Chapter 4

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 4

International Financial Reporting Standards

(IFRSs)

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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)

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Learning Objectives1. 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.


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Learning Objectives4. 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.


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Recognition and Measurement:Some background

Review of important terminologyAssets – 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

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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



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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.



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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.



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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.


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Recognition and Measurement: IFRSs and U.S. GAAP compared

Types of Differences Definitions Recognition Measurement Alternatives Lack of requirements or guidance Presentation Disclosure


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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


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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)



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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.



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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.



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IAS 2, Inventories – numerical comparison to U.S. GAAPApplication of lower of cost of net realizable value. Assume the following:

Historical cost $500Replacement cost 400Estimated sales price 450Estimated disposal costs 25Normal profit margin 20% of sales price



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IAS 2, Inventories – numerical comparison to U.S. GAAPLower 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)



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IAS 2, Inventories – numerical comparison to U.S. GAAPLower 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



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IAS 2, Inventories – numerical comparison to U.S. GAAPThe 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.



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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.



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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.



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IAS 16, PP&E – compared to U.S. GAAPAccounting 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.



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IAS 16, PP&E – compared to U.S. GAAPAccounting for revaluations Revaluation decreases require a journal entry to

decrease the asset to fair value:Expense xxxx

Property, plant, and equipment xxxx



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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 $10,000Accumulated depreciation 2,000Current market value 18,000Ratio of carrying value to cost 80%



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IAS 16, PP&E – numerical comparison to U.S. GAAP, Revaluation adjustment to accumulateddepreciation: 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.



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IAS 16, PP&E – numerical comparison to U.S. GAAP: Treatment 1

Original Revaluation Total Cost

Gross carrying amount $10,000 + 12,500 = $22,500Accumulated depreciation 2,000 + 2,500 = $4,500Carrying value $ 8,000 + 10,000 = $18,000



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IAS 16, PP&E – numerical comparison to U.S. GAAP, Revaluation adjustment toaccumulated 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).



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IAS 16, PP&E – numerical comparison to U.S. GAAP: Treatment 2

Accumulated Depreciation 2,000Asset 2,000

Asset 10,000Revaluation surplus 10,000



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IAS 38, Intangible Assets Purchased intangibles. Intangibles acquired in a business combination. Internally generated intangibles. Does not address Goodwill (see IAS 3).



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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.



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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.



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IAS 38, Intangible Assets – numerical comparison to U.S. GAAPInternally 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



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IAS 38, Intangible Assets – numerical comparison to U.S. GAAPInternally generated intangibles – Development Costs2005: Accounting treatment under IAS 38Development expense 30,000Deferred development costs 70,000

Cash, payables, etc. 100,000



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IAS 38, Intangible Assets – numerical comparison to U.S. GAAPInternally generated intangibles – Development Costs 2006: Accounting treatment under IAS 38Amortization expense 14,000

Deferred development costs 14,000



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IAS 38, Intangible Assets – numerical comparison to U.S. GAAPInternally generated intangibles – Development Costs2005: Accounting treatment under U.S. GAAPDevelopment expense 100,000

Cash, payables, etc. 100,0002006: Accounting treatment under U.S. GAAPNo entry



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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.



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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.



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IAS 36, Impairment of Assets – numerical comparison to U.S. GAAPAssume the following:

Carrying value $440

Selling price 400Cost of disposal 25Expected future cash flows

450Present value of expected future cash flows 380



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IAS 36, Impairment of Assets – numerical comparison to U.S. GAAPImpairment under IAS 36

Value in use $380Net selling price 375Recoverable amount $380 (greater of these

two)Impairment loss = carrying amount – recoverable amount = $440 – 380 = $60



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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.



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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.



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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.



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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.



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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.



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IFRSs and U.S. GAAP differ somewhat in eachof 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


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