IFRS – An Overview

Beta Alpha Psi Loyola University Maryland Baltimore, MD September 24, 2009 McGladrey & Pullen LLP is a member firm of RSM International – an affiliation of separate and independent legal entities.

Richard A. Rate, Jr., CPA

• • •

Partner, National Professional Standards Group Member, Eastern Regional Professional Practice Office Member, AICPA and MACPA

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Agenda

• • • • • Structure and Conceptual Framework of IFRS vs. US GAAP Status of IFRS and US GAAP Convergence Efforts Differences between IFRS and US GAAP by Topical Area Impact to private companies Conclusion 10 minutes 5 minutes 20 minutes 5 minutes 5 minutes 3

Differences Between US GAAP and IAS/IFRS

• • • This presentation does not cover all the topics With regard to the topics covered: – – IFRS accounting is covered at a very high level Not all the differences between the two frameworks have been identified It is intended just to give a “flavour” on major differences 4

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• •

US GAAP Hierarchy*

Category (a), officially established accounting principles, consists of:

– FASB Statements and Interpretations – – APB Opinions AICPA Accounting Research Bulletins

Category (b) consists of:

– – FASB Technical Bulletins AICPA Industry Audit and Accounting Guides – AICPA Statements of Position • •

Category (c) consists of:

– AICPA Accounting Standards Executive Committee (AcSEC) Practice Bulletins – Consensus positions of the FASB Emerging Issues Task Force

Category (d) includes:

– AICPA accounting interpretations and implementation guides ("Qs and As") published by the FASB staff – Practices that are widely recognized and prevalent either generally or in the industry – FASB Staff Positions (FSPs)

*: Source: AU 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles

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• • • •

The US GAAP Literature

Over 2,000 pronouncements Over 6,500 pages – FASB material alone Some 25,000 pages of standards and guidance in total 501 EITF issued until December 2007 • • •

Example: GAAP on Leasing 9 FAS (FAS 13 + 8 other FAS) 6 FIN 36 EITF

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IFRS Hierarchy

• • Standards and interpretations approved by the IASC/IASB SIC/IFRIC interpretations

IFRS is a “teenager” compared to US GAAP

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The IFRS Literature

55 pronouncements Some 2,500 pages (all pronouncements) • • •

Example: GAAP on Leasing IAS 17 1 IFRIC 2 SIC

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Set of Principles

What is IFRS?

Set of principles to measure assets and liabilities

Set of principles Asset and liability view

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Set of Principles

Asset and liability view Does it meet the definition of an asset/liability?

How much is it?

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Set of Principles vs Set of Rules

• • • • Principles not rules: a question of judgement Principles-based standards requires a clear hierarchy of overarching concepts Principles-based standards provide flexibility in order to deal with new and different situations as they arise Disclosures play a key role 12

Set of Principles vs Set of Rules

• • • Principles-based does not mean principles-only Principles-based accounting standards will be accompanied by guidance Additional guidance is restricted to brief explanation as well as a small number of interpretations on major issues

“Guidance anticipates the use of judgement whereas rules discourages judgement”

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Set of Principles vs Set of Rules

• • Focusing on principles places a significant obligation on preparers and auditors to exercise professional judgement and users to weight the benefits of fair presentation, or a true and fair view, against the risks Use of judgement vs “check-list” culture 14

Set of Principles vs Set of Rules

The diamond of trust

Standard setters Preparers Regulators and other Users Auditors

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Set of Rules

• How did the rules-based approach emerged?

It emerged primarily in US as a result of a rigorous and aggressive regulation of financial reporting driven by: – – Desire of comparability Litigations

“Show me a rule that says I can’t do this”

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i.e. Specific literature on revenue recognition

IAS/IFRS/IFRIC/SIC

IAS 18 Revenue IAS 11 Construction contract SIC-13 Jointly Controlled Entities—Non-Monetary Contributions by Venturers SIC-27 Evaluating the Substance of Transactions involving the Legal Form of a Lease SIC-31 Revenue - Barter Transactions Involving Advertising Services IFRIC 12 Service Concession Arrangements IFRIC 13 Customer Loyalty Programmes IFRIC 15 Agreements for the Construction of the Real Estate

8 pronouncements in total U.S. GAAP literature on revenue recognition

27 Statements of Financial Accounting Standards 72 EITF issues 11 Statements of Position 3 FASB Interpretations 4 Staff Accounting Bulletins 6 FASB Staff Positions 2 Accounting Research Bulletins 2 Accounting Principles Board Opinions 3 FASB Technical Bulletins 1 REG S-X 1 FASB Staff implementation guidance Various audit and accounting guidance Various AICPA Technical Practice Aids

More than 130 pronouncements

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“Six years ago when we started, if someone said, ‘describe where you’ll be in 2007’, I wouldn’t have described this. This is much , much better than we thought, and it’s happened much, much faster“ “Getting rid of the reconciliation has been our absolute priority” “Major companies have got IFRS research units set up in the US saying, ‘What’s going to happen? What do we have to do ?’ It’s a huge change, a big difference”

Sir David Tweedie Chairman of IASB (source: Accountancy Magazine, “Tweedie’s best of breed“, January 2008)

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“A ‘Pax Americana’ in financial reporting where everybody around the world does US GAAP is not on the table. Ten years ago, people talked about that. But the world’s moved on. So it’s likely to be IFRS. But, in our view, it needs to be what we call ‘improved IFRS’ because there are so many critical issues relating to the IASB and IFRS” “The SEC could say, ‘we think broad choice is just fine. No end game. Just let the market decide between GAAP and IFRS’”

Realistic time frame for convergence?: “I’d say,

if everything went absolutely right, it’s a minimum of five years”

Bob Herz Chairman of FASB (source: Journal of Accountancy, “Change Agent”, February 2008)

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SEC Proposes Roadmap Toward Global Accounting Standards

(27 August 2008)

Proposed phased approach Targeted U.S. issuers Limited early eligible entities Large accelerate filers Accelerated filers Non-accelerated filers Type Optional Mandatory Mandatory Mandatory First IFRS reporting date Fiscal years ending on or after 15 December 2009 Fiscal years ending on or after 15 December 2014 Fiscal years ending on or after 15 December 2015 Fiscal years ending on or after 15 December 2016 Financial statements will include two years of comparatives

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SEC Proposes Roadmap Toward Global Accounting Standards

(27 August 2008)

Limited eligible entities Non-accelerated filers Accelerated filers Large accelerated filers

31 December 2006 2007 2008 2009 2010 2011 2012 2013 Evaluation period SEC Final decision 2014 2015 2016 Transition date Reporting date

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IASB Work Plan -

New Standards and Major Projects

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IFRS for SMEs Consolidation Liabilities

• • • •

Derecognition Emission Trading Fair Value Income taxes 2009 2010

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Financial statement presentation Insurance contracts Leases Financial Instruments with the characteristics of equity Post-employment benefits (including pensions) Revenue recognition

• • •

Financial instruments: replacement Government grants Common control transactions In RED IASB-FASB Joint projects 2011 TBD

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Examples of Key Differences between US GAAP and IFRS

• • • • • • • Presentation of Financial Statements Fair value Goodwill Revenue recognition Intangible and tangible assets Leases Inventories 23

Financial Statements: Balance Sheet

Topic Balance Sheet format Current/Non current distinction Offsetting IFRS US GAAP

• IAS 1 does not prescribe a particular format, but minimum lines to be presented • Required except for when a liquidity presentation is used. In general, 12 months represents the border • Permitted only if allowed by specific Standards/ Interpretations. Offset involving different parties is allowed • Offsetting derivatives based on “master netting arrangement” is not allowed • Similar to IFRS, but items are normally presented in decreasing order of liquidity • An entity is elected to choose whether to present Current/Non-current distinction • Permitted where there is:  intention of offset  offset is enforceable by law  offset permitted when only two parties involved • Offsetting derivatives based on “master netting arrangement” is allowed 24

Financial Statements: Income Statement

Topic Income statement format Extraordinary items IFRS

• IAS 1 does not prescribe a particular format, but minimum lines to be presented. Both classification “by function” and “by nature” are allowed

US GAAP

• Entities are elected to choose:  Full “by function” format  Gross profit computed as Sales less COGS. Then other costs • Expressly prohibited • Virtually not allowed 25

Financial Statements: Cash Flow Statement

Topic Cash flow format Definition of cash and cash equivalents Presentation of specific items IFRS US GAAP

• Both direct and indirect methods are allowed. Indirect method is more common • Includes overdraft that fluctuates from being positive to overdrawn. Investment qualifies as a cash equivalent only when maturity of three months or less from the date of acquisition • Interest paid/received and dividends paid/received can be both financing or operating • Similar to IFRS • Similar to IFRS except for overdrafts, which are always excluded from cash and cash equivalents • Interest paid/received and dividends received are operating. Dividends paid are financing 26

Financial Statements: Comparatives

Topic Comparatives presentation IFRS US GAAP

• One year of comparative for all numerical information reported in the financial statement • No “pure” US GAAP requirement 27

Fair Value

Topic Fair value guidance IFRS

• Dispersed widely in IFRS • Inconsistencies:  Business combinations (tax assets/liabilities, pension plans)  PPE: revaluation model – use fair value if can be measured reliably  Leases: require fair value measurement but there is no guidance  Fair value not defined in the Framework • SFAS 157

US GAAP NB: IASB is working on the fair value measurement project. The current project plan envisages that an IFRS on fair value measurement guidance will be published in 2010

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Goodwill (IFRS 3R vs SFAS 141R)

Topic Negative goodwill Provisional accounting Goodwill IFRS US GAAP

• After reassessment any residual excess is recognised immediately in profit or loss (not as extraordinary gain) • Adjustments of provisional fair values can be booked against goodwill within 12 months from acquisition date. After, adjusted to income statement • Not amortised and tested for impairment at least annually at CGU level • Same • Same • Not amortised but tested for impairment at least annually at Reporting unit level 29

CGU vs Reporting Unit

Topic Definition IFRS US GAAP

• CGU: the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets • If an active market exists for the output produced by a CGU, it shall be identified as a CGU, even if some or all of the output is used internally • Considers various factors. i.e. how management monitors the entity’s operations or how management makes decisions about continuing or disposing of the entity’s assets and operations • RU: an operating segment or one level below an operating segment (referred as to a component) • A component is a business for which discrete financial information is available and segment management regularly reviews the operating results • Components of an operating segment shall be aggregated and deemed a single reporting unit if have similar economic characteristics 30

Impairment of Goodwill

Topic IFRS US GAAP Impairment amount calculation methodology

• IAS 36 applies: one-step approach: • Impairment results from the difference between the carrying amount and the higher between the asset’s VIU and its fair value less cost to sell • VIU: reasonable estimate performed by the individual enterprise (not market specific). But IAS 36 includes requirements to prevent an enterprise from using assumptions different from the market place that are unjustified • SFAS 142 applies: two-step approach: 1) If the carrying amount of the reporting unit including goodwill is lesser than its fair value, then step 2 2) Determine the implied fair value of goodwill and compare with goodwill carrying amount. Implied fair value of goodwill shall be determined in the same manner as the amount of goodwill recognised in a business combination is determined 31

Impairment of Goodwill

Topic Indication of impairment IFRS

• IAS 36 applies: assess at each reporting date whether there is any indication that an asset may be impaired and al least annually • List of indicators

US GAAP

• SFAS 142 applies: tested for impairment on an annual basis and between annual tests in certain circumstances • List of indicators

Reversal of impairment

• Prohibited • Prohibited 32

Revenue Recognition

Topic Preliminary Views on Revenue Recognition Revenue recognition framework IFRS US GAAP

• • • • • • • • IASB and FASB Joint project • A contract-based revenue recognition model • Revenue is recognized when performance obligations are satisfied IAS 18 is very much principle-based Goods: “Risk and rewards” approach and the seller retains neither management involvement nor control over goods Services: percentage of completion Interests: effective interest method Dividends: right to receiver payment established Royalties: accrual basis Appendix include additional guidance and examples • No one dedicated standard to revenue recognition • Extensive and detailed guidance included in various statements (more than 200 sources of standards and guidance in existence, including broad conceptual discussions and industry-specific guidance) • SAB 104 33

Revenue Recognition

Topic Multiple-element arrangements Software IFRS

• Some principle-based guidance available in IAS 18 • Little specific guidance

US GAAP

• Revenue arrangements are separated into units of accounting and accounted for separately if conditions of EITF 00-21 are met • Almost non-existent specific guidance • General principles apply • US GAAP can be used to integrate IFRS, but doesn’t have to. • Detailed specific guidance, primarily SOP 97-2 34

Intangible Assets

Topic Development costs Revaluation IFRS US GAAP

• Capitalised since certain criteria are met. Cost previously expensed cannot be capitalised in subsequent period • No specific guidance for software • Permitted only if an active market exist • Strict criteria results in very rare development costs capitalised. Different guidance for computer software to be sold which must be capitalised if certain criteria are met • Prohibited 35

Tangible Assets

Topic Change in depreciation method Subsequent measurement Investment property IFRS US GAAP

• Regarded as a change in accounting estimate and reflected in current and prospective periods • Revaluation model is allowed • Revaluation model: Changes in fair value are recognized in OCI, depreciation and impairment is charged to the income statement • IAS 40 includes specific guidance for investment property. Entities choose between fair value model or depreciated cost model • Fair value model: all changes in fair value are recognised in income statement • Treated as a change in accounting estimate and reflected entirely in the current year’s income statement • Revaluation model is prohibited • There is not a specific definition of investment properties. Depreciated cost model must be applied 36

Leases

Conceptually similar: a finance lease is one where substantially all risks and rewards associated with the asset are transferred to the lessee. US GAAP includes more form-driven and is more quantitative tests oriented

IFRS

US GAAP indicators Classify as finance lease if any one of the following criteria is met: • Transfer of ownership at the end of lease term • Bargain purchase option • PV of minimum lease is payments greater than 90% of the fair value • Lease term higher than 75% of estimated economic life

Qualitative Quantitative

IFRS indicators Similar to US GAAP indicators + others However these are genuine indicators and not triggering events

US GAAP

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Leases

• • • Leases—Preliminary Views IASB and FASB Joint project If this principle is adopted in a new standard on lease accounting, it would result in the lessee recognizing: – – an asset for its right to use the leased item (the right-of-use asset) a liability for its obligation to pay rentals 38

Inventories

Topic Measurement IFRS US GAAP

• Inventories shall be measured at the lower of cost and net realisable value • Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale (this is not fair value) • Inventories shall be measured at the lower of cost and market • Market means current replacement cost (purchase or reproduction), but • Upper limit: market should not exceed the net realisable value (i.e. estimated selling price - cost of completion and disposal) • Lower limit: market should not be less than the net realisable value reduced by an allowance for normal profit margin 39

Inventories

Topic LIFO method FIFO Average cost method Retail method Biological assets

• • Prohibited * • Allowed • Allowed • May be used for convenience if the results approximate cost • Measured at fair value less estimated point-of-sale costs

Reversal of inventory write-downs *: The use of LIFO will be banned in IFRS for SMEs as well IFRS

Required if certain criteria are met • Permitted • Allowed • Allowed

US GAAP

• In some situations may be both practical and appropriate • Not specified. Normally historical cost is used • Prohibited 40

Tax implications of adopting IFRS

• U.S. companies for tax purposes must continue to follow the tax rules of the Internal Revenue Code, Regulations and case law 41

Tax implications of adopting IFRS

• • Book treatment changes may result in changes in tax methods which require the filing of Form 3115s.

Questions to consider: – – – Does the present tax method require book conformity?

Will the new book method omit information required to continue the tax method?

Is the new book method permissible for tax purposes?

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Tax implications of adopting IFRS

• • Tax accounting methods – LIFO – Tax requires book conformity, but IFRS prohibits LIFO – – Intangible asset capitalization Change in depreciation method – – – No revaluation allowed on assets for tax purposes Revenue recognition Lease recognition (capital leases) – Any other change in method that does not conform to tax law or that changes the method used for currently recognizing income or deductions Expected to have a major impact on implementation of FIN 48 43

Importance of IFRS to Preparers

• • • • • Public company?

Private company with foreign parent?

Private company with foreign subsidiaries?

Private company with significant foreign suppliers or customers?

Access to foreign capital markets?

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Importance of IFRS to Bankers

• • • • Public borrowers?

Loan underwriting?

Financial debt covenants?

Global capital markets?

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Importance of IFRS to Attorneys

• • • • • • IPO’s?

Registrations?

Exempt offerings?

Securities law?

Re-writing or renegotiation of any legal contract or agreement containing financial information?

Fraud implications – use of judgment?

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First-time adoption of IFRS

• • • • • • • Scale of the project Use of experts IFRS Accounting manual, IFRS Group Reporting Package, Impact on information systems, etc.

Industry specific issues: what are key players doing? IFRS 1: exemptions and exceptions Communication to stakeholders Industry specific issues 47

A few things to consider before …

• • • • • • Training, training, training Auditor preparation and status Management information systems Compensation plans Government accountability audits Users of your financial information 48

Conclusions

• • • • • Only in some cases is it possible to say that the IFRS requirements are clearly different or equivalent to US GAAP In many cases the same concept is expressed using different words. Therefore, the concept is similar but not identical Similar standards are not identical standards US GAAP literature is much more extensive compared to IFRS Convergence projects are underway 49