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Advanced Financial Accounting (AFA) Summary
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Includes a summary of both the chapters of picker et al. and the lecture notes from lectures 1-10
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Advanced Financial Accountnn 2018(Summary)
Applying IFRS standards (4th edition)
Picker et al.
Subject materr
- Chaptersr 14,20,21,23,24,6,7,16
- Certain paranraphs are not relevant (will be indicated)
Gradinnr
30% (nroup assinnment + analysis)
70% (exam)
100%
Lecture 1: Introduction & Setng the scene
Value relevance
The value relevance of accountnn informaton has increased over the last 40 years. This is atributed to the
increasinn amount of intangible assets. Intannible assets will nive limited assurance and so far there are hardly any
standards for accountnn or reportnn intannible assets.
Earninns Relevance may be important because of the increased use of unrecognized intangible assets, alternatie
real-tie sources of fnancial inforiaton (e.n. not just the fnancial statement, but also websites and social media),
nrowinn iiportance of non-fnancial inforiaton. This is refected in the channinn role of annual reports. The
annual report may be of informatonal value to multple stakeholders (instead of only investors), may be published
real-tme (as opposed to quarterlyaannually), may focus more on comprehensive performance will be more dinital
(like a website).
Non-fnancial informaton
Companies create value throunh their (business-)actvites, their increasinn relatonships (with stakeholders) and
interactons. This means some type of novernance (andaor stewardship) is required, which has led to the increasinn
importance of non-fnancial informaton (think of sustainability, diversity, payinn taxes, beinn responsible).This
increasinn demand for non-fnancial informaton has lead to the increase of requirements for non-fnancial
informaton in fnancial statements or annual report (check-box mentality). Which means the annual report is a
‘convenient’ dump of disclosures by ornanizatons. These disclosures are mostly not intenrated and have mostly an
unclear link with strateny, value chain or performance.
This ‘polluton’ of informaton lead to the Global Reportng Initatve. The GRI has three universal standards that is
applied to all ornanizatons and 33 topic-specifc standards (divided inr Economic, Environmental and Social).
Companies only use the relevant standards based on their material topics.
[Read examples of assurance reports and DSMaPhilips]
The Internatonal Integraten Reportng Council (IIRC) is similar to the IASB that they both have a framework.
However the IIRC covers more than the fnancial reportnn and focuses on value creaton. Intenrated reportnn is
meant tor allocated capital efciently, approach corporate reportnn more cohesive and efciently, enhance
accountability and support intenrated thinkinn. The response of the IASB so far has been somewhat distant. They
communicated with the other bodies, but do not intend to become the standard seter of non-fnancial
informaton.
Disclosure overloan
Disclosure has lost its efectveness over tme. Important informaton is buried in irrelevant details and a “checklist
mentality” has emerned. Financial reportnn has become a renulatory exercise, rather than an actvity to provide
informaton. The IASB presented the beter communicaton initatve, while Accountancy Europe kept to the core
and more principle. However the issue can be resolved easily (e.n. beter use of materiality, use of technolony,
improve navinaton throunh disclosure).
,[Read throunh tll end]
Lecture 2: Business Combinations (IFRS 3 & 10)
Business combinatons are normally sinnifcant transactons with a larne impact on the current and future
performance of the entty. Business combinatons can be divided inr
- Merners of Equalsr Companies of rounhly the same size of operatons decided to merne tonether to 1 entty
with operatons.
- Acquisitonsr A larner company takes over a smaller company.
There are many reasons to consider a business combinaton examples arer Growth strateny of the entty, Synernies
of both companies add value, Consolidaton of the market (less competton), Diversifcaton (sell a larner ranne of
products), Acquirinn Knowledne and enterinn a market.
Mergers ann Acquisitons have an fnancial impact e.n. The acquisiton price may be afected by contnnent
consideratons, the fnancinn of acquisitons may be throunh shares or cash with a loan and the combined earninns
may be subject to synernies between companies (1+1 > 2). Acquisitons are considered to be acquired nrowth,
contrary to ornanic nrowth. Therefore enttes need to disclose in the year of acquisiton the impact of revenue and
income.
Forms of business combinatonss
- Acquisiton of shares in another enttt
- Acquisiton of business iithout acquiring shares
- Combinaton of both
Businesss an intenrated set of actvites and assets, that can be controlled in order to provide a return (in dividends,
lower costs etc).
Contngent Consineratons consideraton that is subject to adjustment dependinn on the outcome of future events.
Fair values Amount at which the asset or liability would be exchanned in arm’s lennth transacton between
knowledneable and willinn partes.
Gooniills diference between fair value of business and fair value of the net assets.
From an accountnn perspectve, merners are not reconnised. Therefore all business combinatons must be
accounted for as acquisitons. However, traces of merger accountng are stll present.
Purchase methons
1) Inentft the acquirers
a. Can ofen be identfed byr Majority of votnn rinhts, control over nominaton of mananement or is
the larnest in term of fair value.
b. Date of takeover is relevant becauser at this point earninns are consolidated, at this point the fair
value of the acquired business is determined, is the date where noodwill is assessed.
2) Measure the value of the business acquiren
a. The fair value of all assets niven up, liabilites incurredaassumed and measured equity instruments
b. By the acquirer in exchanne for control
3) Determine the fair value of the assets ann liabilites (ann contngent liabilites)
a. Determine the identfable assets and liabilites of the company at the date of acquisiton, if they
had not yet been reconnised.
b. Acquirer cannot reconnize liabilites for future losses or costs based on future intentons. However
liabilites of existnn oblinatons of the acquired company may be reconnised.
4) Determine the niference betieen 2) ann 3) for gooniill.
,Lecture 3: Consolidation (IFRS 10)
Consolinatons Process of preparinn sinnle set of fnancial statements for nroup of enttes under control of one of
those enttes.
When consolidatnn, fnancial statements are combined (of individual enttes) as if it were one sinnle entty. This is
done in order to show the fnancial positon and performance of the nroup wherer
- Groups a parent and its subsidiaries
- Parents an entty that controls one or more enttes
- Subsiniarts an entty that is under control of another entty
The denree of consolidaton is determined by the amount of infuencer
Associates an entty that is infuenced for
at least 20% to 50%.
Joint ventures the scenario where the
entty has 50% of infuence (or ownership).
Ofen the case of joint ventures (E.G. the
SENSEO cofee machines were a joint
venture between Philips and Douwe
Enberts where both partes had 50%
ownership).
Subsiniarts entty is infuenced for at least
50% (and is ofen controlled by the parent).
IFRS 10 excludes parents to present consolidated fnancial statements ifr
- The parent is an subsidiary of another enttyy
- The owners do not object to the parent not presentnn the consolidated fnancial statementy
- The entty is not a listed frm
The neneral purpose of consolidaton is to present a set of fnancial statements as if all enttes within the nroup are
one entty. This is achieved byr
- Addinn line-by-line the individual items
- Usinn uniform accountnn policies
- Eliminate intra-nroup transactons and balances
- Adjust for efects of business combinaton(s)
- Measure and present rinhts of the non-controllinn interest (NCI) holders
In order to consolidate successfully, all enttes within the nroup should use one accountnn policy (IFRSaGAAP). If
one of the members of the nroup uses a diferent policy its fnancial statement should be adjusted before
consolidatnn. Consequently, these consolidaton adjustments are either done by the parent (that adjusts the
informaton reported by the subsdiary) or by the subsiniart (that is instructed by the parent to adjust informaton).
This is determined on mostly practcal nrounds. All adjustments at the date of business combinaton always have
follow-up consequences! [See examples]
In order to consolidate, the denree of control has to be determined, however this is mostly determined by
judnement.
Control (accordinn to IFRS 10) is an investor controls an investee when the investor is exposen, or has rights to
variable returns from its involvement with the investee and has the ability to afect those returns throunh its
poier over the investee.
This Poier over the subsiniart is ofen defned as the existnn rinhts that nive the current ability to direct the
relevant actvites. These existnn rinhts ofen arise from lenal contracts. In order to have power it should ber
Substantves
Rinhts (arisinn from contracts) are substantve as they have the practcal ability to be exercised. However in
order to judne whether the rinhts are substantve the followinn should be consideredr the partes that hold
the rinhts and have a beneft to exercise these, any barriers that may prevent to exercise rinhts, multple
, partes are involved that can exercise these rinhts. If a rinht is protectve the holder does not hold any
power. Protectve Rights protect the interest of the parent without nivinn the power.
Examples of exercisinn rinhts arer
o Votnn rinhts
o Rinht to appointareassinnaremove members of the subsidiary board
o Rinht to appoint or remove another entty that partcipates in mananement decisions
o Rinhts to direct the subsidiary to enter into, or veto into any channes to transactons that afect the
subsidiary’s returns.
Examples of protectnn rinhts arer
o Lenders rinht to restrict the undertakinn of actvites by the borrower (subsidiary)
o Rinht of a party with NCI to approve transactons
o Rinht of lender to seize assets in event of default of the borrower.
Abilitt to nirects
The parent must have the ability to direct (instead of actually directnn). This ability must be exercisable any
moment (is current). In additon, the relevant actvites have to be directed. That is the actvites that afect
the parent’s returns sinnifcantly. Lastly, power is presumed to exist when the investor owns the majority of
votnn rinhts (>50% of shares).
Second Element is that the investor (parent) is exposen or has rights to variable returns (e.n. Dividends, economies
of scale, cost savinns, sourcinn scarce products, naininn access to proprietary knowledne, renumeraton for
servicinn)
The last and third element requires that the parent is able to afect Returns and to increase its benefts and limit its
losses from the subsidiaries actvites.
All these elements must be present in order to have control over the subsidiary, if this is not the case there is no
consolidaton.
NOTEr Investment enttes (or venture capitalists) are exempted from these criteria. These investment enttes are
enttes thatr obtain funds from investors to provide investment mananement services, where they invest their
capital sole to nenerate returns and where the performance of investments is measured and evaluated on a fair
value basis.
The consolinaton process
When consolidatnn two frms, into one statement. It is important to check whether there are niferences in
balance sheet nate or accountng policies between the subsidiary and parent. The consolidaton involves mostly
addinn tonether the fnancial statement of the parent and subsidiary. However, some adjustments have to be
mader
- Business combinaton valuaton entries are required to adjust the carryinn amount of the subsidiary’s
assets and liabilites to fair value.
- Pre-acquisitons entriesr required to eliminate the carryinn amount of the parents investment in each
subsidiary (anains the pre-acquisiton equity)
- Transactons between enttes of the nroup before acquisiton date.
These adjustments or consolinaton journal anjustments are only prepared to consolidate and are not recorded in
the books of the parent or subsidiary (but recorded instead onto the consolidaton worksheet)
Acquisiton Analtsiss compares the acquisiton costs with the fair value of identfable net assets and contnnent
liabilites (FVINA).
Gooniill on acquisiton is realized if the costs are hinher than FVINA (or the investoraparent has paid more
to to the investeeasubsidiary than the actual fair value of net assets)
Bargain purchase is realized if the costs are lower than FVINA (or the investoraparent has paid less to the
investeeasubsidiary than the actual fair value of net assets, basically a barnain).
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