CHAPTER 9
ADDITIONAL FINANCIAL REPORTING ISSUES
Chapter Outline
I. In addition to issues involving the accounting for foreign currency, three financial reporting
issues of international importance are: (a) accounting for changing prices (inflation
accounting), (b) accounting for business combinations and consolidated financial
statements, and (c) segment reporting.
II. Historical cost accounting in a period of inflation understates asset values (and related
expenses) and overstates income. Historical cost accounting also ignores the gains and
losses in purchasing power caused by inflation that arise from holding monetary assets
and liabilities.
III. Two methods of accounting for inflation have been used in different countries – general
purchasing power (GPP) accounting and current cost (CC) accounting.
A. Under GPP accounting, nonmonetary assets and stockholders’ equity accounts are
restated for changes in the general price level. Cost of goods sold and
depreciation/amortization are based on restated asset values and the net purchasing
power gain/loss on the net monetary liability/asset position is included in income. GPP
income is the amount that can be paid as a dividend while maintaining the purchasing
power of capital.
B. Under CC accounting, nonmonetary assets are revalued to current cost, and cost of
goods sold and depreciation/amortization are based on revalued amounts. CC
income is the amount that can be paid as a dividend while maintaining physical capital.
IV. IAS 29 requires the use of GPP accounting by firms that report in the currency of a
hyperinflationary economy. IAS 21 requires the financial statements of a foreign operation
located in a hyperinflationary economy to first be adjusted for inflation in accordance with
IAS 29 before translation into the parent company’s reporting currency.
V. Issues that must be resolved in accounting for a business combination relate to (a)
selection of an appropriate method, (b) recognition and measurement of goodwill, and (c)
measurement of minority interest.
A. IFRS 3 and US. GAAP both require the purchase method in accounting for business
combinations; the pooling of interests method is not allowed.
B. Goodwill is recognized on the consolidated balance sheet as an asset and tested
annually for impairment under both IFRS 3 and U.S. GAAP.
C. When less than 100% of a company is acquired, IFRS 3 requires the acquired assets
and liabilities to be recorded at full fair value and minority interest is initially measured
at the minority shareholders’ percentage ownership in the fair value of the acquired
company’s net assets. This is known as the economic unit or entity concept.
1. In addition to the economic unit or entity concept, U.S. GAAP also allows use of
the parent company concept in which the acquired assets and liabilities are initially
measured at book value plus the parent’s ownership percentage in the difference
between fair value and book value. Under this approach, minority interest is
initially measured at the minority shareholders’ percentage ownership in the book
value of the subsidiary’s net assets.
VI. IAS 28 and US. GAAP require use of the equity method when an investor has the ability to
exert significant influence over an investee; significant influence is presumed when the
investor owns 20% or more of the investee’s voting shares.
VII. In accounting for an investment in a joint venture, IAS 31 prefers the use of proportionate
consolidation, but also allows the equity method. The equity method is required under
U.S. GAAP.
VIII. Questions arise as to (a) when an investee should be considered a subsidiary and (b)
which subsidiaries should be consolidated when a parent company prepares consolidated
financial statements.
A. IAS 27 defines a subsidiary as an enterprise controlled by another enterprise known as
the parent. Control is defined as the power to govern the financial and operating
policies of an entity so as to obtain benefits from its activities. Control can exist
without owning a majority of shares of stock, for example, when one company has
power over more than half of the voting rights through agreements with other
shareholders.
1. Historically, U.S. companies have relied on majority stock ownership as evidence of
control.
B. IAS 27 requires a parent to consolidate all subsidiaries unless (a) the subsidiary was
acquired with the intent to dispose of it within 12 months and (b) management is
actively seeking a buyer.
1. U.S. GAAP requires all subsidiaries to be consolidated unless the parent has lost
control due to bankruptcy or severe restrictions imposed by a foreign government.
IX. The aggregation of all of a company’s activities into consolidated totals masks the
differences in risk and potential existing across different lines of business and in different
parts of the world. To provide information that can be used to evaluate these risks and
potentials, companies disaggregate consolidated totals and provide disclosures on a
segment basis.
X. IFRS 8 was issued in 2006 to converge with U.S. GAAP. Both IFRS and U.S. GAAP follow
the so-called management approach in determining operating segments, which are
components of a business that:
Engage in activities from which they earn revenues and incurs expenses.
Are regularly reviewed by the chief operating decision maker to assess performance
and make resource allocation decisions.
Have discrete financial information available.
A. An operating segment is reportable if it meets one of three significance tests: 10% or
more of combined segment revenues, 10% or more of the greater of combined
segment profit or combined segment loss, or 10% or more of combined segment
assets.
B. A sufficient number of segments must be separately reported to disclose at least 75%
of consolidated revenues.
C. Disclosures to be provided for each operating segment include: revenues (external
and Intercompany), interest income and interest expense, depreciation and
amortization expense, unusual items, income tax expense, and profit or loss; total
segment assets, equity method investments, and expenditures for noncurrent assets.
IFRS 8 also requires disclosure of segment liabilities, but SFAS 131 does not.
XI. IFRS and U.S. GAAP also require enterprise-wide disclosures related to:
A. Products and services – if operating segments are not organized along these lines.
External revenues derived from each major product or service line must be disclosed
when the company has only one operating segment or operating segments are based
on something other than products/services.
B. Major customers – any customer from which the enterprise generates 10% or more of
revenues.
The existence of major customers must be disclosed along with the operating segment
generating the revenues, but the identity of the customer need not be revealed.
C. Geographic areas – if operating segments are not organized geographically.
If operating segments are not based on geography, revenues and long-lived assets
must be disclosed for (a) the domestic country, (b) all foreign countries in total, and (c)
for each foreign country in which a material amount of revenues or long-lived assets
are located. A quantitative threshold for determining materiality is not specified.
1. Whereas U.S. GAAP requires disclosure of long-lived assets (often interpreted as
fixed assets only), IFRS requires disclosure of non-current assets, which is
specifically intended to include intangibles.
2. There is considerable diversity in the level of detail provided by U.S. companies
with respect to individual country disclosures. Some companies have determined
that no single foreign country has a material amount of revenues or long-lived
assets.