Chapter 4 International Reporting Standards: Part 1 Flashcards
What are some Differences between IFRS and U.S. GAAP?
- definition differences
- recognition differences
-measurement differences
-alternatives
-lack of requirements or guidance
-presentation differences
-disclosure differences
What are some characteristics of IFRS that differ from GAAP?
IFRS is:
- more flexible in some cases with choice between alternative treatments in accounting
- generally has less bright-line guidance; more judgement is required in IFRS
-IFRS is principles-based vs GAAP being rules-based
What are some important resources for IFRS reporting?
-Critical accounting policies: required by IAS 1
-Similar to disclosures required by U.S. SEC
-(KAMs) Key Audit Matters: required by ISA 701
Most material differences of IFRS/GAAP are revealed in
critical policies or (KAMs) Key Audit Matters
particularly true for differences in:
-asset recognition
-measurement policies
Cost of Inventories in IFRS includes:
Costs of purchase
Cost of conversion
Other costs: design, interest costs if it takes time to bring to saleable condition
Cost of inventories excludes:
-Abnormal amounts of waste
-Storage, unless necessary for the production process
-Selling costs
What does IFRS say about cost formulas?
-LIFO is not allowed
-Standard cost method and retail method are acceptable only if they approximate cost as per IAS 2
-Cost inventories are not ordinarily interchangeable
-Goods and services produced and segregated for specific projects should use Specific Identification
*an entity MUST use the same cost formula for similar inventory items
IAS 2 requires inventory to be reported at
the lower cost or (NRV) Net Realizable Value)
-Typically applied on an item-by-item basis but grouping is allowed for items of inventory relating to the same product line
-Write-downs must be reversed when selling price increases
*U.S. GAAP now uses same approach without allowing reversal of write-downs
What aspects of accounting does IAS 16 cover for fixed assets such as PPE?
- Recognition of initial costs of PPE
- Recognition of subsequent costs
- Measurement at initial recognition
- Measurement after initial recognition
- Depreciation
- Derecognition (retirements and disposals)
How does IFRS recognize Initial Costs
Cost includes:
-Purchase price
-All costs needed for asset to perform as intended
-Estimate of the costs of dismantling and removing asset along with restoring site
-Exchange of assets- FV unless no commercial substance or FV cannot be determined
How does IFRS recognize Subsequent Costs?
IAS 16 allows for 2 treatments for reporting fixed assets:
1) Cost Model: Depreciation
which is consistent with U.S. GAAP
2) Revaluation model
Revaluation model
= FV at the date of revaluation -subsequent accumulated depreciation - subsequent impairment losses
-Must do entire class of assets
-Must revalue often (3-5 yrs)
-Increases in value go to OCI; decreases reduce OCI to historical cost then reduce income
-Accumulated depreciation with revaluation: Proportional to new value and Revaluation to retained earnings when asset is disposed
*Revaluation is covered under IAS 16
IFRS and Accumulated Depreciation (IAS 16)
- Restate the accumulated depreciation proportionally with the change in gross carrying value of the asset.
- Eliminate accumulated depreciation against the gross carrying value of the asset and restate net asset to the revalued amount of the asset.
Treatment 1 of Accumulated Depreciation upon Revaluation
Example:
Building Cost = 1,000,000, Book Value = 400,000 is determined to be worth $750,000
Treatment 2 of Accumulated Depreciation Upon Revaluation
Acc Dep. Bldg. 600k
Bldg. 600k
To eliminate accumulated depreciation on buildings to be revalued
Bldg 350k
Revaluation Surplus 350k
How does IFRS treat Revaluation Surpluses and Deficits?
Fist Revaluation:
-Increases: credited directly to revaluation surplus in the OCI component of equity
-Decreased: expenses against income
Subsequent Revaluations:
-If there is a previous revaluation surplus, then it is first removed with any excess against income
-If a previous revaluation resulted in expense, show income to historical cost and credit the rest to OCI
How does IFRS handle Revaluation Transfers to Retained earnings?
- Lump sum when asset is disposed.
- Within each period, the difference between depreciation expense on the revalued asset and depreciation using historical cost can be transferred to R/E.
IFRS and Depreciation
-it’s based on estimated lives, residual value, and method reviewed annually
-treats any changes prospectively
-when comprised of significant parts, use component depreciation
IFRS and Derocgnition
Derecognize carrying amount of property, plant, and equipment:
-when asset is disposed
-when no future economic benefits are expected
Gain or loss is included in net income
Classify as “noncurrent asset held for sale” if appropriate.
IFRS and Investment Property
Land or buildings held for rental, capital appreciation, or both
Same general principles as per IAS 16-choice of cost or revaluation model:
-Changes in FV is recognized in current income and not revaluation surplus
-With FV, use change in value and not depreciation
-Must show FV in footnotes with cost model
-U.S. GAAP generally requires use of cost model
Disclose fair value in notes when using cost model
Biological Assets and IFRS
U.S. GAAP cost method:
-Ignores growth of biological asset
-No income until final product sold
IFRS (IAS 41) FV (Less costs to sell at point of harvest)
-Changes in value over time go to income even before harvesting
-Mandatory for biological assets
*Once harvested, treat like inventory
The Relevance-Reliability Trade-Off
IASB: FV, relevance over reliability
FASB: Cost Method, reliability over relevance
Reliability challenges with FV
-liquidity of markets, so valuation modeling instead of observed prices is used
-Competing valuation frameworks and models that lead to different results
-Subjectivity in estimates
- Long forecasting horizons, which add to uncertainty
-Management’s incentives to exploit modeling choices
Impairment of assets IFRS
Must test annually for impairment to PPE, intangible assets, goodwill, investments in subsidiaries, associates, and joint ventures.
*DOES NOT apply to inventory, construction in progress, deferred tax assets, employee benefit assets, or financial assets 9e.g., accounts and notes receivable).
Impairment under IAS 36 =
carrying amount > recoverable amount
*recoverable amount is the greater of net selling price and PV of future cash flows
Impairment is more likely under IFRS or U.S. GAAP?
more under IFRS since discounted cash flows are used
U.S. GAAP uses undiscounted future cash flows
Reversal of impairment losses IFRS
Reverse impairment loss when recoverable amount is > new carrying amount
Recognition of a Reversal of Impairment loss is recognized in
income immediately
Does U.S. GAAP allow reversals?
No
What is an intangible asset?
- applies to intangibles that are:
purchased
acquired in business combinations
internally generated
it is an identifiable, non-monetary asset without administrative purposes or physical substance
IAS 38
Is Goodwill covered under Intangible assets?
No, it is covered separately under IFRS 3.
IFRS 3 allows for two options in measuring non-controlling interest, which results in two possible measures of goodwill.
*U.S. GAAP only allows one method for measuring non-controlling interest
Cost Model
The asset is carried at cost less accumulated depreciation and impairment. [IAS 16.30]
= Cost - Acc. Dep.- Impairment loss
also applies to investment property accounted for using the cost model under IAS 40 Investment Property. [IAS 16.5]
Recognition
Items of property, plant, and equipment should be recognized as assets when it is probable that: [IAS 16.7]
-It is probable that the future economic benefits associated with the asset will flow to the entity, and
-The cost of the asset can be measured reliably.
*if the asset is not controlled by the entity it can not be recognized
This recognition principle in IAS 16 is applied to all PPE and costs at the time they are
-are incurred.
-These costs include costs incurred initially to acquire or construct an item of PPE, and costs incurred subsequently to add to, replace part of, or service it.
PPE
-tangible items
-can b movable assets or immovable assets
-held for use in production and supply of goods and services, rented to others, or administrative purposes
-expected to be used for more than one period
*buildings for rental are considered investment property=> IAS 40
Movable tangible assets
items that you can move from one location to another
-motor vehicles
-plant or machinery
-office equipment
-furniture
Tangible immovable assets
assets that cannot be moved from one location to another
-land
-buildings
PPE Initial cost examples
PPE necessary for environmental and safety reasons
Subsequent costs of PPE
Major inspections, overhauling, replacement of parts
Initial measurement of PPE
Cost = Purchase price + Cost attributable to bringing asset to the location and condition for its planned operation+ Removal costs
purchase price *(import duties and non-refundable taxes; expressed net after deducting any rebates or discounts)
Directly attributable costs to PPE
-cost that bring asset to the location
-preparation costs in initial delivery and handling
-professional fees
-capitalized interest
-testing
Removal costs
-dismantling the asset
-removal of the asset
-restoring the site where asset is located (ex. nuclear power plant)
In the revaluation model when the carrying amount is increased it should be
credited to Equity as Revaluation Surplus
If asset was impaired before, under the Revaluation model, and impairment was recognized to profit or loss, then an increase of carrying amount shall be
credited to Income to the extent of such reversal of impairments
Decreases to an asset’s carrying amount under the Revaluation Model shall be
Debited to Expenses in proficient loss but if asset was previously revalued to revaluation surplus, then
-the decrease in carrying amount should be debited to Equity to reverse the revaluation surplus
Depreciable amount:
Cost Model:
= Cost- Residual Value
Residual Value = Estimated Salvage Value - Cost of Asset Disposal
Salvage Value- value of asset after it has been fully depreciated and is no longer useful
Derecognition of PPE
Carrying amount will be derecognized on disposal (sell, finance lease as a lessor, or donate asset.)
Must be derecognized when no future economic benefits are expected from use or disposal
Gain or loss may arise: = Net disposal - Carrying amount
*gains or losses are included in Profit or Loss but not as Revenue; shown as gain on sale/loss on sale
Purchased Intangibles
-initially measured at cost
-useful life could be assessed as finite or indefinite
Distinction between intangibles with finite life and indefinite life is made in
IAS 38
Intangibles with finite lives are
amortized with zero salvage unless:
-A third party has agreed to purchase the asset
-There is an active market for the asset where residual value can be estimated
Intangibles acquired in a business combination
-Patents, trademarks, and customer lists recognized as assets measured at fair value.
*Even if not previously recognized by target.
Must have finite or infinite life.
-Special treatments for in–process research and development.
1) Capitalize when certain criteria is met.
2) Otherwise, include in goodwill.
Internally Generated Intangibles
Major difference with U.S. G A A P.
Research: search for new knowledge.
Development: application of this knowledge to creation of viable products/services.
I F R S allows some development costs to be capitalized.
U.S. G A A P expenses all research and virtually all development.
Criteria for development cost capitalization of Internally Generated Intangibles:
1.Technical feasibility of completion.
2. Intention to complete asset for use or sale.
3. Ability to use or sell the asset.
4. How probable future economic benefits will be generated. (Market or Internal use)
5. Availability of adequate technical, financial, and other resources to complete the asset for use or sale.
6. Ability to reliably measure expenditures pegged to development.
Development Costs of Internally Generated Intangibles
All costs directly attributable to development activities.
Costs that can be reasonably allocated to such activities, including:
- Personnel costs.
- Materials and services costs.
3 . Depreciation of P P E. - Overhead costs.
- Amortization of patents.
Income statement effects of Capitalizing Product Development Costs
With increasing R and D expenditures…higher income.
Inflates shareholder equity (retained earnings).
Balance sheet effects of Capitalizing Product Development Costs
Inflates intangible assets net of accumulated amortization.
Offset is higher shareholder equity (retained earnings).
Increases deferred tax liability.
Cash flow statement effects of Capitalizing Product Development Costs
Reclassifies expenditure as capex (capital expenditure) outflow.
Expenditure is investing instead of operating outflow.
Other issues of Capitalizing Product Development Costs
-Revaluation model is allowed with finite–lived intangibles.
- If there is a price on an active market.
- Through revaluation surplus or income.
-Impairment of intangible assets.
- If carrying amount can’t be recovered on finite–lived assets–need to look at changes in events or circumstances.
- For indefinite–lived intangibles and goodwill: Test annually.
3 Under special circumstances, can be reversed, as per I A S 36. - Goodwill not subject to reversal of impairment.
Business Combinations and Consolidated Financial Statements
Business combination: the acquisition of one business by another.
Ways to combine operations:
- Acquired company is legally dissolved.
- Both companies are legally dissolved;
new company is formed.
-One company controls the other, but both legally exist.
Determination of Control and the Scope of Consideration
Parent must consolidate all subsidiaries over which they exercise control.
Control:
Ownership of more than 50% of voting shares.
Effective control:
-Rights to appoint key managers or install a controlling block of board members.
-The ability to direct the investee to enter agreements that benefit the investor.
-The ability to direct operating activities of the investee, such as selling and purchasing goods.
-The ability to direct investments, such as capital spending or R and D.
-The ability to determine the investee’s financial structure.
-The investor’s right to obtain direct control of the investee by buying additional voting shares at a later date or in response to certain triggering events.
Determination of Control and the Scope of Consideration; control exists when
each of the following is present:
- The investor has direct or indirect ability to make decisions about the entity’s activities.
- The investor has the obligation to absorb the expected losses of the entity if they occur.
- The investor has the right to receive the expected residual returns of the entity if they occur.
The Acquisition Method
Used by both I F R S and G A A P.
Must have acquirer and acquire.
Acquirer’s assets and liabilities shown at F M V.
Goodwill and Noncontrolling Interest
Recognize goodwill only in business combinations.
Goodwill is the difference between:
The consideration paid by the acquirer, plus noncontrolling interest over the fair value of net assets acquired.
Negative goodwill must be recognized as
income
Goodwill depends on the option selected to measure any noncontrolling interest.
Measured at either:
A proportionate share of the fair value of the acquired firm’s net assets, excluding goodwill.
The fair value, including the noncontrolling interest’s share of goodwill.
Impairment of Goodwill
Not amortized as it is an indefinite–lived intangible asset.
Impairment of goodwill must be tested annually.
Impairment is tested at the level of the cash–generating unit (C G U).
Compare the carrying value of the C G U, including goodwill, with its recoverable amount.
*Under U.S. G A A P, impairment is tested at the level of the reporting unit, which can be different (and typically larger) than a C G U.
Prior to 2020, under U.S. G A A P:
If fair value of the reporting unit is less than its book value, the company must determine if the decline is goodwill or
other intangible assets.
Under I F R S, if fair value of G C U is less than its book value, then
first reduce goodwill and, if more reduction is needed, determine which other intangibles to reduce.
2020 onwards: U.S. G A A P is the same as I F R S.
Borrowing Costs
-Similar to U.S. G A A P in general approach.
-Capitalize all borrowing costs to the extent that they are attributable to acquisition, construction, or production of a qualifying asset.
-Expense all other borrowing costs.
-Borrowing costs include interest and other costs incurred in connection with borrowing.
-I A S 23 includes foreign currency exchange to the extent that they related to interest costs.
-Under I A S 23, inventories qualify if they require a substantial period to manufacture.
Borrowing Costs 2
Capitalize interest that could have been avoided in the absence of expenditure on the qualifying asset.
Amount capitalized determined by multiplying the weighted–average accumulated expenditures by an appropriate interest rate.
Can use the actual interest rate if average expenditures are less than specific borrowing total.
Interest income on the temporary investment of a specific new borrowing offsets interest capitalized under I F R S.
*No netting allowed under U.S. G A A P.
IAS 2 requires inventory to be reported on the balance sheet at the
lower of cost and NRV
IAS 16 requires an item of PPE comprised of significant parts for which different useful lives or depreciation methods are appropriate to be split into components for purposes of depreciation. Is component depreciation common with U.S. GAAP?
No
Does GAAP allow fair value accounting or apply any special accounting rules
for investment property?
No. Only IAS 40 does, with revaluation of gains and losses included in the income statement
IAS 41
requires fair value accounting for biological assets, with revaluation gains and losses included in the income statement
*exception made for bearer plants; considered part of PPE for accounting purposes
IAS 36 requires
impairment testing of
PPE
Intangibles: Goodwill
Long-term investments
An asset is impaired when
its carrying value exceeds its recoverable amount, which is greater of net selling price and value in use
IFRS 10 provides
-a comprehensive framework for determining control and the scope of consolidation.
-Consolidation is Required when a parent company exercises effective control over another entity.
-Even if the parent does not own a majority of the entity’s shares of voting stock.
-control is exercised through mechanisms other than through stock rights
IAS 38
requires development costs to be capitalized as an intangible asset when six specific criteria are met.
Finite-lived intangibles are
amortized over their useful lives using the straight line method
are tested for impairment whenever changes in circumstances indicate an asset’s carrying amount may not be recoverable
Indefinite-lived intangibles are reviewed for impairment
each year to determine if the useful life remains indefinite, if no, then it is reclassified as having finite life and amortization begins
IAS 23 requires
borrowing costs to be capitalized to the extent they are attributable to the acquisition of a qualifying asset
other borrow costs are expensed immediately
Borrowing costs included
interest and other costs such as:
foreign exchange gains and losses on foreign currency borrowings, incurred in connections with a borrowing
The amount of borrowing costs to be capitalized is
reduced by any interest income earned from the temporary investment of the amount borrowed.
*U.S. GAAP has a narrower definition of capitalizable interest costs and does not allow the netting of interest income
