IFRS and GAAP Convergence

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IFRS and GAAP Convergence

November 29, 2014

IFRS and GAAP Convergence

1. Briefly describe the corporation you researched.

The global beverage and food company PepsiCo, Inc. was incorporated on November 13, 1986. The corporation sells, distributes, makes, and markets, a variety of beverages and foods, through the contract manufacturers, business's bottlers, and other associates. Their business has expanded in more than 200 territories and countries. PepsiCo comprises four business units: PepsiCo Americas Foods (PAF), PepsiCo Americas Beverages (PAB), PepsiCo Europe, and PepsiCo Asia, Middle East and Africa (AMEA). The PAF consist of Quaker Foods North America (QFNA), Frito-Lay North America (FLNA), and all of its Latin American snack and food businesses (LAF). The PAB consist of all of its Latin American and North American beverage businesses. PepsiCo Europe comprises all food, beverage, and snack businesses in South Africa and Europe, and PepsiCo Asia, Middle East and Africa (AMEA) comprises all food beverage, and snack businesses in AMEA, excluding South Africa. It manufactures sells and markets a range of sweet, salty, and grain-based snacks, non-carbonated and carbonated beverages, dairy products and other foods. Its operations are in Canada, United States, Mexico, the United Kingdom and Russia (Reuters, n.d.).

2. Given the SEC’s current position on requiring U.S. publically traded companies to report using the IFRS method of accounting, discuss whether or not it would be beneficial or punitive to the company when adopting IFRS. Explain your rationale.

The Securities and Exchange Commission (SEC) has been supported the development of a only one set of globally accepted accounting standards since 2002, when it has been announced a Memorandum of Understanding (MOU). The Financial Accounting Standard Board (FASB) and the International Accounting Standard Board (IASB) have been working together to unify the accounting standards and MOU have been created to collaborate on the improvement of high quality standards and having the eventual goal of a only one set of globally accepted accounting standards. The MOU has been updated in 2006 and 2008 to determine the scope of their work program and to identify the most critical targets in order to complete the convergence. Also in 2010, the SEC have been directed the staff to come up with a Working Plan that will inform the SEC to determine whether to incorporate International Financial Reporting Standards (IFRS) into the financial reporting system for U.S. issuers (U.S. SEC, 2010). It seems that there are some difficulties the accounting standard setters are facing when it comes to convergence of the standards. As FASB Chairman Leslie Seidman mentioned, “U.S. financial reporting needs more precise, clear guidance than the IASB’s broad, principles-based approach offers” (Tysiac, 2012).

When adopting IFRS, a company can present its financial statements on the same basis as companies from other countries that also use IFRS, making comparisons much easier. Corporations like PepsiCo with branches in countries that permit or require IFRS have the advantage to use one accounting language corporation-wide. PepsiCo is a U.S. multinational corporation and adopting IFRS will have also the advantage of saving cost because they can use a unique reporting system for their operations at all units around the world. Additionally, if PepsiCo is adopting IFRS, then they could standardize the accounting and financial reporting policies and so, they could have a steady set of accounting policies and financial statements in each country where local reporting is required. They could reduce reliance on local accounting resources for statutory reporting purposes, improve standardized training programs and eliminate divergent accounting systems. Having one accounting language, they could have better control over the quality and issuance of financial statements in other subsidiaries. Another great advantage that PepsiCo could have is a better cash management. This way, the dividends that will be paid from other units, may be based on local financial statements and also the cash flow planning will be improved (Street, 2008).

3. Determine the differences that would occur (or have occurred) by using IFRS for the income statement, balance sheet, and statement of cash flows, and how these differences may attract investors to the company.

If PepsiCo is going to adopt IFRS, investors and other users of financial statement will have a better understanding of this corporation’s present and past financial position and will assess prospective future cash flow. Under IFRS, the statements will include the totals and subtotals including the net income or loss subtotal. According to FASB, the financial statements need to contain a statement of financial position, a statement of changes in equity, a statement of comprehensive income, and a statement of cash flow for a period of two years for comparison purposes. FASB is requiring a subtotal for net income and only one statement of earnings and comprehensive income.

Under the IFRS, PepsiCo will need to change the name of balance sheet to statement of financial position. The big difference for this statement is that liabilities and assets will not be separated into different sections; they will be into the same section and will be netted together. The liabilities and equity will be negative amounts and assets will be positive. There will be totals for each section and category and there will be subtotals disclosed in the footnotes or at the bottom of the statement. The subtotals and grand totals will be for short term assets and liabilities (McClain, & McLelland, 2008).

The revenues, expenses, gains and losses will be presented within the sections and categories based on its primary activities or functions on a statement of comprehensive income. As FASB and IASB decided, the financial statement presentation will not alter existing standards in regards to what items are recognized separate of profit or loss. Therefore, PepsiCo should present a stand-alone statement of comprehensive income with other comprehensive income (OCI) items; however, they will be presented in a separate section. Within the OCI section PepsiCo should indicate which category-operating, financing or investing each OCI item relates to. In the statement of financial position the income taxes segment will include current and deferred income tax assets and liabilities and will be allocated among continuing or discontinued operations, items charged or credited directly to equity and items of other comprehensive income (McClain, & McLelland, 2008).

For the statement of cash flow, PepsiCo will see two significant changes. One is that the notion of cash equivalents will be replaced by cash only. Also by using IFRS, PepsiCo will need to present the cash flow under the direct method.

By using the IFRS, investors and financial statement users will predict cash flows for equity valuation much easier as these financial statements transfer attention from net income to total comprehensive income, because all other comprehensive income items will be presented on the face of the statement.

4. Compare and contrast the differences in the financial statements, and the advantages and disadvantages of using IFRS versus GAAP reporting.

IFRS and GAAP are two different standards and one of the major differences is the conceptual approach. The IFRS is principle-based while GAAP is rule-based. Under the IFRS approach similar transactions could have different interpretations that the standards-setting board can clarify it, and there are fewer exceptions than the GAAP rules-based system. The differences between the two standards are not stopping at the conceptual approach. If we are to take into consideration consolidation, the GAAP favors a risk and reward model while IFRS prefers a control model. The GAAP statement of income is showing the extraordinary items below the net income whereas under IFRS they are not segregated in the income statement. There is also a difference in regards with inventory. Under GAAP, businesses could choose between LIFO and FIFO whereas under IFRS they have to use FIFO only, as LIFO method is prohibited. Earning-per-Share calculation under GAAP averages the individual interim period incremental shares while under IFRS the computation will not average the individual interim period calculations. I would like to mention also the development cost differences. Under GAAP these costs are considered expenses whereas under IFRS they are capitalized when certain criteria are met (Forgeas, 2008).

Along with differences between these two standards are coming the advantages and disadvantages of using IFRS instead of GAAP. One of the advantages is that IFRS is focusing more on investors as these standards are having more comprehensive, accurate and timely financial statement information. The investors can understand more easily the information from the financial statement as there are simpler and are having a better quality. With the harmonization under IFRS the investors will not have to pay anymore for adjusting the statements and so to be able to understand them. One of the important features of IFRS is the fact that the loss in recognized immediately and this is a great benefit for investors and also for the stakeholders and lenders. The efficiency of contracting between firms and their management is increased by this loss recognition and the great transparency of this standard. If all countries will converge to IFRS, the comparability of financial statements will greatly increase as there will be a single reporting standard worldwide. A substantial advantage of the IFRS is the relevance of this standard because it reflects more on economic substance than legal form. I would like to mention, also as an advantage, the fact that the balance sheet under this standard is more useful because of its layout, consistency and the less complexity.

There have been listed here quite a few advantages of IFRS compare to GAAP. However, converting to IFRS has its disadvantage related to the costs that will incur when converting to it. Those who are converting to IFRS will have great costs related to changing the internal system as to make it compatible with IFRS, training cost and so on. After converting, the benefits mentioned earlier will not be seen right away as there will take some years for them to be seen. Besides the major costs, a big disadvantage of converting is that will make the IASB the monopolist of setting standards (Jordan, 2013).

5. Make recommendations as to whether the company you researched should use IFRS or GAAP as its reporting standard. Explain your rationale.

As all businesses are moving toward a global economy, the need to move toward global accounting standards is becoming imminent. Advances in technology, communication, transportation systems, the Internet, and lower trade barriers, have extended the marketplace in which businesses operate. In recent years, the trend toward US businesses earning more profits in a foreign country has accelerated. Many of these worldwide businesses are earning more than 50% of revenue from foreign sales and it’s demonstrating the growing of globalization (Fosbre, Kraft, & Fosbre, 2009). Multinational companies, such as PepsiCo, have their home in the US, but operate in many other countries and adopting IFRS will be beneficial.

For PepsiCo, adopting IFRS will have the advantage of saving cost because they can use a unique reporting system for their operations at the units in countries that are also using IFRS. Additionally, if PepsiCo is adopting IFRS, then they could standardize the accounting and financial reporting policies and so, they could have a steady set of accounting policies and financial statements in each country where local reporting is required. They could reduce reliance on local accounting resources for statutory reporting purposes, improve standardized training programs and eliminate divergent accounting systems. Having one accounting language, they could have better control over the quality and issuance of financial statements in other subsidiaries. Another great advantage that PepsiCo could have is a better cash management. This way, the dividends that will be paid from other units, may be based on local financial statements and also the cash flow planning will be improved (Street, 2008).

References

Forgeas, R. (2008, June 16). Is IFRS that different from U.S. GAAP? Retrieved from http://www.ifrs.com/overview/general/differences.html

Fosbre, A. B., Kraft, E. M., & Fosbre, P. B. (2009). The globalization of accounting standards: IFRS versus US GAAP.Global Journal of Business Research (GJBR),3(1), 61-71.

Jordan, A. (2013, September 26). Advantages and disadvantages of IFRS compared to GAAP. Retrieved from http://research-methodology.net/advantages-and-disadvantages-of-ifrs-compared-to-gaap/

McClain, G., & McLelland, A. J. (2008). Shaking up financial statement presentation.Journal of Accountancy,206(5), 56-64

Reuters. (n.d.). Profile:PepsiCo Inc (PEP). Retrieved from http://www.reuters.com/finance/stocks/companyProfile?symbol=PEP

Street, D. L. (2008). The impact in the United States of global adoption of IFRS. Australian Accounting Review, 18(3), 199. doi:10.1111/j.1835-2561.2008.0025.x

Tysiac, B. (2012, December 4). FASB, IASB union fragile amid SEC indecision on IFRS. Journal of Accountancy. Retrieved from http://www.journalofaccountancy.com/News/20126951.htm

U.S. Securities and Exchange Commission. (2010). Spotlight on Work Plan for Global Accounting Standards. Retrieved from http://www.sec.gov/spotlight/globalaccountingstandards.shtml

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