CPA
Intermediate Leval
Financial Reporting November 2017
ANSWERS

Misclassification of Revenues or Expenses: If a government entity misclassified certain revenues or expenses in a prior period, leading to inaccuracies in the financial statements, it would constitute a prior period error. For example, if a grant received was erroneously recognized as revenue when it should have been deferred, or if an expense was wrongly categorized, resulting in understated or overstated expenses.

Errors in Asset Valuation: Mistakes in the valuation of assets in prior periods can also be prior period errors. For instance, if a public sector entity significantly overvalued a tangible asset, like a building or infrastructure project, in a previous financial statement, it would require correction as a prior period error.

Omissions of Transactions: Failing to record or report a significant transaction in a prior period is a common prior period error. For instance, if a government entity neglected to record the receipt of a substantial grant in a previous year, resulting in an understatement of revenues and assets, it would be considered a prior period error.

Inaccurate Depreciation Calculation: Errors in the calculation of depreciation expenses can lead to prior period errors. For instance, if an organization miscalculated the depreciation on its infrastructure assets, resulting in an overstatement of the asset's value and an understatement of expenses, this would qualify as a prior period error.

Errors in Reconciliation: If there are discrepancies between the financial statements and supporting schedules or subsidiary ledgers, and these discrepancies were not corrected in a prior period, it would constitute a prior period error. These discrepancies may involve bank reconciliations, intergovernmental balances, or other reconciliations.

Incorrect Tax Provisions: Errors in the calculation of income tax provisions, which may lead to overstatements or understatements of deferred tax assets or liabilities in a prior period, would be considered prior period errors.

Inventory Valuation Errors: If a government entity erroneously valued its inventory at an amount significantly different from its actual value in a prior period, this would result in a prior period error. Such errors can affect both the balance sheet and income statement.

(ii) Accounting Treatment of Material Prior Period Errors under IPSAS 3:

The accounting treatment of material prior period errors in accordance with IPSAS 3 involves:

Restatement: Material prior period errors should be corrected by restating the comparative amounts for the earliest period presented in the financial statements. This restatement involves adjusting the opening balances of assets, liabilities, and equity in that earliest period to reflect the corrected figures. This ensures that the financial statements are accurately stated and comparable.

Disclosure: IPSAS 3 mandates comprehensive disclosure of prior period errors in the financial statements. This includes disclosing the nature and impact of the error, the amount of the correction made to each affected financial statement line item, and the cumulative effect on the opening balance of equity for the earliest period presented. Transparent disclosure is vital to provide clarity to users of the financial statements regarding the corrections made and their implications.

(i) Forms of Joint Ventures:

1. Jointly Controlled Operations: In this form of joint venture, the parties involved have joint control over one or more of the operations that constitute the joint venture's activities. Each venturer has rights to the assets and obligations for the liabilities relating to the joint venture's operations.
2. Jointly Controlled Assets: Jointly controlled assets are specific assets (such as property, plant, equipment, or inventory) that are jointly controlled by the venturers. The joint control involves unanimous consent, and the venturers have rights to the net assets' output and obligations for the liabilities relating to these assets.
3. Jointly Controlled Entities: Jointly controlled entities are entities in which the venturers have joint control. Joint control is established when decisions about the relevant activities require unanimous consent. Jointly controlled entities can take various legal forms, such as partnerships or corporations, and are subject to the joint control of the venturers.

(ii) Accounting Treatment of Each Form of Joint Ventures:

Jointly Controlled Operations:

• Each venturer recognizes its share of the jointly controlled operations' revenues, expenses, assets, and liabilities in its individual financial statements.
• The venturer accounts for its interest in the jointly controlled operation using the equity method, recognizing its share of the jointly controlled operation's post-tax profit or loss in the income statement.
• Any dividends received from the jointly controlled operation are recognized as a reduction in the investment.

Jointly Controlled Assets:

• Each venturer recognizes its share of the jointly controlled assets' revenues, expenses, and liabilities in its individual financial statements.
• The venturer accounts for its interest in the jointly controlled assets using the equity method, recognizing its share of the post-tax profit or loss associated with the jointly controlled assets in the income statement.

Jointly Controlled Entities:

• Each venturer includes its share of the jointly controlled entity's assets, liabilities, income, and expenses in its consolidated financial statements.
• The venturer accounts for its interest in the jointly controlled entity using proportionate consolidation or the equity method, depending on the nature and extent of its interest in the entity.
• Proportionate consolidation involves combining the venturer's share of each of the jointly controlled entity's assets, liabilities, income, and expenses with similar items in the venturer's financial statements.

1. Expected Credit Loss Model (ECL):

IFRS 9 introduced the Expected Credit Loss (ECL) model, which requires banks to recognize expected credit losses on financial assets, including loans, as soon as a credit risk exists. This is a fundamental shift from the previous "incurred loss" model, where provisions for bad and doubtful debts were only recognized when a loss event had occurred. Under the ECL model, banks are expected to recognize credit losses earlier, reflecting a forward-looking approach.

2. Three Stages of ECL:

➫ Stage 1: This stage applies to financial assets that have not experienced a significant increase in credit risk since initial recognition. For these assets, banks recognize 12-month ECL.

➫ Stage 2: When a significant increase in credit risk has occurred, but the financial asset has not yet defaulted, banks recognize lifetime ECL.

➫ Stage 3: If a financial asset has defaulted or is credit-impaired, banks recognize lifetime ECL.

3. Impact on Provisions:

IFRS 9 requires banks to set aside provisions based on expected credit losses. As a result, provisions for bad and doubtful debts are expected to be higher under IFRS 9, particularly for financial assets with significant increases in credit risk. This more conservative approach to provisioning ensures that banks account for potential future losses more prudently.

4. Impact on Loan Accessibility:

➫ Stricter Credit Assessment: Banks may conduct more rigorous assessments of borrowers' credit risk, as they need to factor in future expected credit losses. This may lead to stricter lending criteria, making it potentially more challenging for some borrowers to access bank loans, especially those with weaker credit profiles.

➫ Impact on Pricing: Banks may adjust interest rates or fees to account for the higher provisions and credit risk, potentially making loans more expensive for borrowers.

➫ Enhanced Risk Management: With the ECL model, banks are incentivized to improve their risk management practices, which can lead to more accurate credit assessments and better risk-adjusted lending decisions.

key features and advantages of sale and leaseback transactions:

➢ Sale of Asset: The company sells an existing asset to a third party, receiving a lump sum payment as the purchase price. This effectively transfers ownership of the asset to the buyer.

➢ Lease Agreement: Simultaneously with the sale, the company enters into a lease agreement with the buyer (now the lessor) to continue using the asset. The lease agreement specifies the terms, including lease duration, rental payments, and other conditions.

➢ Operating Lease: The leaseback is typically structured as an operating lease, which means it does not appear as a long-term liability on the company's balance sheet. This can help improve financial ratios and reduce debt.

Advantages:

➫ Capital Release: One of the primary advantages of sale and leaseback transactions is the immediate release of capital. By selling the asset, the company receives a cash infusion, which can be used for various purposes, such as debt reduction, working capital, expansion, or other investments.

➫ Improved Cash Flow: Leaseback arrangements can result in predictable and manageable rental payments, which can improve a company's cash flow. This predictability can help with budgeting and financial planning.

➫ Off-Balance Sheet Financing: Since the lease is structured as an operating lease, the asset no longer appears as a liability on the company's balance sheet. This can improve financial ratios and make the company look more financially stable, which can be attractive to investors and lenders.

➫ Asset Utilization: Companies can continue to use the asset even after the sale, ensuring operational continuity. This is particularly beneficial for businesses that rely heavily on specific assets for their operations.

➫ Tax Benefits: Depending on the jurisdiction and specific circumstances, there may be tax advantages associated with sale and leaseback transactions. Companies should consult with tax experts to explore potential tax benefits.

➫ Risk Mitigation: In some cases, companies may choose to enter into sale and leaseback transactions to mitigate risks associated with asset ownership, such as maintenance, depreciation, or obsolescence. The lessor assumes these risks in exchange for rental payments.

➫ Financing Flexibility: Sale and leaseback transactions provide companies with a flexible financing option. They can tailor the terms of the lease to their specific needs, such as lease duration and rental payments.