1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Four International Financial Reporting Standards: Part I Copyright © 2012 The McGraw-Hill Companies, All Rights Reserved

2. 4-2 Chapter Topics Differences between IFRS and US GAAP. Inventories. Property, Plant & Equipment. Investment Property. Impairment of Assets. Intangible Assets. Goodwill. Borrowing Costs. Leases. Disclosure and Presentation Standards.

3. 4-3 Learning Objectives 1. Discuss the differences between IFRS and U.S. GAAP. 2. Describe IFRS requirements for recognition and measurement of inventories; property, plant and equipment; intangibles and leased assets. 3. Explain the major differences between IFRS and U.S. GAAP on the recognition and measurement of assets. 4. Describe the IFRS requirements in a variety of disclosure and presentation standards. 5. Explain the major differences between IFRS and U.S. GAAP on certain disclosure and presentation issues. 6. Analyze the impact that the differences between IFRS and U.S. GAAP can have on financial statements.

4. 4-4 Definitions. Recognition. Measurement. Alternatives. Lack of requirements or guidance. Presentation. Disclosure. Learning Objective 1

5. 4-5 IFRS more flexible in many cases: Choice of alternatives. Less guidance leads to more judgment in applying IFRS. Learning Objective 1

6. 4-6 Initial cost. Cost formulas to allocate cost of inventories to expense. Subsequent balance sheet measurement. Learning Objective 2

7. 4-7 Costs included:  Cost of purchase (purchase price and direct acquisition costs).  Conversion costs (labor and overhead).  Other costs (design, interest if takes time to bring to saleable condition). Costs excluded:  Abnormal waste.  Storage unless necessary for production process.  Purely administrative overhead.  Selling costs. Learning Objective 2

8. 4-8 Cost formulas: No LIFO! Must use same cost formula for similar inventory items. Must report on balance sheet at lower of cost or net realizable value: Unlike U.S. GAAP which uses lower of cost or market. NRV = estimated selling price less costs of completion and other costs to make sale. Learning Objectives 2 and 3

9. 4-9 Historic cost is constant over the life of the inventory. U.S. GAAP—market = replacement cost:  Ceiling = NRV  Floor = NRV –normal profit margin  Any write-down establishes new cost for subsequent periods IFRS and U.S. GAAP both yield same expense over entire life. Learning Objectives 2 and 3

10. 4-10 Recognition of initial costs —when yield probable future benefits which can be measured. Recognition of subsequent costs —i.e. replacements—follow initial recognition rules and then remove cost and a/d of the replaced part. Measurement at initial recognition —purchase price plus costs to put into service. Measurement after initial recognition —can use cost or--- unlike U.S. GAAP, can use revaluation model. Depreciation —review estimated lives, residual value and method annually—any changes are “prospective”---also, unlike U.S. GAAP—separate any significant components. Derecognition --retirements and disposals—no more future benefit. Learning Objectives 2 and 3

11. 4-11 Revaluation Model: Fair value at date of revaluation less subsequent a/d or accumulated impairment losses. Must revalue often enough so carrying value not materially different from fair value. Revalue entire class. Increases are credited to revaluation surplus account in OCI section of equity on the balance sheet. Subsequent decreases reduce previous surplus to zero— then recognized as expense. Present at gross revalued cost and revalued a/d or net. Transfer surplus to retained earnings on sale or disposal. Learning Objective 2

12. 4-12 Land or buildings held for rental, capital appreciation or both. Same general principles as IAS 16 re: choice of cost or revaluation:  EXCEPT gains or losses from changes in FV recognized in current income and not revaluation surplus Even using cost model—disclose FV in notes. U.S. generally requires use of cost model for investment property. Learning Objectives 2 and 3

13. 4-13 Must test annually for impairment to P,P & E; intangible assets; goodwill; investments in subs; 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). Some differences with U.S. GAAP. Impairment indicators—external events (eg economic, legal, technological) or internal events (eg damage, obsolescence). Learning Objective 2

14. 4-14 Impairment means carrying amount > recoverable amount:  Recoverable amount = greater of net selling price and value in use  Net selling price = price in active market less disposal costs  Value in use = PV of future net cash flows (cover maximum of 5 years unless longer period is justified)—based on approved budgets and using appropriate discount rate U.S. GAAP– carrying amount > undiscounted future cash flows (net selling price not considered). Impairment more likely under IFRS since discounted cash flows used—lower threshold. Learning Objectives 2 and 3

15. 4-15 Reverse if recoverable amount > new carrying amount---if changes in estimates used to determine original impairment loss or change in how recoverable amount is determined. Can only reverse up to original carrying amount. Recognize reversal in income immediately. U.S. GAAP—no reversal! Learning Objectives 2 and 3

16. 4-16 Applies to: Purchased intangibles. Intangibles acquired in business combination. Internally-generated intangibles. Goodwill covered separately under IFRS 3—Business Combinations. Definition: Identifiable, nonmonetary asset. No physical substance. Held for production of goods or services, rental to others, or for administrative purposes. Must be controlled by enterprise as result of past events from which future economic benefits are expected to be realized. Learning Objective 2

17. 4-17 Definition ( continued) : Must expense immediately if definition not met unless obtained in business combination and then it is included in goodwill. Purchased intangibles: Similar to U.S. GAAP treatment. Initially measured at cost and life is either finite or infinite. Finite—amortize over useful life—usually assume zero residual value unless 3 rd party agreement to purchase or active market exists. Learning Objectives 2 and 3

18. 4-18 Intangibles acquired in business combination: Like U.S. GAAP—patents, trademarks and customer lists should be separate from goodwill and recognized as long as fair value is measurable (even if not previously recognized by target). Must have finite or infinite life. Special situation re: target’s development costs incurred prior to its being acquired---if meet certain criteria— capitalize—otherwise include in goodwill. Recent changes in U.S. GAAP converged treatment of in- process development costs with IFRS. Learning Objectives 2 and 3

19. 4-19 Internally generated intangibles: Major difference with U.S. GAAP—some development costs may be capitalized whereas U.S. GAAP expenses all research and virtually all development (special rules re: software under U.S. GAAP). If can’t separate R & D—must treat all as research and expense immediately. May not capitalize internally-generated goodwill. Capitalize development when six criteria are met. Learning Objectives 2 and 3

20. 4-20 Must demonstrate the following criteria for development cost capitalization: Technical feasibility so asset can be available for use or sale. Intention to complete asset for use or sale. Ability to use or sell the asset. How probable future economic benefits will be generated (eg—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. Learning Objective 2

21. 4-21 Other considerations re: capitalization of development costs: Considerable management judgment. Include direct costs. Allocate indirect costs (personnel, materials, depreciation of equipment, etc.). Under IAS 23, Borrowing Costs -- must include such costs if they constitute a qualifying asset. Amortize over useful life with appropriate method reflecting pattern of how economic benefits will be realized (e.g. declining balance, units of production and straight-line). Learning Objective 2

22. 4-22 Must demonstrate the following criteria for development cost capitalization: Technical feasibility so asset can be available for use or sale. Intention to complete asset for use or sale. Ability to use or sell the asset. How probable future economic benefits will be generated (eg—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. Learning Objective 2

23. 4-23 Other issues: Revaluation model is allowed with finite-lived intangibles if there is a price on an active market—THIS IS RARE IN PRACTICE. 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 per IAS 36—EXCEPT for goodwill—no reversal allowed! Learning Objective 2

24. 4-24 Other issues: Revaluation model is allowed with finite-lived intangibles if there is a price on an active market—THIS IS RARE IN PRACTICE. 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 per IAS 36—EXCEPT for goodwill—no reversal allowed! Learning Objective 2

25. 4-25 Recognize only in business combinations. Equals consideration paid by acquirer plus recognized noncontrolling interest less fair value of net assets acquired (note—noncontrolling interest may be measured under two options—either proportionate share of fair value of target’s acquired net assets excluding goodwill or fair value of their share including goodwill). Negative goodwill is possible—must recognize in income. Not amortized as life is indefinite. Learning Objective 2

26. 4-26 Impairment of goodwill: Test at least annually. Impairment is tested at the level of the cash-generating unit (CGU)—the smallest identifiable group of assets that generates cash inflows—use bottom-up and top-down test to allocate overall goodwill to each CGU. Compare carrying value of CGU, including goodwill, with recoverable amount (higher of value in use and fair value less costs to sell). 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 only a bottom-up test. Learning Objectives 2 and 3

27. 4-27 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 are interest and other costs incurred in connection with borrowing—broader in scope than U.S. GAAP definition of interest cost. IAS 23 includes foreign currency exchange g/l if regarded as adjustment to interest cost. Qualifying asset takes substantial time to get ready for intended use or sale. Under IAS 23 (and not U.S. GAAP) inventories qualify if substantial time period as above. Learning Objectives 2 and 3

28. 4-28 Capitalize interest that could have been avoided in absence of expenditure on the qualifying asset. Multiply weighted average accumulated expenditures by appropriate interest rate (similar to U.S. GAAP)---can use actual interest rate if can associate specific borrowing as being less than total expenditures. Unlike U.S. GAAP—allowed to net interest income on invested borrowed funds against interest cost. Learning Objectives 2 and 3

29. 4-29 Distinguishes between finance (capitalized) leases and operating leases. Also provides rules for sale-leaseback transactions. Conceptually similar to U.S. GAAP but less specific guidance (one of the best examples of “principles-based” vs. “rules- based” provisions of IFRS and GAAP, respectively). IAS 17 says lease is finance when substantially all the risks and rewards of ownership have been transferred to lessee. Learning Objectives 2 and 3

30. 4-30 Examples of situations normally leading to capitalization, individually or in combination (for U.S. GAAP—any one of the first four criteria will trigger capitalization): Lease transfers ownership to lessees 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 future 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 assets specialized so only usable by lessee without major modifications (not present in U.S. GAAP). Learning Objectives 2 and 3

31. 4-31 Other indicators leading to capitalization, individually or in combination (not present under U.S. GAAP): 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 (U.S. GAAP silent— common practice is defer and amortize over lease term). 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. Learning Objectives 2 and 3

32. 4-32 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, whereas US GAAP requires immediate recognition of loss regardless of source. Sale-Leaseback—Operating Lease: IAS 17 recognizes gain immediately in income. U.S. GAAP amortizes gain over lease term. Learning Objectives 2 and 3

33. 4-33 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—more detailed info—disclose payments for each of Years 1-5 separately by year and then lump remaining years as single amount. Learning Objectives 2 and 3

34. 4-34 IASB/FASB Convergence Project: Exposure draft issued in August 2010 for proposed new standard on accounting for leases. 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 over furthest possible term. Lessors would recognize an asset for right to receive payments and derecognize lease asset or recognize liability depending on exposure to risks and rewards associated with leased asset. Sale-leaseback—seller would recognize as sale or borrowing depending on certain conditions. Learning Objectives 2 and 3

35. 4-35 IAS 17, Statement of Cash Flows: Classified as operating, investing or financing. Operating cash flows may use direct or indirect method (indirect method: can reconcile to operating income or any measure of income). 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. Learning Objective 4

36. 4-36 IAS 17, Statement of Cash Flows (continued ) : Must disclose and reconcile components of cash and cash equivalents with amounts reported on balance sheet (need not agree with a single line item on the balance sheet). Bank overdrafts can reduce cash/cash equivalents if an integral part of cash management—otherwise classified as financing activity. 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 Learning Objectives 4 and 5

37. 4-37 IFRS/U.S. GAAP differences in statement of cash flows (continued): Cash/cash equivalents line must reconcile with same line on balance sheet. 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). Adjusting events—existed at balance sheet date, such as estimated legal settlement—finalized before authorized date of issuance—must adjust as of balance sheet date! Non-adjusting events—events arose after balance sheet date but before issuance authorized—disclose nature of event and estimate of financial effect or that estimate can’t be made. Learning Objectives 4 and 5

38. 4-38 IAS 8, Accounting Policies, Changes in Accounting Estimates, and Errors: Hierarchy of authoritative pronouncements:  IASB Standard or Interpretation specific to 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 required by IFRS  Results in more relevant and reliable information  Apply retrospectively if practical—adjust carrying value of affected assets and liabilities and beginning retained earnings—do not report cumulative effect of change in net income! Learning Objective 4

39. 4-39 IAS 8, Accounting Policies, Changes in Accounting Estimates, and Errors (continued) : Changes in estimates are handled prospectively Correction of errors—if material—handle retrospectively and change all affected comparative periods and beginning retained earnings  If can’t determine period-specific effects—just change earliest period and restate opening balances where practical (U.S. GAAP has no such option— all material errors must be corrected through restatement) Related Party Disclosures: Similar to U.S. GAAP Must disclose transactions in notes if one party has ability to significantly influence or control another party Learning Objectives 4 and 5

40. 4-40 IAS 33, Earnings per Share: Basic and diluted EPS must be on face of income statement U.S. GAAP has more detailed guidance re: diluted EPS, but appears consistent with IAS 33 IAS 34, Interim Financial Reporting: Treat interim periods fundamentally as discrete reporting periods vs. U.S. GAAP which treats interim periods as integral part of full year No guidance as to who should prepare, how often and how soon after end of the period Describes minimum content and accounting principles applied Learning Objectives 4 and 5

41. 4-41 Noncurrent Assets Held for Sale and Discontinued Operations: Report separately on balance sheet at lower of carrying value or fair value less costs to sell—similar to U.S. GAAP. Not depreciable. Discontinued operations:  After-tax profit or loss and after-tax gain on disposal of assets shown as single amount on face of income statement.  Disclose details in notes or on the face of the income statement.  Similar to U.S. GAAP except for U.S. GAAP need to show pre and post tax profit or loss on the income statement.  Definition of what constitutes discontinued operation narrower under IFRS. Learning Objectives 4 and 5

42. 4-42 IFRS 8, Operating Segments (issued in 2006—replaced IAS 14): Part of short-term convergence project with FASB. Extensive disclosures required. Must meet any of three quantitative tests—revenue, profit or loss, asset. Disclosures similar to U.S. GAAP except the latter doesn’t require disclosure of liabilities. If revenue reporting by operating segments less than 75% of total revenues, then report additional segments otherwise not required under the three quantitative tests, until 75% reached. Learning Objectives 4 and 5