Question

QUESTION 4

KAM Ltd (KAM) is a private company in the electronics industry. The company has grown steadily since its incorporation in 1997 and is seeking public listing in the next financial year.

KAM prepared its financial statements under International Financial Reporting Standards (IFRS).

You work in the finance department of KAM and are currently working on the financial statements for the year ended 30 April 2020.

In order to gain maximum interest from the market when shares are offered for public trading, the Directors of KAM are keen to present financial statements showing high profitability.

They are aware that market analysts will look favourably on a higher than average return on capital employed (ROCE) for the electronics industry.

The standard formula to calculate gearing by analysis is:

Profit before interest and tax Equity + Long term liabilities

When reviewing the financial statement the following matters come to light: Part (a)

On 1 May 2019, KAM issued redeemable preference shares for £10 million. The preference shares carry a fixed dividend of 5%.

The dividend of £500,000 has been paid on 30 April 2020 and this amount has been deducted from reserves.

The directors are pleased as the amount paid has not affected the profit for the year.

QUESTION 4 CONTINUES ON THE NEXT PAGE:-

REQUIRED:

1. Explain the correct treatment of the bond under IFRS, identifying any necessary adjustments to the profit for the year ending 30 April 2020.

Maximum word count 200

2. Explain whether the return on capital employed for KAM will change as a result of the adjustments calculated in (a) (i).

Maximum word count: 100

Part (b)

On 1 May 2019, KAM granted 100 share options to all of its employees within its development team on the condition that they remain in its employment for the next four years.

At the grant date, there were 150 employees in the development team and the fair value of each option on the grant date was £52.

During the year ended 30 April 2019, the estimate of the total employee departure was assessed as 10% of the original 150 employees.

During the year ended 30 April 2020, the estimate of total employee departures was reassessed to 8% of the original 150 employees.

The share based payment was correctly accounted in the financial statements for the year ended 30 April 2019. The directors of KAM have stated that they do not wish to make any adjustment for the year ended 30 April 2020, as the impact of the options won’t be felt for another 2 years.

QUESTION 4 CONTINUES ON THE NEXT PAGE:-

REQUIRED:

1. Compute any necessary adjustments to profit before interest and tax for the year ended 30 April 2020 as well as the balance within equity on that date.

2. Provide a brief explanation for the treatment of this type of share based payment in accordance with IFRS 2: Share based payment.

Word count: 200

3. Explain whether the return on capital employed for KAM Plc. will increase or decrease as a result of adjustments calculated in (a) (i).

Word count 100

Having made the adjustments as well as providing explanations for these amendments for the share-based payments, you receive an email from the Managing Director asking:

“Can the estimates for total expected departures be increased, so lessening the impact of profit?”

REQUIRED:

Construct a brief reply to the Managing Director’s email discussing whether this would be permitted under IFRS.

Answer 1

Q.1 Explain the correct treatment of the bond under IFRS, identifying any necessary adjustments to the profit for the year ending 30 April 2020.

As per IAS – 32 financial instrument should be classified as either a financial liability or an equity instrument according to the substance of the contract, not it’s legal form.

The preference shares can be classified as equity, liability, or a combination of the two. The entity must classify the financial instrument when initially recognising it based on the substance over form principle.

Following action is determining whether to consider the preference share as debt or equity

• Are the shares redeemable at a fixed date?
• Are the shares redeemable at the option of the holder?
• Is the issuer obliged to make payments in the form either of interest or dividends?
• Do the terms and conditions oblige the issuer to distribute a specific percentage of profits?

If the answer is yes to all of the above, then the preference shares would most probably be classified as a financial liability (debt), because it would seem that the issuer lacks the unconditional right to avoid delivering cash or another financial asset to settle an obligation.

The KAM Ltd have issued redeemable preference shares hence it will be classified as debt in line of criterial provided under IAS32.

Q.2 Explain whether the return on capital employed for KAM will change as a result of the adjustments calculated in (a) (i).

Once Preference shares is classifed as debt, it will form part of capital employed and hence return on capital employed will change.

Q.3 Compute any necessary adjustments to profit before interest and tax for the year ended 30 April 2020 as well as the balance within equity on that date.

Due to change in estimate of departing employee, there will be change in expese of share based payment. The share based payment expense in year 2019 would be 175,500 whereas for year 2020 it would be 180,700

Share based Payment cost for 2019	Amount
No. of employee	150.00
Estimate of emplyee departure 10%	15.00
Net Employee	135.00
No of option per employee	100.00
Fari value	52.00
Total Cost	702,000.00
Number of year	4.00
Cost per Year	175,500.00

Share based Payment cost for 2020	Amount
No. of employee	150.00
Estimate of emplyee departure 8%	12.00
Net Employee	138.00
No of option per employee	100.00
Fari value	52.00
Total Cost	717,600.00
Cost already accounted	175,500.00
Balance Cost	542,100.00
Number of remaining year	3.00
Cost per Year	180,700.00

Q.4 Provide a brief explanation for the treatment of this type of share based payment in accordance with IFRS 2: Share based payment.

If the equity instruments granted vest immediately, the counterparty is not required to complete a specified period of service before becoming unconditionally entitled to those equity instruments

If the equity instruments granted do not vest until the counterparty completes a specified period of service, the entity shall presume that the services to be rendered by the counterparty as consideration for those equity instruments will be received in the future, during the vesting period. The entity shall account for those services as they are rendered by the counterparty during the vesting period, with a corresponding increase in equity

For example : if an employee is granted share options conditional upon completing three years’ service, then the entity shall presume that the services to be rendered by the employee as consideration for the share options will be received in the future, over that three-year vesting period.

The entity shall recognise an amount for the goods or services received during the vesting period based on the best available estimate of the number of equity instruments expected to vest and shall revise that estimate, if necessary, if subsequent information indicates that the number of equity instruments expected to vest differs from previous estimates.

Q.5 Explain whether the return on capital employed for KAM Plc. will increase or decrease as a result of adjustments calculated in (a) (i)

The share based payment value is increasing and this impacts to amount of capital employed and hence return on capital employed will decrease

Q.6 Response to Managing Director

Pursuant to IFRS 2 the estimates are to be made with best available informaiton. The best estimate would always require excercising judgement. The management based on information available with them and considering best estimate if they feels that the departure rate will be other than 8%, it is possible to revise the number however it has to be based on robust reason.