International Financial
Reporting
WEEK ONE

Course Administration
 Professor Thomas Davis
 Email: tomas.davis@hotmail.com
 Textbook: http://www.pwc.com/en_US/us/issues/ifrsreporting/publications/assets/ifrs-and-us-gaapsimilarities-and-differences-2014.pdf

Course Assessment
 30% midterm exam (23 Feb-5 Mar)
 20% project (around 3 Apr)
 50% final exam (27 April-14 May)

Course Outline
 Introduction (week 1)
 Revaluation Accounting and case study (week 2-3)
 Inventory accounting and case study (week 4-5)
 Remeasurement of non-current assets (week 6)
 Review for midterm exam (week 7)

Course Outline
 Remeasurement case study (week 8)
 Income taxes (week 9)
 Revenue recognition and case study (week 10-12)
 Presentations (week 13)
 Review for final exam (week 14)

International Financial
Reporting
WEEK TWO

References https://www.youtube.com/watch?v=WkxuPxe6BLU http://accountingexplained.com/financial/non-currentassets/revaluation-of-fixed-assets
Additionally, a longer article (for your personal reference):
%20-http://rkpatelco.com/Knowledge%5CPaper%20Article
Revaluation%20model%20of%20PPE%20under%20IFRS%2
0-%20A%20review%20by%20R.%20K.pdf

PPE Revaluation – IAS 16
 Revaluation is an option but not a requirement under IFRS.
 If elected, revaluation must be applied to all assets in same asset class.
 The revaluation amount is the difference between market value and net PPE (PPE – accumulated depreciation).
 Revaluations must occur regularly (not just one time).

Revaluation Accounting
 Upward valuation is recorded in other comprehensive income (OCI) on the balance sheet
(account name: “Revaluation surplus”).
 Downward valuation is recorded as a loss on the income statement.
 Why the difference in treatment?
Conservatism

Revising a Previous Revaluation
 Reverse the original revaluation first
 Reverse prior OCI increases with a decrease to OCI
 Reverse prior losses with a gain
 Record any additional revaluation amount using the regular rules
 Upward valuation: OCI
 Downward valuation: income statement

Depreciation after Revaluation
 Recalculate annual depreciation based on new asset value, remaining life from time of revaluation, and estimated residual value at time of revaluation.
 Eliminate any accumulated depreciation at the time of the revaluation with an offset to the PPE account.

Example One
Land purchase
Value end of year 1
Value end of year 2
$ 100,000
$ 120,000
$ 90,000
Year 1 change
Journal entry:
$ 20,000
PPE $
Other comprehensive income
20,000
$ 20,000

Example One
Year 2 change
Journal entry:
$ (30,000)
First, reverse the OCI increase
Other comprehensive income
PPE
$ 20,000
$ 20,000
Then, record the balance in the income statement
Loss on revaluation $ 10,000
PPE $ 10,000

Example Two
Land purchase
Value end of year 1
Value end of year 2
Year 1 change
Journal entry:
Loss on revaluation
PPE
$ 100,000
$ 90,000
$ 120,000
$ (10,000)
$ 10,000
$ 10,000

Example Two
Year 2 change
Journal entry:
$ 30,000
First, reverse the loss
PPE
Gain on revaluation
$ 10,000
$ 10,000
Then, record the balance in equity
PPE
Other comprehensive income
$ 20,000
$ 20,000

Example Three
Equipment purchase
Value end of year 2
Value end of year 4
Useful life, years
Residual value
$ 1,000,000
$ 500,000
$ 900,000
10
$ -

Example Three
Year 2 journal entries:
First, eliminate accumulated depreciation
Accumulated depreciation $ 200,000
PPE
calculation: $1,000,000/10*2 years = $200,000
$ 200,000
Net PPE balance
Value end of year 2
Change in value
$ 800,000
$ 500,000
$ (300,000)
Then, record the loss in the income statement
Loss on revaluation $ 300,000
PPE $ 300,000

Example Three
NOTE new annual depreciation:
Value
Life, years
Residual value
Annual depreciation
$ 500,000
8
$ -
$ 62,500

Example Three
Year 4 journal entries:
First, reverse accumulated depreciation
Accumulated depreciation
PPE
$ 125,000
calculation: $500,000/8*2 years = $125,000
$ 125,000
Net PPE balance
Value end of year 4
Change in value
$ 375,000
$ 900,000
$ 525,000

Example Three
Then, reverse the loss recorded in prior periods
PPE $ 300,000
Gain on revaluation $ 300,000
Finally, record the balance in equity
PPE
Other comprehensive income
$ 225,000
$ 225,000

Revaluation Accounting
Case Study: Eastern Investments Corp.

International Financial
Reporting
WEEK FOUR

References
Research report about LIFO and IFRS: http://heartland.org/sites/default/files/ga_tech_study
_consequences_of_the_elimination_of_lifo.pdf
Ratio analysis and inventory accounting: http://www.fool.com/investing/smallcap/2005/12/14/understanding-ratios.aspx

Inventory Accounting – IAS 2
 IFRS prohibits the use of LIFO accounting, so any company using the inventory LIFO method who choses to implement IFRS must restate their financial statements using FIFO inventory accounting.

LIFO Financial Statement Effects (vs. FIFO)
 Income statement
 Lower gross profit margin
 Lower net income and taxes
 Cash flow statement
 Inventory adjustment is larger
 Taxes are lower by a portion of the additional COGS
 Net result: increase in operating cash flow vs. FIFO
 Balance sheet
 Lower inventory
 Lower current ratio

LIFO Liquidation Effects
 LIFO liquidation is the sale of inventory acquired in previous periods, usually at a lower cost than current replacement cost.
 The financial effects are essentially the opposite of the effects of using LIFO; LIFO liquidation reverses the effects of using the LIFO method.

FIFO/LIFO Comparison
Beginning inventory
Purchases
Cost of goods sold
Ending inventory
FIFO
$ 11,000
$ 20,000
$ 14,000
$ 17,000
LIFO
$ 10,000
$ 20,000
$ 16,000
$ 14,000
No LIFO liquidation
FIFO > LIFO
Sales
Cost of goods sold
Gross profit
Taxes
Net income
Net income
Change in inventory
Operating cash flow
$ 25,000
$ 14,000
$ 11,000
$ 3,300
$ 7,700
$ 25,000
$ 16,000
$ 9,000
$ 2,700
$ 6,300
FIFO > LIFO
FIFO > LIFO
FIFO > LIFO
$ 7,700
$ (6,000)
$ 1,700
$ 6,300
$ (4,000)
$ 2,300 LIFO > FIFO

FIFO/LIFO Liquidation Comparison
Beginning inventory
Purchases
Cost of goods sold
Ending inventory
FIFO
$ 11,000
$ 20,000
$ 28,000
$ 3,000
LIFO
$ 10,000
$ 20,000
$ 27,200
$ 2,800
LIFO liquidation
FIFO > LIFO (no change)
Sales
Cost of goods sold
Gross profit
Taxes
Net income
Net income
Change in inventory
Operating cash flow
$ 40,000
$ 28,000
$ 12,000
$ 3,600
$ 8,400
$ 40,000
$ 27,200
$ 12,800
$ 3,840
$ 8,960
$ 8,400
$ 8,000
$ 16,400
$ 8,960
$ 7,200
$ 16,160
LIFO > FIFO
LIFO > FIFO
LIFO > FIFO
FIFO > LIFO

This is IMPOSSIBLE… Why?
Beginning inventory
Purchases
Cost of goods sold
Ending inventory
FIFO
$ 11,000
$ 20,000
$ 28,000
$ 3,000
LIFO
$ 10,000
$ 20,000
$ 26,000
$ 4,000

FIFO/LIFO Exercise One
 Prepare financial statements (like slides 5 and 6)
Beginning inventory
Purchases
Cost of goods sold
Sales
Tax rate
FIFO
$ 5,000
$ 18,000
$ 17,000
$ 24,000
30%
LIFO
$ 3,500
$ 18,000
$ 16,000
$ 24,000
30%

FIFO/LIFO Exercise One Solution
Beginning inventory
Purchases
Cost of goods sold
Ending inventory
FIFO
$ 5,000
$ 18,000
$ 17,000
$ 6,000
LIFO
$ 3,500
$ 18,000
$ 16,000
$ 5,500
***LIFO liquidation***
LIFO < FIFO (no change)
Sales
Cost of goods sold
Gross profit
Taxes
Net income
Net income
Change in inventory
Operating cash flow
$ 24,000
$ 17,000
$ 7,000
$ 2,100
$ 4,900
$ 24,000
$ 16,000
$ 8,000
$ 2,400
$ 5,600
LIFO > FIFO
LIFO > FIFO
LIFO > FIFO
$ 4,900
$ (1,000)
$ 3,900
$ 5,600
$ (2,000)
$ 3,600 FIFO > LIFO

Ratio Analysis
 Current ratio = current assets / current liabilities
 Gross profit margin = gross profit / sales
 Inventory turnover = COGS / inventory

FIFO/LIFO Exercise Two
 Calculate and compare the financial ratios for the financial statements from exercise one:
 Gross profit margin
 Inventory turnover

FIFO/LIFO Exercise Two Solution
Ratios
Gross profit margin
Inventory turnover
FIFO
29.2%
2.8
LIFO
33.3%
2.9
The ratios are more favorable for LIFO in this example, but this does not mean that the company’s actual performance is any different; rather, it demonstrates how the choice of accounting method affects financial ratios.

LIFO to FIFO Retrospective Adjustment
 Adjust all years reported (usually two years balance sheet and three years income statement and cash flow statement) based on FIFO.
 Adjust inventory and retained earnings in earliest year reported to eliminate any remaining LIFO reserve.

Retrospective Adjustment Example
LIFO Financial Statements
Balance Sheet
Cash
Inventory
Total assets
2014
$ 29,150
$ 17,000
$ 46,150
2013
$ 24,150
$ 11,000
$ 35,150
Capital stock
Retained earnings
Total liabilities/equity
$ 10,000
$ 36,150
$ 46,150
$ 10,000
$ 25,150
$ 35,150
Income Statement
Sales
Cost of goods sold
Gross profit
Cash Flow Statement
Net income
Change in inventory
Operating cash flow
2014
$ 25,000
$ 14,000
$ 11,000
2013
$ 23,500
$ 13,000
$ 10,500
2012
$ 22,000
$ 12,000
$ 10,000
2014
$ 11,000
$ (6,000)
$ 5,000
2013
$ 10,500
$ (2,000)
$ 8,500
2012
$ 10,000
$ (1,000)
$ 9,000

Retrospective Adjustment Example
Company Records
FIFO inventory
LIFO inventory
LIFO reserve
Change in LIFO reserve
Adjustments
Inventory
COGS
RE
2014
$ 20,400
$ 17,000
$ 3,400
$ 800
2013
$ 13,600
$ 11,000
$ 2,600
$ 600
2012
$ 11,000
$ 9,000
$ 2,000
$ 500
2011
$ 9,500
$ 8,000
$ 1,500
NA
$
2014
800
$ 800
2013
$ 600
$ 600
2012
$ 2,000
$ 500
$ 1,500

Retrospective Adjustment Example
FIFO Financial Statements
Balance Sheet
Cash
Inventory
Total assets
Capital stock
Retained earnings
Total liabilities/equity
2014
$ 29,150
$ 20,400 h
49,550
$ 10,000
$ 39,550
$ 49,550
2013
$ 24,150
$ 13,600
$ 37,750
$ 10,000
$ 27,750
$ 37,750
Income Statement
Sales
Cost of goods sold
Gross profit
Cash Flow Statement
Net income
Change in inventory
Operating cash flow
2014
$ 25,000
$ 13,200
$ 11,800
2013
$ 23,500
$ 12,400
$ 11,100
2012
$ 22,000
$ 11,500
$ 10,500
2014
$ 11,800
$ (6,800)
$ 5,000
2013
$ 11,100
$ (2,600)
$ 8,500
2012
$ 10,500
$ (1,500)
$ 9,000

LIFO and Earnings Management
 Intentionally allow inventory levels to fall
 Eliminate low-cost LIFO layers
 Lower COGS results in increased earnings
But…no real change in operations or strategy!

International Financial
Reporting
WEEK SIX

References
 Asset valuation overview https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0CCMQFjAB&url=http%3A%2F%2Fwww.ifrs.org%2FUse-around-theworld%2FEducation%2FDocuments%2FFrameworkbased%2520teaching%2520presentations%2F4.%2520Fair%2520value%2520measures.pptx&ei=82_sVOiaKobgauHXgPAE&usg=AFQjCNFUnn5IeNn1GCqGDmcXSSSaK
Q3rVg&sig2=vwMc6Y_eldKGJq8zDYFIAw
Property, plant, and equipment (IAS 16) http://www.bdointernational.com/Services/Audit/IFRS/IFRS%20at%20a%20Glance/Documents/IAS%2016.pdf
 Intangible assets (IAS 38) www.bdointernational.com/Services/Audit/IFRS/IFRS%20at%20a%20Glance/Documents/IAS%2038.pdf
 Investment property (IAS 40) http://www.bdointernational.com/Services/Audit/IFRS/IFRS%20at%20a%20Glance/Documents/IAS%2040.pdf
 Impairment (IAS 36) http://www.bdointernational.com/Services/Audit/IFRS/IFRS%20at%20a%20Glance/Documents/IAS%2036.pdf

Remeasurement of Noncurrent Assets
 Under IFRS, three models exist for valuation of noncurrent assets:
 Property, plant, and equipment (IAS 16, week 2 lecture)
 Intangible assets (IAS 38)
 Investment property (IAS 40)
 IAS 16 and 38 are affected by impairment (IAS 36)

Property, Plant, and Equipment (IAS 16)
 Two measurement options: cost and revaluation
 Revaluation applied to all assets in same class
 Revaluation amount = market value – net PPE
 Revaluation occurs regularly (every 1-5 years)
 Upward valuation: OCI on the balance sheet
 Downward valuation: loss on the income statement
 Downward valuation is recoverable as a gain

PPE Example (from week 2)
Land purchase
Value end of year 1
Value end of year 2
$ 100,000
$ 120,000
$ 90,000
Year 1 change
Journal entry:
$ 20,000
PPE $
Other comprehensive income
20,000
$ 20,000

PPE Example (from week 2)
Year 2 change
Journal entry:
$ (30,000)
First, reverse the OCI increase
Other comprehensive income
PPE
$ 20,000
$ 20,000
Then, record the balance in the income statement
Loss on revaluation $ 10,000
PPE $ 10,000

Finite Life Intangible Assets (IAS 38)
 Two measurement options: cost and revaluation
 Revaluation requires an “active market”
 Revaluation applied to all assets in same class
 Revaluation amount = market value – net intangible
 Revaluation occurs regularly (every 1-5 years)
 Upward valuation: OCI on the balance sheet
 Downward valuation: loss on the income statement
 Downward valuation is recoverable as a gain

Intangibles Example
Patent
Value end of year 1
Value end of year 2
Year 1 change
Journal entry:
Loss on revaluation
Patent
* note - simplified example; no amortization
$ 100,000
$ 90,000
$ 120,000
$ (10,000)
$ 10,000
$ 10,000

Intangibles Example
Patent
Value end of year 1
Value end of year 2
Year 1 change
Journal entry:
Loss on revaluation
Patent
* note - simplified example; no amortization
$ 100,000
$ 90,000
$ 120,000
$ (10,000)
$ 10,000
$ 10,000

Intangibles Example
Year 2 change
Journal entry:
First, reverse the loss
Patent
Gain on revaluation
Then, record the balance in OCI
Patent
Other comprehensive income
$ 30,000
$ 10,000
$ 10,000
$ 20,000
$ 20,000

Intangibles Example - Revised
Patent
Value end of year 1
Value end of year 2
Year 1 change
Loss on revaluation
Patent
* note - simplified example; no amortization
$ 100,000
$ 90,000
$ 120,000
$ (10,000)
$ 10,000
$ 10,000

Indefinite Life Intangible Assets and
Goodwill (IAS 38)
 One measurement option: cost
 Indefinite life intangibles are not amortized
 Goodwill amount allocated to company units
 Evaluation of impairment occurs annually
 Impairment: loss on the income statement
 Impairment is not recoverable.

Goodwill Calculation Example
Acquisition price
Fair value of net assets
Goodwill
% allocated to Division A
Amount allocated to division A
$ 2,450,000
$ 2,200,000
$ 250,000
40%
$ 100,000

Goodwill Evaluation Example
Goodwill (division A)
Value end of year 1
Value end of year 2
Year 1 change
Journal entry:
Loss on impairment
Goodwill
Year 2 change
Journal entry: NONE
$ 100,000
$ 90,000
$ 120,000
$ (10,000)
$ 10,000
$ 10,000
$ 30,000

Goodwill Evaluation Example
Goodwill (division A)
Value end of year 1
Value end of year 2
Year 1 change
Journal entry:
Loss on impairment
Goodwill
Year 2 change
Journal entry: NONE
$ 100,000
$ 90,000
$ 120,000
$ (10,000)
$ 10,000
$ 10,000
$ 30,000

Investment Property (IAS 40)
 Two measurement options: cost and fair value
 Fair value applied to all investment property
 Fair value adjustment = market value – net book value
 Fair value property is not depreciated
 Fair value assessment occurs annually
 Fair value adjustment: gain/loss on the income statement (OCI is not used)

Investment Property Example
Building
Value end of year 1
Value end of year 2
$ 100,000
$ 90,000
$ 120,000
Year 1 change
Journal entry:
Fair value adjustment loss
Building
Year 2 change
Journal entry:
Building
Fair value adjustment gain
$ (10,000)
$ 10,000
$ 10,000
$ 30,000
$ 30,000
$ 30,000

Impairment (IAS 36)
 Applies to PPE and intangibles, not to investment property
 Assess assets for impairment each reporting period
 Calculate “recoverable amount”, which is greater of:
 Value-in-use (discounted cash flow value)
 Fair value less disposal costs
 If this amount is less than carrying amount: impairment
 Reduce any OCI revaluation surplus (PPE or intangibles), then
 Record as expense on income statement

Impairment Calculation Examples
B
C
Asset
A
Value-in-Use
$ 900
$ 900
$ 900
FV less
Disposal Costs
$ 1,050
$ 980
$ 850
GREATER Carrying
Amount

1,050
Amount Impairment
Note: Carrying value for all
3 assets is $1,000
(20)
$ 900 $ 1,000 $ (100)

Impairment Calculation Examples
B
C
Asset
A
Value-in-Use
$ 900
$ 900
$ 900
FV less
Disposal Costs
$ 1,050
$ 980
$ 850
GREATER
Amount
$ 1,050
$ 980
$ 900
Carrying
Amount Impairment
$ 1,000
$ 1,000
$ 1,000
$
$
$
-
(20)
(100)
 In slides 5, 8, and 12, the end of year values given are the
GREATER of value-in-use and FV less disposal costs.
 The calculation of impairment is the same for all three remeasurement methods; how we account for the calculations in the financial statements varies.

Impairment Calculation Examples
 Complete the summary below:
Finite Indefinite Life
Intangibles Intangibles Investments
Cost option? (yes/no)
Remeasurement option (yes/no, name)
Depreciation/amortization? (yes/no)
Impairment analysis frequency (time)
Impairment accounting, cost (P/L or OCI?)
Impairment accounting, remeasurement (P/L or OCI?)
PPE

International Financial
Reporting
WEEK NINE

References
 Income taxes – IAS 12 f http://www.bdointernational.com/Services/Audit/IFRS
/IFRS%20at%20a%20Glance/Documents/IAS%2012.pd

Tax Questions during Class
 What are the tax effects of a change to FIFO?
 If a company uses fair value accounting for investments, and they record a large gain, how do they pay the taxes if they haven’t sold the building?
 If a company pays employees in stock options, and does not record an expense, is this tax evasion?

Accounting Change: LIFO to FIFO (week 4)
Company Records
FIFO inventory
LIFO inventory
LIFO reserve
Change in LIFO reserve
2014
$ 20,400
$ 17,000
$ 3,400
$ 800
2013
$ 13,600
$ 11,000
$ 2,600
$ 600
2012
$ 11,000
$ 9,000
$ 2,000
$ 500
Prior
$ 9,500
$ 8,000
$ 1,500
NA
The change in LIFO reserve will increase company income in the year of conversion. Some governments offer a “deferral period” to pay the taxes over time.

Tax Effects of Change to FIFO
 Assumptions: tax rate 30%, deferral period 5 years
Income Taxes
Increase in income
Tax rate
Tax amount
Accounting:
Income tax expense
Retained earnings (decrease)
Total recorded taxes
Deferral period, years
Income tax payable
Deferred tax payable
2014
$ 800
30%
$ 240
2013
$ 600
30%
$ 180
2012
$ 500
30%
$ 150
Prior
$ 1,500
30%
$ 450
$ 240
$ 240
5
$ 48
$ 192
$ 180
$
$
180
$
5
36
144
$ 150
$ 450
$ 600
5
$ 120
$ 480

Retrospective Adjustment with Taxes
FIFO Financial Statements
Balance Sheet
Cash
Inventory
Total assets
Taxes payable
Deferred tax liability
Capital stock
Retained earnings
Total liabilities/equity
2014
$ 22,700
$ 20,400
$ 43,100
2013
$ 21,000
$ 13,600
$ 34,600
2012
$ 15,650
$ 11,000
$ 26,650
$ 204
$ 816
$ 10,000
$ 32,080
$ 43,100
$ 156
$ 624
$ 10,000
$ 23,820
$ 34,600
$ 120
$ 480
$ 10,000
$ 16,050
$ 26,650

Retrospective Adjustment with Taxes
FIFO Financial Statements
Income Statement
Sales
Cost of goods sold
Gross profit
Taxes
Net income
Cash Flow Statement
Net income
Change in inventory
Change in taxes payable
Cha nge i n deferred tax l i a bi l i ty
Operating cash flow
2014
$ 25,000
$ 13,200
$ 11,800
$ 3,540
$ 8,260
2013
$ 23,500
$ 12,400
$ 11,100
$ 3,330
$ 7,770
2012
$ 22,000
$ 11,500
$ 10,500
$ 3,150
$ 7,350
2014
$ 8,260
$ (6,800)
$ 48
$ 192
$ 1,700
2013
$ 7,770
$ (2,600)
$ 36
$ 144
$ 5,350

Annual Journal Entry
Deferred tax liability
Taxes payable
$ 204
$ 204

Investment Property – Fair Value
Accounting (week 6)
Building
Value end of year 1
Value end of year 2
$ 100,000
$ 90,000
$ 120,000
Year 1 change
Journal entry:
Fair value adjustment loss
Building
Year 2 change
Journal entry:
Building
Fair value adjustment gain
$ (10,000)
$ 10,000
$ 10,000
$ 30,000
$ 30,000
$ 30,000

Fair Value Accounting without Tax Deferral
Year 1
Loss
Tax rate
Tax savings
$ 10,000
30%
$ 3,000
Year 2
Gain
Tax rate
Tax payment
$ 30,000
30%
$ 9,000
In order to avoid the “phantom” tax payment in year 2, companies use historical cost accounting for tax reporting.

Fair Value Accounting with Tax Deferral
Fair Value Cost
Year 1
Loss
Depreciation, 20 years
Total income increase/(decrease)
Tax rate
Tax increase/(decrease)
$ (10,000)
$ -
$ (10,000)
30%
$ (3,000)
$ -
$ (5,000)
$ (5,000)
30%
$ (1,500)
Year 2
Gain
Depreciation, 20 years
Total income increase/(decrease)
Tax rate
Tax increase/(decrease)
Total taxes, years 1 and 2
$ 30,000
$ -
$ 30,000
30%
$ 9,000
$ 6,000
$ -
$ (5,000)
$ (5,000)
30%
$ (1,500)
$ (3,000)

Fair Value Accounting with Tax Deferral
Fair Value Cost
Sale, first day of year 3
Book value
Less accumulated depreciation
Net book value
Sales price
Gain
Tax rate
Taxes payable
Total taxes during invesment period
$ 120,000
$ -
$ 120,000
$ 120,000
$ -
30%
$ -
$ 6,000
$ 100,000
$ (10,000)
$ 90,000
$ 120,000
$ 30,000
30%
$ 9,000
$ 6,000

Fair Value Accounting with Tax Deferral
Tax journal entries:
Year 1
Income tax payable
Deferred tax asset
Income tax expense
$ 1,500
$ 1,500
$ 3,000
Year 2
Income tax expense
Income tax payable
Deferred tax liability
Year 3
Deferred tax liability***
Income taxes payable
$ 9,000
$ 1,500
$ 10,500
$ 9,000
$ 9,000
*** - net a mount of yea r 1 deferred tax a s s et a nd yea r 2 deferred tax l i a bi l i ty.

Stock Options Analysis (new topic)
 Year 1: Company issues 100,000 options to purchase shares at $20/share, when the stock price is
$20/share, two year vesting (= earned over two years)
 Year 3:
 Employee exercises option when share price is
$30/share, realizing a gain of $1,000,000
 Company deducts $1,000,000 as an expense

Stock Options Analysis – Deferred Taxes
 The “tax” column reflects tax reporting, the “accrual” reflects financial reporting; in years 1 and 2, we will reflect an expense in our income statement, but not in our tax return.
 This creates an asset for us. Why? Because in year 3, as a result of the options exercise, which will be an expense for us, we will have a lower tax bill.

Stock Options Analysis
Compensation Year 1
Corporate tax deduction
Tax rate
Employee taxes
Corporate tax deduction
$ -
Tax
$ -
30%
$ -
$ -
Accrual
$ 500,000
$ (500,000)
30%
$ 150,000
$ (150,000)
Compensation Year 2
Corporate tax deduction
Tax rate
Employee taxes
Corporate tax deduction
$ -
$ -
30%
$ -
$ -
$ 500,000
$ (500,000)
30%
$ 150,000
$ (150,000)

Stock Options Analysis
Options exercised Year 3
Corporate tax deduction
Tax rate
Employee taxes
Corporate tax deduction
Total employee taxes
Total corporate tax deduction
Tax
$ 1,000,000
$ (1,000,000)
30%
$ 300,000
$ (300,000)
$ 300,000
$ (300,000)
Accrual
$ -
$
$
$
$
30%
-
-
300,000
(300,000)

Stock Options Analysis – Deferred Taxes
Year 1
Deferred tax asset
Income tax expense
$ 150,000
$ 150,000
Year 2
Deferred tax asset
Income tax expense
Year 3
Income tax payable
Deferred tax asset
$ 150,000
$ 150,000
$ 300,000
$ 300,000

Deferred Taxes – IAS 12 Requirements
 All deferred taxes are classified as noncurrent.
 Deferred tax assets and liabilities should not be offset; report asset and liability separately.
 If tax rate changes have been enacted, use future rates to calculate deferred taxes (slide 19).
 If a company does not have probable future income, do not recognize a deferred tax asset (slide 20).

Stock Options Analysis – Tax Rate Change
We use the tax rate enacted by the government for year 3
(assume 34%), because this is the year we will pay the tax.
Year 1
Deferred tax asset
Income tax expense
($500,000 * 34% tax rate year 3)
Year 2
Deferred tax asset
Income tax expense
($500,000 * 34% tax rate year 3)
Year 3
Income tax payable
Deferred tax asset
$ 170,000
$ 170,000
$ 340,000
$ 170,000
$ 170,000
$ 340,000

Stock Options Analysis – Uncertain Income
If we expect probable future income of less than $1,000,000
(assume $400,000), we will only recognize a deferred tax asset for the expected benefit.
Year 1
Deferred tax asset
Income tax expense
($400,000 of future income * 30%)
$
$
120,000
120,000
$ 120,000
Year 2
Deferred tax asset $ -
Income tax expense $
(no additional future income, thus no future tax benefit)
-
Year 3
Income tax payable
Deferred tax asset $ 120,000

International Financial
Reporting
WEEK TEN

References
 Revenue recognition – IFRS 15 www.bdointernational.com/Services/Audit/IFRS/IFRS at a Glance/Documents/IFRS 15.pdf
 Excellent comparison of IFRS 15 and IAS 18, and
outstanding website for IFRS information http://www.ifrsbox.com/ifrs-15-vs-ias-18/

IAS 18
 Current revenue recognition standard (until 1 January
2017, IFRS 15 effective date)
 No guidance regarding selling price allocation for separately identifiable components of a single transaction (e.g., cellphone + wireless service)

IFRS 15 – Five-Step Model for Revenue
Recognition
 Identify the contract
 Identify all performance obligations
 Determine the transaction price
 Allocation transaction price to performance obligations
 Recognize revenue when performance obligation is satisfied

IFRS 15 Example
 Cellphone contract including mobile phone and wireless service
 Monthly fee: $50
 Contract term: 12 months
 Price of phone: “free”
 Price of standalone phone: $150
 Monthly fee without “free” phone: $40

IFRS 15 Example Steps 1-3
 1) The contract: annual wireless plan + phone
 2) The obligation: phone + service
 3) The price: $50 x 12 = $600

IFRS 15 Example Step 4: Allocation
Obligation
Phone
Annual service
Total
Standalone Allocation
Price % of Total (Total x (%))
$ 150 24% $ 143
$ 480
$ 630
76% $ 457
$ 600

IFRS 15 Example Step 5: Recognition
At sale (one time)
Unbilled revenue
Goods revenue
Monthly (12 times)
Accounts receivable
Unbilled revenue
Services revenue
$ 143
$ 143
$ 50
$ 12
$ 38

IFRS 15/IAS 18 Comparison
Contract completed in one fiscal year:
Annual revenue
Total
Difference
%
Goods revenue
Services revenue
IFRS 15
$ 143
$ 457
$ 600
IAS 18
$ -
$ 600
$ 600
$ -
N/A

IFRS 15/IAS 18 Comparison
Contract completed over two fiscal years:
Year 1
Goods revenue
Services revenue
Total
Difference
%
IFRS 15
$ 143
$ 229
$ 371
IAS 18
$ -
$ 300
$ 300
$ 71
24%
Year 2
Goods revenue
Services revenue
Total
Difference
%
IFRS 15
$ -
$ 229
$ 229
IAS 18
$ -
$ 300
$ 300
$ (71)
-24%

IFRS 15/IAS 18 Exercise
Just Do It!
Monthly fee w/handset
Months
Handset fee
Monthly fee w/o handset
$ 30
12
$ 90
$ 25