SKD Limited

 Case 2-2 

SKD Limited is a biotechnology company that prepares financial statements using internally developed accounting rules (referred to as SKD GAAP). To be able to compare SKD’s financial statements with those of companies in their home country, financial analysts in Country A and Country B prepared a reconciliation of SKD’s current year net income and stockholders’ equity. Adjustments were based on the actual accounting policies and practices followed by biotechnology companies in Country A and Country B. The following table shows the adjustments to income and stockholders’ equity made by each country analyst:

Income under SKD GAAP. . . . . . . . . . . . . . . . . . .

Goodwill. SKD capitalizes goodwill and amortizes it over a 20-year period. Goodwill is also treated as an asset in Country A and Country B. However, goodwill is not amortized in Country A, but instead is subjected to an annual impairment test. Goodwill is amortized over a 5-year period in Country B.

Interest. SKD expenses all interest immediately. In both Country A and Country B, interest related to self-constructed assets must be capitalized as a part of the cost of the asset.

Fixed assets. SKD carries assets on the balance sheet at their historical cost, less accumulated depreciation. The same treatment is required in Country A. In Country B, companies in the biotechnology industry generally carry assets on the balance sheet at revalued amounts.

Depreciation is based on the revalued amount of fixed assets.

Required:

1. With respect to the adjustments related to goodwill, answer the following:

a. Why does the adjustment for goodwill amortization increase net income

under Country A GAAP but decrease net income under Country B GAAP?

b. Why does the goodwill adjustment increase stockholders’ equity in Country

A but decrease stockholders’ equity in Country B?

c. Why are the adjustments to stockholders’ equity larger than the adjustments to income?

2. With respect to the adjustments made by the analyst in Country A related to interest, answer the following:

a. Why are there two separate adjustments to income related to interest?

b. Why does the adjustment to income for capitalized interest increase income,

whereas the adjustment for depreciation related to capitalized interest

decreases income?

c. Why is the positive adjustment to stockholders’ equity for capitalized interest smaller than the positive adjustment to income for capitalized interest?

3. With respect to the adjustments made by the analyst in Country B related to fixed assets, answer the following:

a. Why does the adjustment for depreciation related to revalued fixed assets

decrease income, whereas the adjustment for revaluation of fixed assets increases stockholders’ equity?