Question

In: Finance

Client X operates in the US currently and is planning to expand operations globally next year....

Client X operates in the US currently and is planning to expand operations globally next year. As a result, management is considering preparing financial statements in accordance with IFRS rather than with US GAAP. Client X contacted you for clarification and recommendations regarding the following issues: How the use of the LIFO method to value its inventories will be impacted if a switch to financial statements prepared in compliance with IFRS will be made. Whether interest cost on construction of a new warehouse may be included in the cost of the new warehouse. In what instances should goodwill be adjusted for impairment? Provide a 150- word overview of each issue, followed by solid responses supported by research and proper citing.

Solutions

Expert Solution

1st issue:-

The Last In First Out (LIFO) method of inventory valuation, while permitted under the U.S. Generally Accepted Accounting Principles (GAAP), is prohibited under the International Financial Reporting Standards (IFRS). As IFRS rules are based on principles rather than exact guidelines, usage of LIFO is prohibited due to potential distortions it may have on a company’s profitability and financial statements. In principle, LIFO may create a distortion to net income when prices are rising (inflation); LIFO inventory amounts are based on outdated and obsolete numbers, and LIFO liquidations may provide unscrupulous managers with the means to artificially inflate earnings.

2nd issue:-

Borrowing Cost may include:

  • Interest expenses calculated by effective interest method.
  • finance charges in respect of finance leases recognised in accordance with Leases, and
  • exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

Capitalisation should commence when expenditures are being incurred, borrowing costs are being incurred and activities that are necessary to prepare the asset for its intended use or sale are in progress (may include some activities prior to commencement of physical production).

Hence if above conditions satified then only interest cost on construction of a new warehousewill be included in the cost of the new warehouse.

3rd issue:- Instances where goodwill should be adjusted for impairment

Impairment review is required each year to assess whether there are indications that impairment might have occurred. These include:

  • obsolescence due to new technological changes,
  • decline in performance i.e. net cash flows of the asset or CGU,
  • decline in market value of the asset,
  • changes in economy such as an increase in labor cost, raw materials, etc. that would shrink the net cash flows of the asset
  • physical damage to the asset such as fire or other accident
  • major restructuring i.e. reshuffling of products, segments, acquisition of new assets, etc.

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