Additional Financial

Reporting Issues

Inflation
Business Combinations
Segment Reporting
Additional International Financial
Reporting Issues
Inflation accounting
Business combinations and consolidated
financial statements (group accounting).
Segment reporting.

Inflation
Monetary inflation occurs when the money
supply of a country is increased over and above
the demand and need for currency. This results
in depreciation in the value of currency.
Or more simply- when too much money chases
too few goods.
Inflation
The impact of monetary inflation on prices
is typically not evenly distributed across all
goods and services within an economy.
This makes inflation hard to measure and
account for.

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.

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.
A major question:
How do you measure inflation?


The CPI:
Measures a very specific basket of goods and services a
very specific way.

Does this basket truly detect the degree of inflation
impacting an economic system and/or a specific industry
or firm?
Inflation Accounting Conceptual Issues
The two most common approaches to inflation
accounting are general purchasing power
accounting and current cost accounting.
Inflation Accounting Conceptual Issues
Net Income and Capital Maintenance
General purchasing power and current cost accounting
each derive from different concepts of capital
maintenance.
Inflation Accounting Conceptual Issues
Net Income and Capital Maintenance

General purchasing power-adjusted net income focuses
on maintaining the purchasing power of contributed
capital.

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

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.

Inflation Accounting Internationally
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.
Mexicos Bulletin B-10, Recognition of the Effects of
Inflation in Financial Information, is a well-known
example.


Inflation Accounting Internationally
Mexico Bulletin B-10
Requires restatement of nonmonetary assets and
liabilities using the central banks 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.

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 on
replacement costs.
The entry accompanying the asset revaluation was
reported in stockholders equity.

Inflation Accounting Internationally
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.
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.
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.

History of Group Accounting
For many years, there was no group accounting anywhere.
In the 1920s, in the United States, and elsewhere, conglomerates
formed, 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 making
it much harder to use pooling-of-interests.
Around the world, however, group accounting continued to be
ignored.

In the late 1980s, Europe, through the 7
th

directive, adopted group accounting for
multinational enterprises.
Very recently, the IASB adopted group
accounting.
The accounting now part of international
financial reporting standards (IFRS#3) is
essentially identical to that used in USA!
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.

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 two
methods; purchase method or pooling of interests
method.
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.
Business Combinations and
Consolidated Financial Statements
Full Consolidation-Economic Unit Method
IFRS 3, Business Combinations, measures the
minority interest as the minority percentage
multiplied by the fair value of the purchased net
assets.

US GAAP still allows Purchase method, but
Economic Unit Method is also OK.


In both GAAPs:
Minority interest is classified as equity.
In process R&D is expensed.
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.
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.
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.
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.
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.


Segment Reporting
IFRS8, Segment Reporting
IFRS used to require segment reporting both by line-of-business and
geographic area.
Recently, IFRS converged to US GAAP and now requires the
Management 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.



Segment Reporting
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.



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.