Question

Abebio Limited is a listed company with a year end of 31 December 2019. A director of the company has a number of questions relating to the application of International Financial Reporting Standards (IFRS Standards) in its financial statements for the year ended 31 December 2019. The questions appear in notes 1–3.

Note 1 – Pending legal cases

At a recent board meeting, we discussed legal cases which customers A and B are bringing against Abebio in respect of the supply of products which were allegedly faulty. We supplied the goods in the last three months of the financial year.

We have reliably estimated that if the actions succeed, we are likely to have to pay out GHS10 million in damages to customer A and GHS8 million in damages to customer B. Also, Abebio’s legal advisers have reliably estimated that there is a 60% chance that customer A’s claim will be successful and a 25% chance that customer B’s claim will be successful.

I know we have insurance in place to cover us against claims like this. It is highly probable that any claims which were successful would be covered under our policy. Therefore, I would have expected to see a provision for legal claims based on the likelihood of the claims succeeding. However, I would also have expected to see an equivalent asset in respect of amounts recoverable from the insurance company. The financial statements do contain a provision for GHS10 million but no equivalent asset. Disclosure of the information relating to both of the claims and the associated insurance is made in the notes to the financial statements.

Required:

Given the above facts, discuss the correct accounting treatment of the pending legal cases.

Note 2 – Non-current assets

When I look at the statement of financial position, one of the categories of non-current assets is ‘investment properties’ and another category is ‘property, plant and equipment’ – in which all other properties are included. Surely, we invest in all our properties, so why do we have two categories for them in the statement of financial position? How do we decide what goes into ‘property, plant and equipment’ and ‘investment properties’?

In addition, a note to the financial statements states that investment properties are measured at their fair values and not depreciated. Don’t all non-current assets have to be depreciated over their estimated useful lives? Another note states that property included in ‘property, plant and

equipment’ is measured at cost less accumulated depreciation rather than at fair value. Shouldn’t all properties be measured in the financial statements on a consistent basis? Don’t you think this is a clear violation of consistency concept?

Finally, I can’t immediately see from the financial statements where the gains or losses relating to the measurement of investment properties are included. The profit statement seems to include two main components – profit or loss and other comprehensive income. Where would the gains or losses go? Presumably, is the treatment of gains and losses the same for any non-current assets which are measured at fair value?

Required:

Given the above facts, discuss clearly what constitute ‘property, plant and equipment’ and investment property’. You are also required to explain the correct accounting treatment of revaluation gain and loss, and fair value gain and loss.

Note 3 – Inventory

Abebio Limited is a retailer of Italian furniture and has five major product lines: sofas, dining tables, beds, closets, and lounge chairs. At December 31, 2019, quantity on hand, cost per unit, and net realizable value (NRV) per unit of the product lines are as follows:

Required:

Product line

Sofas

Dining tables Bed

Closets Lounge chairs

Quantity on hand

100

200

300

400

500

Cost per unit

GHS 1,000 500 1,500 750 250

NRV per unit

GHS 1,020 450 1,600 770 200

Compute the valuation of the inventory of Abebio Limited at December 31, 2019, under IAS 2 using the “lower of cost and NRV” principle.

Answer 1

Note 1 - Pending Legal Cases (IAS 37 Provisions, Contingent Liabilities and Contingent assets)

GHS 10 Miliion we have to considere provisions for this because of following points:

1. There must be a present obligation as a result of a past event;

2. The outflow of economic benefits to satisfy the obligation must be probable (i.e. more than 50% probable)

3. The amount of economic benefits required to satisfy the obligation must be reliably estimated..

So its fulfill all points so we have to make provision for GHS 10 million in the books of financial

GHS 8 Million we have to consider this one as contingent Liabilities due to following points:

• A possible obligation (not present) from past event that will be confirmed by some future event; or
• A present obligation from past event, but either:
  • The ouflow of economic benefits to satisfy this obligation is not probable (less than 50%), or
  • The amount of obligation cannot be reliably measured (this is very rare, in fact).

We have to disclose all cases filed by customer & all litigation is covered by insurance policy.

So if likely of case filed is lose by company then compensation is offset by insurance company then its get offset with each other. so we have to disclose in notes of accounts regarding all litigation case filed & all convered with insurance policy.

Notes 2 - Non Current Assets:

According to IAS16, Property, Plant and Equipment are classified as tangible assets. Theses tangible assets are held by an entity for more than one accounting period and are for use in the production or supply of goods and services, for administrative purposes or for rental to others. PPE should be recognized as an asset when the cost of the asset can be measured reliably, and likewise when it is probable that future economic benefits associated with the asset will flow to the entity.

The standard likewise goes further to say that the following cost (abnormal cost due to faulty work, spoilage, labor issues, start-up and similar pre-production cost; administration and other general overhead costs; and initial operating losses before the asset reached planned performance) should not be a part of the cost of an item of Property, Plant and Equipment unless all these cost can be attributed directly to the acquisition, or bringing it into its working condition. If not, then all these cost will be recognized as expense rather than an asset.

Moreover, the standard offers two possible treatments as it pertains to the subsequent measurement to initial recognition. Under the cost model it state that the asset should be carried at cost less depreciation and any accumulated impairment losses. It also state that under the revaluation model that the asset should be carried at the revalued amount being its market value at the date of the revaluation, less any subsequent accumulated depreciation and likewise any accumulated impairment losses.

Investment Property is said to be land or building held to earn rentals, or for capital appreciation, or both,rather than for use in the entity or for sale in the ordinary course of business. Under the standard, the owner occupied property is however excluded from the definition of investment property.

The standard outlines that recognition of Investment Property as an asset should be done when two conditions are met. Firstly, when it is probable that the future economic benefits which is associated with the investment property will flow to the entity, and secondly, when the cost of the investment property can be measured reliably.

Furthermore, according to IAS40, there are two choices which investment property initial recognition can be measured. The first being the cost model and the second being that of the fair value. However, the standard states that whichever policy the entity chooses, that same policy should be applied to all investment property item.

Under the cost model, the standard states that the asset should be accounted for in line with the cost model laid out in IAS16. Hence, investment property should be measured at the depreciated cost less any accumulated impairment losses. Likewise, the standard went further to state that an entity which chooses the cost model should disclose the fair value of its investment property. Moreover, as it relates to the fair value model, the standard states that should an entity chooses this model then it should measure all of its investment property at fair value, except in rare cases where it cannot be measured reliably. Should this be the case, the cost model according to IAS16 should be applied.

Revaluation Gain & Loss :

A gain on revaluation is always recognised in equity, under a revaluation reserve (unless the gain reverse’s revaluation losses on the same asset that were previously recognised in the income statement – in this instance the gain is to be shown in the income statement).

The revaluation gain is known as an unrealised gain which later becomes realised when the asset is disposed of (derecognised).

• Dr Non-current asset cost (difference between valuation and original cost/valuation)
• Dr Accumulated depreciation (with any historical cost accumulated depreciation)
• Cr Revaluation reserve (gain on revaluation)

Note 3 - Inventory:

Inventories are the assets that are held for sale in the ordinary course of business, in the process of production for such a sale & in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Inventories should be measured at Lower of Cost or Net Realisable Value

Abebio Limited
		Figures In GHS
Description	Qty	Cost Per Unit	NRV	Lower of Cost/NRV	Inventories Valuation
	A	B	C	D	E=A*D
Sofas	100	1,000.00	1,020.00	1,000.00	100,000.00
Dining Tables	200	500.00	450.00	450.00	90,000.00
Beds	300	1,500.00	1,600.00	1,500.00	450,000.00
Closets	400	750.00	770.00	750.00	300,000.00
Lounge Chairs	500	250.00	200.00	200.00	100,000.00
				Total	1,040,000.00