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Note: Dividends are sometimes classified as an operating cash flow. The profit is included in operating expenses. The financial manager mentions that the accountants allege the company is heading for a possible liquidity crisis. According to him, the company struggled to meet its short-term obligations during the current year. The total increase in creditors was used to partially finance the increase in working capital. The rest of the increase in working capital as well as the interest paid, taxation paid, and dividends paid were financed by cash generated from operations.

The remaining balance of cash generated by operating activities and the proceeds on the sale of fixed assets were used to finance the purchase of fixed assets. The overdrawn bank account was used for the repayment of share capital and the redemption of the long-term loan. Office buildings Balance at beginning of year , Revaluation 20, Purchases balancing figure 10, Balance at end of the year , b. Machinery Balance at beginning of year 20, Depreciation 25, Purchases balancing figure 40, Balance at end of the year 35, c. Vehicles Balance at beginning of year 4, Depreciation 2, Purchases balancing figure 4, Balance at end of the year 6, d.

International Financial Reporting Standards : A Practical Guide, Newly Revised Edition

Taxation Amount due at beginning of year 10, Charge in income statement 44, Paid in cash balancing figure 14, Amount due at end of the year 40, e. Cash receipts from customers Sales , Increase in debtors 63 — 43 20, , f. For example, a change in the method of depreciation results from new information about the use of the related asset and is, therefore, a change in accounting estimate.

If there are no specific transitional provisions, the change in accounting policy should be applied in the same way as a voluntary change. If estimating the future effect is impracticable, that fact should be disclosed. Recurring income is similar to permanent or sustainable income, whereas nonrecur- ring income is considered to be random and unsustainable. Even so-called nonrecurring events tend to recur from time to time. They also might include them on some average per year basis for longer-term analyses.

Furthermore, IFRS does not permit any items to be classified as extraordinary items.

International Financial Reporting Standards by Hennie Van Greuning

It is up to the analyst to use this information, together with information from outside sources and management interviews, to determine to what extent reported profit reflects sustainable income and to what extent it reflects nonrecurring items. The effects of corrections of prior-period errors b.

Income gains or losses from discontinued operations c. Income gains or losses arising from extraordinary items d.

International Financial Reporting in Context

Choice c. The items are included in the Statement of Comprehensive Income but they are not shown as extraordinary items. Extraordinary items are not separately classified under IAS 1. Adjustments from changes in accounting policies should be applied retroactively, as though the new policy had always applied. Opening balances are adjusted at the earliest period fea- sible, when amounts prior to that period cannot be restated.

The following transac- tions and events occurred during the year under review: a. As of the beginning of the year, the remaining useful life of the plant and equipment was reassessed as four years rather than seven years. The financial manager explained that a new incentive scheme was adopted whereby all employees shared in increased sales. How would each transaction and event be treated in the Statement of Comprehensive Income? A change in the useful life of plants and equipment is a change in accounting estimate and is applied prospectively.

A Practical Guide

Therefore, the carrying amount of the plant and equipment is written off over four years rather than seven years. All the effects of the change are included in profit or loss. The nature and amount of the change should be disclosed. The item is included in profit or loss. Given its nature and size, it may need to be disclosed sepa- rately. The contribution is included in profit or loss. It is disclosed separately if it is material.

IFRS 3 prescribes the accounting treatment for business combinations where control is established. It is directed principally to a group of entities in which the acquirer is the parent entity and the acquiree is a subsidiary. IFRS 3 aims to improve the relevance, reliability, and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. To accomplish that, this standard establishes principles and requirements for how the acquirer recognizes and measures the identifiable assets and goodwill acquired in the business combination, or its gain from a bargain pur- chase, in its financial statements.

The core principle established is that a business should recognize assets at their acquisition-date fair values and disclose information that enables users to evaluate the nature and financial effects of the acquisition. The IFRS framework for dealing with equity and other securities investments is outlined in table 6. Table 6. The acquirer purchases net assets and recognizes the as- sets acquired and the liabilities and contingent liabilities assumed from the acquiree, including those not previously recognized by the acquiree. Noncontrolling in- terest is disclosed as equity in consolidated financial statements.

The acquirer is the combining entity that obtains control of the other combining entities or businesses. It includes directly attributable costs but not professional fees or the costs of issuing debt or equity securities used to settle the consider- ation. The acquirer should recognize any adjustments to the provisional values as a result of complet- ing the accounting within 12 months of the acquisition date.

Goodwill is not amortized. It is not recognized on the Statement of Financial Position as negative goodwill. Business Combinations Concluded After the Date of the Statement of Financial Position To the extent practicable, the disclosures mentioned above should be furnished for all business combi- nations concluded after the date of the Statement of Financial Position.

If it is impracticable to disclose any of this information, this fact should be disclosed. Both entities can continue as separate legal entities, producing their own independent set of financial state- ments, or they can be merged in some way. Under IFRS 3, the same accounting principles apply to both ways of carrying out the combination.

The assets and liabilities of the acquired entity are combined into the financial statements of the acquiring firm at their fair values on the acquisition date. The cost of acquisition is determined. Operating results prior to the acquisition are not restated and remain the same as historically reported by the acquirer.

Consequently, the financial statements Statement of Fi- nancial Position, Statement of Comprehensive Income, and cash flow statement of the acquirer will not be comparable before and after the merger, but will reflect the reality of the merger. Values for intangible assets such as computer software might not be easily validated when analyzing purchase acquisitions. If the excess were to be allocated to fixed assets, depreciation would rise, thus reducing net income and producing incorrect financial statements.


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However, in the year following the combination, the gross margin might increase, reflecting the fact that the cost of goods sold decreases after the higher-cost inventory has been sold. Under some unique circumstances—for instance, when an entity purchases another for less than book value—the effect on the ratios can be the reverse of what is commonly found.

Account Options

Therefore, there are no absolutes in using ratios, and analysts need to assess the calculated ratios carefully to determine the real effect. Earnings, earnings per share, the growth rate of these variables, rates of return on equity, profit margins, debt-to-equity ratios, and other im- portant financial ratios have no objective meaning.

There is no rule of thumb that the ratios will always appear better under the purchase method or any other method that might be allowed in non-IASB jurisdictions.