Vysoká škola finanční a správní Accounting Systems 2 Vysoká škola finanční a správní Jaromír R. Stemberg jaromir@mail.vsfs.cz

Literature McEwen, Ruth Ann: Transparency in Financial Reporting: A concise comparison of IFRS and US GAAP Harriman House ltd., Hampshire UK 2009 ISBN-13: 978-1-906659-13-4

Layout of the Course Basic principles of IFRS/IAS Conceptual Framework and reporting requirements Financial statements: items, recording by IFRS, US GAAP differences Assets Liabilities Equity Profit and Loss Cash Flow

Grading Attendance: 30% (6% for each lesson) Short Test: 20% (3rd lesson) Final test: 50% Minimum to pass: 60% 90-100% A (excellent) 85-89% B (excellent minus) 75-84% C (very good) 70-74% D (very good minus) 60-69% E (good) <60% F (failed)

IFRS and US GAAP

Why do differences exist? US Financial Accounting Standards Board (FASB) developed the first set of standards International Accounting Standards Board (IASB) had the advantage of being inspired by some of the perceived problems in the FASB standard Differences: - in standards themselves - in interpretation

Will the differences ever be eliminated? “Norwalk Agreement” in 2002: Both Boards (FASB and IASB) publicly declared their commitment to the convergence of IFRS and US GAAP US Securities and Exchange Commission (SEC) eliminated the requirement for foreign issuers to reconcile their IFRS results to US GAAP Unless the wording of the standards is totally unified, interpretational differences will almost certainly stay Depends on willingness of national regulators and industry groups to cooperate

IAS/IFRS

Standards amended some IASs International Accounting Standards (IASs) were issued by the IASC from 1973 to 2000. In 2001, the IASC was replaced by the IASB. Since then, the IASB has: amended some IASs replaced some IASs with new International Financial Reporting Standards (IFRSs) adopted new IFRSs on topics for which there was no previous IAS issued Interpretations of Standards

Compliance with Standards Financial statements may not be described as complying with IFRSs unless they comply with all of the requirements of each applicable standard and each applicable interpretation

IASB Conceptual Framework “IASB Framework for the Preparation and Presentation of Financial Statements” was Adopted by the IASB in April 2001 Not a standard, serves as a guide Resolves accounting issues that are not addressed directly in a standard If no standard or interpretation applies to a transaction, an entity must use its judgment in developing and applying an accounting policy that results in information that is relevant and reliable

IAS IAS 1 Presentation of Financial Statements IAS 2 Inventories IAS 7 Statement of Cash Flows IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 Events After the Reporting Period IAS 11 Construction Contracts IAS 12 Income Taxes IAS 14 Segment Reporting IAS 16 Property, Plant and Equipment IAS 17 Leases

IAS IAS 18 Revenue IAS 19 Employee Benefits IAS 20 Government Grants and Disclosure of Government Assistance IAS 21 The Effects of Changes in Foreign Exchange Rates IAS 23 Borrowing Costs IAS 24 Related Party Disclosures IAS 26 Accounting and Reporting by Retirement Benefit Plans IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates IAS 29 Financial Reporting in Hyperinflationary Economies

IAS IAS 31 Interests In Joint Ventures IAS 33 Earnings Per Share IAS 34 Interim Financial Reporting IAS 36 Impairment of Assets IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 38 Intangible Assets IAS 39 Financial Instruments: Recognition and Measurement IAS 40 Investment Property IAS 41 Agriculture

IFRS Preface to International Financial Reporting Standards Framework for the Preparation and Presentation of Fin. Statements IFRS 1 First-time Adoption of International Fin. Reporting Standards IFRS 2 Share-based Payment IFRS 3 Business Combinations IFRS 4 Insurance Contracts IFRS 5 Non-current Assets Held for Sale and Discontinued Operations IFRS 6 Exploration for and Evaluation of Mineral Assets IFRS 7 Financial Instruments: Disclosures IFRS 8 Operating Segments IFRS 9 Financial Instruments

Conceptual Framework Preparation and Presentation of Financial Statements is to be based on Accrual principles Continuity and consistency Quality requirements Understandable Relevant Reliable Comparable

Conceptual Framework Basic elements of financial statements Assets Liabilities Owners’ Equity Revenue Expenses Presentation of Financial Statements Balance sheet Income statement Cash flow statement Statement of changes in equity Notes

Reporting Requirements

Financial Statements No given template nor detail contents of financial statements except of: Basics classification of assets, liabilities and equity Distinction of revenue/expenses and gains/losses Required items Notes Principle of relevance - items must be listed separately if they account for: 2% of total assets (B/S) 5% of total revenue or expenses (P&L)

Classification of Balance Sheet Items Assets: Criteria for long and short-term assets distinction Assets can be sorted also by liquidity Both systems are equally acceptable So is a combination of both Liabilities Use the same distinction as in assets Equity Must be listed separately form liabilities

Assets Required in Reporting Property, Plant & Equipment Investment Property Intangible Assets Investment Accounted for Using Equity Method (investment in companies with capital holding of 20-50%) Financial Assets Receivables for Current Tax Biological Assets Assets Held for Sale Inventories Trade and Other Receivables Cash and Cash Equivalents

Liabilities Required in Reporting Trade and Other Payables Provisions (must be certain and measurable) Financial Liabilities Liabilities for Current Tax Liabilities for Deferred Tax Minority Interests

Equity Required in Reporting Issued Capital and Reserves Attributable to Equity Holders of the Parent Except of relevancy, IFRS has no other requirements - structure depends on local rules; typically consists of following items: Common Stock Share Premium Account Additional Paid-in Capital Funds Retained Earnings Net Earnings of current period

P&L Items Required in Reporting Revenue Financial Expenses Participation on Profit or Loss of Affiliated Enterprise Profit or Loss on Discontinued Business Profit or Loss on Revaluation of Assets Net Earnings for Current Period P&L Statement has no given structure, can be vertical or horizontal by function or by kind

Cash Flow Statement Items Required in Reporting is to give clear understanding of sources and usage of cash has no given structure can use direct or indirect method It lists separately Cash at the Beginning of Period Cash Flow from Operations Cash Flow from Investment Activities Cash Flow from Financial Activities Cash at the End of Period

Assets

Asset Classification Assets are result of completed transactions and occurrences (purchase, production, exchange) Expected or unfinished transactions don’t classify Asset books who has disposability rights and economical benefit Ownership is not important Current / long-term

Current Assets Definition: Typical Current Assets: Are expected to be disposed within 12 months Will be disposed within 1 operational cycle (form raw material purchase to collection of A/R) Cash Typical Current Assets: Cash and equivalents Accounts receivable Current part of long-term receivables Inventories Current financial assets Accruals and deferrals Assets Held for Sale

Accounting Transactions Cash purchase of merchandise: Inventory 100.00 Cash 100.00 Non-cash purchase of merchandise: Inventory 100.00 Accounts payable 100.00 Payment of debt: Accounts payable 100.00 Cash 100.00 Each transaction must be recorded with additional information (date, transaction number, description, person who entered it) that are here for simplicity reasons omitted

Accounting Transactions Production of a current asset Inventory of finished goods 100.00 Inventory of raw materials (B/S) 40.00 Production expense (P&L) 60.00 Sale of finished goods Accounts receivable (B/S) 150.00 Revenue (P&L) 150.00 Cost of goods sold (P&L) 100.00 Inventory of finished goods (B/S) 100.00 Bank account (B/S) 150.00 Accounts receivable (B/S) 150.00

Evaluation of Current Assets Accounts receivable Provision for bad debts Inventory Manufactured: cost of material, direct labor and allocated production cost Purchased: cost method (purchase price + transport, customs, etc.) or retail method (retail price – sales margin) Inventory: lower cost or market (LCM – the lower of original price and net realizable value) FiFo, weighted average

Current Assets in US GAAP ARB 43 Chapter 4 Inventory Pricing and IAS 2 Inventories are both based on similar principles: Inventory are assets held for sale in the ordinary course of business Primary basis of accounting for inventory is cost Both standard cost method or retail method can be used Cost of inventory includes all direct expenditures to ready inventory for sale, including allocable overhead Selling costs are excluded from the cost of inventories, as are most storage costs and general administrative costs

Current Assets in US GAAP Differences: LIFO: - US GAAP: acceptable - IFRS: prohibited Reversal of write-downs of inventory to the lower of cost or market: - US GAAP: creates a new cost basis that cannot be reversed - IFRS: reversal can be done max. to the original value if reasons for write-downs no longer exist

Financial Assets Definition: Typical Financial Assets: Non-physical assets that derives value because of a contractual claim that can be readily converted into cash. Typically, financial assets are traded on financial markets In general, the terms of financial assets may include non-financial assets like corn or wheat if they are traded on financial markets. Typical Financial Assets: Stocks, bonds, securities Investment accounts, loans Derivates (options, futures)

Financial Assets and the Standards Both boards are working on standards (IFRS 9, ASC draft version) in classification and measurement of all financial instruments to replace existing guidance Held to maturity: - zero coupon allocates the interest income - mortgage allocates the interest income but also amortizes for the payments Available for sale: - US GAAP treats decline in fair value in consideration of the company’s ability to hold the security - IFRS discounts estimated cash flow for bad debts/credit losses

Zero-Coupon Fair Value Calculation

Coupon Fair Value Calculation

Long-Term Assets Definition: Typical Long-Term Assets: Are expected to be held for 12 months or longer Will not be disposed within 1 operational cycle (spare parts) Tangible / Intangible Extended use regardless of value Typical Long-Term Assets: Property, plant and equipment Long-term receivables Biological assets Licenses, SW, copy rights Goodwill (must be purchased)

Depreciation To show true and honest value of the fixed asset status Straight line or accelerated Residual value Early retirement, change in accounting estimate No major differences between IFRS and US GAAP

Depreciation Straight-line depreciation: (original cost – salvage value) / periods of useful life Units-of-production method: (original cost – salvage value) / estimated units to be produced The sum-of-the-years’-digits (SYD) method (original cost – salvage value) * (remaining years / SYD) Example: 5 years = 1+2+3+4+5=15; hence 1st year (original cost – salvage value) * 5/15 2nd year (original cost – salvage value) * 4/15 etc. The double declining-balance method twice the straight-line rate applied to the remaining book value

Accounting Transactions Fixed asset purchase: Crain purchase 148 000.00 Transportation 1 000.00 Assembly costs 2 000.00 Accounts payable 151 000.00 Depreciation: Depreciation Expense 30 000.00 Accumulated Depreciation 30 000.00

Leasing of Long-Lived Assets Leasing contract: temporarily transferred disposability rights and economical benefits To be recorded as long-lived assets of the entity (except of real estate) Capital/finance leases, operational leases the criteria of a capital lease include - the transfer of ownership to the lessee at the end of the lease term - a purchase option that is reasonably expected to be exercised - the lease term duration is for most of the asset’s economic life

Leasing of Long-Lived Assets Accounting transactions: Leasor: the asset is taken of the long-lived asset and becames a note payable from the lasee Leasee: - the leased asset is recognized as an long-lived asset and liability to the leasor - use the lower of the present value of the outgoing payments or the fair market value - the asset is to be depreciated

Leasing of Long-Lived Assets Differences in accounting standards: Only minor or less important differences between IFRS and US GAAP - terminology: capital lease vs. financial lease - the lease term is a “major part” or “75%” of the asset’s economic life - recognition of gain/loss when only a minor part of the right to use the asset is exercised (IFRS immediately, US GAAP over the lease term) Major difference in Czech standards: - leased asset is to be kept and depreciated in the owners books

Intangible Assets Nonmonetary assets without physical substance, there are probable future economic benefits that can be reliably measured SW, licenses, copy rights, trade marks - amortization over its useful life - development costs can be included only when demonstrating technical feasibility and ability to complete and sell the asset in the future - if there is no foreseeable limit to the period over which it is expected to generate net cash inflows, the useful life is considered to be indefinite and the asset is not amortized Goodwill (in business combinations only)