Accounting Systems 2

Vysoká škola finanční a správní

Jaromír R. Stembergjaromir@mail.vsfs.cz

Literature

McEwen, Ruth Ann: Transparency in Financial Reporting: A concise comparison of IFRS and US GAAP Harriman House ltd., Hampshire UK 2009 ISBN-13: 978-1-906659-13-4

Layout of the Course

• Basic principles of IFRS/IAS• Conceptual Framework and reporting requirements• Financial statements: items, recording by IFRS,

US GAAP differences– Assets– Liabilities– Equity– Profit and Loss– Cash Flow

Grading

• Attendance: 30% (6% for each lesson)Short Test: 20% (3rd lesson)Final test: 50%

• Minimum to pass: 60%• 90-100% A (excellent)

85-89% B (excellent minus)75-84% C (very good) 70-74% D (very good minus)60-69% E (good)<60% F (failed)

IFRS and US GAAP

Why do differences exist?

• US Financial Accounting Standards Board (FASB) developed the first set of standards

• International Accounting Standards Board (IASB) had the advantage of being inspired by some of the perceived problems in the FASB standard

• Differences: - in standards themselves- in interpretation

Will the differences ever be eliminated?

• “Norwalk Agreement” in 2002: Both Boards (FASB and IASB) publicly declared their commitment to the convergence of IFRS and US GAAP

• US Securities and Exchange Commission (SEC) eliminated the requirement for foreign issuers to reconcile their IFRS results to US GAAP

• Unless the wording of the standards is totally unified, interpretational differences will almost certainly stay

• Depends on willingness of national regulators and industry groups to cooperate

IAS/IFRS

Standards

• International Accounting Standards (IASs) were issued by the IASC from 1973 to 2000. In 2001, the IASC was replaced by the IASB.

• Since then, the IASB has:

– amended some IASs – replaced some IASs with new International

Financial Reporting Standards (IFRSs)– adopted new IFRSs on topics for which there was

no previous IAS – issued Interpretations of Standards

Compliance with Standards

Financial statements may not be described as complying with IFRSs unless they comply with all of the requirements of each applicable standard and each applicable interpretation

IASB Conceptual Framework

• “IASB Framework for the Preparation and Presentation of Financial Statements” was Adopted by the IASB in April 2001

• Not a standard, serves as a guide • Resolves accounting issues that are not addressed

directly in a standard• If no standard or interpretation applies to a

transaction, an entity must use its judgment in developing and applying an accounting policy that results in information that is relevant and reliable

IAS

IAS 1 Presentation of Financial StatementsIAS 2 InventoriesIAS 7 Statement of Cash FlowsIAS 8 Accounting Policies, Changes in Accounting Estimates and ErrorsIAS 10 Events After the Reporting PeriodIAS 11 Construction ContractsIAS 12 Income TaxesIAS 14 Segment ReportingIAS 16 Property, Plant and EquipmentIAS 17 Leases

IAS

IAS 18 RevenueIAS 19 Employee BenefitsIAS 20 Government Grants and Disclosure of Government AssistanceIAS 21 The Effects of Changes in Foreign Exchange RatesIAS 23 Borrowing CostsIAS 24 Related Party DisclosuresIAS 26 Accounting and Reporting by Retirement Benefit PlansIAS 27 Consolidated and Separate Financial StatementsIAS 28 Investments in AssociatesIAS 29 Financial Reporting in Hyperinflationary Economies

IAS

IAS 31 Interests In Joint VenturesIAS 33 Earnings Per ShareIAS 34 Interim Financial ReportingIAS 36 Impairment of AssetsIAS 37 Provisions, Contingent Liabilities and Contingent AssetsIAS 38 Intangible AssetsIAS 39 Financial Instruments: Recognition and MeasurementIAS 40 Investment PropertyIAS 41 Agriculture

IFRS

Preface to International Financial Reporting StandardsFramework for the Preparation and Presentation of Fin. StatementsIFRS 1 First-time Adoption of International Fin. Reporting StandardsIFRS 2 Share-based PaymentIFRS 3 Business CombinationsIFRS 4 Insurance ContractsIFRS 5 Non-current Assets Held for Sale and Discontinued OperationsIFRS 6 Exploration for and Evaluation of Mineral AssetsIFRS 7 Financial Instruments: DisclosuresIFRS 8 Operating SegmentsIFRS 9 Financial Instruments

Conceptual Framework

• Preparation and Presentation of Financial Statements is to be based on– Accrual principles– Continuity and consistency

• Quality requirements– Understandable– Relevant– Reliable– Comparable

Conceptual Framework

• Basic elements of financial statements– Assets– Liabilities– Owners’ Equity– Revenue– Expenses

• Presentation of Financial Statements – Balance sheet– Income statement– Cash flow statement– Statement of changes in equity– Notes

Reporting Requirements

Financial Statements

No given template nor detail contents of financial statements except of:

• Basics classification of assets, liabilities and equity• Distinction of revenue/expenses and gains/losses• Required items• Notes

Principle of relevance - items must be listed separately if they account for:

• 2% of total assets (B/S)• 5% of total revenue or expenses (P&L)

Classification of Balance Sheet Items

• Assets:– Criteria for long and short-term assets distinction– Assets can be sorted also by liquidity – Both systems are equally acceptable– So is a combination of both

• Liabilities– Use the same distinction as in assets

• Equity– Must be listed separately form liabilities

Assets Required in Reporting

– Property, Plant & Equipment– Investment Property – Intangible Assets– Investment Accounted for Using Equity Method

(investment in companies with capital holding of 20-50%)– Financial Assets– Receivables for Current Tax– Biological Assets– Assets Held for Sale– Inventories– Trade and Other Receivables– Cash and Cash Equivalents

Liabilities Required in Reporting

– Trade and Other Payables– Provisions (must be certain and measurable)– Financial Liabilities– Liabilities for Current Tax– Liabilities for Deferred Tax– Minority Interests

Equity Required in Reporting

Issued Capital and Reserves Attributable to Equity Holders of the Parent

Except of relevancy, IFRS has no other requirements - structure depends on local rules; typically consists of following items:

– Common Stock– Share Premium Account– Additional Paid-in Capital– Funds– Retained Earnings– Net Earnings of current period

P&L Items Required in Reporting

– Revenue– Financial Expenses– Participation on Profit or Loss of Affiliated Enterprise– Profit or Loss on Discontinued Business– Profit or Loss on Revaluation of Assets– Net Earnings for Current Period

P&L Statement has no given structure, can be – vertical or horizontal– by function or by kind

Cash Flow Statement Items Required in Reporting

Cash Flow Statement – is to give clear understanding of sources and usage of cash– has no given structure– can use direct or indirect method

It lists separately– Cash at the Beginning of Period– Cash Flow from Operations– Cash Flow from Investment Activities– Cash Flow from Financial Activities– Cash at the End of Period

Assets

Asset Classification

• Assets are result of completed transactions and occurrences (purchase, production, exchange)

• Expected or unfinished transactions don’t classify• Asset books who has disposability rights and

economical benefit• Ownership is not important• Current / long-term

Current Assets

Definition:• Are expected to be disposed within 12 months• Will be disposed within 1 operational cycle (form raw material

purchase to collection of A/R)• Cash

Typical Current Assets:• Cash and equivalents• Accounts receivable• Current part of long-term receivables• Inventories• Current financial assets• Accruals and deferrals• Assets Held for Sale

Accounting Transactions

Cash purchase of merchandise: Inventory 100.00Cash 100.00

Non-cash purchase of merchandise: Inventory 100.00

Accounts payable 100.00Payment of debt:

Accounts payable 100.00Cash 100.00

Each transaction must be recorded with additional information (date, transaction number, description, person who entered it) that are here for simplicity reasons omitted

Accounting Transactions

Production of a current assetInventory of finished goods 100.00Inventory of raw materials (B/S) 40.00Production expense (P&L) 60.00

Sale of finished goodsAccounts receivable (B/S) 150.00Revenue (P&L) 150.00Cost of goods sold (P&L) 100.00 Inventory of finished goods (B/S) 100.00Bank account (B/S) 150.00 Accounts receivable (B/S) 150.00

Evaluation of Current Assets

Accounts receivable• Provision for bad debts

Inventory• Manufactured: cost of material, direct labor and allocated

production cost• Purchased: cost method (purchase price + transport, customs,

etc.) or retail method (retail price – sales margin)• Inventory: lower cost or market (LCM – the lower of original

price and net realizable value)• FiFo, weighted average

Current Assets in US GAAP

ARB 43 Chapter 4 Inventory Pricing and IAS 2 Inventories are both based on similar principles:

• Inventory are assets held for sale in the ordinary course of business

• Primary basis of accounting for inventory is cost• Both standard cost method or retail method can be used• Cost of inventory includes all direct expenditures to ready

inventory for sale, including allocable overhead • Selling costs are excluded from the cost of inventories, as are

most storage costs and general administrative costs

Current Assets in US GAAP

Differences:

• LIFO: - US GAAP: acceptable- IFRS: prohibited

• Reversal of write-downs of inventory to the lower of cost or market: - US GAAP: creates a new cost basis that cannot be reversed - IFRS: reversal can be done max. to the original value if reasons for write-downs no longer exist

Financial Assets

Definition:• Non-physical assets that derives value because of a

contractual claim that can be readily converted into cash.• Typically, financial assets are traded on financial markets • In general, the terms of financial assets may include non-

financial assets like corn or wheat if they are traded on financial markets.

Typical Financial Assets:• Stocks, bonds, securities• Investment accounts, loans• Derivates (options, futures)

Financial Assets and the Standards

Both boards are working on standards (IFRS 9, ASC draft version) in classification and measurement of all financial instruments to replace existing guidance • Held to maturity:

- zero coupon allocates the interest income- mortgage allocates the interest income but also amortizes for the payments

• Available for sale:- US GAAP treats decline in fair value in consideration of the company’s ability to hold the security- IFRS discounts estimated cash flow for bad debts/credit losses

Zero-Coupon Fair Value Calculation

Interest (r) 10% 15%

Nominal value (in 5 years)

1000 909 870

Present value =

FVn/(1 + r)n

Coupon Fair Value Calculation

10% 15%

Year (n)Net Receipt

(FV)

1 100 91 87

2 100 83 76

3 100 75 66

4 100 68 57

5 1100 683 547

Total PV of Cash Inflow 1 000 832

Present value =

FVn/(1 + r)n

Interest (r)

Long-Term Assets

Definition:• Are expected to be held for 12 months or longer• Will not be disposed within 1 operational cycle (spare parts)• Tangible / Intangible• Extended use regardless of value

Typical Long-Term Assets:• Property, plant and equipment• Long-term receivables• Biological assets• Licenses, SW, copy rights

• Goodwill (must be purchased)

Depreciation

• To show true and honest value of the fixed asset status

• Straight line or accelerated• Residual value• Early retirement, change in accounting estimate• No major differences between IFRS and US GAAP

Depreciation

• Straight-line depreciation: (original cost – salvage value) / periods of useful life

• Units-of-production method: (original cost – salvage value) / estimated units to be produced

• The sum-of-the-years’-digits (SYD) method(original cost – salvage value) * (remaining years / SYD) Example: 5 years = 1+2+3+4+5=15; hence 1st year (original cost – salvage value) * 5/15 2nd year (original cost – salvage value) * 4/15 etc.

• The double declining-balance methodtwice the straight-line rate applied to the remaining book value

Accounting Transactions

Fixed asset purchase: Crain purchase 148 000.00

Transportation 1 000.00Assembly costs 2 000.00

Accounts payable 151 000.00

Depreciation: Depreciation Expense 30 000.00

Accumulated Depreciation 30 000.00

Leasing of Long-Lived Assets

• Leasing contract: temporarily transferred disposability rights and economical benefits

• To be recorded as long-lived assets of the entity (except of real estate)

• Capital/finance leases, operational leasesthe criteria of a capital lease include - the transfer of ownership to the lessee at the end of the lease term - a purchase option that is reasonably expected to be exercised- the lease term duration is for most of the asset’s economic life

Leasing of Long-Lived Assets

Accounting transactions:• Leasor:

the asset is taken of the long-lived asset and becames a note payable from the lasee

• Leasee: - the leased asset is recognized as an long-lived asset and liability to the leasor- use the lower of the present value of the outgoing payments or the fair market value- the asset is to be depreciated

Leasing of Long-Lived Assets

Differences in accounting standards:• Only minor or less important differences between

IFRS and US GAAP - terminology: capital lease vs. financial lease- the lease term is a “major part” or “75%” of the asset’s economic life- recognition of gain/loss when only a minor part of the right to use the asset is exercised (IFRS immediately, US GAAP over the lease term)

• Major difference in Czech standards:- leased asset is to be kept and depreciated in the owners books

Intangible Assets

Nonmonetary assets without physical substance, there are probable future economic benefits that can be reliably measured• SW, licenses, copy rights, trade marks

- amortization over its useful life- development costs can be included only when demonstrating technical feasibility and ability to complete and sell the asset in the future- if there is no foreseeable limit to the period over which it is expected to generate net cash inflows, the useful life is considered to be indefinite and the asset is not amortized

• Goodwill (in business combinations only)