Question

Case 4-1 Bessrawl Corporation

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 2014 of $1,000,000 and stockholders’ equity at December 31, 2014, of $8,000,000.

The CFO of Bessrawl has learned that the U.S. Securities and Exchange Commission is considering requiring U.S. companies to use 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 five 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

Bessrawl provides the following information with respect to each of these accounting differences.

Inventory

At year-end 2014, inventory had a historical cost of $250,000, a replacement cost of $180,000, a net realizable value of $190,000, and a normal profit margin of 20 percent.

Property, Plant, and Equipment

The company acquired a building at the beginning of 2013 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 2014, 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 2011, 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 2014, 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 2014. Of this amount, 40 percent related to development activities subsequent to the point 178 at which criteria had been met indicating that an intangible asset existed. As of the end of the 2014, development of the new product had not been completed.

Sale-and-Leaseback

In January 2012, 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 five years.

Required

Prepare a reconciliation schedule to convert 2014 income and December 31, 2014, stockholders’ equity from a U.S. GAAP basis to IFRS. Ignore income taxes. Prepare a note to explain each adjustment made in the reconciliation schedule.

Answer 1

	Net Income	Stock Holder Equity
As per US GAPP	$1,000,000	$8,000,000
Inventory ( Note-1)	$10,000	$10,000
Property, Plant, Equipment	-$25,000	$575,000
Intangible Asset ( Note-3)	-$5,000	-$5,000
Research & Development Cost ( Note-4)	$80,000	$80,000
Sale and Lease Back ( Note-5)	$30,000	$60,000
As per IFRS	$1,090,000	$8,720,000

Notes:

1 Under US GAAP, Inventory is valued at lower of cost or market

Market means Replacement cost ($180000)

Cost is $250000

Hence, Inventory to be valued=$180000.This will result in a loss of $70000 (250000-180000) in the company's income statement

Under IFRS , Inventory can be valued at Lower of cost ($250000) and Net realizable value ($190000)

Hence, Inventory to be valued=$190000.This will result in a loss of $60000 (250000-190000) in the company's income statement

Net increase in Net income and stockholder's equity by $10000(70000-60000)

2 Under US GAAP depreciation reported for 2013 & 2014 under SLM=($2750000-250000)/25 years=$100000

Under IFRS revaluation model, Depreciation for 2013=$100000

Carrying value at the beginning of 2014=$2750000-$100000=$2650000

Building has revalued to $3250000, then revaluation surplus=3250000-2650000=$600000

Depreciation for 2014=($3250000-$250000)/24=$125000

Hence, there is an additional depreciation of $25000 under IFRS and it will reduce income

Stockholder's equity will increase by $575000(Revaluation surplus $600000-Additional depreciation $25000)

3 Under US GAAP ,an asset is impaired when it's carrying amount exceeds the future cash flows (Undiscounted) expected to arise from its continued use and disposal of asset

Carrying amount=$40000

Future expected cash flows=$42000

Hence, no impairment

Under IFRS, an asset is said to be impaired when its carrying amount exceeds its recoverable amount.

Recoverable amount=Greater of net selling price ($35000) and value in use (Present value of future cash flows $34000)=$35000

Hence, there is an impairment of $5000 (40000-35000).It will reduce the income and retained earnings by $5000

4 Under US GAAP,$200000 would be recognized as expense.

Under IFRS, $120000(200000*60%) would be recognized as expense $80000 would be capitalized as an intangible asset

Income and stockholder's equity would be increased by $80000

Please note that since the new product has not been brought into the market, no amortization of intangible asset

5 Under US GAAP ,gain on sale and lease back is deferred and amortized over the life of the lease.

Amount to be amortized as gain=$150000/5=$30000

Amount amortized from 2012,13 & 14=3*$30000=$90000

Under IFRS, Gain on sale is recognized as income immediately in 2012.

It will increase the income by $30000 and stockholder's equity by $60000