Ch.11solutions 3c4y5

Chapter 11 - Worldwide ing Diversity and International Standards

ADVANCE ING ACCT 462

CHAPTER 11 WORLDWIDE ING DIVERSITY AND INTERNATIONAL STANDARDS Question Answers to Questions 1.

The five factors most often cited as affecting a country's ing 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 ing principles are established; code law countries generally having legislated ing principles and common law countries having principles established by nonlegislative 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 ing and taxation, ing 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 , banks, and the government are the major providers of business finance, there tends to be less demand for public ability and information disclosure. Chronic high inflation has caused some countries, especially in Latin America, to develop ing principles in which traditional historical cost ing is abandoned in favor of inflation adjusted figures. Political and economic ties can explain the usage of a British style of ing 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 country’s ing system. This influence is described in more detail in the answer to question 3.

2.

Problems caused by ing 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 ing systems in two ways: (1) societal values help shape a country’s institutions, such as legal system and financing system, which in turn influences the development of ing, and (2) societal values influence ing values held by of the ing sub-culture, which in turn influences the development of the ing system. Gray provides specific hypotheses with respect to the manner in which specific cultural dimensions will influence specific ing values. For example, he hypothesizes that in countries in which avoiding uncertainty is important, ants will have a preference for more conservative measurement of profit.

4.

According to Nobes, the purpose for financial reporting determines the nature of a country’s 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 ing 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 ing system oriented toward protecting creditors and providing a basis for taxation.

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Chapter 11 - Worldwide ing Diversity and International Standards

5. Several of the IASC’s original standards were criticized for allowing too many alternative methods of ing for a particular item. As a result, through the selection of different acceptable options, the financial statements of two companies following International ing Standards still might not have been comparable. To enhance the comparability of financial statements prepared in accordance with International ing 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 are selected. IASB has at least 12 and as many as 14 full-time , the IASC had zero. Full-time IASB must sever their employment relationships with former employers and must maintain their independence. Seven of the full-time have a liaison relationship with a national standard setter. At least five must have been auditors, three must have been financial statement preparers, three must have been s 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 of Exhibit 11.6 shows the countries as of July 2009 that (after 2012) do not allow domestic companies to use IFRS in preparing consolidated financial statements. The three most economically important countries in this group are China, Japan, 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. The six key initiatives are: • Short-term convergence project to eliminate differences where convergence is likely in the short-term. • t projects on broader issues in which FASB and IASB share resources and work on a similar time schedule. • Convergence research project to identify all substantive differences between IFRS and U.S. GAAP. • Liaison IASB member on site at FASB offices. • Monitoring of IASB projects. • Explicit consideration of convergence potential in FASB agenda decisions.

11. Convergence implies a t 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 tly 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 ing Diversity and International Standards

12. 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. The SEC’s IFRS Roap proposes the phased-in use of IFRS by U.S. publicly-traded domestic companies beginning in 2014. The SEC will monitor progress on several milestones and make a decision on mandatory IFRS adoption in 2011. 13. 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 ing 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. 14. The extreme approaches that a company might follow in determining appropriate ing policies for preparing its initial set of IFRS financial statements are: 1. Adopt ing policies acceptable under IFRS that minimize change from existing ing policies used under current GAAP. 2. Take a fresh start, clean slate approach and develop ing 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.

15. According to the ing policy hierarchy in IAS 8, if a company is faced with an ing 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 IASB’s Framework does not help in determining an appropriate ing treatment, then the company should consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework. The FASB’s conceptual framework is similar to the IASB’s, so reference to FASB pronouncements would be acceptable under IAS 8 when conditions (a), (b), and (c) exist.16. 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. 17. Even if all countries adopt a similar set of ing 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 ants interpret and apply ing standards. Differences in culture can lead to differences in how the same standard is applied across countries.

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Chapter 11 - Worldwide ing Diversity and International Standards

Answers to Problems 1.

B (LO1)

2.

C (LO2)

3.

D (LO2)

4.

C (LO3)

5.

D (LO4)

6.

D (LO5)

7.

C (LO5)

8.

B (LO5)

9.

D (LO5)

10. B (LO6) 11. C (LO6) 12. A (LO6) 13. A (LO5) 14. C (LO5) Problems 15-19 are based on the comprehensive illustration.

Note to instructors: Problems 15-19 have changed from Problems 11-15 in the Ninth Edition of the book in that they now ask for the adjustments to reconcile from U.S. GAAP to IFRS, whereas in the previous edition the reconciliation was from IFRS to U.S. GAAP. This change is consistent with the nature of the reconciliation that U.S. companies will make if the SEC requires the IFRS as proposed under the IFRS Roap. 15. Carrying inventory at the lower of cost or “market” (LO7) (15 minutes) a. 1. Under U.S. GAAP, the company reports inventory on the balance sheet at the lower of 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, 2011 balance sheet at $95,000. A $5,000 loss will be included in 2011 income. 2. In accordance with IAS 2, the company reports inventory on the balance sheet at the lower of cost and net realizable value. As a result, inventory will be reported on the December 31, 2011 balance sheet at its net realizable value of $98,000 and a loss on writedown of inventory of $2,000 will be reflected in 2011 net income.

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Chapter 11 - Worldwide ing Diversity and International Standards

b. As a result of the differing amounts of inventory loss recognized under U.S. GAAP and IFRS, Lisali will add $3,000 to U.S. GAAP income to reconcile to IFRS income, and will add $3,000 to U.S. GAAP stockholders’ equity to reconcile to IFRS stockholders’ equity. 16. Measurement of property, plant, and equipment subsequent to acquisition (LO7) (25 minutes) a. 1. Under U.S. GAAP, the company would report the equipment at its depreciated historical cost. Straight-line deprecation expense is $8,000 per year [($100,000 – $20,000) / 10 years]. The equipment would be reported at $92,000, $84,000, and $76,000, respectively, on the December 31, 2011, 2012, and 2013 balance sheets.

2. Under IFRS, the equipment would be depreciated by $8,000 in 2011 [($100,000 - $20,000) / 10 years], resulting in a book value of $92,000 at December 31, 2011. Under IAS 16’s allowed alternative treatment, the equipment would be revalued on January 1, 2012 to its fair value of $101,000. The journal entry to record the revaluation on January 1, 2012 would be: Dr. Equipment $9,000 Cr. Revaluation surplus (stock. equity) $9,000 (To revalue equipment from carrying value of $92,000 to appraisal value of $101,000.) Depreciation expense on a straight-line basis in 2012, 2013, and beyond would be $9,000 per year [($101,000 – $20,000) / 9 years]. The equipment would be reported on the December 31, 2012 balance sheet at $92,000 [$101,000 – $9,000], and on the December 31, 2013 balance sheet at $83,000 [$92,000 – $9,000]. The differences can be summarized as follows: Depreciation expense IFRS U.S. GAAP Difference Book value of equipment IFRS U.S. GAAP Difference

2011 $8,000 $8,000 $0

2012 $9,000 $8,000 $1,000

2013 $9,000 $8,000 $1,000

12/31/11 $92,000 $92,000 $0

12/31/12 $92,000 $84,000 $ 8,000

12/31/13 $83,000 $76,000 $ 7,000

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Chapter 11 - Worldwide ing Diversity and International Standards

b. There is no difference in net income between IFRS and U.S. GAAP in 2011, so no reconciliation adjustments are necessary in 2011.

In 2012, the additional amount of depreciation expense of $1,000 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 $1,000 less than U.S. GAAP retained earnings at December 31, 2012. Under IFRS, the revaluation surplus causes IFRS stockholders’ equity to be $9,000 larger than U.S. GAAP stockholders’ equity. The adjustment to reconcile U.S. GAAP stockholders’ equity to IFRS is $8,000, the difference between the original amount of the revaluation surplus ($9,000) and the accumulated depreciation on that surplus ($1,000). $8,000 would be added to U.S. GAAP stockholders’ equity to reconcile to IFRS.

In 2013, $1,000 again is added to IFRS net income to reconcile to U.S. GAAP net income, and $7,000 is now subtracted from IFRS stockholders’ equity to reconcile to U.S. GAAP stockholders’ equity. $7,000 is the original amount of revaluation surplus ($9,000) less accumulated depreciation on that surplus for two years ($2,000). 17. Research and development costs (LO7) (15 minutes) a. 1. Under U.S. GAAP, $500,000 of research and development costs would be expensed in 2011. 2. In accordance with IAS 38, $350,000 [$500,000 x 70%] of research and development costs would be expensed in 2011, and $150,000 [$500,000 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 2012 when the newly developed product is brought to market. b. In 2011, $150,000 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. In 2012, the company would recognize $15,000 [$150,000 / 10 years] of amortization expense on the deferred development costs under IFRS that would not be recognized under U.S. GAAP. In 2012, $15,000 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, 2012 would be $135,000, the sum of the $150,000 smaller expense under IFRS in 2011 and the $15,000 larger expense under IFRS in 2012. $135,000 would be added to U.S. GAAP stockholders’ equity at December 31, 2012 to reconcile to IFRS.

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Chapter 11 - Worldwide ing Diversity and International Standards

18. Gain on sale and leaseback transaction (LO7) (15 minutes) a. 1. Under U.S. GAAP, the gain of $50,000 on the sale and leaseback transaction of is deferred and amortized to income over the life of the lease. With a lease period of five years, $10,000 of the gain would be recognized in 2011. 2. In accordance with IAS 17, the entire gain of $50,000 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 2011, IFRS net income exceeds U.S. GAAP net income by $40,000, the difference in the amount of gain recognized on the sale and leaseback transaction. A positive adjustment of $40,000 would be made to reconcile U.S. GAAP net income and U.S. GAAP stockholders’ equity to IFRS. In 2012, a gain of $10,000 would be recognized under U.S. GAAP that would not exist under IFRS. As a result, $10,000 would be subtracted from U.S. GAAP net income to reconcile to IFRS. By December 31, 2012, $20,000 of the gain would have been recognized under U.S. GAAP and included in retained earnings, whereas retained earnings under IFRS includes the entire $50,000 gain. Thus, $30,000 would be added to U.S. GAAP stockholders’ equity at 12/31/12 to reconcile to IFRS. 19. Impairment of property, plant, and equipment (LO7) (20 minutes) 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 $85,000, which exceeds the carrying value of $80,000, so the asset is not impaired. Depreciation expense for the year is $20,000 [$100,000 / 5 years], and the equipment will carried be on the December 31, 2011 balance sheet at $80,000. 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, 2011 is $80,000; original cost of $100,000 less accumulated depreciation of $20,000 [$100,000 / 5 years]. The asset’s recoverable amount is $75,000 (the higher of value in use of $75,000 and fair value of $72,000), so the asset is impaired. An impairment loss of $5,000 [$80,000 - $75,000] would be recognized at the end of 2011, in addition to depreciation expense for the year of $20,000. The equipment will be carried on the December 31, 2011 balance sheet at $75,000.

b. An impairment loss of $5,000 was recognized in 2011 under IFRS but not under U.S. GAAP. Therefore, $5,000 must be subtracted from U.S. GAAP net income to reconcile to U.S. GAAP net income in 2011. The same amount would be subtracted from U.S. GAAP stockholders’ equity at December 31, 2011 to reconcile to IFRS. In 2012, depreciation under IFRS will be $18,750 [$75,000 / 4 years], whereas depreciation under U.S. GAAP is $20,000. $1,250 would be added to U.S. GAAP net income to reconcile to IFRS net income in 2012. To reconcile stockholders’ equity to IFRS at December 31, 2012, $3,750 must be subtracted from U.S. GAAP stockholders’ equity. This is the difference between the impairment loss of $5,000 in 2011 taken under IFRS and the difference in depreciation expense recognized under the two sets of standards in 2012. It also is equal to the difference in the carrying value of the equipment at December 31, 2012 under the two sets of ing rules: Cost Depreciation, 2011

IFRS $100,000 (20,000) 11-7

U.S. GAAP $100,000 (20,000)

Chapter 11 - Worldwide ing Diversity and International Standards

Impairment loss, 2011 Carrying value, 12/31/11 Depreciation, 2012 Carrying value, 12/31/12

(5,000) $75,000 (18,750) $56,250

This copy of study guide is edited by; Vincent oluoch odhiambo Senior student 2011 University of Eastern Africa Baraton, School of Business Department of ing; BBA(ing) BBA(Finance) Email:[email protected]

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0 $80,000 (20,000) $60,000