Essay: IFRS versus GAAP conversions

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[. . .] Part 2.

This section will analyze the differences between the GAAP balance sheet and the IFRS balance sheet. The analysis will go line by line.

Cash is typically treated the same under both systems, as it simply represent cash and equivalents, and the case did not outline any point where there might be discrepancy here.

With respect to the short-term investments, gains on investment income are recorded as comprehensive income under GAAP, and are recorded on the income statement in IFRS. The assets are valued according to fair market value, which is how the asset has been recorded on the balance sheet. The gain or loss is not recorded on the income statement for tax purposes until the investment is sold and the gain or loss realized. The asset is still held, but the adjustment to the fair market value of the asset has been recorded on the balance sheet. The balance sheet value is the same under GAAP as it is under IFRS, so there is no change.

Inventories are treated differently under these two systems. Where LIFO is an acceptable method under GAAP, it is not acceptable under IFRS. FIFO and the weighted-average method are both acceptable under IFRS. The statement was produced using FIFO, which would result in a lower inventory cost basis. The LIFO system would result in a higher value of inventory expense (or COGS) on the income statement as the more valuable goods are charged. The expectation, therefore, is that by shifting from LIFO to FIFO, the COGS would be diminished on the income statement. The reduction here is by $10,000, which will ultimately affect the taxable income, and therefore will be reflected in an adjustment to the retained earnings that come over from the income statement. On the balance sheet this is reflected by a $45,000 change in the inventory level.

Goodwill has infinite life, and therefore there is no change to the valuation of goodwill. However, there is a difference in the valuation of the trademark and the copyright, because of the differences between GAAP and IFRS in the treatment of the impairment of intangible assets. While reversal of impairment is not allowed under GAAP, it is allowable under IFRS, but not above fair market value. This makes sense, as assets that once took an impairment charge but that have seen an increase in value subsequent to that charge should be revalued so that their balance sheet valuation is as accurate as possible. The fair market value of the copyright is $3,000 more than the GAAP book value and it is also $3,000 for the trademark. Thus, the impairments will be reversed to fair market value for those two asset classes.

It is worth noting that fair market value in IFRS is not normally established differently than GAAP. Under IFRS, an intangible asset can be revalued if a fair market value can be established. It is not known how the figures presented in the case came about. They could be management, estimates, for example. For simplicity, it is assumed that the fair market value given in the case was established in line with the principles of IFRS.

The reason this matters is that without an active market, fair value revaluation would not be done under IFRS and the intangible assets would be carried at their initial value less amortization and impairments. There is no active market for any of these classes, so as per IAS 38.75, which states that "Intangible assets may be carried at a revalued amount (based on fair value) less any subsequent amortisation and impairment losses only if fair value can be determined by reference to an active market." In the absence of such a market, fair market value will not be used under IFRS and the book values will therefore be the same as under GAAP for all three classes of intangible assets. So while for this instance it is assumed that fair market value can be reasonably established for IFRS reporting purposes, it is unclear as to whether such markets exist for trademarks and for copyrights -- they do sometimes, but other times not.

Contingencies for lawsuits are sometimes treated differently under GAAP and IFRS. First, the contingency should be included as a liability if it is probably under both, but under GAAP there is a higher standard, because "probable" is defined as "likely" and given a figure of 70%, where under IFRS "probable" is defined as "more likely than not" to occur. That phrasing is more clear that the percentage merely has to be over 50%. However, the note on the spreadsheet says "most likely will be awarded for $10,000," which means that this contingency should have been listed as a long-term liability under both systems. It is unclear whether this was included in the GAAP statement or not. It is assumed here that it was -- in any situation like this, GAAP has the higher standard so if it is included in the GAAP statement it should be included in the IFRS as well.

The flood damage is deemed extraordinary, and receives basically the same treatment under GAAP and IFRS. This type of extraordinary damage would be a non-operating loss under both systems on the income statement, with no change to the balance sheet.

Taxes payable are not considered "deferred taxes," and therefore result in no change on the statement. Had they been classed as deferred taxes under GAAP, they would not be allowed to be listed as current liabilities, per IAS 1.56.

The changes amounted to changes to the treatment of two intangible asset classes, and the inventory on the asset side. The shareholders' equity is affected in that there are tax consequences to the adjustments. The tax rate is 35%, and the tax adjustment takes into account the $6,000 revaluation of the impairment change on the intangible assets, as well as the revaluation of the inventory that occurred with the conversion from the LIFO system to the FIFO system. All told, retained earnings were increased and the company also saw an increase in taxes payable as the result of the new taxes incurred through these transactions.

The valuation of the intangible assets changes as well. This area was odd, because the GAAP statement was incorrect in that it used 10-year straight line amortization for assets with indefinite life. The amortization issue was left alone due to insufficient information, but normally under IFRS we know that the goodwill and trademarks would not be amortized.

There was no change needed for the long-term contingencies, because the language provided that the cost was "most likely" qualifies it as "probable" under both GAAP and IFRS, so the treatment there should be the same.

Flood damage is listed as extraordinary on the income statement, but this does not affect the balance sheet because the treatment of such an event is the same under both GAAP and IFRS.

The overall adjustments reflected some of the differences that occur between IFRS and GAAP. Inventory is a major one, but there are many others, and most documents covering the conversion are highly-detailed; in the details there are many significant differences between the two codes. It is worth knowing that Jaunty would not actually have a reason to adopt IFRS at this point in time, because as a publicly-traded American company it is legally obligated to use GAAP, and by law does not even have the option to use IFRS.

Part 2, Letter to Management

December 18, 2016

To: Management

Re: choice of accounting standards

Jaunty Coffee should maintained GAAP as its accounting standard. The matter is not actually one of choice, but one of law, in particular the reporting requirements of each jurisdiction. If Jaunty Coffee is an American company trading in the U.S., then it needs to adhere to GAAP until stated otherwise. The SEC does not permit U.S. issuers to produce financial statements using IFRS; GAAP is mandatory (IFRS, 2016) There is no particular will to compel U.S. companies to use IFRS, or even to allow it -- only foreign entities trading in the U.S. can use IFRS standards (Katz, 2015). For its part, the IASB has criticized the SEC over its lack of commitment to IFRS (Crump, 2016), though self-interest might play a tiny role in that opinion.

It does not appear that there has been a court case about U.S. companies wanting to use IFRS -- the law is established SEC policy, so any further debate on the subject after that point is moot from the perspective of someone making a recommendation to management.

Indeed, it is not even that clear that "that is the direction the standard is moving." First, you need the law to change and there is zero evidence that is happening. Second, accountants are not paid to guess at… [END OF PREVIEW]

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IFRS versus GAAP conversions.  (2016, December 22).  Retrieved May 25, 2019, from

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"IFRS versus GAAP conversions."  22 December 2016.  Web.  25 May 2019. <>.

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