International Accounting: Convergence is not Your Only Concern

International Accounting: Convergence is not Your Only Concern

Terry Warfield

University of Wisconsin - Madison Wiley-Asia Workshop – May 2011

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FASB Update – More than Convergence `

Recent IASB/FASB Agenda – Dominated by International Convergence ` ` `

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Things not to Lose Sight Of – Major Projects ` ` ` ` `

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What is it? What is the status? What should / can we do in our classes now?

Fair Value Financial Instruments Financial Statement Presentation Revenue Leases

Summary / Questions

Accounting Convergence – All Consuming `

Working under the “Norwalk Agreement” and Memo-ofUnderstanding, the FASB and IASB have made a lot of progress in converging to a set of high quality standards…

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Refers to the development of a single set of high quality accounting standards for use in financial statements of companies listed in several international markets. High quality means:

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Comprehensive, can be applied to a broad range of transactions, Few alternatives, easily implemented, Transparency – full disclosure, understandable.

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Accounting Convergence – All Consuming `

Much Progress Has Been Made:

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Share-Based Payments (FAS 123R, IAS 2)

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Accounting Changes (FAS 154)

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Exchanges on Non-Monetary Assets (FAS 153)

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Business Combinations (FAS 141R, IFRS 3).

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And the Boards are working on significant projects, that if completed, will lead to converged high quality standards. More on these later…

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Status Report – Are we there yet? ` `

U.S. (major world market) is not yet on board. Some recent events indicate we are getting close... Nearly 120 countries have adopted some form of IFRS and all traded companies in the EU (since 2005) must use IFRS. SEC FPI Reconciliation went away after March 2008 (currently affects ~ 140 SEC registrants) Recent SEC Policy Statement (Feb. 24, 2010) affirms support for a single set of high quality standards (subject to achieving certain milestones).

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Thus, not too long ago, many believed that were on track to adopt IFRS in the U.S. in the not-to-distant future. Maybe not so fast, based on recent developments… 5

SEC Position on Adoption of IFRS `

The February 24, 2010 Statement: affirms support for a single set of high quality standards – and that IFRS appears to be the best option to achieve this. Sets (affirms) a 2011 decision date (this year!!) for the SEC to mandate IFRS use. Public companies could begin using IFRS as early as 2015 (U.S. GAAP will still be used by private companies and not-for-profits. These issues are under discussion now.)

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Staff work plan: Study the following areas to determine if we are ready (protecting investors.) If not met the mandated use of IFRS may be delayed.

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Sufficient development of accounting standards.

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Independence of standard-setting to benefit investors.

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Investor Understanding

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Effects of switch on regulation (e.g., taxes, capital regulation).

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Education and Training

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Human Capital Readiness (e.g., Preparers & Auditors).

SEC Position on Adoption of IFRS `

Began reporting to the Commission late last year and still has some work to do.

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Developing converged standards is more on track that the supporting elements of the so-called “infrastructure”: Independence of the international standard-setter. Auditing (internal controls?) Enforcement Interpretation and on-going standards review (e.g., EITF) Common accounting rules are a necessary condition for International Convergence but without the other infrastructure areas, the rules alone will not be sufficient to achieve high quality international reporting (could be a big risk for U.S. Investors… lowest common denominator).

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SEC Position on Adoption of IFRS `

In essence, the SEC staff has identified areas that it would like to see addressed before we flip the switch on IFRS in the U.S. In addition to converged accounting rules, we need better and robust international: Auditing, Enforcement, and Interpretation

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Standard-setting structure (funded and independent).

Infrastructure needed? You bet…“IFRS Chaos in France: The Incredible Case of Société

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Générale: (http://accountingonion.typepad.com/theaccountingonion/2008/03/socit-gnrale-a.html, based on Floyd Norris's column describing the accounting by Société Générale for the losses incurred by their rogue trader (Breaking the Rules and Admitting It).

And we need to ensure that investors and other who uses financial statements (IRS, other regulators) are ready to use IFRS statements.

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Bottom Line -- recent speeches suggest that adoption, if it does happen may be down the road a bit. Convergence now referred to as “Condorsement” – let the IASB and FASB continue to work to converge to high quality standards, but market regulators will endorse those standards as they see fit. 8

Summary -- Convergence Timeline IFRS

Accounting Plane Converged High Quality Standards

U.S. GAAP Today •Auditing, Interpretation, Enforcement

Build out & Improve

•Standard-setting Structure & Governance •Investor / Regulatory readiness.

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“Infrastructure” Plane

~ 2015 -16 or beyond, if ever.

International Accounting – What to do? `

Given the slow-down in the adoption timeline, some in IFRS jurisdictions must still be tuned into U.S. GAAP. If the SEC delays/never adopts IFRS, many of your students are entering a world in which U.S. GAAP is being used. ` ` `

Clients are U.S. subs Home country clients have U.S. GAAP subs. Some of your students will want to get the U.S. CPA – U.S. GAAP is the main content of the CPA exam.

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Thus, students need some U.S. GAAP knowledge… (e.g., Agriculture, Revaluations, Impairments, Development Costs, Debt – Equity).

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Strategies? 10

U.S. GAAP – U.S. GAAP Differences `

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Agriculture – IFRS requires accounting for biological assets (milking cows, shearing sheep, vineyards) and for the agricultural produce harvested from the biological assets (milk, wool, grapes). Recorded at net realizable value (fair value less costs to sell) with gains / losses recorded in income.

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U.S. GAAP Differences `

Convertible Debt `

IFRS bifurcates the proceeds from convertible bonds between debt & equity elements.

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GAAP records as all debt.

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Teaching U.S. GAAP `

Infusion Approach … Students/Faculty Need: `

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A foundation on the infrastructure and institutional elements of IFRS along some discussion of the importance of gaining familiarity with IFRS. Some awareness of the key similarities and difference is current U.S. GAAP and IFRS. Some sense of how the differences in the two GAAPs will diminish over time.

In Intermediate Accounting (IFRS Edition) - Appendix 1A Convergences Corners

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Intermediate Accounting (IFRS Edition)

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Teaching U.S. GAAP -- Intermediate 14e (13e & 12e). `

U.S. GAAP book with enhanced Convergence Corners… 2-8 pages at the end of each chapter (increases flexibility of use).

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Relevant Facts ON THE HORIZON

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EOC ` Multiple Choice / Questions / Exercises; Financial Reporting Cases (Marks and Spencer plc); Professional Research (IFRS Literature) 15

Sample Assignment - Intermediate II `

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Read the following materials to gain familiarity with the IFRS for your assigned topic: ` IFRS Supplements for Chapter 16, 17, and 20. These discussions are taken from the IFRS edition of your Intermediate Accounting text. The discussions therein will explain the accounting for your assigned topic under IFRS. Four groups are assigned one of three topics (feel free to review the other topics not assigned): Identify a company that uses IFRS for your selected topic (see 1.b.). Find a company in the same industry that uses U.S. GAAP for the same item. Use your web research skills to identify IFRS users – one place to start is at the SEC site (www.sec.gov – and look for foreign private issuer). You can go to the following link ( http://www.sec.gov/divisions/corpfin/internatl/foreignalpha2007.pdf) to find international companies. Or try out the web-site http://www.iasplus.com/index.htm. You can find U.S. companies by industry on Yahoo finance -- http://biz.yahoo.com/ic/. Prepare a report (no longer than 3 pages) that provides: ` Brief summary of IFRS accounting compared to U.S. GAAP for your assigned topic. ` Provide an excerpt from the identified IFRS company and use it to describe one similarity and one difference between U.S. GAAP and IFRS for your topic, based on the selected companies. Please attach the relevant parts of the annual reports to supplement your report. Other assignments – see UW-Madison site for how we attacked IFRS in our curriculum along with some sample assignments: http://www.bus.wisc.edu/accounting/IFRSReadyProgram.asp 16

Ch..Ch.. Changes – (even w/o IFRS Adoption) `

On the Horizon (Circa 3Q 2010) ….

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On the Horizon – Fair Value Measurement `

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An important area of convergence, especially in light of recent events in the markets for financial instruments (relevant to discussions in Chs 2, 5, and 7). FASB has been a leader here. `

Boards issued a converged standard just recently (IFRS 13, FASB ASC 820 (update to FAS 157) -- no new fair value measurements, but developed a single definition of fair value and requires enhanced disclosures of fair value measurements and remeasurements.

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Boards have similar standards regarding the fair value option (FAS 159, IAS 39).

Boards agree about the relevance of fair values for financial instruments, but face different political pressures on recording fair value changes in income… financial instruments project.

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On the Horizon – Financial Instruments (FI) `

BIG Area of Contention - In response to financial crisis, Boards under pressure to improve accounting for FI. Although MOU project, Boards have taken very different paths… face different political pressures on recording URG/L in income.

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IASB (IFRS 9) – 1st of multi-part project `

2 Classifications – Held for Collection (for debt instruments, loans) & Fair Value – some UHGL are recorded in OCI (intent-based!).

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In general, all equity instrument at FV w/ G/L in income.

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On the Horizon – Financial Instruments (FI) `

With amortized cost for “held-for-collection”, IFRS has an impairment model – allows write-ups after impairments are recorded.

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IASB still deliberating hedge accounting provisions.

FASB – June 2010 Exposure Draft (All FI at fair value, with some UHGL

recorded in OCI (+ simplified hedge accounting.) Recent FASB decisions in redeliberations indicate that FASB is moving toward IFRS 9 – there will be an amortized cost bucket.

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Appear to be moving to a converged standard. To do: `

Impairment model (Good Book / Bad Book)

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Disclosures – should fair value and amortized cost be presented on the face of the balance sheet?

(In my view, this is not ideal, but a step forward). 20

On the Horizon - Financial Statement Presentation `

Background `

Joint with the IASB… inception ~ 2001; Partly informed / influenced by a 2005 CFA Report.

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Key Elements ` Major reformatting of statements to gain consistency across statements, but allow companies to choose classifications according to how they manage the business (management approach,) a la IFRS 8.) ` Operating / Financing is the main cut – consistent across IS, BS, SCF

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Project is on hold – other projects have priority. Things to watch out for: ` ` ` 21

New framework for reporting of re-measurements (fair value & accruals). Comprehensive Income Tightening up of netting – gross up balance sheets.

Financial Statement Presentation Project

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FSP – New Disclosures The notes to financial statements would include new or additional disclosure requirements: ƒ Provide an analysis of the changes between the opening balance and the closing balance of asset and liability line items that are important for understanding the current period change in the entity’s financial position. ƒ Present separately the change related to cash transactions, noncash transactions (eg reclassifications), accounting allocations (eg depreciation), write-downs or impairment losses, acquisitions or dispositions, and other remeasurements (eg fair value changes). ƒ Include a note that discloses the remeasurement amounts recognized in the statement of comprehensive income and a narrative description as necessary to place the remeasurement information in context. 23

FSP -- Reconciliation Schedule??

CHANGES IN ASSETS AND LIABILITIES, EXCLUDING TRANSACTIONS WITH OWNERS

Not from remeasurements

Cash component A

Caption in statement of cash flows

From remeasurements

Accrual components

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Cash flows

Accruals, allocations, and other

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Recurring fair value All other changes/valuation categorie adjustments s

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Statement of comprehensive income (B+C+D+E)

Caption in statement of comprehensive income

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Comprehensive Income Reporting Recent decisions: 1 Continuous or 2 Statement format will be permitted (no more reporting in statement of changes in stockholders’ equity).

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On the Horizon – Revenue Recognition `

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Background `

Boards have been working on this project since ~2005. Need more robust and general framework for recognizing revenue.

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Products, Multi-elements, Service arrangements, etc.

Key Elements - Abandon “earned and realized”, “risk and rewards” as primary recognition criteria. `

Analyze revenue transactions based on contractual provisions of revenue arrangements.

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Requires measurement (and re-measurement) of contract assets and performance obligations (no more unearned revenue).

Note – the general model similar to % of completion accounting. FASB has issued some recent guidance that moves in this direction (EITF on multi-element arrangements.) 26

On the Horizon – Leases `

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Background -- Boards began coordinated work on leasing ~ 2006. Responding to concerns around the world with respect to off-balance sheet operating leases. Both GAAPs need improvement. Key Elements -- Lessees `

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No longer capital and operating leases. Abandon transfer of “risks and rewards” or “transfer of ownership” (based on bright-line tests) applied to whole asset. Have agreed to a “right of use” model… lessee records an asset or part of an asset it controls; records a liability for the obligation to make payments over the lease term (based on present value of contractual lease payments). Income effects like a financing – although recent deliberations indicate that straight-line recognition for leases without a significant financing element. 27

On the Horizon – Leases -- Lessors `

Continue to record leased asset on books, with a performance obligation (see rev. rec. discussion) for the right of use by lessee.

Sales-type lease provisions still being debated in coordination with Rev Rec. (will look similar to current accounting). 28

Example – Leases: Old vs. New Rules `

Facts `

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Lessor A owns a 5 story building with a fair value of $1,192,461. The building has a 40 year life and with zero residual value. Lessor A plans to lease each floor of the building to tenants on 5-year non-renewable leases with annual payments at the beginning of the year of $25,000. Lessee B leases the top floor of the building for the first 5-year lease term.

Analysis Under current GAAP ` This lease would most assuredly be classified as an operating g lease (neither the 75% of life test nor the 90 fair value tests are met. Under the IASB/FASB Proposal ` Lessee has a right of use asset for the floor that it controls and a liability measured as the PV of the lease payments. Lessor keeps the building on its books but now has a performance obligation for the right of use.

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Summary `

International Accounting Convergence has dominated the standard-setting scene but a push to adopt IFRS in the U.S. appears to be on hold (SEC to decide later this year). ` `

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IFRS infrastructure has a way to go. Students still need some U.S. GAAP knowledge (International accounting market) -- Doable approaches to getting your students tuned into U.S. GAAP.

Do not lose sight of important joint projects, which will have a big impact on accounting practice, even in the absence of IFRS adoption in the U.S. ` `

Fair value, Financial instruments, Financial statement presentation, Revenue recognition, and leases. Now is the time to get informed/ready for these new standards.

Questions? 30