RCMA 1

IFRS DIFFERENCES IN ACCOUNTING

 

 

    

TOPIC OUTLINE

1. Expense Recognition, in Relation to Share-Based Payments and Employee Benefits

2. Intangible Assets

3. Inventory

4. Leases, Concerning to Lessee Operating and Finance Leases

5. Long-Lived Tangible Assets

6. Asset Impairment with Regard to Loss Determination, Calculation, and Reversal

 

INTRODUCTION

Globally, the two most widely utilized accounting standards are U.S. International Financial Reporting Standards and Generally Accepted Accounting Principles (U.S. GAAP) (IFRS). These two sets of criteria are quite similar in many instances, yet they differ significantly in others. The primary distinctions between these two sets of accounting standards will be covered in this topic.

A. Expense Recognition, in Relation to Share-Based Payments and Employee Benefits

Under IFRS (International Financial Reporting Standards) and U.S. GAAP (Generally Accepted Accounting Principles), the recognition of share-based payments and employee benefits is largely similar, but there are a few key differences, especially regarding share-based compensation.

 

a. Fair Value Approach: Both IFRS and U.S. GAAP require share-based compensation, such as stock options, to be measured using a fair value approach. Fair value is generally determined using pricing models such as Black-Scholes.

 

b. Intrinsic Value Method: In U.S. GAAP, the intrinsic value method can be used in limited situations for measuring share-based compensation. This method calculates intrinsic value as the difference between market price and strike price, multiplied by the number of shares. However, under IFRS, the intrinsic value method is prohibited.

 

c. Expense Recognition for Equity Awards with Graded Vesting: Under IFRS, total compensation expense for equity awards with graded vesting must be spread over the service period using the accelerated method. This method treats each vesting tranche as a separate grant and accelerates the rate at which compensation expense is recorded. This differs from U.S. GAAP, where companies may elect to use the straight-line method, which spreads the expense evenly over the entire vesting period.

 

Illustration of Expense Recognition:

A company offers $90,000 of stock-based compensation to its employees, which will vest in equal amounts at the end of each of the next three years.

 

• U.S. GAAP: Under U.S. GAAP, the company may elect to use the straight-line method, resulting in an even distribution of the $90,000 expense over the three years ($30,000 per year).

• IFRS: Under IFRS, the accelerated method is used. The $90,000 expense is treated like three separate grants (one vesting each year) and allocated accordingly:

  • Year 1: Compensation expense of $55,000, calculated using accelerated recognition across all three grants.

  • Year 2: Compensation expense of $25,000, calculated based on the vesting schedule.

  • Year 3: Compensation expense of $10,000, calculated from the final year's portion of the grant.
     

B. Intangible Assets

Intangible assets and their treatment vary between U.S. GAAP and IFRS, particularly regarding revaluation and development costs. 

 

 Revaluation

• U.S. GAAP: Intangible assets under U.S. GAAP are carried at amortized cost. This means they are initially recognized at cost and then systematically amortized over their useful lives.

• IFRS: Intangible assets under IFRS can be carried either at amortized cost (similar to U.S. GAAP) or revalued to fair value (the revaluation model). The revaluation model is available if there is an active market for the asset. This approach allows for the asset's carrying value to reflect current market conditions.

 

Research and Development Costs

1. Research Costs: Under both U.S. GAAP and IFRS, research costs are expensed as they are incurred.

2. Development Costs:

• IFRS: Development costs for internally developed intangible assets may be capitalized under IFRS once technological feasibility is established and specific conditions are met. These conditions include demonstrating how the asset will generate future economic benefits, the intent and ability to complete the development, and the ability to measure the development costs.

• U.S. GAAP: Unlike IFRS, U.S. GAAP generally requires all development costs to be expensed as incurred. The exception is software development, where capitalization of costs is permitted once the project reaches a certain stage, similar to IFRS.
   

C. Inventory

The accounting treatment of inventory varies between IFRS (International Financial Reporting Standards) and U.S. GAAP (Generally Accepted Accounting Principles) in several key ways:

 

1.  Inventory Methods

• LIFO Method: IFRS prohibits the use of the last-in, first-out (LIFO) inventory method. This inventory costing method assumes that the most recently purchased items are the first to be sold. Companies using IFRS must use other methods such as first-in, first-out (FIFO) or weighted average cost.

 

2. Inventory Write-Downs and Write-Ups

1. Write-Downs: Both IFRS and U.S. GAAP requires inventory to be valued at the lower of cost or net realizable value, which may necessitate a write-down of inventory if its value decreases.

2. Write-Ups:

• IFRS: If the value of inventory previously written down experiences a recovery, IFRS allows the write-up of the inventory back to its original cost. This reversal can only be done up to the original cost of the inventory before the write-down.

• U.S. GAAP: In contrast, U.S. GAAP does not permit the write-up of inventory previously written down, except under a specific condition: both the initial write-down and subsequent recovery must occur within the same fiscal year (e.g., a write-down in Q2 and recovery in Q3). Otherwise, the write-down remains permanent.
   

D. Leases, Concerning to Lessee Operating and Finance Leases

Lease accounting differs significantly between IFRS (International Financial Reporting Standards) and U.S. GAAP (Generally Accepted Accounting Principles) in terms of how lessees account for operating and finance leases.

 

1. Classification of Leases

• IFRS: Under IFRS, there is no distinction between operating and finance leases for lessees. All leases, except for those with low-value assets or short terms, are accounted for similarly to finance leases under U.S. GAAP. This means that lessees must recognize a right-of-use asset and a lease liability on their balance sheets for most leases.

• U.S. GAAP: Under U.S. GAAP, leases are classified as either operating or finance. Operating leases typically involve off-balance-sheet accounting (prior to recent changes), while finance leases require lessees to recognize both an asset and liability similar to IFRS.

 

2. Low-Value and Short-Term Leases

• Exclusions: Both IFRS and U.S. GAAP provide exclusions for leases involving assets with low values (considered immaterial) or leases with a term shorter than 12 months.

• Accounting Treatment: Payments made under these excluded lease agreements are expensed as incurred, rather than recognizing an asset or liability upon lease signing. This simplifies the accounting process for such leases.
   

E.  Long-Lived Tangible Assets

The accounting treatment of long-lived tangible assets varies between IFRS (International Financial Reporting Standards) and U.S. GAAP (Generally Accepted Accounting Principles) in several key areas, including depreciation methods, revaluation, and interest capitalization.

 

1. Separation of Components for Depreciation

• IFRS: Under IFRS, long-lived tangible assets that can be separated into component parts must be separated for depreciation purposes. Each component is depreciated individually based on its useful life.

• U.S. GAAP: In contrast, U.S. GAAP typically treats each asset as a single item for depreciation and does not require separation into component parts.

 

2. Accounting Models and Revaluation of Property, Plant, and Equipment (PP&E)

• Cost Model: Both IFRS and U.S. GAAP allow organizations to carry PP&E at depreciated cost (the cost model) using various depreciation methods.

• Revaluation Model (IFRS Only): IFRS permits organizations to revalue PP&E to fair value if the fair value can be reliably estimated. Revaluation gains and losses are calculated by comparing the book value to the estimated fair value upon revaluation.

a. Depreciation after Revaluation: After revaluation, depreciation is recalculated using the revalued amount and the remaining useful life of the PP&E.

b. Recording Revaluation Gains and Losses:

• Gains on revaluation are recorded in other comprehensive income (directly to equity) unless they reverse a previously recorded loss in income, in which case they are recorded in income until the loss is reversed.

• Losses on revaluation are recorded in income unless they reverse a previously recorded revaluation surplus in other comprehensive income, in which case they are recorded in other comprehensive income until the entire surplus is consumed.

 

3. Capitalization of Interest

 

• IFRS: Requires capitalization of interest that is directly attributable to the construction or production of a long-lived asset being prepared for its intended use.

• U.S. GAAP: Requires capitalization of interest that could have been avoided if the project had not been undertaken. This may include interest from loans for general corporate purposes not directly attributable to the asset, often using an estimate of a weighted average interest rate from various corporate obligations.
   

F. Asset Impairment with Regard to Loss Determination, Calculation, and Reversal

The accounting treatment of impairment of assets differs between IFRS (International Financial Reporting Standards) and U.S. GAAP (Generally Accepted Accounting Principles) in terms of the determination, calculation, and reversal of losses.

 

Determination of Impairment

• U.S. GAAP: Under U.S. GAAP, impairment is reviewed at the individual asset level, which means each asset is assessed for impairment on its own.

• IFRS: Under IFRS, an organization reviews for impairment at the cash-generating unit (CGU) level. A CGU is the smallest group of assets that generate cash flows independent of other assets in the organization. Typically, a CGU is made up of multiple assets and can be as large as an operating segment, such as a division of a business.

 

Calculation of Impairment

• IFRS: IFRS uses a one-step impairment test, which involves comparing the recoverable amount of the CGU to its carrying amount. If the recoverable amount is lower, a loss is recorded. The recoverable amount is the greater of:

1. Fair value of the CGU less selling costs (net realizable value), or

2. Value of the CGU in use (determined through a discounted cash flow analysis).

• U.S. GAAP: U.S. GAAP uses a two-step model for impairment testing. The first step is to assess whether an asset's carrying amount exceeds its undiscounted future cash flows. If it does, the second step determines the impairment loss by comparing the carrying amount to the fair value.

 

G. Reversal of Loss

 

• U.S. GAAP: Recognizing reversals of prior impairment losses is prohibited under U.S. GAAP. Once an asset is impaired, the loss cannot be reversed even if the asset’s value subsequently recovers.

• IFRS: IFRS allows for the reversal of impairment losses under certain conditions. If the cost model is used for long-lived fixed assets or intangible assets with a finite life, recovery of loss is allowed up to the initial carrying cost less an adjustment for depreciation/amortization. For indefinite-lived intangible assets, recovery of past losses is allowed up to the original carrying amount of the intangible asset.

 

THEORY QUESTIONS

 

Which of the following is acceptable under IFRS for financial reporting?

a. Operating lease classification for all leases with terms in excess of one year. 

b. LIFO 

c. Recoveries of previous impairment losses. 

d. Extraordinary items 

 

Regarding impairment, all statements are true, except:

a. Impairment is evaluated at the level of the individual asset under US GAAP and at the cash-generation level unit under IFRS.

b. While goodwill is not independently tested for impairment under IFRS, it is independently tested for impairment under IFRS under US GAAP.

c. According to both US GAAP and IFRS, it is not permitted to reverse previous asset impairments.

d. While CGUs are examined for impairment using a 1-step process under IFRS, depreciable assets are tested for impairment using a step process under US GAAP.

 

With regard to the accounting for inventory under US GAAP and International Financial Reporting Standards (IFRS), which of the following statements is true?

a. LIFO (Last-In, First-Out) is not permitted by US GAAP or IFRS for companies.

b. Companies that follow IFRS and US GAAP may use LIFO.

c. Companies are allowed to use LIFO under US GAAP, but not under IFRS.

d. While IFRS allows the use of LIFO, US GAAP prohibits it for companies.

 

Which of the following expenses is eligible for asset capitalization under U.S. GAAP?

a. The cost of the materials used to test the prototype.

b Costs related to testing and redesigning a prototype.

c. Salary for engineers working on a new product development.

d. The cost of legal fees to get a patent for a new product.

 

Which of the following statements is true regarding how share-based compensation is accounted for under US GAAP and International Financial Reporting Standards (IFRS)?

a. When measuring share-based compensation, US GAAP requires companies to use the fair value approach; however, IFRS permits companies to use the intrinsic value approach.

b. While IFRS requires the fair value approach, US GAAP allows companies to employ the intrinsic value approach in certain situations for calculating share-based compensation.

c. Companies are required by both US GAAP and IFRS to measure share-based compensation using the fair value method.

d. Companies are required by both US GAAP and IFRS to measure share-based compensation using the intrinsic value method.

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ANSWERS

1. C. Recoveries of previous impairment losses. 

2. C. According to both US GAAP and IFRS, it is not permitted to reverse previous asset impairments.

3. C. Companies are allowed to use LIFO under US GAAP, but not under IFRS.

4. D. The cost of legal fees to get a patent for a new product.

5. B. While IFRS requires the fair value approach, US GAAP allows companies to employ the intrinsic value approach in certain situations for calculating share-based compensation.

 

Reference

 

Wiley. (2023). Wiley CMA Exam Review 2023 Study Guide Part 1: Financial Planning, Performance, and Analytics. John Wiley & Sons, Inc.