FRA

Defined Contribution Plans - Financial statement reporting

*From a financial statement perspective, the employer's obligation for contributions into the plan, if any, is recorded as an expense on the income statement. Because the employer's obligation is limited to a defined amount that typically equals its contribution, no significant pension-related liability accrues on the balance sheet. An accrual (current liability) is recognized at the end of the reporting period only for any unpaid contributions.

US GAAP and Variable Interest Entity(VIE)

*The primary beneficiary is defined as the party that will absorb the majority of the VIE's expected losses, receive the majority of the VIE's expected residual returns, or both. US GAAP uses a two-component consolidation model that includes both a variable interest component and a voting interest (control) component. Under the variable interest component, US GAAP requires the primary beneficiary of a variable interest entity (VIE) to consolidate the VIE regardless of its voting interests (if any) in the VIE or its decision-making authority.

Post-employment health care plans assumptions: Holding all else equal, each of the following assumptions would result in a higher benefit obligation and a higher periodic cost:

- A higher assumed near-term increase in health care costs, - A higher assumed ultimate health care cost trend rate (aka future inflation rate), and - A later year in which the ultimate health care cost trend rate is assumed to be reached.

Held-to-Maturity

- positive intent and ability to hold to maturity - fixed or determinable payments and fixed maturities *Reclassifications and sales prior to maturity may call into question - IFRS: no permitted to classify financial asset as held-to-maturity if during the current or two preceding reporting years another held-to-maturity item was sold or reclassified (unless certain criteria is met) - sale or reclassification of this type of investment may be a reason for the company to not allow other financial assets be undertaken in the future to be labeled held-to-maturity.

Ammended IAS 28 (includes investment in associates and join ventures; became effect in 2013) What are some evidenced standards that note significant influence of a company?

- representation on the board of directors; - participation in the policy-making process; - material transactions between the investor and the investee; - interchange of managerial personnel; or - technological dependency.

Available-for-Sale

- under both IFRS & US GAAP, investments initially measured at FV - each subsequent reporting date, the investments are remeasured and recognized at FV - unrealized gain or loss at the end of the reporting period is the difference between FV and carrying amount at that date. Other comprehensive income (in shareholder's equity on B/S) is adjusted to reflect the cumulative unrealized gain/loss, and is net of taxes - when investments are sold, the cumulative gain/loss previously recognized in other comprehensive income and goes on I/S

2. Fair Value Through Profit or Loss: Designated at FV

- under both IFRS and US GAAP, designated at FV is treated the same as held-for-trading

Reading 16: Intercorporate Investments

....

For held-to-maturity (debt) investments and loans and receivables that have become impaired, the amount of the loss is measured as...

...the difference between the security's carrying value and the present value of its estimated future cash flows discounted at the security's original effective interest rate (the effective interest rate computed at initial recognition).

IFRS identify the following common characteristics of joint ventures (2):

1) A contractual arrangement exists between two or more venturers, and 2) the contractual arrangement establishes joint control *IFRS & US GAAP both require equity method of account for JV

IFRS has four basic classifications of investments in financial assets:

1) held-to-maturity 2) fair value through profit or loss (held for trading & "through profit & loss) 3) available-for-sale 4) loans and receivables *dividend and interest income from investments are reported in I/S *passive investments initially recognized at FV

Major changes made by phase one of IFRS 9 are:

1. A business model approach to classification of debt instruments. 1. Three classifications for financial assets: Fair value through profit or loss (FVPL), fair value through other comprehensive income (FVOCI), and amortized cost. 3. Reclassifications of debt instruments are permitted only when the business model changes. The choice to measure equity investments at FVOCI or FVPL is irrevocable.

Impact of Key Defined Benefit Pension Assumptions on Balance Sheet and Periodic Costs

1. Assumption: Higher discount rate a. Impact of Assumption on Balance Sheet = Lower obligation b. Impact of Assumption on Periodic Cost = Periodic pension costs will typically be lower because of lower opening obligation and lower service costs 2. Assumption: Higher rate of compensation increase a. Impact of Assumption on Balance Sheet = Higher obligation b. Impact of Assumption on period cost = Higher service costs 3. Assumption: Higher expected return on plan assets: a. Impact of Assumption on Balance Sheet = no effect, because Fair Value of plan assets is used on balance sheet b. Impact of Assumption on Periodic Cost = N/A for IFRS; US GAAP= Lower periodic pension expense ------------------------------ - Other post-employment benefits also requires assumptions and estimates, like health care costs ^For post-employment health plans, an increase in the assumed inflationary trends in health care costs or an increase in life expectancy will increase the obligation and associated periodic expense of these plans.

The acquisition method addresses three major accounting issues that often arise in business combinations and the preparation of consolidated (combined) financial statements:

1. The recognition and measurement of the assets and liabilities of the combined entity; 2. The initial recognition and subsequent accounting for goodwill; and 3. The recognition and measurement of any non-controlling interest.

FASB ASC Topic 810 [Consolidation] provides guidance for US GAAP, which classifies special purpose entities as variable interest entities if (2 criterion) :

1.total equity at risk is insufficient to finance activities without financial support from other parties, or 2.equity investors lack any one of the following: a.the ability to make decisions; b.the obligation to absorb losses; or c.the right to receive returns. Common examples of variable interests are entities created to: lease real estate or other property, entities created for the securitization of financial assets, or entities created for R&D activity. - If one entity will absorb a majority of the VIE's expected losses and another unrelated entity will receive a majority of the VIE's expected residual returns, the entity absorbing a majority of the losses must consolidate the VIE. If there are non-controlling interests in the VIE, these would also be shown in the consolidated balance sheet and consolidated income statement of the primary beneficiary.

Recognition and Measurement of Financial Assets and Liabilities

At the acquisition date, identifiable assets and liabilities acquired are classified in accordance with IASB (or US GAAP) standards. The acquirer reclassifies the financial assets and liabilities of the acquiree based on the contractual terms, economic conditions, and the acquirer's operating or accounting policies, as they exist at the acquisition date.

Defined Benefit Pension Plans - Financial statement reporting

Balance Sheet: - Both IFRS and US GAAP require a pension plan's funded status to be reported on the balance sheet - Funded status = Fair value of the plan assets - PV of the Defined benefit obligation a. Plan Deficit - occurs when pension obligation exceeds the pension plan assets - If the plan has a deficit, an amount equal to the net underfunded pension obligation is reported on the balance sheet as a net pension liability b. Plan Surplus - occurs when plan assets exceed the pension obligation - If the plan has a surplus, an asset equal to the overfunded pension obligation is reported on the balance sheet as a net pension asset **when a company has a surplus in a defined benefit plan, the amount of asset that can be reported is the LOWER of the surplus and the asset ceiling (the present value of future economic benefits, such as refunds from the plan or reductions of future contributions)

Fair Value Option

Both IFRS and US GAAP give the investor the option to account for their equity method investment at fair value *Under US GAAP, this option is available to all entities *However, under IFRS, its use is restricted to venture capital organizations, mutual funds, unit trusts, and similar entities, including investment-linked insurance funds.

Fair Value Option (Continued)

Both US GAAP & IFRS require that the election to use the fair value option occur at the time of initial recognition and is irrevocable. - Subsequent to initial recognition, the investment is reported at fair value with unrealized gains and losses arising from changes in fair value as well as any interest and dividends received included in the investor's profit or loss (income). - Under the fair value method, the investment account on the investor's balance sheet does not reflect the investor's proportionate share of the investee's profit or loss, dividends, or other distributions. In addition, the excess of cost over the fair value of the investee's identifiable net assets is not amortized, nor is goodwill created.

Business combinations (controlling interest investments) What are business combinations and what are they typically motivated by?

Business combinations involve the combination of two or more entities into a larger economic entity Business combinations are typically motivated by expectations of added value through synergies, including: 1. potential for increased revenues 2. elimination of duplicate costs 3. tax advantages 4. coordination of the production process 5. efficiency gains in the management of assets

IFRS 9: Classification and Measurement - Debt

Debt instruments are measured at amortized cost, fair value through other comprehensive income (FVOCI), or fair value through profit or loss (FVPL) depending upon the business model.

available-for-sale debt and equity securities: IFRS vs US GAAP

Debt: IFRS- FX gains and losses recognized in I/S, while other changes in the carrying amount are recognized in other comprehensive income (shareholders equity) US GAAP- FX gains/losses and other changes in fair value are all included in other comprehensive income ------------------------------------------------- Equity under both IFRS & US GAAP - no separate recognition of FX gain or loss (already included in stock)

IFRS 9: Classification and Measurement - Equity

Equity instruments are measured at FVPL or at FVOCI. Equity investments held-for-trading must be measured at FVPL. Other equity investments can be measured at FVPL or FVOCI; however, the choice is irrevocable. *Derivatives are measured at Fair Value through Profit or Loss (except for hedging instruments)

Joint Control= Joint Ventures Which method of accounting is used?

Equity method with consolidated financial statements

Recognition and Measurement of Identifiable Assets and Liabilities

I- FRS and US GAAP require that the acquirer measure the identifiable tangible and intangible assets and liabilities of the acquiree (acquired entity) at fair value as of the date of the acquisition. - The acquirer must also recognize any assets and liabilities that the acquiree had not previously recognized as assets and liabilities in its financial statements. For example, identifiable intangible assets (for example, brand names, patents, technology) that the acquiree developed internally would be recognized by the acquirer.

Actuarial gains/losses: IFRS vs US GAAP

IFRS - Remeasurement in OCI and not amortized ------------------------------- US GAAP - OCI, amortized with corridor approach

Additional Issues in Business Combinations That Impair Comparability (IFRS vs US GAAP): Contingent Consideration

IFRS - contingent assets are not recognized, only contingent liabilities US GAAP - recognized; recorded at FV

Prior service cost: IFRS vs US GAAP

IFRS - recognized as an expense in P&L ---------------------------- US GAAP- Reported in OCI; amortized to P&L

Recognition and Measurement of Goodwill

IFRS allows two options for recognizing goodwill at the transaction date. The goodwill option is on a transaction-by-transaction basis. 1. "Partial goodwill" is measured as the fair value of the acquisition (fair value of consideration given) less the acquirer's share of the fair value of all identifiable tangible and intangible assets, liabilities, and contingent liabilities acquired. 2. "Full goodwill" is measured as the fair value of the entity as a whole less the fair value of all identifiable tangible and intangible assets, liabilities, and contingent liabilities. ---------------------------------------------- US GAAP views the entity as a whole and requires full goodwill.24 Because goodwill is considered to have an indefinite life, it is not amortized. Instead, it is tested for impairment annually or more frequently if events or circumstances indicate that goodwill might be impaired.

IFRS & US GAAAP treatment of goodwill under equity method

IFRS and US GAAP both treat the difference between the cost of the acquisition and investor's share of the fair value of the net identifiable assets as goodwill. Therefore, any remaining difference between the acquisition cost and the fair value of net identifiable assets that cannot be allocated to specific assets is treated as goodwill and is not amortized. Instead, it is reviewed for impairment on a regular basis, and written down for any identified impairment.

Acquisition Method

IFRS and US GAAP currently require the acquisition method of accounting for business combinations, although both have a few specific exemptions. ------------------------------------- - Fair value of the consideration given by the acquiring company is the appropriate measurement for acquisitions and includes the acquisition-date fair value of contingent consideration. - Direct costs of the business combination, such as professional and legal fees, valuation experts, and consultants, are expensed as incurred.

Restructuring Costs

IFRS and US GAAP do not recognize restructuring costs that are associated with the business combination as part of the cost of the acquisition. Instead, they are recognized as an expense in the periods the restructuring costs are incurred.

In-Process R&D

IFRS and US GAAP recognize in-process research and development acquired in a business combination as a separate intangible asset and measure it at fair value (if it can be measured reliably). In subsequent periods, this research and development is subject to amortization if successfully completed (a marketable product results) or to impairment if no product results or if the product is not technically and/or financially viable.

Held-to-Maturity: IFRS vs. US GAAP How are they initially recognized

IFRS: initially recognized at FV US GAAP: initially recognized at initial price paid -initial FV usually equals initial price paid so treatment should be identical ------------------------------------------------- *at each reporting date, both IFRS & US GAAP require that held-to-maturity securities be reported at amortized cost, using the effective interest rate method, unless objective evidence of impairment exists *any difference--discount or premium-- between maturity (par) and FV existing at the time of purchase is amortized over the life of the security *Any interest payments received are adjusted for amortization and are reported as interest income on I/S

Defined contribution pension plans

Individual accounts to which an employee and typically the employer makes contributions, generally on a tax-advantaged basis. The amounts of contributions are defined at the outset, but the future value of the benefit is unknown. *The employee bears the investment risk of the plan assets.

Loans and Receivables

Loans and receivables are broadly defined as non-derivative financial assets with fixed or determinable payments IFRS: - carried at amortized cost unless designated as either FV through profit or loss or available-for-sale. - does NOT rely on a legal form US GAAP: -relies on a legal form for the classification of debt securities - measured at FV if classified as held-for-trading or held-for-sale (but it can also be classified as held-to-maturity)

Blue box question pg 18 related to reporting for debt security investment in held-to-maturity, held-for-trading, designated at FV, and available-for-sale

Must understand thoroughly!

Recognition and Measurement when Acquisition Price Is Less than Fair Value

Occasionally, a company faces adverse circumstances such that its market value drops below the fair value of its net assets. In an acquisition of such a company, where the purchase price is less than the fair value of the target's (acquiree's) net assets, the acquisition is considered to be a bargain acquisition. - IFRS and US GAAP require the difference between the fair value of the acquired net assets and the purchase price to be recognized immediately as a gain in profit or loss. Any contingent consideration must be measured and recognized at fair value at the time of the business combination. Any subsequent changes in value of the contingent consideration are recognized in profit or loss.

Recognition and Measurement of Indemnification Assets

On the acquisition date, the acquirer must recognize an indemnification asset if the seller (acquiree) contractually indemnifies the acquirer for the outcome of a contingency or an uncertainty related to all or part of a specific asset or liability of the acquiree. The seller may also indemnify the acquirer against losses above a specified amount on a liability arising from a particular contingency. For example, the seller guarantees that an acquired contingent liability will not exceed a specified amount. In this situation, the acquirer recognizes an indemnification asset at the same time it recognizes the indemnified liability, with both measured on the same basis. If the indemnification relates to an asset or a liability that is recognized at the acquisition date and measured at its acquisition date fair value, the acquirer will also recognize the indemnification asset at the acquisition date at its acquisition date fair value.

Recognition and Measurement of Contingent Liabilities

On the acquisition date, the acquirer must recognize any contingent liability assumed in the acquisition if: 1) it is a present obligation that arises from past events, 2) it can be measured reliably. Costs that the acquirer expects (but is not obliged) to incur, however, are not recognized as liabilities as of the acquisition date. Instead, the acquirer recognizes these costs in future periods as they are incurred. - For example, expected restructuring costs arising from exiting an acquiree's business will be recognized in the period in which they are incurred. There is a difference between IFRS and US GAAP in their inclusion of contingent liabilities: *IFRS include contingent liabilities if their fair values can be reliably measured * US GAAP includes only those contingent liabilities that are probable and can be reasonably estimated.

Rare circumstance that JV will be allowed to use proportionate consolidation under IFRS & US GAAP

On the venturer's financial statements, proportionate consolidation requires the venturer's share of the assets, liabilities, income, and expenses of the joint venture to be combined or shown on a line-by-line basis with similar items under its sole control.

Defined benefit pension plans

Plan in which the company promises to pay a certain annual amount (defined benefit) to the employee after retirement. The company bears the investment risk of the plan assets.

Other post-employment benefits (OPB)

Promises by the company to pay benefits in the future, such as life insurance premiums and all or part of health care insurance for its retirees. *Typically classified as DB plans with similar accounting treatment to Defined Benefit Plans **Unlike DB pension plans, however, companies may not be required by regulation to fund an OPB in advance to the same degree as DB pension plans. This is partly because governments, through some means, often insure DB pension plans but not OPB, partly because OPB may represent a much smaller financial liability, and partly because OPB are often easier to eliminate should the costs become burdensome

Consolidation

The distinctive feature of a consolidation is that a new legal entity is formed and none of the predecessor entities remain in existence. A new entity is created to take over the net assets of Company A and Company B. Company A and Company B cease to exist and Company C is the only entity that remains. Company A + Company B = Company C

Merger

The distinctive feature of a merger is that only one of the entities remains in existence. One hundred percent of the target is absorbed into the acquiring company. Company A may issue common stock, preferred stock, bonds, or pay cash to acquire the net assets. The net assets of Company B are transferred to Company A. Company B ceases to exist and Company A is the only entity that remains. Company A + Company B = Company A

Special Purpose or Variable Interest Entities

The distinctive feature of a special purpose (variable interest) entity is that control is not usually based on voting control, because equity investors do not have a sufficient amount at risk for the entity to finance its activities without additional subordinated financial support. Furthermore, the equity investors may lack a controlling financial interest. The sponsoring company usually creates a special purpose entity (SPE) for a narrowly defined purpose. IFRS require consolidation if the substance of the relationship indicates control by the sponsor.

Acquisition

The distinctive feature of an acquisition is the legal continuity of the entities. Each entity continues operations but is connected through a parent-subsidiary relationship. Each entity is an individual that maintains separate financial records, but the parent (the acquirer) provides consolidated financial statements in each reporting period. Unlike a merger or consolidation, the acquiring company does not need to acquire 100% of the target. In fact, in some cases, it may acquire less than 50% and still exert control. If the acquiring company acquires less than 100%, non-controlling (minority) shareholders' interests are reported on the consolidated financial statements. Company A + Company B = (Company A + Company B)

What happens if assumptions change in calculating pension obligation?

The estimates and assumptions about future salary increases, the discount rate, and the expected vesting can change. Of course, any changes in these estimates and assumptions will change the estimated pension obligation. * If the changes increase the obligation, the increase is referred to as an actuarial loss. If the changes decrease the obligation, the change is referred to as an actuarial gain.

Pension obligation

The present value of future benefits earned by employees for service provided to date. The obligation is called the: - IFRS: present value of the defined benefit obligation (PVDBO) under IFRS, and - US GAAP: the projected benefit obligation (PBO) under US GAAP

IFRS distinction among business combinations

There is no distinction among business combinations based on the resulting structure of the larger economic entity. For all business combinations, one of the parties to the business combination is identified as the acquirer.

Corridor Approach Example

To illustrate the corridor approach, assume that the beginning balance of the defined benefit obligation is $5,000,000, the beginning balance of fair value of plan assets is $4,850,000, and the beginning balance of unrecognized actuarial losses is $610,000. The expected average remaining working lives of the plan employees is 10 years. In this scenario, the corridor is $500,000, which is 10 percent of the defined benefit obligation (selected as the greater of the defined benefit obligation or the fair value of plan assets). Because the balance of unrecognized actuarial losses exceeds the $500,000 corridor, amortization is required. The amount of the amortization is $11,000, which is the excess of the unrecognized actuarial loss over the corridor divided by the expected average remaining working lives of the plan employees [($610,000 - $500,000) ÷ 10 years]. Actuarial gains or losses can also be amortized more quickly than under the corridor method; companies may use a faster recognition method, provided the company applies the method of amortization to both gains and losses consistently in all periods presented.

Total Periodic Pension Cost equals...

Total Periodic Pension Cost = contributions - (ending funded status-beginning funded status) *remember: funded status= plan status - PBO

How to determine a foreign currency transaction gain or loss

Transaction: Export sale Type of Exposure: asset (account receivable Strengthens: gain Weakens: loss --------------------- Transaction: Import purchase Type of Exposure: liability (account payable) Strengthens: loss Weakens: gain

Fair Value Option - Impairment under US GAAP

US GAAP takes a different approach. If the fair value of the investment declines below its carrying value AND the decline is determined to be permanent, US GAAP requires an impairment loss to be recognized on the income statement and the carrying value of the investment on the balance sheet is reduced to its fair value. Under Fair Value Option, both IFRS and US GAAP prohibit the reversal of impairment losses even if the fair value later increases.

Fair Value Through Profit or Loss

Under IFRS, securities classified as FV through profit or loss include securities: 1. held-for-trading 2. Designated at FV (those designated by management as carried at fair value)

The Projected Unit Credit Method is the IFRS approach to measuring the Defined Benefit Obligation

Under the projected unit credit method, each period of service (e.g., year of employment) gives rise to an additional unit of benefit to which the employee is entitled at retirement. In other words, for each period in which an employee provides service, they earn a portion of the post-employment benefits that the company has promised to pay. An equivalent way of thinking about this is that the amount of eventual benefit increases with each additional year of service. The employer measures each unit of service as it is earned to determine the amount of benefits it is obligated to pay in future reporting periods.

IFRS 9 - Financial Assets upon acquisiton

Upon acquisition, in accordance with IFRS 9, financial assets are subsequently measured at either amortized cost, or fair value, on the basis of both: a. the Company's business model for managing the financial assets; and b. the contractual cash flow characteristics of the financial asset. ------------------------------------ A financial asset shall be measured at amortized cost if both of the following conditions are met: a. the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows, and b. the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. *Additionally, for assets that meet the abovementioned conditions, IFRS provides for an option to designate, at inception, those assets as measured at fair value if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an 'accounting mismatch') that would otherwise arise from measuring assets or liabilities or recognizing the gains and losses on them on different bases

Blue Box Question on Upstream & Downstream transactions pg 32

Very important - this will be tested. Calculations should be automatic come gametime

Blue box question pg39 - Recognition and Measurement of Goodwill

easy but must understand difference between partial and full goodwill

Both IFRS and US GAAP require total periodic pension cost to be disclosed where in financial statements?

in the notes to the financial statements

Downstream transaction (between two affiliates)

investor to associate - In a downstream sale, the profit is recorded on the investor's income statement. Both IFRS and US GAAP require that the unearned profits be eliminated to the extent of the investor's interest in the associate. The result is an adjustment to equity income on the investor's income statement.

under the new standard, is the reclassification of debt instruments permitted?

it is only permitted if the business model for the financial assets (objective for holding the financial assets) has changed in a way that significantly affects operations -if the financial asset is reclassified from amortized cost to FVPL, the asset is measured at fair value with gain or loss recognized in profit or loss. -If the financial asset is reclassified from FVPL to amortized cost, the fair value at the reclassification date becomes the carrying amount.

Blue Box Question pg 40 - Impact of the Acquisition Method on Financial Statements, Post-Acquisition

make sure you understand, the section highlighted in yellow is important to remember how Stockholders' Equity is treated at acquisition date

Goodwill Impairment blue box questions under IFRS and US GAAP on pg 46-47

must learn!

Blue box question page 28 & 29!

must understand

Blue box question pg 43: Non-controlling Asset Valuation

must understand *Although net income to parent's shareholders is the same, the impact on ratios would be different because total assets and stockholders' equity would differ.

under the new standard, is the reclassification of equity permitted?

no, because the reclassification of equity instruments is not permitted because the initial classification of FVPL and FVOCI is irrevocable.

What happens when the cost of the investment exceeds the investor's proportionate share of the book value of the investee's (associate's) net identifiable tangible and intangible assets (e.g., inventory, property, plant and equipment, trademarks, patents)...?

the difference is first allocated to specific assets (or categories of assets) using fair values. These differences are then amortized to the investor's proportionate share of the investee's profit or loss over the economic lives of the assets whose fair values exceeded book values. - what appears initially in the investment account on the balance sheet of the investor is the cost. Over time, as the differences are amortized, the balance in the investment account will come closer to representing the ownership percentage of the book value of the net assets of the associate.

IMPAIRMENT OF FINANCIAL ASSETS: A financial asset or group of financial assets is impaired and impairment losses are incurred if:

◾there is objective evidence of impairment as a result of a loss event that occurred after the initial recognition of the asset and up to the balance sheet date ("a loss event"); ◾the loss event had an impact on the estimated future cash flows of the financial asset or the group of financial assets ◾a reliable estimate of the amount can be made. ------------------------------------------------- - when AFS debs security is impaired, any subsequent decrease in FV is recognized in I/S. The same goes for any increase until the asset is no longer considered impaired. - When the fair value of the AFS(available-for-sale) debt security recovers to at least amortized cost it is no longer considered impaired and subsequent changes in fair value are reported in other comprehensive income (oppose to profit and loss) - Reversals of impairment losses on equity investments classified as AFS are not reversed through the consolidated statement of income; increases in their fair value after impairment are recognized in other comprehensive income.

US GAAP determination of impairment and the calculation of the impairment loss.....

- For securities classified as available-for-sale or held-to-maturity, the investor is required to determine at each balance sheet date whether the decline in value is other than temporary. -------------------------------------------- - For debt securities classified as held-to-maturity, this means that the investor will be unable to collect all amounts due according to the contractual terms existing at acquisition. If the decline in fair value is deemed to be other than temporary, the cost basis of the security is written down to its fair value, which then becomes the new cost basis of the security. The amount of the write-down is treated as a realized loss and reported on the income statement. - For available-for-sale securities (both debt and equity), if the decline in fair value is other than temporary, the cost basis of the security is written down to its fair value. This value becomes the new cost basis, and the amount of the write-down is treated as a realized loss. However, the new cost basis cannot be increased for subsequent increases in fair value. Instead, subsequent increases in fair value (and decreases, if other than temporary) are treated as unrealized gains or losses and included in other comprehensive income. Example 1

Cash Flow Information

- If a sponsoring company's periodic contributions to a plan exceed the total pension costs of the period, the excess can be viewed from an economic perspective as a reduction of the pension obligation. - The contribution covers not only the pension obligation arising in the current period but also the pension obligations of another period. - Such a contribution would be similar in concept to making a principal payment on a loan in excess of the scheduled principal payment. *Example from blue box: Interpreting the excess contribution as similar to a repayment of borrowing (financing use of funds) rather than as an operating cash flow would increase the company's cash outflow from financing activities by ₤48 (this is after-tax for gross amount of $67 with effective tax rate of 28.7), from ₤1,741 to ₤1,789, and increase the cash inflow from operations by ₤48, from ₤6,161 to ₤6,209. -------------------------------------------------------- - Conversely, a periodic contribution that is less than the total pension cost of the period can be viewed as a source of financing.

Variable Interest and Special Purpose Entities

- SPEs can be a legitimate financing mechanism for a company to segregate certain activities and thereby reduce risk - Beneficial interest in an SPE may take the form of a debt instrument, an equity instrument, a participation right, or a residual interest in a lease. - To address the accounting issues arising from the misuse and abuse of SPEs (previously did not need to consolidate SPE in financial reporting), the IASB and the FASB have worked to improve the consolidation models to take into account financial arrangements where parties other than the holders of the majority of the voting interests exercise financial control over another entity. IFRS 10, Consolidated Financial Statements, revised the definition of control to encompass many special purpose entities. This standard is effective for annual periods beginning on or after 1 January 2013, with early application permitted. Special purpose entities involved in a structured financial transaction will require an evaluation of the purpose, design, and risks.

Additional Issues in Business Combinations That Impair Comparability (IFRS vs US GAAP): Contingent Assets and Liabilities

- Under IFRS, the cost of an acquisition is allocated to the fair value of assets, liabilities, and contingent liabilities. Contingent liabilities are recorded separately as part of the cost allocation process, provided that their fair values can be measured reliably. Subsequently, the contingent liability is measured at the higher of the amount initially recognized or the best estimate of the amount required to settle. Contingent assets are not recognized under IFRS. - Under US GAAP, contractual contingent assets and liabilities are recognized and recorded at their fair values at the time of acquisition. Non-contractual contingent assets and liabilities must also be recognized and recorded only if it is "more likely than not" they meet the definition of an asset or a liability at the acquisition date. Subsequently, a contingent liability is measured at the higher of the amount initially recognized or the best estimate of the amount of the loss. A contingent asset, however, is measured at the lower of the acquisition date fair value or the best estimate of the future settlement amount.

To estimate the future benefits of a pension obligation, the company must make a number of assumptions such as: - future compensation increases and levels - discount rates - expected vesting.

- an estimate of future compensation is made if the pension benefit formula is based on future compensation levels (examples include pay-related, final-pay, final-average-pay, or career-average-pay plans). - discount rate—the interest rate used to calculate the present value of the future benefits. This rate is based on current rates of return on high-quality corporate bonds (or government bonds in the absence of a deep market in corporate bonds) with currency and durations consistent with the currency and durations of the benefits. - Vesting" refers to a provision in pensions plans whereby an employee gains rights to future benefits only after meeting certain criteria, such as a pre-specified number of years of service

Business Combination with Less than 100% Acquisition

- both the acquirer and the target remain separate legal entities. - Both IFRS and US GAAP presume a company has control if it owns more than 50% of the voting shares of an entity. In this case, the acquiring company is viewed as the parent, and the target company is viewed as the subsidiary. -Both the parent and the subsidiary typically prepare their own financial records, but the parent also prepares consolidated financial statements at each reporting period. The consolidated financial statements are the primary source of information for investors and analysts.

1. Fair Value Through Profit or Loss: Held-for-Trading

- debt or equity acquired with the intent to sell them in the near term - at each reporting date, the held-for-trading investments are remeasured and recognized at FV with any unrealized gains/losses, interest received or dividends received in profit and loss

IFRS 9, Financial Instrument

- new standard that replaces IAS 39 (initially set to take effect on Jan 1 2013 but was extended to Jan 1 2018) - it appears there will be significant (but not total) convergence with IFRS - To be measured at amortized cost, financial assets must meet two criteria: 1. A business model test: The financial assets are being held to collect contractual cash flows; and 2. A cash flow characteristic test: The contractual cash flows are solely payments of principal and interest on principal. - the terms available-for-sale and held-to-maturity no longer appear in IFRS 9.

Impairment

A debt security is impaired if one or more events (loss events) occur that have a reliably estimated impact on its future cash flows *Losses expected as a result of future (anticipated) events, no matter how likely, are not recognized

Non-controlling (Minority) Interests: Balance Sheet

A non-controlling (minority) interest is the portion of the subsidiary's equity (residual interest) that is held by third parties (i.e., not owned by the parent). Non-controlling interests are created when the parent acquires less than a 100% controlling interest in a subsidiary. IFRS and US GAAP have similar treatment for how non-controlling interests are classified. Non-controlling interests in consolidated subsidiaries are presented on the consolidated balance sheet as a separate component of stockholders' equity. IFRS and US GAAP differ, however, on the measurement of non-controlling interests. * Under IFRS, the parent can measure the non-controlling interest at either its fair value (full goodwill method) or at the non-controlling interest's proportionate share of the acquiree's identifiable net assets (partial goodwill method). *Under US GAAP, the parent must use the full goodwill method and measure the non-controlling interest at fair value.

Examples of loss events causing impairment, and ones do not:

Cause impairment: ◾ The issuer experiences significant financial difficulty; ◾Default or delinquency in interest or principal payments; ◾The borrower encounters financial difficulty and receives a concession from the lender as a result; and ◾It becomes probable that the borrower will enter bankruptcy or other financial reorganization. --------------------------------------- Does NOT cause impairment: ◾ The disappearance of an active market because an entity's financial instruments are no longer publicly traded is not evidence of impairment. ◾ A downgrade of an entity's credit rating or a decline in fair value of a security below its cost or amortized cost is also not by itself evidence of impairment. However, it (do not cause impairment section) may be evidence of impairment when considered with other available information... For equity securities, objective evidence of a loss event includes: ◾Significant changes in the technological, market, economic, and/or legal environments that adversely affect the investee and indicate that the initial cost of the equity investment may not be recovered. ◾A significant or prolonged decline in the fair value of an equity investment below its cost.

Consolidation Process

Consolidated financial statements combine the separate financial statements for distinct legal entities, the parent and its subsidiaries, as if they were one economic unit. - Consolidation combines the assets, liabilities, revenues, and expenses of subsidiaries with the parent company. - Transactions between the parent and subsidiary (intercompany transactions) are eliminated to avoid double counting and premature income recognition. It is important for the analyst to consider the differences in IFRS and US GAAP, valuation bases, and other factors that could impair the validity of comparative analyses

The IASB issued IFRS 10 (replaces former statements), "Consolidated Financial Statement," which is the new standard that applies to SPE's when determined to have the underlying framework based on the new definition of "control." What is this definition based on?

Control is present when: 1) the investor has the ability to exert influence on the financial and operating policy of the entity; and 2) is exposed, or has rights, to variable returns from its involvement with the investee. *Consolidation criteria apply to all entities that meet the definition of control.

What is "current service cost?"

Current service cost is the increase in the present value of a defined benefit obligation as a result of employee service in the current period.

Periodic Pension Cost under IFRS

Under IFRS, the periodic pension cost is viewed as having three components, two of which are recognized in P&L and one of which is recognized in OCI. 1. Service costs - Under IFRS, service costs (including both current service costs and past service costs) are recognized as an expense in P&L. 2. Net interest expense/income - is calculated by multiplying the net pension liability or net pension asset by the discount rate used in determining the present value of the pension liability. A net interest expense represents the financing cost of deferring payments related to the plan, and a net interest income represents the financing income from prepaying amounts related to the plan. Under IFRS, the net interest expense/income is recognized in P&L. 3. Remeasurement - The third component of periodic pension cost is remeasurement of the net pension liability or asset. Remeasurement includes (a) actuarial gains and losses and (b) any differences between the actual return on plan assets and the amount included in the net interest expense/income calculation. Under IFRS, remeasurement amounts are recognized in OCI.

Fair Value Option - Impairment under IFRS

Under IFRS, there must be objective evidence of impairment as a result of one or more (loss) events that occurred after the initial recognition of the investment, and that loss event has an impact on the investment's future cash flows, which can be reliably estimated. Because goodwill is included in the carrying amount of the investment and is not separately recognized, it is not separately tested for impairment. Instead, the entire carrying amount of the investment is tested for impairment by comparing its recoverable amount with its carrying amount. The impairment loss is recognized on the income statement, and the carrying amount of the investment on the balance sheet is either reduced directly or through the use of an allowance account.

Under IFRS and US GAAP, what accounting method is used for business combination financial reporting?

Under both IFRS and US GAAP, business combinations are accounted for using the *acquisition method.*

Goodwill Impairment under IFRS

Under both IFRS and US GAAP, the impairment loss is recorded as a separate line item in the consolidated income statement. ----------------------- Under IFRS, at the time of acquisition, the total amount of goodwill recognized is allocated to each of the acquirer's cash-generating units that will benefit from the expected synergies resulting from the combination with the target. A cash-generating unit represents the lowest level within the combined entity at which goodwill is monitored for impairment purposes. -Goodwill impairment testing is then conducted under a one-step approach. The recoverable amount of a cash-generating unit is calculated and compared with the carrying value of the cash-generating unit. An impairment loss is recognized if the recoverable amount of the cash-generating unit is less than its carrying value. The impairment loss (the difference between these two amounts) is first applied to the goodwill that has been allocated to the cash-generating unit. Once this has been reduced to zero, the remaining amount of the loss is then allocated to all of the other non-cash assets in the unit on a pro rata basis.

Goodwill Impairment under US GAAP

Under both IFRS and US GAAP, the impairment loss is recorded as a separate line item in the consolidated income statement. -------------------------------- Under US GAAP, at the time of acquisition, the total amount of goodwill recognized is allocated to each of the acquirer's reporting units. A reporting unit is an operating segment or component of an operating segment that is one level below the operating segment as a whole. -Goodwill impairment testing is then conducted under a two-step approach: identification of impairment and then measurement of the loss. 1. First, the carrying amount of the reporting unit (including goodwill) is compared to its fair value. If the carrying value of the reporting unit exceeds its fair value, potential impairment has been identified. 2. The second step is then performed to measure the amount of the impairment loss. The amount of the impairment loss is the difference between the implied fair value of the reporting unit's goodwill and its carrying amount. The implied fair value of goodwill is determined in the same manner as in a business combination (it is the difference between the fair value of the reporting unit and the fair value of the reporting unit's assets and liabilities). The impairment loss is applied to the goodwill that has been allocated to the reporting unit. After the goodwill of the reporting unit has been eliminated, no other adjustments are made automatically to the carrying values of any of the reporting unit's other assets or liabilities. However, it may be prudent to test other asset values for recoverability and possible impairment.

Corridor Approach

Under the corridor approach, the net cumulative unrecognized actuarial gains and losses at the beginning of the reporting period are compared with the defined benefit obligation and the fair value of plan assets at the beginning of the period. If the cumulative amount of unrecognized actuarial gains and losses becomes too large (i.e., exceeds 10 percent of the greater of the defined benefit obligation or the fair value of plan assets), then the excess is amortized over the expected average remaining working lives of the employees participating in the plan and is included as a component of periodic pension cost in P&L. The term "corridor" refers to the 10 percent range, and only amounts in excess of the corridor must be amortized.

US GAAP distinction among business combinations

an acquirer is identified, but the business combinations are categorized as: 1. merger 2. acquisition, or 3. consolidation, ... ...based on the legal structure after the combination.

what is an "associate?"

an entity in which the Group has significant influence, but not a controlling interest, over the operating and financial management policy decisions of the entity. - Significant influence is generally presumed when the Group holds between 20% and 50% of the voting rights ***The existence of previously mentioned factors that evidence significant influence could require the application of the equity method of accounting for a particular investment even though the Group's investment is for less than 20% of the voting stock.

Upstream transaction (between two affiliates)

associate to investor - In an upstream sale, the profit on the intercompany transaction is recorded on the associate's income (profit or loss) statement. The investor's share of the unrealized profit is thus included in equity income on the investor's income statement.

Blue box questions pg 82-86: Calculation of Defined Benefit Pension Obligation for an Individual Employee

calculations must become automatic

Equity Method of Accounting: Basic Principles

the equity investment is initially recorded on the investor's balance sheet at cost. In subsequent periods, the carrying amount of the investment is adjusted to recognize the investor's proportionate share of the investee's earnings or losses, and these earnings or losses are reported in income. Dividends or other distributions received from the investee are treated as a return of capital and reduce the carrying amount of the investment and are not reported in the investor's profit or loss. - he equity method is often referred to as "one-line consolidation" because the investor's proportionate ownership interest in the assets and liabilities of the investee is disclosed as a single line item (net assets) on its balance sheet, and the investor's share of the revenues and expenses of the investee is disclosed as a single line item on its income statement. Equity method investments are classified as non-current assets on the balance sheet. *The investor's share of the profit or loss of equity method investments, and the carrying amount of those investments, must be separately disclosed on the income statement and balance sheet. *Investment is carried as a non-current asset on B/S as a single line item on acquisition date

Equity Method reporting for Join Venture

the equity method results in a single line item (equity in income of the joint venture) on the income statement and a single line item (investment in joint venture) on the balance sheet.

Transactions with Associates (deferred income)

the investor company's share of any unrealized profit must be deferred by reducing the amount recorded under the equity method. In the subsequent period(s) when this deferred profit is considered confirmed, it is added to the equity income. At that time, the equity income is again based on the recorded values in the associate's accounts.

Periodic Pension Cost under US GAAP

under US GAAP current service cost is recognized in P&L. *However, under US GAAP, past service costs are reported in OCI in the period in which the change giving rise to the cost occurs. In subsequent periods, these past service costs are amortized to P&L over the average service lives of the affected employees