F2: Reporting standards

Answer: C. IFRS 15's five-step model: (1) identify the contract with a customer; (2) identify the separate performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations; (5) recognise revenue when (or as) each performance obligation is satisfied. The other options scramble the steps, mix in incorrect elements such as 'sign the contract' or 'allocate costs', or omit key steps entirely. The five-step model is central to IFRS 15 and applies consistently across all contracts with customers.

Answer: D. IFRS 15 requires revenue to be recognised over time if the customer controls the asset as it is being created or enhanced. Here, the local authority gains control of the bridge incrementally as construction progresses, satisfying this criterion. Point-in-time recognition would apply only if none of the over-time criteria are met — for example, a standard product where the customer does not control the asset until delivery. Equal monthly instalments are not a permitted basis unless they happen to correspond to actual progress. Revenue cannot be recognised at contract start simply because it has been signed; performance obligations must first be (at least partially) satisfied.

Answer: A. IFRS 15 distinguishes principal (recognises gross revenue) from agent (recognises net revenue — commission only). The key indicator is whether the entity controls the specified good or service before it is transferred to the customer. Since the travel agency does not control the holidays — the tour operator does — the agency is acting as an agent and recognises only its commission on a net basis. Gross recognition is not appropriate simply because the customer pays the agency directly; the underlying control test determines principal versus agent status, not the payment mechanic. The employee count of the tour operator is not a relevant criterion.

Answer: B. For a finance lease (where substantially all risks and rewards transfer to the lessee), the lessor removes the underlying asset from its balance sheet and recognises a lease receivable equal to the net investment in the lease (the present value of future lease payments plus any unguaranteed residual value). Subsequent recognition unwinds the finance charge using the effective interest method. Keeping the asset on the balance sheet describes operating lease accounting for lessors, where risks and rewards are retained. Straight-line income recognition applies to operating leases only. Lessors do not recognise right-of-use assets — that treatment applies to lessees under IFRS 16.

Answer: C. Under an operating lease, the lessor retains substantially all the risks and rewards of ownership, so the asset remains on the lessor's balance sheet (subject to its normal depreciation policy) and rental income is recognised on a straight-line basis over the lease term. Under a finance lease, the lessor transfers risks and rewards to the lessee, so the asset is derecognised and replaced with a lease receivable. These are genuinely different accounting treatments, not identical. The lessor does recognise income from an operating lease — it is simply recognised as rental income rather than as finance income on a receivable.

Answer: D. IAS 37 requires all three conditions: (1) a present obligation (legal or constructive) arising from a past event; (2) it is probable that an outflow of economic benefits will be required; and (3) a reliable estimate of the amount can be made. The obligation must be present (existing), not merely planned or expected for the future. 'Possible' rather than 'probable' would result in a contingent liability disclosure instead of a provision. Constructive obligations are explicitly included, not excluded. The exact amount need not be known — only a reliable estimate is required.

Answer: A. IAS 37 requires long-term provisions to be discounted when the time value of money is material. Initial provision = £500,000 × 0.864 = £432,000. The provision is then unwound each year (unwinding of discount is charged to finance costs in P&L) until it reaches £500,000 at the settlement date. Using the undiscounted amount (£500,000) overstates the liability at initial recognition. The precise PV factor = 1/1.05^3 = 0.8638, giving £431,918 ≈ £432,000. The £375,000 and £450,000 figures arise from applying incorrect discount factors.

Answer: B. Deferred tax liability = taxable temporary difference × tax rate = (carrying amount − tax base) × tax rate = (£200,000 − £120,000) × 25% = £80,000 × 25% = £20,000. The £80,000 figure is the taxable temporary difference itself, not the DTL. The £50,000 would arise from applying 25% to the full carrying amount (£200,000 × 25% = £50,000). The £30,000 might come from applying 25% to the tax base (£120,000 × 25% = £30,000). The DTL arises because the asset generates more taxable profit in future (when it reverses) than the current carrying value implies.

Answer: C. IAS 12 permits recognition of a deferred tax asset for deductible temporary differences only to the extent it is probable that sufficient taxable profit will be available in future periods to allow the deductible temporary difference to be utilised. If future taxable profit is insufficient, the asset cannot be recognised — or must be partially written down — since there would be no tax benefit to recover. Recognition is not automatic whenever a difference exists; it requires the probability assessment. The nature of the underlying asset and management approval are not relevant criteria under IAS 12.

Answer: D. IFRS 9 classifies financial assets based on two criteria: the business model for managing the asset and whether its cash flows are solely payments of principal and interest (SPPI test). If the business model is 'both collecting contractual cash flows AND selling' (a 'hold to collect and sell' model) and the asset passes SPPI, classification is FVTOCI. Amortised cost applies only when the business model is exclusively 'hold to collect' (not to sell). FVTPL is the residual category or where the SPPI test fails. Exchange listing does not determine classification.

Answer: A. For financial assets classified as FVTPL under IFRS 9, all fair value movements are recognised in profit or loss for the period in which they arise. The gain of £15,000 (£115,000 − £100,000) is therefore included in the income statement. The alternative treatment — recognising gains in OCI — applies only to equity investments designated at FVTOCI (an irrevocable election available at initial recognition for equity instruments not held for trading). No split between P&L and OCI applies, and deferring until sale would be incorrect under FVTPL measurement.

Answer: B. IFRS 15 Step 4 requires the transaction price to be allocated to each performance obligation in proportion to its relative standalone selling price. Total standalone prices = £12,000 + £8,000 = £20,000. Product allocation = £17,000 × (£12,000 ÷ £20,000) = £17,000 × 0.60 = £10,200. Service allocation = £17,000 × (£8,000 ÷ £20,000) = £6,800. Recognising the full standalone price of £12,000 ignores the bundle discount. Equal allocation (£8,500 each) ignores the different standalone prices. The £9,000 figure might arise from dividing the total incorrectly.

Answer: C. Under IAS 16, an upward revaluation is recognised in other comprehensive income (OCI) and accumulated in a revaluation surplus (a component of equity), unless it reverses a previous revaluation decrease that was recognised in profit or loss — in which case it is taken to the income statement to the extent of that previous decrease. The gain here (£70,000) is a first-time revaluation upward, so it goes entirely to OCI. It is never split between P&L and OCI, and it is not netted against the asset's cost directly.

Answer: D. Amortised cost (effective interest method): interest income = carrying amount × effective rate = £95,000 × 6.2% = £5,890. Cash received (coupon) = £100,000 × 5% = £5,000. Carrying amount at end of year 1 = £95,000 + £5,890 − £5,000 = £95,890. The bond accretes towards par over its life. Leaving the value at £95,000 treats it as though no time has passed. Par value (£100,000) is only reached at maturity. The £94,110 would arise from deducting the coupon from cost without adding interest income, which misunderstands the amortised cost method.

Answer: A. IAS 21 defines functional currency as the currency of the primary economic environment in which an entity operates — typically the currency in which it primarily generates and expends cash. Key indicators include the currency in which sales prices are denominated, wages are paid, and financing is raised. Presentation currency, which may differ from functional currency, is the currency chosen for presenting financial statements. Incorporation jurisdiction and dividend currency may be relevant indicators but do not define functional currency — the standard focuses on economic environment, not legal or administrative choices.

Answer: B. Trade receivables are monetary items (a right to receive a fixed amount of cash) and must be retranslated at the closing rate. Original: $50,000 ÷ 1.50 = £33,333. Closing: $50,000 ÷ 1.40 = £35,714. Gain = £35,714 − £33,333 = £2,381. Under IAS 21, exchange differences on monetary items are recognised in profit or loss in the period they arise. OCI treatment applies only to exchange differences on the net investment in a foreign operation, not to individual trading monetary items. The closing rate must be applied — using the original transaction rate throughout would freeze a stale value.

Answer: C. Under IAS 32, substance governs classification over legal form. A financial liability exists when there is a contractual obligation to deliver cash (e.g. repay principal, pay interest) or another financial asset to the holder. Equity instruments, by contrast, give the holder only a residual interest in the net assets — there is no contractual obligation to pay a fixed amount. The interest rate relative to market is not the distinguishing criterion. Legal labelling ('shares' or 'bonds') does not determine classification; the contractual terms do. Treasury policy has no bearing on IAS 32 classification requirements.

Answer: D. IAS 32 requires compound financial instruments to be split into their component parts. For a convertible bond: the liability component is measured at the present value of the future cash flows (interest payments and principal repayment) discounted at the market rate for equivalent non-convertible debt; the equity component is the residual (issue proceeds less the liability component) — representing the fair value of the conversion option. This split reflects the substance of the instrument: part debt (cash flows owed if conversion does not occur) and part equity (the option to convert). Neither pure equity nor pure liability presentation is correct, and a contingent liability does not arise since the obligation to pay cash (if not converted) is present and probable.

Answer: A. IAS 38 requires an intangible asset to be: identifiable (separable or arising from contractual rights); controlled by the entity (able to restrict others from accessing the benefits); and expected to generate probable future economic benefits. Physical form is not required — by definition, intangible assets lack physical substance. Internally generated assets are not always excluded: development costs meeting specific criteria (technical feasibility, intention to complete, ability to use/sell, probable future benefits, adequate resources, ability to measure expenditure) can be capitalised. An indefinite life is neither required nor the norm — most intangibles have finite useful lives and are amortised.

Answer: B. IAS 36 requires impairment testing when there is an indication that an asset may be impaired — both external indicators (e.g. market value decline, adverse changes in environment) and internal indicators (e.g. physical damage, worse performance than expected) are considered. Goodwill and intangible assets with indefinite useful lives are tested annually regardless of whether indications exist, since they are not amortised and may otherwise go unreviewed. For other assets, annual testing without indication is not required. Auditor requests do not trigger the IAS 36 test — the standard itself defines the triggers.

Answer: B. Indirect method: start with operating profit, add back non-cash charges, then adjust for working capital movements. Cash from operations = £300,000 + £50,000 (depreciation add-back) − £30,000 (receivables increase = cash outflow) − £20,000 (inventory increase = cash outflow) + £10,000 (payables increase = cash inflow) = £310,000. £350,000 adds back depreciation but ignores all the working capital movements. £360,000 also adds the payables increase but still ignores receivables and inventory. £270,000 does not follow from the adjustments; omitting the depreciation add-back would give £260,000 (£300,000 − £40,000). Increases in assets are cash outflows; increases in liabilities are cash inflows.

Answer: C. Percentage of completion = costs incurred ÷ total estimated costs = £300,000 ÷ £800,000 = 37.5%. Revenue recognised to date = 37.5% × £1,000,000 = £375,000. A common error is to recognise revenue equal to costs (£300,000) — this would only apply if revenue equals costs, which is the loss-contract scenario. Recognising £700,000 applies the remaining cost proportion (70%) to revenue. Full contract revenue (£1,000,000) is recognised only on completion, not throughout the contract.

Answer: D. The deferred tax liability has increased from £15,000 to £20,000 — an increase of £5,000. An increase in a deferred tax liability represents additional future tax that will arise when the temporary difference reverses, recognised as a deferred tax charge in profit or loss for the current period. A credit would be appropriate if the liability had decreased (i.e. deferred tax was reversing). The full closing balance (£20,000) or full opening balance (£15,000) is not the movement — only the change of £5,000 is recognised in the current year's income statement.

Answer: B. IAS 12 permits a deferred tax asset for unused tax losses only to the extent it is probable that future taxable profit will be available for the losses to be used against. Here only £80,000 of the £120,000 losses is expected to be usable, so the DTA = £80,000 × 25% = £20,000. Recognising the full £120,000 × 25% = £30,000 ignores the probability restriction — the excess £40,000 of losses has no probable future benefit and is not recognised (though it may be disclosed). The £80,000 figure is the profit base, not the tax asset. The £10,000 figure applies the rate to the unusable portion, which is precisely the part that cannot be recognised.

Answer: C. IAS 24 defines related parties as those with the ability to control or significantly influence an entity, or who are controlled or significantly influenced by the entity. A company controlled by a key management person is a related party because key management are defined as related parties, and their controlled entities fall within the related party net. A major customer, government regulator, or long-standing supplier do not meet the IAS 24 definition simply because of commercial significance or longevity — the relationship must involve control, significant influence, or family/entity connection as defined in the standard.

Answer: D. Under IAS 37, when an outflow is 'possible but not probable', the three criteria for a provision are not all met (probability of outflow fails). Instead, a contingent liability is disclosed in the notes — describing the nature of the obligation, an estimate of the financial effect, and the uncertainties relating to amount and timing. No amount is recognised in the statements. Recognising a full or partial provision would require 'probable' (more likely than not) as the threshold. Possible outflows are not simply ignored — IAS 37 specifically requires note disclosure for contingent liabilities unless the possibility of outflow is remote.

Answer: C. IAS 16 permits two models for subsequent measurement of PP&E: the cost model (carrying amount = cost less accumulated depreciation and any accumulated impairment losses) and the revaluation model (carrying amount = fair value at revaluation date less subsequent accumulated depreciation and impairment). Fair value through profit or loss applies to certain financial assets under IFRS 9, not to PP&E. Net realisable value is used for inventories under IAS 2. Current replacement cost is a specific concept used in some insurance and management contexts, not a permitted IAS 16 model.

Answer: D. IFRS 13 establishes a three-level fair value hierarchy prioritising the most objective inputs. Level 1 (highest priority) uses unadjusted quoted prices in active markets for identical assets or liabilities — these are the most reliable since they directly reflect market pricing with no need for adjustment or estimation. Level 2 uses observable inputs other than Level 1 (such as benchmark yield curves or quoted prices for similar assets). Level 3 uses unobservable entity-developed inputs, requiring the most estimation and therefore considered least reliable. There is no Level 4 in the IFRS 13 hierarchy.

Answer: A. IAS 2 requires inventory to be measured at the lower of cost and net realisable value (NRV). This embodies the principle of prudence — ensuring that inventories are not overstated when their selling price (less costs to complete and sell) falls below what was paid for them. If NRV exceeds cost, inventory remains at cost. Only when NRV falls below cost is a write-down required. Measuring at cost only would overstate assets when NRV is lower. Measuring at NRV only would understate assets when cost is lower. The higher-of rule does not apply to inventories.

Answer: B. IFRS 16 requires lessors (unlike lessees) to classify each lease as either a finance lease or an operating lease. A lease is a finance lease when it transfers substantially all the risks and rewards incidental to ownership. Two of the standard indicators are present here: the lease term covers the major part of the asset’s economic life, and the present value of the lease payments amounts to substantially all of the asset’s fair value. Retention of legal title does not prevent finance lease classification — substance overrides legal form. There is no default classification by asset type, and lessor accounting depends fundamentally on this classification: finance leases produce a receivable, operating leases keep the asset on the lessor’s books.

Answer: C. Equity investments cannot be measured at amortised cost under IFRS 9 because their cash flows are not solely payments of principal and interest. The default treatment is fair value through profit or loss. However, for an equity instrument that is not held for trading, the entity may make an irrevocable election at initial recognition to present fair value changes in other comprehensive income (FVTOCI). Under this election, gains and losses stay in OCI and are never recycled to profit or loss, even on disposal (though dividends are generally recognised in profit or loss). The election is irrevocable — switching between categories at each reporting date is not permitted, and historical cost without remeasurement is not an available treatment.

Answer: D. IAS 12 requires deferred tax assets and liabilities to be measured at the tax rates expected to apply in the period when the asset is realised or the liability settled, based on rates enacted or substantively enacted by the reporting date. When the rate falls from 25% to 22%, all existing deferred tax balances must be remeasured at 22%, because the temporary differences will now reverse at the lower rate. The remeasurement difference is recognised in profit or loss (or in OCI/equity if the underlying item was recognised there). Both assets and liabilities are remeasured — not just one side — and the adjustment applies to existing balances, not only to new temporary differences.

Answer: A. IAS 37 requires a reimbursement to be recognised only when it is virtually certain to be received if the entity settles the obligation — the threshold met here. The reimbursement is recognised as a separate asset, capped at the amount of the provision; the provision itself remains at the full £200,000 on the balance sheet (no netting of asset and liability). In the income statement, however, the expense relating to the provision may be presented net of the reimbursement. Netting on the balance sheet is prohibited because the entity remains liable for the whole obligation if the insurer fails. Waiting for physical receipt is too restrictive once virtual certainty exists, and a reimbursement of a cost is not revenue.

Answer: B. Treasury shares are shares that have been repurchased and are held by the company itself. They are deducted from equity (not treated as assets) and carry no right to vote, receive dividends, or share in earnings. IAS 33 therefore excludes them from the weighted average number of ordinary shares used in calculating basic EPS. The effective share count is 5,000,000 − 200,000 = 4,800,000. Using all 5,000,000 shares would understate EPS by including shares with no earnings entitlement. The other options misunderstand what treasury shares are.

Answer: C. IAS 1 requires OCI to present items that are excluded from profit or loss but recognised in the statement of comprehensive income. Revaluation gains under IAS 16 (upward revaluations of PP&E not reversing previous losses recognised in P&L) are a key OCI item, credited to the revaluation surplus in equity. Revenue, finance costs and depreciation are all recognised in profit or loss, not OCI. OCI captures items where immediate P&L recognition would cause excessive volatility or otherwise be misleading — such as asset revaluations, actuarial gains and losses on defined benefit plans, and certain foreign exchange differences.

Answer: B. IFRS 2 requires the fair value of equity-settled options, measured at the grant date, to be recognised as an expense spread over the vesting period (here, 3 years), with a matching credit to equity rather than a liability. The number of options expected to actually vest is estimated and revised at each reporting date as better information becomes available, adjusting the cumulative expense recognised so far. It is not expensed in full at grant, is not left unrecognised just because it's non-cash, and — critically — it is the grant-date fair value that is used throughout, not a figure remeasured to the vesting-date share price (that treatment applies to cash-settled schemes instead, which are accounted for differently).

Answer: D. IFRS 15 permits (or in some cases requires) capitalisation of incremental costs of obtaining a contract — such as sales commissions payable only on securing the contract — when the entity expects to recover them through the contract (via the revenue it will recognise). These are recognised as an asset (a contract cost asset) and amortised on a basis consistent with the transfer of the goods or services. A practical expedient allows immediate expensing if the amortisation period would be one year or less. The 5-year and 10% thresholds are not in IFRS 15. Immediate expensing of all costs is not required; recoverability determines treatment.

Answer: A. Under IAS 37, an onerous contract is one in which the unavoidable costs of fulfilling the obligations exceed the economic benefits expected to be received from it. Once identified, a provision must be recognised immediately for the net loss — the lower of the cost of fulfilling the contract and the penalty for exiting it. Mere commercial inconvenience without a net loss does not make a contract onerous. Disclosure only (without provision recognition) would be incorrect — a provision is required when the three IAS 37 criteria are met, which they are for onerous contracts. Certainty of all outflows is not required; a reliable estimate suffices.