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Analysis of Financial Statements & Other Reporting Issues

This week we will conclude with the following specific financial reporting topics:

  • Inflation – accounting for changing prices.
  • Business combinations and consolidated financials.
  • Segment reporting.

Historical cost accounting in a period of inflation understates asset values (and related expenses) and overstates income.  It ignores the gains and losses in purchasing power caused by inflation that arise from monetary assets and liabilities.

Methods of accounting for inflation are

  • general purchasing power (GPP) accounting, and 
  • current cost (CC) accounting. 

General Purchasing Power Accounting

  • Nonmonetary assets and stockholders’ equity accounts are restated for changes in the general price level. 
  • Cost of goods sold and depreciation/amortization are based on restated asset values and the net purchasing power gain/loss on the net monetary liability/asset position is included in income. 
  • Income is the amount that can be paid as a dividend while maintaining the purchasing power of capital.

 Current Cost Accounting 

  • Nonmonetary assets are revalued to current cost.
  • Cost of goods sold and depreciation/amortization are based on revalued amounts.   
  • Income is the amount that can be paid as a dividend while maintaining physical capital.

IAS 29 

IAS 29 Financial Reporting in Hyperinflationary Economies applies where an entity’s functional currency is that of a hyperinflationary economy. The standard does not prescribe when hyperinflation arises but requires the financial statements (and corresponding figures for previous periods) of an entity with a functional currency that is hyperinflationary to be restated for the changes in the general pricing power of the functional currency.

IAS 29 was issued in July 1989 and is operative for periods beginning on or after 1 January 1990.

IAS 21 The Effects of Changes in Foreign Exchange Rates outlines how to account for foreign currency transactions and operations in financial statements and how to translate financial statements into a presentation currency. An entity is required to determine a functional currency (for each of its operations if necessary) based on the primary economic environment in which it operates and generally records foreign currency transactions using the spot conversion rate to that functional currency on the date of the transaction.

IAS 21 was reissued in December 2003 and applies to annual periods beginning on or after 1 January 2005.

IAS 29 requires the use of GPP accounting by firms that report in the currency of a hyperinflationary economy. 

IAS 21 requires the financial statements of a foreign operation located in a hyperinflationary economy to first be adjusted for inflation in accordance with IAS 29 before translation into the parent company’s reporting currency.

IFRS 3 Business Combinations outlines the accounting when an acquirer obtains control of a business (e.g. an acquisition or merger). Such business combinations are accounted for using the ‘acquisition method’, which generally requires assets acquired and liabilities assumed to be measured at their fair values at the acquisition date.

A revised version of IFRS 3 was issued in January 2008 and applies to business combinations occurring in an entity’s first annual period beginning on or after 1 July 2009.

The core principle of IFRS 3 is that an acquirer of a business recognizes the assets acquired and liabilities assumed at their acquisition-date fair values and discloses information that enables users to evaluate the nature and financial effects of the acquisition.

The objective of IFRS 3 is to improve the relevance, reliability, and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. To accomplish this, IFRS 3 establishes principles and requirements for how the acquirer:

  • recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; 
  • recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and
  • determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.


Issues that must be resolved in accounting for a business combination:


  • Selection of an appropriate method

IFRS 3 and US GAAP both require the purchase method in accounting for business combinations; the pooling-of-interests method is not allowed.

  • Recognition and measurement of goodwill

Goodwill is recognized on the consolidated balance sheet as an asset and tested annually for impairment under both IFRS 3 and U.S. GAAP.

  • Measurement of minority interest.

When less than 100% of a company is acquired, IFRS 3 requires the acquired assets and liabilities to be recorded at full fair value and minority interest is initially measured at the minority shareholders’ percentage ownership in the fair value of the acquired company’s net assets.  This is known as the economic unit or entity concept.

     Note:         In addition to the economic unit or entity concept, U.S. GAAP also allows use of the parent company concept in which the acquired assets and liabilities are initially measured at book value plus the parent’s ownership percentage in the difference between fair value and book value.  Under this approach, minority interest is initially measured at the minority shareholders’ percentage ownership in the book value of the subsidiary’s net assets.  

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