Question

Connor and Martin have heard that IFRS is used internationally for financial statements but they know very little about it. Since they will most likely be going public and expanding internationally in the near future, they are considering switching to IFRS from GAAP and would like more information. They also realize if they go public and expand their business, they will have to deal with some issues they have not had to deal with previously, such as interim and segment reporting. For their first request, they would like you to research the following topics:

What are the similarities between GAAP and IFRS?

What are the major differences between GAAP and IFRS?

What are the requirements for interim reporting under both GAAP and IFRS?

Are there any problems or issues associated with interim reporting?

What are the advantages and disadvantages of providing segmented reporting?

What are the requirements for segment reporting under both GAAP and IFRS? Include the definition of an operating segment.

Memorandum Mechanics should be as follows:

The body of the memorandum should be a professional presentation centered on clear and concise writing. The responses to the questions should be detailed, well researched, and specifically related to CMC's industry.

The memorandum itself does not have to be in APA format. However, you should have in-text citations and a reference page. Both of these items should be in APA format.

Use the FASB Codification and IFRS to address all technical accounting issues presented in the questions, being certain to reference the applicable sections of the Codification and IFRS in your report. You may quote directly from the Codification and IFRS as long as all direct quotes are included in quotation marks.

Answer 1

1) Similarities between IFRS and US GAAP

a) Both are guiding principles that help in the preparation and presentation of a statement of accounts. A professional accounting body issues them, and that is why they are adopted in many countries of the world. Both of the two provides relevance, reliability, transparency, comparability, understandability of the financial statement.

b) GAAP and IFRS are alike in many ways, thus making the convergence a realizable task. The conceptual frameworks of both methods are very similar in structure, referring to their accounting objectives, elements, and qualitative characteristics.

c) Both standards use an income statement, a balance sheet, statement of cash flows,statement of changes in equity and related notes.

d) Both GAAP and IFRS prepare financial statements on an accrued basis; meaning revenue is recognized when it is realized or realizable.

2) Differences between US GAAP and IFRS

While this is not a comprehensive list of differences that exist, these examples provide a flavor of impacts on the financial statements and therefore on the conduct of businesses.

a. 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.

b. 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.

c. 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.

d. 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.

e. 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.

f. 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.

g. 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.

h. 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.

i. 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.

j. 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.

It’s important to understand these top differences between IFRS and GAAP accounting, so that your company can accurately do business internationally. U.S.-based companies must abide by specific accounting regulations, even if they plan to do business internationally.

3) I - Requirements for Interim Reporting under IFRS (IAS 34)

a) Minimum content - he minimum components specified for an interim financial report are: [IAS 34.8]

• a condensed balance sheet (statement of financial position)
• either (a) a condensed statement of comprehensive income or (b) a condensed statement of comprehensive income and a condensed income statement
• a condensed statement of changes in equity
• a condensed statement of cash flows
• selected explanatory notes

If a complete set of financial statements is published in the interim report, those financial statements should be in full compliance with IFRSs. [IAS 34.9]

If the financial statements are condensed, they should include, at a minimum, each of the headings and sub-totals included in the most recent annual financial statements and the explanatory notes required by IAS 34. Additional line-items or notes should be included if their omission would make the interim financial information misleading. [IAS 34.10]. If the annual financial statements were consolidated (group) statements, the interim statements should be group statements as well.

b) Note disclosures - The explanatory notes required are designed to provide an explanation of events and transactions that are significant to an understanding of the changes in financial position and performance of the entity since the last annual reporting date. IAS 34 states a presumption that anyone who reads an entity's interim report will also have access to its most recent annual report. Consequently, IAS 34 avoids repeating annual disclosures in interim condensed reports. [IAS 34.15]

c) Accounting policies - The same accounting policies should be applied for interim reporting as are applied in the entity's annual financial statements, except for accounting policy changes made after the date of the most recent annual financial statements that are to be reflected in the next annual financial statements. [IAS 34.28]

d) Measurement - Measurements for interim reporting purposes should be made on a year-to-date basis, so that the frequency of the entity's reporting does not affect the measurement of its annual results. [IAS 34.28]

Several important measurement points:

• Revenues that are received seasonally, cyclically or occasionally within a financial year should not be anticipated or deferred as of the interim date, if anticipation or deferral would not be appropriate at the end of the financial year. [IAS 34.37]
• Costs that are incurred unevenly during a financial year should be anticipated or deferred for interim reporting purposes if, and only if, it is also appropriate to anticipate or defer that type of cost at the end of the financial year. [IAS 34.39]
• Income tax expense should be recognised based on the best estimate of the weighted average annual effective income tax rate expected for the full financial year. [IAS 34 Appendix B12]

e) Materiality - In deciding how to recognise, measure, classify, or disclose an item for interim financial reporting purposes, materiality is to be assessed in relation to the interim period financial data, not forecast annual data. [IAS 34.23]

f) Disclosure in annual financial statements - If an estimate of an amount reported in an interim period is changed significantly during the financial interim period in the financial year but a separate financial report is not published for that period, the nature and amount of that change must be disclosed in the notes to the annual financial statements. [IAS 34.26]

II - Requirements for Interim Reporting under US GAAP (ASC 270)

a) It should also be clearly stated whether the interim financial statements are audited or unaudited.

b) It is permitted that interim financial statements are produced in a summarised or condensed format, that is, they do not have to show all of the information and disclosures that are included in a full annual set of financial statements. Condensed information must be clearly identified as such. A full set of financial statements can be prepared for an interim period, if this is preferred.

c) Changes in accounting policy in an interim period from any of the following must be disclosed: changes since

• The comparable interim period of the prior year
• The preceding interim period of the current year (if any)
• The prior annual period.

d) Changes in accounting estimates - The effect of any changes in accounting estimates during the period on the interim financial statements should be separately disclosed.

e) Income - Income should be recognised and reflected in the statement of operations on the same basis as is used for the annual financial statements. For example: recognising dividends on their ex-date

f) Expenses - Expenses are recognised and reflected in the statement of operations, so as to reflect an appropriate allocation of the expense to the interim period. The calculation of an expense charge will depend on the type of expense:

• Expenses incurred in the period: such as management fees, and
• Expenses accrued which will be paid later in the year: for example 50% of the annual audit fee charge is accrued in the interim financial statements for a 6 month period

Expenses should not be allocated to an interim period on an arbitrary basis, and the allocation method used should be consistent with that used for the annual financial statements.

Both IAS 34 and ASC 270 are similar except for treatment of certain costs. Under US GAAP each interim period is treated as integral part of an annual period. As a result certain costs that benefit more than one interim period are allocated among those interim periods, resulting in deferral or accrual of certain costs. Whereas under IFRS each interim period is reported as a discrete reporting period. cost that does not meet the definition of an asset is not deferred, a liability recognised at interim peripd must represent an exisitng obligation.

4) Interim reporting is the financial reporting made by a company on a less than annual basis, such as half yearly or quarterly financial reports. Annual data are insufficient to evaluate developments in general economic, industry, and company activities and making or revising projections of earnings and financial position as a basis for investment decisions.

Basically two problems—Accounting Problems and Conceptual Problems are involved in interim financial reporting.

I. Accounting Problems:

Accounting Problems are of the following types:

1. Inventory Problems:

In a business enterprise, inventory is a major element in the generation of income. Inventory problem in interim reporting has three types of problems; determination of inventory quantities, valuation of inventories, and adjustments of valuation. The development of inventory data for interim reporting depends largely on the making of accurate physical counts and its costing procedure. However, the valuation problem is more important than the quantity problem.

It is almost invariably considered impractical to count and price the inventory every quarter or every month, so estimates of gross profit must be used to determine cost of goods sold. Alternatively, the company may have perpetual inventory records integrated with the accounting records, allowing direct determination of cost of goods sold, but the perpetual records may not be verified by cycle counts, and some interim allowance will be needed for annual physical inventory adjustments.

2. Matching Problem:

Business operations are not similar and uniform throughout the year. Resources are acquired and output is done in advance of sales. Some costs related to current sales do not mature into liabilities or readily measurable expenses until a subsequent time. Because of various lead and lag relationships between cost and sales, difficulties are created in matching costs and revenues. The relationship between costs and revenues becomes unclear.

Interim accruals for various selling expenses, general and administrative expenses, allowances for doubtful accounts, and deferrals and contingencies are illustrations of items that normally require companies to rely heavily on estimates.

3. Extent of Disclosure Problem:

There is a problem of deciding the quantity of disclosures in interim financial reports. Generally speaking, disclosure requirements applicable for annual reporting are not applicable to interim reporting. In the absence of mandatory interim disclo­sures, the interim disclosure practices are likely to vary.

There is a problem of determining materiality criteria for deciding the information to be disclosed in interim reports. The treat­ment to be given in respect of prior period adjustments, extraordinary items and earnings per share can create difficulties in interim reporting.

II. Conceptual Issues:

The primary conceptual issue is whether the interim period is part of a longer period or is a period in itself. The former position is known as the integral view, the latter as the discrete view. Under the integral view, revenue and expenses for interim periods are based on estimates of total annual revenues and expenses.

The discrete view holds that earnings for each period are not affected by projections of the annual results; the methods used to measure earnings are the same for any period, whether a quarter or a year. As a practical matter some elements of both positions are recognized in current reporting practices.

Those who favour the second, the integral approach, view each interim period primarily as being an integral part of the annual period. Under this view deferrals, accruals, and estimates at the end of each interim period are affected by judgments made at the interim date as to the results of operations for the balance of the annual period.

5) Information reported in a business enterprise’s financial statements constitutes an important input to financial statement analysis which is generally made in investment and lending decisions. Investors and lenders analyse information relating to a business enterprise to evaluate the risk and return associated with an investment or lending alternative.

A) Advantages of Segmental reporting

a)  Segment Disclosure and Investment Decision-Making:

A major argument in support of segmental reporting is that if investors are provided with information about the profitability, risk and growth of the different segments of a company’s operations, they will be better able to assess the earnings potential and the risk of the company as a whole.They will be able to predict more accurately a firm’s future earnings and cash flows than can be done by using consolidated data alone. Investor uncertainty about company prospects will thus be reduced, share prices will be set more accurately, and a more efficient allocation of resources will be promoted.

b. Segments Disclosure and Other Users (Other than Investors):

Besides the investors, it has been suggested that segmental reports are likely to be useful to employees and trade unions, consumers, the general public, government and also for the purpose of promoting managerial efficiency. Employees and trade unions are interested in the performance and prospects of the firm from the standpoint of wage negotiations and job security and hence, segmental reports may be just as relevant to them as to investors.There is also a need for information on segmental performance so that policy decisions by management to develop or curtail particular activities can be verified and understood. Lack of information, on the other hand, may lead to distrust and labour relations problems.

B) Segment Reporting Problem

a. Base of Segmentation:

Basic problem which arises in segment reporting is division of a diversified company for segment reporting purposes. Every base of segmentation may create segments differently. Identification of segmentation is also problematic. Segmentation can be done on the basis of organisational division, Industry, Market, Product etc. Each base has its own limitation and own problem.

b. Allocation Problem:

In business organisation where more than one product are dealt. There are likely to be costs which are common to two or more products. Joint Costs can be general administrative expenses and legal expenses. Allocation of these joint costs becomes a complex problem while doing segment reporting. However there can be some common costs which can be apportioned on some reasonable basis for example electricity charges which can be apportioned on the basis of light Points in a particular segment on the other hand there can be some common costs like salary of a director which can only be apportioned on some arbitrary basis.

c. Disclosure Costs:

Segment reporting also involves costs of disclosures. The provision of additional information along with routine information increases firm’s operating costs in terms of cost of collection processing and costs of management control systems. Cost argument is also related with increased competition that may result from segment reporting.

d. Managerial Conservatism:

In the absence of some regulatory provisions to disclose segment reports; voluntary disclosures are likely to be perceived by manager to be beneficial only in certain situations. For example management will do the segment reporting when they believe that company’s attractiveness can be enhanced.

e. Inter-Segment Transactions:

In a diversified business entity which may have some inter-segment transactions. There are number of methods for inter segment transfers i.e. cost, cost-plus, market price and negotiated prices. All these methods result in different operating results for reporting segment.

f. Difficulty in Providing Data:

Measurement problems have created problem of difficulty in providing at while doing segment reporting. Since the measurement problem influences the feasibility of disclosing certain information, one should look at the problem of determining segment information. If we look upon profit and loss account statement, we immediately run into trouble with the sales figure particularly inter segment sales.

7)  The segment reporting requirements under International Financial Reporting Standards are essentially identical to the requirements just noted under GAAP.

a) ASC 280 - Segment Reporting

Under Generally Accepted Accounting Principles (GAAP), an operating segment engages in business activities from which it may earn revenue and incur expenses, has discrete financial information available, and whose results are regularly reviewed by the entity's chief operating decision maker for performance assessment and resource allocation decisions. Follow these rules to determine which segments need to be reported:

• Aggregate the results of two or more segments if they have similar products, services, processes, customers, distribution methods, and regulatory environments.
• Report a segment if it has at least 10% of the revenues, 10% of the profit or loss, or 10% of the combined assets of the entity.
• If the total revenue of the segments you have selected under the preceding criteria comprise less than 75% of the entity's total revenue, then add more segments until you reach that threshold.
• You can add more segments beyond the minimum just noted, but consider a reduction if the total exceeds ten segments.

The information you should include in segment reporting includes:

• The factors used to identify reportable segments
• The types of products and services sold by each segment
• The basis of organization (such as being organized around a geographic region, product line, and so forth)
• Revenues
• Interest expense
• Depreciation and amortization
• Material expense items
• Equity method interests in other entities
• Income tax expense or income
• Other material non-cash items
• Profit or loss

b) IFRS 8

IFRS 8 defines an operating segment as follows. An operating segment is a component of an entity: [IFRS 8.2]

• that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity)
• whose operating results are reviewed regularly by the entity's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance and
• for which discrete financial information is available

Reportable segments

IFRS 8 requires an entity to report financial and descriptive information about its reportable segments. Reportable segments are operating segments or aggregations of operating segments that meet specified criteria: [IFRS 8.13]

• its reported revenue, from both external customers and intersegment sales or transfers, is 10 per cent or more of the combined revenue, internal and external, of all operating segments, or
• the absolute measure of its reported profit or loss is 10 per cent or more of the greater, in absolute amount, of (i) the combined reported profit of all operating segments that did not report a loss and (ii) the combined reported loss of all operating segments that reported a loss, or
• its assets are 10 per cent or more of the combined assets of all operating segments.

Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the core principles of the the standard, the segments have similar economic characteristics and are similar in various prescribed respects. [IFRS 8.12]

If the total external revenue reported by operating segments constitutes less than 75 per cent of the entity's revenue, additional operating segments must be identified as reportable segments (even if they do not meet the quantitative thresholds set out above) until at least 75 per cent of the entity's revenue is included in reportable segments. [IFRS 8.15]

Disclosure requirements

Required disclosures include:

• general information about how the entity identified its operating segments and the types of products and services from which each operating segment derives its revenues [IFRS 8.22]
• judgements made by management in applying the aggregation criteria to allow two or more operating segments to be aggregated [IFRS 8.22(aa)]#
• information about the profit or loss for each reportable segment, including certain specified revenues* and expenses* such as revenue from external customers and from transactions with other segments, interest revenue and expense, depreciation and amortisation, income tax expense or income and material non-cash items [IFRS 8.21(b) and 23]
• a measure of total assets* and total liabilities* for each reportable segment, and the amount of investments in associates and joint ventures and the amounts of additions to certain non-current assets ('capital expenditure') [IFRS 8.23-24]
• an explanation of the measurements of segment profit or loss, segment assets and segment liabilities, including certain minimum disclosures, e.g. how transactions between segments are measured, the nature of measurement differences between segment information and other information included in the financial statements, and asymmetrical allocations to reportable segments [IFRS 8.27]
• reconciliations of the totals of segment revenues, reported segment profit or loss, segment assets*, segment liabilities* and other material items to corresponding items in the entity's financial statements [IFRS 8.21(b) and 28]
• some entity-wide disclosures that are required even when an entity has only one reportable segment, including information about each product and service or groups of products and services [IFRS 8.32]
• analyses of revenues and certain non-current assets by geographical area – with an expanded requirement to disclose revenues/assets by individual foreign country (if material), irrespective of the identification of operating segments [IFRS 8.33]