Appendix E - International Financial Reporting Standards
Appendix E
International Financial Reporting Standards
REVIEW QUESTIONS
Question E-1 (LOE-1)
Convergence refers to the process by which U.S. GAAP and IFRS will eventually merge to
become a single set of accounting standards.
Question E-2 (LOE-1)
Financial accounting standards and practices differ from country to country for many reasons,
including different legal systems, the influence of tax laws, sources of financing, inflation, culture,
political influence of other countries, and the level of economic development. See Illustration D-1 in
the textbook for further details.
Question E-3 (LOE-1)
Legal system (common law vs. code law) is often used as a way to describe overall differences in
accounting practices between countries. Common law countries such as the U.S., U.K., Australia,
and Canada have separate rules for financial accounting and tax accounting, rely more on equity
financing, and have political and economic ties with Britain. Code law countries such as those in
Central Europe and Japan, have similar rules for financial accounting and tax accounting, rely more
on debt financing, and many have political and economic ties with Germany.
Question E-4 (LOE-1)
Differences in accounting standards cause problems for investors in comparing companies whose
financial statements are prepared under different accounting rules. Investors unfamiliar with the
accounting practices of a particular country are less likely to invest in firms from that country
because of this uncertainty.
Question E-5 (LOE-1)
Differences in accounting standards make it more difficult and more costly for multinational
corporations to comply with multiple sets of accounting rules.
Question E-6 (LOE-2)
-quality, understandable, and
users make economic decisions.
Question E-7 (LOE-2)
One argument against convergence between U.S. GAAP and IFRS is that U.S. GAAP is needed
to meet the specific legal and regulatory requirements of the U.S. business environment. A one size
fits all approach taken by the IFRS may not work. Another argument for maintaining the two sets of
standards is that competition between alternative standard-setting regimes is healthy and can lead to
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Appendix E - International Financial Reporting Standards
improved standards
Question E-8 (LOE-2)
The Norwalk Agreement formalized the commitment to convergence of U.S. GAAP and IFRS.
Under this agreement, the two boards pledged to remove existing differences between their standards
and to coordinate their future standard-setting agendas so that major issues are worked on together.
The agreement is significant because it was a major step in the convergence of U.S. accounting with
international accounting standards.
Question E-9 (LOE-3)
A conceptual framework in accounting is a common structure useful in setting accounting
standards. It is important that the FASB and the IASB work together in developing a common
conceptual framework as this framework will be relied upon in developing future accounting
standards.
Question E-10 (LOE-3)
Revenues and expenses
revenue, cost of goods sold, and operating expenses would be included in operating activities.
Revenues and expenses from investing such as interest revenue or a loss on sale of an investment
would be included as investing activities. Revenues and expenses from financing such as interest
expense incurred on borrowing or a gain on repurchase of long-term debt would be included in a
separate section labeled financing activities.
Question E-11 (LOE-3)
LIFO is allowed under U.S. GAAP, but not under IFRS. U.S. companies currently using LIFO
will lobby to keep this method because a switch from LIFO would greatly increase taxes for many
U.S. companies.
Question E-12 (LOE-3)
In the U.S., market value is defined as replacement cost, which is the cost to replace the item in
its identical form. However, the designated market value according to IFRS is net realizable value,
which is the selling price of inventory less any selling costs.
Question E-13 (LOE-3)
An inventory write down causes total assets and net income to decrease. The reversal of an
inventory write down causes just the opposite: total assets and net income increase.
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Appendix E - International Financial Reporting Standards
Question E-14 (LOE-3)
To revalue a long-term asset is to periodically adjust the asset to fair value. Under U.S. GAAP,
companies are not allowed to revalue long-term assets to fair value for financial reporting purposes.
IFRS allows, but does not require, revaluation of long-term assets to fair value.
Question E-15 (LOE-3)
U.S. GAAP requires all research and development expenditures to be expensed in the period
incurred. IFRS draws a distinction between research activities and development activities. Research
expenditures are expensed in the period incurred. However, development expenditures that meet
specified criteria are capitalized as an intangible asset. U.S. GAAP is more conservative as it
requires all research and development costs to be expensed as incurred.
Question E-16 (LOE-3)
A company would be more likely to report a contingent liability under IFRS. We accrue a
contingent liability
si
IFRS is more conservative in the reporting of contingent liabilities. Companies are more likely
under IFRS to report a contingent liability resulting in lower net income.
Question E-17 (LOE-3)
reported as a reduction of retained earnings. Under IFRS, most preferred stock is reported as debt
with the dividends reported in the income statement as interest expense.
As we learned in Chapter 10, preferred stock has characteristics of both liabilities and
characteristics nearly identical to common stock.
Question E-18 (LOE-3)
U.S. GAAP provides for the separate reporting, as an extraordinary item, of a material gain or
loss that is both unusual in nature and infrequent in occurrence. On the other hand, IFRS does not
allow for the reporting of extraordinary items at all.
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Appendix E - International Financial Reporting Standards
EXERCISES
Exercise E-1 (LOE-1)
Reason
Description
1. _c__ Legal system
a. More developed economies have more
complex business transactions.
2. _e__ Tax laws
b. The extent of public disclosure depends
on the secretiveness of society.
3. _g__ Sources of financing
c. Common law countries rely more
heavily on public information.
4. _f__
d. Countries share business activities and
have political connections.
Inflation
5. _b__ Culture
e. Alignment between financial reporting
and tax reporting rules.
6. _d__ Political and economic
ties
f. In some countries, asset values increase
rapidly because of the general price
level changes.
7. _a__ Economic development g. Some countries rely more heavily on
debt capital than on equity capital to
fund operations.
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Appendix E - International Financial Reporting Standards
Exercise E-2 (LOE-1)
Requirement 1
Austria’s accounting is very similar to that of Germany.
1. Legal system
(b) Code law
2. Tax laws
(b) Similar tax and financial accounting rules
3. Sources of financing
(b) More debt financing
4. Inflation
(a) Low inflation
5. Culture
(b) Secretive
6. Political and economic ties (b) German ties
7. Economic development
(a) Developed economy
Requirement 2
Australia’s accounting is very similar to that of the United Kingdom.
1. Legal system
(a) Common law
2. Tax laws
(a) Different tax and financial accounting rules
3. Sources of financing
(a) More equity financing
4. Inflation
(a) Low inflation
5. Culture
(a) Transparent
6. Political and economic ties (a) British ties
7. Economic development
Solutions Manual, Appendix E
(a) Developed economy
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Appendix E - International Financial Reporting Standards
Exercise E-3 (LOE-2)
For the idea
There are several reasons to allow U.S. companies the choice of reporting under
either U.S. GAAP or IFRS. It is important to allow U.S. companies the opportunity to
report under IFRS because the rest of the world is moving to IFRS. A single set of
global standards can improve comparability of financial reporting across countries
and facilitate access to capital. Without the ability to report under IFRS, U.S.
companies may be at a competitive disadvantage in raising debt and equity capital in
international markets.
Against the idea
There are also several reasons to not allow U.S. companies the choice of reporting
under either U.S. GAAP or IFRS. U.S. GAAP is customized to fit the stringent legal
and regulatory requirements of the U.S. business environment. U.S. GAAP provides a
better fit and should therefore be required for U.S. companies. Furthermore, allowing
the choice of reporting either U.S. GAAP or IFRS could create confusion for users of
financial accounting information. Investors and creditors have to compare a company
using U.S. GAAP to another company using IFRS. This emphasizes the continuing
need for convergence of accounting standards between U.S. GAAP and IFRS.
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Appendix E - International Financial Reporting Standards
Exercise E-4 (LOE-3)
Requirement 1
Principles-based accounting standards emphasize broad principles of accounting with
relatively less emphasis on detailed implementation rules. Rules-based accounting
standards provide additional detailed guidance to help users implement the standard.
Requirement 2
Principles-based standards are more concise, allowing preparers and users of
accounting information to focus on the key issues.
Requirement 3
Rules-based standards are more precise, providing additional guidance to preparers
and users on an issue.
Requirement 4
Most people agree that, in order to reduce the volume of accounting rules
internationally, future international accounting standards will need to more
principles-based.
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Appendix E - International Financial Reporting Standards
Exercise E-5 (LOE-3)
Requirement 1
Operating activities include transactions relating to the primary operating activities of
the business. Investing activities include transactions involving the purchase and sale
of long-term assets and current investments. Financing activities include transactions
relating to long-term debt and stockholders’ equity.
Requirement 2
(a) Sales, cost of goods sold, and operating expenses would be classified as an
operating activity.
(b) Interest revenue, dividend income, and a gain or loss on sale of an investment
would be classified as an investing activity.
(c) Interest expense, bond issue costs, stock issue costs, and the gain or loss on the
repurchase of long-term debt would be classified as a financing activity.
Requirement 3
(a) Most current assets and current liabilities would be classified as an operating
activity.
(b) Long-term assets and current investments would be classified as an investing
activity.
(c) Long-term debt and stockholders’ equity would be classified as a financing
activity.
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Appendix E - International Financial Reporting Standards
Exercise E-6 (LOE-3)
Requirement 1
Date
Jan. 1
Apr. 7
Date
Apr. 7
Oct. 9
a
Transaction
Beginning Inventory
Purchase
Number
of units
70
10
70
Unit
cost
$83
85
Ending
Inventory
$5,810
850
$6,660
Transaction
Purchase
Purchase
Number
of units
180
90
270a
Unit
cost
$85
87
Cost of
Goods Sold
$15,300
7,830
$23,130
Last 270 units purchased are assumed sold
Sales revenue = 270 units X $100 = $27,000
Gross profit = Sal
= $27
Solutions Manual, Appendix E
23,130 = $3,870
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Appendix E - International Financial Reporting Standards
Requirement 2
Date
Oct. 9
Date
Jan. 1
Apr. 7
Oct. 9
a
Transaction
Purchase
Transaction
Beginning inventory
Purchase
Purchase
Number
of units
80
Unit
cost
$87
Ending
Inventory
$6,960
Number
of units
70
190
10
270a
Unit
cost
$83
85
87
Cost of
Goods Sold
$ 5,810
16,150
870
$22,830
First 270 units purchased are assumed sold
Sales revenue = 270 units X $100 = $27,000
Gross profit
s sold
= $27
22,830 = $4,170
Requirement 3
FIFO will result in a higher income of $300 (gross profit of $4,170 vs. $3,870)
reported on the income statement. FIFO will also result in higher assets of $300
(ending inventory of $6,960 vs. $6,660) reported on the balance sheet.
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Appendix E - International Financial Reporting Standards
Exercise E-7 (LOE-3)
Requirement 1
U.S. GAAP requires all research and development expenditures to be expensed in the
period incurred. Therefore, all $700,000 would be expensed.
Requirement 2
IFRS draws a distinction between research activities and development activities.
Research expenditures are expensed in the period incurred. However, development
expenditures that meet specified criteria are capitalized as an intangible asset.
Therefore, $200,000 in research costs would be expensed, and the $500,000 in
development costs would be capitalized as an intangible asset.
Requirement 3
Income under IFRS would be $500,000 higher than under U.S. GAAP. Total assets
0,000 higher under
IFRS than under U.S. GAAP.
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Appendix E - International Financial Reporting Standards
Exercise E-8 (LOE-3)
Requirement 1
to company resources.
Requirement 2
Under the IFRS position, preferred stock is a liability. The true owners of the
business are the common shareholders as they control the company through voting
rights. Preferred shareholders usually do not have voting rights. Preferred
shareholders receive preference in the payment of dividends similar to an interest
payment to a creditor.
Requirement 3
equity. Unlike long-term debt, preferred stock usually does not have a maturity date.
The lack of a maturity date makes
a liability on the balance sheet.
Requirement 4
The classification of preferred stock depends on the characteristics of the preferred
stock issue. Non-voting, mandatorily redeemable preferred stock with a fixed annual
dividend is similar to bonds and should be reported as a liability. Preferred stock with
voting rights or convertible to common stock and lacking a dividend preference is
similar to common stock and probably should be reported as part of st
equity.
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