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Chapter 11 - Worldwide Accounting Diversity and International Standards

CHAPTER 11
WORLDWIDE ACCOUNTING DIVERSITY
AND INTERNATIONAL STANDARDS
Chapter Outline
I.

Accounting and financial reporting rules differ across countries. There are a variety of
factors influencing a countrys accounting system.
A. Legal systemprimarily relates to how accounting principles are established; code
law countries generally having legislated accounting principles and common law
countries having principles established by non-legislative means.
B. Taxationfinancial statements serve as the basis for taxation in many countries. In
those countries with a close linkage between accounting and taxation, accounting
practice tends to be more conservative so as to reduce the amount of income subject
to taxation.
C. Financing systemwhere shareholders are a major provider of financing, the
demand for information made available outside the company becomes greater. In
those countries in which family members, banks, and the government are the major
providers of business finance, there is less demand for public accountability and
information disclosure.
D. Inflationhistorically, caused some countries, especially in Latin America, to develop
accounting principles in which traditional historical cost accounting is abandoned in
favor of inflation adjusted figures. As inflation has been brought under control in most
countries, this factor is no longer of significant influence.
E. Political and economic tiescan explain the usage of a British style of accounting
throughout most of the former British Empire. They also help to explain similarities
between the U.S. and Canada, and increasingly, the U.S. and Mexico.
F. Cultureaffects a countrys accounting system in two ways: (1) through its influence
on a countrys institutions, such as its legal system and system of financing, and (2)
through its influence on the accounting values shared by members of the accounting
sub-culture.

II.

Nobes developed a general model of the reasons for international differences in financial
reporting that has only two explanatory factors: (1) national culture, including institutional
structures, and (2) the nature of a countrys financing system.
A. A self-sufficient Type I culture will have a strong equity-outsider financing system
which results in a Class A accounting system oriented toward providing information for
outside shareholders.
B. A self-sufficient Type II culture will have a weak equity-outsider financing system
which results in a Class B accounting system oriented toward protecting creditors and
providing a basis for taxation.
C. Countries dominated by a country with a Type I culture will use a Class A accounting
system even though they do not have strong equity-outsider financing systems.
D. Companies with strong equity-outsider financing located in countries with a Class B
accounting system will voluntarily attempt to use a Class A accounting system to
compete in international capital markets.

III. Differences in accounting across countries cause several problems.


A. Consolidating foreign subsidiaries requires that the financial statements prepared in
accordance with foreign GAAP must be converted into the parent companys GAAP.
B. Companies interested in obtaining capital in foreign countries often are required to
provide financial statements prepared in accordance with accounting rules in that
country, which are likely to differ from rules in the home country.
C. Investors interested in investing in foreign companies may have a difficult time in
making comparisons across potential investments because of differences in
accounting rules across countries.
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Chapter 11 - Worldwide Accounting Diversity and International Standards

IV. The International Accounting Standards Committee (IASC) was formed in 1973 in hopes
of improving and promoting the worldwide harmonization of accounting principles. It was
superseded by the International Accounting Standards Board (IASB) in 2001.
A. The IASC issued 41 International Accounting Standards (IAS) covering a broad range
of accounting issues. Ten IASs have been superseded or withdrawn, leaving 31 in
effect.
B. The membership of the IASC was composed of over 140 accountancy bodies from
more than 100 nations.
C. The IASC was not in a position to enforce its standards. Instead, member
accountancy bodies pledged to work toward acceptance of IASs in the respective
countries.
D. Because of criticism that too many options were allowed in its standards and
therefore true comparability was not being achieved, the IASC undertook a
Comparability Project in the 1990s, revising 10 of its standards to eliminate
alternatives.
E. The IASC derived much of its legitimacy as an international standard setter through
endorsement of its activities by the International Organization of Securities
Commissions. IOSCO and the IASC agreed that, if the IASC could develop a set of
core standards, IOSCO would recommend that stock exchanges allow foreign
companies to use IASs in preparing financial statements. The IASC completed the
set of core standards in 1998, IOSCO endorsed their usage by foreign companies in
2000, and many members of IOSCO adopted this recommendation.
V.

The International Accounting Standards Board (IASB) replaced the IASC in 2001.
A. The IASB originally consisted of 14 members 12 full-time and 2 part-time. The
number of board members was increased to 16 members in 2012, at least 13 of
whom must be full-time. Full-time IASB members are required to sever their
relationships with former employers to ensure independence. To ensure a broad
international diversity, there normally are four members from Europe; four from North
America; four from the Asia/Oceania region; one from Africa; one from South America;
and two from any area to achieve geographic balance.
B. IASB GAAP is referred to as International Financial Reporting Standards (IFRS) and
consists of (a) IASs issued by the IASC (and adopted by the IASB), (b) individual
International Financial Reporting Standards developed by the IASB, and (c)
Interpretations issued by the Standing Interpretations Committee (SIC) (until 2001)
and International Financial Reporting Interpretations Committee (IFRIC).
C. In addition to 31 IASs and 13 IFRSs (as of January 2013), the IASB also has a
Framework for the Preparation and Presentation of Financial Statements, which
serves as a guide to determine the proper accounting in those areas not covered by
IFRS.
D. As of June 2012, more than 90 countries required the use of IFRS by all domestic
publicly traded companies, and several important countries were to begin using IFRS
in the near future. Other countries allow the use of IFRS by domestic companies.
Many countries also allow foreign companies that are listed on their securities
markets to use IFRS.
E. There are two primary methods used by countries to incorporate IFRS into their
financial reporting requirements for listed companies: (1) full adoption of IFRS as
issued by the IASB, without any intervening review or approval by a local body, and
(2) adoption of IFRS after some form of national or multinational review and approval
process.

VI. The U.S. FASB has adopted a strategy of convergence with IASB standards.
A. In 2002, the IASB and FASB signed the so-called Norwalk Agreement to use their
best efforts to (a) make their existing financial reporting standards fully compatible as
soon as is practicable and (b) coordinate their work program to ensure that once
achieved, compatibility is maintained.
B. The FASB-IASB convergence process has resulted in changes made to U.S. GAAP,
IFRS, or both in a number of areas including: Business combinations, Non-controlling
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Chapter 11 - Worldwide Accounting Diversity and International Standards

C.

interests, Acquired in-process research costs, Share-based payment, Borrowing


costs, Segment reporting, and Presentation of other comprehensive income.
At the beginning of 2013, the FASB listed joint convergence projects with either an
Exposure Draft or final standard expected to be issued in 2013 in the following areas:
Leases, Insurance contracts, Financial instruments, Revenue recognition, Investment
companies, and Consolidation: Policy and Procedures

VII. The U.S. SECs early interest in IFRS stemmed from IOSCOs endorsement of IFRS for
cross-listing purposes.
A. After considering this issue for several years, in 2007 the SEC amended its rules to
allow foreign registrants to prepare financial statements in accordance with IFRS
without reconciliation to U.S. GAAP. Since 2007, foreign companies using IFRS have
been able to list securities on U.S. securities markets without providing any U.S.
GAAP information in their annual reports.
B. To level the playing field for U.S. companies, in July 2007, the SEC issued a concept
release to determine public interest in allowing U.S. companies to choose between
IFRS and U.S. GAAP in preparing financial statements. Many comment letter writers
were not in favor of allowing U.S. companies to choose between IFRS and U.S.
GAAP instead recommending that U.S. companies be required to use IFRS.
C. In November 2008, the SEC issued the so-called IFRS Roadmap. The SEC
indicated it would monitor several milestones until 2011 at which time it decide
whether to require U.S. companies to follow IFRS over a three-year phase-in period.
The Roadmap indicated 2014 as the first year of IFRS adoption, but a subsequent
SEC Release in February 2010 pushed that date back to approximately 2015 or
2016.
D. In 2011, the SEC Staff published a discussion paper that suggests an alternative
framework for incorporating IFRS into the U.S. financial reporting system. This
framework combines the existing FASB-IASB convergence project with the
endorsement process followed in many countries and the EU. Some refer to this
method as condorsement. The framework would retain both U.S. GAAP and the
FASB as the U.S. accounting standard setter. At the end of a transition period, a U.S.
company following U.S. GAAP also would be able to represent that its financial
statements are in compliance with IFRS.
E. The 2011 deadline established by the SEC in its IFRS Roadmap came and went
without the Commission making a decision whether to require the use of IFRS in the
U.S. In July 2012, the SEC staff issued a Final Staff Report that summarized analysis
conducted by the SEC Staff on the possible use of IFRS by U.S. companies, but it did
not include conclusions or recommendation for action by the Commission and did not
provide insight into the nature or timetable for next steps. Thus, at the time this book
went to press, the SEC had not signaled when it might make a decision about
whether and, if so, how IFRS should be incorporated into the U.S. financial reporting
system.
VIII. IFRS 1, First-time Adoption of IFRS, established guidelines that a company must use in
transitioning from previously-used GAAP to IFRS.
A. Companies transitioning to IFRS must prepare an opening balance sheet at the date
of transition. The transition date is the beginning of the earliest period for which an
entity presents full comparative information under IFRS. For example, for a company
preparing its first set of financial statements for the calendar year 2017, the date of
transition is January 1, 2015.
B. An entity must complete the following steps to prepare the opening IFRS balance
sheet:
1. Determine applicable IFRS accounting policies based on standards in force on
the reporting date.
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Chapter 11 - Worldwide Accounting Diversity and International Standards

2. Recognize assets and liabilities required to be recognized under IFRS that were
not recognized under previous GAAP and derecognize assets and liabilities
previously recognized that are not allowed to be recognized under IFRS.
3. Measure assets and liabilities recognized on the opening balance sheet in
accordance with IFRS.
4. Reclassify items previously classified in a different manner from what is
acceptable under IFRS.
IX. IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, establishes
guidelines for determining appropriate IFRS accounting polices.
A. Companies must use the following hierarchy to determine accounting polices that will
be used in preparing IFRS financial statements.
1. Apply specifically relevant standards (IASs, IFRSs, or Interpretations) dealing with
an accounting issue.
2. Refer to other IASB standards dealing with similar or related issues.
3. Refer to the definitions, recognition criteria, and measurement concepts in the
IASB Framework.
4. Consider the most recent pronouncements of other standard-setting bodies that
use a similar conceptual framework, other accounting literature, and accepted
industry practice to the extent that these do not conflict with sources in 2. and 3.
above.
B. Because the FASB and IASB conceptual frameworks are similar, step 4 provides an
opportunity for entities to adopt FASB standards in dealing with accounting issues
where steps 1 through 3 are not helpful.
X.

Numerous differences exist between IFRS and U.S. GAAP.


A. Differences exist with respect to recognition, measurement, presentation, and
disclosure. Exhibit 11.8 lists several key differences.
B. IAS 1, Presentation of Financial Statements, provides guidance with respect to the
purpose of financial statements, components of financial statements, basic principles
and assumptions, and the overriding principle of fair presentation. There is no
equivalent to IAS 1 in U.S. GAAP.
C. The IASB follows a principles-based approach to standard setting, rather than the socalled rules-based approach used by the FASB. The IASB tends to avoid the use of
bright line tests and provides a limited amount of implementation guidance in its
standards.

XI. Even if all countries adopt a similar set of accounting standards, two obstacles remain in
achieving the goal of worldwide comparability of financial statements.
A. IFRS must be translated into languages other than English to be usable by nonEnglish speaking preparers of financial statements. It is difficult to translate some
words and phrases into other languages without a distortion of meaning.
B. Culture can affect the manner in which an accountant interprets and applies an
accounting standard. Differences in culture can lead to differences in application of
the same standard across countries.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

Answer to Discussion Question: Which Accounting Method Really is Appropriate?


Students in the United States often assume that U.S. GAAP is superior and that all reporting
issues can (or should) be resolved by following U.S. rules. However, the reporting of research
and development costs is a good example of a rule where different approaches can be justified
and the U.S. rule might be nothing more than an easy method to apply. In the United States,
all such costs are expensed as incurred because of the difficulty of assessing the future value
of these projects. International Financial Reporting Standards require capitalization of
development costs when certain criteria are met.
The issue is not whether costs that will have future benefits should be capitalized. Most
accountants around the world would recommend capitalizing a cost that leads to future
revenues that are in excess of that cost. The real issue is whether criteria can be developed
for identifying projects that will lead to the recovery of those costs. In the U.S., the FASB felt
that such decisions were too subjective and open to manipulation.
Conversely, under IFRS, development costs must be recognized as an intangible asset when
an enterprise can demonstrate all of the following:
(a) the technical feasibility of completing the intangible asset so that it will be available for use
or sale;
(b) its intention to complete the intangible asset and use or sell it;
(c) its ability to use or sell the intangible asset;
(d) how the intangible asset will generate probable future economic benefits. Among other
things, the enterprise should demonstrate the existence of a market for the output of the
intangible asset or the existence of the intangible asset itself or, if it is to be used internally,
the usefulness of the intangible asset;
(e) the availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset; and
(f) its ability to measure the expenditure attributable to the intangible asset during its
development reliably.
The IFRS treatment of development costs begs the question: How easy is it for an accountant
to determine whether the development project will result in an intangible asset, such as a
patent, that will generate future economic benefits?
In the U.S., a conservative approach has been taken because of the difficulty of determining
whether an asset has been or will be created. To ensure comparability, all companies are
required to expense all R&D costs. As a result, costs related to development costs that prove
to be very valuable to a company for years to come are expensed immediately. Do the
benefits of consistency and comparability (each company expenses all costs each year)
outweigh the cost of producing financial statements that might omit valuable assets from the
balance sheet? No definitive answer exists for that question. However, the reader of financial
statements needs to be aware of the fundamental differences in approach that exist in
accounting for development costs before making comparisons between companies from
different countries.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

Answers to Questions
1.

The five factors most often cited as affecting a country's accounting system are: (1) legal
system, (2) taxation, (3) providers of financing, (4) inflation, and (5) political and economic
ties. The legal system is primarily related to how accounting principles are established;
code law countries generally having legislated accounting principles and common law
countries having principles established by non-legislative means. In some countries,
financial statements serve as the basis for taxation and in other countries they do not. In
those countries with a close linkage between accounting and taxation, accounting practice
tends to be more conservative so as to reduce the amount of income subject to taxation.
Shareholders are a major provider of financing in some countries. As shareholder
financing increases in importance, the demand for information made available outside the
company becomes greater. In those countries in which family members, banks, and the
government are the major providers of business finance, there tends to be less demand
for public accountability and information disclosure. Historically, chronic high inflation
caused some countries, especially in Latin America, to develop accounting principles in
which traditional historical cost accounting is abandoned in favor of inflation adjusted
figures. Because inflation has been brought under control in most countries of the world,
this factor is no longer of much significance. Political and economic ties can explain the
usage of a British style of accounting throughout most of the former British empire. They
also help to explain similarities between the U.S. and Canada, and increasingly, the U.S.
and Mexico.
Culture also is viewed as a factor that has significant influence on the development of a
countrys accounting system. This influence is described in more detail in the answer to
question 3.

2.

Problems caused by accounting diversity for a company like Nestle include: (a) the
additional cost associated with converting foreign GAAP financial statements of foreign
subsidiaries to parent company GAAP to prepare consolidated financial statements, (b)
the additional cost associated with preparing Nestle financial statements in foreign GAAP
(or reconciling to foreign GAAP) to gain access to foreign capital markets, and (c) difficulty
in understanding and comparing financial statements of potential foreign acquisition
targets.

3.

Gray developed a model that hypothesizes that societal values, i.e., culture, affect the
development of accounting systems in two ways: (1) societal values help shape a
countrys institutions, such as legal system and financing system, which in turn influences
the development of accounting, and (2) societal values influence accounting values held
by members of the accounting sub-culture, which in turn influences the development of
the accounting system. Gray provides specific hypotheses with respect to the manner in
which specific cultural dimensions will influence specific accounting values. For example,
he hypothesizes that in countries in which avoiding uncertainty is important, accountants
will have a preference for more conservative measurement of profit.

4.

According to Nobes, the purpose for financial reporting determines the nature of a
countrys financial reporting system. The most relevant factor for determining the purpose
of financial reporting is the nature of the financing system. Some countries have a
culture, and accompanying institutional structure, that leads to a strong equity financing
system with large numbers of outside shareholders.
A country with a self-sufficient Type I culture will have a strong equity-outsider financing
system which in turn will lead that country developing a Class A accounting system
oriented toward providing information for outside shareholders. A self-sufficient Type II
culture will have a weak equity-outsider financing system which results in a Class B
accounting system oriented toward protecting creditors and providing a basis for taxation.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

5.

Several of the IASCs original standards were criticized for allowing too many alternative
methods of accounting for a particular item. As a result, through the selection of different
acceptable options, the financial statements of two companies following International
Accounting Standards still might not have been comparable.
To enhance the
comparability of financial statements prepared in accordance with International Accounting
Standards, and at the urging of the International Organization of Securities Commissions,
the IASC systematically reviewed its existing standards (in the so-called Comparability
Project) and revised ten of them by eliminating previously acceptable alternatives.

6.

A major difference between the IASB and the IASC is the composition of the Board and
the manner in which Board members are selected. IASB has at least 12 and as many as
14 full-time members, the IASC had zero. Full-time IASB members must sever their
employment relationships with former employers and must maintain their independence.
Seven of the full-time members have a liaison relationship with a national standard setter.
At least five members must have been auditors, three must have been financial statement
preparers, three must have been users of financial statements, and at least one must
come from academia. The most important criterion for appointment to the IASB is
technical competence. (Although not stated in the body of the chapter, there was a
perception that some appointments to the IASC were based on politic connections and not
competence.)
[Some of the common features of the IASC and IASB are that both (a) issue/d
international standards, (b) have/had their headquarters in London, and (c) use/d
English as the working language.]

7.

This statement is true in that EU publicly traded companies are required to use IFRS in
preparing consolidated financial statements. It is false in that non-public companies are
not required to use IFRS and publicly traded companies do not use IFRS in preparing their
parent company only financial statements.

8.

The bottom section of Exhibit 11.6 shows the countries as of June 2012 that do not allow
domestic companies to use IFRS in preparing consolidated financial statements. The two
most economically important countries in this group are China and the United States.

9.

The IASB and FASB have agreed to use their best efforts to (a) make their existing
financial reporting standards fully compatible as soon as is practicable and (b) coordinate
their work program to ensure that once achieved, compatibility is maintained.

10. Convergence implies a joint effort between two standard setters to reduce differences in
the sets of standards for which they are responsible. Convergence could result in one
standard setter adopting an existing standard developed by the other standard setter or
by the two standard setters jointly developing a new standard. Convergence does not
necessarily mean the two sets of standards that result from the convergence process will
be the same. Indeed, the FASB and IASB acknowledge that differences between IFRS
and U.S. GAAP will continue to exist even after convergence.
In contrast to the approach taken by the FASB to influence future IASB standards, the
European Union simply adopted IFRS as the national GAAP in member nations.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

11. Since 2007, foreign companies listed on U.S. stock exchanges may file IFRS financial
statements with the U.S. SEC without providing any reconciliation to U.S. GAAP.
Domestic companies listed on U.S. stock exchanges must file financial statements
prepared in accordance with U.S. GAAP.
The SECs proposed condorsement framework combines the FASBIASB convergence
process with the IFRS endorsement process followed in many countries and in the EU.
The framework would retain both U.S. GAAP and the FASB as the U.S. accounting
standard setter. At the end of a transition period, a U.S. company following U.S. GAAP
also would be able to represent that its financial statements are in compliance with IFRS.
The two components of the framework are:
The FASB continues to participate in the process of developing new IFRSs and
incorporates those standards into U.S. GAAP by means of an endorsement process.
The FASB would incorporate existing IFRSs into U.S. GAAP over a defined period of
time, for example, five to seven years, with a focus on minimizing transition costs for
U.S. companies.
At the time this book went to press in the third quarter of 2013, the SEC still had not yet
made a decision on the issue of incorporating IFRS into the U.S. financial reporting
system.
12. When adopting IFRS, a company must prepare an IFRS opening balance sheet at the
date of transition. The date of transition is the beginning of the earliest period for which
comparative information must be presented, i.e., two years prior to the reporting date. A
company must follow five steps in preparing its IFRS opening balance sheet:
1. Determine applicable IFRS accounting policies based on standards that will be in force
on the reporting date.
2. Recognize assets and liabilities required to be recognized under IFRS that were not
recognized under prior GAAP, and derecognize assets and liabilities recognized under
prior GAAP that are not allowed to be recognized under IFRS.
3. Measure assets and liabilities recognized on the IFRS opening balance sheet in
accordance with IFRS (that will be in force on the reporting date).
4. Reclassify items previously classified in a different manner from what is acceptable
under IFRS.
5. Comply with all disclosure and presentation requirements.
13. The extreme approaches that a company might follow in determining appropriate
accounting policies for preparing its initial set of IFRS financial statements are:
1. Adopt accounting policies acceptable under IFRS that minimize change from existing
accounting policies used under current GAAP.
2. Take a fresh start, clean slate approach and develop accounting policies acceptable
under IFRS that will result in financial statements that reflect the economic substance of
transactions and present the most economically meaningful information possible.
14. According to the accounting policy hierarchy in IAS 8, if a company is faced with an
accounting issue for which (a) there is no specific IASB standard that applies, (b) there are
no IASB standards on related issues, and (c) reference to the IASBs Framework does not
help in determining an appropriate accounting treatment, then the company should
consider the most recent pronouncements of other standard-setting bodies that use a
similar conceptual framework. The FASBs conceptual framework is similar to the IASBs,
so reference to FASB pronouncements would be acceptable under IAS 8 when conditions
(a), (b), and (c) exist.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

15. Potentially significant differences between IFRS and U.S. GAAP related to asset
recognition and measurement are:
Acceptable use of LIFO under U.S. GAAP, but not IFRS.
Definition of market in the lower of cost or market rule for inventory replacement
cost under U.S. GAAP; net realizable value under IFRS.
Reversal of inventory writedowns allowed under IFRS, but not under U.S. GAAP.
Possible revaluation of property, plant, and equipment under IFRS (allowed alternative),
but not under U.S. GAAP.
Capitalization of development costs as an intangible asset under IFRS, which is not
acceptable under U.S. GAAP (except for computer software development costs).
Difference in the determination of whether an asset is impaired.
Subsequent reversal of impairment losses allowed by IFRS, but not U.S. GAAP.
16. Even if all countries adopt a similar set of accounting standards, two obstacles remain in
achieving the goal of worldwide comparability of financial statements. First, IFRS must be
translated into languages other than English to be usable by non-English speaking
preparers of financial statements. It is difficult to translate some words and phrases found
in IFRS into non-English languages without a distortion of meaning. Second, culture can
affect the manner in which accountants interpret and apply accounting standards.
Differences in culture can lead to differences in how the same standard is applied across
countries.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

Answers to Problems
1.

2.

3.

4.

5.

6.

7.

8.

9.

10. C
11. B
12. D
13. A
14. C

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Chapter 11 - Worldwide Accounting Diversity and International Standards

Problems 15-19 are based on the comprehensive illustration.


15. (15 minutes) (Carrying inventory at the lower of cost or market)
Historical cost
Replacement cost
Net realizable value
Normal profit margin
Net realizable value less normal profit [$117,000 (20% x$117,000)]

$120,000
$111,900
$117,000
20%
$93,600

a. 1. Under U.S. GAAP, the company reports inventory on the balance sheet at the
lower of historical cost or market, where market is defined as replacement
cost (with net realizable value as a ceiling and net realizable value less a
normal profit as a floor). In this case, inventory will be written down to
replacement cost and reported on the December 31, 2015 balance sheet at
$111,900. A $8,100 loss will be included in 2015 income.
2. In accordance with IAS 2, the company reports inventory on the balance
sheet at the lower of historical cost and net realizable value. As a result,
inventory will be reported on the December 31, 2015 balance sheet at its net
realizable value of $117,000 and a loss on writedown of inventory of $3,000
will be reflected in 2015 net income.
b. As a result of the differing amounts of inventory loss recognized under U.S.
GAAP and IFRS, Lisali will add $5,100 to U.S. GAAP income to reconcile to
IFRS income, and will add $5,100 to U.S. GAAP stockholders equity to reconcile
to IFRS stockholders equity.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

16. (25 minutes) (Measurement of property, plant, and equipment subsequent to


acquisition)
Cost
Residual value
Useful life
Straight-line depreciation

$78,400
$10,000
6 years
$11,400 per year

a. 1. Under U.S. GAAP, the company would report the equipment at its
depreciated historical cost. Straight-line depreciation expense is $11,400 per
year. The equipment would be reported at $67,000, $55,600, and $44,200,
respectively, on the December 31, 2015, 2016, and 2017 balance sheets.
2. Under IFRS, the equipment would be depreciated by $11,400 in 2015,
resulting in a book value of $67,000 at December 31, 2015. Under IAS 16s
allowed alternative treatment, the equipment would be revalued on January
1, 2016 to its fair value of $74,500.
The journal entry to record the revaluation on January 1, 2016 would be:
Dr. Equipment
$7,500
Cr. Revaluation Surplus (stockholders equity)
$7,500
(To revalue equipment from carrying value of $67,000
to appraisal value of $74,500.)
Depreciation expense on a straight-line basis in 2016, 2017, and beyond
would be $12,900 per year [($74,500 $10,000) / 5 years]. The equipment
would be reported on the December 31, 2016 balance sheet at $61,600
[$74,500 $12,900], and on the December 31, 2017 balance sheet at
$48,700 [$61,600 $12,900].
The differences can be summarized as follows:
Depreciation expense
IFRS
U.S. GAAP
Difference
Book value of equipment
IFRS
U.S. GAAP
Difference

2015
$11,400
$11,400
$0

2016
$12,900
$11,400
$1,500

2017
$12,900
$11,400
$1,500

12/31/15
$67,000
$67,000
$0

12/31/16
$61,600
$55,600
$ 6,000

12/31/17
$48,700
$44,200
$ 4,500

11-12

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Chapter 11 - Worldwide Accounting Diversity and International Standards

16. (continued)
b. There is no difference in net income between IFRS and U.S. GAAP in 2015, so
no reconciliation adjustments are necessary in 2015.
In 2016, the additional amount of depreciation expense of $1,500 related to the
revaluation surplus under IFRS must be subtracted from U.S. GAAP income to
reconcile to IFRS net income. The additional depreciation taken under IFRS
causes IFRS retained earnings to be $1,500 less than U.S. GAAP retained
earnings at December 31, 2016. Under IFRS, the revaluation surplus causes
IFRS stockholders equity to be $7,500 larger than U.S. GAAP stockholders
equity. The adjustment to reconcile U.S. GAAP stockholders equity to IFRS is
$6,000, the difference between the original amount of the revaluation surplus
($7,500) and the accumulated depreciation on that surplus ($1,500). $6,000
would be added to U.S. GAAP stockholders equity to reconcile to IFRS.
In 2017, $1,500 again is added to IFRS net income to reconcile to U.S. GAAP
net income, and $4,500 is subtracted from IFRS stockholders equity to reconcile
to U.S. GAAP stockholders equity. $4,500 is the amount of revaluation surplus
($7,500) less accumulated depreciation on that surplus for two years ($3,000).
17. (15 minutes) (Research and development costs)
Research and development costs
Useful life

$650,000 (30% related to development)


10 years

a. 1. Under U.S. GAAP, $650,000 of research and development costs would be


expensed in 2015.
2. In accordance with IAS 38, $455,000 [$650,000 x 70%] of research and
development costs would be expensed in 2015, and $195,000 [$650,000 x
30%] of development costs would be capitalized as an intangible asset. The
intangible asset would be amortized over its useful life of ten years, but only
beginning in 2016 when the newly developed product is brought to market.
b. In 2015, $195,000 would be added to U.S. GAAP net income to reconcile to
IFRS and the same amount would be added to U.S. GAAP stockholders equity.

18.

In 2016, the company would recognize $19,500 [$195,000 / 10 years] of


amortization expense on the deferred development costs under IFRS that would
not be recognized under U.S. GAAP. In 2016, $19,500 would be subtracted from
U.S. GAAP net income to reconcile to IFRS net income. The net adjustment to
reconcile from U.S. GAAP stockholders equity to IFRS at December 31, 2016
would be $175,500, the sum of the $195,000 smaller expense under IFRS in
2015 and the $19,500 larger expense under IFRS in 2016. $175,500 would be
added to U.S. GAAP stockholders equity at December 31, 2016 to reconcile to
IFRS.
(15 minutes) (Gain on sale and leaseback transaction)
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Chapter 11 - Worldwide Accounting Diversity and International Standards

Gain on sale of asset


Life of leaseback

$76,000
4 years

a. 1. Under U.S. GAAP, the gain of $76,000 on the sale and leaseback transaction
is deferred and amortized to income over the life of the lease. With a lease
period of four years, $19,000 [$76,000 / 4 years] of the gain would be
recognized in 2015.
2. In accordance with IAS 17, the entire gain of $76,000 on the sale and
leaseback would be recognized in income in the year of the sale when the
lease is an operating lease.
b. In 2015, IFRS net income exceeds U.S. GAAP net income by $57,000, the
difference ($76,000 vs. $19,000) in the amount of gain recognized on the sale
and leaseback transaction. A positive adjustment of $57,000 would be made to
reconcile U.S. GAAP net income and U.S. GAAP stockholders equity to IFRS.
In 2016, a gain of $19,000 would be recognized under U.S. GAAP that would not
exist under IFRS. As a result, $19,000 would be subtracted from U.S. GAAP net
income to reconcile to IFRS. By December 31, 2016, $38,000 of the gain would
have been recognized under U.S. GAAP and included in retained earnings,
whereas retained earnings under IFRS includes the entire $76,000 gain. Thus,
$38,000 would be added to U.S. GAAP stockholders equity at 12/31/16 to
reconcile to IFRS.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

19. (20 minutes) (Impairment of property, plant, and equipment)


Cost of equipment
Salvage value
Useful life
Depreciation expense, 2015
Carrying value, 12/31/15
Expected future cash flows, 12/31/15
PV of expected future cash flows, 12/31/15
Fair value (net selling price) less costs to dispose, 12/31/15

$135,000
zero
5 years
$27,000
$108,000
116,000
100,000
96,600

a. 1. Under U.S. GAAP, an asset is impaired when its carrying value exceeds the
expected future cash flows (undiscounted) to be derived from use of the
asset. Expected future cash flows are $116,000, which exceeds the carrying
value of $108,000, so the asset is not impaired. Depreciation expense for
the year is $27,000 [$135,000 / 5 years], and the equipment will be carried
on the December 31, 2015 balance sheet at $108,000.
2. In accordance with IAS 36, an asset is impaired when its carrying value
exceeds its recoverable amount, which is the greater of (a) value in use
(present value of expected future cash flows), and (b) net selling price, less
costs to dispose. The carrying value of the equipment at December 31,
2015 is $108,000; original cost of $135,000 less accumulated depreciation of
$27,000 [$135,000 / 5 years]. The assets recoverable amount is $100,000
(the higher of value in use of $100,000 and fair value of $96,600), so the
asset is impaired. An impairment loss of $8,000 [$108,000 - $100,000] would
be recognized at the end of 2015, in addition to depreciation expense for the
year of $27,000. The equipment will be carried on the December 31, 2015
balance sheet at $100,000.
b. An impairment loss of $8,000 was recognized in 2015 under IFRS but not under
U.S. GAAP. Therefore, $8,000 must be subtracted from U.S. GAAP net income
to reconcile to IFRS net income in 2015. The same amount would be subtracted
from U.S. GAAP stockholders equity at December 31, 2015 to reconcile to IFRS
stockholders equity.
In 2016, depreciation under IFRS will be $25,000 [$100,000 / 4 years], whereas
depreciation under U.S. GAAP is $27,000. $2,000 would be added to U.S.
GAAP net income to reconcile to IFRS net income in 2016. To reconcile
stockholders equity to IFRS at December 31, 2016, $6,000 must be subtracted
from U.S. GAAP stockholders equity. This is the difference between the
impairment loss of $8,000 in 2015 taken under IFRS and the difference in
depreciation expense recognized under the two sets of standards in 2016. It
also is equal to the difference in the carrying value of the equipment at
December 31, 2016 under the two sets of accounting rules:
Cost
Depreciation, 2015
Impairment loss, 2015
Carrying value, 12/31/15
Depreciation, 2016
Carrying value, 12/31/16

IFRS
$135,000
(27,000)
(8,000)
$100,000
(25,000)
$75,000

11-15

U.S. GAAP
$135,000
(27,000)
0
$108,000
(27,000)
$81,000

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Education.

Chapter 11 - Worldwide Accounting Diversity and International Standards

Chapter 11 Develop Your Skills


Analysis Case 1Application of IAS 16
This assignment demonstrates the effect one difference between IFRS and U.S.
GAAP would have on a company's net income and stockholders' equity over a
20-year period.
Depreciation expense in Years 1 and 2 under both sets of rules: $10,000,000 / 20
years = $500,000 per year
The building has a book value of $9,000,000 on January 1, Year 3. On that date,
under IFRS, Abacab would revalue the building through the following journal entry:
Dr. Building
$3,000,000
Cr. Accumulated Other Comprehensive Income (AOCI)

$3,000,000

Under IFRS, the revalued amount of the building will be depreciated over the
remaining useful life of 18 years at the rate of $666,667 per year [$12,000,000 / 18
years].
a.

Depreciation Expense
IFRS
U.S. GAAP

Year 2
$500,000
$500,000

Year 3
$666,667
$500,000

b.

Book Value of Building


IFRS
U.S. GAAP
Difference

1/2/Y3
$12,000,000
$9,000,000
$3,000,000

12/31/Y3
$11,333,333
$8,500,000
$2,833,333

c.

Pre-tax income will be $166,667 smaller in each year (Year 3 -Year 20) under
IFRS. Cumulatively, IFRS-pretax income will be $3,000,000 smaller than U.S.
GAAP pretax income over this 18-year period. Stockholders' equity will be
$3,000,000 greater under IFRS at January 1, Year 3. This difference will
decrease by $166,667 each year (due to greater IFRS depreciation expense),
such that stockholders' equity will be the same under both sets of rules at
December 31, Year 20. The difference in stockholders' equity each year is
equal to the difference in the book value of the building.

11-16

Year 4
$666,667
$500,000
12/31/Y4
$10,666,666
$8,000,000
$2,666,666

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Education.

Chapter 11 - Worldwide Accounting Diversity and International Standards

Analysis Case 2 Reconciliation of IFRS to U.S. GAAP


Quantacc Ltd.
Schedule to Reconcile IFRS Net Income and Stockholders Equity
to U.S. GAAP
2015
Income under IFRS

100,000

Adjustments:
Add depreciation on revaluation amount in current year under IFRS

3,500

Add gain on sale and leaseback recognized in current year under U.S. GAAP

10,000

Add current years amortization of deferred development costs

16,000

Income under U.S. GAAP

129,500
12/31/2015

Stockholders equity under IFRS

1,000,000

Adjustments:
(35,000
)

Subtract revaluation surplus


Add accumulated depreciation on revaluation amount under IFRS (2015
only)
Subtract total amount of gain on sale and leaseback recognized under IFRS
in 2014
Add cumulative amount of gain on sale and leaseback that would have been
recognized under U.S. GAAP in 2014 and 2015

3,500
(200,000
)
20,000
(80,000
)

Subtract total amount of development costs capitalized under IFRS in 2014


Add cumulative amount of amortization expense on development costs
recognized under IFRS (2015 only)
Stockholders equity under U.S. GAAP

16,000
$

724,500

Explanation for adjustments:


1. Under IFRS Quantacc recorded a Revaluation Surplus (stock equity account) of
$35,000 on 1/1/2015. In 2015, $3,500 of depreciation expense was taken on the
revaluation amount ($35,000 / 10 years).
Under U.S. GAAP neither of these would have been recognized.
To reconcile from IFRS to GAAP add $3,500 to IFRS 2015 net income; subtract a
total of $31,500 from IFRS 12/31/2015 stockholders equity (subtract $35,000
Revaluation Surplus and add $3,500 of accumulated depreciation on the
revaluation amount).

11-17

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Chapter 11 - Worldwide Accounting Diversity and International Standards

2. Under IFRS Quantacc recognized a gain on sale/leaseback of $200,000 in 2014.


No gain was recognized in 2015.
Under GAAP Quantacc would recognize a gain on sale/leaseback of $10,000 in
both 2014 and 2015.
To reconcile from IFRS to GAAP add $10,000 to IFRS 2015 net income.
At the end of 2015, the increase in retained earnings related to the gain on
sale/leaseback under IFRS is $200,000, but would only be $20,000 under GAAP.
To reconcile from IFRS to GAAP subtract a total of $180,000 from IFRS
12/31/2015 stockholders equity.
3. Under IFRS Quantacc recognized a development cost asset of $80,000 in 2014.
In 2015, amortization expense related to this asset was $16,000 ($80,000 / 5 years).
Under GAAP Quantacc would have expensed development costs of $80,000 in
2014.
In 2015, there is $16,000 more expense under IFRS than under GAAP. To reconcile
from IFRS to GAAP add $16,000 to IFRS 2015 net income. At 12/31/2015, the
decrease in retained earnings is $64,000 larger under IFRS than under GAAP. To
reconcile from IFRS to GAAP, subtract a total of $64,000 from IFRS 12/31/2015
stockholders equity.
Research CaseReconciliation to U.S. GAAP
Note to instructors: The SEC no longer requires a U.S. GAAP reconciliation
from foreign companies using IFRS. As more foreign companies adopt IFRS
over time, it will become increasingly more difficult for students to find
foreign companies that provide a U.S. GAAP reconciliation in their Form 20-F.
Exhibit 11.6 can help in identifying countries not using IFRS.
In addition, students may find EDGAR to be of limited use in accessing
foreign company annual reports because few foreign companies file
electronically with the SEC. Instructors might want to emphasize to their
students that they might have more luck accessing the annual report of their
selected company from the company's website.
This assignment requires students to find the note in Form 20-F in which foreign
companies reconcile net income and stockholders' equity from foreign GAAP to
U.S. GAAP. The responses to this assignment will depend upon the company
selected by the student to research. Examining the reconciliation from foreign
GAAP to U.S. GAAP in Form 20-F is a good way to learn some of the major
differences between foreign and U.S. GAAP. Students may be surprised to learn
how few adjustments most foreign companies make in reconciling to U.S. GAAP.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

Communication CaseVoluntary Adoption of IFRS


The response to the requirement in this case will vary by student. Potential benefits
and potential risks from the voluntary adoption of IFRS that students might discuss in
their memo include the following:

Potential benefits.
Preparing IFRS financial statements would make it easier for analysts to compare
the company with foreign competitors that use IFRS. This could result in a lower
cost of capital for the company. It also would make it easier for the company to
benchmark against foreign competitors.
For multinational companies with subsidiaries primarily using IFRS as their local
GAAP, the use of IFRS would allow the parent company to avoid IFRS to U.S.
GAAP conversions in preparing consolidated financial statements.

Potential risks.
The major risk of voluntary adoption of IFRS is that the SEC might ultimately decide
not to require the use of IFRS in the United States. In that case, the company
would probably be required to switch back to U.S. GAAP. The company would have
incurred substantial costs in changing its systems to IFRS, without being able to
reap the potential benefits over a long period of time, and it would have to incur the
cost of switching back to U.S. GAAP.

Internet CaseForeign Company Annual Report


The responses to this assignment will depend on the company selected by the
student. A comparison of the findings across companies selected by students can
lead to a lively classroom discussion.
The instructor might wish to complete this assignment for a non-U S. company of
his/her choice to lead the discussion.

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