International Financial Reporting (Final) 8 (Far)

8/2/2019 International Financial Reporting (Final) 8 (Far)

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International

Financial ReportingStandards (IFRS)Transition

Prepared by L. Murphy Smith

Professor of Accounting

Texas A&M University

For permission to use or adapt

this presentation, please contact

Dr. Smith, [email protected]


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Questions and Comments are Welcome Any Time


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IFRSs are now accepted or required in more than 100

countries.

International Financial Reporting Standards (IFRSs)are shooting down the competition (other GAAPs)


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U.S. Leaders Call for Acceptance of IFRSs

Among those calling for acceptance ofIFRSs are John Thain, CEO of theNew York Stock Exchange, and formerFederal Reserve Chairman PaulVolcker.

FASB Chairman Robert Herz hasexpressed his expectation that UScompanies would eventually be

required to follow a single accountingstandard, which would be the IFRSs.


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Why do we need IFRSs and financialreporting comparability?

Expanding world trade Proliferation of multinational

corporations

Increasing role of global capital

markets Increased foreign direct

investment

Growth of multinational politicalorganizations

A way to minimize costs


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Why Does GAAP Differ Among Countries?

Political/Legal System

Sources of Capital

Inflation

Taxation

Culture

Accidents of History

Business Complexity

Stop & Reflect: Is there one GAAPthat works best everywhere?


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Key Problems that Cause Resistance to IFRSs

Agreeing on who willcreate the rules

How different the ruleswill be from currentnational GAAP

Costs of changingGAAPs

National sovereignty


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International Financial Reporting Standards (IFRSs)

IFRSs are the accounting standardspublished by the International Accounting

Standards Board (IASB). The IASB was established in 2001 by its

forerunner, the International AccountingStandards Committee, which itself wasestablished in 1973.

In the past decade, the IFRSs went frombeing little used to what is now theworlds dominant set of accountingstandards.

Leading accounting experts anticipatethat IFRSs will be accepted for financial

reporting, in place of US GAAP, for allcompanies listed in US stock market, asearly as 2016.


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Pivotal Events Propelling the IFRSs Juggernaut

Financial scandals occurring in the US in theearly 2000s, notably Enron, whichhighlighted shortcomings in US GAAP.

IOSCO recommended use of IFRSs in 2000.

Adoption of IFRSs for financial reporting bylisted companies in the EU in 2005.

U.S. Securities and Exchange Commissionsannouncement in 2007 to accept IFRSs forfinancial reporting by non-US companieslisted in the US stock market (no Form 20-Freconciliation to U.S. GAAP).

SEC Commissioners propose timeline forIFRS adoption by 2016.


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SEC Proposed Timeline for Moving Companies toIFRSs

End of 2009: Limited group of large companies given the option

to use IFRS. SEC estimates 110 U.S. companies will be able totake advantage of the offer.

2011: SEC evaluates the progress of achieving proposedmilestones, and makes a decision about whether to mandateadoption of IFRS. If IFRS is mandated, the commission will

develop a staged roll out, starting with the largest publiccompanies first.

2014: Year the first wave of companies will be mandated toreport financial results using international accounting standards,if IFRS requirements are adopted in 2011.

2016: Year that all public companies, big and small, will bemandated to report financial results using internationalaccounting standards, if IFRS requirements are adopted in2011.

Stop & Reflect: Is the timeline moving too fast?


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Overview of the International Accounting Standards

Board (IASB)

The London-based IASB is an independent,privately funded accounting standard-settingbody.

Board members are from nine countries andinclude a variety of functional backgrounds.

The over-arching commitment of the IASB is todevelop, in the public interest, one set of high-quality, understandable, and enforceable globalaccounting standards that require transparentand comparable information in general purposefinancial statements.

National accounting standard-setters haveworked with the IASB to converge accountingstandards around the globe.


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Overview of the International Accounting Standards

Board (IASB) -- continued

The International Accounting StandardsCommittee Foundation is the parent body of theIASB.

The IASBs structure and organization resulted

from a strategy review undertaken by itspredecessor body, the Board of the InternationalAccounting Standards Committee.

The body of standards issued by the Board ofthe International Accounting StandardsCommittee was subsequently adopted by theIASB.

These older standards were issued between1973 and 2000, and continue to be designatedInternational Accounting Standards (IASs).


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Structure of the International Accounting Standards

Board (IASB)

IASB projects generally takethree years or more, fromformation to standardissuance.

Release of an IFRS,Exposure Draft, or final SIC

Interpretation requiresapproval by 8 of the boards

14 members.


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Major Contributions of the IASB

Harmonizing accounting standards anddisclosures to meet the needs of the worlds

capital markets.

Providing an accounting foundation forunderdeveloped or newly industrialized countriesto use as the accounting profession emerges in

those countries.

Advancing compatibility of domestic andinternational accounting requirements.


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Principles-Based Versus Rules-Based

IFRSs are often referred to as being principles-based.

US GAAP is said to be more rules-based.

This has led to about 25,000 pages of US GAAPversus about 2,000 pages of IFRSs.

With fewer pages and less detail, IFRSs stilladdress all major accounting issues, fromfinancial statement presentation to businesscombinations.

Stop & Reflect: Which is better, rules-based or principles-based?


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Region

Total

countries

Required for all

domestic listed

companies in 2003

Required for all

domestic listed

companies in

2006

Europe 47 7 33

North America 3 0 0

Central and South America 19 7 8

Africa 54 3 5

Asia 49 6 11

Australia Oceania 6 1 2Total 178 24 59

Required Use of IFRSs by World Region 2003-2006


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Impact of Cultural and Economic Factors on

International Financial Reporting

Accounting standards vary among countries due

to the culture, economics, politics, and the legalenvironment that are unique to each country.

For example, in economies where inflation ishigh set up rules to improve period to periodcomparability by use of inflation indices.

In countries like the U.S., stockholders providethe majority of capital to businesses. Individualstockholders generally own relatively smallownership stakes and are not involved withcompany operations.

Consequently, U.S. GAAP is geared towards

full- disclosure and relative transparency. Incountries where capital-providers have access tocorporate financial information from sourcesother than financial reports, transparency anddisclosure is not as critical.


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Benefits to Countries with Weak Financial ReportingRequirements

In nations with weak financial disclosurerequirements, investors often demandadditional financial information whencompanies issue stock.

Consequently, governments in these nationsmay be compelled to revise or create securitieslaws that require improved financial reportingdisclosure.

A simpler and better solution is to adopt IFRSs,which have a higher level of financial reportingdisclosure than most countries GAAP.

Stop & Reflect: Will better GAAP (i.e.,IFRS) lead to economic development indeveloping countries?


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Benefits to Countries with Strong Financial ReportingRequirements

While there is lower motivation to adopt IFRSs,

due to a smaller incremental benefit of investorprotection, a nation with strong financialdisclosure requirements in its existing GAAPcan still benefit from adopting IFRSs.

Such a nation benefits by participating in

uniform, multinational financial reportingstandards.

Investors are aided by this cross-nationalcomparability.

Uniform reporting standards reduce costs offinancial statement reconciliation associatedwith multinational stock listings.

Stop & Reflect: Do you believe that oneset of GAAP (i.e., IFRS) is really the best

thing for the US? For the world?


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IFRSs Reduce Complexity

Complexity is associated with global

operations resulting from subsidiaryoperations in cultural settings that differsubstantially from the parent.

This leads to complex operating,reporting, and information

environments. Multinational companies do business in

a more complex environment thanstrictly domestic firms and financialreporting differences contribute to this

complexity. Use of one set of accounting standards,

such as the IFRSs, will help reduce thiscomplexity.

Parent

(c,l,p,x,r,g,i)

Subsidiary 1

(c,l,p,x,r,g,i)

Subsidiary 2

(c,l,p,x,r,g,i)

Subsidiary 3

(c,l,p,x,r,g,i)

Joint Venture

(c,l,p,x,r,g,i)

InvestorS,C

Financial

AnalystS,C


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Examining Differences Between U.S. GAAP and IFRS

There are many areas ofdifference between U.S. GAAPand IFRSs, but similarities faroutweigh differences.

Accounting rules vary across

countries and differences can becosmetic or substantive.


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Cosmetic Differences:

Financial Statement Presentation Per IAS 1

IAS 1 does not prescribe a particular format for

presentation of financial statements (B/S, I/S,SCF, SCE); multiple formats have evolved inpractice. In the U.S., a common format hasevolved.

Re: Balance Sheet An illustration of a cosmetic difference is the

presentation of the balance sheet in manycountries that are, or were, members of the

British Commonwealth. The balance sheet of a UK company is often

presented (1) in the form of A L = OE ratherthan A = L + OE and (2) in reverse order of

liquidity.


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Comparing U.S. GAAP and IFRSs: Cosmetic Differences

Turnover Sales

Stocks Inventory

Share Capital Common Stock or Paid-inCapital

Share Issue Premium Additional Paid-inCapital

Debtors Accounts Receivable Creditors Accounts Payable

Revenue Reserves Retained Earnings

Another example of a cosmetic difference is use

of different word to refer to the same item. A fewexamples are as follows, international termfollowed by U.S. counterpart:


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GlaxoSmithKline

Consolidated Balance Sheet

Notes

2001

m

2000

m

Goodwill 15 174 170

Intangible Assets 16 1,673 966

Tangible Assets 17 6,845 6,642

Investments 18 3,228 2,544

Fixed Assets 11,920 10,322

Equity investments 19 185 171

Stocks 20 2,090 2,277

Debtors 21 5,591 5,399

Liquid investments 25 1,415 2,138

Cash at bank 25 716 1,283

Current assets 9,997 11,268

Loans and overdrafts 25 (2,124) (2,281)

Other creditors 22 (7,306) (6,803)

Creditors: amounts due within one year (9,430) (9,084)

Net current assets 567 2,184

Total assets less current liabilities 12,487 12,506

Loans 25 (2,108) (1,751)

Other creditors 22 (190) (143)


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GlaxoSmithKlineConsolidated Balance Sheet - Continued

Creditors: amounts due after one year (2,298) (1,894)

Provisions for liabilities and charges 23 (1,810) (1,657)

Net assets 8,379 8,955

Called up share capital 27 1,543 1,556

Share premium account 27 170 30

Other reserves 29 1,866 1,849Profit and loss account 29 3,938 4,276

Equity shareholders funds 7,517 7,711

Non-equity minority interest 28 621 1,039

Equity minority interests 241 205

Capital employed 8,379 8,955

Approved by the BoardSir Richard Sykes, Chairman12

thMarch 2002

Note: Differences from U.S. GAAP include order of reverse liquidity and model ofA - L (Net assets) = SE (Capital Employed) instead of A + L = SE.


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Re: Income Statement

No distinction betweenRevenues/Gains orExpenses/Losses

Re: Statement of Changes in Equity

Two different approaches can beused

Benchmark treatment similar to US

GAAP

Alternative treatment include portionse.g. capital transactions in notes


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Re: Statement of Cash Flows

Per IAS 7, the cash flow statement is arequired statement. Requirements of IAS 7are much the same as SFAS 95 in the U.S.with a few differences.

In the U.S., interest paid, interest received,and dividends received are shown in the

operating section, while dividends paid isshown in the financing section.

Under IFRS, interest paid, interest received,and dividends received are normallyaccounted for as operating cash flows as well.However, interest paid may be accounted for

as a financing cash flow, while interestreceived and dividends received may beaccounted for as investing cash flows,because they are costs of obtaining financialresources or returns on investments.


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Re: Statement of Cash Flows Non-cash transactions (e.g.,

issue bonds for LT assets) donot need to be disclosed on theface of the cash flow statement

CF from extraordinary &discontinued items must bedisclosed separately in eachsection

Stop & Reflect: Do you see anyproblems with the IFRS approach to theSCF?


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Re: Notes

IFRS requires disclosure of currencyused in the FS

Does not need to be the primarycurrency of the enterprise

For example, Jardine Matheson, adiversified Bermuda-based companywith operations primarily in Asia andAustralia uses the U.S. dollar.

Stop & Reflect: Why is it necessary todisclose currency used under IFRS, butnot US GAAP?


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Comparing U.S. GAAP and IFRSs:PP&E

Under IFRS, the benchmark treatment under IAS16 is to report PP&E at cost net of depreciationand potential impairments.

IAS 16 provides for an alternative treatment, torevalue PP&E to fair value. Companies may usehighest and best use to determine fair value.

After a company begins to revalue PP&E, it mustcontinue to doing so . . .with sufficient regularity toensure that the carrying amount does not differmaterially from that which would be determinedusing fair value at the balance sheet date.

Example: Journal entry to revalue land that cost200,000 to FV of 240,000:

Land 40,000

Revaluation Surplus 40,000


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Comparing U.S. GAAP and IFRSs:PP&E

Re. revaluation, downward revaluations are

possible Determined on an asset-by-asset basis, not by

the class as a whole

If downward revaluation, it is offset against therevaluation equity, to the extent it exists. Any

excess goes to expense If subsequent upward revaluation, goes to

income to extent of any prior revaluationexpense taken

Construction period interest may be

expensed or capitalized (US GAAPrequires capitalization only)

Depreciation determined similarly underIFRS & US GAAP


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Comparing U.S. GAAP and IFRSs:Leases

Under US GAAP, leases are classifiedas capital if one or more of the 4criteria are met (title transfer, bargainpurchase option, 75% of economic

life, MLP >= 90% of asset FMV) Under IFRS, criteria are less rigid.


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Comparing U.S. GAAP and IFRSs:Leases

Under IAS 17, a leases is classified as either anoperating lease or a finance lease (U.S. GAAPrefers to finance leases as capital leases).

Per IAS 17 a finance lease transferssubstantially all the risks and rewards incidental toownership of an asset. Title may or may not

eventually be transferred. Example situations:

1. The lease transfers ownership to the lessee,

2. The lessee has a bargain purchase option,

3. The lease term is for the major part of the

economic life of the asset,4. The present value of the minimum lease payments

amounts to at least substantially all of the fairvalue of the leased asset,

C i U S GAAP d IFRS L


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Comparing U.S. GAAP and IFRSs: Leases

Example situations continued:

5. The leased assets are of a specialized nature such

that only the lessee can use them,6. If the lease is cancelable by the lessee, the lessors

costs associated with the cancellation are borne bythe lessee,

7. Gains or losses associated with fluctuations in the

leased asset FMV are borne by the lessee, and8. The lessee can continue to lease the asset for a

secondary period for a substantially lower rent thanmarket rent.

The first four criteria are similar to criteria under

U.S. GAAP but are not identical; criteria 5 through8 are not included in U.S. GAAP.

Stop & Reflect: Regarding leases, which do you think gives the betterresult, rules-based US GAAP or principles-based IFRS?


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Comparing U.S. GAAP and IFRSs: Intangible Assets

Accounting may differ in development phase

Under US GAAP, costs are expensed Under IFRS, costs can be capitalized if ALL

the following are met:

Completion is technically feasible

Intention is to complete asset and use or sell

Company has ability to do so

Can demonstrate how asset will generate futurebenefit

Company has resources to complete the asset

Company can reliably measure developmentexpenditures

Stop & Reflect: Do you think it makes sense to allow capitalization ofsome R&D, as permitted under IFRS?


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Comparing U.S. GAAP and IFRSs:Accounting Changes

IFRS 2, Stock-BasedPayment, includes stockcompensation

US GAAP followed with

SFAS 123 (R) (fair value)


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FASB IASB Working Together

In October 2002, the FASB and the IASB issued a

memorandum of understanding (referred to as theNorwalk Agreement or MoU) formally announcingtheir commitment to converging U.S. GAAP andIFRSs.

In recent years, both the FASB and IASB have issued

rules that converge (or almost converge) theiraccounting standards with the standards of the otherbody.

For example, the IASB essentially conformed to U.S.GAAP for pooling and accounting for goodwill with theissuance of IFRS 3, Business Combinations.

The FASB conformed to IFRS when it issued SFAS151 on Inventory, SFAS 153 on Like-Kind Exchanges,and SFAS 154 on Accounting Changes.


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If Everyone Adopts IFRSs, its Still Not a Perfect World

Uniformity in accounting standards is a gigantic step

toward understanding financial statements preparedin different nations; however, uniformity alone is not atotal solution.

Environmental factors such as culture, language, legalsystem, and economic conditions affect how anyGAAP, including IFRS, is applied.

For example, regarding environmental factors, thelitigation environment affects conservatism in financialreporting.

For a company located in a nation where there is ahigh risk of investor lawsuits, such as the US, therewill be a different perspective on conservatism than in

a nation that is less litigious. Thus, IFRS will be applied differently depending on

the national culture. Properly evaluating investmentopportunities in any country requires that the investorunderstand the culture of that country.


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Impact of Ethics on International Financial Reporting

No set of accounting standards, whether IFRSs,US GAAP, or other set of accounting standards,can replace the necessity for accountants to havethe highest level of ethical character.

Corporate financial scandals rarely ever resultfrom deficiencies in accounting standards alone,but are frequently the result from weaknesses in

the ethical character of the perpetrators, whichmay include top management, corporateaccountants, and auditors.

Greed and over-reaching ambition have led todisastrous consequences for corporations andtheir stakeholders.

Considering the problem of greed, Solomonwrote: Whoever loves money never has moneyenough; whoever loves wealth is never satisfiedwith his income (Ecclesiastes 5:10).


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Author, Army veteran, U.S CongressRepresentative from Tennessee, andhero of the Alamo, David Crockett used

the following campaign slogan:Be sure youre right, then go ahead.


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Winning isnt everything, but doing whats right is.


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Without ethical character, properprofessional judgment is virtuallyimpossible.

Since IFRSs are regarded as moreprinciples-based as opposed to the morerules-based US GAAP, ethical character

and professional judgment will be evenmore critical (if that is possible) in anIFRS-based financial reportingenvironment.


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Take-Away Points

IFRSs are the accounting standards published by the InternationalAccounting Standards Board (IASB).

IFRSs are now accepted or required in more than 100 countries. Leading accounting experts anticipate that IFRSs will be accepted for

financial reporting, in place of US GAAP, for all companies listed inUS stock market, as early as 2012 or 2013.

Since IFRSs are regarded as more principles-based as opposed to

the more rules-based US GAAP, ethical character and professionaljudgment will be even more critical (if that is possible) in an IFRS-based financial reporting environment.

Be sure youre right, then go ahead.

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International Financial Reporting (Final) 8 (Far)

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