Appendix 9A-1: Sample Brief Memorandum Using IFRS RE: Sony ✓ Solved

Appendix 9A-1: Sample Brief Memorandum Using IFRS RE: Sony’s

Sony is a Japanese multinational company that decided to expand its entertainment business in the United States. Sony purchased CBS Records and Columbia Pictures to form Sony Music and Sony Pictures. Because of these acquisitions, Sony assumed debt of $1.2 billion and allocated $3.8 billion to goodwill. On Sony’s Annual Report filed with the SEC, Sony reported only two industry segments: electronics and entertainment. Although Sony Music was profitable, Sony Pictures produced continued losses of approximately $1 billion.

When Sony purchased the motion pictures operations, it projected a loss for only five years because it assumed that the motion pictures entertainment would become profitable. However, Sony suffered a significant loss after amortization and the costs of financing the acquisition for the past four years. In the current year, Sony Pictures sustained a loss of nearly $450 million, double the amount that Sony had planned. To date, Sony Pictures has had total net losses of nearly $1 billion. Early in the year, Sony declared that it had written down $2.7 billion in goodwill associated with the acquisition of Sony Pictures.

Sony combined the results of Sony Music and Sony Pictures and reported them as Sony Entertainment. Little profit was shown in Sony Entertainment. Sony’s consolidated financial statements did not disclose the losses from Sony Pictures.

Issues

1. Whether an annual write-down of goodwill and its impairment is necessary under IFRS for the acquisition of a company with continued losses.

2. Whether financial statement disclosures of two segments are needed when one industry has two businesses with different financial trends in order to avoid misleading financial statement users under Securities Exchange Act Section 13(a).

Conclusions

1. A write-down of goodwill of an acquired entity with continuous losses is required under ASC 350.

2. The financial statement disclosure of only two industries when one industry has two businesses with different financial trends is misleading under Securities Exchange Act § 13(a) and needs revising under ASC 350.

Authorities on goodwill

A summary of the relevant authorities on goodwill is as follows: Goodwill is an intangible asset that often arises from a business combination. It is a separate line item in the statement of financial position. Goodwill is not amortizable because it has an indefinite useful life. Potential impairment of goodwill in each reporting unit requires annual testing. IAS 36.10. A reporting unit includes segments of an operating unit for which disclosure is needed. The impairment is generally measured by comparing the fair value to the reported carrying value of goodwill. IAS 36.105. Impairment losses are recognized in the income statement. IAS 36.126. The notes to the financial statements must disclose each goodwill impairment loss if the loss is probable and can be reasonably estimated. The segment from which the business arose must disclose the loss. IAS 36.129.

Caution: The tax treatment of goodwill differs from financial accounting. Goodwill is a qualifying intangible for amortization over 15 years under IRC §197(a) and (d)(1)(A). Also, years ago for financial accounting purposes goodwill was presumed to have a finite life and was amortized over 40 years.

Authorities on segment disclosure

The following is a summary of the relevant portions of accounting and SEC accounting literature on segment disclosure: Segment disclosure reporting is required of public companies in their annual financial statements. IFRS 8.2. The objective of segment disclosure is to provide users of financial statements with information about the business’s different types of business activities and various economic environments. IFRS 8.1. Operating segments earn revenues and expenses, have results regularly reviewed by management, and have discrete types of financial information. IFRS 8.5. Operating segments should be recognized if the revenue is 10 percent or more of the combined revenues or assets are 10 percent or more of the combined assets. IFRS 8.13.

Disclosure of segment information must include nonfinancial general information such as how the entity identified its operating segments and the types of products and services from which each reportable segment derives its revenues. IFRS 8.22. Required financial information includes the reported segment profit or loss, segment assets, the basis of measurement. IFRS 8.21. Reconciliation is required of the totals of segment revenues, reported segment profit or loss, segment assets, and other significant items to corresponding business enterprise amounts. IFRS 8.28.

Filing reports periodically with the SEC is required for every issuer of a security under the Exchange Act of 1934. The reports must include any information needed to ensure that the required financial statements were not misleading in light of the circumstances. After 2008, foreign-owned companies with registered securities have not had to reconcile their accounting in the annual financial statement to U.S. GAAP under SEC Form 20-F.

Application of authorities

1. The carrying value of Sony Pictures exceeded its fair value; the carrying amount of Sony Pictures’ goodwill exceeded the implied fair value of Sony Pictures’ goodwill. The impairment of goodwill loss was probable and can be reasonably estimated.

2. Sony should report separate information about each operating segment that met any of the 10 percent quantitative thresholds.

3. Sony may not combine Sony Music and Sony Pictures as one reportable segment for any of the following reasons. They do not have similar economic characteristics. These businesses are not similar in the nature of the products, the nature of the production processes, the type or class of customer for their products and services, and the methods used to distribute their products.

4. Sony should disclose segmental information for Sony Music and Sony Pictures, providing information about their reported segment profit or loss. Other information to report includes the types of products from which each reportable segment derives its revenues, any reconciliations needed of the total segment revenues, and interim period information.

5. The amount assigned to goodwill acquired was significant in relation to the total cost of acquiring Sony Pictures. Thus, Sony must disclose the following information for goodwill in the notes to Sony Entertainment’s financial statements: (1) the total amount of goodwill and the expected amount deductible for tax purposes and (2) the amount of goodwill by reportable segment.

6. The authoritative sources require recognizing writing down goodwill of an acquired entity with continuous losses. Write down goodwill when a loss is probable and can be reasonably estimated. On the other hand, Sony must provide separate financial reporting for Sony Pictures because Sony Music and Sony Pictures do not share similar economic characteristics.

Paper For Above Instructions

The case of Sony Corporation offers a clear illustration of how financial statement preparation and reporting standards, particularly under IFRS, apply in real-world situations. The company made strategic acquisitions to bolster its entertainment segment in the U.S. market but faced continuous operational losses in one of those segments, Sony Pictures. This situation raises crucial questions about goodwill impairment and the accuracy of segment disclosures for more informed financial reporting and transparency.

The principal issue at hand concerns the necessity of an annual goodwill write-down when acquisitions continue to incur substantial losses. Goodwill, defined as the premium paid over fair value during acquisition, represents an intangible asset that is subjected to impairment testing rather than amortization under IFRS standards (IAS 36). According to IFRS guidelines, a goodwill write-down is mandated when a loss is probable and can be reasonably estimated. In Sony's scenario, given the continuous losses reported by the Sony Pictures segment, it becomes evident that a reduction in goodwill value, here manifesting as a $2.7 billion write-down, is not only justified but also required under these regulations (IAS 36.126).

Evaluating the circumstances under which impairment tests are conducted reveals that the carrying value of Sony Pictures has significantly outstripped its fair value, thus confirming the likelihood of impairment recognized by the company's financial management. Here, the implications revolve around ensuring that the financial statements present a true and fair view of the economic condition of Sony's divisions while maintaining adherence to legal frameworks governing the Securities Exchange Act, particularly as it relates to disclosures under Section 13(a).

The second issue pertains to the adequacy of disclosing two separate industry segments. Sony's decision to combine results from the two contrasting segments into a single category, 'Sony Entertainment,' presents stakeholders with insufficient and potentially misleading financial information. As stipulated by IFRS 8, companies must provide segment disclosures that reflect distinct operating results. The separation of operations into reportable segments prevents dilution of financial results that could obscure significant losses arising from one segment, thus misleading users of financial statements about the company's performance.

Separate reporting for Sony Music and Sony Pictures is essential, not only for compliance reasons but also for facilitating stakeholder understanding of each segment's economic realities. Financial performance indicators, including revenues, expenses, and segment results, should each cover specific nuances between both divisions. It is evident from the impairments and continuing losses that these divisions operate under different market conditions, target clientele, and overall business strategies.

Regulatory authorities such as the Financial Accounting Standards Board (FASB) and emerging global standards overseen by the International Accounting Standards Board (IASB) underline the necessity of transparency in segment reporting for public companies (IFRS 8.1). Compliance with these reporting standards will not only uphold the integrity of Sony's financial health but also ensure the accuracy of forecasts and reports, thereby cultivating stakeholder trust and confidence.

For companies operating in various domains, like Sony, the diversity in business models implies differing operational strategies, and thus financial results. The expectation laid out by the ASC and IFRS to follow distinct segment reporting frameworks underlines the rationale as to why the combination of dissimilar segments would result in a misrepresentation of Sony's financial performance.

Furthermore, in assessing the goodwill impairment process, it is evident that strategic financial governance involves continual analysis of operational performance, market viability, and the accrued goodwill relative to ongoing valuations. Sony's operational forecast already anticipated a turnaround that, in hindsight, proved overly optimistic, given the persistent difficulties in Sony Pictures. This situation shows that clear screening mechanisms are vital to identifying vulnerability in segments where finances may erode goodwill over time.

Looking ahead, it will be necessary for Sony to maintain robust financial oversight mechanisms that align operational performance with valuation assessments and shareholder disclosures. Maintaining segment transparency, as advised by regulatory standards, ensures that stakeholders receive full comprehension of the risks associated with investing in any of the company's distinct business units.

The financial landscape of multinational corporations like Sony inherently requires stratification of financial results to ensure they accurately reflect the potential for risks along with the profitability of varying operational units. Drawing upon best accounting practices, adjusting disclosures forthwith, and adopting more rigorous impairment testing cycles will serve to enhance financial reporting accuracy and stakeholder protections in alignment with IFRS requirements.

References

• International Accounting Standards Board (IASB). (2021). "International Financial Reporting Standards." Retrieved from [https://www.ifrs.org/](https://www.ifrs.org/)
• Financial Accounting Standards Board (FASB). (2021). "Accounting Standards Codification." Retrieved from [https://www.fasb.org/](https://www.fasb.org/)
• Financial Accounting Standards Board. (2019). "ASC 350: Intangibles - Goodwill and Other."
• IASB. (2018). "IFRS 8: Operating Segments." Retrieved from [https://www.ifrs.org/](https://www.ifrs.org/)
• Marsh, S., & Sudhakar, K. P. (2020). "Goodwill Impairment and Financial Reporting Quality." Journal of Accounting & Finance, 20(3), 15-29.
• PWC. (2020). "Goodwill Impairment: The Charge Against Earnings." Retrieved from [https://www.pwc.com/goodwill](https://www.pwc.com/goodwill)
• Grant Thornton. (2020). "Public Company Segment Reporting: An Overview." Retrieved from [https://www.grantthornton.com](https://www.grantthornton.com)
• Baker, H. K., & Anderson, R. (2019). "Understanding Financial Statements." Journal of Business and Finance, 25(4), 345-360.
• SEC. (2020). "Disclosure Requirements Under the Securities Exchange Act of 1934." Retrieved from [https://www.sec.gov/](https://www.sec.gov/)
• CFA Institute. (2019). "Financial Reporting and Analysis." CFA Institute Publications.