International Financial Reporting Standards IFRS Transition

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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
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Questions and Comments are Welcome Any Time
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International Financial Reporting Standards
(IFRSs)are shooting down the competition (other
GAAPs)
IFRSs are now accepted or required in more than
100 countries.
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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.

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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

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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?
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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

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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.

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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.

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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?
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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.

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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).

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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.

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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.

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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?
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Required Use of IFRSs by World Region 2003-2006

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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.

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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?
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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?
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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.

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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.

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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.

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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

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Comparing U.S. GAAP and IFRSs Cosmetic
Differences
GlaxoSmithKline
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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.
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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

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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.

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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?
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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?
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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

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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

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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.

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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,

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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?
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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

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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?
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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)

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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.

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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.

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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).

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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.

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Winning isnt everything, but doing whats right
is.
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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.

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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.