Week 1
Conceptual Framework basics
Framework gives the logic behind IFRS recognition and measurement.
In this course, know mainly: asset, liability, control, recognition, measurement
basis.
Asset
A present economic resource controlled by the entity as a result of past events.
Economic resource = a right with potential to produce economic benefits.
Key word: control, not ownership.
If you do not control the resource, no asset.
Example logic: trained employees can leave, so training cost is usually not an asset.
Liability
A present obligation of the entity to transfer an economic resource as a result of past
events.
Does not require 100% certainty.
What matters is that a present obligation exists.
Recognition
Recognise an item if:
it meets the definition of asset or liability, and
recognition provides useful information, so in practice usually:
o existence is sufficiently supportable
o amount can be measured reliably enough
Measurement
Main bases:
historical cost
current value / fair value / value in use / fulfilment value
For exam logic:
Framework tells you what kind of item it is
Standard tells you how to measure it
Control
Control means entity can direct use of resource and obtain benefits from it.
No control = no asset.
Main traps
Probability is not “must be certain”.
Legal ownership is not necessary for control.
Spending money does not automatically create an asset.
Framework is broad; for specific accounting, the standard wins.
,IAS 37 Provisions
What it is
Standard for provisions, contingent liabilities, contingent assets.
Provision: recognise when all 3 hold
1. Present obligation from past event
2. Probable outflow of resources
3. Reliable estimate possible
Measurement
Best estimate of expenditure required to settle obligation
Population of items: often expected value
Single obligation: often most likely outcome
Discount if time value is material
Contingent liability
Possible obligation, or
Present obligation but either outflow not probable or amount not reliably measurable
Usually disclose, do not recognise.
Main traps
Below “more likely than not” outflow → usually contingent liability, not provision
No provision for future operating losses
Executory contracts not recognised, unless onerous
Summary - Week 1
Asset = present economic resource controlled by entity
Liability = present obligation to transfer economic resource
Provision = present obligation + probable outflow + reliable estimate
35% legal claim? usually disclose contingent liability, no provision
Week 2
Finance vs Operating lease
Finance lease = in substance, buying
A lease is a finance lease when the lessee is basically paying for almost the entire asset.
Very small residual value.
Present value of lease payments >= fair value of the asset
Accounted for as sale + loan to client: recognize profit at start of lease
Manufacturer lessor finance lease: Gain = (lower of FV or PV of payments) − cost.
Operating lease = in substance, renting
Significant residual value. Payments < asset value
Accounted for as periodic services: recognize income over time on either a straight-line or
another systematic basis
For lessor:
,Operating lease
asset stays on balance sheet
initial direct costs → add to asset
Finance lease
asset derecognized
initial costs included in lease receivable.
IFRS 16 – How do we account for leases? (renting assets → right-of-use + liability)
1. Start with initial recognition
From the slide example:
Lease liability = 355,391 = PV of lease payments you must make. You always
recognize it on the balance sheet. (IFRS 16)
ROU asset = 420,391 = liability (355,391) + adjustments (payments already made,
so here the first lease payment of 50,000 + costs (15,000, so the initial direct costs of
20,000 – the received lease incentive of 5,000)).
Cash paid at start = 65,000
Journal entry at commencement:
Dr ROU asset 420,391
Cr Lease liability 355,391
Cr Cash 65,000 the cash paid in adjustments previously
2. Build year 1 schedule
Use these formulas:
Interest expense = opening lease liability × interest rate
Principal repaid = lease payment − interest
Ending lease liability = opening liability − principal repaid
Depreciation = initial ROU asset ÷ lease term
For year 1 in the slide:
Opening liability = 355,391
Interest = 17,770 355,391 x 5%
Lease payment = 50,000 = interest + principal same yearly
o interest → P&L expense
o principal → reduces lease liability
o cash → outflow
Principal reduction = 32,230 50,000 – 17,770
Ending liability = 323,161 355,391 – 32,230
Depreciation = 42,039 420, same yearly
3. Journal entries for year 1
1) Depreciation:
Dr Depreciation expense (P&L) 42,039
Cr ROU asset 42,039
2) Lease payment reduces liability + unwinding (interest):
Dr Interest expense (P&L) 17,770
Dr Lease liability (BS) 32,230
, Cr Cash 50,000
4. What the lecturer wants you to see
A lease payment is split into:
interest part = P&L
principal part = reduces liability
That is the whole logic. The slide literally says payment first covers interest; remainder repays
principal.
Assignment 2 Question 1
1. BLUE journal entries
Initial recognition
−n
1−(1+ r)
Lease liability = PV of payments= P × = 866
r
ROU asset = 866 + 100 + 100 = 1066
Cash paid at start = 200
1) Journal entry at commencement:
Dr ROU asset 1066
Cr Lease liability 866
Cr Cash 200
Depreciation = ROU asset / 5yrs = = 213.2
2) Journal entry year 1:
Dr Depreciation expense 213
Cr ROU asset 213
Interest = 5% * 866 = 43
Principal = 200
Dr Interest expense 43
Dr Lease liability 157
Cr Cash 200
2. RED journal entries
PV lease payments = 866 < Fair value of asset = 1120 it’s an operating lease. Red still keeps
the asset on its balance sheet because this is an operating lease. The carrying amount of the
asset on Red’s balance sheet prior to the commencement of the lease was €900.
1) For income:
Commencement (1 jan 2023) the 100 blue prepaid but lease service hasn’t yet been provided
Dr Cash 100
Cr Prepaid lease payments 100 cash received before revenue is earned
Year end (31 dec 2023) now PART OF the liability becomes revenue.
The lease lasts 5 years, so that €100 relates to 5 years of service. = 20 per year
Conceptual Framework basics
Framework gives the logic behind IFRS recognition and measurement.
In this course, know mainly: asset, liability, control, recognition, measurement
basis.
Asset
A present economic resource controlled by the entity as a result of past events.
Economic resource = a right with potential to produce economic benefits.
Key word: control, not ownership.
If you do not control the resource, no asset.
Example logic: trained employees can leave, so training cost is usually not an asset.
Liability
A present obligation of the entity to transfer an economic resource as a result of past
events.
Does not require 100% certainty.
What matters is that a present obligation exists.
Recognition
Recognise an item if:
it meets the definition of asset or liability, and
recognition provides useful information, so in practice usually:
o existence is sufficiently supportable
o amount can be measured reliably enough
Measurement
Main bases:
historical cost
current value / fair value / value in use / fulfilment value
For exam logic:
Framework tells you what kind of item it is
Standard tells you how to measure it
Control
Control means entity can direct use of resource and obtain benefits from it.
No control = no asset.
Main traps
Probability is not “must be certain”.
Legal ownership is not necessary for control.
Spending money does not automatically create an asset.
Framework is broad; for specific accounting, the standard wins.
,IAS 37 Provisions
What it is
Standard for provisions, contingent liabilities, contingent assets.
Provision: recognise when all 3 hold
1. Present obligation from past event
2. Probable outflow of resources
3. Reliable estimate possible
Measurement
Best estimate of expenditure required to settle obligation
Population of items: often expected value
Single obligation: often most likely outcome
Discount if time value is material
Contingent liability
Possible obligation, or
Present obligation but either outflow not probable or amount not reliably measurable
Usually disclose, do not recognise.
Main traps
Below “more likely than not” outflow → usually contingent liability, not provision
No provision for future operating losses
Executory contracts not recognised, unless onerous
Summary - Week 1
Asset = present economic resource controlled by entity
Liability = present obligation to transfer economic resource
Provision = present obligation + probable outflow + reliable estimate
35% legal claim? usually disclose contingent liability, no provision
Week 2
Finance vs Operating lease
Finance lease = in substance, buying
A lease is a finance lease when the lessee is basically paying for almost the entire asset.
Very small residual value.
Present value of lease payments >= fair value of the asset
Accounted for as sale + loan to client: recognize profit at start of lease
Manufacturer lessor finance lease: Gain = (lower of FV or PV of payments) − cost.
Operating lease = in substance, renting
Significant residual value. Payments < asset value
Accounted for as periodic services: recognize income over time on either a straight-line or
another systematic basis
For lessor:
,Operating lease
asset stays on balance sheet
initial direct costs → add to asset
Finance lease
asset derecognized
initial costs included in lease receivable.
IFRS 16 – How do we account for leases? (renting assets → right-of-use + liability)
1. Start with initial recognition
From the slide example:
Lease liability = 355,391 = PV of lease payments you must make. You always
recognize it on the balance sheet. (IFRS 16)
ROU asset = 420,391 = liability (355,391) + adjustments (payments already made,
so here the first lease payment of 50,000 + costs (15,000, so the initial direct costs of
20,000 – the received lease incentive of 5,000)).
Cash paid at start = 65,000
Journal entry at commencement:
Dr ROU asset 420,391
Cr Lease liability 355,391
Cr Cash 65,000 the cash paid in adjustments previously
2. Build year 1 schedule
Use these formulas:
Interest expense = opening lease liability × interest rate
Principal repaid = lease payment − interest
Ending lease liability = opening liability − principal repaid
Depreciation = initial ROU asset ÷ lease term
For year 1 in the slide:
Opening liability = 355,391
Interest = 17,770 355,391 x 5%
Lease payment = 50,000 = interest + principal same yearly
o interest → P&L expense
o principal → reduces lease liability
o cash → outflow
Principal reduction = 32,230 50,000 – 17,770
Ending liability = 323,161 355,391 – 32,230
Depreciation = 42,039 420, same yearly
3. Journal entries for year 1
1) Depreciation:
Dr Depreciation expense (P&L) 42,039
Cr ROU asset 42,039
2) Lease payment reduces liability + unwinding (interest):
Dr Interest expense (P&L) 17,770
Dr Lease liability (BS) 32,230
, Cr Cash 50,000
4. What the lecturer wants you to see
A lease payment is split into:
interest part = P&L
principal part = reduces liability
That is the whole logic. The slide literally says payment first covers interest; remainder repays
principal.
Assignment 2 Question 1
1. BLUE journal entries
Initial recognition
−n
1−(1+ r)
Lease liability = PV of payments= P × = 866
r
ROU asset = 866 + 100 + 100 = 1066
Cash paid at start = 200
1) Journal entry at commencement:
Dr ROU asset 1066
Cr Lease liability 866
Cr Cash 200
Depreciation = ROU asset / 5yrs = = 213.2
2) Journal entry year 1:
Dr Depreciation expense 213
Cr ROU asset 213
Interest = 5% * 866 = 43
Principal = 200
Dr Interest expense 43
Dr Lease liability 157
Cr Cash 200
2. RED journal entries
PV lease payments = 866 < Fair value of asset = 1120 it’s an operating lease. Red still keeps
the asset on its balance sheet because this is an operating lease. The carrying amount of the
asset on Red’s balance sheet prior to the commencement of the lease was €900.
1) For income:
Commencement (1 jan 2023) the 100 blue prepaid but lease service hasn’t yet been provided
Dr Cash 100
Cr Prepaid lease payments 100 cash received before revenue is earned
Year end (31 dec 2023) now PART OF the liability becomes revenue.
The lease lasts 5 years, so that €100 relates to 5 years of service. = 20 per year
