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Chapter 04 - International Financial Reporting Standards: Part I

CHAPTER 4 D 3e Edit for class site INTERNATIONAL FINANCIAL REPORTING STANDARDS: PART I
Chapter Outline
I. The International Accounting Standards Board (IASB) had 29 International Accounting Standards (IAS) and 9 International Financial Reporting Standards (IFRS) in force in September 2010. A. In 2002, the IASB and U.S. Financial Accounting Standards Board (FASB) agreed to work together to reduce differences between IFRS and U.S. GAAP. There are several types of differences between IFRS and U.S. GAAP. A. Definition differences. Differences in definitions can occur even though concepts are similar. Definition differences can lead to differences in recognition and/or measurement. B. Recognition differences. Differences in recognition criteria and/or guidance related to (a) whether an item is recognized, (b) how it is recognized, and/or (c) when it is recognized (timing difference). C. Measurement differences. Differences in approach for determining the amount recognized resulting from either (a) a difference in the method required, or (b) a difference in the detailed guidance for applying a similar method. D. Alternatives. One set of standards allows a choice between two or more alternative methods; the other set of standards requires one specific method to be used. E. Lack of requirements or guidance. IFRS do not cover an issue addressed by U.S. GAAP, and vice versa. F. Presentation differences. Differences in the presentation of items in the financial statements. G. Disclosure differences. Differences in information presented in the notes to financial statements related to (a) whether a disclosure is required and/or (b) the manner in which a disclosure is required to be made. A variety of differences exist between IFRS and U.S. GAAP with respect to the recognition and measurement of assets. A. Inventory IFRS require inventory to be reported on the balance sheet at the lower of cost or net realizable value; U.S. GAAP requires the lower of cost or replacement cost, with net realizable value as a ceiling and net realizable value less a normal profit margin as the floor. U.S. GAAP allows the use of LIFO; IFRS do not. B. Property, plant and equipment subsequent to acquisition, IFRS allow fixed assets to be reported on the balance sheet using a cost model (historical cost less accumulated depreciation and impairment losses) or a revaluation model (fair value at the balance sheet date less accumulated depreciation and impairment losses); U.S. GAAP requires the use of the cost model. Component depreciation must be applied under IFRS when items of property, plant and equipment are comprise of significant parts; this is not the case under U.S. GAAP

II.

III.

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Chapter 04 - International Financial Reporting Standards: Part I

C. Impairment of assets an asset is impaired under IFRS when its carrying amount exceeds its recoverable amount, which is the greater of net selling price and value in use. Value in use is calculated as the present value of future cash flows expected from continued use of the asset and from its disposal. An asset is impaired under U.S. GAAP when its carrying amount exceeds the undiscounted future cash flows expected from the assets continued use and disposal. 1. Measurement of impairment loss the impairment loss under IFRS is the difference between carrying amount and recoverable amount; under U.S. GAAP, the impairment loss is the amount by which carrying amount exceeds fair value. Recoverable amount and fair value are likely to be different. 2. Reversal of impairment loss if subsequent to recognizing an impairment loss, the recoverable amount of an asset is determined to exceed its new carrying amount, IFRS require the original impairment loss to be reversed; U.S. GAAP does not allow the reversal of a previously recognized impairment loss. D. Development costs when certain criteria are met, IFRS require development costs to be capitalized as an asset and then amortized over their useful life; U.S. GAAP requires development costs to be expensed as incurred. An exception exists in U.S. GAAP for software development costs. E. Borrowing costs similar to U.S. GAAP, IFRS requires borrowing costs to be capitalized to the extent they are attributable to the acquisition, construction, or production of a qualifying asset. Other borrowing costs are expensed as incurred. However, the amount of borrowing costs to be capitalized differs between IFRS and U.S. GAAP. F. Leases both IFRS and U.S. GAAP distinguish between operating and finance (capitalized) leases. U.S. GAAP provides bright line tests to determine when a lease must be capitalized; IFRS do not. IV. A number of IASB standards deal primarily with disclosure and presentation issues, and in some cases requirements differ from U.S. GAAP. A. In the statement of cash flows, IAS 7 allows interest and dividends received to be classified as operating or investing, whereas these are always classified as operating under U.S. GAAP. IAS 7 allows interest and dividends paid to be classified as operating or financing, whereas interest paid is operating and dividends paid is financing under U.S. GAAP. B. IAS 10 requires financial statements to be adjusted for so-called adjusting events that occur up to the point that the financial statements have been authorized for issuance. U.S. GAAP uses the date the financial statements are issued or are available to be issued as the cutoff date for adjusting events. C. IAS 8 establishes a hierarchy of authoritative pronouncements to be considered in selecting an accounting policy. The lowest level in the hierarchy would allow the use of U.S.GAAP. Once selected, accounting policies must be applied consistently unless a change is required by IFRS or would result in more relevant information being reported in the financial statements. D. IFRS 5 provides a more liberal definition of what qualifies as a discontinued operation than does U.S. GAAP. E. IAS 34 requires interim periods to be treated as discrete accounting periods, whereas U.S. GAAP treats interim periods as an integral part of the full year.

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Chapter 04 - International Financial Reporting Standards: Part I

Answers to Questions D 3e 1. The types of differences that exist between IFRS and U.S. GAAP can be classified as: Definition differences Recognition differences Measurement differences Differences in allowed alternatives Differences in (lack of) guidance Presentation differences Disclosure differences 2. In applying the lower of cost and market rule for inventories, IAS 2 defines market as net realizable value (NRV) and U.S. GAAP defines market as replacement cost (with NRV as a ceiling and NRV less normal profit margin as a floor). In addition, the rule generally is applied on an item by item basis under IAS 2, whereas it may be applied on an item by item, group of items, or total inventory basis under U.S. GAAP. 3. The estimated costs of dismantling and removing an asset must be included in the assets cost upon initial recognition. 4. The two models allowed by IAS 16 are the cost model and the revaluation model. Under the revaluation model, property, plant, and equipment is reported on the balance sheet at a revalued amount, measured as fair value at the date of remeasurement, less accumulated depreciation and any accumulated impairment losses. 5. Any item of property, plant, and equipment may be accounted for under the revaluation model. However, all other items within that class of PPE must be revalued at the same time. Revaluation must occur frequently enough that the difference between the revalued assets carrying amount and fair value is not material. 6. The revaluation surplus is an element of other comprehensive income in stockholders equity. The revaluation surplus is transferred to retained earnings as the revalued asset is realized, either through its use or upon its disposal. The surplus is transferred to retained earnings either: (1) as a lump sum when the asset is disposed of, or (2) each period, as the difference between depreciation on the revalued amount and depreciation on the historical cost. A third treatment for revaluation surplus is to allow it to stay in other comprehensive income indefinitely. 7. When an item of property, plant, and equipment is comprised of significant parts that have different useful lives, as is the case for an airplane, the asset must be split into components and each component must be depreciated separately. 8. Under the fair value model for investment property, changes in fair value are recognized in net income, whereas changes in fair value under the revaluation model are taken to other comprehensive income.

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Chapter 04 - International Financial Reporting Standards: Part I

9. Under IAS 36, an impairment loss arises when an assets recoverable amount is less than its carrying value, where recoverable amount is the greater of net selling price and value in use. Value in use is determined as the expected future cash flows from use of the asset discounted to present value. The amount of the loss is the difference between carrying value and recoverable amount. Under U.S. GAAP, an impairment loss arises when the expected future cash flows (undiscounted) from the use of the asset are less than its carrying value. If impairment exists, the amount of the loss is equal to the difference between carrying value and fair value, which can be determined in different ways. 10. A previously impaired asset may be written back up only to what its carrying amount would have been if the impairment had never been recognized. 11. The three types of intangible assets are: (1) purchased, (2) acquired in a business combination, and (3) internally generated. (1) and (2) are classified as having a finite or indefinite useful life; (3) can only be classified as finite-lived. Finite-lived intangibles are amortized on a systematic basis over their useful lives. All intangibles are subject to impairment testing. Indefinite-lived intangibles must be tested for impairment at least annually. 12. Under IAS 36, expenditures giving rise to a potential intangible are classified as either research or development expenditures. Research expenditures are expensed as incurred. Development expenditures are recognized as an intangible asset when six criteria are met. Under U.S. GAAP, research and development costs are expensed as incurred. The only exception is for software development costs, which are recognized as an asset when certain criteria have been met. 13. Indefinite-lived intangibles and goodwill are subject to impairment testing at least annually. 14. Goodwill is measured as the excess of (a) consideration transferred plus noncontrolling interest over (b) the fair value of the acquired firms net assets. Two alternative methods are available to measure noncontrolling interest; therefore, two different measures of goodwill exist for a given business combination. 15. A gain on bargain purchase exists when (a) consideration transferred plus noncontrolling interest is less than (b) the fair value of the acquired firms net assets. The difference between (a) and (b) is sometimes referred to as negative goodwill. 16. Goodwill must be tested for impairment annually. Goodwill that can be allocated to a specific cash-generating unit is tested for impairment using a bottom-up test. In this test, the carrying value of the cash-generating unit, including goodwill, is compared with the recoverable amount of the cash-generating unit. If the recoverable amount of a cashgenerating unit is less its carrying value, goodwill is deemed to be impaired and is written down.

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Chapter 04 - International Financial Reporting Standards: Part I

17. IAS 23 (revised in 2007) requires borrowing costs to be capitalized to the extent they are attributable to the acquisition, construction, or production of a qualifying asset; other borrowing costs are expensed in the period in which they are incurred. 18. Borrowing costs are defined more broadly in IAS 23 than are interest costs in U.S. GAAP. For example, foreign exchange gains and losses are treated as borrowing costs to the extent they represent adjustments to interest costs. Another difference is that under IFRS interest income earned on short-term investment of borrowed amounts is netted against interest cost to determine the amount of borrowing cost to capitalize. There is no netting of interest income and interest expense under U.S. GAAP. 19. IAS 17 describes five situations that would normally lead to a lease being classified as a finance lease, but does not describe these as being absolute tests. (The standard provides three additional situations that could lead to a lease being classified as a finance lease.) The criteria implied in four of the situations are similar to the specific criteria in U.S. GAAP, but the IAS 17 criteria provide less bright line guidance. IAS 17 indicates that a lease would normally be capitalized when the lease term is for the major part of the leased assets life U.S. GAAP specifically defines major part as 75%. IAS 17 also indicates that a lease would normally be capitalized when the present value of minimum lease payments is equal to substantially all the fair value of the leased asset U.S. GAAP specifically defines substantially all as 90%. Determining whether a lease should be capitalized is an example of the principles-based approach followed in IFRS versus the rules-based approach of U.S. GAAP. 20. A difference in accounting for a sale-and-leaseback gain exists between IFRS and U.S. GAAP when the lease is classified as an operating lease. Under U.S. GAAP, the gain must be amortized over the life of the lease. Under IAS 17, the portion of the gain equal to the difference between the fair value and the carrying amount of the leased asset is recognized immediately. Any difference between the fair value of the asset and its selling price is amortized over the life of the lease. If the lease is classified as a finance lease, both IFRS and U.S. GAAP require the gain on sale-andleaseback to be amortized over the life of the lease. 21. U.S. GAAP requires interest paid and received and dividends received to be classified as operating; dividends paid must be classified as financing. IAS 7 allows interest paid and dividends paid to be classified either as operating or financing; interest received and dividends received may be classified as either operating or investing. 22. IAS 10 establishes the date that financial statements are authorized for issuance as the cut-off date for recognition of events after the reporting period. U.S. GAAP uses the date that financial statements are available for issuance as the cut-off date.

23. IAS 8 establishes the following hierarchy of authoritative pronouncements to be followed in selecting accounting policies to apply to a specific transaction or event: 1. IASB Standard or Interpretation that specifically applies to the transaction or event. 2. IASB Standard or Interpretation that deals with similar and related issues. 3. Definitions, recognition criteria, and measurement concepts in the IASB Framework. 4. Most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards. A change in accounting policy is allowed only if the change: a. Is required by an IFRS, or b. Results in the financial statements providing reliable and more relevant information.

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Chapter 04 - International Financial Reporting Standards: Part I

Solutions to Exercises and Problems D 3e


Multiple Choice 1. B ($100,000 - $10,000) + $60,000 + $30,000 +$25,000 = $205,000

2. C lower of cost ($50,000) and net realizable value ($45,000) = $45,000

3. A

4. D Total Motor Inspection Machine

$100,000 20,000 / 5 years = $4,000 10,000 / 4 years = 2,500 $70,000 / 20 years = 3,500 $10,000

5. D 6. B 7. D

8. B $80,000 + $4,000 +$8,000

9. C

10. A 11. B 12. A

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Chapter 04 - International Financial Reporting Standards: Part I

Problems D 3e 13. Optiplex Company Inventory (determination of cost) Cost to complete the design of the generators Purchase price for materials and parts Less: Abnormal waste Transportation cost to get materials and parts to manufacturing facility Direct labor (10,000 labor hours at $12 per hour) Variable overhead (10,000 labor hours at $2 per hour) Fixed overhead (10,000 labor hours at $6 per hour based on normal level of production) Cost of inventory $ 3,000 80,000 (5,000) 2,000 120,000 20,000 60,000 $280,000

Note:The fixed overhead application rate based on a normal level of production is used per IAS 2.13. The actual level of production can be used if it approximates the normal level; however, the actual level of production in Year 3 does not approximate the normal level. Storage costs are excluded from the cost of inventory per IAS 2.16, which indicates that storage costs are excluded from the cost of inventories unless they are necessary in the production process before a further production stage. 14. Monroe Company Inventory (LCNRV valuation) IFRS Historical cost 20,000 Estimated selling price Costs to complete and sell Net realizable value Inventory loss 17,000 2,000 Replacement cost 14,000 Net realizable value 15,000 Normal profit margin 5,000 NRV - profit margin Market Inventory loss 15,000 20% 11,600 14,000 6,000 a. (1) IFRS: (2) U.S. GAAP: Year 1 Year 2 Year 1 Year 2 Inventory loss Cost of goods sold Inventory loss Cost of goods sold $5,000 $16,800 $6,000 $15,800 U.S. GAAP Historical cost

20,000

b. Year 1: IFRS result in $1,000 larger income before tax, assets, and stockholders equity. Year 2: IFRS result in $1,000 smaller income before tax; assets and stockholders equity are the same at the end of Year 2 under both IFRS and U.S. GAAP.

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Chapter 04 - International Financial Reporting Standards: Part I

16. Beech Corporation Inventory (reversal of write-down) IAS 2 indicates that an inventory write-down is reversed when, for example, inventory is still on hand and its selling price has increased. The reversal is limited to the amount of the original write-down. The new carrying amount should be the lower of original cost and current NRV.
Carrying Amount 12/31/Y1 $130 133 95 $358 Selling price 12/31/Y2 $190 $160 $130 Selling costs (5%) $9.50 $8.00 $6.50 NRV 12/31/Y2 $180.50 $152.00 $123.50 LCNRV 12/31/Y2 $130.00 152.00 100.00 $382.00

Product 101 202 303 Item-by-item total

Cost $130 $160 $100 $390

Inventory should be reported on the 12/31/Y2 balance sheet at LCNRV of $382. The carrying amount at 12/31/Y1 is $358, so inventory must be written up by $24. Carrying amount LCNRV Reversal of write-down $358 382 $ 24

Inventory valuation allowance $24 Reversal of inventory write-down expense

$24

At 12/31/Y2, the inventory valuation allowance has a credit balance of $8; the difference between the original cost of $390 and LCNRV of $382. Note: If LCNRV at 12/31/Y2 had been greater than $390, inventory could have been written back up only to the original cost of $390. In other words, the inventory valuation allowance would be reduced to zero, but will never have a net debit balance. 18. Stevenson Corporation Property, Plant and Equipment (component depreciation) IAS 16.44 states: an entity allocates the amount initially recognized in respect of an item of property, plant and equipment to its significant parts and depreciates separately each such part. This is referred to as component depreciation. Thus, the total cost of $500,000 must be allocated to carpeting, roof, HVAC system, and the rest of the building, and each component is depreciated separately over its expected useful life. Depreciable base $ 10,000 15,000 30,000 445,000 $500,000 Useful Life 5 years 15 years 10 years 50 years Depreciation $ 2,000 1,000 3,000 8,900 $14,900

Carpeting Roof HVAC system Building Total

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Chapter 04 - International Financial Reporting Standards: Part I

20. Godfrey Company Property, Plant and Equip (dismantling and inspection costs) PV Factor (10%)

Calculation of Initial Cost, January 1, Year 2: Building Construction cost Present value of dismantling and removal costs Total cost of the building Machinery and Equipment Construction cost Present value of dismantling and removal costs Total cost of the machinery and equipment Less: Cost of inspection and overhaul Cost allocated to machinery and equipment Journal entry at January 1, Year 2: Building Machinery and equipment Inspection and overhaul costs Cash Provision for dismantling and removal Calculation of Depreciation Expense, Year 2 Building Cost Useful life Depreciation expense Machinery and Equipment Allocated cost Useful life Depreciation expense Inspection and Overhaul Costs Allocated cost Useful life Depreciation expense Depreciation expense Accumulated depreciation

Amount $ 1,500,000 222,965 $ 1,722,965

1,500,000 0.14864

$ 3,500,000 14,864 $ 3,514,864 200,000 $ 3,314,864 100,000 0.14864

$ 1,722,965 3,314,864 200,000 $ 5,000,000 237,830

$1,722,965 20 years $ 86,148

$3,314,864 20 years $ 165,743

$ 200,000 $ $ 5 years 40,000 291,891 $ 291,891

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Chapter 04 - International Financial Reporting Standards: Part I

21. Jefferson Company Property, Plant and Equipment (measurement subsequent to acquisition) Cost, 1/2/Y1 Useful life Annual depreciation Book value, 12/31/Y2 IFRS Allowed Alternative Fair value, 1/2/Y3 Remaining useful life Annual depreciation a. Depreciation expense Years 1 and 2 Years 3, 4, and 5 $10,000,000 5 years $2,000,000 $6,000,000

$12,000,000 3 years $4,000,000 IFRS $2,000,000 $4,000,000 U.S. GAAP $2,000,000 $2,000,000

Income before tax is the same under IFRS and U.S. GAAP in Years 1 and 2. Income before tax is $2,000,000 smaller under IFRS in Years 3, 4, and 5. b. Equipment (book value) 1 IFRS Beginning $10 mn Revaluation Depreciation expense (2 mn) Ending $8 mn 2 $8 mn (2 mn) $6 mn End of Year 3 $6 mn 6 mn (4 mn) $8 mn

4 $8 mn (4 mn) $4 mn

5 $4 mn (4 mn) $0

U.S. GAAP Beginning $10 mn Depreciation expense (2 mn) Ending $8 mn

$8 mn (2 mn) $6 mn

$6 mn (2 mn) $4 mn

$4 mn (2 mn) $2 mn

$2 mn (2 mn) $0

Stockholders equity 1 IFRS Beginning $0 Revaluation Depreciation expense($2 mn) Ending ($2 mn) U.S. GAAP Beginning $0 Depreciation expense($2 mn) Ending ($2 mn)

2 ($2 mn) ($2 mn) ($4 mn)

End of Year 3 ($4 mn) $6 mn ($4 mn) ($2 mn)

4 ($2 mn) ($4 mn) ($6 mn)

5 ($6 mn) ($4 mn) ($10 mn)

($2 mn) ($2 mn) ($4 mn)

($4 mn) ($2 mn) ($6 mn)

($6 mn) ($2 mn) ($8 mn)

($8 mn) ($2 mn) ($10 mn)

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Chapter 04 - International Financial Reporting Standards: Part I

24. Lincoln Company Research and Development Costs a. IFRS Research expense Deferred development costs (asset) Amortization expense deferred development costs U.S. GAAP Research and development expense Year 1 $6 million $4 million Year 2

$800,000

$10 million

--

b. IFRS result in $4 million larger income before tax in Year 1 and $800,000 smaller income before tax in Years 2-6 compared to U.S. GAAP. Ignoring income taxes, total assets and total stockholders equity are larger under IFRS by the following amounts: Year 1 $4,000,000 Year 2 $3,200,000 Year 3 $2,400,000 Year 4 $1,600,000 Year 5 $800,000 Year 6 $0

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Chapter 04 - International Financial Reporting Standards: Part I

26. Buch Corporation Property, Plant, and Equipment (impairment loss and subsequent reversal of impairment loss) Cost Useful life Residual value Annual depreciation charge Year 1 $100,000 (10,000) $90,000 $100,000 10 years $0 $10,000 Year 2 $90,000 (10,000) $80,000 Year 3 $80,000 (10,000) $70,000

Carrying value (at 1/1) Depreciation expense Carrying value (at 12/31)

Test for impairment at December 31, Year 3: Carrying value Net selling price ($70,000 - $7,000) Value in use Recoverable amount (greater of the two) Impairment loss $70,000 $63,000 $55,000 63,000 $ 7,000

The impairment loss of $7,000 would be recognized in income on December 31, Year 3 with an offsetting reduction in the assets carrying value. As a result, the asset will be reported at on the December 31, Year 3 balance sheet at a carrying value of $63,000. This amount will be depreciated over the remaining useful life of 7 years on a straight-line basis. Year 1 $100,000 (10,000) $90,000 Year 2 $90,000 (10,000) $80,000 Year 3 $80,000 (10,000) (7,000) $63,000 Year 4 $63,000 (9,000) $54,000 Year 5 $54,000 (9,000) $45,000

Carrying value (at 1/1) Depreciation expense Impairment loss Carrying value (at 12/31)

Review for reversal of impairment loss at December 31, Year 5: Carrying value $45,000 Net selling price ($50,000 - $7,000) $43,000 Value in use $53,000 Recoverable amount (greater of the two) 53,000 Impairment loss $ 0

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Chapter 04 - International Financial Reporting Standards: Part I

26. (continued) IAS 36 requires an impairment loss to be reversed if the recoverable amount of an asset is determined to exceed its new carrying amount, but only if there are changes in the estimates used to determine the original impairment loss or there is a change in the basis for determining the recoverable amount (from value in use to net selling price or vice versa). Because recoverable amount has changed from net selling price at the end of Year 3 to value in use at the end of Year 5, and the recoverable amount is greater than the carrying value at the end of Year 5, the impairment loss recognized in Year 3 should be reversed. However, the carrying value of the asset after reversal of the impairment loss should not exceed what it would have been if no impairment loss had been recognized. The carrying value of Machine Z at December 31, Year 5 would have been $50,000 if no impairment loss had been recognized in Year 3 ($100,000 original cost less $10,000 annual depreciation for five years). Thus, an increase in the carrying value of the asset of $5,000 should be recognized at December 31, Year 5 with a reversal of impairment loss in an equal amount. The assets carrying value on the December 31, Year 5 balance sheet will be $50,000 ($45,000 + $5,000). This amount will be depreciated over the remaining useful life of 5 years on a straight-line basis.

Summary of amounts to be reported on the balance sheet and income statement in Years 1 5: Year 1 Year 2 Year 3 Year 4 Year 5 Carrying value (at 1/1) $100,000 $90,000 $80,000 $63,000 $54,000 Income Statement Depreciation expense (10,000) (10,000) (10,000) (9,000) (9,000) Impairment loss (7,000) Reversal of impairment loss 5,000 Carrying value (at 12/31) $90,000 $80,000 $63,000 $54,000 $50,000 Income statement effect (10,000) (10,000) (17,000) (9,000) (4,000)

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Chapter 04 - International Financial Reporting Standards: Part I

27. Holzer Company Property, Plant, and Equipment (capitalization of borrowing costs and measurement of asset subsequent to acquisition using two alternative models) IAS 16 Cost Model Carry asset on the balance sheet at cost less accumulated depreciation and any accumulated impairment losses. Capitalize borrowing costs borrowing costs attributable to the construction of qualifying assets. Annual interest ($900,000 x 10%) $90,000 Interest to be capitalized in Year 1 ($500,000* x 10%) 50,000 Interest expense in Year 1 $40,000 * Expenditures of $1,000,000 were made evenly throughout the year, so the average accumulated expenditures during the year are $500,000 ($1,000,000 / 2). Cost of building: Construction costs Capitalized interest Total initial cost of building Annual depreciation (beginning in Year 2) ($1,050,000 / 40 years) Year 1 Income Statement Depreciation expense Balance Sheet Building (at 1/1) Depreciation Building (at 12/31) $0 Year 2 $26,250 Year 3 $26,250 Year 4 $26,250

$1,000,000 50,000 $1,050,000 $26,250 Year 5 $26,250

$0 $1,050,000 $1,023,750 (26,250) (26,250) $1,050,000 $1,023,750 $997,500

$997,500 (26,250) $971,250

$971,250 (26,250) $945,000

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Chapter 04 - International Financial Reporting Standards: Part I

27. (continued) IAS 16 Revaluation Model Carry asset on the balance sheet at revalued amount equal to fair value less any subsequent accumulated depreciation and any accumulated impairment losses. Capitalize borrowing costs attributable to the construction of qualifying assets. Annual interest ($900,000 x 10%) Interest to be capitalized in Year 1 ($500,000 x 10%) Interest expense in Year 1 Cost of building: Construction costs Capitalized interest Total initial cost of building Annual depreciation (beginning in Year 2) ($1,050,000 / 40 years) Year 1 Income Statement Depreciation expense Subtotal Loss on revaluation Reversal of revaluation loss Total expense (income) $0 $0 Year 2 $26,250 $26,250 Year 3 $26,250 $26,250 27,500 $43,750 Year 4 $25,5262 $25,526 $90,000 50,000 $40,000

$1,000,000 50,000 $1,050,000 $26,250 Year 5 $25,526 $25,526 (27,500) $(1,974)

$0

$26,250

$25,526

Balance Sheet Building (at 1/1) $0 $1,050,000 $1,023,750 Depreciation (26,250) (26,250) Building (at 12/31) $1,050,000 $1,023,750 $997,500 Loss on revaluation (27,500)1 Reversal of revaluation loss Revaluation surplus Building (at 12/31) $1,050,000 $1,023,750 $970,000
1

$970,000 (25,526) $944,474

$944,474 (25,526) $918,948 27,5003 3,5523 $950,000

$944,474

2 3

At December 31,Year 3, the fair value of the building is determined to be $970,000. The carrying value of the building is decreased by $27,500, with a loss on revaluation recognized in Year 3 net income. Depreciation in Year 4 is $25,526 ($970,000 / 38 remaining years). At December 31,Year 5, the fair value of the building is determined to be $950,000. The carrying value of the building is increased by $31,052. A reversal of revaluation loss of $27,500 is recognized in income and $3,552 ($31,052 27,500) is recorded as revaluation surplus in shareholders equity.

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Chapter 04 - International Financial Reporting Standards: Part I

28. Quantacc Company Reconciliation to U.S. GAAP Year 5 Net income under IFRS Adjustments: Reversal of depreciation on revaluation of fixed assets Reversal of amortization of deferred development costs Reversal of gain on sale and leaseback Amortization of gain on sale and leaseback Net income (loss) under U.S. GAAP December 31, Year 5 Stockholders equity under IFRS Adjustments: Reversal of revaluation of fixed assets Reversal of accumulated depreciation on revaluation of fixed assets Reversal of deferred development costs Reversal of accumulated amortization on deferred development costs Reversal of gain on sale and leaseback Accumulated amortization of gain on sale and leaseback Stockholders equity under U.S. GAAP

$100,000 3,500 16,000 (150,000) 7,500 $ (23,000)

$500,000 (35,000) 10,500 (80,000) 16,000 (150,000) 7,500 $ 269,000

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Chapter 04 - International Financial Reporting Standards: Part I

30. Reforce Company Intangible Assets (determination of cost) Intangible Asset No No No Yes No No No Yes Yes No No

Cost Market research costs, Year 1 $ 25,000 Research costs, Year 1 100,000 Research costs, 1st Quarter, Year 2 70,000 Legal fees to register patent, April, Year 2 25,000 nd Development costs for initial prototype, 2 Quarter, Year 2 500,000 Testing of initial prototype, June, Year 2 50,000 Management time to develop business plan, 2nd Quarter, Year 2 15,000 Cost of revisions and second prototype, 3rd Quarter, Year 2 175,000 Legal fees to defend patent, October, Year 2 50,000 Production costs, 4th Quarter, Year 2 400,000 Marketing campaign, 4th Quarter, Year 2 80,000

The legal fees to register and defend the patent are capitalized as an intangible asset (Patent, $75,000). Development costs incurred after both (a) technical feasibility has been established and (b) a business plan has been developed are capitalized (Deferred Development Costs, $175,000). Production costs will be capitalized as Inventory; not as an intangible asset. Note: Under U.S. GAAP, only the costs associated with obtaining and defending the patent would be recognized as an asset.

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Chapter 04 - International Financial Reporting Standards: Part I

32. Bartholomew Corporation Goodwill (impairment) Calculation of Recognized Noncontrolling Interest Fair value of net assets (excluding goodwill) Noncontrolling interest % Noncontrolling interest

$5,000,000 20% $1,000,000

Calculation of Unrecognized Noncontrolling Interest Implied fair value of 100% of Samson Company $5,000,000 / 80% = $6,875,000 Noncontrolling interest % 20% Fair value of noncontrolling interest $1,375,000 Recognized noncontrolling interest 1,000,000 Unrecognized noncontrolling interest $ 375,000 Calculation of Goodwill Consideration transferred Plus: Noncontrolling interest (recognized) Subtotal Less: Fair value of net assets (excluding goodwill) Goodwill

$5,500,000 1,000,000 $6,500,000 ,5,000,000 $1,500,000

The summary journal entry to recognize the acquisition of Samsons shares would be: Samsons net assets $5,000,000 Goodwill 1,500,000 Cash $5,500,000 Noncontrolling interest 1,000,000 Impairment Test, End of Year 1 Carrying amount Unrecognized noncontrolling interest Adjusted carrying amount Net assets $5,000,000 0 $5,000,000 Goodwill $1,500,000 375,000 $1,875,000 Total $6,500,000 375,000 $6,875,000

Determination of recoverable amount: Fair value less costs to sell (a) $5,000,000 - $200,000 = Present value of future cash flows (b) Recoverable amount (higher of (a) and (b)) Impairment loss (adjusted carrying amount less recoverable amount) Allocation of impairment loss Goodwill Samsons net assets Total

$4,800,000 4,750,000 4,800,000 $2,075,000

$1,875,000 200,000 $2,075,000

The allocation of impairment loss to goodwill is shared between the controlling and noncontrolling interest. Thus, $1,500,000 (80%) is allocated to the parents investment in Samson Company; the remaining $375,000 (20%) is attributed to the noncontrolling interest but is not recognized. Bartholomew will reflect Goodwill of zero on its December 31, Year 1 balance sheet, and Samsons net assets will be included in the consolidated amounts at a total of $4,800,000 ($5,000,000 $200,000).

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Chapter 04 - International Financial Reporting Standards: Part I

35. Thurstone Company Borrowing Costs (capitalization) Interest cost (300,000 x 4% = 12,000 x $2.10 exchange rate on 3/31/Y1) Less: Income earned on temporary investment (5,000 x $2.10) Net interest cost Plus: Exchange rate loss (300,000 x ($2.10 - $2.00)) Total borrowing cost to be capitalized at 3/31/Y1 $25,200 (10,500) $14,700 30,000 $44,700

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Chapter 04 - International Financial Reporting Standards: Part I

36. Atlanta Tours Company Leases (classification) Finance Lease Criteria Ownership is transferred to the lessee by the end of the lease term. The lease contains a bargain purchase option. The lease term is a major part of the estimated economic life of the leased property. The PV of MLP is substantially all of the fair value of the leased property. The leased assets are of such a specialized nature such that only the lessee can use them without major modifications being made. Criterion met? No. There is no indication that title transfers to the lessee. No. $4,000 purchase option > $3,500 estimated residual value Perhaps. 5 years / 8 years = 62.5%; might be judged as major part Perhaps. $8,930* / $10,000 = 89.3%; might be judged as substantially all Perhaps. Duck Boats Inc. probably would need to remove the wood carving to be able to sell or lease the vehicle to another customer. It is unclear whether this would be considered a major modification. No. The lease is non-cancelable No.

The lessee bears the lessors losses if the lessee cancels the lease. The lessee absorbs the gains or losses from fluctuations in the fair value of the residual value of the asset. The lessee may extend the lease for a secondary period at a rent substantially below the market rent.

No. The lease may not be extended.

* Calculation of PV of MLP Present value factor for annuity due, 5 payments, 6% = 4.4651: $2,000 x 4.4651 = $8,930 It is unclear whether Atlanta Tours Company should classify this lease as a finance lease or as an operating lease; ultimately, it will be up to managements judgment. Collectively, the three criteria that perhaps have been met might lead to a decision that finance lease classification is appropriate. This exercise demonstrates the judgment needed to apply IAS 17. Note: Under U.S. GAAP this lease definitely would not be capitalized, because it does not meet any of the capital lease criteria.

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Chapter 04 - International Financial Reporting Standards: Part I

38. Bridgets Bakery Operating Lease Total consideration for rent over the lease term is $292,500 ($2,500 for 117 months). This consideration must be recognized on a straight-line basis (unless another systematic basis is more representative of the time pattern of the lessees benefit from using the leased asset) over the entire lease period of 10 years (120 months), resulting in a monthly lease expense of $2,437.50 ($292,500 / 120 months). Monthly journal entry for each of the first three months of the lease: Lease expense Deferred rent payable $2,437.50 $2,437.50

Deferred rent payable has a balance of $7,312.50 at the end of three months. This balance is amortized over the remaining 117 months at the rate of $62.50 per month ($7,312.50 / 117 months). Journal entry in months 4 through 120: Lease expense Deferred rent payable Cash $2,437.50 62.50 $2,500.00

Note: SIC-15 Operating Leases-Incentives directly relates to this situation.

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39. Acceptable Treatments Acceptable under U.S. GAAP Both

IFRS
A company takes out a loan to finance the

Neither

construction of a building that will be used by the company. The interest on the loan is capitalized as part of the cost of the building. Inventory is reported on the balance sheet using the last-in, first-out (LIFO) cost flow assumption. The gain on a sale and leaseback transaction classified as an operating lease is deferred and amortized over the lease term. A company writes a fixed asset down to its recoverable amount and recognizes an impairment loss in Year 1. In a subsequent year, the recoverable amount is determined to exceed the assets carrying amount, and the previously recognized impairment loss is reversed. A company pays less than the fair value of net assets in the acquisition of another company. The acquirer recognizes the difference as a gain on purchase of another company. A company enters into an eight-year lease on equipment that is expected to have a useful life of ten years. The lease is accounted for as an operating lease. An intangible asset with an active market that was purchased two years ago is carried on the balance sheet at fair value. In preparing interim financial statements, interim periods are treated as discrete reporting periods rather than as an integral part of the full year. Research and development costs are capitalized when certain criteria are met. Interest paid on borrowings is classified as an operating activity in the statement of cash flows. This would be acceptable under IAS 17 if 80% of the life of the lease is not viewed as the major part of the lease. Neither IFRS nor U.S. GAAP allows capitalization of research costs.

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