international financial reporting standards1745

7/30/2019 International Financial Reporting Standards1745

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Chapter 4

International Financial ReportingStandards (IFRSs)


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Basics of recognition and measurement.

IFRSs: Recognition and measurement of

assets.

IFRS / U.S. GAAP differences: Recognitionand measurement.

IFRS / U.S. GAAP differences: Presentation

and disclosure.

International Financial ReportingStandards (IFRSs)


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Recognition and Measurement:Some background

Review of important terminologyAssets resources controlled by theenterprise from which future economic

benefits are expected to flow to theenterprise.Recognition inclusion of items (e.g.,assets, liabilities) into the financial

statements with the amount included instatement totals.


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Measurement choice of the attribute bywhich to quantify a recognized item. Themost commonly used attributes:

Historical cost Net realizable value Current (replacement) cost Current market value

Present value of future cash flows



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Historical costamount paid toacquire an asset or, for liabilities, theamount received when the obligation is

incurred. Net realizable value amount of cash

(sometimes the present value) minuscollection and other costs incurred.



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Current (replacement) costamountneeded to acquire an equivalent asset.

Current market value amount of

cash received from an immediate sale ofthe asset.

Present value of future cash flowsamount of cash to be received,

discounted at the appropriate interestrate.



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Recognition and Measurement: IFRSs

IFRSs Substantially similar to U.S. GAAP. However, significant differences do exist.

An effective way to understand IFRSs isto compare to U.S. GAAP.

Describe IFRSs in terms of significantdifferences from U.S. GAAP.


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Questions to consider

In what way(s) would US GAAP andIFRSs be expected to differ?

Why?


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Recognition and Measurement: IFRSs and U.S. GAAPcompared

Types of Differences Definitions Recognition

Measurement Alternatives Lack of requirements or guidance Presentation

Disclosure


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Form 20-F Some firms filing Form 20-F initially use

IFRSs to prepare financial statements.

The Form 20-F of some of these firmscan be used to gain an understanding ofIFRS / U.S. GAAP differences.



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Areas with significant differences Inventory (IAS 2) Property, Plant, and Equipment

(PP&E) (IAS 16) Intangible Assets (IAS 38) Impairment of Assets (IAS 36) Borrowing Costs (IAS 23)

Leases (IAS 17)



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IAS 2, Inventories compared to U.S.GAAP

Requires lower of cost or net realizable

value (U.S. GAAP uses lower of cost ormarket). IAS 2 does not allow use of last-in, first-

out (LIFO). IFRSs would tend to lead to

Higher inventory balances. Lower cost of goods sold. Higher net income compared to U.S.

GAAP if LIFO is used.



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IAS 2, Inventories compared to U.S.GAAP

Allows for capitalization of interest on

borrowings for some inventories. Capitalization of interest on inventories

will lead to Higher inventory balances.

Lower cost of goods sold. Higher net income compared to U.S.

GAAP.



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IAS 2, Inventories numerical comparison to U.S.GAAPApplication of lower of cost of net realizable value.Assume the following:

Historical cost $500Replacement cost 400Estimated sales price 450Estimated disposal costs 25Normal profit margin 20% of sales price



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IAS 2, Inventories numericalcomparison to U.S. GAAPLower of cost or net realizable value using

IAS 2Historical cost = $500

Net realizable value (NRV)= estimated sales price estimated

selling costs= $450 - $25 = $425(lower of cost or

NRV)



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IAS 2, Inventories numericalcomparison to U.S. GAAPLower of cost or market under U.S. GAAP

Historical cost = $500

Designated market is middle value ofNRV ($425), Replacement cost ($400),and NRV normal profit margin ($425 -$90 = $335). Designated market is$400 and lower of cost or market =$400



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IAS 2, Inventories numericalcomparison to U.S. GAAPThe recognized inventory amount under

IAS 2 is $425 and under U.S. GAAP is$400.

Note: under U.S. GAAP the $400 nowrepresents historical cost. Under IAS 2,historical cost remains at $500 whichmight be used as lower of cost or NRV infuture years.



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IAS 16, PP&E compared to U.S. GAAP Subsequent to initial measurement, IAS

16 allows the two different measurement

approaches. Historical cost-- (the benchmark

treatment) recognizes the asset at costless accumulated depreciation, required

by U.S. GAAP.



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IAS 16, PP&E compared to U.S. GAAP Revaluation -- (the alternative

treatment) requires that all assets within

a class be revalued periodically A major difference between IFRSs and

U.S. GAAP as fixed assets are oftensubstantial.

Revaluation is generally not allowedunder U.S. GAAP.



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IAS 16, PP&E compared to U.S. GAAPAccounting for revaluations Revaluation increases require a journal

entry to increase the asset to fair value:

Property, plant, and equipment xxxxRevaluation surplus xxxx

Note: The revaluation surplus is an equity account.



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IAS 16, PP&E compared to U.S. GAAPAccounting for revaluations

Revaluation decreases require a journal

entry to decrease the asset to fair value:

Expense xxxxProperty, plant, and equipment xxxx



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IAS 16, PP&E numerical comparisonto U.S.

GAAP Accounting for accumulated depreciation at time of

revaluation. Assume the following as of 12/31/X2:Historical cost $10,000Accumulated depreciation 2,000Current market value 18,000Ratio of carrying value to cost 80%



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IAS 16, PP&E numerical comparisonto U.S. GAAP

Revaluation adjustment

Treatment 1

Asset and accumulated depreciation are restated. Restated carrying amount equals current market

value.

The ratio of carrying value to gross carryingamount is maintained.



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IAS 16, PP&E numerical comparisonto U.S. GAAP: Treatment 1

Original

Revaluation Total CostGross amt $10,000 + 12,500 = $22,500Acc dep 2,000 + 2,500 = $4,500Carrying value$ 8,000 + 10,000 = $18,000



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IAS 16, PP&E numerical comparisonto U.S. GAAP

Revaluation adjustment

Treatment 2

Asset is first decreased by the amount ofaccumulated depreciation.

Asset account is then increased by the

amount of the revaluation (currentmarket value carrying value).



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IAS 16, PP&E numerical comparisonto U.S. GAAP: Treatment 2

Accumulated Depreciation 2,000

Asset 2,000Asset 10,000

Revaluation surplus 10,000



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When revaluation is applied:

It must be used consistently for anentire class of assets.

Selectivity within a class is not OKbut selectivity ofa class is.

Revaluated assets must be kept atfair value- this need determines the

frequency of future revaluations.


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Treatment of the revaluation surplus

Subsequent decreases in assetvalue are charged first torevaluation surplus, if any, and then

expensed. When the surplus is realized (e.g.,

when the asset is sold), it may betransferred to retained earnings, a

portion depreciated as the asset isused up, or left untouched.


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IAS 38, Intangible Assets Purchased intangibles. Intangibles acquired in a business

combination. Internally generated intangibles. Does not address Goodwill (see IAS 3).



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IAS 38, Intangible Assets comparedto U.S. GAAP

Purchased intangibles consistent

with U.S. GAAP except that fair value isused in some cases.

Intangibles acquired in a business

combination consistent with U.S.GAAP except that in-processdevelopment costs are capitalized.



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IAS 38, Intangible Assets comparedto U.S. GAAP

Internally generated intangibles:

Major difference with U.S. GAAP. U.S. GAAP (SFAS 2) requires expensing

of almost all Research and Development(R&D) costs.

IAS 38 allows capitalization, also calleddeferral, of many development costs.



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Criteria for capitalization of

development costs:

Technical feasibility

Intent to complete and use/sell.

Ability to use/sell.

How the asset will generate futureeconomic benefits, e.g., the existence ofa market and/or usefulness.

Availability of resources to complete

developmnent. Ability to reliably measure the

expenditure needed.


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IAS 38, Intangible Assetsnumerical comparison to U.S. GAAPInternally generated intangibles Development Costs.

Assume the following: Development costs of $100,000 during 2005 70% of costs qualify for capitalization Product sales begin on January 2, 2006 Five years of sales expected

Capitalized costs amortized on a straight-line basis



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IAS 38, Intangible Assets numericalcomparison to U.S. GAAP

Internally generated intangibles

Development Costs

Accounting treatment under IAS 38in 2005:Development expense 30,000Deferred development costs 70,000

Cash, payables, etc. 100,000



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Development Costs

Accounting treatment under IAS 38 in 2006:Amortization expense 14,000

Deferred dev costs 14,000



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Development Costs

Accounting treatment under U.S. GAAP- in 2005:Dev expense 100,000

Cash, payables, etc. 100,000In 2006No entry



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IAS 36, Impairment of Assetscompared to U.S. GAAP

Has lower threshold for impairments,sometimes results in impairments whenU.S. GAAP does not.

For assets considered impairedunderU.S. GAAP, impairment is carryingamount minus fair value.

Impairment is carrying amount minusthe recoverable amount (greater of netselling price or value in use). This islikely to differ from fair value.



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IAS 36, Impairment of Assetscompared to U.S. GAAP

Allows for reversal of impairment loss insubsequent periods when recoverableamount exceeds carrying value.

U.S. GAAP prohibits such reversals. Impairment test for goodwill requires

both a bottom-up and top-down test. U.S. GAAP requires only a bottom-up

test.



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IAS 36, Impairment of Assetsnumerical comparison to U.S. GAAPAssume the following:

Carrying value $440

Selling price 400Cost of disposal 25Expected future cash flows 450Present value of expected future cash flows 380



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IAS 36, Impairment of Assetsnumerical comparison to U.S. GAAP

Impairment under IAS 36:

Value in use $380Net selling price 375Recoverable amount $380 (greater of

these two)Impairment loss = carrying amount recoverable amount = $440 380 = $60



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IAS 36, Impairment of Assetsnumerical comparison to U.S. GAAP

Impairment under U.S. GAAP

Carrying amount of $440 is less thanexpected future (undiscounted) cashflows of $450.

No impairment.



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IAS 23, Borrowing Costs U.S. GAAP (SFAS 34) requires

capitalization of interest on borrowings

attributable to construction, acquisition,or production of qualifying assets.

Capitalization of interest is thebenchmark treatment under IAS 23.

However, an alternative treatment allowsfor expensing of all interest.



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IAS 23, Borrowing Costs Explicitly allows for capitalization of

interest on borrowing for the production

of some inventories. U.S. GAAP explicitly prohibits the

capitalization of interest on borrowingsfor production of most inventories.



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IAS 17, Leases Distinguishes between operating and

finance (capital) leases in much the

same way as U.S. GAAP (SFAS 13). The criteria for classifying a lease as

either operating or finance is lessdetailed than U.S. GAAP

Leases is often used as an example inarguing that U.S. GAAP is rules-basedand IFRSs are principles-based.



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Finance lease criteria,

IAS 17 Lease transfers

ownership. Bargain purchase option. Lease term is for the

majorpart of the leasedassets economic life.

Present value ofminimum leasepayments equalssubstantially allof the

fair value of the asset. The leased asset is

specialized so that onlythe lessee can use it.

Capital lease criteria,

SFAS 13 Lease transfers ownership. Bargain purchase option. Lease term is for 75 percent

of the leased assetseconomic life.

Present value of minimumlease payments equals 90

percentof the fair value ofthe asset.



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IFRSs and U.S. GAAP differ somewhat ineach

of the following areas Cash Flow Statements (IAS 7)

Classification of dividends and interest paidis more flexible under IFRS.

Segment Reporting (IAS 14) U.S. GAAPrequires management approach, IFRS ismore flexible as of March 2005. This item is

part of short-term convergence project. Interim Financial Reporting (IAS 34)

U.S. GAAP treats interim periods as integralpart of the full year.



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Liabilities

Contingent Liabilities vs provisions

If losses are probable, then theymust be recognized.

Same as US GAAP, except that,with IAS37, probable is defined as

more likely than not.

Under US GAAP, the definition ofprobable is left vague.


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Contingent assets

IAS allows recognition if the inflowof economic benefits is virtuallycertain.

US GAAP generally allows norecognition until it has beenrealized.


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Defined Benefit Pension Plans

Past service costs are expensed morequickly than under US GAAP.

A minimum liability (the unfunded

accumulated pension obligation) isrecognized under US GAAP, but not underIAS 19.

Both methods allow gains and losses tobe brought in slowly and smoothly.

IAS caps the amount of a pension assetthat can be booked. US GAAP has no suchcap.


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A few other areas:

Some differences in accounting forincome taxes

Revenue recognition also differs,but differences are hard to pinpoint.

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