Chapter 5 International Financial Reporting Standards Part 2 Flashcards
IAS 1 Presentation of Financial Statements, requires
classification of liabilities:
-current liabilities
-non-current liabilities
Current Liabilities
- Expected to settle in normal operating cycle
2.. Held primarily for purpose of trading - Settled within 12 months of the balance sheet date
- No right to defer until 12 months after the balance sheet date.
Refinanced short -term debt under IFRS
Long-term if refinanced prior to the balance sheet date
Refinanced short-term debt under GAAP
Long-term if refinancing is agreed prior to the balance sheet being issued
Accounts payable on demand due to violation of debt covenants under IFRS
Current liability, unless lender issued waiver of 12 months by the balance sheet date
Accounts payable on demand due to violation of debt covenants under GAAP
Current liability, unless lender issued waiver obtained by the annual report issuance date.
Bank overdrafts under IFRS
Long-term if integral part of cash management netted against cash
Bank overdrafts under GAAP
always treated as current liabilities
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
Reporting liabilities and assets of uncertain timing, amount, or existence
Onerous contracts and restructuring costs
Environmental costs and nuclear decommissioning costs
Under IFRS contingent liabilities are not on the balance sheet they are a
provision of liability with uncertain timing or amount.
Under IFRS, Contingent liabilities are recognized on the balance sheet only when
- There is a present obligation from past events
- It is probable that there will be an outflow of resources.
- A reliable estimate of the obligation can be made.
Constructive obligation arises from
past actions or current statements indicating that a company will accept certain responsibilities
*No concept of constructive obligation in U.S. GAAP
IAS 37 defines a contingent liability as a
- Possible obligation confirmed by occurrence or non-occurrence of a future event
-Present obligation that is not recognized because: 1. No probable outflow of resources
2. Amount of the obligation cannot be measured reliably
A contingent liability is recognized under U.S. GAAP when
outflow is probable
only disclosed if outflow is possible, but not probable
Under U.S. GAAP probable usually means
70-90%
Under IFRS probable usually means
more likely than not, implying a threshold of just over 50%
What is a provision?
liability of uncertain timing or amount
Liability is a
present obligation from a past event that will arise in an outflow of benefits
If there is no passed event, then
there is no obligation
no liability
Past Events create two types of obligations
Legal obligation
Constructive Obligation
When to recognize a provision
3 conditions need to be met
- Present obligation whether legal or constructive a as result of some past event or obligating event
- The outflow of economic benefits required to settle the obligation must be probable; probable is more than 50%; possible means less than 50%
- There must be reliable estimate of outflow of economic benefits that is required to settle the obligation.
If not, then entity discloses contingent liability or nothing if probability of outflow of benefits is remote
How to measure provisions
Best estimate of the expenditure required to settle the obligation at the end of the reporting period
This estimate of outcome and financial effect are determined by the judgment of the management of an entity, supplemented by experience of similar transactions, sometimes reports of independent experts
Two ways to measure provisions
- Expected Value: when measurement of provision involves a large population of items, then the provision is measured as weighted average of all possible outcomes by their probabilities
- Single obligation is measured: provision would be set as most likely outcome
Several considerations to look at when measuring provisions
risk and uncertainties: inflation
present value after 12 months
Future events
gains from disposals shall not be taken into account
A provision is recognized as an
expense in the income statement
but sometimes can be capitalized into the cost of another asset
Provision is reversed when outflow of resources is
no longer probable
Can IFRS omit disclosures that can be expected to prejudice seriously the position of the enterprise in a dispute with other parties?
Yes
U.S. GAAP no such exemption
Onerous Contracts
unfair contract in which the unavoidable cost of meeting the obligations of the contract exceed the economic benefits of the contract
If company identifies contract as onerous,
provision must be made in amount of unavoidable costs of or fulfilling it and unavoidable costs can be either
Recognize provision for the lower of:
-Net cost of fulfilling the contract that means cost less some income from the contract or
-Penalty from non fulfillment of the contract whichever is lower
If onerous from entity’s own action, provision not recognized until that action happens.
Restructuring
A program planned and controlled by management that changes either:
The scope of business or the manner in which business is conducted.
Examples of restructurings:
The sale or termination of a line of business.
The closure of business locations in a country or region.
A change in management structure.
A fundamental reorganization that has a material effect on the nature and focus of the entity’s operations.
Under I A S 37, a restructuring provision is recognized when:
Detailed formal plan for restructuring.
Valid expectation that the plan will be carried out.
Cost is reasonably estimable, and the period of time is reasonable.
U.S. G A A P: no recognition until a liability has been incurred.
Thus, I F R S most likely shows loss earlier.
Contingent asset
probable asset that arises from past events and whose existence will be confirmed only by the occurrence or nonoccurrence of a future event.
Not recognized (I F R S), but should be disclosed when the inflow of economic benefits is probable.
I F R S: is recognized if realization is virtually certain.
G A A P: the asset should be realized before it can be recognized.
I A S 19, Employee Benefits, covers all forms of
employee compensation and benefits.
Excludes share–based compensation.
Four types of employee benefits:
Four types of employee benefits:
1. Short–term benefits (compensated absences and bonuses).
2. Post–employment (pensions, medical benefits, and other post–employment benefits).
3. Other long–term benefits (deferred compensation and disability benefits).
4. Termination benefits (severance pay and early retirement benefits).
How many types of contingent liabilities are there?
Three
Probable
Possible
Remote
GAAP recognizes all 3
Examples of Contingent Liablities
lawsuits
product warranties
*outcomes are uncertain
*amount of liability differs depending on estimated dollar amount of the liability and the likelihood of the event occurring.
How do GAAP and IFRS require companies to record contingent liabilities
in accordance with 3 principles
- full disclosure
- materiality
- prudence
Probable contingent liabilities can be reasonably estimated and must
be reflected within financial statements
Possible but not probable contingent liabilities are as likely to occur as not and need only be
disclosed in the financial statement footnotes
Remote contingent liabilities are extremely unlikely to occur and
do not need to be included in financial statements at all
Contingent liabilities adversely impact
a company’s assets and net profitability
As a result, knowledge of both contingencies and commitments is extremely important to users of financial statements because they:
represent the encumbrance of potentially material amounts of resources during future periods,
and thus affect the future cash flows available to creditors and investors.
also important for potential lenders to a company, who will take these liabilities into account when deciding on their lending terms.
Short-term benefits
recognize an expense and a liability at the time the employee provides services.
Amount recognized is undiscounted.
Compensated absences (for sick/vacation pay) accrue when services are provided only if:
The compensated absences accumulate over time.
They can be carried forward to future periods.
Short-term benefits For non–accumulating compensating balances,
an expense and liability are recognized only when the absence occurs.
Profit–sharing and bonus plans
An expense and a liability are accrued if:
The company has a present legal or constructive obligation to make such payments as a result of past events.
The amount can be reliably estimated.
Post–Employment Benefits
I A S 19 distinguishes between defined contribution plans and defined benefit plans.
Defined contribution plan:
Benefits accrue when services are rendered.
Liability reduces when contributions are made.
Defined benefit plan (generally similar to U.S. G A A P).
Two major issues:
Calculation of the net defined benefit liability (or asset).
Calculation of the defined benefit cost.
Net Defined Benefit Liability (Asset)
Balance sheet amount calculated as:
+ Present value of the defined benefit obligation (P V D B O).
− Fair value of plan assets (F V P A).
Asset recognized is limited to the lower of:
The surplus.
or
The asset ceiling (present value of economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan).
No asset ceiling under U.S. G A A P.
(PVDBO) Present Value of the Defined Obligation
is based on assumptions related to variables such as employee turnover, life expectancy, and future salary levels.
The discount rate used to determine PVDBO is determined by reference to the
yield at the end of the period on high-quality corporate bonds
When does a deficit exist in a benefit plan?
when PCDBO is > (FVPA) Fair Value of Plan Assets
When a deficit exits in a benefit plan the amount reported is the
Net Defined Benefit Liability and gets reported on the Balance Sheet
When FVAP is > FVDBO, the a ____ exists.
Surplus
When a surplus exists in a benefit plan. the amount of the net defined asset is recognized at
the lower of:
Surplus
or
Asset ceiling
which is the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan
Does an asset ceiling exist in GAAP?
No
Components of defined benefit cost reported in net income:
-Current service cost.
-Past service cost and gains and losses on settlements.
-Net interest on the net defined benefit liability (asset).
I A S 19: all past service costs should be
expensed in the period in which the benefit plan is changed; regardless of the status of the employees benefiting from the change
U.S. G A A P: the past service cost should be recognized in
other comprehensive income (O C I).
(NIDBA) Net Interest on the Net Defined Benefit Liability (Asset)
is determined by multiplying
the net defined liability asset by the same discount rate used to measure PVDBO
It is the difference between interest expense (PVDBO x Discount Rate) and interest Income (FVAP x Discount Rate)
Past service cost arises when
an employer improves the benefits to be paid to employees in a defined benefit plan.
Does IAS provide separate guidance for other post-employment benefits?
No, U.S. GAAP provides more guidance
Companies using IFRS are allowed by IASB’s Framework to use Guidance provided by U.S. GAAP to identify an appropriate method.
Other Long–Term Employee Benefits-Liability should be recognized equal to the difference between:
The present value of the defined benefit obligation.
The fair value of plan assets (if any).
I F R S 2, Share–Based Payment, sets out measurement principles and specific requirements for three types of share–based payment transactions:
- Equity–settled share–based payment transactions.
- Cash–settled share–based payment transactions.
- Choice–of–settlement share–based payment transactions.
IFRS 2 and U.S. GAAP are substantially similar
Equity–Settled Share–Based Payment Transactions
Share–based payments to nonemployees.
I F R S measurement:
Fair value of the goods or services, if it can be reliably determined.
Fair value of the equity instruments.
Equity–Settled Share–Based Payment Transactions
Share–based payments to nonemployees.
U.S. G A A P measurement:
Fair value of the instrument at the earlier date of either:
A commitment for performance.
When the performance is completed.
Equity–Settled Share–Based Payment Transactions
Share–based payments to employees.
Measured at the fair value of the equity instruments.
Consider vesting conditions.
Total compensation cost.
Recognized as compensation expense.
Equity–Settled Share–Based Payment Transactions
The estimate of options expected to vested should be revised throughout the vesting period.
Recognition of associated compensation expense.
Straight–line over the service period for cliff vesting.
Amortize each installment (or tranche) over its vesting period for graded vesting.
U.S. G A A P allows choice of accelerated or straight–line recognition.
Modification of Stock Option Plans-Types of modification:
Length.
Vesting conditions.
Exercise price.
Modification of Stock Option Plans-Result of fair value change
Increase in fair value;
Increase compensation cost by the same amount.
Decrease in fair value.
No change in compensation; cost deducted.
Modification of Stock Option Plans
U.S. G A A P.
The fair value determines compensation expense.
Unlike I F R S, there is no minimum compensation.
Cash–Settled Share–Based Payment Transactions- Cash payment when the stock price
increases above a predetermined level.
Cash–Settled Share–Based Payment Transactions-Recognize fair value as a
liability and expense using an option–pricing model.
Remeasure at each balance sheet date.
The change in fair value goes to net income.
Cash–Settled Share–Based Payment Transactions- Under U.S. G A A P, classify certain cash–settled payments as
Equity;
under IFRS classify as a Liability
Choice–of–Settlement Share–Based Payment Transactions
Allow the entity to choose between equity settlement and cash settlement.
If the entity has a present obligation to settle in cash, treat as cash–settled.
If obligation settled in equity, treat as equity–settled.
Choice–of–Settlement Share–Based Payment Transactions 2
Treat as compound financial instrument when receiving entity chooses equity settlement or cash settlement.
Fair value split into separate debt and equity components.
Debt component must be remeasured at fair value for every balance sheet date.
Change in fair value impacts income.
Choice–of–Settlement Share–Based Payment Transactions 3
Apply the cash settlement against the debt component only.
In an equity settlement, transfer the debt component to equity
I A S 12, Income Taxes, and U.S. G A A P take a similar approach.
Asset–and–liability approach:
Recognizes deferred tax assets and liabilities:
For temporary differences.
For operating loss and tax credit carryforwards.
Under I F R S, measure on the basis of tax laws and rates that have been enacted or substantively enacted.
Under U.S. G A A P, measure on the basis of actually enacted tax laws and rates.
Account for double taxation effects and differences in rates (dividends).
Recognition of deferred tax asset
Under I F R S, recognize if future realization of a tax benefit is probable.
I A S 12 provides a more stringent threshold.
Under U.S. G A A P, recognize if realization is more likely than not.
“Probable” is a higher threshold than “more likely than not”.
Income Taxes-Recognition of deferred tax asset-Disclosures:
I F R S requires.
Extensive disclosures of tax expense.
Explanation of hypothetical expense based on two approaches:
- Compare statutory tax expense in the home country and effective tax expense.
- Compare weighted-average statutory tax rate across jurisdictions and tax expense based on the effective tax rate.
Income Taxes
I F R S versus U.S. G A A P.
I F R S application can cause temporary differences unknown under U.S. G A A P.
Income Taxes: Financial statement presentation
Under U.S. G A A P:
Based on the classification of the related asset or liability, deferred tax assets and liabilities are classified as either:
Current.
Noncurrent.
Tax loss or credit carryforwards.
Based on the expected timing of realization.
Under IAS 1:
Deferred tax assets and liabilities.
Only classified as noncurrent.
Revenue Recognition
Most significant example of cross–border cooperation in accounting standard–setting.
Five steps in the recognition of revenue:
Identify the contract with a customer.
Identify the separate performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price to the separate performance obligations.
Recognize the revenue allocated to each performance obligation when the entity satisfies each performance obligation
Shift from the evaluation of the risk and rewards of ownership to the transferal of control.
Revenue Recognition - Bill–and–hold sales:
seller segregates inventory meant for a customer but still maintains physical possession of it.
Has the product been separately identified as belonging to the customer?
Is the product ready for shipment to the customer?
Can the seller use the product or reallocate it to another customer?
Is there a substantive business reason for the bill–and–hold arrangement, such as, that the customer’s warehouse is full?
Customer Loyalty Programs-I F R S 15: award credits should be treated as
a separately identifiable component of the sales transaction in which they are granted.
The revenue allocated between awards credits (liability) and current sale is based on their fair value.
When credit is used, transfer from liability to revenue.
Financial Instruments-3 Standards
I A S 32, Financial Instruments: Presentation.
I F R S 7, Financial Instruments: Disclosure.
I F R S 9, Financial Instruments–issued in November 2009 to replace I A S 39.
IAS 32: a financial instrument is any
contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity.
Financial asset:
A contractual right to:
Receive cash or another financial asset.
Exchange financial assets or financial liabilities under potentially favorable conditions.
An equity instrument of another entity.
A contract that will or may be settled in the entity’s own equity instruments and is not classified as an equity instrument of the entity.
Do not include investments that are part of consolidation or accounted for under the equity method.
Must have less than significant influence to be considered a financial instrument
Financial liability:
A contractual obligation to:
Deliver cash or another financial asset.
Exchange financial assets or financial liabilities under potentially unfavorable conditions.
A contract that will or may be settled in the entity’s own equity instruments.
Equity instrument: any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Exclusions to IAS 32 and IFRS 9
Insurance contracts.
An employer’s rights and obligations under employee benefit plans.
Share–based payment programs.
Transactions in the entity’s own equity instruments, such as treasury stock.
I A S 32.
Financial instruments to be classified as:
Financial liabilities.
Equity.
Both.
If an equity instrument contains a contractual obligation that qualifies as a financial liability, it is classified as
a liability.
For example, preferred stock that can be redeemed by the shareholder.
Compound Financial Instruments
Both a liability and equity element.
For example, a convertible bond.
Split accounting.
Show as part debt and part equity.
The with–and–without method:
-The fair value of the financial instrument with the conversion feature.
-The fair value of the financial instrument without the conversion feature.
-The difference between the fair value as a whole and the amount determined for the liability component.
Classification and Measurement of Financial Assets and Financial Liabilities: 3 Categories of Financial assets:
- Amortized cost: Two Tests (business model and contractual cash flow)
- Financial assets at fair value through OCI (FVOCI): same two tests (business model and contractual cash flow).
- Financial assets at fair value through profit or loss (FVPL).
Business model:
the business objective must be to hold the assets in order to collect contractual cash flows.
Contractual cash flow test:
the asset must give rise to only interest and principal payments.
Categories of Financial Liabilities
Must be classified as either:
1. Financial liabilities at fair value through profit or loss (income).
Liabilities held for trading.
Derivatives not designated as part of a hedging relationship.
Liabilities classified under special rules providing a “fair value option”.
- Financial liabilities measured at amortized cost.
Default category for those not in first list.
Three stages of impairment:
- Insignificant deterioration: estimates a probability of loss over the next 12 months and records a loss provision.
Interest revenue is based on original value. - Significant deterioration: estimates the probability of loss over the loan’s remaining life and records a loss provision
Interest revenue is based on original value. - Credit impaired: estimates the probability of default over the loan’s remaining life and records a loss provision.
Interest revenue is based on impaired value.
U.S. standard does not distinguish between insignificant
and significant deterioration.
American accountants apply Stage Two treatment to all loans.
Derivatives
Options, forwards, futures, and swaps whose value changes in response to a change in a specified:
Interest rate.
Financial instrument price.
Commodity price.
Foreign exchange rate.
Index.
Credit rating.
Other variable.
IFRS 9
Derivatives measured at fair value.
If classified as a hedge, change in value to O C.
if not classified as a hedge, change in value to income.
Sales of Receivables
Question as to whether sold or simply collateral for a loan.
If sold, remove receivables from books.
If collateral, show receivables and liability for loan.
Sales of Receivables-Pass-through arrangement.
Considered a loan unless all three conditions are met:
- The entity has no obligation to pay cash to buyer of the receivables unless it collects equivalent amounts from the receivables.
- The entity is prohibited by terms of the transfer contract from selling or pledging the receivables.
- The entity has an obligation to remit any cash flows it collects on the receivables to the eventual recipient without material delay.
Leases
Account for virtually all leases using the finance lease model.
Signing a lease agreement triggers balance sheet recognition of:
Right–of–use asset (leasehold asset).
Depreciates over life of the lease.
Corresponding lease liability: reduced through effective interest method.
Similar to the new U.S. F A S B dealing with leases.
Disclosure and Presentation Standards: Statement of Cash Flows
I A S 7 requirements
Must be classified as being related to operating, investing, or financing activities.
Operating: direct or indirect method.
No reconciliation required with direct method.
Cash flows related to interest, dividends, and income taxes must be reported separately.
Interest and dividends paid can be classified as operating or financing.
Interest and dividends received can be classified as operating or investing.
Income taxes are classified as operating unless specific to investing or financing activities.
Noncash investing and financing are excluded but disclosed elsewhere within the financial statements.
Cash and cash equivalents reconciled with the balance sheet but need not agree with a single line item on the balance sheet.
Distinction between bank borrowings and bank overdrafts.
Latter may be considered reduction of cash or financing activity.
Disclosure and Presentation Standards: Statement of Cash Flows: U.S. GAAP
Interest paid, interest received, and dividends received are all classified as operating cash flows.
Dividends paid are classified as financing cash flows.
When using the indirect method, the reconciliation from income to cash flows must begin with net income.
When using the direct method, a reconciliation from net income to operating cash flows also must be presented.
The cash and cash equivalents line item in the cash flow statement MUST reconcile with the cash and cash equivalents line in the balance sheet.
Events after the Reporting Period: TWO TYPES
- Adjusting events: provide evidence of conditions that existed at the end of the reporting period.
Must be recognized through adjustment of the financial statements. - Non-adjusting events: conditions that arise after the balance sheet date but before the statements have been issued.
Not recognized on financial statements, but disclosures are required of:
- The nature of the event.
- An estimate of the financial effect, or a statement that an estimate cannot be made.
Selection of Accounting Policies.
Hierarchy of authoritative pronouncements:
I A S B Standard or Interpretation of the transaction/event.
I A S B Standard or Interpretation of similar transaction/event.
Definitions, recognition criteria, and measurement concepts in the I A S B Framework.
Most recent pronouncements of other standard–setting bodies that use a similar conceptual framework.
Changes in Accounting Policy.
Allowed ONLY if:
It is required by an I F R S.
Results in statements that are more relevant and reliable.
Changes in Estimates: a change in estimate should be handled
prospectively.
Correction of Errors: errors should be corrected
retrospectively by restating all prior reported accounts through retained earnings.
Related Party Disclosures: must be disclosed in
footnotes.
Earnings per Share: both basic and diluted must be reported on the
face of the income statement.
Interim Financial Reporting
No mandate on:
Who needs to do them.
How frequently.
Time from the end of the period to the release of an interim report.
Does define the minimum content to be included as required by national jurisdiction.
Discrete reporting periods versus. U.S. G A A P integral part of full year.
Noncurrent Assets Held for Sale
Shown separately on balance sheet.
Shown at the lower of either:
1. Carrying Value
2. The FV - costs to sell
Not Depreciated
Operating segments are components of a business:
That generate revenues and expenses.
Whose operating results are regularly reviewed by the chief operating officer.
That has separate financial information available.
Three quantitative tests to be an operating segment:
Revenue test.
Profit or loss test.
Asset test.
Operating Segment Disclosures
Assets.
Capital expenditures.
Liabilities.
Profit or loss:
External revenues.
Intercompany revenues.
Interest income and expense.
Depreciation and amortization.
Equity method income.
Income tax expense.
Noncash expenses.
Revenue of all segments must be at least 75% of total revenues
