INVENTORIES

IAS 2 Inventories contains the requirements on how to account for most types of inventory. The 

standard requires inventories to be measured at the lower of cost and net realisable value (NRV) and 

outlines acceptable methods of determining cost, including specific identification (in some cases), 

first-in first-out (FIFO) and weighted average cost.

Objective of IAS 2

The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides guidance 

for determining the cost of inventories and for subsequently recognizing an expense, including any 

write-down to net realisable value. It also provides guidance on the cost formulas that are used to 

assign costs to inventories.

Scope

Inventories include assets held for sale in the ordinary course of business (finished goods), assets in 

the production process for sale in the ordinary course of business (work in process), and materials and 

supplies that are consumed in production (raw materials). 

However, IAS 2 excludes certain inventories from its scope: 

- work in process arising under construction contracts

- financial instruments

- Biological assets related to agricultural activity and agricultural produce at the point of harvest.

Also, while the following are within the scope of the standard, IAS 2 does not apply to the 

measurement of inventories held by: 

- producers of agricultural and forest products, agricultural produce after harvest, and minerals and 

mineral products, to the extent that they are measured at net realisable value (above or below cost) 

in accordance with well-established practices in those industries. When such inventories are 

measured at net realisable value, changes in that value are recognised in profit or loss in the 

period of the change

- commodity brokers and dealers who measure their inventories at fair value less costs to sell. 

When such inventories are measured at fair value less costs to sell, changes in fair value less costs 

to sell are recognised in profit or loss in the period of the change.

Fundamental principle of IAS 2

Inventories are required to be stated at the lower of cost and net realisable value (NRV). 

Measurement of inventories

Cost should include all: 

- costs of purchase (including taxes, transport, and handling) net of trade discounts received

- costs of conversion (including fixed and variable manufacturing overheads) and

- other costs incurred in bringing the inventories to their present location and condition.

IAS 23 Borrowing Costs identifies some limited circumstances where borrowing costs (interest) can 

be included in cost of inventories that meet the definition of a qualifying asset. 

Inventory cost should not include: 

- abnormal waste

- storage costs

- administrative overheads unrelated to production

- selling costs

- foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a 

foreign currency

- interest cost when inventories are purchased with deferred settlement terms.

The standard cost and retail methods may be used for the measurement of cost, provided that the 

results approximate actual cost. 

For inventory items that are not interchangeable, specific costs are attributed to the specific individual 

items of inventory. 

For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas. The 

LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.

The same cost formula should be used for all inventories with similar characteristics as to their nature 

and use to the entity. For groups of inventories that have different characteristics, different cost 

formulas may be justified. 

Write-down to net realisable value

NRV is the estimated selling price in the ordinary course of business, less the estimated cost of 

completion and the estimated costs necessary to make the sale. [IAS 2.6] Any write-down to NRV 

should be recognised as an expense in the period in which the write-down occurs. Any reversal should 

be recognised in the income statement in the period in which the reversal occurs. 

Expense recognition

IAS 18 Revenue addresses revenue recognition for the sale of goods. When inventories are sold and 

revenue is recognised, the carrying amount of those inventories is recognised as an expense (often  

called cost-of-goods-sold). Any write-down to NRV and any inventory losses are also recognised as 

an expense when they occur. 

Disclosure

Required disclosures: 

- accounting policy for inventories

- Carrying amount, generally classified as merchandise, supplies, materials, work in progress, and 

finished goods. The classifications depend on what is appropriate for the entity

- carrying amount of any inventories carried at fair value less costs to sell

- amount of any write-down of inventories recognised as an expense in the period

- amount of any reversal of a write-down to NRV and the circumstances that led to such reversal

- carrying amount of inventories pledged as security for liabilities

- cost of inventories recognised as expense (cost of goods sold).

IAS 2 acknowledges that some enterprises classify income statement expenses by nature (materials, 

labour, and so on) rather than by function (cost of goods sold, selling expense, and so on). 

Accordingly, as an alternative to disclosing cost of goods sold expense, IAS 2 allows an entity to 

disclose operating costs recognised during the period by nature of the cost (raw materials and 

consumables, labour costs, other operating costs) and the amount of the net change in inventories for 

the period). This is consistent with IAS 1 Presentation of Financial Statements, which allows 

presentation of expenses by function or nature.

NON CURRENT ASSETS HELD FOR SALE

IFRS 5 Non-current Assets Held for Sale and Discontinued Operations outlines how to account for 

non-current assets held for sale (or for distribution to owners). In general terms, assets (or disposal 

groups) held for sale are not depreciated, are measured at the lower of carrying amount and fair value 

less costs to sell, and are presented separately in the statement of financial position. Specific 

disclosures are also required for discontinued operations and disposals of non-current assets.

Key provisions of IFRS 5 relating to assets held for sale

Held-for-sale classification

In general, the following conditions must be met for an asset (or 'disposal group') to be classified as 

held for sale: 

- management is committed to a plan to sell

- the asset is available for immediate sale 

- an active programme to locate a buyer is initiated 

- the sale is highly probable, within 12 months of classification as held for sale (subject to limited 

exceptions) 

- the asset is being actively marketed for sale at a sales price reasonable in relation to its fair value 

actions required to complete the plan indicate that it is unlikely that plan will be significantly 

changed or withdrawn 

The assets need to be disposed of through sale. Therefore, operations that are expected to be wound 

down or abandoned would not meet the definition (but may be classified as discontinued once 

abandoned). 

An entity that is committed to a sale involving loss of control of a subsidiary that qualifies for held-for-sale classification under IFRS 5 classifies all of the assets and liabilities of that subsidiary as held 

for sale, even if the entity will retain a non-controlling interest in its former subsidiary after the sale. 

Held for distribution to owners classification

The classification, presentation and measurement requirements of IFRS 5 also apply to a non-current 

asset (or disposal group) that is classified as held for distribution to owners. The entity must be 

committed to the distribution, the assets must be available for immediate distribution and the 

distribution must be highly probable. 

Disposal group concept

A 'disposal group' is a group of assets, possibly with some associated liabilities, which an entity 

intends to dispose of in a single transaction. The measurement basis required for non-current assets 

classified as held for sale is applied to the group as a whole, and any resulting impairment loss 

reduces the carrying amount of the non-current assets in the disposal group in the order of allocation 

required by IAS 36. 

Measurement

The following principles apply:

- At the time of classification as held for sale. Immediately before the initial classification of the 

asset as held for sale, the carrying amount of the asset will be measured in accordance with 

applicable IFRSs. Resulting adjustments are also recognised in accordance with applicable IFRSs. 

- After classification as held for sale. Non-current assets or disposal groups that are classified as 

held for sale are measured at the lower of carrying amount and fair value less costs to sell (fair 

value less costs to distribute in the case of assets classified as held for distribution to owners). 

- Impairment;-Impairment must be considered both at the time of classification as held for sale and 

subsequently:

- At the time of classification as held for sale. Immediately prior to classifying an asset or 

disposal group as held for sale, impairment is measured and recognised in accordance with 

the applicable IFRSs (generally IAS 16 Property, Plant and Equipment, IAS 36 Impairment of 

Assets, IAS 38 Intangible Assets, and IAS 39 Financial Instruments: Recognition and 

Measurement/IFRS 9 Financial Instruments). Any impairment loss is recognised in profit or 

loss unless the asset had been measured at revalued amount under IAS 16 or IAS 38, in which 

case the impairment is treated as a revaluation decrease. 

- After classification as held for sale. Calculate any impairment loss based on the difference 

between the adjusted carrying amounts of the asset/disposal group and fair value less costs to 

sell. Any impairment loss that arises by using the measurement principles in IFRS 5 must be 

recognised in profit or loss, even for assets previously carried at revalued amounts. 

- Assets carried at fair value prior to initial classification. For such assets, the requirement to 

deduct costs to sell from fair value may result in an immediate change to profit or loss. 

- Subsequent increases in fair value. A gain for any subsequent increase in fair value less costs to 

sell of an asset can be recognised in the profit or loss to the extent that it is not in excess of the 

cumulative impairment loss that has been recognised in accordance with IFRS 5 or previously in 

accordance with IAS 36.

- No depreciation. Non-current assets or disposal groups that are classified as held for sale are not 

depreciated.

Presentation

Assets classified as held for sale, and the assets and liabilities included within a disposal group 

classified as held for sale, must be presented separately on the face of the statement of financial 

position. 

Disclosures

IFRS 5 requires the following disclosures about assets (or disposal groups) that are held for sale: 

- description of the non-current asset or disposal group 

- description of facts and circumstances of the sale (disposal) and the expected timing 

- impairment losses and reversals, if any, and where in the statement of comprehensive income they 

are recognised 

- if applicable, the reportable segment in which the non-current asset (or disposal group) is 

presented in accordance with IFRS 8 Operating Segments

Key provisions of IFRS 5 relating to discontinued operations

Classification as discontinuing

A discontinued operation is a component of an entity that either has been disposed of or is classified 

as held for sale, and: 

- represents either a separate major line of business or a geographical area of operations 

- is part of a single co-ordinated plan to dispose of a separate major line of business or geographical 

area of operations, or 

- is a subsidiary acquired exclusively with a view to resale and the disposal involves loss of control.

IFRS 5 prohibits the retroactive classification as a discontinued operation, when the discontinued 

criteria are met after the end of the reporting period. 

Disclosure in the statement of comprehensive income

The sum of the post-tax profit or loss of the discontinued operation and the post-tax gain or loss 

recognised on the measurement to fair value less cost to sell or fair value adjustments on the disposal 

of the assets (or disposal group) is presented as a single amount on the face of the statement of 

comprehensive income. If the entity presents profit or loss in a separate statement, a section identified 

as relating to discontinued operations is presented in that separate statement. 

Detailed disclosure of revenue, expenses, pre-tax profit or loss and related income taxes is required 

either in the notes or in the statement of comprehensive income in a section distinct from continuing 

operations. [IFRS 5.33] Such detailed disclosures must cover both the current and all prior periods 

presented in the financial statements. 

Cash flow information

The net cash flows attributable to the operating, investing, and financing activities of a discontinued 

operation is separately presented on the face of the cash flow statement or disclosed in the notes. 

Disclosures

The following additional disclosures are required:

- adjustments made in the current period to amounts disclosed as a discontinued operation in prior 

periods must be separately disclosed 

- if an entity ceases to classify a component as held for sale, the results of that component previously 

presented in discontinued operations must be reclassified and included in income from continuing 

operations for all periods presented.

IMPAIRMENT OF ASSETS (IAS36)

The aim of IAS 36, Impairment of Assets, is to ensure that assets are carried at no more than their 

recoverable amount.

If an asset's carrying value exceeds the amount that could be received through use or selling the asset, 

then the asset is impaired and the standard requires a company to make provision for the impairment 

loss. An impairment loss is the amount by which the carrying amount of an asset or cash-generating 

unit (CGU) exceeds its recoverable amount. The recoverable amount of an asset or a CGU is the 

higher of its fair value less costs to sell and its value in use.

IAS 36 also outlines the situations in which a company can reverse an impairment loss. Certain assets 

are not covered by the standard and these are generally those assets dealt with by other standards, for 

example, financial assets dealt with under IAS 39. A company must assess at each balance sheet date 

whether an asset is impaired. Even if there is no indication of any impairment, certain assets should be 

tested for impairment, for example, an intangible asset that has an indefinite useful life. Additionally, 

the standard specifies the situations that might indicate that an asset is impaired. These are external 

events, such as a decline in market value, or internal causes, such as physical damage to an asset.

If it is not possible to determine the fair value less costs to sell because there is no active market for 

the asset, the company can use the asset's value in use as its recoverable amount. Similarly, if there is 

no reason for the asset's value in use to exceed its fair value less costs to sell, then the latter amount 

may be used as its recoverable amount. For example, where an asset is being held for disposal, the 

value of this asset is likely to be the net disposal proceeds. The future cash flows from this asset from 

its continuing use are likely to be negligible. 

IAS 36 also explains how a company should determine fair value less costs to sell. The best guide is 

the price in a binding sale agreement, in an arm's length transaction adjusted for costs of disposal. 

When calculating the value in use, typically a company should estimate the future cash inflows and 

outflows from the asset and from its eventual sale, and then discount the future cash flows

accordingly. 

It is important that any cash flow projections are based upon reasonable and supportable assumptions 

over a maximum period of five years unless it can be proven that longer estimates are reliable. They 

should be based upon the most recent financial budgets and forecasts. The discount rate to be used in 

measuring value in use should be a pre-tax rate that reflects current market assessments of the time 

value of money, and the risks that relate to the asset for which the future cash flows have not yet been 

adjusted.

Where the recoverable amount of an asset is less than its carrying amount, the carrying amount will be 

reduced to its recoverable amount. This reduction is the impairment loss, which should be recognized 

immediately in profit or loss, unless the asset is carried at a re-valued amount. In this case, the 

impairment loss is treated as a revaluation decrease in accordance with the respective standard. If it is 

not possible to calculate the recoverable amount of an individual asset, then the recoverable amount of 

the CGU to which the asset belongs should be calculated. A CGU is the smallest identifiable group of 

assets that can generate cash flows from continuing use, and that are mainly independent of the cash 

flows from other assets or groups of assets. 

Any impairment loss calculated for a CGU should be allocated to reduce the carrying amount of the 

asset in the following order:

- the carrying amount of goodwill should be first reduced then the carrying amount of other assets 

of the unit should be reduced on a pro rata basis, which is determined by the relative carrying 

value of each asset; then

- Any reductions in the carrying amount of the individual assets should be treated as impairment 

losses. The carrying amount of any individual asset should not be reduced below the highest of its 

fair value less cost to sell and its value in use.

- If this rule is applied then the impairment loss not allocated to the individual asset will be 

allocated on a pro rata basis to the other assets of the group.

Key terms and illustrations

Impairment is the loss in value of intangibles and non-current assets.

IAS36 defines impairment loss as the difference between carrying amount of an asset and its 

receivable amount i.e.

Impairment loss = Carrying amount – Recoverable Amount

Where:

Carrying amount = cost – Accumulated depreciation

Fair value less cost sell refers to amount obtainable from the sale of an asset less disposal cost e.g. 

legal fees and transportation.

Value in use – These are the expected future cash inflows from the asset discounted to their present 

values.

Carrying amount

Refers to amount at which an asset is recognized in the statement of financial position after deducting 

accumulated depreciation from the cost of the asset.

Cash generating Unit (CGU)

This is the smallest identifiable group of assets that generates cash inflows independently from other 

assets or group of assets.

Factors to Consider When Determining Impairment

External factors

1. Unexpected decrease in the market value due to passage of time

2. Increase in market interest rates regarding or in relation to the assets.

3. Adverse changes e.g. technological advancement or legal environment

4. The carrying amount of the net assets of an entity

Internal factors

1. Evidence of obsoleteness or physical damage

2. Reduction in the usage of the asset by the entity

3. Reduction in the level of output expected from the asset.

Further Illustration 

ABC Ltd owns a manufacturing plant with the carrying value with sh.7490000. The government has 

just imposed export quotas on products manufactured by the plant. Following this development ABC 

Ltd has prepared following estimate of cash flows from the usage of the plant over the next 5 years.

Recoverable amount = sh.6, 380

Impairment loss

Impairment = carrying amount (Book value) – Recoverable amount

= 7,490 – 6,380 = 1,110

Impairment loss for multiple assets

The main concern is on how:

- To allocate impairment loss to each Asset in the cash generating unit (CGU)

- On how to allocate impairment loss on an asset with goodwill.

Impairment loss in a cash generating unit (CGU)

If impairment loss arises in the CGU with multiple assets then the impairment loss will be allocated as 

follows:

- Goodwill to be impaired in full

- To the remaining asset on pro-rata basis based on their carrying amounts.

Illustration 

The following information is provided relating to the carrying amounts of the assets comprising the 

cash generating unit of alexo Ltd as at 31st December 2017.

Value in use =93,576,000

Recoverable amount = 93,576,000

Impairment = carrying amount – recoverable amount

155,000,000 – 93,576,000 = 61,424,000

Statement of impairment allocation of CGU 2

ASSETS USED IN EXPLORING AND EVALUATING MINERAL RESOURCES

IFRS 6 Exploration for and Evaluation of Mineral Resources has the effect of allowing entities 

adopting the standard for the first time to use accounting policies for exploration and evaluation assets 

that were applied before adopting IFRSs. It also modifies impairment testing of exploration and 

evaluation assets by introducing different impairment indicators and allowing the carrying amount to 

be tested at an aggregate level.

Definitions

Exploration for and evaluation of mineral resources means the search for mineral resources, 

including minerals, oil, natural gas and similar non-regenerative resources after the entity has obtained 

legal rights to explore in a specific area, as well as the determination of the technical feasibility and 

commercial viability of extracting the mineral resource.

Exploration and evaluation expenditures are expenditures incurred in connection with the 

exploration and evaluation of mineral resources before the technical feasibility and commercial 

viability of extracting a mineral resource is demonstrable.

Accounting policies for exploration and evaluation

IFRS 6 permits an entity to develop an accounting policy for recognition of exploration and 

evaluation expenditures as assets without specifically considering the requirements of paragraphs 11 

and 12 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Thus, an entity 

adopting IFRS 6 may continue to use the accounting policies applied immediately before adopting the 

IFRS. This includes continuing to use recognition and measurement practices that are part of those 

accounting policies.

Impairment

IFRS 6 effectively modifies the application of IAS 36 Impairment of Assets to exploration and 

evaluation assets recognised by an entity under its accounting policy. 

Specifically:

- Entities recognizing exploration and evaluation assets are required to perform an impairment test 

on those assets when specific facts and circumstances outlined in the standard indicate an 

impairment test is required. The facts and circumstances outlined in IFRS 6 are non-exhaustive, 

and are applied instead of the 'indicators of impairment' in IAS 36 

- Entities are permitted to determine an accounting policy for allocating exploration and evaluation 

assets to cash-generating units or groups of CGUs. This accounting policy may result in a 

different allocation than might otherwise arise on applying the requirements of IAS 36 

- If an impairment test is required, any impairment loss is measured, presented and disclosed in 

accordance with IAS 36. 

Presentation and disclosure

An entity treats exploration and evaluation assets as a separate class of assets and make the 

disclosures required by either IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets 

consistent with how the assets are classified. 

IFRS 6 requires disclosure of information that identifies and explains the amounts recognised in its 

financial statements arising from the exploration for and evaluation of mineral resources, including: 

- its accounting policies for exploration and evaluation expenditures including the recognition of 

exploration and evaluation assets 

- the amounts of assets, liabilities, income and expense and operating and investing cash flows 

arising from the exploration for and evaluation of mineral resources.

ACCOUNTING FOR INCOME TAXES

In accounting for income taxes there normally arises a difference between the taxable income and the 

accounting profit.

The reason responsible for these differences are classified into 2

• Temporary differences

• Permanent differences

Temporary differences

These differences arise when an item has been considered in one profit computation but ignored in the 

other profit computation.

Example of temporary differences

(1)Certain types of expenses recognized in accounting profit computation but ignored in the taxable 

profit computation e.g. depreciation, donations, director’s entertainment etc.

(2)Certain types of income recognized in accounting profit computation but ignored for tax purposes 

e.g. government grants and subsidies, windfall gains.

IAS12 defines temporary differences as the difference between the carrying amount of an asset or 

liability and their tax bases i.e. 

Temporary differences = Carrying amount of asset or liability – Tax base

Where, Carrying amount = cost – Accumulated Depreciation

Tax base (WDV) = cost – Accumulated Capital allowances

Permanent differences

It arises when an item has been considered in both profit computations but in different time periods. 

E.g. expenses are recognized in the accounting profit on accruals basis while for tax purposes 

expenses are recognized on cash basis (when paid)

Types of income taxes

1. Current taxes

2. Deferred taxes

Current taxes

These are tax obligation attributable to an organization for the financial year under consideration.

Current tax = taxable profit x Tax rate

Taxable profit = reported Accounting profit before tax + Disallowable expenses – Allowable expenses

Illustration 

Sophistic Ltd a newly listed company has provided the following information with regards to 

computation of its tax expense for the year ended 31 May 2014

3. Plant is depreciated at 20% per annum using the straight line method while wear and tear 

allowance on plant is provided at 25% on a reducing balance basis.

4. Software development commenced in the year ended 31 May 2011 and was completed in the 

immediate subsequent year. The company capitalized development costs which amounted to Sh.9, 

000,000 and amortization commenced on 1 June 2012 using the sum of digits method over the 

estimated useful life of 5 years. Software development costs are allowed in full for tax purposes in 

the year in which they are incurred.

5. Donations made by the company were not tax allowable.

6. Corporate tax rate applicable on the company’s earnings for the year ended 31 March 2015 is 

30% and the company is expected to continue generating taxable profits in the foreseeable future.

Required:

Current tax to be charged in the income statement for the year ended 31 May 2015.

Illustration

A company reported a/c profit after tax of sh.1.2m on 31/12/2018. The company had purchased an 

item of plant at sh.800, 000 on 1st Jan 2016. Depreciation is on straight line at rate of 25% per annum 

while wear and tear at 20% on the cost per annum.

Tax is at 30%

Required:

What is the current tax.

Deferred Tax (IAS12)

Deferred taxes are future tax consequences to an entity 

IAS12 requires that an entity must provide for deferred taxes at the end of each financial period.

Methods determining deferred

1. Income statement liability method

2. Balance sheet liability method

INCOME STATEMENT LIABILITY METHOD

It is divided into three;-

i. Nill provision

ii. Full provision

iii. Partial provision

Nill provision

Under this approach no provision is made for deferred taxes i.e provision is only made for current 

taxes

Full provision (recommended)

Under this approach provision is made for both current and deferred taxes 

It is the method recommended by IAS12 whenever income statement liability method is used.

Partial provision

Similar to full provision with an exemption that deferred taxes are only provided for if there is clear 

evidence that they will reverse in the near future based on the past experience.

Illustration

B Ltd was incorporated 1/4/2011. In the year ended 3/3/2012 the company made a profit before tax of 

sh.10m (Depreciation charged being sh.1m).

The company had made the following capital additions. 

- Plant sh.4.8m

- Motor vehicle sh.1.2m

- Corporation tax is at 30%

Capital deductions are computed at rate of 25% p.a on written down value. The company has prepared 

the capital expenditure budget as 31/3/2012 which revealed the following pattern

From 1/4/2007 capital allowances are expected to exceed depreciation charge each year.

Required:

(i)Compute the corporation tax payable for the year ended 31/3/2012

(ii)Compute the deferred tax charged for the year ended 31/3/2012 using

- NIL provision method 

- Full provision method

- Partial provision method

(Show the income statement and statement of financial position extract with respect with provisions 

under each method)

Answer

(i)Compute the corporation tax payable

Recall, Tax payable = Taxable profit × tax rate

Taxable profit computation

Balance Sheet Liability Method

This method views deferred taxes to arise from temporary differences. It is the method recommended 

by IAS12 for computing deferred taxes. The justification for recommendation is the temporary 

differences is based on the financial position of an entity i.e. temporary differences liability method 

only focuses on income and expenses which may fluctuate during the financial period.

When using the balance sheet liability method deferred taxes will be computed as follows;-

Deferred taxes = Temporary differences ×Tax Rate

Where;

Temporary differences = carrying amount (NBV) – Tax Base (WDV)

NBV = cost – Accumulated depreciation (if any)

WDV = cost – Accumulated capital allowance (if any)

Types of temporary differences

Taxable temporary differences

This arises when the carrying amount is greater than the tax base. They are also known as positive 

temporary differences and they lead to deferred tax liability.

Deductible Temporary difference

It arises when the carrying amount is less than the tax base 

It is also known as the negative temporary differences and leads to deferred tax asset.

Illustration

Lami Limited had a deferred tax liability as at I May 2011 of Sh.100 million. For the purposes of 

preparing financial statements for the year ended 30 April 2012, the following additional information 

is available:

1. Property, plant and equipment has a carrying amount of Sh.1,200 million and a tax base of 

Sh.1,000 million. Some land and buildings were revalued upwards by Sh.50 million during the 

year ended 30 April 2012.

2. Intangible assets consisting of trade licences being amortised over five years had a carrying

amount of Sh. 60 million. This was allowed for tax purposes in full two years ago.

3. The company has available for sale financial assets with a carrying amount of Sh.20 million and 

financial assets at fair value through profit and loss of Sh. 10 million. Both financial assets 

reported losses in fair value of Sh.2 million each as at 30 April 2012.

4. Inventory is shown at the lower of cost and net realisable value. The cost is Sh.800 million while 

the net realisable value is Sh.780 million.

5. Receivables had a carrying amount of Sh.500,million after making an allowance for doubtful debt 

of Sh.20 million and an exchange gain of Sh.40 million (unrealised). Both the allowance and 

exchange gain arc not allowed for tax purposes.

6. Trade and other payable are stated at Sh. 900 million after making provision for discount of Sh. 

10 million.

7. Assume a tax rate of 30%. 

Required;-

(i)Compute the relevant temporary differences.

(ii)Show the journal entry to record changes in the deferred tax liability

Illustration

Jahazi Group is estimating the deferred tax liability as at 31 May 2010 and has provided the following 

information:

1. Property, plant and equipment has a cost and revalued amount of sh.100 million and accumulated 

depreciation of Sh.18 million. Total capital allowances on property, plant and equipment amount 

to Sh.30 million.

2. The group has available for sale (AFS) financial assets that were purchased during the year at a 

cost of sh. 10 million. There was a revaluation gain of sh.2 million reported in the AFS reserve.

3. The group spent Sh.50 million to develop a new product and out of which Sh.10 million has been 

charged in the income statement as amortization for the year. The balance of Sh.40 million is 

shown as intangible assets in the statement of financial position. The full amount of Sh.50 million 

was allowed for tax purposes in the year.

4. Total inventory was carried at Sh. 20 million which was the net realizable value. The cost of the 

inventory was Sh.22 million. There was an unrealized profit of Sh.1 million that had not been 

deducted from the inventory on consolidation.

5. The receivables amounted to sh.30 million after making a provision of Sh.2 million for a doubtful 

debt. The amount also included a foreign exchange gain of Sh.1 million. Exchange gains or losses 

and doubtful debts are only allowed for tax purposes when they are realized.

6. The trade and other payables of Sh.40 million include an accrual of Sh. 5 million which relates to

pension and other employee benefits to be paid in the year 2011. These are only allowed for tax 

purposes when paid.

7. The deferred tax liability as at 1 June 2009 was Sh.8.5 million.

8. Assume that the temporary differences due to the revaluation of property, plant and equipment 

amount to Sh.2 million and the corporation tax rate is 30%.

Required:

Compute the deferred tax balance as at 31 May 2010 and the charge to the income statement for the 

year ended 31 May 2010.

2. Inventories are stated at fair valueless cost to sell which is lower than the original cost due to a 

general provision for price decline of sh. 3.5 million.

3. The intangible assets comprise development cost which is tax deductible when the amount is paid 

out. The cost of intangible assets was paid in the year 2014 and is presented net of the 

amortization cost.

4. Goodwill and employee benefits are tax exempt

5. Trade and other payables include provision for leave allowance of sh.1.4 million which is tax 

deductible on cash basis.

6. Trade receivables are stated net of general allowances for bad debts at the rate of 5% of the gross 

receivables. The general allowance is not tax deductible until it becomes specicific.

7. The building which included property, plant and equipment was revalued during the year. The 

increase in value of sh. 3 million does not affect the tax base.

8. The tax base of other items is equal to their carrying amount.

9. The tax rate applicable is 30 %.

Required;

(i)Deferred tax balance as at 30 April 2017

(ii)Deferred income tax account as at 30 April 2017.

Illustration 

Maji Limited had a deferred tax liability of Sh. 105 million as at 1 June 2010. During the year ended 

31 May 2011, the company had the following items with regard to estimating deferred tax:

1. The carrying amount of property, plant and equipment as at 31 May 2011 was Sh.980 million. 

This included some buildings which were revalued upwards by Sh. 50 million at 31 May 2010 

which had a remaining useful life of 10 years at that date. The company's accounting policy is to 

treat revaluation surpluses as realised on disposal of the revalued assets. The tax base of property, 

plant and equipment as at 31 May 2011 was Sh 640 million

2. Deferred development expenditure amounted to Sh.45 million at year end (Sh.40 million as at 31 

May 2010). Sh.10 million of additional development expenditure was incurred during the year 

and the remaining difference between 2010 and 2011 figures relates to development expenditure 

amortised for products that have started being commercially produced. All development

expenditure is allowed for tax purposes.

3. Included in current assets is an amount of Sh.40 million due in respect of some patent royalties on 

one of the company's older products which is now being produced by other companies. Patent 

royalties are taxed only when received. 

4. The company’s tax rate proposals.

Required:

The deferred tax balance as at 31 May 2011 and the relevant journal entry

2. The company declared a dividend of sh.10 million for the year ended 31 December 2007.

3. Depreciation on plant and equipment is provided at the rate of 20% on straight-line basis. Plant 

and equipment qualify for capital allowances at the rate of 25% of cost on straight –line basis.

4. Accumulated tax depreciation as at 31 December 2006 was sh.50 million. On 1 February 2007, 

the company purchased additional costing sh.150 million. The company’s policy is to charge a 

full year’s depreciation in the year of purchase and none in the year of disposal.

5. Included in selling and distribution expenses is sh.5 million representing an expense which was 

disallowed by the tax authorities.

6. The company charged the income statement with sh.14 million representing pension costs for the 

year ended 31 December 2007. Sh.11.5 million of this amount was allowed for tax purposes.

7. The company made a general provision for bad debts of sh.3 million for the year ended 31 

December 2007. There were no bad debts written off during the year.

8. On 31 July 2007, the company made a tax payment of sh.15 million.

9. Corporation rate of tax is 30%.

10. The company separately accounts for deductible and taxable temporary differences. 

Required:

(i)Determine the charge in the income statement for current tax and deferred tax expenses.

(ii)Prepare the income statement showing the retained profit balance.

(iii)Prepare the complete balance sheet.

Answer 

SHARE BASED PAYMENT TRANSACTIONS (IFRS 2)

A shared based payment transaction refers to a transaction in which an entity receives goods and 

services and pays for those goods and services by issuing its equity instrument or pays the cash but 

the amount to be paid is based on the entity’s share prices.

Terminologies

1) Grant date – refers to the date when the entity and the counter party entered into a shared based 

payment arrangement.

2) Vesting conditions – refers to the conditions that must be satisfied for the counter party to 

become entitled to receive cash or other equity instruments.

There are 2 types of vesting conditions

1. Performance conditions – Are conditions which requires the counter party to achieve a certain 

performance level in order to become entitled to the equity instruments of the company e.g. an 

employee may be required to achieve a certain profitability level in order to receive the shares of 

the company.

2. Service condition – Is where an employee is required to provide services to the company for a 

specified period of time in order to receive equity instruments.

3) Vesting date – Is the date when the counter party becomes entitled to the equity instruments.

4) Vesting period – refers to the period between the grant date and the vesting date.

5) Fair value – refers to the amount at which an asset would be exchanged or a liability settled 

between knowledgeable willing parties in an aims length transaction.

IFRS 2

IFRS 2 Share-based Payment requires an entity to recognise share-based payment transactions (such 

as granted shares, share options, or share appreciation rights) in its financial statements, including 

transactions with employees or other parties to be settled in cash, other assets, or equity instruments of 

the entity. Specific requirements are included for equity-settled and cash-settled share-based payment 

transactions, as well as those where the entity or supplier has a choice of cash or equity instruments.

Definition of share-based payment

A share-based payment is a transaction in which the entity receives goods or services either as 

consideration for its equity instruments or by incurring liabilities for amounts based on the price of the 

entity's shares or other equity instruments of the entity. The accounting requirements for the share-based payment depend on how the transaction will be settled, that is, by the issuance of (a) equity, (b) 

cash, or (c) equity or cash.

Scope

The concept of share-based payments is broader than employee share options. IFRS 2 encompasses 

the issuance of shares, or rights to shares, in return for services and goods. Examples of items 

included in the scope of IFRS 2 are share appreciation rights, employee share purchase plans, 

employee share ownership plans, share option plans and plans where the issuance of shares (or rights 

to shares) may depend on market or non-market related conditions.

Recognition and measurement

The issuance of shares or rights to shares requires an increase in a component of equity. IFRS 2 

requires the offsetting debit entry to be expensed when the payment for goods or services does not 

represent an asset. The expense should be recognised as the goods or services are consumed. For 

example, the issuance of shares or rights to shares to purchase inventory would be presented as an 

increase in inventory and would be expensed only once the inventory is sold or impaired.

The issuance of fully vested shares, or rights to shares, is presumed to relate to past service, requiring 

the full amount of the grant-date fair value to be expensed immediately. The issuance of shares to 

employees with, say, a three-year vesting period is considered to relate to services over the vesting 

period. Therefore, the fair value of the share-based payment, determined at the grant date, should be 

expensed over the vesting period.

As a general principle, the total expense related to equity-settled share-based payments will equal the 

multiple of the total instruments that vest and the grant-date fair value of those instruments. In short, 

there is truing up to reflect what happens during the vesting period. However, if the equity-settled 

share-based payment has a market related performance condition, the expense would still be 

recognised if all other vesting conditions are met. The following example provides an illustration of a 

typical equity-settled share-based payment.

Illustration

Recognition of employee share option grant

Company grants a total of 100 share options to 10 members of its executive management team (10 

options each) on 1 January 2015. These options vest at the end of a three-year period. The company 

has determined that each option has a fair value at the date of grant equal to 15. The company expects 

that all 100 options will vest and therefore records the following entry at 30 June 2015 - the end of its 

first six-month interim reporting period.

Dr. Share option expense 250

 Cr. Equity 250

[(100 × 15) ÷ 6 periods] = 250 per period

If all 100 shares vest, the above entry would be made at the end of each 6-month reporting period. 

However, if one member of the executive management team leaves during the second half of 2016, 

therefore forfeiting the entire amount of 10 options, the following entry at 31 December 2016 would 

be made:

Dr. Share option expense 150

 Cr. Equity 150

[(90 × 15) ÷ 6 periods = 225 per period. [225 × 4] – [250+250+250] = 150

Measurement guidance

Depending on the type of share-based payment, fair value may be determined by the value of the 

shares or rights to shares given up, or by the value of the goods or services received:

- General fair value measurement principle. In principle, transactions in which goods or services 

are received as consideration for equity instruments of the entity should be measured at the fair 

value of the goods or services received. Only if the fair value of the goods or services cannot be 

measured reliably would the fair value of the equity instruments granted be used. 

- Measuring employee share options. For transactions with employees and others providing 

similar services, the entity is required to measure the fair value of the equity instruments granted, 

because it is typically not possible to estimate reliably the fair value of employee services 

received. 

- When to measure fair value - options. For transactions measured at the fair value of the equity 

instruments granted (such as transactions with employees), fair value should be estimated at grant 

date. 

- When to measure fair value - goods and services. For transactions measured at the fair value of 

the goods or services received, fair value should be estimated at the date of receipt of those goods 

or services. 

Disclosure

Required disclosures include:

- the nature and extent of share-based payment arrangements that existed during the period 

- how the fair value of the goods or services received, or the fair value of the equity instruments 

granted, during the period was determined 

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- The effect of share-based payment transactions on the entity's profit or loss for the period and on its 

financial position.

Accounting treatment for equity settled share based payments

As per IFRS2 shared based payment transaction should be recognized immediately as an expense 

from the grant date throughout the vesting period.

The basic rule for shared based payment transaction is that an entity should measure the cost of 

services/goods received at their fair value. The equity should be valued at their fair value throughout 

the vesting period irrespective of the changes in the share prices.

Illustration 

A Ltd awards 1000 share options to its sales team at the end of the year. The shares have a nominal 

value of sh.10 each and a market value of sh.50 each.

Required;-

Show the relevant journal entries to record the above transactions:

ABC Ltd has granted 100 share options to each of its 500 employees. Each grant is conditional upon the employee working for the company over the next three years. The company estimates that the fair value of each share option is Sh. 15. The company also estimates that 20% of the employees will leave during the three-year period, therefore, forfeit their rights to the share options. Required;- Determine how ABC Ltd would account for the share options in each of the three years in accordance with the requirements of IFRS 2 (Share-based Payment)

EMPLOYEE BENEFITS WITH EMPHASIS ON POST EMPLOYMENT

IAS 19 prescribes the accounting for all types of employee benefits except share-based payment, to 

which IFRS 2 applies. Employee benefits are all forms of consideration given by an entity in 

exchange for service rendered by employees or for the termination of employment. IAS 19 requires an 

entity to recognise:

- A liability when an employee has provided service in exchange for employee benefits to be paid 

in the future; and

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