IFRS and US GAAP E-Book

Steven E. Shamrock

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Regulatory Reporting
• Sprache: Englisch

Seitenzahl: 450

Veröffentlichungsjahr: 2012

Beschreibung

A practical comparison of—and expert guidance on—IFRS and GAAP written by a practicing controller

International Financial Reporting Standards (IFRS) are used in over 120 countries. US companies will inevitably encounter IFRS when evaluating the financial health of suppliers and customers. IFRS and US GAAP: A Comprehensive Comparison provides instruction in accounting under IFRS within the context of US accounting standards. Practical and easy-to-use, this book includes a case study of a first time IFRS adoption, emphasizing the much greater degree of professional judgment that is needed for IFRS.

• Provides a heavy emphasis on practical examples
• Includes an online companion website with downloadable spreadsheets and templates
• Reflects current financial reporting trends
• Addresses accounting requirements of which today's auditors, accountants and preparers of financial reports need to be aware

Clarifying IFRS, its impact on US companies, and where to start in understanding it, IFRS and US GAAP prepares US accountants to be knowledgeable with day to day financial accounting issues using IFRS's substantial similarity with US GAAP as a context.

Leseprobe

CONTENTS

About the Author

Introduction

Chapter 1: Standard Setting

Interpretations

Statement Numbering

Chapter 2: The Framework

Financial Elements

Comparisons of Definitions

Chapter Summary

Chapter 3: Property, Plant, and Equipment

Maintenance and Repairs

Disposal

Disclosures

Chapter 4: Inventory

Initial Cost Upon Recognition

Cost of Goods Sold

Inventories Above Costs

Disclosures

Chapter 5: Provisions and Contingencies

Effect of Timing of Settlement

Application of Discounting

Exit Costs

Chapter 6: Intangible Assets

Derecognition

Chapter 7: Share-Based Compensation

Identification of A Share-Based Compensation Plan

Measurement Date and Value

Subsequent Accounting

Balance Sheet Classification

Settlement

Chapter 8: Financial Instruments

Background

What is A Financial Instrument?

Measurement of Financial Instruments

Impairment

Indicators of Impairment

Specific Us GAAP Guidance

Transfers

Hedging and Hedge Accounting

Measurement and Accounting

Chapter 9: Leases

Preface

Currently Effective Standards

Classification of Leases

Identifying A Lease

Sale-Leasebacks

Chapter Summary

Chapter 10: Revenue

Fixed and Determinable Fee

Units of Account

Exchanges and Returns of Software

Software Services

Software Contract Accounting

Combining Contracts

Recognition Pattern

Contract Revenue

Claims Under Contract Accounting

Milestone Method

Entertainment Industry

Federal Government Contracts

Entertainment Industry: Films and Revenue Recognition

Entertainment Industry: Casinos and Revenue Recognition

Oil & Gas Industry—Revenue Recognition

Brokers and Dealers—Revenue Recognition

Financial Services—Investment Companies and Revenue Recognition of Fees

Layaway Sales

Chapter Summary

Chapter 11: Income Taxes

Income Tax Recognition

Deferred Tax Liability Computation

Deferred Tax Asset Computation

Tax Rates

Tax Rates: Manner of Recovery or Settlement

Deferred Tax Valuations

Tax Positions

Income Tax Interest and Penalties

Profit and Loss Presentation

Intraperiod Allocation To Other Than Continuing Operations

Balance Sheet Presentation

Exceptions To Tax Recognition—Investments in Subsidiaries

General Disclosures

Chapter Summary

Chapter 12: Investments in Subsidiaries

Consolidation Under IFRS

Power

Reassessment

Rights

Us GAAP Control

Interest Receipts and Payments

Protective Rights

Participating Rights

Investment Companies and Broker-Dealers

Franchises

For-Profit Entity Not Involved

Controlling Financial Interest Via Majority Voting Interest or Sole Corporate Membership

Control and Economic Interest, But No Controlling Financial Interest/Control By Other Means

Less Than A Complete Interest in The Subsidiary NFP

Agency

Vie Guidance

Deemed Separate Entities

Development Stage Entities

Continuous Assessment

Accounting For Consolidation

Noncontrolling Investments

Presumptions

Investee Comprehensive Income and Adjustments To Investor’s Share

Exemptions From The Equity Method

In-Substance Common Stock

Changes in Level of Influence

Contribution of Equity Awards

Extraordinary Items

Losses of Equity-Method Investees

Additional Funding of Equity-Method Investees and Suspended Losses

Impairment/Other-Than-Temporary Decrease in Value

Proportionate Consolidation

Coterminous Year-Ends and Investee Accounting Policies

Disclosures

Chapter 13: Postretirement Benefits

Section I—IAS 19 (2003)

Section 2—IAS 19 (2010)

Chapter Summary

Chapter 14: Impairments

Impairment Triggers and Timing

Recognition of Impairments

Measurement of Impairment

Unit of Account

Impact of IAS 36 — Recoverable Amount Determination

Allocation of Impairments To Assets in A CGU or Asset Group

Reversal of Impairments

Number of Cash-Generating Units

Goodwill

Chapter Summary

Index

Copyright © 2012 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

ISBN 978-1-118-14430-5 (book); ISBN 978-1-118-22573-8 (ebk); ISBN 978-1-118-23906-3 (ebk); ISBN 978-1-118-26371-6 (ebk)

ABOUT THE AUTHOR

Steven E. Shamrock is and has been a practicing accounting professional for twenty-two years, ten of those years as a controller. During his career, Steven has led accounting teams in both large, multinational public companies and smaller, entrepreneurial enterprises. He has used IFRS simultaneously with US GAAP for eight years. He is a frequent speaker at AICPA and IFRS Foundation events. Steven was a member of the AICPA Special Advisory Group for the creation of the AICPA’s IFRS Certificate Program. Steven has also taught IFRS to executives in both the United States and the United Kingdom. He has been a contributing author to other Wiley publications. His motivation for writing this book is to further the competent use of IFRS by US accounting professionals to empower them in the world of two pervasive accounting standards. US accountants need to know both standards given the large foreign ownership of US companies.

Steven is a native of Cleveland, Ohio, but has resided in Naperville, Illinois, a suburb of Chicago, Illinois, for most of the past ten years with his wife Lisa, and twin sons, Pete and Luke. Steven wishes to thank his wife and sons for their unyielding support during the writing of this book. He also wishes to thank his father, Edward, also an accountant, and his mother, Tina for their positive support.

Steven is a CPA, has a bachelor’s degree in Accounting from John Carroll University in Cleveland, Ohio, and an MBA in Economics from DePaul University in Chicago, Illinois. He also is a Certified Management Accountant, as issued by the Institute of Management Accountants in Montvale, New Jersey.

INTRODUCTION

Much has been made of the convergence of IFRS and US GAAP. In every corner of the country, from Washington to Wall Street, from boardrooms to business schools, the past decade has produced a deluge of information that has inundated the media, trade publications, seminars, and CPE courses with opinions of every shape, form, and point of view. This is not a bad thing. The adoption of IFRS from the tried-and-true US GAAP is both an important and formidable task. Information, debate, and education are essential to this decision.

This book has an accompanying Web site, www.wiley.com/go/shamrockifrsgaap, that contains Excel spreadsheets that illustrate some of the concepts in the book and provide templates for modeling your own organization’s IFRS/US GAAP differences.

However, one could say that adopting IFRS will be less of a decision and more of a process. In 2008, the Gross Domestic Product of countries using IFRS exceeded those that do not, by hundreds of billions of dollars. This includes the United States. Moreover, the ubiquity of IFRS (used or slated to be used in over 117 countries) indicates a near future where providers of capital will insist on receiving financial information using IFRS. Why? Markets dislike uncertainty—uncertainty comes with incomparability. When the volume of business that capital providers do for clients that use IFRS exceeds that of US GAAP, capitalism will dictate standardization in the qualification for financing as a cost-saving measure. This is inevitable. It is much less believable that all the countries who have recently adopted IFRS will suddenly switch to US GAAP.

CPA exams already have IFRS questions. Universities now include it in their curriculums. The signs are bold. The time to learn about IFRS is now.

For all the differences between the two standards, they are roughly 85% identical in core accounting concepts. This assessment does not include the myriad of interpretations that are part of the US GAAP Codification. However, more often than not, these interpretations provide guidance on a very narrow type of transaction.

What do the two have in common? Fortunately, these include most important and seminal characteristics.

The qualitative characteristics and elements of accounting (e.g., assets, liabilities, neutrality, representational faithfulness) are, for all intents and purposes, identical. In other words, the semantics are the same. This provides a robust and easily adopted framework for learning about IFRS.

That said, however, the old “20/80” rule is applicable. More specifically, 20% of things result in 80% of the problems! So the adoption of IFRS cannot be taken lightly.

Perhaps the most pervasive difference is in the application of the standards. As mentioned earlier, US GAAP has become rule-based. Practitioners, auditors, and regulators have grown accustomed to searching diligently for the most specific paragraph in a standard to validate accounting treatment. This is not wrong, only different from IFRS.

The philosophy of IFRS can be construed as to have standards that are flexible enough to accommodate unforeseen economic transactions, yet specific enough to prevent misrepresentation of economic events. Some would argue that there are holes in this approach, that US GAAP is matured and has a large body of interpretation that increases comparability. But another view of this state is that the rules have become so narrow as to decrease comparability. Consider the analogy of a square peg in a round hole. Conversely, IFRS continually refers back to the IFRS Framework (similar to the US GAAP Concepts Statements). In fact, the Framework is authoritative. US GAAP Concepts Statements are not. This strident adherence to principles in using IFRS puts the onus on practitioners and auditors to account for and report transactions based on the economic reality, not a series of increasingly restrictive interpretations. In a world of increasingly diverse transactions, this will serve to increase comparability. It can allow investors to see the economic impact of the unique mix of transactions that an entity is comprised of.

This flexibility does come with a transition cost. Many of the debates about accounting treatment that would have once occurred in EITF meetings and the like will now transpire among the controller, CFO, CEO, and staff, including operational team members. Using IFRS often entails really understanding an entity’s operations, objectives, and processes. This means that as IFRS becomes part of the US accountant tool set, there will be more time spent on accounting and reporting. However, less time will be spent researching, which will balance the workload.

Certainly systems, processes, and tools will need to change. However, accountants are used to projects. The adoption of IFRS is, in fact, a project. Traditional project management tools will work well.

The time is now to embrace IFRS, when the US accounting community can help shape its direction. Many multinational companies already prepare “statutory” financial information using IFRS for local governments. Having a single standard will reduce cost and complexity for these enterprises. So there is an immediate, practical benefit of using IFRS.

Some say that IFRS would only benefit large companies. And certainly, in terms of scale, that is true. However, as IFRS becomes more pervasive, the bank officers that provide loans to private businesses will have begun to use IFRS. It is plausible that they may become more accustomed to IFRS. Thus, small businesses that are conversant with IFRS will benefit by having a wider pool of loan providers. Smaller companies are usually less complex than larger ones. As complexity of businesses decreases, so do the differences between IFRS and US GAAP. Thus the cost will not be as great.

In the final analysis, cash is cash, and timing is everything. No matter what rules and principles are used to measure the performance of an entity, the ability to consistently generate cash is a major factor in success. Lastly, timing is everything. At one time or another, everything that ends up as comprehensive income in IFRS will also be part of comprehensive income under US GAAP. This does not mean timing is unimportant. On the contrary, if it were not, companies would not spend endless efforts on meeting their quarterly numbers. However, understanding that the basis of both US GAAP and IFRS is measuring the timing, amount, and risk of cash flow removes a layer of mystery from IFRS.

IFRS and US GAAP are about measuring the success or failure of an entity. This is something that people of any language or culture can understand.

Chapter 1

STANDARD SETTING

Just as the Financial Accounting Standards Board (FASB) creates and maintains US GAAP Codification, the International Accounting Standards Board (IASB) does the same for International Financial Reporting Standards (IFRS™). Both are overseen by a group of trustees. The FASB reports to the Financial Accounting Foundation. The IASB is accountable in the first instance to the International Accounting Standards Committee (IASC). Both have interpretive bodies. The FASB has the Emerging Issues Task Force (EITF) in addition to many nonauthoritative bodies such as the American Institute of Certified Public Accountants (AICPA). The IASB/IASC have the International Financial Reporting Interpretations Committee (IFRIC).

Where the standard-setting apparatus diverges is with the role of the Securities and Exchange Commission (SEC) with regard to US GAAP. The SEC delegates its day-to-day rule-making authority to the FASB. The SEC also can supersede US GAAP for public companies. Regulations S-X and S-K define the form and content of financial statement reports, as well as disclosures that are not required under the US GAAP Codification.

Since IFRS is not owned by any one country, the IASB is the top-level authoritative body for IFRS standards. In 2008, recognizing the potential shortcomings of not having a rule-making oversight body such as the SEC, the IASC formed the Monitoring Board (MB). The MB’s role is to provide an extra layer of independence from political influence. The need to protect the IASB from the political winds was underscored when in 2008, David Tweedie, chairman of the IASB at the time, temporarily suspended parts of the IFRS statements regarding classification of the fair market value effects on financial instruments. This directive allowed companies to take the large losses from the 2008 global financial crisis out of net income and into comprehensive income. The public fallout was swift and severe. Critics of IFRS pointed to this as an example of the highly political nature of the IFRS standard-setting process as a result of the multinational mix of board members.

However, what these critics did not mention is that the US GAAP has for decades been shaped by corporate lobbying via the exposure draft process. The most egregious example is the number of years and slow evolution of the accounting for pension and postretirement benefits. It took 17 years for the US GAAP to require companies to reflect in their financial statements the full value of these liabilities. Early comments on the first statement brought laments of doom and gloom as companies would become insolvent overnight. This did not happen. The investor community regularly adjusts the financial statements they are analyzing for off-balance-sheet items. Analysis also typically adds future minimum lease payments that are disclosed for operating leases to the liabilities of an entity when assessing financial condition.

Both bodies employ rigorous process in forming standards. Both have position papers, exposure drafts, and specific instructions and the timing of transition from prior standards. In fact, the two bodies have been jointly developing standards since the 2002 Norwalk Agreement, which creates a roadmap to convergence. The broad outline of the plan is that the two boards converge standards where they have mutual interests. Its objective does not include the synchronization of every standard.

The Norwalk Agreement has been prolific. The two boards have produced many joint standards. However, despite these efforts, jointly issued statements, while substantially identical, still have persistent, if not pervasive, differences. Recent standards have included sections that detail the differences between the two statements.

The governance of the IASB also includes a constitution that establishes the overall objectives of IFRS, the integrity of the standard-setting process, funding of the board, and consultations that are required as part of the process. The constitution is reviewed every five years, and the most recent update was in 2009. The board takes a vote to decide which issues are on the standard-setting agenda. Conversely, the FASB chairman decides on issues to undertake after consultation.

INTERPRETATIONS

Both the IASB and FASB provide interpretations of their standards. The FASB, primarily via the EITF, issues many more interpretations than IFRS. The number since the founding of the FASB in 1972 easily reaches into the hundreds. These together with other bodies, including SEC FRM updates, FASB staff positions, and AICPA Statements of Position likely add at least 200. In contrast, IFRS has only 17 active interpretations and a few amendments. Some prior IFRS interpretations (perhaps a dozen) have been subsumed into updated or new standards. It should be noted, however, that when a standard is reconsidered, the IASB, as a matter of process, attempts to incorporate the interpretations (IFRICs) in the main standard. The number of interpretations is still orders of magnitudes less than US GAAP.

While the FASB ratifies interpretations and does reject considering matters, the IFRIC routinely rejects issuing interpretations. Instead, it issues a monthly update that summarizes the interpretations sought by the user community and usually points out paragraphs of existing standards that the board feels provides adequate guidance with which to account for the matters in question. This approach is indicative of the principle-based nature of IFRS. When the IFRIC identifies an issue where there is an obvious gap in guidance or strong possibility of divergence in practice, the matter is placed on the agenda. Additionally, each year the IASB sets an IFRS improvements agenda that is sourced from constituent requests. The improvements typically result in statement amendments.

STATEMENT NUMBERING

In 2008, the FASB released the US GAAP Codification. The Codification summarized and organized into topics the substance of all prior standards such as Statements on Financial Accounting Standards (SFAS), EITFs, AICPA Statements of Position, and standard updates. Updates to the Codification are announced and put into a temporary section of the Codification until they are inserted into the proper sections as they become effective. The topics are numbered as follows.

IFRS uses sequential numbers as the FASB did prior to the Codification. There are two “sets” of IFRS standards. The first begin with IAS which stands for International Accounting Standards. These statements originated before the IASB came into existence and standard setting fell completely on the IASC. In 2000, when the IASB was founded, subsequent statements began with IFRS (and still do).

Similar to the change management of the US GAAP Codification, when standards are changed, the statement retains its number and title, but has a date appended to it to distinguish between prior versions. This convention means that there still are, and will continue to be IASs in effect. However, when a standard is fundamentally rewritten, or a new subject matter is undertaken, the statement begins with IFRS (with the former IAS number standard retired).

Currently there are 29 IASs, 13 IFRSs, 16 IFRICs, and 11 SICs.

Chapter 2

THE FRAMEWORK

The most significant difference between US GAAP and IFRS for a practitioner is the role that the underlying concepts play in day-to-day accounting and reporting. In simple terms, effective practice of US GAAP compels the user to find the best paragraph that fits a transaction or balance. Under IFRS, users are expected to apply the principles in a way that faithfully represents economic reality.

A visual representation could be envisioning US GAAP as a great wall of cubbies in which one finds the one that best fits the transaction at hand and places it in that space. Following this depiction, IFRS is more like an orderly shelf of jars which are taken out as needed, and the contents of those containers combined to create the best mixture that faithfully represents the transaction.

This is not to say that US GAAP does not aim to create financial statements that faithfully represent the combination of transactions that an entity is made up of. The two standards just take different paths to the same destination.

In order to use IFRS effectively, it helps to understand the different political environments under which the statements are designed and interpreted. The Securities and Exchange Commission alone has the statutory responsibility to promulgate accounting rules in the United States. While the SEC has delegated most of this authority to the Financial Accounting Standards Board, the commission can and does supplement accounting rules of public companies. Because the SEC’s commissioner is appointed by the president of the United States, it is influenced by politics, specifically the politics of the United States.

Conversely, the International Accounting Standards Board has no equivalent authority, but must answer to users and investors in over 100 countries. This diffusion of influence gives the IASB the freedom to hew statements close to the theory because using the objective platform of The Framework is an effective way for the IASB to eliminate the perception of favoritism.

This is not to say that the IASB does not need to heed the concerns of its constituents. The European Union (EU), for example, has created the European Financial Reporting Advisory Group (EFRAG) to endorse IFRS standards. The EU was able to effect changes favorable to EU countries in 2003 when IFRS was adopted for those countries. A 2008 decision by the chairman of the IASB to allow companies in the EU to effectively defer losses regarding some financial instruments by allowing them to reclassify losses to Other Comprehensive Income (OCI) demonstrates how broad political issues can affect the IFRS.

The IFRS Framework is a stand-alone statement that defines the elements of financial statements and their qualitative characteristics. In summary, it provides a seminal description of assets, liabilities, equity, revenue, and income. The qualitative characteristics define the boundaries of these financial statement elements. It also considers the tensions and trade-offs between the characteristics. IAS 1 directs practitioners to use The Framework for accounting decisions if IFRS does not address otherwise.

The FASB, however, uses the Concepts Statements as the edifice upon which statements, interpretations, and updates are based. It is clear that preparers are not to use Concepts Statements to decide upon the presentation and accounting for a given transaction. Following is an excerpt from Statement of Financial Accounting Standards No. 6:

Statements of Financial Accounting Concepts do not establish standards prescribing accounting procedures or disclosure practices for particular items or events, which are issued by the Board as Statements of Financial Accounting Standards. Rather, Statements in this series describe concepts and relations that will underlie future financial accounting standards and practices and in due course serve as a basis for evaluating existing standards and practices.

This body of knowledge is only used to provide a fabric from which standards are cut—by the standard setters. As a consequence, US GAAP is very prescriptive compared with IFRS.

This is not to say that uncommon transactions surface frequently for accountants using US GAAP, but these are usually “vanilla” issues, such as an up-front payment to a retail customer for setting up displays and shelves. More complex subjects are dealt with very differently in the two standards.

The IASB through its interpretative arm, the International Financial Reporting Interpretation Committee (IFRIC), often responds to requests for interpretations by pointing out certain paragraphs that should be used to address the accounting or reporting issue. In other words, the IFRIC often refuses to interpret.

Here is an example: A constituent submitted a request to determine if part of the Foreign Currency Translation Adjustments (FCTA) in equity should be recycled through profit and loss if either the absolute investment in an investee changed but not the relative ownership, or if the investment remained the same but the relative ownership in the investee changed. The IFRIC, through its periodic newsletter (issued several times per year) responded that judgment must be used to determine if there “has been a change in interest.” The IFRIC refused to opine.

Conversely, the FASB responds to inquiries only through Accounting Standards Updates (ASU) that have been through due process. These are narrow and specific. One case (2011) concerned determining when a creditor had a “troubled debt” in order to apply the accounting for troubled debt restructuring. The guidance defined a specific mathematical test that must be applied to determine this.

The IASB is disciplined in always referring to The Framework and existing standards when creating official interpretations (IFRICs) or new standards. This practice is aimed at not creating divergence among accounting for similar transactions. The FASB and the SEC have and continue to diverge from the established body of US GAAP.

In 2011, the FASB rejected including potential voting rights when determining control of an investee (and thus the determination of whether to consolidate), even though IFRS does. The potential voting rights of an investor can be used to wield influence and even control over an investee even though the investor does not own a majority of the voting interests. The FASB disagreed and kept its condition that potential rights are not considered. This brings about a trend I will call divergence.

Since the Norwalk Agreement of 2002, the FASB and IASB have issued many joint statements that are in almost all respects identical. However, there are differences, and some statements note these in the appendices. After the converged standard is released, interpretations by the FASB and refusals to interpret by the IASB create divergences in practice and standard. An ASU issued in 2011 proposed to allow companies to not perform Step 1 of the Goodwill Impairment Test if it is more likely than not (greater than 50%) that the reporting unit is not impaired. This increases the tolerance for not performing the test. The existing standard, converged in 2003, allows an entity to effectively not perform Step 1 for a reporting unit if the fair value calculated in the last test exceeded carrying value “by a substantial margin,” provided there were no significant changes to the reporting unit (e.g., restructuring, market upheaval). The proposed ASU lowers this threshold, and this creates a divergence from the converged standard.

One set of characteristics, perhaps more than any other pair, illustrates a key difference between US GAAP and IFRS. The pair is relevance versus reliability. Relevance means that the information matters to a user’s decision based on the financial statements. Reliability is what the general meaning of the word is outside of the accounting realms. Reliable information can be independently verified and is materially accurate given all the information known at the financial statement date, or, in some cases, when the statements are issued.

While there are numerous instances where US GAAP and IFRS are very similar with regard to relevance and reliability, generally speaking, IFRS weighs relevance as more important that reliability as compared to US GAAP. The most prominent area indicative of this disparity is accrued liabilities. IFRS contains the term constructive liability, which is an obligation that an entity has no realistic alternative but to satisfy. Constructive liabilities can arise in the absence of contractual commitments and arise solely on expectations of “creditors” based on the past actions of the entity. While US GAAP employs this concept in the recognition of asset retirement and environmental obligations, IFRS uses constructive liabilities as a main pillar of recognition. Accruals for legal settlements are a significant area of difference.

Characterization is another facet where US GAAP and IFRS have differences. In accounting for financial instruments, some changes in the value of the instruments are recognized as income under US GAAP and OCI (in equity) for IFRS, and vice versa. A more significant difference is the full recognition of pension and postretirement benefits. Under US GAAP, the full value of net obligations (or assets) is recognized at the end of each fiscal year. The adjustment from book value is reflected in OCI. Under IFRS, the change in net obligations (or assets) is kept off the balance sheet and amortized into income (although this will change in 2013).

Basis of accounting is largely consistent between IFRS and US GAAP, except in certain instances of measurement. Both rely on historical cost and fair value as a core basis, although IFRS uses fair value more than US GAAP.

FINANCIAL ELEMENTS

IFRS and US GAAP have very similar definitions of financial elements. That said, however, as we’ll see in this book, there is sometimes a conflict between the two standards as to whether the benefit from an economic resource is certain enough to account for it as an asset. One example is development costs. Under US GAAP, all research and development costs are expensed. IFRS requires capitalization of development costs when certain conditions are met.

Likewise for liabilities, there are multiple instances where IFRS requires accruals before US GAAP does. One such difference is for an onerous contract. Onerous contracts are ones where the future economic benefit of an irrevocable contract is less than the cost of fulfilling the contract. IFRS requires immediate recognition and subsequent adjustment of onerous contracts in earnings. US GAAP does not permit this on the grounds that the future effects are too unreliable to be useful or cost-beneficial.

Turning to the income statement, IFRS defines an element called income that encompasses both revenue and gains. US GAAP defines gains/loss separately from revenue (income from the main activities of the entity). However, IFRS includes revenues and gains within the income definition.

COMPARISONS OF DEFINITIONS

Assets

There are subtle, yet consequential, differences in the definitions of assets between the standards:

US GAAP: Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

IFRS: An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

Note that IFRS uses the term expected. While expected includes those things that are probable, expected opens the door to recognition of assets that are less certain. For example, IFRS allows entities to revalue assets (upward and downward). US GAAP specifically prohibits this. IFRS also requires reversal of impairments when economic conditions turn favorable, while US GAAP does not permit reversals.

Liabilities

US GAAP: Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

IFRS: A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

As is the case when comparing the definition of assets between IFRS and US GAAP, the US GAAP definition of liabilities uses probable versus expected in IFRS.

Equity

US GAAP: Equity, or net assets, is the residual interest in the assets of an entity that remains after deducting its liabilities.

IFRS: Equity is the residual interest in the assets of the entity after deducting all its liabilities.

While these definitions are identical, IFRS and US GAAP differ with regard to some forms of preferred stock. IFRS classifies these forms as liabilities, while US GAAP classifies all preferred stock between liabilities and equity. The classification of some stock-based compensation awards can also be present on the balance sheet differently.

Income Statement

Revenue

US GAAP: Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.

IFRS: Revenues are inflows or enhancements of assets from sources other than stakeholders. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties, and rent.

IFRS takes a residual approach to revenue. While in most cases revenues under IFRS are the same for US GAAP (although the timing of recognition can differ in many cases), IFRS directs that grants of assets by governments can be recorded as revenue. This is usually not the case for US GAAP.

Expenses

US GAAP: Expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.

IFRS: Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Expenses that arise in the course of the ordinary activities of the entity include, for example, cost of sales, wages, and depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, property, plant, and equipment.

Note that the IFRS definition begins with a general definition of expenses. This is because in theory IFRS does not distinguish between expense and losses (expenses incidental to main operations). However, the standards of both US GAAP and IFRS require a distinction between expenses and losses in financial statements.

Gains and Losses

IFRS and US GAAP agree that gains and losses are inflows and outflows that are incidental to the main operations of an entity.

Complete Set of Financial Statements

A complete set of financial statements includes a Statement of Financial Position (balance sheet), Statement of Income, Statement of Cash Flows, Statement of Shareholders’ Equity, and a Statement of Comprehensive Income.

The Statement of Comprehensive Income begins with Net Income and includes effects from transactions that are presented as OCI. OCI includes certain gains and losses from financial instruments, foreign currency translation effects (not remeasurement effects), pension and postretirement gains and losses, effects of share-based compensation, and other items. The tax effect on these items is also included in OCI.

IFRS allows for the presentation of a single statement of comprehensive income rather than a separate Income Statement and Statement of Comprehensive Income. OCI cannot be shown as part of the Statement of Shareholders’ Equity, unlike US GAAP.

US GAAP requires the same statements, although OCI is included in the Statement of Shareholders’ Equity. This difference between the two standards demonstrates a philosophical split. IFRS takes a more inclusive approach to income, whereas US GAAP presents it more or less as information. Generally speaking, OCI includes impacts where the eventual cash outflows or inflows are subject to long-term factors. For instance, currency translation effects may never be realized if the entity monetizes the interest in an investee in a period where the exchange rate is materially different from the current period. Additionally, the fluctuation on currency values is largely outside of the control of the entity (although companies may employ hedges, the offsetting effects of which, if meeting certain requirements, are reflected in OCI). The remeasurement of a transaction, conversely, is included in income because of the relatively near-term probability realization into cash of the transaction.

CHAPTER SUMMARY

The theoretical bases of IFRS and US GAAP are very similar. However, the timing of recognition and basis of assets and liabilities at a given point in time varies and the volume and content of guidance is disparate.

IFRS requires preparers of financial statements to consider The Framework in almost all cases for a transaction or class of transactions. The guidance in a particular IFRS statement is not only principles-based, but can be used as an analogy for transactions outside the scope of that statement where the other transaction does not have specific guidance. IFRS also permits an entity to use the current pronouncements of another standard setter that has a similar framework in cases where specific guidance does not exist, provided the guidance of the other standard setter is not contrary to The Framework. There are few exceptions to The Framework in IFRS statements. Interpretations by the IFRIC are rare.

Conversely, preparers of US GAAP financial statements are prohibited from using the FASB Concept Statements for a particular transaction (although, obviously, the Codification does reflect the principles in the Concepts Statements). US GAAP contains many deviations from its framework. Statements are prescriptive, descriptive, and specific. Interpretations are frequent and narrow. In some cases, the Codification prohibits the use of a standard by analogy.

Both sets of standards have the goal of providing useful, relevant, and reliable information for a broad set of financial statement users. However, the approach each one takes can be very different. This difference requires different processes and decisions. This book attempts to provide practical, plainly described ways to deal with the differences.

Chapter 3

PROPERTY, PLANT, AND EQUIPMENT

The predominant standard that defines the accounting and reporting for Property, Plant, and Equipment (PP&E) is IAS 16. US GAAP guidance for PP&E was formed from several standards issued over many years until they were combined in the Codification. However, except for the areas of software, oil and gas, and mining assets, IFRS and US GAAP use nearly identical criteria for capitalization. Impairment of PP&E is covered later in the book.

PP&E are assets with physical form that an entity uses to make a profit. An example is a metal-forming machine in a plant that produces automobiles. Internally developed software can qualify for capitalization (as well as purchased software). Under IFRS, software is reported under the intangible assets category. Under US GAAP, software is not presented as intangible.

PP&E is recognized at historical costs, with an exception for agricultural assets under IFRS. Costs of PP&E include all materials, labor, permits, and other costs directly attributed to bringing the asset into a condition where it is ready to be used. PP&E does not need to directly contribute profit, but can be used to support or enable profit-making activities to be carried out. Examples include office buildings, furniture, and computers.

PP&E costs can also include certain borrowing costs, such as interest and discount or premium amortization. Capitalization of borrowing costs is covered later in this chapter. Costs that are not includable include costs of plant startup, idle costs, and the like. Spares of critical parts are permitted to be capitalized as part of the asset cost, using professional judgment with regard to how likely it is to be needed. Parts that are expected to last less than one year are included in inventory under IFRS.

Example of PP&E capitalization

In 201X, Company A constructs a custom computerized numerical control bore machine to employ in its new marine division. The company used both contract labor as well as some line workers. The company took out a loan specifically to build the machine for 100,000 LCU (local currency units). The interest rate on the loan is 5 percent/year (simple interest). Parts and components cost 1,000,000 LCU.

The following table summarizes the cost capitalized:

Components and material1,000,000Contract labor   300,000Dedicated internal labor*   100,000Capitalizable interest**      2,500Total costs to capitalize1,402,500

*Internal labor can only be capitalized if it is directly attributable to the construction specifically systematically tracked. Generally speaking, indirect costs such as management time and utilities are not includable since the direct benefit is difficult to attribute to the project.

**Although capitalized borrowing costs will be covered more extensively later in the text, borrowing cost capitalization begins when construction substantially begins and ends when it is ready for operation. Idle time during the construction cannot be capitalized. In this example, the construction took six months, during which time the loan was fully outstanding. Therefore six months of interest were included.

Derecognition of PP&E includes depreciation. Depreciation is the systematic allocation of cost of assets over accounting periods that reflect the economic consumption of the PP&E. Straight-line depreciation is required if there is no other systematic method that is appropriate. IFRS requires entities to assess the useful life of PP&E each reporting period and make prospective adjustments to depreciation for any changes (except for errors, which are discussed later in the book). US GAAP does not contain a requirement for the regular review of useful lives, but reserves this for when impairment triggers are deemed to have been met.

IFRS requires the use of the component approach. A component is a significant part of the asset that has a different useful life than the primary asset. Because of the difference in useful life, the component is depreciated separately. If more than one component has the same useful life, they can, under efficiency principles, be treated as one asset. However, as will be articulated in the next section, major repairs require derecognition of that component and capitalization of the replacement cost.

Other bases of depreciation include units of production, whereby depreciation is based on the inception-to-date production of the asset, compared to the total number of units expected to be produced.

Depreciation begins when the asset is put into service. In practice, entities generally begin depreciation at the beginning of a month, either the month after the asset is in service, or the month of. Whichever method is chosen, it must be applied consistently to promote comparability of the entities’ financial results from period to period.

Depreciation does not cease if an asset is taken out of service. If the idle period is short, there is generally no need to assess a change in useful life. However, if the idle period is the result of a fundamental change in the economics of the business, it could be a trigger for impairment and change in useful life.

Example of depreciation

The CNC bore machine illustrated in the previous example is determined by the controller in consultation with the plant manager to have four components: (1) the metal housing, (2) the motor, (3) the cutting chuck and apparatus, and (4) the circuit board that acts as the interface to the software.

Useful life of the housing and solid parts, which includes the superstructure of the machine, has the longest life, estimated at 15 years. This was based on the fact that the housing can accommodate new motors, cutting tools, and circuit boards. In other words, it will survive product line changes, is durable, and will not need to be replaced soon. The motor is expected to last 5 years under expected operating conditions (e.g., usage hours, horsepower, load, and other factors. The motor may be replaced two, or even three times during the life of the machine. The cutting chuck is somewhat durable, but also subject to tooling upgrades in response to changing product lines. Lastly, the circuit board is assigned a useful life of 3 years. It is subject to changes anytime there is a software change. Because changes are not easily predictable, the controller and plant manager decide that 3 years is reasonable given the history of similar machinery.

Below is a schedule of the costs per component, annual and monthly depreciation.

MAINTENANCE AND REPAIRS

The useful life of an asset takes into account regular or routine expenditures for maintenance. In other words, the cost of maintaining the asset over its useful life is considered in its longevity. Maintenance expenses and small repairs are expensed as incurred.

However, if a repair is significant, and replaces one or more components, the depreciated cost of that component (its carrying value or net book value) is written down to zero and recognized as a depreciation expense in the income statement. The cost to replace the component is capitalized and depreciated over the useful life. Generally, the useful life of the component is not greater than that of the primary asset, unless the component can be readily converted to another use. Because of this, the useful life of the component can be different than the life of the replaced component.

Under US GAAP, the component approach is not defined, although it is not prohibited either. Major repairs are capitalized only if the utility of the asset is significantly extended (considering ongoing maintenance costs, as is the case with new capital assets). Otherwise, it is expensed. Entities typically employ a standard threshold or decision tree to determine expense versus capitalization. Usually accounting policies specify a minimum increase in useful life or output. IFRS also follows this method if an asset is substantially enhanced.

The different approaches to major repairs and to some extent the component approach can result in some material differences in depreciation and maintenance expenses, with IFRS tending to recognize more depreciation and US GAAP more maintenance expense.

Example of PP&E replacement

The following example illustrates the difference between IFRS and US GAAP in the case of a replacement of a major portion of an asset. Note that this example assumes that the replaced portion is a component. Only the cost of the replacement is shown, not the original cost.

PP&E Replacement IFRS vs. US GAAP

The fact that IFRS requires that the carrying value of a replaced PP&E item is derecognized, even if estimated, and that under US GAAP the practice is discouraged, is indicative of a pervasive and persistent difference in the philosophy between the two standards. IFRS weights relevance of information more heavily than reliability, whereas US GAAP favors reliability. This does not mean that IFRS eschews reliability. IFRS includes reliability in its qualitative characteristics as defined in the IFRS Framework. However, the way the standards are written under IFRS compels management to, where relevance and reliability are in contention, provide more information rather than less, that is, record sooner.

DISPOSAL

IFRS and US GAAP are essentially identical to accounting for the disposal of PP&E. The carrying value of the asset(s) is (are) removed from the balance sheet, resulting in the difference between the proceeds received as a gain or loss on the sale of an asset. Gains and losses are not combined with revenue, but displayed as a separate caption on the income statement. Costs incurred directly to dispose of the PP&E are included in the gain or loss.

DISCLOSURES

More detailed disclosures are required for PP&E under IFRS than US GAAP. US GAAP specifies only total depreciation expense, balances by major class (e.g., equipment, land, etc.), total accumulated depreciation, and a description of the depreciation methods used by class.

IFRS requires all of the US GAAP requirements in addition to a reconciliation of balances, changes for additions (capital expenditures), acquisitions, depreciation, impairment losses, impairment reversals, revaluation changes (if the revaluation model is used), changes for foreign currency translation, and other changes that are significant to understanding the change in fixed assets.

Qualitative disclosures for IFRS include

1. The existence and amounts of restrictions on title, and property, plant, and equipment pledged as security for liabilities

2. The amount of expenditures recognized in the carrying amount of an item of property, plant, and equipment in the course of its construction

3. The amount of contractual commitments for the acquisition of property, plant, and equipment

4. If it is not disclosed separately in the statement of comprehensive income, the amount of compensation from third parties for items of property, plant, and equipment that were impaired, lost, or given up that is included in profit or loss

In accordance with IAS 8, an entity discloses the nature and effect of a change in an accounting estimate that has an effect on the current period or is expected to have an effect in subsequent periods. For property, plant, and equipment, such disclosure may arise from changes in estimates with respect to

1. Residual values

2. The estimated costs of dismantling, removing or restoring items of property, plant, and equipment

3. Useful lives

4. Depreciation methods

If items of property, plant, and equipment are stated at revalued amounts, the following shall be disclosed:

1. The effective date of the revaluation

2. Whether an independent valuer was involved

3. The methods and significant assumptions applied in estimating the items’ fair values

4. The extent to which the items’ fair values were determined directly by reference to observable prices in an active market, or recent market transactions on arm’s-length terms, or were estimated using other valuation techniques

5. For each revalued class of property, plant, and equipment, the carrying amount that would have been recognized had the assets been carried under the cost model

6. The revaluation surplus, indicating the change for the period and any restrictions on the distribution of the balance to shareholders

In accordance with IAS 36, an entity discloses information on impaired PP&E in addition to the information required by paragraph 73(e)(iv)-(vi).

Users of financial statements may also find the following information relevant to their needs:

1. The carrying amount of temporarily idle property, plant, and equipment

2. The gross carrying amount of any fully depreciated property, plant, and equipment that is still in use

3. The carrying amount of property, plant, and equipment retired from active use and not classified as held for sale in accordance with IFRS 5

4. When the cost model is used, the fair value of property, plant, and equipment when this is materially different from the carrying amount

Therefore, entities are encouraged to disclose these amounts.

For comparison, below are links to PP&E disclosure for two chemical companies, one IFRS (Akzo Nobel, NV) and one US GAAP (Dow Chemical).

Akzo Nobel (note 10):

http://report.akzonobel.com/2010/ar/servicepages/downloads/files/akzonobel_report10_entire.pdf

Dow Chemical (Note G):

www.dow.com/financial/pdfs/annual-report-2010.pdf

The effect of this greater detail is to decrease the materiality of changes in PP&E by requiring analysis by major class rather than in total. This would obviously require additional work or change in the collection of external reporting information.

Chapter 4

INVENTORY

The accounting and reporting for inventory are very similar under IFRS and US GAAP. It has the same definition and in most cases the same basis. The costs of inventory sold is matched to revenues, and obsolete or slow-moving inventories are written down. However, IFRS requires inventories that are held for trading and used in agriculture to be carried at fair value.

INITIAL COST UPON RECOGNITION

Inventory is made of goods that are held for resale, or used to create goods held for resale (e.g., glue used in constructing furniture). Like property plant and equipment, inventory is generally initially recognized on a historical costs basis (there is some exception for trading and agricultural inventory under IFRS). All the costs, including allocation of certain overhead, to bring the inventory into salable condition must be capitalized to inventory.

Under both IFRS and US GAAP, production overhead is allocated to inventory based on normal capacity, which is the volume that a plant or facility can produce in a period (usually a year) based on the expected work schedule, staffing, and downtime (for repairs, holidays, experience, etc.). Any excess cost is expensed in the period incurred. Conversely, in periods production is higher than normal, allocated overhead is reduced so as to not overstate inventory. To summarize, significant variances as a result of production different from normal capacity is a one-way concept; excess overhead due to lower-than-normal production cannot be capitalized, but overhead allocation must be reduced if production is higher than normal capacity.

Inventory does not include storage of finished goods, administrative costs (whether allocated or not), or interest in the case of routinely, mass-produced goods. However, both IFRS and US GAAP permits capitalization of borrowing to inventory that is not mass produced (e.g., a large freightliner). Storage of work-in-process (WIP) is permitted to be part of inventory cost if storage is routinely needed as part of the production process.

By-Products

The production of goods often produces waste and by-products. If by-products have a market value and can and will be sold, if material, the cost of inventory must be allocated among the finished goods and by-products. This is usually done on relative sales values.

Net Realizable Value

Under both IFRS and US GAAP, inventory must be assessed each period for decreases in value. However, the standards differ with regard to the basis for the reduction and the “floor” down to which inventory can be carried.

Under US GAAP, inventory that has lost value is written down to market. The definition of market under US GAAP is as follows (per the Codification):

As used in the phrase lower of cost or market, the term market means current replacement cost (by purchase or by reproduction, as the case may be) provided that it meets both of the following conditions:

a. Market shall not exceed the net realizable value

b. Market shall not be less than net realizable value reduced by an allowance for an approximately normal profit margin.

Net realizable value (NRV) is defined in US GAAP (per the Master Glossary) as

Estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal.

Under US GAAP, the resulting cost of the reduction in inventory value must produce a normal profit margin when sold. This is done by defining boundaries for the carrying value. US GAAP requires inventory to be carried at the lower of cost or market, but market cannot be greater than NRV, nor can it be less than NRV less a normal profit margin. So an entity cannot realize profit by marking up inventory, nor can it write down inventory excessively, presumably to make future results trend upward.

Under IFRS, inventory is written down to lower of cost or NRV, and market is not in the equation.

IAS 2

9 Inventories shall be measured at the lower of cost and net realizable value.

IAS 2, Inventories, defines NRV as follows: