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THE ECONOMIC IMPACT OF IFRS---A FINANCIAL

ANALYSIS PERSPECTIVE
Sharon S. Seay, University of West Georgia

ABSTRACT

For almost 40 years, a movement has existed to establish one set of global accounting
standards to facilitate international trade and investment. Foreign companies often list their
stock on the NYSE. One common set of accounting standards would promote greater
understandability of international financial reports as well as increase transparency and
comparability on a global scale, facilitating capital flow. On November 14, 2008, the SEC
released a proposed road map toward IFRS (International Financial Reporting Standards)
convergence. The mandated implementation date for large publicly traded companies is 2015.
The purpose of this paper is to examine key reporting differences between IFRS and U.S. GAAP
as reflected in a reporting entity’s financial ratios---key performance metrics used by analysts
and other users. Differences in key metrics measuring liquidity, profitability, efficiency, and
solvency are examined. Implications of IFRS’ elimination of LIFO inventory model are also
explored. Finally, the paper discusses IFRS vs. GAAP valuation models, financial statement
presentation, and disclosure requirements.

INTRODUCTION

In 2000, the SEC issued a concept release on international accounting standards,

soliciting comments. FASB and the International Accounting Standards Board (IASB) initiated
a convergence process in 2002. Since that time, the United States has been on a journey toward
the adoption of International Financial Reporting Standards (IFRS). The shared objective of
FASB and IASB has been the development of common, high-quality accounting standards with
the ultimate goal of a single set of global accounting standards. In November 2008, the SEC
issued a proposed road map to IFRS convergence. Subsequent opposition to the perceived too-
rapid adoption of IRFS has been significant. Another recent milestone in the journey toward
convergence was reached in 2010 with the issuance of the “SEC Statement in Support of
Convergence and Global Accounting,” providing an update and ongoing support for the
convergence of U.S. GAAP and IFRS. The SEC permits foreign companies who list on U.S.
exchanges to use IFRS in lieu of conversion to U.S. GAAP.
To date, approximately 120 countries have adopted IFRS as their home country
standards. The SEC’s convergence approach is “improve and adopt.” IFRS incorporates a
principles-based approach to standard setting vs. the rules-driven regime under U.S. GAAP. The

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Sarbanes-Oxley Act (SOX) of 2002 called for an SEC study addressing the need to adopt a
principles-based approach to standard setting to replace U.S. GAAP’s rule-based system defined
by bright-line rules to establish acceptable practices. The SEC study noted that
weaknesses/imperfections exist when standards are promulgated on either a rules or principles-
only basis. The SEC expressed concern that principles-based standards provide little guidance or
structure on implementation.
Rules-based standards applying bright-line tests often enable company financial
engineers to structure a transaction to achieve technical compliance with a standard while
evading the standard’s intent and thus, contributing to a lack of comparability among firms’
financial statements. The SEC study [SEC 2008] recommends standard development on an
objectives-oriented basis.

LITERATURE REVIEW

In 2005, IFRS replaced U.S. GAAP as the single most widely used accounting standard
in the world. Proponents of IFRS argue that it has become the “gold standard” for financial
reporting in global financial markets, and that its widespread adoption places U.S. GAAP users
at a competitive disadvantage in attracting foreign capital [Bloomberg and Schumer, 2007; SEC
2008]. Prior research has examined the effects of IFRS adoption on firms in adopting countries
[Defond et al. 2011; Landsman et al. 2012], and the resulting evidence supports greater
comparability benefits among IFRS users due to lower information costs. Defund et al. 2012
finds that the widespread adoption of IFRS reduces U.S. firms’, particularly small firms’,
attractiveness to foreign investors.
The case for IFRS adoption in the United States and in other countries is generally made
on the basis of improvements in reporting quality and comparability across firms and countries.
Financial reporting and disclosure quality are generally linked to economic outcomes, such as
market liquidity, cost of capital, and corporate decision making. Empirical studies support this
argument and provide evidence that higher quality disclosures reduce information asymmetry
and increase market liquidity [Welker 1995; Healy et al. 1999; Leuz and Verrecchia 2000;
Bushee and Leuz 2005]. Likewise, empirical studies support the existence of a statistically
significant link between reporting and disclosure quality and firms’ cost of capital [Botosan
1997; Botosan and Plumlee 2002; Hail 2002; Francis et al. 2004, 2005; Hail and Leuz 2006;
Leuz and Schrand 2009]. Better reporting reduces information asymmetries that otherwise
inhibit capital acquisition. Quality reporting facilitates external monitoring, such as from
institutional investors and analysts, which in turn enables more efficient managerial decision
making [Bushman and Smith 2001; Lombardo and Pagano 2002; Lambert et al. 2007]. Quality
reporting and disclosure in one firm may also help reduce agency problems in other firms [Hail
et al. 2010]. Another important dimension of corporate reporting is its comparability across
firms. Making it easier and less costly for investors and other stakeholders to compare across

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firms from different countries facilitates cross-border investment and capital market integration
[Aggarwal et al. 2005; Leuz et al.2009].
Despite the aforementioned benefits of better and more comparable reporting and
disclosure, there also exist direct and indirect costs to improving or changing corporate reporting.
While higher quality and more comparable reporting and disclosure may have economy-wide
benefits and positive externalities, economic assessment of the current reporting environment
within a market or country must determine if changes to the reporting environment can move
reporting quality and comparability to socially optimal levels (net of costs). Prior research
evidence supports that capital markets reward high quality reporting and transparency.
However, recent studies challenge the premise that changing accounting standards in and of
themselves leads to more informative, more comparable corporate reporting. These studies point
to the importance of firms’ reporting incentives as a key driver of reporting quality [Ball et al.
2000, 2003; Leuz et al. 2003; Ball and Shivakumar 2005; Burgstahler et al. 2006]. Managers’
reporting incentives are influenced by a country’s legal institutions (rule of law), enforcement
regime strength (auditing and regulation), capital market forces (financing needs), a firm’s
specific operating characteristics, product market competition, capital structure, and corporate
governance.

RESEARCH METHODOLOGY

The purpose of this paper is to examine key reporting differences between IFRS and U.S.
GAAP as reflected in a reporting entity’s financial ratios---key performance metrics used by
analysts and other users to evaluate a firm’s effectiveness and efficiency. Financial statement
analysis is the use of the financial statements to analyze a company’s current financial position,
results of operations, and cash flows as well as to assess future financial performance. Financial
analysis is an integral part of investment and credit analysis and is useful for internal and
external decision making. Company managers use industry norms as benchmarks in evaluating
performance and as desirable performance targets for future performance.
The research question addressed in this paper is:
What is IFRS’s impact on key financial ratios? In order to answer this question, this study
will address material differences between IFRS and current U.S. GAAP. Ratios evaluating firm
liquidity, profitability, solvency, efficiency, and leverage will be examined to determine the size
and direction of the change induced by IFRS adoption. Implications of IFRS’ elimination of the
LIFO inventory model are explored. The paper also discusses IFRS vs. GAAP valuation models,
consolidation standards, financial statement presentation, and disclosure requirements.
The ratios examined and the performance characteristics measured are listed below:
 Liquidity
1. Current Ratio
2. Quick Ratio

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 Activity/Efficiency
1. Inventory Turnover
2. Fixed Asset Turnover
3. Accounts Receivable Turnover
 Profitability
1. Net Profit Margin
2. Return on Assets
3. Return on Equity
 Coverage/Solvency
1. Times Interest Earned
2. Debt/Equity Ratio
3. Debt/Total Assets Ratio
 Stockholder Ratios
1. Earnings Per Share

Since mandated or early adoption of IFRS by U.S. public companies does not currently
exist, this study examines each area of difference between IFRS and current U.S. GAAP and
from this analysis posits the most likely generic effect on the majority of U.S. firms. A year-end
balance sheet and income statement for a hypothetical U.S. public company transitioning to
IFRS are prepared, showing U.S. GAAP balances, IFRS transition effects, and IFRS balances
with accompanying explanatory notes. Utilizing the derived financial statement information, key
financial ratios are prepared under U.S. GAAP and under IFRS. Following this analysis,
convergence opportunities and challenges are explored.

COMPARISON OF IFRS AND U.S. GAAP---SIGNIFICANT DIFFERENCES

U.S. GAAP IFRS

Inventory
Costing Methods LIFO acceptable. LIFO prohibited.

Measurement Lower of cost or market. Lower of cost or net realizable value.

Write-down
Reversals Reversals prohibited. Reversal of previous impairment losses
up to original impairment loss.
Permanent Inventory
Write-downs Such markdowns reduce Reduction of inventory carrying cost
inventory carrying cost to below the lower of cost or net

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net realizable value, less realizable value is prohibited.

an allowance for a normal
profit, which may be less than
both original cost and net
realizable value.

Property, Plant & Historical Cost Valuation. Cost or Fair Value for entire class of
Equipment (PPE) Revaluation prohibited assets, applied consistently.
Valuation except for impairments. Increases---Other Comprehensive Income
Losses---P&L. Decreases---P&L; Recoveries up to
No write-down original asset value.
recoveries.
Depreciation (PPE) Component depreciation Component depreciation required if
permitted, but uncommon. components have differing benefit
patterns.
Business Combinations
Noncontrolling
Interest Fair value required. Fair value (full goodwill) or at the
Full goodwill (GW). proportionate share of the acquiree’s
identifiable net assets (partial GW).
Development Costs Expensed as incurred. Capitalized when technological &
economic feasibility demonstrated.
Intangible Assets Revaluation prohibited. Revaluation to fair value of intangible
assets other than GW permitted for
entire class of assets, but uncommon.
Impairment
PPE 2-step approach. 1-step approach.
1. Recoverability test Loss calculation if impairment indicators.
**CV compared with Loss=CV-Recoverable Amount
sum of future un- (higher of 1. FV – Cost to sell or
discounted cash flows 2. Value in use (PV of in use future
generated through use cash flows, including disposal value.)
and disposition.
2. Loss=CV – FV

GW Impairment 2-step approach. 1-step approach.

1. Recoverability test Impairment testing at Cash Generating
at Reporting Unit (RU) Unit (CGU) level. Loss=CGU’s CV –

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Level. If CV of RU> recoverable amount.

FV, impairment testing
must be performed.
Loss = CV-FV of GW
within the RU.

Indefinite-Lived
Intangible Assets Loss=CV-FV. Loss=CV-recoverable amount.
Reversals prohibited. Reversals prohibited for GW, but
allowed for other indefinite-lived
intangibles up to original CV.
Financial Instruments
Classification Specifically identifies Focuses on contractual obligation---
instruments with both economic compulsion does not
debt and equity constitute a contractual obligation.
characteristics that Contracts indexed to, and potentially
must be classified as settled, in an entity’s own stock are
liabilities. Other contracts classified as equity if settled only by
indexed to, and potentially delivering a fixed # of shares for a
settled in an entity’s own fixed cash amount.
stock are classified as
equity if they either 1.require
physical settlement, or 2. give
the issuer a choice of net-cash
settlement or settlement in its
own shares.
Compound (hybrid)
Financial Instruments Hybrids (e.g., convertible Hybrids are required to be split into
bonds) are not necessarily debt & equity components.
split into debt & equity
components.
Impairment Impairment loss---P&L. Impairment loss---OCI.
Available for sale No reversals permitted. Reversals recognized---OCI.
Debt & Equity Management intent governs.
Instruments

Held-to-maturity Impairment Loss=amortized Loss=CV-PV of estimated future cash

Debt Instruments cost – FV. Portion of flows. Recognized in OCI.
impairment loss related to

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credit loss recognized in P&L.

Remainder, OCI.

Hedging Definition of derivative Definition does not require notional

requires notional amount amount or net settlement.
and net settlement.
Risk components Flexibility in hedging risk
specifically defined. components.

Hedge Effectiveness Shortcut method for interest Not permitted.

rate swaps permitted. Permits
inclusion of option’s time value.

Recognized even when inputs Evidenced by observable market

are not observable. inputs.
Income Taxes
Intercompany Tax expense from intragroup Tax expense is recognized and
Sales within a sales is deferred until related deferred taxes are recognized for
Consolidated Group asset is sold and no deferred the change in tax basis using
taxes are recognized for buyer’s tax rate.
buyer’s change in tax basis.

Uncertain Tax
Positions (FIN 48) Accounting for tax Treatment based on probability of
consequences reflects a tax position being sustained.
management’s expectations.
Recognition of
Deferred Tax Assets Recognized in full and reduced Recognized to extent their
by valuation allowance for recovery is probable.
non-probable portion.
Classification of
Deferred Tax Assets &
Liabilities Split between current and non- Always non-current.
current based on underlying asset
or expected reversal period.

Deferred Tax Assets &

Liabilities Enacted tax rates must be used. Enacted or substantively enacted
Measurement tax rates as of balance sheet date.

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Contingent
Liabilities(CL) Loss must be “probable” Loss must be “probable”
defined as a high likelihood defined as more likely than
(e.g., 70% or higher). not (> 50%).
Discounting allowed only if Discounting required.
timing and amount of future
cash flows are fixed and determinable.
CL
Measurement Most likely outcome or low end of Best estimate to settle
range. obligation---expected value
method.
Revenue
Recognition Public companies must Revenue recognized only when
recognize revenue when the risks risks and rewards of ownership
and rewards of ownership have have been transferred, buyer has
been transferred, there is control of the goods, revenues
persuasive evidence of an can be reliably measured, and it
arrangement, the fee is fixed or is probable that the economic
determinable, and collectability benefits will flow to company.
is reasonably assured.
Long-Term
Construction
Contracts Completed contract method Completed contract method
is permitted. is not permitted
Pensions
Expected Return on
Plan Assets Based on FV of plan assets or Limited to the “net interest”
a “calculated value” which on the net defined liability/asset
incorporates asset-related gains calculated using the benefit
and losses over a period of no obligation’s discount rate.
more than 5 years.
Recognition of
Actuarial Gains &
Losses May be recognized in net income Recognized immediately in
as they occur or deferred through OCI. Gains & losses not
a corridor approach. subsequently recognized in
net income.
Prior Service
Costs Initially deferred; subsequently Recognized immediately in

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recognized in net income over the net income.

average remaining service life of
employees.
Settlements &
Curtainments Settlement gains & losses recognized Settlement gains & losses
when obligation is settled. recognized as incurred.
Curtainment gains recognized when Curtailment gains & losses
curtailment occurs. Losses recognized the earlier of when
are recognized when curtailment is incurred or when related costs
probable. or termination benefits are
recognized.
Earnings per Share
Calculation of YTD
Diluted EPS When each interim period is Regardless of whether the
profitable, the denominator is the period is profitable, do not
weighted average of the incremental average the individual interim
shares added in each of the period incremental shares.
quarterly periods.
Contracts that
May be Settled in
Shares or Cash at
Issuer’s Option Presumed to be settled in shares Always assumed to be settled
unless evidence is provided to in shares.
the contrary.
Contingently
Convertible Debt Potentially issuable shares are Potentially issuable shares are
included in diluted EPS even if included in diluted EPS only if
contingency is not satisfied at contingency is satisfied at end
the end of the reporting period. of reporting period.
Consolidation Focus on controlling financial Focus on the power to control.
interests.
Special Purpose
Entities (SPE)/VIEs Primary beneficiary must SPEs consolidated when the
consolidate the VIE. substance of the relationship
indicates that an entity controls
the SPE.
Consolidated
Financial Statements Required. Generally required, limited
exemption for parent company

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that is itself a wholly owned

subsidiary.
Parent & Sub
Reporting Dates Permitted to have different Must be prepared as of same
year-ends of up to 3 months. reporting date.
Equity Method
Investments Potential voting rights are not Potential voting rights are
considered in determining considered in determining
significant influence. Fair significant influence. Fair
value option available to value option not available.
account for certain investments.
Uniform accounting policies Uniform accounting policies
between investor & investee between investor & investee
not required. are required.
Presentation
Income Statement
Expense Classification No general requirement. May present expenses by
Public companies must either function or nature.
present expenses by function.
Extraordinary
Items Restricted to items that are both Prohibited.
unusual & infrequent.
Discontinued
Operations Classification is for components Classification is for
held for sale or disposed of, provided components held for sale or
there will be no significant disposed of that are either a
continuing cash flows or separate major line of
involvement with the disposed business or geographical
component. area or a sub acquired
with the intent to sale.
Performance
Measures No general requirements. “Operating profit” not
defined. Diversity in
practice exists regarding
line items, headings, and
subtotals on the Income
Statement.
Third Balance
Sheet Not required. Required when there is a

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retrospective application of a
new accounting policy,
restatement or reclassi-
fication that is material in
effect.
Interim Reporting Each interim period is viewed as Each interim period is
an integral part of an annual period. viewed as a discrete
reporting period.
As a result, costs that benefit more A cost that does not qualify
than one interim period may be as an asset at the end of an
allocated among those periods, interim period is not deferred,
resulting in deferral or accrual of and a liability recognized at
certain costs. an interim reporting date
represents an existing obli-
gation.

INVENTORY VALUATION

U.S. GAAP provides guidance regarding inventory valuation in ARB 43; the IASB offers
detailed guidance under IFRS in IAS 2. Inventories are defined as assets that a company intends
to sell in the normal course of business or is in production of for future sale or are used currently
in production of goods to be sold. Therefore, inventories include raw materials, work-in-process,
and finished goods. Capitalized as inventory costs are purchase costs, conversion costs, as well
as additional costs such as transportation and any cost necessary to bring inventories to their
present location and condition. IAS 2 allows interest capitalization for inventories requiring a
substantial period of time to bring to a saleable condition. While both U.S. GAAP and IFRS
define inventory in a similar manner, there remains divergence with respect to valuation, balance
sheet presentation, impairment losses, and the financial ratios derived there from.
Both IFRS and U.S. GAAP do not require the inventory valuation method selected to
correspond to or approximate the physical flow of inventory within a company. U.S. GAAP
allows companies to choose from FIFO, LIFO, and average costing cost flow assumptions. IFRS
prohibits the use of LIFO. Currently, more than one-third of U.S. companies use LIFO inventory
valuation [Jeffers and Askew 2010]. The primary reason for LIFO’s widespread use can be
attributed to the fact that during a period of rising prices, the LIFO method typically creates
lower taxable income and thus, lower tax liability than other inventory valuation methods. Due to
the IFRS LIFO prohibition, U.S. companies currently using LIFO would be required to switch to
FIFO or average costing. In periods of rising prices, both FIFO and average costing result in
higher ending inventory, lower cost of goods sold and therefore, higher net income and higher
corresponding taxes. In addition, LIFO reserves would be recognized as income over a four year

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period when the LIFO reserve maintains a credit balance, resulting in additional tax liability with
no real additional income to pay for the additional tax. The retrospective adjustment to convert a
company’s inventory valuation from LIFO to FIFO or average costing results in:
 an increase in inventory values
 an increase in current income taxes because of the effective increase in the income tax
base
 and an increase to retained earnings for the effect of the net income increase.

THE IMPACT OF IFRS LIFO PROHIBITION ON COMPANY FINANCIAL RATIOS

Based on the previous analysis, key financial ratios are presented below indicating the
expected directional change induced by conversion from U.S. GAAP to IFRS, under which LIFO
is prohibited.
Liquidity:
A. Current Ratio (Current Assets/Current Liabilities)
Result: Increases due to higher inventory valuation
B. Operating Cash Flow Ratio (Net Cash Flow from Operating Activities/Current Liabilities)
Result: Decreases due to higher inventory valuation, holding all other factors constant
C. Quick Ratio (Cash + Short-Term Investments + Receivables)/Current Liabilities
Result: Unchanged, holding all other factors constant
Activity:
A. Inventory Turnover (Cost of Goods Sold/Average Inventory)
Result: Net Decrease (Decrease in Cost of Goods Sold offset by increase in Average
Inventory valuation)
B. Asset Turnover (Net Sales/Average Total Assets)
Result: Decreases due to higher inventory valuation, holding all other factors constant
C. Accounts Receivable Turnover (Net Sales/Average Accounts Receivable)
Result: Unchanged, holding all other factors constant
Profitability:
A. Net Profit Margin (Net Income/Net Sales)
Result: Increases----Higher net income due to lower cost of goods sold
B. Return on Assets (Net Income/Average Total Assets)
Result: Increases---higher net income offset by higher average inventory values
C. Return on Equity (Net Income/Average Equity)
Result: Increases---higher net income offset by higher average equity, assuming the
company must recognize LIFO reserve in income.
Coverage/Solvency:
A. Times Interest Earned (Operating Income Before Interest and Taxes/Interest Expense)

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Result: Increases due to higher net income

B. Cash Debt Coverage Ratio (Net Cash from Operating Activities/Average Total Liabilities
Result: Decreases---lower net cash flow from operations due to higher inventory values
C. Debt to Equity Ratio (Total Liabilities/Total Equity)
Result: Increases assuming the company must recognize its LIFO reserve in income,
which increases total debt usually offset by a larger increase in total equity.
D. Debt to Total Assets Ratio (Total Liabilities/Total Assets)
Result: Increases assuming the company must recognize its LIFO reserve in income,
which increases total debt usually offset by a larger increase in total assets.
Shareholder Ratios:
A. Earnings Per Share [(Net Income – Preferred Dividends)/Weighted Average Common
Shares Outstanding]
Result: Increases due to higher net income
B. Return on Common Equity (Net Income/Average Common Equity)
Result: Increases assuming the company must recognize its LIFO reserve in income---
higher net income offset by a larger increase in common equity.

INVENTORY IMPAIRMENT AND DISCLOSURE

Under both U.S. GAAP and IFRS, public companies must report inventories at the lower
of cost or market. However, U.S. GAAP defines market as the median of replacement cost, net
realizable value (ceiling), and net realizable value minus a normal profit (floor). IFRS defines
market as net realizable value. Both standards allow this rule to be applied on an individual item
basis or to pools of items. However, it should be noted that IFRS and U.S. GAAP will provide
similar results only when replacement cost is greater than net realizable value [Doupnik and
Perera 2009].
In the event that cost is higher than market value, both IFRS and U.S. GAAP require
recognition of an impairment loss in the year of occurrence. However, while U.S. GAAP
prohibits reversal of an impairment loss in a subsequent year, IFRS requires recognition of the
reversal if the selling price increases. IFRS and U.S. GAAP require accounting policy disclosure
regarding inventory carrying amounts, current period impairments recognized, carrying amounts
of inventories pledged as security for liabilities and cost of goods sold, and in the case of IFRS,
any write down reversals to net realizable value.

ANALYSIS: PROPERTY, PLANT, & EQUIPMENT; BIOLOGICAL &

AGRICULTURAL ASSETS

Property, plant, and equipment may be measured using the cost-depreciation-impairment

model or the revaluation-through-equity model. Revaluation calls for fair value measurement as

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of the revaluation date, less any subsequent accumulated depreciation and impairment losses.
Residual values must be adjusted to fair value under IFRS. The revaluation model would
increase profitability ratios if asset values had increased. Fixed and total asset turnover
(activity/efficiency) ratios would decrease due to the increase in average fixed and total assets.
Leverage/solvency ratios (e.g., debt/total assets) would decrease if the fair value of property,
plant, and equipment has increased.
Depreciation should reflect the expected consumption of the asset’s economic benefits.
Depreciation based on a “components” approach is required under IFRS for assets with differing
patterns of benefits. The components approach could result in either increases or decreases in
otherwise recognized total depreciation expense, with relative effects on profitability and
activity/efficiency ratios.

ANALYSIS: VALUATION

Intangible assets may be measured using the cost model or the revaluation model if an
active market exists, providing observable input values for fair value measurement. Investment
property may be accounted for using the cost model or fair value model. Land use rights may be
reclassified as investment property. Impairment loss recoveries for indefinite-life intangibles
other than goodwill are allowed under IFRS. Reversals of write-downs are also permitted for
financial assets, such as available-for-sale securities. Inventory write-downs may be reversed up
to the amount of the original impairment loss. Permanent inventory write-downs, such as under
the retail inventory method, are not allowed if they reduce the carrying value of inventory below
the lower of cost or net realizable value. Also, LIFO inventory costing is prohibited under IFRS.
Biological and agricultural assets must be reported at fair value under IFRS. If fair value
is greater than original cost, activity ratios would decrease. Changes in fair value would be
recognized in the income statement, resulting in increased earnings per share (assuming fair
value increases) and decreased return on assets due to increased profitability offset by larger
average total asset values.
Biological and agricultural assets must be reported at fair value under IFRS. If fair value
is greater than original cost, activity ratios would decrease. Changes in fair value would be
recognized in the income statement, resulting in increased earnings per share (assuming fair
value increases) and decreased return on assets due to increased profitability offset by larger
average total asset values.
Under IFRS, deferred tax assets may not be recognized in full, as they are with U.S.
GAAP. IFRS recognizes deferred tax assets only to the extent it is probable (more than likely)
that they will be realized. All deferred tax assets and liabilities are classified as non-current in an
IFRS balance sheet.
While all research expenditures must be expensed, development expenditures must be
capitalized if technical and economic feasibility can be demonstrated. Regarding business

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combinations, non-controlling interests may be measured at fair value or measured at the non-
controlling interest’s share of the acquiree’s identifiable net assets. The overall consolidation
approach under IFRS is based on the power to control.
The recognition threshold for contingencies is greater under IFRS. Both U.S. GAAP
and IFRS require that a loss be “probable” to be recognized. However, while “probable” under
IFRS is defined as “more than likely”---meaning a probability of greater than 50%, U.S. GAAP
defines “probable” as denoting a high likelihood (e.g., 70% or more). Therefore, under IFRS,
larger total contingent losses and corresponding liabilities would be expected.

ANALYSIS: REVENUE RECOGNITION

Long-term construction contracts are required to use percentage-of-completion

accounting. The completed contract method is prohibited under IFRS. When the stage of
completion cannot be estimated reliably, revenue is recognized to the extent that recoverable
expenses have been incurred.
While U.S. pension accounting rules initially defer recognition of prior service costs in
favor of periodic allocation of expense over the employees’ average remaining service life, IFRS
requires immediate recognition of the expense in net income. Actuarial gains and losses must be
immediately recognized under IFRS in other comprehensive income without subsequent income
recognition. Under U.S. GAAP actuarial gains and losses could be recognized in net income
immediately or deferred through a corridor approach. Pension settlement gains or losses are
recognized as incurred under IFRS rather than later when the obligation is settled as required
under U.S. GAAP.

PRESENTATION

The Statement of Comprehensive Income must be presented under the single-statement

approach for IFRS. Performance measures, such as “operating profits” are not typically
presented in the IFRS income statement. Likewise, there is great diversity between IFRS and
U.S. GAAP income statements in regard to line items, headings, and subtotals. Extraordinary
items are prohibited on the IFRS income statement.
The Statement of Cash Flows under IFRS allows interest and dividends received or paid
to be classified as operating, investing, or financing on a consistent basis. IFRS requires separate
disclosure of cash flows related to discontinued operations.
Balance sheet classifications may differ under IFRS as previously mentioned. Offsetting
is not permitted under IFRS. Also under IFRS, a third balance sheet is required as of the
beginning of the earliest comparative period when there is a retrospective application of a new
accounting policy, restatement, or reclassification that could have a material effect on the
balances of the third balance sheet.

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ANALYSIS: SUMMARY

Four distinct themes can be gleaned from the comparison of U.S. GAAP to IFRS:
 1. IFRS and U.S. GAAP are broadly similar
 2. IFRS has a balance sheet focus, which can be further described as the 3 Ds: definition,
disaggregation, and discounting.
 3. What goes down can go up.
 4. Disclosure is paramount.

From the previous comprehensive comparison of IFRS and U.S. GAAP, general directional
trends in financial statement elements can be derived/predicted. The following directional trends
have been synthesized from this analysis:

 Higher potential revenues under IFRS; higher total assets; higher contingent liabilities
 Potentially higher depreciation and amortization expenses under IFRS
 Less expense related to development costs; extraordinary items prohibited
 Lower cost of goods sold expense; higher ending inventories; potentially higher taxes
 Reclassification; greater disclosure requirements; higher stockholders’ equity

HYPOTHETICAL END OF YEAR BALANCE SHEET RECONCILIATION TO IFRS

(IN MILLIONS OF $)

Assets Note U.S. GAAP Transition IFRS

Cash & Equivalents 6,000 6,000
Marketable Securities 4,000 4,000
Net Accounts Receivable 6,000 6,000
Inventories (a) 5,500 520 6.020
Other (including Deferred Tax) 3,000 3,000
Total Current Assets 24,500 520 25,020
PPE (b) 14,000 317 14,317
Goodwill (c) 3,000 300 3,300
Other net intangibles (d) 500 850 1,350
Investments in subs (a) 700 (45) 655
Other (including Deferred Taxes) 5,000 5,000
Total Assets 47,700 1,942 49,642

Liabilities
Accounts Payable 2,500 2,500

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Accruals 6,500 6,500

Accrued Taxes Payable 3,500 3,500
Total Current Liabilities 12,500 12,500
Long-Term Debt 12,200 12,200
Pension Liabilities 550 550
Accrued OPEB 2,550 2,550
Other (including Deferred Taxes) (e) 2,150 1,500 3,650
Total Liabilities 29,950 1,500 31,450

Stockholders’ Equity
Share Capital 600 600
Cumulative Translation Adjustment (f) 400 (400)
Retained Earnings (i) 17,125 542 17,667
Non-controlling Interest (a) 25 25
Accumulated Other Comprehensive
Loss (g), (h) (375) 275 (100)
Total Stockholders’ Equity 17,750 442 18,192
Total Liabilities & Stockholders’ Equity 47,700 1,942 49,642

Notes:
(a) Inventory
Restatement of inventory from LIFO to FIFO $470
Consolidation of subs previously excluded 50
Total Impact---Inventory increase $520
(b) Property, plant, & equipment
Restatement to fair value $850
Impact of impairment losses recognized net of (500)
depreciation expense
Additional depreciation on net PPE adjustments (33)
Total Impact---increase to PPE $317
(c) Goodwill
Consolidation of subs previously excluded $300
under U.S. GAAP
Other Intangible Assets
Opening retained earnings adjustment related to $1,325
IPR&D acquired as part of acquisition of ABC
Technologies in 2012.
Amortization for year ended 2013 (475)
Net other intangible adjustment $850

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(d) Deferred tax adjustments & other noncurrent

liabilities adjustments. $1,500
The change in deferred taxes represents the
adjustment necessary to transition to IFRS.
(e) Cumulative translation adjustment
The cumulative translation adjustment account was reset to zero on January 1, 2013.
There were no additional changes in the CTA account for the year ended December 31,
2013.
(f) Pension adjustment
The company elected to recognize all cumulative actuarial gains and losses as of January
1, 2013. On January 1, 2013, the company recognized $100 million in retained earnings
related to actuarial losses recorded in U.S. GAAP accumulated other comprehensive loss.
(g) Hedge accounting exemption
Management had applied the “shortcut” method for its existing interest rate swaps on its
variable rate debt instruments under U.S. GAAP. All changes in fair value were recorded
in accumulated other comprehensive income. Under IFRS, although the hedging
relationship was not adjusted on the opening balance sheet, it did not qualify for hedge
accounting going forward due to different documentation requirements. As a result, an
additional $175 million in unrealized losses were recorded under IFRS during the year
ended December 31, 2013.
(h) Retained Earnings
Other than for reclassification items, all of the above adjustments were recorded against
the opening retained earnings at January 1. 2013, or reflect the income and retained
earnings impact for the year ended December 31, 2013.

Hypothetical End of Year Reconciliation of Net Income to IFRS

(in millions of $) Note U.S. GAAP Transition IFRS
Sales $37,000 $37,000
Cost of sales (a) 30,000 439 30,439
Gross Profit 7,000 (439) 6,561
Other operating income (100) (100)
Selling expenses 2,100 2,100
Administrative expenses 400 400
Other operating expenses 600 600
Operating Profit/Loss 4,000 (439) 3,561
Interest expense (b) (800) (50) (850)
Share of Sub profits 200 200
Income before tax 3,400 (489) 2,911
Income tax expense/benefit (c) 1,525 (196) 1,329

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Net Income 1,875 (293) 1,582

Notes:
(a) Cost of sales affected by:
 Inventory costing method change---quarterly change in LIFO reserve $30
 Additional depreciation on net adjustments to PPE 33
 Amortization of IPR&D 376
Net Decrease in cost of sales 439
(b) Interest expense on interest rate swaps for which the shortcut method was applied under
U.S. GAAP.
(c) Tax impact of adjustments.

FINANCIAL RATIOS CALCULATED USING HYPOTHETICAL COMPANY INCOME

STATEMENT AND BALANCE SHEET

Ratios U.S. GAAP IFRS

Liquidity:
Current ratio 1.96 2.002
Quick ratio 1.28 1.28
Profitability:
Net Profit Margin 5.07% 4.3%
Return on Assets 3.93% 3.19%
Return on Equity 10.56% 8.7%
Activity/Efficiency:
Inventory Turnover 5.45 times 5.06 times
Accounts Receivable Turnover 6.17 times 6.17 times
Fixed Asset Turnover 2,64 times 2.58 times
Total Asset Turnover 0.78 times 0.75 times
Coverage/Solvency:
Times Interest Earned 5.0 4.2
Debt to Total Assets 0.6279 to 1 0.6335 to 1
Debt to Equity 1.69 to 1 1.73 to 1
Shareholder Performance Measures:
Basic Earnings Per Share
(Assuming no preferred stock and
assuming 100 million shares outstanding
the entire year.) $18.75 $15.82

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