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IFRS • Substantially similar to U.S. GAAP • Significant differences do exist. • An effective way to understand IFRS is to compare to U.S. GAAP.

Areas with significant differences I. Inventory (IAS 2) II. Intangible Assets (IAS 38) III. Property, Plant, and Equipment (PP&E) (IAS 16) IV. Impairment of Assets (IAS 36) V. Leases (IAS 17)

Recognition and Measurement: Some background Match the terms below with a definition: Current market value, Present value of future cash flows ~ Fair Value, Historical cost , Net realizable value, Current (replacement) cost Amount paid to acquire an asset or, for liabilities, the amount received when the obligation is incurred.

Amount of cash (sometimes the present value) minus collection and other costs incurred.

Amount needed to acquire an equivalent asset.

Amount of cash received from an immediate sale of the asset.

Amount of cash to be received, discounted at the appropriate interest rate.

Comparisons of IFRS and US-GAAP: Using Health Products & Services Company ‘A’ as an Example

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I. Valuation of Inventories

IFRS: IAS 2 U.S. GAAP: ARB 43

Key Points: Key Points:

• Inventories are recognized at the • Inventories are recognized at the

• Write-downs on inventories • Write-downs on inventories

• Using LIFO inventory costs is • Using LIFO inventory costs is

Inventories are recognized at the lower of cost or net realizable value, which is the estimated selling price less any costs of completion and disposal. (IAS 2.9) Company Policy: The FS-item “Allowances on inventories” (FS-items: 11342101, 11353101) includes write-downs to replacement cost as well as write downs due to obsolete or damaged product. Please contact the consolidation department if the part of the reserves that refers to write-downs to replacement costs is above 200,000 US-$. Write-downs on inventories must be reversed, if the net realizable value has increased, but the reversal is limited to the amount of the original write-down. Cost formulas for inventory costs: LIFO (Last in first out) is prohibited. (IAS 2.25). Company Policy: For Health Products & Services Company A, this difference is not relevant, as inventory costs are determined by using the average or the first in, first out method (inventories that were purchased or produced first are sold first).

Inventories are recognized at the “lower of cost or market”. In the phrase “lower of cost or market”, the term “market” means current replacement cost, whether by purchase or by reproduction, but is limited to the following maximum and minimum amounts: - Maximum: the estimated selling price less any costs of completion

and disposal, referred to as net realizable value.

- Minimum: net realizable value less an allowance for “normal” profit. Normal is based on the amount of work necessary to complete the product.

The write-down of inventories may not be reversed.

Cost formulas for inventory costs: LIFO (Last in first out) is permitted. This formula assumes that the inventories that were purchased or produced last are sold first.

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Demo: Inventory

ABC Inc. has the following inventory item on hand at 12/31/Y1. Record the entry on 12/31 for Y1 &Y2 to reflect the price adjustment. 12/31/Y1   IFRS US Historical cost 1,000   Cost Cost Replacement cost 800   Replacement cost Estimated selling price 880   Estimated costs to complete and sell 50   Net realizable value 830   NRV Ceiling Normal profit margin— 15% 124.50 Net realizable value less normal profit margin 705.50 Floor Designated Market Value Valuation basis   Adjustment, See T-Account Analysis below     12/31/Y2   IFRS US *New Cost (see notes below)   Cost Cost Replacement cost 900   Replacement cost Estimated selling price 980   Estimated costs to complete and sell 50 Net realizable value 930 NRV Ceiling Normal profit margin— 15% 139.50   Net realizable value less normal profit margin 790.50   Floor   Designated Market Value Valuation basis   Adjustment   *For inventory cost on 1/1/Y2 IFRS US The historical cost of $ is used in applying the lower of cost or net realizable value rule over the entire period the inventory is held.

The inventory write-down at the end of Year 1 establishes a new cost of $ is used in subsequent periods in applying the lower of cost or market rule.

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T-Account Analysis on Inventory Inventory IFRS US01/01/Y1 Adjustment 12/31/Y1 Adjustment 12/31/Y2 Entries to adjust inventory value: 12/31/Y1-IFRS Dr. Cr. US Dr. Cr.Inventory Inventory 12/31/Y2-IFRS Inventory   Inventory

E1: Inventory Valuations

To determine the amount at which inventory should be reported on the 12/31/Y1 balance sheet, Monroe Company compiles the following information for its inventory of Product Z on hand at that date:

Historical cost $ 20,000 Replacement cost $ 14,000 Estimated selling price $ 17,000 Estimated costs to complete and sell $ 2,000 Normal profit margin as % of selling price 20%

The entire inventory of Product Z that was on hand at 12/31/Y1 was completed in Year 2 at a cost of $ 1,800 and sold at a price of $ 17,150.

Required: a. Use the information provided in this chapter related to the accounting for inventories to determine the impact on Year 1 and Year 2 income related to Product Z (1) under IFRS and (2) under U. S. GAAP. b. Summarize the difference in income, total assets, and total stockholders’ equity using the two different sets of accounting rules over the two-year period.

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a. How much Inventory Loss is in Y1 and COGS in Y2. IFRS U.S. GAAP Historical cost Historical cost Estimated selling price Replacement cost Costs to complete and sell Net realizable value Net realizable value Inventory loss (gain) 5,000 Normal profit margin 20% NRV - profit margin Market value Inventory loss (gain) 6,000

*T-Account Analysis on Inventory Inventory IFRS US01/01/Y1 Adjustment 12/31/Y1 Additional cost *12/31/Y2

b. Impact on Accounts and Financial Ratios for Y1 and Y2 Account /

Financial Ratio IFRS > = < US The financial ratio

under IFRS is… The company appears…

Year 1 Inventory loss Asset Net Income Stockholders’ equity Current ratio (=CA/CL) EPS Debt-equity ratio Year 2 *Cost of goods sold As all inventory are sold in Y2, IFRS has higher COGS in Y2 and hence, signs on NI and SE reversed in Y2.

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LIFO REPEAL-IMPACT ON TAXES

Example 1: (See Figure I and II, next page) A corporation elected LIFO inventory accounting in 1975. From 1975 to 2008 the company experienced inflation in its inventory equal to CPI of 224%. Because the company did not have to pay current taxes on the inventory holding profits, it was able to use the cash profits to maintain its unit investment in inventory and invest in other income producing assets while maintaining status quo terms with its vendors and static borrowings from its lenders. If the company were forced to recapture the inventory profits, it would have a current federal and state tax bill of approximately $10.6 million, more than ten times the equity value of the company. In order to satisfy the tax liability, the company would need to borrow money from its lenders if it could, infuse more cash equity capital if the owners had it to invest, sell productive assets and cut expenses or some combination of the above. In this example, the value of the tax liability is ten times the total equity value of the company. Even if the tax burden would be spread over a limited number of future years this transfer of capital from the private sector to the government would contract or prevent growth in these companies.

Example 2: A $35 million privately-owned manufacturing company in New Jersey employs 150 people to design, manufacture and distribute its products world-wide. This company has consistently used the LIFO method of inventory accounting for over 35 years.

The nature of this business requires keeping approximately $8 million of inventory on hand at all times, due to the replacement or “spare parts” needed to satisfy the multi-year nature of its customers’ contracts. They manufacture a highly engineered, technical array of products that are customer and application specific. The products are of a very durable nature and can be found in some of the most extreme environments in the universe, literally. Nevertheless, customers regularly request replacement units or outright rebuilding of previously sold units. Maintaining the LIFO based inventory values more closely matches the timing of production with the ultimate shipping point in time. LIFO in this way helps to better match current selling prices with current inventory costs, since the bulk of purchases and manufacturing in any current period do not end up “on the shelf” but instead, are shipped according to current customer specific requirements. LIFO positively impacts that process on several levels.

If LIFO were repealed today, this New Jersey Company would be required to pay retroactive taxes on inventory held since 1973, creating a tax bill of approximately $1 million. Since this is a small, privately held company, the only way to pay this tax bill would be to borrow capital or cut business investment. Either alternative would severely impact the company’s ability to continue operating at current levels, ultimately requiring a reduction in employment levels.

It should also be noted that this current LIFO vs. FIFO adjustment has slowly built up over the last 35 years. Hence the impact on any one year’s tax bill was relatively nominal. And at times, this impact has resulted in an increase in taxable income , with the most recent such increase taking place just two years ago. The perception that LIFO is a one-way tax “loophole” is inaccurate.

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II. Research and Development Costs

IAS 38: Intangible Assets: SFAS 2:Accounting for Research and Development Costs

Key Points: Key Points:

• Capitalization of the development costs under certain conditions is • Capitalization of the development costs is

• The definition of R&D under IFRS and US-GAAP is

Deferred development costs are accounted for using the same rules as any other intangible. They must be amortized over their useful life using a method that best reflects the pattern in which the asset’s economic benefits are consumed. Declining-balance, units-of-production, and straight-line methods are among the acceptable methods. Amortization begins when the intangible asset is available for sale or use.

Major differences

Recognition:

The following described capitalization of the development costs should be only applied when the R&D costs for a single and defined project (Company policy) exceed 1 million EUR (materiality criterion). An intangible asset arising from the development phase of an internal project must be recognized (i.e. the development costs must be capitalized) if all of the following criteria can be demonstrated cumulatively and reliably: 1. The technical feasibility of completing the intangible asset; 2. The intention to complete the intangible asset and use or sell it; 3. The ability to use or sell the intangible asset; 4. How the intangible asset will generate probable future economic benefits; 5. The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible assets; 6. The ability to measure reliably the expenditure attributable to the intangible asset during its development.

Major differences

Recognition:

Development costs are generally

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Company policy When we take the example of the development of a new PRODUCT, the required condition can be demonstrated as following: The technical feasibility can be proven when approximately 2,500 treatments have been successfully accomplished. The intention can be demonstrated within the scope of an approval of test samples (which is defined in SOP). 3. + 4. To demonstrate these requirements, business cases can be used, especially the part concerning the market assessments. These business cases are presented and authorized in management meetings. 5. The availability of adequate financial resources is demonstrated by the existence of the R&D budget. The other resources are proved by the existence of the know-how experts and the R&D locations. 6. The project related costs are collected and analyzed via SAP or via achievement descriptions prepared by all employees involved in the development project. A documentation file is available in order to fulfill the recognition criteria. The differentiation between the research and the development phase is often not clear or especially the technical and commercial feasibility of e.g. a new PRODUCT can be established only in a very late phase: but no retroactive capitalization of development expenditures initially recognized as an expense is possible.

As soon as a product becomes available for use (e.g. by a market launch) no additional development costs will be recognized.

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Demo: Development Costs

• Assume that Szabo Company Inc. incurred costs to develop a specific product for a customer in Year 1, amounting to $300,000. Of that amount, $250,000 was incurred up to the point at which the technical feasibility of the product could be demonstrated. In Year 2, Szabo Company incurred an additional $300,000 in costs in the development of the product.

• The product was available for sale on January 2, Year 3, with the first shipment to the customer occurring in mid- February, Year 3. • Sales of the product are expected to continue for four years, at which time it is expected that a replacement product will need to be developed. • The total number of units expected to be produced over the product’s four-year economic life is 2,000,000. • The number of units produced in Year 3 is 800,000. Residual value is zero.

Discussion In Year 1, $250,000 of development costs is an Asset or Expense? $50,000 is recognized as an Asset or Expense? To record development expense and deferred development costs: Dr. Cr.Development expense Deferred development costs ( intangible asset) Cash, payables, etc    In Year 2, $ 300,000 of development costs is recognized as an Asset or Expense? To record deferred development costs: Dr. Cr.Deferred development costs ( asset) Cash, payables, etc. Amortization of development costs begins on January 2, Year 3, when the product becomes available for sale. Szabo Company determines that the units-of- production method best reflects the pattern in which the asset’s economic benefits are consumed. Amortization expense for Year 3 is calculated as follows: Carrying amount of deferred development cost $350,000 Units produced in Year 3 800,000 Total number of units to be produced over economic life 2,000,000 % of total units produced in Year 3? Amortization expense in Year 3? The journal entry to record amortization of deferred development costs at 12/31/Y3

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E2: R&D Expenditures

In Year 1, in a project to develop Product X, Lincoln Company incurred research and development costs totaling $ 10 million. Lincoln is able to clearly distinguish the research phase from the development phase of the project. Research-phase costs are $ 6 million, and development- phase costs are $ 4 million. All of the IAS 38 criteria have been met for recognition of the development costs as an asset. Product X was brought to market in Year 2 and is expected to be marketable for five years. Total sales of Product X are estimated at over $ 100 million.

Required: a. Use the information provided in this chapter related to the accounting for internally generated intangible assets to determine the impact on Year 1 and Year 2 income related to research and development costs (1) under IFRS and (2) under U. S. GAAP. b. Summarize the difference in income, total assets, and total stockholders’ equity related to Product X over its five- year life under the two different sets of accounting rules.

a. IFRS v. U.S. GAAP IFRS Classification Year 1 Year 2 Research costs Development costs Amortization expense U.S. GAAP Research and development IFRS result in income before tax in Year 1 by IFRS result in income before tax in Year 2-6 by

b. F/S impact Ignoring income taxes, the following amounts on total assets and total stockholders’ equity under IFRS are higher or lower? By the amounts below:

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6    

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III. Property, plant and equipment (PPE): Valuation

IAS 16 U.S. GAAP

Key Points

• In addition to the Cost Model as used under U.S. GAAP, IAS 16 allows the Revaluation Model subsequent to initial measurement and requires that all assets within a class be further revalued periodically.

Key Points

• Cost Model: Recognizes the asset at cost less accumulated depreciation

• Two Alternative Treatments Treatment 1:

o Asset and accumulated depreciation are restated. o Restated carrying amount equals current market value. o The ratio of carrying value to gross carrying amount is

maintained. • Treatment 2:

o Asset is first decreased by the amount of accumulated depreciation.

Asset account is then increased by the amount of the revaluation (current market value – carrying value).

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Demo: PP&E Revaluation

• Accumulated Depreciation upon Revaluation Assume that Kiely Company Inc. has buildings that cost $1,000,000, have accumulated depreciation of $600,000, and a carrying amount of $400,000 on 12/31/Y1.

• On that date, Kiely Company determines that the market value for these buildings is $750,000. • Kiely Company wishes to carry buildings on the 12/31/Y1, balance sheet at a revalued amount.

Treatment 1: RESTATE both the buildings account and accumulated depreciation on buildings such that the ratio of net carrying amount to gross carrying amount (or ratio of carrying value to cost) is 40 percent ($400,000/$1,000,000) and the net carrying amount is $750,000. Original $ % Total/Balance RevaluationCost or Gross carrying amount

$1,000,000 100%

Accumulated depreciation 600,000 60% Net carrying amount $400,000 40%

(net CA/cost ratio)$750,000

Journal entry would be made at 12/31/Y1 Building Accumulated depreciation— building Summary of Treatment 1: Buildings, Net Revaluation surplus

Treatment 2: ELIMINATE accumulated depreciation on buildings to be revalued. S1. To eliminate accumulated depreciation on building to be evaluated BalanceBuildings Accumulated depreciation S2. To reevaluate building Buildings Revaluation surplus

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Treatment of Revaluation Surplus/Loss

On the first revaluation after initial recording: (very straightforward) • Increases are credited directly to a revaluation surplus in the • Decreases are charged as an

At subsequent revaluations, the following rules apply: • To the extent that there is a previous revaluation surplus with respect to an asset, a decrease first should be charged against it and any excess of

deficit over that previous surplus should be expensed. • To the extent that a previous revaluation resulted in a charge to expense, a sub-sequent upward revaluation first should be recognized as income

to the extent of the previous expense and any excess should be credited to other comprehensive income in equity.

Demo: Treatment of Revaluation Surplus/Loss

Example: Assume that Kiely Company Inc. has elected to measure property, plant, and equipment at revalued amounts. Costs and fair values for Kiely Company’s three classes of property, plant, and equipment at 12/31/Y1 and Year 2, are as follows: Land Buildings Machinery Cost $100,000 $500,000 $200,000 Fair value at 12/ 31/ Y1 120,000 450,000 210,000 Fair value at 12/ 31/ Y2 150,000 460,000 185,000 Revaluation Balance at 12/ 31/ Y2 12/31/Y1 PP&E Type Dr. Cr. Revaluation BalanceLand Revaluation LandBuildings Revaluation BuildingMachinery Revaluation Machinery12/31/Y2 Land Revaluation LandBuildings Revaluation BuildingMachinery Revaluation MachineryRevaluation Machinery

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E3 PP&E measurement subsequent to acquisition

Jefferson Company acquired equipment on January 1, Year 1, at a cost of $10 million. The asset has a five- year life, no residual value, and is depreciated on a straight- line basis. On January 21 Year 3, Jefferson Company determines the fair value of the asset (net of any accumulated depreciation) to be $12 million.

Required: a. Determine the impact the equipment has on Jefferson Company’s income in Years 1–5 (1) using IFRS, assuming that the revaluation model allowed

by IAS 16 is used for measurement subsequent to initial recognition, and (2) using U. S. GAAP. b. Summarize the difference in income, total assets, and total stockholders’ equity using the two different sets of accounting rules over the period Year

1–Year 5.

a. IFRS v. U.S. GAAP Cost, 1/1/Y1 $10,000,000Useful life 5 yearsAnnual depreciation $2,000,000Book value, 12/31/Y2 IFRS Allowed Alternative Fair value, 1/1/Y3 $12,000,000Remaining useful life 3 yearsAnnual depreciation Depreciation expense IFRS U.S. GAAPYears 1 and 2 Years 3, 4, and 5

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b. F/S impact Equipment (book value), End of Year in $Millions 1 2 3 4 5 IFRS Beginning Revaluation Depreciation expense Ending U.S. GAAP Beginning Depreciation expense Ending Net Income on IFRS compared to U.S. GAAP is… Asset on IFRS U.S. GAAP is… Stockholders’ equity, End of Year 1 2 3 4 5 IFRS Beginning Revaluation Depreciation expense Ending U.S. GAAP Beginning Depreciation expense Ending SE on IFRS is…

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Property, plant and equipment (PPE): Component Depreciation

IAS 16 U.S. GAAP

Key Points

• The component approach leads to a difference between IFRS and US-GAAP and it may be relevant for areas such as clinics and production units. The materiality criterion has to be proved before applying this approach (which might lead to a different treatment compared to US-GAAP approach).

• The minimum level for applying the component approach is when the cost for a single component asset exceeding 10% of the whole asset costs at the subsidiary level.

Key Points

• Currently there is no requirement which accounts for separate components of an asset.

Major differences

Recognition: • So-called component accounting is appropriate when component assets have different useful lives and the common

depreciation method over the asset's useful life would not reflect the pattern in which the asset's economic benefits are consumed.

• Allocation of the total expenditure on an asset to its component parts and accounting for each component is performed separately.

• The expenditure incurred in replacing or renewing of the component (e.g. in course of major inspections or overhauls) is accounted for as the acquisition of a separate asset and the “new” asset is written down on a systematic basis.

Measurement: In addition to the benchmark treatment (measurement at cost) IAS 16 allows an alternative treatment (the revaluation model). Health Products & Services Company A will apply the benchmark treatment in accordance with the US-GAAP.

In March 2007 IAS 23 has been revised: the standard requires the capitalization of borrowing cost for qualifying assets (assets that take a substantial period of time to get ready for use or sale). This requirement is equal to US-GAAP.

Major differences

Recognition:

• Currently there are no regulations available concerning the component accounting.

Measurement:

Borrowing costs for qualifying assets need to be capitalized.

Disclosure: Additional disclosures concerning PPE in general are necessary: • Reconciliation of the carrying amount at the beginning and the end of the period. For this reconciliation no comparative

information is required. • Amount of expenditures on account of property, plant and equipment in the course of construction during the period.

Disclosure:

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IV-1. Impairment of Assets (Other than Goodwill and Intangible Assets with indefinite useful life)

3.1 Impairment of Assets (Other than Goodwill and Intangible Assets with indefinite useful life): IAS 36

Impairment of Long-lived Assets: SFAS 144

Key Points

• The procedure of testing assets for impairment is not the same under IFRS and US-GAAP. As the related requirements are not included in our US-GAAP Manual, the procedure is described in detail under both accounting systems and the differences are marked appropriately.

• One-step-approach

- An asset is impaired when its carrying amount exceeds its recoverable amount.

- The recoverable amount represents the higher of (1) an asset's fair value less costs to sell and (2) its value in use. The value in use is probably the more common value as the fair value less costs to sell is often not available. The value in use is the discounted value of estimated future cash flows expected to arise from the continuing use of an asset.

Key Points

• The procedure of testing assets for impairment is not the same under IFRS and US-GAAP. As the related requirements are not included in our US-GAAP Manual, the procedure is described in detail under both accounting systems and the differences are marked appropriately.

• Two-step-approach 1st step: Test of recoverability based on undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). If the carrying amount exceeds the undiscounted cash flows, an impairment loss shall be recognized.

2nd step: An impairment loss shall be measured as the amount by which the carrying amount of a long lived asset exceeds its fair value (present value unless quoted market price is not available)

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Demo: Impairment of PP&E

Example: Determination and Measurement of Impairment Loss At 12/31/Y1, Toca Company has specialized equipment with the following characteristics: Carrying value $50,000Selling price 40,000 Costs of disposal 1,000 Expected future cash flows 55,000 Present value of expected future cash flows 46,000 IFRS In applying IAS36, asset’s recoverable amount would be determined as follows: Net selling price Value in use Recoverable amount The determination and measurement of impairment loss would be: IFRS USCarrying value Recoverable amount Expected future cash flows (Undiscounted) Impairment loss The following journal entry would be made to reflect the impairment of this asset under IFRS:

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E4 Impairment of an depreciable asset Madison Company acquired a depreciable asset on 1/1/Y1 at a cost of $12 million. At 12/31/Y1, Madison gathered the following information related to this asset: Carrying amount (net of accumulated depreciation) $10 million Fair value of the asset (net selling price)  $7.5 million Sum of future cash flows from use of the asset $10 million Present value of future cash flows from use of the asset $8 million Remaining useful life of the asset  5 years

Required: a. Use the information provided in this chapter related to the impairment of assets to determine the impact in Year 2 and Year 3 income from the

depreciation and possible impairment of this equipment (1) under IFRS and (2) under U. S. GAAP. b. Determine the difference in income, total assets, and total stockholders’ equity for the period Year 1– Year 6 under the two different sets of

accounting rules. Note: If the asset is determined to be impaired, there would be no adjustment to Year 1 depreciation expense of $2 million.

a. Determine Impairment Loss in Year 1 IFRS U.S. GAAP Carrying amount Carrying amount Net selling price Future cash flows Discounted future cash flows Value in use Impairment loss Impairment loss Depreciation expense for Y2-6

b. F/S Impact

IFRS-Net Income Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 a1. Depreciation expense a2. Impairment loss

b1i. Impact on income U.S. GAAP

a1. Depreciation expense b1us. Impact on income

Sum of Y1-6 Diff. (IFRS-U.S. GAAP)

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IFRS-Total Assets Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Carrying value (at 1/1) Depreciation expense Impairment loss Carrying value (at 12/31) U.S. GAAP Carrying value (at 1/1) Depreciation expense Carrying value (at 12/31) Diff. (IFRS-U.S.GAAP)

IFR S-Stockholders’ Equity

Beginning balance Depreciation expense Impairment loss Ending balance U.S. GAAP Beginning balance Depreciation expense Ending balance Diff. (IFRS-U.S.GAAP)

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E5 Reconciliation from IFRS to US-GAAP: PP&E Revaluation Iptat International Ltd. provided the following reconciliation from IFRS to U. S. GAAP in its most recent annual report (amounts in thousands of CHF): Net Income Shareholders’ Equity As stated under IFRS 541,713 7,638,794 U. S. GAAP adjustments (a) Reversal of additional depreciation charges arising from revaluation of fixed assets

85,720 643,099

(b) Reversal of revaluation surplus of fixed assets — ( 977,240) As stated under U. S. GAAP 627,433 7,305,653

Required: a. Explain why U. S. GAAP adjustment (a) results in an addition to net income. Explain why U. S. GAAP adjustment (a) results in an addition to

shareholders’ equity that is greater than the addition to net income. What is the share-holders’ equity account affected by adjustment (a)? b. Explain why U. S. GAAP adjustment (b) results in a subtraction from share-holders’ equity but does not affect net income. What is the shareholders’

equity account affected by adjustment (b)?

a. + U. S. GAAP adjustment Adjustment (a) relates to of the revaluation amount on fixed assets. Adjustment (a) results in an addition to net income because the additional depreciation taken on the revaluation amount under U.S. GAAP. The addition to net income pertains to the current year only. The addition to net income in the current year plus the addition to net income in previous years is the cumulative effect on retained earnings, which is the shareholders’ equity account affected by adjustment (a). The addition to shareholders’ equity is greater than the addition to net income because of this cumulative effect.

b. - U. S. GAAP adjustment Adjustment (b) relates to the revaluation surplus (increase in shareholders’ equity) that is recorded when fixed assets are revalued. This increase under U.S. GAAP and shareholders’ equity must be reduced accordingly. In this case, the shareholders’ equity account affected is Revaluation Surplus.

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E7 Impairment-PP&E and Subsequent Reversal Buch Corporation purchased Machine Z at the beginning of Year 1 at a cost of $100,000. The machine is used in the production of Product X. The machine is expected to have a useful life of 10 years and no residual value. The straight-line method of depreciation is used. Adverse economic conditions develop in Year 3 that resulted in a significant decline in demand for Product X. At December 31, Year 3, the company develops the following estimates related to Machine Z: Expected future cash flows  $75,000 Present value of expected future cash flows  55,000 Selling price  70,000 Costs of disposal  7,000 At the end of Year 5, Buch’s management determines that there has been a substantial improvement in economic conditions resulting in a strengthening of demand for Product Z. The following estimates related to Machine Z are developed at December 31, Year 5: Expected future cash flows  $70,000 Present value of expected future cash flows  53,000 Selling price  50,000 Costs of disposal  7,000

Required: Apply IAS 36 to determine a. The carrying value for Machine Z to be reported on the balance sheet at the end of Years 1–5. b. The amounts to be reported in the income statement related to Machine Z for Years 1–5.

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a. Up to Year 3 economy Depreciation Expense Cost Useful life Residual value Annual depreciation charge

Year 1 Year 2 Year 3

Carrying value (at 1/1) Depreciation expense Carrying value (at 12/31) Test for impairment at December 31, Year 3: Carrying value Net selling price Value in use Recoverable amount (greater of the two) Impairment loss The impairment loss of ? would be recognized in income on December 31, Year 3 with an offsetting reduction in the asset’s carrying value. As a result, the asset will be reported at on the 12/31/Y3 balance sheet at a carrying value of ? . This amount will be depreciated over the remaining useful life of ? years on a straight-line basis or ? for remaining years. Year 1 Year 2 Year 3 Year 4 Year 5Carrying value (at 1/1) Depreciation expense Impairment loss Carrying value (at 12/31)

b. Up to Year 5 economy Review for reversal of impairment loss at December 31, Year 5: Carrying value Net selling price Value in use Recoverable amount (greater of the two) Impairment loss

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• IAS 36 requires an impairment loss to be reversed if the recoverable amount of an asset is determined to exceed its new carrying amount, but only if there are changes in the estimates used to determine the original impairment loss or there is a change in the basis for determining the recoverable amount (from value in use to net selling price or vice versa).

• Because recoverable amount has changed from net selling price at the end of Year 3 to value in use at the end of Year 5, and the recoverable amount is greater than the carrying value at the end of Year 5, the impairment loss recognized in Year 3 should be reversed.

• However, the carrying value of the asset after reversal of the impairment loss should not exceed what it would have been if no impairment loss had been recognized.

• The carrying value of Machine Z at December 31, Year 5 would have been $50,000 if no impairment loss had been recognized in Year 3 ($100,000 original cost less $10,000 annual depreciation for five years).

• Thus, an increase in the carrying value of the asset of $5,000 should be recognized at December 31, Year 5 with a reversal of impairment loss in an equal amount.

• The asset’s carrying value on the December 31, Year 5 balance sheet will be $50,000 ($45,000 + $5,000). • This amount will be depreciated over the remaining useful life of 5 years on a straight-line basis.

• Summary of amounts to be reported on the balance sheet and income statement in Years 1 – 5:

Year 1 Year 2 Year 3 Year 4 Year 5

Carrying value (at 1/1) Income Statement Depreciation expense Impairment loss Reversal of impairment loss Carrying value (at 12/31) Income statement effect

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IV-2. Impairment: Impairment of Goodwill and Intangible Assets with Indefinite Useful Life

IAS 36 SFAS 142

The requirements for the impairment test of goodwill and intangible assets with indefinite useful life correspond generally with the IFRS-requirements for the impairment testing of assets or asset groups (see section 3.1 of this manual). Whereas the impairment of goodwill and intangible assets with indefinite useful life is included in the “general” standard (IAS 36) for impairment of assets under IFRS, these issues are covered by a separate standard under US-GAAP.

Key Points

• The impairment test of goodwill and intangible assets with indefinite useful life is required at least once a year, or if a triggering event occurs. This impairment test is performed by the consolidation department.

• Generally the procedure is the same under IFRS and US-GAAP for the impairment test of intangible assets with indefinite useful life (a comparison of the recoverable amount with its carrying amount – see section 3.1 of this manual).

• The carrying amount of the CGU does generally not include the carrying amount of any recognized liability. (IAS 36.76(b)). At the most the carrying amount of the CGU may include operational liabilities (IAS 36.78)

• One-step approach for the impairment test of goodwill

• The impairment loss is the excess of the carrying amount of the CGU over its recoverable amount

• If the impairment loss exceeds goodwill, the remaining loss is allocated to the other assets of the CGU on a pro rata basis

• The reversal of an impairment loss is required with the exception an impairment loss for goodwill.

The requirements for the impairment test of goodwill and intangible assets with indefinite useful life are different from the requirements for impairment of long-lived assets (see section 3.1 of this manual). Whereas the impairment of goodwill and intangible assets with indefinite useful life is included in the “general” standard for impairment of assets under IFRS, these issues are covered by a separate standard under US-GAAP.

Key Points

• The impairment test of goodwill and intangible assets with indefinite useful life is required at least once a year, or if a triggering event occurs. This impairment test is performed by the consolidation department.

• Generally the procedure is the same under IFRS and US-GAAP for the impairment test of intangible assets with indefinite useful life (a comparison of the fair value with its carrying amount; fair value is determined by using a discounted cash flow approach).

• The carrying amount of the reporting unit includes the carrying amount of all recognized liabilities.

• Two-step approach for the impairment test of goodwill

• The impairment loss is the excess of the carrying amount of the reporting unit’s goodwill over the implied fair value

• The impairment loss cannot exceed goodwill

• Subsequent reversal of a previously recognized impairment loss is prohibited.

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Major differences

Measurement:

o Goodwill is allocated to those CGUs which are expected to benefit from the synergies. (Please refer to section 3.1 for the definition of CGU). These CGUs represent the lowest level at which goodwill is monitored for internal management purposes. The CGU may not be larger than a segment. For Health Products & Services Company A the reporting units under US-GAAP (which are one level below operating segments) can be maintained as CGUs for goodwill impairment testing under IFRS.

o CGUs identified for goodwill impairment testing will probably differ from CGUs identified for impairment testing of long-lived assets.

o Goodwill is tested for impairment in one step: the recoverable amount of the cash generating unit (CGU) to which goodwill has been allocated is compared with the carrying amount of this CGU (IAS 36.90).

The recoverable amount represents the higher of the CGU’s fair value less costs to sell and its value in use. The value in use is probably the more common value as the fair value less costs to sell is often not available. The value in use is the discounted value of estimated future cash flows expected to arise from the continuing use of an asset.

o The carrying amount of the CGU does generally not include the carrying amount of any recognized liability. (IAS 36.76(b)). At the most the carrying amount of the CGU may include operational liabilities (IAS 36.78). The method applied by Health Products & Services Company A for calculating the impairment test under US-GAAP will remain the same under IFRS. With this method the exclusion of non operational liabilities under IFRS leads to the same result as the impairment test under US-GAAP.

o

Major differences

Measurement:

o The reporting unit is an operating segment or one level below an operating segment (SFAS 142.30).

o Goodwill is tested for impairment in two steps: (SFAS 142.19/20) - First, the fair value of the reporting unit to which goodwill has

been allocated is compared with the carrying amount of this unit. Should the carrying amount of the reporting unit exceed its fair value, the second step is necessary. Health Products & Services Company A determines the fair value of the reporting unit by using the discounted cash flow approach.

- In the second step, the implied fair value of goodwill is compared with the carrying amount of goodwill.

o The carrying amount of the reporting unit includes the carrying amount of all recognized liabilities.

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o The impairment loss is the excess of the carrying amount of the CGU over the recoverable amount of the unit (IAS 36.90)

o Allocation of the impairment loss: The loss is allocated first to goodwill and then to the other assets in the CGU on a pro-rata basis (IAS 36.104).

o The reversal of an impairment loss is required except for an impairment loss for goodwill

o All other assets included in a cash-generating unit have to be tested for impairment before the cash generating unit including goodwill is tested.

o The impairment loss is the excess of the carrying amount of goodwill over the implied fair value of goodwill.

o Allocation of the impairment loss: The loss is allocated to goodwill and cannot exceed the carrying amount of goodwill (SFAS 142.20).

o Subsequent reversal of a previously recognized impairment loss is prohibited.

Disclosure:

o In addition to the disclosure requirements listed in section 3.1 of this manual, it is necessary to complete a checklist “Estimates used to measure recoverable amounts of CGU containing GW or intangible assets with indefinite useful lives” (available on request)

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V. Leases

Leases: IAS 17 Accounting for Leases: SFAS 13, SFAS 28

Key Points Key Points

• IAS 17 and US-GAAP are conceptually similar, but IAS 17 provides less specific guidance and focuses rather on the ? of a lease than on the strict application of certain criteria. IAS 17 requires a lease should be classified and accounted for as a finance lease when it transfers substantially all the risks and rewards of ownership to the lessee. The standard then provides five situations that would normally lead to a lease being capitalized: 1. The lease transfers ownership of the asset to the lessee by the end of the lease term. 2. The lessee has the option to purchase the asset at a price less than fair market value. 3. The lease term is for the major part of the leased asset’s economic life. 4. The present value of minimum lease payments at the inception of the lease is equal to substantially all the fair value of the leased asset. 5. The leased asset is of a specialized nature such that only the lessee can use it.

Company Policy: Please contact the consolidation department or your local auditor before going into lease agreements as there might be slight differences in detail in the consideration under IFRS and US-GAAP (e.g. the calculation of minimum lease payments). For all lease agreements which are not leases – in case of the present value of the minimum lease payments exceeding 1 million USD - please check, whether the substance of the lease agreement is different to the US-GAAP treatment.

• The criteria for classifying leases seeing by lessee are similar to those of IFRS – but specified criteria have to be met (see US-GAAP Manual Appendix X).

1. Title

2. Bargain Purchase Option

3. 75% Useful life

4. PV of Minimum Lease Payment >=90% FMV

• The term finance lease under IFRS is equivalent to the term capital lease under US-GAAP.

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If a sale-and-leaseback transaction results in an operating lease, situations may arise in which profit or loss is ?

In general immediate gain or loss recognition on the sale in a sale-and-leaseback transaction is not allowed – i.e. gain or loss is ?

o Application at Health Products & Services Company A: Sale-and-lease-back transactions resulting in operating lease are among others under the lease agreements with region X and under machine lease agreements in region Y. In the course of these transactions the dialysis machines are sold and simultaneously leased back. Then these machines are available for the final customers (hospitals or doctors) either under rental or package agreement.

Company Policy: If the necessary criteria are satisfied under IFRS (the sale price is below the fair value), the deferred income recorded from such sale-and-lease-back transactions under US-GAAP has to be released within the first adoption of IFRS. In the subsequent periods for IFRS purposes it is necessary to reverse the released deferred income under US-GAAP.

o Under sale-and-lease-back transactions resulting in operating lease, any profit or loss from the initial sale should be deferred by the seller-lessee and amortized in proportion to the rental payments over the period of time the assets are expected to be used.

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E9 Reconciliation from IFRS to US-GAAP: PP&E, Development costs, Leaseback Quantacc Company began operations on January 1, Year 1, and uses IFRS to prepare its financial statements. Quantacc reported net income of $100,000 in Year 5 and had stockholders’ equity of $500,000 at December 31, Year 5. The company wishes to determine what its Year 5 income and December 31, Year 5 stockholders’ equity would be if it had used U. S. GAAP. Relevant information follows: 1. Quantacc carries fixed assets at revalued amounts. Fixed assets were last revalued upward by $35,000 on January 1, Year 3. At that time, fixed

assets had a remaining useful life of 10 years. 2. Quantacc capitalized development costs related to a new product in Year 4 in the amount of $80,000. Quantacc began selling the new product in

January, Year 5, and expects the product to be marketable for a total of five years. 3. Early in January, Year 5, Quantacc realized a gain on the sale and leaseback of an office building in the amount of $150,000. The lease is accounted

for as an operating lease and the term of the lease is 20 years.

Required: Calculate the following for Quantacc Company using U. S. GAAP (ignore income taxes): a. Net income for Year 5. b. Stockholders’ equity at 12/31/Y5 Stockholders’ equity under IFRS $500,000Adjustments: Item No. ExplanationsReversal of revaluation of fixed assets Reversal of accumulated depreciation on revaluation of fixed assets Reversal of deferred development costs Reversal of accumulated amortization on deferred development costs Reversal of gain on sale and leaseback Accumulated amortization of gain on sale and leaseback Stockholders’ equity under U.S. GAAP Net income under IFRS $100,000Adjustments: Reversal of depreciation on revaluation of fixed assets Reversal of amortization of deferred development costs Reversal of gain on sale and leaseback Amortization of gain on sale and leaseback Net income (loss) under U.S. GAAP

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Sales and Leaseback: Exhibit: 20-F Swisscom AG, 2006 Exerpt from Note 43. Differences between International Financial Reporting Standards and U. S. Generally Accepted Accounting Principles The consolidated financial statements of Swisscom have been prepared in accordance with International Financial Reporting Standards ( IFRS), which differ in certain significant respects from generally accepted accounting principles in the United States ( U. S. GAAP). Application of U. S. GAAP would have affected the shareholders’ equity as of December 31, 2006, 2005, and 2004, and net income for each of the years in the three- year period ended December 31, 2006, to the extent described below. A description of the significant differences between IFRS and U. S. GAAP as they relate to Swisscom are discussed in further detail below. Reconciliation of net income from IFRS to U. S. GAAP The following schedule illustrates the significant adjustments to reconcile net income in accordance with IFRS to the amounts determined in accordance with U. S. GAAP for each of the three years ended December 31.

l) Sale and leaseback transaction In March 2001 Swisscom entered into two master agreements for the sale of real estate. At the same time Swisscom entered into agreements to lease back part of the sold property space. The gain on the sale of the properties after transaction costs of CHF 105 million and including the reversal of environmental provisions, was CHF 807 million under IFRS. A number of the leaseback agreements are accounted for as finance leases under IFRS and the gain on the sale of these properties of CHF 129 million is deferred and released to income over the individual lease terms. The remaining gain of CHF 678 million represents the gain on the sale of buildings which were sold outright and the gain on the sale of land and buildings which qualify as operating leases under IFRS. Under IFRS, the gain on a leaseback accounted for as an operating lease is recognized immediately. Under U. S. GAAP, in general the gain is deferred and amortized over the lease term. If the leaseback was minor, the gain was immediately recognized. In addition, certain of the agreements did not qualify as sale and leaseback accounting under U. S. GAAP because of continuing involvement in the form of purchase options. These transactions are accounted for under the finance method and the sales proceeds are reported as a financing obligation and the properties remain on the balance sheet and continue to be depreciated as in the past. The lease payments are split between interest and amortization of the obligation. Explanation: Sale- leaseback transaction if classified as an operating lease U. S. GAAP again requires the seller to amortize any gain over the lease term. IAS 17, in contrast, requires immediate recognition of the gain in income. In its 2006 reconciliation to U. S. GAAP, Swisscom made an adjustment for this accounting difference that resulted in an increase in income, as stated under U. S. GAAP, of 17 million Swiss francs. This reflects the amount of original gain on sale and leaseback that was realized in 2001 that is amortized to income in 2006 under U. S. GAAP. The gain was recognized in full in 2001 under IFRS. An adjustment also is made to stockholders’ equity to reverse the difference between the full amount of gain recognized under IFRS (included in IFRS retained earnings) and the portion of the gain that has been recognized through amortization under U. S. GAAP. This adjustment reduced IFRS equity by 280 million Swiss francs in 2006 to reconcile to a U. S. GAAP basis.

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E10 Comparison of IFRS v. US-GAAP Indicate whether each of the following describes an accounting treatment that is acceptable under IFRS, U. S. GAAP, both, or neither, by checking the appropriate box.

Acceptable under IFRS US-GAAP Both Neither 1. A company takes out a loan to finance the construction of a building that will be used by the

company. The interest on the loan is capitalized as part of the cost of the building.

2. Inventory is reported on the balance sheet using the last-in, first-out (LIFO) cost flow assumption. 3. A company writes a fixed asset down to its recoverable amount and recognizes an impairment loss

in Year 1. In a subsequent year, the recoverable amount is determined to exceed the asset’s carrying value, and the previously recognized impairment loss is reversed.

4. A company enters into an eight-year lease on equipment that is expected to have a useful life of ten years. The lease is accounted for as an operating lease.

5. In preparing interim financial statements, interim periods are treated as discrete reporting periods rather than as an integral part of the full year.

6. Research and development costs are capitalized when certain criteria are met. 7. The gain on a sale and leaseback transaction classified as an operating lease is deferred and

amortized over the lease term.

8. Past service costs related to retired employees that arise when a company makes an improvement to its pension plan are amortized over the remaining expected lives of the retirees.

9. Dividends paid are classified as an operating cash outflow in the statement of cash flows. 10. Dividends paid are classified as a financing cash outflow in the statement of cash flows.         

1 This would be acceptable under IAS 17 if 80% of the life of the lease is not viewed as the “major part” of the lease. 2 Neither IFRS nor U.S. GAAP allows capitalization of research costs. 3 Past service cost arises when an employer improves the benefits to be paid employees in conjunction with a defined benefit plan. IAS 19 provides the following rules related to past service cost:

• Past service cost related to retirees and vested active employees is expensed immediately. • Past service cost related to non-vested employees is recognized on a straight-line basis over the remaining vesting period.

In comparison, U. S. GAAP requires that the past service cost related to retirees be amortized over their remaining expected life, and the past service cost to active employees be amortized over their remaining service period. 4 IAS 7 allows dividends paid to be classified as either an operating or a financing cash flow, whereas U. S. GAAP classifies dividends paid as a financing activity.

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Comprehensive Example: Bessrawl Corporation is a U. S.- based company that prepares its consolidated financial statements in accordance with U. S. GAAP. The company reported income in 20X8 of $1,000,000 and stockholders’ equity at December 31, 20X8, of $8,000,000. The CFO of Bessrawl has learned that the U. S. Securities and Exchange Commission is considering giving U. S. companies the option of using either U. S. GAAP or IFRS in preparing consolidated financial statements. The company wishes to determine the impact that a switch to IFRS would have on its financial statements and has engaged you to prepare a reconciliation of income and stockholders’ equity from U. S. GAAP to IFRS. You have identified the following six areas in which Bessrawl’s accounting principles based on U. S. GAAP differ from IFRS. 1. Inventory 2. Property, plant and equipment 3. Intangible assets 4. Research and development costs 5. Sale and leaseback transaction 6. Pension plan Bessrawl provides the following information with respect to each of these accounting differences. Inventory At year- end 20X8, inventory had a historical cost of $250,000, a replacement cost of $180,000, a net realizable value of

$190,000, and the normal profit margin was 20 percent. Property, Plant, and Equipment

The company acquired a building at the beginning of 20X7 at a cost of $2,750,000. The building has an estimated useful life of 25 years, an estimated residual value of $250,000, and is being depreciated on a straight- line basis. At the beginning of 20X8, the building was appraised and determined to have a fair value of $3,250,000. There is no change in estimated useful life or residual value. In a switch to IFRS, the company would use the revaluation model in IAS 16 to determine the carrying value of property, plant, and equipment subsequent to acquisition.

Intangible Assets As part of a business combination in 20X5, the company acquired a brand with a fair value of $40,000. The brand is classified as an intangible asset with an indefinite life. At year- end 20X8, the brand is determined to have a selling price of $35,000 with zero cost to sell. Expected future cash flows from continued use of the brand are $42,000 and the present value of the expected future cash flows is $34,000.

Research and Development Costs

The company incurred research and development costs of $200,000 in 20X8. Of this amount, 40 percent related to development activities subsequent to the point at which criteria had been met indicating that an intangible asset existed. As of the end of the 20X8, development of the new product had not been completed.

Sale and Leaseback

In January 20X6, the company realized a gain on the sale and leaseback of an office building in the amount of $150,000. The lease is accounted for as an operating lease and the term of the lease is 5 years.

Pension Plan

Pension Plan In 20X7, the company amended its pension plan creating a past service cost of $60,000. Half of the past service cost was attributable to already vested employees who had an average remaining service life of 15 years, and half of the past service cost was attributable to nonvested employees who on average had two more years until vesting. The company has no retired employees.

Required Prepare a reconciliation schedule to convert 20X8 income and December 31, 20X8, stockholders’ equity from a U. S. GAAP basis to IFRS. Ignore income taxes. Pre-pare a note to explain each adjustment made in the reconciliation schedule.

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Reconciliation from U.S. GAAP to IFRS

20X8 Income under U.S. GAAP $1,000,000 Adjustments: Reversal of write-down of inventory to replacement cost Additional depreciation on revaluation of equipment Impairment loss on intangible asset (brand) Recognition of deferred development costs Reversal of amortization of deferred gain on sale and leaseback Difference in amortization of prior service cost (11,000)Income under IFRS Stockholders’ equity under U.S. GAAP $8,000,000 Adjustments: Reversal of write-down of inventory to replacement cost Original revaluation surplus on equipment Accumulated depreciation on revaluation of equipment Impairment loss on intangible assets (brand) Recognition of deferred development costs Recognition of gain on sale and leaseback in 20X6 Accumulated amortization of deferred gain on sale and leaseback (20X6-20X8) Difference in cumulative amortization of prior service cost (52,000)Stockholders’ equity under IFRS

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Explanation of Adjustments

Inventory IFRS U.S. GAAP to Reconciliation to IFRSHistorical cost Historical cost Estimated selling price Replacement cost Costs to complete and sell Net realizable value Net realizable value Normal profit margin

NRV - profit margin Market value NI Equity

Inventory loss (gain) Inventory loss (gain)

Equipment Cost, 1/1/X7 Residual value Depreciable value Useful life Annual depreciation Book value, 12/31/X7 IFRS Revaluation US-GAAPFair value, 1/1/X8 Remaining useful life Annual depreciation Book value, 12/31/X8   Reconciliation to IFRS  IFRS U.S. GAAP NI EquityDepreciation Expense- 12/31/X8 Revaluation Surplus-1/1/X8 * Revaluation Surplus-12/31/X8

* Entry for 1/1/X8   Dr. Cr. Equipment  Revaluation Surplus  

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Intangible Assets. IFRS U.S. GAAP Reconciliation to IFRS Carrying amount Carrying amount NI Equity Net selling price Future cash flows Discounted future cash flows Value in use Impairment loss Impairment loss

Research and Development Costs.     Reconciliation to IFRS Calculation 20X8 $ IFRS US NI EquityResearch costs Development costs

Sale and Leaseback. Gain on the sale and leaseback (operating lease): $150,000 for a 5 year lease Recognized in income 20X6 20X7 20X8 20X9 20X10IFRS-IAS13 U.S. GAAP   Reconciliation to IFRS-NI Reconciliation to IFRS-Equity

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(Skip) Pension Plan. PSC-Unvested Amount: $30,000 Amortization years 20X7 20X8 Unvested + VestedIFRS remaining years until vesting 2 15,000 15,000U.S. GAAP remaining service life 15 2,000 2,000Reconciliation to IFRS-NI -13,000 -13,000Reconciliation to IFRS-Equity -13,000 -26,000PSC-Vested-Expense: $30,000 IFRS Expensed immediately 1 30,000 0U.S. GAAP remaining service life 15 2,000 2,000Reconciliation to IFRS-NI -28,000 +2,000Reconciliation to IFRS-Equity -28,000 -26,000 Reconciliation to IFRS-NI -11,000Reconciliation to IFRS-Equity -52,000