In: Accounting
Tara’s Treasures Inc. is a publicly traded company that develops, manufactures, and distributes professional quality exercise equipment. The firm was established in 1965 in Burlington, Vermont and went public in 1975. Sales were initially from only the Northeast region of the United States, but since going public the company has grown significantly and now supplies exercise equipment in all fifty states. In 2015 the company reported a market capitalization of $950 million. Recently, the company has decided to enter the INTERNATIONAL Market in order to enhance their growth potential. Tara’s Treasures, Inc.’s CFO, has been with Tara’s Treasures, Inc. for 20 years and has held the position of CFO for the past 5 years. Your Role: Assume that you are the Financial Accounting Controller for Tara’s Treasures, Inc. You report directly to the CFO. Recently, the CFO came to you with an article that he found on CFO.com that deals with adoption of International Financial Reporting Standards (IFRS). The CFO wants to know more about the implications of IFRS adoption. Specifically, he has asked you do some research and find answers to the following questions: 1. What are the primary benefits of IFRS adoption for US firms in general? Describe at least three benefits. 2. What are the primary costs of IFRS adoption for US firms in general? Describe at least three costs. 3. The CFO does not understand how IFRS differs from current US GAAP. Briefly describe the differences between GAAP and IFRS and in support of your analysis include two areas of Tara’s Treasures financial statements that could be reported differently under IFRS. 4. Based on your research, do you think that Tara’s Treasures should be in favor of or opposed to IFRS adoption and is there any plans they should be making to prepare for the consequences.
The first and the foremost objective if IFRS is that there should be a single set of globally accepted standards.
Tara’s Treasures Inc a developing organisation is about to put its foot forward in the international market and as far as the financial compliances are concerned, there is a difference between the treatments provided by the US firms which have been following GAAP and the other international companies which have adopted IFRS.
To harmonise the same, adoption of IFRS should be done so that international trade practices can be accomplished without any troubles relating to financial treatments and the results depicted by the financial statements are easily understandable all accross the globe.
1)Primary benefits of IFRS:
1. The first factor is that IFRS promise more accurate, timely and comprehensive financial statement information that is relevant to the national standards. And the information provided by financial statements prepared under IFRS tends to be more understandable for investors as they can understand the financial statement without the necessity of other sources which makes investors more informed.
Businesses using similar standards to prepare financial statements can more accurately compare with each other. This is very useful when comparing businesses that are based in different countries, as they may otherwise have different methodologies and rules in preparing these documents. This greater comparability has aided investors to better identify where their investments should go.
Also . Financial statements prepared using a common set of accounting standards help investors better understand investment opportunities as opposed to financial statements prepared using a different set of national accounting standards.
2. The IFRS can help new and small investors by making reporting standards to have better quality and become simpler, putting these investors in a similar position with professional investors, which was not feasible under previous standards. This also entails a reduced risk for these investors when they trade, as the professionals will not be able to take advantage because the nature of financial statements will just be simple to be understood by all.
This will help the industry raising capital from foreign markets at lower cost as it can create confidence in the minds of even small foreign investors that their financial statements comply with globally accepted accounting standards.
Also due to harmonization and standardization of reporting standards under IFRS, the investors do not need to pay for processing and adjusting the financial statements to be able to understand them, thus eliminating the fees of analysts. Therefore, IFRS reduces the cost for investors.
3. Using a philosophy that is based on principles, instead of rules, this set of standards will have the goal of arriving at a reasonable valuation with various ways to accomplish tasks. This would give businesses the freedom to adopt IFRS to their specific situations, which will result in financial statements that are more easily read and useful.
Therefore Reducing international differences in reporting standards by applying IFRS, in a sense removes a cross border takeovers and acquisitions by investors.
2) Primary cost for US firms for IFRS adoption:
Training of employees
It is the human capital which has to actually deal with the changes and comply with the same, therefore companies will have to train its employees for tackling the new accounting principles.
Increased auditing expenditure
As the auditors will also have to update themselves and have to comply with the international standards there fees for the same will be higher as in comparison to earlier costs.
Conversion cost
As there would be a change in the system of accounting this cost has to incur thereby affecting the cost structure of the companies.
3) Difference between GAAP and IFRS and the areas which will be affected by the adoption of IFRS:
1. Locally vs. Globally
As mentioned, the IFRS is a globally accepted standard for accounting, and is used in more than 110 countries. On the other hand, GAAP is exclusively used within the United States and has a different set of rules for accounting than most of the world. This can make it more complicated when doing business internationally.
2. Rules vs. Principles
A major difference between IFRS and GAAP accounting is the methodology used to assess the accounting process. GAAP focuses on research and is rule-based, whereas IFRS looks at the overall patterns and is based on principle.
With GAAP accounting, there’s little room for exceptions or interpretation, as all transactions must abide by a specific set of rules. With a principle-based accounting method, such as the IFRS, there’s potential for different interpretations of the same tax-related situations.
3. Inventory Methods
Under GAAP, a company is allowed to use the Last In, First Out (LIFO) method for inventory estimates. However, under IFRS, the LIFO method for inventory is not allowed. The Last In, First Out valuation for inventory does not reflect an accurate flow of inventory in most cases, and thus results in reports of unusually low income levels.
4. Inventory Reversal
In addition to having different methods for tracking inventory, IFRS and GAAP accounting also differ when it comes to inventory write-down reversals. GAAP specifies that if the market value of the asset increases, the amount of the write-down cannot be reversed. Under IFRS, however, in this same situation, the amount of the write-down can be reversed. In other words, GAAP is overly cautious of inventory reversal and does not reflect any positive changes in the marketplace.
5. Development Costs
A company’s development costs can be capitalized under IFRS, as
long as certain criteria are met. This allows a business to
leverage depreciation on fixed assets. With GAAP, development costs
must be expensed the year they occur and are not allowed to be
capitalized.
6. Intangible Assets
When it comes to intangible assets, such as research and development or advertising costs, IFRS accounting really shines as a principle-based method. It takes into account whether an asset will have a future economic benefit as a way of assessing the value. Intangible assets measured under GAAP are recognized at the fair market value and nothing more.
7. Income Statements
Under IFRS, extraordinary or unusual items are included in the income statement and not segregated. Meanwhile, under GAAP, they are separated and shown below the net income portion of the income statement.
8. Classification of Liabilities
The classification of debts under GAAP is split between current liabilities, where a company expects to settle a debt within 12 months, and noncurrent liabilities, which are debts that will not be repaid within 12 months. With IFRS, there is no differentiation made between the classification of liabilities, as all debts are considered noncurrent on the balance sheet.
9. Fixed Assets
When it comes to fixed assets, such as property, furniture and equipment, companies using GAAP accounting must value these assets using the cost model. The cost model takes into account the historical value of an asset minus any accumulated depreciation. IFRS allows a different model for fixed assets called the revaluation model, which is based on the fair value at the current date minus any accumulated depreciation and impairment losses.
10. Quality Characteristics
Finally, one of the main differentiating factors between IFRS and GAAP is the qualitative characteristics to how the accounting methods function. GAAP works within a hierarchy of characteristics, such as relevance, reliability, comparability and understandability, to make informed decisions based on user-specific circumstances. IFRS also works with the same characteristics, with the exception that decisions cannot be made on the specific circumstances of an individual.
Based on my research, I believe that IFRS should be adopted by Tara’s Treasures Inc as it is about to enter the international market where it has to compete with international companies.
This will smoothen the working of company in the long run even though it has to bear some primary costs in the beginning.