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  • 3 Marks

FR – Nov 2023 – L2 – Q2d – Financial Reporting Standards and Their Applications

Explain the financial reporting treatment of decommissioning costs in the financial statements of Taini Ltd under IAS 37.

Taini Ltd (Taini) is a listed mining company that operates in the Bono Region with a ten-year term concession commencing on 1 April 2022. After the expiry of the current mining term, Taini has a duty to rehabilitate the area. These rehabilitations are anticipated to cost GH¢12.09 million on April 1, 2032. On April 1, 2022, the present value of the restoration cost was calculated using the company’s 8% cost of capital at GH¢5.6 million.

Required:
In accordance with IAS 37: Provisions, Contingent Liabilities and Contingent Assets, explain the financial reporting treatment of the above transaction in the financial statements of Taini Ltd for the year ended 31 March 2023.

Any amount recorded at the present value of future cash flows should be adjusted as time passes. The adjustment allows for the fact that the time to maturity is shorter. The adjustment is measured as the opening balance multiplied by the original discount rate.

Here, GH¢5.6 million × 8% gives GH¢0.448 million. This is charged (debited) to profit or loss (finance costs) and increases the present value of the provision (credit entry).

Debit profit or loss GH¢0.448 million
Credit provision for restoration GH¢0.448 million
Alternatively:

DR Non-current Asset GH¢5.6 million

CR Provision for decommissioning cost GH¢5.6 million
(To initially recognise the asset and liability relating to decommissioning cost.)

DR Statement of profit or loss (depreciation) GH¢0.56 million

CR Non-current asset GH¢0.56 million
(To recognise depreciation charge for the year.)

DR Statement of profit or loss (unwound discount) GH¢0.448 million

CR Provision for decommissioning cost GH¢0.448 million
(To recognise the unwound discount on the liability for the year.)

(Total: 3 marks)

  • 20 Marks

AA – Nov 2015 – L2 – Q5 – Completion Procedures and Reporting, Audit and Assurance Evidence

Discussing financial statement amendments for inventory valuation, depreciation, and contingent liabilities, and their impact on the auditor’s report.

Big Build is a listed construction company with an annual revenue of GHS350m. Big Build’s draft statement of profit or loss shows a profit before tax for the year ended December 31, 2008, of GHS40m.

Big Build’s audit firm is conducting an audit. This is the first audit of Big Build that this audit firm has conducted. An enquiry to the previous audit firm revealed no reasons for concern. On completing audit work at the company’s premises, the audit senior drafts a memo, extracts from which are reproduced below:

(a) Inventory valuation:
Inventories include GHS7m, at cost, for scrap rubber from used car tyres. This material is widely used as a road surface in other countries. Contracts for road building with this country’s Highways Agency, the state authority for road construction, do not currently permit the use of this material. However, the matter was known to be under review, and Big Build speculated on a favourable outcome of this review and purchased the material. In February 2009, shortly before the financial statements were approved by the directors, the Highways Agency reported that it would not, currently, accept the use of this material. If used on non-Highways Agency contracts, the material’s net realisable value would not exceed GHS2m.

The finance director maintains that the issue of the Highways Agency report was a non-adjusting event after the reporting period. The write-down of the inventory should, therefore, be reflected in the next period’s financial statements.

(b) Depreciation:
During the year ended December 31, 2005, the company purchased two computer-controlled earth movers at a cost of GHS2,500,000 each and a further two at the same price during the year ended December 31, 2006. Depreciation has been provided at 10% straight line, the same basis as it previously depreciated conventional earth movers. This year, 2008, the company has decided that improvements in technology made it worthwhile scrapping their first two computer-controlled earth movers and replacing them with the latest model at a cost of GHS6,000,000 each. The company provides a full year’s depreciation charge in the year of acquisition and none in the year of disposal.

The company’s chief engineer tells you that technology is developing so rapidly it appears likely they will continue to replace these machines every five years. In spite of this, the finance director claims that the depreciation rate of 10% is in line with the industry standard and reflects the physical life of the machines. He urges that continued improvements in technology cannot be foreseen, and that there is no justification for increasing depreciation to 20% because of the possibility of technological obsolescence.

(c) Contingent liability:
The company is being sued for GHS50m by the Highways Agency for defective work on a recently completed road. The company maintains that it met the Highways Agency’s specification and it is the Agency’s engineers who are at fault in drawing up the specification. Big Build maintains that it has no case to answer, that the possibility of loss is remote, and that the claim need not be disclosed as a contingent liability. An investigative journalist has recently published an article suggesting that other roads constructed by the company exhibit similar faults. The managing director has admitted that the company’s road building techniques are under investigation by the Highways Agency. If the company were to lose the case, its future going concern would be threatened. No disclosure has been made in the financial statements.

Required:
For each of the following three issues, discuss whether the financial statements require amendment and describe the impact on the auditor’s report if the issue remains unresolved.
a) Inventory valuation.
(6 marks)
b) Depreciation.
(7 marks)
c) Contingent liability.
(7 marks)

Total: 20 marks

a) Inventory valuation:

  • Whether the financial statements require amendment:
    IAS 2 Inventories states that inventory should be valued at the lower of cost and net realizable value (NRV). Since the Highways Agency does not currently allow the use of the scrap rubber for road surfaces, its NRV has decreased to GHS2m. Therefore, the inventory is overstated by GHS5m, and profits are materially overstated. The director’s argument that this is a non-adjusting event is incorrect because the event provides further evidence of a condition that existed at the reporting date. The write-down should be reflected in this period’s financial statements, not in the next period.
  • Impact on the auditor’s report:
    If the financial statements are not amended, the error would be considered material (the GHS5m overstatement represents 12.5% of profit before tax). The audit report would need to be qualified for material misstatement. A “basis for qualified opinion” paragraph would be added, and the opinion would be qualified “except for” the inventory valuation misstatement.

b) Depreciation:

  • Whether the financial statements require amendment:
    IAS 16 Property, Plant and Equipment requires that depreciation be charged over the asset’s useful life. The earth movers are being replaced every five years, not ten as currently estimated. Therefore, the depreciation rate should be increased to reflect the shorter useful life. The current 10% depreciation rate is incorrect and understates the depreciation expense, leading to an overstatement of non-current assets and profits. An adjustment to a 20% depreciation rate is required.
  • Impact on the auditor’s report:
    The adjustment is potentially material as the difference in depreciation (GHS2.03m) represents about 5% of profit before tax. If management refuses to amend the financial statements, the audit report would be qualified for material misstatement. A “basis for qualified opinion” paragraph would explain the misstatement, and the opinion would be qualified “except for” the depreciation error.

c) Contingent liability:

  • Whether the financial statements require amendment:
    Under IAS 37 Provisions, Contingent Liabilities, and Contingent Assets, a contingent liability should be disclosed if there is a possible obligation arising from past events. Given the investigation by the Highways Agency and the potential impact on the company, the probability of losing the case appears greater than remote. Therefore, the failure to disclose this contingent liability is a material misstatement. Furthermore, the issue raises going concern concerns, as losing the case could threaten the company’s future viability.
  • Impact on the auditor’s report:
    If the financial statements do not disclose the contingent liability, the auditor would issue a qualified opinion for material misstatement. If the going concern issue is significant and pervasive, an adverse opinion may be necessary. In that case, the opinion paragraph would state that the financial statements do not give a true and fair view due to the omission of a significant disclosure related to the contingent liability.
  • 5 Marks

FR – May 2017 – L2 – Q2a – Financial Reporting Standards and Their Applications

Discuss how to account for the cost of site reclamation and the financial effects of an earthquake.

Akakpo Ltd obtained a license free of charge from the government to dig and operate a gold mine. Akakpo Ltd spent GH¢6 million digging and preparing the mine for operation and erecting buildings on site. The mine commenced operations on 1 September 2014. The license requires that at the end of the mine’s useful life of 20 years, the site must be reclaimed, all buildings and equipment must be removed, and the site landscaped. At 31 August 2015, Akakpo Ltd estimated that the cost in 19 years’ time of the removal and landscaping would be GH¢5 million, and its present value is GH¢3 million.

On 31 October 2015, there was a massive earthquake in the area, and Akakpo Ltd’s mine shaft was badly damaged. It is estimated that the mine will be closed for at least six months and will cost GH¢1 million to repair.

Required:

i) Demonstrate how Akakpo Ltd should record the cost of the site reclamation as at 31 August 2015 in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
(3 marks)

ii) Explain how Akakpo Ltd should treat the effects of the earthquake in its financial statements for the year ended 31 August 2015 in accordance with IAS 10 Events after the Reporting Period.
(2 marks)

i) IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that future costs of reinstatement be provided for as soon as they become an unavoidable commitment. The mine’s license requires the work to be done, so there is a commitment as soon as the mine starts operations. The present value of the full cost must be provided for. GH¢3 million will be credited to provisions and added to the cost of the non-current asset.
(3 marks)

ii) The earthquake occurred after the end of the accounting period. Assets and liabilities at 31 August 2014 were not affected. The earthquake is indicative of conditions that arose after the reporting period and does not give any further evidence in relation to assets and liabilities in existence at the reporting date. Therefore, according to IAS 10 Events after the Reporting Period, it will be classified as a non-adjusting event after the reporting period. The cost of the repairs will be charged to the Statement of Comprehensive Income in the period when it is incurred. Due to the impact on Akakpo Ltd (closure and loss of earnings for six months), the earthquake and an estimate of its effect will need to be disclosed by way of a note in Akakpo Ltd’s financial statements for the year ended 31 August 2015.

  • 6 Marks

CR – Nov 2021 – L3 – Q2c – IAS 38: Intangible Assets

Advise Zunka Ltd on how to account for the cost of adapting equipment and the provision for potential damages in a legal case for patent infringement.

Zunka Ltd (Zunka) is a private pharmaceutical company in Ghana, which imports medical equipment manufactured under a patent. Zunka subsequently adapts the equipment to fit the market in Ghana and sells the equipment under its own brand name. Zunka originally spent GH¢6 million in developing the know-how required to adapt the equipment, and, in addition, it costs GH¢100,000 to adapt each piece of equipment. Zunka has capitalised the cost of the know-how and the cost of adapting each piece of equipment sold as patent rights.

Zunka is being sued for patent infringement by Sajida Ltd (Sajida), the owner of the original patent, on the grounds that Zunka has not materially changed the original product by its subsequent adaptation. If Sajida can prove infringement, the court is likely to order Zunka to pay damages and stop infringing its patent. Zunka’s lawyers are of the view that the court could conclude that Sajida’s patent claim is not valid.

Sajida has sued Zunka for GH¢10 million for using a specific patent and a further GH¢16 million for lost profit due to Zunka being a competitor in the market for this product. Zunka has offered GH¢14 million to settle both claims but has not received a response from Sajida.

As a result, the directors of Zunka estimate that the damages it faces will be between the amount offered by Zunka and the amount claimed by Sajida. The directors of Zunka would like advice as to whether they have correctly accounted for the costs of the adaptation of the equipment and whether they should make a provision for the potential damages in the above legal case in the financial statements for the year ended 31 March 2021.

Required:

Advise the directors of Zunka on how the above transaction should be accounted for in its financial statements for the year ended 31 March 2021 in accordance with relevant International Financial Reporting Standards (IFRS).

In accordance with IAS 38: Intangible Assets, the three features to intangible assets are:

  1. Identifiability: The asset must be separable or arise from contractual or other legal rights.
  2. Control: The entity controls the future economic benefits of the asset.
  3. Future Economic Benefits: The asset will generate probable future economic benefits.

In addition, the cost of the intangible asset should be capable of reliable measurement. Development costs are capitalised only after the technical and commercial feasibility of the asset have been established. The entity must intend and be able to complete the intangible asset, and either use it or sell it, and be able to demonstrate how the asset will generate future economic benefits.

It appears in principle that the above criteria may have been satisfied in the case of the costs of adapting the medical equipment imported by Zunka Ltd. However, only the costs incurred in developing the initial know-how of GH¢6 million may be capitalised, as these are the costs of establishing the technical and commercial feasibility of the equipment.

The costs of adapting each piece of equipment of GH¢100,000 are simply production costs to be included in cost of sales, and if the equipment is not sold, they should be included in the inventory valuation of the equipment.

Provisions under IAS 37:

IAS 37: Provisions, Contingent Liabilities, and Contingent Assets requires that a provision be recognised if the following conditions are met:

  1. There is a present obligation (legal or constructive) due to a past event.
  2. It is probable that an outflow of economic resources will be required to settle the obligation.
  3. The amount of the obligation can be estimated reliably.

An outflow of economic resources is deemed probable when the outflow of resources is more likely than not to occur. For an estimate of the amount of the obligation to be reliable, it is sufficient if a range of probable outcomes can be determined.

The amount recognised as a provision should be the best estimate of the expenditure that an entity would rationally pay to settle. Zunka Ltd’s lawyers feel that the court could conclude that the patent claim is not valid. However, Zunka Ltd has offered GH¢14 million to settle both claims without going to court. Therefore, this implies that Zunka Ltd believes that it is more likely than not that a present obligation exists, resulting from a past event.

The amount of the provision may not correspond to the amount which has been offered to Sajida Ltd, as there is no certainty that Sajida Ltd will accept the offer. Therefore, as it is difficult to determine the amount of the provision within a range of probable outcomes, IAS 37 states that where a continuous range of possible outcomes exists, and each point in that range is as likely as any other, the mid-point of the range should be used.

Thus, Zunka Ltd should recognise a provision of GH¢10 million in its financial statements at 31 March 2021 and disclose the uncertainties relating to the amount or timing of these cash outflows.

  • 5 Marks

CR – Dec 2022 – L3 – Q3a – IAS 36: Impairment of Assets ,IAS 37: Provisions, contingent liabilities and contingent assets

Determine the appropriate accounting treatment for Samed Ltd's production facility impairment.

Samed Ltd is a Ghanaian company located in the Northern Region that manufactures goods such as washing machines, tumble dryers, and dishwashers. The manufacturing industry in Ghana is highly competitive with many products on the market. Samed Ltd’s current accounting year-end is 31 December 2022.

Samed Ltd has a production facility that started showing serious cracks and signs of possible leakage since July 2022. It is probable that Samed Ltd will have to undertake major repairs sometime during 2023 to rectify the problem. Samed Ltd does not have an insurance policy covering the production facility. The Chief Operating Officer has refused to disclose the issue in the financial statements for the year ended 31 December 2022, and no repair costs have yet been undertaken, although he is aware that this is contrary to International Financial Reporting Standards (IFRSs). According to the Chief Operating Officer, he does not believe that the need for major repairs on the production facility is an indicator of impairment. Furthermore, the Chief Operating Officer argues that no provision for the repair to the production facility should be made as there is no legal or constructive obligation to repair the facility.

Samed Ltd has a revaluation policy for property, plant, and equipment, and there is a balance on the revaluation surplus of GH¢20 million in the financial statements for the year ended 31 December 2022. However, this balance does not relate to the production facility, but the Chief Operating Officer is of the opinion that this surplus can be used for any future loss arising from the collapse of the production facility.

Required:
In accordance with relevant IFRSs, discuss the accounting treatment which Samed Ltd should adopt to account for the above transaction in its financial statements for the year ended 31 December 2022.
(5 marks)

In line with IAS 36, the cracks and possible leakage are indicators of impairment for the production facility. The following accounting treatment should be adopted:

  1. Impairment Testing:
    • The production facility should be tested for impairment as it is likely part of a cash-generating unit (CGU). Since the production facility does not independently generate cash flows, it is necessary to combine it with other assets, such as plant and machinery, to form a CGU.
    • The recoverable amount should be determined as the higher of its fair value less costs to sell and value in use.
    • If the carrying amount exceeds the recoverable amount, an impairment loss must be recognized.
  2. Fair Value Consideration:
    • Reference should be made to IFRS 13 for fair value measurement. The fair value could be estimated by considering similar production facilities that have been recently sold, if available.
    • Value in use should be calculated by estimating the future cash flows the facility is expected to generate, discounted at an appropriate rate.
  3. Recognition of Impairment Loss:
    • Any impairment loss should be expensed in the profit or loss statement. The revaluation surplus cannot be used to offset the impairment loss since the revaluation surplus does not specifically relate to the impaired production facility.
  4. No Provision for Repairs:
    • IAS 37 specifies that no provision for repairs should be recognized, as there is no legal or constructive obligation to repair the facility at the reporting date.

(Marks are evenly distributed = 5 marks)

  • 8 Marks

Title: AAA – May 2019 – L3 – Q1a – The audit approach, Audit evidence, Reportin

Analyze the impact of a significant explosion on financial statements, assess contingent liabilities, and determine appropriate audit evidence.

Abuakwa Ltd (Abuakwa) is a multinational mining group that is involved in different operations. The draft financial statements for the year ended 31 March 2019 show the following:

Financial Statement Extracts 2019 (draft) 2018 (audited)
Revenue GH¢30.60 million GH¢28.08 million
Profit before tax GH¢3.12 million GH¢3.00 million
Total net assets GH¢29.76 million GH¢27.24 million

You are the manager responsible for the audit for the year ended 31 March 2019. You have just visited the client’s premises to review the audit team’s work to date. The audit senior has drafted the following “points for the attention of the manager”.

a) On 12 March 2019, an explosion occurred in one of Abuakwa’s premises, destroying about one quarter of the premises. Luckily, the explosion happened at night when the premises were empty, and there were no injuries to any persons. Structural engineers and surveyors are currently assessing the stability of the remainder of the premises, and it is, as yet, unclear whether they can be repaired or will need to be demolished and rebuilt in their entirety.

In the last few days, notifications have been received from the owners of four nearby businesses claiming that the structural integrity of their premises may have been compromised by the impact of the explosion.

They also advised that structural engineers are currently assessing their premises to ensure they are still safe. These business owners have formally notified Abuakwa that if their premises were adversely affected by the explosion, they will claim an “appropriate and justifiable” level of compensation from Abuakwa.

Abuakwa’s insurers have been informed but at this point are refusing to comment on the situation until, they say, all the facts are clear in relation to the explosion and its effects.

(8 marks)

Matters to be considered

  • This event occurred before the period end and so must be fully reflected in the financial statements for the year ended 31 March 2019.
  • The explosion will mean that the property and other assets that were affected are probably impaired in value, and this impairment will need to be quantified and reflected in the financial statements (IAS 36).
  • It has also created a potential liability to the owners of the other businesses who claim to have been affected. This may need to be quantified and disclosed in the financial statements, although there is currently so much uncertainty in this regard that disclosure may not be required. (IAS 37)
  • There is also the possibility of an off-setting contingent asset in the form of the potential for an insurance claim. It is unlikely, however, that this could be seen as virtually certain at this point and so it will not be accrued in the financial statements. It may, however, be noted depending on how satisfied the company is that it will be received.

(4 points for 4 marks)

Audit evidence to be documented

  • Details of the explosion and such reports about it as may exist, e.g., to the Health and Safety Authority, Environmental Protection Agency, to the Insurers, etc.
  • Preliminary reports from the surveyors and structural engineers.
  • All correspondence with the insurance company, including the insurance policy and evidence that it has been paid up to date.
  • The notification of claim from the other business owners and copies of any legal correspondence with them.
  • Minutes of board meetings at which the explosion was discussed. In particular, the cause will need to be established to eliminate (or mitigate) the susceptibility of the company to a recurrence.

(4 points for 4 marks)

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