Author: Mohammed Haque

  • Intangible assets (IAS 38)

    International Accounting Standard (IAS) 38, “Intangible Assets,” provides guidance on the recognition, measurement, and disclosure of intangible assets. IAS 38 applies to all intangible assets, except for certain intangible assets that are specifically excluded from the scope of the standard, such as financial instruments, deferred tax assets, and assets arising from employee benefits.

    IAS 38 defines an intangible asset as an identifiable non-monetary asset without physical substance. An intangible asset is identifiable if it is separable, meaning that it can be sold, transferred, licensed, or exchanged separately from the entity’s other assets. An intangible asset is non-monetary if it cannot be measured in terms of money.

    Intangible assets are required to be recognized as assets if they meet certain criteria, including the criterion that they are identifiable and meet the definition of an intangible asset. Intangible assets that are recognized as assets are required to be measured at cost less accumulated amortization and accumulated impairment losses, unless they are measured at fair value through profit or loss.

    Intangible assets with finite useful lives are required to be amortized over their useful economic lives, which is the period over which the assets are expected to generate economic benefits for the entity. The amortization period should be determined based on the expected pattern of consumption of the economic benefits of the assets, taking into account the nature of the assets and the entity’s expected future use of the assets.

    Intangible assets with indefinite useful lives are not amortized, but are required to be tested for impairment at least annually, or more frequently if there are indicators of impairment. The impairment test for intangible assets with indefinite useful lives involves comparing the carrying value of the assets to their recoverable amount. The recoverable amount is the higher of the assets’ fair value less costs to sell and their value in use.

    Intangible assets that are measured at fair value through profit or loss are required to be recognized at fair value at the date of acquisition, with any subsequent changes in fair value recognized in profit or loss in the period in which they arise. Intangible assets measured at fair value through profit or loss are not amortized, but are tested for impairment in the same way as intangible assets with indefinite useful lives.

    Disclosure of intangible assets is required in the financial statements, including information about the carrying amount, amortization, and impairment of intangible assets. The financial statements should also disclose any relevant assumptions and estimates used in determining the useful lives and impairment of intangible assets.

  • Share issue transaction costs

    Share issue transaction costs are costs incurred by a company in connection with issuing new shares. Share issue transaction costs can include costs such as legal fees, accounting fees, printing costs, and broker fees.

    Share issue transaction costs are usually required to be recognized as a deduction from equity (FRS 102 s22.9 and IAS 32 s37) and are usually offset against share premium.

  • Goodwill

    Goodwill is an intangible asset that arises when one entity acquires another entity and pays more than the fair value of the acquired entity’s net assets. Goodwill is typically assigned to a cash-generating unit (CGU), which is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

    Goodwill is required to be tested for impairment at least annually, or more frequently if there are indicators of impairment. The impairment test for goodwill involves comparing the carrying value of the goodwill to its recoverable amount. The recoverable amount is the higher of the goodwill’s fair value less costs to sell and its value in use.

    The value in use of goodwill is the present value of the future cash flows expected to be generated by the CGU to which the goodwill is assigned. The future cash flows should be based on the entity’s best estimate of the CGU’s future cash flows, taking into account the entity’s plans and assumptions about future market conditions, competition, and other factors. The future cash flows should be discounted at a rate that reflects the risks associated with the cash flows.

    If the carrying value of the goodwill exceeds its recoverable amount, the goodwill is impaired and the entity must recognize an impairment loss. The impairment loss is the difference between the carrying value of the goodwill and its recoverable amount. The impairment loss should be recognized in the income statement as an expense, and the carrying value of the goodwill should be reduced to its recoverable amount.

    For example, if an entity has goodwill with a carrying value of £500,000 assigned to a CGU, and the recoverable amount of the goodwill is determined to be £450,000, the goodwill is impaired and the entity must recognize an impairment loss of £50,000. The impairment loss of £50,000 would be recognized as an expense in the income statement, and the carrying value of the goodwill would be reduced to £450,000.

    Goodwill relating to a foreign subsidiary would need to be re-translated at each year end, with the exchange gain/loss recognised in an FX equity reserve relating to the subsidiary.

  • Restrospective correction of prior period errors

    A retrospective correction of prior period errors is a correction of errors that occurred in a previous period, but were not discovered until a subsequent period. Retrospective correction of prior period errors is required by IAS 8 and also FRS 102 s10.21 which state that errors should be corrected retrospectively by adjusting the opening balance of retained earnings for the earliest period presented.

    To correct a prior period error retrospectively, the entity should first determine the amount of the error and the period in which the error occurred. The entity should then adjust the opening balance of retained earnings for the earliest period presented in the financial statements, by the amount of the error and a corresponding adjustment to the appropriate item in the statement of financial position.

    For example, if an entity discovers a material £50,000 error in the calculation of opening balances for prepayments carried forward from 2022 during the audit of 2023, the entity would need to correct the error retrospectively. The other side of the entry would be to adjust the opening balance of retained earnings carried forward from 2022.

    The journal in 2023 would be:
    Dr prepayments £50,000
    Cr retained earnings b/fwd £50,000

    The comparatives column in the 2023 accounts would also be restated and the error would need to be disclosed.

  • Estimating fair value of unlisted shares

    The fair value of unlisted shares is the price at which the shares would be bought or sold between knowledgeable, willing parties in an arm’s length transaction. Estimating the fair value of unlisted shares can be challenging, as there is no readily available market price for the shares and the fair value must be determined using other methods.

    One method for estimating the fair value of unlisted shares is the income approach, which values the shares based on the present value of future cash flows. The income approach involves estimating the future cash flows that the shares are expected to generate, and then discounting those cash flows at a rate that reflects the risks associated with the cash flows.

    Another method for estimating the fair value of unlisted shares is the market approach, which values the shares based on comparable listed shares. The market approach involves identifying similar listed shares and comparing their market prices to the unlisted shares. The market approach can be challenging if there are no comparable listed shares, or if the listed shares are not sufficiently similar to the unlisted shares.

    A third method for estimating the fair value of unlisted shares is the cost approach, which values the shares based on the cost of reproducing or replacing the assets of the company. The cost approach involves estimating the cost of reproducing or replacing the assets of the company, and then adjusting the cost for any changes in the value of the assets since they were acquired.

    Overall, estimating the fair value of unlisted shares is a complex and uncertain process that requires careful analysis and judgment. The fair value of unlisted shares can be sensitive to the assumptions and methodologies used, and can vary significantly depending on the approach and the specific circumstances of the company.

  • Accounting for a convertible loan

    A convertible loan is a type of loan that can be converted into shares of the borrower’s common stock at the option of the lender. In accounting, a convertible loan is typically accounted for as a liability, with the potential conversion option being accounted for as a separate instrument, either as a liability or as equity.

    According to International Accounting Standard (IAS) 32, “Financial Instruments: Presentation,” a convertible loan should be initially recognized at fair value, with any difference between the loan’s fair value and the proceeds received from the lender being recognized as a gain or loss in the income statement. The loan should then be subsequently measured at amortized cost, using the effective interest method, with any difference between the loan’s amortized cost and its redemption value being recognized as a gain or loss in the income statement.

    The potential conversion option should be accounted for separately from the loan. If the conversion option is classified as a liability, it should be initially recognized at fair value, with any difference between the option’s fair value and the proceeds received from the lender being recognized as a gain or loss in the income statement. The option should then be subsequently measured at fair value, with any changes in fair value being recognized in the income statement.

    If the conversion option is classified as equity, it should be initially recognized at fair value, with any difference between the option’s fair value and the proceeds received from the lender being recognized as a contribution to equity. The option should then be subsequently measured at fair value, with any changes in fair value being recognized directly in equity.

    For example, if a company borrows £100,000 from a lender and the loan includes a conversion option that allows the lender to convert the loan into shares of the company’s common stock at a conversion price of £10 per share, the company would initially recognize the loan at fair value. If the fair value of the loan is £105,000, the company would recognize a gain of £5,000 in the income statement. The loan would then be subsequently measured at amortized cost using the effective interest method, with any difference between the amortized cost and the redemption value being recognized as a gain or loss in the income statement.

    If the conversion option is classified as a liability, it would be initially recognized at fair value. If the fair value of the option is £10,000, the company would recognize a gain of £10,000 in the income statement. The option would then be subsequently measured at fair value, with any changes in fair value being recognized in the income statement.

    If the conversion option is classified as equity, it would be initially recognized at fair value. If the fair value of the option is £10,000, the company would recognize a contribution to equity of £10,000. The option would then be subsequently measured at fair value, with any changes in fair value being recognized directly in equity.

  • IFRS 15 Revenue recognition

    International Financial Reporting Standard 15 (IFRS 15) is a new accounting standard that provides guidance on how to account for revenue from contracts with customers. IFRS 15 replaces the previous revenue recognition standards, including IAS 18, “Revenue,” and IAS 11, “Construction Contracts,” and is effective for annual periods beginning on or after January 1, 2018.

    IFRS 15 establishes a single, principles-based five-step model for recognizing revenue from contracts with customers. The five steps are:

    1. Identify the contract with the customer.
    2. Identify the performance obligations in the contract.
    3. Determine the transaction price.
    4. Allocate the transaction price to the performance obligations in the contract.
    5. Recognize revenue when (or as) the entity satisfies a performance obligation.

    The first step in applying IFRS 15 is to identify the contract with the customer. A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. A contract with a customer exists when the entity has approved the contract and the customer has accepted the offer to enter into the contract.

    The second step is to identify the performance obligations in the contract. A performance obligation is a promise to transfer a good or service to the customer in the contract. The entity should assess the contract to determine which promises are performance obligations, and which promises are not.

    The third step is to determine the transaction price. The transaction price is the amount of consideration to which the entity expects to be entitled in exchange for transferring the goods or services to the customer. The transaction price should be determined based on the contract, using the expected value of the consideration that the entity expects to receive from the customer.

    The fourth step is to allocate the transaction price to the performance obligations in the contract. The transaction price should be allocated to each performance obligation in the contract based on the relative standalone selling prices of the goods or services promised in the contract. The standalone selling price is the price at which the entity would sell the good or service separately to the customer.

    The fifth and final step is to recognize revenue when (or as) the entity satisfies a performance obligation. The entity should recognize revenue when it satisfies a performance obligation by transferring a good or service to the customer. This means that the entity should recognize revenue when it completes the performance obligation, or when it receives payment from the customer, whichever comes first.

    IFRS 15 includes detailed guidance on how to apply the five-step model in various situations, including contracts with multiple performance obligations, contracts with variable consideration, and contracts with non-cash consideration.

  • Accruals concept

    The accruals concept is a fundamental principle of accounting that states that income and expenses should be recognized in the period in which they are earned or incurred, rather than in the period in which they are paid or received. The accruals concept is based on the idea that the financial statements should reflect the economic substance of transactions, rather than their legal form.

    The accruals concept is applied through the use of accrual-based accounting, in which income and expenses are recognized based on the underlying economic events that give rise to them. This means that income is recognized when it is earned, and expenses are recognized when they are incurred, regardless of whether the cash has been received or paid.

    The accruals concept is applied in a number of ways in accounting, including the recognition of revenue, the recognition of expenses, and the matching of revenue and expenses.

    One example of the application of the accruals concept is the recognition of revenue. According to the accruals concept, revenue should be recognized in the period in which it is earned, rather than in the period in which it is received. This means that if a company performs a service or sells a product in one period, but does not receive payment until the next period, the revenue should be recognized in the first period, rather than the second period.

    For example, if a company provides consulting services to a client in December and issues an invoice for £10,000, but does not receive payment until January, the company would recognize the £10,000 of revenue in December, rather than in January. This is because the revenue was earned in December, when the consulting services were provided, rather than in January, when the cash was received.

    Another example of the application of the accruals concept is the recognition of expenses. According to the accruals concept, expenses should be recognized in the period in which they are incurred, rather than in the period in which they are paid. This means that if a company incurs an expense in one period, but does not pay the cash until the next period, the expense should be recognized in the first period, rather than the second period.

    For example, if a company purchases office supplies in December for £500 and receives an invoice, but does not pay the cash until January, the company would recognize the £500 of expense in December, rather than in January. This is because the expense was incurred in December, when the office supplies were purchased, rather than in January, when the cash was paid.

  • Useful economic life

    The useful economic life of an asset is the period over which the asset is expected to generate economic benefits for the entity. In other words, it is the period of time during which the asset is expected to be used by the entity to generate revenue or other economic benefits.

    The useful economic life of an asset is an important concept in accounting, as it is used to determine the amount of depreciation or amortization that should be recognized for the asset. Depreciation is the systematic allocation of the depreciable amount of a tangible asset over its useful life, while amortization is the systematic allocation of the amortizable amount of an intangible asset over its useful life.

    The useful economic life of an asset is determined by the entity based on its expected use of the asset. The useful economic life of an asset may be shorter than its physical life, if the entity expects to dispose of the asset before the end of its physical life. For example, a vehicle may have a physical life of 15 years, but the entity may expect to dispose of the vehicle after 5 years, in which case the useful economic life of the vehicle would be 5 years.

    The useful economic life of an asset may also be affected by obsolescence or technological changes. If an asset becomes obsolete or is replaced by a newer technology, the useful economic life of the asset may be shorter than its physical life. For example, a computer may have a physical life of 5 years, but if it becomes obsolete after 3 years, the useful economic life of the computer would be 3 years.

  • Acquisition with contingent consideration

    Contingent consideration is a type of payment that is dependent on the occurrence of a future event. In accounting, contingent consideration is recognized and measured when it is probable that the event will occur and the amount of the payment can be reasonably estimated.

    According to International Financial Reporting Standard 3 (IFRS 3), “Business Combinations,” contingent consideration is recognized as a liability in the acquirer’s balance sheet at the acquisition date. The liability is measured at fair value, which is the best estimate of the amount of the future payment at the acquisition date.

    The fair value of contingent consideration is determined using a valuation technique, such as a discounted cash flow analysis or a probability-weighted expected return calculation. The fair value of the liability is then adjusted for the passage of time and changes in the probability of the event occurring, until the event is no longer probable or the amount of the payment can no longer be reasonably estimated.

    Once the event has occurred and the amount of the payment has been determined, the acquirer is required to remeasure the liability at the amount of the payment. The difference between the original measurement of the liability and the remeasurement of the liability is recognized in the acquirer’s income statement as a gain or loss on the contingent consideration.

    For example, if a company acquires another company and agrees to pay a contingent consideration of £1 million if the acquired company achieves certain financial targets, the company would recognize a liability of £1 million at the acquisition date, measured at fair value. If the acquired company achieves the financial targets and the amount of the payment is determined to be £1 million, the company would remeasure the liability at £1 million and recognize any difference between the original measurement and the remeasurement as a gain or loss on the contingent consideration.