Financial Risk Manager

The International Financial Reporting Standards (IFRS), and US Generally Accepted Accounting Principles (GAAP), are the two most widely used accounting standards in the world. IFRS standards are set forth by International Accounting Standards Board (IASB), and GAAP principles are set forth by Financial Accounting Standards Board (FASB).

GAAP is more widely used by US companies, while IFRS is more common with companies listed outside the US.

U.S. GAAP is scheduled to start converging with IFRS by the end of 2014.

Let’s take a look at the key differences between the two:

In a company the inventory can be tracked using one of the two methods, namely, Last In First Out (LIFO) and First In First Out (FIFO). The US GAAP allows the use of any of the two methods, while in IFRS, LIFO accounting is not allowed.

The various cash flows of an operation can be identified as operating, financing or investing activities. In IFRS, the interest payments and receipts can be identified as any of these three activities, while in US GAAP, interest receipts can be identified only as operating activity.

Consolidation refers to inclusion of the financial statements of a subsidiary into the parent company’s financial statements.

In US GAAP, to be able to consolidate, the focus is on controlling financial interest. As long as the parent company has control over the financial interest of the subsidiary, the consolidation can be carried out. In case of IFRS, the focus is on having the ability to control both the financial interest and the operating policies. The control is assumed to exist of the parent company has over 50% of votes.

In general, US GAAP recognizes only two types of accounts for properties, i.e., held for sale, or held for use. The US GAAP does not have a separate account for investment properties; so all investment properties are recognized as either held for use, or as held for sale. However, in IFRS, investment property is separately defined in IAS 40 as an asset held to earn rent or for capital appreciation (or both) and may include property held by lessees under a finance/operating lease. Therefore, accountants can account for investment property based on a historical cost basis or on a fair value basis.

Under US GAAP, most of the lease transactions only affect the income statement, and are not recorded as balance sheet items. However, in IFRS, most leases are recognized as financing leases, so, the company must recognize the asset as well as the future lease liability.

Both IFRS and GAAP do not recognize revenue until it is earned, however, there are certain differences. For example, let’s take the case of sale of goods. In case of US GAAP, revenue is recognized once the delivery has occurred, there is persuasive

evidence of the sale, the fee is fixed or determinable, and collectibility is reasonably assured. In IFRS, the revenue is recognized only when the ownership has been transferred, and the revenue can be measured reliably.

With respect to receivables, IFRS considers it to be a financing agreement. All future receivables should be discounted using the appropriate interest rates in order to determine the value of revenue.

The US GAAP allows construction contract revenues to be recognized using the percentage-completed or the completed-contract method. The IFRS prohibits the use of completed contract method.

The two accounting standards also have differences in the way the financial reports are presented.

The International Accounting Standards Board met in London on 6 October 2009 for an additional Board meeting to continue work on the project Financial Instruments: Replacement of IAS 39,


Classification and Measurement - phase 1

􀁺 Interaction between the two classification conditions
􀁺 Amortised cost
􀁺 Fair value option (FVO)
􀁺 Reflecting changes in own credit risk for financial liabilities not measured at amortised cost
􀁺 Accounting for embedded derivatives
􀁺 Unquoted equity instruments: elimination of cost exception

Impairment - phase 2

􀁺 Guidance for variable interest rates
􀁺 Presentation and Disclosures
􀁺 Impairment - interaction with other IFRSs (IAS 28 and IFRS 4)

Hedge Accounting - phase 3

􀁺 Applying cash flow hedge accounting mechanics to a fair value

IASB will hold round table discussions in November and December 2009, on its proposals for
fair value measurement. Round tables will be held in North America, Asia and Europe. An audio recording of the round table discussions will be made available on the website shortly after each round table.

The objective of this IFRS is to specify the financial reporting by an entity when it undertakes a share-based payment transaction. In particular, it requires an entity to reflect in its profit or loss and financial position the effects of share-based payment transactions, including expenses associated with transactions in which share options are granted to employees.

The IFRS requires an entity to recognise share-based payment transactions in its financial statements, including transactions with employees or other parties to be settled in cash, other assets, or equity instruments of the entity. There are no exceptions to the IFRS, other than for transactions to which other Standards apply.

This also applies to transfers of equity instruments of the entity’s parent, or equity instruments of another entity in the same group as the entity, to parties that have supplied goods or services to the entity.

The IFRS sets out measurement principles and specific requirements for three types of share-based payment transactions:

(a) equity-settled share-based payment transactions, in which the entity receives goods or services as consideration for equity instruments of the entity (including shares or share options);

(b) cash-settled share-based payment transactions, in which the entity acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price (or value) of the entity’s shares or other equity instruments of the entity; and

(c) transactions in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash or by issuing equity instruments.

For equity-settled share-based payment transactions, the IFRS requires an entity to measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the goods or services received, the entity is required to measure their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted. Furthermore:

(a) for transactions with employees and others providing similar services, the entity is required to measure the fair value of the equity instruments granted, because it is typically not possible to estimate reliably the fair value of employee services received. The fair value of the equity instruments granted is measured at grant date.

(b) for transactions with parties other than employees (and those providing similar services), there is a rebuttable presumption that the fair value of the goods or services received can be estimated reliably. That fair value is measured at the date the entity obtains the goods or the counterparty renders service. In rare cases, if the presumption is rebutted, the transaction is measured by reference to the fair value of the equity instruments granted, measured at the date the entity obtains the goods or the counterparty renders service.

(c) for goods or services measured by reference to the fair value of the equity instruments granted, the IFRS specifies that vesting conditions, other than market conditions, are not taken into account when estimating the fair value of the shares or options at the relevant measurement date (as specified above). Instead, vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so that, ultimately, the amount recognised for goods or services received as consideration for the equity instruments granted is based on the number of equity instruments that eventually vest. Hence, on a cumulative basis, no amount is recognised for goods or services received if the equity instruments granted do not vest because of failure to satisfy a vesting condition (other than a market condition).

(d) the IFRS requires the fair value of equity instruments granted to be based on market prices, if available, and to take into account the terms and conditions upon which those equity instruments were granted. In the absence of market prices, fair value is estimated, using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm’s length transaction between knowledgeable, willing parties.

(e) the IFRS also sets out requirements if the terms and conditions of an option or share grant are modified (eg: an option is repriced) or if a grant is cancelled, repurchased or replaced with another grant of equity instruments. For example, irrespective of any modification, cancellation or settlement of a grant of equity
instruments to employees, the IFRS generally requires the entity to recognise, as a minimum, the services received measured at the grant date fair value of the equity instruments granted.

For cash-settled share-based payment transactions, the IFRS requires an entity to measure the goods or services acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the entity is required to remeasure the fair value of the liability at each reporting date and at the date of settlement, with any changes in value recognised in profit or loss for the period.

For share-based payment transactions in which the terms of the arrangement provide either the entity or the supplier of goods or services with a choice of whether the entity settles the transaction in cash or by issuing equity instruments, the entity is required to account for that transaction, or the components of that transaction, as a cash-settled share-based payment transaction if, and to the extent that, the entity has incurred a liability to settle in cash (or other assets), or as an equity-settled share-based payment transaction if, and to the extent that, no such liability has been incurred.

The IFRS prescribes various disclosure requirements to enable users of financial statements to understand:

(a) the nature and extent of share-based payment arrangements that existed during the period;

(b) how the fair value of the goods or services received, or the fair value of the equity instruments granted, during the period was determined; and

(c) the effect of share-based payment transactions on the entity’s profit or loss for the period and on its financial position.

IFRIC Draft Interpretation D25 Extinguishing Financial Liabilities with Equity Instruments is published by the International Accounting Standards Board (IASB) for comment only. Comments on the draft Interpretation should be sent in writing so as to be received by 5 October 2009. Respondents are asked to send their comments electronically to the IASB Website (www.iasb.org) using the ‘Open to Comments’ page with a copy emailed to ifric@iasb.org.

Background

A debtor and creditor may renegotiate the terms of a financial liability with the result that the liability is fully or partially extinguished by the debtor issuing equity instruments to the creditor. These transactions are sometimes referred to as ‘debt for equity swaps’. The IFRIC has received requests for guidance on the accounting for such transactions.

Scope

The [draft] Interpretation addresses only the accounting by an entity that renegotiates the terms of a financial liability and issues equity instruments to the creditor to extinguish the liability fully or partially. It does not address the accounting by the creditor.

Issues

This [draft] Interpretation addresses the following issues: