Hyperinflation Economies Described in IAS 29 - Assignment Example

Corporate Financial Reporting Table of Contents Accounting treatment of impairment of intangible assets 3 2.Characteristics of Hyperinflation economies described in IAS 29 4 3.Accounting treatment described in IAS 21 4 4. Accounting treatment described in IAS 11 5 Reference List 8 1. Accounting treatment of impairment of intangible assets IAS 36 specifically requires an entity to assess whether there is any indication that an asset may be impaired at the end of every reporting period. Thereafter the asset identified is tested for impairment. The initial step of impairment testing is to estimate the recoverable amount and then the recoverable amount is compared to the carrying amount at the end of each reporting period. In cases where the carrying amount is greater than the recoverable amount, an impairment loss is incurred and the same is recognized. The depreciation or amortization calculations as well as policies will be revisited for this particular asset (Deloitte, 2014a). Example: Suncor energy inc. declared force majeure under a contractual obligation, suspended and ceased its operations as a result of a political unrest. Since there has been no resolution of the political situation at the end of second quarter of the year 2012, an impairment test was conducted in the company’s assets in Syria. Consequently, the company identified after-tax impairment charges and write downs worth $694 million. The impairment losses identified were recorded as part of depletion, depreciation, amortization and impairment expense and were charged against property plant, and equipment ($604 million) as well as other current assets worth $23 million. Thereafter the company wrote off the remaining Syrian receivables in Syria for $67 million. Previously in December 2011, receivables worth of $64 million were written off. In 2012 (4th quarter), the company received risk mitigation proceeds worth $300 million that were associated with its Syrian operations. After the proceeds were received, the impairment test was conducted in December 31, 2012, implementing the value-in-use methodology. Unexpected cash flow approach was adopted by the company which was based on the year end reserves data of 2011 which were updated with three scenarios for the company’s best estimate of price realizations as well as remaining revenues. The scenarios represent: recommencement of operations in a year, recommencement of operations is 5 years, total loss. The scenarios where the companies recommence their operations include repayment of the risk mitigation proceeds according to the terms within the agreement. The scenarios were weighted equally on the basis of the company’s best estimate and were valued according to the risk adjusted discount rate of 19%. On the basis of this assessment, the company identified an impairment reversal worth $177 million which were related to the company’s assets in Syria. The $177 million impairment reversal was recorded in the fourth quarter of 2012 as a part of depletion, depreciation, amortization and impairment expense. A change in the discount rate and pricing assumptions by 2% and 5% respectively would affect the after tax earnings of approximately $20 million. Thus the resultant carrying value of the company’s property, plant and equipment less the risk mitigation proceed at 31 December 2012 stood at $130 million (Wiecek, Dunlop and Bowen, 2013). 2. Characteristics of Hyperinflation economies described in IAS 29 In a hyper-inflated economy: The general population are inclined towards keeping their wealth in the form of either non monetary asset or in stable foreign currencies. The amount that is held in local currency is invested with immediate effect in order to maintain the purchasing power. The general population regards money in terms of stable foreign currencies instead of regarding them in terms of local currency. This suggests that prices can be quoted in the foreign currency. Purchases on sells on credit usually take place at price that recompenses for the expected loss of purchasing power which might happen during the credit period, even though the period might be short. Price, wages and interest rates are linked to a price index. The cumulative inflation rate over the three years either is approaching or exceeds 100% (IFRS, 2012a; Economy watch, 2010; Princeton, n.d.). 3. Accounting treatment described in IAS 21 I. Any goodwill that arises on the balance sheet as a result of acquisition of a foreign operation along with the fair value adjustments of the goodwill to the carrying amount of assets and liabilities that arises on the acquisition o the foreign operation needs to be treated as assets and liabilities of the foreign operation. Over here the foreign operation refers to the entity which is an associate, subsidiary, joint venture or branch of the reporting entity. Their activities are based and are conducted in the country or currency other than that of the reporting entity. According to the regulations stipulated within the IAS 21, the goodwill (including any comparatives) has to be translated at the closing rate and at the date of that balance sheet. This suggest that the goodwill is treated as an asset if the subsidiary. However, before 2003 the goodwill could be treated both as an asset of the parent or acquiring company and the assets of the subsidiary (Deloitte, 2014b, IFRS, 2012b; Europa, 2011). II. According to IAS 21, the carrying amount of an item (which in this case is plant, property and equipment) can be measured either in terms of the historical cost of the item or fair value. The choice of the method depends on the regulations stated under IAS 16. The carrying amount, whether determined on the basis of fair value cost or on the basis of historical cost, has to be determined in the foreign currency. Thereafter the carrying amount of the item has to be translated into the functional currency that is defined under the standard IAS 21. The carrying amount or cost of that item is to be translated at the exchange rate on the particular date when the amount was determined. This is the date on which the transaction happened which wax measured in terms of the historical cost. This is what has happened in case of Overgrown plc’s acquisition of Shade inc. The asset was translated in year end 2007 balance sheet at the functional currency which is British pound sterling (the exchange rate in that particular day was $1.6/£). In the year end 2008 the value of the equipment depreciated by $20,000 and the resultant value was $280,000 which was again translated in the balance sheet (2008) at the functional currency (the exchange rate in that particular day was $2.4/£). When the depreciation value of $20,000 is translated into the functional currency ($20,000/1.6 = £12.5k), it indicates that there is a loss in value apart from the already incurred depreciation cost primarily because the dollar would produce lesser pounds if the asset is sold as a result of increased exchange rate. III. According to the regulation stated in the IAS 21, the assets and liabilities for every statement of financial position that is presented (including the comparatives) has to be translated into the functional currency at the closing rate and at the date when the statement of financial position is reported. It is evident from the case of Overgrown plc that they borrowed $10 million from a US bank in 2007. After translating the loan value at the closing rate of 2007 (which is $1.6/£) the value stands at £6.25 million. The exchange rate for dollars in the year 2008 increased from $1.6/£ to $2.4/£. Thus when the loan value of $10 million was translated at year end 2008, the value stood at £4.16 million. As is evident from this case that Overgrown plc has an unrealized profit precisely because of the fact that the value of £ strengthened over the year which reduced the overall value of the loan when it was translated. This suggests that now the company has to pay fewer dollars to repay the loan (IFRS, 2012b; Europa, 2011). IV. Since the building acquired by Overgrown plc has zero depreciation that is why it is recorded in 2008 at the value at which it was acquired in 2003. However, as far as the translation of this on current asset is concerned, the historical value of the building is divided by 5 in order to get a value of £4 million. 4. Accounting treatment described in IAS 11 I. IAS 11 stipulates the rules of accounting treatment of costs and revenues associated with construction contracts. Because of the nature of the activity that is performed in construction contracts, the date at which the activity is initiated and the date at which the activity is completed generally falls into different accounting periods. The contract revenue comprise of the following factors: The initial amount of revenue that has been agreed within the contract. Variations in claims, contract work and incentive payments. However the variations that are recorded are limited to the extent that they are probable and that they will generate revenue. Another criterion for recording these variations is that they should be capable of being reliably measured. The contract revenue is determined at the fair value of the consideration received or that is receivable. The contract cost comprise of the following factors: Cost directly associated to the specific contract. Cost that can be attributed to contract activity as well as to the contract. Other costs those are chargeable to the customers as per the terms and agreements of the contract. The revenue can be determined only to the extent of the contract cost that has been incurred and that the revenue is recoverable. The contract cost should be identified as an expense during the period in which they are incurred (BDO International, 2014). As is evident from the financial statement of Hardfloor House, their reporting standard is in accordance with the regulations stipulated within the IAS 11. The contract revenue has been reported separately for each contraction contracts which are £416K, £684K and £300K for three separate contracts. The contract cost has also been recorded separately for individual contracts as per the requirements of the IAS 11 accounting standard. Thereafter the total profit net of costs has also been reported distinctly for each of the contracts. II. The determination of revenue or expenses based on the stage of completion of the project is done using the percentage of completion method. The same method has been implemented by Hardfloor House. They have matched the contract revenue with the contract cost that was incurred while reaching the stage of the completion of the particular project. This resulted in the recording of revenue, expenses and profit associated with that project that can be attributed to the percentage of work that has been completed. This method provides the readers with useful information regarding the extent of contract activity completed performed during the time period. As is evident from the financial statements of the company, the profit that has been determined according to the percentage of work that is completed. However, an exception can be witnessed in case of project L where the company had to recognize loss in full since cannot be attributed to the work that is completed. III. The financial statement reports the work certified (which is the sales that the company generated). The cost has been reported by balancing the figures. The gross profit is calculated by deducting the cost associated with each project from the sales generated from each of the projects. As is evident from the income statement of the company they realized an overall loss. IV. The statement of financial position includes the costs that were incurred for each project. They have been reported distinctly for individual projects as per the requirement of the IAS 11 accounting standard. Following that, the profit has been reported separately for each of projects with an exception in case of project L where the company realized total loss. Thus, the loss recognized has also been reported separately. The progressive payments which have already been made by the client to the company have also been recorded and will be deducted from the overall value. The balance for each of the projects has also been reported separately which are $112K, $226K and loss of $50K. Thus the total asset value stands at $112K + $226K = $338K and the loss has been recorded as the total liability. This treatment is in accordance with the IAS 21 accounting standard which states that the gross amount that is due to customers as a result of contract has to be reported as a liability (Deloitte, 2014c, IFRS, 2013c, Europa, 2009). The gross amount has been calculated by the following formula: (Cost incurred + recognized profits) – (Sum of recognized losses and progressive payments). Reference List BDO International, 2014. IFRS at a glance: IAS 11 construction contracts. [pdf] BDO International Available at: [Accessed 12 February 2014]. Deloitte, 2014a. IAS 36 — Impairment of Assets. [online] Available at: [Accessed 11 February 2014]. Deloitte, 2014b. IAS 21-The Effects of Changes in Foreign Exchange Rates. [online] Available at: [Accessed 12 February 2014]. Deloitte, 2014c. IAS 11-Construction Contracts. [online] Available at: [Accessed 12 February 2014]. Economy watch, 2010. Characteristics of Hyperinflation. [online] Available at: [Accessed 12 February 2014]. Europa, 2009. International Accounting Standard 11 Construction Contracts. [pdf] Europa Available at: [Accessed 12 February 2014]. Europa, 2011. International Accounting Standard 21: The Effects of Changes in Foreign Exchange Rates. [pdf] Europa Available at: [Accessed 12 February 2014]. IFRS, 2012a. IAS 29 Financial Reporting in Hyperinflationary Economies. [pdf] IFRS Available at: [Accessed 12 February 2014]. IFRS, 2012b. The Effects of Changes in Foreign Exchange Rates. [pdf] IFRS Available at: [Accessed 12 February 2014]. IFRS, 2013c. IAS 11 Construction Contracts. [pdf] IFRS Available at: [Accessed 12 February 2014]. Princeton, no date. Hyperinflation. [online] Available at: [Accessed 12 February 2014]. Wiecek, I., Dunlop, M. and Bowen, J., 2013. Guide to International Financial Reporting Standards in Canada: IAS 36 Impairment of Assets. [pdf] CPA Available at: [Accessed 12 February 2014]. Read More