additional financial reporting issues_5
TRANSCRIPT
-
8/11/2019 Additional Financial Reporting Issues_5
1/35
Additional Financial
Reporting Issues
Inflation
Business Combinations
Segment Reporting
-
8/11/2019 Additional Financial Reporting Issues_5
2/35
Additional International Financial
Reporting Issues
Inflation accounting
Business combinations and consolidated
financial statements (group accounting).
Segment reporting.
-
8/11/2019 Additional Financial Reporting Issues_5
3/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
4/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
5/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
6/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
7/35
A major question:
How do you measure inflation?
-
8/11/2019 Additional Financial Reporting Issues_5
8/35
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?
-
8/11/2019 Additional Financial Reporting Issues_5
9/35
Inflation Accounting Conceptual Issues
The two most common approaches to inflation
accounting are general purchasing power
accountingand current cost accounting.
-
8/11/2019 Additional Financial Reporting Issues_5
10/35
Inflation Accounting Conceptual Issues
Net Income and Capital Maintenance
General purchasing power and current cost accounting
each derive from different concepts of capitalmaintenance.
-
8/11/2019 Additional Financial Reporting Issues_5
11/35
Inflation Accounting Conceptual Issues
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.
-
8/11/2019 Additional Financial Reporting Issues_5
12/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
13/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
14/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
15/35
Inflation Accounting Internationally
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.
-
8/11/2019 Additional Financial Reporting Issues_5
16/35
Inflation Accounting Internationally
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.
-
8/11/2019 Additional Financial Reporting Issues_5
17/35
Inflation Accounting Internationally
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.
-
8/11/2019 Additional Financial Reporting Issues_5
18/35
Inflation Accounting Internationally
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.
-
8/11/2019 Additional Financial Reporting Issues_5
19/35
Inflation Accounting Internationally
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.
-
8/11/2019 Additional Financial Reporting Issues_5
20/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
21/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
22/35
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!
-
8/11/2019 Additional Financial Reporting Issues_5
23/35
Business Combinations and
Consolidated Financial Statements
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.
-
8/11/2019 Additional Financial Reporting Issues_5
24/35
Business Combinations and
Consolidated Financial Statements
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.
-
8/11/2019 Additional Financial Reporting Issues_5
25/35
Business Combinations and
Consolidated Financial Statements
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.
-
8/11/2019 Additional Financial Reporting Issues_5
26/35
Business Combinations and
Consolidated Financial Statements
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.
-
8/11/2019 Additional Financial Reporting Issues_5
27/35
In both GAAPs:
Minority interest is classified as equity.
In process R&D is expensed.
-
8/11/2019 Additional Financial Reporting Issues_5
28/35
Business Combinations and
Consolidated Financial Statements
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.
-
8/11/2019 Additional Financial Reporting Issues_5
29/35
Business Combinations and
Consolidated Financial Statements
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.
-
8/11/2019 Additional Financial Reporting Issues_5
30/35
Business Combinations and
Consolidated Financial Statements
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.
-
8/11/2019 Additional Financial Reporting Issues_5
31/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
32/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
33/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
34/35
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.
-
8/11/2019 Additional Financial Reporting Issues_5
35/35
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.