Even for non-public US companies, having a basic understanding of International Financial Reporting Standards (“IFRS”) is beneficial. The continued global adoption of IFRS impacts US companies due to the convergence of generally accepted accounting principles in the US (“US GAAP”) and IFRS, as well as increased cross-border merger and acquisition activity, and the growing number of companies doing business globally. Included is a summary of 5 areas of existing differences between the frameworks and any corresponding guidance updates.
1. Revenue Recognition
Under US GAAP, if certain criteria are met at the inception of an arrangement, multiple deliverables should be identified, separated and recognized as each item is considered delivered. IFRS addresses ‘multiple-element’ arrangements in general terms only, and generally, revenue recognition criteria are applied separately to each transaction.
Under US GAAP, if certain criteria are met, construction contracts are accounted for using the percentage of completion method (“POC”). Otherwise, the completed contract method is used. IFRS also provides for POC, however, the completed contract method is not permitted unless the outcome of the contract cannot be estimated reliably, then the zero profit method of recognizing revenue to the extent of recoverable costs incurred shall be used, which is one of the approaches to the completed contract method under US GAAP.
On the horizon: Joint FASB/IASB Project
In May 2014, the extensive, converged standard, ‘Revenue from Contracts with Customers’ was issued. The new contract-based model provides for revenue to be recognized based on the satisfaction of performance obligations. Application would require entities to perform a 5-step process in identifying and recognizing revenue upon the satisfaction of performance obligations. The new standard for non-public entities issuing US GAAP financial statements will be effective for annual periods beginning after December 15, 2018, and for annual reporting periods beginning on or after January 1, 2017, under IFRS.
Under US GAAP, the existence of any one of four following conditions at inception calls for automatic classification of the lease as a capital (finance) lease (i.e., capitalized onto the balance sheet versus a period expense):
- Ownership transfer of the property
- Bargain purchase option
- Lease term relative to the economic life of the asset (equal to or greater than 75%)
- Present value of minimum lease payments relative to the fair value of the leased asset (equal to or greater than 90%)
IFRS requires classification of a finance lease after consideration of the existence of various additional factors (individually or collectively), but does not establish quantitative thresholds as US GAAP does.
On the horizon: Joint FASB/IASB Project
The objective of the project is to increase transparency and comparability among organizations and in general, a lessee would recognize assets and liabilities with a lease term of more than 12 months. The final update is estimated to be released in the fourth quarter of 2015.
Under US GAAP, last-in, first-out (“LIFO”) inventory costing is an acceptable costing methodology, which is not permitted under IFRS.
Lower of cost or net realizable value
The FASB recently issued ASU 2015-11 – Simplifying the Measurement of Inventory. Previously under US GAAP when the cost of inventory was no longer deemed to be recoverable, inventories were required to be written down to the lower of cost or market value (the replacement cost), which was subject to a ceiling and a floor. ASU 2015-11 requires that inventory be measured at the lower of cost or net realizable value (“NRV”). As a result, the consideration of replacement cost is no longer required. Under US GAAP any write-down from cost may not be reversed. IFRS also requires write-down to the NRV. IFRS permits reversal of a write-down if circumstances indicate that the NRV has increased in subsequent periods.
Under US GAAP, a deferred tax asset (“DTA”) is recognized in full and is reduced by a valuation allowance if it is more likely than not that some portion of or all of the DTA will not be realized. IFRS requires recognition of a DTA to the extent that it is probable that taxable profits will be available against which the deductible temporary differences will be utilized, with no concept of a valuation allowance.
Uncertain tax positions
Under US GAAP, a threshold is established that a tax position must meet for any part of the benefit of that position to be recognized in the financial statements. A recognized tax position is initially and subsequently measured at the largest amount of the benefit that carries a greater than 50% likelihood of being realized. IFRS does not prescribe any specific guidance over uncertain tax positions.
Under US GAAP, most research and development costs are charged to expense as incurred. Software development costs for external use are capitalized once technological feasibility is established. Software development costs for internal use incurred during the application development stage may be capitalized. IFRS establishes that certain development costs meeting specific criteria are capitalized as an internally generated intangible asset. No specific guidance on software development costs is addressed under IFRS.
Although US companies will not have to outright adopt IFRS any time soon, the converged set of standards is likely to continue to evolve. It is prudent for US companies to stay up-to-date on their understanding of the primary differences between IFRS and US GAAP as well as the impact of any convergence standards on their reporting objectives.