E2 Financial Reporting

A. Fair value and measurement bases

Fair value (IFRS 13) is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. It is an exit price, so it is not adjusted for the transaction costs of buying or selling, though it does take account of transport costs if location matters. It is measured in the principal market, or if there is none, in the most advantageous market. For a non-financial asset, it uses the highest and best use that a market participant would make of it, which is physically possible, legally permissible and financially feasible.

The fair value hierarchy ranks the inputs used. Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date. Level 2 inputs are observable inputs other than Level 1, such as quoted prices for similar assets, interest rates and yield curves. Level 3 inputs are unobservable, based on the entity's own assumptions about what market participants would use. The measurement is classified in the level of the lowest input that is significant to the whole measurement, and it is always better to use Level 1 where possible. Level 3 measurements need more disclosure because they are more subjective.

Historical cost is objective, verifiable and simple, but it can be out of date, ignore inflation and make comparison between entities harder. Current value measures (fair value, current cost and value in use) give more relevant information about present values, but may be less reliable, cost more to prepare and need judgement. Neither is perfect: the use of current values does not solve all the problems of historical cost, because it also includes estimates and changes in value that may not be realised.

Key terms

• Exit price: The price received to sell an asset or paid to transfer a liability.
• Level 1 input: A quoted price in an active market for an identical item.
• Level 3 input: An unobservable input based on the entity's own assumptions.
• Highest and best use: The use of a non-financial asset that gives the highest value to market participants.

Study tip: When asked to classify a fair value, find the lowest level input that is significant to the measurement.

Practice questions for section A

B. IFRS Sustainability Disclosure Standards and ethics

IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information requires an entity to disclose information about sustainability-related risks and opportunities that could reasonably be expected to affect its cash flows, its access to finance or its cost of capital over the short, medium or long term. The core content has four parts: governance (the processes and people that oversee risks and opportunities), strategy (how they affect the business model, strategy and decision making), risk management (how risks are identified, assessed and managed) and metrics and targets (how performance is measured and progress is tracked). The information must be connected to the financial statements, and it is reported for the same reporting entity and the same period.

IFRS S2 Climate-related Disclosures applies the same structure to climate. It covers physical risks (from events such as floods and from longer-term shifts in climate), transition risks (from the move to a low carbon economy, such as new regulation, technology and changes in demand), and climate-related opportunities. Entities disclose metrics, including greenhouse gas emissions (Scope 1 direct emissions, Scope 2 emissions from purchased energy and Scope 3 other value chain emissions), as well as climate-related targets and the use of scenario analysis to test the resilience of their strategy.

Materiality. In the IFRS Sustainability Disclosure Standards, information is material if omitting or obscuring it could reasonably be expected to influence the decisions of the primary users of general purpose financial reports, who are investors, lenders and other creditors. This is financial materiality. The European Sustainability Reporting Standards also use double materiality, which adds the entity's impacts on people and the environment, whether or not they affect the entity's finances. As a result, a topic can be material under the European approach but not under the IFRS approach.

Ethics. The ACCA Code of Ethics and Conduct applies in financial reporting. Examples are pressure to change figures, to delay the recognition of a loss, to present the going concern assumption in a favourable way without enough evidence, or to overstate sustainability performance (greenwashing). The accountant should identify the threat to the fundamental principles, assess it, and apply safeguards, such as discussing the matter with those charged with governance, refusing to be associated with misleading information, and, if the issue is not resolved, seeking advice or resigning.

Key terms

• Governance, strategy, risk management, metrics and targets: The four pillars of the core content of IFRS S1 and S2.
• Physical risk: Climate risk from acute events or longer-term shifts in climate.
• Transition risk: Risk from the change to a low carbon economy.
• Double materiality: Materiality that includes both financial effects on the entity and the entity's impact on people and the environment.

Study tip: When comparing the two materiality concepts, name the users each one is aimed at.

Practice questions for section B

C. Employee benefits

Employee benefits are all forms of consideration given for the services of employees. Short-term benefits are due within 12 months of the end of the period in which the service is rendered, and they include wages, social security contributions, paid annual leave and sick leave, profit-sharing and bonuses, and non-monetary benefits. They are recognised as an expense, and as a liability if unpaid, in the period in which the employee provides the service, at the undiscounted amount expected to be paid.

Paid absences that accumulate (for example holiday that can be carried forward) are accrued as the service is rendered: the entity recognises the expected cost of the unused entitlement that it expects to be used. Non-accumulating absences, such as sick leave in some systems, are recognised when the absence occurs. Bonuses and profit-sharing are recognised when the entity has a present legal or constructive obligation to make the payment as a result of past events and a reliable estimate can be made.

Termination benefits are recognised at the earlier of the date on which the entity can no longer withdraw the offer of the benefits and the date it recognises restructuring costs that involve the payment of them. The syllabus covers those that are settled within 12 months.

Under a defined contribution plan, the entity pays fixed contributions into a separate fund and has no further obligation. The expense for the period is the contribution payable for service in that period. If the contributions paid are less than those due, the difference is a liability, and if more, it is a prepayment to the extent that it will reduce future payments or give a refund. The risk that the benefits will be less than expected falls on the employee, so there is no actuarial calculation.

Worked figures

Accumulating leave: 120 employees are expected to carry forward an average of 1.5 unused days each, and the daily pay is $80. The accrual is 120 x 1.5 x 80 = $14,400.

Defined contribution: the entity must contribute 8 percent of salaries of $2,500,000, which is $200,000. It paid $180,000 during the year, so a liability of $20,000 is recognised at the year end.

Key terms

• Short-term employee benefit: A benefit that falls due within 12 months after the period in which the service is given.
• Accumulating absence: Paid leave that can be carried forward and used in later periods.
• Defined contribution plan: A plan in which the entity pays fixed contributions and has no further obligation.

Study tip: For defined contribution plans, the expense is simply what is payable for the year. The calculation is short, but check the prepayment or liability.

Practice questions for section C

D. Groups: acquisitions, disposals and associates

At E2, the preparation of consolidated statements extends to a group with up to two subsidiaries and an associate. A parent controls an investee when it has power over it, exposure to variable returns, and the ability to use its power to affect those returns. An investor has significant influence over an associate where it has the power to take part in policy decisions. The acquisition method is used for subsidiaries (100 percent of the assets and liabilities, with a non-controlling interest), and the equity method for associates (a single line for the investment and for the share of profit).

Acquisition accounting. The consideration is measured at fair value, and includes shares issued, cash and the fair value of any contingent consideration. Acquisition-related costs are expensed. The subsidiary's identifiable assets and liabilities are included at fair value, and adjustments are made so that the subsidiary's accounting policies are uniform with the group's, for example if the subsidiary uses a different depreciation rate. The non-controlling interest can be measured at fair value or at its proportionate share of the net assets, and goodwill is the consideration plus the non-controlling interest less the fair value of the net assets acquired. Goodwill is tested for impairment each year. If the net assets acquired are worth more than the consideration plus the non-controlling interest, the difference is a gain on a bargain purchase, after the acquirer has checked that it has identified and measured all the assets and liabilities correctly, and it is recognised in profit or loss.

Intra-group transactions and balances are eliminated in full, with the unrealised profit removed from inventories, and from the profit of the seller, so that, if the seller is a subsidiary, the non-controlling interest shares in the adjustment.

Loss of control. If a parent sells its entire shareholding in a subsidiary, it stops consolidating from the date control is lost. The gain or loss in the group statements is the proceeds, less the subsidiary's net assets and unimpaired goodwill at the date of disposal, plus the carrying amount of any non-controlling interest that is derecognised. If the subsidiary is a separate major line of business, the result is presented as a discontinued operation.

Worked figures

Bargain purchase: consideration $700, NCI at fair value $100 and net assets at fair value $850. The excess of net assets over the total is 850-800 = $50, which is recognised as a gain in profit or loss after the checks above.

Disposal: a parent sells all of its shares in a subsidiary for $1,500. At the disposal date the subsidiary's net assets are $1,100, unimpaired goodwill is $200 and the NCI is $220. The group gain = 1,500 - (1,100 + 200) + 220 = $420.

Key terms

• Bargain purchase: An acquisition in which the fair value of net assets is more than the consideration plus the NCI, which gives a gain.
• Uniform accounting policies: The same policies used by all members of the group in the consolidated statements.
• Loss of control: The point at which a parent stops consolidating a subsidiary.

Study tip: Always check what happened to goodwill and the non-controlling interest on a disposal. Both are removed.

Practice questions for section D