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10/28/2017
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International Financial Reporting
Standards (IFRS)Dr. Regan Garey, CPA
IFRS Convergence Update
Items to discuss:
Adoption vs. Convergence with IFRS
IFRS vs. US GAAP
Updates on where key players stand on convergence
Advantages to convergence
Examination of Germany’s progress
Contentious areas delaying convergence
New Revenue Recognition rules
New Lease Accounting rules: IFRS complexities
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IFRS
International Financial Reporting Standards (IFRS) issued by the International Accounting Standard Board (IASB) comprise a comprehensive set of standards providing guidance for the preparation and presentation of financial statements.
Adoption vs. Convergence
Adoption is less likely More likely, the U.S. will converge U.S. GAAP with IFRS
Constant debate on this fundamental issue
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IASB
IFRS How are they interrelated?
IASB
The International Accounting Standards Board (IASB) had 28 International Accounting Standards (IAS) and 13 International Financial Reporting Standards (IFRS) in force in 2013.
In 2002, the IASB and U.S. Financial Accounting Standards Board (FASB) agreed to work together to reduce differences between IFRS and U.S. GAAP.
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IFRS vs. US GAAP
IFRS is the accounting standard for more than 52 per cent of the largest companies in the world, according to the Fortune 500 listing.
US GAAP is the second largest accounting standard in the world, with 29 per cent of those companies using it.
“Based on” or “converged with”
Many jurisdictions that maintain their own local GAAP claim that their local GAAP is "based on" or "similar to" or "converged with" IFRSs. In some cases the wording changes seem minor, and in other cases the wording is quite different. Sometimes, the jurisdiction's local GAAP is not in English.
Often, not all IASs/IFRSs have been adopted locally. Often there is a time lag in adopting an IFRS as local GAAP. Few are in a position to compare national or regional GAAPs to IFRSs in detail.
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Credible Source
IAS (International Accounting Standards)
Created by the IASB (International Accounting Standards Board).
Background for the link (next slide)
Note: They are currently reconsidering the format of the table to reflect differing degrees of convergence with IFRSs - you can access our revised approach in relation to use of IFRSs by domestic listed companies of the G20 countries.
Merged entries with only a footnote in the table below are temporary only and are not included in the totals at the end of the table.
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Countries that have adopted IFRS
http://www.iasplus.com/country/useias.htm
EU No Longer Dominant!
The European Union continues to be a major user of IFRSs but it is no longer the dominant one.
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Danjou’s Comments
.Mr Danjou writes about the many jurisdictions that have adopted IFRSs since then as well as about the jurisdictions that haven't - among them China and the United States.
He lists three lessons that are to be learned from this analysis:
IFRS: Three “Lessons”
IFRSs now play a preeminent role throughout the world -the majority of jurisdictions have made a commitment to IFRSs and the jurisdictions that apply them represent more than half of the world's wealth.
The European Union continues to be a major user of IFRSs but it is no longer the dominant one.(as stated above)
IFRSs are applied by 52 per cent of the Fortune 500 companies; US GAAP is applied by 29 per cent of these companies (as stated above)
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International Market Segment
Hence, in the international market segment, in other words the companies whose securities are likely to be acquired by foreign investors, 84 per cent of the companies apply IFRS, compared with 16 per cent that apply US GAAP.
Discussion Question
What are your thoughts about the previous slide’s statement about the strong hold IFRS based companies have on the world stock market?
What are some pros and cons to this supposed change?
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Differences between IFRS and U.S. GAAP
A. Definition differences. Differences in definitions can occur even though concepts are similar. Definition differences can lead to differences in recognition and/or measurement.
B. Recognition differences. Differences in recognition criteria and/or guidance related to (a) whether an item is recognized, (b) how it is recognized, and/or (c) when it is recognized (timing difference).
Differences between IFRS and U.S. GAAP
C. Measurement differences. Differences in approach for determining the amount recognized resulting from either (a) a difference in the method required, or (b) a difference in the detailed guidance for applying a similar method.
D. Alternatives. One set of standards allows a choice between two or more alternative methods; the other set of standards requires one specific method to be used.
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Differences between IFRS and U.S. GAAP
E. Lack of requirements or guidance. IFRS do not cover an issue addressed by U.S. GAAP, and vice versa.
F. Presentation differences. Differences in the presentation of items in the financial statements.
G. Disclosure differences. Differences in information presented in the notes to financial statements related to (a) whether a disclosure is required and/or (b) the manner in which a disclosure is required to be made.
Example: Germany
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An exception applies to banks / financial institutions, where all financial instruments are held for trading to be carried at fair value.
A second exception applies to assets that are withdrawn from all other creditors and only accessed to the pension liability or comparable long-term liabilities. You must also be accounted for at fair value.
Accounting Framework and accounting principles (Germany)
Fulfillment of capital market expectations to a higher degree
Improvement of comparability to industry peers
Financial objectives pursued in changing to an international GAAP regime
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International reporting systems such as IFRS or US GAAP are viewed as capital-market oriented systems whose main feature is the supply of relevant information for investors.
Theoretical Differences German vs. US GAAP
German GAAP are characterized by:
Creditor protection,
Limitations on profit distribution and
Linkage with tax-reporting requirements,
Making both the balance sheet as well as the income statement less informative for investment decisions
(Breker et al., 1999: 148; Niehus and Thyll, 2000: 558).
Theoretical Differences German vs. US GAAP
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Increased diversification of investor community
Internationalization of investor community Increased attractiveness for institutional investors
Planning of a foreign listing
Reduction of the cost of equity Enhancement of credit rating
Financial objectives pursued in changing to an international GAAP regime
China and the U.S.
“The two largest economies on the planet, China and the United States, have made a commitment in favour of IFRS, as have all the countries in the G20, but have not (yet?) put it into effect.”
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IFRS’ representation of global GDP
“This is the reason why, although the jurisdictions which have made a commitment in favour of IFRS represent 96 per cent of global GDP, the score falls to 58 per cent when the jurisdictions that actually apply them are taken into consideration.
However, there is no suggestion that IFRS is not applied there at all.”
Discrepancy between favoring and applying IFRS
Discussion Question: How and why could that occur?
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In the United States, IFRS is present in two ways
“Firstly, there are approximately 500 publicly traded companies that apply IFRS. These are the Foreign Private Issuers, the non-US companies that raise capital in the USA (some of which are among the largest corporations in the world: Daimler, Nestlé, Total, Sanofi, etc).”
Primary Benefits of Switching to IFRS
“One of the main benefits for these companies of the switch to IFRS has been the end of the obligation to prepare and publish a reconciliation between the financial statements published in their country of origin and the amounts that would have been reported under US GAAP.”
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Since 2008 in the U.S.
“
Since 2008, if the financial statements are prepared using IFRS (without restriction), they are admissible in the United States without any accounting reconciliation. The reconciliation was a source of cost and complexity for these large corporations.”
Power Struggle?
Next, the US standards are converging with IFRS standards. From a European perspective, there is a tendency to only see the efforts made by IASB to achieve convergence with US GAAP, but US GAAP is also converging with IFRS.
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Progress in Convergence
Although the USA has not made a decision to switch to IFRS, work on convergence has continued and the differences between the two bodies of standards are being reduced.
Lastly, it should not be forgotten that US investors are major buyers of securities in companies that use IFRS and are therefore major users of IFRS.
Key Players
Power Struggle IASB:
International Accounting Standards Board
Hans Hoogervorst (new Chairman)
Loss of Power?
FASB: Financial Accounting Standards Board
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Advantages to IFRS
A Broad Overview
“U.S. convergence really began in earnest a number of years ago. In 2002 the FASB and the IASB signed what came to be known as the Norwalk Agreement.
Both Boards pledged to work together to converge their standards.”
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Benefits of One Set of Accounting Standards
In capital markets, the enhanced communication that results from using one set of accounting standards translates into increased investor confidence and understanding, which means reduced risk.
•Greater transparency, credibility, and comparability of companies, regardless of political boundaries.
•Investor confidence and understanding provides for the free flow of capital across borders.
•These cross-border capital flows allow for the most efficient allocation of capital to the benefit of all participating economies.
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Framework for Financial Reporting
Getting away from a ‘problem-by-problem’ approach
“sets forth fundamental objectives and concepts that the Board uses in developing future standards of financial reporting” (Weiso)
International Accounting Convergence: SEC Roadmap
2008: Foreign issuers allowed to file in the U.S. without reconciliation
2008: SEC issues Roadmap
2011: SEC supposedly to decide on required use of IFRS by US companies
2012-2014: US Companies, investors, auditors and regulators prepare for use of IFRS
2015: Required use of IFRS
2017 – what happened????
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2017- Date Missed!
Many deadlines for convergence have come and gone.
Progress is slow and cumbersome.
Break Out Discussion Questions
What timeframe for convergence seems reasonable to you and why?
In your line of work, does this issue get discussed? If not, why not?
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Business executives, financial staff, and accountants of U.S. companies need to understand:
•What IFRS is•Where IFRS come from•Differences between US GAAP and IFRS
Principles vs. Rules Based
Principles Principles based= IFRS
IFRS = approximately 2,900 pages
Use of judgment
Interpretations
Rules Rules based= US GAAP US GAAP= 10 times as
long as IFRS Over 70 year history
many interpretations Circumventing rules can
occur Use of red line
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Examples of Rules based U.S. GAAP
Leases (capital vs. operating)
SPE’s
Bank covenants
What challenges has your company had in keeping both principles and rules?
If No IFRS equivalent
Some experts have expressed concerns that, especially in the U.S., companies will simply default to U.S. GAAP if IFRS are sanctioned for U.S. issuers, potentially affecting the move toward IFRS as the one set of globally accepted accounting standards.
Included in IFRS is guidance for when a standard or interpretation does not address an accounting matter.
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Question
What do issuers believe the cost of converting from U.S. GAAP to IFRS would be? How would one conclude that the benefits of converting justify those costs?
List of IFRS Issued Since IASB’s Inception
IFRS 1–First-Time Adoption of International Financial Reporting Standards
IFRS 2–Share-Based Payment
IFRS 3–Business Combinations
IFRS 4–Insurance Contracts
IFRS 5–Noncurrent Assets Held for Sale and DiscontinuedOperations
IFRS 6–Exploration for and Evaluation of Mineral Resources
IFRS 7–Financial Instruments: Disclosures
IFRS 8–Operating Segments
IFRS 9–Financial Instruments
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First Time Adoption of IFRS Steps
Identify the timing of the first IFRS statements
Prepare an opening balance sheet at the date of transition to IFRS
Select accounting principles that comply with IFRS, and apply these principles retrospectively
Make extensive disclosures to explain the transition to IFRS
Self Quiz
Which statement is correct regarding IFRS?
A) IFRS reverses the rules of DR’s and CR’s, that is, debits are on the right and credits are on the left
B) IFRS uses the same process for recording transactions as GAAP
C) The chart of accounts under IFRS is different because revenues follow assets
D) None of the above are correct
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Answer!
Which statement is correct regarding IFRS?
A) IFRS reverses the rules of DR’s and CR’s, that is, debits are on the right and credits are on the left
B) IFRS uses the same process for recording transactions as GAAP
C) The chart of accounts under IFRS is different because revenues follow assets
D) None of the above are correct
Similiarity Index Between US GAAP and IFRS
In the neighborhood of 70-80% the same.
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Self Quiz Question Number 2
Information in a company’s first IFRS statements must:
A) have a cost that does not exceed the benefits
B) be transparent
C) provide a suitable starting point
D) all of the above
Answer!
Information in a company’s first IFRS statements must:
A) have a cost that does not exceed the benefits
B) be transparent
C) provide a suitable starting point
D) all of the above
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Differences exist between IFRS and U.S. GAAP with respect to the recognition and measurement of assets.
IFRS require inventory to be reported on the balance sheet at the lower of cost or net realizable value; U.S. GAAP requires the lower of cost or replacement cost, with net realizable value as a ceiling and net realizable value less a normal profit margin as the floor.
U.S. GAAP allows the use of LIFO; IFRS do not.
Property, plant and equipment
– Subsequent to acquisition, IFRS allow fixed assets to be reported on the balance sheet using a cost model (historical cost less accumulated depreciation and impairment losses) or
A revaluation model (fair value at the balance sheet date less accumulated depreciation and impairment losses);
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PPE cont’d
• U.S. GAAP requires the use of the cost model. Componentdepreciation must be applied under IFRS when items of property, plant and equipment are comprise of significant parts;
• This is not the case under U.S. GAAP
Development Costs
When certain criteria are met, IFRS require development costs to be capitalized as an asset and then amortized over their useful life; U.S. GAAP requires development costs to be expensed as incurred.
An exception exists in U.S. GAAP for software development costs.
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Borrowing Costs
Similar to U.S. GAAP, IFRS requires borrowing costs to be capitalized to the extent they are attributable to the acquisition, construction, or production of a qualifying asset.
Other borrowing costs are expensed as incurred.
However, the amount of borrowing costs to be capitalized differs between IFRS and U.S. GAAP.
Impairment of Assets
An asset is impaired under IFRS when its carrying amount exceeds its recoverable amount, which is the greater of net selling price and value in use.
Value in use is calculated as the present value of future cash flows expected from continued use of the asset and from its disposal. An asset is impaired under U.S. GAAP when its carrying amount exceeds the undiscounted future cash flows expected from the asset’s continued use and disposal.
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Financial Statement Presentation
GAAP: single step or multi-step I/S
IFRS: no mention of the differences
IFRS states minimum items that must be on the I/S; not so for GAAP
IFRS does not define key measures like income from operations. SEC regulations define many key measures and provide requirements and limitations on companies reporting non-GAAP/IFRS information.
Disclosure and Presentation Issues
In the statement of cash flows, IAS 7 allows interest and dividends received to be classified as operating or investing, whereas these are always classified as operating under U.S. GAAP.
IAS 7 allows interest and dividends paid to be classified as operating or financing, whereas interest paid is operating and dividends paid is financing under U.S. GAAP.
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Disclosures cont’d
IAS 10 requires financial statements to be adjusted forso-called adjusting events that occur up to thepoint that the financial statements have beenauthorized for issuance.
U.S. GAAP uses the date the financial statements areissued or are available to be issued as the cutoffdate for adjusting events.
IAS 8
IAS 8 establishes a hierarchy of authoritative pronouncements to be considered in selecting an accounting policy. The lowest level in the hierarchy would allow the use of U.S.GAAP. Once selected, accounting policies must be applied consistently unless a change is required by IFRS or would result in more relevant information being reported in the financial statements.
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Disclosures cont’d
IFRS 5 provides a more liberal definition of what qualifies as a discontinued operation than does U.S. GAAP.
Statement of Comprehensive Income
This statement shall include all items of income and expense, including:– Components of profit or loss (components of the
normal Income Statement), and
– Components of other comprehensive income (items not recognized in profit or loss)
These items may be presented either:– In a single Statement of Comprehensive Income, in
which there is sub-total for profit or loss
– In a separate Income Statement (displaying components of profit or loss) and a Statement of Comprehensive Income (beginning with profit or loss and displaying components of other comprehensive income)
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Statement of Comprehensive Income
More focus on this statement with IFRS
May be shown in two alternate forms.
Statement of Comprehensive Income
In May 2010, the IASB issued a mandate for a single statement presentation
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Other Comprehensive Income
Actuarial gains/losses on defined benefit plans IAS 19 Foreign currency translations IAS 21 Gains/losses on remeasuring assets IAS 39 Effective portion of gains/losses on cash flow hedges IAS
39 Changes in revaluation surplus IAS 16 and IAS 38
Income Statement
Presentation is based on either “nature of the expense” or “function of expense” (cost of sales presentation)
If function of expense is used, the nature of expenses must be separately disclosed in the footnotes
Also disclose on the Income Statement or in notes
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Different Statement Names
Balance Sheet Statement of Financial Position
Following are the principal differences from GAAP in the presentation of the Statement of Financial PositionThe following line items are required:Required
a. Property, plant and equipment
b. Investment property
c. Intangible assets
d. Financial assets [excluding amounts shown under (e), (h), and (i)]
e. Investments accounted for using the Equity Method
f. Biological assets
g. Inventories
h. Trade and other receivables
i. Cash and cash equivalents
j. The total of assets classified as held for sale and assets included in disposal groups classified as held for sale
Line Itemsk. Trade and other payables
l. Provisions
m. Financial liabilities [excluding amounts shown under (k) and (l)]
n. Liabilities and assets for current tax
o. Deferred tax liabilities and deferred tax assets
p. Liabilities included in disposal groups classified as held for sale
q. Noncontrolling interests, presented within equity
r. Issued capital and reserves attributable to equity holders of the parent
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Break Out Activity
In your group, discuss what elements of the Income Statement and Balance Sheet must be reported separately and in what order.
Statement of Financial Position (SOFP)No specific format is prescribed for the SOFP.
All IFRS examples use the European structure of putting long-term assets and equity at the top and cash and current assets at the bottom, but this is not required—the conventional GAAP presentation is OK.
Two years of comparative information are required.
A third SOFP is required for the beginning of the first year displayed, if: An accounting policy has been applied retrospectively, or Items in the financial statements have been restated or reclassified
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Statement of Financial Position Format
Assets, liabilities and equity Separately stated with totalsDifferentiate between current
and non-current assets and liabilities
Special sub-categories –investments, assets held for sale, deferred items, etc.
If there is a long-term debt liability on the SOFP and the company is in violation of a debt covenant for that liability
:
– IFRS 1 allows the liability to remain long-term, if the lender has granted a waiver before the end of the reporting period, ending at least 12 months after the reporting period, during which the lender cannot demand immediate payment.
– U.S. GAAP allows the liability to remain long-term:
• If the lender has granted a waiver for a period greater than one year before the issuance of the financial statements
• When it is probable that the violation will be cured within any grace period in the liability contract
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Self Quiz Question
When converting to IFRS, a company must:
A) Recast previously issued financial statements in accordance with IFRS
B) Use GAAP in the reporting period but subsequently use IFRS
C) Prepare at least three years of comparative statements
D) Use GAAP in the transition year but IFRS in the reporting year
Answer!
When converting to IFRS, a company must:
A) Recast previously issued financial statements in accordance with IFRS
B) Use GAAP in the reporting period but subsequently use IFRS
C) Prepare at least three years of comparative statements
D) Use GAAP in the transition year but IFRS in the reporting year
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In the Opening Statement of Financial Position the entity shall:
– Recognize all assets and liabilities whose recognition is required by IFRS
– Not recognize items as assets or liabilities if IFRS do not permit such recognition
– Reclassify items that it recognized under previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity under IFRS
– Apply IFRS in measuring all recognized assets and liabilities
Self Quiz
Which of the following statements about IFRS and GAAP accounting and reporting requirements for the balance sheet is NOT correct?
A) both IFRS and GAAP distinguish between current and noncurrent assets and liabilities
B) the presentation formats required by both are similar
C) both require that comparative information be reported
D) one difference between them is that IFRS balance sheets may list long term assets first
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Answer!
Which of the following statements about IFRS and GAAP accounting and reporting requirements for the balance sheet is NOT correct?
A) both IFRS and GAAP distinguish between current and noncurrent assets and liabilities
B) the presentation formats required by both are similar
C) both require that comparative information be reported
D) one difference between them is that IFRS balance sheets may list long term assets first
Preliminary Views on Financial Statement Presentation
After deliberations thru March 2010, the boards have tentatively decided to require: Assets, liabilities, revenues and expenses be
categorized as operating, investing, financing, taxes or disc ops
The direct method for cash flows, with certain indirect information presented in the notes
A ‘roll forward’ presentation in the notes of significant statement of financial position line items
Disaggregation of information by function (cost of sales, selling and marketing) on the comprehensive income statement and by nature (rent, payroll, depreciation) in the notes
Reconciliation of the changes in debt and related financial balances
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Provisions and Contingent Liabilities
IAS 37 distinguishes between a contingent liability, which is not recognized on the balance sheet, and a provision, which is.
A provision is defined as a “liability of uncertain timing or amount.”
Provisions
A provision should be recognized when:
a. the entity has a present obligation (legal or constructive) as a result of a past event,
b. it is probable (more likely than not) that an outflow of resources embodying economic events will be required to settle the obligation, and
c. a reliable estimate of the obligation can be made.
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The Statement of Financial Position The increase in the value of the asset is placed directly in
equity in a separate Revaluation Reserve Account.
Revaluations must be frequent enough that the gross valueof the asset less depreciation is equivalent to the fair value of the asset.
Revaluation Reserve
The Revaluation Reserve Account can be either:– Proportionally transferred to
retained earnings as the asset is depreciated
– Kept in equity until the asset is retired or sold, when it is transferred to Retained Earnings
The Revaluation Reserve can never have a debit balance.
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Self Quiz
Which of the following statements is TRUE?
A) the fair value option requires that some types of financial instruments be recorded at FV
B) the fair value option requires that all noncurrent financial instruments be recorded at amortized cost
C) the fair value option allows but does NOT require that some types of financial instruments be recorded at FV
D) the FASB and IASB would like to reduce the reliance on fair value accounting for financial instruments in the future
Answer!
Which of the following statements is TRUE?
A) the fair value option requires that some types of financial instruments be recorded at FV
B) the fair value option requires that all noncurrent financial instruments be recorded at amortized cost
C) the fair value option allows but does NOT require that some types of financial instruments be recorded at FV
D) the FASB and IASB would like to reduce the reliance on fair value accounting for financial instruments in the future
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Break Out Question
What are the incentives and barriers to adapting the training curricula for experienced professionals to address both IFRS and U.S. GAAP? Separate from ongoing training, how long might it take for a transition to occur? How much would it cost?
An entity’s first IFRS financial statements shall include:
– Reconciliations of its equity reported under previous GAAP to its equity under IFRS
– A reconciliation to its total comprehensive income under IFRS for the latest period in the entity’s most recent annual financial statements
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First Year Financials Details Cont’d
If the entity recognized or reversed any impairment losses for the first time in preparing its opening IFRS Statement of Financial Position, the disclosures that lAS 36–Impairment of Assets would have required if the entity had recognized those impairment losses or reversals in the period beginning with the date of transition to IFRS
Lack of Guidance in IFRS
For the most part, the detailed guidance in U.S. GAAP for specific transactions types is not in IFRS. Examples include:
– Software revenue recognition
– Multiple element arrangements
– Right of return transactions
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Inventories
The major differences from U.S. GAAP and IAS 2–Inventories in accounting for inventory are:– The LIFO method of calculating
inventory value is prohibited.– The same value formula must be
applied to all inventories that have a similar nature and use to the entity.
• U.S. GAAP does not require this.
LIFO Example
The difference between the inventory used for internal reporting purposes and LIFO is referred to as the Allowance to Reduce Inventory to LIFO or the LIFO reserve. The change in the allowance balance from one period to the next is called the LIFO effect.
LIFO subtracts inflation from inventory costs by charging the items purchased recently to cost of goods sold. As a result, ending inventory (assuming increasing prices) will be lower than FIFO or average cost.
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LIFO Effect Example
With LIFO With LIFO
Revenue 3,200,000
COGS 2,800,000
Oper Exp 150,000
Operating income 250,000
LIFO adjustment 40,000
Taxable income 210,000
Income taxes 36% 75,600
Cash flow 174,400
Extra cash 14,400
Increased cash flow 9 %
Without LIFO Without LIFO Revenue 3,200,000 COGS 2,800,000 Oper Exp 150,000 Operating income 250,000 LIFO adjustment 0 Taxable income 250,000 Income taxes 36% 90,000 Cash flow 160,000 Extra cash 0 Increased cash flow 0%
Cash flow was computed as follows:
Sales revenue 3,200,000
COGS (2,800,000)
Operating expenses (150,000)
Income taxes (75,600)
Cash flow $174,400
(assuming cash vs. accrual basis)
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Example Continued
The company has extra cash because its taxes are less. The reason taxes are lower is because cost of goods sold (in a period of inflation) is higher under LIFO than FIFO. As a result, net income is lower which leads to lower income taxes. If prices are decreasing, the opposite effect results.
Inventories
– Impairment of inventory is reported at Net Realizable Value (NRV).
• NRV is the estimated selling price in the normal course of business, less the estimated cost to complete the transaction and make a sale.
• U.S. GAAP requires revaluation down to Market Value, not taking into account cost to complete the transaction and make a sale.
– Earlier write-downs must be reversed if changes in economic circumstances warrant.
• This is prohibited in U.S. GAAP.
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The Statement of Financial Position
The costs associated with the creation of intangible assets are classified between the following two phases:
The Research Phase
The Development Phase
The Research Phase is always expensed. Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
PP&E: Component Depreciation
IAS 16 also requires that “each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.”
◦ No such requirement exists in U.S. GAAP.◦ Systems for tracking parts of asset need to be established.
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Depreciation
Method must be systematic and rational over the asset life net of residual value
Buildings require componentization due to separate lives (building shell, roof, electrical, HVAC, parking lots, elevators)
Initial Cost Basis of PPE
All costs required to bring asset into working condition, including Purchase costs and fees Value added, sales, duties and other taxes Freight Site preparation, setup and installation Decommissioning (ARO) costs
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Asset Retirement
Recognize when … Entity has present obligation (legal or constructive) from a
past event (acquisition or construction) It is probable resources will be needed to satisfy the
obligation Can make a reliable estimate
Discount cash flows to calculate Exclude future operating costs
Break Out Questions
In your groups, discuss the general and specific challenges of asset retirements.
Why is IFRS making the rules so specific for asset retirement and do you agree with them?
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Questions
What are the incentives and barriers relevant to the college and university education system’s ability to prepare its students for a U.S. public capital market in which U.S. issuers might report under IFRS? What are the incentives and barriers relevant to changing the content of the Uniform CPA Examination? How should the Commission address these incentives and barriers, if at all?
Statement of Cash Flows
Direct Method Cash collected from customers Interest and dividends received Cash paid to employees and suppliers Interest paid Income taxes paid Other operating cash receipts and
disbursements
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Statement of Cash Flow
Indirect Method Focuses on differences between operating
results and cash flows Reconciles net income by …
Adding back depreciation and amortization Subtracting gains and adding back losses Adjusting for changes in working capital
Revenue Recognition
IAS 18, Revenue, is a single standard that covers most revenues, in particular revenues from the sale of goods, the rendering of services, and interest, royalties, and dividends. There is no equivalent single standard in U.S. GAAP.
The general principle in IAS 18 is that revenue should be measured at the fair value of the consideration received or receivable.
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Revenue Recognition
Five conditions must be met in order for revenue from the sale of goods to be recognized.
One of these conditions requires an evaluation of whether significant risks and rewards of ownership have been transferred to the buyer; sometimes this can be difficult to determine and requires the exercise of judgment.
Revenue Recognition
In June 2010, the IASB and FASB published a joint Exposure Draft, Revenue from Contracts with Customers, which proposes a contract-based revenue recognition model to be applied across a wide range of transactions and industries.
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Revenue
Revenue = income including sales, fees, interest, dividends and royalties Generally record at gross excepting agents Excludes gains – treated elsewhere Excludes pass-through items collected on behalf of 3rd
parties
Revenue recognition convergence update• This project, which resulted in the
issuance of an exposure draft by the Boards earlier this year, is expected to supersede most of the existing industry-specific revenue recognition accounting rules and interpretations which have been used for many years, and have evolved under U.S. GAAP over time.
• Would apply broad principles to contracts for the sale of goods or services
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Recognize revenue
When all of the following have occurred: Buyer has assumed risks and rewards Seller does not retain …
(1) continuing involvement or control Revenue can be reliably measured Economic benefits will flow to seller Costs incurred or anticipated can be reliably measured
Default: revenue is earned straight line over multiple periods
Revenue Convergence cont’d
The revenue convergence efforts will mark a change for those industries that have industry-specific revenue recognition guidance provided under U.S. GAAP.
Applying a broad principles-based framework (in contrast to a rules-based framework) also has the potential to generate different accounting interpretations for similar transactions.
For example, in the technology industry, software is increasingly delivered as a service, blurring the differences between products and services.
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New Revenue Recognition Rules Implemented as of 2018
https://www.pwc.com/us/en/audit-assurance-services/accounting-advisory/revenue-recognition.html
Short video by Price Waterhouse Coopers
Break Out Question
Who do commenters think should make the decision as to whether a U.S. issuer should switch to reporting in IFRS: a company’s management, its board of directors or its shareholders?
What, if any, disclosure would be warranted to inform investors of the reasons for and the timing to implement such a decision? If management were to make the decision to switch to IFRS, do investors and market participants have any concerns with respect to management’s reasons for that decision?
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Break Out Session Questions Part 2
According to GAAP, what does the term ‘probable’ mean?
Why do semantics matter?
IAS 37: Provisions, Contingent Liabilities and Contingent Assets
ProvisionsProbable + Estimatable = Book – Disclose
ContingencyReasonably Possible = Disclose Only
Remote = Silent
Contingent Gains = Silent
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Translation of Foreign Currency
In preparing consolidated financial statements on a worldwide basis, the foreign currency financial statements prepared by foreign operations must be translated into the parent company’s reporting currency.
A. The two major issues related to the translation of foreign currency financial statements are: (1) which method should be used, and (2) where should the resulting translation adjustment be reported in the consolidated financial statements.
Translation of Foreign Currency
B. Translation methods differ on the basis of which accounts are translated at the current exchange rate and which are translated at historical rates. Accounts translated at the current exchange rate are exposed to translation adjustment (balance sheet exposure).
C. Different translation methods give rise to different concepts of balance sheet exposure and translation adjustments of differing sign and magnitude.
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Hot off the Presses: Leases
Beginning in January 2019 significant changes will be made to Lease Accounting
Leases – Update
The proposed lease standard, unless
modified based on stakeholder comments, will likely result
in some of the following changes:
• Discontinuing the operating lease classifi cation,
resulting in all leases being recorded on the balance
sheet
• Replacing rental expense with depreciation/amortization
and interest expense, impacting performance measures,
such as earnings before interest and taxes (EBIT) and
earnings before interest, taxes, depreciation, and
amortization (EBITDA)
•
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Leases Update Cont’d
Changing the timing of income statement recognition,since interest expense/income under the effective interest method will be higher in early years compared to the current straight-line recognition of rental expense/income under an operating lease
• Increasing the amount of effort needed to account for Leases
• Increasing the disclosures about leasing activities
Goal: Increased Transparency
Specifically, to show leases as part of the Balance Sheet, not just as an expense on the Income Statement.
Group 1 criteria and Group 2 criteria are now established. Group 1 criteria will be discussed here!
Standalone Pricing issues with bundling products and services
Other complexities
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Companies using IFRS Transitioning NOW
Companies are phasing in new software that addresses the new lease accounting rules as well as the new
Revenue Recognition rules
Transition period: at least two years
Three additional indicators that IFRS recognizes individually or in combination that could lead to classifying a lease as a FINANCE LEASE
1. The lessee bears the lessor’s losses if the lessee cancels the lease.
2. The lessee absorbs the gains or losses from fluctuations in the fair value of the residual value of the asset.
3. The lessee may extend the lease for a secondary period at a rent substantially below the market rent in a bargain renewal option
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Group 1 Criteria
Group I criteria provide guidance to operationalize the concept of ownership and control of an asset. To meet the Group I criteria, a transaction only needs to meet one of the five criterion!
The lease transfers ownership to the lessee at the end of the lease term. If the lease transfers ownership then the lessee firm has, in essence, purchased the asset.
The lessee is given an option to purchase the asset that the lessee is reasonably certain to exercise. For example, it might be reasonably certain that the lessee would exercise a purchase option if the specified purchase price is well below the expected value of the leased asset at the completion of the lease term.
Group 1 Criteria continued
The lease term is for a major part of the economic life of the asset. If the lease term provides the lessee the use and control over substantially all of the asset’s useful life, then the agreement should be considered equivalent to purchasing the asset.
The present value of the sum of the lease payments and any residual value the lessee guarantees to pay (that is not otherwise included in the lease payment) is equal to substantially all of the asset’s fair value. The present value computation includes lease payments in the renewal periods, if any. Meeting this criterion implies that the lessee is providing the lessor compensation that is equivalent to the purchase of the asset.
The leased asset is of a specialized nature. An asset with a specialized nature has no alternative use to the lessor at the end of the lease term. Because the asset has no alternative use to the lessor, its specialized nature implies that the lessor must have transferred control over the asset to the lessee.
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Solve for the implicit rate
Use the following information.
Kataran Company enters into a 4-year lease transaction, with payments due at the beginning of each year.
The lease payments are $68,000 per year.
The fair value of the leased asset is $280,000.
The lessor’s deferred initial direct costs are equal to $14,000.
The lessor’s estimate of the unguaranteed residual asset is $125,000.
No Observable Standalone Price
If there is not an observable standalone selling price, the lessor must use an estimate of the standalone selling price and allocate based on any of the following methods:
Adjusted market assessment approach
Expected-cost-plus-a-margin approach
Residual approach
Any of the above approaches
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Answer!
Kataran solves for the implicit rate using the following equality:
Present value of lease payments + Present value of estimated residual value
= Fair value of asset + Deferred initial direct costs
Kataran applies time value of money concepts to identify the terms needed to solve for the implicit rate: the present value, PV; the number of periods, N; the payments per period, PMT; and the future value, FV. As the payments are due at the beginning of the period, this is a present value of an annuity due problem. The present value, PV, is the present value of lease payments plus the expected residual value:
New Lease Accounting Example Use the following information for the next three questions Alpha Company
has three components in their lease agreement: the building, the equipment and the maintenance service. Total consideration in the contract is $575,000 per year. Alpha Company has identified the following standalone prices:
Component Standalone Price
Building $400,000
Equipment $100,000
Maintenance/Service $50,000
Total $550,000
For Questions 1-3 calculate percentage and allocate the consideration.
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Answer continued
Present value of lease payments + Present value of estimated residual value
= $280,000 fair value of leased asset + $14,000 initial direct costs = $294,000
Answer!
As the total consideration in the contract is not equal to the sum of the standalone prices, Alpha Company uses the relative standalone prices to allocate the total consideration to each component. The $575,000 total consideration is allocated as follows: (rounded)
Component Standalone Price Percentage Allocated Consideration
Building $400,000 73 $419,750
Equipment $100,000 18 $103,500
Maintenance/Service $50,000 9 $51,750
Total $550,000
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What companies need to know
Whether some of their operations will be required to use IFRS.
Companies should determine whether their subsidiaries, equity investees, and joint ventures are or will be required to produce IFRS financial statements.
What companies need to know
How will your company assess whether and when they should make the switch to IFRS.
For non-U.S. registrants, the reconciliation to U.S. GAAP is no longer required, provided that they use IFRS as published by the IASB.
Potential for a subset of U.S. registrants to be able to use IFRS financial statements in their SEC filings on a voluntary basis in the near term, and possibly on a mandatory basis some time thereafter.
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Conclusion
Convergence between US GAAP and IFRS may be inevitable
Timing of this change keeps changing
Monumental choices involved
Numerous pros and cons
How to educate and inform management, accountants, investors
Many free resources
www.ifrs.com
www.pwc.com
www.deloitte.com
www.aicpa.org
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Stay Informed
Who will be affected once IFRS usurps US GAAP?
Investors
Management
Attorneys
Business consultants
Small Business Enterprises
Accountants
Future accountants
Bankers
Tax professionals
Next Steps
Enroll in a three to five day intensive IFRS training course
Read updates from big four CPA firms
Follow changes on SEC and AICPA sites
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