Intermediate Accounting

common law

legal system that provides answers to specific cases rather than formulating specific rules about financial reporting

civil/code law

a more prescribed/structured legal system with rules on preparing financial statements

characteristics of common law countries

• strong equity markets

• many SHs in a company

• accounting rules differ from tax rules

characteristic of civil/code law countries

• weaker equity markets 

• few core/insider SHs

• tax dominating rules

link between legal system and equity markets

common law countries have stronger equity markets because there’s more legal protection for investors

link between ownership and published information

common law countries with widespread ownership need more published information, alternatively civil/code law countries with less ownership dispersion require less information

accounting regulation history

• countries used to have personal set of rules (GAAP)

• the International Accounting Standards Board (IASB) based in London began publishing the International Financial Reporting Standards which has been adopted by most countries (notably not the US who still uses US GAAP)

• IFRS used to be the International Accounting Standards (IAS) and some IAS rules are still used, defer to IFRS when they differ

• there are still differences in IFRS adoption between countries

benefits of a single-set of accounting rules

• transparency

• accountability

• efficiency

key difference between IFRS and US GAAP

IFRS→ principle-based

US GAAP→ rules-based

annual report

• a comprehensive document detailed company performance/activity over the past year through audited financial reports and narrative information

what’s included in narrative reporting in the annual report

highlights, director/chairman/CEO reviews, corporate governance reports, auditors reports

IAS 1

• details the complete set of financial statements:

  • SOFP→ doesn’t dictate structure but suggests a C/NC split and liquidity-reverse

  • SOCI or (I/S + OCI)

  • SOCE

  • C/S

  • notes

the statement of comprehensive income (SOCI)

a financial statement that includes both the I/S and other comprehensive income which refers to incomes that haven’t necessarily been realized

• structured either by costs by function for opex or by nature

the statement of changes in equity (SOCE)

a financial statement showing comprehensive income, the effect of changes in accounting policies and corrected errors, and capital transactions with owners

IAS 8

a criteria for selecting accounting policies and accounting for changes in policies, estimates, and errors to improve financial statements.

• Rules:

  • must apply IFRS standards

  • must be consistent

  • can only change policy if it improves reporting

  • estimates change prospectively

  • errors must be corrected by restating values

IAS 10

adjusting events must be included or explained in financial reports and companies must disclose any information that cast doubt on the company’s ability to continue as a going concern

adjusting event

an event after the reporting date that provides evidence of conditions existing at the end of the period, including events indicating the going concern assumption isn’t appropriate

non adjusting event

an event after the reporting period that’s indicative of a condition arising after the period 

IFRS 5

NCAs or disposals must be classified as held for sale if its carrying amount will be recovered principally through a sale transaction instead of continued use

function categories of the SOCI

1. CoS

2. distribution costs

3. admin expenses

structure of SOCE

• opening E (share cap/ret earnings)

• changes in E

• +total comprehensive income

• closing E

Note on PPE

before preparing the SOFP, you must prepare the note for movement on PPE showing costs, depreciation, and carrying amounts

IAS 36

requires that an asset's carrying amount in the financial statements cannot exceed its recoverable amount

when does asset impairment occur?

when carrying amount is greater than the recoverable amount 

recoverable amount

the higher of an asset's net selling price and its value in use

impairment

the permenant reduction of an asset’s value

value in use (VIU)

the expected future CFs that the asset, in its current condition, will generate discounted to PV

impairment loss

the amount that the carrying exceeds the recoverable

external impairment indicators

• lower market value

• change in tech/econ/legal environment

• higher int rates

internal impairment indicators

• damage

• discontinuation plans for where the asset is used

• business reorganization

how does IAS 36 relate to prudence/conservatism

because its overstating the asset’s value to continue carrying it at its NBV is its larger than the amount that would be gained from sale or continued use 

how often must impairment be tested?

review if the expected net selling price is lower than the carrying amount

• goodwill and intangible assets w indefinite useful lives must be reviewed for their recoverable amounts yearly

how to include impairment loss on financial statements

• revised carrying amount on SOFP

• Dr. impairment loss (expense) on I/S

• Cr. asset value in SOFP

when is impairment reversal possible?

if internal/external conditions indicate the recoverable amount has been recovered

how to include impairment reversal on financial statements

record reversal as income on I/S

how to record goodwill impairment reversal

cannot reverse goodwill impairment

cash-generating unit (CGU)

the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets/groups of assets

why must a CGU be the smallest group?

to prevent firms from purposefully disguising poorly performing units by grouping them with better performing ones

why are CGUs used in asset impairment?

because it’s not always possible to find an asset’s recoverable amount if they don’t generate independent CFs

how to allocate impairment loss among a CGU?

• reduce goodwill first

• spread the remaining loss across the other CGU assets proportionally (based on carrying values)

• dont reduce an individual asset below the higher of:

  • net selling price

  • VIU

  • zero

IAS 16

sets out the accounting and disclosure rules for property, plant, and equipment (PPE). It requires companies to initially record PPE at cost and then depreciate it over its useful life. The standard also permits companies to revalue assets to fair value, provided this is done consistently for an entire class of assets

PPE

tangible assets that are held by an entity for use in production or supply of goods/services, for rental to others, or for admin purposes AND that are expected to be used in more than 1 accounting period (>12 months)

carrying amount/NBV

value of an asset on the SOFP

initial carrying amount

the asset’s cost

subsequent carrying amount

the amount that an asset is recognized after deducting any accumulated depreciation and accumulated impairment losses

capitalizing

recording an expense as an asset

directly expensing

recognizing the full cost of an item on the I/S in the current period

when to capitalize or directly expense a cost?

• capitalize when the fixed/intangible asset is expected to provide long term (>1yr) benefits

• directly expense when the item is expected to provide short-term benefits (<1yr)

PPE at cost formula

purchase price + import duties - trade discounts + any directly attributable costs

types of subsequent PPE measurement models

1. cost model

2. revaluation model

cost model of PPE subsequent measurement

cost - accum dep - impairment loss

revaluation model of PPE subsequent measurement

• an alternative approach for subsequent measurement to the cost model

• banned by US GAAP

• revalued amount = fair value (market value) - subsequent accum dep or impairment loss

accounting procedure for a higher carrying amount from the revaluation model

• debit PPE item

• credit “revaluation surplus” reserve under equity (OCI in SoCI)

• this doesn’t directly affect the I/S to prevent overstating 

accounting procedure for a lower carrying amount from the revaluation model

• credit PPE item

• debit expense

accounting treatment: revaluation increase reversing a prior revaluation decrease already recognzied as an expense

revaluation increase recognized as income on the I/S

accounting treatment: asset already had a revaluation surplus

any following revaluation decreases are charged against the revaluation surplus until it’s 0

procedure for depreciating a revalued PPE item

revised depreciable amount = new value - residual value

• subsequent dep based off this revised amount until the end of the useful life

• higher dep for an upwards revaluation

IAS 40

perscribes the treatment for investment property as well as its definition

investment property

property held to earn rentals or capital appreciation or both, rather than holding for sale, production, admin, business activities

items that don’t count as investment property

• property held for use in production of goods/services

• property held for sale

• property occupied by owner

2 options for the measurement of investment property after initial measurment 

• all investment property must be measured the same way

  • 1. measure at fair value at end of period

    • more profit volatility, no dep

  • 2. measured at cost

    • depreciated as you go

    • disclose fair value in notes

when can assets be classified as held for sale

when they are available for immediate sale in their current state and when sale is very probable (management commitment, ready buyer, expected within the year)

treatment of held for sale NCAs (IFRS 5)

not depreciated, measured at lower of carrying and fair value less selling costs, presented separately on SOFP (“NCAs classified as held for sale”)

5 types of financial ratios

1. profitability

2. efficiency

3. liquidity

4. gearing

5. investment

two uses for financial ratios

• internal benchmarking: past periods, time-series

• external benchmarking: other firms, cross-sectional

6 profitability ratios

1. GPM

2. OPM

3. NPM

4. ROCE

5. ROE

6. ROA

3 efficiency ratios

1. inventory days (turnover)

2. TR days (turnover)

3. TP days (turnover)

2 liquidity ratios

1. current ratio

2. acid-test (quick) ratio

2 gearing ratios

1. gearing ratio (d/e)

2. interest cover ratio

4 investment ratios

1. dividend payout ratio

2. dividend yield ratio

3. earnings per share (EPS)

4. p/e ratio

ratio analysis limits

• no agreement

• historical info

• inflation

• accounting policies

• up for interpretation