Chapter 1

Part A: Accounting for transactions

Accounting for assets and liabilities

Last updated November 20268 sectionsabout 13 min read

Key takeaways

Investment property is land or a building held to earn rentals or for capital appreciation; under the fair value model it is carried at fair value with movements in profit or loss and no depreciation.
An asset classified as held for sale is measured at the lower of its carrying amount and fair value less costs to sell, and depreciation stops.
IFRS 9 measures a financial asset at amortised cost, FVOCI or FVTPL depending on the business model and its contractual cash flows; financial liabilities are never reclassified.
A lessee under IFRS 16 recognises a right-of-use asset and a lease liability at the present value of the unpaid lease payments, unless the short-term or low-value exemption applies.
A provision needs a present obligation from a past event, a probable outflow and a reliable estimate; fail any one and the item is at most a contingent liability, disclosed unless remote.

CPA Financial Accounting covered the basics of property, plant and equipment, intangibles, inventory and simple financial instruments. This chapter picks up where that left off: the more specialised assets and liabilities a preparer meets once transactions get more complex, from investment property to leases to deferred tax. Assets and liabilities already covered in Financial Accounting remain examinable there and are assumed knowledge here.

Investment property

IFRS/IAS reference

IAS 40 (Investment Property) governs land or a building held to earn rentals or for capital appreciation, rather than for use in production or administration (which stays PPE under IAS 16) or for sale in the ordinary course of business (which is inventory under IAS 2).

Cost model

Investment property is carried at cost less accumulated depreciation and impairment, exactly like PPE under IAS 16, with fair value disclosed in the notes.

Fair value model

Investment property is carried at fair value, with movements recognised in profit or loss each period, and no depreciation charged at all.

Kenyan example

A Nairobi-based holding company owns an office block it fully rents out to unrelated tenants: that block is investment property. A retail chain's own supermarket premises are not, they are PPE, used in the entity's own operations.

An entity chooses one model and applies it to all its investment property; the choice is disclosed and, once made under the fair value model, is rarely changed given the requirement that a change in accounting policy must produce more reliable and relevant information (see the chapter on published financial statements).

Exploration and evaluation assets

IFRS/IAS reference

IFRS 6 (Exploration for and Evaluation of Mineral Resources) is a narrow, transitional standard permitting an entity to continue whatever exploration and evaluation accounting policy it already used before adopting IFRS, subject to an impairment test, rather than mandating a single treatment. Relevant to a company holding a mining or prospecting licence under Kenya's Mining Act, 2016, for example a titanium mining operation on the Kenyan coast.

Exploration and evaluation expenditure

Costs incurred in searching for mineral resources and determining the technical feasibility and commercial viability of extracting them, before a decision to develop the resource has been made.

Recognition

May be capitalised as an exploration and evaluation asset under the entity's chosen accounting policy, then classified as tangible or intangible according to the nature of the assets acquired.

Impairment trigger

A specific indicator, such as an exploration licence expiring without renewal, or a decision to discontinue exploration in a specific area, requires an impairment test under IAS 36 (Impairment of Assets).

Non-current assets held for sale

IFRS/IAS reference

IFRS 5 (Non-current Assets Held for Sale and Discontinued Operations) governs both the classification and measurement of an individual asset held for sale, and discontinued operations (see the chapter on published financial statements).

Classification criteria

An asset (or disposal group) is classified as held for sale when its carrying amount will be recovered principally through sale rather than continuing use, it is available for immediate sale in its present condition, and the sale is highly probable within one year.

Measurement

Once classified as held for sale, the asset is measured at the lower of its carrying amount and fair value less costs to sell, and depreciation stops.

A Thika textile manufacturer decides to sell an idle factory building

Carrying amount at the reclassification date: KES 42,000,000

Fair value less estimated costs to sell: KES 38,500,000

Since fair value less costs to sell is lower, the asset is written down and re-measured at KES 38,500,000; no further depreciation is charged while it remains held for sale.

Financial instruments

IFRS/IAS reference

IFRS 9 (Financial Instruments) is examined here at full depth (CPA Financial Accounting covered only definition, examples and classification).

Initial recognition

A financial asset or liability is recognised when the entity becomes party to the contract; initially measured at fair value, plus transaction costs unless the instrument is measured at fair value through profit or loss.

Amortised cost classification

Applies where the asset is held within a business model to collect contractual cash flows, and those cash flows are solely payments of principal and interest, for example a fixed-rate corporate bond a Kenyan pension scheme holds to maturity.

Fair value through other comprehensive income (FVOCI)

Applies where the asset is held both to collect contractual cash flows and to sell, common for a treasury bond portfolio a bank holds for liquidity management.

Fair value through profit or loss (FVTPL)

The default classification for anything not meeting the amortised cost or FVOCI conditions, such as NSE-listed equity shares held for trading.

Reclassification

Financial assets are reclassified only when the entity changes its business model for managing them, expected to be rare; financial liabilities are never reclassified.

De-recognition

A financial asset is de-recognised when the contractual rights to its cash flows expire, or substantially all the risks and rewards of ownership are transferred, for example when a receivable is genuinely sold (factored without recourse) rather than merely used as loan security.

Classifying a bank loan received (a financial liability)

A Sacco borrows KES 20,000,000 from a development finance institution, repayable with interest.

Initial measurement: fair value of the loan received (net of any transaction costs, e.g. arrangement fees), typically the cash proceeds.

Subsequent measurement: amortised cost, using the effective interest method to spread interest expense over the loan term.

Leases

IFRS/IAS reference

IFRS 16 (Leases) requires a lessee to recognise almost every lease on the statement of financial position: a right-of-use asset and a corresponding lease liability, replacing the old operating/finance lease distinction for lessees. Sale and leaseback, and lessors in the business of leasing assets, are excluded from this paper.

Right-of-use asset

Initially measured at the amount of the lease liability, plus any lease payments made at or before commencement, initial direct costs, and estimated restoration costs, then depreciated over the lease term (or the asset's useful life if shorter).

Lease liability

Initially measured at the present value of the lease payments not yet paid, discounted at the rate implicit in the lease or, where that cannot be readily determined, the lessee's incremental borrowing rate.

Short-term and low-value exemptions

A lease of 12 months or less, or of an asset of low value when new (a laptop, office furniture), may be expensed on a straight-line basis instead, avoiding the full right-of-use treatment.

A Mombasa clearing agent leases a forklift for 5 years

Annual lease payments KES 900,000, payable in arrears; incremental borrowing rate 13%.

Lease liability = present value of 5 annual payments of 900,000 discounted at 13% (annuity factor 3.5172) = KES 3,165,480

Right-of-use asset initially recognised at the same KES 3,165,480 (no other adjustments), then depreciated over 5 years, KES 633,096 per year on a straight-line basis.

Each period, the lease liability accretes interest at 13% and is reduced by the cash payment made, mirroring how a loan amortises.

Current and deferred tax

IFRS/IAS reference

IAS 12 (Income Taxes) governs both current tax (the amount actually payable to KRA, computed on taxable profit under the Income Tax Act) and deferred tax (the future tax consequence of temporary differences between an asset or liability's carrying amount and its tax base).

Taxable temporary difference

Gives rise to a deferred tax liability, for example where accounting depreciation on plant is slower than KRA's wear-and-tear capital allowances, so the tax base is lower than the carrying amount.

Deductible temporary difference

Gives rise to a deferred tax asset, recognised only to the extent future taxable profit is probable against which it can be utilised, for example a tax loss carried forward under the Income Tax Act.

Measurement

Deferred tax is measured at the tax rate expected to apply when the asset is realised or liability settled, using rates enacted or substantively enacted at the reporting date, which in Kenya means the corporation tax rate the Income Tax Act sets.

Government grants

IFRS/IAS reference

IAS 20 (Accounting for Government Grants and Disclosure of Government Assistance) requires a grant to be recognised in profit or loss on a systematic basis over the periods in which the entity recognises the related costs the grant is intended to compensate, not immediately on receipt.

Grants related to income

Recognised in profit or loss over the period necessary to match them with the costs they are intended to compensate, for example a county government wage subsidy matched against the payroll periods it covers.

Grants related to assets

Either presented as deferred income released to profit or loss over the asset's useful life, or deducted from the asset's carrying amount, reducing the depreciation charge over its life, for example a development-partner grant funding water infrastructure equipment for a county water utility.

Repayable grants

Where a grant becomes repayable (a condition is breached), the repayment is accounted for as a change in accounting estimate (see the chapter on published financial statements).

Provisions and contingencies

IFRS/IAS reference

IAS 37 (Provisions, Contingent Liabilities and Contingent Assets) governs recognition of a provision only where a present obligation exists as a result of a past event, an outflow of resources is probable, and a reliable estimate can be made; all three conditions must hold.

Item	Present obligation?	Recognised how
Provision	Yes, and outflow probable, reliably estimated	Recognised as a liability, best estimate of the amount required to settle it
Contingent liability	Possible obligation, or present obligation but outflow not probable / not reliably measurable	Not recognised; disclosed in the notes unless the possibility of outflow is remote
Contingent asset	Possible asset whose existence will be confirmed only by an uncertain future event	Not recognised; disclosed only where an inflow is probable

A Kenyan manufacturer facing litigation at year end

Lawyers advise a customer's product-liability claim is more likely than not to succeed, estimated settlement KES 6,000,000: a provision of KES 6,000,000 is recognised.

A separate, unrelated claim is assessed as only possible, not probable: disclosed as a contingent liability in the notes, not recognised as a liability.

Exam tip

The three-condition test (present obligation, probable outflow, reliable estimate) is the fastest way to sort a scenario into provision, contingent liability, or nothing at all, walk through all three explicitly rather than jumping to a conclusion.

Self-check

(a) A Kisumu logistics firm leases a warehouse for 4 years, annual payments KES 1,200,000 in arrears, incremental borrowing rate 11% (4-year annuity factor at 11% = 3.1024). Compute the initial lease liability and the annual straight-line depreciation on the right-of-use asset. (5 marks)

(b) A company's accounting depreciation on plant is KES 2,000,000 for the year, while KRA's wear and tear allowance is KES 2,800,000 for the same plant. State whether this creates a deferred tax asset or liability, and explain why. (3 marks)

(d) State the three conditions that must all hold before a provision is recognised under IAS 37. (3 marks)

Show worked answer

(a) Lease liability = 1,200,000 x 3.1024 = KES 3,722,880. Right-of-use asset is initially recognised at the same amount, depreciated over 4 years: 3,722,880 / 4 = KES 930,720 a year (5 marks).

(b) A deferred tax liability. The tax base of the plant (cost less the higher wear and tear allowance) is lower than its accounting carrying amount, a taxable temporary difference, since the tax deduction is being received faster than the accounting expense, future taxable profit will be correspondingly higher, generating the deferred tax liability (3 marks).

(c) Investment property is held to earn rentals or for capital appreciation, for example an office block let out to unrelated tenants; owner-occupied property is used in the entity's own production or administration, for example a retailer's own supermarket premises, and stays PPE under IAS 16 rather than IAS 40 (3 marks).

(d) A present obligation exists as a result of a past event; an outflow of resources is probable; a reliable estimate of the amount can be made (3 marks).

Accounting for assets and liabilities

Investment property

Exploration and evaluation assets

Non-current assets held for sale

Financial instruments

Leases

Current and deferred tax

Government grants

Provisions and contingencies

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