Advanced Accounting

Chapter 1 A Survey of International Accounting

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A brief description of the major points covered in each case and problem. CASES
Case 1 In this case, students are introduced to the difference in accounting for R&D costs between IFRS and U.S. GAAP and asked to comment on whether one method is better than the other, as well as whether any part of R&D should be capitalized. Case 2 (prepared by Peter Secord, Saint Mary’s University) In this real life case, students are asked to discuss the merits of historical costs vs. replacement costs. Actual note disclosure from a company’s financial statements is provided as background material. Case 3 (adapted from a case prepared by Peter Secord, Saint Mary’s University) A Canadian company prepares two sets of financial statement: one based on Canadian GAAP, and the other on U.S. GAAP. investigated. Case 4 This case is based on Homburg Invest Inc.’s 2006 financial statements. A reconciliation of differences between two sets of financial statements is required along with a brief note explaining why differences exist. Case 5 This case is adapted from a CICA case. It provides details regarding a company`s activities as well as financial details that were revealed as part of planning and interim work performed in the context of an audit of the financial statements. It places the student in the role of CA, reporting to the audit partner, and asks for a memo on the results of the interim audit work as well as any issues that should be raised in an upcoming meeting between the partner and the client. The reasons for some of the differences in numbers are

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PROBLEMS
Problem 1 (40 min.) A single asset is acquired, and students are asked to prepare and compare financial statement numbers during the life of the asset using both a historical cost and a current value model.

Problem 2

(40 min.)

Details of a European company that reports using IFRS are given along with specific details relating to certain account balances. Students are asked to show how these balances should be reported under 1) U.S. GAAP, and 2) IFRS using the facts provided. Students are also asked to reconcile Net Income and Shareholders` Equity to from IFRS to U.S. GAAP.

WEB-BASED PROBLEMS
Problem 1 The student chooses a public company incorporated in China and listed on a U.S. stock exchange. The student answers a series of questions based on the company’s financial statements. The questions are aimed at highlighting the differences between IFRS and U.S. GAAP. Problem 2 The student chooses a public company incorporated in India and listed on a U.S. stock exchange. The student answers a series of questions based on the company’s financial statements. The questions are aimed at highlighting the differences between IFRS and U.S. GAAP. Problem 3 The student chooses a public company incorporated in Japan and listed on a U.S. stock exchange. The student answers a series of questions based on the company’s financial statements. The questions are aimed at highlighting the differences between IFRS and U.S. GAAP. Problem 4 The student compares the 2006 and most recent financial statements of Cadbury, a British chocolate manufacturer, and answers a series of questions aimed at highlighting the differences between IFRS and U.S. GAAP.
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Problem 5 The student compares the 2006 and most recent financial statements of Philips Electronics, a Dutch company, and answers a series of questions aimed at highlighting the differences between IFRS and U.S. GAAP.

REVIEW QUESTIONS
1. Accounting students and professionals need to be aware of the differences between accounting practices in Canada and in other countries for three reasons. First, as the markets become more and more international, there is a higher chance that they may need to interpret financial statements from other countries at some point in their career. Second, they may want to move to another country to further their careers, and they should have an awareness of the different accounting practices that may exist. However, the most compelling reason is that the profession is quickly moving toward harmonization of accounting practices around the world. Canada has moved towards this end with mandating conversion to IFRS by January 1, 2011. Accounting students and practitioners need to be aware of the impact this move will have on their employers and clients. 2. One factor that is causing a shift towards a global capital market is that market-driven economies are replacing many former communist economies, and the demand for capital is increasing. As well, many countries are forming agreements with international allies, to increase their competitiveness. Finally, improvements in computer and communication technology are facilitating international trading and investing and allowing companies to list their shares on many exchanges throughout the world. 3. Five factors that have affected a particular country's accounting standards are: the role of taxation; the level of development of capital markets, especially the mix of debt and equity financing; differing legal systems; the ties, both current and historical, between the country and other countries; and inflation levels. 4. Countries with highly developed capital markets often have sophisticated investors who demand current and useful accounting information and full disclosure. This leads to the establishment of a body of generally accepted accounting principles that investors can rely
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upon and that companies must comply with. In countries where capital markets are not fully developed, there are fewer suppliers of capital and these suppliers demand and receive whatever information they require from companies. As a result there is less need for standardized accounting principles. 5. The assumption underlying many countries' accounting policies is that the monetary unit is stable. When this is the case, historical costs have meaning and there is no need for price level adjustments. When the inflation level is sufficiently high in a country to make historical costs meaningless, accounting adjustments that provide for the impact of inflation have been made in order to provide information that is useful. In these countries we have seen price level adjustments and/or current value accounting as part of the generally accepted accounting practices being used. 6. In Canada items are usually listed from current to non-current, whereas in some countries, long-term assets are listed before current assets, and owners’ equity is listed before liabilities. 7. Some of the differences between Canadian and U.S. GAAP are: • • Canadians capitalize and amortize development costs (under certain More U.S. companies use the LIFO method to calculate ending inventory and circumstances) while they are expensed immediately in the U.S. cost of goods sold, as it is allowable for tax purposes if used in the financial statements. Canadian companies favour weighted average and FIFO, as LIFO is not an acceptable alternative under GAAP. • There are also some differences in the accounting for post-retirement benefits.

8. The IASB works to develop a single set of high-quality, global accounting standards that will be used uniformly for financial reporting around the world. 9. The convergence project between FASB and the IASB hopes to have IASB standards acceptable for use by all companies required to report under the SEC rules in the United States. First, the two bodies will focus on the elimination of differences that appear capable of quick resolution and are not part of major projects of either of the boards. Then the two groups plan on working together on contentious issues so that any standards issued by the
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two boards will have similar outcomes. The two organizations have recently outlined a roadmap towards conversion that could result in U.S. domestic companies reporting in IFRS by 2014. Currently, foreign public companies filing on U.S. stock exchanges are permitted to file their financial statements in accordance with IFRS without reconciliation to U.S. GAAP. 10. At the end of 2009, over 100 countries had adopted IASB standards while a number of countries still did not allow their use. Three major holdouts were Canada, the United States, and Japan. In January 2006, the CICA announced it would adopt IASB standards for use by public companies effective January 1, 2011. The U.S. could convert as early as 2014 if major differences between U.S. GAAP and IFRS can be resolved by then. In August 2007, the ASBJ and the IASB agreed on a process for converging Japanese GAAP and IFRSs. Major differences between Japanese GAAP and IFRSs will be eliminated by 30 June 2011. The target date of 2011 does not apply to any major new IFRSs now being developed that will become effective after 2011. 11. In January 2006, the CICA announced it would adopt IASB standards for use by publicly accountable enterprises effective in January 2011. 12. Even if all the countries in the world adopt IFRSs, comparability will not completely exist if preparers do not interpret the standards on a consistent basis. The standards are broad based and require professional judgment. Also some countries are adding additional “home-grown standards” to cover local conditions. 13. The main reason the Accounting Standards Board decided to create a separate section of the CICA handbook for private enterprises was to address the cost/benefit discrepancy with respect to smaller private companies’ ability to comply with GAAP. GAAP has become increasingly complex and for smaller private enterprises this often means that the cost of complying with such rules outweighs the benefit received from compliance. In 2002, the AcSB adopted differential reporting, which allows private enterprises choices with the respect to certain complex accounting standards (e.g. the option to use the cost method for investments that would otherwise require the equity method). In 2009, the AcSB decided to create a self-contained set of standards for private enterprises. These standards will be effective in January 2011 with earlier adoption allowed starting in 2009.
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14. There are a few reasons why a private company would want to comply with IFRSs even though it is not required to do so. It may have plans to become publicly listed at some point in the future and will then be required to comply with IFRS after January 1, 2011 as a publicly accountable enterprise. In this case it would make sense to prepare IFRS compliant statements in anticipation of the public transaction since the company would have to provide multiple years of comparative financial statements that comply with IFRS. A private company may have users of their financial statements that find IFRS statements more useful for their purposes (e.g. creditors, customers, partners, and other stakeholders that may receive the company’s financial statements). Given the global economy and the increased number of countries that have converted to IFRS, this is more likely than it once might have been. 15. It is true that financial statements are complicated by accounting methods, such as the method of accounting for deferred income taxes, foreign currency translation, and so on. However, some of these complexities cannot be avoided. The business environment and business transactions are themselves more complex. Since the financial statements try to reflect these business events, it is inevitable that the financial statements will be more complex. Thus, it is not accounting methods per se that make financial statements difficult to understand. Financial statements are not directed at the average person, so they cannot be criticized on the grounds that they are beyond the comprehension of the “average person”. Instead, they are intended for users with a reasonable understanding of financial statements. The question then becomes should additional explanations be provided for users who have a reasonable understanding of the financial statements? The answer depends on what type of information the “explanations” will contain. Additional explanations might be of three types: They could provide more detail on information that is already contained in financial statements. For example, certain dollar amounts reported in the financial statements might be broken down into more detail, or the significance of certain amounts might be discussed;

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They could make information that is currently in the financial statements easier to understand by explaining technical accounting terms and concepts used in the statements; or

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They could provide entirely new information not included in financial statements that might help users better understand the significance of the information that appears in the financial statements.

In all three cases, the information provided might concern the future or the past. It is important to note that for publicly accountable enterprises, there is already a considerable amount of supplemental information provided in a company’s MD&A. This document provides supplementary discussion of financial results and in many cases explanations of accounting treatments used in a company’s financial statements for the period. Further, it is important to note that at some point additional information may “overload” the user. Too much information may achieve the undesired result of making financial statements more difficult to understand. This must be taken into account when considering supplemental information and explanations.

MULTIPLE-CHOICE QUESTIONS
1. d 2. d 3. d 4. b 5. a 6. b 7. a 8. d 9. b 10. c 11. b 12. d 13. b 14. a 15. c

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CASES
Case 1
Students often assume that U.S. GAAP is superior and that all reporting issues can (or should) be resolved by following U.S. rules. However, the reporting of research and development costs is a good example of a rule where many different approaches can be justified and the U.S. rule might be nothing more than an easy method to apply. In the United States, all such costs are expensed as incurred because of the difficulty of assessing the future value of these projects. IFRS, as well as countries such as Canada, Brazil, Japan, and Korea, allow capitalization of development costs when certain criteria are met. The issue is not whether costs that will have future benefits should be capitalized. Most

accountants around the world would recommend capitalizing a cost that leads to future revenues that are in excess of that cost. The real issue is whether criteria can be developed for identifying projects that will lead to the recovery of those costs. In the U.S., the FASB felt that such decisions were too subjective and open to manipulation. experienced good years and bad. the question can be met. How easy is it for an accountant to determine whether the development project will result in an intangible asset, such as a patent, that will generate future economic benefits? For Korean businesses, research and development costs are capitalized when they are incurred in relation to a specific product or technology, when costs can be separately identified, and when the recovery of costs is reasonably expected. Can an accountant determine with appropriate accuracy whether the recovery of costs is reasonably expected? In the U.S., a conservative approach has been taken because of the difficulty of determining whether an asset has been or will be created. To ensure comparability, all companies are required to expense all R&D costs. As a result, some discoveries that prove to be very valuable to a company for years to come are expensed immediately. In other countries, companies will tend to capitalize a differing array of projects because of flexibility in their guidelines. Do the
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History has shown that the

amount of research and development costs capitalized tended to vary as a company Conversely, under IFRS, development costs must be recognized as an intangible asset when an enterprise can show that the six criteria mentioned in

benefits of consistency and comparability (each company expenses all costs each year) outweigh the cost of producing financial statements that might omit valuable assets from the balance sheet? No definitive answer exists for that question. However, the reader of financial statements needs to be aware of the fundamental differences in approach that exist in accounting for research and development costs before making comparisons between companies from different countries.

Case 2
(a) Can any alternative to historical cost provide for fair presentation in financial reports or are the risks too great? Discuss.
In most countries, when we refer to “fair presentation” or a “true and fair view” in the preparation of financial statements, we generally qualify the statement (as the auditors here have): “in accordance with generally accepted accounting principles.” That is, fair presentation has a contextual, rather than an absolute, meaning. In order for any presentation to be fair to the user, the basis of presentation must be known and understood, but does not necessarily have to follow any one particular model. The first Company’s Act which included the phrase “a true and fair view” is now over 150 years old, and there is still some controversy as to whether the authors of this legislation intended “historical cost” to be a part of the model. The historical cost principle, as we know it, had not yet been fully articulated in textbooks and become a firm basis for accounting practice. As a result of these factors, financial statements may be considered to provide “fair presentation,” whether prepared in accordance with the historical cost convention, in terms of replacement cost, the purchasing power units in a general price level adjusted model, or a variety of hybrid models. Note that U.S. accounting is hardly a pure historical cost model, with many exceptions to historical cost involved (mostly downward adjustments) in the scheme of asset valuation and earnings determination. The important issue is that the model employed is known, understood, and consistently followed. Although in Europe (and especially in the Netherlands), it is common to encounter current value accounting, elsewhere (especially in Latin America) general price level accounting and its variations are more common when changing prices are a problem. Arguably, current value (replacement cost) accounting is the model most likely to provide fair presentation, especially where asset values are volatile, as historical costs become rapidly out
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of date. For many long-established companies, historical costs for some assets are significantly out of date and of no value in support of managerial decisions. In managerial accounting, we have long recognized that the relevant costs are the current costs. In some European countries, an approach to financial reporting has developed that adopts more of a managerial approach and seeks to provide the most relevant information for decision-making. As a result, many companies follow alternatives to historical cost, generally replacement cost, in the financial statements. There are risks, however, that arise from the adoption of alternatives to historical cost. Some of these are the same risks that arise from the historical cost model in that the recorded amount may soon be out of date. Prices may go up or down, and even “current costs” of prior periods may display no relationship to current costs at the present date. Cost is always cost in a particular context and a cost determined for a particular context or decision may not be valid for a different context or decision and the user should be aware of this. The question of objective determination also arises. The reported values in current cost basis financial statements are not directly supportable by arms’ length transactions. This introduces the risk of an important (and potentially deliberate) misstatement. This is the principal risk issue arising from current value accounting, and leads many countries to have highly detailed rules for the preparation, audit, and publication of financial statement asset values under current cost. Current value accounting and general price level accounting are both responses to the problem of changing prices and the impact on financial reporting. Current value accounting departs from the historical cost basis of accounting, whereas general price level adjustment is not a departure from historical cost. General price level (“GPL”) accounting changes the measuring unit in which the historical cost is reported, but does not change the underlying basis of valuation for items on the income statement and balance sheet. Current value accounting changes this underlying basis of valuation. Historical cost is not restated; new values are determined, based on current information, for all items on the balance sheet (with the exception of monetary items which are not restated, as they are already stated at current values). Current value accounting has many variations, each of which uses a different valuation base. All of these models bear little relation to historical cost accounting, and in many ways less relationship to GPL-adjusted amounts. In all cases, the historical cost relationship among financial statement items is disregarded in favour of the new basis of accountability.
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(b) Discuss the relative merits of historical cost accounting and replacement cost accounting. Consider the question of the achievement of a balance between relevance and reliability and the provision of a “true and fair view” or “fair presentation” in financial reporting.
Students will provide a wide range of responses to this question; at this stage (unless they have been provided with supplementary material or have background from other courses) responses will just scratch the surface. The following note may be helpful: Historical cost accounting has the advantage that it is verifiable, and therefore more reliable and free from bias than replacement cost accounting. Historical cost amounts are based on objective information and have the “paper trail” of an actual transaction that provides support. Historical costs, however, are sunk costs and have limited value in support of decisions. They are particularly deficient if a long time has passed since the transaction occurred, or if there have been significant technical developments. These are serious difficulties which the accounting profession has tried to address through a variety of different mechanisms, but no other method has become universally acceptable as an answer to the problem and so historical cost accounting persists, largely because of inertia, and because no better model has emerged. Replacement cost accounting has the advantage of enhanced relevance because the values included have been determined at the current time, rather than at some uncertain past date. These amounts may therefore be better for investment decisions than historical costs. However, current costs are potentially deficient in that they might not be objectively determined and lack reliability. At the worst, they could contain bias to support a particular management policy or decision. In other cases, they could be guesses or otherwise based on invalid information. Also, the use of current cost in financial statements in no manner makes the financial statements more “accurate,” although (if the amounts are carefully and objectively determined) there may be advantages in the fairness of presentation and therefore the relevance of financial statement amounts. With respect to income measurement, in a period of inflation, historical cost accounting will result in an overstatement of income. Income is overstated, as a portion of the
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reported profits must be reinvested in the business to maintain the productive capacity and not all profits are available for distribution. If all profits are distributed, the business will not have the capacity to replace the items that have been consumed in the process of earning income. Replacement cost accounting will alleviate this problem by charging to expense the replacement cost of all items consumed. With replacement cost charged to expense, the income remaining is a true income, potentially available for distribution without impairment of the productive capacity of the enterprise. A further important point is that both the preparer and the user of financial statements should understand the basis of preparation of the statements, and the strengths and weaknesses of the approach employed.

CASE 3
Case Note Ajax Communications presents the classic case of the conflict among the accounting standards that are in force in different jurisdictions. Each set of rules can be seen to be correct, although dramatically different amounts may be presented on a variety of dimensions. Certainly, the standard-setters (and, generally, the accounting practitioners) of each jurisdiction believe that the rules in place locally are the best rules available, in that they present results that are consistent with the prevailing views on a fair presentation of both financial performance and financial position. While the meaning of this concept can differ dramatically among jurisdictions, accounting standards in Canada and the United States may differ in the detail yet are quite similar at the conceptual level of user orientation. Despite the conceptual similarity, the actual rules in place are quite different in some areas, and there is no guidance for the user in choosing the right set of accounting standards to base decisions upon. Harmonization efforts are ongoing to resolve these differences, yet regardless of the changes in accounting standards, there will remain differences in interpretation of the rules and differences in the practices that are in place. For example, in Europe, more than 20 years of effort directed toward accounting harmonization did not completely resolve differences in accounting practices in the countries of the European Union. Efforts in North America are more recent but are proceeding rapidly. Responses to specific questions:
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(a) As John McCurdy, outline the initial approach that you will take in order to determine the reasons for the difference in the numbers. Items throughout the income statement, from total revenue through earnings per share, differ between the two sets of financial statements, as do all the aspects of the balance sheet presented. As a start, McCurdy may be able to determine where some of the difference arises by examining the summary of significant accounting policies included with the financial statements. This source will not identify all of the accounting policies in place. More detailed knowledge of the accounting policies in place could come from the specific notes to the financial statements. In addition he should search for publications or web sites that discuss differences in accounting policies among countries. One such publication is by the CICA under the title Significant Differences in GAAP in Canada, Chile, Mexico and the United States. A website provided by Deloitte (www.iasplus.com) could also provide useful information. (This website presents comparisons of international accounting standards with those of other countries including the United States and Canada.) (b) List some of the obvious items that need resolution and indicate some of the possible causes of the discrepancies. • • Why is total revenue significantly higher in the U.S. for the same period? (Are their revenue recognition policies the same?) Why are operating income and income before extraordinary items higher in Canada for the same period? (Revenue differences would be part of the answer, but are there also major differences in expenses?) • • What is the nature of the extraordinary item, classified as such in the United States, and not so in the U.S.? Is classification as an extraordinary item appropriate? What is the nature of the accounting policy differences that have lead to such dramatic differences in asset valuation between the two sets of financial statements? (Two possible reasons: (1) consolidation in Canada of some investments that would not be consolidated in the U.S. financial statements; this might explain the differences in the investments account, and arises because there are different rules for the determination of when an investment is classified as a subsidiary and consolidated; and (2) the use of LIFO in the U.S. and FIFO in Canada might produce different results if there have been major changes in inventory costs during the year.)
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• •

Given the higher asset values in the Canadian financial statements, the Canadian entity may be using the revaluation option under IFRS. What items, if any, have been deferred and are being amortized for Canadian purposes that are directly expensed in the U.S. statements? (R&D comes to mind) Does this account for the difference in intangibles?

•

A variety of other specific points could be raised, including, for example, policies associated with tax allocation.

Although the differences represent a dilemma to the Board of Directors in this case, neither set of financial statements may be said to be unequivocally superior to the other for the purpose of making investment decisions. This is the general dilemma of international comparisons, and a principal reason why accounting harmonization is so important.

CASE 4
(a) Net Income – Canadian GAAP Unrealized valuation changes Revenue less operating expenses and COS Goodwill impairment loss Depreciation and amortization Income taxes Net income – IFRS (b) The major difference between the two net income numbers is contained in the accounting for the company’s development properties and investment properties. Under Canadian GAAP, these properties are valued at the lower of depreciated cost and market, whereas under IFRS, these properties are valued on a yearly basis at fair market value with the unrealized gains reported in income. The properties are not depreciated under IFRS. The difference in income tax is represented entirely by the future taxes that will be paid when (and if) these gains are actually realized. $ (96,083) (286,060) (8,306) 14,862 62,860 36,074 $ (276,653)

CASE 5 Memorandum
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To: Re:

Partner Roman Systems Inc. Interim Audit Results

From: CA

Given that Roman Systems Inc. (RSI) plans to go public within the next year, it should probably follow IFRS. This will avoid retrospective restatement of the financial statements at a later date. RSI’s bias is to maximize revenue, net income and shareholder’s equity in order to attract potential investors. The major financial reporting issues arising from our planning and interim work are: I. Accounting for the costs of the new accounting system II. Revenue recognition a. Maintenance and contract revenue b. Product revenue c. ABM revenue III. Convertible debentures IV. Receivable from Mountain Bank Accounting for new accounting system costs During fiscal Year 12, RSI implemented a new general ledger package. It was required because the old general ledger package would no longer be compatible with other software modules such as inventory, payroll and purchasing. The new package has been functioning in parallel with the old system since April 1, Year 12, and will no longer be used in parallel effective July 1, Year 12. The new package has been used to generate RSI’s financial results since April. RSI has incurred $720,000 in third-party costs associated with the new general ledger package, together with $70,000 of internal salary costs. These costs have all been capitalized in Year 12. IAS 38 offers guidance as to the costs that may be capitalized when internally developing intangible assets. In particular:

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The cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. Examples of directly attributable costs are: (a) costs of materials and services used or consumed in generating the intangible asset; (b) costs of employee benefits (as defined in IAS 19) arising from the generation of the intangible asset; (c) fees to register a legal right; and (d) amortization of patents and licenses that are used to generate the intangible asset. IAS 23 specifies criteria for the recognition of interest as an element of the cost of an internally generated intangible asset. The following are not components of the cost of an internally generated intangible asset: (a) selling, administrative and other general overhead expenditure unless this expenditure can be directly attributed to preparing the asset for use; (b) identified inefficiencies and initial operating losses incurred before the asset achieves planned performance; and (c) expenditures on training staff to operate the asset. Based on the above: Costs of $110,000 related to initial review and recommendations would be considered business process re-engineering activities and not directly related to the creation of the new system. These costs should be expensed. Costs of $320,000 for new software and implementation costs represent a betterment, as they extend the life of the accounting system and enhance the service capacity. They should be capitalized. Training costs of $225,000 should be expensed, as the costs are not directly attributable to the development, betterment, or acquisition of the software. The monthly support fee of $25,000 (and all future monthly fees) is an operational cost of the system and should be expensed.

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The other consulting fees of $40,000 should be reviewed in more detail, but they appear to be part of the ongoing costs of the new system with no specific value added, and should likely be expensed.

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RSI has capitalized $70,000 of salaries related to employees involved with the implementation of the new system. These salaries could be capitalized if they are directly attributable to the implementation of the new software package. Since only two additional individuals were hired to handle the work previously done by the four employees, it is questionable whether the four employees were 100% dedicated to the task of implementing the new software. Only the costs related to the implementation should be capitalized.

Effective July 1, RSI should start amortizing the new system and effective June 30, Year 12, it should write off the remaining net book value of the old system. Revenue Recognition Maintenance contracts During the year, the company changed its revenue recognition policy on maintenance contracts. Assuming that the company previously recognized maintenance revenue on a straight-line basis over the course of the contract, the new method will recognize a greater proportion of the revenue earlier in the contract life. This new method recognizes 25% of the revenue in each of the first two months and may not be appropriate. Maintenance services must be provided over the full life of the contract. The preventive maintenance is entirely at the discretion of the company. It may not be continued in the future and may not consistently reduce future service calls. As well, the study serving as a basis for the policy is two years old, and may no longer be an accurate reflection of the pattern of maintenance calls. Revenue recognition for service contracts should be based on the service obligation over the term of the contract. Product Revenue Product revenue is recognized at the time of delivery and installation. Customer acceptance is evidenced by customer sign-off once installation is complete. It is RSI’s standard practice to obtain such evidence of acceptance. It would therefore be inappropriate to recognize revenue without such evidence of customer acceptance.
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In performing the interim work, we determined that revenue of $640,000 was recorded prior to obtaining customer sign-off. This has not been an issue in the past and may be an isolated case related to new employees who may be unfamiliar with RSI’s standard procedures. We need to ensure that Marge communicated the policy to all staff members and ensure that customer sign-off is obtained for all installations prior to year-end. Since it is early June, Marge would have a month to ensure that there are no issues at year-end. ABM business RSI began selling ABMs in fiscal Year 12. The machines are purchased from an electronic manufacturer and resold at margins of 5%. It is important to consider whether RSI is recording revenue on a gross or net basis. Recognizing revenue on a gross basis is appropriate if RSI bears the risk of selling the product. Recognizing revenue on a net basis is more appropriate if RSI is simply fulfilling orders obtained by the manufacturer, for a fee. It is important to better understand the relationship between RSI, the manufacturer, and the end-party customer in order to recommend an appropriate revenue recognition policy. Transaction fee revenue The company has begun a new line of business related to transaction fee revenue generated from the sale of ABM machines. A total of 2,830,000 ABM transactions were processed at a fee of $1.50 per transaction, for a total of $4,245,000. RSI’s share of this fee is 40%. RSI is currently recording the transaction fee revenue on a gross basis, with an associated expense for the 60% attributable to other parties. The following factors suggest that the ABM transaction fee revenue should be recorded on a net basis: RSI has no ownership of the ABM machines; RSI has no responsibility for stocking or emptying the machines; RSI has no responsibility for cash collection; RSI is being paid on a net basis;
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RSI does not have responsibility for maintenance of the ABMs, and RSI cannot set the transaction fee amount.

On this basis, it would be appropriate for the ABM transaction fee revenue to be recorded on a net basis. Convertible debentures The debentures are currently classified as long-term debt. Since they are convertible into common shares, RSI should consider the reclassification of a portion of the debentures based on the fair value of the conversion feature. This reclassification will result in higher charges to the income statement through the addition of the debt discount. The reclassification is currently not required since RSI is not a public company. Marge Roman should be made aware that if RSI is going public, a detailed analysis should be done related to the split between debt and equity. The financial statements in an offering document would have to be modified to split the debenture between debt and equity. The debt is repayable on demand should RSI not go public by June 30, Year 13. The debt may therefore have to be reclassified as a short-term item in the current financial statements. While there are plans to go public and negotiations have begun (which supports a long-term classification), there is no document such as terms of agreement or a memorandum of understanding providing evidence that this will likely occur. Also, the ability to issue the IPO is beyond the strict control of the company. Reclassifying the debentures as short-term appears to be the more appropriate form of presentation. Receivable from Mountain Bank In reviewing the aged accounts received at April 30, Year 12 we determined that there was a balance of $835,000 from Mountain Bank, which was overdue by more than 120 days. The client has told us that this relates to a contract to install security cameras at all of the customers’ branches. The cameras were installed and customer sign off at each branch was received. We learned that payment was being withheld as several branches requested that fixes be made to the angles at which the cameras were mounted, which takes a service person approximately one hour to complete. Although not required to do so under contract, the client has been accommodating the changes. On June 1, $450,000 was received from the customer and the balance remains outstanding. There are between five and ten sites that remain to be fixed. Two issues arise which must be analyzed in succession. First, is it appropriate to recognize
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revenue upon delivery, installation, and sign off by the customer? And second, if revenue recognition is appropriate, is collection of the remaining accounts receivable doubtful? On the issue of revenue recognition, IAS 8 par .14 says that revenue from the sale of goods can be recognized when all of the following conditions have been met: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits associated with the transaction will flow to the entity; and (e) the costs incurred or to be incurred in respect of the transaction can be measured reliably. In this case all of the above conditions were met upon delivery and installation of the cameras. Revenue may be held back, however, to the extent that a customer acceptance term exists in the arrangement. Although no terms exists in the contract with Mountain that requires the client to come back and adjust the installation of the cameras, it could be argued that such a term exists implicitly since the client has been willing to do so and has accommodated the customer. The question then becomes whether this implicit acceptance is material such that it could be argued that the delivery criterion has not been met. In this case I believe the answer is no. The work required to complete the adjustments is minimal and within the control of RSI, and has nothing to do with the quality of the product. On this basis, it appears that revenue recognition was appropriate. On the issue regarding collectibility, it must be determined whether collectibility is reasonably assured. In this case, there is evidence that the customer is willing to pay once the minor fixes are complete given the $450,000 payment that was made in June. It appears unlikely that the customer will not pay. We should examine Mountain’s payment history a little closer to determine whether amounts were unpaid regarding prior work/product sold and whether any
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amounts were written off/forgiven. In the absence of either, it would appear supportable that the accounts receivable related to this sale are collectible and do not need to written down/off. Overall Impact The affects of my recommendations on the key financial metrics are presented in Exhibit I. As indicated therein, revenue, net income and shareholder’s equity will decrease. RSI will not like these adjustments because they worsen the key financial metrics. The adjustments are appropriate as they better reflect the results of operations and financial position of RSI in accordance with GAAP. Exhibit I Impact of Recommendations on Key Financial Metrics Issue Software costs Revenue recognition for maintenance contracts products ABM business Transaction fees split between debt & equity amortize discount on debt - ??? - ??? - ??? - ??? - ??? - ??? - 2,547 +??? - ??? - ??? - ??? - ??? - ??? - ??? Revenue Income - 350 Equity - 350

Convertible debentures

Mountain Bank Overall impact

PROBLEMS
Problem 1
Historical Cost (U.S. GAAP) Jan 1 /1 Asset cost 10,000,000 Current Value (IAS 16) 10,000,000

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Year 1 Year 2 Jan 2/3 Year 3 Year 4

Depreciation Depreciation Appraisal Depreciation Depreciation

500,000 9,500,000 500,000 9,000,000 500,000 8,500,000 500,000 8,000,000 Year 2 500,000 500,000 Jan 2/3 666,667 500,000 Dec 31/3 11,333,333 8,500,000 Year 3 666,667 500,000 Dec 31/4 10,666,666 8,000,000 Year 4

500,000 9,500,000 500,000 9,000,000 12,000,000 666,667 11,333,333 666,667 10,666,666

Dec 31/1 Balance Dec 31/2 Balance

Dec 31/3 Balance Dec 31/4 Balance (a) 1. IAS 16 2. U.S. GAAP (b) 1. IAS 16 2. U.S. GAAP (c) IAS 16

12,000,000 9,000,000

total depreciation over 20 years Years 1 & 2 Next 18 years 1,000,000 12,000,000 13,000,000 10,000,000 3,000,000

U.S. GAAP Profit

total depreciation over 20 years

U.S. GAAP > IAS 16

There would be no difference in shareholders’ equity at the end of 20 years During the first two years the reduction in shareholders’ equity is the same under the two alternatives (2 x 500,000 = 1,000,000) During the last 18 years depreciation IAS 16 > U.S. GAAP Offset by appraisal surplus Difference in shareholders’ equity (18 x 166,667) 3,000,000 3,000,000 0

Problem 2
(a) (i)
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Solutions Manual, Chapter 1

IFRS1 Inventory @ Dec 31, Yr 2
1

U.S. GAAP2 $95,000

$98,000

Under IFRS (IAS 2), inventory is stated at the lower of cost or market. Net realizable value is

used as the market value. Thus, inventory should be stated at the lower of $100,000, and $98,000, which is the net realizable value (market value).
2

Under U.S. GAAP, inventory is stated at the lower of cost or market. However, under U.S.

GAAP the market value is the midpoint between replacement cost ($95,000), net realizable value ($98,000) and net realizable value less normal profit margin ($98,000 - .20 x $100,000 = $78,000). (ii) R&D @ Dec 31, Yr 2
3

IFRS3 $135,000

U.S. GAAP4 $0

$500,000 - ($500,000*.30)/10 = $135,000 – only development costs are capitalized. (IAS 38) R&D costs are expensed under U.S. GAAP. IFRS5 $0 U.S. GAAP6 $30,000

4

(iii) Deferred gain on lease @ Dec 31, Yr 2
5

Under IFRS (IAS 17), a gain on sale-leaseback is recognized immediately in income if the

lease qualifies as an operating lease.
6

Under U.S. GAAP, if the lessee does not relinquish more than a minor part of the right to use the asset, the gain is deferred and amortized over the lease term. ($50,000 - $50,000/5*2 = $30,000)

(iv) Equipment @ Dec 31, Yr 2

IFRS7 $56,250

U.S. GAAP8 $60,000

7

Under IFRS (IAS 36), an asset is impaired if the carrying amount exceeds the higher of assets

value in use (discounted cash flows = $75,000 at Dec 31, Yr 1) and its FV less costs to dispose
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($72,000). If impaired, the asset is written down to its value in use. The balance at Dec 31, Yr 2 is therefore determined using the $75,000 value in use at Dec 31, Yr 1 less one year of depreciation ($75,000/4 = $18,750).
8

Under U.S. GAAP, there is no indicator of impairment if the undiscounted cash flows from its use ($85,000) are greater than the carrying amount ($80,000 = $100,000 - $20,000 at Dec 31, Yr 1). ($50,000 - $50,000/5*2 = $30,000). The balance under U.S. GAAP at Dec 31, Yr 2 is therefore $100,000 less two years of depreciation ($20,000 per year).

(b) Net Income Year 2 under IFRS Less: additional write-down of inv ($98,000-$95,000) lease gain amort not recognized under IFRS additional depreciation under U.S. GAAP ($20,000 - $18,750) Add: development cost amort, not recognized under U.S. GAAP Net Income Year 2 under U.S. GAAP S/E Dec 31 Year 2 under IFRS Less: additional write-down of inv ($98,000-$95,000) development cost amort, not recognized under U.S. GAAP additional depreciation under U.S. GAAP ($20,000 - $18,750) Add: lease gain deferred under U.S. GAAP S/E @ Dec 31, Year 2 under U.S. GAAP $2,000,000 ($3,000) ($10,000) ($1,250) $15,000 $2,000,750 $16,000,000 ($3,000) ($135,000) ($1,250) $30,000 $15,890,750

WEB-BASED PROBLEMS
Problem 1
To illustrate the response to this problem, the 2008 Form 20-F (Annual Financial Statements and MD&A) was selected for China Mobile Limited, a mobile services provider headquartered in China. (a) The financial statements are presented in Rinminbi (Chinese Yuan). This is disclosed on the face of the financial statements;

Solutions Manual, Chapter 1

Copyright © 2010 McGraw-Hill Ryerson Limited. All rights reserved. 25

(b) The financial statements are prepared in accordance with International Financial Reporting Standards. This is disclosed in the statement of compliance in Note 1 on page F-11. (c) There is no reconciliation provided between IFRS and U.S. GAAP as recently the SEC approved the use of IFRS without reconciliation for all foreign companies listed on U.S. exchanges. (d) Current ratio 2008 = 240,170 / 180,573 = 1.33:1, 2007 = 207,635 / 154,953 = 1.34:1. Although the current ratio would seem to indicate that the liquidity position of the company slightly weakened during the year, the working capital position (current assets minus current liabilities) has actually increased (WC = 2008 – 59,597, 2007 – 52,682). On this basis, the liquidity of the company has slightly increased year over year. (e) Debt/equity 2008 = (180,573 + 34,217)/442,907 = .485:1, 2007 = (154,953 + 34,401)/374,239 = .506:1. The solvency of the company improved slightly from 2007 to 2008. (f) Net income improved from 87,179 in 2007 to 112,954 in 2008. The biggest item affecting net income was usage fees, which increased by approximately 34,000 year over year.

Problem 2
To illustrate the response to this problem, the 2009 Form 20-F (Annual Financial Statements and MD&A) was selected for Dr. Reddy’s Laboratories Limited, a leading India-based pharmaceutical company. (a) As per note 2(d), the consolidated financial statements have been prepared in Indian rupees for both the 2008 and 2009 figures. Solely for the convenience of the reader, the 2009 figures are also presented in United States dollars using the exchange rate at the end of the year. (b) The financial statements were prepared in accordance with International Financial Reporting Standards for the first time in 2009. In prior years, the company used U.S. GAAP. This is disclosed in note 2(a). (c) There is no reconciliation provided between IFRS and U.S. GAAP for 2009, the current year, because the SEC recently approved the use of IFRS without reconciliation for all foreign companies listed on U.S. exchanges. However, in
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note 4, the company provides a reconciliation of profit for 2008, the prior year. The three major differences related to impairment of intangibles, share based payment and amortization of intangibles. (d) Current ratio 2009 = 39,010 / 26,553 = 1.47:1, 2008 = 33,988 / 19,601 = 1.73:1. Since the current ratio and the working capital position declined during the year, the liquidity position of the company weakened during the year. (e) Debt/equity 2009 = 41,747 / 42,045 = .99:1, 2008 = 38,284 / 47,350 = .81:1. The solvency of the company weakened during the year. (f) Net income decreased from a profit of 3,836 in 2008 to a loss of 5,168 in 2009. The biggest item affecting the change in net income was a goodwill impairment loss of 10,856 in 2009 compared to 90 in 2008.

Problem 3
To illustrate the response to this problem, the 2009 Form 20-F (Annual Financial Statements and MD&A) was selected for Toyota Motor Corporation, a car manufacturer headquartered in Japan. (a) As per the title of each statement, the consolidated financial statements have been prepared in Japanese yen for both the 2008 and 2009 figures. However, the 2009 figures are also presented in United States dollars using the exchange rate at the end of the year. (b) As per note 2, the parent company and its subsidiaries in Japan maintain their records and prepare their financial statements in accordance with accounting principles generally accepted in Japan, and its foreign subsidiaries in conformity with those of their countries of domicile. Certain adjustments and reclassifications have been incorporated in the accompanying consolidated financial statements to conform to accounting principles generally accepted in the United States of America. In the end, the financial statements are presented in accordance with U.S. GAAP. (c) There is no reconciliation provided between IFRS and U.S. GAAP because the company reports in accordance with U.S. GAAP. (d) Current ratio 2009 = 11,299 / 10,589 = 1.07:1, 2008 = 12,086 / 11,941= 1.01:1. The current ratio has increased slightly; therefore, the liquidity position of the company improved slightly during the year.
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Solutions Manual, Chapter 1

(e) Debt/equity 2009 = (10,589 + 7,872) / (539 + 10,061) = 1.74:1, 2008 = (11,941 + 7,991) / (657 + 11,870) = 1.59:1. The debt to equity ratio increased. Therefore, the solvency of the company weakened during the year. (f) Net income decreased from a profit of 1,717 in 2008 to a loss of 437 in 2009. The biggest item affecting the change in net income was a decline in sales, which reduced the gross margin from 4,368 in 2008 to 1,705 in 2009.

Problem 4
(a) The financial statements are presented in British Pounds for 2006 and 2008. This is disclosed on the face of the financial statements. (b) The financial statements for 2006 and 2008 were prepared in accordance with IFRSs as endorsed and adopted for use in the EU and IFRSs as issued by the International Accounting Standards Board. (c) Profit for 2006 under IFRS was 1,165 million British Pounds. Under U.S. GAAP, profit for 2006 would have been 1,034 million British Pounds. This represents an 11% difference. This is disclosed in Note 40 to the financial statements on page F-73 of the 2006 Form 20-F filing. In 2008, the company did not prepare a reconciliation between IFRS and U.S. GAAP because the SEC recently approved the use of IFRS without reconciliation for all foreign companies listed on U.S. exchanges. (d) The largest difference between the profits under each set of standards was the treatment of gain/losses on cumulative translation adjustments upon the sale of a subsidiary. This is discussed on page F-81 of the 2006 Form 20-F filing. The following two largest differences were the treatment of retirement benefits (40(h)) and the amortization of intangible assets (50(b)(g)). (e) If a reconciliation of to U.S. GAAP were not provided, a financial analyst would have to read and understand the significant accounting policies of the company under IFRS, and compare accounting policy selections to what treatments would be allowable under U.S. GAAP in order to determine what the potential differences might be. In some cases, quantifying the difference may be difficult to the extent that specific figures are not presented that would be necessary to reconcile to U.S. GAAP treatments. This highlights the benefit of having a

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consistent set of standards that is followed by all publicly accountable entities as it greatly improves comparability.

Problem 5
(a) The financial statements are presented in euros for 2006 and 2009. This is disclosed on the face of the financial statements. (b) The financial statements for 2006 were prepared in accordance with U.S. GAAP. The financial statements for 2009 were prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU). (c) In 2006, the company did not prepare a reconciliation between IFRS and U.S. GAAP because it reported under U.S. GAAP. In 2009, the company did not prepare a reconciliation between IFRS and U.S. GAAP the SEC recently approved the use of IFRS without reconciliation for all foreign companies listed on U.S. exchanges. (d) This is not applicable since they did not provide a reconciliation for the reasons mentioned in (c). (e) If a reconciliation to U.S. GAAP were not provided, a financial analyst would have to read and understand the significant accounting policies of the company under IFRS, and compare accounting policy selections to what treatments would be allowable under U.S. GAAP in order to determine what the potential differences might be. In some cases, quantifying the difference may be difficult to the extent that specific figures are not presented that would be necessary to reconcile to U.S. GAAP treatments. This highlights the benefit of having a consistent set of standards that is followed by all publicly accountable entities as it greatly improves comparability.

Solutions Manual, Chapter 1

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