Cambridge AS & A Level9706

International Accounting Standards (A Level)

Accounting 9706 Chapter Notes

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International Accounting Standards (A Level)Ethical considerations (A Level)Auditing and stewardship of limited companies (A Level)
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International Accounting Standards (A Level) notes

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In this chapter

  1. 1IAS 2: Valuing Inventories
  2. 2IAS 16: Property, Plant and Equipment
  3. 3IAS 36: Impairment of Assets
  4. 4IAS 38: Intangible Assets

1. IAS 2: Valuing Inventories

International Accounting Standard 2 (IAS 2) provides the rules for valuing inventory in financial statements. The core principle is that inventory must be measured at the lower of its cost and its net realisable value (NRV). Cost includes all expenses incurred to bring the inventory to its present location and condition, such as purchase price and conversion costs. Net Realisable Value (NRV) is the estimated selling price in the normal course of business, minus any estimated costs needed to complete the item and any costs required to make the sale. This rule ensures that inventory is not overstated on the statement of financial position.

Inventory Value = Lower of (Cost, Net Realisable Value)

Net Realisable Value (NRV) = Estimated Selling Price - Estimated Costs of Completion - Estimated Costs to Sell

Key term

Net Realisable Value (NRV): The estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

Examiner insight

Examiners reward clear working that shows the comparison of cost and NRV for each individual inventory item before arriving at a total valuation.

Common pitfall

Students often forget to deduct selling costs from the estimated selling price when calculating NRV, leading to an incorrect valuation.

Worked example 14 marks

A business has three different products in inventory at the end of its financial year. Calculate the total value of inventory that should be reported in the statement of financial position based on the following data:

  • Product X: Cost $20,000, Net Realisable Value (NRV) $25,000.
  • Product Y: Cost $30,000, Net Realisable Value (NRV) $28,000.
  • Product Z: Cost $15,000, Net Realisable Value (NRV) $14,500.
  1. 1

    IAS 2 requires inventory to be valued at the lower of cost and NRV for each item or group of items.

  2. 2

    For Product X: The lower value is the Cost ($20,000) as it is less than the NRV ($25,000). Valuation = $20,000.

  3. 3

    For Product Y: The lower value is the NRV ($28,000) as it is less than the Cost ($30,000). Valuation = $28,000.

  4. 4

    For Product Z: The lower value is the NRV ($14,500) as it is less than the Cost ($15,000). Valuation = $14,500.

  5. 5

    Total Inventory Value = $20,000 (Product X) + $28,000 (Product Y) + $14,500 (Product Z) = $62,500.

Recap

  • Inventory is valued at the lower of cost and net realisable value (NRV).
  • Cost includes all costs of purchase, conversion, and other costs to bring inventories to their present location and condition.
  • NRV is the estimated selling price less estimated costs of completion and sale.
  • The comparison between cost and NRV should be made on an item-by-item basis.
  • The First-In, First-Out (FIFO) and Weighted Average Cost methods are permitted, but Last-In, First-Out (LIFO) is not.

Quick check

  1. What is the fundamental valuation principle for inventories under IAS 2?1 mark
  2. An item of inventory cost $100. Its estimated selling price is $130. To sell it, the business must pay a sales commission of $15. At what value should the inventory be recorded?2 marks

2. IAS 16: Property, Plant and Equipment

IAS 16 deals with the accounting treatment for Property, Plant and Equipment (PPE), which are tangible assets held for use in production, for rental, or for administrative purposes for more than one accounting period. The standard covers the initial recognition of assets at cost, subsequent measurement, depreciation, and derecognition. The initial cost includes not just the purchase price but also any directly attributable costs to bring the asset to the location and condition necessary for it to be capable of operating. After initial recognition, a company can choose either the 'cost model' (cost less accumulated depreciation) or the 'revaluation model' (fair value less subsequent accumulated depreciation).

Initial Cost = Purchase Price + Directly Attributable Costs

Carrying Amount (Cost Model) = Cost - Accumulated Depreciation - Accumulated Impairment Losses

Carrying Amount (Revaluation Model) = Revalued Amount - Subsequent Accumulated Depreciation - Subsequent Impairment Losses

Depreciation (Straight-Line) = (Cost - Residual Value) / Useful Life

Key term

Carrying Amount: The amount at which an asset is recognised in the statement of financial position after deducting any accumulated depreciation and accumulated impairment losses.

Examiner insight

Examiners look for the correct calculation of an asset's initial cost. Marks are often lost by excluding directly attributable costs or including costs that should be expensed (like staff training).

Common pitfall

Incorrectly expensing costs that should be capitalised as part of the asset's initial cost, such as delivery fees, installation, and site preparation.

Worked example 14 marks

On 1 January, a company purchased a new machine. The list price was $150,000. The company paid delivery costs of $5,000 and installation costs of $10,000. The machine is expected to have a useful life of 8 years and a residual value of $15,000. Calculate the depreciation charge for the first year using the straight-line method.

  1. 1

    Step 1: Calculate the initial cost to be capitalised under IAS 16.

  2. 2

    Initial Cost = Purchase Price + Delivery Costs + Installation Costs = $150,000 + $5,000 + $10,000 = $165,000.

  3. 3

    Step 2: Calculate the depreciable amount.

  4. 4

    Depreciable Amount = Cost - Residual Value = $165,000 - $15,000 = $150,000.

  5. 5

    Step 3: Calculate the annual depreciation charge.

  6. 6

    Annual Depreciation = Depreciable Amount / Useful Life = $150,000 / 8 years = $18,750.

Recap

  • IAS 16 applies to tangible non-current assets like buildings and machinery.
  • The initial cost of an asset includes its purchase price and all directly attributable costs.
  • Subsequent measurement uses either the cost model or the revaluation model.
  • Depreciation allocates the cost of an asset over its useful life.
  • The carrying amount is the value shown on the statement of financial position.

Quick check

  1. List two costs, other than the purchase price, that can be included in the initial cost of a machine.2 marks
  2. What is the difference between the cost model and the revaluation model for PPE?2 marks

3. IAS 36: Impairment of Assets

IAS 36 ensures that a company's assets are not carried in the financial statements at a value higher than their 'recoverable amount'. An asset is impaired if its carrying amount exceeds its recoverable amount. The 'recoverable amount' is defined as the higher of an asset's 'fair value less costs to sell' and its 'value in use'. If an impairment exists, the company must recognise an 'impairment loss' by writing down the asset's value. This loss is typically recognised as an expense in the statement of profit or loss.

Impairment Loss = Carrying Amount - Recoverable Amount (if Carrying Amount > Recoverable Amount)

Recoverable Amount = Higher of (Fair Value less Costs to Sell, Value in Use)

Key term

Impairment Loss: The amount by which the carrying amount of an asset exceeds its recoverable amount.

Examiner insight

Marks are awarded for a methodical approach: calculate 'fair value less costs to sell', identify 'value in use', select the higher of the two as the 'recoverable amount', and then compare this to the carrying amount.

Common pitfall

Confusing the recoverable amount calculation. Students must remember it is the *higher* of 'fair value less costs to sell' and 'value in use', not the lower, average, or just one of the two.

Worked example 15 marks

A company owns a specialised machine with a carrying amount of $80,000. Due to a decline in demand for its products, the company performs an impairment test. The machine could be sold for $65,000, with selling costs of $3,000. The present value of the future cash flows expected from the machine's continued use (its value in use) is estimated to be $68,000. Calculate the impairment loss, if any.

  1. 1

    Step 1: Identify the asset's carrying amount. Carrying Amount = $80,000.

  2. 2

    Step 2: Calculate the 'fair value less costs to sell'. Fair Value ($65,000) - Costs to Sell ($3,000) = $62,000.

  3. 3

    Step 3: Identify the 'value in use'. Value in Use = $68,000.

  4. 4

    Step 4: Determine the 'recoverable amount'. This is the higher of 'fair value less costs to sell' ($62,000) and 'value in use' ($68,000). Recoverable Amount = $68,000.

  5. 5

    Step 5: Compare the carrying amount with the recoverable amount. Carrying Amount ($80,000) is greater than the Recoverable Amount ($68,000), so the asset is impaired.

  6. 6

    Step 6: Calculate the impairment loss. Impairment Loss = Carrying Amount ($80,000) - Recoverable Amount ($68,000) = $12,000.

Recap

  • An asset is impaired if its carrying amount is more than its recoverable amount.
  • Recoverable amount is the higher of 'fair value less costs to sell' and 'value in use'.
  • An impairment loss reduces the asset's carrying amount.
  • The impairment loss is recognised as an expense in the statement of profit or loss.
  • Impairment tests prevent assets from being overstated on the statement of financial position.

Quick check

  1. Define 'recoverable amount' as per IAS 36.2 marks
  2. An asset's carrying amount is $40,000 and its recoverable amount is $45,000. What is the value of the impairment loss?1 mark

4. IAS 38: Intangible Assets

IAS 38 prescribes the accounting treatment for intangible assets, which are identifiable, non-monetary assets without physical substance. Examples include patents, trademarks, copyrights, and computer software. A key part of IAS 38 is the distinction between research and development costs. 'Research' is original investigation to gain new scientific or technical knowledge; all research costs must be expensed as they are incurred. 'Development' is the application of research findings to a plan for the production of new or substantially improved products or processes. Development costs can be capitalised as an intangible asset, but only if strict criteria are met (e.g., technical feasibility, intention to complete, and ability to generate future economic benefits). Internally generated goodwill or brands cannot be recognised as assets.

Carrying Amount = Cost - Accumulated Amortisation - Accumulated Impairment Losses

Amortisation (Straight-Line) = (Cost - Residual Value) / Useful Life

Key term

Amortisation: The systematic allocation of the depreciable amount of an intangible asset over its useful life, similar to depreciation for tangible assets.

Examiner insight

Examiners frequently test the research vs. development distinction. A good answer will not only state the rule but also apply it correctly to the figures provided in a scenario.

Common pitfall

Capitalising research expenditure is a major error. IAS 38 is unequivocal that all research costs must be expensed as incurred.

Fun fact

The world's most valuable brands, like Apple and Google, are worth hundreds of billions of dollars. However, because they are internally generated, their value does not appear as an intangible asset on their own companies' statements of financial position.

Worked example 15 marks

In the year ended 31 December 2023, a company incurred the following costs on a project:

  • Research phase costs: $150,000.
  • Development phase costs: $400,000.

The development phase met the IAS 38 criteria for capitalisation from 1 July 2023. The total development cost of $400,000 was incurred evenly throughout the year. Explain how these costs should be treated in the financial statements for the year ended 31 December 2023.

  1. 1

    Step 1: Treat the research costs. All research costs must be expensed. Therefore, $150,000 is recognised as an expense in the statement of profit or loss.

  2. 2

    Step 2: Treat the development costs. Development costs incurred before the capitalisation criteria were met must be expensed. Costs were incurred evenly, so costs from 1 Jan to 30 June ($400,000 / 2) = $200,000 must be expensed.

  3. 3

    Step 3: Identify capitalised development costs. Costs from 1 July to 31 Dec ($400,000 / 2) = $200,000 can be capitalised as an intangible asset.

  4. 4

    Step 4: Summarise the impact. Total expense in Profit or Loss = $150,000 (research) + $200,000 (development) = $350,000. An intangible asset of $200,000 is recognised in the Statement of Financial Position.

Recap

  • IAS 38 covers non-physical assets like patents and software.
  • A clear distinction is made between research and development.
  • All research costs must be expensed in the period they are incurred.
  • Development costs can be capitalised as an intangible asset if specific criteria are met.
  • Internally generated goodwill and brands cannot be capitalised.
  • Intangible assets with a finite life are amortised over that life.

Quick check

  1. What is the accounting treatment for expenditure on research according to IAS 38?1 mark
  2. Give one example of an intangible asset that can be capitalised and one that cannot be capitalised if generated internally.2 marks

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Define Net Realisable Value (NRV) and state the valuation rule for inventory according to IAS 2.3 marks
  2. A business purchased a machine for $80,000. It also paid $3,000 for delivery, $5,000 for installation, and $1,000 to train staff on how to use it. The machine is expected to have a useful life of 8 years and a residual value of $8,000. Calculate the depreciation charge for the second year using the reducing balance method at 20%.5 marks
  3. A pharmaceutical company spent $2 million on 'research' activities and $3 million on 'development' activities during the year. The development project meets the criteria for capitalisation under IAS 38 and is expected to generate revenue for 6 years starting from the beginning of the next financial year. Explain the accounting treatment for the $5 million expenditure in the current year's financial statements.4 marks
  4. An asset has a carrying amount of $120,000. Its fair value is $95,000 and estimated costs to sell are $5,000. Its value in use is calculated as $98,000. Calculate the impairment loss to be recognised.4 marks
  5. A company's draft profit is $500,000. An audit reveals that development costs of $60,000, which met the criteria for capitalisation, had been incorrectly treated as an expense. It was also found that closing inventory, which cost $40,000, had a net realisable value of $32,000 but was included in the accounts at cost. Calculate the corrected profit.6 marks
  6. Explain why internally generated goodwill is not recognised as an asset under IAS 38, but purchased goodwill in a business acquisition is.4 marks
  7. A company uses the revaluation model for its head office building. The building had a carrying amount of $800,000 on 1 January. On 31 December, it was revalued to $1,000,000. Explain the accounting entries required to record this revaluation, stating the names of the accounts affected.4 marks
  8. A machine was purchased on 1 January Year 1 for $200,000. It is depreciated at 10% per annum on a straight-line basis, with zero residual value. On 31 December Year 3, an impairment review was conducted. The asset's recoverable amount was determined to be $120,000. Calculate the impairment loss and the new carrying amount of the asset at 31 December Year 3.6 marks
  9. Calculate the total value of inventory to be included in the statement of financial position based on the following: Item X: 100 units, cost $10 each, selling price $15 each. Item Y: 200 units, cost $8 each, selling price $12 each, but require $3 per unit of modification work before they can be sold. Item Z: 50 units, cost $20 each, selling price $18 each. Selling costs are $1 per unit.6 marks
  10. State the main objective of International Accounting Standards (IASs) and explain how they improve the comparability of financial statements.3 marks

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