Executive summary IFRS permits periodic revaluation of an entire class of fixed assets to fair value. US GAAP does not allow revaluation. IFRS requires depreciation of components of an asset when the components have different periods of benefit. Component depreciation is permissible using US GAAP but is not a common practice.
IFRS US GAAP Definition PP&E includes long-term tangible assets acquired for use in operations and not for resale. Similar
IFRS US GAAP AcquisitionGeneral PP&E should be recorded based on the fair value given up or the value received, whichever is more clearly evident. Similar Costs include purchase price and related taxes, directly attributable costs and estimated retirement obligation costs. Similar Costs that are not directly attributable should be expensed as a period cost. Similar
US GAAP Voluntary investments in safety or environmental equipment are capitalized. Acquisition General IFRS • Voluntary investments in safety or environmental equipment are expensed, unless they extend the economic life of the related asset or a constructive obligation exists to improve the asset’s safety or environmental standards.
Acquisition General Example 1: Clean Company wants to be viewed as the most environmentally friendly company in its industry. As a result, the company installs equipment on its smoke stacks to reduce emissions. The equipment costs $30,000 and has a three-year life. • How would this equipment be accounted for using US GAAP and IFRS?
Example 1 solution: Using US GAAP, this equipment would be capitalized and depreciated over its three-year life. Using IFRS, the $30,000 cost of this voluntary investment in environmental equipment might be expensed in year one, unless it extends the economic life of the smoke stacks or this expenditure fulfills a constructive obligation. Acquisition General
IFRS US GAAP Valuation at acquisitionExchange of non-monetary assets Valuation should be based on fair value given up or fair value received, whichever is more clearly evident. Similar If the transaction has commercial substance, any related gain or loss should be recognized in income. Similar If the exchange lacks commercial substance, losses should be recognized immediately and gains should be deferred if no cash is received as part of the exchange. Similar
US GAAP If the exchange lacks commercial substance and some cash is received, a portion of the gain can be recognized: The formula for recognizing gain is: (cash received/(fair value of assets received plus cash received)) x total gain. When cash represents 25% or more of the exchanged value, the transaction should be accounted for as a monetary exchange. Valuation at acquisitionExchange of non-monetary assets IFRS • IAS 16, paragraph 24, states “unless (a) the exchange lacks commercial substance or (b) the fair value of neither the asset received nor the asset given up is reliably measurable,” then the value of the acquired item is measured at fair value. If the exchange lacks commercial substance or the fair value of neither asset is reliably measurable, then the cost is measured as the cost of the asset given up. In this case, this would result in gains being deferred using IFRS.
Example 4: A company exchanges two used printing presses with a total net book value of $24,000 ($40,000 cost less accumulated depreciation of $16,000) for a new printing press with a fair value of $24,000 and $3,000 in cash. The fair value of the two used printing presses is $27,000. The transaction is deemed to lack commercial substance. What gain or loss would be recognized using US GAAP and IFRS? Show corresponding journal entries. Valuation at acquisitionExchange of non-monetary assets
Example 4 solution: The portion of the gain to be recognized using US GAAP would be computed as follows: cash received of $3,000/(fair value of assets of $24,000 + cash received of $3,000) x total the gain of $3,000 = recognized gain of $333. New printing press $ 21,333 Cash 3,000 Accumulated depreciation 16,000 Old printing presses $ 40,000 Gain on disposal 333 The cost of the new printing press is the $24,000 fair value reduced by the unrecognized gain of $2,667. Valuation at acquisitionExchange of non-monetary assets
Example 4 solution (continued): Using IFRS, no gain would be recognized since the transaction lacks commercial substance. The entry would be as follows: New printing press $ 21,000 Cash 3,000 Accumulated depreciation 16,000 Old printing presses $ 40,000 If there is a computed loss on the exchange, recognize the amount of the loss immediately. Valuation at acquisitionExchange of non-monetary assets
IFRS US GAAP Valuation at acquisitionPurchases paid for using company stock If the company’s stock is actively traded, the value of the stock should be used to determine the value of the asset received in the exchange. If a company cannot determine the market value of its stock, it should determine the fair value of the asset received in the exchange. Similarly, “the fair value of the asset given up is used to measure the cost of the asset received unless the fair value of the asset received is more clearly evident.” (IAS 16.24)
US GAAP Revaluation of fixed assets is not allowed. Periodic valuationCarrying value IFRS • A company can choose to account for PP&E and natural resources at fair value using the revaluation method: • Cost or fair value must be applied to an entire class of PP&E. • Different classes can have different policies. • Fair value is the amount at which an asset could be exchanged in an arm’s length transaction between knowledgeable and willing parties. • A professional appraiser may be used to establish fair value. • Revaluations must be performed periodically to ensure the carrying value of that asset class is not materially different than its fair value.
Periodic valuationCarrying value US GAAP • Revaluation of fixed assets is not allowed. IFRS • Accounting for revaluation: • Increases in value should be credited through OCI to a revaluation surplus account in equity, unless it reverses a loss that was previously expensed, in which case that portion may be credited to income. • Decreases in value should be expensed unless it reverses a previous revaluation surplus account relating to the same asset. That portion can be debited through OCI to the revaluation surplus account in equity. • If the revalued basis of an asset exceeds the cost basis, there will be an increase in annual depreciation. To the extent there is an increase in depreciation expense, per IAS 16.4-1, an entity may reverse the portion of reserve surplus related to this increase by debiting revaluation surplus and crediting retained earnings. Alternatively, this transfer may be computed upon disposal.
Periodic valuationCarrying value US GAAP • Revaluation of fixed assets is not allowed. IFRS • Accounting for revaluation (continued): • When an asset is disposed of, any remaining related revaluation surplus account in equity may be transferred to retained earnings. The revaluation surplus can never be credited to income. • If an asset is revalued, an entity may account for the accumulated depreciation at the date of revaluation in two ways: • Depreciation elimination method: The accumulated depreciation can be eliminated against the asset itself. • Proportionate restatement method: The accumulated depreciation can be restated proportionately with the change in the gross carrying value of the asset so that the carrying value of the asset after revaluation equals its revalued amount.
US GAAP Revaluation of fixed assets is not allowed. Periodic valuationCarrying value IFRS • In 2006, Ernst & Young LLP provided an overview of 65 selected large, multinational companies reporting using IFRS. Only one company used the revaluation option for any of its PP&E. • In a recent study, Hans B. Christensen and Valeri Nikolaev of the University of Chicago Booth School of Business looked at the valuation choices made by 1,539 German and UK companies in the first year of preparing IFRS financial statements. They found that only 3% of the companies chose to use fair value accounting for at least one class of assets.
Example 5: A company that reports using IFRS acquired weight-lifting equipment on January 1, 2010, at a cost of $10,000. This is the company’s only equipment. The company uses fair value for its equipment using IAS 16. On December 31, 2011, the net book value is $8,000 (cost of $10,000 less accumulated depreciation of $2,000), while the fair value is determined to be $8,800. What journal entries would be required to record the revaluations in 2011? Periodic valuationCarrying value
Example 5 solution: Accumulated depreciation $ 2,000 Equipment $ 2,000 (To eliminate accumulated depreciation.) Equipment $ 800 Revaluation surplus – equipment (OCI) $ 800 (To write equipment up to fair value.) Periodic valuationCarrying value
Example 6: A company that reports using IFRS acquired an excavator on January 1, 2010, at a cost of $10,000. This excavator represents the company’s only piece of equipment. The company uses fair value for its equipment using IAS 16. This excavator is being depreciated on a straight-line basis over its 10-year useful life. There is no residual value at the end of the 10-year period. In both 2010 and 2011, depreciation would be $1,000. On December 31, 2011, the fair value is determined to be $8,800. On December 31, 2013, the fair value is determined to be $5,000. The company’s accounting policy is to reverse a portion of revaluation surplus related to the increased depreciation expense. Determine what accounts would be impacted if this activity is recorded for 2010 through 2013. Periodic valuationCarrying value
Periodic valuationCarrying value Example 6 solution:
Periodic valuationCarrying value 2012: Depreciation expense $ 1,100 Accumulated depreciation $ 1,100 (To record depreciation.) Revaluation surplus – equipment (OCI) $ 100 Retained earnings $ 100 (To reverse portion of reserve surplus related to increased depreciation expense. Note that this journal entry is optional.) Example 6 solution (continued): 2010: Equipment $ 10,000 Cash $ 10,000 (To record purchase of equipment.) Depreciation expense $ 1,000 Accumulated depreciation $ 1,000 (To record depreciation.) 2011: Depreciation expense $ 1,000 Accumulated depreciation $ 1,000 (To record depreciation.) Accumulated depreciation $ 2,000 Equipment $ 1,200 Revaluation surplus – equipment (OCI) 800 (To record revaluation.)
Periodic valuationCarrying value Example 6 solution (continued): 2013: Depreciation expense $ 1,100 Accumulated depreciation $ 1,100 (To record depreciation.) Revaluation surplus – equipment (OCI) $ 100 Retained earnings $ 100 (To reverse portion of reserve surplus related to increased depreciation expense. Note that this journal entry is optional.) Accumulated depreciation $ 2,200 Revaluation surplus – equipment (OCI) 600 Loss 1,000 Equipment $ 3,800 (To record devaluation of equipment.)
IFRS US GAAP Cost allocation issuesDepreciation Definition: the systematic and rational manner of allocating the cost of a tangible asset to expense over the asset’s expected life. Similar Similar Useful life: the expected service period of the asset, which could be shorter than its physical life. Similar, but IFRS requires each significant component of an asset to be identified and its depreciable base to be determined. Depreciable base: if the cost basis is used, then the depreciable base is the cost of the asset less the estimated salvage value. Depreciation method: attempt to match the cost of an asset to the period benefited from the use of the asset. Typical methods are the straight-line method, the units-of-production method and various accelerated methods. Similar
US GAAP Depreciable base: component depreciation is allowed, but is rarely done because it complicates the accounting. Cost allocation issuesDepreciation IFRS • Depreciable base: IAS 16.43 states, “each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.”
Example 10: A company acquires a truck at a cost of $60,000. The service life is expected to be four years. Based on reliable historical data, the company believes the truck can be sold at the end of four years for $10,000. Additionally, the tires must be replaced every two years. The transmission must be replaced every three years. On the initial date of acquisition, the tires have a cost of $4,000 and the transmission has a cost of $6,000. What is the depreciable base and service life using US GAAP and IFRS? Assume the company chooses not to use component depreciation using US GAAP. Cost allocation issuesDepreciation
Example 10 solution: Depreciable base Service life US GAAP IFRS Truck 4 years $ 50,000 $ 40,000 Tires 2 years – 4,000 Transmission 3 years – 6,000 $ 50,000 $ 50,000 Cost allocation issuesDepreciation
Example 11: Use the same facts as the previous example. Assume straight-line depreciation and compute the depreciation expense in year one using US GAAP and IFRS. Assume that all of the salvage value is assigned to the truck itself and none to the tires or transmission. Cost allocation issuesDepreciation
Example 11 solution: Service life Truck 4 years $ 50,000 $ 12,500 Service life Truck 4 years $ 40,000 $ 10,000 Tires 2 years 4,000 2,000 Transmission 3 years 6,000 2,000 $ 50,000 $ 14,000 Cost allocation issuesDepreciation US GAAP US GAAP depreciable depreciation base expense IFRS IFRS depreciable depreciation base expense
US GAAP The revaluation method is not allowed. DispositionSale IFRS • If the revaluation method is used, the accounting for a sale may be slightly different, as follows: • If the revaluation resulted in a write-down of the asset, then the gain or loss on the sale is calculated based on the sales proceeds less the net adjusted asset value. • If the revaluation resulted in a write-up of the asset, then the revaluation surplus account can be reversed to retained earnings. There are no significant differences if the cost method is used.
Example 12: A company acquired its only building on January 1, 2010, at a cost of $4 million. The building has a 20-year life and is being depreciated on a straight-line basis. On December 31, 2011, the net book value of the building was $3.6 million. The company revalued the building when the fair value of the building was $3.78 million on December 31, 2011. On December 31, 2013, the company sold the building for $3.6 million. The company’s accounting policy is to reverse a portion of the surplus account related to increased depreciation expense. Determine what accounts would be impacted and, in table format, show the activity for the years 2010 through 2013. Show the journal entry to record the sale. DispositionSale
DispositionSale Example 12 solution: * Calculated as $3,780,000 NBV divided by remaining 18-year life.
Example 12 solution (continued): The entry to record the sale would be as follows: Cash $ 3,600,000 Accumulated depreciation 420,000 Revaluation surplus (OCI) 160,000 Building cost 3,780,000 Gain on sale 240,000 Retained earnings 160,000 Note: if the asset hadn’t been revalued, the NBV of the building would have been $3.2 million (cost of $4.0 million less $200,000 depreciation x 4 years). If the building was sold for $3.6 million, the gain would have been $400,000. Since the building was revalued, the depreciation expense over the four years was $820,000 ($200,000 in 2010 and 2011 and $210,000 in 2012 and 2013). Reserve surplus was reduced by $20,000 during this period with the credit applied directly to retained earnings. Reserve surplus can never be credited to income. Therefore, after reversing the remaining reserve surplus of $160,000 to retained earnings, the resulting gain is $240,000. DispositionSale
IFRS US GAAP Disclosures The measurement basis used for each class of PP&E. Similar The balance of each class of PP&E as of the balance sheet date. Similar A description of the depreciation method, the useful lives of PP&E, the amount of accumulated depreciation and depreciation expense during the period. Similar The amount of impairment losses recognized in income during the year. Similar