Chapter 4: International Financial Reporting Standards: Part I

Learning Objectives Discuss the types of differences that exist between International Financial Reporting Standards (IFRS) and U.S. generally accepted accounting principles (GAAP) Describe IFRS requirements related to the recognition and measurement of assets, specifically inventories; property, plant, and equipment; intangibles; and leased assets Explain major differences between IFRS and U.S. GAAP on the recognition and measurement of assets Describe the requirements of IFRS in a variety of disclosure and presentation standards

Learning Objectives Explain major differences between IFRS and U.S. GAAP on certain disclosure and presentation issues Analyze the impact that differences between IFRS and U.S. GAAP can have on the financial statements

Types of Differences Between IFRS and U.S. GAAP Definition differences Recognition differences Measurement differences Alternatives Lack of requirements or guidance Presentation differences Disclosure differences

IFRS and U.S. GAAP IFRS more flexible in many cases Choice between alternative treatments in accounting IFRS generally have less bright-line guidance More judgment is required in applying IFRS IFRS is a principles-based accounting system: whereas U.S. GAAP is a rules-based system

IAS 2, Inventories Provides more extensive guidance than U.S. GAAP Cost of inventories include: Costs of purchase Costs of conversion Other costs design, interest if takes time to bring to saleable condition Cost of inventories exclude: Abnormal waste Storage unless necessary for the production process Administrative overhead Selling costs

IAS 2, Inventories Limited choice with regard to cost formulas Does not allow LIFO Standard cost method and retail method are acceptable only if they approximate cost as per IAS 2 Cost of inventories not ordinarily interchangeable and produced and segregated for specific projects should use specific identification An entity must use same cost formula for similar inventory items IAS 2 requires inventory to be reported at the lower of cost or net realizable value Typically applied on item-by-item basis, but grouping allowed for items of inventory relating to same product line Write-downs are reversed when selling price increases

IAS 16, Property, Plant, and Equipment Recognition of initial costs Probable future benefits Can be measured Recognition of subsequent costs Must follow initial recognition rules Carrying amount of the replaced part should be de-recognized Measurement at initial recognition Purchase price + costs to perform as intended + costs of dismantling and removing the asset Measurement subsequent to initial recognition Can use cost model or revaluation model

IAS 16, Property, Plant, and Equipment Depreciation Review estimated lives, residual value, and method annually Treat any changes prospectively When comprised of significant parts, use component depreciation Derecognition Derecognize carrying amount of property, plant, and equipment When asset is disposed When no future economic benefits are expected Gain or loss is included in net income

IAS 40, Investment Property Land or buildings held for rental, capital appreciation, or both Same general principles as per IAS 16: choice of cost or revaluation model: Changes in fair value is recognized in current income and not revaluation surplus U.S. GAAP generally requires use of cost mode Disclose fair value in notes when using the cost model

IAS 36, Impairment of Assets Must test annually for impairment to plant, property and equipment; intangible assets; goodwill; investments in subsidiaries; associates, and joint ventures Does not apply to inventory, construction in progress, deferred tax assets, employee benefit assets or financial assets (eg: accounts and notes receivable) Impairment under IAS 36 = carrying amount > recoverable amount Recoverable amount is the greater of net selling price and present value of future net cash flows Impairment more likely under IFRS since discounted cash flows are used U.S. GAAP uses undiscounted future cash flows

IAS 36, Impairment of Assets Reverse impairment loss when recoverable amount exceeds new carrying amount: if changes in estimates used to determine original impairment loss or change in how recoverable amount is determined Reversal only up to original carrying amount Recognize reversal in income immediately U.S. GAAP allows no reversal

IAS 38, Intangible Assets Applies to purchased intangibles, intangibles acquired in business combination, internally generated intangibles Goodwill is covered separately under IFRS 3 Intangible asset is identifiable, nonmonetary asset without physical substance: Held for production of goods or services, rental to others, or for administrative purposes Controlled by enterprise as result of past events from which future economic benefits are expected to be realized Must be expenses immediately if it does not meet the definition Except when obtained in business combination

IAS 38, Intangible Assets Purchased intangibles measured at cost Useful life could be assessed as finite or indefinite Distinction between intangibles with finite life and indefinite life is made in IAS 38

Intangibles Acquired in Business Combination Patents, trademarks, and customer lists recognized as assets measured at fair value Even if not previously recognized by target Must have finite or infinite life Special treatments for in-process research and development Capitalize when certain criteria is met Otherwise include in goodwill

Internally Generated Intangibles Major difference with U.S. GAAP IFRS allows some development costs to be capitalized U.S. GAAP expenses all research and virtually all development

Internally Generated Intangibles Criteria for development cost capitalization: Technical feasibility of completion Intention to complete asset for use or sale Ability to use or sell the asset How probable future economic benefits will be generated Market or internal use Available adequate technical, financial, and other resources to complete the asset for use or sale Ability to reliably measure expenditures pegged to development

Internally Generated Intangibles Other issues: Revaluation model is allowed with finite-lived intangibles If there is a price on an active market Impairment of intangibles If carrying amount can’t be recovered on finite-lived assets—need to look at changes in events or circumstances For indefinite-lived intangibles and goodwill Test annually Under special circumstances can reverse as per IAS 36

IFRS 3, Business Combinations Recognize goodwill only in business combinations Difference between: Consideration paid by acquirer plus noncontrolling interest Fair value of net assets acquired Negative goodwill must be recognized as income Goodwill depends on the option selected to measure any noncontrolling interest Measured at either A proportionate share of the fair value of the acquired firm’s net assets excluding goodwill Fair value, including the noncontrolling interest’s share of goodwill

IFRS 3, Business Combinations Not amortized as it is an indefinite-lived intangible asset Impairment of goodwill must be tested annually Impairment is tested at the level of the cash-generating unit (CGU) Compare carrying value of CGU, including goodwill, with recoverable amount U.S. GAAP is tested at level of the reporting unit which can be different and typically larger than CGU U.S. GAAP only requires a bottom-up test

IAS 23, Borrowing Costs Revised in 2007 to be similar to U.S. GAAP as part of convergence project Capitalize all borrowing costs to extent they are attributable to acquisition, construction, or production of a qualifying asset Expense all other borrowing costs Borrowing costs include interest and other costs incurred in connection with borrowing IAS 23 includes foreign currency exchange to the extent they related to interest costs Under IAS 23, inventories qualify if they require substantial period to manufacture

IAS 23, Borrowing Costs Capitalize interest that could have been avoided in absence of expenditure on the qualifying asset Amount capitalized by multiplying weighted-average accumulated expenditures by appropriate interest rate Can use actual interest rate if can associate specific borrowing as being less than total expenditures

IAS 17, Leases Distinguishes between finance (capitalized) leases and operating leases Provides rules for sale-leaseback transactions Conceptually similar to U.S. GAAP but provides less specific guidance Finance leases transfer substantially all the risks and rewards of ownership to lessee

IAS 17, Leases Situations normally leading to capitalization, individually or in combination Lease transfers ownership to lessee by end of lease term Lessee has option to purchase at less than FMV Lease term is for major part of the asset’s economic life U.S. GAAP says 75% Present value of minimum lease payments at lease inception is equal to substantially all of the fair value of the leased asset U.S. GAAP says 90% Leased asset is specialized that only the lessee can use it without major modifications Not present in U.S. GAAP

IAS 17, Leases Other indicators leading to capitalization, individually or in combination: Lessee bears loss on lease cancellation Lessee absorbs gain or loss from fluctuation in market value of residual asset value Lessee may extend lease for additional period at substantially below market rent Other finance lease considerations Capitalize lease acquisition costs IAS 36 impairment rules apply Depreciate over shorter of useful life or lease term Finance leases must be classified as such by lessor and lessee

IAS 17, Leases Sale-Leaseback—Finance Lease: Must defer any gain on sale and recognize it in income over the lease term U.S. GAAP rules generally similar If fair value less than carrying value, IAS 17 recognizes loss only if loss due to impairment Sale-Leaseback—Operating Lease: IAS 17 recognizes gain immediately in income U.S. GAAP amortizes gain over lease term

IAS 17, Leases Disclosures: Lessees must disclose future minimum payments related to finance leases and operating leases separately as follows: Amount to be paid in Year 1 Amount to be paid in Years 2-5 as a single amount Amounts to be paid in Year 6 and beyond as single amount Present value of future minimum payments under finance leases U.S. GAAP requires disclosure payments for each of years 1–5 separately by year and then lump remaining years as single amount

IAS 17, Leases IASB/FASB Convergence Project: Exposure draft issued in August 2010 for proposed new standard on accounting for leases Revised draft on leases in 2013 Significant changes proposed for lessors and lessees Lessee would recognize “right-of-use” asset and liability to make lease payments for all leases No more finance and operating lease distinction All leases would be finance leases Take furthest possible term On sale-leaseback, seller would recognize as sale or borrowing depending on certain conditions

Disclosure and Presentation Standards IAS 7, Statement of Cash Flows: Classified as operating, investing or financing Operating cash flows may use direct or indirect method Interest, dividends, and income taxes must be reported separately Interest and dividends paid may be classified operating or financing Interest and dividends received may be classified operating or investing Income taxes are operating unless specifically identified with investing or financing activities Can only disclose noncash investing and financing activities outside of this statement

Disclosure and Presentation Standards IFRS/U.S. GAAP differences in statement of cash flows: Interest paid and received and dividends received all operating cash flows Dividends paid are financing cash flows Indirect method Reconciliation must begin with net income Direct method Must reconcile operating cash flows to net income

Disclosure and Presentation Standards IAS 10, Events After Reporting Period: Known under U.S. GAAP as “subsequent events” Covers events between balance sheet date and authorized date of issuance of financial statements U.S. GAAP—through date of issuance Types of after-the-reporting-period events Adjusting events Non-adjusting events

Disclosure and Presentation Standards IAS 8, Accounting Policies, Changes in Accounting Estimates, and Errors: Hierarchy of authoritative pronouncements IASB Standard or interpretation specific to the event or transaction IASB Standard or Interpretation dealing with similar and related issues Definitions, recognition criteria, and measurement concepts in the IASB Framework Most recent pronouncements of other standards setting bodies that use similar framework (like FASB) Changes in accounting policy only if the change: Is required by IFRS Results in more relevant and reliable information

Disclosure and Presentation Standards IAS 8, Accounting Policies, Changes in Accounting Estimates, and Errors: Changes in estimates due to new developments and new information accounted for in current or future periods Correction of errors material, prior-period errors should be corrected retrospectively When impractical to determine period-specific effects of an error, the entity retrospectively restates the opening balances for the earliest period practicable Related party disclosures must be disclosed in the notes to financial statements

Disclosure and Presentation Standards IAS 33, Earnings per Share: Basic and diluted EPS must be on face of income statement U.S. GAAP has more detailed guidance on diluted EPS: But application appears consistent with IAS 33 IAS 34, Interim Financial Reporting: No guidance as to who should prepare, how often, or how soon after end of the period Treats interim periods as discrete reporting periods U.S. GAAP treats interim reporting as integral part of full year Describes minimum content and accounting principles applied

Disclosure and Presentation Standards Noncurrent assets held for sale reported separately on balance sheet at lower of carrying value or fair value less costs to sell These assets are not depreciable Similar to U.S. GAAP After-tax profit/gain or loss on disposal of discontinued operation must be reported as a single amount Details must be disclosed in the notes or on the income statement

Disclosure and Presentation Standards IFRS 8, Operating Segments, issued in 2006 Replaced IAS 14, Segment Reporting Requires extensive disclosures for each separate operating segment Disclosures similar to U.S. GAAP except the latter doesn’t require disclosure of liabilities

End of Chapter 4