1. McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 4 International Financial Reporting Standards (IFRSs)

2. 4-2 Chapter Topics Basics of recognition and measurement. IFRSs: Recognition and measurement of assets. IFRS / U.S. GAAP differences: Recognition and measurement. IFRS / U.S. GAAP differences: Presentation and disclosure. International Financial Reporting Standards (IFRSs)

3. 4-3 Learning Objectives 1. Describe the requirements of IFRSs on the recognition and measurement of assets. 2.Explain the differences between IFRSs and U.S. GAAP on recognition and measurement issues. 3. Describe the requirements of IFRSs related to the disclosure of financial information. International Financial Reporting Standards (IFRSs)

4. 4-4 Learning Objectives 4. Explain the differences between IFRSs and U.S. GAAP on disclosure issues. 5. Use numerical examples to highlight the differences between IFRSs and U.S. GAAP. International Financial Reporting Standards (IFRSs)

5. 4-5 Recognition and Measurement: Some background Review of important terminology Assets – resources controlled by the enterprise from which future economic benefits are expected to flow to the enterprise. Recognition – inclusion of items (e.g., assets, liabilities) into the financial statements with the amount included in statement totals. Learning Objective 1

6. 4-6 Measurement – choice of the attribute by which to quantify a recognized item. The most commonly used attributes:  Historical cost  Net realizable value  Current (replacement) cost  Current market value  Present value of future cash flows Learning Objective 1 Recognition and Measurement: Some background

7. 4-7  Historical cost – amount paid to acquire an asset or, for liabilities, the amount received when the obligation is incurred.  Net realizable value – amount of cash (sometimes the present value) minus collection and other costs incurred. Learning Objective 1 Recognition and Measurement: Some background

8. 4-8  Current (replacement) cost – amount needed to acquire an equivalent asset.  Current market value – amount of cash received from an immediate sale of the asset.  Present value of future cash flows – amount of cash to be received, discounted at the appropriate interest rate. Learning Objective 1 Recognition and Measurement: Some background

9. 4-9 Recognition and Measurement: IFRSs IFRSs  Substantially similar to U.S. GAAP.  However, significant differences do exist.  An effective way to understand IFRSs is to compare to U.S. GAAP.  Describe IFRSs in terms of significant differences from U.S. GAAP. Learning Objective 1

10. 4-10 Recognition and Measurement: IFRSs and U.S. GAAP compared Types of Differences  Definitions  Recognition  Measurement  Alternatives  Lack of requirements or guidance  Presentation  Disclosure Learning Objective 2

11. 4-11 Form 20-F  Some firms filing Form 20-F initially use IFRSs to prepare financial statements.  The Form 20-F of some of these firms can be used to gain an understanding of IFRS / U.S. GAAP differences. Learning Objectives 2 and 4 Recognition and Measurement: IFRSs and U.S. GAAP compared

12. 4-12 Areas with significant differences  Inventory (IAS 2)  Property, Plant, and Equipment (PP&E) (IAS 16)  Intangible Assets (IAS 38)  Impairment of Assets (IAS 36)  Borrowing Costs (IAS 23)  Leases (IAS 17) Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

13. 4-13 IAS 2, Inventories – compared to U.S. GAAP  Requires lower of cost or net realizable value (U.S. GAAP uses lower of cost or market).  IAS 2 does not allow use of last-in, first-out (LIFO).  IFRSs would tend to lead to  Higher inventory balances.  Lower cost of goods sold.  Higher net income compared to U.S. GAAP if LIFO is used. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

14. 4-14 IAS 2, Inventories – compared to U.S. GAAP  Allows for capitalization of interest on borrowings for some inventories.  Capitalization of interest on inventories will lead to  Higher inventory balances.  Lower cost of goods sold.  Higher net income compared to U.S. GAAP. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

15. 4-15 IAS 2, Inventories – numerical comparison to U.S. GAAP Application of lower of cost of net realizable value. Assume the following: Historical cost $500 Replacement cost 400 Estimated sales price 450 Estimated disposal costs 25 Normal profit margin 20% of sales price Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

16. 4-16 IAS 2, Inventories – numerical comparison to U.S. GAAP Lower of cost or net realizable value using IAS 2 Historical cost = $500 Net realizable value (NRV) = estimated sales price – estimated selling costs = $450 - $25 = $425 (lower of cost or NRV) Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

17. 4-17 IAS 2, Inventories – numerical comparison to U.S. GAAP Lower of cost or market under U.S. GAAP Historical cost = $500 Designated market is middle value of NRV ($425), Replacement cost ($400), and NRV – normal profit margin ($425 - $90 = $335). Designated market is $400 and lower of cost or market = $400 Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

18. 4-18 IAS 2, Inventories – numerical comparison to U.S. GAAP The recognized inventory amount under IAS 2 is $425 and under U.S. GAAP is $400. Note: under U.S. GAAP the $400 now represents historical cost. Under IAS 2, historical cost remains at $500 which might be used as lower of cost or NRV in future years. Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

19. 4-19 IAS 16, PP&E – compared to U.S. GAAP  Subsequent to initial measurement, IAS 16 allows the two different measurement approaches.  Historical cost -- (the benchmark treatment) recognizes the asset at cost less accumulated depreciation, required by U.S. GAAP. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

20. 4-20 IAS 16, PP&E – compared to U.S. GAAP  Revaluation -- (the alternative treatment) requires that all assets within a class be revalued periodically  A major difference between IFRSs and U.S. GAAP as fixed assets are often substantial.  Revaluation is generally not allowed under U.S. GAAP. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

21. 4-21 IAS 16, PP&E – compared to U.S. GAAP Accounting for revaluations  Revaluation increases require a journal entry to increase the asset to fair value: Property, plant, and equipment xxxx Revaluation surplus xxxx Note: The revaluation surplus is an equity account. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

22. 4-22 IAS 16, PP&E – compared to U.S. GAAP Accounting for revaluations  Revaluation decreases require a journal entry to decrease the asset to fair value: Expense xxxx Property, plant, and equipment xxxx Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

23. 4-23 IAS 16, PP&E – numerical comparison to U.S. GAAP  Accounting for accumulated depreciation at time of revaluation. Assume the following as of 12/31/X2: Historical cost $10,000 Accumulated depreciation 2,000 Current market value 18,000 Ratio of carrying value to cost 80% Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

24. 4-24 IAS 16, PP&E – numerical comparison to U.S. GAAP, Revaluation adjustment to accumulated depreciation: Treatment 1  Asset and accumulated depreciation are restated.  Restated carrying amount equals current market value.  The ratio of carrying value to gross carrying amount is maintained. Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

25. 4-25 IAS 16, PP&E – numerical comparison to U.S. GAAP: Treatment 1 Original Revaluation Total Cost Gross carrying amount $10,000 + 12,500 = $22,500 Accumulated depreciation 2,000 + 2,500 = $4,500 Carrying value $ 8,000 + 10,000 = $18,000 Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

26. 4-26 IAS 16, PP&E – numerical comparison to U.S. GAAP, Revaluation adjustment to accumulated depreciation: Treatment 2  Asset is first decreased by the amount of accumulated depreciation.  Asset account is then increased by the amount of the revaluation (current market value – carrying value). Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

27. 4-27 IAS 16, PP&E – numerical comparison to U.S. GAAP: Treatment 2 Accumulated Depreciation 2,000 Asset 2,000 Asset 10,000 Revaluation surplus 10,000 Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

28. 4-28 IAS 38, Intangible Assets  Purchased intangibles.  Intangibles acquired in a business combination.  Internally generated intangibles.  Does not address Goodwill (see IAS 3). Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

29. 4-29 IAS 38, Intangible Assets – compared to U.S. GAAP  Purchased intangibles – consistent with U.S. GAAP except that fair value is used in some cases.  Intangibles acquired in a business combination – consistent with U.S. GAAP except that in-process development costs are capitalized. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

30. 4-30 IAS 38, Intangible Assets – compared to U.S. GAAP internally generated intangibles  Major difference with U.S. GAAP.  U.S. GAAP (SFAS 2) requires expensing of almost all Research and Development (R&D) costs.  IAS 38 allows capitalization, also called deferral, of many development costs. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

31. 4-31 IAS 38, Intangible Assets – numerical comparison to U.S. GAAP Internally generated intangibles – Development Costs. Assume the following:  Development costs of $100,000 during 2005  70% of costs qualify for capitalization  Product sales begin on January 2, 2006  Five years of sales expected  Capitalized costs amortized on a straight- line basis Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

32. 4-32 IAS 38, Intangible Assets – numerical comparison to U.S. GAAP Internally generated intangibles – Development Costs 2005: Accounting treatment under IAS 38 Development expense30,000 Deferred development costs 70,000 Cash, payables, etc. 100,000 Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

33. 4-33 IAS 38, Intangible Assets – numerical comparison to U.S. GAAP Internally generated intangibles – Development Costs 2006: Accounting treatment under IAS 38 Amortization expense14,000 Deferred development costs 14,000 Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

34. 4-34 IAS 38, Intangible Assets – numerical comparison to U.S. GAAP Internally generated intangibles – Development Costs 2005: Accounting treatment under U.S. GAAP Development expense 100,000 Cash, payables, etc. 100,000 2006: Accounting treatment under U.S. GAAP No entry Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

35. 4-35 IAS 36, Impairment of Assets – compared to U.S. GAAP  Has lower threshold for impairments, sometimes results in impairments when U.S. GAAP does not.  For assets considered impaired under U.S. GAAP, impairment is carrying amount minus fair value.  Impairment is carrying amount minus the greater of net selling price or value in use. This is likely to differ from fair value. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

36. 4-36 IAS 36, Impairment of Assets – compared to U.S. GAAP  Allows for reversal of impairment loss in subsequent periods when recoverable amount exceeds carrying value.  U.S. GAAP prohibits such reversals.  Impairment test for goodwill requires both a bottom-up and top-down test.  U.S. GAAP requires only a bottom-up test. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

37. 4-37 IAS 36, Impairment of Assets – numerical comparison to U.S. GAAP Assume the following: Carrying value $440 Selling price 400 Cost of disposal 25 Expected future cash flows 450 Present value of expected future cash flows 380 Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

38. 4-38 IAS 36, Impairment of Assets – numerical comparison to U.S. GAAP Impairment under IAS 36 Value in use$380 Net selling price 375 Recoverable amount$380(greater of these two) Impairment loss = carrying amount – recoverable amount = $440 – 380 = $60 Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

39. 4-39 IAS 36, Impairment of Assets – numerical comparison to U.S. GAAP  Impairment under U.S. GAAP  Carrying amount of $440 is less than expected future (undiscounted) cash flows of $450.  No impairment. Learning Objective 5 Recognition and Measurement: IFRSs and U.S. GAAP compared

40. 4-40 IAS 23, Borrowing Costs  U.S. GAAP (SFAS 34) requires capitalization of interest on borrowings attributable to construction, acquisition, or production of qualifying assets.  Capitalization of interest is the benchmark treatment under IAS 23. However, an alternative treatment allows for expensing of all interest. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

41. 4-41 IAS 23, Borrowing Costs  Explicitly allows for capitalization of interest on borrowing for the production of some inventories.  U.S. GAAP explicitly prohibits the capitalization of interest on borrowings for production of most inventories. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

42. 4-42 IAS 17, Leases  Distinguishes between operating and finance (capital) leases in much the same way as U.S. GAAP (SFAS 13).  The criteria for classifying a lease as either operating or finance is less detailed than U.S. GAAP  Leases is often used as an example in arguing that U.S. GAAP is rules-based and IFRSs are principles-based. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

43. 4-43  Finance lease criteria, IAS 17  Lease transfers ownership.  Bargain purchase option.  Lease term is for the major part of the leased asset’s economic life.  Present value of minimum lease payments equals substantially all of the fair value of the asset.  The leased asset is specialized so that only the lessee can use it.  Capital lease criteria, SFAS 13  Lease transfers ownership.  Bargain purchase option.  Lease term is for 75 percent of the leased asset’s economic life.  Present value of minimum lease payments equals 90 percent of the fair value of the asset. Learning Objective 2 Recognition and Measurement: IFRSs and U.S. GAAP compared

44. 4-44 IFRSs and U.S. GAAP differ somewhat in each of the following areas  Cash Flow Statements (IAS 7) – Classification of dividends and interest paid is more flexible under IFRS.  Segment Reporting (IAS 14) – U.S. GAAP requires management approach, IFRS is more flexible as of March 2005. This item is part of short-term convergence project.  Interim Financial Reporting (IAS 34) – U.S. GAAP treats interim periods as integral part of the full year. Learning Objectives 2 and 3 Recognition and Measurement: IFRSs and U.S. GAAP compared