Financial Reporting – Summary

Chapter 1 – Introduction
What is financial reporting?
- «Accounting is the essential language of business»
- Tool for companies to communicate their financial information with its
stakeholders
- Accountants are trained communicators

Why do we need financial reporting?

- Decision-making based on financial reports
o Investment decisions (yes or no)
o Monitor management performance
o Reward for good performance
- Helps allocate resource efficiently
o Who needs capital and who wants to invest?

Types of financial reporting

- Depending on purpose
o External reporting  for stakeholders
o Internal/management reporting  stays intern in the firm
o Tax reporting
- Depending on accounting practice
o Cash flow basis (outdated)  journal of spending (intake and outtake)
o Accrual basis  double entry journal
- Depending on the type of company
o Proprietorship  full liability
o Partnership  full liability
o Corporation
 Publicly traded  share-based system and limited liability (until 0
money left)
 Privately held  big enough for reporting duty

Financial reporting by public companies

- Provides financial information to external stakeholders
- Typically Done periodically
- Follows some reporting standards (IFRS, Swiss GAAP FER, US GAAP, bank
law, etc.)
- Includes documents like financial statements and notes, annual reports, press
releases, etc.

Regulatory framework in Switzerland

- Schweizer Obligationenrecht is the fundamental commercial law
- Companies that meet certain criteria (size or structure) must provide audited
consolidated financial statements
- Financial statements need to follow a standard
- Publically-traded firms in SIX Swiss Exchange
o Must follow IFRS, US GAAP if traded in main standard
 o May also follow Swiss GAAP FER if traded in domestic standard
(investors mainly in Switzerland)

Major accounting standards in Switzerland

- IFRS
o Issued since 1973
o Most used worldwide by large firms
- US GAAP
o Oldest standard 1930
o Most complex
- Swiss GAAP FER
o Mid 1980s
o Smaller Swiss firms
o Low implementation cost
- Co-existence of different accounting standards

Comparing the standards

- Which standard to follow depends on the needs (structure, region)
- Possible to follow multiple standards
- Switching is possible

Future trends
- Convergence due to similarities between accounting standards
- 75% of Swiss GAAP, IFRS and US GAAP is the same
- New standards are often jointly used or with significant reference to each other

Chapter 2 – The Accounting Cycle

Review of basics
- An account shows the effect of transactions
- Double-entry accounting system (two-sided effect)
o Recording done by debiting at least one account and crediting another
- Debits (Soll) must equal credits (Haben)

Five fundamental reporting elements (Debit/Credit)

- Assets  Aktiven (+/-)
- Liabilities  Fremdkapital (-/+)
- Shareholder’s equity  Eigenkapital (-/+)
- Revenues  Erträge (-/+)
- Expenses  Aufwand (+/-)
Assets and Expenses grow by debiting. Liabilities, equity and revenues grow by
crediting.

The accounting equation

Equation must be in balance after every transaction  for every debit there must be
a credit.
The accounting cycle

Transactions and events

- Every event that affects the business enterprise needs to be recorded
- External events
o Between a business and its environment
- Internal event
o Occurs entirely within a business

Example

Charter of accounts
1. Journalizing
- General journal: chronological record of transactions
- Journal entries: records in the journal

2. Posting
- Process of transferring amounts from journal to ledger accounts
Double check with accounting equation
3. Trial balance
- List of each account and its balance
- Used to prove equality of debit and credit balances

4. Adjusting entries (periodenfremde Buchung)

- Revenues recorded in the period in which they are earned
- Expenses recognized in the period in which they are incurred
- Needed to ensure that the recognition and matching principles are followed

Types of adjustment
- Prepayments (before used / earned)
o Prepaid expenses
 Expenses paid and recorded as assets before they are used or
consumed
o Unearned revenues
 Revenues received and recorded as liabilities before they are
earned
- Accruals (not yet received / paid)
o Accrued revenues
 Earned but not yet received or recorded
o Accrued expenses
 Expenses incurred but not yet paid or recorded

Example – adjusting unpaid expenses

150000CHF∗12%
Rod owes ZKB for monthly interest of =1500 CHF
12
Jan. 31 Interest expense 1500
Accrued interest expense 1500
Example – adjusting for depreciation
Rod’s factory building has a 10 year useable life, with salvage value of CHF 30’000. It
has depreciated by CHF 1’000.
( 150' 000−30' 000 ) CHF ' 12' 000 '
=12 000CHF → =1 000CHF
10 years 12 months

Jan. 31 Depreciation expense 1’000

Accumulated depreciation 1’000

Dividend declared and paid

Rod decides to withdraw CHF 2’000 as dividend for himself.
Jan. 31 Dividend 2’000
Cash 2’000

5. Adjusted Trial Balance

6. Preparing financial statements
Financial Statements are prepared directly from the Adjusted Trial Balance:
- Balance Sheet
- Income Statement
- Statement of Retained Earnings
- Statement of Cash Flows

Income Statement
- Usually first statement
- Shows Revenues and Expenses

Statement of Retained Earnings

- Needed for balance sheet
- Net income – dividends

Balance Sheet
- Give information about assets, liabilities and equity

7. Closing entries (Abschlussbuchungen)

 - Reduce the balance of the income statement (revenue and expense) accounts
to zero
- Transfer net income / loss to owner’s equity
- Balance sheet (asset, liability and equity) accounts are not closed
- Dividends are closed directly to the Retained Earnings account

Exercise – closing entries

Sales 75’000
Income summary 75’000

Income summary 32’500

Cost of goods sold 30’000
Interest expense 1’500
Depreciation expense 1’000

Income summary 42’500

Retained earnings 42’500

Retained earnings 2’000

Dividends declared 2’000

8. Post-closing trial balance

Statement of cash flows

Major financial statements
Publicly-listed firms must provide 5 major statements:
- Income statement
- Statement of comprehensive income
- Statement of changes in equity
- Statement of financial positions (Balance sheet)
- Statement of Cash flows

Statement of comprehensive income

- Consists of
o income
 shown in income statement
o and other comprehensive income (OCI)
 included in the shareholder’s equity section of the balance sheet
- in general companies follow the all-inclusive income concept
- some items (OCI) bypass the income statement and are taken directly to the
equity section of the balance sheet
- typically unrealized gains or losses in
o foreign currency translation
o future contracts
o pensions
o investments in debt and equity securities
Chapter 3 – Reporting of Shareholders’ Equity
Forms of business organization
- Proprietorship  sole ownership
- Partnership  few people joining ownership
- Corporation
o Modern form of business organization
o Newer concept
o Limited liability  separation private/company
- Special characteristics of the corporate form:
o Influence of corporate form
o Use of share system
o Variety of ownership interests

The share system

Each share carries following rights:
- Proportionately profits and losses per share
- Right to vote for directors
- Assets upon liquidation
- New issues of shares  preemptive right (Vorkaufsrecht)

Types of shares
Common stock (Ordinary shares)
- Basic ownership interest
- Ultimate risk of loss in case of bankruptcy
- Neither dividends nor assets upon dissolution is guaranteed
- Controls the management
- Profit most when company is successful

Preferred stock (Preference shares)

- Special contracts between company and stockholders
- Stockholder sacrifice some rights in return for other rights or privileges:
o No right to vote for management
o No right to share in profits beyond stated rate (more than agreed to)
o Gets prior claim on earnings (higher packing order)

Shareholders’ equity accounts

Issuance of shares
- Authorized shares: maximum number of shares that can be issued
- Issued shares: number of authorized shares that is sold to and held by
shareholders of a company
- Outstanding shares: shares of a company’s stock that have been issued,
excluding those repurchased by the company
- Treasury shares: shares that are bought back by the company

Par value stock

- Par value  fair value
- Par value is often very low
o Helps companies avoid contingent liability associated with stock sold
below par
- Two separate accounts
o Common stock and preffered stock:
 Reflect the par value of the issued shares
o Share premium for common stocks and preffered stocks
 Reflects any excess over par value paid in by stockholders when
company goes Initial Public Offering (IPO)
 Other name: Additional Paid-in Capital (APIC)

Example
Platte AG issued 300 shares of 10 CHF par value common stock for 4’500 CHF.

Cash 4’500
Common Stock 3’000 (par value) (300 sh x 10 CHF)
Share premium 1’500 (shareholders paid more to buy the shares)

Common stock and premium can also be added together and called “Share capital”.

Cash 4’500
Share capital 4’500

No-par value stock

- Avoid contingent liability
- Avoid the confusion over relationship between par value and fair value
- Exact amount received is credited to common stock or preferred stock
o No premium (APIC)
- Some countries require that no-par stock have a stated value

Example
Platte AG has 10’000 ordinary shares authorized without par value. 500 shares are
issued at 10 CHF per share in cash.

Cash 5’000
Share Capital – Ordinary 5’000

Platte issues another for 11 CHF per share

Cash 5’500
 Share Capital – Ordinary 5’500
Non cash transaction
- Sometimes stocks are issued for services, land, property, technology etc.
instead of cash
- Companies should records shares issued at
o Fair value of the goods or services received
o Fair value of shares issued, if fair value of goods or services cannot be
measured reliabily

Costs of issuing shares

- Direct costs should reduce the proceeds received from the sale of shares
o Underwriting costs
o Accounting and legal fees
o Printing costs
o Taxes

Treasury shares (share repurchase)

Corporation purchase their own outstanding shares to
- Provide tax-efficient distributions of excess cash to shareholders
- Increase earnings per share and return on equity
- Provide shares for employee compensation contracts or to meet potential
merger needs
- Thwart takeover attempts or to reduce the number of shareholders
- Make a market in the shares

Treasury share transactions

After repurchasing shares, companies can either
- Write them off, or
- Hold them in the treasury for reissue (Treasury Stock, contra-equity account)

Example
Rennweg AG had the following stockholders’ equity as of January 1, 2020

Common stock, 5 CHF par value, 20’000 shares issued and outstanding 100’000
Share premium in excess of par value (issue 20 CHF) 300’000
Retained earnings 320’000
Total stockholder’s equity 720’000

On Feb. 1, Rennweg purchased 2’000 shares of treasury stock at price of 19 CHF

per share  generally Cost method is used to account for treasury stocks

Treasury Stock (+) 38’000

Cash (-) 38’000 (19 CHF x 2’000)

Common stock, 5 CHF pv, 20’000 issued, 18’000 outstanding 100’000

Share premium 300’000
Retained earnings 320’000
- Cost of treasury stock (2’000 shares) (38’000)
Total stockholders’ equity 682’000
On Mar. 1, 800 shares of treasury stock repurchased by Rennweg were reissued at
20 CHF per share. The cost of purchase was 19 CHF, the reissuance price 20 CHF
per share.  Should Rennweg recognize a gain of 1 CHF per share?

Answer: NO!  never recognize gain or loss in any equity transaction. Treasury
stock is not an asset. Balance changes, but income doesn’t.

Cash (20 CHF x 800 shares) 16’000

Treasury stock (19 CHF x 800) 15’200
Share Premium – TS (1 CHF x 800) 800

Common stock, 5 CHF pv, 20’000 shares issued, 18’800 outstanding 100’000
Paid-in capital in excess of par – Common stock 300’000
Paid-in capital – Treasury Stock 800
Retained earnings 320’000
- Cost of treasury stock (1’200 shares) 22’800
Total stockholders’ equity 698’000

On Mar. 18, 500 shares of treasury stock repurchased by Rennweg were reissued at
18 CHF per share. Cost was 19 CHF per share.  should a loss of 1 CHF per share
be recognized

Answer: NO!  debit the excess of the cost over sellic price to Share Premium from
Treasury Stock

Cash (18 CHF x 500) 9’000

Share Premium – Treasury Stock 500
Treasury Stock (19 CHF x 500) 9’500

Common stock, 5 CHF pv, 20’000 issued, 19’300 outstanding 100’000

Share Premium in excess of par – Common stock 300’000
Share Premium – Treasury stock 300
Retained earnings 320’000
- Cost of treasury stock (700 shares) 13’300
Total stockholders’ equity 707’000

On Apr. 22, 600 shares of treasury stock repurchased by Rennweg were reissued at
16 CHF per share. The cost was 19 CHF per share.  3 CHF difference per share (3
CHF x 600 = 1’800 CHF)

1. Eliminate Share Premium – Treasury Stock

2. debit any additional excess of cost over selling price to Retained Earnings

Cash (16 CHF x 600) 9’600

Share Premium – Treasury Stock 300
Retained Earnings 1’500
Treasury Stock (19 CHF x 600) 11’400
Common stock, 5 CHF pv, 20’000 issued, 19’900 outstanding 100’000
Share Premium in excess of par – Common Stock 300’000
Share Premium – Treasury stock 0
Retained earnings 318’500
- Cost of treasury stock (100 shares) 1’900
Total stockholders’ equity 716’600

Preferred stocks
- Cumulative Preferred Stock
o Company must make up unpaid dividends from the past in a later year
before paying any dividends to common stockholders
o Passed dividend on cumulative preferred stock is called “dividend in
arrears”
o Dividend in arrears is not a liability
o Ofen used in practice
- Participating Preferred Stock
o Share ratably with the common stockholders in any profit distribution
beyond the prescribed rate
o May be only partially participating
o Seldom used in practice
- Convertible Preferred Stock
o Allows stockholders, at their option, to exchange preferred stocks for
common stocks at a predetermined rate
- Callable Preferred Stock
o Allows the company, at its option, to call or redeem the outstanding
preferred stocks at specified dates and at stipulated prices
o Before company redeems preferred stock, it must pay any dividends in
arrears first
- Redeemable Preferred Stock
o Has a mandatory redemption period or a redemption feature that the
issuer cannot control
o Classified as liabilities

Example
Fluntern Company consists of 2’000 shares of 100 CHF par valie, 6% preferred, and
5’000 shares of 50 CHF par value common
Common = 250’000
Preferred = 200’000 (6% = 12’000)
Company has retained earnings of 70’000 CHF which contains to be paid dividends
and unpaid preferred dividends from past 2 years.

(a) Preferred stock is noncumulative  passed dividends are lost forever

Preferred stockholders get: 2’000 shares x 100 CHF x 6% = 12’000 CHF
Common stockholder get: 70’000 CHF (retained earnings) – 12’000 = 58’000 CHF

(b) Preferred stock is cumulative  first pay dividends in arrears

Preferred stockholders get: Dividends in arrears (12’000 CHF x 2) + Current year
dividend (12’000) = 36’000 CHF
Common stockholders get: 70’000 CHF – 36’000 CHF = 34’000 CHF
Dividend policy
Dividend distributions are generally based on accumulated profits (retained earnings)
- Cash dividends
o Most common
- Property dividends
o Paid in other assets than cash
- Liquidating dividends
o Return of the shareholders’ investments
- Stock dividends
o Issuance of its own stock to its stockholders on a pro rata basis

Cash dividend
Three dates
- Date of declaration (recognize a current liability)
- Date of record (No journal entry)
- Date of payment (Settle the liability)
No dividends on treasury stock

Date of declaration:
Retained Earnings xxx
Dividend Payable xxx

Date of payment:
Dividend Payable xxx
Cash xxx

Chapter 4 – Reporting of Corporate Equity Investment

Intercorporate Equity Investments
Companies invest in other companies
- To earn a high rate of return
- To secure certain operating or financing arrangements with another company
Companies report these investments based on their intent with respect to the
investment.

Influence depending on investor’s power over the investee:

0% - 20%:
- Passive investment
- Fair value method

20% - 50%:
- Active investment
- Significant influence
- Equity method

50% - 100%:
- Active investment
- Control
- Consolidated financial statements
Fair value method
Used when:
- Investor holds a small percentage (<20%) of equity securities of investee
- Cannot significantly affect investee’s operations
- Investment is made in anticipation of dividends or market appreciation
- Investments are recorded at cost and subsequently adjusted to fair value, if
determinable, otherwise they remain at cost

Equity method
Used when:
- Investor has significant influence on investee operations
- Ownership between 20% and 50%
- Significant influence might be present with much lower ownership percentages
- Under equity method, investor’s share of investee dividends declared are
recorded as decreases in the investment account, not as income.

Consolidation of Financial Statements

Use when:
- Ownership exceeds 50%
- Control exists through legal or contractual agreement, even when ownership is
less than 50%
- Special purpose entities must also be consolidated
- One set of financial statements prepared to consolidate all accounts of the
parent company and all of its controlled subsidiaries as a single entity

Fair value method

Under IFRS, presumption is that equity investments less than 20% are held for
trading
- Investments valued at fair value
- Record unrealized gains and losses in net income

IFRS allows companies to classify some equity investments less than 20% as
non-trading.
- Investments valued at fair value
- Record unrealized gains and losses in other comprehensive income
Example – trading securities
On Nov. 3., Republic Corp. purchased ordinary shares of three companies, each
investment representing less than a 20% interest, for trading.

Equity Investments 718’550

Cash 718’550

On Dec. 6, Republic receives a cash dividend of 4’200€ on it’s investment in ordinary

shares of Nestlé.

Cash 4’200
Dividend Revenue 4’200

Unrealized Holding Gain or Loss – Income (Loss) 35’550

Fair Value Adjustments (Credit) 35’550

On Jan. 23, Rep sold all of its Burberry shares for 287’220€.

Cash 287’220
Equity investment – Burberry (Carrying value) 259’700
Gain on sale of investment (Fair value - CV) 27’520

On Feb 10, Rep purchased 255’000€ of Continental Trucking ordinary shares (20’000
shares 12.75€ per share), plus brokerage commissions of 1’850€. Rep’s equity
investment portfolio:

Fair Value Adjustment (now Debit) 101’650

Unrealized Holding Gain/Loss – Income 101’650
Example – non-trading securities
On Dec. 27, Rep receives cash dividend of 450€ on its investment in ordinary shares
of Hawthorne Company.

Cash 450
Dividend Revenue 450

At Dec. 31, investment in Hawthorne has following values:

Adjustments:
Fair value adjustment (Debit) 3’250
Unrealized Holding Gain/Loss – OCI 3250

Excerpts of financial statements:

On Dec. 20, Rep sold all its Hawthorne Company ordinary shares for 22’500€

Adjustment of carrying value:

Unrealized Holding Gain/Loss – Equity (Loss) 1’500
Fair Value Adjustment 1’500

Record of sale of investment

Cash 22’500
Equity Investments 20’750
Fair Value Adjustment 1’750
Equity Method
Sole criterion  significant influence
- Representation of investee’s Board of Directors
- Participation in policy-making process
- Intra-entity transactions
- Interchange of managerial personnel
- Technological dependency
- Other investee ownership percentages

Fair value method vs. equity method

Under fair value method:
- Cash dividends from investee reported as revenue
- Investor has no/little influence over distribution of investee’s net income

Under equity method:

- Investor reports as revenue its share of the investee’s net income
- With significant influence, investor can ensure that the investee will pay
dividends
- Dividend received from the investee reduce the carry amount of Investment
Account (“payment received” from the investee)

Example – equity method

Gross AG owns 20% interest in Klein AG purchased on Jan. 1 for 200’000CHF.
Klein then reports net income of CHF 200’000, CHF300’000 and CHF400’000 in the
next three years while declaring dividends of 50’000, 100’000 and 200’000.

Journal Entries:
Investment in Klein 40’000
Revenue from Klein Income 40’000
To accrue earnings of a 20% owned investee (200’000 x 20%= 40’000)

Dividend Receivable 10’000

Investment in Klein 10’000
To record a dividend declaration by Klein (50’000 x 20%= 10’000)

Cash 10’000
Dividend Receivable 10’000
To record collection of the cash dividend

*determined by outside market

Financial reporting effects of different types of accounting for investment
Choice of accounting method for investment matters. Measurements of financial
performance often affect the following:
- The firm’s ability to raise capital
- Managerial compensation
- Abylity to meet debt covenants and future interest rates
- Managers’ reputations
Chapter 5 – Consolidation at Acquisition Date
Consolidation is required when an investor hold more than 50% of a investee’s share.

Business Combinations
- Acquirer obtains control over other business
- Firmed by a wide variety of transactions or events
- Can differ widely in legal form
- Unites two or more enterprises into a single economic entity  require
consolidated financial statements

Reasons for firms to combine

- Vertical integration  buying up suppliers
- Cost savings
- Quick entry into new markets  buying a local firm
- Economies of scale  like cost savings but related to earnings
- More attractive financing opportunities
- Diversification of business risk  reduce leverage ratio
- Business expansion
- Increasingly competitive environment

Types of Business Combination

Statutory merger

- Acquired company merges into main company

- Ex. Nestlé buying local water firms

Statutory consolidation

- Both companies dissolve and merge into a new company

- Ex. UBS

Stock acquisition

- Both companies still operate independently, but A holds acquired company B

- Doesn’t have to be a 100% acquisition
- Ex. Lufthansa % Swiss

Control can also be achieved by other means than ownership

Why consolidate financial statements?
- More meaningful information than separate statements
- More fairly present the activities of the consolidated companies
- Consolidated companies may retain their legal identities as separate
corporations

What is to be consolidated?
For statutory merger and statutory consolidation
- Acquired company ceases to be
- All appropriate account balances are physically consolidated
- Consolidation done only once

For stock acquisition

- Acquirer and acquired both remain financially and operationally independent
- Only financial statement information is consolidated
- Consolidation done regularly

Goodwill vs. bargain purchase

- If considerations is more than the fair value of the assets acquired, the
difference is attributed to Goodwill (asset)
o Paid too much
- If the consideration is less than the fair value of the assets acquired, we got a
bargain and record a Gain (income) on the acquisition
o Paid less

Example
Zurich AG acquired all of Basel Company’s outstanding shares on Dec 31. Basel
becomes a wholly owned subsidiary of Zurich with separate legal and accounting
identity. Several accounts have fair values that differ from book values. Basel has
additionally internally developed assets that remain unrecorded on its books.
Acquisition prices derived:

Book Values Fair Values Adjustments

Computer software 20’000 70’000 +50’000
Equipment 40’000 30’000 -10’000
Client contracts 0 100’000 +100’000
In-process R&D 0 40’000 +40’000
Notes payable (60’000) (65’000) (5’000)
175’000

Book value of the two companies

Basel’s fair value

When the subsidiary is dissolved:

Consideration transferred equals net identified asset fair values – Zurich agrees to
pay 440’000 (fair value) in cash
1. Zurich pays Basel’s shareholders
2. Basel becomes part of Zurich AG and Basel’s shareholders leave with the
cash

Alternatively  Zurich acquires Basel by issuing 4’400 shares, 1 CHF par value, 100
CHF market price
1. Basel shareholders convert to Zurich AG shareholders and stay in the
company
2. Basel becomes part of Zurich AG
Preparation of journal entry for consolidation of accounts if dissolution takes place
Consideration transferred exceeds net identified asset fair values – Zurich pays
95’000 CHF in cash and issue 4’000 shares (1 CHF par value, 100 CHF market
price), totaling 495’000 CHF  there is goodwill.

Total consideration transferred 495’000

- Fair value of net identifiable assets 440’000
= Goodwill 55’000

When subsidiary is dissolved:

Consideration transferred is less than net identified asset fair values – Zurich agrees
to pay 400’000 CHF in cash  there is a gain from the bargain purchase
Fair value of net identifiable assets 440’000
- Total consideration transferred 400’000
= Gain (income) from bargain purchase 40’000

When subsidiary dissolved:

When subsidiary is not dissolved

- Separate incorporation maintained, no dissolution
- Consolidation process similar to previous example
- Fair value is basis
- Subsidiary is a legally incorporated separate entity
- Independent record-keeping for each company
- Consolidation of financial information is simulated
- Acquiring company does not physically record the transaction

Consolidation worksheet entries are entered on the worksheet only

Steps:
1. Parent prepares a formal allocation of the acquisition date fair value similar to
equity method procedures
2. Financial information for Parent and Sub is recorded in the first two columns of
the worksheet (Sub’s prior revenue and expenses already closed)
3. Remove Sub’s equity account balances
4. Remove Investment in Sub balance
5. Allocate Sub’s Fair Values, including excess of cost over Book Value or
goodwill
6. Combine all account balances and add to columns
7. Subtract consolidated expenses from revenues to arrive at net income
Example
Zurich acquires Basel and consideration transferred is 495’000 CHF in cash,
exceeding fair value of net identifiable assets

Prepare a workpaper for consolidation process:

Two types of consolidation entries:

- Journal entry S, to eliminate the Basel’s equity account
- Journal entry A, to eliminate Zurich’s excess investment in Basel’s

S: Elimination of the equity account:

Share capital 100’000
Share premium 25’000
Retained earnings 140’000
Investment in Basel 265’000

A: Fair value adjustment:

Computer software 50’000
In Process R&D 40’000
Client contracts 100’000
Goodwill 55’000
Equipment 10’000
Notes payable 5’000
Investment in Basel 230’000

Add to Consolidation workpaper:

Consolidated Balance Sheet:

Chapter 6 – Goodwill and Other Intangible Assets

Nature of assets
- Tangible (something you can touch)
o Fixed
 Land, buildings, equipment, etc.
o Current (turnover within business cycle (1 year))
 Cash, inventory, accounts, receivable, investments, etc.
- Intangible (not touchable)
o Identifiable (clear label) & separable
 Brand names, copyrights, patents, trademarks, etc.
o Unidentifiable & inseparable
 Goodwill (unclear label; is a filler)

Intangible assets
- Important accounting topic
- Went through many changes
- Many disagreements among different accounting regimes
- Goodwill remains major difference between accounting standards
- May see more changes in the future

Intangibles (other than goodwill) are assets that:

- Lack physical substance, non-monetary in nature (not financial assets)
- Arise from contractual or other legal rights
- Is capable of being sold or otherwise separated from acquired enterprise
- Financial reporting only shows acquired intangibles, rarely internally-
generated ones

Types of intangible assets:

- Marketing-related: trademarks, trade names, newspaper mastheads, internet
domain names, etc.
- Customer-related: customer lists, customer orders or contracts, customer
relationships
- Artistic-related: plays, operas, books, magazines, musical works, pictures,
videos, etc.
 - Contract-based: license, royalty, contracts, franchise, construction permits,
etc.
- Technology-based: patents, computer software, databases, etc.

Goodwill
- Intangible asset
- Unidentifiable and inseparable from other assets
- Never internally generated!!!
- Only arises during business combination
- Amount is the excess of consideration transferred over the sum of fair values
of all other identifiable assets
- Captures synergy, market power, etc.
Reporting of intangible assets
During regular business (before M&A):
- Internally-generated intangible are mostly expensed, rarely reported as assets

During M&A:
- Recorded and reported at fair market value
- If fair value is attributed to identifiable asset, record as the identified asset
o If not, record as goodwill

After M&A:
- Amortized and tested for impairment
- New intangibles will be expensed as incurred

Goodwill – IFRS:
- Allocated to cash-generating units (i.e. shop/store), lower than an operating
segment
- Goodwill subsequent to acquisition is required to be tested for impairment,
rather than to be amortized
- Reduced for any excess carrying value, down to zero, and then other assets
are reduced pro-rata
- Impairment cannot be reversed

Goodwill – US GAAP
- Allocated to reporting units expected to benefit from it
- Goodwill subsequent to acquisition is required to be tested for impairment,
rather than to be amortized
- If carrying amount is more than its implied value, an impairment loss is
recognized
- Impairment cannot be reversed

Goodwill – Swiss GAAP FER

- Can be accounted for as a periodical reduction of equity at date of acquisition,
or capitalized as an asset and then amortized after acquisition (5-20 years)
- Should be tested for impairment when there is an indication that it may be
impaired
- Reduced for any excess carrying value, down to zero, and then other assets
are reduced pro-rata
- Cannot be reversed

IFRS Goodwill Impairment one-step test

Carrying amount of cash generating unit (CGU) compared with recoverable amount
of CGU

Recoverable amount of CGU: The higher amount of

- Fair value less costs to sell
o Amount obtainable from sale of asset less cost of disposal  external
market value
- Or, Value in use
o Present value of future cash flows from use of the asset  internal
value for the entity
 1. Compute difference between CGU’s carrying value and recoverable value
2. First allocate all impairment to goodwill, then pro rata to other assets

Example
Ace Inc. has allocated goodwill of 1’000’000 to Segment Z under IFRS. Carrying
value including goodwill is 2’000’000.
Segment Z is tested for recoverability. Z’s fair value (net of cost to sell) is 1’500’000,
and its value in use (discounted future cash flow) is 1’400’000. Fair value of net
identifiable assets and liabilities of Z equals 900’000.

Goodwill impairment to record under IFRS:

- Recoverable amount = 1’500’000 (> 1’400’000)
- Carrying amount = 2’000’000
- Impairment: 2 Mio. – 1.5 Mio. = 500’000  Answer

Other intangibles
All identified intangible assets with limited lives should be amortized over their
economic useful life.
Factors that should be considered in determining the useful life of an intangible asset
include:
- Legal, regulatory, or contractual provisions
- The effects of obsolescence, demand, competition, industry stability, rate of
technological change, and expected changes in distribution channels

Intangible assets with indefinite lives (beyond foreseeable future) are tested for
impairment on an annual basis.
- IFRS and US GAAP do not allow amortization and both require regular test of
impairment.
- Swiss GAAP FER allows amortization over 5-20 years.

Chapter 7 – Subsequent Consolidation

After date of acquisition
What happens with financial reporting after acquisition of another firm:
- Both companies maintain their own separate financial records
- Parent company must account for its investment in the subsidiary for its
financial reporting
- Single set of consolidated financial statements for the combined business
entity is prepared regularly
- Passage of time creates complexities for internal record keeping

Investment accounting by parent company

- For each subsidiary there must be created an asset, investment account and
an income account to record the earnings on the investment
- Typically equity methods is used to internally account for its investment
- Same equity method as before, even when ownership exceeds 50%
Equity method for parent company
Parent will adjust its investment account for the subsidiary during the year, under
application of the equity method. Original investment, recorded of acquisition, is
adjusted for:
- Amortization of fair value adjustments (difference between book and market
value paid) made on acquisiton date
- Parent’s share of sub’s income (loss)
- Receipt of dividends from the sub (decrease of investment)

Example
Jan. 3, Alpstein Corporation acquired all outstanding voting stock of Säntis, Inc., in
exchange for 6’000’000 in cash. Alpstein elected to exercise control over Säntis as
wholly owned sub with an independent accounting system. Both companies have
Dec. 31 as fiscal year-ends. At acquisition date, Sänti’s stockholders’ equity was
2’500’000 including retained earnings of 1’700’000.
Purpose of acquisition was utilization of Säntis’s technology and computer software,
which have fair values differing from book values:

Asset Book Value Fair Value Adjustments Remaining

useful life
Patented 140’000 2’240’000 2’100’000 7 years
technology
Computer 60’000 1’260’000 1’200’000 12 years
software

Säntis’s remaining identifiable assets and liabilities had acquisition-date book values
that closely approximated fair values. No assets have been impaired yet. For the next
three years, Säntis reported following income and dividends:
Net income Dividends (100% to Alpstein)
2016 900’000 150’000
2017 940’000 150’000
2018 975’000 150’000

On Dec 31, financial statements appear. Parentheses indicate credit balances.

Dividends declared were paid in the same period.

Computation of goodwill amount and other fair value adjustments:

Säntis acquisition-date fair value 6’000’000

Säntis book value (2’500’000)
Fair value in excess of book value 3’500’000

Excess assigned to specific accounts based on fair value:

Computer software 1’200’000
Patented technology 2’100’000
Goodwill (overpayment) 200’000
Total 3’500’000
Annual amortization of fair value adjustment (IFRS Case):
Every year afterwards, Alpstein amortizes the fair value adjustment it made during
acquisition:

Remaining life Annual excess

amortization
Computer software 1’200’000 12 years 100’000
Patented 7 years
2’100’000 300’000
technology
Goodwill 200’000 Indefinite 0
Total 3’500’000 400’000

Alpstein deducts 400’000 from its income from investment in Säntis for 7 years, then
it deducts 100’000 for another 5 years, then nothing for the years to follow.

Alpstein’s income from investment in Säntis:

Determine Alpstein’s income from investment in Säntis for the year ended Dec 31.

Net income for 2018 975’000

Amortization - 400’000
575’000

Because Alpstein uses the equity method, its income from investment for 2018
reflects 975’000 equity accrual less 400’000 in excess amortization expense
computed above, totalling 575’000.

Alpstein’s investment in Säntis for the year ended Dec. 31 2018:

Fair value at Jan. 3, 2016 6’000’000

Alpstein’s equity in Säntis earnings (net of amortization):
2016 500’000
2017 540’000
2018 575’000
Post-acquisition earnings net of amortization 1’615’000
Säntis dividends since acquisition (3 x 150’000) (450’000)
Investment balance at Dec. 31, 2018 7’165’000

Next steps:
- Both finished their separate financial reporting, Alpstein is ready to prepare a
consolidated financial statement with Säntis as a sub
- Process is similar to consolidation on acquisition date
- Additional to journal entries S (eliminating subsidiary equity) and A (recording
fair value adjustment at acquisition date), there is:
o E – recording current year amortization of fair value adjustment
o I – eliminating equity income
o D – eliminating dividend issued by subsidiary
Income Statement:

Explanation:
- Depreciation: hard physical assets, i.e. equipment, land, etc.
- Amortization: intangible assets
- Depletion: natural resources go down

Consolidation worksheet:
S – Elimination of the equity account:
Common stock 800’000
Retained earnings (Jan. 1) 3’240’000
Investment in Säntis 4’040’000

A – Fair value adjustment (two years passed):

Computer software (1’200’000 – 2 * 100’000) 1’000’000
Patented technology (2’100’000 – 2 * 300’000) 1’500’000
Goodwill 200’000
Investment in Säntis 2’700’000

E – Amortization expense for fair value adjustment:

Amortization expense 400’000
Computer software 100’000
Patented technology 300’000

I – Eliminate equity earnings:

Equity earnings in Säntis 575’000
Investment in Säntis 575’000

D – Eliminate intra-company dividend:

Investment in Säntis 150’000
Dividend declared 150’000

What if Alpsein follow Swiss GAAP FER?

Two options for goodwill reporting:
1. Directly offset goodwill against equity at acquisition date
2. Recognize goodwill as an asset but amortize it over 5-20 years
Even if option 1 is chosen, it will still be needed to disclose the hypothetical goodwill
amortization in footnotes.
Option 1 – offset goodwill against equity
- Alpstein records 5’800’000 of investment in Säntis, and simultaneously reduce
its own equity by 200’000
- No goodwill recorded as asset, so there is no amortization of goodwill in the
future
- Amortization of other fair value adjustments is same as before

Option 2 – amortization of goodwill for 5 years

Full investment in Säntis including goodwill:
Remaining life Excess
amortization
Computer software 1’200’000 12 years 100’000
Patented 7 years
2’100’000 300’000
technology
Goodwill 200’000 5 years 40’000
Total 3’500’000 440’000

Alpstein deducts 440’000 from its income from investment in Säntis for 5 years, then
400’000 for another 2 years, then 100’000 for another 5 years, then nothing for years
to follow.

Alpstein’s income from investment in Säntis for the year ended Dec. 31. 2018 is:

Fair value at Jan. 3, 2016 6’000’000

Alpstein’s equity in Säntis earnings (net of amortization):
2016 460’000
2017 500’000
2018 535’000
Post-acquisition earnings net of amortization 1’495’000
Säntis dividends since acquisition (3 * 150’000) (450’000)
Investment balance at Dec. 31, 2018 7’045’000