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The Impacts Of Ifrs On The Financial Statement Accounting Essay

RIESE CORPORATION Effects of switching from U.S. GAAP to IFRS Financial reporting in the U.S. is changing dramatically. Consistent with the

Securities and Exchange Commission’s proposed "Roadmap" (SEC, 2008), the

U.S. likely will join the more than 100 nations worldwide that currently utilize

International Financial Reporting Standards (IFRS), and require the use of IFRS in

the U.S. Because of the globally widespread use of IFRS, multinational entities

with subsidiaries that prepare IFRS-based financial statements already have to be

knowledgeable about IFRS as well as the current differences between

U.S. GAAP and IFRS.

Answer 1)

The impacts of IFRS on the financial statement while switching from US GAAP:

Statement of Financial Position-

The statement of financial position would be grouped by major activities

(operating, Investing , and financing), not by assets, liabilities, and equity as it is

today. The presentation of assets and liabilities in the business and financing

sections will clearly communicate the net assets that management uses in its

business and financing activities. That change in presentation coupled with the

separation of business and financing activities in the statements of comprehensive

income and cash flows should make it easier for users to calculate some key

financial ratios for an entity’s business activities or its financing activities.

Assets and liabilities would be disaggregated into short-term and long-term

subcategories within each category unless an entity believes presenting assets and

liabilities in order of liquidity provides more relevant information. Totals for

assets and liabilities and subtotals for short-term and long-term assets and

liabilities would be presented in the statement of financial position or in the notes

to financial statements.

Statement of Comprehensive Income-

The proposed presentation model eliminates the choice an entity currently has of

presenting components of income and expense in an income statement and a

statement of comprehensive income (two-statement approach) or, alternatively, of

presenting information about other comprehensive income in its statement of

changes in equity (U.S. generally accepted accounting principles only). All entities

would present a single statement of comprehensive income, with items of other

comprehensive income presented in a separate section. This statement would

include a subtotal of profit or loss or net income and a total for comprehensive

income for the period. Because the statement of comprehensive income would

include the same sections and categories used in the other financial statements, it

would include more subtotals than are currently presented in an income statement

or a statement of comprehensive income. Those additional subtotals will allow for

the comparison of effects across the financial statements. For example, users will

be able to assess how changes in operating assets and liabilities generate operating

income and cash flows.

Convergence between UK GAAP and IFRS and its impact on financial statement.

Similarities

The ultimate goal of UK GAAP and IFRS is same – to present information about

financial performance and position to all concerned stakeholders. If the aim is

same, then should be the main approach adopted by both accounting standards.

Differences

Though the overall aim is same, the differences in implementation and financial

reporting do occur due to social, economic and political backgrounds of different

nations.

Main concepts behind UK GAAP and IFRS are same, but when we look at micro

level, we see many differences at the individual standards level. Following are the main differences

between UK GAAP and IFRS:

The Statement of Principles allows use of both historical cost and current value

approaches in measuring balance sheet categories. The dual use of historical and

current value methods is known as modified historical cost basis (ASB, 1999).

Under historical cost, the carrying values of assets and liabilities are stated at the

lower of cost and recoverable amount. This approach is more conservative as

compared to IAS approach which uses fair value method. Also the choice of

historical or current value method is based on subjective analysis of a company’s

management and hence it is open to some manipulation.

Fair value - If we look at global level, both UK GAAP and IFRS have adopted fair

value method as the foundation of their accounting standards. IFRS takes fair value

adoption even higher when it says that income statement will include the changes

in the fair value of items that have not been yet traded like derivatives. The emphasis in new accounting standards is on mark-to-market fair value of assets and

liabilities rather than on actual market price based fair values. Now both realised

and unrealised changes in fair values would be incorporated in income statements.

The first year of transition will see high volatility in earnings and balance sheet

statements. Though this brings higher volatility, it will also test the management

skills in proper presentation and explanation of changes. It may also change the

benchmarks of success for managements.

Acquisitions- Acquisition accounting will change under new accounting standards.

Under UK GAAP, companies can choose between purchase and merger accounting.

Under IFRS, companies will have to account under purchase method only.

Goodwill- UK GAAP allowed amortisation of goodwill and companies had the

option of not segregating intangible assets from goodwill. Under IFRS, intangible

assets have to be separated from goodwill. Goodwill can not be amortised now but

companies will have to undertake annual impairment tests to justify the value of

goodwill on the balance sheets.

Consolidation of accounts- Under new accounting rules, companies may have to

consolidate certain additional subsidiaries into group accounts. On the other hand

companies will have to exclude certain subsidiaries or special purpose vehicles

which were not included till now.

Research and development costs- Under IAS 39, research costs can’t be carried on

the balance sheet and would have to write them off as incurred. Companies would

still be allowed to capitalize development in line with UK GAAP.

Stock options- Internet and share market last boom in late 1990s led to rapid

increase in share options as a way to reward employees. The new requirements to

record an expense on income statement for the value of share options granted to

employees could have a significant impact on earnings. AstraZeneca said in its pro

forma 2004 IFRS numbers that new accounting rules on stock options has made it

re-consider the use of stock options in rewarding its employees (Tricks, 2005).

Distributable profits- Organizations ability to pay dividends is dependent on their

distributable profits. Following are some of the major impacts of IFRS on

distributable profits - Inability to discount deferred tax liabilities, higher provisions

for deferred tax when companies move from historical costs to fair value and

inclusion of pension deficits in income statement. All of the above will reduce

distributable profits. Many companies would have to financially restructure

themselves in order to have sufficient distributable profits to meet dividends paid

in last year.

Deferred tax credit- Deferred tax credit is available under UK GAAP but not under

IFRS. Inclusion of business disposals gains in profits from operations. Adding

disposal gains to operating profits will make it harder for investors and analysts to

separate the earnings from continuing businesses.

Derivative contracts- Under IFRS, some derivative contracts will not qualify as

hedges as they won’t meet the criteria. UK GAAP allowed deferment of such

contracts until transaction took place. IFRS won’t allow the deferment of such

contract and would impact the profit and loss account even before the transaction

took place. It is better in a way that investors will know the current value of the

firm as on date rather than historical costs of such instruments, especially if the

duration of financial instruments was long. At the same time, it would increase the

burden on the company to calculate the fair value of all such transactions.

Answer 2)

Proposed Format of Financial Statements by FASB/IASB

Statement of Financial Position

Statement of Comprehensive Income

Statement of Cash Flows

Business section

Business section

Business section

Operating category

Operating category

Operating category

Operating finance subcategory

Operating finance subcategory

Investing category

Investing category

Investing category

Financing section

Financing section

Financing section

Debt category

Debt category

Equity category

Multi-category transaction section

Multi-category transaction section

Income tax section

Income tax section

Income tax section

Discontinued operation section

Discontinued operation section

Net of tax Discontinued operation section

Other comprehensive income, net of tax

As per IFRS the proposed format for financial statement disclosure

Considering from the perspective of Riese Corporation, the new format

for the presentation of Financial Statements would play an essential

role in the Sales forecast and determination of the Operating

Income. On employing the use of this format for the Financial

Information presentation the main advantage that will flow to the Riese

Corporation is as under:-

Financial Statement presentation in this format would enable to

attract the prudent investor’s vision towards the company.

As in this new format of the financial Statement Presentation all

the categories are disclosed individually in separate column, the

financial data can be shown more effectively and efficiently and

hence would enable the users to get their required information

from the Financial Report.

From the perspective of the Financial Statements Users the use

of new format of Financial Statement Presentation will impact

their decisions as follows:

The present format of Financial Statements Presentation will

give the Users a clear and transparent view of the financial

position of the concerned Company and enable the investors to

analyze the fundamentals in a more positive and appropriate

manner.

It provides a comparative view of Financial Information, Income

Statement and Cash Flow of the Company at the same place and

thus enable the users to make effective decision making and plan

their investment in a long term perspective.

Answer 3)

Advantage & Disadvantage of IFRS:

The accounting standards are the rules of measurements for financial statements

that companies issuing stock to the public must provide to stockholders. There are

various advantages and disadvantages of the U.S. companies changing their

systems from U.S.GAAP to IFRS. As the markets have grown to become more

complex and global, the disparities between the two standards have been a

significant issue as consumers and producers call for reform.

+ The first benefit of the conversion is comparability. Switching to IFRS would

allow people to see various companies from different parts of world on the same

plane. As willingness to trade increases, cross-border investment and integration of

capital markets are easier with greater market liquidity and lower cost of capital.

+ Investor bases would increase as the financial reports are becoming comparable.

+ Companies would be able to more effectively allocate their capital. Having one

standard, however, does not guarantee comparability. With the same standard,

practices and enforcement can differ considerably across firms and countries. It is

only natural because diversity in accounting standards would result from diversity

of the countries’ institutional infrastructures.

+ IFRS has wider rules and less specific guidance applications, giving more room

to interpretation. Thus, IFRS incorporates the value judgment of an accountant in

its financial report. These value judgments can easily be influenced by incentives a

company may have, causing a variety of ways to implement IFRS. This further

interferes with creating a global standard.

+The five principal areas where there are disparities are fair values, revenue

recognition, share-based payment, financial liabilities and equity, and

consolidation.

+In the area of consolidation, one of the specific differences is the order of the

inventory.

+U.S.GAAP uses the Last-In-First-Out (LIFO) method, which “assumes that goods

purchased most recently are sold first and that the remaining items have been

purchased at earlier periods”

Using the LIFO method results in lower gross profit, which allows a company to

be taxed less. Under IFRS, however, the LIFO method is prohibited. Implementing

IFRS would “trigger a big tax hike for the company”. This would probably

diminish a company’s position because of a higher tax burden. Thus, the

differences between the standards in the various areas affect a firm holistically.

+ The second benefit of the conversion is cost savings, primarily for multinational

companies.

+IFRS is a set of standards of higher quality.

Answer 4)

As per SEC, transition to IFRS states the following summarization:

The roadmap spells out seven milestones that would influence the SEC’s 2011 decision

on whether to move forward. The milestones are:

• Improvements in accounting standards

• The accountability and funding of the International Accounting Standards

Committee Foundation

• Improvement in the ability to use interactive data for IFRS reporting

• Education and training in the U.S. relating to IFRS

• Limited early use of IFRS, beginning with filings in 2010, where this would

enhance comparability for U.S. investors. Eligibility would be based on both the

prevalence of the use of IFRS and the significance of the issuer in a given

industry. The SEC estimates that a minimum of 110 companies could be eligible.

• The anticipated timing of future rulemaking by the Commission

• Implementation of the mandatory use of IFRS, including considerations relating

to whether any mandatory use of IFRS should be staged or sequenced among

groups of companies based on their market capitalization.

ADVANTAGES AND DISADVANTAGES

There are many advantages and disadvantages of converting from GAAP to IFRS.

Advantages

• The use of one common global reporting language.

• It will allow for comparability over all financial markets, regardless of the country of

origin.

• Investors will have better information for decision making.

• Companies will have more flexibility for applying accounting principles. IFRS is more

principles based, whereas GAAP is more rules based. Transactions will be required to be

reported using substance over form criteria. More professional judgment will be

exercised which will lead to better disclosure to support those judgments.

• There is the potential for reduced financial reporting complexity, especially for large,

multinational companies that currently prepare many different sets of financial statements

in many different forms.

• All levels of management, including the audit committee, will have to be more involved

in financial reporting and aware of transactions.

• In the end, companies should be more efficient and have the advantage of cost-savings.

Disadvantages

• Small companies that have no dealings outside of the United States have no incentive to

adopt IFRS unless mandated.

• Incompatibility may arise as companies claim to have converted to IFRS but in reality

have only selected the portions that best fit their needs.

• There is an extremely high price-tag – “…the SEC estimates the costs for issuers of

transitioning to IFRS would be approximately $32 million per company and relate to the

first three years of filings on Form 10-K under IFRS. Total estimated costs for the

approximately 110 issuers estimated to be eligible for early adoption would be

approximately $3.5 billion” (SEC, 2008).

•There is no incentive for early adoption due to the fact that it could be a colossal waste of

time and resources. Also, companies would be required to have two sets of records, one

GAAP, one IFRS, during this time just in case IFRS is not adopted.

• Many feel that during this financial crisis that the world is currently experiencing, a

conversion of this magnitude is too much to ask of executives and management.

• A minimum of two years of financial information prior to conversion would need to be

maintained on two sets of books, both GAAP and IFRS, to meet the requirement of

financial statements to contain three years of financial data.

Answer 5)

The exposure draft issued by FASB & IASB has affected the revenue recognition as follows:

Time for measurement of revenue

When an entity satisfies a performance obligation, it shall recognize as revenue the

amount of the transaction price allocated to that performance obligation.

An entity shall consider the terms of the contract and its customary business practice to

determine the transaction price for the contract with the customer. The transaction price

reflects the probability-weighted amount of consideration that an entity expects to receive

from the customer in exchange for transferring goods or services. In many contracts, the

transaction price is readily determinable because the customer promises to pay a fixed

amount of consideration and that payment is made at or near the time of the transfer of the

promised goods or services. In other contracts, the amount of consideration is variable, and

the transaction price must be estimated at each reporting period to represent faithfully the

circumstances present at the reporting date and the changes in circumstances during the

reporting period. The amount of consideration could vary because of discounts, rebates,

refunds, credits, incentives, performance bonuses/penalties, contingencies, price

concessions, the customer’s credit risk, or other similar items.

If an entity receives consideration from a customer and expects to refund some or all of

that consideration to the customer, the entity shall recognize a refund liability. The entity

shall measure that liability at the probability-weighted amount of consideration that the

entity expects to refund to the customer (that is, the difference between the amount of

consideration received and the transaction price). The refund liability shall be updated at

each reporting period for changes in circumstances.

An entity shall recognize revenue from satisfying a performance obligation only if

the transaction price can be reasonably estimated. The transaction price can be reasonably

estimated only if both of the following conditions are met:

(a) the entity has experience with similar types of contracts (or access to the experience of

other entities if it has no experience of its own); and (b) the entity’s experience is relevant

to the contract because the entity does not expect significant changes in circumstances.

For determining the transaction price, following effects of following should be considered.

(a) collectibility;

(b) the time value of money;

(c) noncash consideration; and

(d) consideration payable to the customer.

Answer 6)

The Revenue recognition being a crucial matter for accounting personnel & company

executive attracts more concern and importance for the financial position of the company.

Determining and defining appropriate revenue recognition has been a primary focus of

companies, regulators, standard setters, and auditors.

Improper revenue recognition has been one of the leading causes of financial statement

restatements. Perhaps no area of revenue recognition has received as much scrutiny as "bill-

and-hold" transactions. Also known as "ship-in place" transactions, these transactions

generally refer to scenarios where revenue is recognized after a seller has substantially

completed its obligations under an arrangement, but prior to the buyer, or a common carrier,

taking physical possession of the goods.

The company executive aims at ensuring the promptness of the following for revenue recognition:

+ The risks of ownership must have passed to the buyer.

+ The buyer must have a commitment to purchase, preferably in written documentation.

+ The buyer, not the seller, must originate the request that the transaction be on a bill-and-

hold basis.

+ The buyer must have a substantial business purpose for ordering the goods or equipment

on a bill-and-hold basis.

+ Delivery must be for a fixed date and on a schedule that is reasonable and consistent with

the buyer's purpose.

+ The seller must not retain any significant specific performance obligations under the

agreement such that the earnings process is not complete. The goods or equipment must be

segregated from the seller's inventory and may not be subject to being used to fill other

orders.

+ The goods or equipment must be complete and ready for shipment.

Answer 7)

The ethical Challenges that could arise from the changes proposed under the Revenue

Recognition Project are:

The main problem of financial reporting is that firm tries all sorts of ways to attract

investors and creditors when the firms themselves had never made a serious profit. It tends

to attract investors with glowing reports of their R&D projects, new patents, and in some

cases by soaring revenues that did not yet lead to profits. When firms cannot generate profits

under traditional accounting GAAP, they sometimes turn to creative accounting for revenue.

It's too early to know whether the company's various investments will pay off.

The CEO and CFO’s compensation is more highly weighted toward incentive

compensation than base compensation. This situation can cause negative motivations

and earnings to be increased more creatively to ensure a larger portion of executive

pay packages. Close attention should be paid to revenue recognition.

Many corporate stakeholders hold true to the statement that where there’s smoke,

there’s fire. Directors should no longer accept “no worries” explanations on

regulatory matters. Compliance tests should be employed routinely and if regulatory

action does occur, management needs to take action.

The amount of goodwill carried on the balance sheet, when compared to total assets,

is high. When intangible assets such as goodwill grow, boards should ask more

probing questions about how the business model generated these assets and about

concomitant valuation protocols.

Operating revenue is high when compared to operating expenses. Riskier companies

have revenue recognition in excess of what is expected based on operating revenues.

Directors should fully understand revenue recognition policies and instruct

management to test them to be sure they are not aggressive.

A repurchase of stock is usually presented to investors as an avenue to increase

market demand for the stock, thereby elevating overall shareholder value.

Management must provide reasoning for why there are no other ways to invest

excess funds. Boards should also request the general auditor to review insider sales

during the period of share repurchase programs.

An inventory valuation to total revenue is increasing. When inventory increases in

relation to revenue it should raise control questions about inventory valuation. It

could indicate changing consumer preferences, which should spur an analysis of a

corporation’s business model.

Accounts receivable to sales is increasing. This situation can typically be indicative

of relaxed credit standards. Directors should ask whether sales are decreasing due to

market conditions and instruct the general auditor to probe receivables to determine

their viability.

Asset turnover has slowed when compared to industry peers. If assets are increasing

and sales are not flowing it could indicate less productive assets are being brought,

or retained, on the balance sheet. Conversely, if sales are decreasing, executives and

auditors will again want to analyze changing customer preferences.

Answer 8)

Exposure draft on Hedging instrument and its impact:

This exposure draft proposes requirements in the following areas:

(a) what financial instruments qualify for designation as hedging

instruments;

(b) what items (existing or expected) qualify for designation as hedged

items;

(c) an objective-based hedge effectiveness assessment;

(d) how an entity should account for a hedging relationship (fair value

hedge, cash flow hedge or a hedge of a net investment in a foreign operation.

(e) hedge accounting presentation and disclosures.

It proposes an objective for hedge accounting that relates to linking accounting with

risk management.

The Board decided not to address open portfolios or macro hedging as part of this

exposure draft. The Board considered hedge accounting only in the context of

groups of items that constitute a gross position or a net position in closed portfolios

(in which hedged items and hedging instruments can be added or removed by de-

designating and re designating the hedging relationship).

The exposure draft proposes that if it is in accordance with the entity’s fair value-

based risk management strategy derivative accounting shall apply to contracts that

can be settled net in cash that were entered into and continue to be held for the

purpose of the receipt or delivery of a non-financial item in accordance with the

entity’s expected purchase, sale or usage requirements.

The Board believes that hedge accounting does not necessarily provide appropriate

accounting for hedging relationships that include commodity contracts.

It is proposed to amend that a commodity contract should be accounted for as a

derivative in appropriate circumstances. The Board believes that this approach

combines the purpose for a contract that can be settled net to buy or sell non-

financial items (normally commodities) that are entered into and continue to be held

for the purpose of the receipt or delivery of a non-financial item in accordance with

the entity’s expected purchase,sale or usage requirements and also how they are

managed. This better reflects the contract’s effect on the entity’s financial

performance and provides more useful information.

Answer 9)

Exposure draft on Hedging instrument and its impact:

The lessee accounting model is based on a right-of-use approach. Upon lease

commencement, the lessee obtains a right to use an asset for a specified period and

would recognize an asset reflecting that right and a liability for its obligation to pay

rentals. The proposed model differs from the current lease accounting model where a

lessee accounts for its right to use the leased asset either by recognizing an asset and

liability (i.e., capital/finance lease) or as an executory contract (i.e., operating lease)

depending on the terms of the lease.

Initial measurement & valuation of Lease:

A lessee would recognize a right-to-use asset and an obligation to make lease payments

during the lease term for all leases. Other than short-term leases, the initial

measurement of the obligation to make lease payments would be at the present value of

the lease payments, discounted using the lessee’s incremental borrowing rate or the rate

the lessor charges the lessee, if it can be readily determined. The right-of-use asset

would be initially measured at the same amount as the obligation to make lease

payments plus any initial direct costs. The two key components that a lessee must take

into account when initially measuring the right-of-use asset and the lease liability are

(1) the lease term and (2) the lease payments.

The ED does not address the effect of lease incentives (that is, payments a lessor makes

to a lessee as an incentive for the lessee to enter into the lease) on the initial

measurement of the right-of-use asset and lease liability.

Impact on financial position & profitability:

The proposals will affect the following key performance metrics.

+ An increase in assets and liabilities could result in lower asset turnover ratios, lower

return on capital, and an increase in debt to equity ratios which could impact borrowing

capacity or compliance with loan covenants.

Subsequent measurement and reassessment

After the date of commencement of the lease, a lessee would measure the liability for

lease payments at amortized cost and recognize interest expense using the effective

interest method. The draft exposure provides two approaches to measuring the right-of-

use asset – at amortized cost or fair value in accordance with the revaluation model in

IAS 16 Property, Plant and Equipment. A lessee that chooses to measure the right-of-

use asset at amortized cost would amortized the asset on a systematic basis over the

lease term or useful life, if shorter, in accordance with Intangible Assets.

Impact:

Total lease related expense will be front-end loaded as compared to current operating

lease treatment due to the recognition of interest expense using the effective interest

method. However, because rental expense is not recorded under the new mode –

EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) would be

higher as compared to current operating lease accounting.

Answer 10)

Progress Report on Commitment to Convergence of Accounting Standards and a Single

Set of High Quality Global Accounting Standards.

The strategies for financial statement presentation, financial instruments with

characteristics of equity, consolidations, and derecognition.

Achievements:

In the light of stakeholder feedback received, it was decided to engage in additional

outreach and analysis before finalising and publishing exposure drafts on financial

statement presentation (including issues relating to discontinued operations) and

financial instruments with characteristics of equity.

The consolidation requirements (including disclosures) relating to entities used as

vehicles for securitisation, structured investment, and other similar activities will

substantially be converged as a result of our separate, yet co-operative standard-setting

projects (the FASB recently amended its consolidation guidance and the IASB will

finalise its consolidation project in 2010 as planned).

The publication of exposure drafts and related consultations (such as public round-table

meetings) to enable the broad-based and effective stakeholder participation in due process

that is critically important to the quality of our standards.

This change is intended to address stakeholder concerns about their capacity to respond. It

also reduces the number of major proposals we are re-deliberating at the same time,

improving our ability to focus on the input received and reconcile differences in views in

ways that produce improved and more internationally comparable financial reporting.

A separate consultation document seeking stakeholder input about effective dates and

transition methods. Through this separate consultation we will gather information to help us

establish reasonable effective dates and transition methods for the major MoU projects taken

as a whole. Consistent with its present practice, the IASB will consider permitting early

adoption of its standards for new adopters of IFRS.

Impact:

The strategies and work plan will bring about significant improvement and

convergence of IFRSs and US GAAP. This revised strategy and work plan would

provide a stable platform of standards for those countries adopting IFRSs in 2011 or

2012, while assisting other countries, including Japan and the United States, in their

evaluation of the role IFRSs might play in their capital markets.

Finalizing these new standards will require significant effort and focused intensity by

both us and our stakeholders. Over-arching goal remains arriving at high quality,

improved and converged standards developed using robust due process and

deliberation. The nature of the comments received on our exposure drafts will

determine the extent of the re deliberations necessary and other steps and efforts that

will be required to reach this goal.

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