Chapter 4 - IFRS1

2/13/2021
Chapter 4:
International
Financial
Reporting
Standards:
Part I
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objectives
 Discuss the types of differences that exist between International
Financial Reporting Standards (IFRS) and U.S. generally
accepted accounting principles (GAAP)
 Describe IFRS requirements related to the recognition and
measurement of assets, specifically inventories; property, plant,
and equipment, and leased assets
 Explain major differences between IFRS and U.S. GAAP on the
recognition and measurement of assets
 Analyze the impact that differences in asset recognition and
measurement rules have on financial statements
 Explain how investment property and biological assets differ
from PPE and what special rules govern their accounting
treatment under IFRS
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Learning Objectives (2)

 Describe IFRS requirements related to business
combinations, goodwill, and non-controlling interests.
 Describe IFRS requirements for determining effective
control and the scope of consolidation.
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Types of Differences Between IFRS and U.S.

GAAP
 Definition differences
 Recognition differences
 Measurement differences
 Alternatives
 Lack of requirements or guidance
 Presentation differences
 Disclosure differences
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IFRS and U.S. GAAP

 IFRS more flexible in many cases
 Choice between alternative treatments in accounting
 IFRS generally have less bright-line guidance
 More judgment is required in applying IFRS
 IFRS is a principles-based accounting system:
 whereas U.S. GAAP is a rules-based system
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IAS 2, Inventories
 Provides more extensive guidance than U.S. GAAP
 Cost of inventories include:
 Costs of purchase
 Costs of conversion
 Other costs
 design, interest if takes time to bring to saleable condition
 Cost of inventories exclude:
 Abnormal waste
 Storage, unless necessary for the production process
 Administrative overhead
 Selling costs
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IAS 2, Inventories (2)

 Limited choice with regard to cost formulas
 Does not allow LIFO
 Standard cost method and retail method are acceptable only if
they approximate cost as per IAS 2
 Cost of inventories not ordinarily interchangeable.
 Goods and services produced and segregated for specific projects
should use specific identification
 An entity must use same cost formula for similar inventory items
 IAS 2 requires inventory to be reported at the lower of cost or
net realizable value
 Typically applied on item-by-item basis, but grouping allowed for
items of inventory relating to same product line
 Write-downs are reversed when selling price increases
 U.S. GAAP now uses same approach without allowing reversal of
write-downs
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IAS 16, Property, Plant, and Equipment

 Recognition of initial costs
 Cost includes
 Purchase price
 All costs needed for asset to perform as intended
 Estimate of cost of dismantling and removing asset along with restoring site
 Exchange of assets
 Fair value unless no commercial substance or fair value can’t be determined
 Measurement subsequent to initial recognition
 IFRS allows 2 treatments
 Cost model: depreciation
 Revaluation model: fair value date of revaluation minus subsequent
depreciation
 Must do entire class of assets
 Must revalue often
 Increases in value go to OCI; decreases reduce OCI to historical cost then reduce
income
 Accumulated depreciation with revaluation
 Proportional to new value
 Eliminated with excess/shortage against asset account
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IAS 16, Property, Plant, and Equipment (2)

 Depreciation
 Based on estimated lives, residual value, and method
annually
 Treat any changes prospectively
 When comprised of significant parts, use component
depreciation
 Derecognition
 Derecognize carrying amount of property, plant, and
equipment
 When asset is disposed
 When no future economic benefits are expected
 Gain or loss is included in net income
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IAS 40, Investment Property

 Land or buildings held for rental, capital appreciation, or
both
 Same general principles as per IAS 16: choice of cost or
revaluation model:
 Changes in fair value is recognized in current income and not
revaluation surplus
 Must show fair value in footnotes with cost model
 U.S. GAAP generally requires use of cost model
 Disclose fair value in notes when using the cost model
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Biological Assets
 U.S. GAAP cost method…ignores growth of biological
asset; no income until final product sold
 IFRS fair value (less costs to sell at point of harvest)
changes in value over time go to income even before
harvesting
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Relevance-Reliability Trade-Off
 IASB: fair value, relevance over reliability
 FASB: cost method, reliability over relevance
 Reliability challenges with fair value

 Illiquidity of markets so models instead of observed prices
used
 Competing valuation frameworks and models…different
results
 Subjectivity in estimates
 Long forecasting horizon…uncertainty
 Management incentives to exploit model choices
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IAS 36, Impairment of Assets

 Must test annually for impairment to plant, property and
equipment; intangible assets; goodwill; investments in
subsidiaries; associates, and joint ventures
 Does not apply to inventory, construction in progress,
deferred tax assets, employee benefit assets or financial
assets (eg: accounts and notes receivable)
 Impairment under IAS 36 = carrying amount >
recoverable amount
 Recoverable amount is the greater of net selling price and
present value of future net cash flows
 Impairment more likely under IFRS since discounted cash
flows are used
 U.S. GAAP uses undiscounted future cash flows
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IAS 36, Impairment of Assets (2)

 Reverse impairment loss when recoverable amount
exceeds new carrying amount:
 if changes in estimates used to determine original impairment
loss or change in how recoverable amount is determined
 Reversal only up to original carrying amount
 Recognize reversal in income immediately
 U.S. GAAP allows no reversal
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IAS 38, Intangible Assets

 Applies to purchased intangibles, intangibles acquired in
business combination, internally generated intangibles
 Goodwill is covered separately under IFRS 3
 Intangible asset is identifiable, nonmonetary asset without
physical substance:
 Held for production of goods or services, rental to others, or
for administrative purposes
 Controlled by enterprise as result of past events from which
future economic benefits are expected to be realized
 Must be expensed immediately if it does not meet the
definition
 Except when obtained in business combination
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IAS 38, Intangible Assets (2)

 Purchased intangibles measured at cost
 Useful life could be assessed as finite or indefinite
 Distinction between intangibles with finite life and indefinite life
is made in IAS 38
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Intangibles Acquired in Business Combination
 Patents, trademarks, and customer lists recognized as

assets measured at fair value
 Even if not previously recognized by target
 Must have finite or infinite life
 Special treatments for in-process research and
development
 Capitalize when certain criteria is met
 Otherwise include in goodwill
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Internally Generated Intangibles

 Major difference with U.S. GAAP
 IFRS allows some development costs to be capitalized
 U.S. GAAP expenses all research and virtually all
development
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Internally Generated Intangibles (2)

 Criteria for development cost capitalization:
 Technical feasibility of completion
 Intention to complete asset for use or sale
 Ability to use or sell the asset
 How probable future economic benefits will be generated
 Market or internal use
 Available adequate technical, financial, and other resources
to complete the asset for use or sale
 Ability to reliably measure expenditures pegged to
development
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 Financial Statement Effects
 Income Statement effects
 With increasing R&D expenditures….higher income
 Therefore inflates shareholder equity (retained earnings)
 Balance sheet effects
 Inflates intangible assets net of accumulated amortization
 Offset is higher shareholder equity (retained earnings)
 Cash Flow Statement effects
 Reclassifies expenditure as capex (capital expenditure) outflow
 Expenditure is investing instead of operating outflow
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 Other issues:
 Revaluation model is allowed with finite-lived intangibles
 If there is a price on an active market
 Impairment of intangibles
 If carrying amount can’t be recovered on finite-lived assets—
need to look at changes in events or circumstances
 For indefinite-lived intangibles and goodwill
 Test annually
 Under special circumstances can reverse as per IAS 36
 Goodwill not subject to reversal of impairment
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Acquisition Method of Combinations

 Used by both IFRS and GAAP
 Must have acquirer and acquiree
 Acquiree’s assets and liabilities shown at FMV
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Business Combinations
 Recognize goodwill only in business combinations
 Goodwill is Difference between:
 Consideration paid by acquirer plus noncontrolling interest
 Fair value of net assets acquired
 Negative goodwill must be recognized as income
 Goodwill depends on the option selected to measure any
noncontrolling interest
 Measured at either
 A proportionate share of the fair value of the acquired firm’s net
assets excluding goodwill
 Fair value, including the noncontrolling interest’s share of
goodwill
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Business Combinations (2)

 Not amortized as it is an indefinite-lived intangible asset
 Impairment of goodwill must be tested annually
 Impairment is tested at the level of the cash-generating
unit (CGU)
 Compare carrying value of CGU, including goodwill, with
recoverable amount
 U.S. GAAP is tested at level of the reporting unit which can
be different and typically larger than CGU
 U.S. GAAP only requires a bottom-up test
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VIEs
 VIE is an entity where equity investment at risk is
insufficient to finance operations
 Control over VIE exists when following conditions met:
 Direct or indirect ability to make decisions about entities’
activities
 Obligation to absorb expected losses of entity if they occur
 Right to receive expected residual returns of the entity if they
occur.
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Business Combinations (3)

 Parent must consolidate all subsidiaries over which they
exercise control
 Control:
 Ownership of more than 50% voting shares
 Effective control
 Ability to direct investee to enter agreements that benefit investor
 Ability to direct operating activities of investee, such as selling and
purchasing goods
 Ability to direct investments, such as capital spending or R&D
 Ability to determine investee’s financial structure
 Investor’s right to obtain direct control of investee by buying additional
voting shares at a later date in response to certain triggering events
 Control exists when each of the following is present:
 Investor has power over investee
 Investor has rights or exposure to downside risk from variable returns of
investee
 Investor has ability to use power over investee to affect those returns
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IAS 23, Borrowing Costs

 Similar to U.S. GAAP in general approach
 Capitalize all borrowing costs to extent they are
attributable to acquisition, construction, or production of a
qualifying asset
 Expense all other borrowing costs
 Borrowing costs include interest and other costs incurred in
connection with borrowing
 IAS 23 includes foreign currency exchange to the extent
they related to interest costs
 Under IAS 23, inventories qualify if they require
substantial period to manufacture
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IAS 23, Borrowing Costs (2)

 Capitalize interest that could have been avoided in
absence of expenditure on the qualifying asset
 Amount capitalized determined by multiplying weighted-
average accumulated expenditures by appropriate
interest rate
 Can use actual interest rate if average expenditures are less
than specific borrowing total
 Interest income on temporary investment of specific new
borrowing offsets interest capitalized under IFRS…no
netting allowed under GAAP
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End of Chapter 4
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Chapter 4 - IFRS1

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2/13/2021

Learning Objectives (2)

Types of Differences Between IFRS and U.S.

IFRS and U.S. GAAP

IAS 2, Inventories (2)

IAS 16, Property, Plant, and Equipment

IAS 16, Property, Plant, and Equipment (2)

IAS 40, Investment Property

 Reliability challenges with fair value

IAS 36, Impairment of Assets

IAS 36, Impairment of Assets (2)

IAS 38, Intangible Assets

IAS 38, Intangible Assets (2)

Intangibles Acquired in Business Combination

 Patents, trademarks, and customer lists recognized as

Internally Generated Intangibles

Internally Generated Intangibles (2)

Internally Generated Intangibles (3)

Internally Generated Intangibles (4)

Acquisition Method of Combinations

Business Combinations (2)

Business Combinations (3)

IAS 23, Borrowing Costs

IAS 23, Borrowing Costs (2)

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