Presentation on theme: "RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY"— Presentation transcript:
1 RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY FINANCIAL ACCOUNTINGTHEORY AND ANALYSIS: TEXT AND CASES11TH EDITIONRICHARD G. SCHROEDERMYRTLE W. CLARKJACK M. CATHEY4
2 LONG-TERM ASSETS II: INVESTMENTS AND INTANGIBLES CHAPTER 10LONG-TERM ASSETS II:INVESTMENTS AND INTANGIBLES
3 IntroductionReasons for making long-term investments in corporate securities – income, desirable relationships, control, new productsClassification as long-term is based on the concept of managerial intentIntangibles
4 Investments in Equity Securities What are equity securities?Methods of accountingConsolidationThe equity methodThe cost methodThe fair value methodThe market value method
5 Consolidation The concept of control SFAS No. 94: Ownership of majority voting interestDiscussed in more detail in Chapter 16
6 The Equity Method The concept of significant influence The twenty percent guidelineOther methods of determiningHow to account forEarningsDividendsSFAS No. 115 (FASB ASC 320)Allows fair value method for some investments - discussed later in the chapter
7 The Equity MethodCircumstances which limit significant influence when holding a 20 percent investmentOpposition by the investeeSurrender of significant rightsMajority ownership by small groupInability to obtain the financial information to apply the equity methodFailure to obtain representation on the Board of Directors
8 The Cost Method Lack of significant influence Investment carried at historical costDividends reported as revenue
9 The Lower Cost or Market Method SFAS No. 12 (since superseded): LCMCurrent and long-term portfoliosConservatismCriticismDid not result in consistent treatment
10 The Fair Value Method: SFAS No. 115 (FASB ASC 320) The concept of readily determinable fair valueAvailability of information on current price in U. S. marketsAvailability of information on current prices in a foreign marketMutual fund information
11 The Fair Value Method Categories Rationale for the fair value method TradingAvailable-for-saleTransfers between categoriesAvailable-for-sale to tradingTrading to available-for-saleRationale for the fair value method
12 Market Value Method When to use Accounting treatment Dividends recognized as incomeUnrealized gains and losses recognized in earnings
13 Recent DevelopmentsMay 26, 2010: FASB issued proposed Accounting Standards UpdateClassification to be determined at acquisition or issuanceFinancial assets with variable cash flows to be accounted for at fair valueChanges in fair value of certain securitiesFinancial assets held for collection of cashBoth amortized cost and fair value presented on balance sheetSome fair value changes to be recognized in net incomeOther FV changes to be recognized in other comprehensive income
14 Accounting for Investments in Equity Securities Percentage ofownership2050100AccountingMethodEquity MethodFair ValueMethod (if fairvalue is readilydeterminable)ConsolidationCost method (iffair value is notreadilydeterminable)Market ValueMethod (for certaincompanies)
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 stocksA 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 TradingAvailable-for-saleHeld-to-maturityTrading and available-for-sale accounted for in a manner similar to equity securities - fair value
19 Permanent Decline in Value of Available-for-Sale and Held-to-Maturity Securities Write-down to fair valueLoss included in earnings and a new cost basis is establishedNo future recovery included in cost
20 Impairment of Investments in Unsecuritized Debt Impairment is based on the present value of expected future cash flowsIn subsequent periods, impairment is remeasured and may be accounted for by one of the following proceduresIncreases attributable to passage of time are reported as interest incomeBalance is recorded as an adjustment to bad debt expenseEntire 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 loanInterest should reflect the fair value associated with riskAllows earnings management
22 Transfers of Financial Assets Debt and equity securitiesAccounting for financial assets was first outlined in SFAS No. 125Recently 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:The transferred assets have been isolated from the transferorEach transferee has the right to pledge or exchange the assets it receivedNo 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 The transferor does not maintain effective control over the transferred assetBy having an agreement that obligates it to repurchase or redeem the asset before maturityOr 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 assetsAccounted for as a saleTo 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 assetsInitially measured at their fair market values.Servicing assets and liabilitiesMeasured by amortization over the period of servicing income or lossAssessment for asset impairment or increased obligation based on their fair market values.Liabilities are derecognizedOnly when repaid or when the debtor is legally relieved of the obligation.In-substance defeasance is not permitted.
27 Classifications VS VS Externally acquired Internally developed IdentifiableUnidentifiable
28 Accounting Treatment Cost Subsequent amortization Factors to consider Limited term of existenceNo term of existenceFactors to consider
29 Goodwill The concept Accounting Theoretical value 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 goodwillFrom an amortization period not to exceed 40 yearsTo 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 RequirementsTest for goodwill impairment is a two-step process that involves: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.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 DefinitionResearchDevelopmentExpense as incurred
33 International Accounting Standards The IASB has issued pronouncements on the following issues:Accounting for investments in associates in a revised IAS No. 28, “Accounting for Investments in Associates.”Accounting for financial assets in IAS No. 32, “Financial Instruments: Presentation.”Accounting for intangibles in IAS No. 38, “Intangible Assets.”The recognition and measurement of financial assets in a reissued IAS No. 39, “Financial Instruments: Recognition and Measurement.”
34 International Accounting Standards Accounting for goodwill in SFRS No. 3, “Business Combinations,” which replaced IAS No. 22.The disclosure of information on financial instruments in IFRS No. 7, “Financial Instruments: Disclosures.”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. 28IASB 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 atCostRevalued amountsOr lower of cost or marketIf carried at revalued amountMust frequently revalue and revalue on, at least an investment category basis
36 IAS No. 28: Accounting for Investments in Associates Revaluation increasesRecorded in stockholders’ equity, decreases in income unless they are recoveriesRecognize non-temporary declines in value
37 IAS No. 32: Financial Instruments: Disclosure and PresentationFinancial assetCashRight to receive cashRight to exchange financial asset under favorable conditions or equityMust 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 ifThe asset is identifiableThe future economic benefits specifically attributable to the asset will flow to the enterprise, andCost 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:Benchmark treatment: historical cost less any amortization and impairment losses; orAllowed 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 lifeIncludes 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 yearsAmortize the intangible asset over the best estimate of its useful life and:Test the intangible asset for impairment at least annually in accordance with IAS 36, Impairment of AssetsDisclose 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 valueHow to assess impairmentHow to determine fair valueSome 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:Loans and receivables originated by the enterprise and not held for tradingOther fixed maturity investments, such as debt securities and mandatorily redeemable preferred shares, that the enterprise intends, and is able, to hold to maturityFinancial 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:An asset in its entiretySpecifically identified cash flows from an assetA fully proportionate share of the cash flows from an assetA fully proportionate share of specifically identified cash flows from a financial asset
45 SFRS No 3: Business Combinations IASB indicated that goodwillShould be recognized by the acquirer as an asset from the acquisition dateAnd be initially measuredAs 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. 7Requires disclosures of risks arising from financial instrumentsRequires 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 assetsAll financial assets initially measured at fair value plus, in some cases transaction costsAll financial assets divided intoThose measured at amortized costThose measured at fair value
48 IFRS No. 9Financial asset debt instrument that meets following 2 requirements is measured at amortized costBusiness model testCash flow characteristics testAll other debt instruments measured at fair value through profit or loss (FVTPL)
49 IFRS No. 9Equity assets that fall under scope of IFRS No. 9 measured at fair value.All derivatives are to be measured at fair value.