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International Accounting Standard(IAS) is standards for the preparation and presentation of financial statement created by the International Accounting Standards Committee(IASC).They were first written in 1973, and stopped when the International Accounting Board(IASB) took over their creation in 2001. The Board is committed to developing, in the public interest, a single set of high-quality, understandable, and enforceable global accounting standards that require transparent and comparable information in general-purpose financial statements and other financial reporting to help participants in the world's capital markets and other users make economic decision.
2.0 IAS 17 Leases
IAS17 is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to finance and operating leases.
Creative accounting is the practice of producing financial accounts that suit a particular purpose but do not really show the true and fair view. IAS17 play a major role in minimizing or eliminating the use of creative accounting. Under IAS 17, the standard requires finance leases to be capitalized in the lessee's accounts. The leased item should be recorded as a liability in the balance sheet. It is not permissible for the leased asset and lease obligation to be left out of the balance sheet. This information has the quality of relevance, it aims to prevent lessee and accountants motivated to produce accounts that do not show a true and fair view.
Classification of lease
The classification is based on the extent to which risks and rewards of ownership of the leased asset are transferred to the lessee or remain with the lessor. A lease is classified as a finance lease if it transfers substantially all the risks and reward of ownership to the lessee. If it does not, then it is an operating lease. When classifying a lease, it is important to recognize the substance of the agreement and not just its legal form. The commercial reality is important. IAS 17 is relevant to users of accounting statement. The Diagram1 show how to determining if the lease is finance or operating.
Is the lease non cancellable?
Is the Ownership expected to be transferred at the end of the lease term?
Is there a bargain purchase option?
Are the leased assets of a specialized nature?
Is the lease term a major part of the economic life of the leased asset?
Is the present value of the minimum lease payments substantially all of the fair value of the leased asset?
Do gains/ losses relating to the fair value changes accrue to the lessee?
Is there an option to continue the lease at a rent lower than market?
Is the substance of the leasing arrangement and any related arrangements such that substantially all the risks and rewards incident to ownership are transferred to the lessee?
To be reliable, IAS 17 applies to all leases other than lease agreements for minerals, oil, natural gas, and similar regenerative resources and licensing agreements for films, videos, plays, manuscripts, patents, copyrights, and similar items.
To be reliable, an entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages. IAS 17 require disclosure of the following in relation to finance lease include contingents rents recognized as an expense for the period, the total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date and general description of significant leasing arrangements, including contingent rent provisions, renewal or purchase options, and restrictions imposed on dividends, borrowings, or further leasing.
Depreciation of the leased asset
Since there is lease asset recorded on the books, it must be depreciated just like any other asset. A finance lease gives rise to a depreciation expense for depreciable assets as well as a finance expense for each accounting period. The depreciation policy for depreciable leased assets shall be consistent with that for depreciable assets that are owned. For an operating lease the depreciation policy for depreciable leased assets shall be consistent with the lessor's normal depreciation policy for similar asset.
Guaranteed residual value is for a lessee, that part of the residual value that is guaranteed by the lessee or by a party related to the lessee, and for a lessor, that part of the residual value that is guaranteed by the lessee or by a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee. Unguaranteed residual value is that portion of the residual value of the leased asset, the realisation of which by the lessor is not assured or is guaranteed solely by a party related to the lessor. For this purpose, enable users readily understand difference between guaranteed residual value and unguaranteed residual value.
Sale and leaseback transaction
In sale and leaseback transaction, the entity sells the asset to a third party, receives proceeds for the sale and then leases the asset back and pays rentals for its use. Companies adopt this type of approach to release cash. A sale and leaseback transaction can result in finance or operating lease, depending on the substance of the transaction. If the lease is identified as a finance lease, finance has been provided and the asset has been given as security for that finance. The excess of sale proceeds over the carrying amount of the asset at the date of the transaction is deferred in the financial statement and amortised through profit or lose over the period of the lease. If the lease is identified as operating lease and sale price are established at fair value, any profit made on the sale should be recognized immediately in profit or lose. So that, users must also be able to compare the financial statements of different enterprises in order to evaluate their relative financial position, performance and changes in financial position.
IAS 17 meets the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.
3.0 IAS 23 Borrowing Cost
IAS 23 is to prescribe the accounting treatment for borrowing costs. Borrowing costs include interest on bank overdrafts and borrowings, amortisation of discounts or premiums on borrowings, amortisation of ancillary costs incurred in the arrangement of borrowings, finance charges on finance leases and exchange differences on foreign currency borrowings where they are regarded as an adjustment to interest costs.
A qualifying asset is an asset that takes a substantial period of time to get ready for its intended use or sale. That could be property, plant, and equipment and investment property during the construction period, intangible assets during the development period, or "made-to-order" inventories .Inventories that are routinely manufactured or are produced on a repetitive basis over a short period of time are obviously not qualifying assets. However, inventories that require a substantial period of time to bring to a saleable condition can be regarded as qualifying assets for the purposes of this standard. For example, a power plant that takes a substantial period of time to get ready for its intended use .IAS 23 helps users to define the relevance of qualifying asset under the standard.
Relationship between IAS23 and IAS 11
An entity incurs borrowing costs for the construction of an asset accounted for under IAS 11.Borrowing costs that are directly attributable to the construction of an asset are treated as contract costs in accordance with IAS 23 and IAS 11.If an entity finances the construction contract with the general borrowings. The determination of the amount of general borrowing costs to be capitalized in the financial statements of the constructor are based on the net position of the contract, after taking into account any customer payments in respect of the contract. IAS 23 is relevant to users of accounting statement.
To be reliable, IAS 23 list out two types of assets that would otherwise be qualifying assets are excluded from the scope of IAS 23 are qualifying assets measured at fair value, such as biological assets accounted for under IAS 41 Agriculture and inventories that are manufactured or otherwise produced, in large quantities on a repetitive basis and that take a substantial period to get ready for sale. For example, maturing whisky.
To be reliable, the information in financial statements must be complete and consistency. So that, an entity shall disclose its accounting policy for the recognition of borrowing costs capitalized during the period and the capitalization rate used to determine the amount of borrowing costs eligible for capitalization.
An entity shall begin capitalizing borrowing costs as part of the cost of a qualifying asset on the commencement date. The commencement date for capitalization is the date when the entity first meets all of the following conditions include it incurs expenditures for the asset, it incurs borrowing costs and it undertakes activities that are necessary to prepare the asset for its intended use or sale.
An entity shall suspend capitalization of borrowing costs during extended periods in which it suspends active development of a qualifying asset.
An entity shall cease capitalizing borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. For this purpose, users able to understand when start capitalizing and when stop capitalizing in financial statement.
IAS23 prescribes two alternative treatments for recognizing borrowing costs. Under the benchmark treatment, all borrowing costs should be expensed in the period in which they are incurred and the allowed alternative treatment is borrowing costs in relation to the acquisition, construction and production of a qualifying asset should be treated as part of the cost of the relevant asset. For this purpose, user able to understand different financing methods can result in different amounts capitalized for the same asset.
Under IAS 23 allow users to compare the financial statements of an enterprise through time in order to identify trends in its financial position and performance. IAS 23 allows users or reader to do comparing between year and company.
If an enterprise adopts the allowed alternative treatment, that treatment should be applied consistently to all borrowing costs that are directly attributable to the acquisition, construction or production of all qualifying assets of the enterprise. If all the conditions laid down are met, an enterprise should continue to capitalize such borrowing costs even if the carrying amount of the asset exceeds its recoverable amount. Beside that, IAS 23 define the standard leaves no room for further discretion once an enterprise has chosen this accounting policy for these assets. So that, accounting policies and financial statements easier to compare.
IAS 23 meets the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.
4.0 IAS 36 Impairment of assets
IAS36 prescribes procedures to ensure that assets are carried at no more than their recoverable amount. The standard specifies when impairment losses are to be recognized and the condition under which such losses should be reversed.IAS36 also provides guidance on required disclosures.
An impairment loss must be recognized whenever an asset recoverable amount is less than its carrying amount. The impairment loss must be recognized immediately as an expense in the income statement, subject to one exception, namely if the asset is carried at revalued amount in accordance with another standard. For example, if an asset is accounted for under the revaluation model in IAS16 or IAS38, any impairment loss if the revalued asset would be treated as a revaluation decrease in accordance with that standard. The amortization expense for the asset is adjusted in future periods to allocate the asset's revised carrying amount, less its residual value, on a systematic basis over its remaining useful life. This information has the quality of relevance. It influences the economic decisions of users by helping them evaluate past, present or future events or confirming or correcting, their past evaluations.
Carrying amount is the amount at which an asset is recognized in the balance sheet after deducting accumulated depreciation and accumulated impairment losses. Recoverable amount is the higher of an asset's net selling price and its value in use. The comparison of the recoverable amount of an asset with its carrying amount to determine whether there is an impairment charge should be made on a consistent basis.
Fair value less costs to sell is the amount obtainable form the sale of an asset or cash-generating unit in an arm's length transaction between knowledgeable, willing parties, less the costs of disposal. If there is no binding sale agreement or active market for an asset, fair value less costs of disposal. If there is no active market for the asset, the entity uses the best information available. Diagram 2 show how to determine fair value. So that, users able to understand how to determine fair value and identify fair value less costs to sell.
Is there a binding sale agreement in an arm's length transaction?
Use price in sale agreement as fair value (less costs to sell)
Is there an active market in similar assets?
Is a current bid price available?
Use current bid price as fair value
Estimate fair value based on price of most recent transaction (provided there are no significant changes in circumstances since this occurred)
Estimate fair value less costs to sell based on best information available
Diagram 2 Summary of how to determine fair value
To be reliable, IAS36 applies in accounting for impairment of all assets but does not apply to the impairment of inventories(IAS2), assets arising form construction contracts(IAS11), deferred tax assets(IAS12), assets arising from employee benefits(IAS19), financial assets that are within the scope of( IAS39), investment property that is measured at fair value(IAS40), certain biological assets(IAS41), IFRS 4 and IFRS 5.
To be reliable, IAS36 gives a list of common indicators of impairment form external and internal sources of information. IAS 36 requires the following to be considered as a minimum. External sources include significant decline in an assets market value, significant adverse changes in the entity's technological, market, economic, or legal environment, increase in interest rates that is likely to materially decrease the assets recoverable amount and the entity's market capitalization being lower than the carrying amount of its net assets. Internal source include evidence of obsolescence or physical damage of an asset, significant adverse changes in how an asset is used or is expected to be used, and evidence that the economic performance of an asset is worse than expected.
IAS36 provides a long list of disclosure requirements. To begin, for each class of assets, the financial statements must disclose. The amount of impairment losses and reversals recognized in profit or loss during the period and the line items of the statement of comprehensive income in which those impairment losses and reversals are included and the amount of impairment losses and reversals on revalued assets recognized in other comprehensive income during the period. IAS 36 adds a degree of transparency to financial statements by allowing comparison over time and among entities.
Test an intangible asset
Test an intangible asset with an indefinite useful life or an intangible asset not yet available for use for impairment annually by comparing its carrying amount with its recoverable amount. This impairment test may be performed at any time during an annual period, provide it is performed at the same time every year. Different intangible assets maybe tested for impairment at different times. However, if such intangible asset was initially recognized during the current annual period, that intangible asset shall be tested for impairment before the end of the current annual period, that intangible asset shall be tested for impairment before the end of the current annual period. So that, users must be able to compare the financial statements of different enterprises in order to evaluate their relative financial position and performance.
(http://www.ifrs-portal.com/Texte_englisch/Standards/Standards_aktuell/IAS_36/IAS_36_2.htm#Identifying an asset that may be impaired)
IAS 36 meets the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.
5.0 IAS 37 Provision, Contingent Liabilities and Contingent Assets
IAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount.
A provision is recognized in the financial statements when a present obligation (legal or constructive) has arisen as a result of a past event(the obligating event), payment is probable('more likely than not'), and the amount can be estimated reliably. As a result of the requirements of IAS 37 provisions can still be made but only where there is some degree of obligation on the part of the company. A mere board decision is no longer sufficient. This information has the quality of relevance, it aim is to prevent unnecessary provisions that can be used to artificially enhance profits in subsequent periods.
Contingent assets and contingent liabilities
Contingent assets can show the relevance of the accounting report because there are possible assets that arise form past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. The relevance can see in contingent liabilities are a possible obligation depending on whether some uncertain future event occurs or a present obligation but payment is not probable or the amount cannot be measured reliably.
To be reliable, IAS 37 excludes obligations and contingencies arising from financial instruments that are in the scope of IAS 39, non-onerous executory contracts, insurance company policy liabilities (but IAS 37 does apply to non-policy-related liabilities of an insurance company) and items covered by another IAS. For example, IAS 11, Construction Contracts, applies to obligations arising under such contracts.
Measurement of provision
To be reliable, the amount recognized as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. The best estimate of the expenditure required to settle the present obligation is the amount that an entity would rationally pay to settle the obligation at the end of reporting period or to transfer it to a third party at that time. (To see example, please refer to appendix 1)
Distinguishes between provision and contingent liabilities
Provision which mean that they have already been recognized as liabilities because they represent and present obligations is likely to meet the entity an outflow of resources embodying economic benefit. Contingent liabilities which have not been recognized as liabilities because they are possible obligations to the extent that has yet to be confirmed whether the entity has a present obligation that may involve an outflow of resources embodying economic benefit or present obligations that do not meet the recognition criteria of this standard. For this purpose, enable users to understand difference between provision and contingent liabilities. (To get more information, please refer to appendix2)
Use of provision
Provisions should only be used for the purpose for which they were originally recognized. They should be reviewed at each reporting date and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources will be required to settle the obligation, the provision should be reversed. A provision is used only for expenditures for which the provision was originally recognized. Example, only expenditures that related to the original provision are set against it. The use of provision can help the readers have a better understanding about IAS37.
Under IAS 37 allow users to compare the financial statements of an enterprise through time in order to identify trends in its financial position and performance. IAS 37 allows users or reader to do comparing between year and amount in financial statement. Example provision - methodology between companies in the industries.
For each class of provision, shall disclose the carrying amount at the beginning and end of the period, additional provisions made in the period, including increases to existing provisions, amounts used during the period, unused amounts reversed during the period and the increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate. IAS 37 adds a degree of transparency to financial statements by allowing comparison over time and among entities.
IAS 37 meets the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.
In conclusion, IASB has issued forty International Accounting Standard(IASs) to date covering a range of topic, such as lease, borrowing cost, impairment of asset and provision, contingent asset and contingent liabilities. Under IASB, the financial statements are prepared based on a framework. The framework incorporates the qualitative characteristics of relevance, reliability, understandability and comparability. Based on above, it helps make the financial information useful to the different users of the information.
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