CPA CFE Financial Reporting 2 — Questions and Answers
Question 1: Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, when should a provision be recognized?
- When a future event is possible but not probable
- When a present obligation exists, an outflow is probable, and a reliable estimate can be made (Correct answer)
- When management decides it is prudent to set aside funds
- Only when a court order requires payment
Correct answer: When a present obligation exists, an outflow is probable, and a reliable estimate can be made
IAS 37 requires recognition of a provision when there is a present obligation (legal or constructive) from a past event, it is probable that an outflow of resources will be required, and a reliable estimate of the amount can be made.
Question 2: Which of the following best describes the concept of 'fair value' under IFRS 13?
- The amount an asset could be sold for in a forced liquidation
- The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (Correct answer)
- The replacement cost of the asset in its current condition
- The present value of expected future cash flows using a risk-free rate
Correct answer: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants
IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price).
Question 3: A company issues convertible bonds. Under IAS 32, how should the instrument be classified?
- Entirely as a financial liability
- Entirely as equity
- Split into a liability component and an equity component (Correct answer)
- As a contingent liability until conversion occurs
Correct answer: Split into a liability component and an equity component
IAS 32 requires a compound financial instrument like a convertible bond to be split into its liability component (obligation to make cash payments) and equity component (option for the holder to convert into shares). This is known as split accounting.
Question 4: Under IAS 2 Inventories, which cost formula is NOT permitted under IFRS?
- First-in, first-out (FIFO)
- Weighted average cost
- Last-in, first-out (LIFO) (Correct answer)
- Specific identification
Correct answer: Last-in, first-out (LIFO)
IFRS (IAS 2) prohibits the use of LIFO as a cost formula for inventories. The permitted methods are FIFO, weighted average cost, and specific identification (for items that are not ordinarily interchangeable).
Question 5: How should government grants related to assets be presented under IAS 20?
- Only as revenue in the income statement
- Either as deferred income or by deducting the grant from the carrying amount of the asset (Correct answer)
- As a direct credit to retained earnings
- As a reduction in the cost of goods sold
Correct answer: Either as deferred income or by deducting the grant from the carrying amount of the asset
IAS 20 allows two methods for presenting government grants related to assets: setting up the grant as deferred income recognized over the asset's useful life, or deducting the grant from the carrying amount of the asset.
Question 6: Under IFRS 9, when should an entity recognize expected credit losses on a financial asset measured at amortized cost?
- Only when a loss event has occurred (incurred loss model)
- At initial recognition, using a 12-month expected credit loss model, moving to lifetime ECL if credit risk increases significantly (Correct answer)
- Only at the end of the reporting period if the asset is past due
- When the counterparty declares bankruptcy
Correct answer: At initial recognition, using a 12-month expected credit loss model, moving to lifetime ECL if credit risk increases significantly
IFRS 9 uses a forward-looking expected credit loss model. At initial recognition, 12-month ECL is recognized. If credit risk increases significantly, the entity must recognize lifetime expected credit losses, ensuring earlier recognition of potential losses.
CPA CFE Financial Reporting 2
Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, when should a provision be recognized?