CHAPTER 5
INTERNATIONAL FINANCIAL REPORTING STANDARDS:
PART II
Chapter Outline
I. International Financial Reporting Standards (IFRS) issued by the International Accounting
Standard Board (IASB) comprise a comprehensive set of standards providing guidance for
the preparation and presentation of financial statements.
A. This chapter focuses on the recognition and measurement of current liabilities,
provisions and contingent liabilities, employee benefits, share-based payment, income
taxes, revenue recognition, and financial instruments.
II. Current Liabilities
A. IAS 1, Presentation of Financial Statements, requires liabilities to be classified as
current or noncurrent. Current liabilities are those liabilities that a company:
a. expects to settle in its normal operating cycle,
b. holds primarily for the purpose of trading,
c. expects to settle within twelve months of the balance sheet date, or
d. does not have the right to defer until twelve months after the balance sheet date.
III. Provisions and Contingent Liabilities
A. IAS 37 distinguishes between a contingent liability, which is not recognized on the
balance sheet, and a provision, which is. A provision is defined as a “liability of
uncertain timing or amount.” A provision should be recognized when:
a. the entity has a present obligation (legal or constructive) as a result of a past event,
b. it is probable (more likely than not) that an outflow of resources embodying
economic events will be required to settle the obligation, and
c. a reliable estimate of the obligation can be made.
B.Contingent liabilities are defined in IAS 37 as:
a. Possible obligations that arise from past events and whose existence will be
confirmed by the occurrence or nonoccurrence of a future event, or
b. A present obligation that is not recognized because (1) it is not probable that an
outflow of resources will be required to settle the obligation or (2) the amount of the
obligation cannot be measured with sufficient reliability.
Contingent liabilities are disclosed unless the possibility of an outflow of resources
embodying the economic future benefits is remote.
IV. Employee Benefits
A. IAS 19, Employee Benefits, is a single standard that covers all forms of employee
compensation and benefits (other than share-based compensation), including
postemployment benefits such as pensions.
B. The accounting for defined benefit pension plans and other defined post-employment
benefit plans (such as medical and life insurance benefits) is basically the same, and is
generally similar to the accounting under U.S. GAAP, with some exceptions.
C. Differences between IFRS and U.S. GAAP exist with respect to:
a. The amount recognized on the employer’s balance sheet as an asset or liability,
and
b. The recognition of past service costs and actuarial gains/losses.
V. Share-based Payment
A. IFRS 2, Share-based Payment, establishes measurement principles and specific
requirements for three types of share-based payment transactions: equity-settled
share-based payment transactions, cash-settled share-based payment transactions,
and choice-of-settlement share-based payment transactions.
B. Similar to U.S. GAAP, IFRS uses a fair value approach in accounting for share-based
payment transactions. In some situations, these transactions are recognized at the fair
value of the goods or services obtained, in other cases, at the fair value of the equity
instrument awarded. Fair value of shares and stock options should be based on
market prices, if available; otherwise a generally accepted valuation model should be
used.
VI. Income Taxes
A. IAS 12, Income Taxes, and U.S. GAAP take a similar approach to accounting for
income taxes. Both standards adopt an asset-and-liability approach that recognizes
deferred tax assets and liabilities for temporary differences and for operating loss and
tax credit carryforwards. However, differences do exist between the two sets of
standards.
VII. Revenue Recognition
A. IAS 18, Revenue, is a single standard that covers most revenues, in particular
revenues from the sale of goods, the rendering of services, and interest, royalties, and
dividends. There is no equivalent single standard in U.S. GAAP.
B. The general principle in IAS 18 is that revenue should be measured at the fair value of
the consideration received or receivable.
C. Five conditions must be met in order for revenue from the sale of goods to be
recognized. One of these conditions requires an evaluation of whether significant risks
and rewards of ownership have been transferred to the buyer; sometimes this can be
difficult to determine and requires the exercise of judgment.
D. When the outcome of a service transaction (1) can be estimated reliably and (2) it is
probable that economic benefits of the transaction will flow to the enterprise, revenue
should be recognized on a stage-of-completion basis.
E. In June 2010, the IASB and FASB published a joint Exposure Draft, Revenue from
Contracts with Customers, which proposes a contract-based revenue recognition
model to be applied across a wide range of transactions and industries. VIII.
Financial Instruments
A. Current IFRS guidance for the financial reporting of financial instruments is located in:
IAS 32, Financial Instruments: Presentation; IAS 39, Financial Instruments:
Recognition and Measurement; and IFRS 7, Financial Instruments: Disclosure. In
addition, IFRS 9, Financial Instruments was issued in November 2009 to begin the
process of replacing IAS 39; IFRS 9 becomes effective in 2013.
B. IAS 32 defines a financial instrument as any contract that gives rise to both a financial
asset of one entity and a financial liability or equity instrument of another entity.
C. A financial asset is any asset that is:
a. cash,
b. a contractual right to receive cash or another financial asset or to exchange
financial assets or financial liabilities under potentially favorable conditions,
c. an equity instrument of another entity, or
d. a contract that will or may be settled in the entity’s own equity instruments and is
not classified as an equity instrument of the entity
D. A financial liability is defined as:
a. a contractual obligation to deliver cash or another financial asset or to exchange
financial assets or financial liabilities under potentially unfavorable conditions, or
b. a contract that will or may be settled in the entity’s own equity instruments.
E. An equity instrument is defined as:
a. Any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.
F. A compound financial instrument is one that contains both a liability element and an
equity element, such as bonds convertible into common stock. Compound financial
instruments should be split into two components that are reported separately. This is
referred to as “split accounting.”
G. IAS 39 establishes categories into which all financial assets and liabilities must be
classified. The classification of a financial asset or financial liability determines how the
item will be measured.
H. The classes of financial assets are: financial assets at fair value through profit or loss,
and available-for-sale financial assets (both of which are measured at fair value); held-
to-maturity investments, and loans and receivables (both of which are measured at
amortized cost).
I. The two classes of financial liabilities are: financial liabilities at fair value through profit
or loss, and financial liabilities measured at amortized cost.