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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.
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.
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.
Though the overall aim is same, the differences in implementation and financial
reporting do occur due to social, economic and political backgrounds of different
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.
Proposed Format of Financial Statements by FASB/IASB
Statement of Financial Position
Statement of Comprehensive Income
Statement of Cash Flows
Operating finance subcategory
Operating finance subcategory
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
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.
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
+In the area of consolidation, one of the specific differences is the order of the
+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
+IFRS is a set of standards of higher quality.
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:
â€¢ Improvements in accounting standards
â€¢ The accountability and funding of the International Accounting Standards
â€¢ Improvement in the ability to use interactive data for IFRS reporting
â€¢ Education and training in the U.S. relating to IFRS
â€¢ 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.
â€¢ The anticipated timing of future rulemaking by the Commission
â€¢ 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.
â€¢ The use of one common global reporting language.
â€¢ It will allow for comparability over all financial markets, regardless of the country of
â€¢ Investors will have better information for decision making.
â€¢ 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.
â€¢ 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.
â€¢ All levels of management, including the audit committee, will have to be more involved
in financial reporting and aware of transactions.
â€¢ In the end, companies should be more efficient and have the advantage of cost-savings.
â€¢ Small companies that have no dealings outside of the United States have no incentive to
adopt IFRS unless mandated.
â€¢ Incompatibility may arise as companies claim to have converted to IFRS but in reality
have only selected the portions that best fit their needs.
â€¢ There is an extremely high price-tag - "â€¦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).
â€¢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.
â€¢ 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.
â€¢ 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.
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.
(b) the time value of money;
(c) noncash consideration; and
(d) consideration payable to the customer.
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-
+ 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
+ The goods or equipment must be complete and ready for shipment.
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
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.
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
(b) what items (existing or expected) qualify for designation as hedged
(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
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.
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.
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.
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.
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.
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.