Assignment #7 On January 1,Year 1, Parker, Inc., a U.S.-based firm listed on the NY Stock Exchange, purchased 100 percent of Suffolk PLC, an entity operating in the oil industry, located in Great Britain. Parker paid 52,000,000 British pounds (£) for its purchases. The excess of cost over book values is attributable to land (part of property, plant, and equipment) and is not subject to depreciation. Parker accounts for its investment in Suffolk at cost. On January 1, Year 1, Suffolk reported the following balance sheet: Cash……………………. £ 2,000,000 Accounts receivable….. 3,000,000 Inventory……………….. 14,000,000 PP&E (net)……………… 40,000,000 £ 59,000,000 Accounts payable ……………………..£ 1,000,000 Long-term debt………………………… 8,000,000 Common Stock………………………… 44,000,000 Retained earnings……………………… 6,000,000 £ 59,000,000 Suffolk’s Year 1 income was recorded at £2,000,000. No dividends were declared or paid by Suffolk in 2015. On December 31, Year 2, two years after the date of acquisition, Suffolk submitted the following trial balance to Parker for consolidation: Cash………………………………………………….£ 1,500,000 Accounts receivable…………………………….. 5,200,000 Inventory…………………………………………….. 18,000,000 Property, Plant, & Equipment (net)……… 36,000,000 Accounts Payable………………………………….. (1,450,000) Long-term debt…………………………………….. (5,000,000) Common Stock…………………………………….. (44,000,000) Retained Earnings (1/1/16)………………………. (8,000,000) Sales……………………….……………………….. (28,000,000) Cost of Goods Sold……………………………….. 16,000,000 Depreciation…………………………………………. 2,000,000 Other Expenses…………………………………….. 6,000,000 Dividends Paid (1/30/16)………………………. 1,750,000 0 +++ Other than the payment of dividends, no intercompany transactions occurred between the two companies. Relevant exchange rates for the British pound were as follows: Year 1 Year 2 January 1 $1.60 1.64 January 30 $1.61 1.65 Average $1.62 1.66 December 31 $1.64 1.68 December 31, Year 2, financial statements (before consolidation with Suffolk) follow. Dividend income is the U.S. dollar amount of dividends received from Suffolk translated at the $1.65/£ exchange rate at January 30, 2016. The amounts listed for dividend income and all affected accounts (i.e., net income, December 31, retained earnings, and cash) reflect the $1.65/£ exchange rate at January 30, Year 2. Credit balances are in parentheses. Sales…………………………………………………. $ (70,000,000) Cost of Goods Sold…………………………………. 34,000,000 Depreciation…………………………………………. 20,000,000 Other Expenses……………………………………... 6,000,000 Dividend income……………………………………... (2,887,500) Net income…………………………………………….$ (12,887,500) Retained Earnings (1/1/Year 2)………………… $ (48,000,000) Net income, Year 2……………………………… (12,887,500) Dividends, 1/30/Year 2 ………………………..… 4,500,000 Retained Earnings (12/31/ Year 2)………… …..$(56,387,500) Cash…………………………………………….… $ 3,687,500 Accounts receivable………………………………. 10,000,000 Inventory…………………………………………… 30,000,000 Investment in Suffolk……………………………. 83,200,000 Property, Plant, & Equipment (net)……… 105,000,000 Accounts Payable…………………………………. (25,500,000) Long-term debt……………………………………. (50,000,000) Common Stock…………………………………….. (100,000,000) Retained Earnings (12/31/Year 2)………… $ (56,387,500) Parker’s chief financial officer (CFO) wishes to determine the effect that a change in the value of the British pound would have on consolidated net income and consolidated stockholders’ equity. To help assess the foreign currency exposure associated with the investment in Suffolk, the CFO requests assistance in comparing consolidated results under actual exchange rate fluctuations with results that would have occurred had the dollar value of the pound remained constant or declined during the first two years of Parker’s ownership. In addition to the risk Parker faces from its exposure to the British pound, Suffolk’s oil operations sometimes result in soil contamination. Suffolk cleans up any contamination when required to do so under the laws of the particular country in which it operates. In one of the countries in which Suffolk operates, there is no legislation requiring cleanup. In that same country, Suffolk had inadvertently contaminated land in prior years. As of October 31, Year 2, it is virtually certain that a law requiring the remediation of contaminated land will be enacted in this jurisdiction, though it is not expected to be issued until after the December 31 year-end. A consultant has been hired to help estimate the cost of clean-up. The CFO has requested assistance in assessing the risk and disclosure requirements Parker faces from its foreign exchange exposure and environmental exposure. Suffolk prepares its financial statements in accordance with (1) U.S. GAAP in reporting to its parent and (2) IFRS in reporting to its U.K. based lender. The CFO has requested that you prepare a memorandum with a supporting report that addresses the following requirements. Required: Part A. Given the relevant exchange rates presented, use an spreadsheet to complete the following parts: Translation of Suffolk’s December 31, Year 2, trial balance from British pounds to U.S. dollars. The British pound is Suffolk’s functional currency. A schedule that details the change in Suffolk’s cumulative translation adjustment (beginning net assets, income, dividends, etc.) for Year 1 and Year 2. 1. The spreadsheet is automatically populated directly from the general ledger, but the exchange rates must be input manually. The CFO wants you to ensure that the correct exchange rates are input and then that they are not accidently changed. Since the exchange rates are input manually, what internal controls can you suggest to ensure that the rates in the spreadsheet are accurate? (Note: You may refer back to your Auditing or AIS classes for controls regarding validity of inputs and spreadsheet integrity) 2. Discuss the impacts that the change in the value of the pound has had on results due to exchange rate fluctuations with results that would have occurred had the dollar value of the pound remained constant or declined during the first two years of Parker’s ownership. ASSESS THREATS TO QUALITY OF INFORMATION. Part B. 3. Should Suffolk recognize a provision for the environmental contingency as of December 31, Year 2 in reporting to its U.S. parent under U.S. GAAP? How about when it reports to its U.K. based lender under IFRS? 4. Parker’s purchase of Suffolk has created additional accounting complexities. Identify some of the additional accounting issues that Parker now faces. How do these additional complexities potentially impact the quality of the accounting information for Parker? What internal controls can Parker implement to assure that the company is able to meet all information quality and disclosure requirements? 5. Parker is considering adopting IFRS for financial reporting. What are some of the key differences between IFRS and US GAAP that might impact Parker? What are some of the advantages and disadvantages that might accrue to Parker if it adopted IFRS for all of its operations? 6. Would adoption of IFRS require additional reporting requirements for the SEC? What role does the IASB, FASB, PCAOB and SEC play in promoting high-quality accounting information for US and global businesses? Does the retention of a separate US GAAP in an otherwise IFRS world environment present any challenges for US based companies? US GAAP versus IFRS The basics February 2018 Table of contents Introduction............................................................................. 1 Financial statement presentation............................................ 3 Interim financial reporting ....................................................... 7 Consolidation, joint venture accounting and equity method investees/associates.................................................. 8 Business combinations ..........................................................14 Inventory ...............................................................................18 Long-lived assets ..................................................................20 Intangible assets ...................................................................23 Impairment of long-lived assets, goodwill and intangible assets ...................................................................25 Financial instruments ............................................................29 Foreign currency matters......................................................38 Leases — before the adoption of ASC 842 and IFRS 16 ........40 Leases — after the adoption of ASC 842 and IFRS 16 ...........43 Income taxes .........................................................................47 Provisions and contingencies ................................................51 Revenue recognition — after the adoption of ASC 606 and IFRS 15 ...........................................................................53 Share-based payments..........................................................57 Employee benefits other than share-based payments ..........61 Earnings per share ................................................................63 Segment reporting ................................................................65 Subsequent events ................................................................67 Related parties ......................................................................69 IFRS resources ......................................................................70 Error! No text of specified style in document. Introduction There are two global scale frameworks of financial reporting: US GAAP, as promulgated by the Financial Accounting Standards Board (FASB), and IFRS, as promulgated by the International Accounting Standards Board (IASB) (collectively, the Boards). In this guide, we provide an overview, by accounting area, of the similarities and differences between US GAAP and IFRS. We believe that any discussion of this topic should not lose sight of the fact that the two sets of standards generally have more similarities than differences for most common transactions, with IFRS being largely grounded in the same basic principles as US GAAP. The general principles and conceptual framework are often the same or similar in both sets of standards and lead to similar accounting results. The existence of any differences — and their materiality to an entity’s financial statements — depends on a variety of factors, including the nature of the entity, the details of the transactions, the interpretation of the more general IFRS principles, industry practices and accounting policy elections where US GAAP and IFRS offer a choice. This guide focuses on differences most commonly found in current practice and, when applicable, provides an overview of how and when those differences are expected to converge. 1 Key updates Our analysis generally reflects guidance effective in 2017 and finalized by the FASB and the IASB as of 31 May 2017. We updated this guide to include Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers,1 (largely codified in Accounting Standards Codification (ASC) 606); IFRS 15, Revenue from Contracts with Customers; ASU 2016-02, Leases (largely codified in ASC 842); IFRS 16, Leases; ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities; and IFRS 9, Financial Instruments. We have not included differences before the adoption of ASC 606, IFRS 15, ASU 2016-01 and IFRS 9. Please refer to the October 2016 edition of the tool for these differences. This update doesn’t include differences related to ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, because of the standard’s delayed effective date. Our analysis does not include any guidance related to IFRS for small and medium-sized entities or Private Company Council alternatives that are embedded within US GAAP. We will continue to update this publication periodically for new developments. The guide also includes subsequent amendments in ASU 2015-14, Deferral of the Effective Date; ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net); ASU 2016-10, Identifying Performance Obligations and Licensing; ASU 2016-12, Narrow-Scope Improvements and Practical Expedients; ASU 2016-20, Technical Corrections and Improvements to Topic 606; and ASU 2017-05, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. US GAAP versus IFRS The basics | 1 Introduction * * * * * Our US GAAP/IFRS Accounting Differences Identifier Tool publication provides a more indepth review of differences between US GAAP and IFRS as of 31 May 2017. The tool was developed as a resource for companies that need to analyze the accounting decisions and changes involved in a conversion to IFRS. Conversion is more than just an accounting exercise, and identifying accounting differences is only the first step in the process. Successfully converting to IFRS also entails ongoing project management, systems and process change analysis, tax considerations and a review of all company agreements that are based on financial data and measures. EY assurance, tax and advisory professionals are available to share their experiences and assist companies in analyzing all aspects of the conversion process, from the earliest diagnostic stages through the adoption of the international standards. To learn more about the US GAAP/IFRS Accounting Differences Identifier Tool, please contact your local EY professional. February 2018 US GAAP versus IFRS The basics | 2 Financial statement presentation Financial statement presentation Similarities There are many similarities in US GAAP and IFRS guidance on financial statement presentation. Under both sets of standards, the components of a complete set of financial statements include: a statement of financial position, a statement of profit and loss (i.e., income statement) and a statement of comprehensive income (either a single continuous statement or two consecutive statements), a statement of cash flows and accompanying notes to the financial statements. Both US GAAP and IFRS also require the changes in shareholders’ equity to be presented. However, US GAAP allows the changes in shareholders’ equity to be presented in the notes to the financial statements, while IFRS requires the changes in shareholders’ equity to be presented as a separate statement. Further, both require that the financial statements be prepared on the accrual basis of accounting (with the exception of the cash flow statement) except for rare circumstances. IFRS and the conceptual framework in US GAAP have similar concepts regarding materiality and consistency that entities have to consider in preparing their financial statements. Differences between the two sets of standards tend to arise in the level of specific guidance provided. Significant differences US GAAP IFRS Financial periods required Generally, comparative financial statements are presented; however, a single year may be presented in certain circumstances. Public companies must follow SEC rules, which typically require balance sheets for the two most recent years, while all other statements must cover the three-year period ended on the balance sheet date. Comparative information must be disclosed with respect to the previous period for all amounts reported in the current period’s financial statements. Layout of balance sheet and income statement There is no general requirement within US GAAP to prepare the balance sheet and income statement in accordance with a specific layout; however, public companies must follow the detailed requirements in Regulation S-X. IFRS does not prescribe a standard layout, but includes a list of minimum line items. These minimum line items are less prescriptive than the requirements in Regulation S-X. Balance sheet — presentation of debt as current versus noncurrent Debt for which there has been a covenant violation may be presented as noncurrent if a lender agreement to waive the right to demand repayment for more than one year exists before the financial statements are issued or available to be issued. Debt associated with a covenant violation must be presented as current unless the lender agreement was reached prior to the balance sheet date. US GAAP versus IFRS The basics | 3 Financial statement presentation US GAAP IFRS Balance sheet — Before the adoption of ASU 2015-17, All amounts classified as noncurrent in classification of deferred Balance Sheet Classification of the balance sheet. tax assets and liabilities Deferred Taxes, deferred taxes are classified as current or noncurrent, generally based on the nature of the related asset or liability. After the adoption of ASU 2015-17, all deferred tax assets and liabilities will be classified as noncurrent. (ASU 2015-17 is effective for public business entities (PBEs) in annual periods beginning after 15 December 2016, and interim periods within those annual periods. For other entities, it is effective for annual periods beginning after 15 December 2017, and interim periods within annual periods beginning after 15 December 2018. Early adoption is permitted.) Income statement — classification of expenses No general requirement within US GAAP to classify income statement items by function or nature although there are requirements based on the specific cost incurred (e.g., restructuring charges, shipping and handling costs). However, SEC registrants are generally required to present expenses based on function (e.g., cost of sales, administrative). Entities may present expenses based on either function or nature (e.g., salaries, depreciation). However, if function is selected, certain disclosures about the nature of expenses must be included in the notes. Income statement — discontinued operations criteria Discontinued operations classification is for components that are held for sale or disposed of and represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. Also, a newly acquired business or nonprofit activity that on acquisition is classified as held for sale qualifies for reporting as a discontinued operation. Discontinued operations classification is for components held for sale or disposed of and the component represents a separate major line of business or geographical area, is part of a single coordinated plan to dispose of a separate major line of business or geographical area of or a subsidiary acquired exclusively with an intention to resell. US GAAP versus IFRS The basics | 4 Financial statement presentation US GAAP IFRS Statement of cash flows — restricted cash After the adoption of ASU 2016-18, Statement of Cash Flows (Topic 230) — Restricted Cash, changes in restricted cash and restricted cash equivalents will be shown in the statement of cash flows. In addition, when cash, cash equivalents, restricted cash and restricted cash equivalents are presented in more than one line item on the balance sheet, ASU 2016-18 requires a reconciliation of the totals in the statement of cash flows to the related captions in the balance sheet. This reconciliation can be presented either on the face of the statement of cash flows or in the notes to the financial statements. (ASU 2016-18 is effective for PBEs in annual periods beginning after 15 December 2017, and interim periods within those annual periods. For all other entities, it is effective for annual periods beginning after 15 December 2018, and interim periods within annual periods beginning after 15 December 2019. Early adoption is permitted.) There is no specific guidance about the presentation of changes in restricted cash and restricted cash equivalents on the statement of cash flows. Disclosure of performance measures There is no general requirements within US GAAP address the presentation of specific performance measures. SEC regulations define certain key measures and require the presentation of certain headings and subtotals. Additionally, public companies are prohibited from disclosing non-GAAP measures in the financial statements and accompanying notes. Certain traditional concepts such as “operating profit” are not defined; therefore, diversity in practice exists regarding line items, headings and subtotals presented on the income statement. IFRS permits the presentation of additional line items, headings and subtotals in the statement of comprehensive income when such presentation is relevant to an understanding of the entity’s financial performance. IFRS has requirements on how the subtotals should be presented when they are provided, US GAAP versus IFRS The basics | 5 Financial statement presentation Third balance sheet US GAAP IFRS Not required. A third balance sheet is required as of the beginning of the earliest comparative period when there is a retrospective application of a new accounting policy, or a retrospective restatement or reclassification, that have a material effect on the balances of the third balance sheet. Related notes to the third balance sheet are not required. A third balance sheet is also required in the year an entity first applies IFRS. Standard-setting activities The FASB currently has a simplification project to amend today’s guidance for determining whether to classify debt as current or noncurrent on the balance sheet. The FASB issued an exposure draft in January 2017 that would replace today’s rules-based guidance with a principle-based approach, and in June 2017 it discussed comments received on the proposals. In November 2017, the FASB completed a maintenance update to locate all guidance related to the income statement and the statement of comprehensive income in one place. The guidance that was previously in ASC 225, Comprehensive Income Statement, was relocated to ASC 220, Income Statement — Reporting Comprehensive Income. The IASB currently has a project on its agenda to amend IAS 1, Presentation of Financial Statements, to clarify the criteria for classifying a liability as either current or noncurrent. The IASB issued its exposure draft, Classification of Liabilities, in February 2015, and in December 2015 it discussed comment letters received on that proposal. The IASB has decided to defer making a decision about whether to finalize the proposals until it has redeliberated the definitions of assets and liabilities in the conceptual framework exposure draft. US GAAP versus IFRS The basics | 6 Interim financial reporting Interim financial reporting Similarities ASC 270, Interim Reporting, and IAS 34, Interim Financial Reporting, are substantially similar except for the treatment of certain costs described below. Both require an entity to apply the accounting policies that were in effect in the prior annual period, subject to the adoption of new policies that are disclosed. Both standards allow for condensed interim financial statements and provide for similar disclosure requirements. Under both US GAAP and IFRS, income taxes are accounted for based on an estimated average annual effective tax rates. Neither standard requires entities to present interim financial information. That is the purview of securities regulators such as the SEC, which requires US public companies to comply with Regulation S-X. Significant differences Treatment of certain costs in interim periods US GAAP IFRS Each interim period is viewed as an integral part of an annual period. As a result, certain costs that benefit more than one interim period may be allocated among those periods, resulting in deferral or accrual of certain costs. Each interim period is viewed as a discrete reporting period. A cost that does not meet the definition of an asset at the end of an interim period is not deferred, and a liability recognized at an interim reporting date must represent an existing obligation. Standard-setting activities There is currently no standard-setting activity in this area. US GAAP versus IFRS The basics | 7 Consolidation, joint venture accounting and equity method investees/associates Consolidation, joint venture accounting and equity method investees/associates Similarities ASC 810, Consolidation, contains the main guidance for consolidation of financial statements, including variable interest entities (VIEs), under US GAAP. IFRS 10, Consolidated Financial Statements, contains the IFRS guidance. Under both US GAAP and IFRS, the determination of whether entities are consolidated by a reporting entity is based on control, although there are differences in how control is defined. Generally, all entities subject to the control of the reporting entity must be consolidated (although there are limited exceptions for a reporting entity that meets the definition of an investment company). An equity investment that gives an investor significant influence over an investee (referred to as “an associate” in IFRS) is considered an equity method investment under both US GAAP (ASC 323, Investments — Equity Method and Joint Ventures) and IFRS (IAS 28, Investments in Associates and Joint Ventures). Further, the equity method of accounting for such investments generally is consistent under US GAAP and IFRS. The characteristics of a joint venture in US GAAP (ASC 323) and IFRS (IFRS 11, Joint Arrangements) are similar but certain differences exist. Both US GAAP and IFRS also generally require investors to apply the equity method when accounting for their interests in joint ventures. Significant differences US GAAP IFRS Consolidation model US GAAP provides for primarily two consolidation models (variable interest model and voting model). The variable interest model evaluates control based on determining which party has power and benefits. The voting model evaluates control based on existing voting rights. All entities are first evaluated as potential VIEs. If an entity is not a VIE, it is evaluated for control pursuant to the voting model. Potential voting rights are generally not included in either evaluation. The notion of “de facto control” is not considered. IFRS provides a single control model for all entities, including structured entities (the definition of a structured entity under IFRS 12, Disclosure of Interests in Other Entities, is similar to the definition of a VIE in US GAAP). An investor controls an investee when it is exposed or has rights to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Potential voting rights are considered. Notion of “de facto control” is also considered. Preparation of consolidated financial statements — general Consolidated financial statements are required, although certain industryspecific exceptions exist (e.g., investment companies). Consolidated financial statements are required, although certain industryspecific exceptions exist (e.g., investment entities), and there is a limited exemption from preparing consolidated financial statements for a parent company that is itself a wholly owned or partially owned subsidiary, if certain conditions are met. US GAAP versus IFRS The basics | 8 Consolidation, joint venture accounting and equity method investees/associates US GAAP IFRS Preparation of consolidated financial statements — Investment companies Investment companies do not consolidate entities that might otherwise require consolidation (e.g., majority-owned corporations). Instead, equity investments in these entities are reflected at fair value as a single line item in the financial statements. A parent of an investment company is required to retain the investment company subsidiary’s fair value accounting in the parent’s consolidated financial statements. Investment companies (“investment entities” in IFRS) do not consolidate entities that might otherwise require consolidation (e.g., majority-owned corporations). Instead, these investments are reflected at fair value as a single line item in the financial statements. However, a parent of an investment company consolidates all entities that it controls, including those controlled through an investment company subsidiary, unless the parent itself is an investment company. Preparation of consolidated financial statements — different reporting dates of parent and subsidiaries The reporting entity and the consolidated entities are permitted to have differences in year-ends of up to three months. The effects of significant events occurring between the reporting dates of the reporting entity and the controlled entities are disclosed in the financial statements. The financial statements of a parent and its consolidated subsidiaries are prepared as of the same date. When the parent and the subsidiary have different reporting period end dates, the subsidiary prepares (for consolidation purposes) additional financial statements as of the same date as those of the parent, unless it is impracticable. If it is impracticable, when the difference in the reporting period end dates of the parent and subsidiary is three months or less, the financial statements of the subsidiary may be adjusted to reflect significant transactions and events, and it is not necessary to prepare additional financial statements as of the parent’s reporting date. Uniform accounting policies Uniform accounting policies between Uniform accounting policies between parent and subsidiary are not required. parent and subsidiary are required. Changes in ownership interest in a subsidiary without loss of control Transactions that result in decreases in the ownership interest of a subsidiary without a loss of control are accounted for as equity transactions in the consolidated entity (i.e., no gain or loss is recognized) when: (1) the subsidiary is a business or nonprofit activity (except in a conveyance of oil and gas mineral rights) or (2) the subsidiary is not a business or nonprofit activity, but the substance of the transaction is not addressed directly by other ASC Topics. Consistent with US GAAP, except that this guidance applies to all subsidiaries, including those that are not businesses or nonprofit activities and those that involve the conveyance of oil and gas mineral rights. US GAAP versus IFRS The basics | 9 Consolidation, joint venture accounting and equity method investees/associates 2 US GAAP IFRS Loss of control of a subsidiary For certain transactions that result in a loss of control of a subsidiary, any retained noncontrolling investment in the former subsidiary is remeasured to fair value on the date the control is lost, with the gain or loss included in income along with any gain or loss on the ownership interest sold. This accounting is limited to the following transactions: (1) loss of control of a subsidiary that is a business or nonprofit activity (except for a conveyance of oil and gas mineral rights) and (2) loss of control of a subsidiary that is not a business or nonprofit activity if the substance of the transaction is not addressed directly by other ASC Topics. Consistent with US GAAP, except that this guidance applies to all subsidiaries, including those that are not businesses or nonprofit activities and those that involve conveyance of oil and gas mineral rights. In addition, the gain or loss resulting from the loss of control of a subsidiary that does not constitute a business in a transaction involving an associate or a joint venture that is accounted for using the equity method is recognized only to the extent of the unrelated investors’ interests in that associate or joint venture. 2 Loss of control of a group of assets that meet the definition of a business For certain transactions that result in a loss of control of a group of assets that meet the definition of a business or nonprofit activity, any retained noncontrolling investment in the former group of assets is remeasured to fair value on the date control is lost, with the gain or loss included in income along with any gain or loss on the ownership interest sold. There are two exceptions: a conveyance of oil and gas mineral rights and a transfer of a good or service in a contract with a customer within the scope of ASC 606. For transactions that result in a loss of control of a group of assets that meet the definition of a business, any retained noncontrolling investment in the former group of assets is remeasured to fair value on the date control is lost, with the gain or loss included in income with any gain or loss on the ownership interest sold. Sale or Contribution of Assets between an Investor and its Associate or Joint Venture, Amendments to IFRS 10 and IAS 28 was issued by the IASB in September 2014. In December 2015, the IASB indefinitely deferred the effective date of this amendment. However, early adoption of this amendment is still available. US GAAP versus IFRS The basics | 10 Consolidation, joint venture accounting and equity method investees/associates Equity method investments Joint ventures US GAAP IFRS An investment of 20 % or more of the voting common stock of an investee leads to a presumption that an investor has the ability to exercise significant influence over an investee, unless this presumption can be overcome based on facts and circumstances. An investment of 20% or more of the equity of an investee (including potential rights) leads to a presumption that an investor has the ability to exercise significant influence over an investee, unless this presumption can be overcome based on facts and circumstances. When determining significant influence, potential voting rights are generally not considered. When determining significant influence, potential voting rights are considered if currently exercisable. When an investor in a limited partnership, limited liability company (LLC), trust or similar entity with specific ownership accounts has an interest greater than 3% to 5% in an investee, normally it accounts for its investment using the equity method. When an investor has an investment in a limited partnership, LLC, trust or similar entity, the determination of significant influence is made using the same general principle of significant influence that is used for all other investments. ASC 825-10, Financial Instruments, gives entities the option to account for certain equity method investments at fair value. If management does not elect to use the fair value option, the equity method of accounting is required. Conforming accounting policies between investor and investee is generally not permitted. Investments in associates held by venture capital organizations, mutual funds, unit trusts and similar entities are exempt from using the equity method, and the investor may elect to measure their investments in associates at fair value. Uniform accounting policies between investor and investee are required. Joint ventures are generally defined as entities whose operations and activities are jointly controlled by their equity investors. Joint ventures are separate vehicles in which the parties that have joint control of the separate vehicle have rights to the net assets. These rights could be through equity investors, certain parties with decision-making rights through a contract. Joint control is defined as existing when two or more parties must unanimously consent to each of the significant decisions of the entity. Joint control is not defined, but it is commonly interpreted to exist when all of the equity investors unanimously consent to each of the significant decisions of the entity. An entity can be a joint venture, regardless of the rights and obligations the parties sharing joint control have with respect to the entity’s underlying assets and liabilities. In a joint venture, the parties cannot have direct rights and obligations with respect to the underlying assets and liabilities of the entity (In this case the arrangement would be classified as a joint operation). US GAAP versus IFRS The basics | 11 Consolidation, joint venture accounting and equity method investees/associates US GAAP IFRS The investors generally account for their interests in joint ventures using the equity method of accounting. They also can elect to account for their interests at fair value. The investors generally account for their interests in joint ventures using the equity method of accounting. Investments in associates held by venture capital organizations, mutual funds, unit trusts and similar entities are exempt from using the equity method and the investor may elect to measure its investment at fair value. Proportionate consolidation is not permitted, regardless of industry. However, when a joint arrangement meets the definition of a joint operation instead of a joint venture under IFRS, an investor would recognize its share of the entity’s assets, liabilities, revenues and expenses and not apply the equity method. Proportionate consolidation may be permitted to account for interests in unincorporated entities in certain limited industries when it is an established practice (i.e., in the construction and extractive industries). Standard-setting activities The FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which eliminates the deferral of FAS 167, Amendments to FASB Interpretation No. 46(R), and makes changes to both the variable interest model and the voting model. While the ASU is aimed at asset managers, all reporting entities will have to re-evaluate limited partnerships and similar entities for consolidation and revise their documentation. It also may affect reporting entities that evaluate certain corporations or similar entities for consolidation. The guidance is now effective for PBEs. For all other entities, it is effective for annual periods beginning after 15 December 2016 and for interim periods within annual periods beginning after 15 December 2017. After issuing ASU 2015-02, the FASB amended the consolidation guidance two additional times. In October 2016, the FASB issued ASU 2016-17, Consolidation (Topic 810): Issues Held through Related Parties That Are under Common Control, to amend the primary beneficiary determination related to interests held through related parties under common control. For PBEs, the guidance is effective for annual periods beginning 15 December 2016, and interim periods therein. For all other entities, the effective date is consistent with that of ASU 2015-02. In January 2017, the FASB issued ASU 2017-02, Not-for-Profit Entities — Consolidation (Subtopic 958-810): Clarifying When a Not-forProfit Entity That is a General Partner or a Limited Partner Should Consolidate a ForProfit Limited Partnership or Similar Entity, to retain the presumption that a not-for-profit (NFP) entity that is a general partner in a forprofit limited partnership or similar entity controls the entity, unless that presumption can be overcome. For NFPs, the amendments on the presumption are effective for annual periods beginning after 15 December 2016, US GAAP versus IFRS The basics | 12 Consolidation, joint venture accounting and equity method investees/associates and within interim periods after 15 December 2017. Early adoption is permitted for both ASU 2016-17 and ASU 2017-02, although entities that have not yet adopted ASU 2015-02 are required to adopt all ASUs at the same time. In June 2017, the FASB proposed more changes to the consolidation guidance, including allowing private companies to make an accounting policy election to not apply the VIE guidance for certain common control arrangements. It also proposed changing two aspects of the VIE model for related party groups. Readers should monitor this project for developments. Certain differences between the consolidation guidance in IFRS and that in US GAAP (e.g., effective control, potential voting rights) continue to exist. In March 2016, the FASB issued ASU 2016-07, Investments — Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. ASU 2016-07 eliminates the requirement that an investor retrospectively apply equity method accounting when an investment that it had accounted for by another method initially qualifies for the equity method. By eliminating retrospective application of the equity method, ASU 2016-07 converges US GAAP with IFRS. However, measurement differences may still exist. ASU 2016-07 is effective for all entities for annual periods, and interim periods within those annual periods, beginning after 15 December 2016. Early adoption is permitted. In February 2017, the FASB issued ASU 201705. This guidance changed the measurement of transfers of nonfinancial assets and in substance nonfinancial assets in transactions that are not with customers and that are not businesses. It requires any noncontrolling interest retained or received to be measured at fair value. This aspect of ASU 2017-05 converges US GAAP with IFRS. However, the guidance also requires all transactions in the scope of ASC 610-20 (including sales to equity method investees or joint ventures) to result in a full gain or loss. That is, there will be no intraentity profit elimination in a downstream transaction if the sale is in the scope of ASC 610-20. This aspect of ASU 2017-05 creates a difference between US GAAP and IFRS, because IFRS requires profit to be eliminated in all downstream transactions. In June 2016, the IASB issued an exposure draft that would amend IFRS 3, Business Combinations, to clarify that when an entity obtains control of a business that is a joint operation, it remeasures previously held interests in that business. It also would amend IFRS 11 to clarify that when an entity obtains joint control of a business that is a joint operation, the entity does not remeasure previously held interests in that business. In April 2017, the IASB tentatively decided to finalize the amendments to IFRS 3 and IFRS 11 as proposed. US GAAP versus IFRS The basics | 13 Business combinations Business combinations Similarities The principal guidance for business combinations in US GAAP (ASC 805, Business Combinations) and IFRS (IFRS 3) are largely converged. Pursuant to ASC 805 and IFRS 3, all business combinations are accounted for using the acquisition method. When an entity obtains control of another entity, the underlying transaction is measured at fair value, establishing the basis on which the assets, liabilities and noncontrolling interests of the acquired entity are measured. As described below, IFRS 3 provides an alternative to measuring noncontrolling interest at fair value with limited exceptions. Although the standards (before the issuance of ASU 2017-01, Clarifying the Definition of a Business) are substantially converged, certain differences exist, including those with respect to the definition of a business as described below. For US GAAP/IFRS accounting similarities and differences before the adoption of ASC 606 and IFRS 15, please see the October 2016 edition. Significant differences US GAAP IFRS Measurement of noncontrolling interest Noncontrolling interest is measured at fair value, including goodwill. Noncontrolling interest components that are present ownership interests and entitle their holders to a proportionate share of the acquiree’s net assets in the event of liquidation may be measured at: (1) fair value, including goodwill, or (2) the noncontrolling interest’s proportionate share of the fair value of the acquiree’s identifiable net assets, exclusive of goodwill. All other components of noncontrolling interest are measured at fair value unless another measurement basis is required by IFRS. The choice is available on a transaction-by-transaction basis. Acquiree’s operating leases for a lessor (before and after the adoption of ASC 842, Leases, and IFRS 16) If the terms of an acquiree operating lease are favorable or unfavorable relative to market terms, the acquirer recognizes an intangible asset or liability, respectively. The terms of the lease are taken into account in estimating the fair value of the asset subject to the lease. Separate recognition of an intangible asset or liability is not required. US GAAP versus IFRS The basics | 14 Business combinations Assets and liabilities arising from contingencies Combination of entities under common control US GAAP IFRS Initial recognition and measurement Assets and liabilities arising from contingencies are recognized at fair value (in accordance with ASC 820, Fair Value Measurement and Disclosures) if the fair value can be determined during the measurement period. Otherwise, those assets or liabilities are recognized at the acquisition date in accordance with ASC 450, Contingencies, if those criteria for recognition are met. Contingent assets and liabilities that do not meet either of these recognition criteria at the acquisition date are subsequently accounted for in accordance with other applicable literature, including ASC 450. (See “Provisions and contingencies” for differences between ASC 450 and IAS 37, Provisions, Contingent Liabilities and Contingent Assets). Initial recognition and measurement Liabilities arising from contingencies are recognized as of the acquisition date if there is a present obligation that arises from past events and the fair value can be measured reliably, even if it is not probable that an outflow of resources will be required to settle the obligation. Contingent assets are not recognized. Subsequent measurement If contingent assets and liabilities are initially recognized at fair value, an acquirer should develop a systematic and rational basis for subsequently measuring and accounting for those assets and liabilities depending on their nature. If amounts are initially recognized and measured in accordance with ASC 450, the subsequent accounting and measurement should be based on that guidance. Subsequent measurement Liabilities subject to contingencies are subsequently measured at the higher of: (1) the amount that would be recognized in accordance with IAS 37 or (2) the amount initially recognized less, if appropriate, the cumulative amount of income recognized in accordance with the principles of IFRS 15. The receiving entity records the net assets at their carrying amounts in the accounts of the transferor (historical cost). The combination of entities under common control is outside the scope of IFRS 3. In practice, entities either follow an approach similar to US GAAP (historical cost) or apply the acquisition method (fair value) if there is substance to the transaction (policy election). US GAAP versus IFRS The basics | 15 Business combinations US GAAP IFRS An acquired entity can choose to apply pushdown accounting in its separate financial statements when an acquirer obtains control of it or later. However, an entity’s election to apply pushdown accounting is irrevocable. No guidance exists, and it is unclear whether pushdown accounting is acceptable under IFRS. However, the general view is that entities may not use the hierarchy in IAS 8, Accounting Polices, Changes in Accounting Estimates and Errors, to refer to US GAAP and apply pushdown accounting in the separate financial statements of an acquired subsidiary, because the application of pushdown accounting will result in the recognition and measurement of assets and liabilities in a manner that conflicts with certain IFRS standards and interpretations. For example, the application of pushdown accounting generally will result in the recognition of internally generated goodwill and other internally generated intangible assets at the subsidiary level, which conflicts with the guidance in IAS 38, Intangible Assets. Adjustments to provisional An acquirer recognizes measurementamounts within the period adjustments during the period in measurement period which it determines the amounts, including the effect on earnings of any amounts it would have recorded in previous periods if the accounting had been completed at the acquisition date. An acquirer recognizes measurementperiod adjustments on a retrospective basis. The acquirer revises comparative information for any prior periods presented, including revisions for any effects on the prior-period income statement. Definition of a business after the adoption of ASU 2017-01 Definition of a business A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business. The term “substantive process” is not defined in IFRS 3. An integrated set of activities and assets requires two essential elements — inputs and processes applied to those inputs, which together are or will be used to create outputs. However, a business does not have to include all of the inputs or processes that the seller used in operating that business if market participants are capable of Pushdown accounting Definition of a business A business must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. An output is the result of inputs and processes applied to those inputs that provide goods or services to customers, investment income (such as dividends or interest, or other revenues. That is, the focus is on revenue-generating activities, which more closely aligns the definition with the description of outputs in the new revenue guidance in ASC 606. US GAAP versus IFRS The basics | 16 Business combinations US GAAP IFRS An entity does not need to evaluate acquiring the business and continuing whether any missing elements could be to produce outputs, for example, by replaced by a market participant. integrating the business with their own inputs and processes. Outputs are defined as the result of inputs and processes applied to those inputs that provide or have the ability to provide a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants. Threshold test Threshold test An entity must first evaluate whether There is no threshold test under IFRS 3. substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets. If that threshold is met, the set is not a business and does not require further evaluation. Gross assets acquired should exclude cash and cash equivalents, deferred tax assets and any goodwill that would be created in a business combination from the recognition of deferred tax liabilities. Other differences may arise due to different accounting requirements of other existing US GAAP and IFRS literature (e.g., identifying the acquirer, definition of control, replacement of share-based payment awards, initial classification and subsequent measurement of contingent consideration, initial recognition and measurement of income taxes, initial recognition and measurement of employee benefits). Standard-setting activities The FASB and the IASB issued substantially converged standards in December 2007 and January 2008, respectively. Both boards have completed post-implementation reviews of their respective standards and separately discussed several narrow-scope projects. In January 2017, the FASB issued ASU 2017-01 to clarify certain aspects of the definition of a business. In June 2016, the IASB issued an exposure draft on the definition of a business as a result of concerns raised in its post-implementation review about the complexity of its application. In addition, the IASB has a research project on business combinations of entities under common control. US GAAP versus IFRS The basics | 17 Inventory Inventory Similarities ASC 330, Inventory, and IAS 2, Inventories, are based on the principle that the primary basis of accounting for inventory is cost. Both standards define inventory as assets held for sale in the ordinary course of business, in the process of production for such sale or to be consumed in the production of goods or services. Significant differences Permissible techniques for cost measurement, such as the retail inventory method (RIM), are similar under both US GAAP and IFRS. Further, under both sets of standards, the cost of inventory includes all direct expenditures to ready inventory for sale, including allocable overhead, while selling costs are excluded from the cost of inventories, as are most storage costs and general administrative costs. US GAAP IFRS Costing methods Last in, first out (LIFO) is an acceptable LIFO is prohibited. Same cost formula method. A consistent cost formula for must be applied to all inventories all inventories similar in nature is not similar in nature or use to the entity. explicitly required. Measurement Before the adoption of ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, inventory is carried at the lower of cost or market. Market is defined as current replacement cost, but not greater than net realizable value (estimated selling price less reasonable costs of completion, disposal and transportation) and not less than net realizable value reduced by a normal sales margin. After the adoption of ASU 2015-11, inventory other than that accounted for under the LIFO or RIM is carried at the lower of cost and net realizable value. Reversal of inventory write-downs Any write-down of inventory below cost Previously recognized impairment losses creates a new cost basis that are reversed up to the amount of the subsequently cannot be reversed. original impairment loss when the reasons for the impairment no longer exist. Permanent inventory markdowns under RIM Permanent markdowns do not affect the gross margins used in applying the RIM. Rather, such markdowns reduce the carrying cost of inventory to net realizable value, less an allowance for an approximately normal profit margin, which may be less than both original cost and net realizable value. Inventory is carried at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling price less the estimated costs of completion and the estimated costs necessary to make the sale. Permanent markdowns affect the average gross margin used in applying the RIM. Reduction of the carrying cost of inventory to below the lower of cost and net realizable value is not allowed. US GAAP versus IFRS The basics | 18 Inventory US GAAP Capitalization of pension After the adoption of ASU 2017-07, costs Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, the service cost component of net periodic pension cost and net periodic postretirement benefit cost is the only component directly arising from employees’ services provided in the current period. Therefore, when it is appropriate to capitalize employee compensation in connection with the construction or production of an asset, the service cost component applicable to the pertinent employees for the period is the relevant amount to be considered for capitalization. (ASU 2017-07 is effective for PBEs in annual periods beginning after 15 December 2017, and interim periods within those annual periods. For all other entities, it is effective for annual periods beginning after 15 December 2018, and interim periods within annual periods beginning after 15 December 2019. Early adoption is permitted.) IFRS Any post-employment benefit costs included in the cost of inventory include the appropriate proportion of the components of defined benefit cost (i.e., service cost, net interest on the net defined benefit liability (asset) and remeasurements of the net defined benefit liability (asset). Standard-setting activities In July 2015, the FASB issued ASU 2015-11, which requires that inventories, other than those accounted for under the LIFO method or RIM, be measured at the lower of cost and net realizable value. The guidance is effective for PBEs for annual periods beginning after 15 December 2016, and interim periods within those annual periods. For all other entities, it is effective for annual periods beginning after 15 December 2016, and interim periods within annual periods beginning after 15 December 2017. Early adoption is permitted as of the beginning of an interim or annual reporting period. This ASU will generally result in convergence in the subsequent measurement of inventories other than those accounted for under the LIFO method or RIM. US GAAP versus IFRS The basics | 19 Long-lived assets Long-lived assets Similarities Although US GAAP does not have a comprehensive standard that addresses longlived assets, its definition of property, plant and equipment is similar to IAS 16, Property, Plant and Equipment, which addresses tangible assets held for use that are expected to be used for more than one reporting period. Other concepts that are similar include the following: Cost Both accounting models have similar recognition criteria, requiring that costs be included in the cost of the asset if future economic benefits are probable and can be reliably measured. Neither model allows the capitalization of start-up costs, general administrative and overhead costs or regular maintenance. Both US GAAP and IFRS require that the costs of dismantling an asset and restoring its site (i.e., the costs of asset retirement under ASC 410-20, Asset Retirement and Environmental Obligations — Asset Retirement Obligations or IAS 37) be included in the cost of the asset when there is a legal obligation, but IFRS requires provision in other circumstances as well. Capitalized interest ASC 835-20, Interest — Capitalization of Interest, and IAS 23, Borrowing Costs, require the capitalization of borrowing costs (e.g., interest costs) directly attributable to the acquisition, construction or production of a qualifying asset. Qualifying assets are generally defined similarly under both accounting models. However, there are differences between US GAAP and IFRS in the measurement of eligible borrowing costs for capitalization. Depreciation Depreciation of long-lived assets is required on a systematic basis under both accounting models. ASC 250, Accounting Changes and Error Corrections, and IAS 8 both treat changes in residual value and useful economic life as a change in accounting estimate requiring prospective treatment. Assets held for sale Assets held for sale criteria are similar in the Impairment or Disposal of Long-Lived Assets subsections of ASC 360-10, Property, Plant and Equipment (and in ASC 205-20, Presentation of Financial Statements — Discontinued Operations), and IFRS 5, Non-current Assets Held for Sale and Discontinued Operations. Under both standards, the asset is measured at the lower of its carrying amount or fair value less costs to sell, the assets are not depreciated and they are presented separately on the face of the balance sheet. Exchanges of nonmonetary similar productive assets are also treated similarly under ASC 845, Nonmonetary Transactions, and IAS 16, both of which allow gain or loss recognition if the exchange has commercial substance and the fair value of the exchange can be reliably measured. US GAAP versus IFRS The basics | 20 Long-lived assets Significant differences US GAAP IFRS Revaluation of assets Revaluation is not permitted. Revaluation is a permitted accounting policy election for an entire class of assets, requiring revaluation to fair value on a regular basis. Depreciation of asset components Component depreciation is permitted, but it is not common. Component depreciation is required if components of an asset have differing patterns of benefit. Measurement of borrowing costs Eligible borrowing costs do not include exchange rate differences. Interest earned on the investment of borrowed funds generally cannot offset interest costs incurred during the period. For borrowings associated with a specific qualifying asset, borrowing costs equal to the weighted-average accumulated expenditures times the borrowing rate are capitalized. Eligible borrowing costs include exchange rate differences from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. For borrowings associated with a specific qualifying asset, actual borrowing costs are capitalized offset by investment income earned on those borrowings. Costs of a major overhaul Multiple accounting models have evolved in practice for entities in the airline industry, including expense costs as incurred, capitalize costs and amortize through the date of the next overhaul, or follow the built-in overhaul approach (i.e., an approach with certain similarities to composite depreciation). Costs that represent a replacement of a previously identified component of an asset are capitalized if future economic benefits are probable and the costs can be reliably measured. Otherwise, these costs are expensed as incurred. Investment property Investment property is not separately defined and, therefore, is accounted for as held and used or held for sale. Before the adoption of IFRS 16, investment property is separately defined in IAS 40, Investment Property, as property held to earn rent or for capital appreciation (or both) and may include property held by lessees under a finance or operating lease. Investment property may be accounted for on a historical cost basis or on a fair value basis as an accounting policy election. Capitalized operating leases classified as investment property must be accounted for using the fair value model. US GAAP versus IFRS The basics | 21 Long-lived assets US GAAP IFRS After the adoption of IFRS 16, investment property is separately defined in IAS 40 as property held to earn rent or for capital appreciation (or both) and may include property held by lessees as right-of-use assets. Investment property may be accounted for on a historical cost or fair value basis as an accounting policy election. IFRS 16 requires a lessee to measure right-ofuse assets arising from leased property in accordance with the fair value model of IAS 40 if the leased property meets the definition of investment property and the lessee elects the fair value model in IAS 40 as an accounting policy. Other differences include: hedging gains and losses related to the purchase of assets, constructive obligations to retire assets, the discount rate used to calculate asset retirement costs and the accounting for changes in the residual value. Standard-setting activities There is currently no standard-setting activity in this area. US GAAP versus IFRS The basics | 22 Intangible assets Intangible assets Similarities Both US GAAP (ASC 805 and ASC 350, Intangibles — Goodwill and Other) and IFRS (IFRS 3 and IAS 38) define intangible assets as nonmonetary assets without physical substance. The recognition criteria for both accounting models require that there be probable future economic benefits from costs that can be reliably measured, although some costs are never capitalized as intangible assets (e.g., start-up costs). Goodwill is recognized only in a business combination. With the exception of development costs (addressed below), internally developed intangibles are not recognized as assets under either ASC 350 or IAS 38. Moreover, internal costs related to the research phase of research and development are expensed as incurred under both accounting models. Amortization of intangible assets over their estimated useful lives is required under both US GAAP and IFRS, with one US GAAP minor exception in ASC 985-20, Software — Costs of Software to be Sold, Leased or Marketed, related to the amortization of computer software sold to others. In both sets of standards, if there is no foreseeable limit to the period over which an intangible asset is expected to generate net cash inflows to the entity, the useful life is considered to be indefinite and the asset is not amortized. Goodwill is never amortized under either US GAAP or IFRS. For US GAAP/IFRS accounting similarities and differences before the adoption of ASC 606 and IFRS 15, please see the October 2016 edition. Significant differences US GAAP IFRS Development costs Development costs are expensed as incurred unless addressed by guidance in another ASC Topic. Development costs related to computer software developed for external use are capitalized once technological feasibility is established in accordance with specific criteria (ASC 985-20). In the case of software developed for internal use, only those costs incurred during the application development stage (as defined in ASC 350-40, Intangibles — Goodwill and Other — Internal-Use Software) may be capitalized. Development costs are capitalized when technical and economic feasibility of a project can be demonstrated in accordance with specific criteria, including: demonstrating technical feasibility, intent to complete the asset and ability to sell the asset in the future. Although application of these principles may be largely consistent with ASC 985-20 and ASC 350-40, there is no separate guidance addressing computer software development costs. Advertising costs Advertising and promotional costs are either expensed as incurred or expensed when the advertising takes place for the first time (policy choice). Advertising and promotional costs are expensed as incurred. A prepayment may be recognized as an asset only when payment for the goods or services is made in advance of the entity having access to the goods or receiving the services. US GAAP versus IFRS The basics | 23 Intangible assets Revaluation US GAAP IFRS Revaluation is not permitted. Revaluation to fair value of intangible assets other than goodwill is a permitted accounting policy election for a class of intangible assets. Because revaluation requires reference to an active market for the specific type of intangible, this is relatively uncommon in practice. Standard-setting activities The FASB is conducting research with the objective of further reducing the cost and complexity of the subsequent accounting for goodwill (e.g., considering an amortization approach). The FASB also is conducting research on accounting for identifiable intangible assets in a business combination with the objective of evaluating whether certain identifiable intangible assets acquired in a business combination should be subsumed into goodwill. The IASB has a similar project on its research agenda to consider improvements to the impairment requirements for goodwill that was added in response to the findings in its postimplementation review of IFRS 3. Currently, these are not joint projects and generally are not expected to converge the guidance on accounting for goodwill impairment. In its research project on goodwill and impairment, the IASB plans to similarly consider the subsequent accounting for goodwill. The IASB also is considering which intangible assets should be recognized apart from goodwill as part of the research project on goodwill and impairment. US GAAP versus IFRS The basics | 24 Impairment of long-lived assets, goodwill and intangible assets Impairment of long-lived assets, goodwill and intangible assets Similarities Under both US GAAP and IFRS, long-lived assets are not tested annually, but rather when there are similarly defined indicators of impairment. Both standards require goodwill and intangible assets with indefinite useful lives to be tested at least annually for impairment and more frequently if impairment indicators are present. In addition, both US GAAP and IFRS require that the impaired asset be written down and an impairment loss recognized. ASC 350, subsections of ASC 360-10 and IAS 36, Impairment of Assets, apply to most long-lived and intangible assets, although some of the scope exceptions listed in the standards differ. Despite the similarity in overall objectives, differences exist in the way impairment is tested, recognized and measured. Significant differences US GAAP IFRS Method of determining impairment — long-lived assets The two-step approach requires that a recoverability test be performed first (the carrying amount of the asset is compared with the sum of future undiscounted cash flows using entityspecific assumptions generated through use and eventual disposition). If it is determined that the asset is not recoverable, an impairment loss calculation is required. The one-step approach requires that an impairment loss calculation be performed if impairment indicators exist. Impairment loss calculation — long-lived assets An impairment loss is the amount by which the carrying amount of the asset exceeds its fair value using market participant assumptions, as calculated in accordance with ASC 820. An impairment loss is the amount by which the carrying amount of the asset exceeds its recoverable amount, which is the higher of: (1) fair value less costs to sell and (2) value in use (the present value of future cash flows in use, including disposal value). Assignment of goodwill Goodwill is assigned to a reporting unit, which is defined as an operating segment or one level below an operating segment (component). Goodwill is allocated to a cashgenerating unit (CGU) or group of CGUs that represents the lowest level within the entity at which the goodwill is monitored for internal management purposes and cannot be larger than an operating segment (before aggregation) as defined in IFRS 8, Operating Segments. US GAAP versus IFRS The basics | 25 Impairment of long-lived assets, goodwill and intangible assets US GAAP IFRS Method of determining impairment — goodwill A company has the option to qualitatively assess whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Before the adoption of ASU 2017-04, Simplifying the Test for Goodwill Impairment, the company performs a recoverability test under the two-step approach first at the reporting unit level (the carrying amount of the reporting unit is compared with the reporting unit’s fair value). If the carrying amount of the reporting unit exceeds its fair value, the company performs impairment testing. After the adoption of ASU 2017-04, the company performs an impairment test under the one-step approach at the reporting unit level by comparing the reporting unit’s carrying amount with its fair value. (ASU 2017-04 is effective for annual and interim impairment tests performed in periods beginning after (1) 15 December 2019 for PBEs that meet the definition of an SEC filer, (2) 15 December 2020 for PBEs that are not SEC filers, and (3) 15 December 2021 for all other entities. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates on or after 1 January 2017. The ASU will be applied prospectively.) Qualitative assessment is not permitted. The one-step approach requires that an impairment test be done at the CGU level by comparing the CGU’s carrying amount, including goodwill, with its recoverable amount. Method of determining impairment — indefinitelived intangibles Companies have the option to qualitatively assess whether it is more likely than not that an indefinite-lived intangible asset is impaired. If a quantitative test is performed, the quantitative impairment test for an indefinite-lived intangible asset requires a comparison of the fair value of the asset with its carrying amount. If the carrying amount of an intangible asset exceeds its fair value, a company should recognize an impairment loss in an amount equal to that excess. Qualitative assessment is not permitted. The one-step approach requires that an impairment test be done at the CGU level by comparing the CGU’s carrying amount, including goodwill, with its recoverable amount. US GAAP versus IFRS The basics | 26 Impairment of long-lived assets, goodwill and intangible assets US GAAP IFRS Impairment loss calculation — goodwill Before the adoption of ASU 2017-04, an impairment loss is the amount by which the carrying amount of goodwill exceeds the implied fair value of the goodwill within its reporting unit. After the adoption of ASU 2017-04, an impairment loss is the amount by which the reporting unit’s carrying amount exceeds the reporting unit’s fair value. The impairment loss will be limited to the amount of goodwill allocated to that reporting unit. The impairment loss on the CGU (the amount by which the CGU’s carrying amount, including goodwill, exceeds its recoverable amount) is allocated first to reduce goodwill to zero, then, subject to certain limitations, the carrying amount of other assets in the CGU are reduced pro rata, based on the carrying amount of each asset. Level of assessment — indefinite-lived intangible assets Indefinite-lived intangible assets separately recognized should be assessed for impairment individually unless they operate in concert with other indefinite-lived intangible assets as a single asset (i.e., the indefinitelived intangible assets are essentially inseparable). Indefinite-lived intangible assets may not be combined with other assets (e.g., finite-lived intangible assets or goodwill) for purposes of an impairment test. If the indefinite-lived intangible asset does not generate cash inflows that are largely independent of those from other assets or groups of assets, then the indefinite-lived intangible asset should be tested for impairment as part of the CGU to which it belongs, unless certain conditions are met. Impairment loss calculation — indefinitelived intangible assets The amount by which the carrying amount of the asset exceeds its fair value. The amount by which the carrying amount of the asset exceeds its recoverable amount. Reversal of loss Prohibited for all assets to be held and used. Prohibited for goodwill. Other assets must be reviewed at the end of each reporting period for reversal indicators. If appropriate, loss should be reversed up to the newly estimated recoverable amount, not to exceed the initial carrying amount adjusted for depreciation. US GAAP versus IFRS The basics | 27 Impairment of long-lived assets, goodwill and intangible assets Standard-setting activities The FASB is conducting research with the objective of further reducing the cost and complexity of the subsequent accounting for goodwill (e.g., considering an amortization approach). The FASB also is conducting research on accounting for identifiable intangible assets in a business combination with the objective of evaluating whether certain identifiable intangible assets acquired in a business combination should be subsumed into goodwill. The IASB has a similar project on its research agenda to consider improvements to the impairment requirements for goodwill that was added in response to the findings in its postimplementation review of IFRS 3. In its research project on goodwill and impairment, the IASB plans to similarly consider the subsequent accounting for goodwill. The IASB also is considering which intangible assets should be recognized apart from goodwill, as part of the research project on goodwill and impairment. US GAAP versus IFRS The basics | 28 Financial instruments Financial instruments Similarities The US GAAP guidance for financial instruments is located in numerous ASC topics, including ASC 310, Receivables; ASC 320, Investments — Debt Securities; ASC 321, Investments — Equity Securities; ASC 470, Debt; ASC 480, Distinguishing Liabilities from Equity; ASC 815, Derivatives and Hedging; ASC 820; ASC 825, Financial Instruments; ASC 860, Transfers and Servicing; and ASC 948, Financial Services — Mortgage Banking. The IFRS guidance for financial instruments, on the other hand, is limited to IAS 32, Financial Instruments: Presentation; IFRS 9; IFRS 7, Financial Instruments: Disclosures; and IFRS 13, Fair Value Measurement. Both US GAAP and IFRS (1) require financial instruments to be classified into specific categories to determine the measurement of those instruments, (2) clarify when financial instruments should be recognized or derecognized in financial statements, (3) require the recognition of all derivatives on the balance sheet and (4) require detailed disclosures in the notes to the financial statements for the financial instruments reported in the balance sheet. Both sets of standards also allow hedge accounting and the use of a fair value option. Significant differences US GAAP IFRS US GAAP specifically identifies certain instruments with characteristics of both debt and equity that must be classified as liabilities. Classification of certain instruments with characteristics of both debt and equity is largely based on the contractual obligation to deliver cash, assets or an entity’s own shares. Economic compulsion does not constitute a contractual obligation. Certain other contracts that are indexed to, and potentially settled in, an entity’s own stock may be classified as equity if they either: (1) require physical settlement or net-share settlement, or (2) give the issuer a choice of net-cash settlement or settlement in its own shares. Contracts that are indexed to, and potentially settled in, an entity’s own stock are classified as equity if settled only by delivering a fixed number of shares for a fixed amount of cash. Debt versus equity Classification US GAAP versus IFRS The basics | 29 Financial instruments Compound (hybrid) financial instruments US GAAP IFRS Compound (hybrid) financial instruments (e.g., convertible bonds) are not split into debt and equity components unless certain specific requirements are met, but they may be bifurcated into debt and derivative components, with the derivative component accounted for using fair value accounting. Compound (hybrid) financial instruments are required to be split into a debt and equity component or, if applicable, a derivative component. The derivative component is accounted for using fair value accounting. Recognition and measurement Measurement — debt securities, loans and receivables Classification and measurement depend largely on the legal form of the instrument (i.e., whether the financial asset represents a security or a loan) and management’s intent for the instrument. At acquisition, debt instruments that meet the definition of a security are classified in one of three categories and subsequently measured as follows: • Held to maturity (HTM) — amortized cost • Trading — fair value, with changes in fair value recognized in net income (FV-NI) • Available for sale (AFS) — fair value, with changes in fair value recognized in other comprehensive income (FV-OCI) Unless the fair value option is elected, loans and receivables are classified as either: (1) held for investment, and then measured at amortized cost, or (2) held for sale, and then measured at the lower of cost or fair value. Regardless of an instrument’s legal form, its classification and measurement depend on its contractual cash flow (CCF) characteristics and the business model under which it is managed. The assessment of the CCF determines whether the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. Financial assets that pass the cash flow characteristics test are subsequently measured at amortized cost, FV-OCI or FV-NI, based on the entity’s business model for managing them, unless the fair value option is elected. Financial assets that fail the cash flow characteristics test are subsequently measured at FV-NI. US GAAP versus IFRS The basics | 30 Financial instruments Measurement — equity investments (except those accounted for under the equity method, those that result in consolidation of the investee and certain other investments) US GAAP IFRS Equity investments are measured at FVNI. A measurement alternative is available for equity investments that do not have readily determinable fair values and do not qualify for the net asset value (NAV) practical expedient under ASC 820. These investments may be measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. Equity investments are measured at FV-NI. An irrevocable FV-OCI election is available for nonderivative equity investments that are not held for trading. If the FV-OCI election is made, gains or losses recognized in other comprehensive income (OCI) are not recycled (i.e., reclassified to earnings) upon derecognition of those investments. Measurement — effective US GAAP requires a catch-up interest method approach, retrospective method or prospective method of calculating the interest for amortized cost-based assets (when estimated cash flows are used), depending on the type of instrument. IFRS requires the original effective interest rate to be used throughout the life of the financial instrument, except for certain reclassified financial assets. When estimated cash flows change, an entity follows an approach that is analogous to the catch-up method under US GAAP. Impairment Impairment recognition — Declines in fair value below cost may debt instruments result in an impairment loss being measured at FV-OCI recognized in the income statement on a debt instrument measured at FV-OCI due solely to a change in interest rates (risk-free or otherwise) if the entity has the intent to sell the debt instrument or it is more likely than not that it will be required to sell the debt instrument before its anticipated recovery. In this circumstance, the impairment loss is measured as the difference between the debt instrument’s amortized cost basis and its fair value. When a credit loss exists, but (1) the entity does not intend to sell the debt instrument, or (2) it is not more likely than not that the entity will be required to sell the debt instrument before the recovery of the remaining cost basis, the impairment is separated into the amount representing the credit loss and the amount related to all other factors. Under IFRS, there is a single impairment model for debt instruments recorded at amortized cost and at FV-OCI, including loans and debt securities. The guiding principle is to reflect the general pattern of deterioration or improvement in the credit quality of financial instruments. The amount of expected credit loss (ECL) recognized as a loss allowance depends on the extent of credit deterioration since initial recognition. Generally there are two measurement bases: • In stage 1, 12-month ECL, which applies to all items (on initial recognition and thereafter) as long as there is no significant deterioration in credit risk • In stages 2 and 3, lifetime ECL, which applies whenever there has been a significant increase in credit risk. In stage 3, a credit event has occurred, and interest income is calculated on the asset’s amortized cost (i.e., net of the allowance). In contrast, in stage 2 interest income is calculated on the asset’s gross carrying amount. US GAAP versus IFRS The basics | 31 Financial instruments Impairment recognition — equity instruments US GAAP IFRS The amount of the total impairment related to the credit loss is recognized in the income statement and the amount related to all other factors is recognized in OCI, net of applicable taxes. For financial assets that are debt instruments measured at FV-OCI, impairment gains and losses are recognized in net income. However, the ECLs do not reduce the carrying amount of the financial assets in the statement of financial position, which remains at fair value. Instead, impairment gains and losses are accounted for as an adjustment to the revaluation reserve accumulated in OCI (the “accumulated impairment amount”), with a corresponding charge to net income. When a debt security measured at FVOCI is derecognized, IFRS requires the cumulative gains and losses previously recognized in OCI to be reclassified to net income. When an impairment loss is recognized in the income statement, a new cost basis in the instrument is established, which is the previous cost basis less the impairment recognized in earnings. As a result, impairment losses recognized in the income statement cannot be reversed for any future recoveries. If the amount of ECLs decreases, the accumulated impairment amount in OCI is reduced, with a corresponding adjustment to net income. Under US GAAP, equity investments are generally measured at FV-NI and therefore not reviewed for impairment. However, an equity investment without a readily determinable fair value for which the measurement alternative has been elected is qualitatively assessed for impairment at each reporting date. If a qualitative assessment indicates that the investment is impaired, the entity will have to estimate the investment’s fair value in accordance with ASC 820 and, if the fair value is less than the investment’s carrying value, recognize an impairment loss in net income equal to the difference between carrying value and fair value. Equity instruments are measured at FV-NI or FV-OCI. For equity instruments measured at FV-OCI, gains and losses recognized in OCI are never reclassified to earnings. Therefore, equity instruments are not reviewed for impairment. US GAAP versus IFRS The basics | 32 Financial instruments US GAAP Impairment recognition — Under US GAAP, the impairment model financial assets measured for loans and other receivables is an at amortized cost incurred loss model. Losses from uncollectible receivables are recognized when (1) it is probable that a loss has been incurred (i.e., when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the receivable) and (2) the amount of the loss is reasonably estimable. The total allowance for credit losses should include amounts that have been measured for impairment, whether individually under ASC 310-10 or collectively (in groups of receivables) under ASC 450-20. Changes in the allowance are recognized in earnings. Write-downs (charge-offs) of loans and other receivables are recorded when the asset is deemed uncollectible. For HTM debt securities the impairment analysis is the same as it is for debt securities measured at FV-OCI, except that an entity should not consider whether it intends to sell, or will more likely than not be required to sell, the debt security before the recovery of its amortized cost basis. That is because the entity has already asserted its intent and ability to hold an HTM debt security to maturity. When an investor does not expect to recover the entire amortized cost of the HTM debt security, the HTM debt security is written down to its fair value. The amount of the total impairment related to the credit loss is recognized in the income statement, and the amount related to all other factors is recognized in OCI. The carrying amount of an HTM debt security after the recognition of an impairment is the fair value of the debt instrument at the date of the impairment. The new cost basis of the debt instrument is equal to the IFRS Under IFRS, there is a single impairment model for debt instruments recorded at amortized cost or FV-OCI, including loans and debt securities. Refer to “Impairment recognition — debt instruments measured at FV-OCI” above for a discussion of this model. For financial assets measured at amortized cost, the carrying amount of the instrument is reduced through the use of an allowance account. In subsequent reporting periods, if the amount of ECLs decreases, the allowance is reduced with a corresponding adjustment to net income. Write-downs (charge-offs) of loans and other receivables are recorded when the entity has no reasonable expectation of recovering all or a portion of the CCFs of the asset. US GAAP versus IFRS The basics | 33 Financial instruments US GAAP IFRS previous cost basis less the impairment recognized in the income statement. The impairment recognized in OCI for an HTM debt security is accreted to the carrying amount of the HTM instrument over its remaining life. This accretion does not affect earnings. Derivatives and hedging Definition of a derivative To meet the definition of a derivative, an and scope exceptions instrument must (1) have one or more underlyings, and, one or more notional amounts or payment provisions or both, (2) require no initial net investment, as defined, and (3) be able to be settled net, as defined. Certain scope exceptions exist for instruments that would otherwise meet these criteria. The IFRS definition of a derivative does not include a requirement that a notional amount be indicated, nor is net settlement a requirement. Certain of the scope exceptions under IFRS differ from those under US GAAP. Hedging risk components The risk components of financial instruments that may be hedged are specifically defined by the literature, with no additional flexibility. With the exception of foreign currency risk, a risk component associated with a nonfinancial item may not be hedged. Hedging of risk components of both financial and nonfinancial items is allowed, provided that the risk component is separately identifiable and reliably measurable. Hedge effectiveness To qualify for hedge accounting the relationship must be “highly effective.” Prospective and retrospective assessment of hedge effectiveness is required on a periodic basis (at least quarterly). The shortcut method for interest rate swaps hedging recognized debt instruments is permitted. The long-haul method of assessing and measuring hedge effectiveness for a fair value hedge of the benchmark interest rate component of a fixed rate debt instrument requires that all CCFs be considered in calculating the change in the hedged item’s fair value even though only a component of the contractual coupon payment is the designated hedged item. To qualify for hedge accounting, there must be an economic relationship between the hedged item and the hedging instrument, the value changes resulting from that economic relationship cannot be dominated by credit risk, and the hedge ratio should generally be the same as the ratio management actually uses to hedge the quantity of the hedged item. Only prospective assessment of effectiveness is required at each reporting period. The shortcut method for interest rate swaps hedging recognized debt is not permitted. Under IFRS, the assessment and measurement of hedge effectiveness for a fair value hedge of the benchmark interest rate component of a fixed rate debt instrument generally considers only the change in fair value of the designated benchmark cash flows. US GAAP versus IFRS The basics | 34 Financial instruments US GAAP IFRS A hedging instrument’s time value can be excluded from the effectiveness assessment. The change in fair value of any excluded time value is recognized currently in earnings. A hedging instrument’s time value and foreign currency basis spread can be excluded from the effectiveness assessment. The change in fair value of any excluded components is deferred in accumulated other comprehensive income and reclassified based on the nature of the hedged item (i.e., transaction-related or time-period related). Derecognition of financial assets (i.e., sales treatment) occurs when effective control over the financial asset has been surrendered: • The transferred financial assets are legally isolated from the transferor • Each transferee (or, if the transferee is a securitization entity or an entity whose sole purpose is to facilitate an asset-backed financing, each holder of its beneficial interests), has the right to pledge or exchange the transferred financial assets (or beneficial interests) • The transferor does not maintain effective control over the transferred financial assets or beneficial interests (e.g., through a call option or repurchase agreement) Derecognition of financial assets is based on a mixed model that considers transfer of risks and rewards and control. Transfer of control is considered only when the transfer of risks and rewards assessment is not conclusive. If the transferor has neither retained nor transferred substantially all of the risks and rewards, there is then an evaluation of the transfer of control. Control is considered to be surrendered if the transferee has the practical ability to unilaterally sell the transferred asset to a third party without restrictions. There is no legal isolation test. The derecognition criteria may be applied to a portion of a financial asset only if it mirrors the characteristics of the original entire financial asset. The derecognition criteria may be applied to a portion of a financial asset if the cash flows are specifically identified or represent a pro rata share of the financial asset or a pro rata share of specifically identified cash flows. Day one gains and losses Entities are not precluded from recognizing day one gains and losses on financial instruments reported at fair value even when all inputs to the measurement model are not observable, including when the fair value measurement is based on a valuation model with significant unobservable inputs (i.e., level 3 measurements). Day one gains and losses on financial instruments are recognized only when their fair value is evidenced by a quoted price in an active market for an identical asset or liability (i.e., a level 1input) or based on a valuation technique that uses only data from observable markets. Excluded components Derecognition Derecognition of financial assets Fair value measurement US GAAP versus IFRS The basics | 35 Financial instruments US GAAP Practical expedient for alternative investments IFRS Entities are provided a practical expedient There is no practical expedient for to estimate the fair value of certain estimating fair value using NAV for alternative investments (e.g., a limited certain alternative investments. partner interest in a Private Equity fund) using NAV or its equivalent. Other differences include: (1) definitions of a derivative and embedded derivative, (2) cash flow hedge — basis adjustment and effectiveness testing, (3) normal purchase and sale exception, (4) foreign exchange gain and/or losses on AFS investments, (5) recognition of basis adjustments when hedging future transactions, (6) hedging net investments, (7) cash flow hedge of intercompany transactions, (8) hedging with internal derivatives, (9) impairment criteria for equity investments, (10) puttable minority interest, (11) netting and offsetting arrangements, (12) unit of account eligible for derecognition and (13) accounting for servicing assets and liabilities. Standard-setting activities The FASB and the IASB have been engaged in projects to simplify and improve the accounting for financial instruments. Recognition and measurement In January 2016, the FASB issued ASU 2016-01. The FASB ultimately decided to make only targeted amendments to existing guidance. As a result, entities that report under US GAAP will use a significantly different model for classifying and measuring financial instruments than entities that report under IFRS. ASU 2016-01 is effective for PBEs in annual periods beginning after 15 December 2017, and interim periods within those annual periods. For all other entities, it is effective for annual periods beginning after 15 December 2018, and interim periods in annual periods beginning after 15 December 2019. Other entities can adopt the entire standard at the same time as PBEs, and all entities can early adopt certain provisions. IFRS 9 is effective for annual periods beginning on or after1 January 2018. In July 2014, the IASB issued the final version of IFRS 9, which made significant changes to the guidance on the recognition and measurement of financial instruments. Impairment The FASB initially worked with the IASB to develop new guidance, but the Boards ultimately were unable to reach a converged solution. The FASB’s ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, issued in June 2016, differs from the three-stage impairment model the IASB finalized as part of IFRS 9. Under the FASB’s approach, an entity will record an allowance for credit losses that reflects the portion of the amortized cost balance the entity does not expect to collect over the contractual life of (1) all financial assets that are debt instruments measured at amortized cost, (2) net investments in leases and (3) off-balance sheet credit exposures. AFS debt securities will be subject to today’s impairment model with a few modifications, including the use of an allowance to recognize credit losses, as opposed to a direct write-down of the amortized cost as is done today. The FASB’s final standard has tiered effective dates starting in 2020 for calendar-year entities that are SEC filers. Early adoption in 2019 is permitted for all calendar-year entities. US GAAP versus IFRS The basics | 36 Financial instruments Hedge accounting IFRS 9 introduces a substantial overhaul of the hedge accounting model that aligns the accounting treatment with risk management activities. The aim of the new standard is to allow entities to better reflect these activities in their financial statements and provide users of the financial statements with better information about risk management and the effect of hedge accounting on the financial statements. In August 2017, the FASB issued ASU 201712, Targeted Improvements to Accounting for Hedging Activities, to make certain targeted improvements to its hedge accounting model in an effort to more clearly portray an entity’s risk management activities in its financial statements and reduce operational complexity in the application of certain aspects of the model. ASU 2017-12 is effective for PBEs for annual periods beginning after 15 December 2018, including interim periods within those years. For all other entities, it is effective in annual periods beginning after 15 December 2019, and interim periods within fiscal years be...
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