Accounting for the substance of transactionsSyllabus A4Substance over form Required by IASB Framework and IAS1 Part of the reliability characteristic Financial statements must provide the information that reflects the economic substance of events and transactions, and not merely their legal form.F72Continued Creative accounting The practice of applying inappropriate accounting policies or entering into complex or special purpose transactions with the objective of making a companys financial statements appear to disclose a more favorable position, particularly in relation to the calculation of certain key ratios, than would otherwise be the case. Off-balance sheet financingF73Example1, p295Features of transactions whose substance is not obvious Separation of legal title to an asset from the principal benefits and risks associated with the asset Linking of a transaction with others such that the commercial effect cannot be understood without looking at the series as a whole Inclusion of options in a transaction, where it is highly likely that the option will be exercised.F743a, Dec02 4a, Jun10Determining the substance of a transaction Meet the definitions of assets or liabilities? To consider which party bears the risks and rewards To identify the effect on the assets and liabilities of the enterprise. Meet the recognition criteria of assets or liabilities? Assets and liabilities should be included in the SFP where there is a sufficient evidence that an asset or liability exists, and the asset or liability can be measured at a monetary amount with sufficient reliability. Derecognised if notF75Examples where substance and form may differ Finance lease Quasi-subsidiaries Goods on consignment Goods on sale or return Sale and repurchase agreement Sale and leaseback agreement Factoring of accounts receivableF76Finance lease Transfers substantially all the risks and rewards incident to ownership of an assets to the lessee The lessee records the leased asset and the corresponding liability on the SFP.F77Quasi-subsidiaries A vehicle that does not meet the definition of a subsidiary, yet in substance is no different from a subsidiary Should be consolidated into the group accounts as though they were normal subsidiaries. Should be disclosed in the notesF78Goods on consignment Consignment goods are held by one party but owned by another If the risks and rewards of ownership are remained by the consignor, the consignment goods should be shown on the consignors SFP. otherwise on the consignees SFP Q: Who bears the risk of slow-moving inventory and has the benefits or rewards of the inventory?F79Continued- AnalysisBelong to consignor/ legal ownerList price at the date of sale No deposit Insurance and maintenance cost are born by consignor Option to return or recall is highly likely to be exercisedBelong to consignee/ holderPrice which varies with time or interest rate, factory price at the date of delivery Existence of other payments: deposit, rental and display charge, etc.-similar to finance cost Insurance and maintenance cost are born by consignee Option to return or recall is not highly likely to be exercisedF710Example 2, p298 Test 1, p299 2note1/3b(i), Dec02 3b(iii), Dec06Goods on sale or return If the purchaser still has the right to return the goods, no genuine sale has occurred until this right lapses.F7112note1, Pilot01 2note1, Jun08Sale and repurchase agreement Agreements under which assets are sold by one party to another that provide for the seller to repurchase the assets in certain circumstances at some point in the future. a genuine sale has occurred, or a secured loanF712Example 3, p300 Test 2, p301 3c(i), Pilot01 3b(ii), Dec02 2note(i), Jun03 2note1, Jun07 4bc, Jun10Continued- Analysis (Repurchase agreement) Call option of seller or put option of purchaser: whether exists and will be exercised Sales price: whether or not fair value Repurchase price: fixed + other charges over the periods/ designed to recover the holding loss / market value at the repurchase date The nature of assets: whether useful for the operating of the purchaser The location of assets: seller /purchaser The right to use the assets: seller /purchaserF713Sale and leaseback agreement If the leaseback is a finance lease, no genuine sale has occurred. This agreement results in a secured loan. (1) record finance lease and (2)* deferred P/L on sale of the asset. an operating lease, a genuine sale may have occurred.F714Test 3, p302 2note1, Dec03 3b(ii), Dec06Seller Lessee (holder) Buyer Lessor Sale (raise money) Lease (pay rentals/debt) Factoring of accounts receivable The company sells its own accounts receivable to the factor who advance cash to the company and collects the receivables as they pay up. If the risks and r