MHM Executive Education Series: US GAAP and IFRS. Presented by: Keith Peterka Shareholder, Mayer Hoffman McCann P.C.

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1 MHM Executive Education Series: Understanding di the Differences Between US GAAP and IFRS Presented by: Keith Peterka Shareholder, Mayer Hoffman McCann P.C. August 30, 2012

2 Today s Agenda SEC s Work Plan for the Consideration of Incorporating IFRS into the Financial Reporting System for U.S. Issuers - Final Staff Report IAS 2 Inventories IAS 16 Property Plant and Equipment

3 SEC Final Staff Report Overview of Significant Areas 1. Development of IFRS 2. Interpretive Process 3. IASB s Use of National Standard Setters 4. Global l Application and Enforcement 5. Governance of the IASB 6. Status of Funding 7. Investor Understanding

4 Inventory Accounting Under IAS Inventory within the scope of the measurement provisions of IAS 2, Inventories, should be carried at the lower of cost or net realizable value. Depending on the nature of the inventory, cost may be determined using the specific identification, first-in, firstout (FIFO), or weighted-average method. Last-in, first-out (LIFO) is not an acceptable method for pricing inventory.

5 Inventory Accounting Under IAS 2 Inventories: Held for sale in the ordinary course of business; In the process of production for such sale; or In the form of materials or supplies to be consumed in the production process or in the rendering of services. Inventories are required to be stated at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

6 Inventory Accounting Under IFRS Scope exceptions: Work in progress from construction contracts Financial instruments Biological assets IAS 2 does not apply to the measurement of inventories held by: Producers of agricultural and forest products, minerals and mineral products. Commodity od broker-traders who measure e their inventories es at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognized in profit or loss in the period of the change.

7 Inventory Accounting Under IAS 2 Measurement of Inventories The cost of inventories includes all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. The costs of conversion of inventories include costs directly related to the units of production, such as direct labor. Including a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Other costs incurred in bringing the inventories to their present location and condition.

8 Inventory Accounting Under IAS 2 Costs excluded from the cost of inventories and recognized as expenses in the period in which they are incurred are: Abnormal amounts of wasted materials, labor or other production costs; Storage costs, unless those costs are necessary in the production process before a further production stage; Administrative overheads that do not contribute to bringing inventories i to their present location and condition; and Selling costs.

9 Inventory Accounting Under IAS 2 Inventory Costing - The cost of inventories should be assigned by using the first-in, first-out (FIFO) or weighted average cost formula. An entity uses the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified. Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate cost.

10 Inventory Accounting Under IAS 2 Net Realizable Value are based on the most reliable evidence available at the time the estimates are made, of the amount the inventories are expected to realize. Inventories are usually written down to net realizable value item by item. In some circumstances, however, it may be appropriate to group similar or related items. A new assessment of net realizable value in each subsequent period. When the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net realizable value because of changed economic circumstances, the amount of the write-down is reversed (the reversal is limited to the amount of the original write-down) so that the new carrying amount is the lower of the cost and the revised net realizable value.

11 Inventory Accounting Under IAS 2 Disclose Requirements: The accounting policies adopted in measuring inventories, including the cost formula used. The total carrying amount of inventories and the carrying amount in classifications appropriate to the entity. The carrying amount of inventories carried at fair value less costs to sell. The amount of inventories recognized as an expense during the period.

12 Inventory Accounting Under IAS 2 Disclose Requirements: The amount of any write-down of inventories recognized as an expense in the period. The amount of any reversal of any write-down that is recognized as a reduction in the amount of inventories recognized as expense in the period. The circumstances or events that led to the reversal of a write-down of inventories. The carrying amount of inventories pledged as security for liabilities.

13 Inventory Accounting Under IAS 2 Differences from US GAAP: IFRS permits the use of first-in, first-out or weighted average cost inventory valuation methodologies; U.S. GAAP permits the same methodologies as IFRS. U.S. GAAP also permits the use of the lastin, first-out (LIFO) method, which IFRS does not permit. IFRS requires that an entity use the same formula for all inventories having a similar nature and use to the entity; U.S. GAAP does not contain such a restriction.

14 Inventory Accounting Under IAS 2 Differences from US GAAP: IFRS requires that inventory is carried at the lower of cost or net realizable value. U.S. GAAP requires that inventory is carried at the lower of cost or market (with market defined as current replacement cost, provided market is not greater than net realizable value and is not less than net realizable value reduced by a normal sales margin). Accordingly, required write-downs may be for different amounts under U.S. GAAP compared to IFRS. IFRS requires reversal of inventory impairments in the period in which an impairment condition reverses (reversal limited to the amount of the original write-down). U.S. GAAP precludes a reversal of previous inventory write-downs,,(unless the recovery of inventory occurs within the same annual reporting period in which the writedown occurred).

15 IAS 16 Property Plant and Equipment

16 Definitions Under IAS 16 Carrying amount is the amount at which an asset is recognised after deducting any accumulated depreciation and accumulated impairment losses. Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction.

17 Definitions Under IAS 16 Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm s length transaction. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.

18 Definitions Under IAS 16 Property, plant and equipment are tangible items that: are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and are expected to be used during more than one period. Useful life is: the period over which h an asset is expected to be available for use by an entity; or the number of production or similar units expected to be obtained from the asset by an entity.

19 Definitions Under IAS 16 Recoverable amount is the higher of an asset s net selling price and its value in use. The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

20 The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment. The principal issues are: The timing of recognition of asset; The determination of their carrying amounts; and The depreciation charges to be recognized. IAS-16 applied to all Property Plant & Equipment until IAS 16 applied to all Property, Plant & Equipment until and unless any other standard requires or permits a different accounting treatment.

21 Measurement & Recognition The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if: It is probable that future economic benefits associated with the item will flow to the entity, and The cost of the item can be measure reliably. Spare parts are carried as inventory and charged to income statement as consumed. Major spare parts qualify as property, plant and equipment when an entity expects to use them during more than one period. If the spare parts can be used only with an item of property, p plant and equipment, they are accounted for as property, plant and equipment.

22 Measurement & Recognition Initial measurement PPE is initially measured at cost. This comprises costs directly attributable to acquiring the asset (purchase price) and the costs necessary to bring such an asset to the location and working condition for its intended use. Measurement of cost The cost of an item of property, plant and equipment is the p p y, p q p cash price equivalent at the recognition date.

23 Measurement & Recognition Examples of directly attributable costs are: 1. Costs of employee benefits arising directly from the construction or acquisition of the item of property, plant and equipment; 2. Costs of site preparation; 3. Initial delivery and handling costs; 4. Installation and assembly costs; 5. Costs of testing whether the asset is functioning properly, p after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment); and 6. Professional fees.

24 Measurement & Recognition Examples of costs that are not costs of an item of property, plant and equipment are: 1. costs of opening a new facility; 2. costs of introducing a new product or service (including costs of advertising i and promotional activities); iti 3. costs of conducting business in a new location or with a new class of customer (including costs of staff training); and 4. administration and other general overhead costs.

25 Subsequent Measurement Subsequent expenditure Such costs should be added when it is probable that future economic benefits, exceeding the original standard of performance, will flow to the entity can be reliably measured. The cost of major inspection or overhaul occurring at regular intervals is capitalised where it is identified as a separate component of the asset and the replaced components are fully depreciated

26 Capitalization i of Cost Widget Manufacturing is installing a new plant at its production facility. It has incurred these costs: - Cost of the plant = $1,500,000 - Initial delivery and handling cost = $75,000 - Cost of site preparation = $100,000 - Consultants used to advice on the development = $25,000 - Interest paid on construction loan = $20,000 - Estimated dismantling cost to be incurred after 15 years = $100,000 - Operating losses before commercial production = $50,000 What are the cost to be capitalized under IAS 16?

27 Cost of the plant $1,500,000 Initial delivery and handling cost $75,000 Cost of site preparation $100,000 Estimated dismantling cost to be incurred $150,000 after 15 years Interest expense* $20,000 Total cost $1,845,000, * IAS 23 on Borrowing cost allows optionality

28 Subsequent Measurement Measurement after recognition An entity shall choose either the cost model or the revaluation model as its accounting policy and shall apply that policy to an entire class of property, p plant and equipment. Cost Model Revaluation Model

29 Subsequent Measurement Cost Model: After recognition, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses. Revaluation Model: After recognition, an item of property, p plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made 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.

30 Subsequent Measurement If an item of property, plant and equipment is re-valued, the entire class to which that asset belongs shall be re-valued. A class of property, plant and equipment is a grouping of assets of a similar nature and use in an entity s operations. Example: land; land and buildings; machinery; ships; aircraft; motor vehicles; furniture and fixtures; and office equipment.

31 Subsequent Measurement A realty company has an office building with an initial cost of $10,000,000. At the date of revaluation, accumulated depreciation amounted to $500, The fair value of asset is assessed to be $9,800,000. Accumulated depreciation Dr $500, Asset Cost (Bldg) Cr $500,000 Asset Cost (Bldg) Dr $300,000 Revaluation reserve Cr $300,000 The net result is that the asset has a carrying amount of $9,800,000 ($10,000,000 $500,000 + $300,000 = $9,800,000).

32 Subsequent Measurement Items within a class of property, plant and equipment are re-valued simultaneously to avoid selective revaluation of assets. If an asset s carrying amount is increased as a result of a revaluation, the increase shall be credited directly to equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. If an asset s carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be debited directly to equity under the heading of revaluation surplus to the extent of any credit balance existing in the revaluation surplus in respect of that t asset

33 Subsequent Measurement Depreciation Each item of property, plant and equipment shall be depreciated. d Depreciation charge for each period shall be recognised in profit or loss. The depreciable amount of an asset shall be allocated on a systematic basis over its useful life. The residual value and the useful life of an asset shall be reviewed at least at each financial year-end and, if expectations differ from previous estimates, the change shall be accounted for as a change in an accounting estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

34 Subsequent Measurement Depreciation The depreciation method used shall reflect the pattern in which h the asset s future economic benefits are expected to be consumed by the entity. The depreciation method applied to an asset shall be reviewed ed at least at each financial year-end and, if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern. Such a change shall be accounted for as a change in an accounting estimate in accordance with IAS 8.

35 Derecognition The carrying amount of an item of property, p plant and equipment shall be derecognised: a) on disposal; or b) when no future economic benefits are expected from its use or disposal. The gain or loss arising from the derecognition of an item of property, plant and equipment shall be included in profit or loss when the item is derecognised. Gains shall not be classified as revenue.

36 Derecognition If an entity recognises in the carrying amount of an item of property, plant and equipment the cost of a replacement for part of the item, then it derecognises the carrying amount of the replaced part regardless of whether the replaced part had been depreciated separately. The gain or loss arising from the derecognition of an item of property, plant and equipment shall be determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item.

37 Disclosures The financial statements shall disclose, for each class of property, plant and equipment: a) the measurement bases used for determining the gross carrying amount; b) the depreciation methods used; c) the useful lives or the depreciation rates used; d) the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period; and

38 Disclosures e) a reconciliation of the carrying amount at the beginning and end of the period showing: additions; assets classified as held for sale; acquisitions through business combinations; increases or decreases resulting from revaluations and from impairment losses recognised or reversed directly in equity; impairment losses recognised or reversed in profit or loss; depreciation; and other changes.

39 Disclosures The financial statements shall also disclose: a) the existence and amounts of restrictions on title, and property, p plant and equipment pledged as security for liabilities; b) the amount of expenditures recognised in the carrying amount of an item of property, p plant and equipment in the course of its construction; and c) the amount of contractual commitments for the acquisition of property, plant and equipment.

40 Disclosures If items of property, plant and equipment are stated at revalued amounts, the following shall be disclosed: a) the effective date of the revaluation; b) whether an independent valuer was involved; c) the methods and significant assumptions applied in estimating the items fair values; d) the extent to which the items fair values were determined by reference to observable prices in an active market or recent market transactions or were estimated using other valuation techniques; e) for each revalued class of property, plant and equipment, the carrying amount that would have been recognised had the assets been carried under the cost model; and f) the revaluation surplus, indicating the change for the period and any restrictions ti on the distribution ib ti of the balance to shareholders. h

41 US GAAP Differences in PP&E Asset depreciation IAS 16 requires that each part of an item of PP&E with a cost that is significant in relation to the total cost of the item shall be depreciated separately (i.e., as if each part was a separate asset). Under U.S. GAAP, an item of PP&E with multiple l parts is generally depreciated over a useful life attributed to the item as a whole, regardless of the significance of the cost of the individual parts in relation to the total asset. While an entity applying U.S. GAAP may be permitted to calculate depreciation in a manner similar to the method required under IFRS, such an approach is not explicitly required.

42 US GAAP Differences in PP&E Remeasurement of residual value of PP&E Under IFRS, if expectations of the residual value of an asset differ from what was previously estimated, the change in residual value is accounted for prospectively as a change in estimate, t whether the change in residual value is upward or downward. Under U.S. GAAP, there is no explicit guidance on this issue. However, the Staff has noted that practice appears to have developed such that a change in residual value generally is recorded only if the residual value has decreased (which would result in an increase in depreciation expense in future periods because of a corresponding increase in the depreciable amount of the asset).

43 US GAAP Differences in PP&E Option for revaluation After initial recognition, IAS 16 permits two measurement alternatives: at cost less accumulated depreciation; or, if fair value can be measured reliably, at a revalued amount that equals its fair value at the date of the revaluation less any subsequent accumulated depreciation. An entity must make an accounting policy choice to use either the cost model (that would be consistent with U.S. GAAP) or the revaluation model to measure each class of PP&E. The accounting policy that is selected must be applied to the entire class of PP&E. U.S. GAAP does not permit use of a revaluation model.

44 US GAAP Differences in PP&E Impairment IAS 36, Impairment of Assets, requires that an impairment loss is calculated as the excess of the asset s carrying amount over its recoverable amount. The recoverable amount is the higher h of the asset s (1) fair value less costs to sell and (2) value in use. U.S. GAAP requires that entities use a two-step approach to measure impairment. In the first step, entities are required to perform a recoverability test by comparing the expected undiscounted future cash flows to be derived from the asset with its carrying amount. If the asset fails the recoverability test, the second step is triggered, under which the entity must record an impairment loss calculated as the excess of the asset s carrying amount over its fair value.

45 US GAAP Differences in PP&E Impairment reversals Under IFRS, long-lived assets (other than goodwill) must be reviewed for any indication that a previously recognized impairment loss no longer exists or has decreased. If an impairment i loss has decreased, d the impairment i loss should be reversed up to the newly estimated recoverable amount, not to exceed the initial carrying amount adjusted for depreciation. Under U.S. GAAP, reversal of impairment losses is prohibited for all longlived assets held and used.

46 Questions?

47 Speaker Biography Keith Peterka, CPA Shareholder Mayer Hoffman McCann P.C With more than 19 years of experience in public accounting, Keith performs national firm responsibilities for IFRS, fair value accounting and auditing, revenue recognition and business combinations. He has also developed national training programs for accounting pronouncements and complex accounting topics. Keith isasubject matter expert for IFRS, SEC reporting and fair value accounting in MHM s Professional Standards Group. He also is a member on the IFRS Foundation's Small & Medium-sized Entities (SMEs) Implementation Group.