Acctg 5140 Ch. 9
Explain why the legal concept of control may be appropriate in some countries, such as Japan.
Because of their extensive cross-ownership of companies, identifying the legal ownership patterns of Japanese company groups (Keiretsu) can be extremely difficult.
Why is return on assets (net income / total assets) generally smaller under current cost accounting than under historical cost accounting?
Current cost accounting generally results in a larger amount of nonmonetary assets, as well as a larger amount of stockholders' equity, being reported on the balance sheet. Expenses based on the current cost of nonmonetary assets (carried at larger amounts) generally results in a smaller amount of net income being reported under current cost accounting. With smaller income and larger stockholders' equity, return on equity measured under current cost accounting is generally smaller than under historical cost accounting.
What are the circumstances under which a subsidiary could, and perhaps should, be excluded from consolidation?
IAS 27 requires a parent to consolidate all subsidiaries, foreign and domestic, unless (a) control of the subsidiary is temporary because it is held with a view to its disposal in the near future, or (b) the subsidiary operates under severe long-term restrictions that significantly affect its ability to send funds to its parent. IAS 27 does not allow a subsidiary to be excluded from consolidated financial statements solely because its operations are dissimilar to those of the other companies that comprise the group. In publishing its equivalents to IFRS 3 and IAS 27 in early 2008, the FASB has made fundamental changes to its accounting for business combinations, bringing the accounting requirements for business combinations in IFRS and U.S. GAAP closer together.
What are the major differences in the calculation of income between the historical cost (HC) model and the current cost (CC) model of accounting?
Under historical cost method assets are carried in balance sheet at their cost of acquisition and depreciation is charged on this basis. The liabilities are recorded in the financial statement on price at which they were incurred. This model reflects traditional approach and income is calculated on the basis of the cost incurred at the time of generation of assets and liabilities. Under current costing model the certain assets and liabilities are recorded at fair value in the financial statements like derivatives such as future contracts. The price of purchase or sales contracts like interest rates are used to reduce the risk associated with price of commodity, weather and foreign exchange rates. FASB statement 133 states techniques to refine measurement of fair value of all financial instruments. The International Accounting Standards Committee (IASC) also recommends certain assets and liabilities to be shown at current cost. Justification for Each Model The historical cost is better measure in terms of the fact that historical cost can be accurately assessed and calculated and income assessed on the basis of historical cost is comparable with the result of other periods. There is no variation in valuation of assets and liabilities if they are valued at historical cost. Under current cost model as assets and liabilities are at present value, therefore the financial statements reflects the present worth of the organization and as a fact the assets or liabilities generated in number of years back may not be at the value at which it was generated. The income statement also reflects income or loss under current scenario. Recommendation The current cost model is better approach because it relies upon the present value or current cost of assets and liabilities but it can be useful only when the current cost of assets and liabilities can be measured correctly and efficiently and for all assets and liabilities. Hybrid system that some assets are taken at historical cost in financial statements and few at current cost does not serve purpose as it suffers from comparison aspects and makes difficult inter and intra firm comparisons.
Why is it important that in countries with high inflation, financial statements be adjusted for inflation?
Historical cost accounting causes assets to be significantly understated in a country experiencing high inflation. Understated assets, such as inventory and fixed assets, leads to understated expenses, such as cost of goods sold and depreciation, which in turn leads to overstated income and stockholders' equity. Understated asset values can have a negative impact on a company's ability to borrow because the collateral is understated. Understated asset values also can be an invitation for a hostile takeover to the extent that the current market price of a company's stock does not reflect the current value of assets. Overstated income results in more taxes being paid to the government than would otherwise be paid, and could lead to stockholders demanding a higher level of dividend than would otherwise be expected. Through the payment of taxes on inflated income and the payment of dividends out of inflated net income, both of which result in cash outflows, a company may find itself in a liquidity crisis. To the extent that companies are exposed to different rates of inflation, the understatement of assets and overstatement of income will differ across companies; this can distort comparisons across companies. For example, a company with older fixed assets will report a higher return on assets than a company with newer assets because income is more overstated and assets are more understated than for the comparison company. Because inflation rates tend to vary across countries, comparisons made by a parent company across its subsidiaries located in different countries can be distorted.
In what ways do International Financial Reporting Standards (IFRS) address the issue of accounting for changing prices (inflation)?
IAS 15, "Information Reflecting the Effects of Changing Prices," required supplementary disclosure of the following items reflecting the effects of changing prices:The standard only applied to enterprises "whose levels of revenues, profits, assets or employment are significant in the economic environment in which they operate," and allowed those enterprises to choose between making adjustments on a GPP or a CC basis. Because of a lack of international support for inflation accounting disclosures, in 1989, the IASC decided to make IAS 15 optional. However, the IASB encourages presentation of inflation-adjusted information as required by IAS 15. IAS 29, "Financial Reporting in Hyperinflationary Economies," was issued in 1989 and applies to the primary financial statements of any company that reports in a currency of a hyperinflationary economy. IAS 29 requires the use of GPP accounting following procedures outlined above in the answer to question 2.IAS 21, "The Effects of Changes in Foreign Exchange Rates," requires application of IAS 29 to restate the foreign operation's financial statements to a GPP basis. The GPP adjusted financial statements are then translated into the parent company's reporting currency using the current exchange rate. This approach is referred to as the restate/translate method.
Define control. When does control exist in accordance with IAS 27?
IAS 27 states that control exists when the investor owns more than 50 of the stock of another company. However, control also can exist for an investor owning less than 50% of the stock of another company when the investor has power:
What is a group? Compare and contrast the different concepts of a group.
IAS 27, "Consolidated Financial Statements and Accounting for Investments in Subsidiaries," defines a group as a parent and all its subsidiaries, and requires parents to present consolidated financial statements.
In accordance with IFRS 8, how does a company determine which operating segments to report separately?
IFRS 8 defines an operating segment as a component of a company that (a) engages in activities from which it earns revenues and incurs expenses, (b) is regularly reviewed by the chief operating decision maker to assess performance and make resource allocation decisions, and (c) for which discrete financial information available. An operating segment is a reportable segment if it meets any one of the following three significance tests:If total external revenue attributable to reportable segments constitutes less than 75% of the total consolidated revenue, additional segments should be reported even if they do not meet the 10% threshold. All segments that are neither separately reported nor combined should be included in the segment reporting disclosures as an unallocated reconciliation item or in an "all other" category.
What types of entity-wide disclosures are required by IFRS 8?
IFRS and U.S. GAAP require enterprise-wide disclosures related to: A. Products and services - if operating segments are not organized on these lines External revenues derived from each major product or service line must be disclosed when operating segments are based on something other than products/services or the company has only one operating segment and otherwise would not provide segment information. B. Major customers - which is any customer from which the enterprise generates 10% or more of its 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 (IFRS 8 - noncurrent 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 (noncurrent assets) are located. A quantitative threshold for determining materiality is not specified.
Which balance sheet accounts give rise to purchasing power gains, and which accounts give rise to purchasing power losses?
Monetary assets (cash and receivables) give rise to purchasing power losses and monetary liabilities (payables) give rise to purchasing power gains.
How does a company determine whether sales or non-current assets located in an individual foreign country are material?
Neither IFRS nor U.S. GAAP provides a quantitative threshold for determining the materiality of an individual foreign country. Companies are expected to apply the general concept that an item is material if its omission could change a user's decision about the enterprise as a whole.
What are the major differences in the clculation of income between the historical cost (HC) model and the general purchasing power (GPP) model of accounting?
Non-monetary assets and non-monetary liabilities are restated for changes in the general purchasing power of the monetary unit. Most non-monetary items are carried at historical cost. In these cases, the restated cost is determined by applying to the historical cost the change in general price index from the date of acquisition to the balance sheet date. Some non-monetary items are carried at revalued amounts, for example, property, plant and equipment revalued according to the allowed alternative treatment in IAS 16, "Property, Plant and Equipment." These items are restated from the date of the revaluation.All components of owners' equity are restated by applying the change in the general price index from the beginning of the period or the date of contribution, if later, to the balance sheet date. Monetary assets and monetary liabilities (cash, receivables, and payables) are not restated because they are already expressed in terms of the monetary unit current at the balance sheet date.All income statement items are restated by applying the change in the general price index from the dates when the items were originally recorded to the balance sheet date.The gain or loss on net monetary position (purchasing power gain or loss) is included in net income.
What are the major differences in the segment information required to be reported in accordance with IFRS and in accordance with U.S. GAAP?
Only three substantive differences exist in the segment reporting required by IFRS and U.S. GAAP: a. IFRS requires the disclosure of operating segment liabilities, and U.S. GAAP does not. b. For geographic areas, U.S. GAAP requires disclosure of "long-lived assets," which many companies interpret as fixed assets only. IFRS requires disclosure of "non-current assets," which specifically includes intangibles. c. Companies with a matrix form of organization may identify operating segments either by products and services or geographic areas under IFRS. U.S. GAAP requires segments to be defined on the basis of products and services in this situation.
To which specific type of business combination does the concept of a group relate?
The concept of a group relates to a business combination in which one company obtains control over another company but the acquired company continues its separate legal existence.
