Additional Financial Reporting Issues_5

8/11/2019 Additional Financial Reporting Issues_5

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Additional Financial

Reporting Issues

Inflation

Business Combinations

Segment Reporting


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Additional International Financial

Reporting Issues

Inflation accounting

Business combinations and consolidated

financial statements (group accounting).

Segment reporting.


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Inflation

Monetary inflation occurs when the moneysupply of a country is increased over and abovethe demand and need for currency. This resultsin depreciation in the value of currency.

Or more simply- when too much money chasestoo few goods.


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Inflation

The impact of monetary inflation on pricesis typically not evenly distributed across all

goods and services within an economy. This makes inflation hard to measure and

account for.


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The Problem with

Inflation

Inflation distorts, or eradicates, the

meaning of financial statement numbers

that are not stated in current cost. Inflation also can create real wealth effects

that are not always easy to measure.


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Inflation Accounting

Inflation creates two basic reporting

mistakes when traditional accounting

methods are alone employed:Purchasing power gains/losses are not

detected and reported.

Historical cost numbers lose their relevance.


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A major question:

How do you measure inflation?


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The CPI:

Measures a very specific basket of goods and services avery specific way.

Does this basket truly detect the degree of inflationimpacting an economic system and/or a specific industryor firm?


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Inflation Accounting Conceptual Issues

The two most common approaches to inflation

accounting are general purchasing power

accountingand current cost accounting.


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Net Income and Capital Maintenance

General purchasing power and current cost accounting

each derive from different concepts of capitalmaintenance.


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Net Income and Capital Maintenance

General purchasing power-adjusted net income focuseson maintaining the purchasing power of contributed

capital.

Current cost-adjusted net income focuses on maintainingthe productive capacity of physical capital.


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Inflation Accounting -- Methods

General Purchasing Power (GPP) Accounting

Updates historical cost accounting for changes in the

general purchasing power of the monetary unit. Also referred to as General Price-Level-Adjusted

Historical Cost Accounting (GPLAHC).

Nonmonetary assets and liabilities, stockholders equity

and income statement items are restated using theGeneral Price Index (GPI).

Requires purchasing power gains and losses to be

included in net income.


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Inflation Accounting -- Methods

Current Cost (CC) Accounting

Updates historical cost of assets to the current cost to

replace those assets. Also referred to as Current Replacement Cost

Accounting.

Nonmonetary assets are restated to current replacement

costs and expense items are based on these restatedcosts.

Holding gains and losses included in equity.


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Inflation Accounting Internationally

United States and United Kingdom

SFAS 33, Financial Reporting and Changing Prices

briefly required large U.S. companies to provide GP andCC accounting disclosures.

This information is now optional and few companies

provide it.

In the UK, SSAP 16 required current cost information,this was also was only briefly required.

Both countries have experienced low rates of inflation

since the 1980s.


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Latin America

Latin America has a long history of significant inflation.

Brazil, Chile, and Mexico have developed sophisticatedinflation accounting standards over time.

Like the U.S. and UK, Brazil has abandoned inflation

accounting.

Mexicos Bulletin B-10, Recognition of the Effects ofInflation in Financial Information, is a well-known

example.


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Mexico Bulletin B-10

Requires restatement of nonmonetary assets and

liabilities using the central banks general price levelindex.

An exception is the option to use replacement cost for

inventory and related cost of goods sold.

Another exception is imported machinery andequipment.

This exception allows a combination of country of origin

price index and the exchange rate between Mexico and

country of origin.


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Netherlands Replacement Cost Accounting

Prior to the required use of IFRSs in 2005, Dutch

companies could use replacement cost accounting. In 2003 only Heineken used this approach.

Heineken presented inventories and fixed assets at

replacement cost.

Cost of sales and depreciation were also based onreplacement costs.

The entry accompanying the asset revaluation was

reported in stockholders equity.


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International Financial Reporting Standards

IAS 15, Information Reflecting the Effects of Changing

Priceswas issued in 1981. This standard has been withdrawn due to lack of

support.

The relevant standard now is IAS 29, Financial

Reporting in Hyperinflationary Economies. IAS 29 is required for some companies located in

environments experiencing very high levels of inflation.


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International Financial Reporting Standards

IAS 29 includes guidelines for determining the

environments where it must be used. Nonmonetary assets and liabilities and stockholders

equity are restated using a general price index.

Income statement items are restated using a general

price index from the time of the transaction. Purchasing power gains and losses are included in net

income.


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Business Combinations and

Consolidated Financial Statements

Background and conceptual issues

Business combinations are the primary mechanism used

by MNEs for expansion. Sometimes the acquiree ceases to exist.

In other cases, the acquiree remains a separate legal

entity as a subsidiary of the acquirer (parent).

Accounting for the parent and one or more subsidiariesis often called group accounting.


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History of Group Accounting

For many years, there was no group accounting anywhere.

In the 1920s, in the United States, and elsewhere, conglomeratesformed, composed of many separate legal entities.

Group accounting began to develop in these market-based

economies. By the late 1960s (the peak of another boom), the topic had become

quite controversial. A crucial issue was purchase versus pooling-of-interests accounting.

In the 1970s, the newly formed FASB issued a new standard makingit much harder to use pooling-of-interests.

Around the world, however, group accounting continued to beignored.


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In the late 1980s, Europe, through the 7thdirective, adopted group accounting for

multinational enterprises. Very recently, the IASB adopted group

accounting.

The accounting now part of internationalfinancial reporting standards (IFRS#3) isessentially identical to that used in USA!


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Group Accounting Determination of control

Control provides the basis for whether a parent and a

subsidiary should be accounted for as a group. Legal control through majority ownership or legal

contract is often used to determine control.

Effective control can be achieved without majority

ownership. IAS 27, Consolidated and Separate Financial

Statements, uses the effective control definition.


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Group Accounting Full Consolidation

Full consolidation involves aggregation of 100 percent of

the subsidiarys financial statement elements. When the subsidiary is not 100 percent owned, the non-

owned portion is presented in a separate item called

minority interest.

Full consolidation is accomplished using one of twomethods; purchase method or pooling of interests

method.


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Full Consolidation Purchase Method

When one company purchases a majority of the voting

shares of another company, the purchased assets and

liabilities are stated at fair value.

The excess of the purchase price over the fair value of

the net assets is goodwill.


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Full Consolidation-Economic Unit Method

IFRS 3, Business Combinations, measures the

minority interest as the minority percentagemultiplied by the fair value of the purchased net

assets.

US GAAP still allows Purchase method, but

Economic Unit Method is also OK.


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In both GAAPs:

Minority interest is classified as equity.

In process R&D is expensed.


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Full Consolidation Goodwill

Significant variation exists internationally in accounting

for goodwill.

U.S., IFRS, and most other countries require goodwill to

be capitalized as an asset.

Some countries require amortization over a period of up

to 40 years.

U.S., Canada, and IFRS do not require amortization but

do require an annual impairment test.

Japan allows immediate expensing of goodwill.


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Group Accounting Equity Method

When companies do not control, but have significant

influence over an investee, the equity method is used.

Twenty percent ownership is often used as the threshold

for significant influence.

The equity method is sometimes referred to as one-line

consolidation.

Some differences exist between countries regarding

standard pertaining to the equity method.


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Group Accounting Other

Pooling of interests method is now prohibited by IFRS

and in many countries.

Pooling of interests was historically a popular method

because it allowed for lower expense recognition

compared to the purchase method.

Proportionate consolidation method under IAS 31,

Financial Reporting of Interests in Joint Ventures, but is

prohibited by U.S. GAAP.


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Segment Reporting

Background

MNEs typically have multiple types of businesses

located around the world.

Consolidated financial statements aggregate this

information.

Different types of business activity and location involve

different growth prospects and risks.

Financial statement users desire information to be

disaggregated in order to facilitate its usefulness.


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Segment Reporting

Background

Beginning in the 1960s, standard setters began to

require disclosures by segment.

Segments are defined both by line-of-business and

geographic area.

The AICPA and Association of Investment Management

and Research (AIMR) recommend segment reporting

consistent with how a business is managed.

A significant point of resistance to segment reporting is

concerns about competitive disadvantage.


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Segment Reporting

IFRS8, Segment Report ing IFRS used to require segment reporting both by line-of-business and

geographic area.

Recently, IFRS converged to US GAAP and now requires theManagement approach.

Under this approach operating segments are identified, based on

internal management methods.

Segments are disclosed if they are material enough-

A three way test for this is required.


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Segment Reporting

Segment Repo rt ingSignificance Test

Reportability of a segment is based on the significance

of the segment.

A segment is deemed reportable if it meets one of three

significance tests.

The significance tests are based on revenue, profit or

loss, and assets.

A segment is reportable if it equals or exceeds 10

percent on any one of these tests.


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Segment Reporting

Segment Reporting Internationally

There is a significant lack of convergence internationally

in the area of segment reporting.

In a number of countries, segment reporting is not

required if deemed to be of competitive disadvantage by

the company.

Additional Financial Reporting Issues_5

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