Revise lecture 22

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Reporting financial performance

Income statement and statement showing other comprehensive income

The IAS 1 requirements is to produce income statement and statement showing other comprehensive income.

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Exceptional items

• Exceptional items is the name often given to material items of income and expense of such size, nature or incidence that disclosure is necessary in order to explain the performance of the entity.

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Exceptional items

The accounting treatment is to:

1. Include the item in the standard income statement line.

2. Disclose the nature and amount in notes.

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Exceptional items

In some cases it may be more appropriate to show the item separately on the face of the income statement.

Examples include:

1. Write down of inventories to net realisable value (NRV)

2. Write down of property, plant and equipment to recoverable amount

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Exceptional items

Examples include:

3. Restructuring

4. Gains / losses on disposal of non-current assets

5. Discontinued operations

6. Litigation settlements

7. Reversals of provisions

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IFRS 5 Non-current assets held for sale and discontinued operations

The objectives of IFRS 5 are to set out:

• Requirements for the classification, measurement and presentation of non-current assets held for sale, in particular requiring that such assets should be presented separately on the face of the statement of financial position.

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IFRS 5 Non-current assets held for sale and discontinued operations

The objectives of IFRS 5 are to set out:

• Updated rules for the presentation of discontinued operations, in particular requiring that the results of discontinued operations should be presented separately in the income statement.

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IFRS 5 Non-current assets held for sale and discontinued operations

Classification as held for sale

• A non-current asset should be classified as ‘held for sale’ if its carrying amount will be recovered principally through a sale transaction rather than through continuing use.

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Classification as held for sale

For this to be the case, the following conditions must apply:

1. The asset must be available for immediate sale in its present condition.

2. The sale must be highly probable, meaning that:

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Classification as held for sale

• Management are committed to a plan to sell the asset• There is an active programme to locate a buyer• The asset is being actively marketed3. The sale is expected to be completed within 12

months of its classification as held for sale4. It is unlikely that the plan will be significantly

changed or will be withdrawn.

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Measurement of non-current assets held for sale

Non-current assets that qualify as held for sale should be measured at the lower of:

• Their carrying amount

• Fair value less costs to sell

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Measurement of non-current assets held for sale

Held for sale non-current assets should be:

• Presented separately on the face of the statement of financial position under current assets

• Not depreciated

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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:

1. Represents a separate major line of business or geographical area of operations

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Discontinued operations

2. Is a part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations

3. Is a subsidiary acquired exclusively with a view to resale.

Discontinued operations are required to be shown separately in order to help users to predict future performance, i.e. based upon continuing operations.

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Discontinued operations

Presentation in the income statement An entity must disclose a single amount on the face

of the income statement, comprising the total of:

1. The post-tax profit or loss of discontinued operations

2. The post-tax gain or loss of recognised on the measurement to fair value less cost to sell, or on the disposal, of the assets constituting the discontinued operation

• Leases

What is a leasing agreement?

• A leasing agreement is an agreement whereby one party, the lessee, pays lease rentals to another party, the lessor in order to gain the use of an assets over a period of time.

Types of leases

There are two types of lease:

1. A finance lease

2. An operating lease

Finance lease

• A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee.

Operating lease

• An operating lease is any lease other than a finance lease

Classification of leases

• To decide whether a lease is finance or operating, the first step is to assess whether the risks and rewards of ownership have transferred to the lessee.

Classification of leases

Risks and rewards

Risks and rewards of ownership include:

Risks:

1. Lessee carries out repairs and maintenance2. Lessee insures asset3. Lessee runs the risk of losses from idle capacity4. Lessee runs the risk of technological obsolescence

Classification of leases

Risks and rewards of ownership include:

Rewards:

1. Lessee has right to use asset for most or all of its useful life.

IAS 17 Leases - guidance

• IAS 17 provides guidance as to the classification of leases as finance leases or operating leases.

• It gives the following list of situations in which a lease would normally be classified as a finance lease.

IAS 17 Leases - guidance

1. The lease transfers ownership of the asset to the lessee by the end of the lease term.

2. The lessee has the option to buy the asset at a price expected to be lower than the fair value at the time the option is exercised.

3. The lease term is for the major part of the economic life of the asset even if title is not transferred.

IAS 17 Leases - guidance

4. At the beginning of the lease, the present value of the minimum lease payment (MLP’s) is approximately equal to the fair value of the asset.

5. The leased assets are of a specialised nature so that only the lessee can use them without major modification.

IAS 17 Leases - guidance

6. If the lease gives the lessee the right to cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee.

7. Gains or losses from fluctuations in fair value are borne by the lessee.

8. The lessee has the ability to continue the lease for a secondary period at a rent below the market rent.

Question 1 – Lease classification

A company has entered into a 4 year lease for a machine, with lease rentals of Rs150,000 payable annually in advance and with an optional secondary period of 3 years at rental of 80%, 60% and 40% of the annual rental in the primary period.

It is agreed that these rentals represent a fair commercial rate. The machine has a useful life of 8 years and a cash value of Rs600,000.

• Would this lease agreement be a finance lease or an operating lease?

Question1 - Solution

The contracted lease term is only for half of the useful life of the machine and there is no strong likelihood that the company will exercise the option in 4 years time, because the option is priced at fair value, not a discount.

Thus the risks and rewards of ownership have not passed to the lessee and this lease should be treated as an operating lease.