Case Study (Carnarvon Petroleum Ltd.):

Carnarvon Petroleum Ltd. is an oil and gas Exploration Company that prepares financial statements using internally developed accounting rules according to GAAP. To be able to compare Carnarvons financial statements with those of companies in their home country, financial analysts in Country I and Country II prepared a reconciliation of Carnarvons current year net income and stockholders equity. Adjustments were based on the actual accounting policies and practices followed by biotechnology companies in Country I and Country II. The following table shows the adjustments to income and stockholders equity made by each country analyst:

Country I Country II

Income under Carnarvon GAAP. . . . . . . . . . . . . . . . .1,050 1,050

Adjustments: Goodwill amortization . . . . . . . . . . . . .300 (100)

Capitalized interest. . . . . . . . . . . . . . . . . . . . . . ..50 50

Depreciation related to capitalized interest . . . (20) (20)

Depreciation related to revalued fixed assets (8)

Income under local GAAP . . . . . . . . . . . . . . . . . 1,380972

Stockholders equity under CARNARVON GAAP.. . .15,000 15,000

Adjustments: Goodwill . . . . . . . . . . . . . . . . . . . . . . . . 900 (300)

Capitalized interest. . . . . . . . . . . . . . . . . . . . . . 3030

Revaluation of fixed assets . . . . . . . . . . . . . . . 56

Stockholders equity under local GAAP . . . . . . . ... 15,93014,786

Description of Accounting Differences:

Carnarvon capitalizes goodwill and amortizes it over a 20-year period. Goodwill is also treated as an asset in Country I and Country II. However, goodwill is not amortized in Country I, but instead is subjected to an annual impairment test. Goodwill is amortized over a 5-year period in Country II. Interest. Carnarvon expenses all interest immediately. In both Country I and Country II, interest related to self-constructed assets must be capitalized as a part of the cost of the asset. Fixed assets. Carnarvon carries assets on the balance sheet at their historical cost, less accumulated depreciation. The same treatment is required in Country I. In Country II, 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 I GAAP but decrease net income under Country II GAAP?

b) Why does the goodwill adjustment increase stockholders equity in Country I but decrease stockholders equity in Country II?

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 I 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 II related to fixed assets, why does the adjustment for depreciation related to revalue fixed assets decrease income, whereas the adjustment for revaluation of fixed assets increases stockholders equity?

.ill etisalat 12:33 AM vle.aau.ac.ae Case Study (Carnarvon Petroleum Ltd.): Carnarvon Petroleum Ltd. is an oil and gas Exploration Company that prepares financial statements using internally developed accounting rules according to GAAP. To be able to compare Carmarvon's financial statements with those of companies in their home country, financial analysts in Country I and Country II prepared a reconciliation of Carnarvon's current year net income and stockholders' equity. Adjustments were based on the actual accounting policies and practices followed by biotechnology companies in Country I and Country II. The following table shows the adjustments to income and stockholders' equity made by each country analyst: Country Country II 1,050 1,050 300 50 (20) (100) Capitalized interest... . Depreciation related to capitalized interest. . Depreciation related to revalued fixed assets.. 50 (20) Income under local GAAP 1,380 Stockholders' equity u ....15,000 nder CARNARVON GAAP 15,000 (300) 30 30 Revaluation of fixed assets .. , , ,-.... 56 Stockholders' equity under local GAAP 15,930 14.786 Description of Accounting Diferences: Carnarvon capitalizes goodwill and amortizes it over a 20-year period. Goodwill is also treated as an asset in Country I and Country II. However, goodwill is not amortized in Country I, but instead is subjected to an annual impairment test. Goodwill is amortized over a 5-year period in Country II. Interest. Carnarvon expenses all interest immediately. In both Country I and Country II, interest related to self