Ifrs Vs. Us Gaap Inventory
Essay by mjwilli2 • May 19, 2018 • Research Paper • 1,782 Words (8 Pages) • 866 Views
IFRS versus U.S. GAAP Assignment
Difference #1: Inventories
The underlying principle for inventory is defined similarly in IFRS and US GAAP. In both cases, inventory includes those assets held by a company that are either necessary for production, work-in process (e.g. partial products), or fully completed products that are stored and not yet delivered to a customer. Under both US and international standards, cost includes all those direct expenses used in preparing the inventory for sale, but excludes selling, storage, and administrative costs. I’ll touch on 3 key differences between IFRS and U.S. GAAP when it comes to handling inventory: costing (is LIFO permitted?), measurement (what is the basis for calculating inventory), and the reversal of write-downs (can previous write-downs be reversed).
First, in terms of costing, LIFO (Last In, First Out) is permissible under US GAAP, but not under IFRS. The international standard allows for FIFO and weighted-average costing, while in the US, both these methods are allowed, in addition to LIFO. If a US GAAP reporting company reports in IFRS as well, the difference between these methods may result in significantly different reporting of operating results. Under IFRS’ principles based approach, LIFO is prohibited since it may distort key profitability metrics such as net income. For example, under inflationary economic conditions, the carrying costs represented by LIFO inventory may be artificially low since the inventory cost is represented by an outdated price point for those assets. This can give managers with compensation tied to earnings a tool to be able to artificially inflate earnings (using LIFO) for their own short term gain.
Next, calculating the method used for measuring the value of inventory differs between IFRS and US GAAP. Before we go any further, let’s knock out a few definitions:
- Net realizable value = estimated selling price - costs of completion, disposal, & transport
- Market = current replacement cost
Under IFRS, inventory is measured as the lower of cost and net realizable value. Under US GAAP, inventory is measured at the lower of cost and market. Market value is bound in that in cannot be higher than net realizable value or lower than net realizable value reduced by a reasonable sales margin.
Finally, let’s discuss the reversal of write downs under each system. Under both systems, inventory is required to be written down if cost exceeds the net realizable value, similar to a house that is “underwater” - the outstanding costs exceeds the value of the house. However, if market conditions change and the real estate market is booming, your house could recover and return to being “in the black.” Similarly, this phenomenon can happen with a company’s inventory. In these cases, IFRS and US GAAP differ on how to treat that bounce-back. Under US GAAP, reversing these write downs is prohibited, but under IFRS, the write downs can be reversed in the period in which they occur. The reversals are limited to the amount of the original write-down.
Difference #2: Intangible Assets
Intangible assets, which are defined by both IFRS and US GAAP as non-monetary assets lacking physical substance, are required to have both reliably measurable costs and be tied to probably future economic benefits in order to be recognized under both systems. Both systems will only recognize goodwill after a business combination (merger, acquisition, etc.) and require the expensing of research phase costs as they are incurred (I’ll address the development portion of R&D below). There are several key differences between the two reporting methods that center around development costs, advertising costs, and revaluation of these intangible assets.
Development costs for internally generated intangible assets are generally expensed as they are incurred under US GAAP, unless otherwise addressed in the US GAAP guidelines. One such exception is for development costs for marketable (external use) computer software. These expenses can be capitalized once technological feasibility of the software product can be demonstrated. Under IFRS, development costs are capitalized once a project can establish both technical and economic feasibility. This is broader principle than in US GAAP; and IFRS offers no specific guidelines on computer software. In order to capitalize a research expense, the following criteria must be met under IFRS:
1. It is technically feasible to complete the intangible asset
2. The firm as the intention to complete it
3. The firm has the ability to use or sell said asset
4. The product must have probable economic benefits either through an external market or internal usefulness
5. The firm must have the resources to see the project through development to sale or use
6. The firm can reliably measure the costs accrued during development
In terms of advertising costs, IFRS is a bit more stringent in its guidelines which may result in the need to expense advertising costs sooner. Under IFRS, promotional or advertising costs are expensed when they are incurred and prepayments for advertising good or services can only be treated as an asset if the purchasing firm does not yet have the right to access said goods and services. US GAAP offers the option to either expense advertising costs as they are incurred or to expense them when the advertising is presented to the marketplace for the first time. A firm has the ability to choose which method to use, but must apply it consistently to advertising costs once it has been selected.
Similar to what I mentioned with write-downs of US GAAP, revaluations of intangible assets are not permitted under US accounting guidelines. In contrast, IFRS allows for the revaluation of intangible assets (excluding goodwill). However, since an active market for the asset in question must be referenced, this practice is relatively rare in practice.
Difference #3: Goodwill
I mentioned above that Goodwill is treated separately from other intangible assets in that it can only be recognized in the event of a business combination. Both standards hold that acquired goodwill with an indefinite useful life should not be amortized and that the value of goodwill should be tested for impairment at least annually, and more frequently if the value of
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