��Chapter 9:�Additional Financial Reporting Issues��

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Learning Objectives

• Explain the concepts underlying two methods of accounting for changing prices (inflation)—general purchasing power accounting and current cost accounting
• Describe attempts to account for inflation in different countries, as well as the rules found in International Financial Reporting Standards (IFRS) related to this issue
• Discuss the various issues related to the accounting for business combinations and the preparation of consolidated financial statements (group accounting)
• Present the approaches used internationally to address the issues related to group accounting, focusing on IFRS
• Describe IFRS segment reporting requirements

9-2

�Inflation Accounting – Impact on financial statements�

• Impact of inflation on financial statements
• Understated asset values
• Overstated income and overpayment of taxes
• Differing rate of inflation
• Differing impacts across companies
• Lack of comparability

9-3

Purchasing Power Gains and Losses

• Historical cost ignores
• Purchasing power gains and losses
• During inflation
• Holding cash and receivables
• Purchasing power losses
• Holding monetary liabilities
• Purchasing power gains
• Two approaches to inflation accounting
• General purchasing power accounting
• Current cost accounting

9-4

Approaches to inflation accounting

• General purchasing power
• Adjusts historical costs of assets
• Updates currency purchasing power changes
• Referred as
• General price-level-adjusted historical cost (GPLAHC) accounting
• Purchasing power gains and losses included in net income

9-5

Approaches to inflation accounting

• Current cost accounting
• Accounts specific price changes
• Updates assets value
• From historical cost to the current cost
• Referred as
• Current Replacement Cost Accounting (CRC)
• Nonmonetary assets restated
• To current replacement costs
• Expense items based on restated costs
• Holding gains and losses included in equity

9-6

Inflation Accounting Internationally

• United States
• In 1979, (FASB)
• SFAS 33, Financial Reporting and Changing Prices
• Required large U.S. companies
• Provide GPP and CC accounting disclosures
• In 1984, (FASB)
• Discontinued supplemental GPP information
• Two years later
• Information is optional (SFAS 89)
• Few companies provide
• Since the 1980s
• Experienced low rates of inflation
• Inflation accounting lifted

9-7

Inflation Accounting Internationally

• United Kingdom
• Introduced in 1980
• Statement of Standard Accounting Practice (SSAP) 16
• Required current cost information
• Rescinded
• Since the 1980s
• Experienced low rates of inflation
• Inflation accounting lifted

9-8

Inflation Accounting Internationally

• Latin America
• Long history of inflation
• Brazil, Chile, and Mexico
• Sophisticated standards
• Brazil abandoned

9-9

Inflation Accounting Internationally

• Mexico – Bulletin B-10
• Restatement of nonmonetary assets and liabilities
• Central bank’s general price level index
• Exception
• Option to use replacement cost
• For inventory and related cost of goods sold
• Imported machinery and equipment
• Combination of
• Country of origin price index
• Exchange rate between Mexico and country of origin
• Bulletin B-10 abandoned in 2007

9-10

Inflation Accounting Internationally

• Netherlands – Replacement Cost Accounting
• Allowed companies to use replacement cost accounting
• In 2005, IFRS introduced in Europe

9-11

Inflation Accounting Internationally

• International Financial Reporting Standards
• IAS 15, Information Reflecting the Effects of Changing Prices
• Issued in 1981
• Standard withdrawn
• Lack of support
• Relevant standard now
• IAS 29, Financial Reporting in Hyperinflationary Economies
• IAS 29 required by companies
• Located in highly inflationary environments
• IAS 21, The effects of Changes in Foreign Exchange Rates
• Requires restatement of foreign operations
• Located in highly inflationary environments

9-12

Inflation Accounting Internationally

• International Financial Reporting Standards
• IAS 29 – determines the environments
• Restatement using a general price index
• Nonmonetary assets
• Nonmonetary liabilities
• Stockholders’ equity
• Income statement items from the time of the transaction
• Purchasing power gains and losses
• Included in net income
• Comparative Information
• Restated previous period information
• Adjusted for change in general price index

9-13

Business Combinations and Consolidated Financial Statements

• Business Combinations is
• Acquisition of one business by another
• Referred as
• Mergers and acquisitions activity
• Primary expansion mechanism of MNCs
• Different ways
• Acquired company
• Ceases to exist
• Merged into acquiring company
• Merging companies
• Legally dissolve
• New company formed
• Group accounting
• Accounting for
• The parent
• One or more subsidiaries

9-14

Business Combinations and Consolidated Financial Statements

• Determination of control
• Legal control
• Ownership of more than 50 percent
• Shares and voting rights
• Contract
• Two companies
• Legal control of one by other company
• Effective control
• Widely distributed stock ownership
• Representation on the board of directors

9-15

Business Combinations and Consolidated Financial Statements

• Scope of Consolidation
• IAS 27, Consolidated and Separate Financial Statements
• Requires consolidation
• Parent and subsidiaries
• No consolidation
• Subsidiary intended to be disposed in 12 months
• Management seeking a buyer
• Subsidiary is dormant
• Insignificant operations
• U.S. GAAP
• Exclusion of subsidiary not allowed
• Although subsidiary held for sale

9-16

Business Combinations and Consolidated Financial Statements

• Full consolidation
• Subsidiary’s financial statement
• Line-by-line aggregation
• 100% of the elements
• Minority interest
• A separate item
• Subsidiary not 100 percent owned
• The non-owned portion
• Methods
• Purchase method or
• Pooling of interests method
• IFRS 3, issued in 2004,
• Purchase method only
• Pooling of interests is no longer acceptable under IFRS, or in the U.S., Canada, Brazil or Mexico

9-17

Business Combinations and Consolidated Financial Statements

• Full Consolidation – Purchase Method
• Acquisition of majority of voting shares
• Assets and liabilities revalued
• Fair value used for revaluation
• Goodwill
• Purchase price minus fair value
• IFRS 3, Business Combinations
• Purchase method referred as acquisition method

9-18

Business Combinations and Consolidated Financial Statements

• Full Consolidation – Goodwill
• Accounting for goodwill
• Significant variation internationally
• U.S., IFRS, and most other countries
• Goodwill capitalized
• Amortization
• Over five to 40 years
• IFRS 3
• Prohibits amortization over useful life
• Require annual impairment test
• Japan allows immediate expensing of goodwill

9-19

Business Combinations and Consolidated Financial Statements

• Project for Convergence of U.S. GAAP and IFRS
• IFRS 3, Business Combinations
• SFAS 141(R), Business Combinations
• Unifies M&A accounting across capital markets
• Removal from IFRS
• Accounting of step and partial acquisitions
• Goodwill measured as
• On acquisition date
• Difference in
• Value of investment held plus consideration
• Net asset acquired

9-20

Business Combinations and Consolidated Financial Statements

• Group Accounting – Equity Method
• The equity method is used by investors that
• Do not control
• Have significant influence over an investee
• 20% or more ownership of the voting shares
• One-line consolidation
• Relevant standards
• IAS 28, Investment in Associates and Joint Ventures
• IFRS 11, Joint Arrangements

9-21

Segment Reporting

• Facilitates
• Analysis
• Evaluation of financial statements
• In November 2006
• IASB issued IFRS 8, Operating Segments
• Converges IFRS with U.S. GAAP
• IASB adopted
• Management approach
• Segments defined by
• Line-of-business
• Geographic area

9-22

Segment Reporting

• An operating segment
• Earns revenues and incurs expenses
• Operating results reviewed for
• Performance
• Resource allocation
• Discrete financial information available
• Significant if
• Meets revenue test
• Meets profit and loss test
• Meets asset test

9-23

Segment Reporting

• Differences between IFRS 8 and U.S. GAAP
• U.S. GAAP– no disclosure of segment liabilities
• IFRS 8–intangibles included in
• Long-lived assets
• For geographic area disclosures
• Basis of operating segments
• IFRS 8 allows
• Products or services or geographic areas
• U.S. GAAP allows
• Products or services basis

9-24

Segment Reporting—Disclosures�

• General information
• Segment profit or loss and the following line items:
• Revenues from external customers
• Intersegment revenues
• Interest revenue and expense
• Depreciation, depletion and amortization
• Significant noncash items in segment profit or loss
• Unusual items (e.g. discontinued operations and extraordinary items)
• Income tax expense or benefit

9-25

Segment Reporting—Disclosures

• Total segment assets (and liabilities for IFRS)
• Investment in equity method affiliates
• Expenditures for additions to
• Long-lived assets (U.S. GAAP)
• Noncurrent assets (IFRS 8)

9-26

Entity Reporting—IFRS and U.S. GAAP

• IFRS and U.S. GAAP require
• Entity-Wide Disclosures about
• Products and services
• Major customers (if 10% or more of total entity revenue)
• Geographic areas

9-27

End of Chapter 9

9-28