International Financial Reporting

Standards (IFRS)Transition

Prepared by L. Murphy SmithProfessor of AccountingTexas A&M University

For permission to use or adapt this presentation, please contact Dr. Smith, Lmsmith@tamu.edu

Questions and Comments are Welcome Any Time

IFRSs are now accepted or required in more than 100

countries.

International Financial Reporting Standards (IFRSs)are shooting down the competition (other GAAPs)

U.S. Leaders Call for Acceptance of IFRSs

Among those calling for acceptance of IFRSs are John Thain, CEO of the New York Stock Exchange, and former Federal Reserve Chairman Paul Volcker.

FASB Chairman Robert Herz has expressed his expectation that US companies would eventually be required to follow a single accounting standard, which would be the IFRSs.

Why do we need IFRSs and financial reporting comparability?

Expanding world trade Proliferation of multinational

corporations Increasing role of global capital

markets Increased foreign direct

investment Growth of multinational political

organizations A way to minimize costs

Why Does GAAP Differ Among Countries?

Political/Legal System Sources of Capital Inflation Taxation Culture Accidents of History Business Complexity

Stop & Reflect: Is there one GAAP that works best everywhere?

Key Problems that Cause Resistance to IFRSs

Agreeing on who will create the rules

How different the rules will be from current national GAAP

Costs of changing GAAPs

National sovereignty

International Financial Reporting Standards (IFRSs) IFRSs are the accounting standards

published by the International Accounting Standards Board (IASB).

The IASB was established in 2001 by its forerunner, the International Accounting Standards Committee, which itself was established in 1973.

In the past decade, the IFRSs went from being little used to what is now the world’s dominant set of accounting standards.

Leading accounting experts anticipate that IFRSs will be accepted for financial reporting, in place of US GAAP, for all companies listed in US stock market, as early as 2016.

Pivotal Events Propelling the IFRSs Juggernaut

Financial scandals occurring in the US in the early 2000s, notably Enron, which highlighted shortcomings in US GAAP.

IOSCO recommended use of IFRSs in 2000. Adoption of IFRSs for financial reporting by

listed companies in the EU in 2005. U.S. Securities and Exchange

Commission’s announcement in 2007 to accept IFRSs for financial reporting by non-US companies listed in the US stock market (no Form 20-F reconciliation to U.S. GAAP).

SEC Commissioners propose timeline for IFRS adoption by 2016.

SEC Proposed Timeline for Moving Companies to IFRSs

End of 2009: Limited group of large companies given the option to use IFRS. SEC estimates 110 U.S. companies will be able to take advantage of the offer.

2011: SEC evaluates the progress of achieving proposed milestones, and makes a decision about whether to mandate adoption of IFRS. If IFRS is mandated, the commission will develop a staged roll out, starting with the largest public companies first.

2014: Year the first wave of companies will be mandated to report financial results using international accounting standards, if IFRS requirements are adopted in 2011.

2016: Year that all public companies, big and small, will be mandated to report financial results using international accounting standards, if IFRS requirements are adopted in 2011.

Stop & Reflect: Is the timeline moving too fast?

Overview of the International Accounting Standards Board (IASB)

The London-based IASB is an independent, privately funded accounting standard-setting body.

Board members are from nine countries and include a variety of functional backgrounds.

The over-arching commitment of the IASB is to develop, in the public interest, one set of high-quality, understandable, and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements.

National accounting standard-setters have worked with the IASB to converge accounting standards around the globe.

Overview of the International Accounting Standards Board (IASB) -- continued

The International Accounting Standards Committee Foundation is the parent body of the IASB.

The IASB’s structure and organization resulted from a strategy review undertaken by its predecessor body, the Board of the International Accounting Standards Committee.

The body of standards issued by the Board of the International Accounting Standards Committee was subsequently adopted by the IASB.

These older standards were issued between 1973 and 2000, and continue to be designated International Accounting Standards (IASs).

Structure of the International Accounting Standards Board (IASB)

IASB projects generally take three years or more, from formation to standard issuance.

Release of an IFRS, Exposure Draft, or final SIC Interpretation requires approval by 8 of the board’s 14 members.

Major Contributions of the IASB

Harmonizing accounting standards and disclosures to meet the needs of the world’s capital markets.

Providing an accounting foundation for underdeveloped or newly industrialized countries to use as the accounting profession emerges in those countries.

Advancing compatibility of domestic and international accounting requirements.

Principles-Based Versus Rules-Based

IFRSs are often referred to as being principles-based.

US GAAP is said to be more rules-based. This has led to about 25,000 pages of US GAAP

versus about 2,000 pages of IFRSs. With fewer pages and less detail, IFRSs still

address all major accounting issues, from financial statement presentation to business combinations.

Stop & Reflect: Which is better, rules-based or principles-based?

RegionTotal

countries

Required for all domestic listed

companies in 2003

Required for all domestic listed companies in

2006

Europe 47 7 33North America 3 0 0Central and South America 19 7 8Africa 54 3 5Asia 49 6 11Australia Oceania 6 1 2Total 178 24 59

Required Use of IFRSs by World Region 2003-2006

Impact of Cultural and Economic Factors on International Financial Reporting

Accounting standards vary among countries due to the culture, economics, politics, and the legal environment that are unique to each country.

For example, in economies where inflation is high set up rules to improve period to period comparability by use of inflation indices.

In countries like the U.S., stockholders provide the majority of capital to businesses. Individual stockholders generally own relatively small ownership stakes and are not involved with company operations.

Consequently, U.S. GAAP is geared towards full- disclosure and relative transparency. In countries where capital-providers have access to corporate financial information from sources other than financial reports, transparency and disclosure is not as critical.

Benefits to Countries with Weak Financial Reporting Requirements

In nations with weak financial disclosure requirements, investors often demand additional financial information when companies issue stock.

Consequently, governments in these nations may be compelled to revise or create securities laws that require improved financial reporting disclosure.

A simpler and better solution is to adopt IFRSs, which have a higher level of financial reporting disclosure than most countries’ GAAP.

Stop & Reflect: Will better GAAP (i.e., IFRS) lead to economic development in developing countries?

Benefits to Countries with Strong Financial Reporting Requirements

While there is lower motivation to adopt IFRSs, due to a smaller incremental benefit of investor protection, a nation with strong financial disclosure requirements in its existing GAAP can still benefit from adopting IFRSs.

Such a nation benefits by participating in uniform, multinational financial reporting standards.

Investors are aided by this cross-national comparability.

Uniform reporting standards reduce costs of financial statement reconciliation associated with multinational stock listings.

Stop & Reflect: Do you believe that one set of GAAP (i.e., IFRS) is really the best thing for the US? For the world?

IFRSs Reduce Complexity

Complexity is associated with global operations resulting from subsidiary operations in cultural settings that differ substantially from the parent.

This leads to complex operating, reporting, and information environments.

Multinational companies do business in a more complex environment than strictly domestic firms and financial reporting differences contribute to this complexity.

Use of one set of accounting standards, such as the IFRSs, will help reduce this complexity.

Parent(c,l,p,x,r,g,i)

Subsidiary 1

(c,l,p,x,r,g,i)

Subsidiary 2

(c,l,p,x,r,g,i)

Subsidiary 3

(c,l,p,x,r,g,i)

Joint Venture

(c,l,p,x,r,g,i)

InvestorS,C

Financial

AnalystS,C

Examining Differences Between U.S. GAAP and IFRS

There are many areas of difference between U.S. GAAP and IFRSs, but similarities far outweigh differences.

Accounting rules vary across countries and differences can be cosmetic or substantive.

Cosmetic Differences: Financial Statement Presentation Per IAS 1

IAS 1 does not prescribe a particular format for presentation of financial statements (B/S, I/S, SCF, SCE); multiple formats have evolved in practice. In the U.S., a common format has evolved.

Re: Balance Sheet An illustration of a cosmetic difference is the

presentation of the balance sheet in many countries that are, or were, members of the British Commonwealth.

The balance sheet of a UK company is often presented (1) in the form of A – L = OE rather than A = L + OE and (2) in reverse order of liquidity.

Comparing U.S. GAAP and IFRSs: Cosmetic Differences

Turnover – Sales Stocks – Inventory Share Capital – Common Stock or Paid-in

Capital Share Issue Premium – Additional Paid-in

Capital Debtors – Accounts Receivable Creditors – Accounts Payable Revenue Reserves – Retained Earnings

Another example of a cosmetic difference is use of different word to refer to the same item. A few examples are as follows, international term followed by U.S. counterpart:

Comparing U.S. GAAP and IFRSs: Cosmetic Differences

GlaxoSmithKline

Consolidated Balance Sheet

Notes 2001

£m 2000

£m Goodwill 15 174 170 Intangible Assets 16 1,673 966 Tangible Assets 17 6,845 6,642 Investments 18 3,228 2,544

Fixed Assets 11,920 10,322

Equity investments 19 185 171 Stocks 20 2,090 2,277 Debtors 21 5,591 5,399 Liquid investments 25 1,415 2,138 Cash at bank 25 716 1,283

Current assets 9,997 11,268

Loans and overdrafts 25 (2,124) (2,281) Other creditors 22 (7,306) (6,803)

Creditors: amounts due within one year (9,430) (9,084)

Net current assets 567 2,184

Total assets less current liabilities 12,487 12,506

Loans 25 (2,108) (1,751) Other creditors 22 (190) (143)

Comparing U.S. GAAP and IFRSs: Cosmetic DifferencesGlaxoSmithKline

Consolidated Balance Sheet - Continued

Creditors: amounts due after one year (2,298) (1,894)

Provisions for liabilities and charges 23 (1,810) (1,657)

Net assets 8,379 8,955

Called up share capital 27 1,543 1,556 Share premium account 27 170 30 Other reserves 29 1,866 1,849 Profit and loss account 29 3,938 4,276

Equity shareholders’ funds 7,517 7,711

Non-equity minority interest 28 621 1,039 Equity minority interests 241 205

Capital employed 8,379 8,955

Approved by the Board Sir Richard Sykes, Chairman 12th March 2002

Note: Differences from U.S. GAAP include order of reverse liquidity and model of A - L (Net assets) = SE (Capital Employed) instead of A + L = SE.

Financial Statement Presentation Per IAS 1

Re: Income Statement No distinction between

Revenues/Gains or Expenses/Losses

Re: Statement of Changes in Equity Two different approaches can be

used Benchmark treatment similar to US

GAAP Alternative treatment – include portions

e.g. capital transactions in notes

Financial Statement Presentation Per IAS 1

Re: Statement of Cash Flows Per IAS 7, the cash flow statement is a

required statement. Requirements of IAS 7 are much the same as SFAS 95 in the U.S. with a few differences.

In the U.S., interest paid, interest received, and dividends received are shown in the operating section, while dividends paid is shown in the financing section.

Under IFRS, interest paid, interest received, and dividends received are normally accounted for as operating cash flows as well. However, interest paid may be accounted for as a financing cash flow, while interest received and dividends received may be accounted for as investing cash flows, because they are costs of obtaining financial resources or returns on investments.

Financial Statement Presentation Per IAS 1

Re: Statement of Cash Flows Non-cash transactions (e.g.,

issue bonds for LT assets) do not need to be disclosed on the face of the cash flow statement

CF from extraordinary & discontinued items must be disclosed separately in each section

Stop & Reflect: Do you see any problems with the IFRS approach to the SCF?

Financial Statement Presentation Per IAS 1

Re: Notes IFRS requires disclosure of currency

used in the FS Does not need to be the primary

currency of the enterprise For example, Jardine Matheson, a

diversified Bermuda-based company with operations primarily in Asia and Australia uses the U.S. dollar.

Stop & Reflect: Why is it necessary to disclose currency used under IFRS, but not US GAAP?

Comparing U.S. GAAP and IFRSs: PP&E

Under IFRS, the benchmark treatment under IAS 16 is to report PP&E at cost net of depreciation and potential impairments.

IAS 16 provides for an alternative treatment, to revalue PP&E to fair value. Companies may use “highest and best use” to determine fair value.

After a company begins to revalue PP&E, it must continue to doing so “. . .with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.”

Example: Journal entry to revalue land that cost 200,000 to FV of 240,000:

Land 40,000Revaluation Surplus 40,000

Comparing U.S. GAAP and IFRSs:PP&E

Re. revaluation, downward revaluations are possible Determined on an asset-by-asset basis, not by

the class as a whole If downward revaluation, it is offset against the

revaluation equity, to the extent it exists. Any excess goes to expense

If subsequent upward revaluation, goes to income to extent of any prior revaluation expense taken

Construction period interest may be expensed or capitalized (US GAAP requires capitalization only)

Depreciation determined similarly under IFRS & US GAAP

Comparing U.S. GAAP and IFRSs:Leases

• Under US GAAP, leases are classified as capital if one or more of the 4 criteria are met (title transfer, bargain purchase option, 75% of economic life, MLP >= 90% of asset FMV)

• Under IFRS, criteria are less rigid.

Comparing U.S. GAAP and IFRSs:Leases

Under IAS 17, a leases is classified as either an operating lease or a finance lease (U.S. GAAP refers to finance leases as capital leases).

Per IAS 17 a finance lease “…transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.”

Example situations:1. The lease transfers ownership to the lessee,2. The lessee has a bargain purchase option,3. The lease term is for the “major part” of the

economic life of the asset,4. The present value of the minimum lease payments

“amounts to at least substantially all of the fair value of the leased asset,”

Comparing U.S. GAAP and IFRSs: Leases

Example situations – continued:

5. The leased assets are of a specialized nature such that only the lessee can use them,

6. If the lease is cancelable by the lessee, the lessor’s costs associated with the cancellation are borne by the lessee,

7. Gains or losses associated with fluctuations in the leased asset FMV are borne by the lessee, and

8. The lessee can continue to lease the asset for a secondary period for a substantially lower rent than market rent.

The first four criteria are similar to criteria under U.S. GAAP but are not identical; criteria 5 through 8 are not included in U.S. GAAP.

Stop & Reflect: Regarding leases, which do you think gives the better result, rules-based US GAAP or principles-based IFRS?

Comparing U.S. GAAP and IFRSs: Intangible Assets

Purchased intangibles Recorded at cost Amortized finite life intangibles over useful

life. Both IFRS and US GAAP have no upper amortization term

Internally-generated intangibles Normally expensed as incurred In the case of internal R&D, IFRS splits the

costs into a research phase and a development phase (similar definition to US GAAP)

Research phase costs are expensed under US GAAP and IFRS

Comparing U.S. GAAP and IFRSs: Intangible Assets

Accounting may differ in development phase Under US GAAP, costs are expensed Under IFRS, costs can be capitalized if ALL

the following are met: Completion is technically feasible Intention is to complete asset and use or sell Company has ability to do so Can demonstrate how asset will generate future

benefit Company has resources to complete the asset Company can reliably measure development

expenditures

Stop & Reflect: Do you think it makes sense to allow capitalization of some R&D, as permitted under IFRS?

Comparing U.S. GAAP and IFRSs: Accounting Changes

IFRS 2, Stock-Based Payment, includes stock compensation

US GAAP followed with SFAS 123 (R) (fair value)

FASB – IASB Working Together

In October 2002, the FASB and the IASB issued a memorandum of understanding (referred to as the Norwalk Agreement or MoU) formally announcing their commitment to converging U.S. GAAP and IFRSs.

In recent years, both the FASB and IASB have issued rules that converge (or almost converge) their accounting standards with the standards of the other body.

For example, the IASB essentially conformed to U.S. GAAP for pooling and accounting for goodwill with the issuance of IFRS 3, Business Combinations.

The FASB conformed to IFRS when it issued SFAS 151 on Inventory, SFAS 153 on Like-Kind Exchanges, and SFAS 154 on Accounting Changes.

If Everyone Adopts IFRSs, it’s Still Not a Perfect World

Uniformity in accounting standards is a gigantic step toward understanding financial statements prepared in different nations; however, uniformity alone is not a total solution.

Environmental factors such as culture, language, legal system, and economic conditions affect how any GAAP, including IFRS, is applied.

For example, regarding environmental factors, the litigation environment affects conservatism in financial reporting.

For a company located in a nation where there is a high risk of investor lawsuits, such as the US, there will be a different perspective on conservatism than in a nation that is less litigious.

Thus, IFRS will be applied differently depending on the national culture. Properly evaluating investment opportunities in any country requires that the investor understand the culture of that country.

Impact of Ethics on International Financial Reporting

No set of accounting standards, whether IFRSs, US GAAP, or other set of accounting standards, can replace the necessity for accountants to have the highest level of ethical character.

Corporate financial scandals rarely ever result from deficiencies in accounting standards alone, but are frequently the result from weaknesses in the ethical character of the perpetrators, which may include top management, corporate accountants, and auditors.

Greed and over-reaching ambition have led to disastrous consequences for corporations and their stakeholders.

Considering the problem of greed, Solomon wrote: “Whoever loves money never has money enough; whoever loves wealth is never satisfied with his income” (Ecclesiastes 5:10).

Impact of Ethics on International Financial Reporting

Author, Army veteran, U.S Congress Representative from Tennessee, and hero of the Alamo, David Crockett used the following campaign slogan:

Be sure you’re right, then go ahead.

Winning isn’t everything, but doing what’s right is.

Impact of Ethics on International Financial Reporting

Without ethical character, proper professional judgment is virtually impossible.

Since IFRSs are regarded as more principles-based as opposed to the more rules-based US GAAP, ethical character and professional judgment will be even more critical (if that is possible) in an IFRS-based financial reporting environment.

Take-Away Points

IFRSs are the accounting standards published by the International Accounting Standards Board (IASB).

IFRSs are now accepted or required in more than 100 countries. Leading accounting experts anticipate that IFRSs will be accepted for

financial reporting, in place of US GAAP, for all companies listed in US stock market, as early as 2012 or 2013.

Since IFRSs are regarded as more principles-based as opposed to the more rules-based US GAAP, ethical character and professional judgment will be even more critical (if that is possible) in an IFRS-based financial reporting environment.

Be sure you’re right, then go ahead.