IFRS Update AGENDA 8/7/2011. GSCPA Southeastern Accounting Show 2011 August 19, IASB/FASB Convergence Projects. IFRS for SME s.

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1 IFRS Update GSCPA Southeastern Accounting Show 2011 August 19, 2011 AGENDA Overview IASB/FASB Convergence Projects IFRS for SME s SEC Workplan, Progress Report, SEC Paper on IFRS Implementation Examples of Differences between IFRS and US GAAP 1

2 IFRS of 195 Countries Permit/Require Source: AICPA May 26: SEC issues paper seeking comment on IFRS incorporation Comparison 2,000 pronouncements 17,000 + pages of standards and guidance in total Contains 37 standards, 27 interpretations Approximately 2,500 pages of standards and guidance 4 2

3 Principles Based U.S. GAAP Transaction analysis IFRS Accounting research Decision making Transaction analysis Accounting research Decision making 5 SEC IFRS WORK PLAN & PROGRESS REPORT 3

4 SEC Work Plan Issued on February 24, 2010 The purpose of the Work Plan is to consider six specific areas and factors relevant to an SEC determination in 2011 of whether, when, and how the U.S. should be transitioned to a system incorporating IFRS Successful completion of FASB/IASB MoU critical steps in process Promise of periodic staff reports beginning no later than October 2010 Mandatory adoption, if any, would likely be no earlier than 2015 or 2016 SEC s First Progress Report Issued October 29, 2010 Progress report provides details about the specific plans the SEC staff is in the process of undertaking or that it plans to undertake on each of the six key issues identified in the Work Plan Additional progress reports are expected in the coming months 4

5 Characteristics of IFRS and its Standard Setting Process 1. Sufficient Development and Application of IFRS for the U.S. Domestic Reporting System 2. The Independence of Standard Setting for the Benefit of Investors Sufficient Development and Application of IFRS Evaluating comprehensiveness by inventorying areas where U.S. GAAP contains more or less guidance than IFRS and how constituents manage these situations Analyzing how other jurisdictions incorporate IFRS Reviewing the role of the national standard setter in other jurisdictions to help identify future role of FASB 5

6 Independence of Standard Setting for the Benefit of Investors The Staff expects to perform a significant portion of its review of the oversight of the IFRS Foundation and composition of the IFRS Foundation and the IASB in early 2011 after the Monitoring Board has completed its governance review Funding mechanisms of the IFRS Foundation are being reviewed including use of financial sector regulators, stock exchanges or national standard setters Currently reviewing the IASB s policies and procedures and its compliance with those policies Who Funds the IASB? 35.00% IASB Funding % 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Americas Europe Asia-Oceania South Africa International Accounting Firms Central Banks & International Organisations 6

7 Transition Considerations 3. Investor Understanding and Education Regarding IFRS 4. Examination of the U.S. Regulatory Environment that Would Be Affected by a Change in Accounting Standards 5. The Impact on Issuers, Both Large and Small, Including Changes to Accounting Systems, Changes to Contractual Arrangements, Corporate Governance Considerations, and Litigation Contingencies 6. Human Capital Readiness SEC Staff Paper: IFRS Incorporation Issued on May 26, 2010 Outline a possible approaches for incorporation of IFRS into the U.S. financial reporting system Incorporation of IFRS would have the objectives of achieving the goal of having a single set of highquality, globally accepted accounting standards The framework would retain a FASB and would facilitate the transition process by incorporating IFRSs into U.S. GAAP over some defined period of time (e.g., five to seven years), Providing for a U.S. issuer complying with U.S. GAAP also to be in a position to assert that it is compliant with IFRS as issued by the IASB. 7

8 Role of FASB Remain the standard-setting body in the US. Participate in the process for developing IFRS Play an instrumental role in global standard setting by providing input and support to the IASB in developing and promoting high-quality, globally accepted standards; by advancing the consideration of U.S. perspectives in those standards; and by incorporating those standards, by way of an endorsement process, into U.S. GAAP. One Approach: Condorsement IFRSs could be organized into one of the following categories: 1. IFRSs subject to MoU projects 2. IFRSs included on the IASB s current standard-setting agenda 3. All other existing IFRSs and areas not addressed by IFRSs 8

9 One Approach: Condorsement IFRSs could be organized into one of the following categories: 1. IFRSs subject to MoU projects 2. IFRSs included on the IASB s current standard-setting agenda 3. All other existing IFRSs and areas not addressed by IFRSs Possible Approach to IFRS Incorporation Period IASB Convergence Quiet Period Post Convergence FASB Convergence Incorporation Endorsement Entities Assessment Voluntary Use US GAAP=IFRS Source: AICPA 2 nd Qtr IFRS Update 18 9

10 SEC s Casey Pushes to Incorporate IFRS The SEC can no longer kick the can down the road, with regard to IFRS adoption. In the absence of a credible step by the United States to increase its use of IFRS, our ability to influence IFRS and thus ensure their continued quality and comparability will quickly dissipate. Smaller issuers that have no international operations should be allowed to opt out of IFRS and continue with U.S. GAAP, at least initially. The decision a critical one and it is being closely watched by other jurisdictions around the world. In this area, our global leadership still matters greatly. I hope we rise to the challenge and continue to lead. IASB/FASB CONVERGENCE PROJECTS 10

11 Completed MoU Projects Share-based payments Segment reporting Borrowing costs Research Costs Non-controlling interests Business Combinations Derecognition IFRS 12 Disclosure Interest in Other Entities IFRS 13 Fair Value Measurement IFRS 11 Joint Agreements IAS 19 Employee Benefits (post employment benefits improvement) IFRS 10 - Consolidated Financial i Statements Recent MoU Completed Projects IAS 1 - Presentation of Financial Statements t t (presentation of OCI improvement) 11

12 IASB Workplan 6/30/ H H1 Type of Project Leases Re-expose or Review IFRS MoU Draft Revenue Recognition Re-expose IFRS MoU Financial Instruments: Impairment Re-expose or Review Draft IFRS MoU Financial Instruments: General Hedging IFRS MoU Financial Instruments: Macro Hedging Exposure Draft MoU Financial Instruments: Offsetting IFRS MoU Insurance Contracts Re-expose or Review Draft IFRS Joint Financial Presentation Project (MoU) FASB and the IASB have been working on a project to overhaul the presentation of the financial statements. The scope of this project encompasses all business entities, both public and private, but will not apply to non-business entities 12

13 Financial Presentation Project (MoU) October 2008 IASB/FASB issue a Discussion Paper July 2010 IASB/FASB issue a staff draft of the proposed project October 2010 the bulk of project was pushed back until 2 nd half of 2011 because of the lack of resources Statement of Financial Position Business Section Operating Category Operating Finance Subcategory Investing Category Statement of Comprehensive Income Business Section Operating Category Operating Finance Subcategory Investing Category Statement of Cash Flows Business Section Operating cash flows Investing cash flows Financing Section Debt Category Equity Category Financing Section Debt Category Financing Section Multi-Category Transaction Section Multi-Category Transaction Section Income Tax Section Income Tax Section Income Tax Section Discontinued Operations Section Discontinued Operations Section, net of tax Other Comprehensive Income, net of tax Discontinued Operations Section 13

14 Consolidation IFRS 10 A single control model that applies to all entities. The changes will require management to exercise significant judgment to determine which entities are controlled, and are required to be consolidated. Consolidations IFRS 10 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 h its power over the investee. The investor must possess all of the following elements: Power over the investee: having existing rights that give the ability to direct the activities of the investee that significantly affect the investee s returns Exposure, or rights, to variable returns from its involvement with the investee Ability to use its power over the investee to affect the amount of the investor s returns 14

15 Fair Value IFRS 13 IFRS 13 establishes a single framework for measuring fair value. The Standard applies to both financial and non-financial items measured at fair value Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., an exit price) IFRS 13 is effective for annual periods beginning on or after January 1, 2013 with early adoption permitted Fair Value IFRS 13 An entity must determine the following to arrive at an appropriate measure of fair value: The asset or liability being measured The principal (or most advantageous) market in which an orderly transaction would take place for the asset or liability. For a non-financial asset, the highest and best use of the asset and whether the asset is used in combination with other assets or on a stand-alone basis. Those assumptions that market participants would use when pricing the asset or liability. 15

16 Fair Value Disclosures 31 Level 1 inputs - are fully observable (e.g., unadjusted quoted prices in an active market for identical assets and liabilities that the entity can access at the measurement date); Level 2 inputs - are those other than quoted prices within Level 1 that are directly or indirectly observable; and Level 3 inputs - are unobservable. Source: Deloitte IFRS Focus: May 2011 IASB/FASB - Leases August 17, 2010: Exposure Draft Released Comment Period Ended December 15, 2010 Received 784 comment letters Redeliberations began in February

17 IASB/FASB - Leases A lessee has acquired a right to use the underlying asset, and it pays for that right with the lease payments. A lessee would record: an asset for its right to use the underlying asset (the right-of-use asset), and a liability to pay rentals (liability for lease payments). The proposal includes simplified accounting for short-term leases leases having a maximum term of 12 months or less. Example A five year lease with rental payments of $20,000 with an 8% discount rate. PV of lease payments = $79,854 (lease asset & lease liability) Operating Lease: $20,000 rent expense in years 1 5 Proposed model Amortization expense (S/L) and Interest Expense (effective interest method) Amortization Interest Total Rent Expense Difference Year 1 $15,971 $6,388 $22,359 20, $2,359 Year 2 $15,971 $5,299 $21,270 20,000 $1,270 Year 3 $15,971 $4,123 $20,094 20,000 $94 Year 4 $15,971 $2,853 $18,824 20,000 ($1,176) Year 5 $15,971 $1,481 $17,452 20,000 ($2,548) 17

18 P&L Effect $25,000 Proposed Existing $23,000 $21,000 $19,000 $17,000 $15,000 Year 1 Year 2 Year 3 Year 4 Year 5 Examples (in millions) Capital Lease Operating Lease Delta (U.S.$) $626 $14,946 American Airlines (U.S.$) $689 $9,327 Qantas (A$) $633 $3,994 Nestle (CHF) $494 $2,452 Walmart (U.S.$) $600 $1,800 18

19 Lessor Performance Obligation Asset right to receive lease payments PV of lease payments plus initial direct costs incurred by the lessor Derecognition Asset right to receive lease payments PV of lease payments plus initial direct costs incurred by the lessor Lease Liability PV of lease payments underlying asset is not derecognized Derecognize portion of carrying amount of underlying asset (FV of right to receive lease payments/fv underlying asset) X Carrying amount of underlying asset Reclassify remaining portion as a residual asset Discount rate = rate the lessor charges the lease Discount rate = rate the lessor charges the lease Initial direct costs = recoverable costs directly attributable to negotiating and arranging the lease Initial direct costs = recoverable costs directly attributable to negotiating and arranging the lease Redeliberations Comments are almost unanimous in censuring the proposed hybrid model. Many judge this model to be less comprehensive than the one developed for lessees. The boards are deliberation whether to have a one-step or a two-step model for lessor accounting. However in both cases, the residual asset model is still on the table. 19

20 IASB/FASB Revenue Recognition July 24, 2010: Exposure Draft Released Comment Period Ended October 22, 2010 Received 972 comment letters Redeliberations began in January 2011 Re-expose 3 rd QTR 2011 IASB/FASB Revenue Recognition Revenue would be recognized only from the transfer of goods or services to a customer. % of completion revenue would be allowed but only if the customer owns the WIP as it is built or developed A company would be required to account for all goods or services that are distinct. Collectability would affect how much revenue is recognized, rather than whether revenue is recognized. Greater use of estimates would be required 20

21 5 Steps to Revenue Recognition Identify the contract(s) with the customer Identify the separate performance obligations Determine the transaction price Allocate the transaction price to the performance obligations Recognise revenue when a performance obligation is satisfied Separate Performance Obligations Account for a component of the contract separately if it is distinct and: a) it is sold separately or b) it could be sold separately because it has a distinct function and it has a distinct profit margin 21

22 Separate Performance Obligations The Exposure Draft identify s six situations that call for performance obligations to be separated: Sale of a product with a right of return Product warranties and product liabilities Principal versus agent considerations Customer options for additional goods or services Non-refundable upfront fees and Licensing and rights to use Separate Performance Obligations Significant Changes From the ED Step 1: Identify the Contract With the Customer eliminating the criteria i to segment tifth the price of some goods and services in the contract is independent of the price of other goods or services in the contract. Step 2: Identify the Separate Performance Obligations Eliminating the use of a distinct profit margin Step 3: Determine the Transaction Price Practical expedient for TVM if period between payment and transfer of goods or service is one year or less. Also, eliminating the reduction in amount of promised consideration and revenue to reflect the customer s credit risk and change to allowance for loss. Source: Advocacy Standards Guidance, The FASB/IASB Revenue Recognition Project, June 16,

23 Separate Performance Obligations Significant Changes From the ED Step 5: Recognize Revenue Separate guidance provided for transfer of goods and services and criteria for determining continuous transfer. Costs of Obtaining a Contract Eliminating the requirement to expense all costs of obtaining a contract as incurred, and a practical expedient that short-term contracts do not have to capitalize costs of obtaining a contract Source: Advocacy Standards Guidance, The FASB/IASB Revenue Recognition Project, June 16, 2011 EXAMPLES OF THE DIFFERENCES BETWEEN IFRS AND US GAAP 23

24 Inventory US GAAP IFRS LIFO is acceptable method LIFO is prohibited Inventory is carried at LCM. Market is defined as current replacement cost as long as the market is not > NRV (ceiling) and is not less than net realizable value reduced by a normal sales margin (floor) Any write-downs of inventory to LCM creates a new cost basis that can not be reversed. Inventory is carried at the lower of cost or net realizable value. (NRV = estimated selling price less estimated costs to complete and sell) Previously recognized impairment losses are reversed, up to the amount of the original impairment loss when the reason for the impairment no longer exists. 47 PP&E US GAAP No annual review of the depreciation method required. Component depreciation is permitted but not common IFRS The depreciation method applied to an asset shall be reviewed at least at each financial year-end Component depreciation is required if components of an asset have differing patterns of benefit Revaluation is not permitted Revaluation is a permitted alternative accounting election for an entire class of assets, requiring revaluation to fair value on a regular basis

25 Intangible Assets US GAAP Research costs are expensed as incurred. Development costs are expensed as incurred unless addressed by a separate standard. Development costs related to computer software developed for external use are capitalized once technological feasibility is established. IFRS Research costs are expensed as incurred. Development costs are capitalized when technical and economic feasibility of a project can be demonstrated There is no separate guidance addressing computer software development costs. 49 IFRS for SME s 25

26 IFRS for SME s On July 9, 2009 the IASB issued "International Financial Reporting Standard for Small and Medium- sized Entities" (IFRS for SMEs). IFRS for SMEs is a self-contained set of standards that consist of 230 pages Revisions to the IFRS will be limited to once every three years. (7/12, 7/15, 7/18, etc ) 51 AICPA On May 18, 2008 AICPA's governing Council voted unanimously to recognize the IASB as a designated accounting standard-setter. The Council's vote amended Appendix A of the AICPA Code of Professional Conduct AICPA members may now issue audit opinions on financial statements prepared and presented in accordance with any standards issued by the IASB 52 26

27 IFRS is Already Here Consolidations: US private company with foreign parent US private company with foreign subs Associates: A foreign company owns 25% stake in a US company A foreign company begins operations in your geographic area. Your client is complaining about standards overload and wants to move to IFRS for SME s Q&A 27

28 Thank you Peter A. Margaritis