CHAPTER 11
WORLDWIDE ACCOUNTING DIVERSITY AND
INTERNATIONAL ACCOUNTING STANDARDS
Chapter Outline
I. Accounting and financial reporting rules differ across countries. There are a variety of factors
influencing a country’s accounting system.
A. Legal system—primarily relates to how accounting principles are established; code law countries generally having legislated accounting principles and common law countries having principles established by non-legislative means.
B. Taxation—financial statements serve as the basis for taxation in many countries. In those countries with a close linkage between accounting and taxation, accounting practice tends to be more conservative so as to reduce the amount of income subject to taxation. C. Financing system—where shareholders are a major provider of financing, the demand for information made available outside the company becomes greater. In those countries in which family members, banks, and the government are the major providers of business finance, there tends to be less demand for public accountability and information disclosure.
D. Inflation—has caused some countries, especially in Latin America, to develop accounting principles in which traditional historical cost accounting is abandoned in favor of inflation adjusted figures.
E. Political and economic ties—can explain the usage of a British style of accounting throughout most of the former British Empire. They also help to explain similarities between the U.S. and Canada, and increasingly, the U.S. and Mexico.
F. Culture—affects a country’s accounting system in two ways: (1) through its influence on a
country’s institutions, such as its legal system and system of financing, and (2) through its
influence on the accounting values shared by members of the accounting sub-culture.
II. Nobes developed a general model of the reasons for international differences in financial reporting that has only two explanatory factors: (1) national culture, including institutional structures, and (2) the nature of a country’s financing system.
A. A self-sufficient Type I culture will have a strong equity-outsider financing system which results in a Class A accounting system oriented toward providing information for outside shareholders.
B. A self-sufficient Type II culture will have a weak equity-outsider financing system which results in a Class B accounting system oriented toward protecting creditors and providing a basis for taxation.
C. Countries dominated by a country with a Type I culture will use a Class A accounting system even though they do not have strong equity-outsider financing systems. D. Companies with strong equity-outsider financing located in countries with a Class B
accounting system will voluntarily attempt to use a Class A accounting system to compete in international capital markets.
III. Differences in accounting across countries cause several problems.
A. Consolidating foreign subsidiaries requires that the financial statements prepared in accordance with foreign GAAP must be converted into the parent company’s GAAP. B. Companies interested in obtaining capital in foreign countries often are required to provide
C. Investors interested in investing in foreign companies may have a difficult time in making comparisons across potential investments because of differences in accounting rules across countries.
IV. Harmonization is the process of reducing differences in financial reporting practices across countries.
A. The European Union attempted to harmonize accounting through the 4th and 7th Directives.
1. The 4th Directive dealt with valuation rules, disclosure, and formats of financial statements.
2. The 7th Directive dealt with the consolidation of financial statements.
3. The EU Directives caused significant change in accounting practice across Europe and reduced previous differences. However, because of considerable flexibility associated with allowed alternatives, the Directives did not achieve complete comparability across EU countries.
4. Since 2005, EU publicly traded companies have been required to use International Financial Reporting Standards issued by the International Accounting Standards Board in preparing consolidated financial statements. Parent company statements continue to be prepared in accordance with national accounting standards based on the EU Directives.
B. The International Accounting Standards Committee (IASC) was formed in 1973 in hopes of improving and promoting the worldwide harmonization of accounting principles. It was superseded by the International Accounting Standards Board (IASB) in 2001.
1. The IASC issued 41 International Accounting Standards (IAS) covering a broad range of accounting issues. Ten IASs have been superseded or withdrawn, leaving 31 in effect.
2. The membership of the IASC was composed of over 140 accountancy bodies from more than 100 nations.
3. The IASC was not in a position to enforce its standards. Instead, member accountancy bodies pledged to work toward acceptance of IASs in the respective countries.
4. Because of criticism that too many options were allowed in its standards and therefore true comparability was not being achieved, the IASC undertook a Comparability Project in the 1990s, revising 10 of its standards to eliminate alternatives.
5. The IASC derived much of its legitimacy as an international standard setter through endorsement of its activities by the International Organization of Securities Commissions. IOSCO and the IASC agreed that, if the IASC could develop a set of core standards, IOSCO would recommend that stock exchanges allow foreign companies to use IASs in preparing financial statements. The IASC completed the set of core standards in 1998, IOSCO endorsed their usage by foreign companies in 2000, and many members of IOSCO adopted this recommendation.
V. The International Accounting Standards Board (IASB) replaced the IASC in 2001.
A. The IASB originally consisted of 14 members – 12 full-time and 2 part-time. The number of board members was increased to 16 only full-time members in 2012. Full-time IASB members are required to sever their relationships with former employers to ensure independence. However, seven of the IASB members have a formal liaison responsibility with a national standard setter, such as the U.S. FASB. Technical competence is the most important criterion for selection as a Board member.
Interpretations issued by the Standing Interpretations Committee (SIC) (until 2001) and International Financial Reporting Interpretations Committee (IFRIC).
C. In addition to 31 IASs and 13 IFRSs (as of July 1, 2011), the IASB also has a Framework for the Preparation and Presentation of Financial Statements, which serves as a guide to determine the proper accounting in those areas not covered by IFRS.
D. As of July 2011, more than 90 countries required the use of IFRS by all domestic publicly traded companies, and several important countries were to begin using IFRS in the near future. Other countries allow the use of IFRS by domestic companies. Many countries also allow foreign companies that are listed on their securities markets to use IFRS. E. There are two primary methods used by countries to incorporate IFRS into their financial
reporting requirements for listed companies: (1) full adoption of IFRS as issued by the IASB, without any intervening review or approval by a local body, and (2) adoption of IFRS after some form of national or multinational review and approval process.
VI. The U.S. FASB has adopted a strategy of convergence with IASB standards.
A. In 2002, the IASB and FASB signed the so-called “Norwalk Agreement” to “use their best efforts to (a) make their existing financial reporting standards fully compatible as soon as is practicable and (b) coordinate their work program to ensure that once achieved,
compatibility is maintained.”
B. The FASB has six key initiatives to further convergence between IFRS and U.S. GAAP including a short-term convergence project and joint projects on broader accounting issues. As a result of the short-term convergence project, the FASB has revised several authoritative pronouncements that are part of U.S. GAAP, adopting the IASB treatment in those areas. For its part, the short-term convergence project has resulted in the IASB adopting several accounting practices used in U.S. GAAP.
VII. The U.S. SEC’s early interest in IFRS stemmed from IOSCO’s endorsement of IFRS for cross -listing purposes.
A. After considering this issue for several years, in 2007 the SEC amended its rules to allow foreign registrants to prepare financial statements in accordance with IFRS without reconciliation to U.S. GAAP. Since 2007, foreign companies using IFRS have been able to list securities on U.S. securities markets without providing any U.S. GAAP information in their annual reports.
B. To level the playing field for U.S. companies, in July 2007, the SEC issued a concept release to determine public interest in allowing U.S. companies to choose between IFRS and U.S. GAAP in preparing financial statements. Many comment letter writers were not in favor of allowing U.S. companies to choose between IFRS and U.S. GAAP instead recommending that U.S. companies be required to use IFRS.
C. In November 2008, the SEC issued the so-called “IFRS Roadmap.” The SEC
indicated it would monitor several milestones until 2011 at which time it decide whether to require U.S. companies to follow IFRS over a three-year phase-in period. The Roadmap indicated 2014 as the first year of IFRS adoption, but a subsequent SEC
Release in February 2010 pushed that date back to “approximately 2015 or 2016.”
D. In 2011, the SEC Staff published a discussion paper that suggests an alternative framework for incorporating IFRS into the U.S. financial reporting system. This framework combines the existing FASB-IASB convergence project with the endorsement process followed in many countries and the EU. Some refer to this
method as “condorsement.” The framework would retain both U.S. GAAP and the
FASB as the U.S. accounting standard setter. At the end of a transition period, a U.S. company following U.S. GAAP also would be able to represent that its financial
VIII. IFRS 1, First-time Adoption of IFRS, established guidelines that a company must use in transitioning from previously-used GAAP to IFRS.
A.
C
ompanies transitioning to IFRS must prepare an opening balance sheet at the “date oftransition.” The transition date is the beginning of the earliest period for which an entity presents full comparative information under IFRS. For a company preparing its first set of financial statements for the calendar year 2014, the date of transition is January 1, 2013.
B. An entity must complete the following steps to prepare the opening IFRS balance sheet: 1. Determine applicableIFRS accounting policies based on standards in force on the
reporting date.
2. Recognize assets and liabilities required to be recognized under IFRS that were not recognized under previous GAAP and derecognize assets and liabilities previously recognized that are not allowed to be recognized under IFRS. 3. Measure assets and liabilities recognized on the opening balance sheet in
accordance with IFRS.
4. Reclassify items previously classified in a different manner from what is acceptable under IFRS.
IX. IAS 8, “Accounting Policies, Changes in Accounting Estimates and Errors,” establishes guidelines for determining appropriate IFRS accounting polices.
A. Companies must use the following hierarchy to determine accounting polices that will be used in preparing IFRS financial statements.
1. Apply specifically relevant standards (IASs, IFRSs, or Interpretations) dealing with an accounting issue.
2. Refer to other IASB standards dealing with similar or related issues.
3. Refer to the definitions, recognition criteria, and measurement concepts in the IASB Framework.
4. Consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework, other accounting literature, and accepted industry practice to the extent that these do not conflict with sources in 2. and 3. above.
B. Because the FASB and IASB conceptual frameworks are similar, step 4 provides an opportunity for entities to adopt FASB standards in dealing with accounting issues where steps 1 through 3 are not helpful.
X. Numerous differences exist between IFRS and U.S. GAAP.
A. Differences exist with respect to recognition, measurement, presentation, and disclosure. Exhibit 11.8 lists several key differences.
B. IAS 1, “Presentation of Financial Statements,” provides guidance with respect to the
purpose of financial statements, components of financial statements, basic principles and assumptions, and the overriding principle of fair presentation. There is no equivalent to
IAS 1 in U.S. GAAP.
C. The IASB follows a principles-based approach to standard setting, rather than the so-called rules-based approach used by the FASB. The IASB tends to avoid the use of bright line tests and provides a limited amount of implementation guidance in its standards.
A. IFRS must be translated into languages other than English to be usable by non-English speaking preparers of financial statements. It is difficult to translate some words and phrases into other languages without a distortion of meaning.
B. Culture can affect the manner in which an accountant interprets and applies an accounting standard. Differences in culture can lead to differences in application of the same standard across countries.
Answer to Discussion Question: Which Accounting Method Really is Appropriate?
Students often assume that U.S. GAAP is superior and that all reporting issues can (or should) be resolved by following U.S. rules. However, the reporting of research and development costs is a good example of a rule where different approaches can be justified and the U.S. rule might be nothing more than an easy method to apply. In the United States, all such costs are expensed as incurred because of the difficulty of assessing the future value of these projects. International Financial Reporting Standards require capitalization of development costs when certain criteria are met.
The issue is not whether costs that will have future benefits should be capitalized. Most accountants around the world would recommend capitalizing a cost that leads to future revenues that are in excess of that cost. The real issue is whether criteria can be developed for identifying projects that will lead to the recovery of those costs. In the U.S., the FASB felt that such decisions were too subjective and open to manipulation.
Conversely, under IFRS, development costs must be recognized as an intangible asset when an enterprise can demonstrate all of the following:
(a) the technical feasibility of completing the intangible asset so that it will be available for use or sale;
(b) its intention to complete the intangible asset and use or sell it; (c) its ability to use or sell the intangible asset;
(d) how the intangible asset will generate probable future economic benefits. Among other things, the enterprise should demonstrate the existence of a market for the output of the intangible asset or the existence of the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset;
(e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and
(f) its ability to measure the expenditure attributable to the intangible asset during its development reliably.
How easy is it for an accountant to determine whether the development project will result in an intangible asset, such as a patent, that will generate future economic benefits?
Answers to Questions
1. The five factors most often cited as affecting a country's accounting system are: (1) legal system, (2) taxation, (3) providers of financing, (4) inflation, and (5) political and economic ties. The legal system is primarily related to how accounting principles are established; code law countries generally having legislated accounting principles and common law countries having principles established by non-legislative means. In some countries, financial statements serve as the basis for taxation and in other countries they do not. In those countries with a close linkage between accounting and taxation, accounting practice tends to be more conservative so as to reduce the amount of income subject to taxation. Shareholders are a major provider of financing in some countries. As shareholder financing increases in importance, the demand for information made available outside the company becomes greater. In those countries in which family members, banks, and the government are the major providers of business finance, there tends to be less demand for public accountability and information disclosure. Chronic high inflation has caused some countries, especially in Latin America, to develop accounting principles in which traditional historical cost accounting is abandoned in favor of inflation adjusted figures. Political and economic ties can explain the usage of a British style of accounting throughout most of the former British empire. They also help to explain similarities between the U.S. and Canada, and increasingly, the U.S. and Mexico.
Culture also is viewed as a factor that has significant influence on the development of a
country’s accounting system. This influence is described in more detail in the answer to
question 3.
2. Problems caused by accounting diversity for a company like Nestle include: (a) the additional cost associated with converting foreign GAAP financial statements of foreign subsidiaries to parent company GAAP to prepare consolidated financial statements, (b) the additional cost associated with preparing Nestle financial statements in foreign GAAP (or reconciling to foreign GAAP) to gain access to foreign capital markets, and (c) difficulty in understanding and comparing financial statements of potential foreign acquisition targets.
3. Gray developed a model that hypothesizes that societal values, i.e., culture, affect the
development of accounting systems in two ways: (1) societal values help shape a country’s
institutions, such as legal system and financing system, which in turn influences the development of accounting, and (2) societal values influence accounting values held by members of the accounting sub-culture, which in turn influences the development of the accounting system. Gray provides specific hypotheses with respect to the manner in which specific cultural dimensions will influence specific accounting values. For example, he hypothesizes that in countries in which avoiding uncertainty is important, accountants will have a preference for more conservative measurement of profit.
4. According to Nobes, the purpose for financial reporting determines the nature of a country’s financial reporting system. The most relevant factor for determining the purpose of financial reporting is the nature of the financing system. Some countries have a culture, and accompanying institutional structure, that leads to a strong equity financing system with large numbers of outside shareholders.
5. Several of the IASC’s original standards were criticized for allowing too many alternative methods of accounting for a particular item. As a result, through the selection of different acceptable options, the financial statements of two companies following International Accounting Standards still might not have been comparable. To enhance the comparability of financial statements prepared in accordance with International Accounting Standards, and at the urging of the International Organization of Securities Commissions, the IASC systematically reviewed its existing standards (in the so-called Comparability Project) and revised ten of them by eliminating previously acceptable alternatives.
6. A major difference between the IASB and the IASC is the composition of the Board and the manner in which Board members are selected. IASB has at least 12 and as many as 14 full-time members, the IASC had zero. Full-full-time IASB members must sever their employment relationships with former employers and must maintain their independence. Seven of the full-time members have a liaison relationship with a national standard setter. At least five members must have been auditors, three must have been financial statement preparers, three must have been users of financial statements, and at least one must come from academia. The most important criterion for appointment to the IASB is technical competence. (Although not stated in the body of the chapter, there was a perception that some appointments to the IASC were based on politic connections and not competence.)
[Some of the common features of the IASC and IASB are that both (a) issue/d “international
standards,” (b) have/had their headquarters in London, and (c) use/d English as the working language.]
7. This statement is true in that EU publicly traded companies are required to use IFRS in preparing consolidated financial statements. It is false in that non-public companies are not required to use IFRS and publicly traded companies do not use IFRS in preparing their parent company only financial statements.
8. The second from bottom panel of Exhibit 11.6 shows the countries as of July 2011 that do not allow domestic companies to use IFRS in preparing consolidated financial statements. The two most economically important countries in this group are China and the United States.
9. The IASB and FASB have agreed to “use their best efforts to (a) make their existing financial reporting standards fully compatible as soon as is practicable and (b) coordinate their work
program to ensure that once achieved, compatibility is maintained.”
10. The six key initiatives are:
•
Short-term convergence project to eliminate differences where convergence is likely in the short-term.•
Joint projects on broader issues in which FASB and IASB share resources and work on a similar time schedule.•
Convergence research project to identify all substantive differences between IFRS and U.S. GAAP.•
Liaison IASB member on site at FASB offices.•
Monitoring of IASB projects.•
Explicit consideration of convergence potential in FASB agenda decisions.In contrast to the approach taken by the FASB to influence future IASB standards, the European Union simply adopted IFRS as the national GAAP in member nations.
12. Since 2007, foreign companies listed on U.S. stock exchanges may file IFRS financial
statements with the U.S. SEC without providing any reconciliation to U.S. GAAP. The SEC’s
IFRS Roadmap proposed the phased-in use of IFRS by U.S. publicly-traded domestic companies beginning as early as 2014 (subsequently pushed back to 2015 or 2016). The SEC indicated it would monitor progress on several milestones and make a decision on mandatory IFRS adoption in 2011. When this book went to press in September 2011, the SEC still had not made a decision on this issue.
13. When adopting IFRS, a company must prepare an “IFRS opening balance sheet” at the date of transition. The date of transition is the beginning of the earliest period for which comparative information must be presented, i.e., two years prior to the “reporting date.” A company must follow five steps in preparing its IFRS opening balance sheet:
1. Determine applicableIFRS accounting policies based on standards that will be in force on the reporting date.
2. Recognize assets and liabilities required to be recognized under IFRS that were not recognized under prior GAAP, and derecognize assets and liabilities recognized under prior GAAP that are not allowed to be recognized under IFRS.
3. Measure assets and liabilities recognized on the IFRS opening balance sheet in accordance with IFRS (that will be in force on the reporting date).
4. Reclassify items previously classified in a different manner from what is acceptable under IFRS.
5. Comply with all disclosure and presentation requirements.
14. The extreme approaches that a company might follow in determining appropriate accounting policies for preparing its initial set of IFRS financial statements are:
1. Adopt accounting policies acceptable under IFRS that minimize change from existing accounting policies used under current GAAP.
2. Take a fresh start, clean slate approach and develop accounting policies acceptable under IFRS that will result in financial statements that reflect the economic substance of transactions and present the most economically meaningful information possible.
15. According to the accounting policy hierarchy in IAS 8, if a company is faced with an
accounting issue for which (a) there is no specific IASB standard that applies, (b) there are no IASB standards on related issues, and (c) reference to the IASB’s Framework does not help in determining an appropriate accounting treatment, then the company should
consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework. The FASB’s conceptual framework is similar to the IASB’s, so reference to FASB pronouncements would be acceptable under IAS 8 when conditions (a), (b), and (c) exist.
16. Potentially significant differences between IFRS and U.S. GAAP related to asset recognition and measurement are:
•
Acceptable use of LIFO under U.S. GAAP, but not IFRS.•
Definition of “market” in the lower of cost or market rule for inventory – replacement cost under U.S. GAAP; net realizable value under IFRS.•
Reversal of inventory writedowns allowed under IFRS, but not under U.S. GAAP.•
Capitalization of development costs as an intangible asset under IFRS, which is not acceptable under U.S. GAAP (except for computer software development costs).•
Difference in the determination of whether an asset is impaired.•
Subsequent reversal of impairment losses allowed by IFRS, but not U.S. GAAP.17. Even if all countries adopt a similar set of accounting standards, two obstacles remain in achieving the goal of worldwide comparability of financial statements. First, IFRS must be translated into languages other than English to be usable by non-English speaking preparers of financial statements. It is difficult to translate some words and phrases found in IFRS into non-English languages without a distortion of meaning. Second, culture can affect the manner in which accountants interpret and apply accounting standards. Differences in culture can lead to differences in how the same standard is applied across countries.
Answers to Problems
1. B
2. C
3. D
4. C
5. D
6. D
7. C
8. A
9. A
10. C
11. B
12. D
13. A
14. C
Problems 15-19 are based on the comprehensive illustration.
a. 1. Under U.S. GAAP, the company reports inventory on the balance sheet at the
lower of cost or market, where market is defined as replacement cost (with net
realizable value as a ceiling and net realizable value less a normal profit as a
floor). In this case, inventory will be written down to replacement cost and
reported on the December 31, 2013 balance sheet at $95,000. A $5,000 loss
will be included in 2013 income.
2. In accordance with
IAS 2
, the company reports inventory on the balance sheet at
the lower of cost and net realizable value. As a result, inventory will be reported
on the December 31, 2013 balance sheet at its net realizable value of $98,000
and a loss on writedown of inventory of $2,000 will be reflected in 2013 net
income.
b. As a result of the differing amounts of inventory loss recognized under U.S. GAAP
and IFRS, Lisali will add $3,000 to U.S. GAAP income to reconcile to IFRS income,
and will add $3,000 to U.S. GAAP
stockholders’ equity to reconcile to
IFRS
stockholders’ equity.
16. (25 minutes) (Measurement of property, plant, and equipment subsequent to
acquisition)
a. 1. Under U.S. GAAP, the company would report the equipment at its depreciated
historical cost. Straight-line deprecation expense is $8,000 per year [($100,000
–
$20,000) / 10 years]. The equipment would be reported at $92,000, $84,000,
and $76,000, respectively, on the December 31, 2013, 2014, and 2015 balance
sheets.
2. Under IFRS, the equipment would be depreciated by $8,000 in 2013 [($100,000
- $20,000) / 10 years], resulting in a book value of $92,000 at December 31,
2013. Under
IAS 16
’s
allowed alternative treatment, the equipment would be
revalued on January 1, 2014 to its fair value of $101,000.
The journal entry to record the revaluation on January 1, 2014 would be:
Dr. Equipment
$9,000
Cr. Revaluation Surplus (stock
holders’
equity)
$9,000
(To revalue equipment from carrying value of $92,000 to appraisal value of
$101,000.)
Depreciation expense on a straight-line basis in 2014, 2015, and beyond would
be $9,000 per year [($101,000
–
$20,000) / 9 years]. The equipment would be
reported on the December 31, 2014 balance sheet at $92,000 [$101,000
–
$9,000], and on the December 31, 2015 balance sheet at $83,000 [$92,000
–
$9,000].
Depreciation expense
2013
2014
2015
IFRS
$8,000
$9,000
$9,000
U.S. GAAP
$8,000
$8,000
$8,000
Difference
$0
$1,000
$1,000
Book value of equipment
12/31/13
12/31/14
12/31/15
IFRS
$92,000
$92,000
$83,000
U.S. GAAP
$92,000
$84,000
$76,000
Difference
$0
$ 8,000
$ 7,000
b. There is no difference in net income between IFRS and U.S. GAAP in 2013, so no
reconciliation adjustments are necessary in 2013.
In 2014, the additional amount of depreciation expense of $1,000 related to the
revaluation surplus under IFRS must be subtracted from U.S. GAAP income to
reconcile to IFRS net income. The additional depreciation taken under IFRS causes
IFRS retained earnings to be $1,000 less than U.S. GAAP retained earnings at
December 31, 2014. Under IFRS, the revaluation surplus causes IFRS
stockholders’ equity
to
be $9,000 larger than U.S. GAAP stockholders’ equity. The
adjustment to reconcile U.S. GAAP
stockholders’ equity to
IFRS is $8,000, the
difference between the original amount of the revaluation surplus ($9,000) and the
accumulated depreciation on that surplus ($1,000). $8,000 would be added to U.S.
GAAP
stockholders’ equity to reconcile to
IFRS.
In 2015, $1,000 again is added to IFRS net income to reconcile to U.S. GAAP net
income, and $7,000 is now
subtracted from IFRS stockholders’ equity to reconcile to
U.S. GAAP stockholders’ equity. $7,000 is the original amount of revaluation
surplus ($9,000) less accumulated depreciation on that surplus for two years
($2,000).
17. (15 minutes) (Research and development costs)
a. 1. Under U.S. GAAP, $500,000 of research and development costs would be
expensed in 2013.
2. In accordance with
IAS 38
, $350,000 [$500,000 x 70%] of research and
development costs would be expensed in 2013, and $150,000 [$500,000 x 30%]
of development costs would be capitalized as an intangible asset. The intangible
asset would be amortized over its useful life of ten years, but only beginning in
2014 when the newly developed product is brought to market.
In 2014, the company would recognize $15,000 [$150,000 / 10 years] of
amortization expense on the deferred development costs under IFRS that would not
be recognized under U.S. GAAP. In 2014, $15,000 would be subtracted from U.S.
GAAP net income to reconcile to IFRS net income. The net adjustment to reconcile
from U.S. GAAP stockholders equity to IFRS at December 31, 2014 would be
$135,000, the sum of the $150,000 smaller expense under IFRS in 2013 and the
$15,000 larger expense under IFRS in 2014. $135,000 would be added to U.S.
GAAP stockholders
’
equity at December 31, 2014 to reconcile to IFRS.
18. (15 minutes) (Gain on sale and leaseback transaction)
a. 1. Under U.S. GAAP, the gain of $50,000 on the sale and leaseback transaction of
is deferred and amortized to income over the life of the lease. With a lease
period of five years, $10,000 of the gain would be recognized in 2013.
2. In accordance with
IAS 17
, the entire gain of $50,000 on the sale and leaseback
would be recognized in income in the year of the sale when the lease is an
operating lease.
b. In 2013, IFRS net income exceeds U.S. GAAP net income by $40,000, the
difference in the amount of gain recognized on the sale and leaseback transaction.
A positive adjustment of $40,000 would be made to reconcile U.S. GAAP net
income and U.S. GAAP
stockholders’ equity to
IFRS.
In 2014, a gain of $10,000 would be recognized under U.S. GAAP that would not
exist under IFRS. As a result, $10,000 would be subtracted from U.S. GAAP net
income to reconcile to IFRS. By December 31, 2014, $20,000 of the gain would
have been recognized under U.S. GAAP and included in retained earnings, whereas
retained earnings under IFRS includes the entire $50,000 gain. Thus, $30,000
would be added to U.S. GAAP
stockholders’ equity at 12/31/
14 to reconcile to IFRS.
19. (20 minutes) (Impairment of property, plant, and equipment)
a. 1. Under U.S. GAAP, an asset is impaired when its carrying value exceeds the
expected future cash flows (undiscounted) to be derived from use of the asset.
Expected future cash flows are $85,000, which exceeds the carrying value of
$80,000, so the asset is not impaired. Depreciation expense for the year is
$20,000 [$100,000 / 5 years], and the equipment will carried be on the
December 31, 2013 balance sheet at $80,000.
fair value of $72,000), so the asset is impaired. An impairment loss of $5,000
[$80,000 - $75,000] would be recognized at the end of 2013, in addition to
depreciation expense for the year of $20,000. The equipment will be carried on the
December 31, 2013 balance sheet at $75,000.
b. An impairment loss of $5,000 was recognized in 2013 under IFRS but not under
U.S. GAAP. Therefore, $5,000 must be subtracted from U.S. GAAP net income to
reconcile to U.S. GAAP net income in 2013. The same amount would be subtracted
from U.S. GAAP
stockholders’ equity at December 31,
2013 to reconcile to IFRS.
In 2014, depreciation under IFRS will be $18,750 [$75,000 / 4 years], whereas
depreciation under U.S. GAAP is $20,000. $1,250 would be added to U.S. GAAP
net income to reconcile to IFRS net income in 2014. To reconcile stockh
olders’
equity to IFRS at December 31, 2014, $3,750 must be subtracted from U.S. GAAP
stockholders’ equity. This is the difference between the impairment loss of $5,000 in
2013 taken under IFRS and the difference in depreciation expense recognized
under the two sets of standards in 2014. It also is equal to the difference in the
carrying value of the equipment at December 31, 2014 under the two sets of
accounting rules:
IFRS
U.S. GAAP
Cost
$100,000
$100,000
Depreciation, 2013
(20,000)
(20,000)
Impairment loss, 2013
(5,000)
0
Carrying value, 12/31/13
$75,000
$80,000
Depreciation, 2014
(18,750)
(20,000)
Carrying value, 12/31/14
$56,250
$60,000
Chapter 11 Develop Your Skills
Analysis Case 1
—
Application of
IAS 16
This assignment demonstrates the effect one difference between IFRS and U.S. GAAP
would have on a company's net income and stockholders' equity over a 20-year period.
Depreciation expense in Years 1 and 2 under both sets of rules: $10,000,000 / 20
years = $500,000 per year
The building has a book value of $9,000,000 on January 1, Year 3. On that date, under
IFRS, Abacab would revalue the building through the following journal entry:
Dr. Building
$3,000,000
Cr. Accumulated Other Comprehensive Income (AOCI)
$3,000,000
a. Depreciation Expense
Year 2
Year 3
Year 4
IFRS
$500,000
$666,667
$666,667
U.S. GAAP
$500,000
$500,000
$500,000
b. Book Value of Building
1/2/Y3
12/31/Y3
12/31/Y4
IFRS
$12,000,000
$11,333,333
$10,666,666
U.S. GAAP
$9,000,000
$8,500,000
$8,000,000
Difference
$3,000,000
$2,833,333
$2,666,666
c. Pre-tax income will be $166,667 smaller in each year (Year 3 -Year 20) under
IFRS. Cumulatively, IFRS-pretax income will be $3,000,000 smaller than U.S.
GAAP pretax income over this 18-year period. Stockholders' equity will be
$3,000,000 greater under IFRS at January 1, Year 3. This difference will decrease
by $166,667 each year (due to greater IFRS depreciation expense), such that
stockholders' equity will be the same under both sets of rules at December 31,
Year 20. The difference in stockholders' equity each year is equal to the difference
in the book value of the building.
Analysis Case 2
—
Reconciliation of IFRS to U.S. GAAP
Quantacc Ltd.
Schedule to Reconcile IFRS
Net Income and Stockholders’ Equity
to U.S. GAAP
2013
Income under IFRS $ 100,000
Adjustments:
Add depreciation on revaluation amount in current year under IFRS 3,500
Add gain on sale and leaseback recognized in current year under U.S. GAAP 10,000
Add current year’s amortization of deferred development costs 16,000
Income under U.S. GAAP $ 129,500
12/31/2013
Stockholders’ equity under IFRS $ 1,000,000
Adjustments:
Subtract revaluation surplus (35,000)
Add accumulated depreciation on revaluation amount under IFRS (2013 only) 3,500 Subtract total amount of gain on sale and leaseback recognized under IFRS in
2012 (200,000)
Add cumulative amount of gain on sale and leaseback that would have been
Subtract total amount of development costs capitalized under IFRS in 2012 (80,000) Add cumulative amount of amortization expense on development costs
recognized under IFRS (2013 only) 16,000
Stockholders’ equity under U.S. GAAP $ 724,500
Explanation for adjustments:
1.
Under IFRS
–
Quantacc recorded a Revaluation Surplus (stock equity account) of
$35,000 on 1/1/13. In 2013, $3,500 of depreciation expense was taken on the
revaluation amount ($35,000 / 10 years).
Under U.S. GAAP
–
neither of these would have been recognized.
To reconcile from IFRS to GAAP
–
add $3,500 to IFRS 2013 net income; subtract a
total of $31,500 from IFRS 12/31/13 stockholders equity (subtract $35,000
Revaluation Surplus and add $3,500 of accumulated depreciation on the revaluation
amount).
2.
Under IFRS
–
Quantacc recognized a gain on sale/leaseback of $200,000 in 2012.
No gain was recognized in 2013.
Under GAAP
–
Quantacc would recognize a gain on sale/leaseback of $10,000 in
both 2012 and 2013.
To reconcile from IFRS to GAAP
–
add $10,000 to IFRS 2013 net income.
At the end of 2013, the increase in retained earnings related to the gain on
sale/leaseback under IFRS is $200,000, but would only be $20,000 under GAAP.
To reconcile from IFRS to GAAP
–
subtract a total of $180,000 from IFRS 12/31/13
stockholders’ equity.
3.
Under IFRS
–
Quantacc recognized a development cost asset of $80,000 in 2012.
In 2013, amortization expense related to this asset was $16,000 ($80,000 / 5 years).
Under GAAP
–
Quantacc would have expensed development costs of $80,000 in
2012.
In 2013, there is $16,000 more expense under IFRS than under GAAP. To reconcile
from IFRS to GAAP
–
add $16,000 to IFRS 2013 net income. At 12/31/13, the
Research Case
—
Reconciliation to U.S. GAAP
Note to instructors: The SEC no longer requires a U.S. GAAP reconciliation from
foreign companies using IFRS. As more foreign companies adopt IFRS over
time, it will become increasingly more difficult for students to find foreign
companies that provide a U.S. GAAP reconciliation in their Form 20-F. Exhibit
11.6 can help in identifying countries not using IFRS.
In addition, students may find EDGAR to be of limited use in accessing foreign
company annual reports because few foreign companies file electronically with
the SEC. Instructors might want to emphasize to their students that they might
have more luck accessing the annual report of their selected company from the
company's website.
This assignment requires students to find the note in Form 20-F in which foreign
companies reconcile net income and stockholders' equity from foreign GAAP to U.S.
GAAP. The responses to this assignment will depend upon the company selected by
the student to research. Examining the reconciliation from foreign GAAP to U.S. GAAP
in Form 20-F is a good way to learn some of the major differences between foreign and
U.S. GAAP. Students may be surprised to learn how few adjustments most foreign
companies make in reconciling to U.S. GAAP.
Communication Case
—
SEC
“IFRS Roadmap”
The responses to these questions will vary by student. Issues that might be discussed
for each question are listed below.
•
Potential benefits.
Preparing IFRS financial statements would make it easier for analysts to compare
the company with foreign competitors that use IFRS. This could result in a lower cost
of capital for the company. It also would make it easier for the company to
benchmark against foreign competitors.
•
