlled by another entity. (SLFRS 10)
Control an investor controls an investee when the investor is exposed, or has
rights, to variable returns from its involvement with the investee and has the
ability to affect those returns through power over the investee. (SLFRS 10)
Power is existing rights that give the current ability to direct the relevant
activities. (SLFRS 10)
Relevant activities are activities of the investee that significantly affect the
investees returns. (SLFRS 10)
An associate is an entity over which an investor has significant influence that is
neither a subsidiary nor a joint venture. (LKAS 28)
Significant influence is the power to participate in the financial and operating
policy decisions of an investee but is not control or joint control over those
policies. (LKAS 28)
A joint arrangement is an arrangement of which two or more parties have joint
control. (SLFRS 11, LKAS 28)
Joint control is the contractually agreed sharing of control of an arrangement,
which exists only when decisions about the relevant activities require the
unanimous consent of the parties sharing control. (SLFRS 11, LKAS 28)
A joint venture is a joint arrangement whereby the parties that have joint control
of the arrangement have rights to the net assets of the arrangement. (SLFRS 11,
LKAS 28)
A joint operation is a joint arrangement whereby the parties that have joint
control of the arrangement have rights to the assets and obligations for the
liabilities relating to the arrangement. (SLFRS 11)
Further definitions are provided in the relevant Sections of this Chapter.
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1.2 Levels of investment

The treatment applied by an investor (parent company) to its investee is
summarised in the following table:
Investment
Criteria
Required treatment in
group accounts
Subsidiary
Control
Full consolidation
Associate
Significant influence
Equity accounting
Joint venture
Joint control
Equity accounting
Investment
Asset held for accretion of

wealth / dividend income
As a financial asset
Sections 24 of this chapter deal with the consolidation of a subsidiary. Section 5

deals with identifying and accounting for associates and joint ventures in the
consolidated financial statements. Financial asset investments are dealt with in
Chapter 12 Financial Instruments.
1.2.1 Separate financial statements
LKAS 27 Separate Financial Statements provides accounting guidance to be
applied in the preparation of the parents single company financial statements.
Investments in subsidiaries, joint ventures and associates included in the
consolidated financial statements should be either:
(a)
(b)
Accounted for at cost, or

In accordance with LKAS 39 /SLFRS 9 as a financial asset.
The same accounting must be applied to each category of investments.

Where an entity opts to measure investments at cost, these should be measured in
accordance with SLFRS 5 at such time as they become classified as held for sale.
An investor should recognise a dividend from a subsidiary, joint venture or
associate in profit or loss in its separate financial statements when a right to
receive the dividend is established.
An investor should disclose in its separate financial statements the consolidated
financial statements that they relate to as well as:
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(a)
The fact that the statements are separate financial statements
(b)
A list of significant investments including the name of investees, the

principal place of business, the country of incorporation, the proportion of
ownership interest held and the proportion of voting rights held.
(c)
A description of the method used to account for the investments.

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Where a parent company is exempt from preparing consolidated financial

statements (see section 2.2) and takes advantage of that exemption, it must
disclose (a) (c) as listed above together with:
The fact that the exemption has been used,
Details of the ultimate parent company that has produced consolidated
financial statements
An investment entity that prepares separate financial statements as its only
financial statements should disclose that fact.
2 Principles of consolidation
A subsidiary is an entity that is controlled by a parent company; unless the
parent company is an investment entity it must consolidate all subsidiaries.
2.1 Identification of a subsidiary

As defined above, a subsidiary is an entity that is controlled by another entity. An
investor has control over an investee if and only if it has all of the following:
(1)
Power over the investee
(2)
Exposure to, or rights to, variable returns from its involvement with the
investee; and
(3)
The ability to use its power over the investee to affect the amount of the
investors returns
If there are changes to one or more of these three elements of control, then an
investor should reassess whether it controls an investee.
2.1.1 Power
Power is defined as existing rights that give the current ability to direct the
relevant activities of the investee. There is no requirement for that power to have
been exercised.
Relevant activities may include:
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Selling and purchasing goods or services

Managing financial assets
Selecting, acquiring and disposing of assets
Researching and developing new products and processes
Determining a funding structure or obtaining funding
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In some cases assessing power is straightforward, for example, where power is

obtained directly and solely from having the majority of voting rights or potential
voting rights, and as a result the ability to direct relevant activities.
In other cases, assessment is more complex and more than one factor must be
considered. SLFRS 10 gives the following examples of rights, other than voting or
potential voting rights, which individually, or alone, can give an investor power.
Rights to appoint, reassign or remove key management personnel who can
direct the relevant activities
Rights to appoint or remove another entity that directs the relevant activities
Rights to direct the investee to enter into, or veto changes to transactions for
the benefit of the investor
Other rights, such as those specified in a management contract
SLFRS 10 suggests that the ability rather than contractual right to achieve the
above may also indicate that an investor has power over an investee.
An investor can have power over an investee even where other entities have
significant influence or other ability to participate in the direction of relevant
activities.
2.1.2 Exposure to variable returns
An investor must have exposure, or rights, to variable returns from its
involvement with the investee in order to establish control.
This is the case where the investors returns from its involvement have the
potential to vary as a result of the investees performance.
Returns may include:
Dividends
Remuneration for servicing an investees assets or liabilities
Fees and exposure to loss from providing credit support
Returns as a result of achieving synergies or economies of scale through an
investor combining use of their assets with use of the investees assets
2.1.3 Link between power and returns
In order to establish control, an investor must be able to use its power to affect its
returns from its involvement with the investee. This is the case even where the
investor delegates its decision making powers to an agent.
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2.1.4 Potential voting rights

An entity may own share warrants, share call options, or other similar
instruments that are convertible into ordinary shares in another entity. If these
are exercised or converted they may give the entity voting power or reduce
another party's voting power over the financial and operating policies of the other
entity (potential voting rights). The existence and effect of potential voting rights,
including potential voting rights held by another entity, should be considered
when assessing whether an entity has control over another entity (and therefore
has a subsidiary). Potential voting rights are considered only if the rights are
substantive (meaning that the holder must have the practical ability to exercise
the right).
In assessing whether potential voting rights give rise to control, the investor
should consider the purpose and design of the instrument. This includes an
assessment of the various terms and conditions of the instrument as well as the
investor's apparent expectations, motives and reasons for agreeing to those terms
and conditions.
QUESTION
Identification of subsidiaries
The following scenarios are unrelated:

1
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AB Co and CD Co establish XY Co, each holding 50% of the voting shares. The
shareholders agreement specifies that:
(a)
XY Co exists to generate capital gains from property investment; its

activities are limited to buying, managing and selling investment
properties.
(b)
All decisions about major capital activities require the agreement of

both investors.
(c)
AB Co is responsible for day to day management activities of XY Co

such as negotiating rental agreements, collecting rent and property
maintenance. AB Co is paid for these services on the basis of costs plus
a fixed margin.
HJ Co holds 48% of the ordinary shares in KL Co. KL Cos relevant activities

are directed by voting rights conferred by ordinary shares. The remaining
52% of the shares are owned by hundreds of unrelated investors, none of
whom own more than 1% individually. There are no arrangements for the
other shareholders to consult one another or act collectively and past
experience indicates that few of the other owners exercise their voting rights
at all.
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EF Bank establishes a special purpose vehicle SP and owns 100% of its shares.
SP simultaneously enters into a trade receivables factoring agreement with PQ
Co. This is the sole purpose of SP. An agreement sets out the terms on which
SP will purchase PQ Cos receivables and EF Bank will provide financing for
that purpose. PQ Co will continue to be responsible for collecting and
managing the receivables and it is required to provide a guarantee that losses
on the transferred receivables will not exceed a certain amount. The shares
held by EF Bank confer voting rights but cannot override the restriction on
SPs activities or invalidate the contract with PQ Co.
RS Co holds 40% of the equity shares of XY Co and has an option to acquire a

further 30% shareholding from MN Co. XY Co is controlled by shareholder
vote and there are no other contractual or non-voting rights that affect
assessment of control. RS Cos option was acquired recently and is exercisable
at any time over the next two years. The exercise price is fixed and the fixed
price exceeds the current fair value of the underlying shares by 30%. The fair
value of the underlying shares is expected to increase substantially over the
coming two years. It is RS Cos intention to acquire the ability to control XY Co.
Required
Discuss whether control is established in each of these scenarios.
ANSWER
1
Both major capital activities and day to day management activities are likely
to be relevant activities ie affect XY Cos returns. We should therefore
consider which activities have the greatest effect on returns.
If capital activities have the most significant impact (which may be the
case because the stated objective is to achieve capital gains) then AB Co
and CD Co have joint control of XY Co.
If day to day management activities are considered more significant then
AB Co has control because it directs these activities unilaterally.
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HJ Co controls KL Co. Its voting power is sufficient to provide the practical

ability to direct. A large number of other investors would have to act
collectively to outvote HJ Co and there is no mechanism in place to facilitate
collective action.
EF Bank owns 100% of SP however it is unlikely that the voting rights confer
the ability to direct the relevant activities. This is due to the restrictions on
SPs activities and the factoring agreement. PQ Co is likely to be the entity
that directs the relevant activities of SP because it manages the receivables.
It is therefore likely that PQ Co controls SP.
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RS Co must consider whether its potential voting rights are substantive ie

whether RS Co has the practical ability to exercise the option. It must
consider whether the exercise price is a barrier to exercise. The premium of
30% may or may not prevent the option from being substantive. In deciding
this, RS Co should consider:
Whether 30% is a reasonable premium
If the premium is a disincentive at present, whether the fair value of the
underlying shares is expected to increase so that the premium reduces
within the timeframe for directing relevant activities
Managements intentions and motivations for purchasing an option.
In this case RS intends to acquire control of XY Co and the premium is
expected to decrease over the period during which the option can be
exercised. Therefore the potential voting rights are included in the
assessment of control and it can be concluded that RS Co controls XY Co.
2.2 Preparation of consolidated financial statements

Consolidated financial statements are financial statements in which the assets,
liabilities, equity, income, expenses and cash flows of the parent and its
subsidiaries are presented as those of a single economic entity. When a parent
issues consolidated financial statements, it should consolidate all subsidiaries,
both foreign and domestic.
2.2.1 Exemption from preparing consolidated financial statements
A parent need not present consolidated financial statements if and only if all of the
following hold:
(a)
The parent is itself a wholly-owned subsidiary or it is a partially owned

subsidiary of another entity and its other owners, including those not
otherwise entitled to vote, have been informed about, and do not object to,
the parent not presenting consolidated financial statements
(b)
Its securities are not publicly traded
(c)
It is not in the process of issuing securities in public securities markets; and
(d)
The ultimate or intermediate parent publishes consolidated financial

statements that comply with International Financial Reporting Standards
A parent that does not present consolidated financial statements must comply
with the LKAS 27 rules on separate financial statements.
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2.2.2 Exclusion of a subsidiary from consolidation

An entity that is not an investment entity must consolidate all of the subsidiaries
that it controls. An entity may not be excluded from consolidation on the grounds
of:
Dissimilar activities (since more relevant information is provided where
consolidated financial statements include all subsidiaries and then additional
information is provided about different business activities)
Severe long term restrictions (if the long term restrictions under which a
subsidiary operates do not result in a loss of control, then that subsidiary must
be consolidated).
These rules are necessarily strict as historically the exclusion of subsidiaries from
consolidation has been a method used by groups to manipulate their results. Note
that the definition of a subsidiary is an entity and this term includes
unincorporated entities. Therefore structuring a controlled business as a
partnership does not result in its exclusion from consolidation.
2.2.3 Investment entities
An investment entity is an entity that:
(a)
Obtains funds from one or more investors for the purpose of providing those
investor(s) with investment management services;
(b)
Commits to its investor(s) that its business purpose is to invest funds solely
for returns from capital appreciation, investment income or both; and
(c)
Measures and evaluates the performance of substantially all of its

investments on a fair value basis. (SLFRS 10)
Investment entities include entities such as pension funds, venture capital

organisations and other investment funds.
These entities do not consolidate the results of the subsidiaries that they control
as this does not result in relevant or useful information. Instead investment
entities are required to measure their subsidiaries at fair value through profit or
loss.
This requirement does not extend to the subsidiaries of an investment entity that
provide services relating to the investment entitys activities. These subsidiaries
are consolidated as normal.
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2.3 Mechanics of consolidation

SLFRS 10 makes the following points:
If a subsidiary prepares its financial statements to a different reporting date
from that of the group it should prepare additional financial statements to the
group reporting date, or if that is not possible its most recent accounts may be
used for consolidation providing that:
(i)
The gap between the reporting dates is three months or less, and
(ii)
Adjustments are made for the effects of significant transactions or other

events that occur between the reporting dates.
Uniform accounting policies should be applied in the consolidated financial

statements; where a group member uses different accounting policies, its
financial statements are adjusted for consolidation.
The results of a subsidiary are included in the consolidated financial statements
from the date on which the investor obtains control of the investee.
The results of a subsidiary cease to be included in the consolidated financial
statements on the date on which the investor loses control of the investee.
3 SLFRS 3 Business Combinations

SLFRS 3 Business Combinations provides guidance on the measurement of net
assets acquired in a business combination and the calculation of goodwill.
SLFRS 3 deals with business combinations and in particular addresses the
recognition and measurement of the following at the acquisition date:
The assets and liabilities of the acquired subsidiary (the acquiree) at the
acquisition date
Consideration paid for shares in the acquiree
The non-controlling interest in the acquiree.
3.1 Definitions
SLFRS 3 provides a number of definitions including the following:
Acquiree is the business that the acquirer obtains control of in a business
combination.
Acquirer is the entity that obtains control of the acquiree.
Acquisition date is the date on which the acquirer obtains control of the acquiree.
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Business combination is a transaction or other event in which an acquirer

obtains control of one or more businesses.
Contingent consideration is usually an obligation of the acquirer to transfer
additional assets or equity interests to the former owners of an acquiree as part of
the exchange for control of the acquiree if specified future events occur or
conditions are met.
measurement date.
Goodwill is an asset representing the future economic benefits arising from other
assets acquired in a business combination that are not individually identified and
separately recognised.
An asset is identifiable if it either:
(a)
Is separable ie capable of being separated or divided from the entity and

sold, transferred, licensed, rented or exchanged, either individually or
together with a related contract, identifiable asset or liability, regardless of
whether the entity intends to do so; or
(b)
Arises from contractual or other legal rights, regardless of whether those

rights are transferable or separable from the entity or from other rights and
obligations.
Non-controlling interest is the equity in a subsidiary not attributable, directly or

indirectly, to a parent.
3.2 The acquisition method

The acquisition method takes a four-step approach:
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Acquirer is
identified
One party must be the acquirer; a business combination

cannot be a merger.
Acquisition date
is determined
The acquisition date is the date on which control is

gained; this is normally the date on which consideration
is transferred and assets and liabilities acquired.
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Assets, liabilities
and NCI of
acquiree are
recognised and
measured
Identifiable assets, assumed liabilities and the noncontrolling interest should be recognised on acquisition.
Some assets or liabilities that were not previously
recognised by the acquiree may be recognised on
consolidation eg internally generated intangible assets.
Goodwill is
recognised and
measured
Goodwill is the excess of the fair value of consideration

transferred plus the non-controlling interest over the
fair value of identifiable net assets acquired.
3.3 Goodwill
Goodwill arises in consolidated financial statements as a consolidation adjustment
and is calculated as:
Rs.
Fair value of consideration transferred
X
X
Less: Fair value of identifiable assets acquired and liabilities
(X)
Assumed
Goodwill
3.3.1 Consideration
Consideration of any form is included in the calculation of goodwill at the
acquisition date fair value. Acquisition costs are not part of consideration; these
are expensed as incurred.
Contingent consideration is included at its acquisition date fair value. The
acquirer may be required to pay contingent consideration in the form of equity or
of a debt instrument or cash. Debt instruments are presented in accordance with
LKAS 32.
Contingent consideration may occasionally be an asset, for example if the
consideration has already been transferred and the acquirer has the right to the
return of part of it, an asset may occasionally be recognised in respect of that right.
Postacquisition, the subsequent accounting for contingent consideration depends
on the circumstances:
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(a)
If the change in fair value is due to additional information obtained that

affects the position at the acquisition date, goodwill should be re-measured.
(b)
If the change is due to events which took place after the acquisition date, for
example, meeting earnings targets:
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(i)
Account for under LKAS 39 if the consideration is in the form of a

financial instrument, for example loan notes.
(ii)
Account for under LKAS 37 if the consideration is in the form of cash.
(iii) An equity instrument is not remeasured.
3.3.2 Non-controlling interest

SLFRS 3 views a group as an economic entity. This means that it treats all
providers of equity including non-controlling interests as shareholders in the
group, even if they are not shareholders of the parent.
It is for this reason that the non-controlling interests are included in the
calculation of goodwill.
SLFRS 3 applies a different rule to the measurement of the non-controlling
interest at acquisition depending on whether the relevant shareholders are
entitled to a proportionate share of the entitys net assets in the event of a
liquidation.
Where non-controlling interest shareholders are entitled to a proportionate
share of the net assets on a liquidation, the non-controlling interest at
acquisition is measured either at fair value or as a proportionate share of the
fair value of the acquirees identifiable net assets. This choice is available on a
transaction by transaction basis.
Where non-controlling interest shareholders are not entitled to a proportionate
share of the net assets on a liquidation, the non-controlling interest is measured
at fair value.
The non-controlling interest at fair value will be different from the non-controlling
interest as a proportionate share of the acquiree's net assets. The difference is
goodwill attributable to non-controlling interest, which may be, but often is not,
proportionate to goodwill attributable to the parent.
3.3.3 Assets and liabilities acquired
The net assets of the subsidiary on the acquisition date are measured at fair value
for inclusion within the consolidated financial statements and the goodwill
calculation.
The basic recognition rule is that assets and liabilities must meet the definitions
of assets and liabilities in the Conceptual Framework and must be part of the
business combination transaction rather than a separate transaction.
Fair value is normally determined by reference to SLFRS 13 Fair Value
Measurement.
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The subsidiary company may incorporate fair value adjustments in its own
financial statements; if it does not, fair value adjustments must be made as a
consolidation adjustment.
SLFRS 3 provides guidance on the recognition of certain assets and liabilities as
follows:
Restructuring and future losses
An acquirer should not recognise liabilities for future losses or other costs
expected to be incurred as a result of the business combination.
SLFRS 3 explains that a plan to restructure a subsidiary following an acquisition is
not a present obligation of the acquiree at the acquisition date. Neither does it
meet the definition of a contingent liability. Therefore an acquirer should not
recognise a liability for such a restructuring plan as part of allocating the cost of
the combination unless the subsidiary was already committed to the plan before
the acquisition.
This prevents creative accounting. An acquirer cannot set up a provision for
restructuring or future losses of a subsidiary and then release this to profit or loss
in subsequent periods in order to reduce losses or smooth profits.
Intangible assets
The acquiree may have intangible assets, such as development expenditure. These
can be recognised separately from goodwill only if they are identifiable. An
intangible asset is identifiable only if it:
(a)
Is separable, ie capable of being separated or divided from the entity and

sold, transferred, or exchanged, either individually or together with a related
contract, asset or liability, or
(b)
Arises from contractual or other legal rights
Contingent liabilities
Contingent liabilities of the acquirer are recognised if their fair value can be
measured reliably. A contingent liability must be recognised even if the outflow is
not probable, provided there is a present obligation.
This is a departure from the normal rules in LKAS 37; contingent liabilities are not
normally recognised, but only disclosed.
After their initial recognition, the acquirer should measure contingent liabilities
that are recognised separately at the higher of:
(a)
(b)
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The amount that would be recognised in accordance with LKAS 37

The amount initially recognised
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Other exceptions to the recognition or measurement principles

Deferred tax: use LKAS 12 values.
Employee benefits: use LKAS 19 values.
Indemnification assets: measurement should be consistent with the
measurement of the indemnified item, for example an employee benefit or a
contingent liability.
Reacquired rights: value on the basis of the remaining contractual term of the
related contract regardless of whether market participants would consider
potential contractual renewals in determining its fair value.
Share-based payment: use SLFRS 2 values.
Assets held for sale: use SLFRS 5 values.
QUESTION
Goodwill
You are the financial accountant at SL Traders Ltd. SL Traders Ltd acquired 90%
of the 2 million shares in Columbo Imports Ltd on 31 August 20X2. This is the
latest in a series of acquisitions and SL Traders Ltd has adopted a consistent policy
of measuring the non-controlling interest at fair value.
Consideration provided to the shareholders of Columbo Imports Ltd comprised
Rs. 4.2 Mn cash payable immediately; one share in SL Traders Ltd for every 50
acquired; and Rs. 1 Mn payable on 31 August 20X5 if Columbo Imports achieves a
specified revenue growth. This growth is considered unlikely at the acquisition
date and as such the fair value of contingent consideration at the acquisition date
is assessed as 25% of its face value. The market value of an SL Traders share at
the acquisition date is Rs. 45 and the market value of a Columbo Imports share is
Rs. 3.
You have discovered the following information relevant to Columbo Imports at the
acquisition date:
In its most recent financial statements to 31 July 20X2 the company disclosed
details of an on-going legal case. No provision was made for the possible costs
of Rs. 90,000 as these were not considered probable of payment. This
assessment of the situation remains in place at the acquisition date.
The company has a well-established trade name and logo. Both are registered
with the relevant authorities but are not recognised in Columbo Imports
financial statements. The fair value of the trade name has been assessed as
Rs. 300,000.
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A junior accountant at SL Traders has produced a draft calculation of the goodwill

arising on the acquisition:
Rs'000
Rs'000
4,200
Cash consideration
108
Share for share exchange
(90% 2m)/50 Rs 3
794
Contingent cash consideration
1m 1/1.083
120
Legal fees of acquisition
5,222
Net assets acquired
2,000
Stated capital
4,100
Reserves
(6,100)
(878)
Goodwill
(figures to the nearest '000)
Required
Review and correct the draft calculation, explaining any adjustments that you make.
Note
Rs'000
Rs'000
4,200
Cash consideration
1
1,620
Share for share exchange
(90% 2m)/50 Rs 45
2
250
Contingent cash consideration
6,070
4
600
(10% 2m Rs 3)
6,670
Fair value of identifiable assets acquired and liabilities assumed
2,000
Stated capital
4,100
Reserves
5
(90)
Contingent liability
6
300
Registered trade name
(6,310)
360
Goodwill
Explanatory notes
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The share-for-share exchange results in the previous owners of Columbo

Imports Ltd receiving a total of 36,000 shares in SL Imports Ltd. These
shares each have a market value of Rs. 45 and so share consideration is a
total of 36,000 Rs. 45 = Rs. 1.62 Mn. The junior accountant has
erroneously used Columbo Imports own share price in the calculation.
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Contingent cash consideration is included in the calculation of goodwill at

fair value at the acquisition date. The fair value at the acquisition date takes
into account the time value of money and therefore should not be
discounted.
Legal fees are acquisition costs and do not form part of consideration.
The non-controlling interest (NCI) forms part of the calculation of goodwill in

accordance with SLFRS 3. Group policy is to measure the NCI at fair value ie
based on the market value of Columbo Imports shares at the acquisition date.
Columbo Imports contingent liability is included as a liability of the

company at the acquisition date in accordance with SLFRS 3 despite it not
being probable of payment. This is because there is a present (legal)
obligation.
The registered trade name meets the contractual-legal criterion for

identifiability of intangible assets. Therefore SLFRS 3 requires that it is
recognised as an acquisition date asset at its fair value.
3.4 Accounting for goodwill

Positive goodwill is recognised at the acquisition date as a group asset. It is not
amortised, but must be tested for impairment at least annually.
Negative goodwill (gain on a bargain purchase) is credited to profit or loss
immediately. Before recognising a gain on a bargain purchase the acquirer must:
(i)
Reassess whether it has correctly identified all of the assets acquired and all
of the liabilities assumed and must recognise any additional assets or
liabilities that are identified in that review
(ii)
Review the procedures used to measure each element of the goodwill

calculation.
3.5 Measurement period adjustments

Sometimes the fair values of the acquiree's identifiable assets, liabilities or
contingent liabilities or the cost of the combination can only be determined
provisionally by the end of the period in which the combination takes place.
In this situation, the acquirer should account for the combination using those
provisional values and then continue to work to identify actual values.
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The period during which this work to identify actual values is carried out is known
as the measurement period. It ends on the earlier of:
The date by which the acquirer has received all of the information it was
seeking or learns that the information cannot be obtained, or
12 months after acquisition.
During this period the acquirer may adjust provisional amounts to reflect new
information obtained about facts and circumstances that existed on the
acquisition date. Amounts are adjusted retrospectively, meaning that the goodwill
initially calculated may change.
Any adjustments after the measurement period are recognised only to correct an
error in accordance with LKAS 8.
3.6 Disclosures
An acquirer must disclose information to enable the users of its financial
statements to evaluate the nature and financial effect of a business combination
that occurs during the current period or after the end of the period but before the
financial statements are authorised for issue. This information should include:
The name and a description of the acquiree
The acquisition date
The percentage of voting equity interests acquired
The reasons for the business combination
A qualitative description of the factors that make up the goodwill recognised
The acquisition date fair value of the total consideration transferred and each
major class of consideration
For contingent consideration:
the amount recognised at acquisition
a description of the arrangement
an estimate of the range of outcomes
Details of acquired receivables
Amounts recognised for each class of assets and liabilities acquired
Disclosure in accordance with LKAS 37 for contingent liabilities recognised
The amount of a gain in a bargain purchase and a description of reasons why
the transaction resulted in a gain
516
CA Sri Lanka
The amount of any non-controlling interests and the measurement basis

applied
Valuation techniques used to determine the fair value of the non-controlling
interests where relevant.
4 Preparation of consolidated financial statements

In the consolidated statement of financial position assets and liabilities are
added together on a line by line basis; in the consolidated statement of profit or
loss and other comprehensive income, income and expenses are added
together on a line by line basis. Consolidation adjustments include those for
goodwill, goodwill impairment and the effects of intra-group trading.
The preparation of a consolidated statement of financial position and consolidated
statement of profit or loss and other comprehensive income were covered in
detail at KB1 level. This section revises that knowledge in brief, however you may
wish to go back and review your earlier notes since Chapters 17 and 18 of this
Study Text assume that you fully understand the basics of consolidation.
4.1 Summary of techniques consolidated statement of financial

position
Prepare a consolidation schedule with the parent and subsidiary statements of
financial position listed in columns side by side.
Add the columns together to create a total column.
Calculate goodwill and record the acquisition journal:
DEBIT
DEBIT
DEBIT
DEBIT/CREDIT
CREDIT
CREDIT
Goodwill
Stated capital (of S)
Retained earnings / reserves (of S)
Fair value adjustments
Cost of investment (of P)
Recognise any subsequent impairment of goodwill:

If the NCI is measured as a proportion of net assets and goodwill is parent
goodwill only:
DEBIT
CREDIT
CA Sri Lanka
Retained earnings
Goodwill
517
If the NCI is measured at fair value and goodwill is full goodwill:

DEBIT
DEBIT
CREDIT
Retained earnings (group %)

Non-controlling interest (NCI %)
Goodwill
Allocate the relevant share of post acquisition retained earnings and other
reserves to the NCI:
DEBIT
CREDIT
Retained earnings / reserves

Cancel any intra-group balances (after accounting for cash / goods in transit by
assuming they have been received):
DEBIT
CREDIT
Payables/Loan
Receivables/investment
Eliminate unrealised profits:

Where the parent company is the seller:
DEBIT
CREDIT
Retained earnings
Inventory / PPE
Where the subsidiary is the seller:

DEBIT
DEBIT
CREDIT
518
Retained earnings (group %)

Non-controlling interest (NCI %)
Inventory/PPE
CA Sri Lanka
QUESTION
Consolidated statement of financial position
You are provided with the following statements of financial position for Lakegala
and Purijjala.
STATEMENTS OF FINANCIAL POSITION AS AT 31 OCTOBER 20X0
Lakegala
Purijjala
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Non-current assets, at net book value
325
70
Plant
200
50
Fixtures
525
120
Investment
200
Shares in Purijjala at cost
Current assets
220
70
Inventory at cost
145
105
Receivables
0
100
Bank
175
465
1,190
295
Equity
700
170
Stated capital
215
50
Retained earnings
915
220
Current liabilities
275
55
Payables
0
20
Bank overdraft
75
275
295
1,190
The following information is also available.
CA Sri Lanka
(a)
Lakegala purchased 70% of the 170 Mn issued ordinary shares of Purijjala

four years ago, when the retained earnings of Purijjala were Rs. 20 Mn. There
has been no impairment of goodwill.
(b)
For the purposes of the acquisition, plant in Purijjala with a book value of
Rs. 50 Mn was revalued to its fair value of Rs. 60 Mn. The revaluation was
not recorded in the accounts of Purijjala. Depreciation is charged at 20%
using the straight-line method.
(c)
Lakegala sells goods to Purijjala at a mark up of 25%. At 31 October 20X0,

the inventories of Purijjala included Rs. 45 Mn of goods purchased from
Lakegala.
519
(d)
Purijjala owes Lakegala Rs. 35 Mn for goods purchased and Lakegala owes
Purijjala Rs. 15 Mn.
(e)
It is the group's policy to measure the non-controlling interest at fair value.
(f)
The market price of the shares of the non-controlling shareholders just

before the acquisition was Rs. 1.50.
Required
Prepare the consolidated statement of financial position of Lakegala as at
31 October 20X0.
ANSWER
Consolidated statement of financial position at 31 October 20XO
Plant
Total
(W1)
(W2)
(W3)
(W4)
(W5)
Cons.
Rs Mn
325
Rs Mn
70
Rs Mn
395
Rs Mn
10
Rs Mn
Rs Mn
(8)
Rs Mn
Rs Mn
Rs Mn
397
Fixtures
200
50
250
Investment
200
200
(200)
76.5
76.5
Goodwill
Inventory
220
70
290
Receivables
145
105
250
Bank
100
100
250
(9)
1,190
295
1,485
700
170
870
(170)
Retained earnings
215
50
265
(20)
(9)
(5.6)
76.5
(2.4)
275
55
330
20
20
1,190
295
1,485
Payables
Bank overdraft
200
100
Stated capital
NCI
281
(50)
1,304.5
700
(9)
221.4
83.1
(50)
280
20
1,304.5
WORKINGS
1
Calculate goodwill
Goodwill
Rs Mn
Fair value of NCI (30% 170,000 Rs 1.50)
Net assets acquired:
Stated capital
Retained earnings at acquisition
FV Adjustment (60 50)
Goodwill
520
Rs Mn
200
76.5
170
20
10
(200)
76.5
CA Sri Lanka
The consolidation journal is (Rs Mn):

DEBIT
DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
2
Goodwill
Stated capital
Retained earnings
Plant
Investment
NCI
76.5
170
20
10
200
76.5
NCI allocation of post acquisition reserves

Post acquisition retained earnings are Rs. 50 Mn Rs. 20 Mn = Rs. 30 Mn.
These are allocated to the NCI by (Rs Mn):
DEBIT
Retained earnings (30% 30m)
CREDIT NCI (30% 30m)
9
9
Depreciation of fair value adjustment

A plant fair value adjustment of Rs. 10 Mn was recognised at acquisition.
This is depreciated at 20% straight line (ie over 5 years) and therefore at the
reporting date has been depreciated by 80% ie Rs. 10 Mn 80% = Rs. 8 Mn.
This is recorded by (Rs Mn):
DEBIT
Retained earnings
DEBIT NCI (30% 8m)
CREDIT Plant
(70% 8m)
5.6
2.4
8
Unrealised profit
The unrealised profit is Rs. 45 Mn 25%/125% = Rs. 9 Mn. The selling
company is Lakegala and therefore the unrealised profit is eliminated by
(Rs Mn):
DEBIT
CREDIT
Retained earnings
Inventory
9
9
Intragroup balances
Purijjala has an intercompany payable balance of Rs. 35 Mn and Lakegala an
intercompany receivable balance of the same amount; Lakegala has an
intercompany payable balance of Rs. 15 Mn and Purijjala an intercompany
receivable balance of the same amount.
These are eliminated by (Rs Mn):
DEBIT
CREDIT
CA Sri Lanka
Payables (35m + 15m)

Receivables
50
50
521
4.2 Summary of techniques consolidated statement of profit or

loss and other comprehensive income
Prepare a consolidation schedule with the parent and subsidiary statements of
profit or loss and other comprehensive income listed in columns side by side. If
the subsidiary is acquired mid year or disposed of mid year, pro rate its results
before listing.
Add the columns together to create a total column.
Allocate Ss profit and total comprehensive income between owners of the
parent and the NCI in additional rows at the bottom of the consolidation
schedule.
Eliminate any dividend income in Ps profit or loss from S:
DEBIT
CREDIT
Dividend income (CSPL)

Retained earnings (CSOFP)
Cancel any intercompany trading transactions:

DEBIT
CREDIT
Revenue
Cost of sales
Other intercompany transactions such as intercompany interest should also be

cancelled.
Recognise any impairment of goodwill in the year:
DEBIT
CREDIT
Goodwill (CSOFP)
The debit entry is allocated in its entirety to the owners of the parent where the
NCI is measured as a proportion of net assets; it is allocated between the
owners of the parent and the NCI where the NCI is measured at fair value.
Eliminate any unrealised profits by:
DEBIT
CREDIT
Cost of sales/expense
Inventory/PPE (SOFP)
The debit entry is allocated in its entirety to the owners of the parent where the
parent is the selling company; it is allocated between the owners of the parent
and the NCI where the subsidiary is the selling company.
522
CA Sri Lanka
QUESTION
Consolidated statement of profit or loss

and other comprehensive income
Dias owns two subsidiaries acquired as follows:

1 July 20X1
80% of Kalu for Rs. 5 Mn when the carrying amount of the net
assets of Kalu was Rs. 4 Mn.
30 November 20X7 65% of Beira for Rs. 2.6 Mn when the carrying amount of
the net assets of Beira was Rs. 3.35 Mn.
The companies' statements of profit or loss and other comprehensive income for
the year ended 31 March 20X8 were:
Dias
Kalu
Beira
Rs'000
Rs'000
Rs'000
5,000
3,000
2,910
Revenue
(3,000)
(2,300)
(2,820)
Cost of sales
2,000
700
90
Gross profit
(1,000)
(500)
(150)
230
Other income
(50)
(210)
Finance costs
1,230
150
(270)
Profit/(loss) before tax
(300)
(50)
Income tax expense

930
100
(270)
PROFIT/(LOSS) FOR THE YEAR
130
40
120
Other comprehensive income, net of tax
1,060
140
(150)
TOTAL COMPREHENSIVE INCOME FOR THE
YEAR
200
50
Dividends paid during the year

Additional information
CA Sri Lanka
(1)
On 1 April 20X7, Beira issued Rs. 2.1 Mn 10% loan stock to Dias. Interest is
payable twice yearly on 1 October and 1 April. Dias has accounted for the
interest received on 1 October 20X7 only (within other income).
(2)
On 1 July 20X7, Kalu sold a freehold property to Dias for Rs. 800,000 (land
element Rs. 300,000). The property originally cost Rs. 900,000 (land
element Rs. 100,000) on 1 July 20W7. The property's total useful life was
50 years on 1 July 20W7 and there has been no change in the useful life
since. Kalu has credited the profit on disposal to 'Administrative expenses'.
(3)
The property, plant and equipment of Beira on 30 November 20X7 was fair
valued at Rs. 500,000 (carrying amount Rs. 350,000) and was acquired in
April 20X7. The property, plant and equipment has a total useful life of ten
years. Beira has not adjusted its accounting records to reflect fair values. The
group accounting policy is to measure non-controlling interests at the
proportionate share of the fair value of net identifiable assets at acquisition.
523
(4)
All companies use the straight-line method of depreciation and charge a full
year's depreciation in the year of acquisition and none in the year of
disposal. Depreciation on fair value adjustments is time apportioned from
the date of acquisition.
(5)
Dias has accounted for its dividend received from Kalu in 'Other income'.
(6)
Impairment tests conducted at the year end revealed recoverable amounts of

Rs. 7,040,000 for Kalu and Rs. 3,700,000 for Beira versus carrying amounts
of net assets of Rs. 4,450,000 and Rs. 3,300,000 in the separate financial
statements of Kalu and Beira respectively (adjusted for the effects of group
fair value adjustments). No impairment losses had previously been
recognised.
Required
Prepare the consolidated statement of profit or loss and other comprehensive
income for Dias for the year ended 31 March 20X8.
ANSWER
Consolidated statement of profit or loss and other comprehensive income of
Dias for the year ended 31 March 20X8
D
B (4/12)
Rs'000
Rs'000
5,000
3,000
Cost of sales
(3,000)
(2,300)
(940)
Gross profit
2,000
700
30
(1,000)
(500)
(50)
Revenue
Admin expense
Other income
230
Finance costs
PBT
Income tax exp
1,230
Total
(W2)
(W3)
(W4)
(W5)
(W6)
Consol
Rs'000
Rs'000
Rs'000
Rs'000
Rs'000
Rs'000
Rs'000
Rs'000
970
8,970
(50)
(70)
150
(90)
-
8,970
(6,240)
(6,240)
2,730
2,730
(63.5)
(1,550)
230
35
(120)
70
(5)
(65)
(40)
(1,683.5)
225
(50)
1,290
1,221.5
(350)
(300)
(50)
(350)
Profit for yr
930
100
(90)
940
871.5
OCI
130
40
40
210
210
TCI
1,060
140
(50)
1,150
1,081.5
Profit:
NCI
Owners of group
930
20
(31.5)
(11.5)
80
(58.5)
951.5
28
(17.5)
10.5
112
(32.5)
1,139.5
105
(12.7)
(1.75)
(50.8)
(3.25)
(12.7)
(1.75)
(50.8)
(3.25)
(25.95)
(40)
(65)
897.45
TCI:
NCI
Owners of group
524
1,060
105
(3.95)
(40)
(65)
1,085.45
CA Sri Lanka
Workings
1
Allocation of profits and TCI

Profits and total comprehensive income of the subsidiaries are allocated
between the NCI and the owners of Dias:
Kalu
Profits
TCI
Beira
Loss
TCI
NCI: 100 20%

Owners of parent: 100 80%
NCI: 140 20%
Owners of parent: 140 80%
Rs'000
20
80
28
112
NCI: (90) 35%

Owners of parent: (90) 65%
NCI: (50) 35%
Owners of parent (50) 65%
(31.5)
(58.5)
(17.5)
(32.5)
Loan stock interest

Rs'000
Interest income: 2,100m 10% 6/12

6/12
105 recorded on 1 October 20X7

105 to be recorded
210
Pre-acquisition
210
12
= 140
Post-acquisition
(210
12
) = 70
Genuine finance income Cancel on consolidation:

Overall adjustment to other income:
Interest income not yet recorded (210 6/12)
4
Less: post acquisition intragroup element (210 12 )
Rs'000
105
(70)
35
The correct journal to record the net Rs. 35,000, and cancel the finance cost
and payable figures in Beiras financial statements is therefore (Rs'000)
DEBIT Payables (CSOFP)
CREDIT Other income
CREDIT Finance costs
105
35
70
The adjustment is allocated to the owners of the parent.

CA Sri Lanka
525
Sale of property
Unrealised profit
Rs'000
300
(100)
Land Proceeds
Carrying amount
Profit on disposal (in Kalu)
Rs'000
200
Buildings Proceeds (800 300)

40
Carrying amount (800 50 )

Loss on disposal (in Kalu)
Proportion of loss depreciated (1/40)
500
(640)
(140)
3.5
63.5
This unrealised profit is eliminated by (Rs'000):

DEBIT
CREDIT
PPE (CSOFP)
63.5
63.5
As Kalu is the selling company, the adjustment to profit is allocated between

the NCI and the owners of the parent in the ratio 20%:80%
4
Fair value depreciation

At
Additional
acquisition depreciation*
Rs'000
Rs'000
150
(5)
PPE (500 350)

* Additional depreciation =
150
10
= 15 per annum
4
12
At year end
Rs'000
145
= Rs. 5 Mn
This is recognised by (Rs'000):

DEBIT
CREDIT
PPE (CSOFP)
5
5
The adjustment to profit is allocated between the NCI and the owners of the
parent in the ratio 35%:65%.
5
Dividend income
The dividend from Kalu is eliminated by (Rs'000):
DEBIT
CREDIT
Other income (50 80%)

Retained earnings (CSOFP)
40
40
This adjustment is allocated to the owners of the parent company.
526
CA Sri Lanka
Impairment losses
(a)
Goodwill
Kalu
Rs'000
Consideration
transferred
Non-controlling
interests
FV net assets at acq'n:
Carrying amount per Q
Fair value adjustment
(W4)
4,000
20%
Rs'000
5,000
800
4,000
-
Beira
Rs'000
3,500
35%
1,225
3,350
150
(4,000)
1,800
(b)
Rs'000
2,600
(3,500)
325
Losses
Goodwill
'Notional' goodwill ( 100%/80%)
( 100%/65%)
Net assets at 31 March 20X7
Recoverable amount
Impairment loss
Allocated to:
'Notional' goodwill
Other assets
Recognised impairment loss:
Recognised goodwill (100 65%)
Other assets (100%)
Kalu
Rs'000
1,800
Beira
Rs'000
325
2,250
500
4,450
6,700
7,040
0
3,300
3,800
3,700
100
100
100
65
The impairment loss is recognised by (Rs'000):

DEBIT
CREDIT
Goodwill (CSOFP)
65
65
As the NCI is not measured at fair value none of the loss is allocated to
it.
CA Sri Lanka
527
5 Associates and joint arrangements

LKAS 28 requires that an associate and joint venture are accounted for using
the equity method. A parent has significant influence over an associate and
joint control over a joint venture.
5.1 Associates
At the start of the chapter an associate was defined as an entity over which an
investor has significant influence.
5.1.1 Significant influence
We have also defined significant influence as the power to participate in the
financial and operating policy decisions of the investee but is not control or joint
control over those policies.
If an investor holds 20% or more of the voting power of the investee, it can be
presumed that the investor has significant influence over the investee, unless it
can be clearly shown that this is not the case.
Significant influence can be presumed not to exist if the investor holds less than
20% of the voting power of the investee, unless it can be demonstrated
otherwise.
Significant influence may be evidenced by:
(a)
(b)
(c)
(d)
(e)
Representation on the board of directors (or equivalent) of the investee

Participation in the policy making process
Material transactions between investor and investee
Interchange of management personnel
Provision of essential technical information
5.1.2 Accounting for an associate

LKAS 28 requires that all investments in associates are accounted for in the
consolidated accounts using the equity method unless one of the following
exemptions applies:
(a)
It is a parent exempt from preparing consolidated financial statements under

LKAS 27, or
(b)
All of the following apply:

(i)
528
The investor is a wholly-owned subsidiary or it is a partially owned

subsidiary of another entity and its other owners, including those not
CA Sri Lanka
otherwise entitled to vote, have been informed about, and do not object
to, the investor not applying the equity method;
(ii)
The investor's securities are not publicly traded
(iii) It is not in the process of issuing securities in public securities markets;

and
(iv) The ultimate or intermediate parent publishes consolidated financial
statements that comply with International Financial Reporting
Standards.
(c)
The investment associate is classified as 'held for sale' in accordance with

SLFRS 5 (in which case it should be accounted for under SLFRS 5).
The equity method is applied from the date on which significant influence
commences and ceases to be applied when the investor ceases to have significant
influence.
5.1.3 The equity method
The equity method is a method of accounting whereby the investment is initially
recognised at cost and adjusted thereafter for the post-acquisition change in the
investors share of the investees net assets. The investors profit or loss includes
its share of the investees profit or loss and the investors other comprehensive
income includes its share of the investees other comprehensive income.
At acquisition
An associate is initially recognised at cost. Cost is notionally allocated to the
fair value of net assets acquired:
Where cost exceeds net assets acquired notional goodwill is included within
the carrying amount. This is not separately recognised.
Where cost is less than net assets acquired, the difference is included as
income in the determination of the investor's share of the associate's profit
or loss in the period in which the investment is acquired.
A single figure for investment in associates is shown in the consolidated
statement of financial position. At the time of the acquisition this is stated at
cost. This is subsequently increased or decreased by the groups share of the
total comprehensive income made in the year by the associate.
CA Sri Lanka
529
Any dividend declared or paid by an associate reduces the carrying amount of

the investment in associate.
Any impairment loss in respect of an associate reduces the carrying amount of
the associate.
The group share of losses made by an associate reduce the carrying amount of
the associate in the consolidated statement of financial position until such time
as the carrying amount is reduced to nil. After this, additional losses are
provided for and a liability recognised to the extent that the parent has legal or
constructive obligations or made payments on behalf of the associate. If the
associate later returns to profit, the parent resumes recognising its share of
profits only after they equal the share of losses not recognised.
In the consolidated statement of profit or loss and other comprehensive
income, the group share of the profit or loss of the associate is recognised
together with group share of the associates other comprehensive income.
Consolidation adjustments
Intragroup transactions and balances are not eliminated.
The group share of unrealised profits is eliminated:
Upstream transactions are sales from the associate to a group company. The
group share of unrealised profits is eliminated by:
DEBIT
CREDIT
Cost of sales (parent/subsidiary)

Group inventory
Downstream transactions are sales from a group company to the associate.

The group share of unrealised profits is eliminated by:
DEBIT
CREDIT
Cost of sales (parent/subsidiary)

Investment in associate
Practical considerations
If an associate prepares its financial statements to a different reporting date
from that of the group it should prepare additional financial statements to the
group reporting date, or if that is not possible its most recent accounts may be
used for consolidation providing that:
The gap between the reporting dates is three months or less, and
Adjustments are made for the effects of significant transactions or other
events that occur between the reporting dates.
530
CA Sri Lanka
Uniform accounting policies should be applied in the consolidated financial

statements; where an associate uses different accounting policies, its financial
statements are adjusted for consolidation.
QUESTION
Allice Group acquires 35% of Brandon Co on 1 July 20X6 at a cost of Rs. 16 Mn. At
that date the Equity in Brandon Co was made up of:
Stated capital of Rs. 10 Mn

Retained earnings of Rs. 22 Mn
A revaluation surplus of Rs. 7 Mn
An AFS investment reserve with a credit balance of Rs. 2 Mn.
In the year ended 31 December 20X7:

1.
A company in the Allice Group sold goods to Brandon Co for Rs. 2.5 Mn,
recognising a margin of 20%. At 31 December 20X7, half of these goods
remained unsold.
2.
Brandon Co paid a dividend of Rs. 1 Mn to its shareholders and proposed a

further dividend of Rs. 1.5 Mn.
At 31 December 20X7 extracts from the statement of financial position of Brandon

Co were as follows:
Rs'000
Stated capital
10,000
Retained earnings
24,670
Revaluation surplus
7,500
AFS investment reserve
1,200
The fall in the AFS investment reserve included a Rs. 300,000 unrealised loss on
remeasurement to fair value and a Rs. 500,000 reclassification adjustment in
respect of derecognised investments.
Required
What is the carrying amount of the investment in associate in the Allice Group
consolidated statement of financial position?
CA Sri Lanka
531
ANSWER
Cost
Share of post acquisition retained earnings (30%
(24,670 22,000))
Share of post acquisition movement in revaluation
surplus (30% (7,500 7,000))
Post acquisition share of movement in AFS reserve
(30% (1,200 2,000))
Adjustment for unrealised profit (2,500 20%
30%)
Dividend paid to Allice Group (30% 1,000)
Carrying amount of associate in group SOFP:
Rs'000
16,000
801
150
(240)
(75)
(300)
16.336
Notes:
1.
The proposed dividend is not accounted for
2.
In terms of the AFS investment reserve, the group should recognise its share
of the Rs. 800,000 fall. The Rs. 500,000 reclassification adjustment is a debit
to Brandons AFS investment reserve and a credit to Brandons retained
earnings. These movements net to zero and so no further adjustment is
required.
5.2 Joint arrangements

As defined earlier in the chapter a joint arrangement is an arrangement over
which two or more parties have joint control.
5.2.1 Joint control
The definition of joint control refers to a contractually agreed sharing of control. It
further states that joint control only exists when decisions about relevant
activities require the unanimous consent of the parties sharing control.
Therefore there is no joint control if:
There is no contractual arrangement, or
There is a contractual arrangement but unanimous consent is not required to
make decisions.
In addition SLFRS 11 states that where there is joint control:
No individual party controls the arrangement alone
532
CA Sri Lanka
A party with joint control can prevent one of the other parties from controlling
the arrangement
An arrangement can still be a joint arrangement even if not all parties have
joint control (some parties may participate rather than have joint control)
Judgement must be applied when assessing whether a party has joint control of
an arrangement.
The existence of a contractual agreement distinguishes a joint arrangement from
an investment in an associate.
Evidence of a contractual arrangement could be in one of several forms.
Contract between the parties
Minutes of discussion between the parties
Incorporation in the articles or by-laws of the joint venture
The contractual arrangement is usually in writing, whatever its form, and it will
deal with the following issues surrounding the joint arrangement.
Its activity, duration and reporting obligations
The appointment of its board of directors (or equivalent) and the voting rights
of the parties
Capital contributions to it by the parties
How its output, income, expenses or results are shared between the parties
It is the contractual arrangement that establishes joint control over the joint
venture, so that no single party can control the activity of the joint venture on its
own.
The terms of the contractual arrangement are key to deciding the form of the joint
arrangement.
QUESTION
1.
Companies A, B, C and D each hold a 25% interest in JJ Co. The 4 companies

are party to a contractual agreement, which states that a 75% majority is
required to approve decisions about JJ Co.
2.
The ownership structure of GG Co is as follows:

Company Q
Company R
Other investors
CA Sri Lanka
Joint control
51%
30%
19%
533
A contractual agreement between the shareholders of GG Co requires a 75%

majority to approve decisions regarding relevant activities and states that
each shareholder is entitled to vote in proportion to ownership interests.
3.
The facts are the same as in point 2 above, however Company Q has an
option to buy Company Rs shared in GG Co. The option can be exercised by
Company Q at any time in the event that Companies Q and R do not agree on
a decision regarding the relevant activities of GG Co. The option price is not
set so high that the possibility of exercise is remote.
4.
Pacific and Atlantic both have a 24% interest in Southern; the remaining
52% of ordinary voting shares are widely dispersed. Decisions about
relevant activities require a majority of the voting rights and Pacific and
Atlantic have an agreement that they will agree on decisions about relevant
activities.
5.
The facts are the same as in point 4 above, however there is no agreement
between Pacific and Atlantic that they will agree on decisions.
Required
Analyse the scenarios in order to conclude as to whether joint control exists.
ANSWER
534
1.
Joint control requires a contractual agreement and unanimous consent to

make decisions. Here the voting arrangements allow agreement of any
combination of three of the four investing companies in order to make
decisions. Unanimous consent would require agreement of all 4 parties.
This scenario exhibits collective control rather than joint control. Here each
of the 4 investors should account for its interest in JJ Co as an associate since
each is presumed to have significant influence (unless it can be proved
otherwise).
2.
Here a contractual agreement exists and based on their ownership interests

(collectively 81%), Company Q and Company R must act together to make
decisions about the relevant activities of GG Co. Therefore the two entities
have joint control over GG Co. Company Q does not have control as it cannot
unilaterally make decisions as a 75% majority is required.
3.
There is no joint control here; because Company Q can impose its decisions
at any time by exercising its option to purchase Company Rs shares,
Company Q is deemed to have unilateral control. Therefore Company R
should consolidate GG Co as a subsidiary.
4.
Joint control does exist here. Collectively Pacific and Atlantic have control
over Southern. Since there is a contractual agreement for Pacific and Atlantic
CA Sri Lanka
to agree on all decisions, the two entities have joint control and Southern is a
joint arrangement.
5.
In this case although Pacific and Atlantic collectively control the

arrangement, there is no requirement for unanimous consent and therefore
there is no joint control. Here Pacific and Atlantic are each likely to have
significant influence over the arrangement.
5.2.2 Joint venture or joint operation?

SLFRS 11 classes joint arrangements as either joint operations or joint ventures.
The classification of a joint arrangement as a joint operation or a joint venture
depends upon the rights and obligations of the parties to the arrangement.
A joint operation is a joint arrangement whereby the parties that have joint
control (the joint operators) have rights to the assets, and obligations for the
liabilities, of that joint arrangement. A joint arrangement that is not structured
through a separate entity is always a joint operation.
A joint venture is a joint arrangement whereby the parties that have joint control
(the joint venturers) of the arrangement have rights to the net assets of the
arrangement.
A joint arrangement that is structured through a separate entity may be either a
joint operation or a joint venture. In order to ascertain the classification, the
parties to the arrangement should assess the terms of the contractual
arrangement together with any other facts or circumstances to assess whether
they have:
Rights to the assets, and obligations for the liabilities, in relation to the
arrangement (indicating a joint operation)
Rights to the net assets of the arrangement (indicating a joint venture)
SLFRS 11 includes a table of issues to consider and explains the influence of a
range of points that could be included in the contract. The table below is included
in your KB1 study text and summarises the table in SLFRS 11.
CA Sri Lanka
535
Joint operation
Joint venture
The terms of
the contractual
arrangement
The parties to the joint

arrangement have rights to
the assets, and obligations for
the liabilities, relating to the
arrangement.

arrangement have rights to
the net assets of the
arrangement (ie it is the
separate vehicle, not the
parties, that has rights to the
assets, and obligations for the
liabilities).
Rights to assets

arrangement share all
interests (eg rights, title or
ownership) in the assets
relating to the arrangement
in a specified proportion (eg
in proportion to the parties
ownership interest in the
arrangement or in proportion
to the activity carried out
through the arrangement that
is directly attributed to
them).
The assets brought into the

arrangement or subsequently
acquired by the joint
arrangement are the
arrangements assets. The
parties have no interests (ie
no rights, title or ownership)
in the assets of the
arrangement.
Obligations for
liabilities
The parties share all

liabilities, obligations, costs
and expenses in a specified
proportion (eg in proportion
to their ownership interest in
the arrangement or in
proportion to the activity
carried out through the
arrangement that is directly
attributed to them).
The joint arrangement is

liable for the debts and
obligations of the
arrangement.
The parties are liable to the
arrangement only to the
extent of:
their respective:
Investments in the
arrangement, or
Obligations to contribute
any unpaid or additional
capital to the arrangement,
or
Both
536
CA Sri Lanka
Joint operation
Joint venture

arrangement are liable for
claims by third parties.
Creditors of the joint

arrangement do not have
rights of recourse against
any party.
Revenues,
expenses, profit
or loss
Guarantees
The contractual arrangement

establishes the allocation of
revenues and expenses on
the basis of the relative
performance of each party to
the joint arrangement. For
example, the contractual
arrangement might establish
that revenues and expenses
are allocated on the basis of
the capacity that each party
uses in a plant operated
jointly.
The contractual arrangement

establishes each partys share
in the profit or loss relating to
the activities of the
arrangement.
The provision of guarantees to third parties, or the

commitment by the parties to provide them, does not, by
itself, determine that the joint arrangement is a joint
operation.
5.2.3 Accounting for joint arrangements
CA Sri Lanka
Joint Operation
Joint venture
A joint operator recognises the

following in both its separate and
consolidated financial statements:
The equity method as described in section

5.1.3 is applied to a joint venture.
(a)
Its assets, including its share of

any jointly held assets;
Downstream transactions (investor to

JV)
(b)
Its liabilities, including its share

of any jointly incurred liabilities;
(c)
Its revenue from the sale of its

share of the output arising from
the joint operation;
Where there is an unrealised gain, only

the amount attributable to the interest of
the other joint venturers is recognised.
(d)
Its share of the revenue from the

sale of the output by the joint
Where there is an unrealised loss, the full

loss is recognised if the transaction
537
Joint Operation
operation; and
(e)
Its expenses, including its share

of any expenses incurred jointly.
Joint venture
provides evidence that the net realisable
value of current assets is less than cost or
there is an impairment loss.
Upstream transactions (JV to investor)
Where there is an unrealised gain, the
joint venturers share of gain is not
recognised until the profit is realised.
Where there is an unrealised loss the loss
is recognised immediately if it represents
a reduction in the net realisable value of
current assets or a permanent decline in
the carrying amount of non-current
assets.
QUESTION
Joint operation
Olbas Group has a 30% share of a joint operation Goldmine. Assets, liabilities,
revenue and costs are apportioned on the basis of shareholding.
In the year, Goldmine built an excavation centre in Africa at a cost of Rs. 6 Mn. It
was completed on 1 October 20X4 and is to be dismantled at the end of its life of
ten years. The present value of this dismantling cost to the joint arrangement at 1
October 20X4, using a discount rate of 4%, was Rs. 1.5 Mn.
Goldmine has earned revenue of Rs. 1.3 Mn in the year ended 31 March 20X5. The
terms of the agreement between Olbas Group and the other joint operators
require that Goldmine collects all revenues and distributes these to other joint
operators on an annual basis. At 31 March 20X4, Goldmine had not yet paid the
other joint operators their share of revenue for the year.
In the year ended 31 March 20X5 the joint operation incurred operating costs of
Rs. 0.8 Mn. These were paid by another joint operator and recharged to Olbas
Group. Olbas Group has not yet been charged for its share of the costs for the year.
Required
Calculate what amounts are included in the consolidated statement of financial
position of the Olbas Group for the year ended 31 March 20X5 in respect of the
joint operation?
538
CA Sri Lanka
ANSWER
The Olbas Group must recognise on a line-by-line basis its assets, liabilities,
revenues and expenses plus its share (40%) of the joint assets, liabilities, revenue
and expenses. The following amounts are therefore included in the consolidated
statement of financial position:
Non-current assets
Property plant and equipment (W1)
Equity
Retained earnings (W4)
Current liabilities
Trade payables (W2)
Dismantling provision (W3)
(W1)
Property, plant and equipment:
Cost of excavation centre (6m 30%)
dismantling provision (1.5m 30%)
Accumulated depreciation: 2,250/10 6/12m
31 March 20X5 carrying amount
(W2)
Trade payables (to other joint operators):
Revenue 70% 1.3m
Costs 30% 800,000
(W3)
Dismantling provision:
At 1 October 20X4
Finance cost (unwinding of discount): 450 4% 6/12m
At 31 March 20X5
CA Sri Lanka
Rs'000
2,137
28
1,150
459
1,800
450
2,250
(113)
2,137
910
240
1,150
450
9
459
539
Profit or loss for the year

Rs'000
390
(240)
(113)
(9)
28
Revenue: 1,300 30%

Operating costs: 800 30%
Depreciation
Finance cost (unwinding of discount)
Profit from joint operation (to retained earnings
QUESTION
Equity accounting
The statements of financial position of Jaipura and its investee companies, Adikari
and Guptha, at 30 September 20X6 are shown below.
STATEMENTS OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X6
Jaipura
Rs Mn
Non-current assets
Freehold property
Plant and machinery
Investments
Current assets
Inventory
Trade receivables
Cash
Total assets
Equity
Stated capital
Retained earnings
12% loan stock
Current liabilities
Trade payables
Bank overdraft
540
Adikari
Rs Mn
Guptha
Mn
420
230
240
890
177
97
274
98
65
163
75
40
2
117
60
27
9
96
35
18
1
54
1,007
370
217
200
423
623
50
200
250
40
158
198
320
100
52
12
384
20
120
19
19
1,007
370
217
CA Sri Lanka
Additional information
(a)
Jaipura acquired 750,000 of the 1 million ordinary shares in Adikari on

1 October 20X1 for Rs. 200 Mn when the retained earnings of Adikari were
Rs. 120 Mn.
(b)
Jaipura acquired 150,000 of the 600,000 ordinary shares in Guptha on

1 October 20X4 for Rs. 40 Mn when the retained earnings of Guptha were
Rs. 112 Mn.
(c)
At the date of acquisition of Adikari, the fair value of its freehold property
was considered to be Rs. 50 Mn greater than its value in Adikari's statement
of financial position. Rs. 30 Mn of this increase related to buildings and the
remainder to land. Adikari had acquired the property ten years previously
and the buildings element is depreciated on cost over 50 years.
(d)
In the year Jaipura sold goods to Guptha of which Guptha had Rs. 15 Mn in
inventory at 30 September 20X6. Jaipura had priced these goods to earn a
profit margin of 20%.
An impairment loss of Rs. 15 Mn is to be recognised on the investment in
Guptha.
The non-controlling interest is measured at fair value. Adikari shares were
trading at Rs. 240 Mn just prior to the acquisition by Jaipura.
(e)
(f)
Required
Prepare the consolidated statement of financial position for the Jaipura Group at
30 September 20X6.
CA Sri Lanka
541
ANSWER
JAIPURA GROUP CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT
30 SEPTEMBER 20X6
J
Total
W1
W2
W3
W4
(i)
W4
(ii)
W4
(iii)
W4
(iv)
Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn
Total
Rs Mn
420
177
597
P&M
230
97
327
Invts
240
240
Ass
GW
890
274
1,164
Inv
75
60
135
135
Tr rec
40
27
67
67
Cash
11
11
117
96
213
213
Total
assets
1,007
370
1,377
St cap
200
50
250
(50)
Ret Egs
423
200
623
(120)
(2.9)
(20)
60
(0.9)
20
623
250
883
757.2
320
100
420
420
Tr Pay
52
20
72
72
O/d
12
12
12
384
120
504
504
1,007
370
1,377
Free
50
643.2
(3.8)
Prop
NCI
Loan
327
(200)
(40)
40
13.8
(0.8)
38
(15)
40
40
1,048.2
1,261.2
200
13.8
(0.8)
(15)
478.1
79.1
1,261.2
WORKINGS
1
Goodwill on acquisition of Adikari

Rs Mn
Non-controlling interest (250,000 240)
Net assets acquired
Stated capital
Retained earnings
Goodwill at acquisition
542
Rs Mn
200
60
50
120
50
(220)
40
CA Sri Lanka
The acquisition consolidation journal is therefore (Rs Mn):

DEBIT
Goodwill
DEBIT
Stated capital
DEBIT
Retained earnings
DEBIT
Freehold property
CREDIT Investment
CREDIT NCI
2
40
50
120
50
200
60

Additional depreciation (30 40) 5 years = Rs. 3.75 Mn (round to 3.8)
DEBIT
Retained earnings (75%)
DEBIT
NCI (25%)
CREDIT Freehold property
2.9
0.9
3.8
Profits of NCI since acquisition

Profits of Adikari since acquisition are Rs. 200 Rs. 120 = Rs. 80 Mn. 25%
are allocated to the NCI by (Rs Mn):
DEBIT
Retained earnings
20
CREDIT NCI
20
(i)
The cost of the investment is transferred to investments in associates

by (Rs Mn):
DEBIT
40
CREDIT Investments
40
(ii)
Post acquisition profits of (158112) 30% = Rs. 13.8 Mn are allocated

to the investment in associate by (Rs Mn):
DEBIT
13.8
CREDIT Retained earnings
13.8
(iii) The unrealised profit made on sales by Jaipura to Guptha is 15 x 20% =

Rs3m. Adjustment is required for the group part (25%) This is
recorded by (Rs Mn):
DEBIT
Retained earnings
0.8
CREDIT Investment in associate
0.8
(iv) The impairment loss of Rs. 15 Mn is recognised by (Rs Mn):
DEBIT
Retained earnings
15
15
CA Sri Lanka
543
6 SLFRS 12 Disclosure of Interests in Other Entities

SLFRS 12 provides the disclosure requirements in respect of all group entities.
SLFRS 12 requires an entity to disclose information that enables users to evaluate

the nature of, and risks associated with, its interests in other entities and the
effects of those interests on its financial position, financial performance and cash
flows. This is particularly relevant in light of the financial crisis and recent
accounting scandals. It is believed that better information about interests in other
entities is necessary to help users to identify the profit or loss and cash flows
available to the reporting entity and to determine the value of a current or future
investment in the reporting entity.
6.1 Scope
SLFRS 12 covers disclosures for entities that have interests in:
Subsidiaries
Joint arrangements
Associates, and
Unconsolidated structured entities.
A structured entity is an entity that has been designed so that voting or similar
rights are not the dominant factor in deciding who controls the entity, such as
when any voting rights relate to administrative tasks only and the relevant
activities are directed by means of contractual arrangements. (SLFRS 12)
A structured entity may have some or all of the following features:
Restricted activities
A narrow and well defined objective eg to carry out research and development
activities
Insufficient equity to finance its own activities without support
6.2 Significant judgements and assumptions

SLFRS 12 requires disclosure of the significant judgements and assumptions the
reporting entity has made (and changes to those judgements and assumptions) in
determining:
That it has control of another entity;
544
CA Sri Lanka
That it has joint control of an arrangement or significant influence over another

entity; and
The type of joint arrangement (ie joint venture or joint operation) when the
arrangement has been structured through a separate vehicle.
To comply, an entity should disclose, for example, significant judgements and
assumptions made in determining that:
It does not control another entity even though it holds more than half of the
voting rights of the other entity.
It controls another entity even though it holds less than half of the voting rights
of the other entity.
It does not have significant influence even though it holds 20% or more of the
voting rights of another entity.
It has significant influence even though it holds less than 20% of the voting
rights of another entity.
6.2.1 Investment entity status
When an entity determines that it is an investment entity,
information about significant judgements and assumptions
determining that it is an investment entity. If it does not
characteristics of an investment entity, it should disclose
concluding that it is nevertheless an investment entity.
it shall disclose
it has made in
have the typical
the reasons for
6.2.2 Example: Significant judgements and assumptions disclosure

Group composition
The Group has 12 subsidiaries that are material in 20X8. The Group holds a
majority of voting rights in 11 subsidiaries and less than a majority of the voting
rights in Matka.
Although the Group has less than half the voting rights in Matka (45%),
management has determined that the Group controls Matka. This is on the basis
that the remaining voting rights are widely dispersed, there is no indication that
other shareholders exercise their votes collectively and the Group has been able to
control the outcome of voting historically.
CA Sri Lanka
545
6.3 Interests in subsidiaries

In respect of interests in subsidiaries, consolidated financial statements must also
disclose information to enable the users of financial statements to:
(a)
Understand:
The composition of the group, and
The interest that non-controlling interests have in the groups activities
and cash flows.
(b)
Evaluate:
The nature and extent of significant restrictions on its ability to access or
use assets and settle liabilities of the group.
The nature of, and changes in, risks associated with interests in
subsidiaries.
The consequences of losing control of a subsidiary during the reporting
period.
6.3.1Interest that the NCI has in the groups activities and cash flow
For each subsidiary with a material non-controlling interest, the following should
be disclosed:
(a)
The name of the subsidiary.
(b)
The principal place of business.
(c)
The proportion of ownership interests held by the NCI.
(d)
The proportion of voting rights held by the NCI.
(e)
The profit or loss allocated to the NCI during the period.
(f)
Accumulated non-controlling interests of the subsidiary at the end of the

reporting period.
(g)
Summarised financial information about the subsidiary
6.3.2 Nature and extent of significant restrictions

An entity should disclose:
(a)
546
Significant restrictions on its ability to access or use the assets and settle the
liabilities of the group.
CA Sri Lanka
(b)
The nature and extent to which protective rights of the NCI can significantly
restrict the entitys ability to access or use the assets and settle the liabilities
of the group.
(c)
The carrying amounts in the consolidated financial statements of the assets

and liabilities to which those restrictions apply.
6.3.3 Nature of risks associated with an entitys interests in subsidiaries

An entity shall disclose:
(a)
The terms of contractual arrangements that could require a parent or its

subsidiaries to provide financial support to another subsidiary.
(b)
Details of any such support provided in the period where there was no
contractual obligation to do so.
(c)
Any current intentions to provide financial or other support to a subsidiary.
6.3.4 Consequences of losing control of a subsidiary in the period

An entity shall disclose the gain or loss on disposal and the line item in profit or
loss in which it is recognised.
6.4 Interests in joint arrangements and associates

6.4.1 Nature, extent and financial effects
For each joint arrangement and associate that is material to the reporting entity
the following should be disclosed:
(a)
The name of the joint arrangement or associate.
(b)
The nature of the entity's relationship with the joint arrangement or

associate.
(c)
The principal place of business/country of incorporation of the joint

arrangement or associate.
(d)
The proportion of ownership interest held by the entity/proportion of voting

rights held.
For each joint venture and associate that is material to the reporting entity the
following should be disclosed:
CA Sri Lanka
(a)
Whether the investment in the joint venture or associate is measured using

equity method or fair value.
(b)
Summarised financial information about the joint venture or associate.
547
(c)
The fair value of the investment in the joint venture or associate (where the
equity method is applied).
Financial information should be disclosed about the entitys investments in joint

ventures and associates that are not individually material:
(a)
In aggregate for all individually immaterial joint ventures and
(b)
In aggregate for all individually immaterial associates.
The following should also be disclosed by the reporting entity:

(a)
The nature and extent of any significant restrictions on the ability of joint
ventures or associates to transfer funds to the entity.
(b)
When the financial statements of a joint venture or associate are prepared to

a date different from the group reporting date:
(c)
(i)
The date of the end of the reporting period of the joint venture /
associate.
(ii)
The reason for using a different date or period.
The unrecognised share of losses of a joint venture or associate both for the
reporting period and on a cumulative basis.
6.4.2 Risks associated with interests in joint ventures and associates.

An entity should disclose:
(a)
Commitments that it has relating to its joint ventures separately from the
amount of other commitments
(b)
Contingent liabilities incurred relating to its interests in joint ventures or

associates, separately from the amount of other contingent liabilities.
6.5 Interests in unconsolidated structured entities

The following should be disclosed in respect of unconsolidated structured entities:
Nature of interests
(a)
Qualitative and quantitative information about interests in unconsolidated

structured entities eg the nature, purpose, size and activities of the
structured entity and how it is financed.
(b)
If an entity has sponsored an unconsolidated structured entity but does not

have an interest in it at the year end it should disclose:
How it has determined which structured entities it has sponsored;
Income from those structured entities during the reporting period; and
548
CA Sri Lanka
The carrying amount (at the time of transfer) of all assets transferred to
those structured entities in the period.
Nature of risks
(a)
The carrying amounts of assets and liabilities recognised in the financial

statements relating to interests in unconsolidated structured entities.
(b)
The line items in the statement of financial position in which those assets
and liabilities are recognised.
(c)
The amount that best represents the entitys maximum exposure to loss
from its interests in unconsolidated structured entities including how the
maximum loss is determined.
(d)
A comparison of the carrying amounts of the assets and liabilities of the

entity that relate to its interests in unconsolidated structured entities and
the entitys maximum exposure to loss from those entities.
If in the reporting period an entity has, without being required to do so

contractually, provided financial or other support to an unconsolidated structured
entity in which it previously had or currently has an interest, it should disclose:
(a)
(b)
The type and amount of support provided

The reasons for providing the support.
An entity should also disclose its intentions to provide financial or other support
to an unconsolidated structured entity, including intentions to assist the
structured entity in obtaining financial support.
These disclosures are not required by investment entities.
QUESTION
Jaffna Co acquired 100% of a private company Ocean Co on 1 September 20X5.
Jaffna Co agreed to pay Rs. 80 Mn in cash, issue 1 of their shares for 5 of Ocean Cos
shares and pay Rs. 10 Mn in two years time. In addition if Ocean Co makes
Rs. 200 Mn profit over the next two years Jaffna Co will pay an additional
Rs. 50 Mn. Profit this year was Rs. 130 Mn and forecasts indicate a similar profit
will be made next year. The fair value of this contingent consideration was
estimated as Rs. 3 Mn at 1 September 20X5. Before the acquisition Jaffna Co had
20 million shares and Ocean Co had 5 million shares. The market value of Jaffna
Co shares were Rs. 250 each and Rs. 360 for Ocean shares.
Assume a discount rate of 5%.
Required
Explain how the above item should be dealt with in the financial statements of
Jaffna Co at the acquisition date, 1 September 20X5.
CA Sri Lanka
549
ANSWER
SLFRS 3 Business combinations states that the cost of a business combination
should be the fair value of the consideration transferred by the acquirer. Any
costs associated with the business combination are expensed (or debited to share
premium if they are share issue costs). The fair value will be measured at
1 September 20X5.
The consideration transferred will be:
Cash
Deferred consideration (Rs 10 Mn 1/1.052)
Contingent consideration
Shares (5 Mn shares/5 Rs 250)
Rs'000
80,000
9,070
3,000
250,000
342,070
Notes:
Only the fair value of the contingent consideration of Rs. 50 Mn is included in the
consideration transferred. As it is unlikely that the conditions will be met, this is
relatively small compared to the potential amount payable as fair value takes into
account the probability of payment.
The deferred consideration must be discounted to its present value of Rs. 9.07 Mn
and shown as a liability. The discount of Rs. 930,000 will be shown as a finance
cost in profit or loss over the 2 years until the full amount becomes payable.
QUESTION
Pasikuda acquired 80% of the ordinary share capital of Sigiriya for Rs. 160 Mn and
40% of the ordinary share capital of Ampara for Rs. 70 Mn on 1 January 20X7
when the retained earnings balances were Rs. 64 Mn in Sigiriya and Rs. 24 Mn in
Ampara. Pasikuda, Ampara and Sigiriya are public limited companies.
550
CA Sri Lanka
The statements of financial position of the three companies at 31 December 20X9

are set out below:
Pasikuda
Sigiriya
Ampara
Rs Mn
Rs Mn
Rs Mn
Non-current assets
220
160
78
Investments
230
450
160
78
Current assets
Inventories
384
234
122
Trade receivables
275
166
67
10
34
Cash at bank
42
701
410
223
1,151
570
301
Equity
Share capital ordinary shares
Retained earnings
Current liabilities
Trade payables
416
278
694
99
128
227
80
97
177
457
1,151
343
570
124
301
You are also given the following information:
CA Sri Lanka
On 30 November 20X9 Pasikuda sold some goods to Sigiriya for Rs. 32 Mn.
These goods had originally cost Rs. 22 Mn and none had been sold by Sigiriya
by the year-end. On the same date Pasikuda also sold goods to Ampara for
Rs. 22 Mn. These goods originally cost Rs. 10 Mn and Ampara had sold half
by the year end.
On 1 January 20X7 Sigiriya owned some items of equipment with a book

value of Rs. 45 Mn that had a fair value of Rs. 57 Mn. These assets were
originally purchased by Sigiriya on 1 January 20X5 and are being
depreciated over 6 years.
Pasikuda elected to measure the non-controlling interests in Sigiriya at fair

value at the date of acquisition. The fair value of the non-controlling interests
in Sigiriya on 1 January 20X7 was calculated as Rs. 39 Mn.
Cumulative impairment losses on recognised goodwill amounted to

Rs. 15 Mn at 31 December 20X9. No impairment losses have been necessary
to date relating to the investment in the associate.
551
Required
Prepare a consolidated statement of financial position for The Pasikuda Group as
at 31 December 20X9.
ANSWER
2
Consolidated statement of financial position at 31 December 20X9

P
Total
(W1)
(W2)
(W3)
(W4)
(W5)
(W6)
Cons.
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs'000
PPE
220
160
380
12
(9)
383
Investments
230
230
(160)
(70)
Goodwill
24
(15)
Invt in Ass
96.8
96.8
450
160
610
Inventory
384
234
618
(10)
608
Receivables
275
166
441
441
42
10
52
52
1,151
510
1,721
St capital
416
99
515
(99)
Retained
earnings
278
128
406
(64)
(12)
(7.2)
(12.8)
(10)
26.8
326.8
39
(3)
(1.8)
12.8
47
457
343
800
800
1,151
510
1,721
Cash
NCI
Payables
488.8
1,589.8
-
416
1,589.8
Goodwill on acquisition of Sigiriya

Rs Mn
Net assets acquired
Stated capital
Retained earnings
Rs Mn
160
39
99
64
12
(175)
24
The acquisition consolidation journal is therefore:
DEBIT
Goodwill
Rs. 24 Mn
DEBIT
Stated capital
Rs. 99 Mn
DEBIT
Retained earnings
Rs. 64 Mn
DEBIT
PPE
Rs. 12 Mn
CREDIT Investment
Rs. 160 Mn
CREDIT NCI
Rs. 39 Mn
552
CA Sri Lanka
Goodwill impairment
The goodwill is impaired by Rs. 15 Mn; as the NCI is measured at fair value
this is allocated to the NCI and owners of the parent in proportion to their
shareholdings. It is recorded by;
DEBIT
Rs. 12 Mn
DEBIT
NCI (20%)
Rs. 3 Mn
CREDIT Goodwill
Rs. 15 Mn

Additional depreciation (12m/4 remaining years) 3 years = Rs. 9 Mn.
Again this is allocated between the NCI and owners of the parent.
This is recorded by:
DEBIT
DEBIT
NCI (20%)
CREDIT PPE
Rs. 7.2 Mn
Rs. 1.8 Mn

NCI share of post-acquisition retained earnings in P is
(128 64) 20%)
Rs. 9 Mn
12.8m

DEBIT
Retained earnings
CREDIT NCI
Rs. 12.8 Mn
Rs. 12.8 Mn
Unrealised profit on sales by P to S

DEBIT
Retained earnings
CREDIT Inventory
Rs. 10 Mn
Rs. 10 Mn
(i)
The cost of the investment is transferred to investments in associates

by:
DEBIT
Rs. 70 Mn
CREDIT Investments
Rs. 70 Mn
(ii)
Post acquisition profits of (97 24) 40% = Rs. 29.2 Mn are allocated
to the investment in associate by:
DEBIT
Rs. 29.2 Mn
Rs. 29.2 Mn
(iii) The unrealised profit made on sales by P to A is (22-10) 1/2 x 40% =

Rs2.4m. This is recorded by:
DEBIT
Retained earnings
Rs. 2.4 Mn
Rs. 2.4 Mn
The net effect of these 3 adjustments is:
DEBIT
CREDIT
CREDIT
CA Sri Lanka
Investments
Retained earnings
Rs. 96.8 Mn
Rs. 70 Mn
Rs. 26.8 Mn
553
CHAPTER ROUNDUP
554
A parent company prepares consolidated financial statements to include its

subsidiaries. Associates and joint ventures are accounted for using the equity
method. Other investments are financial assets accounted for under LKAS 39.
A subsidiary is an entity that is controlled by a parent company; unless the

parent company is an investment entity it must consolidate all subsidiaries.
SLFRS 3 Business Combinations provides guidance on the measurement of net

assets acquired in a business combination and the calculation of goodwill.
In the consolidated statement of financial position assets and liabilities are

added together on a line by line basis; in the consolidated statement of profit or
loss and other comprehensive income, income and expenses are added
together on a line by line basis. Consolidation adjustments include those for
goodwill, goodwill impairment and the effects of intra-group trading.
LKAS 28 requires that an associate and joint venture are accounted for using
the equity method. A parent has significant influence over an associate and
joint control over a joint venture.
SLFRS 12 provides the disclosure requirements in respect of all group entities.
CA Sri Lanka
PROGRESS TEST
What three criteria are required to demonstrate control?
How does an investment entity measure the subsidiaries that it controls?
How does SLFRS 3 deal with contingent consideration and contingent liabilities?
When is a goodwill impairment loss allocated to the NCI?
What is the journal adjustment in the CSOFP for an unrealised profit in inventory?
How is an interest in an associate or joint venture measured in the consolidated

statement of financial position?
What must exist in order for there to be joint control?
SLFRS 13 requires that an entity discloses significant judgements and assumptions

about what?
CA Sri Lanka
555
556
(a)
Power over the investee
(b)
Exposure to, or rights to, variable returns from its involvement with the
investee; and
(c)
The ability to use its power over the investee to affect the amount of the
investors returns
At fair value through profit or loss (with the exception of subsidiaries that provide
services relevant to the normal activities of the investment entity; these are
consolidated as normal).
Contingent consideration forms part of the cost of an acquisition measured at its

fair value at the acquisition date; contingent liabilities are recognised in the
acquisition date statement of financial position of the acquiree as long as there is a
present obligation and regardless of whether payment is probable.
When the NCI is measured at fair value at acquisition such that goodwill is full
goodwill.
DEBIT retained earnings CREDIT inventory (where the parent company is the
seller) or DEBIT retained earnings (group %) DEBIT NCI (NCI %) CREDIT
inventory (where the subsidiary is the seller).
Cost plus (or minus) the investors share of total comprehensive income since
acquisition less dividends paid or declared to the investor less impairment losses.
A contractual agreement and the requirement for unanimous consent in order to

make decisions.
Whether it has control, significant influence or joint control over an entity and
whether a joint arrangement is a joint venture or a joint operation.
CA Sri Lanka
CHAPTER
INTRODUCTION
A parent company may achieve control of a subsidiary in stages rather than in one
transaction. Goodwill arises only where control is achieved, and its calculation takes into
account the previously held interest.
Similarly, a parent company may dispose of part of an investment rather than the whole
shareholding. In this case, the disposal calculation takes into account the retained interest.
Both of these topics are new at KC1 level.
Knowledge Component
1 Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
2
2.1
Level A
1.1.1
Advise on application of Sri Lanka Accounting Standards in solving

complicated matter.
1.1.2

circumstances in conformity with Sri Lanka Accounting Standards.
1.1.3
Evaluate the impact of application of different accounting treatments.
1.1.4

circumstances.
1.1.5
Evaluate the impact of use of different expert inputs to financial reporting.
1.1.6
Advise appropriate application and selection of

1.1.7
accounting/reporting
Preparation and presentation of Consolidated Financial Statements

Consolidated
financial
statements
2.1.1
2.1.2
Recompile a consolidated set of financial statements post acquisition /

merger / divestment
557
KC1 | Chapter 17: Step acquisitions and disposals
CHAPTER CONTENTS
1 Step acquisitions
2 Disposals

group structures.
Prepare group financial statements where activities have been discontinued or
have been acquired or disposed of in the period.
Continuing and Discontinued Interests Learning objectives

Apply and discuss the treatment of a subsidiary which has been acquired
exclusively with a view to subsequent disposal.
1 Step acquisitions
Business combinations achieved in stages (step or piecemeal acquisitions) can
result in a company being an investment in equity instruments, an associate
and then a subsidiary over time.
A parent company may acquire a controlling interest in the shares of a subsidiary
as a result of several successive share purchases, rather than by purchasing the
shares all on the same day. Business combinations achieved in stages may also be
known as 'piecemeal acquisitions'.
1.1 Types of business combinations achieved in stages

There are three possible types of business combinations achieved in stages:
Business combinations in which control is achieved:
A previously held interest, say 10%, with no significant influence (accounted
for under LKAS 39) is increased to a controlling interest of 50% or more.
558
CA Sri Lanka
A previously held equity interest, say 35%, accounted for as an associate under
LKAS 28, is increased to a controlling interest of 50% or more.
Business combinations in which control is maintained:
A controlling interest in a subsidiary is increased, say from 60% to 80%.
Business combinations where control is achieved are treated in the same way,
but business combinations where control is maintained are not.
1.2 Business combinations in which control is achieved

1.2.1 Crossing the accounting boundary
Under SLFRS 3 a business combination occurs only when one entity obtains
control over another, which is generally when 50% or more has been acquired.
This has been referred to as 'crossing an accounting boundary'.
When this happens, the original investment whether an investment in equity
instruments with no significant influence, or an associate is treated as if it were
disposed of at fair value and re-acquired at fair value. This previously held interest
at fair value, together with any consideration transferred, is the 'cost' of the
combination used in calculating the goodwill.
If the 50% boundary is not crossed, as when the interest in a subsidiary is
increased, the event is treated as a transaction between owners.
1.2.2 Calculation of goodwill
When control is achieved, the previously held investment is re-measured to fair
value, with any gain being reported in profit or loss, and the goodwill calculated as
follows:
Rs.
X
X
X
Fair value of acquirer's previously held equity interest
Less net fair value of identifiable assets
(X)
acquired and liabilities assumed
X
Goodwill
CA Sri Lanka
559
QUESTION
Equity investment to subsidiary
Negombo, whose year-end is 30 June 20X9 has a subsidiary, Amanwella, which it

acquired in stages. The details of the acquisition are as follows.
Holding
Retained earnings
Purchase
Date of acquisition
acquired
at acquisition
consideration
%
Rs Mn
Rs Mn
1 July 20X7
20
270
120
1 July 20X8
60
450
480
The share capital of Amanwella has remained unchanged since its incorporation at
Rs300m. The fair values of the net assets of Amanwella were the same as their
carrying amounts at the date of the acquisition. Negombo did not have significant
influence over Amanwella at any time before gaining control of it. The group
policy is to measure the non-controlling interest at its proportionate share of the
fair value of the subsidiary's identifiable net assets.
Required
(a)
Calculate the goodwill on the acquisition of Amanwella that will appear in

the consolidated statement of financial position at 30 June 20X9.
(b)
Calculate the profit on the derecognition of any previously held investment

in Amanwella to be reported in group profit or loss for the year ended 30
June 20X9.
(c)
Provide the journal entries required to record recognition of goodwill on

consolidation.
ANSWER
(a)
Goodwill (at date control obtained)

Rs Mn
NCI (20% 750)
Fair value of previously held equity interest
(Rs 480 Mn 20/60)
Fair value of identifiable assets acquired and
liabilities assumed
Stated capital
Retained earnings
Rs Mn
480
150
160
300
450
(750)
40
560
CA Sri Lanka
(b)
Profit on derecognition of investment

Rs Mn
160
(120)
40
Fair value at date control obtained (see part (a))

Cost
(c)
In Negombos individual financial statements the investment is held at cost

of Rs600m. Therefore on consolidation the following adjustment is required
to recognise the gain on the previously held investment and goodwill on the
subsidiary investment:
DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
CREDIT
QUESTION
Goodwill
Stated capital
Retained earnings
Profit or loss
Investment
Rs. 40 Mn
Rs. 300 Mn
Rs. 450 Mn
Rs. 40 Mn
Rs. 600 Mn
Rs. 150 Mn
Associate to subsidiary
Pinnawala acquired a controlling interest in Arattana in 2 stages:

1
It acquired 30% for cash consideration of Rs. 80 Mn in 20X5. On the date of

acquisition the fair value of the net assets of Arattana was Rs. 250 Mn.
It acquired a further 40% in 20X7 for cash consideration of Rs. 122 Mn. On
this date fair value of the net assets of Arattana was Rs. 284 Mn and the
previously held interest had a fair value of Rs. 88 Mn.
Between 20X5 and 20X7, Arattana retained profits of Rs. 20 Mn and recognised a
revaluation surplus of Rs. 5 Mn.
It is group policy to measure the non-controlling interest as a proportion of net
assets.
Required
CA Sri Lanka
(a)
Calculate the profit on derecognition of any previously held investment in

Arattana to be reported in group profit or loss for the year ended
31 December 20X7.
(b)
Provide the journal entries required to record recognition of goodwill on

consolidation.
561
ANSWER
(a)
Profit on derecognition of previously held investment

Rs Mn
Fair value of previously held interest
Carrying amount of previously held interest
under
LKAS 28:
Cost
Share of post acquisition TCI (30% 25m)
80
7.5
(87.5)
0.5
Gain
(b)
Rs Mn
88
Goodwill on consolidation
Rs Mn
122
88
85.2
295.2
(284)
11.2
Consideration
Fair value of previously held interest
NCI (284m 30%)
Fair value of net assets
Goodwill
Journal
DEBIT
DEBIT
CREDIT
CREDIT
CREDIT
CREDIT
Goodwill
Stated capital / reserves
Cash
Investment
Profit or loss
NCI
Rs. 11.2 Mn
Rs. 284 Mn
Rs. 122 Mn
Rs. 87.5 Mn
Rs. 0.5 Mn
Rs. 85.2 Mn
1.2.3 Preparation of the consolidated financial statements

Where an equity investment becomes a subsidiary:
In the statement of financial position the investment is consolidated based on
the year-end shareholding. Goodwill is calculated as demonstrated in section
1.2.2.
In the statement of profit or loss and other comprehensive income dividend
income is recognised until the date on which control was achieved; after this
date the results of the investment are consolidated.
562
CA Sri Lanka
Where an associate becomes a subsidiary:

In the statement of financial position the investment is consolidated based on
the year-end shareholding. Goodwill is calculated as demonstrated in section
1.2.2.
In the statement of profit or loss and other comprehensive income the
investments results are equity accounted until the date on which control was
achieved; after this date the results of the investment are consolidated.
QUESTION
Acquiring control
Opalagala acquired 25% of Talawatta on 1 January 20X1 for Rs. 2,020 Mn when
Talawatta's reserves were standing at Rs. 5,800 Mn. The fair value of Talawatta's
identifiable assets and liabilities at that date was Rs. 7,200 Mn. Both Opalagala
and Talawatta are stock market listed entities.
At 31 December 20X1, the fair value of Opalagala's 25% stake in Talawatta was
Rs. 2,440 Mn.
A further 35% stake in Talawatta was acquired on 30 September 20X2 for
Rs. 4,025 Mn giving Opalagala control over Talawatta. The fair value of
Talawatta's identifiable assets and liabilities at that date was Rs. 9,400, the fair
value of a 25% and 40% shareholding were Rs. 2,875 Mn and Rs. 4,600 Mn
respectively, and Talawatta's reserves stood at Rs. 7,800 Mn.
For consistency with the measurement of other group held shares, Opalagala
holds all investments in subsidiaries and associates as available-for-sale (fair
value through other comprehensive income) in its separate financial statements
as permitted by SLFRS 10 Consolidated financial statements.
At 31 December 20X2, the fair value of Opalagala's 60% holding in Talawatta was
Rs. 7,020 Mn (and total cumulative gains recognised in other comprehensive
income in Opalagala's separate financial statements amounted to Rs. 975 Mn).
CA Sri Lanka
563
Summarised financial statements of the two companies are as follows:

STATEMENTS OF FINANCIAL POSITION AT 31 DECEMBER 20X2
Opalagala
Rs Mn
Non-current assets
38,650
7,020
Investment in equity instrument (Talawatta)
45,670
12,700
Current assets
58,370
Equity
Stated capital
Reserves
Liabilities
Talawatta
Rs Mn
10,200
40,720
50,920
7,450
58,370
7,600
7,600
2,200
9,800
800
7,900
8,700
1,100
9,800
SUMMARISED STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR TO 31 DECEMBER 20X2:
Opalagala
Talawatta
Rs Mn
Rs Mn
1,280
420
Profit before interest and tax
(80)
(20)
Finance costs
1,200
400
Profit before tax
(360)
(80)
Income tax expense
840
320
PROFIT FOR THE YEAR
Other comprehensive income (items that will not be
reclassified to profit or loss):
240
80
Gain on property valuation, net of tax
555
Investment in equity instrument (Talawatta)

80
795
Other comprehensive income for the year, net of tax
1,635
400
TOTAL COMPREHENSIVE INCOME FOR THE YEAR
The difference between the fair value of the identifiable assets and liabilities of
Talawatta and their book value relates to the value of a plot of land. The land had
not been sold by 31 December 20X2.
Income and expenses are assumed to accrue evenly over the year.
company paid dividends during the year.
Neither
Opalagala elected to measure non-controlling interests at the date of acquisition at

fair value. No impairment losses on recognised goodwill have been necessary to
date.
564
CA Sri Lanka
Required
income and statement of financial position of the Opalagala Group as at 31
December 20X2 assuming that the 25% interest in Talawatta allowed Opalagala
significant influence over the financial and operating policy decisions of Talawatta.
ANSWER
(a)
OPALAGALA GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT
31 DECEMBER 20X2
Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn
O
T
W4
W6
W3i
W3ii W3iii
38,650
7,600
800
PPE
7,020
Invt
(975)
500
355 (6,900)
2,100
Gwill
12,700
2,200
C Assets
58,370
9,800
10,200
800
(800)
S. Cap
40,720
7,900 (975)
Reserves
500
355 (7,800) (40)
4,600
40
NCI
7,450
1,100
Liabilities
58,370
9,800
Rs Mn
Total
47,050
2,100
14,900
64,050
10,200
40,660
4,640
8,550
64,050
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X2
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
O
T
W3i
W3ii
W3iii
Total
355
1,740
1,280
105
PBIT
(80)
(5)
(85)
F Costs
60
60
Inv in Ass
(360)
(20)
(380)
Tax
840
80
1,335
Ret profit
240
20
260
Revaln
555
(555)
Invt
______
_____
15
15
OCI of Ass
1,635
100
1,610
TCI
CA Sri Lanka
565
Profit attributable to:

Owners of Parent (balance)
NCI
TCI attributable to:
Owners of Parent (balance)
NCI (32 + 8)
1,303
32
1,570
40
Workings
1
Group structure
Opalagala
1.1.20X1
30.9.20X2
25%
+ 35% = 60%
Rs. 2,020 Mn Rs. 4,025 Mn
Rs. 5,800 Mn Rs. 7,800 Mn
Cost
Pre-acq'n reserves
Talawatta
2
Timeline
1.1.X2
SPLOCI
30.9.X2
Associate Equity account 9/12
Had 25%
associate
31.12.X2
Consolidate
3/12
Acquired 35%
25% + 35%
= 60% Subsidiary
Consol in
SOFP with
40% NCI
Equity accounting
In Os statement of financial position the investment in T is carried at fair
value; for the purposes of group accounting it is carried (until 30 September
20X2) at cost plus 25% of post-acquisition reserves movements.
Therefore at 30 September 20X2, the carrying amount for group purposes is:
Rs Mn
Cost
Share of post acquisition
increase in reserves (25% x (7,800 5,800)
Carrying amount
566
2,020
500
2,520
CA Sri Lanka
(i)
For group purposes therefore, the fair value increase since acquisition
is reversed by:
DEBIT
CREDIT
Reserves
Investment
975
975
Of this, the Rs. 555 Mn recognised in the year as OCI is also reversed in
the statement of profit or loss and other comprehensive income.
(ii)
The share of post acquisition reserves is recognised by:

DEBIT
CREDIT
Investment
Reserves
500
500
Of this, Rs 60 Mn (25% 320m 9/12) profit and Rs. 15 Mn (25%

80m 9/12) OCI of T arising in the first 9 months of the year is also
credited to the statement of profit or loss and other comprehensive
income.
After these adjustments, in the consolidated financial statements, the
investment in O is carried at Rs. 2,520 Mn at 30 September 20X2.
(iii) This is re-measured on gaining control to Rs. 2,875 Mn by:
DEBIT Investment 355
CREDIT Reserves 355
The credit entry is also recognised in the statement of profit or loss for
the year.
4
Goodwill
On gaining control, goodwill is measured as:
Rs Mn
FV of O's previously held equity interest
Fair value of identifiable net assets
Stated capital
Reserves
Fair value adjustment (W5)
Rs Mn
4,025
4,600
2,875
800
7,800
800
(9,400)
2,100
Goodwill is recognised by (Rs Mn):

DEBIT Goodwill
DEBIT Stated capital
DEBIT Reserves
CA Sri Lanka
2,100
800
7,800
567
DEBIT PPE
CREDIT Investment (4,025 + 2,875)
CREDIT NCI
5
800
6,900
4,600

Measured at date control achieved (only)
At
acquisition
30.9.X2
Rs Mn
800
Land (9,400 (800 + 7,800))

6
Movement
Rs Mn
At year end
31.12.X2
Rs Mn
800
The NCI is allocated its share of post-acquisition profits and OCI by (Rsm):
DEBIT Reserves (40% 400 3/12)
40
CREDIT NCI 40
In the statement of profit or loss and other comprehensive income, amounts
allocated to the NCI are:
Profit (40% 320 3/12)
OCI (40% 80 3/12)
Rs. 32 Mn
Rs. 8 Mn
1.3 Business combinations in which control is maintained

Where control is maintained but the controlling interest increases (and so the
non-controlling interest decreases):
Goodwill is not recalculated
The previously held interest is not remeasured
The acquisition is accounted for as a transaction between shareholders.
Accordingly the parent's equity is adjusted. The required adjustment is calculated
by comparing the consideration paid with the decrease in non-controlling interest.
The calculation is as follows.
Rs.
Fair value of consideration paid
(X)
Decrease in NCI in net assets at date of transaction
X
Decrease in NCI in goodwill at date of transaction *
X
Adjustment to parent's equity
(X)
*Note. This line is only required where non-controlling interests are measured at
fair value at the date of acquisition (ie where there is a decrease in the noncontrolling interest share of goodwill already recognised).
568
CA Sri Lanka
QUESTION
Increase in controlling interest
P owns 70% of S, a company with net assets of Rs. 250 Mn. The carrying amount of
the non-controlling interest is Rs. 75 Mn. P acquires an additional 15% interest
from the non-controlling interest for Rs. 40 Mn.
Required
What journal entry is required to recognise the increased shareholding in the
consolidated financial statements of P?
ANSWER
Fair value of consideration
Decrease in NCI net assets at acquisition date (15% Rs 250 Mn)
Adjustment to parents equity
Rs Mn
(40)
37.5
(2.5)

DEBIT
DEBIT
CREDIT
Equity (controlling interest)
Cash
QUESTION
Rs. 37.5 Mn
Rs. 2.5 Mn
Rs. 40 Mn
Increase in controlling interest 2
P acquired 80% of S in 20X5 for Rs. 300 Mn. On that date the fair value of the
identifiable net assets of S was Rs. 310 Mn and the fair value of the non-controlling
interest was Rs70m. Between the acquisition date in 20X5 and 30 June 20X7, S
made total comprehensive income of Rs. 34 Mn. On 30 June 20X7, P increased its
shareholding in S to 90%. Rs. 36 Mn was paid as consideration for the additional
10% shareholding. The NCI on the acquisition was measured at fair value.
Required
What journal entry is required to recognise the increased shareholding in the
consolidated financial statements of P on 30 June 20X7?
ANSWER
In this question the NCI is measured at fair value and therefore part of the initial
goodwill on acquisition is attributable to the NCI. NCI goodwill forms part of the
adjustment journal on the step acquisition.
CA Sri Lanka
569
NCI goodwill is included within the carrying amount of the NCI and therefore the
simplest way to calculate the required adjustment on 30 June 20X7 is to calculate
the NCI (including its share of net assets and goodwill) at that date and use this as
the basis for calculating the decrease in the NCI.
NCI at 30 June 20X7
NCI at acquisition
NCI share of post-acquisition total comprehensive income (20%
Rs 34 Mn)
NCI at 30 June 20X7
Rs Mn
70
6.8
76.8
Rs Mn
(36)
38.4
Decrease in NCI net assets at acquisition date (10/20% Rs 76.8 Mn)
2.4
DEBIT
CREDIT
CREDIT
Equity (controlling interest)
Cash
Rs. 38.4 Mn
Rs. 2.4 Mn
Rs. 36 Mn
2 Disposals
A parent company may dispose of a full or partial shareholding. In some cases,
control is retained. The accounting treatment depends on the level of
disposal.
2.1 Types of disposal

The accounting treatment of a disposal of equity investment depends on the type
of disposal.
2.1.1 Disposals where control is lost
There are three main kinds of disposals in which control is lost:
(a)
(b)
(c)
Full disposal: all the holding is sold (say, 80% to nil)

Subsidiary to associate (say, 80% to 30%)
Subsidiary to equity investment (say, 80% to 10%)
In these cases a gain or loss on disposal is calculated and recognised in the

570
CA Sri Lanka
2.1.2 Disposals where control is retained

In a subsidiary to subsidiary disposal, control is retained, however the controlling
shareholding is reduced. This type of disposal is accounted for differently from
those where control is lost.
2.2 Control is lost: full disposal

In the case of a full disposal, whereby an entire shareholding is sold, two separate
gain or loss on disposal figures are calculated:
1
2
The gain or loss on disposal in the parent companys financial statements

The gain or loss on disposal in the consolidated financial statements.
In both cases this figure is calculated as the fair value of consideration received
less the carrying amount of the subsidiary disposed of. The difference between the
two gain (or loss) figures is due to the different carrying amount of a subsidiary in
each set of financial statements.
If the gain (or loss) is material, it should be disclosed separately.
2.2.1 Gain or loss in parent companys financial statements
This is calculated as:
Fair value of consideration received
Carrying amount of investment disposed of
Gain / (loss) on disposal
Rs.
X
(X)
X/(X)
2.2.2 Gain or loss in consolidated financial statements

The gain or loss in the consolidated financial statements is calculated as:
Rs.
Carrying amount of investment prior to disposal:
X
Net assets at disposal date
X
Goodwill at disposal date
(X)
NCI at disposal date
Gain / (Loss) on disposal
Rs.
X
(X)
X/(X)
The two gains figures are related, as the following example demonstrates.
CA Sri Lanka
571
2.2.3 Example: Full disposal

Columbo Carpets PLC owns 75% of the ordinary shares in Floor Dcor Ltd. The
shares cost Rs. 230 Mn in 20X4, when the fair value of the net assets of Floor
Dcor was Rs. 280 Mn and the fair value of the NCI was Rs. 73 Mn. On
30 September 20X9, Columbo Carpets PLC disposed of its shareholding in Floor
Dcor for Rs. 370 Mn, on which date Floor Dcor had net assets of Rs. 380 Mn and
the NCI had a carrying amount of Rs. 98 Mn.
The gain reported in Columbo Carpets individual financial statements (assuming
that the investment is carried at cost) is calculated as:
Rs Mn
370
(230)
Carrying amount of investment disposed of
140
Gain on disposal
The gain reported in the consolidated financial statements is:
Rs Mn
Carrying amount of investment disposed of:
380
23
Goodwill at disposal date (230 + 73 280)
(98)
Gain on disposal
Rs Mn
370
(305)
65
The difference between the two gains figures is Rs. 75 Mn. This is equal to the
group share of the Rs. 100 Mn post acquisition increase in reserves of Floor Dcor
- 75% Rs. 100 Mn = Rs. 75 Mn.
2.2.4 Preparation of consolidated financial statements
Where a full disposal has taken place in the accounting period:
The subsidiarys assets and liabilities are not recognised
There is no non-controlling interest
Retained earnings include either:
The group share of the reserves movement in the subsidiary between the
acquisition and disposal date plus the group gain (or loss) on disposal, or
The parent company gain or loss on disposal.
572
CA Sri Lanka
Consolidated statement of profit or loss and other comprehensive income

The results of the subsidiary are consolidated until the date on which control is
lost.
The NCI is allocated its share of results until the date on which control is lost.
The group gain or loss on disposal is recognised.
Note that if the subsidiary is classified as a discontinued operation in accordance
with SLFRS 5, then its result for the year together with the group gain or loss on
disposal is presented in one line profit for the period from discontinued
operations.
2.3 Control is lost: subsidiary to associate

Where control is lost, however a full disposal does not take place:
1
The parent companys gain or loss on disposal is calculated in the same way
as that described in section 2.2.1.
The group gain or loss on disposal is calculated to take into account the fair
value of the retained shareholding.
2.3.1 Group gain or loss on disposal

Where shares in a subsidiary are disposed of such that an investment in an
associate is retained, the group gain or loss on disposal is calculated as:
Rs.
Rs.
X
X
Fair value of interest retained
X
X
Goodwill at disposal date
(X)
(X)
X/(X)
Gain / (Loss) on disposal
The calculation requires that the retained interest is remeasured to fair value at
the disposal date. Therefore the gain or loss on disposal is comprised of two parts:
CA Sri Lanka
A realised gain or loss on the shares that have been sold, and
An unrealised gain or loss on the remeasurement of the shares that have

been retained.
573
2.3.2 Example: Gain on part disposal

Minneriya Ltd acquired 90% of Wilpattu Ltd in 20X1 and held the investment until
30 September 20X4 when it sold 2/3 of its holding to various parties for
Rs. 420 Mn. The remaining 30% investment was classified as an associate holding.
At the disposal date the net assets of Wilpattu were Rs. 580 Mn, goodwill was fully
impaired and the fair value of a 30% interest in the company was Rs. 220 Mn.
The non-controlling interest is measured using the proportion of net assets
method.
Required
What is the gain on disposal in the consolidated accounts? How much of this is a
gain on disposal of the 60% holding and how much is a gain on remeasurement of
the 30% holding?
Solution
Rs Mn
Fair value of interest retained
NCI at disposal date (10% 580 Mn)
Gain on disposal
Rs Mn
420
220
580
(58)
(522)
118
The calculation can be set out differently to show the split of the gain between the
realised and unrealised amounts:
On sale
On FV
of 60%
of 30%
Rs Mn
Rs Mn
420
220
Fair value (of consideration received)
(348)
(174)
Carrying amount (60%/30% 580)
72
46
Gain
Where a subsidiary to associate disposal has taken place in the accounting period:
The interest in the associate is equity accounted based on the year end
shareholding. The cost of the investment is taken to be the fair value of the
interest retained at the disposal date and this is subsequently increased by the
group share of post-acquisition retained total comprehensive income.
574
CA Sri Lanka

The results of the subsidiary investment are consolidated until the date on
which control is lost.
Thereafter the results of the associate investment are equity accounted.
A gain or loss on disposal is recognised.
QUESTION
Subsidiary to associate disposal
Yala Co, the parent company of Yala Group bought 100% of the voting share
capital of Sinharaja Co on its incorporation on 1 January 20X2 for Rs. 160 Mn.
Sinharaja Co earned and retained Rs. 240 Mn from that date until
31 December 20X7. At that date the statements of financial position of the
company and the group were as follows.
Sinharaja Consolidated
Yala Group
(excluding
Co
S Co)
Rs Mn
Rs Mn
Rs Mn
160
Investment in Sinharaja
500
1,500
Assets
1,000
500
1,500
1,160
Stated capital
Retained earnings
Liabilities
400
560
200
1,160
160
240
100
500
400
800
300
1,500
It is the group's policy to value the non-controlling interest at its proportionate

share of the fair value of the subsidiary's identifiable net assets.
On 31 December 20X7 Yala Co sold 60% of its holding in Sinharaja Co for
Rs. 440 Mn. The fair value of the 40% associate holding retained was Rs. 200 Mn.
Required
Calculate the parent company and group gain or loss on disposal and prepare the
consolidated statement of financial position at 31 December 20X7.
ANSWER
The gain or loss on disposal in the books of the parent company is calculated as
follows:
Parent company
Rs Mn
440
(96)
Carrying amount of investment (60% 160)
344
Profit on sale
CA Sri Lanka
575
The group gain is calculated as follows:

Rs Mn
440
200

Fair value of investment retained
Less Yala's share of consolidated carrying
amount at date control lost 100% 400
Group profit on sale
(400)
240
Notes:
1
Note that there was no goodwill arising on the acquisition of Sinharaja,

otherwise this too would be deducted in the calculation.
The group gain can be split into the amount attributable to the disposal of
Rs. 440 Mn (60% 400 Mn) = Rs. 200 Mn and the amount attributable to
the fair value uplift of the retained portion Rs. 200 Mn (40% 400 Mn) =
Rs. 40 Mn.
The gain attributable to the disposal is Rs. 144 Mn less than the parents gain
on disposal. As previously, this amount is equal to the profits made between
acquisition and disposal date that are attributable to the disposed of
shareholding:
Acquisition
Retd
earnings
Rs 0
Disposal
Profits for period between acquisition and disposal Rs 240 Mn
60% profits (attributable to disposed of shareholding) Rs 144 Mn
40% profits (attributable to retained shareholding) Rs 96 Mn
Retd
earnings
Rs 240 Mn
After the disposal, the consolidated statement of financial position is prepared as

follows:
Investment in S
Assets
Stated capital
Retained earnings
Liabilities
576
Y Co
Rs Mn
160
1,000
S Co
Rs Mn
1,160
400
560
200
1,160
500
160
240
100
500
W1
Rs Mn
(160)
500
W2
Rs Mn
200
440
(500)
(160)
240
(100)
Consol
Rs Mn
200
1,440
1,640
400
1,040
200
1,640
CA Sri Lanka
Workings
(W1) For consolidation purposes, the cost of the investment in the subsidiary in Y
Cos books is initially cancelled against the stated capital of S Co by (Rs Mn):
DEBIT
CREDIT
Stated capital
Investment in S
160
160
(W2) The group disposal journal is recorded by (Rs Mn):

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
Assets (cash)
Investment in ass
Liabilities
Assets
Retained earnings
440
200
100
500
240
The credit to retained earnings is also reported as the gain on disposal in the
consolidated statement of profit or loss.
Tutorial note
An alternative approach to the preparation of the consolidated statement of
financial position, and the approach that would be taken in subsequent years
assumes that Yala Co has recorded the disposal by:
DEBIT
CREDIT
CREDIT
Cash
Investment
Retained earnings
440
96
344
The Yala Group statement of financial position is then adjusted to:

(i)
record the 40% profits since acquisition of Sinharaja Co (now an associate

holding) that are attributable to the group (Rs. 96 Mn see diagram above),
and
(ii)
record the fair value uplift of Rs. 40 Mn
Investment in S
(i)
W2
Consol
Rs Mn
Rs Mn
Rs Mn
Rs Mn
96
40
64
200
1,440
1,440
1,504
1,640
Stated capital
400
400
Retained earnings
904
Liabilities
200
200
1,504
1,640
Assets
CA Sri Lanka
Y Co
96
40
1,040
577
2.4 Control is lost: subsidiary to equity investment

Where control is lost, however an equity investment is retained:
1
The parent companys gain or loss on disposal is calculated in the same way
as that described in section 2.2.1.
The group gain or loss on disposal is calculated in the same way as that
described in section 2.3.1.

Where a subsidiary to equity investment disposal has taken place in the
accounting period:
The equity investment is recognised at its fair value at the date of disposal and
is accounted for thereafter in accordance with LKAS 39.
The results of the subsidiary investment are consolidated until the date on
which control is lost.
Thereafter any dividend income is recognised.
A gain or loss on disposal is recognised.
2.5 Control is retained: subsidiary to subsidiary

Where a controlling shareholding is retained, SLFRS 3 and SLFRS 10 do not
consider that a disposal has taken place. Therefore in the consolidated financial
statements, a gain or loss on disposal is not recognised and instead the disposal is
recognised as a transaction between shareholders.
The adjustment to the parent's equity is calculated as follows.
Rs.
Increase in NCI in net assets at disposal
(X)
Increase in NCI in goodwill at disposal *
(X)
* Note. This line is only required where non-controlling interests are measured at
fair value at the date of acquisition (ie where there is an increase in the noncontrolling interest share of goodwill already recognised).
578
CA Sri Lanka
2.5.1 Example: subsidiary to subsidiary disposal

P acquired 90% of S in 20X1 giving rise to goodwill of Rs. 30 Mn, including
Rs. 3 Mn attributable to the NCI. Goodwill has not been impaired. On 12 December
20X7, P disposed of 1/3 of its holding in S for Rs. 56 Mn when the net assets of that
company were Rs. 170 Mn. At this date, the carrying amount of the NCI was
Rs. 19 Mn.
The adjustment to the parent's equity is calculated as follows.
Rs Mn
56

Increase in NCI in net assets at disposal (30% x 170m
(51)
Increase in NCI in goodwill at disposal (30% x 30m)
(9)
4
The journal required to recognise the disposal in the consolidated financial

statements is:
DEBIT
DEBIT
CREDIT
Cash
Equity
NCI (Rs. 51 Mn + 9 Mn)
Rs. 56 Mn
Rs. 4 Mn
Rs. 60 Mn

Where a subsidiary to subsidiary disposal has taken place in the accounting
period:
Goodwill on acquisition is unchanged.
The assets and liabilities of the subsidiary are consolidated as normal.
The NCI is based on the year-end NCI percentage.
The increase in NCI is shown as an adjustment to group equity.
The results of the subsidiary are consolidated for the whole period.
The non-controlling interest is calculated by pro-rating the results for the year
and taking the relevant NCI percentage of the results pre and post disposal
date.
2.5.3 Parent company financial statements
In the parent companys own financial statements, a gain or loss on disposal is
calculated in the same way as that described previously, as the difference between
CA Sri Lanka
579
proceeds and the carrying amount of the investment disposed of. The resulting
gain or loss is recognised in profit or loss.
QUESTION
Disposal of a subsidiary
P Co, part of the P Group bought 80% of the share capital of S Co for Rs. 324 Mn on
1 October 20X5. At that date S Co's retained earnings balance stood at Rs. 180 Mn.
The statements of financial position at 30 September 20X8 and the summarised
statements of profit or loss to that date are given below. (There is no other
comprehensive income.)
P Group
S Co
Rs Mn
Rs Mn
360
270
Non-current assets
324
Investment in S Co
370
370
Current assets
1,054
640
Equity
540
180
Stated capital
414
360
Retained earnings
100
Current liabilities
100
1,054
640
Profit before tax
Tax
Profit for the year
153
(45)
108
126
(36)
90
No entries have been made in the accounts for any of the following transactions.
Assume that profits accrue evenly throughout the year.
It is the group's policy to value the non-controlling interest at its proportionate
share of the fair value of the subsidiary's identifiable net assets.
Ignore taxation.
Required
Prepare the consolidated statement of financial position and statement of profit
or loss at 30 September 20X8 in each of the following circumstances. (Assume no
impairment of goodwill.) In each case calculate the group gain or loss on disposal.
580
(a)
P Co sells its entire holding in S Co for Rs. 650 Mn on 30 September 20X8.
(b)
P Co sells one quarter of its holding in S Co for Rs. 160 Mn on 30 June 20X8.
(c)
P Co sells one half of its holding in S Co for Rs. 340 Mn on 30 September

20X8, and the remaining holding (fair value Rs. 250 Mn) is to be dealt with as
an investment in equity instruments.
CA Sri Lanka
ANSWER
(a)
Complete disposal at year end (80% to 0%)

30 SEPTEMBER 20X8
P Co
S Co
(W2)
(W3)
(W4)
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
NCA
360
270
(270)
Goodwill
36
(36)
Invt
324
(324)
370
650
C. Assets
370
(370)
1,054
640
St Capital
540
180
(180)
Retd
414
360
(180)
(36)
182
Earnings
NCI
72
36
(108)
100
(100)
C Liabilities
100
1,054
640
Group
Rs Mn
360
0
0
1,020
1,380
540
740
0
100
1,380
CONSOLIDATED STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED

30 SEPTEMBER 20X8
PBT
Tax
Att.to:
Owners of
parent
NCI
P Co
Rs Mn
153
(45)
108
S Co
Rs Mn
126
(36)
90
(W3)
Rs Mn
182
Group
Rs Mn
461
(81)
380
108
72
182
362
18
18
380
Workings
1
Timeline
1.10.X7
30.9.X8
P/L
Subsidiary all year
Group gain on
disposal not sub at y/e
CA Sri Lanka
581
(W2) Goodwill on acquisition

Rs Mn
324
72
(360)
36
NCI (20% 360)
Acquired: (180 + 180)
Consolidation adjustment journal (Rs Mn):
DEBIT Goodwill
36
DEBIT Stated capital
180
DEBIT Retained earnings
180
CREDIT Investment
324
CREDIT NCI
72
(W3) Non-controlling interest
The NCI share of post acquisition profits is allocated by (Rs Mn)

DEBIT Retained earnings (360 180) 20%
CREDIT NCI
36
36
(W4) Group gain on disposal of S Co

Rs Mn
Less share of carrying amount when control
lost:
net assets
goodwill (W3)
non-controlling interest: 20% 540
Rs Mn
650
540
36
(108)
(468)
182

DEBIT Cash
DEBIT NCI
DEBIT Liabilities (of S)
CREDIT Goodwill
CREDIT Gain on disposal
CREDIT Non-current assets (of S)
CREDIT Current assets (of S)
582
650
108
100
36
182
270
370
CA Sri Lanka
(b)
Partial disposal: subsidiary to subsidiary (80% to 60%)

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30
SEPTEMBER 20X8
P Co
S Co
(W2)
(W3)
(W4)
Group
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
NCA
360
270
630
Goodwill
36
36
Invt
324
(324)
0
370
160
900
C. Assets
370
1,054
640
1,566
St Capital
540
180
(180)
540
Retd
414
360
(180)
(40.5)
56.5
610
Earnings
NCI
72
40.5
103.5
216
100
200
C Liabilities
100
1,054
640
1,566
30 SEPTEMBER 20X8
P Co
S Co
Group
Rs Mn
Rs Mn
Rs Mn
PBT
153
126
279
Tax
(45)
(36)
(81)
108
90
198
Att.to:
Owners of parent
108
67.5
175.5
NCI
22.5
13.5
20% 90 x 9/12
9.0
40% 90 x 3/12
198
Workings
1
Timeline
1.10.X7
30.6.X8
30.9.X8
P/L
Subsidiary all year
20% NCI 9/12
Retained control (60%)

so adjust parent's
CA Sri Lanka
40% NCI 3/12
Sells 60,000 shares
Consol 40% NCI
583
(W2) is as in part (a)

(W3) Non-controlling interest
The allocation of post-acquisition profits must take account of the change in
the NCI on 30 June as follows:
1 October 20X5 30 June 20X8 20% [(360 (3/12 90)) 180] 31.5m
30 June 20X8 30 September 20X8 40% (3/12 90)
=9
Therefore (Rs Mn):

DEBIT Retained earnings 40.5
CREDIT NCI
(W4)
40.5
Adjustment to parents equity on disposal of 20% of S

Rs Mn

Less increase in NCI in net assets at disposal
20% (540 (3/12 90))
DEBIT Cash
CREDIT NCI
(c)
160
(103.5)
56.5
160
103.5
56.5
Partial disposal: subsidiary to investment in equity instruments (80% to 40%)

30 SEPTEMBER 20X8
P Co
S Co
(W2)
(W3)
(W4)
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
360
270
(270)
NCA
36
(36)
Goodwill
324
(324)
250
Invt
370
370
(370)
C. Assets
340
1,054
640
540
180
(180)
St Capital
414
360
(180)
(36)
122
Retd Earnings
72
36
(108)
NCI
100
100
(100)
C Liabilities
1,054
640
584
Group
Rs Mn
360
0
250
710
1,320
540
680
0
100
1,320
CA Sri Lanka

30 SEPTEMBER 20X8
S Co (9/12)
P Co
(W3)
Group
Rs Mn
Rs Mn
Rs Mn
Rs Mn
153
94.5
247.5
PBT
122
122
Profit on disposal
(27)
(72)
(45)
Tax
108
67.5
297.5
Att.to:
108
54
122
284
Owners of parent
13.5
13.5
NCI (20%)
297.5
Workings
1
Timeline
1.10.X7
30.6.X8
30.9.X8
P/L
Subsidiary (80% 9/12)
IEI 3/12
Sells =
40% of S Co
IEI in SOFP
Group gain
on disposal
(W2) and (W3) are as in part (a)

(W4) Group gain on disposal
Rs Mn
FV of consideration
FV of retained investment
Less assets at disposal date:
Net assets
Goodwill
NCI
Gain on disposal
CA Sri Lanka
540
36
(108)
Rs Mn
340
250
(468)
122
585

DEBIT
DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
CREDIT
CREDIT
Cash
Investment
NCI
Liabilities (of S)
Non-current assets (of S)
Current assets (of S)
Goodwill
Retained earnings
340
250
108
100
270
370
36
122
QUESTION
P has owned a 70% holding in S for many years. During the year ended
31 December 20X6, it decided to dispose of 15% of S's shares to aid other
expansion plans. The shares were put up for sale on 28 February 20X6, a
purchaser was found on 31 March 20X6 and the legal documentation was
completed by 30 April 20X6. P paid a significant premium for its interest in S and
goodwill was recognised amounting to Rs. 80 Mn. Due to some market difficulties
this was written down to Rs. 65 Mn 2 years ago. It has not been necessary to
recognise any further impairment losses.
The group policy is to measure non-controlling interests at their proportionate
share of the fair value of the acquiree's identifiable net assets.
Required
Discuss how this transaction would affect the consolidated statement of profit or
loss and other comprehensive income of the P Group for the year ended
31 December 20X6 and the consolidated statement of financial position at that
date.
ANSWER
Disposal of 15% of the shares in S leaves a 55% holding which means that P still
retains control of S. Consequently, S's income and expenses are consolidated in
full for the whole period as they were under the control of P throughout the
period.
The non-controlling interests in S have changed during the year and this change in
ownership occurred legally on 30 April 20X6. Consequently the NCI will be
allocated 30% of profits and other comprehensive income arising in the first 4
months of the year, and 45% for the final 8 months of the year.
586
CA Sri Lanka
No profit or loss on disposal is recognised as control is retained.

The consolidated statement of financial position is prepared at the reporting date
based on the shareholding at that date. At the reporting date P controls S and noncontrolling interests are 45%, so S's assets and liabilities will be consolidated in
full and 45% non-controlling interests in them shown in the equity section of the
statement of financial position.
Group reserves will reflect the fact that P owned 70% of profits made from the
date S was acquired until 30 April 20X6 and only 55% thereafter.
An adjustment to equity is also made to reflect the disposal. The NCI is credited
with an additional 15% of the consolidated book value of the identifiable net
assets of S at 30 April 20X6, proceeds are recognised and any difference is taken to
group retained earnings:
DEBIT
Cash
Proceeds
CREDIT Non-controlling interest
15% net assets
DEBIT/CREDIT retained earnings
Balance
QUESTION
Polonnaruwa PLC acquired 25% of the shares in Dambulla Ltd on 1 January 20X3
by issuing one million shares with a fair value of Rs. 200 each. Polonnaruwa PLC
did not exercise significant influence over Dambulla, and accounted for the
investment at cost. At 1 January 20X3 the net assets of Dambulla Ltd had a
carrying amount of Rs. 690 Mn and a fair value of Rs. 710 Mn.
On 1 May 20X4, Polonnaruwa PLC bought a further 60% of the share capital of
Dambulla by issuing a further two million shares with a fair value of Rs. 250 each.
At that date the net assets of Bismuth had a carrying amount of Rs. 750 Mn and a
fair value of Rs. 775 Mn. The difference between book and fair value is due to land
held at cost Rs. 25 Mn below its fair value. The non-controlling interest at
1 May 20X4 had a fair value of Rs. 100 Mn, and the 25% interest already held by
Polonnaruwa had a fair value of Rs. 205 Mn.
Polonnaruwa measures the non-controlling interest at fair value.
Required
(a) What goodwill figure is recognised in the consolidated statement of financial
position at 31 December 20X3, in accordance with SLFRS 3, Business
Combinations?
(b) What journal entries are required to record the acquisition?
CA Sri Lanka
587
ANSWER
Goodwill is not calculated until control is gained on the second acquisition. At
this date the calculation includes the fair value of the retained interest as follows:
Rs Mn
FV of consideration transferred (2m x Rs 250)
500
NCI at fair value
100
FV of retained interest
205
(775)
FV of net assets of Dambulla
Goodwill
30 Mn
The first consolidation journal recognises the disposal of the existing interest in
Dambulla and its purchase at fair value:
DEBIT Investment
205
CREDIT Investment (Rs. 200 x 1m)
200
CREDIT Gain (P/L)
5
The second consolidation journal records goodwill on acquisition as follows
(Rsm):
DEBIT
Goodwill
30
DEBIT
Land
25
DEBIT
Share capital / reserves
750
CREDIT Investment (205 + 500)
705
CREDIT NCI
100
588
CA Sri Lanka
CHAPTER ROUNDUP
Business combinations achieved in stages (step or piecemeal acquisitions) can

result in a company being an investment in equity instruments, an associate and
then a subsidiary over time.
Goodwill is calculated only when control is achieved; where there is a

previously held investment, this is remeasured to fair value and included
within the goodwill calculation.
Where an interest in an existing subsidiary is increased, the acquisition is

treated as a transaction between shareholders. Goodwill is not recalculated.
A parent company may dispose of a full or partial shareholding. In some cases,

control is retained. The accounting treatment depends on the level of
disposal.
In all cases the parent company gain or loss on disposal is the difference between
the fair value of consideration and the carrying amount (usually cost) of the
investment disposed of.
In a full disposal, the group gain on disposal is the difference between the fair
value of consideration and the recognised net assets and goodwill of the
subsidiary.
In a disposal in which an associate or equity investment is retained, the

group gain on disposal is the difference between the fair value of
consideration plus the fair value of the retained interest and the recognised
net assets and goodwill of the subsidiary.
In a disposal in which control is retained, a group gain or loss is not calculated;

the disposal is treated as a transaction between shareholders.
CA Sri Lanka
589
PROGRESS TEST
590
As a result of which of the following transactions, if any, is goodwill calculated?

A
A 5% shareholding is increased to become a 30% shareholding
A 60% controlling shareholding is increased to become an 85% controlling

shareholding
What journal is required to record an increase in a subsidiary shareholding?
What journal is required to record a decrease in a subsidiary shareholding?
P has held a non-controlling shareholding in S for a number of years. In 20X8 P

acquired additional shares in S to achieve a controlling interest. How is goodwill
calculated?
How is the group gain on disposal calculated when control of a subsidiary is lost
but a non-controlling shareholding is retained?
CA Sri Lanka
C and D. In both of these cases control is achieved where it did not previously
exist.
DEBIT
CREDIT
DEBIT/CREDIT
NCI
Cash
Equity
X
X
X
CREDIT
DEBIT/CREDIT
DEBIT
NCI
Equity
Cash
X
X
X

Fair value of existing shareholding
NCI (fair value or proportion of net assets of acquiree)
Fair value of net assets of acquiree
Goodwill
Consideration received
Fair value of retained interest
Net assets disposed of (net assets + goodwill
NCI interest)
Gain / loss
CA Sri Lanka
X
X
X
(X)
X
X
X
(X)
X
591
592
CA Sri Lanka
CHAPTER
INTRODUCTION
Complex groups involve sub-subsidiaries; the basic consolidation procedures seen in your earlier studies should still be
applied.
In questions about complex groups and reorganisations, it is very helpful to sketch a diagram of the group structure, as
we have done. This clarifies the situation and it should point you in the right direction: always sketch the group
structure as your first working and double check it against the information in the question.
Knowledge Component
1 Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
2
2.1
Level A
1.1.1
Advise on application of Sri Lanka Accounting Standards in solving

complicated matter.
1.1.2

circumstances in conformity with Sri Lanka Accounting Standards.
1.1.3
Evaluate the impact of application of different accounting treatments.
1.1.4

circumstances.
1.1.5
Evaluate the impact of use of different expert inputs to financial reporting.
1.1.6

1.1.7
Preparation and presentation of Consolidated Financial Statements

Consolidated
financial
statements
2.1.1
2.1.2
Recompile a consolidated set of financial statements post acquisition / merger

/ divestment
593
KC1 | Chapter 18: Complex groups and group reorganisations
CHAPTER CONTENTS
1 Vertical groups
2 D-shaped groups
3 Group reorganisations

group structures.
Changes in group structures Learning objectives

Discuss the reasons behind a group reorganisation.
Evaluate and assess the principal terms of a proposed group reorganisation.
1 Vertical groups
A vertical group exists where a parent has a subsidiary and that subsidiary
has its own subsidiary. The effective group holding in the sub-subsidiary must
be calculated and used in the consolidation workings.
1.1 Introduction
The following group structure shows a vertical group:
P
80%
S
75%
SS
P holds a controlling interest in S which in turn holds a controlling interest in SS.

SS is therefore a subsidiary of a subsidiary of P, in other words, a sub-subsidiary of
P.
594
CA Sri Lanka
1.2 The non-controlling interest

In the case of a vertical group, the important issue is identification of the noncontrolling interest.
Suppose P owns 80% of the equity of S, and that S in turn owns 60% of the equity
of SS.
P
80%
S
60%
SS
P owns 80% of S and 80% 60% = 48% of SS

The non-controlling interest in S is 20%
The non-controlling interest in S also owns 20% 60% = 12% of SS
The non-controlling interest in SS itself owns the remaining 40% of the SS
equity
The total non-controlling interest in SS is therefore 12% + 40% = 52%
Even though the non-controlling interest own 52% of SS, it is a sub-subsidiary of
P. That is because P controls S which in turn controls SS. As a result, although P
owns only 48% of the equity of SS, it controls SS.
The total non-controlling interest in SS may be checked by considering a dividend
of Rs. 100 Mn paid by SS:
Rs Mn
Rs 60 Mn
S will receive
80% Rs 60 =
48
P will receive
52
Leaving a dividend payable to the other
shareholders of SS (the NCI)
100
QUESTION
Effective interest
Top owns 60% of the equity of Middle Co, which owns 75% of the equity of
Bottom Co. What is Top Co's effective holding in Bottom Co?
CA Sri Lanka
595
ANSWER
Top owns 60% of 75% of Bottom Co = 45%.
1.3 Date of effective control

Before preparing the consolidated financial statements of a vertical group it is
important to identify the date on which control over the sub-subsidiary was
achieved.
This may be one of two dates:
(a)
If S controlled SS prior to joining the group, it will be the date on which P

acquired control of S.
(b)
If S did not control SS prior to joining the group, it will be the date on which S
acquired control of SS.
Determining the acquisition date of SS is important when identifying the preacquisition reserves of the sub-subsidiary.
1.4 Consolidation method

The basic consolidation method is unchanged from that revised in the previous
chapter:
Assets and liabilities: add the assets and liabilities of the parent, subsidiaries
and sub-subsidiaries, eliminating any intra-group amounts.
Recognise goodwill on acquisition.
Share capital is that of P only
Reserves include Ps reserves and the post-acquisition reserves of subsidiaries
and sub-subsidiaries based on effective holdings.
A non-controlling interest is recognised.
As you will see in the examples in this chapter, there are some new complications
to be aware of in the workings for goodwill and non-controlling interests.
As we have already said, the date on which the sub-subsidiary is acquired is key.
This may be:
A different date from the date on which the subsidiary is acquired (where the
subsidiary is acquired first), or
The same date as that on which the subsidiary is acquired (where the subsubsidiary is acquired first).
596
CA Sri Lanka
The following two examples demonstrate how this affects consolidation

procedures, in particular group retained earnings.
Example 1.4.1 : Subsidiary acquired first
The draft statements of financial position of P Co, S Co and SS Co on 30 June 20X7
were as follows.
P Co
S Co
SS Co
Rs'000
Assets
Rs'000
Rs'000
Non-current assets
105,000
125,000
180,000
Tangible assets
Investments, at cost
120,000
80,000 shares in S Co
110,000
60,000 shares in SS Co
70,000
60,000
80,000
Current assets
305,000
305,000
240,000
Equity
80,000
100,000
100,000
Stated capital
195,000
170,000
115,000
Retained earnings
275,000
270,000
215,000
30,000
35,000
25,000
Payables
305,000
305,000
240,000
P Co acquired its 80% shareholding in S Co on 1 July 20X4 when the reserves of
S Co stood at Rs. 40 Mn; and
S Co acquired its 60% shareholding in SS Co on 1 July 20X5 when the reserves of
SS Co stood at Rs. 50 Mn.
It is the group's policy to measure the non-controlling interest at acquisition at its
proportionate share of the fair value of the subsidiary's net assets.
Required
Prepare the draft consolidated statement of financial position of P Group at
30 June 20X7.
Note. Assume no impairment of goodwill.
Solution
This is two acquisitions from the point of view of the P group:
In 20X4, the group buys 80% of S.
In 20X5 S (which is now part of the P group) buys 60% of SS.
CA Sri Lanka
597

P
S
SS
W2(i)
Rs Mn Rs Mn Rs Mn Rs Mn
NC Assets
105
125
180
Goodwill
8
Investments 120
110
(120)
70
60
Current
80
assets
305
305
240
Equity
80
100
100 (100)
Retained
195
170
115
(40)
earnings
NCI
28
35
25
Payables
30
305
305
240
W2(ii)
Rs Mn
W3(i)
Rs Mn
W3(ii)
Rs Mn
16
(88)
W4
Rs Mn
(22)
(100)
(50)
(26)
(33.8)
78
26
33.8
Consol
Rs Mn
410
24
210
644
80
330.2
(22)
143.8
90
644
Workings
1
Group structure
P
1.7.20X4
80%
S
1.7.20X5
Effective interests in SS:

P Group (80% 60%)
= 48%
NCI
= 52%
60%
SS
Goodwill
In this working, the cost of each investment from a group perspective is
compared with the effective group interest acquired.
Note that:
598
the cost of Ss investment in SS from a group perspective is 80% of the

total cost.
The NCI in net assets at acquisition is based on the 52% NCI calculated
above
CA Sri Lanka
P in S
Rs'000
Rs'000
Fair value of identifiable

net assets acquired:
Stated capital
Retained earnings
120,000
(20%
140,000)
28,000
100,000
40,000
S in SS
Rs'000
(80%
110,000)
(52%
150,000)
Rs'000
88,000
78,000
100,000
50,000
(140,000)
(150,000)
8,000
16,000
24,000
(i)
The acquisition journal for P in S is therefore:

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
(ii)
Rs. 8 Mn
Rs. 100 Mn
Rs. 40 Mn
Rs. 120 Mn
Rs. 28 Mn
The acquisition journal for S in SS is therefore:

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 16 Mn
Rs. 100 Mn
Rs. 50 Mn
Rs. 88 Mn
Rs. 78 Mn
Retained earnings allocation

The NCI share of post-acquisition retained earnings must be allocated to the
NCI in net assets.
(i)
Ss post acquisition profits

20% (170 Mn 40 Mn) = Rs. 26 Mn
(ii)
SSs post acquisition profits

52% (115 Mn 50 Mn) = Rs. 33.8 Mn
CA Sri Lanka
599
In both cases the required journal is:

DEBIT
CREDIT
4
Retained earnings
NCI
Non-controlling interest in cost of sub-subsidiary

The NCI in S must be adjusted for its interest in SS. The NCI of Ss interest in
SS is 20% of the cost of the investment of Rs. 110 Mn ie Rs. 22 Mn. This is
eliminated against the carrying amount of the NCI in S by:
DEBIT
CREDIT
NCI
Investment
Rs. 22 Mn
Rs. 22 Mn
Example 1.4.2: Sub-subsidiary acquired first

Using the figures in the example above, assume that:
(a)
(b)
S Co purchased its holding in SS Co on 1 July 20X4

P Co purchased its holding in S Co on 1 July 20X5
The retained earnings figures on the respective dates of acquisition are the same,
but on the date P Co purchased its holding in S Co, the retained earnings of SS Co
were Rs. 60 Mn.
It is the groups policy to measure the non-controlling interest at its proportionate
share of the fair value of the subsidiarys net assets.
Required
30 June 20X7.
Note. Assume no impairment of goodwill.
SOLUTION
In this example, SS Co only became part of the P group on 1 July 20X5, not on
1 July 20X4.
Therefore only the retained earnings of SS Co arising after 1 July 20X5 are
included in the post-acquisition reserves of P Co group.
600
CA Sri Lanka

P
S
SS
W2(i) W2(ii) W3(i)
Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn
105 125 180
NC Assets
8
11.2
Goodwill
(120) (88)
Investments 120 110
80
70
60
Current
assets
305 305 240
80 100 100 (100) (100)
Equity
195 170 115 (40)
(60)
(26)
Retained
earnings
28
83.2
26
NCI
30
35
25
Payables
305 305 240
W3(ii)
W4
Rs Mn Rs Mn
(22)
639.2
80
325.4
(28.6)
28.6
Consol
Rs Mn
410
19.2
210
(22)
143.8
90
639.2
WORKINGS
1
Group structure
P
1.7.20X5
80%
S
1.7.20X4
60%
SS
P owns an effective interest of 48% in SS. NCI in SS is 52%. This is unchanged

from the previous example.
CA Sri Lanka
601
Goodwill
P in S
Rs'000

Stated capital
Retained earnings
Rs'000
120,000
(20%
140,000)
28,000
100,000
40,000
S in SS
Rs'000
Rs'000
(80%
110,000)
(52%
160,000)
88,000
83,200
100,000
60,000
(140,000)
(160,000)
8,000
11,200
14,000
(i)

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
(ii)
Rs. 8 Mn
Rs. 100 Mn
Rs. 40 Mn
Rs. 120 Mn
Rs. 28 Mn

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 11.2 Mn
Rs. 100 Mn
Rs. 60 Mn
Rs. 88 Mn
Rs. 83.2 Mn

NCI in net assets.
(i)

20% (170 Mn 40 Mn) = Rs. 26 Mn
(ii)

52% (115 Mn 60Mn) = Rs. 28.6 Mn
602
CA Sri Lanka

DEBIT
CREDIT
4
Retained earnings
NCI

As before the NCI in S must be adjusted for its interest in SS. The NCI of Ss
interest in SS is 20% of the cost of the investment of Rs. 110 Mn ie Rs. 22 Mn.
This is eliminated against the carrying amount of the NCI in S by:
DEBIT
CREDIT
NCI
Investment
Rs. 22 Mn
Rs. 22 Mn
1.5 NCI at fair value

Both examples that we have seen so far required the NCI to be measured as a
proportion of net assets. Where the NCI is measured at fair value the workings
remain the same as those in the previous examples, but goodwill and the NCI will
both include NCI goodwill.
Example 1.5.1: Subsidiary acquired first NCI at fair value
The draft statements of financial position of P Co, S Co and SS Co on 30 June 20X7
were as follows (these are the same as in the examples above).
Assets
Non-current assets
Tangible assets
Investments, at cost
80,000 shares in S Co
60,000 shares in SS Co
Current assets
Equity
Stated capital
Retained earnings
Payables
P Co
Rs'000
S Co
Rs'000
SS Co
Rs'000
105,000
125,000
180,000
120,000
80,000
305,000
110,000
70,000
305,000
60,000
240,000
80,000
195,000
275,000
30,000
305,000
100,000
170,000
270,000
35,000
305,000
100,000
115,000
215,000
25,000
240,000
P Co acquired its 80% holding in S Co on 1 July 20X4 when the reserves of S Co

stood at Rs. 40 Mn; and
CA Sri Lanka
603
S Co acquired its 60% holding in SS Co on 1 July 20X5 when the reserves of SS Co

stood at Rs. 50 Mn.
It is the group's policy to measure the non-controlling interest at fair value at the
date of acquisition. The fair value of the non-controlling interests in S on 1 July
20X4 was Rs. 29 Mn. The fair value of the 52% non-controlling interest in SS on
1 July 20X5 was Rs. 80 Mn.
Required
30 June 20X7.
SOLUTION
P
S
SS
W2(i) W2(ii) W3(i)
Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn
105 125 180
NC Assets
9
18
Goodwill
(120) (88)
Investments 120 110
80
70
60
Current
assets
305 305 240
80 100 100 (100) (100)
Equity
195 170 115 (40)
(50)
(26)
Retained
earnings
29
80
26
NCI
30
35
25
Payables
305 305 240
W3(ii)
W4
Consol
Rs Mn Rs Mn Rs Mn
410
27
(22)
210
647
80
330.2
(33.8)
33.8
(22)
146.8
90
647
WORKINGS
1
Group structure
P
1.7.20X4
80%
S
1.7.20X5
Effective interests in SS:

P Group (80% 60%)
= 48%
NCI
= 52%
60%
SS
604
CA Sri Lanka
Goodwill
P in S
Rs'000
Rs'000
Consideration
transferred
Non-controlling
interests
120,000
S in SS
Rs'000
Rs'000
(80%
110,000)
29,000
Fair value of
identifiable net assets
acquired:
Stated capital
Retained earnings
100,000
40,000
88,000
80,000
100,000
50,000
(140,000)
(150,000)
9,000
18,000
27,000
(i)

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
(ii)
Rs. 9 Mn
Rs. 100 Mn
Rs. 40 Mn
Rs. 120 Mn
Rs. 29 Mn

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 18 Mn
Rs. 100 Mn
Rs. 50 Mn
Rs. 88 Mn
Rs. 80 Mn

NCI in net assets.
(i)

20% (170 Mn 40 Mn) = Rs. 26 Mn
(ii)

52% (115 Mn 50 Mn) = Rs. 33.8 Mn
CA Sri Lanka
605

DEBIT
CREDIT
4
Retained earnings
NCI

As before the NCI in S must be adjusted for its interest in SS. The NCI of Ss
interest in SS is 20% of the cost of the investment of Rs. 110 Mn ie Rs. 22 Mn.
This is eliminated against the carrying amount of the NCI in S by:
DEBIT
CREDIT
NCI
Investment
Rs. 22 Mn
Rs. 22 Mn
1.6 Consolidation adjustments

Where financial statements are being prepared for a vertical group, consolidation
adjustments for intra-group balances, unrealised profits and so on are made as
normal.
The following question tests your ability to combine these adjustments as seen in
the previous chapter with the workings applicable to vertical groups as seen in
this chapter.
QUESTION
Sub-subsidiary
The statements of financial position of Antelope Co, Yak Co and Zebra Co at

31 March 20X4 are summarised as follows.
Antelope Co
Yak Co
Zebra Co
Rs Mn
Rs Mn
Rs Mn Rs Mn Rs Mn Rs Mn
Assets
Non-current assets
100
100
Freehold property
210
80
3
Plant and machinery
310
180
3
Investments in
subsidiaries
110
6.2
Shares, at cost
3.8
Loan account
10
12.2
Current accounts
120
22.2
606
CA Sri Lanka
Antelope Co
Rs Mn
Rs Mn
Current assets
Inventories
Receivables
Cash at bank
170
140
60
Yak Co
Rs Mn Rs Mn
20.5
50
16.5
370
800
Equity
Stated capital
Retained earnings
200
379.6
15
1
4
87
289.2
100
129.2
579.6
Current liabilities
Trade payables
Due to Antelope Co
Due to Yak Co
Taxation
160.4
60
Zebra Co
Rs Mn Rs Mn
20
23
10
(1)
229.2
40.2
12.8
9
0.8
0.6
12.6
220.4
800
60
289.2
14
23
Antelope Co acquired 75% of the shares of Yak Co in 20X1 when the credit balance
on the retained earnings of that company was Rs. 40 Mn. No dividends have been
paid since that date.
Yak Co acquired 80% of the shares in Zebra Co in 20X3 when there was a debit
balance on the retained earnings of that company of Rs. 3 Mn.
Subsequently Rs. 0.5 Mn was received by Zebra Co and credited to its retained
earnings, representing the recovery of an irrecoverable debt written off before the
acquisition of Zebra's shares by Yak Co.
During the year to 31 March 20X4 Yak Co purchased inventory from Antelope Co
for Rs. 20 Mn which included a profit mark-up of Rs. 4 Mn for Antelope Co. At
31 March 20X4 one half of this amount was still held in the inventories of Yak Co.
Group accounting policies are to make a full allowance for unrealised intra-group
profits.
It is the group's policy to measure the non-controlling interest at its proportionate
share of the fair value of the subsidiary's net assets.
Required
Prepare the draft consolidated statement of financial position of Antelope Co at
31 March 20X4.
CA Sri Lanka
607
ANSWER
Consolidated statement of financial position of the Antelope Group at
31 March 20X4
Property
P&M
Goodwill
Invt in
Subs
Shares
Loan
Current a/c
Current
assets
Inventories
Receivables
Cash
Stated
capital
Retained
earnings
NCI
Payables
Due to A
Due to Y
Taxation
A
Rs Mn
100
210
Y
Rs Mn
100
80
Z
W2(i)
Rs Mn Rs Mn
3
5
(110)
W2(ii)
Rs Mn
W3
Rs Mn
W4
W5
Rs Mn Rs Mn
W6
Rs Mn
0.15
110
10
6.2
3.8
12.2
(4.65)
170
140
60
800
200
20.5
50
16.5
289.2
100
15
1
4
23
10
(100)
(10)
379.6
129.2
(1)
(40)
2.5
160.4
60
800
40.2
12.8
7
289.2
0.8
0.6
12.6
23
(1.55)
(3.8)
(22.2)
35
(22.9)
22.9
Consol
Rs Mn
200
293
5.15
(2)
203.5
191
80.5
973.15
200
(2)
445.4
(1.55)
(13.4)
(12.6)
59.35
201.4
67
973.15
WORKINGS
1
Group structure
A
20X1
75%
Y
20X3
Effective interests in Z:
A Group (75% 80%) = 60%
NCI
= 40%
80%
Z
608
CA Sri Lanka
Goodwill
A in Y
Rs Mn
110
35
(25% 140)

Stated capital
Retained earnings (3) + 0.5
Y in Z
Rs Mn
Rs Mn
Rs Mn
(75% 6.2)
(40% x 7.5)
100
40
4.65
3
10
(2.5)
(140)
(7.5)
0.15
5.15
(i)
The acquisition journal for A in Y is therefore:

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
(ii)
Rs. 5 Mn
Rs. 100 Mn
Rs. 40 Mn
Rs. 110 Mn
Rs. 35 Mn
The acquisition journal for Y in Z is therefore:

DEBIT
DEBIT
CREDIT
CREDIT
CREDIT
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 0.15 Mn
Rs. 10 Mn
Rs. 2.5 Mn
Rs. 4.65 Mn
Rs. 3 Mn

NCI in net assets.
(i)
Ys post acquisition profits

25% (129.2 Mn 40 Mn) = Rs. 22.3 Mn
(ii)
Zs post acquisition profits

40% (2.5 Mn 1 Mn) = Rs. 0.6 Mn
The required journal is:

DEBIT
CREDIT
CA Sri Lanka
Retained earnings (47.4 + 4.6)

NCI
Rs. 22.9 Mn
Rs. 22.9 Mn
609

As before the NCI in Y must be adjusted for its interest in Z. The NCI of Ys
interest in Z is 25% of the cost of the investment of Rs. 6.2 Mn ie Rs. 1.55 Mn
This is eliminated against the carrying amount of the NCI in Y by:
DEBIT
CREDIT
NCI
Investment
Rs. 1.55 Mn
Rs. 1.55 Mn
Unrealised profit
Rs. 4 Mn = Rs. 2 Mn
This is eliminated by:
DEBIT
CREDIT
Retained earnings
Inventories
Rs. 2 Mn
Rs. 2 Mn
(The unrealised profit is charged to retained earnings in full because

Antelope is the selling company).
6
Intercompany balances
Receivable amounts (3.8 Mn + 10 Mn + 12.2 Mn)
Payable amounts (12.8 Mn + 0.6 Mn + 12.6Mn)
26 Mn
26 Mn
These are equal and so are eliminated by:

DEBIT
DEBIT
CREDIT
CREDIT
Amounts due to A (12.8 + 0.6)

Amounts due to Y
Loan
Current a/c (10 Mn + 12.2 Mn)
Rs. 13.4 Mn
Rs. 12.6 Mn
Rs. 3.8 Mn
Rs. 22.2 Mn
1.7 Section summary

You should follow this step by step approach in all questions using the singlestage method. This applies to Section 2 below as well.
610
Step 1
Sketch the group structure and check it to the question.
Step 2
Add details to the sketch of dates of acquisition, holdings acquired and

cost.
Step 3
Draw up a proforma for the statement of financial position.
Step 4
Work methodically down the statement of financial position,

transferring figures to proforma or workings.
Step 5
Use the notes in the question to make adjustments such as eliminating

intra-group balances and unrealised profits.
CA Sri Lanka
Step 6
Goodwill working. Compare consideration transferred with effective

group interests acquired.
Step 7
Reserves working. Include the group share of subsidiary and subsubsidiary post-acquisition retained earnings (effective holdings
again).
Step 8
Non-controlling interests working: total NCI in subsidiary plus total

NCI in sub-subsidiary.
Step 9
Prepare the consolidated statement of financial position (and

statement of profit or loss if required).
2 D-shaped groups
A D-shaped group exists where a parent company has both a direct and an
indirect ownership interest in a sub-subsidiary. Again the effective group
holding in the sub-subsidiary is important when preparing the consolidated
2.1 Introduction
The following group structure shows a D-shaped group:
P
80%
S
10%
75%
SS
In this example, SS is a sub-subsidiary of P with additional shares held directly by

P.
CA Sri Lanka
611
2.2 The non-controlling interest

In the case of a 'D-shaped' group, identification of the non-controlling interest is
key.
Think about the NCI in the example above:
P
80%
20%
(NCI direct)
10%
75%
15%
(NCI direct)
SS
In the structure above:

The non-controlling interest in S is 20%
The direct non-controlling interest in SS is 15%
The indirect non-controlling interest in SS is 20% 75% = 15%
The total non-controlling interest in SS is therefore 15% + 15% = 30%
Ownership of SS can be expressed as follows:
Group indirect holding (80% 75%)
Group direct holding
NCI
60%
10%
30%
100%
2.3 Consolidation procedures

Consolidation procedures in respect of a D-shaped group are the same as those in
the case of a vertical group, ie:
1
Establish the effective holding in SS and therefore the NCI
In the goodwill working, the cost of investment in SS includes:

The cost of Ps investment (the direct investment)
Ps share of the cost of Ss investment (the indirect investment)
612
In the NCI working, the NCI share of the cost of Ss investment in SS is

deducted from the NCI in S
Calculations are based on the group and NCI effective shareholdings.

CA Sri Lanka
QUESTION
D shaped group
The draft statements of financial position of Hulk Co, Molehill Co and Pimple Co as
at 31 May 20X5 are as follows.
Hulk Co
Molehill Co
Pimple Co
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Assets
Non-current assets
60
Tangible assets
90
60
Investments in
Subsidiaries (cost)
90
Shares in Molehill Co
42
25
Shares in Pimple Co
115
42
205
102
60
40
50
40
Current assets
245
152
100
Equity
100
50
50
Stated capital
50
20
Revaluation surplus
32
25
45
Retained earnings
195
102
75
12% loan
Current liabilities
Payables
CA Sri Lanka
195
10
112
75
50
245
40
152
25
100
(a)
Hulk Co acquired 60% of the shares in Molehill on 1 January 20X3 when the
balance on that company's retained earnings was Rs. 8 Mn (credit).
(b)
Hulk acquired 20% of the shares of Pimple Co and Molehill acquired 60% of
the shares of Pimple Co on 1 January 20X4 when that company's retained
earnings stood at Rs. 15 Mn.
(c)
There has been no payment of dividends by either Molehill or Pimple since

they became subsidiaries.
(d)
There was no impairment of goodwill.
(e)
It is the group's policy to measure the non-controlling interest at acquisition

at its proportionate share of the fair value of the subsidiary's net assets.
613
Required
Prepare the consolidated statement of financial position of Hulk Co as at 31 May
20X5.UESTION
ANSWER
Consolidated statement of financial position of the Hulk Group at
31 May 20X5
H
M
P
W2(i) W2(ii)
W3
W4
Consol
Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn
90
60
60
210
Tangible
assets
55.2
13.8
69
Goodwill
Invts in
subsidiaries
90
(90)
Molehill
25
42
(50.2)
(16.8)
Pimple
40
50
40
130
Current
assets
245
152
100
409
100
50
50
(50) (50)
100
Stated capital
50
20
(8)
62
Revaluation
surplus
45
32
25
(8) (15)
(14)
65
Retained
earnings
23.2
28.6
22
(16.8)
57
NCI
10
10
12% loan
50
40
25
115
Payables
245
152
100
409
WORKINGS
1
Group structure
Hulk
60%
(NCI direct)
40%
Molehill
60%
(NCI direct)
614
20%
Pimple
20%
Effective interests in Pimple:

Hulk (60% 60% + 20%)
= 56%
NCI
= 44%
CA Sri Lanka
Note. Pimple comes into Hulk's control on 1 January 20X4. As the investments in
Pimple by Hulk and Molehill both happened on the same date, only one goodwill
calculation is needed in respect of Pimple.
The direct NCI interest in Molehill is 40%

The Group share in Molehill is therefore 60%
The direct NCI interest in Pimple is 20%
The indirect NCI interest in Pimple is 40% 60% = 24%
Therefore the total NCI interest in Pimple is 44%
The Group share in Pimple is therefore 56%
Goodwill
Hulk in
Molehill
Rs Mn
direct
indirect
(58m 40%)/(65m 44%)
Fair value of NA acquired
Share capital
Retained earnings
Hulk and Molehill in Pimple

Rs Mn
90
Rs Mn
Rs Mn
25
(60% 42)
23.2
25.2
28.6
50
15
50
8
(58)
55.2
(65)
13.8
69
(i)
The acquisition journal for H in M is therefore:

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
(ii)
Rs. 55.2 Mn
Rs. 50 Mn
Rs. 8 Mn
Rs. 90 Mn
Rs. 23.2 Mn
The acquisition journal for H and M in P is therefore:

DEBIT
DEBIT
DEBIT
CREDIT
CREDIT
CA Sri Lanka
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 13.8 Mn
Rs. 50 Mn
Rs. 15 Mn
Rs. 50.2 Mn
Rs. 28.6 Mn
615
Retained earnings and revaluation surplus allocation

The NCI share of post-acquisition retained earnings and revaluation surplus
must be allocated to the NCI in net assets.
(i)
Ms post acquisition profits

40% (32m 8m) = Rs. 9.6 Mn
(ii)
Ms post acquisition revaluation surplus

40% 20m
= Rs. 8 Mn
(iii) Ps post acquisition profits

44% (25m 15m) = Rs. 4.4 Mn
The required journal is:
DEBIT
DEBIT
CREDIT
4
Retained earnings (9.6+ 4.4)

Revaluation surplus
NCI
Rs. 14 Mn
Rs. 8 Mn
Rs. 22 Mn

As before the NCI in M must be adjusted for its interest in P. The NCI of Ms
interest in P is 40% of the cost of the investment of Rs. 42 Mn ie Rs. 16.8 Mn.
This is eliminated against the carrying amount of the NCI in M by:
DEBIT
CREDIT
NCI
Investment
Rs. 16.8 Mn
Rs. 16.8 Mn
3 Group reorganisations
Changes in direct ownership (ie internal group reorganisations) can take many
forms. With the exception of divisionalisation, internal reorganisations do not
affect the consolidated financial statements, but they will affect the accounts
of individual companies within the group.
Groups will reorganise on occasions for a variety of reasons.
616
(a)
A group may want to float a business to reduce the gearing of the group. The
holding company will initially transfer the business into a separate company.
(b)
Companies may be transferred to another business during a divisionalisation

process.
(c)
The group may 'reverse' into another company to obtain a stock exchange
quotation.
CA Sri Lanka
(d)
Internal reorganisations may create efficiencies of group structure for tax

purposes.
Such reorganisations involve a restructuring of the relationships within a group.

Companies may be transferred to another business during a divisionalisation
process. There is generally no effect on the consolidated financial statements,
provided that no non-controlling interests are affected, because such
reorganisations are only internal. The impact on the individual companies within
the group, however, can be substantial. A variety of different transactions are
described here, only involving 100% subsidiaries.
3.1 New top parent company

A new top holding company might be needed as a vehicle for flotation or to
improve the co-ordination of a diverse business. The new company, P, will issue
its own shares to the holders of the shares in S.
Before
shareholders
After
shareholders
3.2 Subsidiary moved up

This transaction is shown in the diagram below. It might be carried out to allow S1
to be sold while S2 is retained, or to split diverse businesses.
Before
P
S1
After
P
S1
S2
S2
CA Sri Lanka
617
S1 could transfer its investment in S2 to P as a dividend in specie or by P paying

cash. A share for share exchange is not possible because an allotment by P to S1 is
void. A dividend in specie is simply a dividend paid other than in cash.
S1 must have sufficient distributable profits for a dividend in specie. If the
investment in S2 has been revalued then that can be treated as a realised profit for
the purposes of determining the legality of the distribution. For example, suppose
the statement of financial position of S1 is as follows.
Rs Mn
900
Investment in S2 (cost Rs 100 Mn)
100
Other net assets
1,000
100
800
100
1,000
Stated capital
Revaluation surplus
Retained earnings
It appears that S1 cannot make a distribution of more than Rs100m. If, however, S1
makes a distribution in kind of its investment in S2, then the revaluation surplus
can be treated as realised.
It is not clear how P should account for the transaction. The carrying value to S2
might be used, but there may be no legal rule. P will need to write down its
investment in S1 at the same time. A transfer for cash is probably easiest, but there
are still legal pitfalls as to what is distributable, depending on how the transfer is
recorded.
There will be no effect on the group financial statements as the group has stayed
the same: it has made no acquisitions or disposals.
3.3 Subsidiary moved along

This is a transaction which is treated in a very similar manner to that described
above.
Before
P
S1
S3
618
After
P
S2
S1
S2
S3
CA Sri Lanka
The problem of an effective distribution does not arise here because the holding
company did not buy the subsidiary. There may be problems with financial
assistance if S2 pays less than the fair value to purchase S3 as a prelude to S1
leaving the group.
3.4 Subsidiary moved down

This situation could arise if P is in one country and S1 and S2 are in another. A tax
group can be formed out of such a restructuring.
After
Before
P
S1
S2
S1
S2
If S1 paid cash for S2, the transaction would be straightforward (as described
above). It is unclear whether P should recognise a gain or loss on the sale if S2 is
sold for more or less than carrying value. S1 would only be deemed to have made a
distribution (avoiding any advance tax payable) if the price was excessive.
Where a share for share exchange takes place, it must be recorded so as to
preserve the book value of the transferred investment.
Example
Axim Co has two 100% subsidiaries, Beyin and Ketan. The statements of financial
position at 31 December 20X5 are as follows.
Axim Co
Beyin Co
Ketan Co
Group
Rs Mn
Rs Mn
Rs Mn
Rs Mn
1,000
Investment in Beyin Co
500
Investment in Ketan Co
1,500
1,375
1,500
4,375
Net assets
3,000
1,375
1,500
4,375
2,500
1,000
500
2,500
Stated capital
500
375
1,000
1,875
Retained earnings
3,000
1,375
1,500
4,375
Axim Co wants to transfer Ketan Co to Beyin Co.
CA Sri Lanka
619
Solution
Beyin Co issues 250,000 shares in exchange for Axim Co's investment in Ketan Co.
The carrying amount of Axims investment in Ketan is Rs. 500 Mn therefore this is
the amount that the investment is transferred at and this is recorded as the
increase in Beyins stated capital. The statements of financial position are now as
follows.
Axim Co
Beyin Co
Ketan Co
Group
Rs Mn
Rs Mn
Rs Mn
Rs Mn
1,500
Investment in Beyin
500
Investment in Ketan
1,500
1,375
1,500
4,375
Net assets
3,000
1,875
1,500
4,375
2,500
1,500
500
2,500
Stated capital
500
375
1,000
1,875
Retained earnings
3,000
1,875
1,500
4,375
3.5 Divisionalisation
This type of transaction involves the transfer of businesses from subsidiaries
into just one company. The businesses will all be similar and this is a means of
rationalising and streamlining. The savings in administration costs can be quite
substantial. The remaining shell company will leave the cash it was paid on an
intragroup balance as it is no longer trading. The accounting treatment is
generally straightforward.
QUESTION
The A Group has three wholly owned subsidiaries, B, C and D. The directors of the
A Group have decided to restructure its internal ownership as follows:
Before
A
After
A
Required
Discuss why the A Group might wish to restructure the group in this way and how
it might go about effecting the transaction.
620
CA Sri Lanka
ANSWER
Possible reasons for such a reorganisation include:
Combining the businesses of D and C into one business
Cost savings by running D and C, which may have economies of scale, together
To allow the management of D to manage C's business rather than the
management of B
Potential tax advantages, such as loss relief, or channelling dividend payments
through D which may operate in a tax regime with lower taxes
To allow B to be sold off from the group without selling D
To allow B to become a dormant company.
The reorganisation could be achieved by B selling its shares in C to D. Any profit
or loss on such a sale would be an unrealised one from the group point of view and
would require elimination in the group financial statements. However, if C were
sold at a loss, this would imply that an impairment test should be done to ensure
its value is not overstated.
Another possibility is for the sale to occur through an intercompany account
which remains outstanding, ie a receivable in B's books and a payable in D's books
for the purchase consideration. An advantage of this is that it does not strip D of
assets, and would be particularly sensible if the plan is for B to become a dormant
company.
B would be unable to transfer its investment in C as a dividend to D as D is a fellow
subsidiary rather than its parent. However, B could potentially pay a dividend in
specie (ie a dividend paid in assets other than cash) to A of the shares in C and A
could then pass that investment to its subsidiary D as a capital injection (DEBIT
investment in C, CREDIT Share capital, in D's books), which would have a potential
advantage of increasing D's share capital if this were considered desirable.
QUESTION
A acquired 60% of B on 1 January 20X3. One other party holds 40%. There is a
contractual agreement between the two parties to undertake an economic activity
that is subject to joint control. Each party is entitled to a share of net profit in
proportion to ownership and the same share of the proceeds of the realisation of
net assets in the event of the business being wound up.
A acquired 60% of C on 1 March 20X1 and C acquired 30% of D on 1 April 20X4.
A acquired 80% of E on 1 August 20X4. E has been acquired with a view to be sold.
CA Sri Lanka
621
Required
Propose what accounting treatment should be adopted for B,C,D and E in the
consolidated statement of profit or loss and other comprehensive income for the
A group for the year ended 31 December 20X4. State any relevant SLFRS.
ANSWER
B would be considered a joint arrangement under SLFRS 13 Joint Arrangements
due to the contractual agreement to undertake an economic activity that is subject
to joint control. SLFRS 13 distinguishes between joint arrangements that are 'joint
operations' (where the venturers have direct rights to the assets and liabilities of
the joint arrangement and 'joint ventures' (where the venturers have rights to the
net assets). In this case, as the venturers are entitled to a proportionate share of
the realisation of the net assets, the arrangement would be classed as a joint
venture. LKAS 28 Investments in Associates and Joint Ventures requires the equity
method to be used for accounting for joint ventures in the consolidated financial
statements. Under the equity method the group's 60% share of B's profit for the
year would be shown on one line (before group profit before tax). Similarly, the
group's 60% share of each item of B's other comprehensive income for the year
would be shown separately.
Group structure
A
1.1.X3
60%
B
1.3.X1 60%
C
80%
E
1.8.X4
1.4.X4 30%
D
C is controlled by A and therefore would be classed as a subsidiary under
SLFRS 10 Consolidated Financial Statements. 100% of all income and
expenses would be consolidated in order to present the financial
performance of the group as a single economic entity. A 40% non-controlling
interest will be shown in profit for the year and total comprehensive income
for the year.
D is an indirect associate. A controls C and therefore A can control C's 30%
of D. A is presumed to exert significant influence over the operating and
622
CA Sri Lanka
financial policies of D. D will be equity accounted under LKAS 28

Investments in Associates and Joint Ventures. The group's 30% of profit and
other comprehensive income for nine months will be shown separately in
the consolidated statement of profit or loss and other comprehensive
income. Also C's non-controlling interests will be credited with their 40%
non-controlling share in these items.
Provided that E meets the criteria of being a disposal group per SLFRS 5
Non-current Assets Held for Sale and Discontinued Operations, the subsidiary
should be classified as held for sale. The company must be held for
immediate sale and the sale must be highly probable. In the consolidated
statement of profit or loss and other comprehensive income, E should be
treated as a discontinued operation showing a single amount representing
the post tax profit or loss for the 5 months. Further breakdown will be made
in the notes to the accounts. Non-controlling interests will also need to be
shown for 5 months of the profit/loss for the year.
CA Sri Lanka
623
CHAPTER ROUNDUP
624
A vertical group exists where a parent has a subsidiary and that subsidiary
has its own subsidiary. The effective group holding in the sub-subsidiary must
be calculated and used in the consolidation workings.
A D-shaped group exists where a parent company has both a direct and an
indirect ownership interest in a sub-subsidiary. Again the effective group
holding in the sub-subsidiary is important when preparing the consolidated
Changes in direct ownership (ie internal group reorganisations) can take many
forms. With the exception of divisionalisation, internal reorganisations do not
affect the consolidated financial statements, but they will affect the accounts
of individual companies within the group.
CA Sri Lanka
PROGRESS TEST
B Co owns 60% of the equity of C Co which owns 75% of the equity of D Co. What
is the total non-controlling interest percentage ownership in D Co?
What is the cost of the investment in a sub-subsidiary in the goodwill calculation?
How is the NCI in a subsidiary that holds a sub-subsidiary calculated?
P Co owns 25% of R Co's equity and 75% of Q Co's equity. Q Co owns 40% of R
Co's equity. What is the total non-controlling interest percentage ownership in R
Co?
CA Sri Lanka
625
B
60%
C
75%
D
Non-controlling interest = 25% + (40% of 75%) = 55%
P% holding in S cost of investment in Ss SOFP
NCI at acquisition + NCI% of Ss post acquisition reserves NCI% of cost of

investment in SS
4
P
75%
25%
(NCI direct)
25%
40%
35%
(NCI direct)
Total non-controlling interest in R is 35% + (25% 40%) = 45%
626
CA Sri Lanka
CHAPTER
INTRODUCTION
A statement of cash flows is key to understanding the liquidity position
of a company. At KC1 level, your existing knowledge is extended to
include the preparation of a consolidated statement of cash flows.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

circumstances.
627
KC1 | Chapter 19: Statements of cash flows
CHAPTER CONTENTS
1 Individual company statement of cash flows
2 Consolidated statement of cash flows

Prepare and discuss group statements of cash flows.
Recommend appropriate presentation of cash flow streams under the concept
of operating activities, investing activities and financial activities, non-cash
transactions
1 Individual company statement of cash flows

A statement of cash flows classifies cash flows as resulting from operating
activities, investing activities and financing activities.
This section of the chapter revises KB1 material.
1.1 LKAS 7
The general requirements of the standard are as follows:
The objective of LKAS 7 is to provide information to users of financial statements
about the ability of an entity to generate cash and cash equivalents, as well as
indicating the cash needs of the entity.
A statement of cash flows should be presented as an integral part of the financial
statements of an entity.
All types of entity are required by the Standard to produce a statement of cash
flows.
Definitions provided by the standard include the following:
Cash comprises cash on hand and demand deposits.
Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant
risk of changes in value.
Cash flows are inflows and outflows of cash and cash equivalents.
628
CA Sri Lanka
Operating activities are the principal revenue-producing activities of the

entity and other activities that are not investing or financing activities.
Investing activities are the acquisition and disposal of non-current assets and
other investments not included in cash equivalents.
Financing activities are activities that result in changes in the size and
composition of the equity capital and borrowings of the entity.
The following table summarises instruments that may or may not be classified as
cash equivalents:
Cash equivalents
Deposits available on demand
Short-term government bonds
Treasury bills
Money market holdings
Not cash equivalents
Deposits with a fixed maturity of

more than 3 months
Amounts held by banks as security

(pledged deposits)
Preference share investments

acquired within a short period of
maturity and with a specified
redemption date.
Equity investments
Preference share investments and

bank overdrafts other than those
qualifying as cash equivalents.
Bank overdrafts repayable on

demand and treated as part of an
entitys cash management system.
Loans and other borrowings
1.2 Presentation of a statement of cash flows

LKAS 7 requires statements of cash flows to report cash flows during the period
classified by operating, investing and financing activities.
Cash flows from operating activities include cash receipts from sales and cash
payments to suppliers and staff; these cash flows are the cash generated by
day-to-day operations. A strong cash flow in this part of the statement is
usually required in order to meet mandatory interest and tax payments.
Cash flows from investing activities include cash payments to acquire noncurrent assets, including financial asset investments, and cash receipts from the
sale of such assets.
Cash flows from financing activities include cash receipts from and payments
to capital providers.
CA Sri Lanka
629
Certain cash flows may be classified as cash flows from operating activities,
investing activities or financing activities. Such cash flows include interest and
dividends:
Interest and dividends paid
Operating or financing cash flows
Interest and dividends received
Operating or investing cash flows
Each should be classified in a consistent manner from period to period.

Cash flows from taxes should be classified as cash flows from operating activities
unless they can be specifically identified with financing and investing activities.
1.3 Format of a statement of cash flows

The following format of a statement of cash flows is taken from LKAS 7. It includes
cash flows associated with consolidated financial statements, which are discussed
in section 2 of this chapter:
STATEMENT OF CASH FLOWS YEAR ENDED 31 DECEMBER 20X7
Rs Mn
Cash flows from operating activities:
2,730
Cash generated from operations
(270)
Interest paid
(900)
Income taxes paid
Net cash from operating activities
Cash flows from investing activities:
Acquisition of Subsidiary X
(550)
(350)
Purchase of property, plant and equipment
20
Proceeds from sale of equipment
200
Interest received
200
Dividends received from associate investments
Net cash used in investing activities
Cash flows from financing activities:
250
Proceeds from issue of stated capital
250
Proceeds from long-term borrowings
Payment of finance lease liabilities
(90)
Dividends paid to the NCI
(200)
(1,000)
Dividends paid to the owners of the parent
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
630
Rs Mn
1,560
(480)
(790)
290
120
410
CA Sri Lanka
1.4 Preparation of a statement of cash flows

When preparing a statement of cash flows, whether for a single company or a
group, you should set up a proforma and use the information and financial
statements provided to find figures to insert into the proforma.
1.4.1 Cash generated from operations
The Standard offers a choice of method for this part of the statement of cash flows.
The direct method requires individual cash flows from customers and to
suppliers and employees and so on to be established.
Rs'000
Rs'000
Cash flows from operating activities
Cash receipts from customers
X
Cash paid to suppliers and employees
(X)
X
Interest paid
(X)
Income taxes paid
(X)
X
The indirect method, takes net profit or loss and adjusts it for non-cash and nonoperating items as well as changes in working capital.
Rs.
X
Profit before tax
X
Add depreciation
X
Add interest expense
X
Less investment expense
X
Loss (profit) on sale of non-current assets
(X)/X
(Increase)/decrease in inventories
(X)/X
(Increase)/decrease in receivables
X/(X)
Increase/(decrease) in payables
X
(X)
Interest paid
(X)
Income taxes paid
X
1.4.2 Other items
Interest paid and received is calculated by reference to finance costs / interest
income within the statement of profit or loss, adjusted for any accrual or other
relevant amount in the statement of financial position.
CA Sri Lanka
631
Tax paid (or refunded) is calculated by reference to the income tax

charge/credit in the statement of profit or loss, adjusted for both the tax
liability and deferred tax balance at the start and end of the reporting period.
A working should be set up to reconcile the carrying amount of property, plant
and equipment at the start of the period to the end of the period. Reconciling
amounts may include depreciation, disposals (at carrying amount),
revaluations, acquisitions and finance lease additions.
The capital element of a finance lease payment is reported as a financing cash
flow and calculated by reconciling the total finance lease liability at the start of
the period to that at the end of the period.
The proceeds of a share issue or loan issued or repaid is calculated by
comparing the balance at the start of the period with that at the end of the
period.
The following question is reproduced from the KB1 learning material. You should
attempt it to ensure that you remember how to prepare an individual company
statement of cash flows before considering consolidated statements of cash flows.
QUESTION
The financial statements of Meepitiya Models (Pvt) Ltd for the year ended
31 December 20X4 are set out below.
Meepitiya Models (Pvt) Ltd
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20X4
Rs'000
7,740
Revenue
(5,290)
Cost of sales
2,450
Gross profit
50
Release of government grant
(67)
Provision for warranties
(91)
Distribution costs
(164)
2,178
(320)
Finance cost
1,858
Profit before taxation
(368)
Taxation
1,490
Profit for the year
(180)
Other comprehensive income: property revaluation
1,310
632
CA Sri Lanka

STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER
20X4
Rs'000
Assets
Non-current assets:
3,480
3,342
Intangible assets
1,200
Investments
Current assets:
Inventories
620
490
Receivables
200
Short term investments
Cash in hand
Total assets
9,332
Equity:
Stated capital
Revaluation reserve
Retained earnings
Non-current liabilities:
Loan stock
Redeemable preference shares
Finance lease obligation
Deferred tax
Provision for warranties
Government grant
Current liabilities:
Trade payables
Government grant
Bank overdraft
Taxation
20X3
Rs'000
3,024
3,100
900
615
425
90
8,154
500
220
3,600
390
400
2,340
1,375
1,200
140
325
474
250
1,560
1,200
120
240
407
300
350
390
50
106
352
9,332
320
480
50
347
8,154
The following information is available.
CA Sri Lanka
(a)
Depreciation of Rs. 280,000 is included in cost of sales. No amortisation has

been charged on intangible assets as these are the costs of developing a new
product that is not yet ready for use.
(b)
Equipment with a fair value of Rs. 60,000 was acquired under a finance lease
during the year.
633
(c)
Finance costs include loan stock interest of Rs. 110,000, finance lease
interest of Rs. 35,000 and a redeemable preference share dividend of
Rs. 95,000.
Required
(a)
Prepare the statement of cash flows for Meepitiya Models (Pvt) Ltd for the
year to 31 December 20X4.
ANSWER
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20X4
Rs'000
Profit before tax
Finance cost
Depreciation charge
Non cash income grant release
Increase in warranty provision
(Increase)/decrease in inventories
(Increase)/decrease in receivables
Increase/(decrease) in payables
Cash generated from operating activities
Interest paid
Dividends paid (W1)
Tax paid (W2)
Cash flows from investing activities
Payments to acquire property, plant and equipment (W3)
Payments to acquire intangible non-current assets
(3,342 3,100)
Payments to acquire long-term investments (1,200 900)
Payments to acquire short-term investments
Cash flows from financing activities
Issue of stated capital (500-390)
Finance lease capital repayments (W4)
Repayment of loan stock (1,560 1,375)
634
Rs'000
1,858
320
280
(50)
67
(5)
(65)
30
2,435
(320)
(230)
(278)
1,607
(856)
(242)
(300)
(200)
(1,598)
110
(130)
(185)
(205)
CA Sri Lanka
Rs'000
Increase in cash and cash equivalents
Cash and cash equivalents b/f
Cash and cash equivalents at c/f
Rs'000
(196)
90
(106)
Workings
1
Dividends paid
Retained earnings b/f
Profit for the year
Dividends paid (balance)
Retained earnings c/f
Rs'000
3,024
(180)
(280)
60
856
3,480

Balance b/f (120 + 480)
Additions
Cash repayment (balancing figure)
Balance c/f (140 + 390)
CA Sri Lanka
Rs'000
587
368
(278)
677

Balance b/f
Revaluation
Depreciation
Finance lease additions
Cash additions (balancing figure)
Balance off
3,600
Tax paid
Balance b/f (240 + 347)
Tax paid (balancing figure)
Balance c/f (325 + 352)
Rs'000
2,340
1,490
(230)
Rs'000
600
60
(130)
530
635
2 Consolidated statement of cash flows

A consolidated statement of cash flows is prepared using the consolidated
financial statements. It includes cash flows associated with the acquisition or
disposal of group companies, the non-controlling interest and interests in
associates / joint ventures.
Consolidated statements of cash flows are prepared in the same way as an
individual company statement, using the consolidated statement of financial
position and consolidated statement of profit or loss and other comprehensive
income.
They do, however, include up to three extra line items:
Item
Cash flow from:
Payments to acquire or proceeds of disposal of

subsidiaries
Investing activities
Dividends paid to the non-controlling interest
Financing activities
Dividends received from associates and joint ventures

accounted for using the equity method
Operating or investing
activities
2.1 Intra-group cash flows

Intra-group cash flows should not be reported in the consolidated statement of
cash flows.
Provided that the consolidated statement of cash flows is prepared using the
consolidated financial statements, consolidation adjustments will have eliminated
intra-group amounts and therefore no further adjustments are necessary when
preparing the consolidated statement of cash flows.
In some cases individual company information may be provided, in which case
adjustment may be required.
2.1.1 Example: Elimination of intra-group cash flows
Extracts from the statements of financial position of P Co and its subsidiary S Co
show the following loan balances outstanding:
P Co
Loan
636
20X4
Rs Mn
45
S Co
20X3
Rs Mn
60
20X4
Rs Mn
80
20X3
Rs Mn
30
CA Sri Lanka
During 20X4, P Co made a loan to S Co of Rs. 30 Mn. The first repayment is due in
20X5.
Required
What financing cash flow should be reported in respect of loans in the
consolidated statement of cash flows?
Solution
Proceeds of loan issue S Co
Repayment of loan P Co
Intercompany loan
Net proceeds from issue of loan
Rs Mn
50
(15)
35
(30)
5
2.2 Acquisition / disposal of subsidiaries

2.2.1 Acquisition of a subsidiary
Where a subsidiary is acquired by a group, its cash flows should be included in the
consolidated statement of cash flows from the acquisition date.
The net cash effect of the acquisition is disclosed separately under cash flows from
investing activities. It is calculated as:
Cash price
Subsidiarys cash and cash equivalents at acquisition date
Cash receipt on disposal of subsidiary
(X)
X
(X)
When calculating the movement in PPE, inventories, payables, receivables, loans

and so on for the purposes of calculating cash flows, the subsidiarys balance at the
acquisition date is subtracted from the movement calculated.
2.2.2 Disposal of a subsidiary
Where a subsidiary is disposed of by a group, its cash flows should be included in
the consolidated statement of cash flows until the disposal date.
The net cash effect of the disposal is disclosed separately under cash flows from
investing activities. It is calculated as:
Cash proceeds
Subsidiarys cash and cash equivalents at disposal date
Cash payment to acquire subsidiary
CA Sri Lanka
X
(X)
X
637
When calculating the movement in PPE, inventories, payables, receivables, loans

and so on for the purposes of calculating cash flows, the subsidiarys balance at the
disposal date is added to the movement calculated.
2.3 Dividends to the non-controlling interest

Dividends paid to the non-controlling interest are calculated by reference to the
non-controlling interest in net assets brought and carried forward and the noncontrolling interest in total comprehensive income.
They are included under the heading cash from financing activities and disclosed
separately.
QUESTION
Dividend to the non-controlling interest
The following are extracts of the consolidated results for Jaffna Co for the year
ended 31 December 20X8.
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE
INCOME (EXTRACT)
Rs Mn
90
Group profit before tax
(30)
Income tax expense
60
Profit for the year
Owners of the parent
CONSOLIDATED STATEMENT OF FINANCIAL POSITION (EXTRACT)
2017
Rs Mn
300
45
15
60
20X8
Rs Mn
306
Required
Calculate the dividend paid to the non-controlling interest.
ANSWER
Non-controlling interest in net assets b/f
Profit attributable to NCI
Non-controlling interest in net assets c/f
Cash dividend paid
638
Rs Mn
300
15
(306)
9
CA Sri Lanka
2.4 Dividends from associates and joint ventures

Dividends received from associates and joint ventures that are equity accounted
are calculated by reference to the carrying amount of the investment brought and
carried forward and the share of total comprehensive income of the associate or
joint venture.
They are included as either cash from operating activities or cash from investing
activities and disclosed separately.
In addition the share of profit from a joint venture included in profit or loss is
treated as a non-cash item of income and deducted from consolidated profit in
calculating cash generated by operations.
QUESTION
Dividend from associate
The following are extracts of the consolidated results of Pripon Co for the year
INCOME (EXTRACT)
Rs Mn
150
Group profit before tax
30
Share of associate's profit after tax
180
75
Tax (group)
105
Profit after tax
CONSOLIDATED STATEMENT OF FINANCIAL POSITION (EXTRACTS)
20X7
Rs Mn
264
20X8
Rs Mn
276
Required
Calculate the dividend received from the associate in the year.
ANSWER
Investment in associate b/f
Profit after tax of associate
Investment in associate c/f
Cash dividend received
CA Sri Lanka
Rs Mn
264
30
(276)
18
639
QUESTION
Consolidated statement of cash flows
Pacific Stone Co is a 40 year old company producing garden statues carved from
marble. 22 years ago it acquired a 100% interest in a marble importing company,
Kandy Stone Imports Co. In 20W9 it acquired a 40% interest in a competitor,
Columbo Ornaments Co and on 1 January 20X7 it acquired a 75% interest in
Garden Furniture Designs. The draft consolidated accounts for the Pacific Stone
Group are as follows.
DRAFT CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X7
Rs Mn
Rs Mn
4,455
Operating profit
1,050
Share of profit after tax of associate
600
Income from long-term investment
(450)
Interest payable
5,655
Tax on profit
1,173
Income tax
Deferred taxation
312
Tax attributable to investment income
135
(1,620)
4,035
Profit for the year
Attributed to:
640
owners of the parent

non-controlling interest
3,735
300
4,035
CA Sri Lanka
DRAFT CONSOLIDATED STATEMENT OF FINANCIAL POSITION

AS AT 31 DECEMBER
20X6
20X7
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Assets
Non-current assets
Tangible assets
6,600
6,225
Buildings at carrying amount
4,200
9,000
Machinery: cost
(3,300)
(3,600)
depreciation
5,400
900
Carrying amount
7,500
11,625
300
Goodwill
3,000
3,300
Investments in associates
1,230
1,230
Long-term investments
11,730
16,455
Current assets
3,000
5,925
Inventories
3,825
5,550
Receivables
5,460
13,545
Cash
25,020
12,285
24,015
41,475
Equity
Stated capital
12,285
20,469
7,500
10,335
Retained earnings
19,785
30,804
Total equity
345
19,785
31,149
510
2,130
Obligations under finance leases
1,500
4,380
Loans
90
39
Deferred tax
2,049
6,600
Current liabilities
840
1,500
Trade payables
600
720
Obligations under finance leases
651
1,386
Income tax
120
90
Accrued interest and finance
charges
3,726
2,181
24,015
41,475
CA Sri Lanka
641
Note
1
There had been no acquisitions or disposals of buildings during the year.

Machinery costing Rs. 1,500 Mn was sold for Rs. 1,500 Mn resulting in a
profit of Rs. 300 Mn. New machinery was acquired in 20X7 including
additions of Rs. 2,550 Mn acquired under finance leases.
Information relating to the acquisition of Garden Furniture Designs

Machinery
Inventories
Trade receivables
Cash
Trade payables
Income tax
Goodwill
2,640,000 shares issued as part consideration

Balance of consideration paid in cash
3
Rs Mn
495
96
84
336
(204)
(51)
756
(189)
567
300
867
825
42
867
Loans were issued at a discount in 20X7 and the carrying amount of the
loans at 31 December 20X7 included Rs. 120 Mn representing the finance
cost attributable to the discount and allocated in respect of the current
reporting period.
Required
Prepare a consolidated statement of cash flows for the Pacific Stone Group for the
year ended 31 December 20X7 as required by LKAS 7, using the indirect method.
There is no need to provide notes to the statement of cash flows.
642
CA Sri Lanka
ANSWER
PACIFIC STONE GROUP
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED 31 DECEMBER 20X7
Rs Mn
Net profit before tax
Adjustments for:
Depreciation (W1)
Profit on sale of plant
Share of associate's profits
Investment income
Interest payable
Operating profit before working capital changes
Increase in trade and other receivables (5,550 3,825 84)
Increase in inventories (5,925 3,000 96)
Increase in trade payables (1,500 840 204)
Interest paid (W2)
Income taxes paid (W3)
Purchase of subsidiary undertaking (W4)
Purchase of property, plant and equipment (W5)
Proceeds from sale of plant
Dividends from investment (600 135)
Dividends from associate (W6)
Dividends paid to non-controlling interest (W7)
Issue of ordinary share capital (W8)
Issue of loan notes (W9)
Capital payments under finance leases (W10)
Dividends paid (3,735 + 7,500 10,335)
Net cash from financing activities
Cash and cash equivalents at 1.1.X7
Cash and cash equivalents at 31.12.X7
CA Sri Lanka
Rs Mn
5,655
975
(300)
(1,050)
(600)
450
5,130
(1,641)
(2,829)
456
1,116
(300)
(750)
66
294
(3,255)
1,500
465
750
(144)
(390)
7,359
2,760
(810)
(900)
8,409
8,085
5,460
13,545
643
Workings
1
Depreciation charges
Balance b/f
Charge for year
PLANT AND EQUIPMENT

Rs Mn
3,300
Depreciation on disposal
600
Balance c/f
3,900
Rs Mn
300
3,600
3,900
Freehold buildings (Rs. 6,600 Mn Rs. 6,225 Mn) = Rs. 375 Mn

Total charge: (Rs. 375 Mn + Rs. 600 Mn) = Rs. 975 Mn
2
Interest
Discount
Interest paid
Accrued interest c/f
3
C/f current tax

deferred tax
INCOME TAX PAYABLE

Rs Mn
B/f current tax
deferred tax
750 P/L transfer
(1,173 + 312)
1,386 On acquisition
90
2,226
450
540
Rs Mn
651
39
1,485
51
2,226
Purchase of subsidiary
Cash received on acquisition
Less cash consideration
Cash inflow
644
Rs Mn
90
Taxation
Cash outflow
INTEREST PAYABLE
Rs Mn
120 Accrued interest b/f
300
120 Expenses
540
Rs Mn
336
(42)
294
CA Sri Lanka
Purchase of property, plant and equipment; machinery

MACHINERY
Rs Mn
4,200
495
Disposal
2,550
3,255
C/f
10,500
B/f
On acquisition
Leased
Cash additions
6
NON-CONTROLLING INTEREST
Rs Mn
144 Balance b/f
345 Profit for year
On acquisition
489
Issue of ordinary share capital

STATED CAPITAL
Rs Mn
B/f
Stated capital
Non-cash consideration
Shares
C/f
Stated capital
20,469 Cash inflow
20,469
Rs Mn
750
3,300
4,050
Rs Mn
Nil
300
189
489
Rs Mn
12,285
825
7,359
20,469
Issue of loan notes
Balance c/f
CA Sri Lanka
9,000
10,500
Dividend paid
Balance c/f
1,500
Dividends from associate

INVESTMENT IN ASSOCIATE
Rs Mn
3,000 Dividends received
B/f
1,050 C/f
Share of profit after tax
4,050
Rs Mn
LOAN NOTES
Rs Mn
Balance b/f
Finance cost
4,380 Cash inflow
4,380
Rs Mn
1,500
120
2,760
4,380
645
10
Capital payments under finance leases
Cash outflow
C/f
Current
Long-term
QUESTION
FINANCE LEASES
Rs Mn
B/f
810 Current
Long-term
720 New lease commitment
2,130
3,660
Rs Mn
600
510
2,550
3,660
Consolidated statement of cash flows 2
The following are extracts from the financial statements of Bentota PLC and one of
its wholly owned subsidiaries, Hikkaduwa Ltd, the shares in which were acquired
on 31 October 20X2.
STATEMENTS OF FINANCIAL POSITION
Bentota
and subsidiaries
Hikkaduwa
31 December
31 December
31 October
20X2
20X1
20X2
Rs Mn
Rs Mn
Rs Mn
4,764
3,685
694
2,195
2,175
7,001
5,860
694
Current assets
Inventories
1,735
1,388
306
Receivables
2,658
2,436
185
43
77
4,436
3,901
498
11,437
9,761
1,192
Stated capital
5,112
4,776
400
Retained earnings
2,540
2,063
644
7,652
6,839
1,044
Non-current assets
Property, plant & equipment
Goodwill
Investment in associates
Bank balances and cash
42
Equity
646
CA Sri Lanka
Bentota
and subsidiaries
Loans
Hikkaduwa
31 December
31 December
31 October
20X2
20X1
20X2
Rs Mn
Rs Mn
Rs Mn
1,348
653
111
180
1,459
833
1,915
1,546
Bank overdrafts
176
343
Current tax payable
235
200
2,326
2,089
148
11,437
9,761
1,192
Deferred tax
Current liabilities
Payables
148

INCOME FOR THE YEAR ENDED 31 DECEMBER 20X2
Profit before interest and tax
Rs Mn
546
Finance costs
120
Profit before tax
666
Income tax expense
126
PROFIT/TOTAL COMPREHENSIVE INCOME FOR THE YEAR
540
Attributable to:
540
0
540
The following information is also given:
CA Sri Lanka
(a)
The consolidated figures at 31 December 20X2 include Hikkaduwa
(b)
The amount of depreciation on property, plant and equipment during the

year was Rs. 78 Mn. There were no disposals.
(c)
The cost on 31 October 20X2 of the shares in Hikkaduwa was Rs. 1,086 Mn
comprising the issue of Rs. 695 Mn unsecured loan stock at par, 120,000
ordinary shares at a value of Rs. 2,800 Mn and Rs. 55 Mn in cash.
647
(d)
No write down of goodwill was required during the period.
(e)
Total dividends paid by Bentota (the parent company) during the period
amounted to Rs. 63 Mn.
Required
Prepare a statement of cash flows for the Bentota Group for the year ended
31 December 20X2 using the indirect method.
Notes to the statement of cash flows are not required.
ANSWER
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20X2
Rs Mn
Adjustments for:
Depreciation
Interest expense
Rs Mn
666
78
(120)
624
Increase in receivables (2,658 2,436 185)
(37)
Increase in inventories (1,735 1,388 306)
(41)
Increase in payables (1,915 1,546 148)
221

Interest paid
767
(160)
607

Acquisition of subsidiary net of cash acquired (55 7)
Dividends received from associates (W3)
648
(48)
(463)
100
(411)
CA Sri Lanka
Rs Mn
Dividends paid
Rs Mn
(63)
(63)
133
Cash and cash equivalents at beginning of year
(266)
Cash and cash equivalents at end of year
(133)
Workings
1

PROPERTY, PLANT AND EQUIPMENT
Rs Mn
3,685
b/f
694
Depreciation
Acquisition of H
c/f
463
Cash additions
4,842
78
4,764
4,842
Goodwill
b/f
Acquisition of H
(1,086 (1,044 100%))
3
Rs Mn
GOODWILL
Rs Mn
42 Impairment losses
c/f
42
Dividends received from associates

INVESTMENT IN ASSOCIATE
Rs Mn
2,175
b/f
120
Dividends received
Share of profit
c/f
2,295
Rs Mn
0
42
42
Rs Mn
100
2,195
2,295
Reconciliation of share capital

Stated capital b/f
Issued to acquire sub (120,000 Rs 2,800)
Stated capital c/f
Rs Mn
4,776
336
5,112
no shares have been issued for cash during the year.
CA Sri Lanka
649
Income taxes paid
Cash paid
c/f current tax
deferred tax
QUESTION
INCOME TAX PAYABLE

Rs Mn
b/f current tax
deferred tax
160
P/L
235
111
506
Rs Mn
200
180
126
506
Consolidated statement of cash flows 3
The following draft group financial statements relate to Pacific Palm a public
limited company.
PACIFIC PALM GROUP STATEMENT OF FINANCIAL POSITION AS AT 30
NOVEMBER
20X2
20X1
Rs Mn
Rs Mn
Assets
Non-current assets
327
254
Investment property
8
6
Goodwill
48
68
Intangible assets
85
72
54
Financial asset investments

94
90
490
616
Current assets
Inventories
105
128
Trade receivables
62
113
232
143
399
384
874
1,015
Equity and Liabilities
Equity attributable to the owners of the parent:
Stated capital
290
275
Retained earnings
351
324
Other components of equity
15
20
656
619
55
36
Total equity
711
655
650
CA Sri Lanka
Long-term borrowings
Deferred tax
Long-term provisions: pension liability
Total non-current liabilities
Current liabilities
Trade payables
Current tax payable
Total current liabilities
Total liabilities
20X2
Rs Mn
20X1
Rs Mn
67
35
25
127
71
41
22
134
144
33
177
304
1,015
55
30
85
219
874
PACIFIC PALM GROUP STATEMENT OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 NOVEMBER 20X2
Rs Mn
432.0
Revenue
(317.0)
Cost of sales
115.0
Gross profit
25.0
Other income
(55.5)
Distribution costs
(36.0)
(6.0)
Finance costs paid
10.5
Gains on property
6.0
Share of profit of associate
59.0
Profit before tax
(11.0)
Income tax expense
48.0
Profit for the year
Other comprehensive income after tax (items that will not be
reclassified to profit or loss)
Gain on financial asset investments
Losses on property revaluation
Remeasurement losses on defined benefit plan
Other comprehensive income for the year, net of tax
Total comprehensive income for the year
Profit attributable to
CA Sri Lanka
2.0
(7.0)
(6.0)
(11.0)
37.0
38.0
10.0
48.0
651
Rs Mn
Total comprehensive income attributable to
27.0
10.0
37.0
PACIFIC PALM GROUP STATEMENT OF CHANGES IN EQUITY FOR THE YEAR

ENDED 30 NOVEMBER 20X2
Balance at 1
December 20X1
Shares issued
Dividends
Rights issue
Acquisitions
Total
comprehensive
income for the
year
Balance at 30
November 20X2
Stated
capital
Rs Mn
275
Retained
earnings
Rs Mn
324
Financial
asset
reserve
Rs Mn
4
Revaluation
surplus
(PPE)
Rs Mn
16
15
15
(5)
(5)
290
32
351
Total
Rs Mn
619
2
6
(7)
9
27
656
Noncontrolling
interest
Rs Mn
36
Total
equity
Rs Mn
655
(13)
2
20
15
(18)
2
20
10
55
37
711
The following information relates to the financial statements of Pacific Palm.

(i)
On 1 December 20X0, Pacific Palm acquired 8% of the ordinary shares of

Sandy Beach. Pacific Palm had treated this as a held for trading financial
asset in the financial statements to 30 November 20X1 with changes in fair
value recognised in profit or loss for the year. There were no changes in fair
value in the year to 30 November 20X1. On 1 January 20X2, Pacific Palm
acquired a further 52% of the ordinary shares of Sandy Beach and gained
control of the company. The consideration for the acquisitions was as
follows.
Holding
Consideration
Rs Mn
1 December 20X0
8%
4
30
1 January 20X2
52%
34
60%
At 1 January 20X2, the fair value of the 8% holding in Sandy Beach held by
Pacific Palm at the time of the business combination was Rs. 5 Mn and the
fair value of the non-controlling interest in Sandy Beach was Rs. 20 Mn. The
purchase consideration at 1 January 20X2 comprised cash of Rs. 15 Mn and
shares of Rs. 15 Mn.
652
CA Sri Lanka
The fair value of the identifiable net assets of Sandy Beach, excluding
deferred tax assets and liabilities, at the date of acquisition comprised the
following.
Rs Mn
15
Intangible assets
18
Trade receivables
5
Cash
7
The tax base of the identifiable net assets of Sandy Beach was Rs. 40 Mn at
1 January 20X2. The tax rate of Sandy Beach is 30%.
(ii)
On 30 November 20X2,Sandy Beach made a rights issue on a 1 for 4 basis.

The issue was fully subscribed and raised Rs. 5 Mn in cash.
(iii) Pacific Palm purchased a research project from a third party including
certain patents on 1 December 20X1 for Rs. 8 Mn and recognised it as an
intangible asset. During the year, Pacific Palm incurred further costs, which
included Rs. 2 Mn on completing the research phase, Rs. 4 Mn in developing
the product for sale and Rs. 1 Mn for the initial marketing costs. There were
no other additions to intangible assets in the period other than those on the
acquisition of Sandy Beach
(iv) Pacific Palm operates a defined benefit scheme. The current service costs for
the year ended 30 November 20X2 are Rs. 10 Mn. Pacific Palm enhanced the
benefits on 1 December 20X1. The total cost of the enhancement is Rs. 2 Mn.
The net interest on net plan assets was Rs. 8 Mn for the year and Pacific Palm
recognises remeasurement gains and losses in accordance with
LKAS 19.
(v)
Pacific Palm owns an investment property. During the year, part of the
heating system of the property, which had a carrying amount of Rs. 0.5 Mn,
was replaced by a new system, which cost Rs. 1 Mn. Pacific Palm uses the fair
value model for measuring investment property.
(vi) Pacific Palm had exchanged surplus land with a carrying amount of
Rs. 10 Mn for cash of Rs. 15 Mn and plant valued at Rs. 4 Mn. The transaction
has commercial substance. Depreciation for the period for property, plant
and equipment was Rs. 27 Mn.
(vii) Goodwill relating to all subsidiaries had been impairment tested in the year
to 30 November 20X2 and any impairment accounted for. The goodwill
impairment related to those subsidiaries which were 100% owned.
(viii) Deferred tax of Rs. 1 Mn arose in the year on the gains on available for sale
financial assets.
CA Sri Lanka
653
(ix) The associate did not pay any dividends in the year.
Required
Prepare a consolidated statement of cash flows for the Pacific Palms Group using
the indirect method under LKAS 7 Statements of cash flows.
ANSWER
PACIFIC PALM GROUP STATEMENT OF CASH FLOWS FOR YEAR ENDED 30
NOVEMBER 20X2
Rs Mn
Rs Mn
59.0
Adjustments for:
Depreciation
27.0
Amortisation (W1)
17.0
Impairment of goodwill (W1)
31.5
Profit on exchange of land*: 15 + 4 10
(9.0)
Gain on investment property* (W1)
(1.5)
Loss on replacement of investment property
0.5
Gain on revaluation of held for trading financial assets
(Sandy Beach fair value on derecognition less fair
value at 1 December 20X1: 5 4)
(1.0)
Retirement benefit expense (W7)
4.0
Cash paid to defined benefit plan (W3)
(7.0)
Share of profit of associate (per question)
(6.0)
6.0
Interest expense (per question)
120.5
Decrease in trade receivables (W4)
56.0
Decrease in inventories (W4)
23.0
89.0
Increase in trade payables (W4)
288.5
(6.0)
Interest paid
(16.5)
266
Acquisition of subsidiary, net of cash acquired: 15 7
(8.0)
Acquisition of associate (W1)
(48.0)
(98.0)
Purchase of investment property (per question)
(1.0)
Purchase of intangible assets (W6)
(12.0)
Purchase of investments in equity instruments (W1)
(5.0)
15.0
Proceeds from sale of land
(157)
654
CA Sri Lanka
Rs Mn
Cash flows used in financing activities
Proceeds from issue of share capital (W2)
Repayment of long-term borrowings (W3)
Rights issue to non-controlling shareholders (from SOCIE)
Dividends paid (from SOCIE or (W2))
Dividends paid to non-controlling interest shareholders
(from SOCIE or (W2))
Cash and cash equivalents at the beginning of the year
Cash and cash equivalents at the end of the year
Rs Mn
0.0
(4.0)
2.0
(5.0)
(13.0)
(20)
89
143
232
*Note. The statement of profit or loss and other comprehensive income in the
question shows 'gains on property' of Rs. 10.5 Mn, which need to be added back to
profit in arriving at cash generated from operations. This is made up of Rs. 1.5 Mn
gain on investment property (W2) and Rs. 9 Mn gain on the exchange of surplus
land for cash and plant (Note (vi) of the question. The double entry for the
exchange is:
DEBIT
DEBIT
CREDIT
CREDIT
Cash
Rs. 15 Mn
Plant
Rs. 4 Mn
Land
Rs. 10 Mn
Profit or loss
Rs. 9 Mn
Separate from this, also shown in W2, is an impairment loss on the old heating
system, for which the double entries are:
CA Sri Lanka
DEBIT
CREDIT
Profit or loss (old heating system)

Investment property (old heating system)
Rs. 0.5 Mn
DEBIT
CREDIT
Investment property (new heating system)

Cash
Rs. 1 Mn
Rs. 0.5 Mn
Rs. 1 Mn
655
Workings
1
Assets
PPE
b/f
P/L
OCI
Dep'n/ Amort'n/
Impairment
Acquisition of
sub/assoc
Non-cash
additions
Disposals/
derecognition
Cash
paid/(rec'd)
c/f
Rs Mn
254
Investment
property
Rs Mn
6.0
1.5
Goodwill
Rs Mn
68.0
(7)
(27)
(31.5)
15
(W5)
Intangible
assets
Rs Mn
72
Associate
Rs Mn
0
6
Financial
assets
Rs Mn
90
1
3*
(17)
11.5
18
48
4
(10)
(0.5)
(5)
98
1.0
0.0
327
8.0
48.0
(W6)
12
(0)
85
54
94
* Grossed up for related tax: 2 Mn + 1 Mn

2
Equity
Stated
capital
Rs Mn
275
b/f
P/L
OCI
Acquisition of subsidiary
Rights issue (5 40%)
Cash (paid)/rec'd
c/f
Retained
earnings
Rs Mn
324
NCI
Rs Mn
36
38
(6)
10
15
0
290
20
2
(13) *
55
(5) *
351
* Note. Cash flow given in question, but working shown for clarity.
3
Liabilities
b/f
P/L
OCI
Cash (paid)/rec'd
c/f
656
Long-term
borrowings
Rs Mn
71
(4)
67
Tax
payable
Rs Mn
(41 + 30)
71.0
11.0
1.0
(W5) 1.5
(16.5)
(35 + 33)
68.0
Pension
liability
Rs Mn
22
(W7) 4
6
(7)
25
CA Sri Lanka
Working capital changes

Inventories
b/f
... Increase/(decrease)
c/f
5
Rs Mn
128
(23)
105
Trade
receivables
Rs Mn
113
5
(56)
62
Trade
payables
Rs Mn
55
89
144
Goodwill on acquisition of Tigret

Rs Mn
Consideration transferred: 15m + 15m
Fair value of non-controlling interests
Fair value of previously held equity interest
Identifiable net assets: 15 + 18 + 5 + 7
Deferred tax: (45m 40m) 30%
Rs Mn
30.0
20.0
5.0
55.0
45.0
(1.5)
(43.5)
11.5
Intangible assets
The research costs of Rs. 2 Mn and the marketing costs of Rs. 1 Mn are
charged to profit or loss for the year.
The Rs. 8 Mn cost of the patents and the Rs. 4 Mn development costs =
Rs. 12 Mn are cash outflows to acquire intangible assets.
Pension costs
The total net pension cost charged to profit or loss is:
Current service cost
Past service cost (recognised immediately)
Net interest income on plan assets
Rs Mn
10
2
(8)
4
2.5 Disclosure
LKAS 7 requires disclosure of non-cash transactions, components of cash and cash
equivalents and other disclosures
Non-cash investing and financing transactions such as a bonus issue of shares
should be disclosed in the financial statements in a way that provides all
relevant information about these investing and financing activities. This
CA Sri Lanka
657
enables users of the financial statements to assess the impact of these

transactions on future cash flows.
The components of cash and cash equivalents should be disclosed and a
reconciliation should be presented, showing the amounts in the statement of
cash flows, reconciled with the equivalent items reported in the statement of
financial position.
All entities should disclose, together with a commentary by management, any
other information likely to be of importance, for example:
(a)
Restrictions on the use of, or access to, any part of cash equivalents
(b)
The amount of undrawn borrowing facilities that are available
(c)
Cash flows that increased operating capacity, compared to cash flows that
merely maintained operating capacity
2.5.1 CASE STUDY Illustration Lion Brewery Ceylon PLC

The following extracts are taken from the 2013/2014 annual report of Lion
Brewery Ceylon PLC.
5 Accounting policies Cash flow statement
5.1 Cash and cash equivalents
Cash and cash equivalents are defined as cash in hand, demand deposits and
short-term highly liquid investments, readily convertible to known amounts of
cash and subject to insignificant risk of changes in value.
For the purpose of cash flow statement, cash and cash equivalents consist of cash
in hand and deposits in banks net of outstanding bank overdrafts. Investments
with short maturities ie three months or less from the date of acquisition are also
treated as cash equivalents.
The Cash Flow Statement has been prepared using the indirect method.
Interest paid is classified as operating cash flows, interest and dividend received
are classified as investing cash flows while dividends paid are classified as
financing cash flows for the purpose of presenting the cash flow statement.
658
CA Sri Lanka
14 CASH AND CASH EQUIVALENTS

As at 31st March 15 In Rs. 000s
Fixed deposits with financial institutions
Savings accounts
Short term deposits
Cash at bank
Cash in hand
2014
6,449,484
4,861
401,092
1,865
2013
2,052,435
1,528
58,719
118,161
1,940
6,857,302
2,232,783
Cash and cash equivalents includes the following for the purpose of the Statement
of Cash Flows.
CASH AND CASH EQUIVALENTS
Cash at bank
Bank overdrafts
6,857,302
2,232,783
(801,204) (3,445,702)
6,056,098
(1,212,919)
2.5.2 Additional disclosures where a subsidiary is acquired or disposed of

When control of a subsidiary is obtained or lost in a period, the following amounts
are disclosed in aggregate:
(a)
total consideration paid or received
(b)
the portion of consideration consisting of cash and cash equivalents
(c)
the amount of cash and cash equivalents in the subsidiaries or other

businesses over which control is obtained or lost.
(d)
The amount of the assets and liabilities other than cash or cash equivalents
in the subsidiaries or other businesses over which control is obtained or lost,
summarised by each major category.
Disclosures (c) and (d) are not required in respect of subsidiaries controlled by
investment entities and measured at fair value through profit or loss.
CA Sri Lanka
659
QUESTION
Critically evaluate LKAS 7's approach to statements of cash flows of reconciling
the movement in cash and cash equivalents.
ANSWER
Cash is defined by LKAS 7 as 'cash on hand and demand deposits'. Cash
equivalents are 'short-term, highly liquid investments that are readily convertible
to known amounts of cash and which are subject to insignificant risk of changes in
value'.
LKAS 7 amalgamates these two concepts together and shows the movement in the
statement of cash flows. This is effectively treating cash equivalents as if they
were pure cash, reinforced by the naming of the statement of cash flows, which
refers only to cash.
One could argue that this is misleading to the user of the financial statements as
short-term bonds and other investments of up to 3 months maturity from the
reporting date are treated as if they are liquid cash, which is not the case. The
breakdown of cash and cash equivalents is shown in a note to the statement of
cash flows. A more transparent alternative might be to show such investments as
inflows and outflows of pure cash under 'Investing activities', and to reconcile
therefore to the movement in pure cash.
QUESTION
On 1 February 20X3, P Group acquired 70% of a subsidiary S Co. Purchase
consideration was 100,000 shares issued at their market price of Rs. 225 plus
Rs. 300 Mn in cash. At the acquisition date the statement of financial position for
S Co was as follows:
Rs Mn
570
PPE
120
Inventories
170
Trade receivables
85
945
200
Stated capital
515
Reserves
715
150
Trade payables
80
Income taxes payable
945
660
CA Sri Lanka
The NCI on acquisition was measured as a proportion of net assets.

At the year end, 31 December 20X3, the goodwill arising on the acquisition of S Co
was found to be impaired by 50%.
Required
(a)
What amount is shown in the consolidated statement of cash flows as a

payment to acquire a subsidiary?
(b)
How does the impairment of goodwill affect the preparation of the

consolidated statement of cash flows?
(c)
Assuming that:
The NCI in net assets of P Group at 1 January 20X3 was Rs. 604 Mn
The NCI in net assets of P Group at 31 December 20X3 was Rs. 850 Mn
The NCI in total comprehensive income for the year ended 31 December
20X3 was Rs. 241.5 Mn
What amount is disclosed as dividends paid to the NCI in the consolidated

statement of cash flows?
(d)
Assuming the following extracts from the consolidated statement of financial

position, what is the change in trade receivables to be included in the
reconciliation of profit to cash generated by operations?
Trade receivables
20X3
Rs Mn
540
20X2
Rs Mn
430
ANSWER
(a)
Cash to acquire S Co
Cash acquired with S Co
Net payment to acquire S Co
(b)
CA Sri Lanka
Rs Mn
(300)
85
215
The goodwill impairment is a non-cash expense charged to profit or loss;

therefore it is added back to profit in the reconciliation to cash generated
from operations in the same way as depreciation or a loss on disposal of PPE.
661
(c)
Rs Mn
604
241.5
214.5
(850)
210
NCI b/f
NCI in TCI
Acquisition of S (715 x 30%)
NCI c/f
Dividends paid to the NCI
(d)
Rs Mn
110
(170)
60
Increase in trade receivables

Acquisition of S
ED/2014/6 Disclosure Initiative proposes changes to IAS 7 (LKAS 7)
The IASB is involved in a broad-based initiative to explore how disclosures in IFRS

financial reporting can be improved. This disclosure initiative is made up of a
number of projects, the first of which resulted in amendments to IAS 1 (LKAS 1)
Presentation of Financial Statements .
ED/2014/6 is relevant to the second project and proposes amendments to IAS 7
(LKAS 7) in order to require a reconciliation of amounts in the opening and closing
statements of financial position for each item from which cash flows are classified
as financing activities, with the exception of equity items. As a result, investors
would be provided with improved disclosure about an entitys debt and
movements in that debt during the period.
The example disclosure note included in the exposure draft is as follows:
Long-term
borrowings
Lease liabilities
Long-term debt
20X1
1,040
Cash flow
250
1,040
(90)
160
Non-cash changes
Acquisition New leases
200
200
900
900
20X2
1,490
810
2,300
In addition short-term amendments to improve disclosures about restrictions on

cash and cash equivalent balances have been proposed. These disclosures would
help users to understand the liquidity of the reporting entity.
662
CA Sri Lanka
CHAPTER ROUNDUP
A statement of cash flows classifies cash flows as resulting from operating

activities, investing activities and financing activities.
A consolidated statement of cash flows is prepared using the consolidated

financial statements. It includes cash flows associated with the acquisition or
disposal of group companies, the non-controlling interest and interests in
associates.
Cash paid to acquire a subsidiary is stated net of cash acquired as an asset of

the subsidiary.
Cash received to sell a subsidiary is stated net of cash disposed of as an asset

of the subsidiary.
Dividends paid to non-controlling interests are calculated by reference to the

NCI in net assets and total comprehensive income.
Dividends received from associates and joint ventures are calculated by

reference to the carrying amount of the investment and group share of total
comprehensive income from the investment.
ED/2014/6 Disclosure Initiative proposes changes to IAS 7 (LKAS 7).
CA Sri Lanka
663
PROGRESS TEST
664
What is the objective of LKAS 7?
Which entities must prepare a statement of cash flows?
What are the standard headings required by LKAS 7 to be included in a statement

of cash flows?
What is the 'indirect method' of preparing a statement of cash flows?
How should an acquisition or disposal of a subsidiary be shown in the statement

of cash flows?
CA Sri Lanka
To provide users of financial statements with information about the entity's ability
to generate cash and cash equivalents, and the entity's cash needs
All entities
Operating, investing and financing activities.
The net profit or loss for the period is adjusted for non-cash items; changes in
inventories, receivables and payables from operations; and other items resulting
from investing or financing activities.
Cash flows from acquisitions and disposals are presented separately under
investing activities.
CA Sri Lanka
665
666
CA Sri Lanka
CHAPTER
INTRODUCTION
Where a company acquires a subsidiary that reports its results in a foreign currency, the financial
statements of the subsidiary must be translated prior to consolidation.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
1.2
Level B
1.2.1
1.2.2
1.2.5

Recommend the appropriate accounting treatment to be used in complicated circumstances
in accordance with Sri Lanka Accounting Standards.
Demonstrate a thorough knowledge of Sri Lanka Accounting standards in the selection and
1.3.1
1.3.2
1.3.3

Apply the concepts/principals of the standards to resolve a simple/straight forward matter.
1.2.3
1.2.4
1.3
Level C
Advise on the application of Sri Lanka Accounting Standards in solving complicated matters.
Recommend the appropriate accounting treatment to be used in complicated circumstances
in accordance with Sri Lanka Accounting Standards.
standards.
667
KC1 | Chapter 20: Foreign exchange issues
CHAPTER CONTENTS
2 LKAS 29 Financial Reporting in Hyperinflationary Economies
Foreign Transactions and Entities Learning objectives

Outline and apply the translation of foreign currency amounts and transactions
into the functional currency and the presentation currency.
Account for the consolidation of foreign operations and their disposal.
State indications of hyperinflation.
Explain historical cost approach and current cost approach.
List the disclosure requirements with regard to financial reporting in
hyperinflationary economies as per the standard.

Where a subsidiary has a different functional currency from group functional
currency, its results must be translated for the purposes of consolidation.
LKAS 21 deals with two aspects of foreign exchange:
1
2
Accounting for foreign currency transactions by an individual company

Translating and consolidating the financial statements of a foreign operation.
The first of these aspects was considered in Chapter 3; the second is considered in
this chapter.
1.1 Definitions
The following definitions are relevant:
Foreign operation A subsidiary, associate, joint venture or branch of a reporting
entity, the activities of which are based or conducted in a country or currency
other than those of the reporting entity.
Net investment in a foreign operation. The amount of the reporting entity's
interest in the net assets of that operation.
668
CA Sri Lanka
Functional currency is the currency of the primary economic environment in

which the entity operates.
Presentation currency is the currency in which the financial statements are
presented.
Closing rate is the spot exchange rate at the end of the reporting period.
Spot exchange rate is the exchange rate for immediate delivery.
1.2 Determining functional currency

LKAS 21 states that an entity should consider the following factors in determining
its functional currency:
(a)
The currency that mainly influences sales prices for goods and services
(often the currency in which prices are denominated and settled).
(b)
The currency of the country whose competitive forces and regulations

mainly determine the sales prices of its goods and services.
(c)
The currency that mainly influences labour, material and other costs of
providing goods or services (often the currency in which prices are
denominated and settled).
Sometimes the functional currency of an entity is not immediately obvious.

Management must then exercise judgement and may also need to consider:
(a)
The currency in which funds from financing activities (raising loans and
issuing equity) are generated.
(b)
The currency in which receipts from operating activities are usually

retained.
In determining the functional currency of a foreign operation within a group, a

number of additional factors are considered:
CA Sri Lanka
(a)
Whether the activities of the foreign operation are carried out as an

extension of the parent, rather than being carried out with a significant
degree of autonomy.
(b)
Whether transactions with the parent are a high or a low proportion of the
foreign operation's activities.
(c)
Whether cash flows from the activities of the foreign operation directly affect
the cash flows of the parent and are readily available for remittance to it.
(d)
Whether the activities of the foreign operation are financed from its own
cash flows or by borrowing from the parent.
669
Where the functional currency of a foreign operation is different from that of the
group, the results of the operation must be translated.
1.3 Translation of financial statements

The financial statements of the foreign operation are translated as follows:
position
Assets
Closing rate
Pre-acquisition stated
capital and retained
earnings
Historic rate (at date of

acquisition)
Post acquisition retained

earnings
Note 1
Foreign exchange reserve
Note 2
Liabilities
Closing rate
Statement of profit or loss Income, expenses and

and other comprehensive other comprehensive
income
income
Spot rate at date of

transaction (note 3)
Note 1
Post acquisition retained earnings are translated as a balancing figure for ease. If
this balance were calculated it would include the profit of the operation for each
year since acquisition translated at the average rate for those years. In an exam
situation where a subsidiary was acquired many years ago, this is impracticable.
Note 2
An exchange difference arises on the translation of the financial statements. LKAS
21 requires that this is recognised as other comprehensive income and taken to a
separate reserve in equity.
The foreign exchange reserve therefore includes exchange differences arising on
translation of the financial statements for each year since acquisition.
Again in an exam situation the calculation of this reserve on a cumulative basis
when a subsidiary was acquired many years ago is impracticable. Therefore the
foreign exchange reserve and post-acquisition retained earnings are usually
combined for exam purposes and calculated as a balancing figure.
Note 3
Although items in the statement of profit or loss and other comprehensive income
are translated at the spot rate on the date on which each transaction took place,
670
CA Sri Lanka
LKAS 21 allows the use of an average rate for the period provided that this does
not fluctuate too much.
1.3.1 Example: Translation of financial statements
The abridged financial statements of Europa Co, an 80% subsidiary of a Sri Lankan
company, Lanka Imports Ltd appear below.
DRAFT STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X9
Europa Co
'000
Assets
PPE
Plant at cost
Less depreciation
Current assets
Inventories
Receivables

Equity
Stated capital
Retained earnings
Long-term loans
Current liabilities
500
(200)
300
200
100
300
600
100
280
380
110
110
600
DRAFT STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED

31 DECEMBER 20X9
Revenue
Expenses
Profit before tax
Tax
Retained profit
Europa Co
'000
250
(160)
90
(20)
70
Europa Co was acquired by Lanka Imports Ltd on 1 January 20X9 when its
retained earnings were 210,000.
CA Sri Lanka
671
Exchange rates:
1 to Rs. 168 on 1 January 20X9

1 to Rs. 175 on 31 December 20X9
1 to Rs. 170 average for the year ended 31 December 20X9
Required
Translate the financial statements of Europa Co.
Solution
SUMMARISED STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 20X9
PPE
Inventories
Receivables
Stated capital
Retained earnings pre Acq
Retained earnings post Acq
Long-term loans
Current liabilities
'000
300
200
100
600
100
210
70
110
110
600
Rate
175
175
175
168
168
Balance
175
175
Rs Mn
52.5
35
17.5
105
16.8
35.28
14.42
19.25
19.25
105
SUMMARISED STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31

DECEMBER 20X9
'000
Rate
Rs Mn
250
170
42.5
Revenue
(160)
170
(27.2)
Expenses
(20)
170
(3.4)
Tax
70
11.9
Retained profit
1.3.2 Exchange difference arising on translation

The exchange difference arising on translation is due to the fact that the opening
net assets and profit for the year is being translated at a different rate from the
closing net assets of a foreign operation.
Consider the following accounting equation which relates to the previous example,
Europa Co:
672
Opening net
assets
Profit for the

year
Closing net
assets
310,000
70,000
380,000
CA Sri Lanka
If we translate the separate elements of the equation at the relevant exchange

rates, the equation no longer holds:
Opening net
assets
Profit for the

year
Closing net
assets
310,000
70,000
380,000
168
Rs 52,080,000
170
+
Rs 11,900,000
175
Rs 66,500,000
In this case the translated opening net assets plus the translated profit for the year
amount to less than the translated closing net assets. Therefore there is an
exchange gain of the difference, in this case Rs. 2.52 Mn (66.5 52.08 11.9)
If, however, we translate the separate elements of the equation all at the closing
exchange rates, the equation does hold:
Opening net
assets
Profit for the

year
Closing net
assets
310,000
70,000
380,000
175
Rs 54,250,000
175
+
Rs 12,250,000
175
=
Rs 66,500,000
It therefore follows that the exchange difference on translation is calculated as:

Opening net assets
Translated at opening rate
Translated at closing rate
Gain / (loss)
(X)
X
X/(X)
Retained profit for the year

Translated at average rate
Translated at closing rate
Gain / (loss)
Overall gain or loss on retranslation
(X)
X
X/(X)
X/(X)
Remember that this is the exchange difference for the current year. It is:
Reported as an item of other comprehensive income that may be reclassified to
profit or loss, and
Accumulated in a separate reserve in equity.
CA Sri Lanka
673
1.3.3 Example: calculation of exchange difference

The exchange difference on translation of Europa Co is calculated as:
Opening net assets
Translated at opening rate 310 x 168
Translated at closing rate 310 x 175
Gain
Rs'000
(52,080)
54,250
Rs'000
2,170
Retained profit for the year

Translated at average rate 70 x 170
Translated at closing rate 70 x 175
Gain
Overall gain on retranslation
(11,900)
12,250
350
2,520
In the translated financial statements this gain is reported in other comprehensive

income and therefore the translated statement of profit or loss and other
comprehensive income becomes:
SUMMARISED STATEMENT OF PROFIT OR LOSS AND OCI FOR THE YEAR ENDED
31 DECEMBER 20X9
Revenue
Expenses
Tax
Profit for the year
Other comprehensive income that may be reclassified to profit
or loss
Exchange gain
674
Rs Mn
42.5
(27.2)
(3.4)
11.9
2.52
14.42
CA Sri Lanka
The translated statement of financial position can also more accurately be

presented as:
SUMMARISED STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 20X9
PPE
Inventories
Receivables
Stated capital
Retained earnings pre Acq
Retained earnings post Acq (14.42 2.52)
Foreign exchange reserve
Long-term loans
Current liabilities
Rs Mn
52.5
35
17.5
105
16.8
35.28
11.9
2.52
19.25
19.25
105
Lanka Imports Ltd has owned Europa Co for one year and therefore:
The balance of post-acquisition retained earnings is equal to the translated
profit for the year
The balance on the foreign exchange reserve is equal to the exchange difference
for the year.
Remember that you will not be able to split these reserves easily where a foreign
operation was acquired several years prior to the reporting date and therefore it
is acceptable to merge them. You should, however, calculate the exchange
difference for the year when preparing a statement of profit or loss and other
1.4 Consolidation procedures

Having translated the financial statements of a foreign subsidiary, they should be
consolidated as normal. On consolidation:
CA Sri Lanka
(i)
The exchange difference arising on translation and recognised as other

comprehensive income of the subsidiary is allocated between the owners of
the parent and the NCI in proportion to their ownership interest.
(ii)
Cumulative exchange differences in the subsidiarys foreign exchange

reserve are allocated between the parent and the NCI in relation to their
ownership interest. This treatment is also applied to the post acquisition
reserves of the subsidiary, and therefore where a separate foreign exchange
675
reserve is not maintained, allocation of exchange differences is achieved as

part of the allocation of post-acquisition reserves.
1.4.1 Example: Consolidation
Continuing with the previous example, assume that the financial statements of
Lanka Imports Ltd for the year ended 31 December 20X9 are as follows:
DRAFT STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X9
LI Ltd
Rs'000
Assets
PPE
Investment in Europa
Current assets
Inventories
Receivables

Equity
Stated capital
Retained earnings
Long-term loans
Current liabilities
78,900
41,664
120,564
12,700
16,500
29,200
149,764
20,000
82,364
102,364
30,000
17,400
149,764

LI Ltd
Rs'000
71,400
Revenue
(58,900)
Expenses
12,500
Profit before tax
(2,050)
Tax
10,450
Retained profit
The NCI is measured as a proportion of net assets.
Required
Prepare the consolidated financial statements of the Lanka Imports Group for the
year ended 31 December 20X9.
676
CA Sri Lanka
Solution
PPE
Invt in E
Inventories
Receivables
Stated capital
Retained
earnings
NCI
Loans
Current
liabilities
LI Ltd
Rs'000
78,900
41,664
12,700
16,500
149,764
20,000
82,364
E Co
Rs'000
52,500
(W1)
Rs'000
(W2)
Rs'000
(41,664)
35,000
17,500
105,000
16,800
49,700
(16,800)
(35,280)
(2,884)
10,416
2,884
Group
Rs'000
131,400
47,700
34,000
213,100
20,000
93,900
30,000
17,400
19,250
19,250
13,300
49,250
36,650
149,764
105,000
213,100

for the year ended 31 December 20X9
Revenue
Expenses
Tax
Retained profit
Exchange diff
TCI
Owners of parent (80%)
NCI (20%)
Owners of parent
NCI
CA Sri Lanka
LI Ltd
Rs'000
71,400
(58,900)
(2,050)
10,450
E Co
Rs'000
42,500
(27,200)
(3,400)
11,900
2,520
14,420
Group
Rs'000
113,900
(86,100)
(5,450)
22,350
2,520
24,870
10,450
9,520
2,380
19,970
2,380
10,450
11,536
2,884
21,986
2,884
677
Workings
Cost of investment
NCI 20% (100 + 210)
Net assets at acquisition
Stated capital
Retained earnings
Goodwill
'000
rate
62
168
(100)
(210)
nil
168
168
Rs'000
41,664
10,416
(16,800)
(35,280)
nil
Therefore the acquisition journal is (Rs'000):

DEBIT
Stated capital
16,800
DEBIT
Retained earnings
35,280
CREDIT
Investment
41,664
CREDIT
NCI
10,416
(W2) Allocation of post acquisition reserves movement to NCI

The reserves of Europa Co have increased by Rs. 14.42 Mn since acquisition. 20%
of this is allocated to the NCI by (Rs'000):
DEBIT
Retained earnings (20% 14,420)
CREDIT
NCI
2,884
2,884
Note that in this example, since Europa was purchased in the current year, this
reallocation is equal to the TCI attributable to the NCI as disclosed in the
consolidated statement of profit or loss and other comprehensive income.
1.4.2 Goodwill
Goodwill arising on the acquisition of a foreign subsidiary is considered to be a
foreign asset. It is:
1.
2.
3.
4.
678
Initially calculated in the functional currency of the subsidiary

Translated at the acquisition date
Translated at the start of the current accounting period
Translated at the reporting date
CA Sri Lanka
Retranslation at three separate dates is necessary in order to calculate the

exchange difference on goodwill arising in the period and cumulative exchange
differences:
The difference between goodwill as translated at acquisition and goodwill as
translated at the reporting date is the cumulative exchange difference which is
recognised in equity
The difference between goodwill as translated at the start of the current
accounting period and goodwill as translated at the reporting date is the
exchange difference for the year which is recognised as other comprehensive
income
1.4.3 Example: Goodwill
Continuing with the previous example, now assume that Lanka Imports Ltd
acquired only 70% rather than 80% of Europa Co.
Required
Calculate goodwill arising on acquisition in Euros, goodwill as reported in the
consolidated statement of financial position and the exchange difference arising
on goodwill in the year.
Solution
Goodwill is calculated as:
Cost of investment
NCI 30% (100 + 210)
Stated capital
Retained earnings
Goodwill at acquisition / start of period
Goodwill as retranslated at reporting date
Therefore exchange gain
'000
248
93
(100)
(210)
31
31
rate
168
168
Rs'000
41,664
15,624
168
168
168
175
(16,800)
(35,280)
5,208
5,425
217
1.4.4 Reporting exchange differences on goodwill

As we have already said, the annual exchange difference on the retranslation of
goodwill is recognised in other comprehensive income and the cumulative
difference is recognised in reserves.
The allocation of the exchange difference between the owners of the parent and
the NCI depends on whether goodwill is full goodwill ie whether the NCI is
measured at fair value.
CA Sri Lanka
679
Where the NCI is measured at fair value and therefore has an interest in
goodwill the exchange difference is allocated between the owners of the parent
and the NCI in proportion to their ownership interest.
Where the NCI is measured as a proportion of net assets the exchange
difference is allocated to the parent only.
QUESTION
Consolidated financial statements
Redraft the consolidated financial statements for the Lanka Imports Group for the
year ended 31 December 20X9 assuming that:
(i)
(ii)
Lanka Imports Ltd acquired 70% of Europa Co

The NCI was measured on acquisition at its fair value of 98,000
ANSWER
PPE
Invt in E
Goodwill
Inventories
Receivables
Stated
capital
Retained
earnings
NCI
Loans
Current
liabilities
680
LI Ltd
Rs'000
78,900
41,664
E Co
Rs'000
52,500
(W1)i
Rs'000
(41,664)
6,048
(W1)ii
(W2)
Rs'000
Group
Rs'000
131,400
5,796
47,700
34,000
218,896
20,000
(252)
12,700
16,500
149,764
20,000
35,000
17,500
105,000
16,800
(16,800)
82,364
49,700
(35,280)
(176)
(2,884)
93,724
16,464
(76)
2,884
30,000
19,250
19,272
49,250
17,400
149,764
19,250
105,000
36,650
218,896
CA Sri Lanka

for the year ended 31 December 20X9
LI Ltd
E Co
(W1)ii
Group
Rs'000
Rs'000
Rs'000
71,400
42,500
113,900
Revenue
(58,900)
(27,200)
(86,100)
Expenses
(2,050)
(3,400)
(5,450)
Tax
10,450
11,900
22,350
Retained profit
2,520
252
2,772
Exchange diff
14,420
25,122
TCI
10,450
9,520
19,970
Owners of parent (80%)
2,380
2,380
NCI (20%)
10,450
11,536
252
22,238
Owners of parent
2,884
2,884
NCI
Workings
Cost of investment
NCI
Stated capital
Retained earnings
Goodwill at reporting date
Exchange gain
(i)
(ii)
CA Sri Lanka
'000
248
98
(100)
(210)
36
36
rate
168
168
Rs'000
41,664
16,464
168
168
168
175
(16,800)
(35,280)
6,048
6,300
252
The acquisition journal is (Rs'000):

DEBIT
Goodwill
6,048
DEBIT
Stated capital
16,800
DEBIT
Retained earnings
35,280
CREDIT
Investment
41,664
CREDIT
NCI
16,464
The journal to record the retranslation of goodwill is (Rs'000):

DEBIT
Goodwill
CREDIT
Retained earnings (70% 252)
CREDIT
NCI (30% 252)
252
176.4
75.6
681
(W2) Allocation of post acquisition reserves movement to NCI

The reserves of Europa Co have increased by Rs. 14.42 Mn since acquisition. 20%
of this is allocated to the NCI by (Rs'000):
DEBIT
Retained earnings (20% 14,420)
CREDIT
NCI
2,884
2,884
(W3) Exchange difference on translation

See section 1.3.3
QUESTION
Comprehensive question
Horana Co acquired 70% of Mazini Co, a foreign company 4.5m Units on

31 December 20X4 when the retained reserves of Mazini were 1.125m Units. No
impairment losses had been recognised up to 31 December 20X7. Neither
company paid or declared dividends during the year.
The financial statements of the two companies for the year ended 31 December
20X7 are as follows:

Investment in Mazini
Current assets
Share capital
Horana
Rs Mn
Mazini
U'000
5,297
4,000
203
2,400
3,000
7,900
7,000
2,000
2,250
Pre-acquisition reserves
Post-acquisition reserves
Loans
682
1,125
4,400
2,825
6,400
6,200
1,500
800
7,900
7,000
CA Sri Lanka
STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Income tax expense
Profit for the year
Horana
Rs Mn
Mazini
U'000
12,000
(7,000)
5,000
(3,025)
1,975
(500)
1,475
5,700
(2,470)
3,230
(570)
2,660
(760)
1,900
Group policy is to measure non-controlling interests at acquisition at their

proportionate share of the fair value of the identifiable net assets.
Exchange rates
31 December 20X4
31 December 20X6
31 December 20X7
Average exchange rate for year ended 31 December 20X7
Rs to Units
45
43
40
38
Required
income and statement of financial position for the Horana Group for the year
You should work to the nearest Rs Mn.
CA Sri Lanka
683
ANSWER
Property, plant and

equipment
Investment in Mazini
Horana
Mazini
(W3)i
(W3)ii
(W4)
Group
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
5,297
160
5,457
203
(203)
Goodwill
Current assets
Share capital
Pre-acquisition
reserves
Post-acquisition
reserves
NCI
Loans
97
(12)
85
2,400
120
2,520
7,900
280
8,062
2,000
101
(101)
51
(51)
2,000
4,400
96
6,400
248
1,500
32
1,532
7,900
280
8,062
(12)
46
(29)
29
4,455
75
STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Income tax expense
Profit for the year
OCI
Exchange loss
TCI
Owners of parent
NCI
684
Horana
Rs Mn
12,000
(7,000)
5,000
(3,025)
1,975
(500)
1,475
Mazini
Rs Mn
217
(94)
123
(22)
101
(29)
72
(W3)
Rs Mn
Group
Rs Mn
12,217
(7,094)
5,123
(3,047)
2,076
(529)
1,547
(7)
1,475
(9)
63
(16)
1,531
1,475
NCI
50
22
1,525
22
CA Sri Lanka
Horana
Rs Mn
Owners of parent
NCI
1,475
Mazini
Rs Mn
44
19
(W3)
Rs Mn
(7)
Group
Rs Mn
1,512
19
(W1) Translation of financial statements of Mazini

SOFP
Mazini
Rate
Units'000
Mazini
Rs Mn
4,000
40
160
Current assets
3,000
40
120
7,000
280
Share capital
2,250
45
101
Pre-acquisition reserves
1,125
45
51
Post-acquisition reserves
2,825
96
6,200
Loans
800
248
40
280
7,000
Mazini
Units'000
Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Income tax expense
Profit for the year
OCI exchange difference (W2)
TCI
5,700
(2,470)
3,230
(570)
2,660
(760)
1,900
32
Rate
Mazini
Rs Mn
38
38
217
(94)
123
(22)
101
(29)
72
(9)
63
38
38
(W2) Exchange difference on translation

Opening net assets are U6,200,000 U1,900,000 = U4,300,000
Opening net assets:
At OR: 4,300,000 43 =
At CR: 4,300,000 40 =
Loss
CA Sri Lanka
185 Mn
172 Mn
(13 Mn)
685
Profit :
At AR: 1,900,000 38
At CR: 1,900,000 40
Gain
Net loss
72 Mn
76 Mn
4 Mn
(9 Mn)
(W3) Goodwill
Non-controlling interests (30% 3,375)
Share capital
Retained reserves
Exchange loss 20X5-20X6 b/f

At 31.12.X6
Exchange loss 20X7
At 31.12.X7
(i)
(ii)
Units'000
4,500
1,012
(2,250)
(1,125)
Rate
45
45
45
45
Rs Mn
203
46
(101)
(51)
2,137
2,137
2,137
45
43
40
97
(5)
92
(7)
85
Recognise goodwill by (Rs Mn):

DEBIT
Goodwill
DEBIT
Share capital
DEBIT
Retained earnings
CREDIT
NCI
CREDIT
Investment
97
101
51
46
203
Recognise cumulative exchange difference to date by (Rs Mn):

DEBIT
Retained earnings (5+7)
CREDIT
Goodwill
12
12
Of this amount the Rs. 7 Mn loss arising in the year is recognised as other
(W4) Allocation of post acquisition profits to NCI
Mazini has made post acquisition profits of Rs. 96 Mn (including cumulative
exchange differences on retranslation of its financial statements). 30% of this is
allocated to the NCI by (Rs Mn):
686
DEBIT
Retained earnings (30% x 96m)
CREDIT
NCI
29
29
CA Sri Lanka
1.5 Disposal of a foreign subsidiary

When a parent disposes of a foreign entity, the cumulative amount of exchange
differences relating to that foreign entity should be recognised reclassified to
profit or loss in the same period in which the gain or loss on disposal is
recognised.
Effectively, this means that these exchange differences are recognised once in
other comprehensive income and are then reversed out of other comprehensive
income and recognised for a second time in profit or loss on disposal of the foreign
operation.
If the parent part disposes of a foreign subsidiary such that it still retains control
after the disposal, the cumulative exchange differences previously recognised in
other comprehensive income are re-allocated between the group and noncontrolling interest in proportion to the new ownership interests.
2 LKAS 29 Financial
Economies
Reporting
in
Hyperinflationary
LKAS 29 applies where the functional currency of an entity is the currency of a

hyperinflationary economy. It requires that such an entitys financial statements
are restated in terms of measuring units current at the reporting date.
Hyperinflation exists where prices are rising at such a fast pace that the price of an
item bought at the end of a reporting period is several times more expensive than
the price of the same item bought at the start of a reporting period. A recent
example of a hyperinflationary economy is Zimbabwe. Here, in November 2008
prices doubled every 24 hours such that a loaf of bread eventually cost 35 million
Zimbabwean Dollars!
In a hyperinflationary economy money loses purchasing power at such a fast rate
that transactions that take place at the start of a reporting period result in
reported amounts that are meaningless. Therefore LKAS 29 requires that financial
statements are restated to take account of hyperinflation.
2.1 Indicators of hyperinflation

Although LKAS 29 does not define hyperinflation, it does suggest characteristics of
an economic environment that indicate hyperinflation. They are:
(a)
CA Sri Lanka
The general population prefers to keep its wealth in non-monetary assets or

in a relatively stable foreign currency. Amounts of local currency held are
immediately invested to maintain purchasing power.
687
(b)
The general population regards monetary amounts not in terms of the local
currency but in terms of a relatively stable foreign currency. Prices may be
quoted in that currency.
(c)
Sales and purchases on credit take place at prices that compensate for the
expected loss of purchasing power during the credit period, even if the
period is short.
(d)
Interest rates, wages and prices are linked to a price index, and
(e)
The cumulative inflation rate over three years is approaching or exceeds

100%.
2.2 Historical cost and current cost financial statements

Financial statements are usually produced on the basis of historical cost or
current cost.
Under the historical cost convention, assets are held at historical cost with
revaluations permitted in some instances.
Under the current cost convention, changes in the value of specific assets held by
an entity are reflected.
LKAS 29 requires adjustment to be made to financial statements produced on both
bases so that amounts are reported in terms of measuring units that are current at
the reporting date.
2.3 Restating historical cost financial statements

The following procedures are applied to restate the statement of financial
position:
Balances not already expressed in terms of the measuring unit current at the
end of the reporting period are restated by applying a general price index;
Monetary items are not restated as they are already expressed in terms of the
monetary unit current at the end of the reporting period;
Assets and liabilities linked by agreement to changes in prices (such as index
linked loans) are adjusted in accordance with the agreement to ascertain the
outstanding amount at the reporting date;
Non-monetary items carried at net realisable value and fair value are not
restated (as they are already expressed in terms of the measuring unit current
at the reporting date);
688
CA Sri Lanka
Other non-monetary items are restated by applying a general prices index from
the date of acquisition (or revaluation where relevant) to the reporting date.
2.3.2 Example: Restating non-monetary assets
An entity operating in a hyperinflationary economy where the currency is the Bitt
acquired land for B100,000 when the price index was 200. At the reporting date
the price index is 900 and therefore the restated value of the land is:
B100,000 900/200 = B450,000
All amounts of income and expense are restated in terms of measuring units
current at the reporting date. Therefore all amounts are restated by applying the
change in the general prices index from the dates when the items of income and
expenditure were initially recorded.
2.3.4 Gain or loss
The restatement of the financial statements will result in a gain or loss known as
the gain or loss on net monetary position. This is included in profit or loss.
2.4 Restating current cost financial statements

Items stated at current cost are not restated as they are already expressed in
terms of the measuring unit current at the end of the reporting period.
Other items are restated as described in section 2.3.1 above.
All amounts in the statement of profit or loss and other comprehensive income
are restated into the measuring unit current at the reporting date by applying a
general price index.
2.4.3 Gain or loss
The gain or loss on net monetary position is recognised in profit or loss.
CA Sri Lanka
689
2.5 Taxes
The restatement of financial statements in accordance with LKAS 29 may result in
differences between the carrying amount of items and their tax bases. These
differences result in deferred tax amounts in accordance with LKAS 12.
2.6 Disclosure
LKAS 29 requires the following disclosures:
The fact that the financial statements and the corresponding figures for
previous periods have been restated for the changes in the general purchasing
power of the functional currency and, as a result, are stated in terms of the
measuring unit current at the end of the reporting period.
Whether the financial statements are based on a historical cost approach or a
current cost approach.
The identity and level of the price index at the end of the reporting period and
the movement in the index during the current and the previous reporting
period.
2.7 IFRIC 7 Applying the Restatement Approach under LKAS 29

Financial Reporting in Hyperinflationary Economies
IFRIC 7 provides guidance on the application of LKAS 29 in a reporting period that
first identifies the existence of hyperinflation.
It requires that:
LKAS 29 is applied as if the economy had always been hyperinflationary.
Therefore, in relation to non-monetary items measured at historical cost, the
entitys opening statement of financial position is restated to reflect the effect of
inflation from the date the assets were acquired and the liabilities were
incurred or assumed until the end of the reporting period
At the end of the period, deferred tax items are recognised and measured in
accordance with LKAS 12. Opening deferred tax amounts are determined as
follows:
After restating nominal carrying amounts of non-monetary items at the start
of the period, deferred tax items are remeasured by applying the measuring
unit at that date.
Remeasured deferred tax items are then restated for the change in the
measuring unit from the start of the reporting period to the end of the
period.
690
CA Sri Lanka
QUESTION
Singhe, a listed company whose functional currency is the Rupee has recently
purchased a foreign subsidiary Lion. The functional currency of Lion is the crown.
Singhe purchased 75% of the ordinary share capital of Lion on 1 September 20X5
for 80 million crowns. The fair value of the net assets at that date was 100 million
crowns. At the year-end the goodwill was tested for impairment and this review
indicated that it had been impaired by 2 million crowns.
The exchange rates were as follows:
1 September 20X5
1 : 2.5
31 December 20X5
1 : 2.1
Crowns to Rs
Single chose to measure the non-controlling interests in Lion at fair value at the
date of acquisition. The fair value of the non-controlling interests in Lion on
1 September 20X5 was 26 million crowns.
The directors are unsure how to treat the subsidiary in the consolidated accounts
of Singhe.
Required
(a)
Advise the directors of the correct accounting treatment of Lion in the

consolidated statement of profit or loss and other comprehensive income
and statement of financial position of Singhe for the year ended
31 December 20X5.
(b)
Assess the value of reported goodwill at 31 December 20X5.
ANSWER
(a)
Lion is a foreign operation as defined by LKAS 21 The Effects of Changes in

Foreign Exchange Rates as it is a subsidiary of the reporting entity where the
activities are conducted in a currency other than that of the reporting entity
(Singhe). Lions results will therefore need to be translated into Rupees
before consolidation.
The consolidated statement of profit or loss and other comprehensive
income will include the post acquisition income and expenses of Lion, ie for
4 months, translated into Rupees at the actual rate at the date of the
transactions (average rate for the 4 months if insignificant fluctuations).
The consolidated statement of financial position will include the assets and
liabilities of Lion translated into Rupees at the closing rate at the reporting
date.
CA Sri Lanka
691
Any exchange differences are recognised in other comprehensive income

and the group share is shown as a separate component of equity (the
translation reserve).
(b)
Goodwill
Non-controlling interests (at fair value)
Less: Fair value of net assets at acquisition
Impairment losses
Exchange gain/(loss) (balancing figure)
Goodwill at year end
Crowns Mn
80.0
26.0
(100.0)
6.0
(2.0)
4.0
Rate
Rs Mn
2.5
2.1
2.1
15
(4.2)
(2.4)
8.4
The goodwill should be calculated in the functional currency of Lion and

retranslated into Rupees at the closing rate at each reporting date.
Therefore Rs8.4m is recognised on the consolidated statement of financial
position.
The exchange loss of Rs. 2.4 Mn is recognised in other comprehensive
income. The impairment loss is recognised in profit or loss.
As the NCI is measured at fair value (and so part goodwill is attributable to
the NCI), both of these amounts are split between the owners of the parent
and the NCI in proportion to the ownership interests.
The group share of the exchange loss is accumulated in a foreign exchange or
translation reserve alongside gains or losses on the translation of net assets.
692
CA Sri Lanka
QUESTION
Polina owns 75% of the shares of a foreign subsidiary, Santana which has the
functional currency of the Pret. The subsidiary was acquired on 1 January 20X3 at
a cost of Pret 90 Mn and on that date the retained earnings of Santana were
Pret 70 Mn.
The abbreviated statements of financial position of Polina and Santana at
31 December 20X3 were as follows:
Polina
Santana
Rs'000
Pret'000
238,500
Investment in Santana
320,000
98,000
Other assets
558,500
98,000
50,000
10,000
Stated capital
233,500
76,000
Retained earnings
283,500
86,000
275,000
12,000
Liabilities
558,500
98,000
Notes:
1.
Goodwill is not impaired.
2.
Polina measures the non-controlling interest as a proportion of the net

assets of the subsidiary.
3.
Relevant exchange rates are:

1 January 20X3
Rs. 2.65: Pret 1
31 December 20X3
Rs. 2.7: Pret 1
Average for the year
Rs. 2.68: Pret 1
Required
Prepare the abbreviated consolidated statement of financial position for the
Polina Group at 31 December 20X3.
CA Sri Lanka
693
ANSWER
Inv in S
Goodwill
Other assets
St capital
Retained
earnings
FX reserve
NCI
Liabilities
P
Rs Mn
238.5
320
558.5
50
233.5
S (W1)
Rs Mn
264.6
264.6
26.5
201.58
275
558.5
4.12
32.4
264.6
(W4)
Rs Mn
(238.5)
79.5
(W5)
Rs Mn
1.5
(W6)
Rs Mn
(26.5)
(185.5)
1.5
(4.02)
53
Stated capital
FX reserve
Retained earnings
Liabilities
Santana
Pret'000
98,000
98,000
10,000
Exchange
Rate
2.7
76,000
86,000
12,000
98,000
Cons.
Rs Mn
81
584.6
665.6
50
247.06
(1.03)
1.03
3.09
58.05
307.4
665.6
2.65
(W2)
(W3)
2.7
Santana
Rs'000
264,600
264,600
26,500
4,120
201,580
232,200
32,400
264,600
FX Reserve
Opening net assets (80 Mn) at opening rate (2.65)
Opening net assets (80 Mn) at closing rate (2.7)
Gain
Profit for the year (6 Mn) at average rate (2.68)
Profit for the year (6 Mn) at closing rate (2.7)
Gain
Total gain
694
4.02
(W7)
Rs Mn
Translation of Santana
Other assets
Total
Rs Mn
238.5
584.6
823.1
76.5
435.0
8
4.12
307.4
823.1
Rs 212 Mn
Rs 216 Mn
4 Mn
Rs 16.08 Mn
Rs 16.2 Mn
0.12 Mn
4.12 Mn
CA Sri Lanka
Retained earnings of Santana
Rs'000
Retained earnings at acquisition Pret 70 Mn x acqn date rate 2.65 185,500

16,080
Profit since acquisition Pret 6 Mn x average rate 2.68
201,580
4
Goodwill on acquisition of Santana

Pret Mn
XR
Rs Mn
Non-controlling interest (25% (10 + 70))
Net assets acquired
Stated capital
Retained earnings
90
20
2.65
2.65
238.5
53
10
70
2.65
2.65
26.5
185.5
30
2.65
79.5
The acquisition consolidation journal is therefore:
DEBIT
Goodwill
Rs. 79.5 Mn
DEBIT
Stated capital
Rs. 26.5 Mn
DEBIT
Retained earnings
Rs. 185.5 Mn
CREDIT
Investment
Rs. 238.5 Mn
CREDIT
NCI
Rs. 53 Mn
Goodwill retranslation
Goodwill is a group asset and must be retranslated based on the closing rate.
It is retranslated to Pret 30 Mn 2.7 = Rs. 81 Mn. This is recorded by;
DEBIT
Goodwill
CREDIT
Retained earnings
Rs. 1.5 Mn
Rs. 1.5 Mn
None of the exchange difference is allocated to the NCI as the full goodwill
method is not used.
6

NCI share of post-acquisition retained earnings in P is 25% Pret 6 Mn =
Pret 1.5 Mn. This is translated at the average rate of 2.68 to be Rs. 4.02 Mn
and allocated to the NCI by:
CA Sri Lanka
DEBIT
Retained earnings
CREDIT
NCI
Rs.4.02 Mn
Rs. 4.02 Mn
695
Exchange reserve allocation to NCI

25% of the exchange difference arising on the translation of the financial
statements of Santana is allocated to the NCI by:
696
DEBIT
Retained earnings (25% 4.12 Mn)
CREDIT
NCI
Rs. 1.03 Mn
Rs. 1.03 Mn
CA Sri Lanka
CHAPTER ROUNDUP
Where a subsidiary has a different functional currency from group presentation

currency, its results must be translated for the purposes of consolidation.
Assets and liabilities in the statement of financial position are translated at the
closing rate; pre acquisition stated capital and reserves are translated at the
acquisition date rate; post acquisition reserves include cumulative exchange
differences on translation.
The exchange difference arising in a year on the translation of the financial

statements is the difference between opening net assets at opening and
closing rates and profit for the year at average and closing rates.
This exchange difference is recognised in OCI and is attributable to the owners

of the parent and the NCI in their ownership interest.
Goodwill is a foreign asset. It is calculated in the functional currency of the

subsidiary and translated at each reporting date.
The exchange difference arising on goodwill is recognised in OCI. Where the

NCI is measured as a proportion of net assets, it is attributable to the owners
of the parent; where the NCI is measured at fair value, it is attributable to the
owners of the parent and the NCI in their ownership interest.
LKAS 29 applies where the functional currency of an entity is the currency of a

hyperinflationary economy. It requires that such an entitys financial statements
are restated in terms of measuring units current at the reporting date.
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697
PROGRESS TEST
698
What additional factors must management take into account when determining
the functional currency of a foreign operation that is part of a group?
How should goodwill and fair value adjustments be treated on consolidation of a

foreign operation?
What exchange difference is recognised in OCI?
When is the exchange difference in relation to goodwill allocated in part to the

NCI?
How are monetary items adjusted in the financial statements of an entity that
operates in a hyperinflationary economy?
CA Sri Lanka
(a)
Whether the activities of the foreign operation are carried out as an

extension of the parent, rather than being carried out with a significant
degree of autonomy.
(b)
Whether transactions with the parent are a high or a low proportion of the
foreign operation's activities.
(c)
Whether cash flows from the activities of the foreign operation directly affect
the cash flows of the parent and are readily available for remittance to it.
(d)
Whether the activities of the foreign operation are financed from its own
cash flows or by borrowing from the parent.
As assets / liabilities of the group and therefore they are retranslated at the period
end.
Two exchange differences are recognised in OCI: the exchange difference on

translating the financial statements of the subsidiary for the year and the
exchange difference arising in the year in relation to goodwill.
When the NCI is measured at fair value and therefore goodwill is full goodwill.
Monetary items are not restated as they are already expressed in terms of the
monetary unit current at the end of the reporting period.
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699
700
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CHAPTER
INTRODUCTION
The SLFRS for SMEs was covered at KB1 level in some detail. In this chapter we revise which entities
can use the SLFRS, the contents of the standard and the differences between the SLFRS for SMEs and full
SLFRS. We also consider why certain topics are not included in the SLFRS for SMEs.
This chapter also considers first-time adoption of SLFRS. The relevant standard is SLFRS 1, which is new
at this level.
Knowledge Component
1
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7

matters.
under standards.
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KC1 | Chapter 21: Small company reporting and firsttime adoption
CHAPTER CONTENTS
1 Eligibility to use the SLFRS for SMEs
2 Content of the SLFRS for SMEs
3 Comparison with full SLFRS
4 SLFRS 1 First-time adoption of SLFRS
5 SLFRS 14 Regulatory Deferral Accounts
SLFRS for SMEs Learning objectives

Discuss the reasons why the SLFRS for SMEs does not address certain topics.
Advise on what circumstances an entity could adopt the SLFRS for SMEs.
Outline the main differences between accounting treatments given in SLFRS for
SMEs and full SLFRS.
1 Eligibility to use the SLFRS for SMEs

SMEs are defined by reference to the fact that they are entities that do not have
public accountability. Specified Business Entities are not eligible to use the
SLFRS for SMEs.
The SLFRS for SMEs may be used by entities that meet the definition of an SME as
provided in the standard and are not a Specified Business Entity (SBE).
1.1 Small and medium-sized entities

The SLFRS for SMEs defines a small and medium sized entity as an entity that:
(a)
(b)
Does not have public accountability, and

Publishes general purpose financial statements for external users.
1.2 Specified Business Entities

Specified Business Entities (SBEs) may not use the SLFRS for SMEs. The following
companies are SBEs:
Companies licensed under the Banking Act No 30 of 1988
Companies authorised under the Control of Insurance Act No 25 of 1962 to
carry on insurance business
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Companies carrying on leasing business

Factoring companies
Companies registered under the Finance Companies Act No 78 of 1988
Companies licensed to operate unit trusts under the Securities and Exchange
Commission Act No 36 of 1987
Fund management companies
Companies licensed to carry on business as stock brokers or stock dealers
under the Securities and Exchange Commission Act No 36 of 1987
Companies licensed to operate a Stock Exchange under the Securities and
Exchange Commission Act No 36 of 1987
Companies listed in a Stock Exchange licensed under the Securities and
Exchange Commission Act No 36 of 1987
Public corporation engaged in the sale of goods or the provision of services.
1.3 Group companies

The SLFRS for SMEs states that a subsidiary whose parent company uses full
SLFRS may use the SLFRS for SMEs in its own financial statements provided that
the subsidiary itself does not have public accountability.
QUESTION
An entity can only use the SLFRS for SMEs if it does not have public accountability.
Explain which entities do not have public accountability.
ANSWER
An entity has public accountability if:
CA Sri Lanka
(a)
Its debt or equity instruments are traded in a public market or it is in the

process of issuing such instruments for trading in a public market, or
(b)
It holds assets in a fiduciary capacity for a broad group of outsiders as one of

its primary businesses. This is typically the case for banks, credit unions,
insurance companies, securities brokers/dealers, mutual funds and
investment banks. This is not the case for travel or real estate agents,
schools, sellers that receive payment in advance of delivery of goods and so
on. These entities hold the assets of outsiders for reasons incidental to their
primary business.
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2 Content of the SLFRS for SMEs

The SLFRS for SMEs is a standalone SLFRS that simplifies the recognition and
measurement requirements of full SLFRS and reduces the disclosure
requirements.
2.1 Introduction
The SLFRS for SMEs is a single document of 230 pages that is designed to address
the accounting concerns of smaller, private entities whilst taking into account
cost-benefit considerations.
The SLFRS for SMEs is a standalone standard with a single exception: Entities may
choose to apply LKAS 39 rather than the financial instruments section of the
SLFRS for SMEs. Other than this, entities are not allowed to mix and match the
requirements of the SLFRS for SMEs with those of full SLFRS.
2.2 Contents
The SLFRS for SMEs has 35 chapters, which cover individual topics that may be
relevant to entities without public accountability. They are:
1
Small and medium sized entities
19 Business combinations and

goodwill
Concepts and pervasive principles
20 Leases
Financial statement presentation
21 Provisions and contingencies
22 Liabilities and equity
Statement of comprehensive
income and income statement
23 Revenue
Statement of changes in equity and

statement of income and retained
earnings
24 Government grants
25 Borrowing costs
Notes to the financial statements
26 Share-based payment
Consolidated and separate financial

statements
27 Impairment of assets
10 Accounting policies, estimates and

errors
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28 Employee benefits
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11 Basic financial instruments
29 Income tax
12 Other financial instruments issues
30 Foreign currency translation
13 Inventories
31 Hyperinflation
14 Investments in associates
32 Events after the end of the

reporting period
15 Investments in joint ventures
33 Related party disclosures
16 Investment property
34 Specialised activities
17 Property, plant and equipment
35 Transition to the SLFRS for SMEs
18 Intangible assets other than

goodwill
As you can see, most of the chapters can be related back to an individual full
SLFRS. In some cases the accounting treatment prescribed is the same as full
SLFRS and in other cases it is simplified. These similarities and differences are
discussed in more detail in section 3 of this chapter.
2.3 Concepts and pervasive principles

Chapter 2 of the SLFRS for SMEs deals with concepts and pervasive principles; this
chapter is the SME equivalent of the Conceptual Framework. In line with the
Conceptual Framework it:
States the objective of financial statements, being to provide information
about financial position, performance and cash flows that is useful for decision
making to a wide range of users.
States the qualitative characteristics of financial information. They are
understandability, relevance, materiality, reliability, substance over form,
completeness, comparability and timeliness.
Identifies the elements of financial statements as assets, liabilities, equity,
income and expenses.
Clarifies the recognition criteria for these elements, being:
Future economic benefit will probably flow to / from the entity.
The element is capable of reliable measurement.
Clarifies that elements are initially measured at cost (unless alternative
measurement is required by the SLFRS for SMEs), and that they are
subsequently measured at amortised cost with certain exceptions.
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2.4 Accounting policies

Where the SLFRS for SMEs does not provide specific guidance, it provides a
hierarchy for determining a suitable accounting policy. An SME must consider, in
descending order:
The guidance in the SLFRS for SMEs on similar and related issues.
The definitions, recognition criteria and measurement concepts in Section 2
Concepts and Pervasive Principles of the standard.
The entity also has the option of considering the requirements and guidance in full
SLFRS dealing with similar topics. However, it is under no obligation to do this, or
to consider the pronouncements of other standard setters.
2.5 Cost-benefit considerations

Several sections of the SLFRS for SMEs contain exemptions from certain
requirements on the basis of undue cost or effort or because they are
impracticable.
The SLFRS states that applying a requirement is impracticable when an entity
cannot apply it after making every reasonable effort to do so.
Undue cost or effort is not defined as it depends on an individual entitys specific
circumstances and managements professional judgement in assessing costs and
benefits.
An assessment of costs and benefits should include consideration of how the
economic decisions of the users of the financial statements could be affected by
the availability of the information. Undue cost or effort would arise if either cost or
endeavours by employees would exceed benefits that users of SME financial
statements would receive from having the information.
3 Comparison with full SLFRS

The SLFRS for SMEs mirrors the requirements of full SLFRS in some cases,
however in most cases it simplifies recognition, measurement and disclosure
requirements of full SLFRS.
3.1 Overview
In comparison to full SLFRS, the SLFRS for SMEs:
Contains equivalent guidance on certain topics
Omits certain topics because they are not relevant to typical SMEs
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Removes certain accounting treatments available in full SLFRS because a

simpler method is applied instead
Simplifies many of the recognition and measurement requirements of full
SLFRS.
Simplifies presentation requirements of full SLFRS
Reduces the number of required disclosures
In addition the SLFRS for SMEs is written in user-friendly language and simplifies
explanations.
3.2 Comparison
The following table explains the SLFRS for SME requirements that differ from
those within full SLFRS.
SLFRS for SMEs as compared to full SLFRS
Financial
statement
presentation
No requirement to present a third SOFP when there is a

retrospective adjustment.
Financial
instruments
Under the SLFRS for SMEs, financial instruments are basic or

complex.
A single statement of income and retained earnings may be

presented in the place of a statement of comprehensive
income and statement of changes in equity if the only changes
to equity are from profit or loss, dividends, corrections of
errors and changes in accounting policy.
Most basic financial instruments are measured at

amortised cost
Most complex financial instruments are measured at fair
value through profit or loss.
There is no quantitative hedge effectiveness test under the
SLFRS for SMEs.
Hedge accounting is only allowed for a limited number of
risks and hedging instruments.
Investments
in associates
Investments
in joint
ventures
The SLFRS for SMEs allows an associate or jointly controlled

entity (joint venture) to be accounted for in the consolidated
financial statements using any of:
1. The cost model
2. The fair value through profit or loss model
3. The equity method.
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Investment
property
Investment property must be measured at fair value if fair

value can be reliably measured. Otherwise historical cost is
used.
Property,
plant and
equipment
The revaluation model is not available under the SLFRS for

SMEs.
Intangible
assets other
than goodwill
R&D costs must be expensed under the SLFRS for SMEs
There is no need to review estimates such as residual value

unless there is indication of a change since last reporting
date.
The revaluation model is not available

Impairment tests are performed only if there are indications
of impairment.
All intangible assets are assumed to have finite lives and are
amortised.
Business
combinations
and goodwill
Under the SLFRS for SMEs transaction costs form part of the
cost of an acquisition.
Contingent consideration is included as part of the cost of the
acquisition if it is probable of payment and the fair value can
be measured reliably.
Goodwill is assumed to have a finite life (presumed 10 years)
and is amortised.
Goodwill is tested for impairment only if there is an indicator
of impairment.
Government
grants
No guidance is provided in the SLFRS for SMEs on nonmonetary government grants, government assistance or the
repayment of government grants.
Borrowing
costs
Must be expensed under the SLFRS for SMEs.
Employee
benefits
A simplified calculation of the plan obligation is allowed

under the SLFRS for SMEs if the projected unit credit method
requires undue cost or effort.
Past service costs are recognised in full in profit or loss in the
period in which they occur.
Under the SLFRS for SMEs there is no distinction between
expected and actual return on plan assets; all are recorded in
profit or loss.
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Income tax
There is no exception in the SLFRS for SMEs to recognising

deferred tax on the initial recognition of an asset or liability
in a transaction that is not a business combination and affects
neither accounting nor taxable profit.
All deferred tax assets and liabilities are classified as noncurrent.
Foreign
currency
translation
Exchange differences recognised initially in other

comprehensive income are not reclassified to profit or loss on
disposal of a subsidiary.
Specialised
activities
For biological assets the cost model is used unless the fair
value is readily determinable without undue cost and effort.
3.3 Equivalent guidance

Guidance in the SLFRS for SMEs is identical to guidance in full SLFRS in respect of:
provisions and contingencies
hyperinflation
events after the reporting period.
3.4 Omitted topics

The SLFRS for SMEs does not address the following topics that are covered in full
SLFRS because they are generally not relevant to SMEs:
Earnings per share

Segment reporting
Classification for non-current assets (or disposal groups) as held for sale.
Note that although the SLFRS for SMEs has no guidance on assets held for sale, a
plan to dispose of an asset is identified as an indicator of impairment by the
standard.
3.5 Reduced disclosure

The disclosure requirements of the SLFRS for SMEs are substantially reduced
compared to those in full SLFRS. There are approximately 300 points rather than
the 3,000 in full SLFRS. Certain disclosures have been omitted for two main
reasons:
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709
They relate to topics or accounting policy options in full SLFRS that are omitted
or simplified in the SLFRS for SMEs, or
They are not considered appropriate based on users needs and cost-benefit
considerations. In particular some disclosures in full SLFRS are more relevant
to investment decisions in public capital markets than the transactions and
other events and conditions encountered by a typical SME.
4 SLFRS 1 First-time Adoption of SLFRS

SLFRS 1 provides guidance to entities applying SLFRS for the first time.
The adoption of a new body of accounting standards will inevitably have a

significant effect on the accounting treatments used by an entity and on the
related systems and procedures.
SLFRS 1 First-time adoption of SLFRS was issued to ensure that an entity's first
SLFRS financial statements contain high quality information that:
(a)
(b)
(c)
Is transparent for users and comparable over all periods presented

Provides a suitable starting point for accounting under SLFRS
Can be generated at a cost that does not exceed the benefits to users
4.1 General principles

An entity applies SLFRS 1 in its first SLFRS financial statements.
An entity's first SLFRS financial statements are the first annual financial
statements in which the entity adopts SLFRS by an explicit and unreserved
statement of compliance with SLFRS.
Any other financial statements (including fully compliant financial statements that
did not state so) are not the first set of financial statements under SLFRS.
4.2 Opening SLFRS statement of financial position

An entity prepares and presents an opening SLFRS statement of financial
position at the date of transition to SLFRS as a starting point for SLFRS
accounting.
Generally, this will be the beginning of the earliest comparative period shown
(ie full retrospective application). Given that the entity is applying a change in
accounting policy on adoption of SLFRS, LKAS 1 Presentation of Financial
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CA Sri Lanka
Statements requires the presentation of at least three statements of financial

position (and two of each of the other statements).
Illustration: Opening SLFRS SOFP
Comparative year
1.1.20X8
1st year of adoption
31.12.20X8
31.12.20X9
Transition
date
Preparation of an opening SLFRS statement of financial position typically involves
adjusting the amounts reported at the same date under previous GAAP.
All adjustments are recognised directly in retained earnings (or, if appropriate,
another category of equity) not in profit or loss.
4.2.1 Estimates
Estimates in the opening SLFRS statement of financial position must be consistent
with estimates made at the same date under previous GAAP even if further
information is now available (in order to comply with LKAS 10).
4.2.2 Transition process
(a)
Accounting policies
The entity should select accounting policies that comply with SLFRSs
effective at the end of the first SLFRS reporting period.
These accounting policies are used in the opening SLFRS statement of
financial position and throughout all periods presented. The entity does not
apply different versions of SLFRS effective at earlier dates.
(b)
Derecognition of assets and liabilities

Previous GAAP statement of financial position may contain items that do not
qualify for recognition under SLFRS.
For example, SLFRS does not permit capitalisation of research, staff training
and relocation costs.
(c)
Recognition of new assets and liabilities

New assets and liabilities may need to be recognised.
For example, deferred tax balances and certain provisions such as
environmental and decommissioning costs.
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711
(d)
Reclassification of assets and liabilities

For example, compound financial instruments need to be split into their
liability and equity components.
(e)
Measurement
Value at which asset or liability is measured may differ under SLFRS.
For example, discounting of deferred tax assets/liabilities is not allowed
under SLFRS.
4.2.3 Main exemptions from applying SLFRS in the opening SLFRS statement
of financial position
(a)
Property, plant and equipment, investment properties and intangible

assets
(i)
(b)
Fair value/previous GAAP revaluation may be used as a substitute for

cost at date of transition to SLFRS.
Business combinations
For business combinations prior to the date of transition to SLFRS:
(i)
The same classification (acquisition or uniting of interests) is retained

as under previous GAAP.
(ii)
For items requiring a cost measure for SLFRS, the carrying value at the
date of the business combination is treated as deemed cost and
SLFRS rules are applied from thereon.
(iii) Items requiring a fair value measure for SLFRS are revalued at the date
of transition to SLFRS.
(iv) The carrying value of goodwill at the date of transition to SLFRS is the
amount as reported under previous GAAP.
(c)
Employee benefits
Unrecognised actuarial gains and losses can be deemed zero at the date of
transition to SLFRS. LKAS 19 is applied from then on.
(d)
Cumulative translation differences on foreign operations

Translation differences (which must be disclosed in a separate translation
reserve under SLFRS) may be deemed zero at the date of transition to SLFRS.
LKAS 21 is applied from then on.
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(e)
Adoption of SLFRS by subsidiaries, associates and joint ventures

If a subsidiary, associate or joint venture adopts SLFRS later than its parent,
it measures its assets and liabilities:
Either: At the amount that would be included in the parents financial
statements, based on the parents date of transition
Or:
At the amount based on the subsidiary (associate or joint venture)s

date of transition.
4.2.4 Disclosure
(a)
A reconciliation of previous GAAP equity to SLFRS is required at the date

of transition to SLFRS and for the most recent financial statements presented
under previous GAAP.
(b)
A reconciliation of profit for the most recent financial statements

presented under previous GAAP.
4.3 Practical issues

The implementation of the change to SLFRS is likely to entail careful management
in most companies. Here are some of the change management considerations
that should be addressed.
CA Sri Lanka
(a)
Accurate assessment of the task involved. Underestimation or wishful

thinking may hamper the effectiveness of the conversion and may ultimately
prove inefficient.
(b)
Proper planning. This should take place at the overall project level, but a
detailed task analysis could be drawn up to control work performed.
(c)
Human resource management. The project must be properly structured

and staffed.
(d)
Training. Where there are skills gaps, remedial training should be

provided.
(e)
Monitoring and accountability. A relaxed 'it will be alright on the night'

attitude could spell danger. Implementation progress should be monitored
and regular meetings set up so that participants can personally account
for what they are doing as well as flag up any problems as early as
possible. Project drift should be avoided.
(f)
Achieving milestones. Successful completion of key steps and tasks should

be appropriately acknowledged, ie what managers call 'celebrating success',
so as to sustain motivation and performance.
713
(g)
Physical resourcing. The need for IT equipment and office space should
be properly assessed.
(h)
Process review. Care should be taken not to perceive the change as a oneoff quick fix. Any change in future systems and processes should be
assessed and properly implemented.
(i)
Follow-up procedures. As with general good management practice, the

follow up procedures should be planned in to make sure that the changes
stick and that any further changes are identified and addressed.
4.3.1 Financial reporting infrastructure

As well as sound management judgement, implementation of SLFRS requires a
sound financial reporting infrastructure. Key aspects of this include the following:
(a)
A robust regulatory framework. For SLFRS to be successful, they must be

rigorously enforced.
(b)
Trained and qualified staff. Many preparers of financial statements will

have been trained in local GAAP and not be familiar with the principles
underlying SLFRS, let alone the detail.
(c)
Availability and transparency of market information. This is particularly

important in the determination of fair values, which are such a key
component of many SLFRSs.
(d)
High standards of corporate governance and audit. This is all the more
important in the transition period, especially where there is resistance to
change.
Overall, there are significant advantages to the widespread adoption of SLFRS, but
if the transition is to go well, there must be a realistic assessment of potential
challenges.
4.4 Other implementation challenges

4.4.1 More detailed rules
Implementation of SLFRS entails a great deal of work for many companies,
particularly those where local GAAP has not been so onerous. For example, many
jurisdictions will not have had such detailed rules about recognition,
measurement and presentation of financial instruments, and many will have had
no rules at all about share-based payment.
A challenge for preparers of financial statements is also a challenge for users.
When financial statements become far more complex under SLFRS than they were
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under local GAAP, users may find them hard to understand, and consequently of
little relevance.
4.4.2 Presentation
Many developed countries have legislation requiring set formats and layouts for
financial statements. SLFRS demands that presentation is in accordance with LKAS
1 Presentation of financial statements, but this standard allows alternative forms of
presentation. In choosing between alternatives, companies tend to adopt the
format that is closest to preview GAAP, even if this is not necessarily the best
format.
4.4.3 Concepts and interpretation
Although later LKAS and SLFRS are based to an extent on the Conceptual
Framework, there is no consistent set of principles underlying them. The
Conceptual Framework itself is being revised, and there is controversy over the
direction the revision should take. Consequently, preparers of accounts are likely
to think in terms of the conceptual frameworks if any that they have used in
developing local GAAP.
Where SLFRS themselves give clear guidance, this may not matter, but where
there is uncertainty, preparers of accounts will fall back on their traditional
conceptual thinking.
4.4.4 Choice of accounting treatment
Although many so-called 'allowed alternatives' have been eliminated from SLFRS
in recent years, choice of treatment remains. For example, LKAS 16 Property, plant
and equipment gives a choice of either the cost model or the revaluation model for
a class of property, plant or equipment.
It could be argued that choice is a good thing, as companies should be able to
select the treatment that most fairly reflects the underlying reality. However, in
the context of change to SLFRS, there is a danger that companies will choose the
alternative that closely matches the approach followed under local GAAP, or
the one that is easier to implement, regardless of whether this is the best
choice.
4.4.5 Inconsistency in recognition or measurement methods
As well as the broader choice of which accounting model to adopt (cost or
revaluation, and so on), SLFRS allows further choice on recognition and
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measurement within a particular reporting standard. In companies where

previous GAAP was not very developed on this matter, preparers of accounts
might well choose the least complex option, or the option that does not involve
making a decision, rather than the correct one.
4.4.6 Timing and exemptions taken
SLFRSs have provision for early adoption, and this can affect comparability,
although impact of a new standard must be disclosed under LKAS 8 Accounting
policies, changes in accounting estimates and errors. Further, SLFRS 1 First time
adoption of SLFRS permits a number of exemptions during the periods of
transition to SLFRS. This gives scope for manipulation, if exemptions are 'cherrypicked' to produce a favourable picture.
4.4.7 Subjectivity
The extent of the impact will vary, depending on how developed local GAAP was
before the transition. However, in general it is likely that management
judgement will have a greater impact on financial statements prepared under
SLFRS than under local GAAP. The main reasons for this are as follows:
(a)
The volume of rules and number of areas addressed by SLFRS is likely to be

greater than that under local GAAP
(b)
Many issues are perhaps addressed for the first time, for example sharebased payment
(c)
SLFRSs are likely to be more complex than local standards
(d)
SLFRSs allow choice in many cases, which leads to subjectivity
(e)
Selection of valuation method (see above)
5 SLFRS 14 Regulatory Deferral Accounts

SLFRS 14 provides guidance to first-time adopters that operate rate-regulated
activities.
5.1 Definitions
Rate-regulated activities are an entitys activities that are subject to rate
regulation.
Rate regulation is a framework for establishing the prices that can be charged to
customers for goods or services and that framework is subject to oversight and/or
approval by a rate regulator.
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CA Sri Lanka
A rate regulator is an authorised body that is empowered by statute or regulation

to establish the rate or range of rates that bind an entity. The rate regulator may
be a third-party body or a related party of the entity, including the entitys own
governing board, if that body is required by statute or regulation to set rates both
in the interest of the customers and to ensure the overall financial viability of the
entity.
Rate regulation is therefore a restriction in the setting of prices that can be
charged to customers for services or products. It is usually imposed by a
government or regulatory bodies when an entity has a monopoly or dominant
market position that gives it excessive market power.
As a result of being subject to rate-regulation, and entity is likely to recognise
regulatory deferral account balances.
A regulatory deferral account balance is defined as the balance of any expense
(or income) account that would not be recognised as an asset or a liability in
accordance with other Standards, but that qualifies for deferral because it is
included, or expected to be included, by the rate regulator in establishing the
rate(s) that can be charged to customers.
Regulatory deferral balances usually represent timing differences between the
recognition of items of income or expenses for regulatory purposes and the
recognition of those items for reporting purposes. They might include:
Volume or price variations
Non-directly attributable overheads that are treated as capital costs for rateregulation purposes but are not permitted by LKAS 16 to be recognised as PPE
Project cancellation costs
5.1.1 Example: regulatory deferral balance

AsiaGas Co Ltd provides gas to several Asian countries. Its activities are rate
regulated and it recognises the under / over recovery of costs as a regulatory
deferral balance in accordance with local GAAP. These balances are amortised
over a period of 3 years:
Rs Mn
Amount charged to customers based
on regulated rates
Part of rate that recovers
deficit/surplus of previous years
(117/3 years)
(45/3 years)
CA Sri Lanka
20X0
20X1
20X2
917
1,124
1,079
(39)
(39)
15
717
Rs Mn
Net amount charged to customers
in respect of current year
Actual supply costs of current year
Net amount of (under)/over
recovery of costs for the year
20X0
20X1
20X2
917
1,034
1,085
1,040
1,055
980
45
75
(117)
Therefore the carrying amount of the regulatory deferral balance is:

20X0
20X1
20X2
Rs Mn
(117)
(33)
B/f
39
39
Amortisation of 20X0 under-recovery
(15)
Amortisation of 20X1 over-recovery
(117)
75
45
(under)/over-recovery arising in the
year
(117)
(33)
66
C/f
5.2 Accounting guidance

Until 2014, IFRS (and so SLFRS) did not address the issue of accounting for rateregulated activities.
IFRS (SLFRS) 14 was therefore issued in 2014 as an interim measure, applicable to
first-time adopters of IFRS (SLFRS). It allows first-time adopters to continue to
apply the requirements of previous GAAP in respect of rate regulation until such
time as the IASB completes its comprehensive rate regulation project.
5.2.1 Scope of SLFRS 14
SLFRS 14 is permitted (but not required) to be applied by entities that:
Are first-time adopters of SLFRS, and
Conduct rate-regulated activities, and
Recognise amounts that qualify as regulatory deferral account balances in their
financial statements in accordance with their previous GAAP.
Where an entity applies the requirements of SLFRS 14 to its first SLFRS financial
statements, it must continue to apply it in subsequent years.
5.2.2 Accounting for regulatory deferral account balances
Ordinarily where no SLFRS is relevant a balance in the financial statements, LKAS
8 requires that an entity determines its accounting policies after considering the
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CA Sri Lanka
requirements of SLFRS in dealing with similar matters and the Conceptual

Framework.
In respect of regulatory deferral balances, SLFRS 14 removes this requirement and
as a result, entities may continue to account for regulatory deferral balances in
accordance with their previous GAAP.
Entities may change their accounting policies for regulatory deferral account
balances in accordance with LKAS 8, however only where this makes the financial
statements more relevant and no less reliable or more reliable and no less
relevant.
An entity may not change its accounting policy on adoption of SLFRS to start to
recognise regulatory deferral balances.
5.2.3 Presentation of regulatory deferral balances
Regardless of the presentation requirements of an entitys previous GAAP, SLFRS
14 requires that:
(a) separate line items are presented in the statement of financial position for the
total of all regulatory deferral account debit balances and all regulatory
deferral account credit balances.
(b) Regulatory deferral account balances are not classified between current and
non-current, but are separately disclosed using subtotals
(c) The net movement in regulatory deferral account balances are separately
presented in the statement of profit or loss and other comprehensive income
using subtotals.
5.2.4 Disclosure
Disclosures are required that allow users to assess:
(a) the nature of, and risks associated with, the rate regulation that establishes
the prices the entity can charge customers for the goods or services it
provides.
(b) The effects of rate regulation on the entitys financial position, performance
and cash flows.
5.3 Interaction with other standards

Other than where SlFRS 14 provides specific guidance, other standards are
applicable to regulatory deferral balances in the same way that they apply to other
assets, liabilities, income and expenses.
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719
Specific guidance is provided by SLFRS 14 as follows:

LKAS 10 Events after the
Reporting Period
LKAS 10 is applied when determining which

amounts after the end of the reporting period are
taken into account in the recognition and
measurement of regulatory deferral account
balances.
LKAS 12 Income Taxes
Deferred tax in relation to regulatory deferral

balances must be presented separately from other
deferred tax assets/liabilities/income/expense.
LKAS 33 Earnings per

Share
An additional basic and diluted EPS that excludes

the effects of the regulatory deferral balances is
presented.
LKAS 36 Impairment of
Assets
Regulatory deferral balances are included in the

carrying amount of a CGU and treated in the same
way as other assets where an impairment loss
arises.
SLFRS 3 Business
Combinations
The investors accounting policy for regulatory

deferral balances is used when applying the
acquisition method; this may result in the
recognition of balances that were not recognised by
the acquiree.
SLFRS 5 Non-current
Assets Held for Sale and
Discontinued Operations
SLFRS 5 measurement requirements do not apply to

regulatory deferral account balances.
SLFRS 10 Consolidated
Financial Statements
The entitys accounting policy in respect of

regulatory deferral balances must be applied in the
consolidated financial statements.
LKAS 28 Investments in
Associates and Joint
Ventures
720
CA Sri Lanka
QUESTION
The SLFRS for SMEs is designed to address the accounting concerns of smaller,
private entities whilst taking into account cost-benefit considerations.
Required
Explain why CA Sri Lanka allows small private entities to apply the SLFRS for
SMEs rather than requiring them to apply full SLFRS.
ANSWER
There are several reasons why the SLFRS for SMEs was introduced rather than
requiring smaller, private entities to apply full SLFRS. These include the
following:
Full SLFRS are designed to meet the needs of large, listed companies. They
cover matters such as complex financial instruments and share-based
payments that are not relevant to smaller, private entities.
If a company adopts full SLFRS, it is required to comply with all of the
requirements of the accounting standards. This compliance places a heavy
reporting burden on smaller entities, and as stated, many of the specific
requirements of standards, and in cases full standards are not relevant to these
entities.
SMEs can be viewed as specialised entities and information that is relevant and
useful to their particular users should be reported in their financial statements.
The main users of the financial statements of companies reporting under full
SLFRS are capital markets, whereas the main users of SME financial statements
are tax authorities, lenders and the owner-managers. In many cases these
parties have limited accounting knowledge and therefore simplified recognition
and measurement criteria are more appropriate.
For many smaller companies the cost of complying with SLFRS would exceed
the benefits received.
QUESTION
You are the financial controller of Ceylon Property (Pvt) Ltd, which owns a
number of properties that its leases out to small businesses. The company
operates it head office from the top floor of one of these properties. The company
is also involved in the continued development of properties to lease out, generally
CA Sri Lanka
721
funded through bank loans. The company applies the SLFRS for SMEs. You have
recently appointed a new assistant who has no knowledge of the SLFRS for SMEs,
having previously been employed at a company that applied full SLFRS.
Required
Explain to your assistant the main differences between the SLFRS for SMEs and
full SLFRS that are relevant to property owned by Ceylon Property (Pvt) Ltd.
ANSWER
Ceylon Property (Pvt) Ltd is an investment property company and therefore the
accounting treatment applied to investment property should be considered.
The SLFRS for SMEs requires that all investment property is recognised initially at
cost and then measured at fair value, if this can be reliably measured without
undue cost or effort. The choice available in full SLFRS to apply either the fair
value or cost model is therefore removed. Under the SLFRS for SMEs the cost
model is applied only if the fair value of investment property cannot be
determined without undue cost or effort.
As regards the property with mixed use (part investment property and part
owner-occupied property), the SLFRS for SMEs requires that the property is
separated for accounting purposes. The floor occupied by Ceylon Property is
therefore accounted for as PPE and those lower floors rented out are accounted
for as investment property. The exception to this rule is where the fair value of the
investment property component cannot be measured reliably without undue cost
or effort. In this case the whole property is accounted for as PPE. This treatment
differs slightly from LKAS 40, which requires that the owner-occupied and
investment components are accounted for separately if they could be sold or
rented separately. Where this is not the case, the entire property is investment
property if the part that is owner occupied is insignificant. Otherwise the entire
property is owner-occupied property.
Where investment property is constructed using loan finance, borrowing costs
arise. Under LKAS 23 eligible borrowing costs on qualifying assets (including
investment property) must be capitalised. The SLFRS for SMEs applies a different
treatment and requires all borrowing costs to be expensed as they arise.
As discussed above, the head office (and possibly the whole property within which
it is found) is classified as PPE. LKAS 16 requires that this is initially measured at
cost and subsequently measured using either the revaluation or the cost model.
The SLFRS for SMEs differs in its treatment of PPE: it requires that all PPE is
measured using the cost model ie held at cost less accumulated depreciation less
accumulated impairment losses. In addition the SLFRS for SMEs takes a more
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CA Sri Lanka
relaxed approach to the review of estimates; where LKAS 16 requires that residual
value, useful life and depreciation method are reviewed at each reporting date, the
SLFRS for SMEs requires that such a review is only performed where there are
indicators that these have changed since the last reporting date.
CA Sri Lanka
723
CHAPTER ROUNDUP
724
SMEs are defined by reference to the fact that they are entities that do not have
public accountability. Specified Business Entities are not eligible to use the
SLFRS for SMEs.
The SLFRS for SMEs is a standalone SLFRS that simplifies the recognition and
measurement requirements of full SLFRS and reduces the disclosure
requirements.
The SLFRS for SMEs mirrors the requirements of full SLFRS in some cases,
however in most cases it simplifies recognition, measurement and disclosure
requirements of full SLFRS.
SLFRS 1 provides guidance to entities applying SLFRS for the first time.
SLFRS 14 provides guidance to first-time adopters that operate rate-regulated

activities.
CA Sri Lanka
PROGRESS TEST
In what areas do the requirements of the SLFRS for SMEs reflect exactly those of
full SLFRS?
How do the requirements of the SLFRS for SMEs differ from full SLFRS in respect
of borrowing costs?
Name 4 of the qualitative characteristics of financial information within the SLFRS

for SMEs.
Where an entity adopts the SLFRS for SMEs, which single full LKAS/SLFRS may it
use instead of the relevant chapter of the SLFRS for SMEs?
What accounting topics are not covered in the SLFRS for SMEs?
How is PPE measured on first time adoption of SLFRS?
CA Sri Lanka
725
726
Provisions and contingencies, hyperinflation and events after the reporting

period.
The SLFRS for SMEs requires them to be expensed; full SLFRS require
capitalisation of eligible borrowing costs relating to a qualifying asset.
Any 4 of: understandability, relevance, materiality, reliability, substance over

form, completeness, comparability and timeliness.
LKAS 39
Fair value/previous GAAP revaluation may be used as a substitute for cost at date
of transition to SLFRS.
Earnings per share

Segment reporting
Classification for non-current assets (or disposal groups) as held for sale.
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises analysis techniques that will be familiar to you from
your KB1 Study Text. At KC1 level you are expected to be able to link
financial information including ratios in order to understand and
appraise an entitys financial position and performance.
Knowledge Component
3
Analysis, Interpretations and Communication of Financial Results
3.1
Internal financial
statement analysis
3.1.1
Evaluate the reasonableness of financial statements relative to the

actual financial status of an entity.
3.2
External financial
statements analysis
common size analysis
trend analysis
3.2.1
3.2.2
Evaluate external financial statements

Criticise external financial statements on the basis of relevant and
rational conclusions drawn from the financial statements analysis.
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KC1 | Chapter 22: Financial statement analysis
CHAPTER CONTENTS
1 Introduction and analysis techniques
2 Common-size analysis
3 Ratio analysis
4 Other matters
1 Introduction and analysis techniques

Financial analysis involves appraising and communicating the position,
performance and prospects of a business based on given and prepared statements
and ratios. Vertical, horizontal, common size and ratio analysis are all
common techniques used in financial analysis.
1.1 Analysis techniques

Analysis of financial statements should always begin with trend analysis in which
the data provided in financial statements is compared with similar data. More in
depth analysis may then be performed through common size and ratio analysis.
Vertical trend analysis involves comparing the financial statements of one
company from one year to the next. It is most useful where more than two
years financial statements are available in order that true trends can be
identified and conclusions are not skewed by unusual transactions.
Horizontal trend analysis involves comparing the financial statements of one
company with those of an equivalent company in the same period or industry
averages in the same period. No two companies are identical in size or type of
operations and therefore this type of analysis is not conclusive.
Common size analysis requires the adoption of a common base figure in the
financial statements (often revenue). All other items are then expressed as a
percentage of this base figure. The percentages should be compared to the
same percentages of previous years or other similar companies.
Ratio analysis involves manipulating amounts in the financial statements to
produce a ratio, which is then compared with the same ratio for previous years,
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CA Sri Lanka
another company or industry averages. Ratios are discussed in more detail in

the next section.
1.2 Comparatives
It must be remembered that financial analysis requires comparison. Raw data or
data manipulated into a ratio is useless without the same data or ratio for a
previous period or another company to compare it to.
1.3 Linkages
It is important when performing financial analysis to link parts of the financial
statements together. For example if you see an increase in loans outstanding in
the statement of financial position you would reasonably expect to see an increase
in finance costs in the statement of profit or loss. It is also, however, important to
understand why an expected link may not be evident. In this case finance costs
may not have increased and this could be explained by the fact that the additional
loan finance was secured at the period end and hence no finance costs had
accrued by the reporting date. Equally it is important to read and understand any
background information that could help your understanding. In this case
background information may explain that the entity that you are appraising has
recently been subject to an acquisition and is now part of a group. You may
therefore suggest that finance costs have not increased alongside an increase in
loans outstanding because the financing is an intercompany interest-free loan.
QUESTION
Linking information
You are about to review the financial statements of a company that manufactures
and sells fruit juices to supermarkets. All sales are on credit. You have been
advised that sales volumes have increased by 20% in the last year, so meaning
that idle capacity in the manufacturing process is greatly reduced.
CA Sri Lanka
(a)
What effect would you expect this information to have on balances in the
financial statements?
(b)
What reasons might explain why balances have not moved as you would
anticipate when compared to the previous year?
729
ANSWER
Balance
(a) Expected
movement
(b) Explanation for different

movement
Revenue
Increase by 20%
Revenue may increase but not by 20% as

prices may have been reduced to achieve
volume increase.
Cost of
sales
Increase
proportionately to
revenue (20%)
Cost of sales will increase by less than

20% if:
Increased level of purchases has

resulted in economies of scale.
New (cheaper) suppliers have been

secured.
The general cost of fruit and other

inputs has decreased.
Machinery is fully depreciated (and

depreciation was previously
charged to cost of sales).
Cost of sales will increase by more than

20% if:
Expenses
Increase
The general price of inputs has

increased.
Better quality/ new different fruit

has been procured.
Not all expenses increase in line with

volume; salaries for example may
increase on an inflationary basis only.
Cost cutting and rationalisation
programmes may cut costs.
Noncurrent
assets
730
No change other than

depreciation (as
increased volume uses
existing capacity)
Old PPE may have been replaced so

increasing the non-current assets
balance.
Non-production assets (eg cars) may
have been bought or sold.
CA Sri Lanka
Inventory
Increase
Inventory will decrease if:
Stock holding procedures have been

tightened to reduce wastage.
Inventory may increase in excess of an

expected rise if:
Trade
receivables
Increase
proportionately to
revenue (20%)
New customers require just in time

delivery.
Year end stock levels are high ahead

of a sales order.
Trade receivables will increase by less

than 20% if:
The credit control function has

tightened procedures.
Bad debts have been written off.
Prompt payment discounts are

made available and used.
Trade receivables will increase by more

than 20% if:
Trade
payables
Increase
proportionately to
revenue (20%)
Increased sales volume has been

achieved by offering extended term
as incentive.
The balance includes bad debts.
The credit control function is not

performing adequately.
Trade payables will increase by less than

20% if:
The company takes advantage of

supplier prompt payment discounts
Trade payables will increase by more

than 20% if:
CA Sri Lanka
Better supplier terms are negotiated
The company delays payment

(where it previously paid early)
731
1.4 Other information in the financial statements

When analysing financial statements it is important to review all information
provided, not only numerical information provided in the financial statements.
The following, for example, should be considered:
The content of any accompanying commentary on the accounts and other
statements.
Current and future developments in the company's markets, at home and
overseas, recent acquisitions or disposals of a subsidiary by the company.
Unusual items separately disclosed in the financial statements.
Any other noticeable features of the report and accounts, such as events after
the end of the reporting period, contingent liabilities, a qualified auditors'
report, the company's taxation position, and so on.
1.5 Considering the future

Most users of financial statements perform analysis because they want to know
not about the past performance of a company, but about its expected future
performance. For example investors analyse accounts to make a decision as to
whether they should sell their shares or acquire more shares. This decision hinges
on whether they expect the company to perform well in the future. Equally
lenders analyse accounts in order to make a lending decision; this decision is
dependent on whether the lender expects the company to have sufficient funds in
the future to meet repayment and interest obligations.
Therefore when analysing financial statements you should consider indications
for the future, for example:
If revenue has increased, consider whether this is a sustainable increase;
If costs are reduced, consider whether this is the result of a one-off item that
will not exist in future years;
Consider the impact of items such as contingent liabilities and operating lease
commitments on future profits and cash balances;
Consider whether PPE is likely to need replacing in the near future and where
funds for this may come from;
Consider the impact of capital expenditure on future ability to generate revenue
Consider when loan repayments are due and where funds for repayment may
come from.
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CA Sri Lanka
QUESTION
The following property, plant and equipment disclosure is taken from the financial
statements of a marketing company:
Cost
b/f
Additions
Disposals
C/f
Depreciation
b/f
Depreciation
charge
Disposals
c/f
Carrying
amount c/f
Carrying
amount b/f
Freehold
Buildings
Rs'000
5,600
5,600
Fixtures and
Fittings
Rs'000
780
780
IT equipment
5,600
624
52
163
145
40
70
5,600
676
104
(30)
278
302
110
100
156
487
80
Rs'000
650
(70)
580
Motor vehicles
Rs'000
120
90
210
What issues can you identify about the future of this company by the information
provided?
ANSWER
Buildings
The buildings are fully depreciated, which indicates that they are old. They may
require expenditure in terms of updating, repairs and maintenance.
The property has a carrying amount of nil however is likely to have a
substantial market value; it may be available as security for loan finance.
Fixtures and fittings
Fixtures and fittings have a carrying amount of Rs. 104,000 and are depreciated
at Rs. 52,000 per annum. Therefore they are close to the end of their useful life
and likely to need replacing. How will this be financed? Fixtures and fittings are
likely to be office furniture and so on expenditure could be delayed if
necessary.
CA Sri Lanka
733
IT Equipment
IT equipment is likely to be core to running a professional services
organisation. The useful life appears to be approximately 4 years which
appears appropriate.
Just over 10% of the equipment (based on cost) has been sold in the year and
has not been replaced. The asset sold was less than half way through its useful
life. These facts could indicate problems in the business a reduction in level of
business, a need for cash etc.
The disposal of IT equipment could however be linked to a change in focus of
the business; new replacement IT equipment may have been acquired by way
of operating lease.
Motor vehicles
The company operates in the area of professional services; it is therefore
unclear how motor vehicles will contribute to generating revenue. The vehicles
are likely to be cars provided to staff as benefits.
There has been heavy expenditure on vehicles in the year however this
expenditure is unlikely to provide the return that similar expenditure in other
parts of the business could have generated.
2 Common size analysis

Common size analysis involves calculating amounts in the financial statements
as a percentage of a base figure.
As with other types of analysis, common size analysis involves comparison
either of the same company in different periods or different companies in the
same period.
In this case, comparison is not of the raw numbers presented in the financial
statements.
Instead, a common base figure is adopted and amounts are expressed as a
percentage of this base number. These percentages are then compared. A common
base figure when analysing the statement of profit or loss is revenue.
This topic was addressed at KB 1 level, and the following example, taken from that
study text will remind you of how it can be useful.
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CA Sri Lanka
2.1 Example: Common size analysis

The following example shows the results of one company for two years:
2014
% of
2013
% of
Rs'000
revenue
Rs.
revenue
100,000
90,000
Revenue
(35,000)
35%
(30,000)
33%
Cost of sales
65,000
60,000
Gross profit
(20,000)
20%
(16,000)
18%
Distribution costs
(15,000)
15%
(21,000)
23%
30,000
23,000
Operating profit
(5,000)
5%
(3,000)
3%
Finance costs
25,000
20,000
Profit before tax
(5,000)
5.3%
(4,000)
4%
Tax
20,000
16,600
Retained profit
As the revenue in the company has increased, it follows that costs might increase.
Common size analysis helps to identify whether costs have increased
proportionately. Questions that might be asked as a result of performing this
analysis are as follows:
Why has cost of sales increased as a proportion of revenue? Have selling prices
reduced whilst cost per unit remains the same or have costs increased?
Why have distribution costs increased as a proportion of revenue? Have costs
such as petrol increased or are proportionately more items being distributed
(this would be the case if prices have decreased)?
There is a significant drop in the proportion of revenue spent on admin
expenses. Is there a one off item of income in 2014 or a one off expense in 2013
that has caused the change?
Finance costs as a proportion of revenue have increased; the company appears
to have borrowed money in the year. This has been employed in the business
and resulted in increased revenue.
2.2 Limitations of common size analysis

Common size statements obscure underlying changes in absolute amounts. For
example if revenue is used as a base figure, it will always represent 100% and
there is no indication whether the absolute revenue has increased or
decreased.
It is not appropriate to express some items as a percentage of revenue. For
example, dividends, which are dictated by dividend policy and are unrelated to
levels of revenue.
CA Sri Lanka
735
On a long-term basis, financial statements are affected by a number of external

factors such as tax legislation and price inflation meaning that common size
analysis and comparison is less meaningful.
3 Ratio analysis
The calculation of ratios can help with the analysis of financial statements; ratios
can be grouped as relevant to profitability, solvency, liquidity, efficiency and
investors interests.
This section concentrates on reminding you of the calculation of ratios and the
considerations when analysing specific ratios. You should refer to your KB1 Study
Text for a more comprehensive discussion of each ratio. At the end of the section
is a full question for you to attempt.
3.1 Profitability ratios

Return on
Capital
Employed
(ROCE)
Return on
Equity
Gross profit
margin
PBIT margin
736
PBIT
Capital employed *
PAT pref divi

Equity s /h funds
Gross profit
Revenue
PBIT
Revenue
Assesses how well capital employed

is used to generate profit eg 25%
ROCE means Rs. 25 profit for every
Rs. 100 capital employed.
Adversely affected by an upwards

revaluation.
Compare to other ROCEs or market

borrowing rates.
Assesses how well shareholders

funds are used to generate profit for
shareholders.
Adversely affected by upwards

revaluation.
Affected by:
Selling prices
Costs per unit
Product mix
Affected by gross profit margin.
Further affected by operating

expenses; look for one off items.
CA Sri Lanka
Net profit
margin
Retained profit for yr

Revenue
Affected by PBIT margin.
Further affected by interest costs

and tax.
Net asset
turnover
Revenue
Capital employed *
Turnover per Rs. 1 invested eg NA

turnover of 4 means Rs4 revenue
generated per Rs. 1 capital
employed.
* Capital employed is total assets less current liabilities (or shareholders equity
plus non-current liabilities).
Remember to look for linkages when analysing profitability, for example, gross
profit margin may have increased significantly, however this does not indicate a
good performance if it is the result of an increased selling price and volumes and
so revenue are reduced.
3.2 Solvency ratios

Debt ratio
Gearing
ratio
(leverage)
Interest
cover
Total debt
Total assets
Interest bearing debt

S /h equity + Debt
PBIT
Finance cost
How much debt exists in the

business in relation to assets.
50% provides a benchmark

however many businesses operate
at a higher debt ratio.
Shows debt funding as a proportion

of total funding.
Gearing varies by industry.
A highly geared company (>50%)

will have difficulty securing further
funds in the future.
Shows whether profits cover

interest payable.
Interest cover of 3 or above is

considered acceptable.
Companies with low interest cover

are sensitive to changes in costs.
3.3 Liquidity ratios

Liquidity ratios include the current and quick ratio. The best indicator of liquidity
is, however, the statement of cash flows.
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737
Current
ratio
Quick ratio
(Acid test
ratio)
Current assets
Current liabilities
Current assets inventory

Current liabilities
Shows whether current assets

are sufficient to meet future
commitments to pay off
current liabilities.
Consider the type of company;

service companies or those
that deal in cash only may have
a current ratio of less than 1
but do not have liquidity
problems.
Too high a ratio indicates

inefficient use of resources.
Removes the least liquid asset,

inventory, from the current
ratio.
Again, consider the type of

company being considered.
Also remember that both

liquidity ratios are based on
SOFP data and this is not
necessarily representative of
balances throughout the year.
3.4 Efficiency ratios

Accounts
receivable
collection
period
Trade receivables
365
Revenue
The average time to collect amounts

due from credit customers.
Reduced by high levels of cash sales.
Use average trade receivables if
known as year-end trade receivables
may be unusually high or low.
Should correspond to terms offered.
Decreased where prompt payment
incentives offered.
738
CA Sri Lanka
Accounts
payable
payment
period
Trade payables
365
Cost of sales
Average time taken to pay credit

suppliers.
Cost of sales is used as an
approximation for credit purchases.
Should correspond to terms given.
An increase above these terms may
indicate poor liquidity.
Inventory
turnover
period
Inventory
365
Cost of sales
Time on average that inventory is

held before it is sold.
Indicator of how vigorous trade is.
Affected by bulk buy discounts, lead
times, seasonality
3.4.1 Operating cycle

Efficiency ratios are used to calculate a companys operating cycle as:
Inventory
turnover days
Receivables
collection
period
Payables
payment
period.
The operating cycle indicates the levels of financing that a company requires as it
gives the average number of days that a company is out of pocket from the day on
which it paid its supplier until the day on which its customer pays the company.
Where a company has cash problems, it should aim to reduce its operating cycle
by:
Reducing the amount of time it holds inventory for;
Shortening terms offered to customers / collecting amounts owed on time; and
Negotiating increased terms with suppliers / using the full terms offered by
suppliers.
3.5 Investor ratios

Investor ratios include earnings per share; this is discussed in more detail in
chapter 15.
CA Sri Lanka
739
Dividend
cover
EPS
Dividend per equity share
Shows the proportion of profit

that can be distributed that will
be distributed.
A dividend cover of 2 times

indicates that a company has
paid 50% of its distributable
profits as dividends, and
retained 50% in the business.
P/E ratio
Share price
EPS
Indicates confidence in a
company.
Dividend
yield
Dividend for year

Share price (ex div)
The return a shareholder is

currently expecting on the
shares of a company.
3.6 Stakeholders
When performing financial analysis, the reasons for performing it and the
audience for which it is for should be considered. Where an exam places you in a
scenario, always consider what type of analysis and which ratios are relevant to
that scenario. Focus on the needs of the stated user and avoid calculating all
possible ratios if you do not think that they are relevant.
For example, when assessing possible investment opportunities for an individual
investor, efficiency ratios should not be calculated; these are of more interest to
management when assessing the operations of a company.
740
CA Sri Lanka
QUESTION
You are the chief accountant of Blue Mountain Ltd, a listed Sri Lankan company.
The managing director has provided you with the financial statements of Blue
Mountain Ltds main competitor, Garten GmbH, a German company. He finds
difficulty in reviewing these statements in an unfamiliar format, presented below.
GARTEN GmbH
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5 (in million)
31.3.X5
31.3.X4
31.3.X5
31.3.X4
ASSETS
CAPITAL AND
LIABILITIES
Capital and
Tangible noncurrent assets
reserves
950
750
1,000
750
Land
Stated capital
750
500
Buildings
200
150
200
200
Plant
Legal reserve
1,950
1,400
Profit & loss
590
300
b/fwd
Profit & loss for
185
290
year
1,925
1,540
Current assets
NET WORTH
150
120
Inventory
180
100
Trade receivables
Payables
20
200
170
150
Cash
Trade payables
420
180
150
350
Taxation
75
50
Other payables
425
350
Prepayments and
accrued income
50
70
Prepayments
2,350
1,890
2,350
1,890
CA Sri Lanka
741
GARTEN GmbH
FOR THE YEAR ENDED 31 MARCH 20X5 (in million)
20X5
20X4
20X5
EXPENSES
INCOME
Operating expenses:
Operating
income:
740
400
1,890
Purchase of raw
Sale of goods
materials
produced
Variation in
Variation in
inventories
inventory of
90
40
120
thereof
finished goods
and WIP
190
125
75
Taxation
Other operating
income
500
285
2,085
Wages
Total operating
income
Valuation
adjustment
on non-current
assets:
200
150
depreciation
Valuation
adjustment
on current assets:
30
20
amounts written
off
Other operating
50
40
expenses
Total operating
1,060
1,800
expenses
Financial expenses
100
50
Interest
Total financial
100
50
expenses
1,900
1,110
2,085
TOTAL EXPENSES
TOTAL INCOME
185
290
Balance: PROFIT
2,085
1,400
2,085
SUM TOTAL
20X4
1,270
80
50
1,400
1,400
1,400
Required
Prepare a report for the managing director:
(a)
742
Analysing the performance of Garten GmbH using the financial statements

provided.
(18 marks)
CA Sri Lanka
(b)
Explaining why a direct comparison of the results of Blue Mountain Ltd and
Garten GmbH may be misleading.
(7 marks)
(Total = 25 marks)
ANSWER
To:
From:
Date:
Re:
(a)
Managing Director
An Accountant
xx.xx.xx
GARTEN GmbH
Analysis of performance plus commentary ( million)
20X4
1,270
20X5
1,890
%
Increase
(decrease)
49
400
40
440
285
150
20
40
(80)
740
90
830
500
200
30
50
(120)
89
75
33
50
25
50
Statement of profit or loss and other

comprehensive income
Sales
Cost of sales
Material purchased
De-stocking of materials
Material cost
Labour cost
Depreciation
Current assets written off
Other operating expenses
Finished goods inventory
increase
Operating profit before other
income
Profit rate on revenue
Other operating income
855
415
32%
50
1,490
400
21%
75
(4)
50
Cash flows
Share capital issued
Increased payables
Increased accruals
Profit ploughed back (185 + 200)
million
200
75
20
385
680
These flows were used to finance:

Purchases of plant (550 + 200)
750
Net inventory
30
More credit to customers
80
860
Difference: reduction in cash reserves
CA Sri Lanka
180
743
Other relevant performance measures

Receivables turnover
Trade receivables
=
365
Sales
Current ratio
Current assets
=
Current liabilities
Quick ratio
Current assets Inventory
=
Current liabilities
20X4
20X5
100
365
1,270
= 29 days
180
365
1,890
= 35 days
420+70
350
= 1.4
350+50
425
= 0.94
100+200+70
350
= 1.06
180+20+50
425
= 0.59
Commentary
(i)
Material costs and labour costs have risen at an alarming rate in 20X5
and to a certain extent other costs have also increased substantially.
These increases are far greater than the increase in revenue. A lack of
co-ordination of production to sales has created a substantial build up
of finished goods in inventory.
(ii)
Interest costs and other operating income have both increased

substantially, but because debt and investments (respectively) are not
disclosed in the statement of financial position it is not possible to
judge why these increases have taken place. One possibility is that the
increases in the value of land and buildings represent additions that
are being rented out.
(iii) Payables have increased only slightly considering the increases in

purchases during the year. This may indicate that the company's trade
supplies are taking a very firm line with the company and thus the
trade payables balance is being held firm.
(iv) Although shares were issued during the year, at a premium of 100%,
the fact that appropriations are not disclosed in the statement of profit
or loss and other comprehensive income makes it very difficult to
determine what type of dividend policy the company is following, and
hence what kind of return shareholders have received over the two
years.
(v)
744
The length of credit period given to customers has increased (if all
sales are on credit). While trading conditions may make this slip in
credit control a necessity, it is regrettable that the company cannot
obtain the same more relaxed terms from its suppliers; this would
balance out working capital requirements, at least to some extent.
CA Sri Lanka
(vi) The inventory situation is what has changed most dramatically

between 20X4 and 20X5. The rise in inventories of 30 Mn may appear
moderate, but it represents a rise of 120 Mn in finished goods and a
fall of 90 Mn in raw materials. It may be the case that the company is
manufacturing less and buying in more finished goods, but the increase
in labour costs would tend to negate this. It seems more likely that the
company has greatly over-estimated the level of sales for 20X5, and has
therefore ended 20X5 with an anomalous inventory position.
(vii) The cash levels held by the business, while perhaps on the high side at
the beginning of the year, now appear far too low. The company is
verging on an overdraft situation, in spite of receiving cash from a
share issue during the year. The working capital situation, and in
particular the inventory levels, must be resolved in order to recover
the liquidity position of the business. If not, then there will be some
difficulty in paying suppliers and taxes in the near future.
(b)
A direct comparison of the results of Blue Mountain Ltd and Garten GmbH
may be misleading for the following reasons.
(i)
It is unlikely that the two companies follow the same, or even similar,
accounting policies, for example on inventory valuation, depreciation,
valuation of land and buildings etc. Also, the general approach to
receivables recoverability may be more or less prudent in Germany
than under Blue Mountain Ltds approach. These policies would have to
be investigated to discover whether comparison is really feasible.
(ii)
Garten GmbH's payables are not split between short and long term, ie
those due within one year and in more than one year (if any). Gearing
ratios cannot be calculated, and the current and quick ratios calculated
in (a) are of limited value.
(iii) There may be local or country-specific types of relationships between

customers and suppliers that are different from Sri Lankan methods of
doing business.
(iv) There is an interest charge shown in the statement of profit or loss and
other comprehensive income but the statement of financial position
shows no separate disclosure of loans. The explanation may be that an
interest charge is payable on the share capital in place of dividends.
(v)
A legal reserve is shown. There is no indication of what type of reserve

this may be comparable with (if any) in Sri Lankan financial
statements.
(vi) The statement of profit or loss and other comprehensive income does
not show a figure of gross profit making it difficult to compare margins.
CA Sri Lanka
745
(vii) The expenses include valuation adjustments for depreciation and

current assets. It is not clear how these arise. They may simply
comprise the normal depreciation charge and, say, a provision against
doubtful receivables and obsolete inventory. It is true of many of the
statement of profit or loss and other comprehensive income figures,
that a lack of knowledge about how, say, 'cost of sales' is computed,
prevents comparison with Sri Lankan accounts.
4 Other matters
Financial analysis does not provide definitive answers or conclusions; it does,
however identify areas that should be investigated in further detail.
A set of financial statements do not usually provide sufficient information for full
analysis of a companys position and performance. This is in part because,
although extensive, SLFRS disclosures do not provide all information that an
analyst may require. It is also the case that there are a number of limitations of
financial analysis as described in this chapter.
4.1 Limitations of financial analysis

The table below provides a summary of limitations discussed in the KB1 study
text; you should go back and review that text as necessary for further detail.
746
Accounting policies
and practices
Where there are areas of choice in accounting policies,

estimates and practices, financial statements are
unlikely to be directly comparable eg one company may
revalue PPE and another may not.
Calculation of ratios
Certain ratios are calculated differently by different

parties, depending on the desired outcome eg a lender is
likely to calculate worst case gearing including an
overdraft as debt, whereas a borrower will not consider
an overdraft to be debt in the calculation of gearing.
Historic financial
statements
As discussed in section 1.5, analysis is based on historic

financial statements, whereas analysts are primarily
interested in how a company will perform in the future.
Window dressing
Year-end balances in the statement of financial position

(SOFP) may be manipulated making them incomparable
with previous years balances.
CA Sri Lanka
Related party
transactions
These may not be conducted at arm's length and as a

result make the financial statements of a group
company incomparable with a similar company that is
not part of a group.
Seasonality
This is relevant in particular to the SOFP and ratios

calculated based on SOFP balances.
4.2 Further information

In a financial analysis question you may be asked to consider further information
that would be useful in conducting analysis. Your answer should relate to the
purpose of the analysis performed and the ratios calculated. Try to identify why
information may be useful. Examples may include:
Management accounts, in order to identify detailed expenses, non-recurring
items and so on;
Revenue and profits by product line or market in order to ascertain whether
certain parts of the business are more profitable than others;
Levels of cash revenue and purchases in order to calculate accurate receivables
collection period/payables payment period;
An aged receivables listing in order to ascertain whether any part of the trade
receivables balance is irrecoverable;
Detailed asset register in order to identify the age of non-current assets and
replacement requirements.
Budget and forecast information in order to identify whether trends are
expected to continue.
CA Sri Lanka
747
QUESTION
Extracts from the financial statements of a commercial catering company for the
years ended 31 December 20X3 and 20X4 are as follows:
20X3
20X4
Rs'000
Rs'000
13,200
13,800
Revenue
(4,620)
(5,220)
Cost of sales
8,580
8,580
Gross profit
4,488
5,244
PBIT
800
8,000
8,800
Share capital
Retained earnings
Revaluation reserve
800
9,000
4,000
13,800
There is no debt in the companys accounts.

Calculate performance ratios for the company and comment on its performance
in 20X4 as compared to 20X3.
ANSWER
Gross profit margin

Operating profit margin
Asset turnover
ROCE
20X3
8,580/13,200 100%
= 65%
4,488/13,200 100%
= 34%
13,200/8,800
= 1.5
4,488/8,800
= 51%
20X4
8,580/13,800 100%
= 62%
5,244/13,800 100%
= 38%
13,800/13,800
= 1.0
5,244/13,800
= 38%
Gross profit margin
The gross margin has fallen from 65% to 62%, however the absolute gross profit
is constant at Rs. 8.58 Mn. The fall in margin may be explained by:
a drop in selling price in order to achieve increased sales volume;
an increase in the cost of sales;
a change in sales mix.
Given that the company operates in catering, it may be that a contributing factor
will be food inflation resulting in increased costs of raw produce.
748
CA Sri Lanka
Operating profit margin
Although the gross margin has decreased, the operating profit margin has
increased. The company may have managed its costs well, or achieved some cost
cutting. This may have been achieved through economies of scale associated with
the increased volume production eg for packaging. Alternatively, 20X3 may have
included a large one off expense (or 20X4 a large one off item of income) which
has distorted the ratios.
Asset turnover and ROCE
Both asset turnover and ROCE have decreased significantly. This is the result of an
increase in net assets. The majority of this increase is due to the revaluation
surplus of Rs. 4 Mn. Stripping this out, the ROCE for 20X4 is 54% (5,244/9,800)
and the asset turnover 1.4 (13,800/9,800). These values are more in line with
20X3 amounts, with a slight decrease in asset turnover and slight increase in
ROCE. The increase in ROCE is driven by the increase in operating profit margin as
discussed above.
QUESTION
Lankagoods, a grocery chain, reports the following amounts in its financial
statements for the years ended 31 December 20X3 and 20X4:
Inventory
Receivables
Cash
Payables
20X3
Rs'000
550
45
12
1,850
20X4
Rs'000
585
20
8
1,960
Calculate the current and quick ratios for both years and comment on them.
ANSWER
Current ratio
Quick ratio
CA Sri Lanka
20X3
550+ 45+12
1,850
= 0.33:1
20X4
585+20+8
1,960
= 0.31:1
45+12
1,850
= 0.03:1
20+8
1,960
= 0.01:1
749
At first glance, these ratios are alarming and indicate that Lankagoods has
considerable liquidity problems, which have worsened in the current year.
However, taking into account the nature of the companys business activities as a
grocery chain, the very low ratios may be acceptable. Characteristics of the retail
industry, and large grocery chains in particular are:
High levels of inventory;
No trade receivables (customers are not allowed goods on credit);
Low cash balances (since cash is invested in non-current assets);
Very high payables (powerful grocery chains are notorious for pushing the
credit of their suppliers).
In order to make a full assessment, industry averages should be obtained.
750
CA Sri Lanka
CHAPTER ROUNDUP
Financial analysis involves appraising and communicating the position,

performance and prospects of a business based on given and prepared statements
and ratios. Vertical, horizontal, common size and ratio analysis are all
common techniques used in financial analysis.
Common size analysis involves calculating amounts in the financial statements

as a percentage of a base figure.
The calculation of ratios can help with the analysis of financial statements; ratios
can be grouped as relevant to profitability, solvency, liquidity, efficiency and
investors interests.
Financial analysis does not provide definitive answers or conclusions; it does,

however identify areas that should be investigated in further detail.
CA Sri Lanka
751
PROGRESS TEST
752
What is common size analysis?
If there is an increase in PPE in the statement of financial position, what else might
you expect in the financial statements?
The machinery (PPE) balance has decreased in a companys statement of financial

position, however the company has increased its production capacity. How?
How is return on capital employed calculated?
Gross profit margin has increased steadily over the last 3 years; what factors
might explain this?
What negative factors could be associated with a reduction in trade receivables

days?
CA Sri Lanka
This involves calculating amounts in the financial statements as a proportion of a

base figure, often revenue.
An increased depreciation charge, increased finance leases, less cash, potentially

increased revenue.
The company has acquired machinery by way of operating leases.
PBIT/Capital employed
One or a combination of:

an increased selling price per item
decreased cost of sale per item
a change in product mix in favour of high margin products.
CA Sri Lanka
Aggressive chasing of customers resulting in lost goodwill; a need to chase debts

as a result of lack of cash; a prompt payment discount that costs more than the
benefits of receiving cash quickly.
753
754
CA Sri Lanka
Index
756
CA Sri Lanka
Index
<IR> Framework, 55, 58
A
Accounting estimates, 84
Accounting policies, 81, 706
Accounting profit, 298
Accounting standards, 5
Accounts payable payment period,
739
Accounts receivable collection period,
738
Acquiree, 508
Acquirer, 508
Acquisition date, 508
Acquisition method, 509
Actuarial gains and losses, 393
Adjusting events, 258
Agricultural activity, 225
Agriculture produce, 225
Amortised cost, 345
Annual improvements, 13
Antidilution, 477
Asset, 136
Asset ceiling, 392, 404
Associate, 316, 500
Associates, 528
(AFS), 344
B
Basic earnings per share, 477
Biological asset, 225
Biological transformation, 225
Borrowing costs, 105
Business combination, 509
C
Carrying amount, 103, 119, 157
Cash, 628
Cash equivalents, 628
Cash flow hedge, 361, 362
Cash flows, 628
Cash-generating unit, 164, 165
Cash-settled share-based payment,
410, 417
CA Sri Lanka
Cash-settled share-based payments

Change in accounting estimate, 84
Close members of the family of an
individual, 451
Closing rate, 669
Commencement of the lease term,
185
Common size analysis, 728
Competence, 14
Compound instruments, 336
Concepts and pervasive principles,
705
Conceptual framework, 20, 22
Conditions for hedge accounting, 359
Confidentiality, 14
Consignment inventory, 277
consolidated financial statements, 517
Consolidated financial statements,
506
Consolidated statement of cash flows,
636, 662
Consolidation, 502, 508
Construction contract, 215
Contingent asset, 243, 251
Contingent consideration, 509
Contingent liabilities, 250
Contingent liability, 243
Contingent settlement provisions, 336
Contract, 288
Control, 500, 502
Convertible debt, 336
Corporate assets, 165, 167
Corporate governance, 41, 42
Cost, 103, 118
Cost model, 108, 123
Cost plus contract, 216
Costs of disposal, 157
Costs to sell, 443
Current developments, 9
Current ratio, 738
Current tax, 298
D
Date of effective control, 596
Deductible temporary differences,
300
757
Index
Deferred tax, 299

Deferred tax and groups, 313
Deferred tax assets, 300
Deferred tax liabilities, 300
Deficit or surplus, 392
Defined benefit plans, 392, 396,
398, 428
Defined contribution plans, 392,
397, 428
Depreciation, 93, 108
Derivative, 334
Derivative instruments, 333
Derivatives, 353
Diluted earnings per share, 481
Directors report, 40
Discontinued operation, 447
Discontinued operations, 447
Discussion papers, 10
Disposal group, 441
Disposals, 570
Dividend cover, 740
Dividend in specie, 618
Dividend yield, 740
Dividends, 269
Divisionalisation, 620
D-shaped groups, 611
Due care, 14
Due process, 8
E
Effective interest method, 345
Effective interest rate, 345
Embedded derivatives, 356
Employee benefits, 391
Environmental reporting, 41
Equity instrument, 334
Equity method, 529
Equity-settled share-based
payment, 410
Equity-settled share-based payments,
411
Errors, 85
Events after the reporting period,
257
Exchange difference, 672
Exposure drafts, 10
758
F
Fair value, 24, 103, 118, 157, 185,
221, 393, 410, 443, 509
Fair value hedge, 360, 361
Fair value model, 122
Finance lease, 182, 190
Financial asset, 333, 343
Financial assets at fair value through
profit or loss (FVTPL), 343
Financial instrument, 333
Financial liability, 333, 351
Financing activities, 629
Fixed price contract, 215
Foreign currency, 93
Foreign currency transactions, 87
Foreign operation, 668
Forgivable loans, 221
Functional currency, 669
G
Gearing ratio, 737
Global Reporting Initiative, 50
Going concern, 74, 260
Goodwill, 167, 509, 510
Government, 221
Government assistance, 221, 223
Government grants, 221, 222, 226
Grant date, 410
Grants related to assets, 221
Grants related to income, 221
Gross investment in the lease, 194
Gross profit margin, 736
Group, 500
Group reorganisations, 616
Guaranteed residual value, 185
H
Harvest, 225
Hedge accounting, 358
Hedge effectiveness, 358
Hedge of a net investment in a
foreign operation, 361
Hedged item, 358
Hedging, 358
Hedging instrument, 358
CA Sri Lanka
Index
Held to maturity financial assets

(HTM), 344
Horizontal trend analysis, 728
Hyperinflation, 687
I
IAS 32 Financial instruments:
presentation, 334
IAS 39, 341
IAS 40 fair value model, 119
IASB, 8
Identifiable, 509
IFRIC 1 Changes in Existing
Decommissioning, Restoring and
Similar Liabilities, 254
IFRIC 2 Members Shares in Cooperative Entities and Similar
Instruments, 339
IFRIC 4 Determining whether an
Arrangement contains a Lease, 200
IFRIC 5 Rights to Interests arising
from Decommissioning, Restoration
and Environmental Rehabilitation
Funds, 255
IFRIC 6 Liabilities Arising from
Participating in a Specific Market
Waste Electrical and Electronic
equipment, 253
IFRIC 7, 690
IFRIC 9 Reassessment of Embedded
Derivatives, 357
IFRIC 12 Service Concession
Arrangements, 279
IFRIC 13 Customer Loyalty
Programmes, 283
IFRIC 15 Agreements for the
Construction of Real Estate, 284
IFRIC 17 Distributions of Non-cash
Assets to Owners, 80
IFRIC 18 Transfers of Assets from
Customers, 286
IFRIC 19 Extinguishing Financial
Liabilities with Equity Instruments,
382
IFRIC 20 Stripping Cost in the
Production Phase of a Mine, 215
CA Sri Lanka
IFRIC 21 Levies, 255

IFRS 5, 440
Impairment loss, 157
Impairment of Assets, 156
Impairment of financial assets, 349
Impracticable, 86
Inception of the lease, 185
Income Statement, 384
Insurance contract, 373
Intangible assets, 136
Integrated reporting, 54
Interest, 269
Interest cover, 737
Interest rate implicit in the lease,
185
Interim financial report, 87
Interim period, 87
Interpretations, 7
Intra-group cash flows, 636
Intrinsic value, 410
Inventories, 211
Inventory turnover period, 739
Investing activities, 629
Investment entities, 507
Investment property, 118
Investor ratios, 739
J
Joint arrangement, 500, 528, 532
Joint control, 500, 532
Joint operation, 500, 535
Joint venture, 316, 500, 535
K
Key management personnel, 451
L
Lease, 182
Lease term, 184
Lessee accounting, 186, 190
Lessor accounting, 188, 194
Liability, 243
Limitations of financial analysis, 746
Liquidity ratios, 737
759
Index
LKAS 1 Presentation of Financial

Statements, 73
LKAS 2 Inventories, 211
LKAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors, 81
LKAS 10 Events after the Reporting
Period, 257
LKAS 11 Construction Contracts, 215
LKAS 16 Property, Plant and
Equipment, 103
LKAS 17, 182
LKAS 18 Revenue, 268
LKAS 19 Employee Benefits, 391
LKAS 20 Government Grants, 221
LKAS 21 The Effects of Changes in
Foreign Exchange Rates, 86, 668
LKAS 23 Borrowing costs, 105
LKAS 24 Related Party Disclosures,
450
LKAS 26 Accounting and Reporting by
Retirement Benefit Plans, 428
LKAS 27 Separate Financial
Statements, 501
LKAS 28, 528
LKAS 29 Financial Reporting in
Hyperinflationary Economies, 687
LKAS 32 Financial Instruments:
Presentation, 333
LKAS 33 Earnings per Share, 476
LKAS 34 Interim Financial Reporting,
87
LKAS 36 Impairment of Assets, 156
LKAS 37 Provisions, Contingent
Liabilities and Contingent Assets,
242
LKAS 38 Intangible Assets, 136
LKAS 39 Financial Instruments:
Recognition and Measurement, 340
LKAS 40 Investment Property, 118
LKAS 41 Agriculture, 224
Loans and receivables, 344
M
Manufacturer and dealer leases, 196
Market condition, 411
Materiality, 91
760
Measurement period, 515

Mineral resources, 230
Minimum lease payments, 185
Monetary assets, 137
Monetary items, 87
Multi-employer plans, 392
N
Net asset turnover, 737
Net defined benefit liability
(asset), 392
Net interest on the net defined
benefit liability (asset), 393
Net investment in a foreign
operation, 668
Net investment in the lease, 194
Net realisable value, 212
New top holding company, 617
Non-adjusting events, 258
Non-controlling interest, 509, 511
Non-current assets held for
sale/distribution, 441
Non-financial reporting, 40
O
Offsetting, 338
Onerous contract, 243, 248
Operating activities, 629
Operating cycle, 739
Operating lease, 182, 186
Operating segment, 469
Options, warrants and their
equivalents, 477
Ordinary share, 477
Other long-term employee
benefits, 391
Owner-occupied property, 118
P
P/E ratio, 740
Parent, 500
Past service costs, 403
Performance condition, 411
Performance obligation, 288
Plan assets, 392
CA Sri Lanka
Index
Post-employment benefit plans,

392
Post-employment benefits, 391,
396
Post-implementation reviews, 12
Potential ordinary share, 477
Potential voting rights, 504
Power, 500, 502
Present value of a defined benefit
obligation, 392
Presentation currency, 669
Prior period errors, 85
Professional behaviour, 14
Profitability ratios, 736
Property, plant and equipment,
103
Prospective application, 84
Provision, 243
Puttable instruments, 337
Q
Qualifying asset, 105
Quick ratio, 738
R
Rate regulation, 716
Rate regulator, 717
Rate-regulated activities, 716
Ratio analysis, 728, 736
Recently issued standards, 11
Reclassification of financial assets,
347
Recoverable amount, 157
Regulatory deferral account
balance, 717
Regulatory Framework, 2
Reimbursement, 246
Related party, 450
Related party transactions, 451,
453
Relevant activities, 500
Remeasurements, 393, 400
Rendering of services, 270
Reportable segments, 470
Research and development, 141
Restructuring, 248
CA Sri Lanka
Retrospective application, 82
Retrospective restatement, 85
Return on Capital Employed, 736
Return on Equity, 736
Return on plan assets, 393
Revaluation model, 108
Revenue, 268, 288
Royalties, 269
S
Sale and leaseback transactions, 197
Sale and repurchase, 275
Sale of goods, 270
SEC Regulations, 3
Separate financial statements, 501
Service condition, 410
Service cost, 393
Settlement, 393
Settlement options, 337
Share option, 410
Share-based payment
arrangement, 409
Short-term employee benefits, 391
SIC-27 Evaluating the Substance of
Transactions in the Legal Form of a
Lease, 199
SIC 29 Disclosure Service
Concession Arrangements, 282
SIC 31 Barter Transactions involving
Advertising Services, 287
SIC 32 Intangible Assets Website
Costs, 147
Significant influence, 500, 528
SLFRS 2 Share-based payments, 409
SLFRS 3 Business Combinations, 508
SLFRS 4 Insurance Contracts, 373
SLFRS 5 Non-Current Assets Held for
Sale and Discontinued Operations,
440
SLFRS 6 Exploration for and
Evaluation of Mineral Resources, 230
SLFRS 7 Financial Instruments:
Disclosures, 376
SLFRS 8 Operating Segments, 468
SLFRS 12 Disclosure of Interests in
Other Entities, 544
761
Index
SLFRS 13 Fair value measurement, 24,

378
SLFRS 14 Regulatory Deferral
Accounts, 716
SLFRS 15 Revenue from Contracts with
Customers, 287
SLFRS for SMEs, 702
Small and medium-sized entities, 702
Social reporting, 41
Solvency ratios, 737
Specified Business Entities, 702
Spot exchange rate, 669
Sri Lankan GAAP, 2
Statement of cash flows, 628
Statement of changes in equity, 80
Statement of financial position, 76
Statement of profit or loss and other
comprehensive income, 78
Step acquisitions, 558
Structured entity, 544
Subsidiary, 500, 502
Subsidiary moved along, 618
Subsidiary moved down, 619
Substance over form, 275
Sustainability reporting, 49
T
Tax, 93
Tax base, 300
762
Taxable profit (tax loss), 298

Taxable temporary differences,
300
Temporary difference, 301, 313
Termination benefits, 392
The Companies Act, 3
The International Integrated
Reporting Council, 55
Transaction price, 288
Translation of financial statements,
670
Treasury shares, 337
U
Unearned finance income, 194
Unguaranteed residual value, 185,
194
Useful life, 104
V
Valuation techniques, 28
Value in use, 157
Vertical groups, 594
Vertical trend analysis, 728
Vest, 410
Vesting conditions, 410
Vesting period, 410
CA Sri Lanka

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CA SRI LANKA CURRICULUM 2015

First edition 2015

All rights reserved. No part of this publication may be

BPP Learning Media Ltd

Action verbs checklist

KC1 Corporate Financial Reporting

The Regulatory and Conceptual Framework

Presentation of financial statements

Other standards related to assets

Provisions and Events after the reporting period

Step acquisitions and disposals

Complex groups and group reorganisations

Statements of cash flows

Foreign exchange issues

Small company reporting and first time adoption

Financial statement analysis

1. Interpretation & Application of Sri Lanka Accounting Standards

2. Preparation & Presentation of Consolidated Financial Statements

3. Analysis, Interpretations & Communication of Financial Results

4. Corporate Governance & Recent Developments in Financial Reporting

5. Ethical Issues in Financial Reporting and the Regulatory Framework

KC1 Corporate Financial Reporting

These are illustrations of particular techniques or concepts with a worked

This summarises the key points to remember from each section.

This provides a recap of the key areas covered in the chapter.

KC1 Corporate Financial Reporting

It may require the analysis, application

A complicated matter includes

Thorough knowledge and comprehension of

(Syllabus Weighting 35%)

1.1.7 Design the appropriate disclosures to be made in

1.1.6 Advise appropriate application and selection of

1.1.5 Evaluate the impact of the use of different expert

1.1.4 Propose appropriate accounting policies to be

1.1.3 Evaluate the outcomes of the application of

1.1.2 Recommend the appropriate accounting

1.1.1 Advise on the application of Sri Lanka Accounting

1. Interpretation and Application of Sri Lanka Accounting Standards (SLFRS/LKAS/IFRIC/SIC)

KC1 Corporate Financial Reporting

A moderately complicated matter includes

Good knowledge and comprehension of the

(Syllabus Weighting 35%)

1.2.1 Apply Sri Lanka Accounting Standards in solving

1.2.5 Outline the disclosures to be made in the financial

1.2.4 Demonstrate the appropriate application and

1.2.3 Demonstrate a thorough knowledge of Sri Lanka

1.2.2 Recommend the appropriate accounting

1. Interpretation and Application of Sri Lanka Accounting Standards (SLFRS/LKAS/IFRIC/SIC)

A simple transaction or event includes

Conceptual knowledge and understanding of

(Syllabus Weighting 35%)

1.3.3 List the disclosures to be made in the financial

1.3.2 Apply the concepts/principals of the standards to

1.3.1 Explain the concepts/principals of Sri Lanka

1. Interpretation and Application of Sri Lanka Accounting Standards (SLFRS/LKAS/IFRIC/SIC)

2.1 Consolidated financial statements

2.2 Joint ventures

2.3 Investments in associates

KC1 Corporate Financial Reporting

(Syllabus Weighting 30%)

2. Preparation and Presentation of Consolidated Financial Statements

2.3.2 Compile financial statements when there is an