McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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.

9-2
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.
3. 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 IFRS.
5. Describe IFRS segment reporting requirements.

9-3
 Im
pact of inflation on financial statements
U
nderstated asset values.

O
verstated income and overpayment of taxes.

D
emands for higher dividends.

D
iffering impacts across companies resulting in lack of comparability.

Learning Objective 1
9-4
 Im
pact of inflation on financial statements
Hi
storical cost ignores purchasing power gains and losses.

Pu
rchasing power losses result from holding monetary assets, such as cash and
accounts receivable.

Pu
rchasing power gains result from holding monetary liabilities, such as
accounts payable.

Th
e two most common approaches to inflation accounting are general
purchasing power accounting and current cost accounting .
Learning Objective 1
9-5
 N
et Income and Capital Maintenance
H
istorical cost, general purchasing power and current cost accounting all
flow from different concepts of capital maintenance.

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

Learning Objective 1
9-6
 N
et Income and Capital Maintenance

H
istorical cost net income maintains a nominal, not adjusted for inflation,
amount of contributed capital.

G
eneral purchasing power net income maintains the purchasing power of
contributed capital.

C
urrent cost net income maintains the productive capacity of physical
capital.

Learning Objective 1
9-7
 Ge
neral Purchasing Power (GPP) Accounting
U
pdates historical cost accounting for changes in the general purchasing power of
the monetary unit.
A
lso referred to as General Price-Level-Adjusted Historical Cost Accounting
(GPLAHC).
N
onmonetary assets and liabilities, stockholders’ equity and income statement items
are restated using the General Price Index (GPI).
R
equires purchasing power gains and losses to be included in net income.

Learning Objective 1
9-8
 urrent Cost (CC) Accounting

pdates historical cost of assets to the current cost to replace those assets.

lso referred to as Current Replacement Cost Accounting (CRC).

onmonetary assets are restated to current replacement costs and expense

items are based on these restated costs.

olding gains and losses are included in equity.

Learning Objective 1
9-9
 U
nited States and United Kingdom

FAS 33, Financial Reporting and Changing Prices briefly required large U.S.
companies to provide GPP and CC accounting disclosures.

his information is now optional (SFAS 89) and few companies provide it.

n the U.K., SSAP 16 required current cost information, but this was later
rescinded.

oth countries have experienced low rates of inflation since the 1980s, which
is why the inflation accounting requirements were lifted.

Learning Objective 2
9-10
 L
atin America
L
atin America has a long history of significant inflation.

B
razil, Chile, and Mexico have developed sophisticated inflation accounting
standards over time.

L
ike the U.S. and U.K., Brazil has abandoned inflation accounting.

M
exico’s Bulletin B-10, Recognition of the Effects of Inflation in Financial
Information, is a well-known example.

Learning Objective 2
9-11
 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.
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, Bulletin B-10 was abandoned late
in 2007.
Companies
no longer are required to use inflation accounting.

Learning Objective 2
9-12
 etherlands – Replacement Cost Accounting

rior to the required use of IFRS in 2005, Dutch companies could use
replacement cost accounting.

n 2003 and 2004 only Heineken used this approach.

eineken presented inventories and fixed assets at replacement cost.

ost of sales and depreciation were also based on replacement costs.

he entry accompanying the asset revaluation was reported in

stockholders’ equity.

Learning Objective 2
9-13
 I
nternational Financial Reporting Standards

AS 15, Information Reflecting the Effects of Changing Prices was issued in 1981.

his standard has been withdrawn due to lack of support.

he relevant standard now is IAS 29, Financial Reporting in Hyperinflationary
Economies.

AS 29 is required for some companies located in environments experiencing
very high levels of inflation.

Learning Objective 2
9-14
 I
nternational Financial Reporting Standards
I
AS 29 includes guidelines for determining the environments where it must be
used.
N
onmonetary assets and liabilities and stockholders’ equity are restated using
a general price index.
I
ncome statement items are restated using a general price index from the
time of the transaction.
P
urchasing power gains and losses are included in net income.

Learning Objective 2
9-15
 ackground and conceptual issues

usiness combinations are the primary mechanism used by MNEs for

expansion.

ometimes the acquiree ceases to exist.

n other cases, the acquiree remains a separate legal entity as a subsidiary

of the acquirer (parent).

ccounting for the parent and one or more subsidiaries is often called
group accounting.

Learning Objective 3
9-16
 G
roup Accounting – Determination of control

ontrol provides the basis for whether a parent and a subsidiary should be
accounted for as a group.

egal control through majority ownership or legal contract is often used to
determine control.

ffective control can be achieved without majority ownership.

AS 27, Consolidated and Separate Financial Statements, uses the effective
control definition.

Learning Objectives 3 and 4

9-17
 Gro
up Accounting – Full Consolidation
Full
consolidation involves aggregation of 100 percent of the subsidiary’s financial
statement elements.
Wh
en 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.
IFR
S 3, issued in 2004, allows the use of the purchase method only.
Poo
ling of interests is no longer acceptable under IFRS, or in the U.S., Canada, Brazil or
Mexico.

Learning Objective 3
9-18
 ull Consolidation – Purchase Method

hen one company purchases a majority of the voting shares of another

company, the purchased assets and liabilities are stated at fair value.

he excess of the purchase price over the fair value of the net assets is
goodwill.

FRS 3, Business Combinations, measures the minority interest as the

minority percentage multiplied by the fair value of the purchased net
assets.

Learning Objectives 3 and 4

9-19
 F
ull Consolidation – Goodwill
S
ignificant variation exists internationally in accounting for goodwill.
U
.S., IFRS, and most other countries require goodwill to be capitalized as an
asset.
S
ome 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.
J
apan allows the option of immediate expensing of goodwil l.

Learning Objectives 3 and 4

9-20
 G
roup Accounting – Equity Method
W
hen companies do not control, but have significant influence over an
investee, the equity method is used.
T
wenty percent ownership is often used as the threshold for significant
influence.
T
he equity method is sometimes referred to as one-line consolidation.
S
ome differences exist between countries regarding standards

pertaining to the equity method.

Learning Objectives 3 and 4

9-21
 G
roup Accounting – Other
A
s stated previously, the pooling of interests method is no longer permitted by IFRS
and in many countries.
P
ooling of interests was historically a popular method because it allowed for lower
expense recognition compared to the purchase method.
T
he proportionate consolidation method is allowed under IAS 31, Financial
Reporting of Interests in Joint Ventures, but is prohibited by U.S. GAAP. The equity
method is used instead.
T
he IASB issued an exposure draft in late 2007, ED 9, Joint Arrangements, that
proposes using the equity method only in joint ventures, in an effort to converge
with U.S. GAAP. The transitional arrangements have not yet been finalized.

Learning Objectives 3 and 4

9-22
 G
roup Accounting – Further Convergence of U.S. GAAP and IFRS
I
n January 2008 IFRS 3 was revised. In addition, an amended version of IAS 27,
Consolidated and Separate Financial Statements was issued, both of which become
effective July 1, 2009, with earlier adoption permitted.
I
n December 2007 FASB issued SFAS 141 (R), Business Combinations and SFAS 160,
Noncontrolling Interests in Consolidated Financial Statements.
T
he major change in IFRS has the acquirer remeasuring its investment in the acquiree at
its fair value at the date of control, with any gain or loss recognized in net income.
T
his replaces the step treatment, which measured the fair value at each step of
achieving control.
T
he major change in U.S. GAAP includes requiring the use of the acquisition method for
business combinations and classifying noncontrolling interests as equity.

Learning Objectives 3 and 4

9-23
 B
ackground
M
NEs typically have multiple types of businesses located around the world.

C
onsolidated financial statements aggregate this information.

D
ifferent types of business activity and location involve different growth
prospects and risks.

F
inancial statement users desire information to be disaggregated in order
to facilitate its usefulness.

Learning Objective 5
9-24
 B
ackground
B
eginning in the 1960s, standard setters began to require disclosures by
segment.
S
egments are defined both by line-of-business and geographic area.
T
he 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.

Learning Objective 5
9-25
 FRS 8, Operating Segments :

ubstantially converges IFRS with U.S. GAAP.

dopts the management approach to segment reporting.

anagement disaggregates components to make operating decisions.

n operating segment is an enterprise component if:

 It earns revenues and incurs expenses.
 Its operating results are regularly reviewed for performance and resource
allocation.
 Discrete financial information is available for it.

Learning Objective 5
9-26
 IFR
S 8, Operating Segments – Significance Tests to Justify Disclosure
Mu
st meet any of the following tests:
Re
venue test—segment revenue (external and intersegment) represents 10% or more of
combined internal and external revenue.

Pr
ofit 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.
As
set test—segment assets are 10% or more of the combined assets of all operating segments.
No
twithstanding the tests above, segments must be disclosed if less than 75% of total company
sales are to outsiders.

Learning Objective 5
9-27
 .S. GAAP

nly three substantive differences exist between IFRS 8 and U.S.

GAAP:
 U.S. GAAP does not require disclosure of segment liabilities.
 IFRS 8 explicitly includes intangibles in the definition of long-
lived assets for geographic area disclosures.
 When a company has a matrix form of organization, IFRS 8
allows operating segments to be based on either products or
services or geographic areas. U.S. GAAP only allows the
products or services basis.

Learning Objective 5
9-28
 isclosures

eneral information about the operating segment (how identified

and products and services).

egment profit or loss and the following line items:

 Revenues from external customers
 Intersegment revenues
 Interest revenue and expense
 Depreciation, depletion and amortization
 Other significant noncash items in segment profit or loss
 Unusual items (e.g. discontinued operations and extraordinary items)
 Income tax expense or benefit

Learning Objective 5
9-29
 isclosures

otal segment assets (and liabilities for IFRS).

xpenditures for additions to long-lived assets (U.S. GAAP) and

noncurrent assets (IFRS 8).

Learning Objective 5
9-30
isclosures

nformation about products and services.

nformation about major customers (if 10% or more of total

entity revenue).

nformation about geographic areas.

9-31