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International Financial Reporting Standards IFRS Transition

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Title: International Financial Reporting Standards IFRS Transition


1
International Financial Reporting Standards
(IFRS)Transition
Prepared by L. Murphy Smith Professor of
Accounting Texas AM University For permission
to use or adapt this presentation, please contact
Dr. Smith, Lmsmith_at_tamu.edu
2
Questions and Comments are Welcome Any Time
3
International Financial Reporting Standards
(IFRSs)are shooting down the competition (other
GAAPs)
IFRSs are now accepted or required in more than
100 countries.
4
U.S. Leaders Call for Acceptance of IFRSs
  • Among those calling for acceptance of IFRSs are
    John Thain, CEO of the New York Stock Exchange,
    and former Federal Reserve Chairman Paul Volcker.
  • FASB Chairman Robert Herz has expressed his
    expectation that US companies would eventually be
    required to follow a single accounting standard,
    which would be the IFRSs.

5
Why do we need IFRSs and financial reporting
comparability?
  • Expanding world trade
  • Proliferation of multinational corporations
  • Increasing role of global capital markets
  • Increased foreign direct investment
  • Growth of multinational political organizations
  • A way to minimize costs

6
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 GAAP that works best
everywhere?
7
Key Problems that Cause Resistance to IFRSs
  • Agreeing on who will create the rules
  • How different the rules will be from current
    national GAAP
  • Costs of changing GAAPs
  • National sovereignty

8
International Financial Reporting Standards
(IFRSs)
  • IFRSs are the accounting standards published by
    the International Accounting Standards Board
    (IASB).
  • The IASB was established in 2001 by its
    forerunner, the International Accounting
    Standards Committee, which itself was established
    in 1973.
  • In the past decade, the IFRSs went from being
    little used to what is now the worlds dominant
    set of accounting standards.
  • Leading accounting experts anticipate that IFRSs
    will be accepted for financial reporting, in
    place of US GAAP, for all companies listed in US
    stock market, as early as 2016.

9
Pivotal Events Propelling the IFRSs Juggernaut
  • Financial scandals occurring in the US in the
    early 2000s, notably Enron, which highlighted
    shortcomings in US GAAP.
  • IOSCO recommended use of IFRSs in 2000.
  • Adoption of IFRSs for financial reporting by
    listed companies in the EU in 2005.
  • U.S. Securities and Exchange Commissions
    announcement in 2007 to accept IFRSs for
    financial reporting by non-US companies listed in
    the US stock market (no Form 20-F reconciliation
    to U.S. GAAP).
  • SEC Commissioners propose timeline for IFRS
    adoption by 2016.

10
SEC Proposed Timeline for Moving Companies to
IFRSs
  • End of 2009 Limited group of large companies
    given the option to use IFRS. SEC estimates 110
    U.S. companies will be able to take advantage of
    the offer.
  • 2011 SEC evaluates the progress of achieving
    proposed milestones, and makes a decision about
    whether to mandate adoption of IFRS. If IFRS is
    mandated, the commission will develop a staged
    roll out, starting with the largest public
    companies first.
  • 2014 Year the first wave of companies will be
    mandated to report financial results using
    international accounting standards, if IFRS
    requirements are adopted in 2011.
  • 2016 Year that all public companies, big and
    small, will be mandated to report financial
    results using international accounting standards,
    if IFRS requirements are adopted in 2011.

Stop Reflect Is the timeline moving too fast?
11
Overview of the International Accounting
Standards Board (IASB)
  • The London-based IASB is an independent,
    privately funded accounting standard-setting
    body.
  • Board members are from nine countries and include
    a variety of functional backgrounds.
  • The over-arching commitment of the IASB is to
    develop, in the public interest, one set of
    high-quality, understandable, and enforceable
    global accounting standards that require
    transparent and comparable information in general
    purpose financial statements.
  • National accounting standard-setters have worked
    with the IASB to converge accounting standards
    around the globe.

12
Overview of the International Accounting
Standards Board (IASB) -- continued
  • The International Accounting Standards Committee
    Foundation is the parent body of the IASB.
  • The IASBs structure and organization resulted
    from a strategy review undertaken by its
    predecessor body, the Board of the International
    Accounting Standards Committee.
  • The body of standards issued by the Board of the
    International Accounting Standards Committee was
    subsequently adopted by the IASB.
  • These older standards were issued between 1973
    and 2000, and continue to be designated
    International Accounting Standards (IASs).

13
Structure of the International Accounting
Standards Board (IASB)
  • IASB projects generally take three years or more,
    from formation to standard issuance.
  • Release of an IFRS, Exposure Draft, or final SIC
    Interpretation requires approval by 8 of the
    boards 14 members.

14
Major Contributions of the IASB
  • Harmonizing accounting standards and disclosures
    to meet the needs of the worlds capital markets.
  • Providing an accounting foundation for
    underdeveloped or newly industrialized countries
    to use as the accounting profession emerges in
    those countries.
  • Advancing compatibility of domestic and
    international accounting requirements.

15
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 GAAP
    versus about 2,000 pages of IFRSs.
  • With fewer pages and less detail, IFRSs still
    address all major accounting issues, from
    financial statement presentation to business
    combinations.

Stop Reflect Which is better, rules-based or
principles-based?
16
Required Use of IFRSs by World Region 2003-2006

17
Impact of Cultural and Economic Factors on
International Financial Reporting
  • Accounting standards vary among countries due to
    the culture, economics, politics, and the legal
    environment that are unique to each country.
  • For example, in economies where inflation is high
    set up rules to improve period to period
    comparability by use of inflation indices.
  • In countries like the U.S., stockholders provide
    the majority of capital to businesses. Individual
    stockholders generally own relatively small
    ownership stakes and are not involved with
    company operations.
  • Consequently, U.S. GAAP is geared towards full-
    disclosure and relative transparency. In
    countries where capital-providers have access to
    corporate financial information from sources
    other than financial reports, transparency and
    disclosure is not as critical.

18
Benefits to Countries with Weak Financial
Reporting Requirements
  • In nations with weak financial disclosure
    requirements, investors often demand additional
    financial information when companies issue stock.
  • Consequently, governments in these nations may be
    compelled to revise or create securities laws
    that require improved financial reporting
    disclosure.
  • A simpler and better solution is to adopt IFRSs,
    which have a higher level of financial reporting
    disclosure than most countries GAAP.

Stop Reflect Will better GAAP (i.e., IFRS)
lead to economic development in developing
countries?
19
Benefits to Countries with Strong Financial
Reporting Requirements
  • While there is lower motivation to adopt IFRSs,
    due to a smaller incremental benefit of investor
    protection, a nation with strong financial
    disclosure requirements in its existing GAAP can
    still benefit from adopting IFRSs.
  • Such a nation benefits by participating in
    uniform, multinational financial reporting
    standards.
  • Investors are aided by this cross-national
    comparability.
  • Uniform reporting standards reduce costs of
    financial statement reconciliation associated
    with multinational stock listings.

Stop Reflect Do you believe that one set of
GAAP (i.e., IFRS) is really the best thing for
the US? For the world?
20
IFRSs Reduce Complexity
  • Complexity is associated with global operations
    resulting from subsidiary operations in cultural
    settings that differ substantially from the
    parent.
  • This leads to complex operating, reporting, and
    information environments.
  • Multinational companies do business in a more
    complex environment than strictly domestic firms
    and financial reporting differences contribute to
    this complexity.
  • Use of one set of accounting standards, such as
    the IFRSs, will help reduce this complexity.

21
Examining Differences Between U.S. GAAP and IFRS
  • There are many areas of difference between U.S.
    GAAP and IFRSs, but similarities far outweigh
    differences.
  • Accounting rules vary across countries and
    differences can be cosmetic or substantive.

22
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 in
    practice. In the U.S., a common format has
    evolved.
  • Re Balance Sheet
  • An illustration of a cosmetic difference is the
    presentation of the balance sheet in many
    countries 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 rather
    than A L OE and (2) in reverse order of
    liquidity.

23
Comparing U.S. GAAP and IFRSs Cosmetic
Differences
Another example of a cosmetic difference is use
of different word to refer to the same item. A
few examples are as follows, international term
followed by U.S. counterpart
  • Turnover Sales
  • Stocks Inventory
  • Share Capital Common Stock or Paid-in Capital
  • Share Issue Premium Additional Paid-in Capital
  • Debtors Accounts Receivable
  • Creditors Accounts Payable
  • Revenue Reserves Retained Earnings

24
Comparing U.S. GAAP and IFRSs Cosmetic
Differences
GlaxoSmithKline
25
Comparing U.S. GAAP and IFRSs Cosmetic
Differences
GlaxoSmithKline Consolidated Balance Sheet -
Continued
Note Differences from U.S. GAAP include order of
reverse liquidity and model of A - L (Net
assets) SE (Capital Employed) instead of A L
SE.
26
Financial Statement Presentation Per IAS 1
  • Re Income Statement
  • No distinction between Revenues/Gains or
    Expenses/Losses
  • Re Statement of Changes in Equity
  • Two different approaches can be used
  • Benchmark treatment similar to US GAAP
  • Alternative treatment include portions e.g.
    capital transactions in notes

27
Financial Statement Presentation Per IAS 1
  • Re Statement of Cash Flows
  • Per IAS 7, the cash flow statement is a required
    statement. Requirements of IAS 7 are 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 is shown in the
    financing section.
  • Under IFRS, interest paid, interest received, and
    dividends received are normally accounted for as
    operating cash flows as well. However, interest
    paid may be accounted for as a financing cash
    flow, while interest received and dividends
    received may be accounted for as investing cash
    flows, because they are costs of obtaining
    financial resources or returns on investments.

28
Financial Statement Presentation Per IAS 1
  • Re Statement of Cash Flows
  • Non-cash transactions (e.g., issue bonds for LT
    assets) do not need to be disclosed on the face
    of the cash flow statement
  • CF from extraordinary discontinued items must
    be disclosed separately in each section

Stop Reflect Do you see any problems with the
IFRS approach to the SCF?
29
Financial Statement Presentation Per IAS 1
  • Re Notes
  • IFRS requires disclosure of currency used in the
    FS
  • Does not need to be the primary currency of the
    enterprise
  • For example, Jardine Matheson, a diversified
    Bermuda-based company with operations primarily
    in Asia and Australia uses the U.S. dollar.

Stop Reflect Why is it necessary to disclose
currency used under IFRS, but not US GAAP?
30
Comparing U.S. GAAP and IFRSs PPE
  • Under IFRS, the benchmark treatment under IAS 16
    is to report PPE at cost net of depreciation and
    potential impairments.
  • IAS 16 provides for an alternative treatment, to
    revalue PPE to fair value. Companies may use
    highest and best use to determine fair value.
  • After a company begins to revalue PPE, it must
    continue to doing so . . .with sufficient
    regularity to ensure that the carrying amount
    does not differ materially from that which would
    be determined using fair value at the balance
    sheet date.
  • Example Journal entry to revalue land that cost
    200,000 to FV of 240,000
  • Land 40,000
  • Revaluation Surplus 40,000

31
Comparing U.S. GAAP and IFRSsPPE
  • 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 the
    revaluation equity, to the extent it exists. Any
    excess goes to expense
  • If subsequent upward revaluation, goes to income
    to extent of any prior revaluation expense taken
  • Construction period interest may be expensed or
    capitalized (US GAAP requires capitalization
    only)
  • Depreciation determined similarly under IFRS US
    GAAP

32
Comparing U.S. GAAP and IFRSsLeases
  • Under US GAAP, leases are classified as capital
    if one or more of the 4 criteria are met (title
    transfer, bargain purchase option, 75 of
    economic life, MLP gt 90 of asset FMV)
  • Under IFRS, criteria are less rigid.

33
Comparing U.S. GAAP and IFRSsLeases
  • Under IAS 17, a leases is classified as either an
    operating lease or a finance lease (U.S. GAAP
    refers to finance leases as capital leases).
  • Per IAS 17 a finance lease transfers
    substantially all the risks and rewards
    incidental to ownership 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 fair value of the leased asset,

34
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 by the lessee,
  • 7. Gains or losses associated with fluctuations
    in the leased asset FMV are borne by the lessee,
    and
  • 8. The lessee can continue to lease the asset for
    a secondary period for a substantially lower rent
    than market rent.
  • The first four criteria are similar to criteria
    under U.S. GAAP but are not identical criteria 5
    through 8 are not included in U.S. GAAP.

Stop Reflect Regarding leases, which do you
think gives the better result, rules-based US
GAAP or principles-based IFRS?
35
Comparing U.S. GAAP and IFRSs Intangible Assets
  • Purchased intangibles
  • Recorded at cost
  • Amortized finite life intangibles over useful
    life. Both IFRS and US GAAP have no upper
    amortization term
  • Internally-generated intangibles
  • Normally expensed as incurred
  • In the case of internal RD, IFRS splits the
    costs into a research phase and a development
    phase (similar definition to US GAAP)
  • Research phase costs are expensed under US GAAP
    and IFRS

36
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 future
    benefit
  • Company has resources to complete the asset
  • Company can reliably measure development
    expenditures

Stop Reflect Do you think it makes sense to
allow capitalization of some RD, as permitted
under IFRS?
37
Comparing U.S. GAAP and IFRSs Accounting Changes
  • IFRS 2, Stock-Based Payment, includes stock
    compensation
  • US GAAP followed with SFAS 123 (R) (fair value)

38
FASB IASB Working Together
  • In October 2002, the FASB and the IASB issued a
    memorandum of understanding (referred to as the
    Norwalk Agreement or MoU) formally announcing
    their commitment to converging U.S. GAAP and
    IFRSs.
  • In recent years, both the FASB and IASB have
    issued rules that converge (or almost converge)
    their accounting standards with the standards of
    the other body.
  • For example, the IASB essentially conformed to
    U.S. GAAP for pooling and accounting for goodwill
    with the issuance of IFRS 3, Business
    Combinations.
  • The FASB conformed to IFRS when it issued SFAS
    151 on Inventory, SFAS 153 on Like-Kind
    Exchanges, and SFAS 154 on Accounting Changes.

39
If Everyone Adopts IFRSs, its Still Not a
Perfect World
  • Uniformity in accounting standards is a gigantic
    step toward understanding financial statements
    prepared in different nations however,
    uniformity alone is not a total solution.
  • Environmental factors such as culture, language,
    legal system, and economic conditions affect how
    any GAAP, including IFRS, is applied.
  • For example, regarding environmental factors, the
    litigation environment affects conservatism in
    financial reporting.
  • For a company located in a nation where there is
    a high risk of investor lawsuits, such as the US,
    there will 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
    investment opportunities in any country requires
    that the investor understand the culture of that
    country.

40
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 have the
    highest level of ethical character.
  • Corporate financial scandals rarely ever result
    from deficiencies in accounting standards alone,
    but are frequently the result from weaknesses in
    the ethical character of the perpetrators, which
    may include top management, corporate
    accountants, and auditors.
  • Greed and over-reaching ambition have led to
    disastrous consequences for corporations and
    their stakeholders.
  • Considering the problem of greed, Solomon wrote
    Whoever loves money never has money enough
    whoever loves wealth is never satisfied with his
    income (Ecclesiastes 510).

41
Impact of Ethics on International Financial
Reporting
  • Author, Army veteran, U.S Congress Representative
    from Tennessee, and hero of the Alamo, David
    Crockett used the following campaign slogan
  • Be sure youre right, then go ahead.

42
Winning isnt everything, but doing whats right
is.
43
Impact of Ethics on International Financial
Reporting
  • Without ethical character, proper professional
    judgment is virtually impossible.
  • Since IFRSs are regarded as more principles-based
    as opposed to the more rules-based US GAAP,
    ethical character and professional judgment will
    be even more critical (if that is possible) in an
    IFRS-based financial reporting environment.

44
Take-Away Points
  • IFRSs are the accounting standards published by
    the International Accounting 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 in US
    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 professional judgment 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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