SBR INT- Chapter 3: Reporting the financial performance of a range of entities

Reporting the financial performance of a range of entities

1. Revenue

a) Revenue Recognition Criteria

For an entity to recognize revenue, three criteria must be met:

• Identification: The entity has identified the performance obligation(s) in the contract.
• Control: The entity has control over the goods or services promised.
• Measurable: The revenue is measurable at a reliable amount.

b) Contract Revenue and Costs

The following principles apply to contract revenue and costs:

• Recognition: Recognize revenue when the performance obligation(s) is satisfied.
• Measurement: Measure revenue at the transaction price, excluding taxes.
• Contract Modifications: Account for modifications as separate contracts if they are significant.

c) Revenue Recognition and Measurement:

• Performance Obligations Satisfied Over Time: Recognize revenue as the performance obligation(s) is satisfied over time.
• Sale with a Right of Return: Recognize revenue only when the customer is unlikely to return the goods.
• Repurchase Agreements: 

Recognize revenue only when the repurchase agreement is outside the normal course of business.

• Consignment Arrangements: Recognize revenue when the consignee sells the goods.
• Warranties: 

Recognize a provision for warranty costs when the warranty is probable and measurable.

• Variable Consideration: Estimate the variable consideration reliably and include it in the transaction price.
• Principal vs. Agent: Recognize revenue only if the entity acts as a principal, not an agent.
• Non-Refundable Upfront Fees: Recognize revenue when the customer obtains control over the goods or services.

2. Non-Current Assets

a) Recognition, Derecognition, and Measurement:

• Recognize non-current assets when probable future benefits will flow and the cost can be measured reliably.
• Derecognize non-current assets when no future benefits are expected or the cost cannot be measured reliably.
• Measure non-current assets at historical cost, less accumulated depreciation and impairment losses (except for revalued assets).

b) Classification and Measurement of Non-Current Assets Held for Sale:

• Classify as held for sale when the entity is committed to selling the asset and actively marketing it.
• Measure at the lower of carrying amount and fair value less costs to sell.

c) Investment Properties:

• Classified as investment property when held to generate rental income or for capital appreciation.
• Recognized initially at cost.
• Subsequently measured at fair value through profit or loss.
• Change of use triggers derecognition from investment property class.

d) Intangible Assets:

Recognized only if:

• Identified, separable, and controlled
• Can be reliably measured
• Expected to generate future economic benefits

Measured at historical cost, less accumulated amortization and impairment losses.

e) Borrowing Costs:

• Capitalize borrowing costs that are directly attributable to the acquisition, construction, or preparation of a qualifying asset.
• Recognize capitalized borrowing costs as part of the asset’s cost.

3. Financial Instruments

a) Initial Recognition and Measurement:

Apply the business model test to classify financial instruments as:

• Financial assets
• Financial liabilities
• Equity instruments

Measure financial assets at fair value through profit or loss (if held for trading) or at amortized cost (if held to collect contractual cash flows).

Measure financial liabilities at fair value through profit or loss (if held for trading) or at amortized cost (if the carrying amount approximates the fair value).

b) Subsequent Measurement:

• Financial assets: Subsequent measurement options are fair value through profit or loss, fair value through other comprehensive income, or amortized cost.
• Financial liabilities: Subsequent measurement is at amortized cost unless fair value hedge accounting applies.

c) Derecognition and Reclassification:

• Derecognize a financial asset when the contractual rights to the cash flows have expired or been transferred.
• Derecognize a financial liability when the obligation is extinguished.
• Reclassify a financial asset when the classification criteria change.

d) Derivative Financial Instruments:

• Recognized and measured at fair value on the balance sheet.
• Changes in fair value are recognized in profit or loss (for trading) or other comprehensive income (for available-for-sale).

e) Hedge Accounting:

• Qualify for hedge accounting if a highly effective relationship exists between the hedging instrument and the hedged item.
• Recognize changes in fair value of the hedging instrument in profit or loss

f) Impairment of Financial Instruments:

• Apply a general approach to assess expected credit losses (ECLs) for all financial instruments.
• Use a loss allowance model to estimate ECLs based on historical information, current information, and forecasts.
• Recognize impairment losses in profit or loss when the carrying amount exceeds the recoverable amount.

g) Significant Increase in Credit Risk:

• Identify significant increase in credit risk (SICR) events that indicate a decline in the creditworthiness of a borrower.
• Recognize an impairment loss when a SICR event has occurred and a loss is probable.

h) Purchased or Originated Credit Impaired Financial Assets:

• Measure at fair value through profit or loss with subsequent changes recognized in profit or loss.

4. Leases

a) Lessee Accounting:

• Identify a lease if it conveys control of the underlying asset to the lessee.
• Measure the right-of-use asset at cost, including the initial lease payment, incremental borrowing costs, and any initial direct costs.
• Measure the lease liability at the present value of the lease payments, less any residual value guarantee.

b) Lessor Accounting:

• Classify leases as either operating leases or finance leases.
• Recognize operating leases’ income on a straight-line basis over the lease term.
• Recognize finance leases’ income using the sales-type approach.

c) Re-measurement of Lease Liability:

• Re-measure the lease liability if the lease payments change due to a lease modification.

d) Separation of Lease Components:

• Separate the lease contract into lease and non-lease components if the non-lease component is significant.

e) Recognition Exemptions:

• Certain low-value or short-term leases are exempt from recognition requirements.

f) Sale and Leaseback Transactions:

• Derecognize the asset and recognize a gain or loss on sale in the lessee’s financial statements.
• Recognize a financing liability for the proceeds received in the lessor’s financial statements.

g) Accounting for Subleases

Introduction

A sublease occurs when a lessee (original tenant) rents out the leased asset to another party (sublessee) while still being responsible for the original lease with the landlord (lessor). Proper accounting treatment depends on whether the sublease is classified as a finance lease or an operating lease under IFRS 16.

Classification of Subleases

A sublease is classified based on whether it transfers substantially all the risks and rewards of ownership to the sublessee:

• Finance Sublease – If the sublease transfers most risks and rewards to the sublessee, it is accounted for as a finance lease.
• Operating Sublease – If the sublease does not transfer most risks and rewards, it is accounted for as an operating lease.

Accounting Treatment

1. Finance Sublease

If the sublease is a finance lease, the original lessee (now the sublessor) must:

• Derecognize the right-of-use (ROU) asset from the main lease.
• Recognize a lease receivable instead.
• Recognize interest income over the lease term.

Example: A company leases equipment for $50,000 over 5 years and subleases it for $12,000 per year for 3 years. The present value (PV) of the sublease payments is $30,000.

Entries for the sublessor:

• Remove ROU Asset: Dr. Lease Receivable $30,000
• Recognize Finance Income: Cr. Interest Income (Over 3 years)

2. Operating Sublease

If the sublease is an operating lease, the sublessor:

• Continues to recognize the ROU asset.
• Recognizes sublease income as rental income.

Example: A company rents office space for $10,000 per year and subleases part of it for $4,000 per year.

Entries for the sublessor:

• Recognize Sublease Income: Dr. Cash $4,000, Cr. Rental Income $4,000
• Continue recognizing lease liability and ROU asset from the main lease.

Summary

• Finance sublease: Derecognize ROU asset, recognize lease receivable, record finance income.
• Operating sublease: Keep ROU asset, recognize sublease income as rental revenue.
• The classification depends on whether substantial risks and rewards are transferred.

Following the correct accounting method ensures compliance with IFRS 16 and accurate financial reporting.

5. Employee Benefits

a) Short-Term and Long-Term Employee Benefits:

• Recognize short-term employee benefits as an expense when the employee renders service.
• Recognize long-term employee benefits as an expense when the related service is rendered.

b) Gains and Losses on Settlements and Curtailments:

• Recognize gains and losses on settlements of defined benefit plans in profit or loss.
• Recognize gains and losses on curtailments of defined benefit plans in other comprehensive income.

c) “Asset Ceiling” Test and Actuarial Gains and Losses:

• Apply the “asset ceiling” test to assess whether a defined benefit obligation exceeds the related plan assets.
• Recognize actuarial gains and losses in other comprehensive income, with reclassification to profit or loss when certain conditions are met.

6. Income Taxes

a) Recognition and Measurement:

• Recognize current tax liabilities as the expected tax payable on taxable income for the current period.
• Recognize deferred tax liabilities (assets) for the tax consequences of temporary differences.
• Measure current and deferred tax liabilities (assets) at the tax rate that is expected to be enacted and applied in the period the liability (asset) is expected to be settled.

b) Deferred Taxation on a Business Combination:

• Recognize the tax effects of identifiable assets and liabilities at fair value on the date of the acquisition.

7. Provisions, Contingencies and Events After the Reporting Period

a) Recognition, Derecognition, and Measurement:

• Recognize a provision when an obligation is present, a probable outflow of resources to settle the obligation will occur, and the amount can be reliably estimated.
• Derecognize a provision when the obligation is no longer present or has been settled.
• Measure provisions at the amount that is most likely to be required to settle the obligation.
• Recognize contingent liabilities and contingent assets only when certain criteria are met.
• Account for events after the reporting period that provide evidence of conditions that existed at the end of the reporting period.

8. Share-based Payment

a) Recognition and Measurement:

• Recognize a cost of employment expense for the fair value of goods or services received from the employee in exchange for the share-based payment.
• Measure the cost of employment expense at the fair value of the share-based payment on the grant date, with subsequent changes recognized in profit or loss.

9. Fair Value Measurement

a) Fair Value and Active Market:

Fair value is the price that would be received in an arm’s length transaction between willing buyer and seller.

An active market is one in which:

• Transactions for identical assets or liabilities are frequently occurring.
• Prices are readily available and publicly observable.

b) Fair Value Hierarchy:

• The fair value hierarchy prioritizes valuation techniques based on the reliability of the inputs used.
• Level 1: Quoted prices in active markets for identical assets or liabilities.
• Level 2: Inputs other than quoted prices in active markets for identical assets or liabilities, such as unquoted prices for similar assets or liabilities, internal data adjusted for market participants’ assumptions, and valuation techniques.
• Level 3: Significant unobservable inputs, such as forecasts or management’s own estimates.

c) Justification for Valuation Principles:

• Highest and Best Use: The asset’s value assuming the most advantageous use, physically possible and legally permissible.
• Most Advantageous Sale: The price that would be received in a forced sale to a willing buyer.
• Principal Market: The market to which the entity would most likely sell the asset or from which it would most likely buy the liability.

10. Reporting Requirements of Small and Medium-Sized Entities (SMEs)

a) Key Differences:

• Simplified Accounting Standards: SMEs can apply the IFRS for SMEs Standard, which offers simplified versions of full IFRS Standards.
• Recognition and Measurement Exemptions: Certain exemptions exist for SMEs regarding specific accounting treatments.
• Disclosure Requirements: May be reduced compared to full IFRS Standards.

b) Simplifications:

• Recognition and measurement exemptions for specific items (e.g., property, plant, and equipment).
• Reduced disclosure requirements for certain areas.

11. Other Reporting Issues

a) Government Grants:

• Recognize government grants as income when the entity meets the specified conditions for receiving the grant and complies with any attached conditions.
• Disclose the nature and amount of government grants.

b) Accounting Policy Judgments, Changes in Estimates, and Prior Period Errors:

• Use professional judgment to select and apply accounting policies consistently.
• Account for changes in estimates prospectively, with adjustments to current and future periods.
• Retrospectively adjust prior periods for material prior period errors.

c) Related Parties:

• Identify related parties and disclose their relationships with the entity.
• Apply arm’s length transaction principles in dealings with related parties.

d) Presentation and Disclosure:

• Present financial statements in a clear and concise manner that faithfully reflects the entity’s financial performance and position.
• Disclose all material information necessary for users to understand the financial statements.

This document provides a comprehensive overview of various topics within the ACCA SBR chapter, covering essential theories, practical applications, and illustrative examples. Remember, this serves as a foundational guide, and further exploration of specific standards and detailed interpretations may be necessary for in-depth understanding and practical application.