Case 9-1 International Accounting Choi/Meet 7th edition-Paper with Bibliography

| August 31, 2017

Question
325

CASES

Case 9-1

Sandvik

One of the accounting development patterns

that was introduced in Chapter 2

was the macroeconomic development

model. Under this framework accounting

practices are designed to enhance

national macroeconomic goals. A national

policy advocating stable employment by

avoiding major swings in business cycles

would sanction accounting practices

that smooth income. Similarly, national

policies supporting growth in certain

industries would sanction rapid writeoffs

of fixed assets to encourage capital

formation. Sweden is a good example of

this reporting pattern. Assets may be

revalued upwards if they are deemed to

have “enduring value,” the tax law permits

shorter asset lives, and ceiling tests for

depreciation charges include the higher

of 130 percent declining balance method

or 20 percent straight line. Companies

are also permitted to allocate a portion of

pre-tax earnings to special tax equalization

reserves which are not available for

dividends until reversed.

Reproduced below are the parent

company financial statements of Sandvik

for the years 2006 and 2007 and selected

notes. Sandvik is a global high technology

company headquartered in Sweden,

with advanced products and well-known

brands. Its core areas of competence

include high speed tools for metal

working, machinery, tools and services

for rock excavation, and specialty steels.

The company states that it applies all

IFRS and IFRIC interpretations approved

by the EU to the extent possible within

the framework of the Swedish Annual

Accounts Act and considering the close

tie between financial reporting and taxation.

Examine the data presented and

answer the following questions.

1.What advantages and disadvantages

arise for firms that chose to

employ the Swedish system of special

reserves?

2.What are the potential benefits of

the system of special reserves to the

Swedish government?

3.In what way does the existence of

the Swedish reserve system affect

the ability of a financial analyst to

evaluate a Swedish firm vis-a-vis a

non-Swedish firm?

4.In what way does the use of

“reserves” affect Sandvik’s financial

statements for the year 2007?

How does this compare with the

effect of reserves in the previous

year?

5.Show the accounting entry used to

create the 2007Appropriationsfigure

in the income statement.

6.If you were to unwind the effect of

reserves for 2007, how would

Sandvik’s key profitability ratios,

such as return on sales and return

on assets change?

326Chapter 9 • International Financial Statement Analysis

Amounts in SEK M 2007 2006

Revenue Note 2 20682 17932

Cost of sales and services-16111-13646

Gross profit4571 4286

Selling expenses-621-577

Administrative expenses-1982-1719

Research and development costs Note 4-1019-778

Other operating income Note 5 488 455

Other operating expenses Note 6-916-1344

Operating profitNote 3, 7, 8 521 323

Income from shares in group companies Note 9 5997 9264

Income from shares in associated companies Note 9 5 1

Income from investments held as non-current assets Note 9 –– 0

Interest income and similar items Note 9 638 657

Interest expenses and similar items Note 9-1165-898

Profit after financial items5996 9347

Appropriations Note 10 3063 305

Income tax expense Note 11-745-29

Profit for the year8314 9623

Parent Company Income Statement

Parent Company Balance Sheet

Amounts in SEK M 2007 2006

ASSETS

Non-current assets

Intangible assets

Patents and similar rights Note 14 26 51

Total 26 51

Property, plant and equipment

Land and buildings Note 14 484 473

Plant and machinery Note 14 3624 3492

Equipment, tools and installations Note 14 305 309

Construction in progress and advance

payments Note 14 1352 974

Total 5765 5248

Financial assets

Shares in group companies Note 15 13762 11723

Advances to group companies 48 34

Investmments in associated companies Note 16 4 4

Advances to associated companies –– 0

Other investments 1 1

Non-current receivables Note 18 20 23

(continued)

Chapter 9 • International Financial Statement Analysis327

Parent Company Balance Sheet(Continued)

Amounts in SEK M 2007 2006

Deferred tax assets Note 11 22 17

Total 13857 11802

Total non-current assets19648 17101

Current assets

InventoriesNote 19 6242 4599

Current receivables

Trade receivables 1255 1150

Due from group companies 16311 15846

Due from associated companies 131 474

Income tax receivables Note 11 393 16

Other receivables Note 18 518 456

Prepaid expenses and accrued income 679 423

Total 19287 18365

Cash and cash equivalents6 19

Total current assets25535 22983

TOTAL ASSETS45183 40084

EQUITY AND LIABILITIES

Equity

Non-distributable equity

Share capital 1424 1424

Legal reserve 1611 1611

Total 3035 3035

Distributable equity

Profit brought forward 1552 1637

Profit for the year 8314 9623

Total 9866 11260

Total equityNote 20 12901 14295

Untaxed reserves

Accelerated depreciation Note 21 –– 2430

Tax allocation reserves Note 22 –– 639

Other untaxed reserves Note 22 19 15

Total 19 3084

Provisions

Provisions for pensions and similar obligations Note 23 108 106

Provisions for taxes Note 11 55 42

Other provisions Note 24 154 127

Total 317 275

Non-current interest-bearing liabilities

Loans from financial institutions Note 25 1718 1669

Loans from group companies Note 25 30 3

Other liabilities Note 25 10131 2511

Total 11879 4183

(continued)

328Chapter 9 • International Financial Statement Analysis

Noncurrent non–interest-bearing liabilities

Other liabilities –– 9

Total –– 9

Current interest-bearing liabilities

Loans from group companies 10902 12766

Other liabilities 1080 1324

Total 11982 14090

Current noninterest-bearing liabilities

Advance payments from customers 159 53

Accounts payable 1721 1734

Due to group companies 3655 27

Due to associated companies 82 125

Other liabilities 136 205

Accrued expenses and deferred income Note 28 2332 2004

Total 8085 4148

TOTAL EQUITY AND LIABILITIES 45183 40084

Pledged assets Note 29 –– ––

Contingent liabilities Note 29 16068 11929

Parent Company Balance Sheet(Continued)

Note 10. Appropriations

Parent Company2007 2006

Accelerated depreciation 2429-143

Changes in tax allocation reserves 638 437

Changes in other untaxed reserves-4 11

Total 3063 305

Note 11. Income tax

Reported in Income Statement

Group

Parent

Company

Income tax expense2007 2006 2007 2006

Current tax-4396-3135-829-115

Adjustment of taxes attributable to prior years 229-16 67 64

Total current tax expense-4167-3151-762-51

Deferred taxes relating to temporary differences

and unused tax losses 763 145 17 22

Total tax expense-3404-3006-745-29

Chapter 9 • International Financial Statement Analysis329

The Group’s tax expense for the year was

SEK 3,404 M (3.006) or 26.2% (27.0) of the

profit after financial items.

The adjustment of taxes attributable

to prior years mainly relates to favorable

tax litigation resolutions and

advance rulings in Sweden and reversal

of tax provisions upon finalization of tax

audits of foreign subsidiaries.

Reconciliation of the Group’s tax

expenseThe Group’s weighted average

tax based on the tax rates in each country,

is 29. 6% (27.0). The nominal tax rate in

Sweden is 28.0% (28.0).

Reconciliation of the Group’s

weighted average tax rate, based on the

tax rates in each country, and the Group’s

actual tax expense:

Reconciliation of the Parent Company’s tax

expenseThe Parent Company’s effective

tax rate of 8.2% (0.8) is less than the nominal

tax rate in Sweden, mainly due to

tax-exempt dividend income from subsidiaries

and associated companies:

2007 2006

Group SEK M % SEK M %

Profit after financial items 12997 11113

Weighted average tax based on each

country’s tax rate-3849-29.6-3001-27.0

Tax effect of:

Non-deductible expenses-195-1.5-179-1.6

Tax exempt income 199 1.5 244 2.2

Adjustments relating to prior year 229 1.8-16-0.1

Effects of unused tax losses, net 75 0.6-22-0.2

Other 137 1.1-32-0.3

Total reported tax expense-3404-26.2-3006-27.0

Reconciliation of the Parent Company’s

nominal tax rate and actual tax

expense:

2007 2006

Parent CompanySEK M % SEK M %

Profit before tax 9059 9652

Tax based on the nominal tax rate for the

Parent Company-2537-28.0-2703-28.0

Tax effects of:

Non-deductible expenses-33-0.4-59-0.6

Tax-exempt income 1758 19.4 2669 27.6

Adjustments relating to prior years 67 0.7 64 0.7

Total reported tax expense-745-8.2 29-0.3

330Chapter 9 • International Financial Statement Analysis

2007 2006

Group

Deferred

tax assets

Deferred

tax

liabilities Net

Deferred

tax assets

Deferred

tax

liabilities Net

Intangible assets 34-666-632 39-282-243

Property, plant,

and equipment 96-965-869 195-1573-1378

Financial non-current assets 58-2 56 26-31-5

Inventories 1445-62 1383 1034-30 1004

Receivables 66-335-269 95-237-142

Interest-bearing liabilities 325-263 62 549-184 365

Noninterest-bearing

liabilities 513-761-248 393-444-51

Group2007 2006

Deferred tax relating to hedging reserve 31 34

Total 31 34

Parent Company2007 2006

Current tax relating to taxable group

contributions 843-95

Total 843-95

Tax items recognized directly in equity

Reported in the balance sheet

Deferred tax assets and liabilitiesThe

deferred tax assets and liabilities reported

in the balance sheet are attributable to the

following assets and liabilities (liabilities

shown with a minus sign):

2007 2006

Group

Deferred

tax assets

Deferred

tax

liabilities Net

Deferred

tax assets

Deferred

tax

liabilities Net

Other 19-49-30 20-261 241

Unused tax losses 84–84– — —

Total 2640-3103-463 2351-3042-691

Offsetting within companies-1317 1317– -1031 1013–

Total deferred tax assets

and liabilities 1323-1786-463 1338-2029-691

Parent Company

Property, plant

and equipment– -37-37– -38-38

Chapter 9 • International Financial Statement Analysis331

Note 21. Parent Company’s Accelerated Depreciation

Land and

buildings

Plant and

machinery

Equipment, tools

and installations

Patents and

similar rights Total

Balance at 1 January 2006 1 2075 182 29 2287

Accelerated depreciation for the year 0 127 13 3 143

Balance at 31 December 2006 1 2202 195 32 2430

Balance at 1 January 2007 1 2202 195 32 2430

Accelerated depreciation for the year-1-2202-195-32-2430

Balance at December 2007– — — — —

Note 22. Parent Company’s Other Untaxed Reserves

2007 2006

Tax allocation reserves

Appropriated at 2002 tax assessment–435

Appropriated at 2004 tax assessment–204

Balance at 31 December–639

Other untaxed reserves 19 15

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