Judgement study book Statistics for Business & Economics of David R. Anderson, Dennis J. Sweeney, Thomas A. Williams, Jeffrey D. Camm, James J. Cochran - ISBN: 9781337901062
On 1 July 20X5, Banana acquired $10 million 5% bonds at par with interest being due at 30 June each
year. The bonds are repayable at a substan+al premium so that the effec+ve rate of interest was 7%.
Banana intended to hold the bonds to collect the contractual cash flows arising from the bonds and
measured them at amor+sed cost.
On 1 July 20X6, Banana sold the bonds to a third party for $8 million. The fair value of the bonds was
$10·5 million at that date. Banana has the right to repurchase the bonds on 1 July 20X8 for $8·8 million
and it is likely that this op+on will be exercised. The third party is obliged to return the coupon interest
to Banana and to pay addi+onal cash to Banana should bond values rise. Banana will also compensate
the third party for any devalua+on of the bonds.
Discuss how the derecogni%on requirements of IFRS 9 Financial Instruments should be applied to the
sale of the bond including calcula%ons to show the impact on the consolidated financial statements
for the year ended 30 June 20X7.
Solu%on:
IFRS 9 Financial Instruments requires that a financial asset only qualifies for derecogni+on once the
en+ty has transferred the contractual rights to receive the cash flows from the asset or where the en+ty
has retained the contractual rights but has an unavoidable obliga+on to pass on the cash flows to a third
party. The substance of the disposal of the bonds needs to be assessed by a considera+on of the risks
and rewards of ownership.
Banana has not transferred the contractual rights to receive the cash flows from the bonds. The third
party is obliged to return the coupon interest to Banana and to pay addi+onal amounts should the fair
values of the bonds increase. Consequently, Banana s+ll has the rights associated with the interest and
will also benefit from any apprecia+on in the value of the bonds. Banana s+ll retains the risks of
ownership as it has to compensate the third party should the fair value of the bonds depreciate in value.
It would be expected that, if the sale were a genuine transfer of risks and rewards of ownership, then the
sales price would be approximate to the fair value of the bonds. It would only be in unusual
circumstances such as a forced sale of Banana’s assets arising from severe financial difficul+es that this
would not be the case. The sales price of $8 million is well below the current fair value of the bonds of
$10·5 million. Addi+onally, Banana is likely to exercise their op+on to repurchase the bonds.
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It can be concluded that no transfer of rights has taken place and therefore the asset should not be
derecognised. To measure the asset at amor+sed cost, the en+ty must have a business model where
they intend to collect the contractual cash flows over the life of the asset. Banana maintains these rights
and therefore the sale does not contradict their business model. The bonds should con+nue to be
measured at amor+sed cost in the consolidated financial statements of Banana. The value of the bonds
at 30 June 20X6 would have been $10·2 million ($10 million + 7% x $10 million – 5% x $10 million).
Amor+sed cost prohibits a restatement to fair value. The value of the bonds at 30 June 20X7 should be
$10·414 million ($10·2 million + 7% x $10·2 million – 5% x $10 million). The proceeds of $8 million should
be treated as a financial liability and would also be measured at amor+sed cost. An interest charge of
$0·8 million would accrue between 1 July 20X6 and 1 July 20X8, being the difference between the sale
and repurchase price of the bonds.
Ques%on 2 :
(i) Discuss the poten%al issues which investors may have with:
- accoun%ng for the different types of intangible asset acquired in a business combina%on;
- the choice of accoun%ng policy of cost or revalua%on models, allowed under IAS 38 Intangible
Assets for intangible assets
- the capitalisa%on of development expenditure.
(ii) Discuss whether integrated repor%ng can enhance the current repor%ng requirements for
intangible assets.
Solu%on :
(i) Under IFRS 3 Business Combina+ons, acquired intangible assets must be recognised and measured at
fair value if they are separable or arise from other contractual rights, irrespec+ve of whether the
acquiree had recognised the assets prior to the business combina+on occurring. This is because there
should always be sufficient informa+on to reliably measure the fair value of these assets. IFRS 3 requires
all intangible assets acquired in a business combina+on to be treated in the same way in line with the
requirements of IAS 38. IAS 38 requires intangible assets with finite lives to be amor+sed over their
useful lives and intangible assets with indefinite lives to be subject to an annual impairment review in
accordance with IAS 36.
However, it is unlikely that all intangible assets acquired in a business combina+on will be homogeneous
and investors may feel that there are different types of intangible assets which may be acquired. For
example, a patent may only last for a finite period of +me and may be thought as having an iden+fiable
future revenue stream. In this case, amor+sa+on of the patent would be logical. However, there are
other intangible assets which are gradually replaced by the purchasing en+ty’s own intangible assets, for
example, customer lists, and it may make sense to account for these assets within goodwill. In such
cases, investors may wish to reverse amor+sa+on charges. In order to decide whether an amor+sa+on
charge makes sense, investors require greater detail about the nature of the iden+fied intangible assets.
IFRS Standards do not permit a different accoun+ng treatment for this dis+nc+on.
IAS 38 requires an en+ty to choose either the cost model or the revalua+on model for each class of
intangible asset. Under the cost model, aaer ini+al recogni+on intangible assets should be carried at cost
less accumulated amor+sa+on and impairment losses. Under the revalua+on model, intangible assets
may be carried at a revalued amount, based on fair value, less any subsequent amor+sa+on and
impairment losses only if fair value can be determined by reference to an ac+ve market. Such ac+ve
markets are not common for intangible assets.
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If an intangible asset is reported using the cost model, the reported figures for intangible assets such as
trademarks may be understated when compared to their fair values. Based upon the principle above
regarding the different types of intangible asset, it would make sense for different accoun+ng treatments
subsequent to ini+al recogni+on. Some intangible assets should be amor+sed over their useful lives but
other intangible assets should be subject to an annual impairment review, in the same way as goodwill.
IAS 38 requires all research costs to be expensed with development costs being capitalised only aaer the
technical and commercial feasibility of the asset for sale or use has been established. If an en+ty cannot
dis+nguish the research phase of an internal project to create an intangible asset from the development
phase, the en+ty treats the expenditure for that project as if it were incurred in the research phase only.
There is some logic to the capitalisa+on of development expenditure as internally generated intangible
assets but the problem for investors is disclosure in this area as companies do not have a consistent
approach to capitalisa+on. It is oaen unclear from disclosures how the accoun+ng policy in respect of
research and development was applied and especially how research was dis+nguished from
development expenditure. One of the issues is that the disclosure of relevant informa+on is already
contained within IFRS Standards but preparers are failing to comply with these requirements or the
disclosure is insufficient.
Intangible asset disclosure can help analysts answer ques+ons about the innova+on capacity of
companies and investors can use the disclosure to iden+fy companies with intangible assets for
development and commercialisa+on purposes.
(ii) Measuring the contribu+on of intangible assets to future cash flows is fundamental to integrated
repor+ng and will help explain the gaps between the carrying amount, intrinsic and market equity value
of an en+ty. As set out above, organisa+ons are required to recognise intangible assets acquired in a
business combina+on. Consequently, the intangible assets are only measured once for this purpose.
However, organisa+ons are likely to go further in their integrated report and disclose the change in value
of an intangible asset as a result of any sustainable growth strategy or a specific ini+a+ve. It is therefore
very useful to communicate the value of intangible assets in an integrated report. For example, an en+ty
may decide to disclose its assessment of the increase in brand value as a result of a corporate social
responsibility ini+a+ve.
Ques%on 3 :
Explain how the probability criterion has not been applied consistently across accoun%ng standards.
Illustrate your answer with reference to how there may be inconsistencies with the measurement of
assets held for sale, provisions and con%ngent considera%on. Your answer should also discuss how the
New Conceptual Framework recogni%on criteria address these issues.
Solu%on :
Different accoun+ng standards use different levels of probabili+es to discuss when assets and liabili+es
should be recognised in the financial statements. For example, economic benefits from property, plant
and equipment and intangible assets need to be probable to be recognised; to be classified as held for
sale, the sale has to be highly probable.
Under IAS® 37 Provisions, Con+ngent Liabili+es and Con+ngent Assets, a provision should be probable to
be recognised. Uncertain assets on the other hand would have to be virtually certain. This could lead to a
situa+on where two sides of the same court case have two different accoun+ng treatments despite the
likelihood of payout being iden+cal for both par+es. Con+ngent considera+on is recognised in the
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