International financial reporting : a practical guide

497 Pages·2009·2.73 MB·English

by  Alan Melville

International
Financial Reporting

A Practical Guide

an imprint of
www.pearson-books.com
Front cover image: © Getty Images

International Financial Reporting
A Practical Guide Alan Melville

As the International Accounting Standards Board (IASB) makes progress towards widespread acceptance
and use of its standards and practices, the need to become familiar with the IASB standards is rapidly
increasing. Melville provides the tools for understanding the international standards and offers expert
guidance on how to implement them. This second edition brings the book completely up-to-date and
covers all international standards issued as at 1 January 2009. Features of the book include interpretive
guidance, coverage of every key International Financial Reporting Standard (IFRS) and International
Accounting Standard (IAS), together with an unparalleled level of student interactivity and assessment.

The book provides a unique practical introduction to the international standards, outlining how these
standards are used on a daily basis by companies in the preparation of their financial statements. The
author examines the recognition, measurement, presentation and disclosure requirements of each IFRS
and IAS and every attempt has been made to explain the standards as clearly and concisely as possible.

Examples and practice questions are provided throughout the book to aid student understanding and to
provide a framework for grasping the key aspects of this complex and fast-moving subject.

FEATURES

unique practical approach, combining theoretical and technical issues
•

class-tested with both professional and degree students
•

every chapter contains a variety of worked examples with solutions
•

every chapter concludes with a set of exercises, some of which are drawn from
•
the past examination papers of the key professional accountancy bodies

comprehensive answers to most of the exercises are provided at the back of
•
the book

supporting website for lecturers’ use, containing answers to the remaining
•
exercises and PowerPoint slides for each chapter

This text is essential reading for all undergraduate and professional courses
on international financial reporting.

Alan Melville FCA BSc Cert. Ed. is a bestselling author and Senior Lecturer
with many years’ experience of teaching accounting and financial reporting.

International Financial Reporting
A Practical Guide second edition

Alan Melville

Alan Melville

second edition
second
edition

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International
Financial Reporting

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International
Financial Reporting

A Practical Guide

Alan Melville
FCA, BSc, Cert. Ed.

Second edition

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Pearson Education Limited
Edinburgh Gate
Harlow
Essex CM20 2JE
England

and Associated Companies throughout the world

Visit us on the World Wide Web at:
www.pearsoned.co.uk

First published 2008
Second edition published 2009

© Pearson Education Limited 2008, 2009

The right of Alan Melville to be identified as author of this work has been asserted
by him in accordance with the Copyright, Designs and Patents Act 1988.

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ISBN: 978-0-273-73011-8

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v

Contents

Preface
ix

Acknowledgements
x

List of international standards
xi

Part 1 INTRODUCTION TO FINANCIAL

REPORTING

1
The regulatory framework
3

The need for regulation
4

Sources of regulation
4

Generally accepted accounting practice
6

The International Accounting Standards

Board (IASB)
7

The standard-setting process
9

The structure of an international

standard
9

The purpose of accounting standards
10

Worldwide use of international

standards
11

First-time adoption of international

standards
11

2
The IASB conceptual framework
17

Purpose and scope of the IASB

Framework
18

Objective of financial statements
19

Underlying assumptions
21

Qualitative characteristics of financial

statements
21

Elements of financial statements
24

Recognition of the elements of

financial statements
26

Measurement of the elements of

financial statements
27

Concepts of capital and capital

maintenance
28

3
Presentation of financial statements
35

Objective of financial statements
36

Components of financial statements
36

General features
37

Structure and content of financial

statements
39

The statement of financial position
40

The statement of comprehensive income
45

The statement of changes in equity
48

The notes to the financial statements
50

Interim financial reporting
51

4
Accounting policies, accounting
estimates and errors
59

Accounting policies
59

Accounting estimates
64

Prior period errors
64

Part 2 FINANCIAL REPORTING IN

PRACTICE

5
Property, plant and equipment
73

Definition of property, plant and

equipment
74

Recognition of property, plant

and equipment
74

Initial measurement of property, plant

and equipment
77

Subsequent measurement of property,

plant and equipment
78

Depreciation
80

Disclosure requirements
84

Borrowing costs
85

Government grants
88

Investment property
91

6
Intangible assets
98

Definition of an intangible asset
99

Initial recognition and measurement

of intangible assets
100

Subsequent measurement of

intangible assets
104

Amortisation of intangible assets
106

Derecognition
108

Disclosure requirements
108

CONTE NTS

vi

Goodwill
109

IFRS3 Business Combinations
110

7
Impairment of assets
116

Indications of impairment
117

Recoverable amount
118

Recognition and measurement of an

impairment loss
121

Cash-generating units
122

Reversal of impairment losses
126

Disclosure requirements
127

8
Non-current assets held for sale
and discontinued operations
132

Classification of non-current assets

as held for sale
133

Measurement of non-current assets

held for sale
135

Presentation of non-current assets

held for sale
139

Discontinued operations
140

9
Leases
146

Classification of leases
147

Accounting for operating leases
148

Accounting for finance leases
148

Disclosure requirements
152

10 Inventories and construction

contracts
157

Inventories
158

Cost of inventories
158

Cost formulas
160

Net realisable value
163

Disclosures relating to inventories
164

Construction contracts
165

Contract revenue and costs
166

Recognition of contract revenue

and expenses
166

Presentation and disclosure for

construction contracts
169

11 Financial instruments
177

Definitions
178

Classification of financial instruments
179

Recognition of financial assets

and liabilities
182

Initial measurement of financial assets

and liabilities
182

Subsequent measurement of financial

assets
182

Subsequent measurement of financial

liabilities
186

Disclosure requirements
187

12 Provisions and events after the

reporting period
193

Recognition of a provision
194

Measurement of a provision
196

Application of the recognition and

measurement rules
197

Contingent liabilities and contingent

assets
199

Disclosure requirements
200

Scope of IAS37
201

Events after the reporting period
201

13 Revenue
207

Definition of revenue
208

Measurement of revenue
208

Recognition of revenue: Sale of goods
209

Recognition of revenue: Rendering

of services
210

Recognition of revenue: Interest,

royalties and dividends
211

Disclosure requirements
211

Guidance to the implementation

of IAS18
212

14 Employee benefits
218

Short-term employee benefits
219

Post-employment benefits
221

Accounting for defined contribution

plans
221

Accounting for defined benefit plans
222

Other long-term employee benefits
228

Termination benefits
228

15 Taxation in financial statements
233

Current tax
234

Deferred tax
236

The tax base concept
238

IAS12 requirements with regard to

deferred tax
243

Disclosure requirements
243

16 Statement of cash flows
248

Cash and cash equivalents
249

Classification of cash flows by activity
250

CONTE NTS

vii

Interest, dividends and taxes
251

Reporting cash flows from

operating activities
252

Disclosures
256

17 Financial reporting in

hyperinflationary economies
267

Historical cost accounting and

its weaknesses
268

Strengths of historical cost accounting
273

Alternatives to historical cost

accounting
274

Hyperinflationary economies
275

The restatement of financial

statements
275

Disclosures required by IAS29
277

Part 3 CONSOLIDATED FINANCIAL

STATEMENTS

18 Groups of companies (1)
283

Requirement to prepare consolidated

financial statements
284

Group statement of financial position

at date of acquisition
285

Group statement of financial position

in subsequent years
289

Partly-owned subsidiaries
292

Preference shares
295

Elimination of intra-group balances
297

Unrealised profits
298

Reporting period and accounting

policies
299

19 Groups of companies (2)
309

Group statement of comprehensive

income
310

Subsidiary acquired part way through

an accounting period
316

20 Associates and joint ventures
324

Significant influence
325

The equity method
326

Application of the equity method
326

IAS28 disclosure requirements
332

Joint ventures
333

Accounting for an interest in a

jointly controlled entity
334

IAS31 disclosure requirements
338

21 Related parties and changes in

foreign exchange rates
344

Related parties
345

Definition of related party and related

party transaction
345

Disclosures required by IAS24
346

Foreign exchange accounting
348

Reporting foreign currency

transactions
349

Translation to a presentation currency
350

Part 4 ANALYSIS OF FINANCIAL

STATEMENTS

22 Ratio analysis
357

Accounting ratios
358

Profitability ratios
359

Liquidity ratios
363

Efficiency ratios
365

Investment ratios
367

Limitations of ratio analysis
375

Multivariate ratio analysis
376

23 Earnings per share
384

Significance of EPS
384

Calculation of basic EPS
385

Shares issued during the period
387

Bonus issues
389

Rights issues
390

Calculation of diluted EPS
393

Presentation and disclosure

requirements
395

24 Segmental analysis
400

IFRS8 Operating Segments
401

Reportable segments
401

Disclosures required by IFRS8
403

IAS14 Segment Reporting
407

Primary and secondary segment

reporting formats
408

Reportable segments
408

Disclosures for the primary format
409

Disclosures for the secondary format
410

Other disclosures
412

Part 5 ANSWERS

Answers to exercises
419

Index
481

ix

Preface

The aim of this book is to explain International Financial Reporting Standards (IFRSs) and
International Accounting Standards (IASs) at a level which is appropriate for students who
are undertaking an intermediate course of study in financial reporting. It is assumed that
the reader has already completed an introductory accounting course and is familiar with
the basics of financial accounting. The book has not been written with any particular
syllabus in mind but should be useful to second-year undergraduates studying for a degree
in accounting and finance and to those who are preparing for the examinations of the
professional accounting bodies.

IFRSs and IASs (referred to in this book as "international standards") are rapidly gaining

acceptance around the world and most accounting students are now required to become
familiar with these standards. The problem is that the standards comprise approximately
2,500 pages of fine print and much of this content is highly technical and difficult to
understand. What is needed is a textbook which explains the main features of each
standard as clearly and concisely as possible and provides students with plenty of worked
examples and exercises. This book tries to satisfy that need.

The standards are of international application but, for the sake of convenience, most of

the monetary amounts referred to in the worked examples and exercises in this book are
denominated in £s. Other than this, the book contains very few UK-specific references and
should be relevant in any country which has adopted international standards.

Each chapter of the book concludes with a set of exercises which test the reader's grasp

of the topics introduced in that chapter. Some of these exercises are drawn from the past
examination papers of professional accounting bodies. Solutions to most of the exercises
are located at the back of the book but solutions to those exercises which are marked with
an asterisk (*) are intended for lecturers' use and are provided on a supporting website.

This second edition is in accordance with all international standards or amendments to

standards issued as at 1 January 2009.

Alan Melville

May 2009

x

Acknowledgements

I would like to thank the International Accounting Standards Committee Foundation for
permission to use extracts from various IASB standards (Copyright © 2009 International
Accounting Standards Committee Foundation. All rights reserved. No permission granted
to reproduce or distribute.).

I would also like to thank the following accounting bodies for granting me permission to

use their past examination questions:


Association of Chartered Certified Accountants (ACCA)


Chartered Institute of Public Finance and Accountancy (CIPFA)


Association of Accounting Technicians (AAT).

I must emphasise that the answers provided to these questions are entirely my own and are
not the responsibility of the accounting body concerned. I would also like to point out that
the questions which are printed in this textbook have been amended in some cases so as to
reflect changes in accounting standards which have occurred since those questions were
originally published by the accounting body concerned.

Finally, I would once again like to express my gratitude to Mrs Margaret Cooper, who

has diligently checked the arithmetic accuracy of every calculation in this book.

Alan Melville

May 2009

xi

List of international standards

A full list of the International Financial Reporting Standards (IFRSs) and International
Accounting Standards (IASs) which are in force at the time of writing this book is given
below. Standards missing from the list have been withdrawn. Alongside each standard is a
cross-reference to the chapter of the book in which that standard is explained.

It is important to realise that new or modified standards are issued fairly often. The

reader who wishes to keep up-to-date is advised to consult the website of the International
Accounting Standards Board (IASB) at www.iasb.org.

International Financial Reporting Standards (IFRSs)
Chapter

IFRS 1
First-time Adoption of International Financial Reporting Standards
1

IFRS 2
Share-based Payment
–

IFRS 3
Business Combinations
6

IFRS 4
Insurance Contracts
–

IFRS 5
Non-current Assets Held for Sale and Discontinued Operations
8

IFRS 6
Exploration for and Evaluation of Mineral Resources
–

IFRS 7
Financial Instruments: Disclosures
11

IFRS 8
Operating Segments
24

International Accounting Standards (IASs)
IAS 1
Presentation of Financial Statements
3

IAS 2
Inventories
10

IAS 7
Statement of Cash Flows
16

IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors
4

IAS 10
Events after the Reporting Period
12

IAS 11
Construction Contracts
10

IAS 12
Income Taxes
15

IAS 14
Segment Reporting (for periods starting before 1 January 2009)
24

IAS 16
Property, Plant and Equipment
5

IAS 17
Leases
9

IAS 18
Revenue
13

IAS 19
Employee Benefits
14

LIST OF IN TER NATION AL S TAN DARD S

xii

IAS 20
Accounting for Government Grants and Disclosure of Government
5

Assistance

IAS 21
The Effects of Changes in Foreign Exchange Rates
21

IAS 23
Borrowing Costs
5

IAS 24
Related Party Disclosures
21

IAS 26
Accounting and Reporting by Retirement Benefit Plans
–

IAS 27
Consolidated and Separate Financial Statements
18

IAS 28
Investments in Associates
20

IAS 29
Financial Reporting in Hyperinflationary Economies
17

IAS 31
Interests in Joint Ventures
20

IAS 32
Financial Instruments: Presentation
11

IAS 33
Earnings per Share
23

IAS 34
Interim Financial Reporting
3

IAS 36
Impairment of Assets
7

IAS 37
Provisions, Contingent Liabilities and Contingent Assets
12

IAS 38
Intangible Assets
6

IAS 39
Financial Instruments: Recognition and Measurement
11

IAS 40
Investment Property
5

IAS 41
Agriculture
–

It should be noted that some of these standards are beyond the scope of this textbook and
are considered no further here. These are IFRS2, IFRS4, IFRS6, IAS26 and IAS41.

The IASB has also published a Framework for the Preparation and Presentation of

Financial Statements (see Chapter 2) which sets out a number of concepts that underlie
financial reporting. This document is not itself a standard but is referred to by the IASB
during the development of new and amended standards.

Part 1

INTRODUCTION TO FINANCIAL
REPORTING