Chapter 08 International Accounting - Additional Financial Reporting Issues

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Chapter 8

Additional Financial Reporting Issues

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Chapter Topics Inflation accounting – general purchasing power and

current cost accounting approaches. Inflation accounting – differences in standards

worldwide. Business combinations and consolidated financial

statements (group accounting). International approaches to group accounting. International approaches to segment reporting.

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Learning Objectives1. Explain the concepts underlying two methods of

accounting for changing prices (inflation)—general purchasing power accounting and current cost accounting.

2. Describe attempts to account for inflation in different countries, as well as the rules found in International Financial Reporting Standards (IFRSs) related to this issue.

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Learning Objectives3. Discuss the various issues related to the accounting for

business combinations and the preparation of consolidated financial statements (group accounting).

4. Present the approaches used internationally to address the issues related to group accounting, focusing on IFRSs.

5. Describe segment reporting requirements in IFRSs and followed in countries around the world.

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Inflation Accounting – Conceptual Issues

Impact of inflation on financial statements Understated asset values. Overstated income and overpayment of taxes. Demands for higher dividends. Differing impacts across companies resulting in lack of

comparability.

Learning Objective 1

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Impact of inflation on financial statements Historical cost ignores purchasing power gains and

losses. Purchasing power losses result from holding monetary

assets, such as cash and accounts receivable. Purchasing power gains result from holding monetary

liabilities, such as accounts payable. The two most common approaches to inflation

accounting are general purchasing power accounting and current cost accounting.


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Net Income and Capital Maintenance Historical cost, general purchasing power and current

cost accounting all flow from different concepts of capital maintenance.

Net income represents the amount of dividends that can be paid out while still maintaining the company’s capital balance.


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Net Income and Capital Maintenance Historical cost net income maintains a nominal, not

adjusted for inflation, amount of contributed capital. General purchasing power net income maintains the

purchasing power of contributed capital. Current cost net income maintains the 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 the General 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 restated costs.

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 and CC 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 sophisticated

inflation accounting standards over time. Like the U.S. and UK, Brazil has abandoned inflation

accounting. Mexico’s Bulletin B-10, Recognition of the Effects of

Inflation 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 bank’s general price level index.

An exception is the option to use replacement cost for inventory and related cost of goods sold.

Another exception is imported machinery and equipment.

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 on

replacement 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

Prices was 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 subsidiaries

is often called group accounting.


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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.

Learning Objectives 3 and 4

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Group Accounting – Full Consolidation Full consolidation involves aggregation of 100 percent of

the subsidiary’s 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 two methods; 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.

IFRS 3, Business Combinations, measures the minority interest as the minority percentage multiplied by the fair value of the purchased net assets.


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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 no 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

IAS 14, Segment Reporting Requires segment reporting both by line-of-business and

geographic area. The company chooses one of these as a primary

reporting format. Significantly more information is required for the primary

reporting format. Generally, the primary reporting format will be consistent

with internal reporting to upper management. Reportability of a segment is based on the significance

of the segment.


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Segment Reporting

IAS 14, Segment Reporting – Significance 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

SFAS 131, Disclosures about Segments of an Enterprise and Related Information

Requires reporting of significant operating segments which can be based on either line-of-business or geographic area.

The significance tests and required disclosures are similar to IAS 14.

SFAS 131 does not, however, require reporting of both line-of-business and geographic segments.

If reporting is based on line-of-business, some additional information about foreign operations is required.


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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.

The IASB-FASB short-term convergence project is looking at this area.

IASB is planning to follow the SFAS 131 management approach to identifying segments.


Chapter 08 International Accounting - Additional Financial Reporting Issues

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