3 Sirus is a large national public limited company (plc). The directors’ service agreements require each director to
purchase ‘B’ ordinary shares on becoming a director and this capital is returned to the director on leaving the
company. Any decision to pay a dividend on the ‘B’ shares must be approved in a general meeting by a majority of
all of the shareholders in the company. Directors are the only holders of ‘B’ shares.
Sirus would like advice on how to account under International Financial Reporting Standards (IFRSs) for the following
events in its financial statements for the year ended 30 April 2008:
(a) The capital subscribed to Sirus by the directors and shareholders is shown as follows in the statement of financial
position as at 30 April 2008:
Equity
$m
Ordinary ‘A’ shares 100
Ordinary ‘B’ shares 20
Retained earnings 30
––––
Total equity 150
––––
On 30 April 2008 the directors had recommended that $3 million of the profits should be paid to the holders of
the ordinary ‘B’ shares, in addition to the $10 million paid to directors under their employment contracts. The
payment of $3 million had not been approved in a general meeting. The directors would like advice as to whether
the capital subscribed by the directors (the ordinary ‘B’ shares) is equity or a liability and how to treat the
payments out of profits to them. (6 marks)
(b) When a director retires, amounts become payable to the director as a form of retirement benefit as an annuity.
These amounts are not based on salaries paid to the director under an employment contract. Sirus has
contractual or constructive obligations to make payments to former directors as at 30 April 2008 as follows:
(i) certain former directors are paid a fixed annual amount for a fixed term beginning on the first anniversary of
the director’s retirement. If the director dies, an amount representing the present value of the future payment
is paid to the director’s estate.
(ii) in the case of other former directors, they are paid a fixed annual amount which ceases on death.
The rights to the annuities are determined by the length of service of the former directors and are set out in the
former directors’ service contracts. (6 marks)
(c) On 1 May 2007 Sirus acquired another company, Marne plc. The directors of Marne, who were the only
shareholders, were offered an increased profit share in the enlarged business for a period of two years after the
date of acquisition as an incentive to accept the purchase offer. After this period, normal remuneration levels will
be resumed. Sirus estimated that this would cost them $5 million at 30 April 2008, and a further $6 million at
30 April 2009. These amounts will be paid in cash shortly after the respective year ends. (5 marks)
(d) Sirus raised a loan with a bank of $2 million on 1 May 2007. The market interest rate of 8% per annum is to
be paid annually in arrears and the principal is to be repaid in 10 years time. The terms of the loan allow Sirus
to redeem the loan after seven years by paying the full amount of the interest to be charged over the ten year
period, plus a penalty of $200,000 and the principal of $2 million. The effective interest rate of the repayment
option is 9·1%. The directors of Sirus are currently restructuring the funding of the company and are in initial
discussions with the bank about the possibility of repaying the loan within the next financial year. Sirus is
uncertain about the accounting treatment for the current loan agreement and whether the loan can be shown as
a current liability because of the discussions with the bank. (6 marks)
Appropriateness of the format and presentation of the report and quality of discussion (2 marks)
Required:
Draft a report to the directors of Sirus which discusses the principles and nature of the accounting treatment of
the above elements under International Financial Reporting Standards in the financial statements for the year
ended 30 April 2008.
(25 marks) 3 Report to the directors of Sirus
Terms of Reference
This report sets out the impact of International Financial Reporting Standards on:
(a) the directors’ interests in Sirus
(b) the directors’ retirement benefits
(c) the acquisition of Marne
(d) the proposed repayment of the loan
(a) Directors’ interests in Sirus
The capital of Sirus should be presented as either a financial liability or equity. IAS32 ‘Financial Instruments: Presentation’
says that a financial liability is:
Any liability that is:
– a contractual obligation:
to deliver cash or another financial asset to another entity; or
to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable
to the entity; or
– a contract that will or may be settled in the entity’s own equity instruments
It also defines equity as: any contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities. Those instruments that do not meet the definition of a liability will be classified as equity. The entity must, therefore,
have an unconditional right to avoid delivery of cash or another financial asset.
The definition of a financial instrument used in IAS32 is the same as that in IAS39.
The fundamental principle of IAS32 is that a financial instrument should be classified as either a financial liability or an equity
instrument according to the substance of the contract, not its legal form. The enterprise must make the decision at the time
the instrument is initially recognised.
The capital subscribed by the directors has a mandatory redemption feature at a future date, thus the substance is that there
is a contractual obligation to deliver cash and, therefore, should be recognised as a liability. In contrast, if the return of capital
was discretionary and Sirus has an unconditional right to avoid paying cash or assets to the directors, then the capital would
be classed as equity. The financial liability will be stated at the present value of the redemption amount. This may be
calculated by discounting the amount over the life of the service contract. Subsequently financial liabilities are carried at fair
value through profit or loss or at amortised cost under IAS39. In this case, the liability is likely to be held at amortised cost.
Any distribution of profits would be classed as an appropriation of equity because the shareholders of Sirus have the right to
refuse payment of profits and thus the $3 million that is to be divided between the directors will be classed as an appropriation
of equity rather than as an expense. As the appropriation has not been paid or approved at the year end, it will not appear
as a liability in the statement of financial position. Effectively it is being treated like a proposed dividend. The $10 million
paid to directors under remuneration contracts will be treated as an expense.
(b) Directors’ retirement benefits
The directors’ retirement benefits are unfunded plans which may fall under IAS19 ‘Employee Benefits’.
Sirus should review its contractual or constructive obligation to make retirement benefit payments to its former directors at the
time when they leave the firm. The payments may create a financial liability under IAS32, or may give rise to a liability of
uncertain timing and amount which may fall within the scope of IAS37 ‘Provisions, contingent liabilities and contingent
assets’. Certain former directors are paid a fixed annuity for a fixed term which is payable annually, and on death, the present
value of future payments are paid to the director’s estate. An annuity meets the definition of a financial liability under IAS32,
if there is a contractual obligation to deliver cash or a financial asset. The latter form of annuity falls within the scope of
IAS32/39. The present value of the annuity payments should be determined. The liability is recognised because the directors
have a contractual right to the annuity and the firm has no discretion in terms of withholding the payment. As the rights to
the annuities are earned over the period of the service of the directors, then the costs should have been recognised also over
the service period.
Where an annuity has a life contingent element and, therefore, embodies a mortality risk, it falls outside the scope of IAS39
because the annuity will meet the definition of an insurance contract which is scoped out of IAS39, along with employers’
rights and obligations under IAS19. Such annuities will, therefore, fall within the scope of IAS37 if a constructive obligation
exists. Sirus should assess the probability of the future cash outflow of the present obligation. Because there are a number of
similar obligations, IAS37 requires that the class of obligations as a whole should be considered (similar to a warranty
provision). A provision should be made for the best estimate of the costs of the annuity and this would include any liability
for post retirement payments to directors earned to date. The liability should be built up over the service period rather than
just when the director leaves. In practice the liability will be calculated on an actuarial basis consistent with the principles in
IAS19. The liability should be recalculated on an annual basis, as for any provision, to take account of changes in directors
and other factors. The liability will be discounted where the effect is material. (c) Acquisition of Marne
All business combinations within the scope of IFRS 3 ‘Business Combinations’ must be accounted for using the purchase
method. (IFRS 3.14) The pooling of interests method is prohibited. Under IFRS 3, an acquirer must be identified for all
business combinations. (IFRS 3.17) Sirus will be identified as the acquirer of Marne and must measure the cost of a business
combination at the sum of the fair values, at the date of exchange, of assets given, liabilities incurred or assumed, in exchange
for control of Marne; plus any costs directly attributable to the combination. (IFRS 3.24) If the cost is subject to adjustment
contingent on future events, the acquirer includes the amount of that adjustment in the cost of the combination at the
acquisition date if the adjustment is probable and can be measured reliably. (IFRS 3.32) However, if the contingent payment
either is not probable or cannot be measured reliably, it is not measured as part of the initial cost of the business combination.
If that adjustment subsequently becomes probable and can be measured reliably, the additional consideration is treated as
an adjustment to the cost of the combination. (IAS 3.34) The issue with the increased profit share payable to the directors
of Marne is whether the payment constitutes remuneration or consideration for the business acquired. Because the directors
of Marne fall back to normal remuneration levels after the two year period, it appears that this additional payment will
constitute part of the purchase consideration with the resultant increase in goodwill. It seems as though these payments can
be measured reliably and therefore the cost of the acquisition should be increased by the net present value of $11 million at
1 May 2007 being $5 million discounted for 1 year and $6 million for 2 years.
(d) Repayment of the loan
If at the beginning of the loan agreement, it was expected that the repayment option would not be exercised, then the effective
interest rate would be 8% and at 30 April 2008, the loan would be stated at $2 million in the statement of financial position
with interest of $160,000 having been paid and accounted for. If, however, at 1 May 2007, the option was expected to be
exercised, then the effective interest rate would be 9·1% and at 30 April 2008, the cash interest paid would have been
$160,000 and the interest charged to the income statement would have been (9·1% x $2 million) $182,000, giving a
statement of financial position figure of $2,022,000 for the amount of the financial liability. However, IAS39 requires the
carrying amount of the financial instrument to be adjusted to reflect actual and revised estimated cash flows. Thus, even if
the option was not expected to be exercised at the outset but at a later date exercise became likely, then the carrying amount
would be revised so that it represented the expected future cash flows using the effective interest rate. As regards the
discussions with the bank over repayment in the next financial year, if the loan was shown as current, then the requirements
of IAS1 ‘Presentation of Financial Statements’ would not be met. Sirus has an unconditional right to defer settlement for longer
than twelve months and the liability is not due to be legally settled in 12 months. Sirus’s discussions should not be considered
when determining the loan’s classification.
It is hoped that the above report clarifies matters. |
发表于 2008-10-11 16:25
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