Question

A1 Systems Inc. is a U.S.-based company that prepares its consolidated financial statements in accordance with U.S. GAAP. The company reported income of $8,000,000 in 2014 and stockholders’ equity of $30,000,000 as of December 31, 2014.

The CFO of A1 Systems has learned that the U.S. Securities and Exchange Commission (SEC) is considering requiring U.S. public firms 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 your team to prepare a reconciliation of income and stockholders’ equity from U.S. GAAP to IFRS. Your team has identified the following five major areas in which accounting principles based on U.S. GAAP differ from those of IFRS.

Inventory

At year-end 2014, inventory had a historical cost of $5,000,000, a replacement cost of 4,750,000, a net realizable value of $4,800,000, and a normal profit margin of $900,000.

Property, plant, and equipment

The company acquired a building on 1/1/2012 at a cost of $10,000,000. The building has an estimated useful life of 30 years, an estimated residual value of $1,000,000, and is being depreciated on a straight-line basis. On 1/1/2013, the building was appraised and determined to have a fair value of $11,150,000. There is no change in estimated useful life or residual value. In a switch to IFRS, the company would use the revaluation model to determine the carrying value of PP&E subsequent to acquisition.

Impairment of Assets

The company purchased a piece of equipment on 1/1/2014 at a cost of $1,000,000. The equipment is expected to have a useful life of 10 years and no residual value. The straight-line method of depreciation is used. Technological innovations took place in the industry during 2014. At year-end 2014, the equipment is determined to have a selling price of $800,000 with zero-cost to sell. Expected future cash flows from continued use of the equipment are $950,000, and the present value of the expected future cash flows is $825,000.

Answer 1

Following would be the key differences between US GAAP and IFRS:

Inventory

Under IFRS, the inventory shall be valued at lower of cost or net realizable value. However, In US GAAP NRV - Net profit margin is used.

Therefore, under IFRS it would be $4,750,000 and under GAAP it would be $3,900,000.

Property, Plant, and Equipment

Yes, as per IAS 16 and 40 read together, the company can follow the revaluation model and raise the carrying value of the PPE to the fair value.

Impairment of Assets

Under US GAAP, two-step process is followed, at first compare the carrying value with undiscounted FCFs. If it exceeds the same, then proceed for impairment. However, under IFRS, carrying shall be compared with DCF or Adjusted Fair value.

Therefore, under US GAAP there will not be any impairment. However, under IFRS impairment will be required for $75,000 i.e. $9,00,000 (Carrying value after depreciation) - $ 8,25,000