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FINANCIAL ACCOUNTING RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY THEORY AND ANALYSIS: TEXT AND CASES 11 TH EDITION.

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Presentation on theme: "FINANCIAL ACCOUNTING RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY THEORY AND ANALYSIS: TEXT AND CASES 11 TH EDITION."— Presentation transcript:

1 FINANCIAL ACCOUNTING RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY THEORY AND ANALYSIS: TEXT AND CASES 11 TH EDITION

2 CHAPTER 10 LONG-TERM ASSETS II: INVESTMENTS AND INTANGIBLES

3 Introduction Reasons for making long-term investments in corporate securities – income, desirable relationships, control, new products Classification as long-term is based on the concept of managerial intent Intangibles

4 Investments in Equity Securities What are equity securities? Methods of accounting  Consolidation  The equity method  The cost method  The fair value method  The market value method

5 Consolidation The concept of control SFAS No. 94: Ownership of majority voting interest Discussed in more detail in Chapter 16

6 The Equity Method The concept of significant influence  The twenty percent guideline  Other methods of determining How to account for  Earnings  Dividends SFAS No. 115 (FASB ASC 320)  Allows fair value method for some investments - discussed later in the chapter

7 The Equity Method Circumstances which limit significant influence when holding a 20 percent investment  Opposition by the investee  Surrender of significant rights  Majority ownership by small group  Inability to obtain the financial information to apply the equity method  Failure to obtain representation on the Board of Directors

8 The Cost Method Lack of significant influence Investment carried at historical cost Dividends reported as revenue

9 The Lower Cost or Market Method SFAS No. 12 (since superseded): LCM  Current and long-term portfolios Conservatism Criticism  Did not result in consistent treatment

10 The Fair Value Method: SFAS No. 115 (FASB ASC 320) The concept of readily determinable fair value 1 Availability of information on current price in U. S. markets 2 Availability of information on current prices in a foreign market 3 Mutual fund information

11 The Fair Value Method Categories 1 Trading 2 Available-for-sale 3 Transfers between categories  Available-for-sale to trading  Trading to available-for-sale Rationale for the fair value method

12 Market Value Method When to use Accounting treatment  Dividends recognized as income  Unrealized gains and losses recognized in earnings

13 Recent Developments May 26, 2010: FASB issued proposed Accounting Standards Update  Classification to be determined at acquisition or issuance  Financial assets with variable cash flows to be accounted for at fair value  Changes in fair value of certain securities  Financial assets held for collection of cash Both amortized cost and fair value presented on balance sheet Some fair value changes to be recognized in net income Other FV changes to be recognized in other comprehensive income

14 Accounting for Investments in Equity Securities Percentage of ownership Accounting Method Fair Value Method (if fair value is readily determinable) Cost method (if fair value is not readily determinable) Market Value Method (for certain companies) 0 20 Equity Method 50 Consolidation 100

15 SFAS No. 159(FASB ASC 825) Deals with financial assets and liabilities  A financial asset is an asset that derives value because of a contractual claim. Examples include bank deposits, bonds, and stocks  A financial liability requires a debtor to make a payment, or payments, to a creditor in circumstances specified in a contract between them. For example, accounts payable, loans issued by an entity, and derivative financial liabilities.

16 SFAS No. 159 (FASB ASC 825) Most financial assets & liabilities may be measured at fair value. Measured using exit prices on balance sheet date. Fair value is price a company would receive to sell an asset or pay to transfer a liability. Unrealized holding gains and losses must be reported in earnings.

17 Investment in Debt Securities Trading Available-for-sale Held-to-maturity Trading and available-for-sale accounted for in a manner similar to equity securities - fair value

18 Held-to-Maturity Criteria Initial measurement Subsequent accounting Transfers  Trading  Available-for-sale Problem - Criteria permit earnings management

19 Permanent Decline in Value of Available-for-Sale and Held-to-Maturity Securities Write-down to fair value Loss included in earnings and a new cost basis is established No future recovery included in cost

20 Impairment of Investments in Unsecuritized Debt Impairment is based on the present value of expected future cash flows In subsequent periods, impairment is remeasured and may be accounted for by one of the following procedures 1 Increases attributable to passage of time are reported as interest income  Balance is recorded as an adjustment to bad debt expense 2 Entire amount is recorded as an adjustment to bad debt expense

21 Impairment of Investments in Unsecuritized Debt Critics have argued that impairment reflects a change in the character of the loan  Interest should reflect the fair value associated with risk Allows earnings management

22 Transfers of Financial Assets Financial assets: Debt and equity securities Accounting for financial assets was first outlined in SFAS No. 125  Recently replaced by SFAS No. 140.

23 Transfers of Financial Assets According to SFAS No. 140, the investor transfers or surrenders control over transferred assets if and only if all of the following 3 conditions are met: 1. The transferred assets have been isolated from the transferor 2. Each transferee has the right to pledge or exchange the assets it received  No condition both constrains the transferee from taking advantage of its right to pledge or exchange and provides more than a trivial benefit to the transferor.

24 Transfers of Financial Assets 3. The transferor does not maintain effective control over the transferred asset  By having an agreement that obligates it to repurchase or redeem the asset before maturity  Or by having an agreement that allows it to repurchase or redeem assets that are not readily obtainable.

25 Transfers of Financial Assets A transfer of financial assets  Accounted for as a sale  To the extent that consideration other than beneficial interests in the transferred asset is received in exchange. Liabilities and derivatives incurred in a transfer of financial assets  Initially measured at their fair market values. Servicing assets and liabilities  Measured by amortization over the period of servicing income or loss  Assessment for asset impairment or increased obligation based on their fair market values. Liabilities are derecognized  Only when repaid or when the debtor is legally relieved of the obligation.  In-substance defeasance is not permitted.

26 Intangibles Definition Classification by the APB  Identifiability  Manner of acquisition  Expected period of benefit  Separability ™ ©

27 Classifications Externally acquired Internally developed Identifiable Unidentifiable

28 Accounting Treatment Cost Subsequent amortization  Limited term of existence  No term of existence Factors to consider

29 Goodwill The concept  Theoretical value Accounting  How to record?  How to amortize?  The cases for and against immediate write-off

30 SFAS No. 142 (FASB ASC 350): Goodwill and Other Intangible Assets Changes accounting for goodwill  From an amortization period not to exceed 40 years  To an approach that requires, at a minimum, annual testing for impairment. The goodwill impairment test is to be performed at the reporting unit level.

31 SFAS No. 142: Goodwill and Other Intangible Assets Disclosure Requirements  Test for goodwill impairment is a two-step process that involves: 1. A comparison of the fair value of the reporting unit to its carrying value.  In the event fair value exceeds carrying value, no further testing is required.  If the carrying value of the reporting unit exceeds its fair value, step two is required. 2. A calculation of the implied fair value of goodwill by measuring the fair value of the net assets other than goodwill and subtracting this amount from the fair value of the reporting unit.

32 Research and Development Costs Definition  Research  Development Expense as incurred

33 International Accounting Standards The IASB has issued pronouncements on the following issues: 1.Accounting for investments in associates in a revised IAS No. 28, “Accounting for Investments in Associates.” 2.Accounting for financial assets in IAS No. 32, “Financial Instruments: Presentation.” 3.Accounting for intangibles in IAS No. 38, “Intangible Assets.” 4.The recognition and measurement of financial assets in a reissued IAS No. 39, “Financial Instruments: Recognition and Measurement.”

34 International Accounting Standards 5.Accounting for goodwill in SFRS No. 3, “Business Combinations,” which replaced IAS No The disclosure of information on financial instruments in IFRS No. 7, “Financial Instruments: Disclosures.” 7.Accounting for financial assets in IFRS No. 9, “Financial Instruments,” as a first step in its project to replace IAS No. 39.

35 IAS No. 28: Accounting for Investments in Associates Revised IAS No. 28  IASB did not change the fundamental accounting for accounting for associates in using the equity method.  Main objective for the revision was to reduce alternatives. Equity investments may be carried at  Cost  Revalued amounts  Or lower of cost or market If carried at revalued amount  Must frequently revalue and revalue on, at least an investment category basis

36 IAS No. 28: Accounting for Investments in Associates Revaluation increases  Recorded in stockholders’ equity, decreases in income unless they are recoveries Recognize non-temporary declines in value

37 IAS No. 32: Financial Instruments: Financial asset a) Cash b) Right to receive cash c) Right to exchange financial asset under favorable conditions or equity Disclosure and Presentation Must disclose how financial assets might affect the amount, timing and certainty of future cash flows, associated accounting policies and measurement bases. Must also disclose exposure to credit risk and fair value

38 IAS No. 38: Intangible Assets Applies to purchased and internally developed intangible assets. Recognize an intangible asset only if a) The asset is identifiable b) The future economic benefits specifically attributable to the asset will flow to the enterprise, and c) Cost is reliably measurable. Recognition criteria apply to both purchased and internally generated intangibles. ™ ™ ™ © © © ™ ©

39 IAS No. 38: Intangible Assets After initial recognition in the financial statements, an intangible asset should be measured under one of the following two treatments: 1. Benchmark treatment: historical cost less any amortization and impairment losses; or 2. Allowed alternative treatment: revalued amount (based on fair value) less any subsequent amortization and impairment losses. The main difference from the treatment for revaluations of property, plant and equipment under IAS 16:  Revaluations for intangible assets are permitted only if fair value can be determined by reference to an active market.  Active markets are expected to be rare for intangible assets ™ ™ © © ™ © $ $ $

40 IAS No. 38: Intangible Assets The statement requires intangible assets to be amortized over the best estimate of their useful life  Includes the presumption that the useful life of an intangible asset will not exceed 20 years from the date when the asset is available for use. In rare cases, where persuasive evidence suggests that the useful life of an intangible asset will exceed 20 years  Amortize the intangible asset over the best estimate of its useful life and: 1. Test the intangible asset for impairment at least annually in accordance with IAS 36, Impairment of Assets 2. Disclose the reasons why the presumption that the useful life of an intangible asset will not exceed 20 years is rebutted and also the factor(s) that played a significant role in determining the useful life of the asset. ™ ™ © © ™ © $ $ $

41 IAS No. 39 Financial Instruments: Recognition and Measurement Main objective of IASB in reissuing IAS No. 39:  To provide additional guidance on selected matters such as: When financial assets and financial liabilities may be measured at fair value How to assess impairment How to determine fair value Some aspects of hedge accounting. IAS No. 39 indicates that an entity should recognize a financial asset or its statement of financial position when, and only when, the entity becomes a party to the contractual provisions of the instrument.

42 IAS No. 39 Financial Instruments: Recognition and Measurement All financial assets are initially measured at cost:  Fair value of whatever was paid or received to acquire the financial asset. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s-length transaction. Subsequently, most financial assets and liabilities are to be measured at fair value, except for the following, which should be carried at amortized cost: 1. Loans and receivables originated by the enterprise and not held for trading 2. Other fixed maturity investments, such as debt securities and mandatorily redeemable preferred shares, that the enterprise intends, and is able, to hold to maturity 3. Financial assets whose fair value cannot be reliably measured (generally limited to some equity securities with no quoted market price and forwards and options on unquoted equity securities)

43 IAS No. 39 Financial Instruments: Recognition and Measurement Additionally, an entity is required to assess, at each balance sheet date, whether there is objective evidence of asset impairments.  Any impairment losses are measured as the difference between the asset’s carrying amount and the present value of estimated cash flows discounted at the financial asset’s original effective interest rate. If, in a subsequent period, the amount of the impairment loss relating to a financial asset carried at amortized cost or a debt instrument carried as available for sale decreases owing to an event occurring after the impairment was originally recognized, the previously recognized impairment loss is reversed; however, impairments relating to investments in available-for-sale equity instruments are not reversed.

44 IAS No. 39 Financial Instruments: Recognition and Measurement If an asset is to be derecognized, the entity must first determine whether the asset under consideration for derecognition is: 1. An asset in its entirety 2. Specifically identified cash flows from an asset 3. A fully proportionate share of the cash flows from an asset 4. A fully proportionate share of specifically identified cash flows from a financial asset

45 SFRS No 3: Business Combinations IASB indicated that goodwill  Should be recognized by the acquirer as an asset from the acquisition date  And be initially measured As the excess of the cost of the business combination over the acquirer's share of the net fair values of the acquiree's identifiable assets, liabilities and contingent liabilities. Prohibits the amortization of goodwill.  Goodwill must be tested for impairment at least annually in accordance with IAS No. 36, “Impairment of Assets.”

46 IFRS No. 7 Requires disclosures of risks arising from financial instruments Requires quantitative disclosures based on internal information

47 IFRS No. 9 November 12, 2009 First step to replace IAS No. 39 New requirements for classifying and measuring financial assets All financial assets initially measured at fair value plus, in some cases transaction costs All financial assets divided into  Those measured at amortized cost  Those measured at fair value

48 IFRS No. 9 Financial asset debt instrument that meets following 2 requirements is measured at amortized cost  Business model test  Cash flow characteristics test All other debt instruments measured at fair value through profit or loss (FVTPL)

49 IFRS No. 9 Equity assets that fall under scope of IFRS No. 9 measured at fair value. All derivatives are to be measured at fair value.

50 Copyright © 2014 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back- up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Prepared by Kathryn Yarbrough, MBA End of Chapter 10


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