Chapter 8


Copyright © 2009 by The McGraw-Hill Companies, Inc. All


Additional Financial Reporting
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



Additional Financial Reporting
Learning Objectives
1. 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 (IFRS) related to this issue.


Present the approaches used internationally to address the issues related to group accounting. 8-4 . Describe segment reporting requirements in IFRS and followed in countries around the world. focusing on IFRS. Additional Financial Reporting Issues Learning Objectives 3. 5. Discuss the various issues related to the accounting for business combinations and the preparation of consolidated financial statements (group accounting). 4.

Learning Objective 1 8-5 . 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.

 Purchasing power gains result from holding monetary liabilities. Learning Objective 1 8-6 . such as accounts payable. Inflation Accounting – Conceptual Issues 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.  The two most common approaches to inflation accounting are general purchasing power accounting and current cost accounting.

Learning Objective 1 8-7 .  Net income represents the amount of dividends that can be paid out while still maintaining the company’s capital balance. Inflation Accounting – Conceptual Issues Net Income and Capital Maintenance  Historical cost. general purchasing power and current cost accounting all flow from different concepts of capital maintenance.

Learning Objective 1 8-8 . not adjusted for inflation. Inflation Accounting – Conceptual Issues Net Income and Capital Maintenance  Historical cost net income maintains a nominal. 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.

 Inflation Accounting -. 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 Learning Objective 1 8-9 .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.

 Inflation Accounting -.  Holding gains and losses are included in equity.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 (CRC)  Nonmonetary assets are restated to current replacement costs and expense items are based on these restated costs. Learning Objective 1 8-10 .

companies to provide GPP and CC accounting disclosures. but this was later rescinded.K.S. SSAP 16 required current cost information.. Financial Reporting and Changing Prices briefly required large U.  This information is now optional (SFAS 89) and few companies provide it. Inflation Accounting Internationally United States and United Kingdom  SFAS 33. Learning Objective 2 8-11 .  In the U.  Both countries have experienced low rates of inflation since the 1980s. which is why the inflation accounting requirements were lifted.

and Mexico have developed sophisticated inflation accounting standards over time. Inflation Accounting Internationally Latin America  Latin America has a long history of significant inflation. Recognition of the Effects of Inflation in Financial Information.K.  Like the U.  Brazil. and U. Learning Objective 2 8-12 .. is a well-known example. Brazil has abandoned inflation accounting. Chile.  Mexico’s Bulletin B-10.S.

 Companies no longer are required to use inflation accounting.  This exception allowed a combination of country of origin price index and the exchange rate between Mexico and country of origin.  Based on inflation being held to under 5% for several consecutive years. Inflation Accounting Internationally Mexico – Bulletin B-10  Required restatement of nonmonetary assets and liabilities using the central bank’s general price level index  An exception was the option to use replacement cost for inventory and related cost of goods sold.  Another exception was imported machinery and equipment. Learning Objective 2 8-13 . Bulletin B-10 was abandoned late in 2007.

 The entry accompanying the asset revaluation was reported in stockholders’ equity.  Cost of sales and depreciation were also based on replacement costs.  In 2003 and 2004 only Heineken used this approach.  Heineken presented inventories and fixed assets at replacement cost. Learning Objective 2 8-14 . Dutch companies could use replacement cost accounting. Inflation Accounting Internationally Netherlands – Replacement Cost Accounting  Prior to the required use of IFRS in 2005.

 This standard has been withdrawn due to lack of support. Financial Reporting in Hyperinflationary Economies. Information Reflecting the Effects of Changing Prices was issued in 1981. Inflation Accounting Internationally International Financial Reporting Standards  IAS 15.  IAS 29 is required for some companies located in environments experiencing very high levels of inflation.  The relevant standard now is IAS 29. Learning Objective 2 8-15 .

 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. Learning Objective 2 8-16 . Inflation Accounting Internationally International Financial Reporting Standards  IAS 29 includes guidelines for determining the environments where it must be used.  Purchasing power gains and losses are included in net income.

 Sometimes the acquiree ceases to exist. the acquiree remains a separate legal entity as a subsidiary of the acquirer (parent). Business Combinations and Consolidated Financial Background and conceptual issues Statements Business combinations are the primary mechanism used by MNEs for expansion.  In other cases. Learning Objective 3 8-17 .  Accounting for the parent and one or more subsidiaries is often called group accounting.

 Business Combinations and Consolidated Financial Group Accounting – Determination of control Statements Control provides the basis for whether a parent and a subsidiary should be accounted for as a group. uses the effective control definition.  Effective control can be achieved without majority ownership. Learning Objectives 3 and 4 8-18 . Consolidated and Separate Financial Statements.  Legal control through majority ownership or legal contract is often used to determine control.  IAS 27.

 Business Combinations and Consolidated Financial Group Accounting – Full Consolidation Statements Full consolidation involves aggregation of 100 percent of the     subsidiary’s financial statement elements. Pooling of interests is no longer acceptable under IFRS. When the subsidiary is not 100 percent owned. Canada. the non-owned portion is presented in a separate item called minority interest. Brazil or Mexico.. Full consolidation is accomplished using one of two methods-purchase method or pooling of interests method.S. Learning Objective 3 8-19 . allows the use of the purchase method only. issued in 2004. or in the U. IFRS 3.

 IFRS 3.  The excess of the purchase price over the fair value of the net assets is goodwill. Business Combinations and Consolidated Financial Full Consolidation – Purchase Method Statements When one company purchases a majority of the voting shares of another company. measures the minority interest as the minority percentage multiplied by the fair value of the purchased net assets. Business Combinations. Learning Objectives 3 and 4 8-20 . the purchased assets and liabilities are stated at fair value.

Canada.S.  U. Business Combinations and Consolidated Financial Full Consolidation – Goodwill Statements Significant variation exists internationally in accounting for goodwill.  Japan allows the option of immediate expensing of goodwill. IFRS. and IFRS do not require amortization but do require an annual impairment test...  U.S. Learning Objectives 3 and 4 8-21 . and most other countries require goodwill to be capitalized as an asset.  Some countries require amortization over a period of up to 40 years.

 The equity method is sometimes referred to as one-line consolidation. Business Combinations and Consolidated Financial Group Accounting – Equity Method Statements When companies do not control.  Some differences exist between countries regarding standards pertaining to the equity method. but have significant influence over an investee. the equity method is used. Learning Objectives 3 and 4 8-22 .  Twenty percent ownership is often used as the threshold for significant influence.

Joint Arrangements. in an effort to converge with U. Business Combinations and Consolidated Financial Group Accounting – Other Statements As stated previously.  Pooling of interests was historically a popular method because it allowed for lower expense recognition compared to the purchase method. the pooling of interests method is no longer permitted by IFRS and in many countries.  The IASB issued an exposure draft in late 2007. but is prohibited by U. ED 9.S. Financial Reporting of Interests in Joint Ventures. GAAP.S. that proposes using the equity method only in joint ventures.  The proportionate consolidation method is allowed under IAS 31. GAAP. Learning Objectives 3 and 4 8-23 .

Business Combinations and SFAS 160. In addition. The major change in U. both of which become effective July 1.S. Business Combinations and Consolidated Financial Group Accounting – Further Convergence of U. In December 2007 FASB issued SFAS 141 (R). an amended version of IAS 27. 2009. Learning Objectives 3 and 4 8-24 .     Consolidated and Separate Financial Statements was issued. with earlier adoption permitted. The major change in IFRS has the acquirer remeasuring its investment in the acquiree at its fair value at the date of control. Noncontrolling Interests in Consolidated Financial Statements. This replaces the step treatment. which measured the fair value at each step of achieving control. with any gain or loss recognized in net income. GAAP and IFRS Statements In January 2008 IFRS 3 was revised. GAAP includes requiring the use of the acquisition method for business combinations and classifying noncontrolling interests as equity.S.

 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  MNEs typically have multiple types of businesses located around the world. Learning Objective 5 8-25 .

 Segment Reporting Background  Beginning in the 1960s.  A significant point of resistance to segment reporting is concerns about competitive disadvantage.  The AICPA and Association of Investment Management and Research (AIMR) recommend segment reporting consistent with how a business is managed.  Segments are defined both by line-of-business and geographic area. standard setters began to require disclosures by segment. Learning Objective 5 8-26 .

 An operating segment is an enterprise component if:  It earns revenues and incurs expenses. Operating Segments (issued November 2006. with an effective date of January 1. Learning Objective 5 8-27 . Segment Reporting IFRS 8.S.  Its operating results are regularly reviewed for performance and resource allocation. GAAP (SFAS 131)  Adopts the management approach to segment reporting  Management disaggregates components to make operating decisions. 2009)  Substantially converges IFRS with U.  Discrete financial information is available for it.

Learning Objective 5 8-28 . segments must be disclosed if less than 75% of total company sales are to outsiders.  Profit or loss test—segment profit or loss is 10% or more of the higher of the combined reported profit of profitable segments or the combined loss of all segments reporting a loss. Segment Reporting IFRS 8.  Asset test—segment assets are 10% or more of the combined assets of all operating segments. Operating Segments – Significance Tests to Justify Disclosure Must meet any of the following tests:  Revenue test—segment revenue (external and intersegment) represents 10% or more of combined internal and external revenue.  Notwithstanding the tests above.

 Segment Reporting SFAS 131.  IFRS 8 explicitly includes intangibles in the definition of longlived assets for geographic area disclosures. Learning Objective 5 8-29 . Disclosures about Segments of an Enterprise and Related Information  Only two substantive differences exist between IFRS 8 and SFAS 131:  SFAS 131 does not require disclosure of segment liabilities.

g. Segment Reporting—IFRS and U. depletion and amortization Other significant noncash items in segment profit or loss Unusual items (e. GAAP Disclosures  General information about the operating segment (how identified and products and services)  Segment profit or loss and the following line items:        Revenues from external customers Intersegment revenues Interest revenue and expense Depreciation.S. discontinued operations and extraordinary items) Income tax expense or benefit Learning Objective 5 8-30 .

Segment Reporting—IFRS and GAAP Disclosures  Total segment assets (and liabilities for IFRS)  Expenditures for additions to long-lived assets (SFAS 131) and noncurrent assets (IFRS 8) Learning Objective 5 8-31 .S. U.

S. Entity Reporting—IFRS and U. GAAP Disclosures  Information about products and services  Information about major customers (if 10% or more of total entity revenue)  Information about geographic areas 8-32 .