Malta: General Accounting Principles For Smaller Entities

INTRODUCTION

This pocket guide provides a summary of the recognition and measurement requirements in the Accountancy Profession (General Accounting Principles for Smaller Entities) Regulations, 2009 ("GAPSE"), that was enacted through Legal Notice 51 of 2009, and subsequently amended through Legal Notice 58 of 2010.

GAPSE has clear benefits for shareholders, lenders and other stakeholders through the application of a framework that provides an alternative standard for smaller entities that are not of the size, nor have the resources, to warrant adoption of IFRSs as adopted by the EU.

Another aim of GAPSE is to provide financial information that is more relevant to smaller entities, and that will be recognised and understood by the different stakeholders.

The volume of accounting guidance has been reduced significantly when compared to IFRSs as adopted by the EU, which had been the only alternative available to entities registered in Malta until the publication of GAPSE. In fact, GAPSE does not contain an equivalent to much of the implementation guidance contained within IFRSs as adopted by the EU; it also omits detailed explanations and requirements relating to the more complex circumstances not usually applicable to smaller entities. GAPSE does not just reduce disclosure requirements; it also simplifies the recognition and measurement requirements – for example, in connection with financial instruments. Specifically, in areas where IFRSs as adopted by the EU allow a policy choice, GAPSE generally adopts, or allows as one of its accounting policy choices, the simpler option. In fact, with the exception of derivate financial instruments, entities generally have the requirement, or the option, to measure other assets and liabilities using the cost model. GAPSE is written in such a manner that it is complete in itself and contains all the mandatory requirements for smaller entities' financial statements.

Where a transaction is not addressed by GAPSE, management is expected to use judgement to determine its accounting policy. If such a transaction is covered in IFRSs as adopted by the EU, management should refer to the appropriate international standard.

This pocket book looks at the key areas covered by GAPSE and explains the basic requirements. It includes all amendments to GAPSE that were published up to May 2012, and is written primarily for those who have a reasonable understanding of basic accounting concepts and terminology.

GAPSE ACCOUNTING FRAMEWORK

1 Scope

The term 'smaller entities' has different meanings in different territories. For entities other than state-owned entities, GAPSE can be applied by those entities, including subsidiaries of larger entities, that do not exceed any of the following criteria in the relevant financial periods, as prescribed by the Legal Notice:

• Revenue: €35 million
• Total assets: €17.5 million
• Average number of employees: 250

Generally speaking, the relevant financial periods are the two consecutive financial reporting periods immediately preceding the period in which GAPSE is applied.

Certain qualitative criteria must however also be met for adoption of GAPSE to be allowable. Specifically, GAPSE cannot be applied if:

• a shareholder holding at least 20% of the entity's shares has served notice at least 6 months before the year end to apply IFRSs as adopted by the EU
• the entity's securities are listed
• the entity is a guarantor of the principal or interest on the securities that are listed
• the entity is a public company
• the entity holds a licence or other authorisation by the Malta Financial Services Authority

Banks, insurance entities, securities brokers and dealers, and pension funds are examples of entities that hold a licence or other authorisation by the MFSA.

State-owned entities can adopt GAPSE if they do not exceed more than one of the following thresholds:

• Revenue: €8.8 million
• Total assets: €4.4 million
• Average number of employees: 50

2 Historical cost

GAPSE mainly requires items to be measured at their historical cost. It however allows certain assets and liabilities, for example property, plant and equipment, investment property and certain types of financial investments, to be carried at fair value. All items other than those carried at fair value are subject to impairment.

3 Concepts

Financial statements are prepared on an accruals basis and on the assumption that the entity is a going concern and will continue in operation for the foreseeable future (which is at least 12 months from the end of the reporting period). Their objective is to provide information about the financial position, performance and cash flows of an entity that is useful to users in making economic decisions.

The principal qualitative characteristics that make information provided in financial statements useful to users are understandability, relevance, materiality, reliability, substance over form, prudence, completeness, comparability, timeliness and achieving a balance between benefit and cost.

Information is material if its omission or misstatement, individually or collectively, could influence the economic decisions of users made on the basis of the financial statements.

Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances.

4 Fair presentation

Financial statements should show a true and fair view, or present fairly the financial position, financial performance and cash flows of an entity. This is achieved by applying GAPSE and the principal qualitative characteristics explained in Section 3 above.

Entities are permitted to depart from GAPSE only in extremely rare circumstances, if management concludes that compliance with one of the requirements would be so inconsistent with the requirement to give a true and fair view. The nature, reason and financial impact of the departure should be explained in the financial statements.

5 First-time adoption

A first-time adopter of GAPSE is an entity that presents its annual financial statements in accordance with GAPSE for the first time, regardless of whether its previous accounting framework was IFRSs as adopted by the EU or another set of generally accepted accounting principles.

First-time adoption requires full retrospective application of GAPSE requirements effective at the reporting date for an entity's first financial statements prepared in accordance with GAPSE. To facilitate transition, there is a general exemption from retrospective application on grounds of impracticability. GAPSE interprets a requirement as being 'impracticable' 'when the entity cannot apply it after making every reasonable effort to do so'.

Comparative information is prepared and presented on the basis of GAPSE. Adjustments arising from the first-time application of GAPSE are recognised directly in retained earnings (or, if appropriate, another category of equity) at the date of transition to GAPSE. The date of transition to GAPSE upon first time adoption is the first day of the earliest period presented in the first financial statements under GAPSE.

If the entity is prohibited from continuing to apply GAPSE (because the qualitative and quantitative criteria are no longer met), or if management chooses not to apply GAPSE in some future period, and then subsequently reverts to it, the same provisions for first-time adoption are applicable also for a subsequent adoption.

6 Selection of accounting policies

Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.

Where GAPSE does not specifically address a transaction, other event or condition, management uses its judgement in developing and applying an accounting policy. The financial information derived from the application of an entity's accounting policies must be relevant to the users' needs and reliable. 'Reliability' means that the financial statements represent faithfully the financial position, financial performance and cash flows of the entity, reflect the economic substance of transactions, and are neutral, prudent and complete in all material respects (see Section 12).

FINANCIAL STATEMENTS

The objective of financial statements is to provide information for economic decisions. A complete set of financial statements comprises a balance sheet; an income statement and a statement of changes in equity or, in the instances permitted by GAPSE (see Section 10 on page 7) a statement of income and retained earnings; a cash flow statement and explanatory notes (including accounting policies).

GAPSE prescribes a format for the balance sheet, but not for the other components of the financial statements. There are minimum disclosures to be made on the face of the financial statements as well as in the notes.

Financial statements disclose corresponding information for the preceding period ('comparatives'), unless there are other specific requirements.

7 Balance sheet

The balance sheet presents an entity's assets, liabilities and equity at a specific time.

Items presented in the balance sheet

The following items, as a minimum, are presented in the balance sheet when applicable.

• Non-current assets – intangible assets; property, plant and equipment; investment property; financial investments; trade and other receivables; current tax receivable; subscribed capital called but not paid; deferred tax assets; and goodwill
• Current assets – inventories; trade and other receivables; current tax receivable; subscribed capital called but not paid; financial investments; and cash and cash equivalents
• Equity – share capital; share premium account; revaluation reserve; other reserves; retained earnings; and minority interest
• Non-current liabilities – long-term borrowings; trade and other payables; deferred tax liabilities; and provisions
• Current liabilities – short-term borrowings; trade and other payables; current tax payable; and provisions

If applicable, the face of the balance sheet must also include line items that present the total of assets classified as held for sale; assets included in disposal groups classified as held for sale and liabilities included in disposal groups classified as held for sale.

Current/non-current distinction

Current and non-current assets and current and non-current liabilities are presented as separate classifications in the balance sheet, unless presentation based on liquidity provides reliable and more relevant information.

An asset is classified as current if it is expected to be realised, sold or consumed in the entity's normal operating cycle (irrespective of length); primarily held for the purpose of being traded; expected to be realised within 12 months after the end of the reporting period; or is cash or cash equivalents (that is not restricted to beyond 12 months after the end of the reporting period).

A liability is classified as current if it is expected to be settled in the entity's normal operating cycle; primarily held for the purpose of being traded; due to be settled within 12 months after the end of the reporting period; or the entity does not have an unconditional right to defer settlement of the liability until at least 12 months after the end of the reporting period.

8 Income statement

The income statement presents an entity's income and expenditure during the reporting period.

Items to be presented in the income statement

Management presents all income and expense recognised in a period either in an income statement or, in the instances permitted by GAPSE (see Section 10 on page 7), a statement of income and retained earnings.

The following items, as a minimum, are presented in the income statement (or the statement of income and retained earnings):

• Revenue
• Other income
• Other expenses
• Income from investments
• Other interest receivable and similar income
• Interest payable and similar charges
• Income from subsidiaries, associates and joint ventures accounted for using the cost method; or share of the profit or loss of subsidiaries, associates and joint ventures accounted for using the equity method
• Profit or loss before tax
• Tax on profit or loss
• Profit or loss for the period from continuing operations
• Profit or loss for the period from discontinued operations
• Profit or loss for the period

Additional line items or subheadings are presented when such presentation is relevant to an understanding of the entity's financial performance. An analysis of total expenses is presented on the face of the income statement using a classification based on either the nature or function of expenses within the entity, whichever provides information that is reliable and more relevant.

Within a consolidated set of financial statements, profit or loss for the period is allocated to the amount attributable to minority interests and to the owners of the parent.

Material and extraordinary items

GAPSE requires the separate disclosure of items of income and expenses that are material. Disclosure may be made in the income statement or in the notes. Such income and expenses may include write-downs of inventories or property, plant and equipment (PPE); restructuring costs and reversals of any provisions for costs of restructuring; gains or losses on disposals of PPE, investment property and investments; litigation settlements; and reversals of other provisions.

Extraordinary items are not permitted.

9 Statement of changes in equity

The statement of changes in equity presents a reconciliation of the balances of equity items at the beginning and end of the reporting period.

The following items are presented in the statement of changes in equity:

• Profit or loss for the period (showing separately, in consolidated financial statements, the total amounts attributable to owners of the parent and to minority interests)
• For each component of equity, the effects of changes in accounting policies and corrections of errors
• For each component of equity, a reconciliation between the carrying amount at the beginning and end of the period, separately disclosing changes resulting from (1) profit or loss, (2) each item of income or expense that is credited or charged directly in equity, and (3) the amounts of investments by, and dividends and other distributions to, equity holders

10 Statement of income and retained earnings

In many cases, the only changes to the equity of an entity during the period will comprise:

• Profit or loss for the period
• Dividends declared and paid or payable during the period
• Restatement of retained earnings for correction of prior-period errors
• Restatement of retained earnings for changes in accounting policy

Where this occurs, management is permitted to present a statement of income and retained earnings, combining the income statement and a statement analysing movements in retained earnings, in lieu of presenting two separate statements, i.e. the income statement and statement of changes in equity.

11 Cash flow statement

The cash flow statement presents the generation and use of cash by category of activity (operating, investing and financing) over the reporting period.

Operating activities are the entity's principal revenue-producing activities. Investing activities are the acquisition and disposal of non-current assets (including business combinations) and investments. Financing activities reflect changes in equity and borrowings.

Management may present operating cash flows by using either the indirect method (adjusting net profit or loss for non-operating and non-cash transactions, and for changes in working capital) or the direct method (gross cash receipts and payments).

Non-cash transactions include impairment losses or reversals, depreciation, amortisation, unrealised fair value gains and losses, and income statement charges for provisions.

Cash flows from investing and financing activities are reported separately at gross amounts (that is, gross cash receipts and gross cash payments).

12 Accounting policies, estimates and errors

If GAPSE specifically addresses a transaction, other event or condition, an entity applies GAPSE. However, if it does not, management uses its judgement in developing and applying an accounting policy that results in information that meets the qualitative characteristics explained in Section 3 on page 2. Where there is no relevant guidance, management considers the applicability of the following sources, in descending order:

• the requirements and guidance in GAPSE for similar and related issues;
• the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in Section 3 on page 2; and
• the requirements and guidance in IFRSs as adopted by the EU dealing with similar and related issues.

Management may also, but is not obliged to, consider the most recent pronounce- ments of other standard-setting bodies that use a conceptual framework to develop accounting standards that is similar to that used in the development of IFRSs as adopted by the EU.

Management chooses and consistently applies its accounting policies to similar transactions and events.

Changes in accounting policies

When GAPSE provides a choice of accounting policy for a specific transaction and management changes its choice, this is a change of accounting policy. An entity may change an accounting policy only if the change is required by GAPSE, or results in the financial statements providing reliable and more relevant information about the effects of transactions, events or conditions on the entity's financial position, financial performance or cash flows.

Changes in accounting policies are accounted for retrospectively.

Changes in accounting estimates

Changes in accounting estimates are recognised prospectively by including the effects in profit or loss in the period that is affected (that is, the period of the change and future periods, where relevant) except if the change in estimate gives rise to changes in assets, liabilities or equity. In this case, it is recognised by adjusting the carrying amount of the related asset, liability or equity in the period of the change.

Corrections of prior-period errors

Errors may arise from mistakes and oversights or misinterpretation of available information.

Material prior-period errors are adjusted retrospectively (that is, by adjusting opening retained earnings and the related comparatives). There is an exception when it is impracticable to determine either the period-specific effects or the cumulative effect of the error. In the latter case, management corrects such errors prospectively from the earliest date practicable. The error and effect of its correction on the financial statements are disclosed.

13 Notes to the financial statements

The notes are an integral part of the financial statements. Information presented on the face of an entity's balance sheet, income statement, statement of changes in equity (or statement of income and retained earnings) and cash flow statement (the primary statements) is cross-referenced to the relevant notes where possible.

Notes provide additional information to the amounts disclosed on the face of the primary statements. The following disclosures are included, as a minimum, within the notes to the financial statements:

• A statement of compliance with GAPSE
• A summary of significant accounting policies applied
• Supporting information for items presented on the face of the primary statements
• Other information not presented in the primary statements but required by GAPSE

14 Related parties

The main categories of related parties are:

• Parents
• Subsidiaries
• Fellow subsidiaries
• Associates
• Joint ventures
• Parties with control, joint control or significant influence over the entity (which include close members of their families, where applicable)
• Directors (which include directors of the parent company)
• Entities that are controlled, jointly controlled or significantly influenced by any individual party referred to above

Related parties exclude finance providers, trade unions, public utilities and governments in the course of their normal dealings with the entity.

The names of the immediate parent and, if different, the ultimate parent, are disclosed irrespective of whether there have been transactions.

Where there have been related-party transactions, disclosure is made of the nature of the relationship. As a minimum, disclosures must also include the amount of the transactions in aggregate for each significant category of transactions, the amount of outstanding balances in aggregate (including provisions for doubtful debts), and the expense recognised during the period in respect of bad or doubtful debts due from related parties.

Disclosure of related party transactions that are eliminated in a set of consolidated financial statements is however not required provided that the entity and all such related entities are consolidated in consolidated financial statements that are available for public use.

Entities are also exempted from the disclosure of related party transactions with a state (a national, regional or local government) that has control, joint control or significant influence over the reporting entity. This exemption is also extended to other entities that are related parties because the same state has control, joint control or significant influence over both the reporting entity and the other entities.

15 Events after the balance sheet date

Events after the balance sheet date may qualify as adjusting events or non-adjusting events. Adjusting events provide further evidence of conditions that existed at the balance sheet date and lead to adjustments to the financial statements. Non- adjusting events relate to conditions that arose after the balance sheet date; they do not lead to adjustments, but they do lead to disclosures in the financial statements.

Dividends proposed or declared after the balance sheet date are not recognised as a liability at the end of the reporting period.

Management discloses the date on which the financial statements were authorised for issue and who gave that authorisation.

ASSETS AND LIABILITIES

An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

A liability is a present obligation of the entity arising from past events, the settle- ment of which is expected to result in an outflow from the entity of resources embodying economic benefits.

The recognition of an asset or a liability depends on whether it is probable that any future economic benefit associated with the item will flow to or from the entity, and whether the item has a cost or value that can be measured reliably.

16 Intangible assets other than goodwill

An intangible asset is an identifiable non-monetary asset without physical sub- stance. The identifiability criterion is met when the intangible asset is separable (that is, it can be sold, transferred, licensed, rented or exchanged), or where it arises from contractual or other legal rights.

Recognition

Expenditure on intangibles is recognised as an asset when it meets the recognition criteria of an asset.

Initial measurement of separately acquired intangible assets

Intangible assets are measured initially at cost. Cost includes (a) the purchase price (including import duties and non-refundable purchase taxes, net of trade discounts and rebates); and (b) any costs directly attributable to preparing the asset for its intended use.

Internally generated intangible assets

The process of generating an intangible asset is divided into a research phase and a development phase. No intangible assets arising from the research phase may be recognised. Intangible assets arising from the development phase are recognised when the entity can demonstrate each of the following:

• technical feasibility of completing the intangible asset;
• its intention to complete the development;
• its ability to use or sell the intangible asset;
• how the intangible asset will generate probable future economic benefits (for example, the existence of a market for the output of the intangible asset or for the intangible asset itself);
• the availability of resources to complete the development; and
• its ability to measure the attributable expenditure reliably.

The costs relating to many internally generated intangible items cannot be capitalised and are expensed as incurred. This includes research, start-up costs, training, advertising and relocation costs. Expenditure on internally generated brands, mastheads, customer lists, publishing titles and goodwill are not recognised as intangible assets.

Subsequent measurement

Intangible assets are carried at cost less any accumulated amortisation and any accumulated impairment losses.

Intangible assets are amortised on a systematic basis over the useful lives of the intangibles. This life is usually determined on the basis of the contractual period of the asset or on other legal rights and cannot be indefinite.

The residual value of such assets at the end of their useful lives is assumed to be zero, unless there is a commitment by a third party to purchase the asset.

17 Property, plant and equipment (PPE)

PPE consists of tangible assets that: (a) are held for use in the production or supply of goods and services, for rental to others or for administrative purposes; and (b) are expected to be used during more than one period.

Initial measurement

PPE is measured initially at cost. Cost includes: (a) purchase price, including legal and brokerage fees, import duties and other non-refundable purchase taxes (net of discounts and rebates); (b) any directly attributable costs to bring the asset to the location and condition necessary for it to be capable of operating in the manner intended by management; and (c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located.

Management has a choice of either capitalising those finance costs that are directly attributable to the acquisition, construction or production of a qualifying asset, or alternatively recognising them as an expense when they are incurred. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use.

Subsequent measurement

Classes of PPE are carried at historical cost less accumulated depreciation and any accumulated impairment losses (the cost model), or at a revalued amount less any subsequent accumulated depreciation and accumulated impairment losses (the revaluation model). A class of PPE comprises assets of a similar nature, function or use in the business.

As outlined above, under the cost model, PPE is carried at cost less accumulated depreciation and any accumulated impairment losses. The depreciable amount of an item of PPE (being the cost/gross carrying value less the estimated residual value) is depreciated on a systematic basis over its useful life.

Under the revaluation model, PPE whose fair value can be measured reliably is carried at a revalued amount, being its fair value at the date of the revaluation, less any subsequent accumulated depreciation and accumulated impairment losses. Revaluations must be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.

If an asset's carrying amount is increased as a result of a revaluation, the increase is credited directly to equity. However, the increase is recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. Similarly, revaluation decreases are debited directly to equity to the extent of any credit balance existing in the revaluation surplus in respect of that asset, with any further decreases recognised in profit or loss.

PPE may have significant parts with different useful lives. Depreciation is calculated based on each individual part's life.

18 Investment property

Investment property is a property (land, a building or part of a building, or both) held by the owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both. A property interest held for use in the production or supply of goods or services or for administrative purposes is not an investment property, nor is a property held for sale in the ordinary course of business.

Initial measurement

Investment property is initially measured at cost. The cost of a purchased invest- ment property is its purchase price plus any directly attributable costs, such as pro- fessional fees for legal services, property transfer taxes and other transaction costs.

Subsequent measurement

Management has a choice of measuring investment property either at historical cost less accumulated depreciation and any accumulated impairment losses (the cost model), or at a revalued amount less any subsequent accumulated depreciation and accumulated impairment losses (the revaluation model).

The measurement rules for both the cost model and the revaluation model are consistent with the rules described in Section 17 on page 13 above for items of PPE.

Transfers to or from investment property apply when the property meets or ceases to meet the definition of an investment property.

19 Inventories

Inventories are initially recognised at cost. The cost of inventories includes all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Cost of purchase of inventories includes the purchase price, import duties, non- refundable taxes, transport and handling costs and any other directly attributable costs less trade discounts, rebates and similar items.

Inventories are subsequently valued at the lower of (a) cost, and (b) estimated selling price, less costs to complete and sell.

The cost of inventories used is assigned by using either the first-in, first-out (FIFO) or weighted average cost formula. Last-in, first-out (LIFO) is not permitted. The same cost formula is used for all inventories that have a similar nature and use to the entity. Different cost formulae may be justified where inventories have a different nature or use.

20 Financial instruments

A financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. A financial instrument is recognised when the entity becomes a party to its contractual provisions.

A financial asset is cash; a contractual right to receive cash or another financial asset; a contractual right to exchange financial assets or liabilities with another entity under conditions that are potentially favourable; or an equity instrument of another entity. A financial liability is a contractual obligation to deliver cash or another financial asset; or to exchange financial instruments with another entity under conditions that are potentially unfavourable.

GAPSE accounting requirements for financial instruments (other than investments in subsidiaries, associates and joint ventures) are addressed in two sections of the Principles: GAPSE section 9 addresses financial investments, and GAPSE section 18 addresses other financial instruments.

Financial investments

A financial investment is a financial asset which is held by an entity for the accretion of wealth through distribution (such as interest, dividends and similar income), for capital appreciation or for other similar benefits to the investing entity.

Initial measurement

On initial recognition, financial investments are measured at cost, including transaction costs that are directly attributable to the acquisition of the financial asset. Transaction costs do not include debt premiums or discounts, financing costs or internal administrative or holding costs.

Subsequent measurement

At the end of each reporting period financial investments are measured as follows:

• Held-for-trading investments are measured using either the cost model or the fair value through profit or loss model
• Quoted investments that are not held for trading are measured using either the cost model or the fair value through equity model
• Unquoted investments that are not held for trading are measured using the cost model

Under the cost model, an entity measures all items in the same class of investment at the lower of cost and fair value less costs to sell. Any adjustments to the carrying amount in this respect are recognised in profit or loss for the period.

Under the fair value model, an entity measures all items in the same class of investment at fair value if their fair value can be measured reliably. Using the fair value through equity model, if an investment's carrying amount is increased as a result of an increase in fair value, the increase is credited directly to equity. However, the increase is recognised in profit or loss to the extent that it reverses a fair value decrease of the same investment previously recognised in profit or loss. Similarly, fair value decreases are debited directly to equity to the extent of any credit balance existing in the equity reserve in respect of that investment, with any further decreases recognised in profit or loss.

Fair value

The fair value of an investment is the price at which the investment could be exchanged between a knowledgeable, willing buyer who is not over-eager nor determined to buy at any price, and a knowledgeable, willing seller who is not over-eager nor forced to sell, both acting independently. Fair value is calculated in accordance with the following hierarchy:

• The quoted price for an identical asset in an active market
• If no active market exists, by use of a valuation technique

Other financial assets and financial liabilities

Other financial assets and financial liabilities include all financial assets and financial liabilities other than financial investments and derivatives.

Initial measurement

Similar to financial investments, other financial assets and financial liabilities are measured on initial recognition at cost, including transaction costs that are directly attributable to the acquisition of the financial asset or the issue of the financial liability.

Subsequent measurement

At the end of each reporting period, entities are encouraged, but not required, to measure other financial assets and financial liabilities which have different initial measurement and maturity amounts at amortised cost using the effective interest method. The difference between the initial and maturity amounts would be amortised over the term of the instrument. The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability.

Entities may nevertheless measure other financial assets and financial liabilities at the initial amounts (subject to impairment considerations in the case of financial assets) without amortising the difference between the initial and maturity amounts.

Entities are required to assess at each balance sheet date whether there is any objective evidence that other financial assets are impaired. If any such evidence exists, the entity determines the amount of any impairment loss, which is recognised in profit or loss.

Derecognition of financial assets

An entity derecognises a financial asset when:

• the rights to the cash flows from the asset have expired or are settled;
• the entity has transferred substantially all the risks and rewards relating to the financial asset; or
• it has retained some significant risks and rewards but has transferred control of the asset to another party. The asset is therefore derecognised, and any rights and obligations created or retained are recognised.

Derecognition of financial liabilities

Financial liabilities are derecognised when they are extinguished – that is, when the obligation is discharged, cancelled or expires.

Derivatives

A derivative is a financial instrument:

• whose value changes in response to a specified variable or underlying rate (for example, interest rate);
• that requires no or little initial net investment; and
• that is settled at a future date.

An entity has a choice on whether or not to recognise derivatives on its balance sheet. Certain disclosures relating to fair value of the derivatives, and information about their extent and nature, are nevertheless required even where an entity opts not to recognise derivatives on its balance sheet.

Hedge accounting is prohibited under GAPSE.

Initial measurement

An entity that chooses to recognise a derivative measures it at initial recognition at its fair value. When the fair value of a derivative at initial recognition materially differs from the initial net investment, if any, paid or received to enter into a derivative contract (i.e. the fair value of the consideration paid or received), that difference is recognised in the period in which it arises. Transaction costs are recognised as an expense in profit or loss.

Subsequent measurement

At the end of each reporting period derivatives are measured at fair value. Any increases or decreases in the fair value of a derivative are recognised in profit or loss in the period in which they arise.

21 Impairment of non-financial assets

Non-financial assets are subject to an impairment test according to the requirements outlined below, with the following exceptions: deferred tax assets, and investment properties measured under the revaluation model.

Impairment of inventories

Inventories are assessed for impairment at each reporting date by comparing the carrying amount with the estimated selling price less costs to complete and sell. Management then reassesses the selling price, less costs to complete and sell, in each subsequent period, to determine if the impairment loss previously recognised should be reversed.

Impairment of assets other than inventories

An asset is impaired when its recoverable amount is less than its carrying amount. The reduction is an impairment loss and is recognised immediately in profit or loss. Assets (including goodwill) are tested for impairment where there is an indication that the asset may be impaired. Existence of impairment indicators is assessed at each reporting date.

When performing the impairment test of an asset, management estimates the recoverable amount. Recoverable amount is the higher of value in use and fair value less costs to sell, which is the amount obtainable at the reporting date from disposal of the asset in an arm's length transaction between knowledgeable, willing parties, less costs of disposal.

The recoverable amount of goodwill is derived from measurement of the recoverable amount of the larger group of assets to which the goodwill belonged. For the purpose of impairment testing, goodwill acquired in a business combination is allocated from the acquisition date to each of the acquirer's groups of assets that are expected to benefit from the synergies of the business combination.

At each reporting date after recognition of the impairment loss on an asset other than goodwill, management assesses whether there is any indication that an impairment loss may have decreased or may no longer exist. The impairment loss on an asset other than goodwill is reversed if the recoverable amount of the asset exceeds its carrying amount.

The increased carrying amount of the asset subsequent to the reversal of an impairment loss may not however exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years.

Goodwill impairment can never be reversed.

22 Provisions and contingencies

Recognition and initial measurement

A provision is recognised only when:

• the entity has a present obligation to transfer economic benefits as a result of a past event;
• it is probable (more likely than not) that an entity will be required to transfer economic benefits in settlement of the obligation; and
• the amount of the obligation can be estimated reliably.

The amount recognised as a provision is the best estimate of the amount required to settle the obligation at the reporting date. Where the impact of the time value of money is material, the amount of the provision is the present value of the amount expected to be required to settle the obligation.

A present obligation arising from a past event may take the form either of a legal or constructive obligation. An obligating event leaves management no realistic alternative to settling the obligation. If management can avoid the future expenditure by its future actions, it has no present obligation, and no provision is required. For example, management cannot recognise a provision based solely on intent or legislative requirement to incur expenditure at some future date.

When some or all of the amount required to settle a provision is reimbursed by another party, management recognises the reimbursement as a separate asset only when it is virtually certain that it will receive the reimbursement on settlement of the obligation. The reimbursement receivable is presented in the balance sheet as an asset and is not offset against the provision.

Management reviews provisions at each reporting date and adjusts them to reflect the current best estimate of the amount that would be required to settle the obligation at that reporting date.

Contingent liabilities

A contingent liability is either a possible but uncertain obligation, or a present obligation that is not recognised as a liability because either it is not probable an outflow will occur or the amount cannot be measured reliably. Management does not recognise (but discloses) a contingent liability as a liability unless it has been acquired in a business combination.

Contingent assets

Contingent assets are not recognised. When the realisation of benefits is virtually certain, the related asset is not a contingent asset but meets the definition of an asset and is recognised as such.

23 Income taxes

Current tax is recognised as a current liability for tax payable on taxable profit for the current and past periods. It is measured at the amount expected to be paid to, or recovered from, the taxation authorities, using the tax rates (and laws) that have been enacted or substantively enacted by the reporting date.

Management recognises (a) a deferred tax liability for temporary differences that are expected to increase taxable profit in future; (b) a deferred tax asset for temporary differences that are expected to reduce taxable profit in the future; and (c) a deferred tax asset for the carry-forward of unused tax losses and unused tax credits. This applies to all such items except for:

• temporary differences arising from the initial recognition of goodwill;
• temporary differences arising from the initial recognition of an asset or liability in a transaction that is not a business combination, and at the time of the transaction, affects neither accounting profit nor taxable profit (loss);
• taxable temporary differences associated with investments in subsidiaries, associates and joint ventures, provided that the parent, investor or venturer is able to control the timing of the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future;
• deductible temporary differences associated with investments in subsidiaries, associates, and joint ventures, to the extent that it is not probable that (a) the temporary difference will reverse in the foreseeable future, and (b) taxable profit will be available against which the temporary difference can be utilised.

Management only recognises a deferred tax asset to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised.

Current and deferred tax is recognised as a tax expense in profit or loss, unless the tax arises from an item recognised directly in equity. In this case, the tax follows the recognition basis of the item from which it arises.

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that apply or have been enacted or substantively enacted by the end of the reporting period. Deferred tax assets and liabilities are not discounted.

Tax relating to dividends that is paid or payable to taxation authorities on behalf of the owners (for example, withholding tax) is charged to equity as part of the dividends.

24 Leases

A lease is an agreement in which the lessor conveys to the lessee in return for a payment or a series of payments the right to use an asset for an agreed period of time.

A lease is classified at inception as a finance lease if it transfers to the lessee substantially all of the risks and rewards incidental to ownership. All other leases are treated as operating leases. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the legal form of the contract.

For sale-and-leaseback transactions resulting in a leaseback being a finance lease, any gain or loss realised by the seller-lessee on the transaction is deferred and amortised through profit or loss over the shorter of the lease term and the useful life of the asset.

Where the transaction results in an operating lease and the transaction is at fair value, any profit or loss is recognised immediately. Different rules apply where the sale price is above or below fair value, with the specific circumstances determining whether any profit or loss is recognised immediately, or deferred and amortised over the period through which the asset is expected to be used.

Lessee

A lessee in a finance lease records an asset and a liability in its financial statements at amounts equal to fair value of the leased asset, or, if lower, the present value of the minimum lease payments. The lessee depreciates this asset in accordance with its depreciation policy for similar assets, or over the lease term if shorter. The lessee apportions minimum lease payments between finance charges and a reduction of the outstanding liability.

Minimum lease payments are the payments that the lessee is or can be required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with:

• for a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or
• for a lessor, any residual value guaranteed to the lessor by the lessee, a party related to the lessee, or a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.

A lessee in an operating lease records the rental payments as an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user's benefit.

Lessor

A lessor records assets leased under a finance lease and presents them as a receivable at an amount equal to the net investment in the lease. This is the gross investment in the lease, discounted at the interest rate implicit in the lease. Gross investment in the lease is the aggregate of:

• the minimum lease payments receivable by the lessor under a finance lease, and
• any unguaranteed residual value accruing to the lessor.

A lessor records assets leased out under operating leases according to the nature of the assets and depreciates them on a basis consistent with the normal depreciation policy for similar owned assets. Rental income is recognised on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern over which the benefit of the leased asset is diminished.

BUSINESS COMBINATIONS, CONSOLIDATED FINANCIAL STATEMENTS, AND INVESTMENTS IN ASSOCIATES AND JOINT VENTURES

25 Business combinations

Business combinations are the bringing together of separate entities or businesses into one entity. An acquirer is identified in all cases, and that entity obtains control of one or more other entities or businesses (the acquiree). Control is the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities.

A business combination may be structured in a variety of ways for legal, taxation or other reasons. It may involve the purchase of the equity of another entity; the purchase of all the net assets of another entity; the assumption of the liabilities of another entity; or the purchase of some of the net assets of another entity that together form one or more businesses. It may be achieved by the issue of equity instruments, the transfer of cash, cash equivalents or other assets, or a combination thereof. The transaction may be between the shareholders of the combining entities or between one entity and the shareholders of another entity. It may involve the establishment of a new entity to control the combining entities or net assets transferred, or the restructuring of one or more of the combining entities.

All business combinations are accounted for by applying the purchase method. The steps in applying the purchase method are: (1) identify the acquirer; (2) measure the cost of the business combination; and (3) allocate the cost of the business combination to the assets acquired and liabilities and contingent liabilities assumed at the acquisition date.

The cost of a business combination includes the fair value at the date of exchange of assets given, liabilities incurred or assumed and equity instruments issued by the acquirer, in exchange for control of the acquiree, and any directly attributable costs. These costs are allocated at the acquisition date by recognising the acquiree's identifiable assets, liabilities and contingent liabilities at their fair value at that date, except for non-current assets that are classified as held for sale. These latter assets are measured at fair value less costs to sell.

The criteria for recognition of items acquired are as follows:

• Assets other than intangible assets are recognised when it is probable that any associated future economic benefits will flow to the acquirer and their fair value can be measured reliably
• Liabilities other than contingent liabilities are recognised when it is probable that an outflow of resources will be required to settle the obligation and their fair value can be measured reliably
• Intangible assets or contingent liabilities are recognised when their fair value can be measured reliably

Goodwill (the excess of the cost of the business combination over the acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities) is recognised as an intangible asset at the acquisition date. After initial recognition, the goodwill is measured at cost less accumulated amortisation and less any accumulated impairment losses. The useful life of goodwill cannot be indefinite; where an entity is unable to make a reliable estimate, the life is presumed to be up to a maximum of 20 years.

Negative goodwill is recognised in profit or loss immediately after management has reassessed the identification and measurement of identifiable items arising on acquisition and the cost of the business combination.

26 Consolidated and individual financial statements

A subsidiary is an entity that is controlled by the parent. Control is presumed to exist when the parent holds more than 50 per cent of the entity's voting power; this presumption may be rebutted if there is clear evidence to the contrary.

The consolidated financial statements present financial information about the group as a single economic entity. This requires the application of the consolidation procedures, elimination of intra-group balances and transactions, and application of uniform reporting date and accounting policies.

GAPSE does not address which companies are required to present consolidated financial statements, and neither does it address whether any subsidiaries may be excluded from consolidated financial statements. This may however be regulated by relevant legislation, where applicable.

If consolidated financial statements are required, they may be prepared in accordance with GAPSE if the group does not exceed any of the following criteria in the immediately preceding two consecutive financial years:

• Revenue: €35 million computed net, or €42 million computed gross
• Total assets: €17.5 million computed net, or €21 million computed gross
• Average number of employees: 250

'Gross thresholds' may only be applied to the group's aggregated revenue and balance sheet, without any adjustments that would be required for the preparation of consolidated financial statements. 'Net thresholds' may be applied when the group's revenue and balance sheet are computed after such adjustments have been effected.

Individual financial statements are those financial statements, other than consolidated financial statements, that are presented by an investor in subsidiaries, associates and joint ventures. In the investor's individual financial statements, the investments in subsidiaries, jointly controlled entities and associates are accounted for using either the cost model (cost less any accumulated impairment losses) or the equity accounting method. The same model is applied to all the investor's investments in subsidiaries, associates and jointly controlled entities.

Under the equity method, the investment (in the subsidiary, associate or jointly controlled entity) is initially carried at cost. It is subsequently increased or decreased to recognise the investor's share of the profit or loss and other movements in equity of the investee after the date of acquisition.

27 Investments in associates

An associate is an entity over which the investor has significant influence but which is neither a subsidiary nor a joint venture of the investor. Significant influence is the power to participate in the financial and operating policy decisions of the associate but is not control or joint control over those policies. It is presumed to exist when the investor holds at least 20 per cent of the investee's voting power; it is presumed not to exist when less than 20 per cent is held. These presumptions may be rebutted if there is clear evidence to the contrary.

Associates are accounted for consistently in the investor's individual financial statements using either the cost model (cost less any accumulated impairment losses) or the equity accounting method. As referred to in Section 26 above, the same model is applied to all the investor's investments in subsidiaries, associates and jointly controlled entities.

Where consolidated financial statements are presented by virtue of an investor's other interests (in one or more subsidiaries), the investor must apply, within those consolidated financial statements, the equity method for investments in associates.

28 Investments in joint ventures

A joint venture is a contractual agreement whereby two or more parties (the venturers) undertake an economic activity that is subject to joint control. Joint control is defined as the contractually agreed sharing of control of an economic activity. A venturer accounts for its investment based on the type of joint venture: jointly controlled operations, jointly controlled assets or jointly controlled entities.

Jointly controlled operations

Jointly controlled operations are operations that involve use of the assets and other resources of the venturers rather than the establishment of a separate entity. Each venturer uses its own property, plant and equipment, carries its own inventory, and incurs its own expenses and liabilities. The joint venture agreement usually provides a means by which the revenue from the sale of the joint product and any expenses incurred in common are shared among the venturers.

Each venturer recognises in its financial statements the assets that it controls and the liabilities that it incurs, as well as the expenses that it incurs and its share of the income that it earns from the sale of goods or services by the joint venture.

Jointly controlled assets

The holding of jointly controlled assets is a type of a joint venture where venturers have joint control of asset(s) contributed or acquired for the purpose of the joint venture.

A venturer recognises in its financial statements its share of the jointly controlled assets, any liabilities that it has incurred, its share of any liabilities incurred jointly with the other venturers in relation to the joint venture, any income from the sale or use of its share of the output of the joint venture, together with its share of any expenses incurred by the joint venture and any expenses that it has incurred in respect of its interest in the joint venture.

Jointly controlled entities

A jointly controlled entity is a joint venture that involves the establishment of a separate entity in which each venturer has an interest. The contractual arrangement between the venturers establishes joint control over the economic activity of the entity.

The venturer reports in its individual financial statements its interest in a jointly controlled entity using either the cost model (cost less any accumulated impairment losses) or the equity accounting method. As referred to in Section 26 on page 26, the same model is applied to all the investor's investments in subsidiaries, associates and jointly controlled entities.

Where consolidated financial statements are presented by virtue of an investor's other interests (in one or more subsidiaries), the investor must apply, within those consolidated financial statements, the equity method for investments in jointly controlled entities.

LIABILITIES AND EQUITY

Equity is the residual interest in the entity's assets after deducting all its liabilities. Equity includes investments by the owners of the entity, plus additions to those investments earned through profitable operations and retained for use in the entity's operations, minus reductions to owners' investments as a result of unprofitable operations and distributions to owners.

A liability is a present obligation of an entity arising from past events that is expected to result in the outflow of economic benefits from the entity. Some instruments issued by reporting entities may have the legal form of shares but in substance are debt, for example, redeemable preference shares with a mandatory redemption date. They are presented as liabilities.

29 Issue of equity shares

Equity instruments (for example, ordinary shares) are usually measured at fair value of cash or other resources received, net of transaction costs and any related income tax benefit.

30 Minority interests

In consolidated financial statements, any minority interests in the net assets of a subsidiary are included in equity.

INCOME AND EXPENSES

31 Revenue

Revenue is measured at the fair value of the consideration received or receivable. Revenue arising from the sale of goods and from the rendering of services is recognised when it is probable that economic benefits will flow to the entity, when these benefits, and related costs, can be measured reliably and when the criteria below are also met.

Revenue arising from the sale of goods is recognised when an entity transfers the significant risks and rewards of ownership and managerial control.

Revenue from the rendering of services is recognised when the outcome of the transaction can be estimated reliably by reference to the stage of completion of the transaction. Revenue is recognised in the accounting periods in which the services are rendered under the percentage-of-completion method.

Interest income is recognised on an accrual or time proportion basis. Royalties are recognised on an accrual basis in accordance with the substance of the relevant agreement. Dividends are recognised when the shareholder's right to receive payment is established.

Construction contracts

Contract costs should be recognised as an expense in the period in which they are incurred. When the outcome of the construction contract can be estimated reliably, the revenue and contract costs associated with the contract are recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the end of the reporting period. Where the outcome of the contract cannot be estimated reliably, recognition of the revenue can only be made to the extent of contract costs that were incurred and for which recovery is probable.

32 Government grants

A government grant is assistance by government in the form of a transfer of resources to an entity in return for past or future compliance with specified conditions relating to the operating activities of the entity.

Government grants are recognised when there is reasonable assurance that the entity will comply with the conditions related to them and that the grants will be received. They however exclude, for the purposes of GAPSE, loans at nil or low interest rates.

Grants related to expenditure are recognised in the income statement over the periods necessary to match them with the related costs that they are intended to compensate. The timing of such recognition in the income statement will depend on the fulfilment of any conditions or obligations attaching to the grant.

Grants related to assets are either offset against the carrying amount of the relevant asset or presented as deferred income in the balance sheet. The income statement will be affected either by a reduced depreciation charge or by deferred income being recognised as income systematically over the useful life of the related asset.

33 Borrowing costs

Entities have a policy choice under GAPSE with respect to borrowing costs incurred that are directly attributable to the acquisition, production or construction of a qualifying asset (see Section 17 on page 13). An entity can choose to capitalise or expense such borrowing costs. All other borrowing costs are expensed as incurred.

CURRENCIES

34 Functional currency

All components of the financial statements are measured in the currency of the primary economic environment in which the entity operates (its functional currency). All transactions entered into in currencies other than the functional currency are treated as transactions in a foreign currency.

Foreign currency transactions

A transaction in a foreign currency is recorded in the functional currency using the exchange rate at the date of the transaction (average rates may be used if they do not fluctuate significantly). At the end of the reporting period, foreign currency monetary balances are reported using the exchange rate at the end of the reporting period. Monetary balances include cash or amounts to be received or paid in cash.

Non-monetary balances denominated in a foreign currency and carried at historical cost are reported using the exchange rate at the date of the transaction. Non- monetary items denominated in a foreign currency and carried at fair value are reported using the exchange rate at the date when the fair values were determined.

Exchange differences are recognised as profit or loss for the period, except for those differences arising on a monetary item that forms part of an entity's net investment in a foreign entity (subject to strict criteria of what qualifies as net investment). In the financial statements that include the foreign operation and the reporting entity (for example, consolidated financial statements when the foreign operation is a subsidiary), such exchange differences are classified separately in equity. They are recognised in profit or loss upon disposal of the net investment.

35 Presentation currency

An entity's presentation currency is the currency in which its financial statements are presented, which may be regulated by relevant legislation where applicable. If the presentation currency differs from the functional currency, management translates its results and financial position into the presentation currency.

Assets and liabilities are translated at the closing rate at the balance sheet date; the income statement is translated using exchange rates at the dates of the transactions. If exchange rates between the functional and presentation currencies do not fluctuate significantly, an entity may use a rate that approximates the exchange rates at the dates of the transactions, for example an average rate for the period. All resulting exchange differences are recognised as a separate component of equity.

When preparing consolidated financial statements, entities in the group may have different functional currencies. The financial statements of all entities are translated into the group's presentation currency. The exchange differences arising from the translation in respect of each entity are recognised as a separate component of equity.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.