DipIFR Exam Dec 25 – Questions, Answers & Examiner Feedback (Q2–Q4)

Question 2

Green prepares financial statements to 30 June each year. You are a trainee accountant employed by Green and report to the finance director (FD).

Background – Email from Finance Director

The FD wants the financial results to show a favourable performance and position as staff bonuses depend on reported profit. The FD has set out two matters with specific instructions on how to treat them. The FD also implies that your brother may receive a job offer if you follow the instructions.

Attachment 1 – Retirement Benefit Plans

Plan A: Company contributes 10% of gross salaries. No future obligation once contributions are made. Gross annual salaries = $30m. Monthly payments = $200,000. FD instruction: Charge only $2.4m to profit or loss.

Plan B: Company contributes 10.5% of $20m gross salaries at year end. Benefit based on final salary and length of service. Company bears risk if plan assets are insufficient. FD instruction: Charge $2.1m contribution as operating expense.

Discount rate (high-quality corporate bonds, 1 Jul 20X7): 5%

Attachment 2 – Contract with Customer C

Green constructed a large asset (cost $30m), delivered 1 Jan 20X8. Customer C had a right of return until 31 Mar 20X8. Cash selling price = $40m. Actual selling price = $48.4m payable 2 years after right of return expires. Interest rate = 10%.

FD instruction: Recognise $48.4m revenue on 1 Jan 20X8 plus $2.42m interest income for year.

Requirements

• (a) Explain and show the correct accounting treatment for both attachments for year ended 30 Jun 20X8. (20 marks)
• (b) Identify and explain THREE ethical issues confronting you from the FD’s email.

Part (a) – Plan A (Defined Contribution – IAS 19)

Plan A has no further obligation once contributions are made — this is a defined contribution plan. The charge to profit or loss must be the full contributions payable for the period.

Contributions payable = $30m × 10% = $3 million. The FD’s instruction of $2.4m is incorrect. The unpaid balance of $600,000 ($3m − $2.4m) must be recognised as a current liability in the SOFP.

Part (a) – Plan B (Defined Benefit – IAS 19)

Benefits are based on final salary and length of service; the company bears residual risk. This is a defined benefit plan. Contributions cannot simply be expensed.

• Net liability in SOFP (30 Jun 20X8): $7,200k − $6,400k = $800,000 (non-current liability)
• Current service cost in P&L: $2,500,000
• Net interest expense in P&L: $30,000 (net liability $600k × 5%)
• Actuarial gain in OCI: $230,000 (see working)

Working – Defined Benefit Reconciliation ($000)

Part (a) – Contract with Customer C (IFRS 15)

Revenue cannot be recognised on 1 Jan 20X8 due to the right of return and Customer C being a new customer with no history. Revenue is recognised on 31 Mar 20X8 when the right of return expires.

On 1 Jan 20X8: $30m cost is removed from inventory and recognised as a right of return asset.

The contract contains a significant financing component. Revenue = cash selling price = $40 million (not $48.4m). The $8.4m difference is recognised as interest income over 2 years.

• Interest income for year ended 30 Jun 20X8 (3 months): $40m × 10% × 3/12 = $1 million
• Trade receivable at 30 Jun 20X8 (non-current asset): $41 million

Part (b) – Ethical Issues

1. Self-interest threat / objectivity: The profit-related bonus creates a personal financial interest in reporting higher profits, threatening the fundamental principle of objectivity.
2. Intimidation threat: The implied job offer for your brother is an intimidation threat to your objectivity and independence.
3. Integrity: Following the FD’s instructions would result in misstatement of the financial statements, breaching the fundamental principle of integrity.
4. Professional competence and due care: As a part-qualified trainee, you may lack the competence to independently assess these complex transactions.

Retirement Plans

• Most candidates correctly identified Plan A as defined contribution and Plan B as defined benefit.
• Plan A accounting was generally satisfactory.
• For Plan B, a significant minority failed to mention the actuarial gain/loss in OCI, indicating only partial understanding of IAS 19.

Construction Contract (IFRS 15)

• A minority incorrectly applied IAS 16 (Property, Plant and Equipment) despite the asset being constructed for sale.
• Some candidates merely restated the five-step IFRS 15 model without applying it — this attracts no marks.
• Most appreciated revenue could not be recognised until 31 Mar 20X8, but very few correctly identified the right of return asset treatment on 1 Jan 20X8.
• Only a minority correctly calculated revenue as $40m and interest income as $1m (3 months to 30 Jun 20X8).

Ethics (Part b)

• Candidates who applied the ethical code principles to the specific scenario generally scored well.
• Simply listing principles without applying them to the scenario earned very few marks.

Question 3

You are Epsilon’s financial controller. Trainee F has raised queries about the recognition and measurement of intangible assets.

Exhibit 1 – Trainee F’s Queries

• Frankie’s brand name is recognised in consolidation but Epsilon’s own brand name is not — is this inconsistent?
• Some R&D costs are capitalised and some are not — why?
• Which IFRS standard applies and what is the definition of an intangible asset?
• What are the recognition and measurement principles (initial and subsequent)?

Exhibit 2(i) – Acquisition of Frankie

Epsilon acquired 100% of Frankie on 1 Oct 20X5 for $60m.

PPE remaining useful life: 5 years. Brand names: indefinite life. Recoverable amount of brands at 31 Mar 20X6: $9 million.

Exhibit 2(ii) – Research & Development Project

Project began 1 Apr 20X5:

• Research phase (3 months to 30 Jun 20X5): Evaluated technical feasibility
• Development phase (1 Jul–31 Oct 20X5): Developed chosen method; ready for use 31 Oct 20X5
• Training (Nov 20X5): Employee training on new process — $1.5m
• In use from 1 Dec 20X5; 4-year competitive advantage

Note 1: Machinery purchased 1 Apr 20X5, useful life 5 years, used exclusively on the project until 31 Oct 20X5.

Requirements

• (a) Answer Trainee F’s two questions from Exhibit 1. (12 marks)
• (b) Explain and show how the Exhibit 2 transactions should be accounted for in Epsilon’s financial statements for the year ended 31 Mar 20X6. (13 marks)

Part (a) – Q1: Relevant Standard and Definition

IAS 38 – Intangible Assets applies. An intangible asset is a non-monetary asset without physical substance that is identifiable. An asset is identifiable if it is either:

• Separable — capable of being sold, transferred or exchanged, or
• Arises from contractual or other legal rights, regardless of whether those rights are separable.

Part (a) – Q2: Recognition and Measurement

Additional criteria: reliably measurable cost and expected future economic benefits.

• Separately purchased: Recognised at cost of purchase.
• Business combination: Recognised at fair value at acquisition date (IFRS 3). This is why Frankie’s brand is recognised in the consolidated financial statements.
• Internally generated: Generally cannot be recognised — cannot be separated from goodwill. This is why Epsilon’s own brand is not recognised.
• R&D exception: Development phase costs must be capitalised if all IAS 38 criteria are met. Research phase costs must always be expensed.

Subsequent measurement: Finite life — cost less amortisation and impairment. Indefinite life — no amortisation; annual impairment review. Revaluation only permitted where an active market exists (rare for intangibles).

Part (b)(i) – Acquisition of Frankie

Under IFRS 3, Frankie’s net assets are incorporated at fair value on 1 Oct 20X5.

PPE: Recognised at $38m. Depreciation = $38m ÷ 5 × 6/12 = $3.8m charged to P&L. Carrying amount at 31 Mar 20X6 = $34.2m.

Brand names: Recognised at fair value = $8m. Indefinite life → no amortisation. Impairment review required: carrying amount $8m < recoverable amount $9m → no impairment. Brands remain at $8m in SOFP. Note: IAS 38 prohibits revaluation of brands (no active market).

Part (b)(ii) – R&D Project

Research phase costs (expensed to P&L):

• Materials: $4,000k
• Staff & specific overheads: $8,000k
• General fixed overheads: $4,500k (expensed in both phases)
• Machinery depreciation – research phase: $90m × 1/5 × 3/12 = $4,500k

Development phase costs (capitalised as intangible asset):

• Materials: $8,000k
• Staff & specific overheads: $16,000k
• Machinery depreciation – development phase: $90m × 1/5 × 4/12 = $6,000k
• Total intangible asset: $30,000k

Training costs ($1,500k): IAS 38 prohibits capitalisation of training → expensed to P&L.

Post-development machinery depreciation (Nov 20X5 – Mar 20X6, 5 months): $90m × 1/5 × 5/12 = $7,500k → P&L.

Amortisation commences 1 Dec 20X5 (available for use). For year ended 31 Mar 20X6 (4 months): $30m × 1/4 × 4/12 = $2,500k.

Machinery carrying amount at 31 Mar 20X6: $90m − $4.5m − $6m − $7.5m = $72m

Part (a) – IAS 38 Recognition

• Where candidates addressed the actual questions asked, answers were generally satisfactory.
• Only a minority addressed the identifiability criterion specifically.
• A significant minority made general references to IAS 38 without answering the questions — this did not generate high marks.

Part (b)(i) – Frankie Acquisition

• Some stated brands should be shown at recoverable amount — this is incorrect under IAS 38 (no active market for brands, so revaluation is not permitted).
• Others concluded impairment had occurred because recoverable amount ($9m) exceeded carrying amount ($8m) — a misunderstanding: impairment only arises when carrying amount exceeds recoverable amount.
• A few attempted a goodwill impairment calculation without the information needed to do so.

Part (b)(ii) – R&D Project

• Failure to include machinery depreciation during the development phase as part of the intangible asset cost.
• Including general fixed overheads in the intangible asset (not permitted under IAS 38).
• Including training costs in the intangible asset (specifically prohibited under IAS 38).
• Failing to commence amortisation from 1 December 20X5 (the date the process was available for use).

Question 4

You are the financial controller of Omega, a large listed entity. An assistant has raised queries on three matters in the draft consolidated financial statements for the year ended 30 June 20X9.

Exhibit 1 – Events After the Reporting Period (IAS 10)

Issue 1: On 7 Jul 20X9, a customer owing $6m was declared legally insolvent (very unlikely to recover anything). The company was aware of financial difficulties before year end but thought they could be overcome. Draft FS show a $6m impairment loss.

Issue 2: On 10 Jul 20X9, a fire caused ~$10m estimated repair cost. Not recognised in draft FS.

Query: How can both treatments comply with IFRS? It seems misleading to report Issue 1 but not Issue 2.

Exhibit 2 – Provisions (IAS 37)

Query 1 – Legal claims:

• Customer A: Claiming $2m damages. 60% probability of success. Provision of $2m recognised.
• Employee B: Claiming $1m for workplace accident (primarily their own fault). 25% probability. No provision recognised.

Query: Shouldn’t the total provision be $1.45m (expected value basis)?

Query 2 – Site restoration:

• No legal obligation to restore, but company always has restored previous sites.
• Provision recognised at $12.28m (PV of $20m in 10 years at 5%; factor 0.614).
• Sub-queries: (a) Why a provision if no legal obligation? (b) What does time value of money have to do with it? (c) Where is the debit entry?

Exhibit 3 – Consolidation of Minnie (IAS 23 / IFRS for SMEs)

Minnie (medium-sized, non-listed subsidiary, same jurisdiction as Omega) does not capitalise borrowing costs on constructed assets in its own accounts. Omega does capitalise these costs under group policy.

Queries: (a) How can they account differently if they’re in the same jurisdiction? Is one wrong? (b) If Minnie’s treatment is acceptable, why adjust it at consolidation?

Requirement

Provide answers to all queries in Exhibits 1, 2 and 3 with reference to relevant IFRS Accounting Standards. (25 marks)

Exhibit 1 – IAS 10: Events After the Reporting Period

IAS 10 classifies post-reporting-period events (occurring after 30 Jun 20X9 but before the financial statements are authorised for issue) into two categories:

Issue 1 – Customer insolvency (Adjusting event): The insolvency on 7 Jul 20X9 provides evidence of a condition that existed at 30 Jun 20X9 (the customer was already in financial difficulty). This is an adjusting event — the $6m impairment loss is correctly recognised in the financial statements.

Issue 2 – Factory fire (Non-adjusting event): The fire on 10 Jul 20X9 arose entirely after the reporting date. The factory was undamaged at 30 Jun 20X9. This is a non-adjusting event — no adjustment is made to the financial statements. However, because the $10m cost is material, it must be disclosed in the notes to the financial statements.

Exhibit 2 – IAS 37: Provisions

Query 1 – Legal claims:

A provision is recognised under IAS 37 when: (i) there is a present obligation from a past event, (ii) an outflow of economic benefits is probable, and (iii) the amount can be reliably estimated.

• Customer A (60%): All criteria met — obligation exists (supply of faulty goods), outflow is probable (60%), amount measurable. Provision of $2m is correct. For a single obligation, IAS 37 uses the individual most likely outcome, not an expected value. The most likely outcome is the full $2m claim succeeding.
• Employee B (25%): Outflow is not probable (only 25%). No provision required. This is a contingent liability, disclosed in the notes only.

The $1.45m expected value approach the assistant suggests is appropriate only for a large population of similar items — not for individual single obligations.

Query 2 – Site restoration:

(a) Constructive obligation: Although there is no legal obligation, IAS 37 recognises constructive obligations. The company’s consistent past practice of restoring previous sites creates a valid expectation in affected parties that restoration will occur again. This constructive obligation is sufficient to justify a provision.

(b) Time value of money: IAS 37 requires that where the effect is material, provisions are measured at the present value of the expected future expenditure. $20m payable in 10 years at a 5% discount rate has a present value of $12.28m ($20m × 0.614). Measuring the full $20m today would overstate the current liability.

(c) Debit entry: Where a restoration provision relates to the construction of an asset on the site, the debit is capitalised as part of the cost of the asset under IAS 16, not charged immediately to profit or loss. The provision unwinds over time as an interest charge to P&L.

Exhibit 3 – IAS 23 / IFRS for SMEs

(a) Can they account differently? Under IAS 23 – Borrowing Costs, borrowing costs directly attributable to the construction of a qualifying asset must be capitalised. However, the IASB has issued the IFRS for SMEs Accounting Standard for entities that are not publicly accountable. Minnie, as a medium-sized non-listed entity, is likely eligible to use the IFRS for SMEs, which prohibits capitalisation of borrowing costs. Therefore, neither entity is accounting incorrectly — they are applying different but each valid frameworks.

(b) Why adjust at consolidation? Under IFRS 10 – Consolidated Financial Statements, the group must apply uniform accounting policies to all entities when preparing consolidated financial statements. Even though Minnie’s policy is valid in its own accounts, it must be adjusted to align with the group’s IAS 23 capitalisation policy at the consolidation stage.

Exhibit 1 – IAS 10

• Most correctly identified IAS 10 as the relevant standard.
• A pleasing number demonstrated complete understanding of adjusting vs. non-adjusting events and achieved near-full marks.
• At the other extreme, some made only brief general references to IAS 10 with little application to the specific events — very few marks earned.

Exhibit 2 – IAS 37

• Most correctly applied IAS 37 — provision for Customer A (60% probable) but not Employee B (25%).
• Only a minority could clearly explain that $2m is appropriate because IAS 37 uses the individual most likely outcome for a single obligation, not an expected value.

• Only a minority clearly identified and explained the concept of a constructive obligation for the site restoration provision.
• A significant number did not appreciate that the debit on initial recognition of the restoration provision goes to property, plant and equipment — not to profit or loss.

Exhibit 3 – IAS 23 / IFRS for SMEs

• Most correctly referenced IAS 23 and concluded that the group policy complies with it.

• Some incorrectly suggested Minnie must be in a different accounting jurisdiction — the question stated both are in the same jurisdiction.

• A pleasing number correctly concluded that Minnie, as a non-publicly accountable entity, is likely applying the IFRS for SMEs.
• Most correctly stated that uniform accounting policies must be applied at consolidation level under IFRS 10.