PWC on IFRS and US GAAP Similarities and Differences 2013

7/18/2019 PWC on IFRS and US GAAP Similarities and Differences 2013

http://slidepdf.com/reader/full/pwc-on-ifrs-and-us-gaap-similarities-and-differences-2013 1/228

IFRS read iness ser ies

October 2013

IFRS and US GAAP: similarities and differences



This page intentionally left blank.



October 2013

The heart of the matter 2

The future US path to IFRS remains uncertain

An in-depth discussion 4

The importance of being nancially bilingualIFRS affects US businesses in multiple ways

What this means for your business 6

Understand and manage nancial reportingchangeWhat companies can and should do now

Table of contents



The heart of the matter

The future US path toIFRS remains uncertain



3The heart of the matter

US companies became increasinglyaware of International FinancialReporting Standards (IFRS) overthe past decade as the Financial Accounting Standards Board (FASB)and the International AccountingStandards Board (IASB) (collec-tively, the Boards) worked jointlyand focused their agendas on theconvergence of US GAAP and IFRS.But that era will soon be coming to

a close as the formal bilateral rela-tionship between the Boards ends,and their joint priority projects onrevenue recognition, leasing, nancialinstruments and insurance are nal -ized. While the Boards’ work bothimproved nancial reporting andbrought the accounting frameworkscloser together, the future of furtherconvergence remains uncertain as theBoards shift attention to their ownindependent agendas.

Although a mandatory (or voluntary)change to IFRS for US public compa-nies is no longer in the foreseeablefuture, IFRS is increasingly relevantto many US companies, big and small,public and non-public:

• Cross-border, merger-and-acqui-sition (M&A) and capital-raisingactivity frenquently require the useof IFRS

• Non-US stakeholders in US compa-nies demand the use of IFRS

• Many non-US subsidiaries of USmultinationals must comply withIFRS-reporting requirements

• US GAAP change continues to bein uenced by IFRS

Therefore, it is clear from a preparerperspective that being nancially“bilingual” in the US is increasingly

important.

From an investor perspective, theneed to understand IFRS is argu-ably even greater. US investors keeplooking overseas for investmentopportunities. Recent estimatessuggest that over $6 trillion of UScapital is invested in foreign securi-ties. The US markets also remain opento non-US companies that preparetheir nancial statements using IFRS.There are currently over 450 non-US

lers with market capitalization inthe multiple of trillions of US dollars who use IFRS without reconciliationto US GAAP.

To assist investors and preparers inobtaining this bilingual skill, thispublication provides a broad under-standing of the major differencesbetween IFRS and US GAAP as theyexist today, as well as an appreciationfor the level of change on the horizon.

While this publication does not coverevery difference between IFRS andUS GAAP, it focuses on those wegenerally consider to be the mostsigni cant or most common.



An in-depth discussion

The importance of beingnancially bilingual



5 An in-depth di scussion

IFRS affects US businessesin multiple waysThe near-term use of IFRS in theUnited States by public companies will not be required, but IFRS remainsor is becoming increasingly relevantto many US businesses. Companies will be affected by IFRS at differenttimes and to a different degree,depending on factors such as size,industry, geographic makeup, M&A

activity, and global expansion plans.The following discussion expands onthese impacts.

Mergers and acquisitionsand capital-raising Global M&A transactions are onthe rise. As more companies lookoutside their borders for potentialbuyers, targets, and capital, knowl-edge and understanding of IFRS

becomes increasingly important.Despite the Boards’ standard-settingcoordination, signi cant differencesin both bottom-line impact anddisclosure requirements will remain.Understanding these differences andtheir impact on key deal metrics, as well as both short- and long-term

nancial-reporting requirements, will lead to a more informed decision-making process and help minimizelate surprises that could signi cantlyimpact deal value or completion.

Non-US stakeholders As our marketplace becomesincreasing global, more US companiesbegin to have non-US stakeholders.These stakeholders may require IFRS

nancial information, audited IFRSnancial statements, and budgets and

management information preparedunder IFRS.

Non-US subsidiariesMany countries currently requireor permit IFRS for statutory nan -cial reporting purposes, while othercountries have incorporated IFRSinto their local accounting framework used for statutory reporting. As a result, multinational compa-nies should, at a minimum, monitorthe IFRS activity of their non-USsubsidiaries. Complex transactions,new IFRS standards, and changes

in accounting policies may have animpact on an organization beyondthat of a speci c subsidiary.

US reporting The impact of the accounting changesresulting from the Boards’ jointefforts will be signi cant and willhave broad-based implications.IFRS has already in uencedUS GAAP, and we believe that this

in uence will continue.



What this means for your business

Understand andmanage nancialreporting change



7What this means for your business

What companies can and should do now Although US public companies willnot be required to adopt IFRS in theforeseeable future, we believe thatfour main challenges merit compa-nies’ attention:

• Keeping pace with nancialreporting change as the FASB andthe IASB continue their standard-setting activities

• Carefully managing the adoptionof new converged standards overthe next several years

• Monitoring subsidiaries’ IFRSaccounting requirements

• Understanding how the structureof deals and transactions withnon-US counterparties may bein uenced by those counterpar -ties’ interest in IFRS accountingoutcomes

To successfully face these challenges,companies should be thoughtful andmeasured in what actions they takein the near term relative to IFRS.Companies should identify whatcan be done now by ensuring a goodunderstanding of the signi cantimpacts that these nancial-reportingchanges may have on their businesses.Maintaining corporate oversight ofnon-US subsidiaries’ IFRS accounting

should also be considered, as complextransactions arise, policies requirechanging, and new IFRS standardsare adopted. Staying engaged in thestandard-setting process by partici-pating in roundtables and commentletter processes is also recommended.Finally, more near-term, detailedfocus may be appropriate in areas thatcan be signi cantly impacted, such asM&A activity and taxes.



A further study IFRS and US GAAPsimilarities and differences



10 PwC


About this publicationThis publication is designed to alert companies to the majordifferences between IFRS and US GAAP as they exist today andto the timing and scope of accounting changes that the Boards’standard setting agendas will bring. It is also designed to put intocontext how convergence with IFRS has rami cations far beyondthe accounting department.

The remainder of this publication contains “A further study”consisting of the following for each topical area:

• An executive summary of current IFRS and US GAAP differ -

ences and the potential implications thereof

• A more detailed analysis of current differences between theframeworks including an assessment of the impact embodied within the differences

• Commentary and insight with respect to recent/proposedguidance including developments in relation to the overallconvergence agenda

In addition this publication also includes an overview of IFRSfor SMEs.

This publication takes into account authoritative pronounce-ments and other developments under IFRS and US GAAPthrough September 1, 2013. This publication is not all-encom -passing. When applying the individual accounting frameworks,companies should consult all of the relevant accounting standardsand, where applicable, national law.

Noteworthy updates since the previouseditionThe 2013 edition incorporates commentary for developments inmultiple areas, including the following:

Revenue recognition• Joint FASB/IASB Exposure Draft, Revenue from Contracts

with Customers

Expense recognition—employee bene ts• US Patient Protection and Affordable Care Act

Assets—non nancial assets• FASB Accounting Standards Update No. 2012-02, Testing

Inde nite-Lived Intangible Assets for Impairment

• Joint FASB/IASB Exposure Draft, Leasing

• FASB Exposure Draft, Investment Properties

Assets— nancial assets• Joint FASB/IASB Financial Instruments Project

Liabilities—taxes• FASB Accounting Standards Update No 2013–11 Income Taxes

(Topic 740)—Presentation of an Unrecognized Tax Bene t Whena Net Operating Loss Carryforward, a Similar Tax Loss, or a TaxCredit Carryforward Exists

Liabilities—other • IASB Interpretation, IFRIC 21 , Levies

• FASB Accounting Standard Updates No. 2013–04, Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date

Financial liabilities and equity • Joint FASB/IASB Financial Instruments Project

• Joint FASB/IASB redeliberations on their respective classi ca -tion and measurement models

• IFRS Interpretations Committee Draft Interpretation, IAS 32 Financial Instruments: Presentation—Put Options Written on Non-controlling Interests



11

A further study

PwC

Derivatives and hedging • Amendments to IAS 39, Financial Instruments and

Measurement: Novation of Derivatives and Continuation of Hedge Accounting

Consolidation• IASB amendments to IFRS 10, Consolidated Financial

Statements , IFRS 12, Disclosure of Interests in Other Entities,and IAS 27 (Amended), Separate Financial Statements— Investment Entities

• IASB proposed amendments to IAS 28 (Amended), Investmentsin Associates and Joint Ventures—Equity Method: Share of Other Net Asset Changes

• IASB proposed amendments to IFRS 10, Consolidated FinancialStatements , and IAS 28(Amended), Investments in Associatesand Joint Ventures

• IASB proposed amendments to IFRS 11, Joint Arrangements— Acquisition of an Interest in a Joint Operation

• FASB Proposed Accounting Standards Update, Consolidation(Topic 810)—Agent/Principal Analysis

• Joint FASB/IASB Investment Entities Project

Other accounting and reporting topics• FASB Accounting Standards Update No. 2011–11, Balance

Sheet, and IASB Amendments to IAS 32, Offsetting Financial Assets and Financial Liabilities, and IFRS 7, Disclosures—Offsetting Financial Assets and Financial Liabilities

• FASB Accounting Standards Update No. 2013–05, Cumulativetranslation adjustment

• FASB Exposure Draft— Reporting discontinued operations



Table of contents

IFRS rst-time adoption 15

Revenue recognition 19

Expense recognition—share-based payments 38

Expense recognition—employee bene ts 50

Assets—non nancial assets 64

Assets— nancial assets 86

Liabilities—taxes 110

Liabilities—other 121

Financial liabilities and equity 129

Derivatives and hedging 145

Consolidation 163Business combinations 181

Other accounting and reporting topics 189

IFRS for small and medium-sized entities 209

FASB/IASB project summary exhibit 215

Index 219



15PwC

IFRS rst-time adoption

IFRS 1, First-Time Adoption of International Financial Reporting Standards, is the standard that is applied during preparation of acompany’s rst IFRS-based nancial statements. IFRS 1 was created to help companies transition to IFRS and provides practicalaccommodations intended to make rst-time adoption cost-effective. It also provides application guidance for addressing dif cultconversion topics.

What does IFRS 1 require?The key principle of IFRS 1 is full retrospective application of all IFRS standards that are effective as of the closing balance sheet orreporting date of the rst IFRS nancial statements. Full retrospective adoption can be very challenging and burdensome. To ease thisburden, IFRS 1 gives certain optional exemptions and certain mandatory exceptions from retrospective application.

IFRS 1 requires companies to:

• Identify the rst IFRS nancial statements.

• Prepare an opening balance sheet at the date of transition to IFRS.

• Select accounting policies that comply with IFRS effective at the end of the rst IFRS reporting period and apply those policiesretrospectively to all periods presented in the rst IFRS nancial statements.

• Consider whether to apply any of the optional exemptions from retrospective application.

• Apply the seven mandatory exceptions from retrospective application. Two exceptions regarding classi cation and measurement

periods of nancial assets and embedded derivatives relate to amendments to IFRS 9, which has an effective date after 2013.

• Make extensive disclosures to explain the transition to IFRS.

IFRS 1 is regularly updated to address rst-time adoption issues. There are currently 18 long-term optional exemptions to ease theburden of retrospective application. These exemptions are available to all rst-time adopters, regardless of their date of transition. Additionally, the standard provides for short-term exemptions, which are temporarily available to users and often address transitionissues related to new standards. There are currently ve such short-term exemptions. As referenced above, the exemptions providelimited relief for rst-time adopters, mainly in areas where the information needed to apply IFRS retrospectively might be particularlychallenging to obtain. There are, however, no exemptions from the disclosure requirements of IFRS, and companies may experiencechallenges in collecting new information and data for retrospective footnote disclosures.

Many companies will need to make signi cant changes to existing accounting policies to comply with IFRS, including in such key areas

as revenue recognition, inventory accounting, nancial instruments and hedging, employee bene t plans, impairment testing, provi -sions, and stock-based compensation.

When to apply IFRS 1Companies will apply IFRS 1 when they prepare their rst IFRS nancial statements, including when they transition from theirprevious GAAP to IFRS. These are the rst nancial statements to contain an explicit and unreserved statement of compliance with IFRS.



16 PwC


The opening IFRS balance sheet The opening IFRS balance sheet is the starting point for all subsequent accounting under IFRS and is prepared at the date of transition, which is the beginning of the earliest period for which full comparative information is presented in accordance with IFRS. For example,preparing IFRS nancial statements for the three years ending December 31, 2015, would have a transition date of January 1, 2013.That would also be the date of the opening IFRS balance sheet.

IFRS 1 requires that the opening IFRS balance sheet:

• Include all of the assets and liabilities that IFRS requires

• Exclude any assets and liabilities that IFRS does not permit

• Classify all assets, liabilities, and equity in accordance with IFRS

• Measure all items in accordance with IFRS

• Be prepared and presented within an entity’s rst IFRS nancial statements

These general principles are followed unless one of the optional exemptions or mandatory exceptions does not require or permit recog-nition, classi cation, and measurement in line with the above.

Important takeawaysThe transition to IFRS can be a long and complicated process with many technical and accounting challenges to consider. Experience with conversions in Europe and Asia indicates there are some challenges that are consistently underestimated by companies makingthe change to IFRS, including:

Consideration of data gaps— Preparation of the opening IFRS balance sheet may require the calculation or collection of informationthat was not previously required under US GAAP. Companies should plan their transition and identify the differences between IFRSand US GAAP early so that all of the information required can be collected and veri ed in a timely manner. Likewise, companies shouldidentify differences between local regulatory requirements and IFRS. This could impact the amount of information-gathering neces -sary. For example, certain information required by the SEC but not by IFRS (e.g., a summary of historical data) can still be presented,in part, under US GAAP but must be clearly labeled as such, and the nature of the main adjustments to comply with IFRS must bediscussed. Other incremental information required by a regulator might need to be presented in accordance with IFRS. The SECcurrently envisions, for example, two years of comparative IFRS nancial statements, whereas IFRS would require only one.

Consolidation of additional entities— IFRS consolidation principles differ from those of US GAAP in certain respects and thosedifferences might cause some companies either to deconsolidate entities or to consolidate entities that were not consolidated underUS GAAP. Subsidiaries that previously were excluded from the consolidated nancial statements are to be consolidated as if they were

rst-time adopters on the same date as the parent. Companies also will have to consider the potential data gaps of investees to comply with IFRS informational and disclosure requirements.

Consideration of accounting policy choices— A number of IFRS standards allow companies to choose between alternative policies.Companies should select carefully the accounting policies to be applied to the opening balance sheet and have a full understanding ofthe implications to current and future periods. Companies should take this opportunity to evaluate their IFRS accounting policies witha “clean sheet of paper” mind-set. Although many accounting requirements are similar between US GAAP and IFRS, companies shouldnot overlook the opportunity to explore alternative IFRS accounting policies that might better re ect the economic substance of theirtransactions and enhance their communications with investors.



Revenue recognition



20 PwC


Revenue recognition

US GAAP revenue recognition guidance is extensive and includes a signi cant number of standards issued by the Financial AccountingStandards Board (FASB), the Emerging Issues Task Force (EITF), the American Institute of Certi ed Public Accountants (AICPA), andthe US Securities and Exchange Commission (SEC). The guidance tends to be highly detailed and is of ten industry-speci c. Whilethe FASB’s codi cation has put authoritative US GAAP in one place, it has not impacted the volume and/or nature of the guidance.IFRS has two primary revenue standards and four revenue-focused interpretations. The broad principles laid out in IFRS are generallyapplied without further guidance or exceptions for speci c industries.

A detailed discussion of industry-speci c differences is beyond the scope of this publication. However, the following examples illustrate

industry-speci c US GAAP guidance and how that guidance can create differences between US GAAP and IFRS and produce con ictingresults for economically similar transactions.

• US GAAP guidance on software revenue recognition requires the use of vendor-speci c objective evidence (VSOE) of fair value indetermining an estimate of the selling price. IFRS does not have an equivalent requirement.

• Activation services provided by telecommunications providers are often economically similar to connection services provided bycable television companies. The US GAAP guidance governing the accounting for these transactions, however, differs. As a result,the timing of revenue recognition for these economically similar transactions also varies.

As noted above, IFRS contains minimal industry-speci c guidance. Rather, the broad principles-based approach of IFRS is to be appliedacross all entities and industries. A few of the more signi cant, broad-based differences are highlighted below:

Contingent pricing and how it factors into the revenue recognition models vary between US GAAP and IFRS. Under US GAAP, revenue

recognition is based on xed or determinable pricing criterion, which results in contingent amounts generally not being recorded asrevenue until the contingency is resolved. IFRS looks to the probability of economic bene ts associated with the transaction owing tothe entity and the ability to reliably measure the revenue in question, including any contingent revenue. This could lead to differencesin the timing of revenue recognition, with revenue potentially being recognized earlier under IFRS.

Two of the most common revenue recognition issues relate to (1) the determination of when transactions with multiple deliverablesshould be separated into components and (2) the method by which revenue gets allocated to the different components. US GAAPrequires arrangement consideration to be allocated to elements of a transaction based on relative selling prices. A hierarchy is in place which requires VSOE of fair value to be used in all circumstances in which it is available. When VSOE is not available, third-partyevidence (TPE) may be used. Lastly, a best estimate of selling price may be used for transactions in which VSOE or TPE does not exist.The residual method of allocating arrangement consideration is no longer permitted under US GAAP (except under software industryguidance), but continues to be an option under IFRS. Under US GAAP and IFRS, estimated selling prices may be derived in a variety of ways, including cost plus a reasonable margin.



21

Revenue recognition

PwC

The accounting for customer loyalty programs may drive fundamentally different results. The IFRS requirement to treat customerloyalty programs as multiple-element arrangements, in which consideration is allocated to the goods or services and the award creditsbased on fair value through the eyes of the customer, would be acceptable for US GAAP purposes. US GAAP reporting companies,however, may use the incremental cost model, which is different from the multiple-element approach required under IFRS. In thisinstance, IFRS generally results in the deferral of more revenue.

US GAAP prohibits use of the cost-to-cost percentage-of-completion method for service transactions (unless the transaction explicitlyquali es as a particular type of construction or production contract). Most service transactions that do not qualify for these types ofconstruction or production contracts are accounted for under a proportional-performance model. IFRS requires use of the percentage-of-completion method in recognizing revenue in service arrangements unless progress toward completion cannot be estimated reliably(in which case a zero-pro t approach is used) or a speci c act is much more signi cant than any other (in which case revenue recogni -tion is postponed until the signi cant act is executed). Prohibition of the use of the completed contract method under IFRS and diver -

sity in application of the percentage-of-completion method might also result in differences.

Due to the signi cant differences in the overall volume of revenue-related guidance, a detailed analysis of speci c fact patterns isnormally necessary to identify and evaluate the potential differences between the accounting frameworks.

While the standard setters continue to make isolated changes to their individual accounting frameworks, they are focused on devel-oping a single converged revenue recognition standard. To that end, the FASB and IASB released, in November 2011, a joint revisedexposure draft on revenue recognition, Revenue from Contracts with Customers . The boards redeliberated the proposals during much of2012 and early 2013, and the nal standard is expected at the end of 2013 or beginning of 2014. The revenue standard will be effec -tive for calendar year-end companies in 2017 (2018 for non-public entities following US GAAP). The new model is expected to impactrevenue recognition under both US GAAP and IFRS. Industries having contracts in the scope of the new standard might be affected,and some will see pervasive changes. Refer to the Recent/proposed guidance section for a further discussion of the joint revenue recognition project.

Further details on the foregoing and other selected current differences are described in the following table.



22 PwC


Impact US GAAP IFRS

Revenue recognition—general

The concept of IFRS being principles-based, and US GAAP being principles-based but also rules-laden, is perhapsnowhere more evident than in the area ofrevenue recognition.

This fundamental difference requires adetailed, transaction-based analysis to iden-tify potential GAAP differences.

Differences may be affected by the waycompanies operate, including, for example,how they bundle various products andservices in the marketplace.

Revenue recognition guidance is extensiveand includes a signi cant volume of litera -ture issued by various US standard setters.

Generally, the guidance focuses onrevenue being (1) either realized or real -izable and (2) earned. Revenue recogni -tion is considered to involve an exchangetransaction; that is, revenue should not be

recognized until an exchange transactionhas occurred.

These rather straightforward concepts areaugmented with detailed rules.

A detailed discussion of industry-speci cdifferences is beyond the scope of thispublication. For illustrative purposes only, we note that highly specialized guidanceexists for software revenue recognition.One aspect of that guidance focuses onthe need to demonstrate VSOE of fair value in order to separate different soft-

ware elements in a contract. This require -ment goes beyond the general fair valuerequirement of US GAAP.

Two primary revenue standards captureall revenue transactions within one of fourbroad categories:

• Sale of goods

• Rendering of services

• Others’ use of an entity’s assets(yielding interest, royalties, etc.)

• Construction contracts

Revenue recognition criteria for each ofthese categories include the probabilitythat the economic bene ts associated with the transaction will ow to the entityand that the revenue and costs can bemeasured reliably. Additional recognitioncriteria apply within each broad category.

The principles laid out within each ofthe categories are generally to be applied without signi cant further rules and/or exceptions.

The concept of VSOE of fair value doesnot exist under IFRS, thereby resulting inmore elements likely meeting the separa-tion criteria under IFRS.

Although the price that is regularlycharged by an entity when an item issold separately is the best evidence ofthe item’s fair value, IFRS acknowl -edges that reasonable estimates of fair value (such as cost plus a reasonablemargin) may, in certain circumstances, beacceptable alternatives.



23

Revenue recognition

PwC

Impact US GAAP IFRS

Contingent consideration—general

Revenue may be recognized earlier underIFRS when there are contingencies associ-ated with the price/level of consideration.

General guidance associated with contin -gencies around consideration is addressed within SEC Staff Accounting Bulletin(SAB) Topic 13 and the concept of theseller’s price to the buyer being xedor determinable.

Even when delivery clearly has occurred

(or services clearly have been rendered),the SEC has emphasized that revenuerelated to contingent consideration shouldnot be recognized until the contingencyis resolved. It would not be appropriate torecognize revenue based upon the prob-ability of a factor being achieved.

For the sale of goods, one looks to thegeneral recognition criteria as follows:

• The entity has transferred to thebuyer the signi cant risks andrewards of ownership;

• The entity retains neither continuingmanagerial involvement to the degree

usually associated with ownership noreffective control over the goods sold;

• The amount of revenue can bemeasured reliably;

• It is probable that the economic bene-ts associated with the transaction willow to the entity; and

• The costs incurred or to be incurred with respect to the transaction can bemeasured reliably.

IFRS speci cally calls for consideration ofthe probability of the bene ts owing tothe entity as well as the ability to reli-ably measure the associated revenue. If it were probable that the economic bene ts would ow to the entity and the amountof revenue could be reliably measured,contingent consideration would be recog-nized assuming that the other revenuerecognition criteria are met. If eitherof these criteria were not met, revenue would be postponed until all of thecriteria are met.



24 PwC


Impact US GAAP IFRS

Multiple-elementarrangements—general

While the guidance often results inthe same treatment under the twoframeworks, careful consideration isrequired, as there is the potential forsigni cant differences.

Revenue arrangements with multipledeliverables are separated into differentunits of accounting if the deliverables inthe arrangement meet all of the speci-

ed criteria outlined in the guidance.Revenue recognition is then evaluatedindependently for each separate unitof accounting.

US GAAP includes a hierarchy for deter -mining the selling price of a deliverable.The hierarchy requires the selling price tobe based on VSOE if available, third-partyevidence (TPE) if VSOE is not available,or estimated selling price if neither VSOEnor TPE is available. An entity must makeits best estimate of selling price (BESP)in a manner consistent with that used todetermine the price to sell the deliver-able on a standalone basis. No estima -tion methods are prescribed; however,

examples include the use of cost plus areasonable margin.

Given the requirement to use BESPif neither VSOE nor TPE is available,arrangement consideration will beallocated at the inception of the arrange-ment to all deliverables using the relativeselling price method.

The residual method is precluded.

The reverse-residual method (whenobjective and reliable evidence of the fair

value of an undelivered item or itemsdoes not exist) is also precluded unlessother US GAAP guidance speci callyrequires the delivered unit of accountingto be recorded at fair value and marked tomarket each reporting period thereafter.

The revenue recognition criteria usuallyare applied separately to each transac-tion. In certain circumstances, however,it is necessary to separate a transactioninto identi able components to re ect thesubstance of the transaction.

At the same time, two or more transac-

tions may need to be grouped together when they are linked in such a way thatthe commercial effect cannot be under-stood without reference to the series oftransactions as a whole.

The price that is regularly charged when an item is sold separately is thebest evidence of the item’s fair value. At the same time, under certain circum -stances, a cost-plus-reasonable-marginapproach to estimating fair value wouldbe appropriate under IFRS. The use of

the residual method and, under rarecircumstances, the reverse residualmethod may be acceptable to allocatearrangement consideration.



25

Revenue recognition

PwC

Impact US GAAP IFRS

Multiple-elementarrangements—contingencies

In situations where the amount allocableto a delivered item includes an amountthat is contingent on the delivery ofadditional items, differences in the frameworks may result in recognizing a portionof revenue sooner under IFRS.

The guidance includes a strict limita-tion on the amount of revenue otherwiseallocable to the delivered element in amultiple-element arrangement.

Speci cally, the amount allocable to adelivered item is limited to the amountthat is not contingent on the delivery of

additional items. That is, the amount allo -cable to the delivered item or items is thelesser of the amount otherwise allocablein accordance with the guidance or thenoncontingent amount.

IFRS maintains its general principles and would look to key concepts including, butnot limited to, the following:

• Revenue should not be recognizedbefore it is probable that economicbene ts would ow to the entity.

• The amount of revenue can be

measured reliably.When a portion of the amount allocableto a delivered item is contingent on thedelivery of additional items, IFRS mightnot impose a limitation on the amountallocated to the rst item. A thoroughconsideration of all factors would benecessary so as to draw an appropriateconclusion. Factors to consider wouldinclude the extent to which ful llment ofthe undelivered item is within the controlof, and is a normal/customary deliverable

for, the selling party, as well as the abilityand intent of the selling party to enforcethe terms of the arrangement. In practice,the potential limitation is often overcome.



26 PwC


Impact US GAAP IFRS

Multiple-elementarrangements—customerloyalty programs

Entities that grant award credits as partof sales transactions, including awardsthat can be redeemed for goods andservices not supplied by the entity, mayencounter differences that impact boththe timing and total value of revenue tobe recognized.

Where differences exist, revenue recogni-tion is likely to be delayed under IFRS.

Currently, divergence exists underUS GAAP in the accounting for customerloyalty programs. Two very differentmodels generally are employed.

Some companies utilize a multiple-element accounting model, wherein

revenue is allocated to the award creditsbased on relative fair value. Other compa -nies utilize an incremental cost model, wherein the cost of ful llment is treatedas an expense and accrued for as a “costto ful ll,” as opposed to deferred based onrelative fair value.

The two models can result in signi cantlydifferent accounting.

IFRS requires that award, loyalty, orsimilar programs, whereby a customerearns credits based on the purchase ofgoods or services, be accounted for asmultiple-element arrangements. As such,IFRS requires that the fair value of theaward credits (otherwise attributed inaccordance with the multiple-elementguidance) be deferred and recognizedseparately upon achieving all applicablecriteria for revenue recognition.

The above-outlined guidance applies whether the credits can be redeemed forgoods or services supplied by the entity or whether the credits can be redeemed forgoods or services supplied by a differententity. In situations where the credits canbe redeemed through a different entity, acompany also should consider the timingof recognition and appropriate presenta-tion of each portion of the considerationreceived, given the entity’s potential roleas an agent versus a principal in eachaspect of the transaction.



27

Revenue recognition

PwC

Impact US GAAP IFRS

Multiple elementarrangements—loss ondelivered element only

The timing of revenue and cost recog-nition in situations with multipleelement arrangements and losses onthe rst element may vary under thetwo frameworks.

When there is a loss on the rst elementof a two-element arrangement (withinthe scope of the general/non-industry-speci c, multiple-element revenuerecognition guidance), an accountingpolicy choice with respect to how the lossis treated may exist.

When there is a loss on the rst elementbut a pro t on the second element (andthe overall arrangement is pro table),a company has an accounting policychoice if performance of the undeliv-ered element is both probable and in thecompany’s control. Speci cally, there aretwo acceptable ways of treating the lossincurred in relation to the delivered unitof accounting. The company may (1)recognize costs in an amount equal to therevenue allocated to the delivered unit ofaccounting and defer the remaining costsuntil delivery of the second element, or(2) recognize all costs associated withthe delivered element (i.e., recognize theloss) upon delivery of that element.

When there is an apparent loss on the rstelement of a two-element arrangement,an accounting policy choice may existas of the date the parties entered intothe contract.

When there is a loss on the rst element

but a pro t on the second element (andthe overall arrangement is pro table), acompany may choose between two accept-able alternatives if performance of theundelivered element is both probable andin the company’s control. The companymay (1) determine that revenue is moreappropriately allocated based on cost plusa reasonable margin, thereby removingthe loss on the rst element, or (2) recog -nize all costs associated with the deliveredelement (i.e., recognize the loss) upondelivery of that element.

Once the initial allocation of revenue hasbeen made, it is not revisited. That is,if the loss on the rst element becomesapparent only after the initial revenueallocation, the revenue allocation isnot revisited.

There is not, under IFRS, support fordeferring the loss on the rst element akinto the US GAAP approach.



28 PwC


Impact US GAAP IFRS

Sales of services—general

A fundamental difference in the guid-ance surrounding how service revenueshould be recognized has the potentialto signi cantly impact the timing ofrevenue recognition.

US GAAP prohibits the use of the cost-to-cost revenue recognition methodfor service arrangements unless thecontract is within the scope of speci cguidance for construction or certainproduction-type contracts.

Generally, companies would apply theproportional-performance model or

the completed-performance model. Incircumstances where output measuresdo not exist, input measures (otherthan cost-to-cost), which approximateprogression toward completion, may beused. Revenue is recognized based on adiscernible pattern and, if none exists,then the straight-line approach maybe appropriate.

Revenue is deferred if a service transac-tion cannot be measured reliably.

IFRS requires that service transactions beaccounted for by reference to the stageof completion of the transaction (thepercentage-of-completion method). Thestage of completion may be determinedby a variety of methods, including thecost-to-cost method. Revenue may berecognized on a straight-line basis if theservices are performed by an indeter-minate number of acts over a speci edperiod and no other method better repre-sents the stage of completion.

When the outcome of a service trans-action cannot be measured reliably,revenue may be recognized to the extentof recoverable expenses incurred. Thatis, a zero-pro t model would be utilized,as opposed to a completed-performancemodel. If the outcome of the transactionis so uncertain that recovery of costs isnot probable, revenue would need to be

deferred until a more accurate estimatecould be made.

Revenue may have to be deferred ininstances where a speci c act is muchmore signi cant than any other acts.

Sales of services—right ofrefund

Differences within IFRS and US GAAPprovide the potential for revenue to berecognized earlier under IFRS whenservices-based transactions include aright of refund.

A right of refund may preclude recogni-tion of revenue from a service arrange-ment until the right of refund expires.

In certain circumstances, companies maybe able to recognize revenue over theservice period—net of an allowance—ifcertain criteria within the guidanceare satis ed.

Service arrangements that contain a rightof refund must be considered to deter-mine whether the outcome of the contractcan be estimated reliably and whetherit is probable that the company wouldreceive the economic bene t related tothe services provided.

When reliable estimation is not possible,revenue is recognized only to the extentof the costs incurred that are probableof recovery.



29

Revenue recognition

PwC

Impact US GAAP IFRS

Construction contracts

There are a variety of differences betweenthe two frameworks with potentially far-reaching consequences.

Differences ranging from the transactionsscoped into the construction contractaccounting guidance to the application ofthe models may have signi cant impacts.

The guidance generally applies toaccounting for performance of contractsfor which speci cations are providedby the customer for the construction offacilities, the production of goods, or theprovision of related services.

The scope of this guidance generally hasbeen limited to speci c industries and

types of contracts.

Completed-contract method

Although the percentage-of-completionmethod is preferred, the completed-contract method is required in certainsituations, such as when management isunable to make reliable estimates.

For circumstances in which reliableestimates cannot be made, but there isan assurance that no loss will be incurredon a contract (e.g., when the scope of thecontract is ill-de ned but the contractoris protected from an overall loss), thepercentage-of-completion method basedon a zero-pro t margin, rather than thecompleted-contract method, is used untilmore-precise estimates can be made.

The guidance applies to contracts speci -cally negotiated for the construction of asingle asset or a combination of assets thatare interrelated or interdependent in termsof their design, technology, and function, ortheir ultimate purpose or use. The guid -ance is not limited to certain industries andincludes xed-price and cost-plus construc -tion contracts.

Assessing whether a contract is within thescope of the construction contract standardor the broader revenue standard continuesto be an area of focus. A buyer’s ability tospecify the major structural elements ofthe design (either before and/or duringconstruction) is a key indicator (althoughnot, in and of itself, determinative) ofconstruction contract accounting.

Construction accounting guidance is gener-ally not applied to the recurring productionof goods.

Completed-contract method

The completed-contract method isprohibited.



30 PwC


Impact US GAAP IFRS

Construction contracts (continued) Percentage-of-completion method

Within the percentage-of-completionmodel there are two acceptableapproaches: the revenue approach andthe gross-pro t approach.

Combining and segmenting contractsCombining and segmenting contracts ispermitted, provided certain criteria aremet, but it is not required so long as theunderlying economics of the transactionare re ected fairly.

Percentage-of-completion method

IFRS utilizes a revenue approach topercentage of completion. When the naloutcome cannot be estimated reliably,a zero-pro t method is used (whereinrevenue is recognized to the extent ofcosts incurred if those costs are expectedto be recovered). The gross-pro tapproach is not allowed.

Combining and segmenting contractsCombining and segmenting contracts isrequired when certain criteria are met.

Sale of goods—continuous transfer

Outside of construction accounting underIFRS, some agreements for the sale ofgoods will qualify for revenue recognition

by reference to the stage of completion.

Other than construction accounting,US GAAP does not have a separate modelequivalent to the continuous transfer

model for sale of goods.

When an agreement is for the saleof goods and is outside the scope ofconstruction accounting, an entity

considers whether all of the sale of goodsrevenue recognition criteria are metcontinuously as the contract progresses.When all of the sale of goods criteriaare met continuously, an entity recog-nizes revenue by reference to the stageof completion using the percentage-of-completion method.

The requirements of the constructioncontracts guidance are generally appli-cable to the recognition of revenue andthe associated expenses for such contin-uous transfer transactions.

Meeting the revenue recognition criteriacontinuously as the contract progressesfor the sale of goods is expected to berelatively rare in practice.



31

Revenue recognition

PwC

Impact US GAAP IFRS

Barter transactions

The two frameworks generally requiredifferent methods for determining the value ascribed to barter transactions.

US GAAP generally requires companiesto use the fair value of goods or servicessurrendered as the starting point formeasuring a barter transaction.

Non-advertising-barter transactions

The fair value of goods or servicesreceived can be used if the value surren-dered is not clearly evident.

Accounting for advertising-bartertransactions

If the fair value of assets surrendered inan advertising-barter transaction is notdeterminable, the transaction should berecorded based on the carrying amount ofadvertising surrendered, which likely willbe zero.

Accounting for barter-credittransactions

It should be presumed that the fair valueof the nonmonetary asset exchanged ismore clearly evident than the fair value ofthe barter credits received.

However, it is also presumed that the fair value of the nonmonetary asset does notexceed its carrying amount unless there ispersuasive evidence supporting a higher value. In rare instances, the fair value ofthe barter credits may be utilized (e.g., if

the entity can convert the barter creditsinto cash in the near term, as evidencedby historical practice).

IFRS generally requires companies to usethe fair value of goods or services receivedas the starting point for measuring abarter transaction.

Non-advertising-barter transactions

When the fair value of items received isnot reliably determinable, the fair value ofgoods or services surrendered can be usedto measure the transaction.

Accounting for advertising-bartertransactions

Revenue from a barter transactioninvolving advertising cannot be measuredreliably at the fair value of advertisingservices received. However, a seller canreliably measure revenue at the fair valueof the advertising services it provides ifcertain criteria are met.

Accounting for barter-credittransactions

There is no further/speci c guidance forbarter-credit transactions. The broad prin -ciples outlined above should be applied.



32 PwC


Impact US GAAP IFRS

Extended warranties

The IFRS requirement to separatelyallocate a portion of the consideration toeach component of an arrangement on arelative fair value basis has the potentialto impact the timing of revenue recog-nition for arrangements that include aseparately priced extended warranty ormaintenance contract.

Revenue associated with separatelypriced extended warranty or productmaintenance contracts generally shouldbe deferred and recognized as incomeon a straight-line basis over the contractlife. An exception exists where experi -ence indicates that the cost of performingservices is incurred on an other-than-straight-line basis.

The revenue related to separately pricedextended warranties is determined byreference to the separately stated pricefor maintenance contracts that are soldseparately from the product. There is norelative fair market value allocation inthis instance.

If an entity sells an extended warranty,the revenue from the sale of the extended warranty should be deferred andrecognized over the period covered bythe warranty.

In instances where the extended warrantyis an integral component of the sale(i.e., bundled into a single transaction),

an entity should attribute considerationbased on relative fair value to eachcomponent of the bundle.

Discounting of revenues

Discounting of revenue (to present value)is more broadly required under IFRS thanunder US GAAP.

This may result in lower revenue underIFRS because the time value portion ofthe ultimate receivable is recognized as

nance/interest income.

The discounting of revenue is required inonly limited situations, including receiv-ables with payment terms greater thanone year and certain industry-speci csituations, such as retail land sales orlicense agreements for motion pictures ortelevision programs.

When discounting is required, the interestcomponent should be computed based onthe stated rate of interest in the instru-ment or a market rate of interest if thestated rate is considered unreasonable.

Discounting of revenue to present value isrequired in instances where the in ow ofcash or cash equivalents is deferred.

In such instances, an imputed interestrate should be used for determining theamount of revenue to be recognizedas well as the separate interest incomecomponent to be recorded over time.

Technical references

IFRS IAS 11, IAS 18, IFRIC 13, IFRIC 15, IFRIC 18, SIC 31

US GAAP ASC 605–20–25-1 through 25–6, ASC 605–20–25–14 through 25-18, ASC 605–25, ASC 605–35, ASC 605–50, ASC 985–605, CON 5,SAB Topic 13

Note

The foregoing discussion captures a number of the more signi cant GAAP differences. It is important to note that the discussion isnot inclusive of all GAAP differences in this area.



33

Revenue recognition

PwC

Recent/proposed guidance

Joint FASB/IASB Revenue Recognition Project

Following the release of its rst exposure draft in June 2010, the FASB and IASB released a revised exposure draft, Revenue fromContracts with Customers , in November 2011 (2011 Exposure Draft) proposing a converged model that would have a signi cantimpact on current revenue recognition under both US GAAP and IFRS. The boards received over 350 comment letters on the 2011Exposure Draft, which highlighted a number of recurring themes that were discussed during redeliberations. The boards addressedseveral areas including the identi cation of separate performance obligations, determining the transaction price, accounting for variable consideration, transfer of control, warranties, contract costs, and accounting for licenses to use intellectual property,among others.

Comments were due on the 2011 Exposure Draft in March 2012. The boards asked whether the proposed guidance is clear, andrequested feedback speci cally on performance obligations satis ed over time, presentation of the effects of credit risk, recognitionof variable consideration, the scope of the onerous performance obligation test, interim disclosures, and transfer of non nancialassets that are outside an entity’s ordinary activities (for example, sale of PP&E). Comments focused on transition, disclosure, theonerous assessment, the time value of money, and several industry-speci c issues. The boards substantially completed their redelib -erations in February 2013. A nal standard is expected at the end of 2013 or beginning of 2014.

The following discussion re ects the guidance in the 2011 Exposure Draft and redeliberations. The decisions reached by the boardsduring redeliberations are tentative and subject to change until a nal standard is issued. The discussion contained herein re ectsthe tentative decisions made through September 1, 2013.

The proposed model employs an asset and liability approach, the cornerstone of the FASB’s and IASB’s conceptual frameworks.Current revenue guidance focuses on an “earnings process,” but dif culties often arise in determining when revenue is earned. Theboards believe a more consistent application can be achieved by using a single, contract-based model where revenue recognition

is based on changes in contract assets (rights to receive consideration) and liabilities (obligations to provide a good or perform aservice). Under the proposed model, revenue is recognized based on the satisfaction of performance obligations. In applying theproposed model, entities would follow this ve-step process:

1. Identify the contract with a customer.

2. Identify the separate performance obligations in the contract.

3. Determine the transaction price.

4. Allocate the transaction price to the separate performance obligations.

5. Recognize revenue when (or as) each performance obligation is satis ed.

Identify the contract with a customer

The model starts with identifying the contract with the customer and whether an entity should combine, for accounting purposes,

two or more contracts (including contract modi cations), to properly re ect the economics of the underlying transaction. That is,two or more contracts (including contracts with different customers) should be combined if the contracts are entered into at or nearthe same time and the contracts are negotiated with a single commercial objective, the amount of consideration in one contractdepends on the other contract, or the goods or services in the contracts are interrelated. A contract modi cation is treated as a sepa -rate contract only if it results in the addition of a separate performance obligation and the price re ects the stand-alone selling price(that is, the price the good or service would be sold for if sold on a stand-alone basis) of the additional performance obligation. Themodi cation is otherwise accounted for as an adjustment to the original contract either through a cumulative catch-up adjustmentto revenue or a prospective adjustment to revenue when future performance obligations are satis ed, depending on whether the



34 PwC


remaining goods and services are distinct. While aspects of this proposal are similar to existing literature, careful consideration willbe needed to ensure the model is applied to the appropriate unit of account.

Identify the separate performance obligations in the contract

An entity will be required to identify all performance obligations in a contract. Performance obligations are promises to transfergoods or services to a customer and are similar to what we know today as “elements” or “deliverables.” Performance obligationsmight be explicitly stated in the contract but might also arise in other ways. Legal or statutory requirements to deliver a good orperform a service might create performance obligations even though such obligations are not explicit in the contract. A perfor -mance obligation may also be created through customary business practices, such as an entity’s practice of providing customersupport, or by published policies or speci c company statements. This could result in an increased number of performance obliga -tions within an arrangement, possibly changing the t iming of revenue recognition.

An entity accounts for each promised good or service as a separate performance obligation if the good or service is distinct (i.e., thecustomer can bene t from the good or service either on its own or together with other resources readily available to the customer);and is distinct based on the substance of the contract (i.e., not highly dependent on or interrelated with other promised goods orservices in the contract).

Sales-type incentives such as free products or customer loyalty programs, for example, are currently recognized as marketingexpense under US GAAP in some circumstances. These incentives might be performance obligations under the proposed model; ifso, revenue will be deferred until such obligations are satis ed, such as when a customer redeems loyalty points. Other potentialchanges in this area include accounting for return r ights, licenses, and options.

Determine the transaction price

Once an entity identi es the performance obligations in a contract, the obligations will be measured by reference to the transactionprice. The transaction price re ects the amount of consideration that an entity expects to be entitled to in exchange for goods or

services delivered. This amount is measured using either a probability-weighted or most-likely-amount approach; whichever is mostpredictive. The amount of expected consideration captures: (1) variable consideration, (2) an assessment of time value of money(as a practical expedient, an entity need not make this assessment when the period between payment and the transfer of goods orservices is less than one year), (3) noncash consideration, generally at fair value, and (4) consideration paid to customers.

Inclusion of variable consideration in the initial measurement of the transaction price might result in a signi cant change in thetiming of revenue recognition. Such consideration is recognized as the entity satis es its related performance obligations, provided(1) the entity has relevant experience with similar performance obligations (or other valid evidence) that allows it to estimate thecumulative amount of revenue for a satis ed performance obligation, and (2) based on that experience, the entity does not expecta signi cant reversal in future periods in the cumulative amount of revenue recognized for that performance obligation. Revenuemay therefore be recognized earlier than under existing guidance if an entity meets the conditions to include variable consider-ation in the transaction price. Judgment will be needed to assess whether the entity has predictive experience about the outcomeof a contract. The following indicators might suggest the entity’s experience is not predictive of the outcome of a contract: (1) the

amount of consideration is highly susceptible to factors outside the in uence of the entity, (2) the uncertainty about the amount ofconsideration is not expected to be resolved for a long period of time, (3) the entity’s experience with similar types of contracts islimited, and (4) the contract has a large number and broad range of possible consideration amounts.

Allocate the transaction price to the separate performance obligations

For contracts with multiple performance obligations (deliverables), the performance obligations should be separately accountedfor to the extent that the pattern of transfer of goods and services is different. Once an entity identi es and determines whether toseparately account for all the performance obligations in a contract, the transaction price is allocated to these separate performanceobligations based on relative standalone selling prices.



35

Revenue recognition

PwC

The best evidence of standalone selling price is the observable price of a good or service when the entity sells that good or serviceseparately. The selling price is estimated if a standalone selling price is not available. Some possible estimation methods include(1) cost plus a reasonable margin or (2) evaluation of standalone sales prices of the same or similar products, if available. If thestandalone selling price is highly variable or uncertain, entities may use a residual approach to aid in estimating the standaloneselling price (i.e., total transaction price less the standalone selling prices of other goods or services in the contract). An entity mayalso allocate discounts and variable amounts entirely to one (or more) performance obligations if certain conditions are met.

Recognize revenue when each performance obligation is satis ed

Revenue should be recognized when a promised good or service is transferred to the customer. This occurs when the customerobtains control of that good or service. Control can transfer at a point in time or continuously over time. Determining when controltransfers will require a signi cant amount of judgment. An entity satis es a performance obligation over time if: (1) the customer

is receiving and consuming the bene ts of the entity’s performance as the entity performs (i.e., another entity would not need tosubstantially re-perform the work completed to date); (2) the entity’s performance creates or enhances an asset that the customercontrols as the asset is created or enhanced; or (3) the entity’s performance does not create an asset with an alternative use to theentity, the entity has a right to payment for performance completed to date, and it expects to ful ll the contract. A good or servicenot satis ed over time is satis ed at a point in time. Indicators to consider in determining when the customer obtains control of apromised asset include: (1) the customer has an unconditional obligation to pay, (2) the customer has legal title, (3) the customerhas physical possession, (4) the customer has the r isks and rewards of ownership of the good, and (5) the customer has acceptedthe asset. These indicators are not a checklist, nor are they all-inclusive. All relevant factors should be considered to determine whether the customer has obtained control of a good.

If control is transferred continuously over time, an entity may use output methods (e.g., units delivered) or input methods(e.g., costs incurred or passage of time) to measure the amount of revenue to be recognized. The method that best depicts thetransfer of goods or services to the customer should be applied consistently throughout the contract and to similar contracts withcustomers. The notion of an earnings process is no longer applicable.

Select other considerationsContract cost guidance

The proposed model also includes guidance related to contract costs. Costs relating to satis ed performance obligations andcosts related to inef ciencies should be expensed as incurred. Incremental costs of obtaining a contract (e.g., a sales commission)should be recognized as an asset if they are expected to be recovered. An entity can expense the cost of obtaining a contract if theamortization period would be less than one year. Entities should evaluate whether direct costs incurred in ful lling a contractare in the scope of other standards (e.g., inventory, intangibles, or xed assets). If so, the entity should account for such costs inaccordance with those standards. If not, the entity should capitalize those costs only if the costs relate directly to a contract, relateto future performance, and are expected to be recovered under a contract. An example of such costs may be certain mobilization,design, or testing costs. These costs would then be amortized as control of the goods or services to which the asset relates is trans -ferred to the customer. The amortization period may extend beyond the length of the contract when the economic bene t will be

received over a longer period. An example might include set-up costs related to contracts likely to be renewed.

Onerous performance obligations

During the July 2012 redeliberations, the FASB and IASB agreed to remove the requirement to assess onerous performance obliga -tions from the nal standard. The boards agreed to retain the current onerous loss guidance within US GAAP and IFRS. Currentonerous loss guidance within US GAAP includes ASC 605-35, Construction-Type and Production-Type Contracts . The IASB tentativelydecided that the requirements for onerous contracts in IAS 37, Provisions, Contingent Liabilities and Contingent Assets , should applyto all contracts with customers.



36 PwC


Summary observations and anticipated timing

The above commentary is not all-inclusive. The effect of the new revenue recognition guidance will be extensive and all indus -tries may be affected. Some will see pervasive changes as the proposed model will replace all existing US GAAP and IFRS revenuerecognition guidance, including industry-speci c guidance with limited exceptions (for example, certain guidance on rate-regu -lated activities in US GAAP). The boards are currently nalizing the drafting of the nal standard, which is expected to be issuedat the end of 2013 or beginning of 2014. Under US GAAP, the revenue standard will be effective (1) for public entities, for annualreporting periods, and interim periods therein, beginning after December 15, 2016 and (2) for non-public entities, for annualreporting periods beginning after December 15, 2017, and for interim periods in the year thereafter. Under IFRS, the nal standard will be effective for the rst interim period within annual reporting periods beginning on or after January 1, 2017.

Entities should continue to evaluate how the model might affect current business activities, including contract negotiations, keymetrics (including debt covenants and compensation arrangements), budgeting, controls and processes, information technology

requirements, and accounting. The proposed standard will permit an entity to either apply it retrospectively or use the followingpractical expedient (note that rst-time adopters of IFRS will be required to adopt the revenue standard retrospectively) tosimplify transition:

• Apply the revenue standard to all existing contracts (i.e., contracts in which the entity has not fully performed its obligationsin accordance with revenue guidance in effect prior to the date of initial application) as of the effective date and to contractsentered into subsequently;

• Recognize the cumulative effect of applying the new standard to existing contracts in the opening balance of retained earningson the effective date; and

• Disclose, for existing and new contracts accounted for under the new revenue standard, the impact of adopting the standard onall affected nancial statement line items in the period the standard is adopted.

The FASB is not permitting early adoption (except for non-public entities which will be permitted to early adopt the new revenue

standard but no earlier than the required effective date for public entities), while the IASB proposes to allow early application ofthe standard.



Expense recognition



38 PwC


Expense recognition—share-based payments

Although the US GAAP and IFRS guidance in this area is similar at a macro conceptual level, many signi cant differences exist at thedetailed application level.

The broader scope of share-based payments guidance under IFRS leads to differences associated with awards made to nonemployees,impacting both the measurement date and total value of expense to be recognized.

Differences within the two frameworks may result in differing grant dates and/or different classi cations of an award as a componentof equity or as a liability. Once an award is classi ed as a liability, it needs to be remeasured to fair value at each period through earn -

ings, which introduces earnings volatility while also impacting balance sheet metrics and ratios. Certain types of awards (e.g., puttableawards and awards with vesting conditions outside of service, performance, or market conditions) are likely to have different equity- versus-liability classi cation conclusions under the two frameworks.

In addition, companies that issue awards with graded vesting (e.g., awards that vest ratably over time, such as 25 percent per yearover a four-year period) may encounter accelerated expense recognition and potentially a different total value to be expensed (for agiven award) under IFRS. The impact in this area could lead some companies to consider redesigning the structure of their share-basedpayment plans. By changing the vesting pattern to cliff vesting (from graded vesting), companies can avoid a front-loading of share-based compensation expense, which may be desirable to some organizations.

The deferred income tax accounting requirements for share-based payments vary signi cantly from US GAAP. Companies can expectto experience greater variability in their effective tax rate over the lifetime of share-based payment awards under IFRS. This variability will be linked with, but move counter to, the issuing company’s stock price. For example, as a company’s stock price increases, a greater

income statement tax bene t will occur, to a point, under IFRS. Once a bene t has been recorded, subsequent decreases to a company’sstock price may increase income tax expense within certain limits. The variability is driven by the requirement to remeasure and recordthrough earnings (within certain limits) the deferred tax attributes of share-based payments each reporting period.

The following table provides further details on the foregoing and other selected current differences.



39


PwC

Impact US GAAP IFRS

Scope

Some awards categorized as nonemployeeinstruments under US GAAP will betreated as employee awards under IFRS.The measurement date and expense willbe different for awards that are catego-rized as nonemployee instruments underUS GAAP as compared with IFRS.

Under IFRS, companies apply a single

standard to all share-based paymentarrangements, regardless of whether thecounterparty is a nonemployee.

The guidance is focused on/driven bythe legal de nition of an employee withcertain speci c exceptions/exemptions.

ASC 718, Compensation—StockCompensation, applies to awards grantedto employees and Employee StockOwnership Plans. ASC 505-50 applies togrants to nonemployees.

IFRS focuses on the nature of the servicesprovided and treats awards to employeesand others providing employee-typeservices similarly. Awards for goods from vendors or nonemployee-type services aretreated differently.

IFRS 2, Share-based payments , includesaccounting for all employee and nonem-

ployee arrangements. Furthermore, underIFRS, the de nition of an employee isbroader than the US GAAP de nition.

Measurement of awardsgranted to employees bynonpublic companies

IFRS does not permit alternatives inchoosing a measurement method.

Equity-classi ed

The guidance allows nonpublic companiesto measure stock-based-compensationawards by using the fair-value (preferred)method or the calculated-value method.

Liability-classi ed

The guidance allows nonpublic compa-nies to make an accounting-policydecision on how to measure stock-based-compensation awards that are classi edas liabilities. Such companies may usethe fair-value method, calculated-valuemethod, or intrinsic-value method.

IFRS does not include such alternativesfor nonpublic companies and requiresthe use of the fair-value method in allcircumstances.



40 PwC


Impact US GAAP IFRS

Measurement of awardsgranted to nonemployees

Both the measurement date and themeasurement methodology may vary forawards granted to nonemployees.

ASC 505-50 states that the fair value ofan equity instrument issued to a nonem-ployee should be measured as of the dateat which either (1) a commitment forperformance by the counterparty hasbeen reached, or (2) the counterparty’sperformance is complete.

Nonemployee transactions should bemeasured based on the fair value of theconsideration received or the fair value ofthe equity instruments issued, whicheveris more reliably measurable.

Transactions with parties other thanemployees should be measured at thedate(s) on which the goods are receivedor the date(s) on which the services arerendered. The guidance does not includea performance commitment concept.

Nonemployee transactions are generally

measured at the fair value of the goods orservices received, since it is presumed thatit will be possible to reliably measure thefair value of the consideration received.If an entity is not able to reliably measurethe fair value of the goods or servicesreceived (i.e., if the presumption isovercome), fair value of the award shouldbe measured indirectly by reference tothe fair value of the equity instrumentgranted as consideration.

When the presumption is not overcome,

an entity is also required to account forany unidenti able goods or servicesreceived or to be received. This wouldbe the case if the fair value of the equityinstruments granted exceeds the fair value of the identi able goods or servicesreceived and to be received.



41


PwC

Impact US GAAP IFRS

Classication of certaininstruments as liabilitiesor equity

Although ASC 718 and IFRS 2 containa similar principle for classi cation ofstock-based-compensation awards, certainawards will be classi ed differently underthe two standards. In some instances,awards will be classi ed as equity underUS GAAP and a liability under IFRS, whilein other instances awards will be classi edas a liability under US GAAP and equityunder IFRS.

In certain situations, puttable shares maybe classi ed as equity awards.

Liability classi cation is required whenan award is based on a xed monetaryamount settled in a variable number ofshares.

ASC 718 contains guidance on deter -mining whether to classify an awardas equity or a liability. ASC 718 alsoreferences the guidance in ASC 480, Distinguishing Liabilities from Equity , when assessing classi cation of an award.

Puttable shares are always classi ed asliabilities.

Share-settled awards are classi ed asequity awards even if there is variabilityin the number of shares due to a xedmonetary value to be achieved.

IFRS 2 follows a similar principle ofequity/liability classi cation as ASC 718.However, while IAS 32 has similar guid -ance to ASC 480, companies applyingIFRS 2 are out of the scope of IAS 32.Therefore, equity/liability classi ca -tion for share-based awards is deter-mined wholly on whether the awardsare ultimately settled in equity or cash,respectively.

Awards with conditions other

than service, performance, ormarket conditions

Certain awards classi ed as liabilitiesunder US GAAP may be classi ed asequity under IFRS.

If an award contains conditions other thanservice, performance, or market condi-tions (referred to as “other” conditions), itis classi ed as a liability award.

If an award of equity instruments containsconditions other than service, perfor-mance, or market vesting conditions, it isstill classi ed as an equity-settled award.Such conditions may be nonvesting condi-tions. Nonvesting conditions are takeninto account when determining the grantdate fair value of the award.

Service-inception date, grant

date, and requisite serviceBecause of the differences in the de ni -tions, there may be differences in thegrant date and the period over whichcompensation cost is recognized.

The guidance provides speci c de nitionsof service-inception date, grant date, andrequisite service, which, when applied, will determine the beginning and end ofthe period over which compensation cost will be recognized. Additionally, the grantdate de nition includes a requirementthat the employee begins to be affected bythe risks and rewards of equity ownership.

IFRS does not include the same detailedde nitions. The difference in the grantdate de nition is that IFRS does not havethe requirement that the employee beginsto be affected by the risks and rewards ofequity ownership.



42 PwC


Impact US GAAP IFRS

Attribution—awards withservice conditions andgraded-vesting features

The alternatives included under US GAAPprovide for differences in both themeasurement and attribution of compen-sation costs when compared with therequirements under IFRS.

Companies are permitted to make anaccounting policy election regardingthe attribution method for awards withservice conditions and graded-vestingfeatures. The choice in attribution methodis not linked to the valuation methodthat the company uses. For awards withgraded vesting and performance ormarket conditions, the graded-vestingattribution approach is required.

Companies are not permitted to choosehow the valuation or attribution methodis applied to awards with graded-vestingfeatures. Companies should treat eachinstallment of the award as a separategrant. This means that each installment would be separately measured and attrib-uted to expense over the related vestingperiod.

Certain aspects ofmodication accounting

Differences between the two standards forimprobable to probable modi cations mayresult in differences in the compensationcosts that are recognized.

An improbable to probable Type IIImodi cation can result in recognition ofcompensation cost that is less than theestimated fair value of the award on theoriginal grant date. When a modi cationmakes it probable that a vesting condition will be achieved, and the company doesnot expect the original vesting conditionsto be achieved, the grant-date fair valueof the award would not be a oor for theamount of compensation cost recognized.

Under IFRS, if the vesting conditions ofan award are modi ed in a manner thatis bene cial to the employee, this wouldbe accounted for as a change in only thenumber of options that are expectedto vest (from zero to a new amount ofshares), and the award’s full originalgrant-date fair value would be recognizedover the remainder of the service period.That result is the same as if the modi edperformance condition had been in effecton the grant date.

See further discussion underRecent/proposed guidance.

Alternative vesting triggers

It is likely that awards that become exer-cisable based on achieving one of severalconditions would result in a revisedexpense recognition pattern (as theawards would be bifurcated under IFRS).

An award that becomes exercisable basedon the achievement of either a servicecondition or a market condition is treatedas a single award. Because such an awardcontained a market condition, compensa-tion cost associated with the award wouldnot be reversed if the requisite serviceperiod is met.

An award that becomes exercisable basedon the achievement of either a servicecondition or a market condition is treatedas two awards with different serviceperiods, fair values, etc. Any compensa -tion cost associated with the servicecondition would be reversed if the service was not provided. The compensation costassociated with the market condition would not be reversed.



43


PwC

Impact US GAAP IFRS

Cash-settled awards with aperformance condition

For a cash-settled award where the perfor-mance condition is not probable, liabilityand expense recognition may occur earlierunder IFRS.

For cash-settled awards with a perfor-mance condition, where the performancecondition is not probable, there may be noliability recognized under US GAAP.

For cash settled awards even where theperformance condition is not probable(i.e., greater than zero but less than50 percent probability), a liability isrecognized under IFRS based on the fair value of the instrument (considering thelikelihood of earning the award).

Derived service periodFor an award containing a market condi-tion that is fully vested and deep out ofthe money at grant date, expense recogni-tion may occur earlier under IFRS.

US GAAP contains the concept of aderived service period for awards thatcontain market conditions. Where anaward containing a market condition isfully vested and deep out of the moneyat grant date but allows employees onlya limited amount of time to exercisetheir awards in the event of termination,US GAAP presumes that employees mustprovide some period of service to earn theaward. Because there is no explicit service

period stated in the award, a derivedservice period must be determined byreference to a valuation technique. Theexpense for the award would be recog-nized over the derived service periodand reversed if the employee does notcomplete the requisite service period.

IFRS does not de ne a derived serviceperiod for fully vested, deep-out-of-the-money awards. Therefore, the relatedexpense for such an award would berecognized in full at the grant datebecause the award is fully vested atthat date.



44 PwC


Impact US GAAP IFRS

Tax withholdingarrangements—impact to

classication

There could be a difference in award clas-si cation as a result of tax withholdingarrangements.

An award containing a net settled tax withholding clause could be equity-classi ed so long as the arrangementlimits tax withholding to the company’sminimum statutory rate. If tax with -holding is permitted at some higher rate,then the whole award would be classi edas a liability.

IFRS does not contain a similar exception.When an employer settles an employee’stax withholding liability using its owncash, the award is bifurcated between acash-settled portion and an equity-settledportion. The portion of the award relatingto the estimated tax payment is treatedas a cash-settled award and marked tomarket each period until settlement of theactual tax liability. The remaining portionis treated as an equity settled award.

See further discussion underRecent/proposed guidance.

Accounting for income tax

effects

Companies reporting under IFRS gener-ally will have greater volatility in their

deferred tax accounts over the life of theawards due to the related adjustments forstock price movements in each reportingperiod.

Companies reporting under US GAAPcould have greater volatility upon exercisearising from the variation between theestimated deferred taxes recognized andthe actual tax deductions realized.

There are also differences in the presenta-tion of the cash ows associated with anaward’s tax bene ts.

The US GAAP model for accounting forincome taxes requires companies to record

deferred taxes as compensation cost isrecognized. The measurement of thedeferred tax asset is based on an estimateof the future tax deduction, if any, basedon the amount of compensation costrecognized for book purposes. Changes inthe stock price do not impact the deferredtax asset or result in any adjustments priorto settlement or expiration. Although theydo not impact deferred tax assets, futurechanges in the stock price will nonethe-less affect the actual future tax deduction(if any).

The measurement of the deferred taxasset in each period is based on an esti-

mate of the future tax deduction, if any,for the award measured at the end of eachreporting period (based on the currentstock price if the tax deduction is based onthe future stock price).

When the expected tax bene ts fromequity awards exceed the recordedcumulative recognized expense multipliedby the tax rate, the tax bene t up to theamount of the tax effect of the cumulativebook compensation expense is recordedin the income statement; the excess isrecorded in equity.



45


PwC

Impact US GAAP IFRS

Accounting for income tax effects(continued)

Excess tax bene ts (“windfalls”) uponsettlement of an award are recordedin equity. “Shortfalls” are recorded asa reduction of equity to the extent thecompany has accumulated windfalls inits pool of windfall tax bene ts. If thecompany does not have accumulated windfalls, shortfalls are recorded toincome tax expense.

In addition, the excess tax bene ts upon

settlement of an award would be reportedas cash in ows from nancing activities.

When the expected tax bene t is less thanthe tax effect of the cumulative amount ofrecognized expense, the entire tax bene tis recorded in the income statement. IFRS2 does not include the concept of a pool of windfall tax bene ts to offset shortfalls.

In addition, all tax bene ts or shortfallsupon settlement of an award generally arereported as operating cash ows.

Recognition of social charges(e.g., payroll taxes)

The timing of recognition of social chargesgenerally will be earlier under IFRS thanUS GAAP.

A liability for employee payroll taxes onemployee stock-based-compensationshould be recognized on the date of theevent triggering the measurement andpayment of the tax (generally the exercisedate for a nonquali ed option).

Social charges, such as payroll taxeslevied on the employer in connection with stock-based-compensation plans,are expensed in the income statement when the related compensation expenseis recognized. The guidance in IFRS forcash-settled share-based payments would

be followed in recognizing an expense forsuch charges.

Valuation—SAB Topic 14guidance on expected volatilityand expected term

Companies that report under US GAAPmay place greater reliance on impliedshort-term volatility to estimate volatility.Companies that report under IFRS do nothave the option of using the “simpli edmethod” of calculating expected termprovided by SAB Topic 14. As a result,there could be differences in estimatedfair values.

SAB Topic 14 includes guidance onexpected volatility and expected term, which includes (1) guidelines for relianceon implied volatility and (2) the “simpli -

ed method” for calculating the expectedterm for qualifying awards.

IFRS does not include comparableguidance.



46 PwC


Impact US GAAP IFRS

Employee stock purchaseplan (ESPP)

ESPPs generally will be deemed compen -satory more often under IFRS than underUS GAAP.

ESPPs are compensatory if terms of theplan:

• Either (1) are more favorable thanthose available to all shareholders, or(2) include a discount from the marketprice that exceeds the percentage ofstock issuance costs avoided (discount

of 5 percent or less is a safe harbor);• Do not allow all eligible employees to

participate on an equitable basis; or

• Include any option features(e.g., look-backs).

In practice, most ESPPs are compensatory;however, plans that do not meet any ofthe above criteria are non-compensatory.

ESPPs are compensatory and treatedlike any other equity-settled share-basedpayment arrangement. IFRS does notallow any safe-harbor discount for ESPPs.

Group share-basedpayment transactions

Under US GAAP, push-down accounting ofthe expense recognized at the parent levelgenerally would apply. Under IFRS, thereporting entity’s obligation will deter -mine the appropriate accounting.

Generally, push-down accounting of theexpense recognized at the parent level would apply to the separate nancialstatements of the subsidiary.

For liability-classi ed awards settled bythe parent company, the mark to marketexpense impact of these awards shouldbe pushed down to the subsidiary’sbooks each period, generally as a capitalcontribution from the parent. However,liability accounting at the subsidiary maybe appropriate, depending on the factsand circumstances.

For the separate nancial statements ofthe subsidiary, equity or liability classi ca -tion is determined based on the nature ofthe obligation each entity has in settlingthe awards, even if the award is settled inparent equity.

The accounting for a group cash-settledshare-based payment transaction inthe separate nancial statements of theentity receiving the related goods orservices when that entity has no obliga-tion to settle the transaction would be asan equity-settled share-based payment.

The group entity settling the transac-tion would account for the share-basedpayment as cash-settled.

The accounting for a group equity-settledshare-based payment transaction isdependent on which entity has the obliga-tion to settle the award.



47


PwC

Impact US GAAP IFRS

Group share-based paymenttransactions (continued)

For the entity that settles the obligation,a requirement to deliver anything otherthan its own equity instruments (equityinstruments of a subsidiary would be“own equity”) would result in cash-settled(liability) treatment. Therefore, a subsid -iary that is obligated to issue its parent’sequity would treat the arrangement as aliability, even though in the consolidated

nancial statements the arrangement would be accounted for as an equity-settled share-based payment. Conversely,if the parent is obligated to issue theshares directly to employees of the subsid-iary, then the arrangement should beaccounted for as equity-settled in both theconsolidated nancial statements and theseparate standalone nancial statementsof the subsidiary.

Hence, measurement could vary betweenthe two sets of accounts.


IFRS IFRS 2, IFRIC 8, IFRIC 11

US GAAP ASC 480, ASC 505–50, ASC 718, ASC 815–40, SAB Topic 14–D

Note




48 PwC



IFRS—Annual Improvements to IFRSs 2010-2012 Cycle

In May 2012, the IASB released an exposure draft that proposes amendments to IFRS as part of its Annual Improvements project.The IASB will consider comments received by September 5, 2012, and nalize amendments with an effective date of January 1,2014. The board proposed to clarify the de nition of “vesting conditions” by separately de ning a “performance condition” and a“service condition” in IFRS 2. The amended de nitions of service and performance conditions include the concept that the counter -party must complete a speci ed period of service to earn the award and make clear that a performance target may relate either tothe performance of the entity as a whole or to some part of the entity, such as a division or an individual employee. Consequently,conditions that do not relate to the performance of the entity or do not require service for at least the period during which theperformance target is being measured would be nonvesting conditions. As described above, nonvesting conditions are taken into

account when determining the grant date fair value of the award.US GAAP does not include the concept of nonvesting conditions. As described above, certain conditions may requireliability classi cation.

IFRS IC current agenda

The Interpretations Committee is considering the appropriate classi cation for awards when an entity withholds a portion of ashare-based payment in return for settling the counterparty‘s tax obligation associated with it. The question is whether the portionof the share-based payment that is withheld should be classi ed as cash-settled or equity-settled, if the entire award would other - wise be classi ed as equity-settled without the net settlement feature.

As a result of the discussions, the Interpretations Committee recommended to the IASB that it should amend IFRS 2 in a narrow-scope amendment project by adding speci c guidance that addresses limited types of share-based payment transactions with anet settlement feature. The guidance would be to clarify that a share-based payment transaction in which the entity settles theshare-based payment arrangement by withholding a speci ed portion of the equity instruments to meet its minimum statutory tax withholding requirements would be classi ed as equity-settled in its entirety, if the entire award would otherwise be classi ed asequity-settled without the net settlement feature. If the narrow-scope amendment is adopted, we believe the difference betweenUS GAAP and IFRS would be mitigated.

The IFRS IC also recently considered whether IFRS 2 lacks guidance to address a modi cation of a share-based payment transactionthat changes its classi cation from cash-settled to equity-settled. As a result, the IFRS IC recommended to the IASB that it shouldamend IFRS 2 in a narrow scope amendment project in a manner consistent with the following:

a. The cancellation of a cash-settled award followed by a replacement equity-settled award should be viewed as a modi cation ofthe share-based award;

b. The new equity-settled award should be measured by reference to the modi cation-date fair value of the equity-settled award,because the modi cation-date should be viewed as the grant date of the new award;

c. The liability recorded for the original cash-settled award should be derecognised upon the modi cation and the equity-settledreplacement award should be recognised to the extent that service has been rendered up to the modi cation date;

d. The unrecognised portion of the modi cation-date fair value of the new equity-settled award should be recognised as compensa -tion expense over the remaining vesting period as the services are rendered; and

e. The difference between the carrying amount of the liability and the amount recognized in equity as of the modi cation dateshould be recorded in pro t or loss immediately in order to show that the liability has been remeasured to its fair value at thesettlement date.



49PwC


If the narrow-scope amendment is adopted, we believe US GAAP and IFRS accounting will be consistent for these typesof modi cations.

Additionally, the IFRS IC is exploring approaches to provide guidance for the classi cation of share-based transactions in whichthe manner of settlement (i.e., cash vs. shares) is contingent on a future event that is outside the control of both the entity and thecounterparty. The Committee will discuss in a future meeting whether guidance can be developed for such a share-based paymenttransaction based on additional analysis.

EITF current agenda

The EITF is considering whether a performance target that is allowed to be met after the requisite service has been provided bythe employee is a vesting condition or a condition that affects the grant-date fair value of the award. Some entities treat such aperformance target as a performance condition and recognize compensation expense only if the performance target is probable of

being achieved, while others treat it as a non-vesting condition that affects the grant-date fair value of the award. These differentapproaches can lead to signi cant differences in the timing and amount of compensation expense recognized. The EITF directed theFASB staff to perform additional analyses and targeted outreach with users. Deliberations will continue at a future EITF meeting.



50 PwC


Expense recognition—employee bene ts

There are a number of signi cant differences between US GAAP and IFRS in the area of accounting for pension and other postretire -ment and postemployment bene ts. Some differences will result in less earnings volatility, while others will result in greater earnings volatility. The net effect depends on the individual facts and circumstances for a given company. Further differences could have asigni cant impact on presentation, operating metrics, and key ratios. Note that the FASB and the IASB use the term postemploymentdifferently. The IASB uses the term postemployment to include pension, postretirement, and other postemployment bene ts, whereasthe FASB uses the term postretirement (OPEB) to include postretirement bene ts, other than pensions and other postemploymentbene ts, and the term postemployment bene ts to include bene ts before retirement.

A selection of differences is summarized below.Under IFRS, gains/losses are recognized immediately in other comprehensive income (OCI) and are not subsequently recycled throughthe income statement. Under IFRS, the amounts do not remain in an accumulated other comprehensive income balance as done underUS GAAP; instead they can be recognised in a speci c reserve, ‘other’ reserves or retained earnings. US GAAP provides a policy choicebetween either (1) immediate recognition within the income statement or (2) delayed recognition through the use of the corridorapproach. Neither of the US GAAP options exist under the IFRS model.

Companies are required to present the full-funded status of their postemployment bene t plans on the balance sheet under bothUS GAAP and IFRS. For income statement purposes, US GAAP permits the use of a calculated asset value (to spread market movementsover periods of up to ve years) in the determination of expected returns on plan assets, while IFRS prohibits the use of a calculated value and requires that the actual fair value of plan assets at each measurement date be used in the determination of net interest cost.

In addition, US GAAP requires an independent calculation of interest cost (based on the application of a discount rate to the projectedbene t obligation) and expected return on assets (based on the application of an expected rate of return on assets to the calculatedasset value), while IFRS applies the discount rate to the net bene t obligation to calculate a single net interest cost or income.

Under IFRS, there is no requirement to present the various components of pension cost as a net amount. As such, companies haveexibility to present components of net pension cost within different line items on the income statement. Components recognized

in determining net income (i.e., service and nance costs, but not actuarial gains and losses) may be presented as (1) a single netamount (similar to US GAAP) or (2) those components may be separately displayed. Differences between US GAAP and IFRS also canresult in different classi cations of a plan as a de ned bene t or a de ned contribution plan. It is possible that a bene t arrangementthat is classi ed as a de ned bene t plan under US GAAP may be classi ed as a de ned contribution plan under IFRS and vice versa.Classi cation differences would result in changes to the expense recognition model as well as to the balance sheet presentation.

Under IFRS, all prior service costs (positive or negative) are recognized in pro t or loss when the employee bene t plan is amended

and are not allowed to be spread over any future service period, which may create volatility in pro t or loss. Prior service cost arises when the terms of a de ned bene t plan are amended to provide additional bene ts (or, in the case of negative prior service costs, toreduce previous bene ts) for service the employee has already delivered. This is different from US GAAP, under which prior servicecost is recognized in OCI at the date the plan amendment is adopted and then amortized into income over the participants’ remaining years of service, service to full eligibility date, or life expectancy.

The current IFRS standard, IAS 19, Employee Bene ts , became effective for annual periods beginning on or af ter January 1, 2013.




52 PwC


Impact US GAAP IFRS

Expense recognition—prior service costs and credits

IFRS accelerates expense/credit recog-nition in income for the effects of planamendments that create an increase(or decrease) to the bene t obligation(i.e., prior service cost).

The IFRS requirements are signi cantlydifferent from US GAAP, which requires

prior service costs, including costs relatedto vested bene ts, to be initially recog -nized in OCI and then amortized throughnet income.

Prior service cost (whether for vested orunvested bene ts) should be recognizedin other comprehensive income at thedate of the adoption of the plan amend-ment and then amortized into incomeover one of the following:

• The participant’s remaining years

of service (for pension plans except where all or almost all plan partici-pants are inactive)

• The participant’s service to fulleligibility date (for other postretire-ment bene t plans except where allor almost all plan participants areinactive)

• The participant’s life expectancy (forplans that have all or almost all inac-tive employees)

Negative prior service cost should be

recognized as a prior service credit toother comprehensive income and used

rst to reduce any remaining positiveprior service cost included in accumu-lated other comprehensive income. Anyremaining prior service credits shouldthen be amortized over the remainingservice period of the active employeesunless all or almost all plan participantsare inactive, in which case the amortiza-tion period would be the plan partici-pants’ life expectancies.

Recognition of all past service costs isrequired in the period of a plan amend-ment. Unvested past service cost cannotbe spread over a future service period.Curtailments that reduce bene tsare no longer disclosed separately,but are considered as part of the pastservice costs.



53

Expense recognition—employee benets

PwC

Impact US GAAP IFRS

Expected return on plan assets

Under IFRS, companies are not permittedto use a calculated value of plan assets(re ecting changes in fair value over aperiod up to ve years) in the determina -tion of expected return on plan assets andin the related accounting for asset gainsand losses.

In addition, US GAAP currently uses an

expected return on plan assets and aseparate discount rate on the liability tocompute interest cost, while IFRS usesthe discount rate to calculate a single netinterest cost or income.

Plan assets should be measured at fair value for balance sheet recognition and fordisclosure purposes. However, for purposesof determining the expected return onplan assets and the related accounting forasset gains and losses, plan assets can bemeasured by using either fair value or acalculated value that recognizes changesin fair value over a period of not more than

ve years.

Plan assets should always be measured atfair value.

Net interest expense or income is calcu-lated by applying the discount rate (asdescribed below) to the de ned bene tasset or liability of the plan. The de nedbene t asset or liability is the surplus orde cit (i.e., the net amount of the de ned

bene t obligation less plan assets) whichis recognized on the balance sheet afterconsidering the asset ceiling test.

Expense recognition—measurement frequency

IFRS requires interim remeasurements inmore circumstances than US GAAP.

The measurement of plan assets andbene t obligations is required as of theentity’s scal year-end balance sheetdate, unless the plan is sponsored by aconsolidated subsidiary or equity methodinvestee with a different scal period.Interim remeasurements generally occuronly if there is a plan amendment, curtail-ment, or settlement.

Entities typically remeasure the bene tobligation and plan assets at each interimperiod to determine the OCI component,but that will not lead to a change inservice cost or interest cost (unless there was a plan amendment, curtailment,or settlement).



54 PwC


Impact US GAAP IFRS

Substantive commitmentto provide pension or otherpostretirement benets

Differences in the manner in which asubstantive commitment to increasefuture pension or other postretirementbene ts is determined may result in anincreased bene t obligation under IFRS.

The determination of whether a substan-tive commitment exists to provide pensionbene ts beyond the written terms of agiven plan’s formula requires carefulconsideration. Although actions takenby an employer can demonstrate theexistence of a substantive commitment,a history of retroactive plan amendmentsis not suf cient on its own. However, inpostretirement bene t plans other thanpensions, the substantive plan shouldbe the basis for determining the obliga-tion. This may consider a company’s pastpractice or communication of intendedchanges, for example in the area of settingcaps on cost-sharing levels.

In certain circumstances, a history ofregular increases may indicate:

• A present commitment to make futureplan amendments, and

• That additional bene ts will accrue toprior service periods.

In such cases, a constructive obligation(to increase bene ts) is the basis for deter -mining the obligation.

Dened benet versus denedcontribution plan classication

Certain plans currently accounted foras de ned bene t plans under US GAAPmay be accounted for as de ned contri -bution plans under IFRS and vice versa.Classi cation differences would result inchanges to the expense recognition modelas well as to balance sheet presentation.

A de ned contribution plan is anyarrangement that provides bene ts inreturn for services rendered, establishesan individual account for each partici-pant, and is based on contributions by theemployer or employee to the individual’saccount and the related investmentexperience.

Multiemployer plans are treated simi-larly to de ned contribution plans. Apension plan to which two or moreunrelated employers contribute is

generally considered to be a multiem-ployer plan. A common characteristicof a multiemployer plan is that there iscommingling of assets contributed by theparticipating employers.

An arrangement quali es as a de nedcontribution plan if a company’s legalor constructive obligation is limited tothe amount it contributes to a separateentity (generally, a fund or an insurancecompany). There is no requirement forindividual participant accounts.

For multiemployer plans, the accountingtreatment used is based on the substanceof the terms of the plan. If the plan isa de ned bene t plan in substance, itshould be accounted for as such, and

the participating employer shouldrecord its proportionate share of allrelevant amounts in the plan. However,de ned bene t accounting may not berequired if the company cannot obtainsuf cient information.



55


PwC

Impact US GAAP IFRS

Curtailments

A number of differences exist in relationto how curtailments are de ned, howboth curtailment gains and losses arecalculated, and when such gains shouldbe recorded. Losses are typically recordedin the same period.

When a curtailment is caused by a planamendment (e.g., a plan freeze), the

timing of recognizing a gain or loss is thesame under US GAAP or IFRS.

There are additional differences in thetiming of the recognition of gains or lossesrelated to plan amendments, curtail-ments, and termination bene ts thatoccur in connection with a restructuring.

A curtailment is de ned as an event thatsigni cantly reduces the expected yearsof future service of present employeesor eliminates for a signi cant number ofemployees the accrual of de ned bene tsfor some or all of their future service.

Curtailment gains are recognized whenrealized (i.e., once the terminations

have occurred or the plan amendmentis adopted).

The guidance permits certain offsetsof unamortized gains/losses but doesnot permit pro rata recognition of theremaining unamortized gains/losses ina curtailment.

The de nition of a curtailment alsocaptures situations in which currentemployees will qualify only for signi -cantly reduced (not necessarily elimi-nated) bene ts.

Curtailment gains should be recorded when the company is demonstrablycommitted to making a material reduc-

tion (as opposed to once the terminationshave occurred).

IFRS requires the gain or loss related toplan amendments, curtailments, andtermination bene ts that occur in connec -tion with a restructuring to be recognized when the related restructuring cost isrecognized, if that is earlier than thenormal IAS 19 recognition date.

Settlements

Fewer settlements may be recog-

nized under US GAAP (because of anaccounting policy choice that is availableunder US GAAP but not IFRS).

Different de nitions of partial settlementsmay lead to more settlements being recog-nized under IFRS.

Varying settlement calculation method -ologies can result in differing amountsbeing recognized in income and othercomprehensive income.

A settlement gain or loss normally is

recognized in earnings when the settle-ment occurs. However, an employermay elect an accounting policy wherebysettlement gain or loss recognition isnot required if the cost of all settlements within a plan year does not exceed thesum of the service cost and interest costcomponents of net periodic pension costfor that period.

A partial settlement does not occur ifa portion of the obligation for vestedbene ts to all plan participants is satis -

ed and the employer remains liablefor the balance of the participants’ vested bene ts.

Settlement accounting requires complexcalculations unique to US GAAP to deter -mine how much is recognized in currentperiod earnings as compared to othercomprehensive income.

A settlement gain or loss is recognized

when the settlement occurs. If the settle -ments are due to lump sum elections byemployees as part of the normal oper-ating procedures of the plan, settlementaccounting does not apply.

A partial settlement occurs if a transactioneliminates all further legal or construc-tive obligations for part of the bene tsprovided under a de ned bene t plan.

Settlement accounting requires complexcalculations unique to IFRS to determinehow much is recognized in current periodearnings as compared to other compre-hensive income.



56 PwC


Impact US GAAP IFRS

Asset ceiling

Under IFRS, there is a limitation on the value of the net pension asset that can berecorded on the balance sheet. Territory-speci c regulations may determine limitson refunds or reductions in future contri-butions and impact the asset ceiling test.

There is no limitation on the size of thenet pension asset that can be recorded onthe balance sheet.

An asset ceiling test limits the amount ofthe net pension asset that can be recog-nized to the lower of (1) the amount ofthe net pension asset or (2) the present value of any economic bene ts avail -able in the form of refunds or reduc-tions in future contributions to the plan.IFRIC 14 clari es that prepayments arerequired to be recognized as assets incertain circumstances.

The guidance also governs the treatmentand disclosure of amounts, if any, inexcess of the asset ceiling. In addition, thelimitation on the asset often will create anadditional liability because contributionsmay be required that would lead to orincrease an irrecoverable surplus.



57


PwC

Impact US GAAP IFRS

Measurement of denedbenet obligation when bothemployers and employeescontribute

Under IFRS guidance, the accounting forplans where an employer’s exposure maybe limited by employee contributions maydiffer under the two frameworks. Thebene t obligation may be smaller under

IFRS than US GAAP.

The measurement of plan obligations doesnot re ect a reduction when the employer’sexposure is limited or where the employercan increase contributions from employeesto help meet a de cit.

Contributions are recorded as a reduc-tion in the bene t obligation only when received.

The measurement of plan obligations where risks associated with the bene t areshared between employers and employeesshould re ect the substance of thearrangements where the employer’s expo -

sure is limited or where the employer canincrease contributions from employees tohelp meet a de cit.

For example, entities where the employ-er’s risk is limited or when employeeshave to pay further future contributionsto cover a de cit will re ect this in themeasurement of the plan obligation. Inaddition, the timing of recognition ofemployee contributions may need to beattributed over the period of service as anegative bene t accrual, in the same wayas a bene t accrual.

See recent/proposed guidance sectionbelow for further discussion on an amend-ment to the standard that is being consid-ered to clarify the current wording



58 PwC


Impact US GAAP IFRS

Deferred compensationarrangements—employmentbenets

The accounting for these arrangements, which include individual senior executiveemployment arrangements, varies underthe two frameworks. IFRS provides less

exibility than US GAAP with respect tothe expense attr ibution methodology.

Individual deferred compensationarrangements that are not considered,in the aggregate, to be a “plan” do notfollow the pension accounting stan-dard. Deferred compensation liabilitiesare measured at the present value ofthe bene ts expected to be provided inexchange for an employee’s service todate. If expected bene ts are attributed tomore than an individual year of service,the costs should be accrued in a system-atic and rational manner over the relevant years of service in which the employeeearns the right to the bene t (to the fulleligibility date).

A number of acceptable attributionmodels are used in practice, including thesinking-fund model and the straight-linemodel. Gains and losses are recognizedimmediately in the income statement.

IFRS does not distinguish betweenindividual senior executive employmentarrangements and a “plan” in the way thatUS GAAP does. Whether a postemploy -ment bene t is provided for one employeeor all employees the accounting is thesame under IFRS. Deferred compensa -tion accounting relates to bene ts thatare normally paid while in service butmore than 12 months after the end ofthe accounting period in which theyare earned.

The liability associated with deferredcompensation contracts classi ed asother long-term bene ts under IAS 19 ismeasured by the projected-unit-creditmethod (equivalent to postemployment-de ned bene ts), with the exception thatall prior service costs and gains and lossesare recognized immediately in pro tor loss.



59


PwC

Impact US GAAP IFRS

Plan asset valuation

Although both models are measured atfair value, US GAAP reduces fair value forthe cost to sell and IFRS does not.

Plan assets should be measured at fair value less cost to sell. Under US GAAP,contracts with insurance companies(other than purchases of annuitycontracts) should be accounted for asinvestments and measured at fair value.In some cases, the contract value may bethe best available evidence of fair valueunless the contract has a determinablecash surrender value or conversion value, which would provide better evidence ofthe fair value.

Plan assets should be measured at fair value, which is de ned as the price that would be received to sell an asset or paidto transfer a liability in an orderly transac-tion between market participants at themeasurement date.

Under IFRS, the fair value of insurancepolicies should be estimated using, for

example, a discounted cash ow model with a discount rate that re ects theassociated risk and the expected matu-rity date or expected disposal date of theassets. Qualifying insurance policies thatexactly match the amount and timing ofsome or all of the bene ts payable underthe plan are measured at the present value of the related obligations. UnderIFRS, the use of the cash surrender valueis generally inappropriate.

Discount rates

Differences in the selection criteria fordiscount rates could lead companiesto establish different discount ratesunder IFRS.

The discount rate is based on the rate at which the pension obligation could beeffectively settled. Companies may look tothe rate of return on high-quality, xed-income investments with similar dura-tions to those of the bene t obligation toestablish the discount rate. The SEC hasstated that the term “high quality” meansthat a bond has received one of the twohighest ratings given by a recognizedratings agency (e.g., Aa or higher byMoody’s).

The guidance does not speci cally addresscircumstances in which a deep marketin high-quality corporate bonds does notexist (such as in certain foreign jurisdic-tions). However, in practice, a hypothet -ical high-quality bond yield is determinedbased on a spread added to representativegovernment bond yields.

The discount rate should be determinedby reference to market yields on high-quality corporate bonds in the samecurrency as the bene ts to be paid withdurations that are similar to those of thebene t obligation.

Where a deep market of high-qualitycorporate bonds does not exist, compa-nies are required to look to the yield ongovernment bonds when selecting thediscount rate. A synthetically constructedbond yield designed to mimic a high-quality corporate bond may not be used todetermine the discount rate.



60 PwC


Impact US GAAP IFRS

Accounting for terminationindemnities

US GAAP allows for more optionsin accounting for terminationindemnity programs.

When accounting for termination indemni-ties, there are two acceptable alternatives toaccount for the obligation: (1) full de nedbene t plan accounting or (2) mark-to-market accounting (i.e., basing the liabilityon the amount that the company would payout if the employee left the company as of thebalance sheet date).

De ned bene t accounting is required fortermination indemnities

Accounting for costs

The timing of recognition for taxes relatedto bene t plans differs.

A contribution tax should be recognizedas a component of net periodic pensioncost in the period in which the contribu-tion is made.

Taxes related to bene t plans should beincluded either in the return on assets orthe calculation of the bene t obligation,depending on their nature. For example,taxes payable by the plan on contributionsare included in actuarial assumptions forthe calculation of the bene t obligation.


IFRS IAS 19, IAS 37, IAS 39, IFRIC 14

US GAAP ASC 710, ASC 712, ASC 715, ASC 820, ASC 835–30

Note




61


PwC


IFRS IC current agenda

The IFRS IC is currently reconsidering the accounting for employee bene t plans with a promised return on contributions ornotional contributions. The Committee has previously considered this issue in 2002-2006. In 2004 it published IFRIC DraftInterpretation D9. In November 2006 it decided to refer the issue to the Board to be included in the Board’s project on post-employment bene ts. Although the Board initially intended to address contribution-based promises in its project, it later decided todefer this work to a future broader project on employee bene ts. In the light of the Board’s decision not to address the accountingfor contribution-based promises at present and the ongoing concerns about how to account for such pension arrangements, theCommittee decided to revisit the issues. Accordingly, the Committee started its discussions in July 2012 and those have continuedthrough the date of publication.

In March 2013, the IASB issued an Exposure Draft with proposed amendments to IAS 19 for the accounting for contributions fromemployees or third parties when the requirements for such contributions are set out in the formal terms of a de ned bene t plan. Itproposes that such contribution may be recognized as a reduction in the service cost in the same period in which they are payableif, and only if, they are linked solely to the employee’s service rendered in that period. An example would be contributions that area xed percentage of an employee’s salary, so the percentage of the employee’s salary does not depend on the employee’s number of years of service to the employer. Comments on the Exposure Draft were due by July 25, 2013.

US Patient Protection and Affordable Care Act

The 2010 Patient Protection and Affordable Care Act (PPACA) and the Health Care and Education Reconciliation Act of 2010(HCERA) include provisions that will impact companies that provide retiree health care bene ts through postretirementbene t plans. Although many of these provisions do not take effect for a number of years, they affect the current measurementof the bene t obligations because the impact of presently enacted law changes must be re ected in the estimate of the future

bene t levels.Many aspects of the legislation remain unclear and may be revisited by Congress. Further guidance is expected as clarifying regula -tions are issued. Until then, companies should continue to make their best estimate of what the future impact will be (based onenacted laws) when measuring their year-end obligations.

At the end of June 2012, the US Supreme Court upheld the constitutionality of the PPACA, with the exception of a narrow rulingregarding federal funding of state Medicaid programs. As such, employers should continue to re ect the anticipated effects of the Acts in their measurement of OPEB obligations. One example of an implication of the PPACA that will create an accounting differ -ence is the changes to the tax treatment of federal subsidies paid to sponsors of retiree healthcare plans that provide a bene t that isat least actuarially equivalent to the bene ts under Medicare Part D. As a result of the PPACA, these subsidy payments will becometaxable effective in tax years beginning after December 31, 2012. The impact of the change in tax law will be treated differentlyunder US GAAP and IFRS. US GAAP requires the impact of the change in tax law to be recognized immediately in continuing opera -tions in the income statement in the period that includes the enactment date. IFRS requires the change in deferred tax balances

to be allocated to the account(s) where the original pre-tax transaction or event was initially recorded (sometimes referred to as“backwards tracing”). US GAAP prohibits backwards tracing. See the Liabilities—taxes chapter for further discussion on the differ -ences in accounting for subsequent changes to deferred taxes.



Assets



64 PwC


Assets—non nancial assets

The guidance under US GAAP and IFRS as it relates to non nancial assets (e.g., intangibles; property, plant, and equipment, includingleased assets; inventory; and investment property) contains some signi cant differences with potentially far-reaching implications.

As it relates to the fundamental carrying basis of non nancial assets, IFRS permits the revaluation of certain non nancial assets to fair value, whereas US GAAP generally does not.

Differences in testing for the potential impairment of long-lived assets held for use might lead to earlier impairment recognition underIFRS. IFRS requires the use of entity-speci c discounted cash ows or a fair value measure in tests for the recoverability of an asset.By comparison, US GAAP uses a two-step model that begins with entity-speci c undiscounted cash ows. These fundamental distinc -

tions between the impairment models can make a difference in whether an asset is impaired. Additional differences exist, such as whatquali es as an impairment indicator or how recoveries in previously impaired assets are treated.

The recognition and measurement of intangible assets could differ signi cantly under IFRS. With limited exceptions, US GAAPprohibits the capitalization of development costs, whereas development costs under IFRS are capitalized if certain criteria are met.Even where US GAAP allows for the capitalization of development costs (e.g., software development costs), differences exist. In thearea of software development costs, US GAAP provides different guidance depending on whether the software is for internal use or forsale. The principles surrounding capitalization under IFRS, by comparison, are the same whether the internally generated intangible isbeing developed for internal use or for sale.

The level at which inde nite-lived intangible assets are tested for impairment might vary signi cantly between the two frameworks.When identifying a unit of account under US GAAP, inde nite-lived intangible assets shall be grouped only with other inde nite-livedintangible assets; those assets may not be tested in combination with goodwill or with a nite-lived asset. Under IFRS, the impairmenttest likely will be performed at the cash-generating unit (CGU) level or a group of CGUs that are bene ted by the inde nite-livedintangible asset.

In the area of inventory, IFRS prohibits the use of the last in, rst out (LIFO) costing methodology, which is an allowable option underUS GAAP. As a result, a company that adopts IFRS and utilizes the LIFO method under US GAAP would have to move to an allowablecosting methodology, such as rst in, rst out (FIFO) or weighted-average cost. For US-based operations, differences in costing meth -odologies could have a signi cant impact on reported operating results as well as on current income taxes payable, given the InternalRevenue Service (IRS) book/tax LIFO conformity rules.

IFRS provides criteria for lease classi cation that are similar to US GAAP criteria. However, the IFRS criteria do not override the basicprinciple that classi cation is based on whether the lease transfers substantially all of the r isks and rewards of ownership to the lessee.This could result in varying lease classi cations for similar leases under the two frameworks. Other key differences involve areas suchas sale-leaseback accounting, leveraged leases, and real estate transactions.

As further discussed in the Recent/proposed guidance section, the FASB and IASB are carrying out a joint project on leases and havere-exposed the proposals in May 2013. The proposed changes are expected to impact almost all entities and would signi cantly changelease accounting.

Spin-off transactions can result in signi cantly different income statement implications under the two frameworks. US GAAP accountsfor spin-off transactions based on the carrying value of the nonmonetary assets, with the distributions recorded against owner’s equityand no gain/loss recorded in income (assuming that the assets were not impaired prior to the spin-off transaction). IFRS requires thatdividends payable be recorded at the fair value of the nonmonetary assets to be distributed. Upon settlement, the difference betweenthe carrying value of the dividend payable and the carrying amount of the nonmonetary assets, if any, is recorded in the incomestatement.




65

Assets—nonnancial assets

PwC

Impact US GAAP IFRS

General

Impairment of long-lived assetsheld for use

The IFRS-based impairment model mightlead to the recognition of impairments oflong-lived assets held for use earlier than would be required under US GAAP.

There are also differences related to such

matters as what quali es as an impair -ment indicator and how recoveries inpreviously impaired assets get treated.

US GAAP requires a two-step impairmenttest and measurement model as follows:

Step 1— The carrying amount is rstcompared with the undiscounted cash

ows. If the carrying amount is lower

than the undiscounted cash ows, noimpairment loss is recognized, although itmight be necessary to review depreciation(or amortization) estimates and methodsfor the related asset.

Step 2— If the carrying amount is higherthan the undiscounted cash ows, animpairment loss is measured as the differ-ence between the carrying amount andfair value. Fair value is de ned as theprice that would be received to sell anasset in an orderly transaction betweenmarket participants at the measurementdate (an exit price). Fair value shouldbe based on the assumptions of marketparticipants and not those of the reportingentity.

IFRS uses a one-step impairment test. Thecarrying amount of an asset is compared with the recoverable amount. The recov -erable amount is the higher of (1) theasset’s fair value less costs of disposal or(2) the asset’s value in use.

In practice, individual assets do notusually meet the de nition of a CGU. As aresult, assets are rarely tested for impair-ment individually but are tested within agroup of assets.

Fair value less costs of disposal representsthe amount obtainable from the sale of anasset or CGU in an arm’s-length transac -tion between knowledgeable, willingparties less the costs of disposal. TheIFRS reference to knowledgeable, willingparties is generally viewed as beingconsistent with the market participantassumptions noted under US GAAP.

IFRS does not contain guidance about which market should be used as a basis formeasuring fair value when more than onemarket exists.

Value in use represents entity-speci cor CGU-speci c future pretax cash owsdiscounted to present value by usinga pretax, market-determined rate thatre ects the current assessment of the time

value of money and the risks speci c tothe asset or CGU for which the cash owestimates have not been adjusted.

Changes in market interest rates are notconsidered impairment indicators.

Changes in market interest rates canpotentially trigger impairment and,hence, are impairment indicators.



66 PwC


Impact US GAAP IFRS

Impairment of long-lived assets held foruse (continued)

The reversal of impairments is prohibited.

Determining the appropriate market— A reporting entity is required to identifyand evaluate the markets into which anasset may be sold or a liability transferred.In establishing fair value, a reportingentity must determine whether there isa principal market or, in its absence, amost advantageous market. However, inmeasuring the fair value of non nancial

assets and liabilities, in many cases, there will not be observable data or a referencemarket. As a result, management will haveto develop a hypothetical market for theasset or liability.

Application of valuation techniques—The calculation of fair value no longer will default to a present value technique. Although present value techniques mightbe appropriate, the reporting entity mustconsider all appropriate valuation tech-niques in the circumstances.

If the asset is recoverable based onundiscounted cash ows, the discountingor fair value type determinations arenot applicable.

If certain criteria are met, the reversal ofimpairments, other than those of goodwill, is permitted.

For noncurrent, non nancial assets(excluding investment properties andbiological assets) carried at fair valueinstead of depreciated cost, impairmentlosses related to the revaluation arerecorded in other comprehensive incometo the extent of prior upward revalu-

ations, with any further losses beingre ected in the income statement.

Cash ow estimates

As noted above, impairment testing underUS GAAP starts with undiscounted cash

ows, whereas the starting point underIFRS is discounted cash ows. Aside fromthat difference, IFRS is more prescrip-tive with respect to how the cash ows

themselves are identi ed for purposes ofcalculating value in use.

Future cash ow estimates used in animpairment analysis should include:

• All cash in ows expected from the useof the long-lived asset (asset group)over its remaining useful life, based onits existing service potential

• Any cash out ows necessary toobtain those cash in ows, includingfuture expenditures to maintain (butnot improve) the long-lived asset(asset group)

• Cash ows associated with the even -tual disposition, including selling costs,of the long-lived asset (asset group)

Cash ow estimates used to calculate value in use under IFRS should include:

• Cash in ows from the continuing useof the asset or the activities of the CGU

• Cash out ows necessarily incurredto generate the cash in ows fromcontinuing use of the asset or CGU(including cash out ows to preparethe asset for use) and that are directlyattributable to the asset or CGU

• Cash out ows that are indirectlyattributable (such as those relating tocentral overheads) but that can be allo-cated on a reasonable and consistentbasis to the asset or CGU



67


PwC

Impact US GAAP IFRS

Cash ow estimates (continued) US GAAP speci es that the remaininguseful life of a group of assets over whichcash ows may be considered should bebased on the remaining useful life of the“primary” asset of the group.

Cash ows are from the perspective of theentity itself. Expected future cash owsshould represent management’s best esti -mate and should be based on reasonableand supportable assumptions consistent

with other assumptions made in thepreparation of the nancial statementsand other information used by the entityfor comparable periods.

• Cash ows expected to be received (orpaid) for the disposal of assets or CGUsat the end of their useful lives

• Cash out ows to maintain the oper -ating capacity of existing assets,including, for example, cash ows forday-to-day servicing

Cash ow projections used to measure value in use should be based on reason-able and supportable assumptions ofeconomic conditions that will exist overthe asset’s remaining useful life. Cash

ows expected to arise from futurerestructurings or from improving orenhancing the asset’s performance shouldbe excluded.

Cash ows are from the perspective of theentity itself. Projections based on manage -ment’s budgets/forecasts shall cover amaximum period of ve years, unless alonger period can be justi ed. Estimatesof cash ow projections beyond the period

covered by the most recent budgets/fore-casts should extrapolate the projectionsbased on the budgets/forecasts using asteady or declining growth rate for subse-quent years, unless an increasing rate canbe justi ed. This growth rate shall notexceed the long-term average growth ratefor the products, industries, or countryin which the entity operates, or for themarket in which the asset is used unless ahigher rate can be justi ed.



68 PwC


Impact US GAAP IFRS

Asset groupings

Determination of asset groupings is amatter of judgment and could result indifferences between IFRS and US GAAP.

For purposes of recognition and measure-ment of an impairment loss, a long-livedasset or asset group should represent thelowest level for which an entity can sepa-rately identify cash ows that are largelyindependent of the cash ows of otherassets and liabilities.

In limited circumstances, a long-lived

asset (e.g., corporate asset) might nothave identi able cash ows that arelargely independent of the cash ows ofother assets and liabilities and of otherasset groups. In those circumstances,the asset group for that long-lived assetshall include all assets and liabilities ofthe entity.

A CGU is the smallest identi able group ofassets that generates cash in ows that arelargely independent of the cash in owsfrom other assets or groups of assets.It can be a single asset. Identi cationof an entity’s CGUs involves judgment.If an active market (as de ned by IFRS13) exists for the output produced byan asset or group of assets, that assetor group should be identi ed as a CGU,even if some or all of the output isused internally.

Carrying basis

The ability to revalue assets (to fairmarket value) under IFRS mightcreate signi cant differences in thecarrying value of assets as compared with US GAAP.

US GAAP generally utilizes historicalcost and prohibits revaluations exceptfor certain categories of nancial instru -ments, which are carried at fair value.

Historical cost is the primary basis ofaccounting. However, IFRS permits therevaluation to fair value of some intan-gible assets; property, plant, and equip-ment; and investment propertyand inventories in certain industries(e.g., commodity broker/dealer).

IFRS also requires that biological assets bereported at fair value.



69


PwC

Impact US GAAP IFRS

Intangible assets

Internally developed intangibles

US GAAP prohibits, with limited excep -tions, the capitalization of developmentcosts. Development costs are capitalizedunder IFRS if certain criteria are met.

Further differences might exist in suchareas as software development costs, where US GAAP provides speci c detailedguidance depending on whether thesoftware is for internal use or for sale.The principles surrounding capitalizationunder IFRS, by comparison, are the same, whether the internally generated intan-gible is being developed for internal useor for sale.

In general, both research costs and devel-opment costs are expensed as incurred,making the recognition of internallygenerated intangible assets rare.

However, separate, speci c rules applyin certain areas. For example, there isdistinct guidance governing the treatmentof costs associated with the develop-ment of software for sale to third parties.Separate guidance governs the treatmentof costs associated with the developmentof software for internal use.

The guidance for the two types of software varies in a number of signi cant ways. There are, for example, differentthresholds for when capitalizationcommences, and there are also differentparameters for what types of costs arepermitted to be capitalized.

Costs associated with the creation ofintangible assets are classi ed intoresearch phase costs and developmentphase costs. Costs in the research phaseare always expensed. Costs in the devel -opment phase are capitalized, if all of thefollowing six criteria are demonstrated:

• The technical feasibility of completingthe intangible asset

• The intention to complete the intan-gible asset

• The ability to use or sell theintangible asset

• How the intangible asset will generateprobable future economic bene ts (theentity should demonstrate the exis-tence of a market or, if for internal use,the usefulness of the intangible asset)

• The availability of adequate resourcesto complete the development and touse or sell it

• The ability to measure reliably theexpenditure attributable to the intan-gible asset during its development

Expenditures on internally generatedbrands, mastheads, publishing titles,customer lists, and items similar insubstance cannot be distinguished fromthe cost of developing the business asa whole. Therefore, such items are notrecognized as intangible assets.

Development costs initially recognized asexpenses cannot be capitalized in a subse-quent period.



70 PwC


Impact US GAAP IFRS

Indenite-lived intangibleassets—level of assessment forimpairment testing

Under US GAAP, the assessment isperformed at the asset level. Under IFRS,the assessment may be performed at ahigher level (i.e., the CGU level). The varying assessment levels can result indifferent conclusions as to whether animpairment exists.

Separately recorded inde nite-lived intan -gible assets, whether acquired or inter-nally developed, shall be combined into asingle unit of accounting for purposes oftesting impairment if they are operated asa single asset and, as such, are essentiallyinseparable from one another.

Inde nite-lived intangible assets may becombined only with other inde nite-livedintangible assets; they may not be testedin combination with goodwill or with a

nite-lived asset.

US GAAP literature provides a number ofindicators that an entity should considerin making a determination of whether tocombine intangible assets.

As most inde nite-lived intangible assets(e.g., brand name) do not generate cash

ows independently of other assets,it might not be possible to calculatethe value in use for such an asset on astandalone basis. Therefore, it is neces -sary to determine the smallest identi ablegroup of assets that generate cash in owsthat are largely independent of the cashin ows from other assets or groups ofassets, (known as a CGU), in order toperform the test.



71


PwC

Impact US GAAP IFRS

Indenite-lived intangibleassets—impairment testing

Under US GAAP, an entity can choose torst assess qualitative factors in deter -

mining if further impairment testing isnecessary. This option does not existUnder IFRS.

ASC 350, Intangibles-Goodwill and other ,requires an inde nite-lived intangibleasset to be tested for impairment annually,or more frequently if events or changesin circumstances indicate that the assetmight be impaired.

An entity may rst assess qualitative

factors to determine if a quantitativeimpairment test is necessary. Furthertesting is only required if the entitydetermines, based on the qualitativeassessment, that it is more likely than notthat a inde nite-lived intangible asset’sfair value is less than its carrying amount.Otherwise, no further impairment testingis required.

An entity can choose to perform the quali-tative assessment on none, some, or all ofits inde nite lived intangible assets. An

entity can bypass the qualitative assess-ment for any inde nite-lived intangibleasset in any period and proceed directly tothe quantitative impairment test and thenchoose to perform the qualitative assess-ment in any subsequent period.

IAS 36, Impairment of Assets , requires anentity to test an inde nite-lived intangibleasset for impairment annually. It alsorequires an impairment test in betweenannual tests whenever there is an indica-tion of impairment.

IAS 36 allows an entity to carry forward

the most recent detailed calculation ofan asset’s recoverable amount whenperforming its current period impairmenttest, provided that certain criteria are met.

Indenite-lived intangibleassets—impairment chargemeasurement

Even when there is an impairment underboth frameworks, the amount of the

impairment charge may differ.

Impairments of inde nite-lived intangibleassets are measured by comparing fair

value to carrying amount.

Inde nite-lived intangible asset impair -ments are calculated by comparing the

recoverable amount to the carryingamount (see above for determinationof level of assessment). The recoverableamount is the higher of fair value lesscosts of disposal or value in use. The valuein use calculation uses the present valueof future cash ows.



72 PwC


Impact US GAAP IFRS

Impairments of software coststo be sold, leased, or otherwisemarketed

Impairment measurement model andtiming of recognition of impairment aredifferent under US GAAP and IFRS.

When assessing potential impairment,at least at each balance sheet date, theunamortized capitalized costs for eachproduct must be compared with the netrealizable value of the software product.The amount by which the unamortizedcapitalized costs of a software productexceed the net realizable value of thatasset shall be written off. The net realiz -able value is the estimated future grossrevenue from that product reduced by theestimated future costs of completing anddisposing of that product.

The net realizable value calculation doesnot utilize discounted cash ows.

Under IFRS, intangible assets not yetavailable for use are tested annually forimpairment because they are not beingamortized. Once such assets are broughtinto use, amortization commences andthe assets are tested for impairment whenthere is an impairment indicator.

The impairment is calculated bycomparing the recoverable amount (thehigher of either (1) fair value less costsof disposal or (2) value in use) to thecarrying amount. The value in use calcu -lation uses the present value of futurecash ows.

Advertising costs

Under IFRS, advertising costs may need tobe expensed sooner.

The costs of other than direct responseadvertising should be either expensed asincurred or deferred and then expensedthe rst time the advertising takes place.This is an accounting policy decision andshould be applied consistently to similartypes of advertising activities.

Certain direct response advertisingcosts are eligible for capitalization if,among other requirements, probablefuture economic bene ts exist. Directresponse advertising costs that havebeen capitalized are then amortized overthe period of future bene ts (subject toimpairment considerations).

Aside from direct response advertising-related costs, sales materials such asbrochures and catalogs may be accountedfor as prepaid supplies until they nolonger are owned or expected to be used,in which case their cost would be a costof advertising.

Costs of advertising are expensed asincurred. The guidance does not providefor deferrals until the rst time the adver -tising takes place, nor is there an excep-tion related to the capitalization of directresponse advertising costs or programs.

Prepayment for advertising may berecorded as an asset only when paymentfor the goods or services is made inadvance of the entity’s having the right toaccess the goods or receive the services.

The cost of materials, such as salesbrochures and catalogues, is recognized

as an expense when the entity has theright to access those goods.



73


PwC

Impact US GAAP IFRS

Property, plant and equipment

Depreciation

Under IFRS, differences in asset compo-nentization guidance might result in theneed to track and account for property,plant, and equipment at a more disaggre-gated level.

US GAAP generally does not require thecomponent approach for depreciation.

While it would generally be expectedthat the appropriateness of signi cantassumptions within the nancial state -ments would be reassessed each reportingperiod, there is no explicit requirementfor an annual review of residual values.

IFRS requires that separate signi cantcomponents of property, plant, and equip-ment with different economic lives berecorded and depreciated separately.

The guidance includes a requirement toreview residual values and useful lives ateach balance sheet date.

Overhaul costs

US GAAP may result in earlier expenserecognition when portions of a largerasset group are replaced.

US GAAP permits alternative accountingmethods for recognizing the costs of amajor overhaul. Costs representing areplacement of an identi ed componentcan be (1) expensed as incurred,(2) accounted for as a separate compo -nent asset, or (3) deferred and amortizedover the period bene ted by the overhaul.

IFRS requires capitalization of the costs ofa major overhaul representing a replace-ment of an identi ed component.

Consistent with the componentizationmodel, the guidance requires that thecarrying amount of parts or componentsthat are replaced be derecognized.



74 PwC


Impact US GAAP IFRS

Asset retirement obligations

Initial measurement might vary becauseUS GAAP speci es a fair value measureand IFRS does not. IFRS results in greater variability, as obligations in subsequentperiods get adjusted and accreted basedon current market-based discount rates.

Asset retirement obligations (AROs) arerecorded at fair value and are based uponthe legal obligation that arises as a resultof the acquisition, construction, or devel-opment of a long-lived asset.

The use of a credit-adjusted, risk-free rateis required for discounting purposes whenan expected present-value technique is

used for estimating the fair value of theliability.

The guidance also requires an entity tomeasure changes in the liability for an ARO due to passage of time by applyingan interest method of allocation to theamount of the liability at the beginningof the period. The interest rate used formeasuring that change would be thecredit-adjusted, risk-free rate that existed when the liability, or portion thereof, wasinitially measured.

In addition, changes to the undiscountedcash ows are recognized as an increaseor a decrease in both the liability for an ARO and the related asset retirement cost.Upward revisions are discounted by usingthe current credit-adjusted, risk-free rate.Downward revisions are discounted byusing the credit-adjusted, risk-free ratethat existed when the original liability was recognized. If an entity cannotidentify the prior period to which thedownward revision relates, it may use a weighted-average, credit-adjusted, risk-free rate to discount the downward revi-sion to estimated future cash ows.

IFRS requires that management’s bestestimate of the costs of dismantling andremoving the item or restoring the siteon which it is located be recorded whenan obligation exists. The estimate is to bebased on a present obligation (legal orconstructive) that arises as a result of theacquisition, construction, or developmentof a xed asset. If it is not clear whether apresent obligation exists, the entity mayevaluate the evidence under a more-likely-than-not threshold. This thresholdis evaluated in relation to the likelihood ofsettling the obligation.

The guidance uses a pretax discount ratethat re ects current market assessmentsof the time value of money and the risksspeci c to the liability.

Changes in the measurement of anexisting decommissioning, restoration, orsimilar liability that result from changesin the estimated timing or amount ofthe cash out ows or other resources, ora change in the discount rate, adjust thecarrying value of the related asset underthe cost model. Adjustments may resultin an increase of the carrying amount ofan asset beyond its recoverable amount. An impairment loss would result in suchcircumstances. Adjustments may notreduce the carrying amount of an assetto a negative value. Once the carrying value reaches zero, further reductions are

recorded in pro t and loss. The periodicunwinding of the discount is recognizedin pro t or loss as a nance cost asit occurs.



75


PwC

Impact US GAAP IFRS

Borrowing costs

Borrowing costs under IFRS are broaderand can include more components thaninterest costs under US GAAP.

US GAAP allows for more judgment in thedetermination of the capitalization rate, which could lead to differences in theamount of costs capitalized.

IFRS does not permit the capitaliza-tion of borrowing costs in relation toequity-method investments, whereasUS GAAP may allow capitalization incertain circumstances.

Capitalization of interest costs is required while a qualifying asset is being preparedfor its intended use.

The guidance does not require that allborrowings be included in the determi-nation of a weighted-average capitaliza-tion rate. Instead, the requirement is tocapitalize a reasonable measure of cost for

nancing the asset’s acquisition in termsof the interest cost incurred that otherwise could have been avoided.

An investment accounted for by usingthe equity method meets the criteriafor a qualifying asset while the investeehas activities in progress necessary tocommence its planned principal opera-tions, provided that the investee’s activi -ties include the use of funds to acquirequalifying assets for its operations.

Borrowing costs directly attributable tothe acquisition, construction, or produc-tion of a qualifying asset are requiredto be capitalized as part of the cost ofthat asset.

The guidance acknowledges that deter-mining the amount of borrowing costsdirectly attributable to an otherwise

qualifying asset might require professional judgment. Having said that, the guid -ance rst requires the consideration ofany speci c borrowings and then requiresconsideration of all general borrowingsoutstanding during the period.

In broad terms, a qualifying asset is onethat necessarily takes a substantial periodof time to get ready for its intended use orsale. Investments accounted for under theequity method would not meet the criteriafor a qualifying asset.

Leases

Lease scope

IFRS is broader in scope and maybe applied to certain leases ofintangible assets

The guidance for leases applies only toproperty, plant, and equipment.

Although the guidance is restricted totangible assets, entities can analogize tothe lease guidance for leases of software.

Speci cally, ASC 985-20 which addressesthe accounting by lessors for leases ofcomputer equipment and software. ASC

350-40-25-16 speci es that a companyacquiring software under a licensing orleasing agreement should account for thetransaction by analogy to ASC 840.

The scope of IFRS lease guidance is notrestricted to property, plant, and equip-ment. Accordingly, it may be applied morebroadly (for example, to some intangibleassets and inventory).

However, the standard cannot be appliedto leases of biological assets, licensingagreements, or leases to explore for or useminerals, oil, natural gas, and similar non-regenerative resources.



76 PwC


Impact US GAAP IFRS

Lease classication—general

Leases might be classi ed differentlyunder IFRS than under US GAAP.Different classi cation can have aprofound effect on how a lease is re ected within the nancial statements.

The guidance contains four speci ccriteria for determining whether a leaseshould be classi ed as an operating leaseor a capital lease by a lessee. The criteriafor capital lease classi cation broadlyaddress the following matters:

• Ownership transfer of the property tothe lessee

• Bargain purchase option

• Lease term in relation to economic lifeof the asset

• Present value of minimum leasepayments in relation to fair value ofthe leased asset

The criteria contain certain speci cquanti ed thresholds such as whetherthe present value of the minimum leasepayments equals or exceeds 90 percent ofthe fair value of the leased property.

• Events of default must be evaluatedpursuant to ASC 840-10-25-14 to

assess whether remedies payable upondefault are minimum lease paymentsfor purposes of applying the 90% test.

• The guidance indicates that themaximum amount of potentialpayments under all non-performanceevents of default must be included inthe lease classi cation 90 percent testunless each of the following 4 criteriaare met: (i) the covenant is customary,(ii) prede ned criteria relating solelyto the lessee and its operations havebeen established for the determina-tion of the event of default, (iii) theoccurrence of the event of default isobjectively determinable; and (iv)it is reasonable to assume at leaseinception that an event of default willnot occur.

For a lessor to classify a lease as a directnancing or sales-type lease under the

guidance, two additional criteria mustbe met.

The guidance focuses on the overallsubstance of the transaction. Lease classi -

cation as an operating lease or a nancelease (i.e., the equivalent of a capital leaseunder US GAAP) depends on whether thelease transfers substantially all of the risksand rewards of ownership to the lessee.

Although similar lease classi cation

criteria identi ed in US GAAP are consid -ered in the classi cation of a lease underIFRS, there are no quantitative break-points or bright lines to apply(e.g., 90 percent). IFRS also lacks guid -ance similar to ASC 840-10-25-14 withrespect to default remedies.

A lease of special-purpose assets that onlythe lessee can use without major modi -cation generally would be classi ed as a

nance lease. This also would be the casefor any lease that does not subject thelessor to signi cant risk with respect tothe residual value of the leased property.

Importantly, there are no incrementalcriteria for a lessor to consider in clas-sifying a lease under IFRS. Accordingly,lease classi cation by the lessor and thelessee typically should be symmetrical.



77


PwC

Impact US GAAP IFRS

Sale-leaseback arrangements

Differences in the frameworks mightlead to differences in the timing of gainrecognition in sale-leaseback transactions.Where differences exist, IFRS might leadto earlier gain recognition.

The gain on a sale-leaseback transactiongenerally is deferred and amortized overthe lease term. Immediate recognition ofthe full gain is normally appropriate only when the leaseback is minor, as de ned.

If the leaseback is more than minor butless than substantially all of the asset life,a gain is recognized immediately to the

extent that the gain exceeds the present value of the minimum lease payments.

If the lessee provides a residual valueguarantee, the gain corresponding to thegross amount of the guarantee is deferreduntil the end of the lease; such amount isnot amortized during the lease term.

When a sale-leaseback transaction resultsin a capital lease, the gain is amortizedin proportion to the amortization of theleased asset.

There are onerous rules for determining when sale-leaseback accounting isappropriate for transactions involving realestate (including integral equipment). Ifthe rules are not met, the sale leaseback will be accounted for as a nancing. Assuch, the real estate will remain on theseller-lessee’s balance sheet, and thesales proceeds will be re ected as debt.Thereafter, the property will continue todepreciate, and the rent payments will berecharacterized as debt service.

When a sale-leaseback transaction resultsin a lease classi ed as an operating lease,the full gain on the sale normally wouldbe recognized if the sale was executed atthe fair value of the asset. It is not neces -sary for the leaseback to be minor.

If the sale price is below fair value, anypro t or loss should be recognized imme -

diately, except that if there is a loss that iscompensated for by future lease paymentsat below-market rates, the loss should bedeferred and amortized in proportion tothe lease payments over the period for which the asset is expected to be used.If the sale price is above fair value, theexcess over fair value should be deferredand amortized over the period for whichthe asset is expected to be used.

When a sale-leaseback transaction resultsin a nance lease, the gain is amor -tized over the lease term, irrespectiveof whether the lessee will reacquire theleased property.

There are no real estate-speci crules equivalent to the US guidance. Accordingly, almost all sale-leasebacktransactions result in sale-leasebackaccounting. The property sold would beremoved from the balance sheet, and ifthe leaseback is classi ed as an operatinglease, the property would not come backonto the seller-lessee’s balance sheet.



78 PwC


Impact US GAAP IFRS

Leases involving landand buildings

More frequent bifurcation under IFRSmight result in differences in the clas-si cation of and accounting for leasesinvolving land and buildings. In addition,accounting for land leases under IFRSmight result in more frequent recordingsof nance leases.

Land and building elements generally areaccounted for as a single unit, unless theland represents 25 percent or more of thetotal fair value of the leased property.

Land and building elements must beconsidered separately, unless the landelement is not material. This meansthat nearly all leases involving land andbuildings should be bifurcated into twocomponents, with separate classi ca -tion considerations and accounting foreach component.

The lease of the land element shouldbe classi ed based on a considerationof all of the risks and rewards indica-tors that apply to leases of other assets. Accordingly, a land lease would normallybe classi ed as a nance lease if thelease term were long enough to causethe present value of the minimum leasepayments to be at least substantially all ofthe fair value of the land.

In determining whether the land elementis an operating or a nance lease, an

important consideration is that landnormally has an inde nite economic life.

Lease classication—other

The exercise of renewal/extension options within leases might result in a new leaseclassi cation under US GAAP, but notunder IFRS.

Leveraged lease accounting is not avail -able under IFRS, potentially resulting indelayed income recognition and grossbalance sheet presentation.

The renewal or extension of a leasebeyond the original lease term, includingthose based on existing provisions ofthe lease arrangement, normally trig-gers accounting for the arrangement as anew lease.

The lessor can classify leases that wouldotherwise be classi ed as direct- nancingleases as leveraged leases if certainadditional criteria are met. Financiallessors sometimes prefer leveraged leaseaccounting because it often results infaster income recognition. It also permitsthe lessor to net the related nonrecoursedebt against the leveraged lease invest-ment on the balance sheet.

If the period covered by the renewaloption was not considered to be part ofthe initial lease term but the option is ulti-mately exercised based on the contractu-ally stated terms of the lease, the originallease classi cation under the guidancecontinues into the extended term of thelease; it is not revisited.

The guidance does not permit leveragedlease accounting. Leases that wouldqualify as leveraged leases underUS GAAP typically would be classi edas nance leases under IFRS. Anynonrecourse debt would be re ected grosson the balance sheet.



79


PwC

Impact US GAAP IFRS

Lease classication—other (continued)

Immediate income recognition by lessorson leases of real estate is more likelyunder IFRS.

Under the guidance, income recognitionfor an outright sale of real estate is appro-priate only if certain requirements aremet. By extension, such requirements alsoapply to a lease of real estate. Accordingly,a lessor is not permitted to classify a leaseof real estate as a sales-type lease unlessownership of the underlying propertyautomatically transfers to the lessee at the

end of the lease term, in which case thelessor must apply the guidance appro-priate for an outright sale.

IFRS does not have speci c requirementssimilar to US GAAP with respect to theclassi cation of a lease of real estate. Accordingly, a lessor of real estate (e.g.,a dealer) will recognize income imme-diately if a lease is classi ed as a nancelease (i.e., if it transfers substantially allthe risks and rewards of ownership tothe lessee).

Additional consideration is requiredunder US GAAP when the lessee isinvolved with the construction of an assetthat will be leased to the lessee whenconstruction of the asset is completed.

Lessee involvement in the construction ofan asset to be leased upon constructioncompletion is subject to speci c detailedguidance to determine whether the lesseeshould be considered the owner of theasset during construction. If the lesseehas substantially all of the constructionperiod risks, the lessee must accountfor construction in progress as if it were

the legal owner and recognize landlordnanced construction costs as debt. Once

construction is complete, the arrangementis evaluated as a sale-leaseback.

ASC 840 provides guidance with respectto accounting for a “construction project”and can be applied not only to newconstruction but also to the renovation orre-development of an existing asset.

No speci c guidance relating to lesseeinvolvement in the construction of anasset exists under IFRS.



80 PwC


Impact US GAAP IFRS

Other

Distributions of nonmonetaryassets to owners

Spin-off transactions under IFRS canresult in gain recognition as nonmon-etary assets are distributed at fair value.Under US GAAP, nonmonetary assets aredistributed at their recorded amount, andno gains are recognized.

Accounting for the distribution ofnonmonetary assets to owners of an enter-prise should be based on the recordedamount (after reduction, if appropriate,for an indicated impairment of value) ofthe nonmonetary assets distributed. Upon

distribution, those amounts are re ectedas a reduction of owner’s equity.

Accounting for the distribution of nonmon-etary assets to owners of an entity shouldbe based on the fair value of the nonmon-etary assets to be distributed. A dividendpayable is measured at the fair value ofthe nonmonetary assets to be distributed.

Upon settlement of a dividend payable,an entity will recognize any differencesbetween the carrying amount of the assetsto be distributed and the carrying amountof the dividend payable in pro t or loss.

Inventory costing

Companies that utilize the LIFO costingmethodology under US GAAP might expe -rience signi cantly different operatingresults as well as cash ows under IFRS.

Furthermore, regardless of the inven-

tory costing model utilized, under IFRScompanies might experience greater earn-ings volatility in relation to recoveries in values previously written down.

A variety of inventory costing methodolo-gies such as LIFO, FIFO, and/or weighted-average cost are permitted.

For companies using LIFO for US incometax purposes, the book/tax conformity

rules also require the use of LIFO for bookaccounting/reporting purposes.

Reversals of write-downs are prohibited.

A number of costing methodologies suchas FIFO or weighted-average costing arepermitted. The use of LIFO, however,is precluded.

Reversals of inventory write-downs

(limited to the amount of the orig-inal write-down) are required forsubsequent recoveries.

Inventory measurement

The measurement of inventory might vary when cost is greater than market(US GAAP) or net realizable value (IFRS).

Inventory is measured at the lower of costor market. Market is the current replace -ment cost; however, the replacement costcannot be greater than the net realizable value or less than net realizable valuereduced by a normal sales margin. Netrealizable value is estimated selling priceless costs of completion and sale.

Inventory is measured at the lower of costand net realizable value. Net realizable value is estimated selling price less costsof completion and sale.



81


PwC

Impact US GAAP IFRS

Biological assets—fair valueversus historical cost

Companies whose operations includemanagement of the transformation ofliving animals or plants into items forsale, agricultural produce, or additionalbiological assets have the potential forfundamental changes to their basis ofaccounting (because IFRS requires fair- value-based measurement).

Historical cost generally is used forbiological assets. These assets are testedfor impairment in the same manner asother long-lived assets.

The accounting treatment for biologicalassets requires measurement at fair valueless costs to sell at initial recognition ofbiological assets and at each subsequentreporting date, except when the measure-ment of fair value is unreliable.

All changes in fair value are recognized

in the income statement in the period in which they arise.

Investment property

Alternative methods or options ofaccounting for investment propertyunder IFRS could result in signi cantlydifferent asset carrying values (fair value)and earnings.

There is no speci c de nition of invest -ment property.

The historical-cost model is used for mostreal estate companies and operatingcompanies holding investment-typeproperty.

Investor entities—such as many invest-ment companies, insurance companies’separate accounts, bank-sponsored realestate trusts, and employee bene t plansthat invest in real estate—carry theirinvestments at fair value.

The fair value alternative for leased prop-erty does not exist.

Investment property is separately de nedas property (land and/or buildings) heldin order to earn rentals and/or for capitalappreciation. The de nition does notinclude owner-occupied property, prop-erty held for sale in the ordinary course ofbusiness, or property being constructed ordeveloped for such sale. Properties underconstruction or development for futureuse as investment properties are withinthe scope of investment properties.

Investment property may be accountedfor on a historical-cost basis or on a fair value basis. When fair value is applied,the gain or loss arising from a change inthe fair value is recognized in the incomestatement. The carrying amount isnot depreciated.

The election to account for investmentproperty at fair value may also be appliedto leased property.


IFRS IAS 2, IAS 16, IAS 17, IAS 23, IAS 36, IAS 37, IAS 40, IAS 41, IFRS 5, IFRS 13, IFRIC 4, IFRIC 17, SIC 15

US GAAP ASC 205, ASC 250, ASC 330, ASC 360-10, ACS 360-20, ASC 410-20, ASC 410-20-25, ASC 835-20, ASC 840, ASC 840-40, ASC 908-30, ASC 976

Note




82 PwC



FASB Accounting Standards Update No. 2012-02, Testing Indenite-Lived Intangible Assets for Impairment

In July 2012, the FASB issued ASU 2012-02, Testing Inde nite- Lived Intangible Assets for Impairment (revised inde nite-livedintangible asset impairment standard). An entity is permitted to rst assess qualitative factors to determine if a quantitative impair -ment test is necessary. Further testing is only required if the entity determines, based on the qualitative assessment, that it is morelikely than not that a inde nite-lived intangible asset’s fair value is less than its carrying amount. Otherwise, no further impairmenttesting is required. An entity can choose to perform the qualitative assessment on none, some, or all of its inde nite lived intangibleassets. An entity can bypass the qualitative assessment for any inde nite-lived intangible asset in any period and proceed directlyto the quantitative impairment test and then choose to perform the qualitative assessment in any subsequent period. The revisedstandard provides examples of events and circumstances that could affect signi cant inputs used to determine the fair value of

the inde nite-lived intangible asset. These examples replace those currently used to determine whether it is necessary to test forimpairment between annual tests. The qualitative assessment is not an accounting policy election.

The revised standard is effective for annual and interim impairment tests performed for scal years beginning after September 15,2012. Early adoption is permitted. The guidance in this chapter incorporates the changes resulting from the revised inde nite-livedintangible asset impairment standard.

Joint FASB/IASB Revised Exposure Draft, Leasing

The FASB and IASB are carrying out a joint project with the objective of recording assets and liabilities arising from leasing transac-tions on the balance sheet. This project comprehensively reconsiders the guidance in ASC 840 on accounting for leases, and IAS17, Leases, along with subsequent amendments and interpretations. The boards issued an exposure draft in August 2010 and thecomment period ended in December 2010. The boards had been redeliberating the exposure draft since January 2011. Based on thefeedback received, the boards made tentative decisions to change the proposals in a number of key areas including the de nition of

a lease, lease term, lessee and lessor accounting, and variable payments. At the June 2012 board meetings, the boards recon rmedthat all leases (other than short term leases) should be recognized on the balance sheet and tentatively decided there should be twotypes of pro t and loss recognition for both lessees and lessors.

A lessee’s expense recognition will either be front-loaded (the “interest and amortization approach”) or recognized consistentlyover the lease (the “single lease expense approach”). To determine which pro t and loss recognition approach to use, lessee wouldconsider whether they acquire and consume more than an insigni cant amount of the underlying asset over the lease term.

Lessors will apply either the receivable and residual approach or an approach similar to existing operating lease accounting. Theboards determined the dividing line will be symmetrical to lessees with a principle of whether the lessor has sold more than aninsigni cant portion of the underlying assets determining which approach should be applied. The decision overturns the previousscope provision to account for investment property similar to today’s operating lease accounting and to account for all other leasesusing the residual and receivable approach.

The boards issued a revised exposure draft in May 2013 with a 120 day comment period. The proposals are summarized below:

Lessee accounting

Based on the revised exposure draft, major aspects of the nal standard are expected to include the following:

• Lease accounting would signi cantly change, with lessees recording the rights and obligations of all leases on the balance sheet, with the exception of short-term leases. There would be no grandfathering. The model being proposed would signi cantlychange the accounting for leases and impact nancial statement presentation and nancial metrics, including many that tiedirectly to debt covenants or compensation arrangements.



83


PwC

• A lessee would be permitted to account for short-term leases—those with a maximum possible lease term of 12 months orless—in a manner consistent with the current requirements for operating leases. The short-term lease guidance would be anaccounting policy choice made on an asset class basis.

• Renewal options would be included in the estimated lease term when the company has a signi cant economic incentive to exer -cise an option to extend the lease, or not to exercise an option to terminate the lease.

• Contingent payments that are (1) based on a rate or an index, (2) in-substance xed lease payments structured as variable leasepayments, and (3) a residual value guarantee expected to be paid would be included in the lease asset and obligation. Contingentpayments that are based upon performance or usage of the leased asset would not be included in the lease asset and obligation.

• For leases that contain lease and non-lease components (including services and executory costs), the lessee must identify thenon-lease component and account for it separately. Lessees should allocate payments between lease and non-lease componentsbased on their relative standalone purchase prices if observable.

• The asset and lease obligation would be initially calculated as the present value of the lease payments discounted using theimplicit rate (if known) or the company’s incremental borrowing rate. The proposal would require lessees to reassess the leaseterm, contingent payments, residual value guarantees, and corresponding lease obligation as facts and circumstances change.

• There would be a dual model for expense recognition. Both models require balance sheet recognition, unless the lease meets anexception for short-term leases. A lease would be classi ed as either an interest and amortization lease or a single lease expenselease using an approach that is based on a principle of “consumption”. If the lessee acquires or “consumes” more than an insig -ni cant portion of the underlying asset, the interest and amortization approach applies. As a practical expedient, the boardsprovided for application guidance based on the nature of the underlying leased asset:

- Leases of property (de ned as land, building or part of a building, or both) should be accounted for using the single leaseexpense approach, unless:

• The lease term is for the major part of the asset’s economic life, or

• The present value of the xed lease payments account for substantially all of the fair value of the underlying asset - Leases of assets other than property, such as equipment, should be accounted for using the interest and amortization

approach, unless:

• The lease term is an insigni cant portion of the economic life of the underlying asset, or

• The present value of the xed lease payments is insigni cant relative to the fair value of the underlying asset

• Differences between the models arise in the geography of the expense in the statement of comprehensive income and theexpense recognition pattern. Under the interest and amortization approach, expense would be front loaded in the incomestatement, similar to their pro le for any other nancing. Amortization expense arising from the right-of-use asset and interestexpense on the lease liability would be reported separately in the statement of comprehensive income. Under the single leaseexpense approach, expense would be recognized evenly over the lease term. To achieve this expense recognition patternthe lessee will accounting for interest in a manner similar to the interest and amortization approach. Asset amortization is abalancing gure, calculated as the difference between the straight line expense and the amortization of the discount on the lease

liability. Both amortization and interest expense would be classi ed as lease expense in the statement of comprehensive income.

Lessor accounting

Based on the revised exposure draft, major aspects of the nal standard are expected to include the following as it relates to lessoraccounting:

• The boards proposed a dual model for lessor accounting and a symmetrical approach to classifying the lease for lessees andlessors. That is, lessor accounting would also depend on whether more than an insigni cant portion of the underlying assets hasbeen “sold” as part of the lease.



84 PwC


• When the lease represents an insigni cant portion of the underlying asset (presumed when the underlying asset is property), alessor would apply an approach similar to today’s operating lease accounting. That is, the underlying asset would remain on thelessor’s balance sheet and income would be recognized on a straight-line basis over the term of the lease.

• Where a lease gives a lessee the r ight to acquire or consume more than an insigni cant portion of the underlying asset(presumed when the underlying asset is not property), the lessor would apply the receivable and residual approach. Under thisapproach, lessors would recognize (1) upfront pro t and a receivable for the portion of the asset sold and (2) a residual assetand no upfront pro t for the portion of the asset deemed not sold. Leases of equipment would likely qualify for this approach.

• A lessor would recognize day one pro t on only the portion of the underlying asset conveyed to the lessee via right of use. Thisupfront pro t would be measured as the difference between the present value of the lease receivable and the cost basis of theunderlying asset allocated to the lease receivable. Any pro t on the portion of the underlying asset retained by the lessor (residualinterest) would be deferred and would be recognized only when the initial lease ends (underlying asset is re-leased or sold).

• Consistent with the proposal in the initial exposure draft, lessors will be allowed to account for short term-leases (a maximumlease term of 12 months or less) similar to current operating lease accounting.

Select other considerations

The proposal on leasing has far-reaching business and operational impacts. Some of the business implications include:

• The proposed guidance does not allow for grandfathering of existing leases. Any contracts determined to be leases under therevised de nition would follow the new rules and be subject to either a modi ed or a full retrospective approach to transition.Implementation could be a signi cant undertaking as personnel will be needed to identify and analyze all arrangements thatmay contain a lease.

• The proposed accounting model for leases is expected to have the greatest impact on lessees of signi cant amounts of “large-ticket” items, such as real estate, manufacturing equipment, power plants, aircraft, railcars, and ships. However, the proposedaccounting model also would affect virtually every company across all industries to varying degrees since nearly all companies

enter into leasing arrangements.• The proposal affects both balance sheet ratios and income statement metrics. For example, EBITDA (earnings before interest,

taxes, depreciation, and amortization) will increase, perhaps dramatically, as rent expense is replaced by amortization andinterest expense for Type A leases. At the same time, balance sheet leveraged ratios will be impacted by the associated increasein the outstanding lease liability. These will affect key contracts and other arrangements that depend on nancial statementmeasures such as loan covenants, credit ratings, and other external measures of performance and nancial strength. Internalmeasurements used for budgeting, incentive and compensation plans, and other nancial decisions might be similarly affected.

• Companies will need additional time to develop, document, and support necessary accounting estimates. Incremental effort willbe necessary to develop estimates at inception of the lease and to reassess those estimates when necessary.

• Enhanced systems likely will be needed to capture and continually track individual contract information, support the process ofdeveloping and reassessing estimates, and report certain newly required information.

• The boards have made signi cant changes since the initial exposure draft proposals in a number of key areas based on thefeedback received from constituents. To date the boards have remained aligned in their decisions on the leasing standard andconvergence is expected to be achieved in the majority of areas. However, some US GAAP / IFRS differences will remain relatingto guidance that interacts with the leases proposals. For example, current requirements differ for impairment, accounting forinvestment properties and scope (i.e., lease of intangibles)

• A nal standard is expected no earlier than 2014.



85


PwC

FASB Exposure Draft, Investment Properties

In the Investment Properties Project, the FASB has tentatively agreed to require qualifying entities to measure an investment prop -erty at fair value through earnings. Entities that meet the following criteria would be required to apply the guidance:

• Nature of business activities—Substantially all of the entity’s business activities must relate to investing in real estate properties.

• Express business purpose—The entity must invest in real estate properties for a total return, including realizing capital apprecia-tion, through disposal of its properties.

• Unit ownership—Ownership is represented by units of investments, such as shares of stock or partnership interests.

• Pooling of funds—The entity investor’s funds are pooled to avail the investors of professional investment management. Theentity has investors who are unrelated to the parent and hold a signi cant ownership interest in the entity.

• Reporting entity—The entity conducts activities and reports results to its investors. The entity does not necessarily need to be a

legal entity.In addition to traditional real estate properties, other non-traditional real estate such as power plants and integral equipment(e.g., pipelines and cellular towers) are also expected to be within the scope of the guidance. Fair value measurement would also berequired for right-of-use assets arising from leasing transactions when the entity is a lessee.

Investment property entities would initially measure investment property at transaction price, including transaction costs.Investment property entities would subsequently measure investment properties at fair value with all changes in fair value recog-nized in net income. The investment property entity will present the fair value of the investment properties held and any debtassociated with the investment property on a gross basis. Rental income would be recognized consistent with the contractual termsof the related lease agreements instead of on a straight line or other basis. Rental income and related property expenses would bepresented separately.

The FASB’s proposal differs from IFRS. The FASB’s expected proposal is applied at the entity level—for entities that meet the criteriaas an investment property entity (as noted above). In contrast, under IAS 40, Investment Property , the guidance is applied at theasset level—for assets that meet the de nition of investment properties. In addition, the FASB’s expected proposal would requireentities to apply fair value accounting, whereas IFRS allows the option to measure investment properties at either fair value or cost.

Redeliberations on the proposal and the future direction of the project are expected to be signi cantly linked to the FASB’s decisionsin the Leases project (speci cally the lessor accounting model) and redeliberations relating to the Investment Companies project.



86 PwC


Assets— nancial assetsThe FASB and IASB are working on a joint project on nancial instruments that is intended to address the recognition and measure -ment of all nancial instruments. Once nalized, the new guidance will replace all of the FASB’s and IASB’s respective nancialinstrument guidance. The two Boards have, however, been working on different timetables. The IASB has been conducting its workin separate phases, the rst of which resulted in the November 2009 issuance of IFRS 9, Financial Instruments (subsequently updatedin October 2010). In December 2011, the IASB issued an amendment to IFRS 9 that delays the effective date to annual periods begin -ning on or after January 1, 2015, with early application continuing to be permitted. In January 2012, the FASB and the IASB decidedto jointly redeliberate selected aspects of the classi cation and measurement guidance in IFRS 9 and the FASB’s tentative classi cationand measurement model for nancial instruments to reduce key differences between their respective classi cation and measurementmodels. As a result, the IASB issued an exposure draft proposing limited amendments to IFRS 9 (2010) in November 2012, and thecomment period ending on March 28, 2013. The FASB issued its exposure draft on February 2013, and the comment period ended onMay 15, 2013. Details on these and other developments are discussed in the Recent/proposed guidance section. The remainder of thissection focuses on the current US GAAP and IFRS guidance.

Under current US GAAP, various specialized pronouncements provide guidance for the classi cation of nancial assets. IFRS currentlyhas only one standard for the classi cation of nancial assets and requires that nancial assets be classi ed in one of four categories:assets held for trading or designated at fair value, with changes in fair value reported in earnings; held-to-maturity investments;available-for-sale nancial assets; and loans and receivables.

The specialized US guidance and the singular IFRS guidance in relation to classi cation can drive differences in measurement (becauseclassi cation drives measurement under both IFRS and US GAAP).

A detailed discussion of industry-speci c differences is beyond the scope of this publication. However, for illustrative purposes only, wenote that the accounting under US GAAP for unlisted equity securities can differ substantially depending on industry-speci c require -ments. US GAAP accounting by general corporate entities that do not choose the fair-value option, for example, differs signi cantlyfrom the accounting by broker/dealers, investment companies, and insurance companies. In contrast, the guidance in relation tounlisted equity securities under IFRS is the same regardless of the entity’s industry.

Under US GAAP, the legal form of the nancial asset drives classi cation. For example, debt instruments that are securities in legalform are typically carried at fair value under the available-for-sale category (unless they are held to maturity)—even if there is noactive market to trade the securities. At the same time, a debt instrument that is not in the form of a security (for example, a corporateloan) is accounted for at amortized cost even though both instruments (i.e., the security and the loan) have similar economic charac -teristics. Under IFRS, the legal form does not drive classi cation of debt instruments; rather, the nature of the instrument (including whether there is an active market) is considered. Additional differences involve nancial assets that are carried at amortized cost. Forsuch assets, both IFRS and US GAAP use the effective interest method to calculate amortized cost and allocate interest income over

the relevant period. The effective interest method is based on the effective interest rate calculated at initial recognition of the nan -cial instrument. Under IFRS, the effective interest rate is calculated based on estimated future cash payments or receipts through theexpected life of the nancial instrument. Under US GAAP, although certain exceptions apply, the effective interest rate generally iscalculated based on the contractual cash ows through the contractual life of the nancial assets. Under IFRS, changes in the estimatedcash ows due to a closely related embedded derivative that is not bifurcated results in a cumulative catch-up re ected in the current-period income statement. US GAAP does not have the equivalent of a cumulative catch-up-based approach for these scenarios.



87

Assets—nancial assets

PwC

For available-for-sale debt instruments, the impairment models for nancial assets may result in different impairment triggers anddifferent impairment measurement criteria. In considering whether a decline in fair value is other than temporary, US GAAP looks to(1) management’s intent and ability to hold the security and (2) expectations of recovery of the cost basis in the security. The impair -ment trigger drives the measurement of the impairment loss. Under IFRS, the impairment triggers for available-for-sale debt instru -ments and loans and receivables are the same; however, the available-for-sale impairment loss is based on fair value while impairmentof loans and receivables is calculated by discounting estimated cash ows (excluding credit losses that have not been incurred) by theoriginal effective interest rate. Additional differences around reversals of impairment losses and impairment of equities also must beconsidered.

There are fundamental differences in the way US GAAP and IFRS currently assess the potential derecognition of nancial assets. Thedifferences can have a signi cant impact on a variety of transactions such as asset securitizations. IFRS focuses on whether a qualifyingtransfer has taken place, whether r isks and rewards have been transferred, and, in some cases, whether control over the asset(s) in

question has been transferred. US GAAP focuses on whether an entity has surrendered control over an asset, including the surren -dering of legal and effective control. The fundamental differences are as follows:

• Under US GAAP, derecognition can be achieved even if the transferor has signi cant ongoing involvement with the assets, such asthe retention of signi cant exposure to credit risk.

• Under IFRS, full derecognition can be achieved only if substantially all of the r isks and rewards are transferred or the entity hasneither retained nor transferred substantially all of the risks and rewards and the transferee has the practical ability to sell the trans-ferred asset.

• Under IFRS, if the entity has neither retained nor transferred substantially all of the risks and rewards and if the transferee does nothave the practical ability to sell the transferred asset, the transferor continues to recognize the transferred asset with an associatedliability in a unique model known as the continuing involvement model, which has no equivalent under US GAAP.

• The IFRS model does not permit many factoring transactions (e.g., sale of receivables with recourse) to qualify for derecognition.

Most factorings include some ongoing involvement by the transferor that causes the transferor to retain some of the r isks andrewards related to the transferred assets—a situation that may preclude full derecognition under IFRS, but not under US GAAP.

Further details on the foregoing and other selected current differences (pre-IFRS 9) are described in the following table.



88 PwC


Impact US GAAP IFRS

Classication

Available-for-sale nancialassets—fair value versus costof unlisted equity instruments

More investments in unlisted equitysecurities are recorded at fair valueunder IFRS.

Unlisted equity investments generallyare scoped out of ASC 320 and would becarried at cost, unless either impaired orthe fair-value option is elected.

Certain exceptions requiring that invest-ments in unlisted equity securities becarried at fair value do exist for speci cindustries (e.g., broker/dealers, invest -ment companies, insurance companies,and de ned bene t plans).

There are no industry-speci c differencesin the treatment of investments in equityinstruments that do not have quotedmarket prices in an active market. Rather,all available-for-sale assets, includinginvestments in unlisted equity instru-ments, are measured at fair value (withrare exceptions only for instances in whichfair value cannot be reliably measured).

Fair value is not reliably measurable when the range of reasonable fair valueestimates is signi cant and the probabilityof the various estimates within the rangecannot be reasonably assessed.

Available-for-sale debtnancial assets—foreign

exchange gains/losses ondebt instruments

The treatment of foreign exchange gainsand losses on available-for-sale debt secu-rities will create more income statement volatility under IFRS.

The total change in fair value of available-for-sale debt securities—net of associatedtax effects—is recorded within othercomprehensive income (OCI).

Any component of the overall change infair market value that may be associated with foreign exchange gains and losseson an available-for-sale debt security istreated in a manner consistent with theremaining overall change in the instru-ment’s fair value.

For available-for-sale debt instruments,the total change in fair value is bifurcated, with the portion associated with foreignexchange gains/losses on the amortizedcost basis separately recognized in theincome statement. The remaining portionof the total change in fair value is recog-nized in OCI, net of tax effect.



89


PwC

Impact US GAAP IFRS

Effective interest rates—expected versus contractualcash ows

Differences between the expected andcontractual lives of nancial assets carriedat amortized cost have different implica-tions under the two frameworks.

The difference in where the twoaccounting frameworks place their

emphasis (contractual term for US GAAPand expected life for IFRS) can affectasset carrying values and the timing ofincome recognition.

For nancial assets that are carried atamortized cost, the calculation of theeffective interest rate generally is basedon contractual cash ows over the asset’scontractual life.

The expected life, under US GAAP, is typi -

cally used only for:• Loans if the entity holds a

large number of similar loansand the prepayments can bereasonably estimated

• Certain structured notes

• Certain bene cial interests in securi -tized nancial assets

• Certain loans or debt securitiesacquired in a transfer

For nancial assets that are carried atamortized cost, the calculation of theeffective interest rate generally is basedon the estimated cash ows (excludingfuture credit losses) over the expected lifeof the asset.

Contractual cash ows over the fullcontractual term of the nancial asset areused only in those rare cases when it is notpossible to reliably estimate the cash owsor the expected life of a nancial asset.



90 PwC


Impact US GAAP IFRS

Effective interest rates—changes in expectations

Differences in how changes in expecta-tions (associated with nancial assetscarried at amortized cost) are treated canaffect asset valuations and the timing ofincome statement recognition.

Different models apply to the waysrevised estimates are treated dependingon the type of nancial asset involved(e.g., prepayable loans, structurednotes, bene cial interests, loans, or debtacquired in a transfer).

Depending on the nature of the asset,

changes may be re ected prospectivelyor retrospectively. None of the US GAAPmodels is the equivalent of the IFRScumulative-catch-up-based approach.

If an entity revises its estimates ofpayments or receipts, the entity adjuststhe carrying amount of the nancialasset (or group of nancial assets) tore ect both actual and revised estimatedcash ows.

Revisions of the expected life or of the

estimated future cash ows may exist,for example, in connection with debtinstruments that contain a put or calloption that doesn’t need to be bifurcatedor whose coupon payments vary becauseof an embedded feature that does notmeet the de nition of a derivative becauseits underlying is a non nancial variablespeci c to a party to the contract(e.g., cash ows that are linked to earn -ings before interest, taxes, depreciation,and amortization; sales volume; or theearnings of one party to the contract).

The entity recalculates the carryingamount by computing the present value ofestimated future cash ows at the nan -cial asset’s original effective interest rate.The adjustment is recognized as incomeor expense in the income statement(i.e., by the cumulative-catch-upapproach).

Generally, oating rate instruments(e.g., LIBOR plus spread) issued at parare not subject to the cumulative-catch-upapproach; rather, the effective interestrate is revised as market rates change.



91


PwC

Impact US GAAP IFRS

Fair-value option for equity-method investments

While both accounting standards includea fair-value option for equity-methodinvestments, the IFRS-based option haslimits as to which entities can exer-cise it, whereas the US GAAP option isbroad-based.

The fair-value option exists for US GAAPentities under ASC 825, Financial Instruments , wherein the option is unre-stricted. Therefore, any investor’s equity-method investments are eligible for thefair-value option.

IFRS permits venture capital organiza-tions, mutual funds, and unit trusts (as well as similar entities, including invest-ment-linked insurance funds) that haveinvestments in associates (entities over which they have signi cant in uence) tocarry those investments at fair value, withchanges in fair value reported in earnings(provided certain criteria are met) in lieuof applying equity-method accounting.

Fair value of investments ininvestment company entitiesContrary to US GAAP, IFRS doesnot include a practical expedientfor the measurement of fair value ofcertain investments

US GAAP provides a practical expedient forthe measurement of fair value of certaininvestments that report a net asset value(NAV), to allow use of NAV as fair value.

Under IFRS, since NAV is not de nedor calculated in a consistent mannerin different parts of the world, theIASB decided against issuing a similarpractical expedient.



92 PwC


Impact US GAAP IFRS

Loans and receivables

Classi cation is not driven by legal formunder IFRS, whereas legal form drivesthe classi cation of “debt securities”under US GAAP. The potential clas -si cation differences drive subsequentmeasurement differences under IFRS andUS GAAP for the same debt instrument.

Loans and receivables may be carried

at different amounts under thetwo frameworks.

The classi cation and accounting treat -ment of nonderivative nancial assetssuch as loans and receivables generallydepends on whether the asset in questionmeets the de nition of a debt securityunder ASC 320. If the asset meets thatde nition, it is generally classi ed astrading, available for sale, or held tomaturity. If classi ed as trading or avail -able for sale, the debt security is carriedat fair value. To meet the de nition of adebt security under ASC 320, the assetis required to be of a type commonlyavailable on securities exchanges or inmarkets, or, when represented by aninstrument, is commonly recognized inany area in which it is issued or dealt in asa medium for investment.

Loans and receivables that are not withinthe scope of ASC 320 fall within the scopeof other guidance. As an example, mort -

gage loans are either:• Classi ed as loans held for investment,

in which case they are measured atamortized cost

• Classi ed as loans held for sale, in which case they are measured at thelower of cost or fair value (market), or

• Carried at fair value if the fair valueoption is elected

IFRS de nes loans and receivables asnonderivative nancial assets with xedor determinable payments not quoted inan active market other than:

• Those that the entity intends to sellimmediately or in the near term, which are classi ed as held for tradingand those that the entity upon initialrecognition designates as at fair valuethrough pro t or loss

• Those that the entity upon initialrecognition designates as availablefor sale

• Those for which the holder may notrecover substantially all of its initialinvestment (other than because ofcredit deterioration) and that shall beclassi ed as available for sale

An interest acquired in a pool of assetsthat are not loans or receivables

(i.e., an interest in a mutual fund or asimilar fund) is not a loan or receivable.

Instruments that meet the de nitionof loans and receivables (regardless of whether they are legal form securities)are carried at amortized cost in the loanand receivable category unless designatedinto either the fair value through pro t-or-loss category or the available-for-salecategory. In either of the latter two cases,they are carried at fair value.

IFRS does not have a category of loans

and receivables that is carried at the lowerof cost or market.



93


PwC

Impact US GAAP IFRS

Reclassications

Transfers of nancial assets into or outof different categories are permitted inlimited circumstances under both frameworks. In general, reclassi cations havethe potential to be more common underIFRS. The ability to reclassify is impactedby initial classi cation, which can also vary (as discussed above).

Changes in classi cation between trading,available-for-sale, and held-to-maturitycategories occur only when justi ed bythe facts and circumstances within theconcepts of ASC 320. Given the natureof a trading security, transfers into orfrom the trading category should be rare,though they do occur.

Financial assets may be reclassi edbetween categories, albeit with conditions.

More signi cantly, debt instruments maybe reclassi ed from held for trading oravailable for sale into loans and receiv-ables, if the debt instrument meets thede nition of loans and receivables and theentity has the intent and ability to hold

them for the foreseeable future. Also, a nancial asset can be transferredfrom trading to available for sale inrare circumstances.

Reclassi cation is prohibited for instru -ments where the fair-value optionis elected.

Impairments and subsequent loss

Impairment principles—available-for-sale debt

securitiesRegarding impairment triggers, IFRSfocuses on events that affect the recoveryof the cash ows from the asset regardlessof the entity’s intent. US GAAP looks toa two-step test based on intent or abilityto hold and expected recovery of thecash ows.

Regarding measurement of impairmentloss upon a trigger, IFRS uses the cumu-lative fair value losses deferred in othercomprehensive income. Under US GAAP,

the impairment loss depends on the trig-gering event.

An investment in certain debt securitiesclassi ed as available for sale is assessedfor impairment if the fair value is less thancost. An analysis is performed to deter -mine whether the shortfall in fair value istemporary or other than temporary.

In a determination of whether impairmentis other than temporary, the followingfactors are assessed for available-for-salesecurities:

Step 1— Can management assert (1) itdoes not have the intent to sell and (2) itis more likely than not that it will not haveto sell before recovery of cost? If no, thenimpairment is triggered. If yes, then moveto Step 2.

A nancial asset is impaired and impair -ment losses are incurred only if there isobjective evidence of impairment as theresult of one or more events that occurredafter initial recognition of the asset (a lossevent) and if that loss event has an impacton the estimated future cash ows of the

nancial asset or group of nancial assetsthat can be estimated reliably. In assessingthe objective evidence of impairment, anentity considers the following factors:

• Signi cant nancial dif culty ofthe issuer

• High probability of bankruptcy

• Granting of a concession to the issuer



94 PwC


Impact US GAAP IFRS

Impairment principles—available-for-sale debt securities (continued)

Step 2— Does management expectrecovery of the entire cost basis of thesecurity? If yes, then impairment isnot triggered. If no, then impairmentis triggered.

Once it is determined that impairmentis other than temporary, the impairmentloss recognized in the income statementdepends on the impairment trigger:

• If impairment is triggered as a resultof Step 1, the loss in equity due tochanges in fair value is released intothe income statement.

• If impairment is triggered in Step2, impairment loss is measured bycalculating the present value of cash

ows expected to be collected fromthe impaired security. The determina -tion of such expected credit loss is notexplicitly de ned; one method couldbe to discount the best estimate of cash

ows by the original effective interest

rate. The difference between the fair value and the post-impairment amor-tized cost is recorded within OCI.

• Disappearance of an active marketbecause of nancial dif culties

• Breach of contract, such as default ordelinquency in interest or principal

• Observable data indicating thereis a measurable decrease in theestimated future cash ows sinceinitial recognition

The disappearance of an active marketbecause an entity’s securities are nolonger publicly traded or the downgradeof an entity’s credit rating is not, by itself,evidence of impairment, although it maybe evidence of impairment when consid-ered with other information.

At the same time, a decline in the fair value of a debt instrument below its amor-tized cost is not necessarily evidence ofimpairment. For example, a decline in thefair value of an investment in a corporatebond that results solely from an increasein market interest rates is not an impair-ment indicator and would not require animpairment evaluation under IFRS.

An impairment analysis under IFRSfocuses only on the triggering creditevents that negatively affect the cash

ows from the asset itself and does notconsider the holder’s intent.

Once impairment of a debt instrument isdetermined to be triggered, the cumu-lative loss recognized in OCI due tochanges in fair value is released into theincome statement.



95


PwC

Impact US GAAP IFRS

Impairment principles—held-to-maturity debt instruments

Regarding impairment triggers, IFRSfocuses on events that affect the recoveryof the cash ows from the asset regardlessof the entity’s intent. US GAAP looks toa two-step test based on intent or abilityto hold and expected recovery of thecash ows.

Regarding measurement of impairmentloss upon a trigger, IFRS looks to theincurred loss amount. Under US GAAP,the impairment loss depends on the trig-gering event.

The two-step impairment test mentionedabove is also applicable to certain invest-ments classi ed as held to maturity. It would be expected that held-to-maturityinvestments would not trigger Step 1 (astainting would result). Rather, evaluationof Step 2 may trigger impairment.

Once triggered, impairment is measured with reference to expected credit lossesas described for available-for-sale debtsecurities. The difference between the fair value and the post-impairment amor-tized cost is recorded within OCI andaccreted from OCI to the carrying valueof the debt security over its remaininglife prospectively.

Impairment is triggered for held-to-maturity investments based on objectiveevidence of impairment described abovefor available-for-sale debt instruments.

Once impairment is triggered, the loss ismeasured by discounting the estimatedfuture cash ows by the original effective

interest rate. As a practical expedient,impairment may be measured based onthe instrument’s observable fair value.



96 PwC


Impact US GAAP IFRS

Impairment of available-for-saleequity instruments

Impairment on available-for-sale equityinstruments may be triggered at differentpoints in time under IFRS compared withUS GAAP.

US GAAP looks to whether the decline infair value below cost is other than tempo-rary. The factors to consider include:

• The length of the time and the extentto which the market value has beenless than cost

• The nancial condition and near-term

prospects of the issuer, including anyspeci c events that may in uencethe operations of the issuer, suchas changes in technology that mayimpair the earnings potential of theinvestment or the discontinuance ofa segment of the business that mayaffect the future earnings potential

• The intent and ability of the holder toretain its investment in the issuer fora period of time suf cient to allow forany anticipated recovery in market value

The evaluation of the other-than-temporary impairment trigger requiressigni cant judgment in assessing therecoverability of the decline in fair valuebelow cost. Generally, the longer andgreater the decline, the more dif cult itis to overcome the presumption that theavailable-for-sale equity is other thantemporarily impaired.

Similar to debt investments, impairmentof available-for-sale equity investments istriggered by objective evidence of impair-ment. In addition to examples of eventsdiscussed above, objective evidenceof impairment of available-for-saleequity includes:

• Signi cant or prolonged decline in fair value below cost, or

• Signi cant adverse changes intechnological, market, economic, orlegal environment

Each factor on its own could triggerimpairment (i.e., the decline in fair valuebelow cost does not need to be bothsigni cant and prolonged).

For example, if a decline has persistedfor more than 12 consecutive months,then the decline is likely to be

considered “prolonged.”

Whether a decline in fair value below costis considered signi cant must be assessedon an instrument-by-instrument basis andshould be based on both qualitative andquantitative factors.

Losses on available-for-saleequity securities subsequent toinitial impairment recognitionIn periods after the initial recognition ofan impairment loss on available-for-saleequity securities, further income state-ment charges are more likely under IFRS.

Impairment charges establish a new costbasis. As such, further reductions in valuebelow the new cost basis may be consid-ered temporary (when compared with thenew cost basis).

Impairment charges do not establish anew cost basis. As such, further reductionsin value below the original impairmentamount are recorded within the current-period income statement.



97


PwC

Impact US GAAP IFRS

Impairments—measurementand reversal of losses

Under IFRS, impairment losses on debtinstruments may be reversed throughthe income statement. Under US GAAP,reversals are permitted for debt instru-ments classi ed as loans; however, one-time reversal of impairment losses on debtsecurities is prohibited. Expected recov -eries are re ected over time by adjustingthe interest rate to accrue interest income.

Impairments of loans held for investmentmeasured under ASC 310-10-35 and ASC 450 are permitted to be reversed;however, the carrying amount of the loancan at no time exceed the recorded invest-ment in the loan.

One-time reversals of impairment

losses for debt securities classi ed asavailable-for-sale or held-to-maturitysecurities, however, are prohibited.Rather, any expected recoveries in futurecash ows are re ected as a prospective yield adjustment.

Reversals of impairments on equity invest-ments are prohibited.

For nancial assets carried at amortizedcost, if in a subsequent period the amountof impairment loss decreases and thedecrease can be objectively associated with an event occurring after the impair-ment was recognized, the previouslyrecognized impairment loss is reversed.The reversal, however, does not exceed what the amortized cost would have beenhad the impairment not been recognized.

For available-for-sale debt instruments,if in a subsequent period the fair valueof the debt instrument increases and theincrease can be objectively related to anevent occurring after the loss was recog-nized, the loss may be reversed throughthe income statement.

Reversals of impairments on equityinvestments through pro t or loss

are prohibited.



98 PwC


Impact US GAAP IFRS

Financial asset derecognition

Derecognition

The determination of whether nancialassets should be derecognized (e.g., insecuritizations or factorings) is basedon very different models under thetwo frameworks.

Full derecognition under US GAAP ismore common than under IFRS. However,the IFRS model includes continuinginvolvement presentation that has noequivalent under US GAAP.

The guidance focuses on an evaluation ofthe transfer of control. The evaluation isgoverned by three key considerations:

• Legal isolation of the transferred assetfrom the transferor

• The ability of the transferee (or, if thetransferee is a securitization vehicle,the bene cial interest holder) topledge or exchange the asset (or thebene cial interest holder)

• No right or obligation of the transferorto repurchase

As such, derecognition can be achievedeven if the transferor has signi cantongoing involvement with the assets, suchas the retention of signi cant exposure tocredit risk.

ASC 860 does not apply to transfers in

which the transferee is considered aconsolidated af liate of the transferor, asde ned in the standard. If this is the case,regardless of whether the transfer criteriaare met, derecognition is not possible asthe assets are, in effect, transferred to theconsolidated entity.

There is no concept of continuinginvolvement/partial derecognition underUS GAAP.

The guidance focuses on evaluation of whether a qualifying transfer has takenplace, whether risks and rewards havebeen transferred, and, in some cases, whether control over the asset(s) in ques-tion has been transferred.

The transferor rst applies the consolida -tion guidance and consolidates any andall subsidiaries or special purpose entitiesit controls.

The model can be applied to part of anancial asset (or part of a group of

similar nancial assets) or to the nancialasset in its entirety (or a group of similar

nancial assets in their entirety).

Under IAS 39, full derecognition is appro -priate once both of the following condi-tions have been met:

• The nancial asset has been trans -ferred outside the consolidated group.

• The entity has transferred substantiallyall of the r isks and rewards of owner-ship of the nancial asset.

The rst condition is achieved in one oftwo ways:

• When an entity transfers the contrac-tual rights to receive the cash ows ofthe nancial asset, or

• When an entity retains the contrac-tual rights to the cash ows butassumes a contractual obligationto pass the cash ows on to one ormore recipients (referred to as apass-through arrangement)



99


PwC

Impact US GAAP IFRS

Derecognition (continued) When accounting for a transfer of anentire nancial asset that quali es for saleaccounting, the asset transferred in thesale must be derecognized from the trans-feror’s balance sheet. The total carryingamount of the asset is derecognized, andany assets and liabilities retained arerecognized at fair value. The transferorshould separately recognize any servicingassets or servicing liabilities retained inthe transfer at their fair values. A gainor loss on the transfer is calculated asthe difference between the net proceedsreceived and the carrying value of theassets sold.

If a participating interest was sold, thetransferor must allocate the previouscarrying value of the entire nancial assetbetween the participating interest soldand retained.

Many securitizations do not meet thestrict pass-through criteria to recognize atransfer of the asset outside of the consoli-dated group and as a result fail the rstcondition for derecognition.

If there is a qualifying transfer, an entitymust determine the extent to which itretains the risks and rewards of owner-ship of the nancial asset. IAS 39requires the entity to evaluate the extent

of the transfer of risks and rewards bycomparing its exposure to the variabilityin the amounts and timing of the trans-ferred nancial assets’ net cash ows,both before and after the transfer.

If the entity’s exposure does not changesubstantially, derecognition would notbe appropriate. Rather, a liability equalto the consideration received wouldbe recorded ( nancing transaction).If, however, substantially all risks andrewards are transferred, the entity would

derecognize the nancial asset transferredand recognize separately any asset orliability created through any rights andobligations retained in the transfer (e.g.,servicing assets).

Many securitization transactions includesome ongoing involvement by the trans-feror that causes the transferor to retainsubstantial risks and rewards, therebyfailing the second condition for derecog-nition, even if the pass-through testis met.

If the transferred asset is part of a largernancial asset (e.g., when an entity trans -

fers interest cash ows that are part of adebt instrument) and the part transferredquali es for derecognition in its entirety,the previous carrying amount of the larger

nancial asset shall be allocated betweenthe part that continues to be recognizedand the part that is derecognized, basedon the relative fair values of those partson the date of the transfer.



100 PwC


Impact US GAAP IFRS

Derecognition (continued) When an asset transfer has been accom-plished but the entity has neither retainednor transferred substantially all risksand rewards, an assessment as to controlbecomes necessary. The transferorassesses whether the transferee has thepractical ability to sell the nancial assettransferred to a third party. The emphasisis on what the transferee can do inpractice and whether it is able, unilater-ally, to sell the transferred nancial asset without imposing any restrictions on thetransfer. If the transferee does not havethe ability to sell the transferred nancialasset, control is deemed to be retained bythe transferor and the transferred nan -cial asset may require a form of partialderecognition called continuing involve-ment. Under continuing involvement, thetransferred nancial asset continues to berecognized with an associated liability.

When the entity has continuing involve-ment in the transferred nancial asset,the entity must continue to recognize thetransferred nancial asset to the extentof its exposure to changes in the value ofthe transferred nancial asset. Continuinginvolvement is measured as either themaximum amount of considerationreceived that the entity could be requiredto repay (in the case of guarantees) or theamount of the transferred nancial assetthat the entity may repurchase (in thecase of a repurchase option).


IFRS IAS 39, IFRS 13, SIC 12,

US GAAP ASC 310, ASC 310-10-30, ASC 310-10-35, ASC 320, ASC 325, ASC 815, ASC 815-15-25-4 through 25-5, ASC 820, ASC 825, ASC 860

Note




101


PwC


FASB Accounting Standards Update No. 2013-08, Financial Services—Investment Companies (Topic 946): Amendmentsto the Scope, Measurement, and Disclosure Requirements

Refer to the Consolidation chapter for a discussion of this topic.

Joint FASB/IASB Financial Instruments ProjectOverview

The FASB and IASB’s joint project on nancial instruments is intended to address the recognition and measurement of nancialinstruments, including impairment and hedge accounting. Once nalized, the new guidance will replace the FASB’s and IASB’srespective nancial instrument guidance. Although the project is a joint project, the FASB and IASB have been working on different

timetables. The IASB has been conducting its work in separate phases: (1) classi cation and measurement of nancial assets,(2) classi cation and measurement of nancial liabilities, (3) impairment, and (4) hedge accounting. The FASB initially elected toissue one comprehensive exposure draft on nancial instruments.

In November 2009, the IASB issued IFRS 9, Financial Instruments , which re ects the decisions it reached in the classi cation andmeasurement phase for nancial assets. In October 2010, the requirements for classifying and measuring nancial liabilities wereadded to IFRS 9. In November 2010, the IASB issued its exposure draft on hedge accounting. In January 2011, the IASB also issueda second exposure draft on impairment of nancial assets carried at amortized cost, together with the FASB. However, the IASB andthe FASB subsequently issued separate proposals on impairment of nancial assets.

On May 26, 2010, the FASB released its nancial instrument accounting exposure draft, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities , and, as mentioned above, subsequently issued a jointsupplemental impairment document together with the IASB to gather input on new impairment approaches.

In January 2012, the FASB and the IASB decided to jointly redeliberate selected aspects of the classi cation and measurement guid -ance in IFRS 9 and the FASB’s tentative classi cation and measurement model for nancial instruments to reduce key differencesbetween their respective classi cation and measurement models. As a result, the FASB issued a revised proposal for the classi ca -tion and measurement of nancial instruments in February 2013.

The IASB issued its exposure draft proposing limited amendments to IFRS 9 (2010), Financial instruments in November 2012. Theproposed amendments are intended to:

• Address application issues that have arisen since the original issuance of IFRS 9 with regard to nancial assets measured atamortized cost.

• Consider the interaction with the IASB’s insurance project.

• Reduce differences between IFRS 9 and the FASB’s proposed classi cation and measurement approach.

Joint FASB/IASB Impairment Project

The FASB and IASB had originally proposed differing impairment models that they developed separately.

On May 26, 2010, the FASB released its nancial instrument accounting exposure draft, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities . The FASB proposed a single model for recognizing andmeasuring impairment of nancial assets recorded at fair value with changes in fair value recognized in OCI.

In November 2009, the IASB issued an exposure draft that proposed fundamental changes to the current impairment guidance fornancial assets accounted for at amortized cost.



102 PwC


Many constituents who commented on those proposals emphasized the need for the Boards to develop a converged impairmentapproach. In January 2011, the Boards issued a joint supplementary document, Accounting for Financial Instruments and Revisionsto the Accounting for Derivative Instruments and Hedging Activities — Impairment , to gather input on new impairment approaches.

In June 2011, the Boards decided to change course on their proposed model for impairment of nancial assets and discussed a newapproach dividing nancial assets into three categories (referred to as “buckets” by the Boards) for impairment purposes. The allo -cation to each category would be based on deterioration in credit quality and would ultimately determine the amount of the creditlosses to be recognized.

In August 2012, the FASB concluded after considering constituent feedback that aspects of the “three bucket” impairment model were dif cult to understand and presented operational challenges that could not be addressed through implementation guidance. As a result, the FASB decided not to move forward with an exposure draft on the “three bucket” approach.

FASB proposed ASU, Financial Instruments—Credit Losses (Subtopic 825-15)

In December 2012, the FASB issued a proposal that introduces a new model for accounting for credit losses on debt instruments.The proposal calls for an entity to recognize an allowance for credit losses based on its current estimate of contractual cash ows notexpected to be collected.

The FASB’s proposed model eliminates any threshold required to record a credit loss and allows entities to consider a broader infor -mation set when establishing their allowance for loan losses. In addition, the model aims to simplify current practice by replacingtoday’s multiple impairment models with one model that applies to all debt instruments.

The FASB’s model, referred to as the “current expected credit loss” (CECL) model, has the following key elements.

Scope

The CECL model applies to all nancial assets subject to credit losses and not recorded at fair value through net income (FV-NI).The scope of the CECL model includes loans, debt securities, loan commitments, reinsurance recoverables, lease receivables, andtrade receivables.

Multiple scenarios

The analysis requires entities to consider multiple scenarios. When estimating the amount of contractual cash ows not expected tobe collected, entities will have to consider at least two possible scenarios. The analysis should consider one scenario where a creditloss occurs and one scenario where a credit loss does not occur. In other words, the analysis cannot be based solely on the mostlikely scenario.

Practical expedient for assets carried at FV-OCI

Assets accounted for at fair value with changes in fair value recorded in other comprehensive income (FV-OCI) will be allowed apractical expedient. The practical expedient allows an entity not to recognize expected credit losses if fair value is at or above amor -tized cost and the expected credit losses on the individual asset are insigni cant.

Purchased credit impaired assets

The accounting for debt instruments purchased with evidence of credit deterioration since origination will change from currentpractice. The CECL model requires an allowance for loan losses to be established at acquisition that represents the buyer’s assess -ment of expected credit losses. The portion of the original purchase discount attributed to expected credit losses will not berecognized in interest income. The remaining portion of the discount not attr ibuted to expected credit losses will be recognized ininterest income over the remaining life of the asset using an effective yield method. The effective yield determined at acquisition will be held constant and any changes in expected cash ows (i.e., changes in the allowance for loan losses) will be recorded asgains and losses through the credit loss provision.



103


PwC

IASB exposure draft, Financial Instruments: Expected Credit Losses

The IASB issued in March 2013 an exposure draft, Financial Instruments: Expected Credit Losses. The proposed guidance intro -duces an expected loss impairment model that will replace the incurred loss model used today. The IASB’s model, now known as the“credit deterioration” model, has the following key elements.

General model

Under the proposed model, an entity will recognize an impairment loss at an amount equal to the 12-month expected credit loss.If the credit r isk on the nancial instrument has increased signi cantly since initial recognition, it should recognize an impairmentloss at an amount equal to the lifetime expected credit loss.

The 12-month expected credit loss measurement represents all cash ows not expected to be received (“cash shortfalls”) overthe life of the nancial instrument that result from those default events that are possible within 12 months after the reportingdate. Lifetime expected credit loss represents cash shortfalls that result from all possible default events over the life of the

nancial instrument.

Scope

The proposed guidance will apply to: (a) nancial assets measured at amortized cost under IFRS 9, Financial instruments; (b) nan -cial assets measured at fair value through other comprehensive income under the exposure draft, Classi cation and Measurement:Limited amendments to IFRS 9; (c) loan commitments when there is a present contractual obligation to extend credit (except forloan commitments accounted for at fair value through pro t or loss (FVPL) under IFRS 9); (d) nancial guarantee contracts withinthe scope of IFRS 9 that are not accounted for at FVPL; and (e) lease receivables within the scope of IAS 17, Leases.

Calculation of the impairment

Expected credit losses are determined using an unbiased and probability-weighted approach and should re ect the time value of

money. The calculation is not a best-case or worst-case estimate. Rather, it should incorporate at least the probability that a creditloss occurs and the probability that no credit loss occurs.

Assessment of credit deterioration

When determining whether lifetime expected losses should be recognized, an entity should consider the best information available,including actual and expected changes in external market indicators, internal factors, and borrower-speci c information. Wheremore forward-looking information is not available, delinquency data can be used as a basis for the assessment.

Under the proposed model, there is a rebuttable presumption that lifetime expected losses should be provided for if contractual cashows are 30 days past due. An entity does not recognize lifetime expected credit losses for nancial instruments that are equivalent

to “investment grade.”

Interest income

Interest income is calculated using the effective interest method on the gross carrying amount of the asset. When there is objectiveevidence of impairment (that is, the asset is impaired under the current rules of IAS 39, Financial instruments: Recognition andMeasurement), interest is calculated on the net carrying amount af ter impairment.

Purchased or originated credit impaired assets

Impairment is determined based on full lifetime expected credit losses for assets where there is objective evidence of impairmenton initial recognition. Lifetime expected credit losses are included in the estimated cash ows when calculating the asset’s effectiveinterest rate (“credit-adjusted effective interest rate”), rather than being recognized in pro t or loss. Any later changes in lifetimeexpected credit losses will be recognize immediately in pro t or loss.



104 PwC


Trade and lease receivables

The exposure draft includes a simpli ed approach for trade and lease receivables. An entity should measure impairment losses atan amount equal to lifetime expected losses for short-term trade receivables resulting from transactions within the scope of IAS 18,Revenue. For long-term trade receivables and for lease receivables under IAS 17, an entity has an accounting policy choice betweenthe general model and the model applicable for short-term trade receivables. The use of a provision matrix is allowed, if appropri -ately adjusted to re ect current events and forecast future conditions.

Disclosures

Extensive disclosures are proposed, including reconciliations of opening to closing amounts and disclosure of assumptionsand inputs.

IFRS 9, Financial InstrumentsIFRS 9 replaces the multiple classi cation and measurements bases in IAS 39 with a single model that has two classi cation catego -ries: amortized cost and fair value. Classi cation under IFRS 9 is driven by the entity’s business model for managing the nancialassets and the contractual cash ow characteristics of the nancial assets. A nancial asset is measured at amortized cost if theobjective of the business model is to hold the nancial asset for the collection of the contractual cash ows and such contractualcash ows solely represent payments of principal and interest, interest being the consideration for the time value of money and thecredit risk of the principal amount outstanding; otherwise the nancial asset is measured at fair value.

The new standard further indicates that all equity investments should be measured at fair value. IFRS 9 removes the cost exemptionfor unquoted equities and derivatives on unquoted equities but provides guidance on when cost may be an appropriate estimate offair value. Fair value changes of equity investments are recognized in pro t and loss unless management has elected the option topresent unrealized and realized fair-value gains and losses on equity investments that are not held for trading in OCI. Such designa -tion is available on initial recognition on an instrument-by-instrument basis and is irrevocable. There is no subsequent recycling

of fair-value gains and losses to pro t or loss; however, dividends from such investments will continue to be recognized in pro tor loss.

Under the new model, management may still designate a nancial asset at fair value through pro t or loss on initial recognitionbut only if this signi cantly reduces an accounting mismatch. The designation at fair value through pro t or loss will continue tobe irrevocable. The new standard removes the requirement to separate embedded derivatives from nancial asset hosts. It requiresa hybrid contract to be classi ed in its entirety at either amortized cost or fair value. As many embedded derivatives introduce variability to cash ows, which is not consistent with the notion that the instrument’s contractual cash ows solely represent thepayment of principal and interest, most hybrid contracts with nancial asset hosts will be measured at fair value in their entirety.The reclassi cation between categories is prohibited except in circumstances where the entity’s business model changes.

On December 16, 2011, the IASB issued an amendment to IFRS 9, Financial Instruments , which delays the effective date of IFRS 9to annual periods beginning on or after January 1, 2015. The original effective date was for annual periods beginning on or afterJanuary 1, 2013. Early application of IFRS 9 continues to be permitted.

Joint FASB/IASB redeliberations on their respective classi cation and measurement models

In January 2012, the FASB and the IASB decided to jointly redeliberate selected aspects of the classi cation and measurement guid -ance in IFRS 9 and the FASB’s tentative classi cation and measurement model for nancial instruments (developed through rede -liberations of its May 2010 proposed ASU) to reduce key differences between their respective models. The joint discussions weresuccessful in achieving a broadly converged approach for debt investments. As a result, the FASB issued in February 2013 a revisedproposal for the classi cation and measurement of nancial instruments and the IASB issued in November 2012 its exposure draftproposing limited amendments to IFRS 9 (2010), Financial instruments .



105


PwC

The IASB’s and the FASB’s proposals present the following common aspects regarding the classi cation and measurement of nan -cial assets:

• Contractual cash ow characteristics assessment The FASB adopted the IASB’s instrument characteristics approach for nancial assets. In order for a nancial asset to qualify formeasurement at other than fair value through net income (e.g., amortized cost), the contractual cash ows of the asset mustrepresent solely payments of principal and interest (SPPI). The IASB also decided to make some minor amendments to its appli -cation guidance on the contractual cash ow characteristics assessment in IFRS 9.

• Business model assessment for amortized cost category The Boards decided that nancial assets that meet the SPPI criteria would qualify for amortized cost if the objective of the busi -ness model is to hold those assets to collect contractual cash ows. The Boards also clari ed the primary objective of “hold tocollect” by providing additional implementation guidance on the types of business activities and the frequency and nature of

sales that would prohibit nancial assets from qualifying for the amortized cost category.• Fair value through other comprehensive income (FVOCI) category

The IASB added a FVOCI measurement category as a third measurement category for debt instruments in IFRS 9. The FASB’sproposed classi cation and measurement model also includes such a category. Under both proposals, nancial assets wouldqualify for the FVOCI category, if they are managed within a business model whose objective is both to hold the nancial assetsto collect contractual cash ows and to sell the nancial assets. The fair value through pro t or loss/net income category wouldbe the residual category. See further discussion below on the use of the fair value option. The proposals also provide applicationguidance on the types of business activities that would qualify for the FVOCI business model.

- The FVOCI measurement category would require that:

• Interest income should be recognized in pro t or loss using the effective interest method that is applied to nancial assetsmeasured at amortized cost.

• Credit impairment losses and reversals should be recognized in pro t or loss using the same credit impairment method -

ology as for nancial assets measured at amortized cost.• The cumulative fair value gain or loss recognized in OCI should be recycled from OCI to pro t or loss when the nancial

asset is derecognized.

• The FVOCI category would be available only for debt instruments that pass the contractual cash ow characteristics assess -ment and that are managed within the relevant business model.

• Reclassi cation of nancial assetsThe IASB extended the current reclassi cation requirements in IFRS 9, which require prospective reclassi cation of nancialassets when the business model changes, to the FVOCI category. The FASB’s proposal requires reclassi cation of nancial assets when the business model changes. Changes in the business model requiring reclassi cations are expected to be very infrequentand must be (1) determined by the entity’s senior management as a result of external or internal changes, (2) signi cant to theentity’s operations, and (3) demonstrable to external parties.

• Hybrid nancial assetsBoth Boards’ proposals indicate that hybrid nancial assets with cash ows that are not solely payments of principal and interest would not be eligible for bifurcation. Rather, those nancial assets would be classi ed and measured in their entirety at fair value through pro t or loss/net income.



106 PwC


• Fair value option The IASB extended the current eligibility condition for designating nancial assets at fair value through pro t or loss (i.e. whendoing so eliminates or signi cantly reduces an accounting mismatch) on initial recognition in the FVOCI category Under theFASB’s model, a group of nancial assets and nancial liabilities may be designated irrevocably at initial recognition at fair valuethrough net income at initial recognition, if both of the following conditions are met:

- The entity manages the net exposure relating to those nancial assets and nancial liabilities (which may be derivative instru -ments); and

- The entity provides information on that basis to the reporting entity’s management.

- Current US GAAP includes an unconditional fair value option for nancial assets.

The following main differences between the FASB’s and IASB’s accounting models for nancial assets would remain:

• Equity investment held (not under equity method)Under the FASB’s proposal, all equity instruments not accounted for under the equity method would be required to be measuredat fair value with changes in fair value recognized in net income with no option to elect for the changes in fair value to be recog-nized in OCI. However, entities would be permitted to measure nonmarketable equity securities at cost less any impairment plusupward or downward adjustments when information about a change in price is observable as a practicability exception. TheFASB retained the current scope for the equity method of accounting unless the investment is “held for sale,” in which case a fair value through net income measurement would be required. The unrestricted fair value option is eliminated.

Under IFRS 9, all equity instruments will be measured at fair value with changes in fair value recognized in net income if heldfor trading. Investments in equity instruments not held for trading may be designated irrevocably at fair value with changes infair value recognized in OCI (irrevocable instrument-by-instrument election at inception). If the irrevocable election is made,dividends are recognized through net income, and there is no impairment or realized gain or loss recognition in net income when sold. However, IFRS 9 indicates that, in limited circumstances, cost may be an appropriate fair value, for example, wheninsuf cient more recent information is available from which to determine fair value, or when there is a wide range of possiblefair value measurements and cost represents the best estimate of fair value within that range. IFRS 9 does not change the scopeof the equity method of accounting.

• Fair value option for nancial assets Based on the FASB’s proposed classi cation and measurement model, a group of nancial assets and nancial liabilities may bedesignated irrevocably at fair value through net income at initial recognition, if both of the following conditions are met:

- The entity manages the net exposure relating to those nancial assets and nancial liabilities (which may be derivative instru -ments); and

- The entity provides information on that basis to the reporting entity’s management.

- Based on the IASB’s proposal, an irrevocable fair-value election at initial recognition can be made for debt investments that would be otherwise measured at amortized cost or at FVOCI if measuring them at fair value through pro t or loss eliminatesor signi cantly reduces an accounting mismatch.

Refer to the Financial liabilities and equity chapter for the recent redeliberations on classi cation and measurement ofnancial liabilities.



107


PwC

FASB Proposed ASU: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities and IASB draft of forthcoming new hedge accounting requirements

Refer to the Derivatives and hedging chapter for discussion of the proposals.

FASB Proposed ASU— Transfers and Servicing (Topic 860): Effective Control for Transfers with Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings

In January 2013, the FASB issued an exposure draft to amend the accounting for repurchase agreements (“repos”) in an effortto identify those transactions that should be accounted for as a secured borrowing and to improve the associated accounting anddisclosure requirements.

This project began from a request that the FASB review the accounting for a particular type of repurchase agreement referred toas a repo-to-maturity. As part of its research, the FASB staff engaged in discussions with nancial statement users, preparers, andaccounting rms to better understand these transactions and the associated accounting.

The proposed amendment would require that a transfer of an existing nancial asset with an agreement that both entitles andobligates the transferor to repurchase or redeem the transferred asset from the transferee with all of the following characteristics beaccounted for as a secured borrowing:

1. The nancial asset to be repurchased at settlement of the agreement is identical to or substantially the same as the nancial assettransferred at inception or, when settlement of the forward agreement to repurchase or redeem the transferred assets is at matu-rity of the transferred assets, the agreement is settled through an exchange of cash (or a net amount of cash).

2. The repurchase price is xed or readily determinable.

3. The agreement to repurchase the transferred nancial asset is entered into contemporaneously with, or in contemplation of, theinitial t ransfer.

As a result, repo-to-maturity transactions, which may currently be accounted for as sales with an obligation to repurchase, are nowlikely to be accounted for as secured borrowings. Arrangements that do not meet the above criteria will be evaluated under theexisting guidance for transfers of nancial assets.

The FASB also proposes certain clari cations to the characteristics to qualify as “substantially the same.”

Repurchase nancing agreements

The proposed amendment eliminates the current model for repurchase nancings that are de ned as a transfer of a nancial assetback to the party from whom it was purchased as collateral for a nancing transaction. The current model requires a determinationof whether repurchase agreements entered into as part of a repurchase nancing should be accounted for separately or as a linkedtransaction. This amendment will require that the initial transfer and repurchase agreement be evaluated separately under the saleaccounting criteria.

DisclosuresThe proposal requires additional disclosures for repurchase agreements and similar transactions depending on if the transaction istreated as a sale or a secured borrowing.

While this is a FASB-only project, it could result in greater consistency in the accounting for repurchase transactions under US GAAPand IFRS, even though the underlying approach differs. IFRS requires a “risk and rewards” approach that generally results intreating repurchase agreements as secured borrowings.



Liabilities



110 PwC


Liabilities—taxes

Although the two frameworks share many fundamental principles, they are at times applied in different manners and there aredifferent exceptions to the fundamental principles under each framework. Differences in the calculations of current and deferred taxeslikely will result in a number of required adjustments in a company’s income tax accounts. After releasing an exposure draft in 2009and receiving comments thereon, the IASB decided to amend and narrow its project on income tax accounting (see Recent/proposedguidance section below). This chapter describes some of the more signi cant existing differences between the two frameworks.

US GAAP includes detailed guidance surrounding the accounting for uncertainty in income taxes. No similar guidance has been issuedby the IASB, though in the IASB’s amended project on income taxes, accounting for uncertain tax positions is included. As the stan -

dards currently exist, differences in respect of recognition, unit-of-account and measurement methodology for uncertain tax positionsmay result in varying outcomes under the two frameworks.

Under US GAAP, any income tax effects resulting from intragroup pro ts are deferred at the seller’s tax rate and recognized uponsale to a third party or other recovery. IFRS requires the recording of deferred taxes based on the buyer’s tax rate at the time of theinitial transaction.

The tax rate applied when calculating deferred and current taxes might differ depending upon the framework used. In addition, underIFRS, a single asset or liability may have more than one tax basis, whereas there would generally be only one tax basis per asset orliability under US GAAP.

Differences in subsequent changes to deferred taxes recorded for certain equity-related items could result in less volatility in theincome statement under IFRS. At the same time, the opposite impact (i.e., additional volatility) could result when share-based equity

awards are considered. Under both US GAAP and IFRS, entities generally record their deferred taxes initially through the income state -ment unless the related item was recorded directly into equity (including other comprehensive income) or in acquisition accounting.Under IFRS, all future increases or decreases in equity-related deferred tax asset or liability accounts are traced back to equity. UnderUS GAAP, however, subsequent changes arising as a result of tax rate and law changes on deferred taxes are recorded through theincome statement even if the related deferred taxes initially arose in equity.

Presentation differences related to deferred taxes could affect the calculation of certain ratios from the face of the balance sheet—including a company’s current ratio—because IFRS requires all deferred taxes to be classi ed as noncurrent.




111

Liabilities—taxes

PwC

Impact US GAAP IFRS

Uncertain tax positions

Differences with respect to recognition,unit-of-account, measurement, method-ology, and the treatment of subsequentevents may result in varying outcomesunder the two frameworks.

Uncertain tax positions are recognizedand measured using a two-step process:(1) determine whether a bene t may berecognized and (2) measure the amountof the bene t. Tax bene ts from uncer -tain tax positions may be recognizedonly if it is more likely than not that thetax position is sustainable based on itstechnical merits.

Uncertain tax positions are evaluated atthe individual tax position level.

The tax bene t is measured by using acumulative probability model: the largestamount of tax bene t that is greater than50 percent likely of being realized uponultimate settlement.

Relevant developments affecting uncer-tain tax positions after the balance sheetdate but before issuance of the nancialstatements (including the discovery of

information that was not available as ofthe balance sheet date) would be consid-ered a nonrecognized subsequent eventfor which no effect would be recorded inthe current-period nancial statements.

Accounting for uncertain tax positions isnot speci cally addressed within IFRS.The tax consequences of events shouldfollow the manner in which an entityexpects the tax position to be resolved with the taxation authorities at thebalance sheet date.

Practice has developed such that uncer -

tain tax positions may be evaluated atthe level of the individual uncertaintyor group of related uncertainties. Alternatively, they may be consideredat the level of total tax liability to eachtaxing authority.

Acceptable methods by which to measuretax positions include (1) the expected- value/probability-weighted-averageapproach and (2) the single-best-outcome/most-likely-outcome method.Use of the cumulative probability modelrequired by US GAAP is not supportedby IFRS.

Relevant developments affecting uncer-tain tax positions occurring after thebalance sheet date but before issuance ofthe nancial statements (including thediscovery of information that was notavailable as of the balance sheet date) would be considered either an adjustingor nonadjusting event depending on whether the new information providesevidence of conditions that existed at theend of the reporting period.



112 PwC


Impact US GAAP IFRS

Unrealized intragroup prots

The frameworks require differentapproaches when current and deferredtaxes on unrealized intragroup activityare considered.

For purposes of the consolidated nancialstatements, any tax impacts to the selleras a result of an intercompany sale aredeferred until realized by third-party saleor otherwise recovered (e.g., amortizedor impaired). In addition, the buyer isprohibited from recognizing a deferredtax asset resulting from the differencebetween the tax basis and consolidatedcarrying amount of the asset.

Any tax impacts to the seller as a result ofthe intercompany transaction are recog-nized as incurred.

Deferred taxes resulting from the intra-group sale are recognized at the buyer’stax rate.

Intraperiod allocations

Differences in subsequent changesto deferred taxes could result in less volatility in the statement of operationsunder IFRS.

Subsequent changes in deferred taxbalances due to enacted tax rate and taxlaw changes are taken through the incomestatement regardless of whether thedeferred tax was initially created throughthe income statement, through equity, orin acquisition accounting.

Changes in the amount of valuation allow-ance due to changes in assessment aboutrealization in future periods are generallytaken through the income statement, withlimited exceptions for certain equity-related items.

Subsequent changes in deferred taxbalances are recognized in the incomestatement, except to the extent that thetax arises from a transaction or event thatis recognized, in the same or a differentperiod, either in other comprehensiveincome or directly in equity.

Deferred taxes on investmentsin subsidiaries, joint ventures,and equity investees

Differences in the recognition criteriasurrounding undistributed pro ts andother outside basis differences couldresult in changes in recognized deferred

taxes under IFRS.

With respect to undistributed pro ts andother outside basis differences, differentrequirements exist depending on whetherthey involve investments in subsidiaries,

joint ventures, or equity investees.

As it relates to investments in domesticsubsidiaries, deferred tax liabilitiesare required on undistributed pro tsarising after 1992 unless the amountscan be recovered on a tax-free basis andunless the entity anticipates utilizingthat method.

With respect to undistributed pro ts andother outside basis differences relatedto investments in foreign and domesticsubsidiaries, branches and associates, and

interests in joint arrangements, deferredtaxes are recognized except when a parentcompany (investor or venturer) is ableto control the timing of reversal of thetemporary difference and it is probablethat the temporary difference will notreverse in the foreseeable future.



113

Liabilities—taxes

PwC

Impact US GAAP IFRS

Deferred taxes on investments insubsidiaries, joint ventures, and equityinvestees (continued)

As it relates to investments in domesticcorporate joint ventures, deferred taxliabilities are required on undistributedpro ts that arose after 1992.

No deferred tax liabilities are recognizedon undistributed pro ts and other outsidebasis differences of foreign subsidiariesand corporate joint ventures that meet theinde nite reversal criterion.

Deferred taxes are generally recognizedon temporary differences related toinvestments in equity investees.

US GAAP contains speci c guidanceon how to account for deferred taxes when there is a change in the status ofan investment. A deferred tax liabilityrelated to undistributed pro ts of a priorforeign investee that would not otherwisebe required after the foreign investeebecomes a subsidiary is “frozen.” Thedeferred tax liability continues to berecognized to the extent that dividendsfrom the subsidiary do not exceed theparent company’s share of the subsidiary’searnings subsequent to the date it becamea subsidiary, until the disposition ofthe subsidiary.

Deferred tax assets for investments insubsidiaries and corporate joint venturesmay be recorded only to the extent they will reverse in the foreseeable future.

There is no speci c guidance under IFRSon the accounting for a deferred taxliability when there is a change in thestatus of an investment from an associateto a subsidiary. The general guidanceregarding deferred taxes on undistributedpro ts should be applied.

Deferred tax assets for investmentsin foreign and domestic subsidiaries,branches and associates, and interests

in joint arrangements are recorded onlyto the extent that it is probable that thetemporary difference will reverse in theforeseeable future and taxable pro t willbe available against which the temporarydifference can be utilized.

Recognition of deferredtax assets

The frameworks take differing approachesto the presentation of deferred tax assets.It would be expected that net deferred taxassets recorded would be similar underboth standards.

Deferred tax assets are recognized infull, but are then reduced by a valuationallowance if it is considered more likelythan not that some portion of the deferredtaxes will not be realized.

Deferred tax assets are recognized tothe extent that it is probable (de ned as“more likely than not”) that suf cienttaxable pro ts will be available to utilizethe deductible temporary difference orunused tax losses. Valuation allowancesare not allowed to be recorded.



114 PwC


Impact US GAAP IFRS

Tax rate applied to current anddeferred taxes

The impact on deferred and currenttaxes as a result of changes in tax lawsimpacting tax rates may be recognizedearlier under IFRS. Special deductionsand tax holidays may be treated differ-ently under IFRS.

US GAAP requires the use of enactedrates when calculating current anddeferred taxes.

The bene t of deductions based onnancial statements line items or nancial

indicators rather than on actual expen-ditures (“special deductions”) ordinarily

is recognized no earlier than the yearin which those special deductions aredeductible on the tax return.

However, some portion of the futuretax effects of special deductions areimplicitly recognized in determining theaverage graduated tax rate to be used formeasuring deferred taxes when gradu-ated tax rates are a signi cant factor andthe need for a valuation allowance fordeferred tax assets exists.

The effect of a tax holiday or extension

of a tax holiday should be recognizedin the deferred tax computation uponreceipt of the last necessary approval forthe tax holiday (or extension). In addi -tion, for differences between book basisand tax basis of assets and liabilitiesthat are scheduled to reverse during thetax holiday, deferred taxes should bemeasured based on the conditions of thetax holiday.

Current and deferred tax is calcu-lated using enacted or substantivelyenacted rates.

There is no speci c guidance under IFRSon the treatment of special deductions ortax holidays.



115

Liabilities—taxes

PwC

Impact US GAAP IFRS

Tax rate on undistributedearnings of a subsidiary

In the case of dual rate tax jurisdiction,the tax rate to be applied on inside basisdifference and outside basis differencein respect of undistributed earnings maydiffer between US GAAP and IFRS.

For jurisdictions that have a tax systemunder which undistributed pro ts aresubject to a corporate tax rate higher thandistributed pro ts, effects of temporarydifferences should be measured usingthe undistributed tax rate. Tax bene tsof future tax credits that will be realized when the income is distributed cannotbe recognized before the period in whichthose credits are included in the entity’stax return.

A parent company with a subsidiaryentitled to a tax credit for dividends paidshould use the distributed rate whenmeasuring the deferred tax effects relatedto the operations of the foreign subsidiary.However, the undistributed rate should beused in the consolidated nancial state -ments if the parent, as a result of applyingthe inde nite reversal criteria, has not

provided for deferred taxes on the unre-mitted earnings of the foreign subsidiary.

For jurisdictions where the undistributedrate is lower than the distributed rate, theuse of the distributed rate is preferablebut the use of the undistributed rate isacceptable provided appropriate disclo-sures are added.

Where income taxes are payable at ahigher or lower rate if part or all of the netpro t or retained earnings are distributedas dividends, deferred tax assets andliabilities are measured at the tax rateapplicable to undistributed pro ts.

However, in consolidated nancial state -

ments, where a parent has a subsidiary ina dual-rate tax jurisdiction and does notexpect to re-invest the earnings perma-nently, it measures the temporary differ-ences related to the investment in theforeign subsidiary at the rate that wouldapply to distributed pro ts.



116 PwC


Impact US GAAP IFRS

Initial recognition of an assetor liability

In certain situations, there will be nodeferred tax accounting under IFRSthat would exist under US GAAP and vice versa.

A temporary difference may arise oninitial recognition of an asset or liability.In asset purchases that are not businesscombinations, a deferred tax asset orliability is recorded with the of fset gener-ally recorded against the assigned value ofthe asset. The amount of the deferred taxasset or liability is determined by using asimultaneous equations method.

An exemption exists from the initialrecognition of temporary differencesin connection with transactions thatqualify as leveraged leases underlease-accounting guidance.

An exemption exists in the accounting fordeferred taxes from the initial recogni-tion of an asset or liability in a transactionthat neither is a business combination noraffects accounting pro t or taxable pro t/loss at the time of the transaction.

No special treatment of leveraged leases

exists under IFRS.

Recognition of deferred taxeswhere the local currency is notthe functional currency

US GAAP prohibits the recognition of

deferred taxes on exchange rate changesand tax indexing related to nonmonetaryassets and liabilities in foreign currency while it is required under IFRS.

No deferred taxes are recognized for

differences related to nonmonetaryassets and liabilities that are remeasuredfrom local currency into their functionalcurrency by using historical exchangerates (if those differences result fromchanges in exchange rates or indexing fortax purposes).

Deferred taxes are recognized for the

difference between the carrying amountdetermined by using the historical rate ofexchange and the relevant tax basis at thebalance sheet date, which may have beenaffected by exchange rate movements ortax indexing.



117

Liabilities—taxes

PwC

Impact US GAAP IFRS

Presentation

Presentation differences related todeferred taxes could affect the calcula-tion of certain ratios from the face of thebalance sheet (including a company’scurrent ratio) because IFRS requiresall deferred taxes to be classi edas noncurrent.

The classi cation of deferred tax assetsand deferred tax liabilities follows theclassi cation of the related asset orliability for nancial reporting (as eithercurrent or noncurrent). If a deferred taxasset or liability is not associated with anunderlying asset or liability, it is classi-

ed based on the anticipated reversalperiods. Within an individual tax jurisdic -tion, current deferred taxes are generallyoffset and classi ed as a single amountand noncurrent deferred taxes areoffset and classi ed as a single amount. Any valuation allowances are allocatedbetween current and noncurrent deferredtax assets for a tax jurisdiction on a prorata basis.

A liability for unrecognized tax bene ts isclassi ed as a current liability only to theextent that cash payments are anticipated within 12 months of the reporting date.

Otherwise, such amounts are re ected asnoncurrent liabilities.

The classi cation of interest and penaltiesrelated to uncertain tax positions (eitherin income tax expense or as a pretaxitem) represents an accounting policydecision that is to be consistently appliedand disclosed.

Generally, deferred tax assets anddeferred tax liabilities are classi ed net(within individual tax jurisdictions andif there is a legally enforceable right tooffset) as noncurrent on the balancesheet. Supplemental note disclosuresare included to describe the compo-nents of temporary differences as wellas the recoverable amount bifurcatedbetween amounts recoverable less thanor greater than one year from the balancesheet date.

A liability for uncertain tax positions isgenerally classi ed as a current liability(because entities typically do not have theunconditional right to defer settlement ofuncertain tax positions for at least twelvemonths after the reporting period).

Interest and penalties related to taxation(e.g., uncertain tax positions) may be:

• classi ed as nance or other operatingexpenses when they can be clearlyidenti ed and separated from therelated tax liability; or

• included in the tax line if they cannotbe separated from the taxes, or asmatter of accounting policy.

The accounting policy decision should beconsistently applied and disclosed.



118 PwC


Impact US GAAP IFRS

Tax basis

Under IFRS, a single asset or liability mayhave more than one tax basis, whereasthere would generally be only one taxbasis per asset or liability under US GAAP.

Tax basis is based upon the relevanttax law. It is generally determined bythe amount that is depreciable for taxpurposes or deductible upon sale orliquidation of the asset or settlement ofthe liability.

Tax basis is based on the expected mannerof recovery. Assets and liabilities may havea dual manner of recovery (e.g., throughuse and through sale). In that case, thecarrying amount of the asset or liabilityis bifurcated, resulting in more than asingle temporary difference related tothat item. A rebuttable presumption existsthat investment property measured at fair value will be recovered through sale.

Interim reporting

A worldwide effective tax rate is usedto record interim tax provisions underUS GAAP. Under IFRS, a separateannual effective tax rate is used foreach jurisdiction.

In general, the interim tax provision isdetermined by applying the estimatedannual worldwide effective tax rate forthe consolidated entity to the worldwideconsolidated year-to-date pretax income.

The interim tax provision is determinedby applying an estimated annual effectivetax rate to interim period pretax income.To the extent practicable, a separate esti-mated average annual effective incometax rate is determined for each taxing jurisdiction and applied individuallyto the interim period pretax income ofeach jurisdiction.

Share-based payment arrangements

Signi cant differences in deferred taxes exist between US GAAP and IFRS with respect to share-based payment arrangements.The relevant differences have been described in the Expense recognition—share-based payments chapter.


IFRS IAS 1, IAS 12, IAS 34, IAS 37

US GAAP ASC 718-740, ASC 740

Note

The foregoing discussion captures a number of the more signi cant GAAP differences. It is important to note that the discussion isnot inclusive of all GAAP/IFRS differences in this area.



120 PwC


FAF post-implementation review

On February 4, 2013, the Financial Accounting Foundation (FAF) announced that it would conduct a post-implementation review(PIR) on ASC 740. A review of the standard has been recommended by many organization and stakeholders. FAF solicits input from

nancial statement users and preparers, accounting practitioners, academia and regulatory bodies. Its observations and ndingscould impact the future direction of accounting for income taxes. The FAF is expected to release its report on the results of the PIRin November, 2013.

FASB Exposure Draft, Financial instruments classication and measurement

In May 2010.as part of its proposal on classi cation and measurement of nancial instruments, the FASB sought to eliminate diver -sity in practice as it relates to assessing the need for a valuation allowance on deferred tax assets that arise from unrealized losses ondebt investments measured at fair value through other comprehensive income. The FASB proposed that the assessment of whether

a valuation allowance is required for deferred tax assets that arise from such losses be evaluated in combination with other deferredtax assets of an entity.

During redeliberations, the FASB changed course in relation to the treatment of these deferred tax assets. In February 2013, theFASB issued a new exposure draft. Under the revised proposal, an entity would assess the need for a valuation allowance on itsdeferred tax assets arising from such debt investment losses separately from its other deferred tax assets. In order to avoid recordinga valuation allowance, an entity would need to assert that it has the intent and ability to hold the investments to maturity (orrecovery).

The effective date for this new standard will be decided during nal deliberations on the project.

In May 2013, the IFRS Interpretations Committee recommended the IASB amend IAS 12 to clarify that deferred tax assets forunrealized losses on debt instruments are recognised, unless recovering the debt instrument by holding it until an unrealized lossreverses does not reduce future tax payments and instead only avoids higher tax losses. This recommendation would not always

achieve an outcome for deferred tax accounting that would be consistent with the one proposed by the FASB. Accordingly, theIFRS IC decided to consult with the IASB on the approach that is to be the basis for the amendment before discussing further detailsand drafting a proposed amendment.



121PwC

Liabilities—other

Liabilities—other

The guidance in relation to non nancial liabilities (e.g., provisions, contingencies, and government grants) includes some fundamentaldifferences with potentially signi cant implications.

For instance, a difference exists in the interpretation of the term “probable.” IFRS de nes probable as “more likely than not,” butUS GAAP de nes probable as “likely to occur.” Because both frameworks reference probable within the liability recognition criteria,this difference could lead companies to record provisions earlier under IFRS than they otherwise would have under US GAAP. The useof the midpoint of a range when several outcomes are equally likely (rather than the low-point estimate, as used in US GAAP) mightalso lead to increased or earlier expense recognition under IFRS.

IFRS does not have the concept of an ongoing termination plan, whereas severance is recognized under US GAAP once probable andreasonably estimable. This could lead companies to record restructuring provisions in periods later than they would under US GAAP.

As it relates to reimbursement rights, IFRS has a higher threshold for the recognition of reimbursements of recognized losses byrequiring that they be virtually certain of realization, whereas the threshold is lower under US GAAP.




122 PwC


Impact US GAAP IFRS

Recognition of provisions

Differences in the de nition of “probable”may result in earlier recognition of liabili-ties under IFRS.

The IFRS “present obligation” criteriamight result in delayed recognition ofliabilities when compared with US GAAP.

A loss contingency is an existing condi-tion, situation, or set of circumstancesinvolving uncertainty as to possible loss toan entity that will ultimately be resolved when one or more future events occur orfail to occur.

An accrual for a loss contingency isrequired if two criteria are met: (1) if it is

probable that a liability has been incurredand (2) the amount of loss can be reason -ably estimated.

Implicit in the rst condition above isthat it is probable that one or more futureevents will occur con rming the fact ofthe loss.

The guidance uses the term “probable” todescribe a situation in which the outcomeis likely to occur. While a numeric stan -dard for probable does not exist, practicegenerally considers an event that has a

75 percent or greater likelihood of occur -rence to be probable.

A contingent liability is de ned as apossible obligation whose outcome willbe con rmed only by the occurrence ornonoccurrence of one or more uncertainfuture events outside the entity’s control.

A contingent liability is not recognized. A contingent liability becomes a provi-sion and is recorded when three criteria

are met: (1) a present obligation from apast event exists, (2) it is probable thatan out ow of resources will be requiredto settle the obligation, and (3) a reliableestimate can be made.

The term “probable” is used for describinga situation in which the outcome is morelikely than not to occur. Generally, thephrase “more likely than not” denotes anychance greater than 50 percent.

Measurement of provisions

In certain circumstances, the measure-ment objective of provisions varies underthe two frameworks.

IFRS results in a higher liability beingrecorded when there is a range of possibleoutcomes with equal probability.

A single standard does not exist to deter-mine the measurement of obligations.Instead, entities must refer to guidanceestablished for speci c obligations(e.g., environmental or restruc -turing) to determine the appropriatemeasurement methodology.

Pronouncements related to provisions

do not necessarily have settlement priceor even fair value as an objective in themeasurement of liabilities, and the guid-ance often describes an accumulation ofthe entity’s cost estimates.

When no amount within a range is abetter estimate than any other amount,the low end of the range is accrued.

The amount recognized should be the bestestimate of the expenditure required (theamount an entity would rationally pay tosettle or transfer to a third party the obli-gation at the balance sheet date).

Where there is a continuous range ofpossible outcomes and each point inthat range is as likely as any other, the

midpoint of the range is used.



123

Liabilities—other

PwC

Impact US GAAP IFRS

Discounting of provisions

Provisions will be discounted morefrequently under IFRS. At the same time,greater charges will be re ected as oper -ating (versus nancing) under US GAAP.

For losses that meet the accrual criteria of ASC 450, an entity will generally recordthem at the amount that will be paid tosettle the contingency, without consid-ering the time that may pass before theliability is paid. Discounting these liabili -ties is acceptable when the aggregateamount of the liability and the timing ofcash payments for the liability are xed ordeterminable. Entities with these liabili -ties that are eligible for discounting arenot, however, required to discount thoseliabilities; the decision to discount is anaccounting policy choice.

The classi cation in the statement ofoperations of the accretion of the liabilityto its settlement amount is an accountingpolicy decision that should be consistentlyapplied and disclosed.

When discounting is applied, the discountrate applied to a liability should notchange from period to period if theliability is not recorded at fair value.

There are certain instances outside of ASC 450 (e.g., in the accounting for assetretirement obligations) where discountingis required.

IFRS requires that the amount of a provi-sion be the present value of the expendi-ture expected to be required to settle theobligation. The anticipated cash ows arediscounted using a pre-tax discount rate(or rates) that re ect(s) current marketassessments of the time value of moneyand the risks speci c to the liability (for which the cash ow estimates have notbeen adjusted) if the effect is material.

Provisions shall be reviewed at the endof each reporting period and adjustedto re ect the current best estimate. Thecarrying amount of a provision increasesin each period to re ect the passage oftime with said increase recognized as aborrowing cost.



124 PwC


Impact US GAAP IFRS

Restructuringprovisions (excludingbusiness combinations)

IFRS does not have the concept of anongoing termination plan, whereas aseverance liability is recognized underUS GAAP once it is probable and reason -ably estimable. This could lead compa -nies to record restructuring provisionsin periods later than they would underUS GAAP.

Guidance exists for different types oftermination bene ts (i.e., special termi -nation bene ts, contractual terminationbene ts, severance bene ts, and one-timebene t arrangements).

If there is a pre-existing arrangement such

that the employer and employees havea mutual understanding of the bene tsthe employee will receive if involuntarilyterminated, the cost of the bene ts areaccrued when payment is probable andreasonably estimable. In this instance,no announcement to the workforce (norinitiation of the plan) is required prior toexpense recognition.

Involuntary termination bene ts, whichhave no future service requirement, arerecognized when the termination planhas been communicated to the affectedemployees and the plan meets speci edcriteria. This guidance applies to all termi -nation bene ts.



125

Liabilities—other

PwC

Impact US GAAP IFRS

Onerous contracts

Onerous contract provisions may berecognized earlier and in differentamounts under IFRS.

Provisions are not recognized for unfavor -able contracts unless the entity has ceasedusing the rights under the contract(i.e., the cease-use date).

One of the most common examples of anunfavorable contract has to do with leasedproperty that is no longer in use. Withrespect to such leased property, estimated

sublease rentals are to be considered ina measurement of the provision to theextent such rentals could reasonably beobtained for the property, even if it isnot management’s intent to sublease orif the lease terms prohibit subleasing.Incremental expense in either instance isrecognized as incurred.

Recording a liability is appropriate only when a lessee permanently ceases use offunctionally independent assets(i.e., assets that could be fully utilizedby another party).

US GAAP generally does not allow therecognition of losses on executorycontracts prior to such costsbeing incurred.

Provisions are recognized when a contractbecomes onerous regardless of whetherthe entity has ceased using the rightsunder the contract.

When an entity commits to a plan to exita lease property, sublease rentals areconsidered in the measurement of anonerous lease provision only if manage-

ment has the right to sublease and suchsublease income is probable.

IFRS requires recognition of an onerousloss for executory contracts if the unavoid-able costs of meeting the obligationsunder the contract exceed the economicbene ts expected to be received under it.



127

Liabilities—other

PwC

Impact US GAAP IFRS

Reimbursement and contingent assets(continued)

Contingent assets— Contingent assetsare not recognized in nancial statementsbecause this may result in the recognitionof income that may never be realized. Ifthe in ow of economic bene ts is prob -able, the entity should disclose a descrip-tion of the contingent asset. However, when the realization of income is virtuallycertain, then the related asset is not acontingent asset, and its recognitionis appropriate.


IFRS IAS 19, IAS 20, IAS 37

US GAAP ASC 410-20, ASC 410-30, ASC 420, ASC 450-10, ASC 450-20, ASC 460-10, ASC 944-40, ASC 958-605

Note



IASB Interpretation, IFRIC 21, Levies

In May 2013, the IASB issued IFRIC 21, ‘Levies’, an interpretation on the accounting for levies imposed by governments. Leviesare de ned as transfer of resources imposed by government on entities in accordance with laws and/or regulations, other thanthose within the scope of other standards (such as IAS 12); and nes or other penalties imposed for breaches of the laws and/or regulations

IFRIC 21 is an interpretation of IAS 37, ‘Provisions, contingent liabilities and contingent assets’. The interpretation clari es that theobligating event that gives rise to a liability to pay a levy is the activity described in the relevant legislation that triggers the paymentof the levy. The fact that an entity is economically compelled to continue operating in a future period, or prepares its nancial state -

ments under the going concern principle, does not create an obligation to pay a levy that will ar ise from operating in the future. Theinterpretation also clari es that a liability to pay a levy is recognised when the obligating event occurs, at a point in time or progres -sively over time, and that an obligation to pay a levy triggered by a minimum threshold is recognised when the threshold is reached.

IFRIC 21 is effective for annual periods beginning on or after 1 January 2014 and should be applied retrospectively.

There is no speci c guidance on this topic under US GAAP.



128 PwC


FASB Accounting Standard Updates No. 2013-04, Obligations Resulting from Joint and Several Liabili ty Arrangementsfor Which the Total Amount of the Obligation is Fixed at the Reporting Date

In February 2013, the FASB issued ASU 2013-04 which amends ASC 405, Liabilities . The objective of the amendments is to provideguidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangementsfor which the total amount of the obligation within the scope of this guidance is xed at the reporting date, except for obligationsaddressed within existing guidance.

The guidance in this Update requires an entity to measure those obligations as the sum of the amount the reporting entity agreed topay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalfof its co-obligors. It also requires an entity to disclose the nature and amount of the obligation as well as other information aboutthose obligations.

The amendments are effective for scal years beginning after December 15, 2013 (public entities) and for scal years ending afterDecember 15, 2014 (non public entities). They should be applied retrospectively to all prior periods presented for those obligations within the Update’s scope that exist at the beginning of an entity’s scal year of adoption. Early adoption is permitted.

IFRS does not have speci c guidance on recognition, measurement, and disclosure of obligations resulting from joint and severalliability arrangements included in the scope of this Update. Under IAS 37, Provisions, Contingent Liabilities and Contingent Asset s, anentity is required to treat the part of a joint and several liability that is expected to be met by other parties as a contingent liability.

FASB Expected Exposure Draft, Disclosure of Certain Loss Contingencies

Nearly two years after issuing its original proposal to enhance disclosures of loss contingencies, the FASB issued an exposure draftof a proposed ASU, Contingencies — Disclosure of Certain Loss Contingencies , in July 2010. The objective of the board is to requireenhanced disclosure of certain loss contingencies under ASC Topic 450, Contingencies , including litigation, environmental remedia-tion, and product warranty liabilities.

The proposed disclosures consist of qualitative and quantitative information about loss contingencies that will enable nancialstatement users to understand their nature, potential magnitude, and potential timing (if known). The disclosures would includepublicly available quantitative information, such as the claim amount for asserted litigation contingencies, other relevant nonprivi-leged information about the contingency, and, in some cases, information about possible recoveries from insurance and othersources. Public companies would be required to provide a tabular reconciliation (i.e., a rollforward) of recognized loss contingen -cies from the beginning to the end of the reporting period.

The comment period for the proposal ended in September 2010, and the board received approximately 380 comment letters.In November 2010, the board discussed its plan for redeliberations. At that time, the board acknowledged the concerns of someconstituents that insuf cient loss contingency disclosures may indicate a compliance issue with the existing guidance rather than aneed for a new standard. The board also acknowledged the recent initiatives by the SEC staf f to improve compliance with the guid -ance in this area through emphasis in comment letters, speeches, a “Dear CFO” letter issued in October 2010, and other means. Inlight of the SEC staff’s emphasis, the board decided to evaluate whether there is improved disclosure of loss contingencies during

the 2010 year-end nancial reporting cycle. In the meantime, this project has been put on hold. Future direction of the projectremains unclear.



Financial liabilities and equity



130 PwC

IFRS and US GAAP: similarities and differencesIFRS and US GAAP: similarities and differences


Under current standards, both US GAAP and IFRS de ne nancial liabilities and require that instruments be assessed to determine whether they meet the de nition of and require treatment as nancial liabilities. In very general terms, nancial instruments that donot meet the de nition of a nancial liability are classi ed as equity (or mezzanine equity under US GAAP only). The US GAAP de ni -tions of what quali es as or requires treatment as a nancial liability are more speci c than the IFRS de nitions. The speci c US GAAPde nitions of what requires nancial liability classi cation result in more instruments being treated as equity/mezzanine equity underUS GAAP and comparatively more instruments being treated as nancial liabilities under IFRS.

Under IFRS, instruments with contingent settlement provisions and puttable instruments are more likely to result in nancial liability

classi cation. When assessing contingent settlement provisions, IFRS focuses on whether the issuer of an instrument has the uncondi -tional right to avoid delivering cash or another nancial asset in any or all potential outcomes. The fact that the contingency associated with the settlement provision might not be triggered does not in uence the analysis unless the contingency is not genuine or it arisesonly upon liquidation. With very limited exceptions, puttable instruments are nancial liabilities under IFRS.

US GAAP examines whether the instrument in question contains an unconditional redemption requirement. Unconditional redemptionrequirements result in nancial liability classi cation. Contingent settlement/redemption requirements and/or put options, however,generally would not be unconditional, as they may not occur. As such, under US GAAP, nancial liability classi cation would not berequired. SEC-listed entities, however, would need to consider the application of mezzanine equity accounting guidance. When aninstrument that quali ed for equity treatment under US GAAP is classi ed as a nancial liability under IFRS, there are potential follow-on implications. For example, an entity must consider and address the further potential need to bifurcate and separately account forembedded derivatives within liability-classi ed host contracts. Also, because the balance sheet classi cation drives the treatment ofdisbursements associated with such instruments, classi cation differences may impact earnings (i.e., interest expense calculated by

using the effective interest method, as opposed to dividends) as well as key balance sheet ratios.

Under IFRS, if an instrument has both a nancial liability component and an equity component (e.g., redeemable preferred stock withdividends paid solely at the discretion of the issuer), the issuer is required to separately account for each component. The liabilitycomponent is recognized at fair value calculated by discounting the cash ows associated with the liability component at a market ratefor a similar debt host instrument, and the equity component is measured as the residual amount. US GAAP generally does not have theconcept of compound nancial instruments outside of instruments with equity conversion features.

For hybrid instruments that contain equity conversion options, IFRS requires split accounting of the equity conversion feature (eitheras an equity component or as a derivative if the de nition of equity is not met) and the debt host. While there are circumstances whereUS GAAP also requires split accounting, there are also circumstances under which the instrument is accounted for entirely as a liabilityand the conversion option is not separated.



131


PwC

Bifurcation/split accounting under IFRS versus singular accounting under US GAAP can create a signi cantly different balance sheetpresentation while also impacting earnings (mainly due to recognition of interest expense at the market rate at inception as opposed toany contractual rate within the compound arrangement).

Whether an instrument (freestanding or embedded) that is settled by delivery or receipt of an issuer’s own shares is considered equitymay be a source of signi cant differences between IFRS and US GAAP. For example, net share settlement would cause a warrant oran embedded conversion option to fail equity classi cation under IFRS; under US GAAP, a similar feature would not automaticallytaint equity classi cation, and further analysis would be required to determine whether equity classi cation is appropriate. Likewise,a derivative contract with settlement alternatives that includes one that does not result in equity classi cation (e.g., a choice betweengross settlement and net cash settlement) would fail equity classi cation under IFRS even if the settlement choice resides withthe issuer.

There are some signi cant differences in the treatment of written puts that will be settled by gross receipt of an entity’s own shares.Under US GAAP, such items are measured initially and subsequently at fair value as a derivative. Under IFRS, even though the contractin itself may meet the de nition of equity if the contract is for the receipt of a xed number of the entity’s own shares for a xed amountof cash, IFRS requires the entity to set up a nancial liability for the discounted value of the amount of cash it may be required to pay.

Additional differences exist relating to nancial liabilities that are carried at amortized cost. For these nancial liabilities, both IFRSand US GAAP use the effective interest method to calculate amortized cost and allocate interest expense over the relevant period.The effective interest method is based on the effective interest rate calculated at initial recognition of the nancial instrument. UnderIFRS, the effective interest rate is calculated based on estimated future cash ows through the expected life of the nancial instru -ment. Under US GAAP, the effective interest rate generally is calculated based on the contractual cash ows through the contrac -tual life of the nancial liability. Certain exceptions to this rule involve (1) puttable debt (generally amortized over the period fromthe date of issuance to the rst put date) and (2) callable debt (a policy decision to amortize over either the contractual life orthe estimated life). Under IFRS, changes in the estimated cash ow due to a closely related embedded derivative that is not bifur -

cated result in a cumulative catch-up re ected in the current-period income statement. US GAAP does not have the equivalent of acumulative-catch-up approach.




132 PwC


Impact US GAAP IFRS

Classication

Contingent settlementprovisions

Contingent settlement provisions, suchas provisions requiring redemption upona change in control, result in nancialliability classi cation under IFRS unlessthe contingency arises only upon liquida-tion or is not genuine.

Items classi ed as mezzanine equityunder US GAAP generally are classi ed as

nancial liabilities under IFRS.

A contingently redeemable nancialinstrument (e.g., one redeemable onlyif there is a change in control) is outsidethe scope of ASC 480 because its redemp -tion is not unconditional. Any conditionalprovisions must be assessed to ensure that

the contingency is substantive.

For SEC-listed companies applyingUS GAAP, certain types of securitiesrequire classi cation in the mezzanineequity category of the balance sheet.Examples of items requiring mezzanineclassi cation are instruments with contin -gent settlement provisions or puttableshares as discussed in the Puttableshares section.

Mezzanine classi cation is a US publiccompany concept that is also preferred(but not required) for private companies.

IAS 32 notes that a nancial instrumentmay require an entity to deliver cash oranother nancial asset in the event of theoccurrence or nonoccurrence of uncertainfuture events beyond the control of boththe issuer and the holder of the instru-

ment. Contingencies may include linkagesto such events as a change in control orto other matters such as a change in astock market index, consumer price index,interest rates, or net income.

If the contingency is outside of the issuer’sand holder’s control, the issuer of suchan instrument does not have the uncon-ditional right to avoid delivering cash oranother nancial asset. Therefore, exceptin limited circumstances (such as if thecontingency is not genuine or if it is trig-

gered only in the event of a liquidationof the issuer), instruments with contin-gent settlement provisions represent

nancial liabilities.

As referenced previously, the guidancefocuses on the issuer’s unconditionalability to avoid settlement no matter whether the contingencies may or maynot be triggered.

There is no concept of mezzanine classi -cation under IFRS.



133


PwC

Impact US GAAP IFRS

Derivative on own shares—xed-for-xed versus indexedto issuer’s own shares

When determining the issuer’s classi ca -tion of a derivative on its own shares,IFRS looks at whether the equity deriva-tive meets a xed-for- xed requirement while US GAAP uses a two-step model. Although Step 2 of the US GAAP modeluses a similar xed-for- xed concept, theapplication of the concept differs signi -cantly between US GAAP and IFRS.

These differences can impact classi cationas equity or a derivative asset or liability(with derivative classi cation morecommon under IFRS).

Equity derivatives need to be indexed tothe issuer’s own shares to be classi ed asequity. The assessment follows a two-stepapproach under ASC 815-40-15.

Step 1— Considers where there are anycontingent exercise provisions and, if

so, they cannot be based on an observ-able market or index other than thosereferenced to the issuer’s own sharesor operations.

Step 2— Considers the settlementamount. Only settlement amounts equalto the difference between the fair valueof a xed number of the entity’s equityshares and a xed monetary amount,or a xed amount of a debt instrumentissued by the entity, will qualify forequity classi cation.

If the instrument’s strike price (or thenumber of shares used to calculatethe settlement amount) is not xed asoutlined above, the instrument may stillmeet the equity classi cation criteria;this could occur where the variables thatmight affect settlement include inputs tothe fair value of a xed-for- xed forwardor option on equity shares and the instru-ment does not contain a leverage factor.

In case of rights issues, if the strike price isdenominated in a currency other than the

issuer’s functional currency, it shall not beconsidered as indexed to the entity’s ownstock as the issuer is exposed to changesin foreign currency exchange rates.Therefore, rights issues of this nature would be classi ed as liabilities at fair value through pro t or loss.

Only contracts that provide for gross phys -ical settlement meet the xed-for- xedcriteria (i.e., a xed number of shares fora xed amount of cash) are classi ed asequity. Variability in the amount of cashor the number of shares to be deliveredresults in nancial liability classi cation.

For example, a warrant issued byCompany X has a strike price adjustmentbased on the movements in Company X’sstock price. This feature would fail the

xed-for- xed criteria under IFRS, butthe same adjustment would meet the

xed-for- xed criteria under US GAAP. Assuch, for Company X’s accounting for the warrant, IFRS would result in nancialliability classi cation, whereas US GAAP would result in equity classi cation.

However, there is a recent exception tothe xed-for- xed criteria in IAS 32 forrights issues. Under this exception, rightsissues are classi ed as equity if they areissued for a xed amount of cash regard -less of the currency in which the exerciseprice is denominated, provided they areoffered on a pro rata basis to all owners ofthe same class of equity.



134 PwC


Impact US GAAP IFRS

Derivatives on own shares—settlement models

Entities will need to consider how deriva-tive contracts on an entity’s own shares will be settled. Many of these contractsthat are classi ed as equity underUS GAAP (e.g., warrants that will be netshare settled or those where the issuer hassettlement options) will be classi ed asderivatives under IFRS. Derivative clas -si cation will create additional volatilityin the income statement.

Derivative contracts that are in the scopeof ASC 815-40 and both (1) requirephysical settlement or net share settle-ment, and (2) give the issuer a choice ofnet cash settlement or settlement in itsown shares are considered equity instru-ments, provided they meet the criteria setforth within the literature.

Analysis of a contract’s terms is necessaryto determine whether the contract meetsthe qualifying criteria, some of which canbe dif cult to meet in practice.

Similar to IFRS, derivative contracts thatrequire net cash settlement are assetsor liabilities.

Contracts that give the counterparty achoice of net cash settlement or settle-ment in shares (physical or net settle-ment) result in derivative classi cation.

However, if the issuer has a choice ofnet cash settlement or share settlement,the contract can still be considered anequity instrument.

Contracts that are net settled (netcash or net shares) are classi ed asliabilities or assets. This is also the caseeven if the settlement method is at theissuer’s discretion.

Gross physical settlement is required toachieve equity classi cation.

Unlike US GAAP, under IFRS, a derivativecontract that gives one party (either theholder or the issuer) a choice over howit is settled (net in cash, net in shares, orby gross delivery) is a derivative asset/liability unless all of the settlement alter-natives would result in the contract beingan equity instrument.



135


PwC

Impact US GAAP IFRS

Written put option on theissuer’s own shares

Written puts that are to be settled bygross receipt of the entity’s own sharesare treated as derivatives under US GAAP, while IFRS requires the entity to set up a

nancial liability for the discounted valueof the amount of cash the entity may berequired to pay.

A nancial instrument—other than anoutstanding share—that at inception(1) embodies an obligation to repurchasethe issuer’s equity shares or is indexed tosuch an obligation, and (2) requires ormay require the issuer to settle the obliga-tion by transferring assets shall be classi-

ed as a nancial liability (or an asset, insome circumstances). Examples include written put options on the issuer’s equityshares that are to be physically settled ornet cash settled.

ASC 480 requires written put options tobe measured at fair value, with changes infair value recognized in current earnings.

If the contract meets the de nition of anequity instrument (because it requiresthe entity to purchase a xed amountof its own shares for a xed amount ofcash), any premium received or paidmust be recorded in equity. Therefore,the premium received on such a wr ittenput is classi ed as equity (whereas underUS GAAP, the fair value of the written putis recorded as a nancial liability).

In addition, when an entity has anobligation to purchase its own sharesfor cash (e.g., under a written put) theissuer records a nancial liability forthe discounted value of the amount ofcash that the entity may be required topay. The nancial liability is recordedagainst equity.

Compound instruments that

are not convertible instruments(that do not contain equityconversion features)

Bifurcation and split accountingunder IFRS may result in signi cantlydifferent treatment, including increasedinterest expense.

The guidance does not have the concept ofcompound nancial instruments outsideof instruments with equity conversionfeatures. As such, under US GAAP theinstrument would be classi ed wholly within liabilities or equity.

If an instrument has both a liabilitycomponent and an equity component—known as a compound instrument(e.g., redeemable preferred stock withdividends paid solely at the discretionof the issuer)—IFRS requires separateaccounting for each component of thecompound instrument.

The liability component is recognized atfair value calculated by discounting thecash ows associated with the liabilitycomponent at a market rate for a similardebt host instrument excluding the equityfeature, and the equity component ismeasured as the residual amount.

The accretion calculated in the applica-tion of the effective interest rate methodon the liability component is classi ed asinterest expense.



136 PwC


Impact US GAAP IFRS

Convertible instruments(compound instrumentsthat contain equityconversion features)

Differences in how and when convertibleinstruments get bifurcated and/or howthe bifurcated portions get measured candrive substantially different results.

Equity conversion features should be sepa-rated from the liability host and recordedseparately as embedded derivatives onlyif they meet certain criteria (e.g., fail tomeet the scope exception of ASC 815).

If the conversion feature is not recordedseparately, then the entire convertibleinstrument may be considered one unit ofaccount—interest expense would re ectcash interest if issued at par. However,there are a few exceptions:

• For certain convertible debt instru-ments that may be settled in cashupon conversion, the liability andequity components of the instrumentshould be separately accounted forby allocating the proceeds from the

issuance of the instrument between theliability component and the embeddedconversion option (i.e., the equitycomponent). This allocation is done by

rst determining the carrying amountof the liability component based onthe fair value of a similar liabilityexcluding the embedded conver-sion option, and then allocating tothe embedded conversion option theexcess of the initial proceeds ascribedto the convertible debt instrumentover the amount allocated to the

liability component.• A convertible debt may contain a

bene cial conversion feature (BCF) when the strike price on the conver-sion option is “in the money.” The BCFis generally recognized and measuredby allocating a portion of the proceedsreceived, equal to the intrinsic value ofthe conversion feature, to equity.

For convertible instruments with aconversion feature that exchanges a

xed amount of cash for a xed numberof shares, IFRS requires bifurcation andsplit accounting between the liability and

equity components of the instrument.The liability component is recognized atfair value calculated by discounting thecash ows associated with the liabilitycomponent—at a market rate for noncon- vertible debt—and the equity conver-sion feature is measured as the residualamount and recognized in equity with nosubsequent remeasurement.

Equity conversion features within liabilityhost instruments that fail the xed-for-

xed requirement are considered to be

embedded derivatives. Such embeddedderivatives are bifurcated from the hostdebt contract and measured at fair value, with changes in fair value recognized inthe income statement.

IFRS does not have a concept of BCF, asthe compound instruments are alreadyaccounted for based on their components.



137


PwC

Impact US GAAP IFRS

Puttable shares/redeemableupon liquidation

Puttable shares

Puttable shares are more likely to be clas -si ed as nancial liabilities under IFRS.

The potential need to classify certaininterests in open-ended mutual funds,unit trusts, partnerships, and the like asliabilities under IFRS could lead to situa-tions where some entities have no equitycapital in their nancial statements.

Redeemable upon liquidation

Differences with respect to the presenta-tion of these nancial instruments issuedby a subsidiary in the parent’s consoli -dated nancial statements can drivesubstantially different results.

Puttable shares

The redemption of puttable shares isconditional upon the holder exercisingthe put option. This contingency removesputtable shares from the scope of instru-ments that ASC 480 requires to be classi -

ed as a nancial liability.

As discussed for contingently redeem-able instruments, SEC registrants wouldclassify these instruments as “mezzanine”.Such classi cation is preferred, but notrequired, for private companies.


ASC 480 scopes out instruments thatare redeemable only upon liquida-tion. Therefore, such instrumentsmay achieve equity classi cation for

nite-lived entities.

In classifying these nancial instru -ments issued by a subsidiary in a parent’sconsolidated nancial statements,

US GAAP permits an entity to defer theapplication of ASC 480; the result is thatthe redeemable noncontrolling interestsissued by a subsidiary are not nancialliabilities in the parent’s consolidated

nancial statements.

Puttable shares

Puttable instruments generally are clas -si ed as nancial liabilities because theissuer does not have the unconditionalright to avoid delivering cash or other

nancial assets. Under IFRS, the legalform of an instrument (i.e., debt or

equity) does not necessarily in uence theclassi cation of a particular instrument.

Under this principle, IFRS may requirecertain interests in open-ended mutualfunds, unit trusts, partnerships, and thelike to be classi ed as liabilities (becauseholders can require cash settlement).This could lead to situations where someentities have no equity capital in their

nancial statements.

However, an entity is required to classifyputtable instruments as equity when they

have particular features and meet certainspeci c conditions in IAS 32.


For instruments issued out of nite-livedentities that are redeemable upon liquida-tion, equity classi cation is appropriateonly if certain conditions are met.

However, when classifying redeemablenancial instruments issued by a subsid -

iary (either puttable or redeemable uponliquidation) for a parent’s consolidated

accounts, equity classi cation at thesubsidiary level is not extended to theparent’s classi cation of the redeem -able noncontrolling interests in theconsolidated nancial statements, asthe same instrument would not meetthe speci c IAS 32 criteria from theparent’s perspective.



138 PwC


Impact US GAAP IFRS

Measurement

Initial measurement of a liabilitywith a related party

Fundamental differences in the approachto related-party liabilities under the twoaccounting models may impact the valuesat which these liabilities initially arerecorded. The IFRS model may, in prac -tice, be more challenging to implement.

When an instrument is issued to a relatedparty at off-market terms, one shouldconsider which model the instrument falls within the scope of as well as the facts andcircumstances of the transaction (i.e., theexistence of unstated rights and privi-leges) in determining how the transactionshould be recorded. There is, however, norequirement to initially record the trans-action at fair value.

The presumption in ASC 850 that relatedparty transactions are not at arm’s lengthand the associated disclosure require-ments also should be considered.

When an instrument is issued to a relatedparty, the nancial liability initially shouldbe recorded at fair value, which may notbe the value of the consideration received.

The difference between fair value andthe consideration received (i.e., anyadditional amount lent or borrowed)is accounted for as a current-periodexpense, income, or as a capital transac-tion based on its substance.



139


PwC

Impact US GAAP IFRS

Effective-interest-ratecalculation

Differences between the expected livesand the contractual lives of nancialliabilities have different implicationsunder the two frameworks unless theinstruments in question are carriedat fair value. The difference in wherethe two accounting frameworks placetheir emphasis (contractual term forUS GAAP and expected life for IFRS) canimpact carrying values and the timing ofexpense recognition.

Similarly, differences in how revisions toestimates get treated also impact carrying values and expense recognition timing, with the potential for greater volatilityunder IFRS.

The effective interest rate used forcalculating amortization under theeffective interest method generallydiscounts contractual cash ows throughthe contractual life of the instrument.However, expected life may be usedin some circumstances. For example,puttable debt is generally amortized overthe period from the date of issuance tothe rst put date and callable debt can beamortized either over the contractual orexpected life as a policy decision.

The effective interest rate used for calcu-lating amortization under the effectiveinterest method discounts estimated cash

ows through the expected—not thecontractual—life of the instrument.

Generally, if the entity revises its estimateafter initial recognition, the carrying

amount of the nancial liability shouldbe revised to re ect actual and revisedestimated cash ows at the originaleffective interest rate, with a cumulative-catch-up adjustment being recorded inpro t and loss. Revisions of the estimatedlife or of the estimated future cash owsmay exist, for example, in connection with debt instruments that contain a putor call option that does not need to bebifurcated or whose coupon payments vary. Payments may vary because of anembedded feature that does not meetthe de nition of a derivative becauseits underlying is a non nancial variablespeci c to a party to the contract(e.g., cash ows that are linked to earn -ings before interest, taxes, depreciation,and amortization; sales volume; or theearnings of one party to the contract).

Generally, oating rate instruments(e.g., LIBOR plus spread) issued at parare not subject to the cumulative-catch-upapproach; rather, the effective interestrate is revised as market rates change.



140 PwC


Impact US GAAP IFRS

Modication or exchangeof debt instruments andconvertible debt instruments

Differences in when a modi cation orexchange of a debt instrument wouldbe accounted for as a debt extinguish-ment can drive different conclusions asto whether extinguishment accountingis appropriate.

When a debt modi cation or exchangeof debt instruments occurs, the rst stepis to consider whether the modi ca -tion or exchange quali es for troubleddebt restructuring. If this is the case, therestructuring follows the speci c troubled

debt restructuring guidance.If the modi cation or exchange of debtinstruments does not qualify for troubleddebt restructuring, one has to consider whether the modi cation or exchange ofdebt instruments has to be accounted foras a debt extinguishment.

An exchange or modi cation of debtinstruments with substantially differentterms is accounted for as a debt extin-guishment. In order to determine whetherthe debt is substantively different, a quan-

titative assessment must be performed.If the present value of the cash owsunder the new terms of the new debtinstrument differs by at least 10 percentfrom the present value of the remainingcash ows under the original debt, theexchange is considered an extinguish-ment. The discount rate for determiningthe present value is the effective rate onthe old debt.

If the debt modi cations involve changesin noncash embedded features, the

following two-step test is required:

Step 1— If the change in cash ows asdescribed above is greater than 10 percentof the carrying value of the original debtinstrument, the exchange or modi cationshould be accounted for as an extinguish-ment. This test would not include anychanges in fair value of the embeddedconversion option.

Under IFRS, there is no concept oftroubled debt restructuring.

A substantial modi cation of the termsof an existing nancial liability or part ofthe nancial liability should be accountedfor as an extinguishment of the original

nancial liability and the recognition ofa new nancial liability. In this regard,the terms are substantially different ifthe discounted present value of the cash

ows under the new terms is at least 10percent different from the discountedpresent value of the remaining cash owsof the original nancial liability. If thistest is met, the exchange is consideredan extinguishment.

It is clear that if the discounted cash owschange by at least 10 percent, the original

debt should be accounted for as an extin-guishment. It is not clear, however, in IAS39 whether the quantitative analysis is anexample or is the de nition of substan -tially different. Accordingly, there is anaccounting policy choice where entitiescan perform either (1) an additionalqualitative analysis of any modi cation ofterms when the change in discounted cash

ows is less than 10 percent or (2) onlythe 10 percent test (quantitative test) asdiscussed above.



141


PwC

Impact US GAAP IFRS

Modication or exchange of debtinstruments and convertible debtinstruments (continued)

Step 2— If the test in Step 1 is not met,the following should be assessed:

• Whether the modi cation or exchangeaffects the terms of an embeddedconversion option, where the differ-ence between the fair value of theoption before and after the modi ca -tion or exchange is at least 10 percentof the carrying value of the originaldebt instrument prior to the modi ca -

tion or exchange.• Whether a substantive conversion

option is added or a conversion optionthat was substantive at the date ofmodi cation is eliminated.

If either of these criteria is met, theexchange or modi cation would beaccounted for as an extinguishment.

For debt instruments with embeddedderivative features, the modi cationof the host contract and the embeddedderivative should be assessed together when applying the 10 percent test as thehost debt and the embedded derivativeare interdependent. However, a conver -sion option that is accounted for as anequity component would not be consid-ered in the 10 percent test. In such cases,an entity would also consider whetherthere is a partial extinguishment of theliability through the issuance of equitybefore applying the 10 percent test.

Transaction costs (also knownas debt issue costs)

When applicable, the balance sheetpresentation of transaction costs (separateasset versus a component of the instru-ment’s carrying value) differs under thetwo standards. IFRS prohibits the balancesheet gross up required by US GAAP.

When the nancial liability is not carriedat fair value through income, third partycosts are deferred as an asset. Creditorfees are deducted from the carrying value of the nancial liability and are notrecorded as separate assets.

Transaction costs are expensed immedi-ately when the nancial liability is carriedat fair value, with changes recognized inpro t and loss.

When the nancial liability is not carriedat fair value through income, transac-tion costs including third party costsand creditor fees are deducted from thecarrying value of the nancial liabilityand are not recorded as separate assets.Rather, they are accounted for as a debtdiscount and amortized using the effec-tive interest method.

Transaction costs are expensed immedi-ately when the nancial liability is carriedat fair value, with changes recognized inpro t and loss.


IFRS IAS 32, IAS 39, IFRS 13, IFRIC 2

US GAAP ASC 470-20, ASC 470-20-25-12, ASC 480, ASC 480-10-65-1, ASC 815, ASC 815-15-25-4 through 25-5, ASC 815-40, ASC 815-40-25, ASC 820, ASC 825, ASC 850, ASC 860, ASR 268, CON 6

Note




142 PwC



IFRS 9, Financial Instruments

In October 2010, the requirements for classifying and measuring nancial liabilities were added to IFRS 9. Most of the addedrequirements were carried forward unchanged from IAS 39.

However, the new requirements related to the fair value option for nancial liabilities were changed to address the issue of thecredit risk of a nancial liability, in response to consistent feedback from users of nancial statements and others that the effects ofchanges in a liability’s credit risk ought not to affect pro t or loss unless the liability is held for trading. IFRS 9 requires for nancialliabilities where the fair value option is elected that changes in the credit risk of a nancial liability be recognized in other compre -hensive income (OCI) and not recycled.

On December 16, 2011, the IASB issued an amendment to IFRS 9, Financial Instruments, which delays the effective date of IFRS 9to annual periods beginning on or after January 1, 2015. The original effective date was for annual periods beginning on or afterJanuary 1, 2013. Early application of IFRS 9 continues to be permitted. It should be noted the mandatory effective date is currentlybeing reconsidered as part of the IASB’s project on expected loan losses. In that exposure draft, there is a consequential amendmentproposed which strikes through the effective date in IFRS 9 and asks for feedback about what the new effective date should be.

IASB Exposure Draft, Classication and Measurement: Limited Amendments to IFRS 9

In November 2012, the IASB published an exposure draft proposing limited amendments to IFRS 9, Financial Instruments . Theexposure draft does not change the requirements for classifying and measuring nancial liabilities as currently stated in IFRS9. However, the proposals include transition guidance that would allow an entity to early apply only the ‘own credit’ provisionsdescribed above in IFRS 9. Refer to the Assets— nancial assets chapter for the proposed changes on the classi cation and measure -ment of nancial assets.

FASB Proposed Accounting Standards Update —Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities

In February 2013, the FASB issued a revised proposal for the classi cation and measurement of nancial instruments. The proposalcalls for a mixed measurement approach for nancial assets and nancial liabilities — either fair value or amortized cost. It isintended to be responsive to the considerable feedback the FASB received on its 2010 exposure draft, which proposed fair valuemeasurement for all nancial instruments. The comment period ended May 15, 2013.

The key proposals with regard to nancial liabilities are as follows:

Classi cation and measurement approach

Financial liabilities will generally be measured at amortized cost. However, if either of the following conditions exists, fair valuethrough net income would be required:

• The nancial liabilities are liabilities for which the company’s business strategy upon initial recognition is to subsequentlytransact at fair value;

• The nancial liabilities are short sales

Comparison to IFRS: IFRS 9 carried forward the classi cation and measurement approach for nancial liabilities in IAS 39 wherethe amortized cost measurement is used for liabilities with the exception of trading liabilities, which are measured at fair valuethrough pro t or loss.

Hybrid nancial and non nancial liabilities

Hybrid nancial liabilities retain the accounting as currently required under ASC 815-15. Therefore, separate accounting forembedded derivative features remains, and embedded derivatives will continue to be measured at fair value through net income.



143


PwC

Once the bifurcation and separate analysis have been performed, the nancial host or debt-equity hybrid host that is recognized asa nancial liability will be subject to the proposed classi cation and measurement model.

Comparison to IFRS: Similarly, IFRS 9 retains a bifurcation approach for hybrid nancial liabilities. However, there are currentlydifferences between IFRS and US GAAP in the de nition of a derivative and the assessment of whether an embedded deriva -tive is closely related to its host, which the boards are not currently addressing (refer to the Derivatives and hedging chapterfor existing differences). As a result, differences will continue to arise as to when bifurcation is required under the two sets ofaccounting standards.

Convertible debt

An issuer’s accounting for convertible debt will remain unchanged under the FASB’s proposed approach. Conventional convertibledebt, i.e., convertible debt that quali es for the derivatives scope exception in ASC 815 and cannot be settled wholly or partially

in cash, will be measured by the issuer at amortized cost in its entirety. Convertible debt that can be settled wholly or partially incash by the issuer will continue to be bifurcated into a conversion option, which is recognized in equity, and a host contract, whichis recognized as a liability and measured at amortized cost. Similarly, the accounting in situations where the embedded conversionoption will need to be separated from the host contract and accounted for as a derivative or where there is a bene cial conversionfeature will remain unchanged.

Comparison to IFRS: The IAS 39 approach to classi cation and measurement was carried forward to IFRS 9. The IAS 32 guidance fordetermining whether an instrument should be recognized entirely or in part in equity or liability remains unchanged. Therefore, theexisting differences for convertible debt instruments will continue to exist after completion of this project.

Non-recourse liabilities

Financial liabilities that can only be settled with speci ed nancial assets and do not have other recourse, are required under theproposal to be measured consistently (same method and same amount) with those speci ed assets. For example, bene cial interests

in a securitization that can only be settled using the cash ows from the debt investments held in the securitization entity will bemeasured consistently with those debt investments held in the entity. If the debt investments are carried at amortized cost andcredit impairment is recognized in the reporting period, the bene cial interests will also be carried at amortized cost and writtendown for the same impairment charge as recognized on the assets.

Comparison to IFRS: IFRS 9 does not provide a separate measurement approach for non-recourse liabilities. Financial assets andliabilities will follow their respective classi cation and measurement models. However, under IFRS 9, a fair value option is providedfor nancial assets and nancial liabilities if measuring those assets or liabilities at fair value through net income would eliminateor signi cantly reduce a measurement mismatch.

Fair value option

The FASB’s proposal will eliminate the unrestricted fair value through net income measurement option. However, a company willbe able to irrevocably elect fair value through net income at initial recognition, in the following limited situations:

• For hybrid nancial liabilities, in order to avoid having to bifurcate and separately account for the embedded derivative,unless either:- The embedded derivative does not signi cantly modify the cash ows, or- It is clear (with little or no analysis) that separation of the embedded derivative is prohibited.

• For a group of nancial assets and nancial liabilities where the company both:- Manages the net exposure of those nancial assets and nancial liabilities on a fair value basis, and- Provides information on that basis to management.



144 PwC


If the fair value option is elected for a nancial liability, any changes in fair value that result from a change in the company’s owncredit risk will be recognized separately in other comprehensive income. The accumulated gains and losses due to changes in acompany’s own credit will be recycled from accumulated other comprehensive income to net income when the nancial liability issettled before maturity.

The change in fair value due to a change in the company’s own credit risk will be measured as the portion of the change in fair value that is not due to a change in the benchmark rate of market risk (e.g., the risk above a base market interest rate). However, acompany can use an alternative method if it believes it to be a more faithful measurement of that credit risk.

Comparison to IFRS: Unlike the FASB’s proposed approach, IFRS 9 allows an irrevocable election at initial recognition to measure anancial asset or a nancial liability at fair value through pro t or loss if that measurement eliminates or signi cantly reduces an

accounting mismatch. Additionally, IFRS 9 has a fair value option for groups of nancial assets and/or liabilities that are managedtogether on a net fair value basis, but unlike the FASB’s proposed approach will not require that there be both assets and liabilities inthat group to elect the fair value option. Finally, IFRS 9 allows a fair value option for hybrid nancial liabilities. In virtually all cases, where the fair value option is elected for nancial liabilities, IFRS 9 requires the effects due to a change in the company’s own creditto be re ected in other comprehensive income, which is similar to the FASB’s proposed approach. However, IFRS 9 does not allowrecycling if the liability is settled before maturity.

IFRS Interpretations Committee Draft Interpretation, IAS 32 Financial Instruments: Presentation—Put Options Writtenon Non-controlling Interests

In May 2012, the IFRS Interpretations Committee published a draft interpretation on the accounting for put options written onnon-controlling interests in the parent’s consolidated nancial statements (NCI puts). NCI puts are contracts that oblige a parentto purchase shares of its subsidiary that are held by a non-controlling-interest shareholder for cash or another nancial asset.Paragraph 23 of IAS 32 requires recognizing a nancial liability for the present value of the redemption amount in the parent’sconsolidated nancial statements.

There is currently diversity in how entities subsequently present the measurement of NCI puts:

• Some account for subsequent changes in the nancial liability in pro t or loss in accordance with IAS 39 or IFRS 9.

• Some account for subsequent changes in the nancial liability as equity transactions (that is, transactions with owners in theircapacity as owners) in accordance with IAS 27 and IFRS 10.

The draft interpretation clari es that the subsequent measurement of NCI puts should be in accordance with IAS 39/IFRS 9, whichrequire changes in the measurement of the nancial liability to be recognized in the income statement.

The draft interpretation only addresses the narrow issue of the presentation of subsequent measurement changes in the nancialstatements. Therefore, the existing differences between IFRS and US GAAP for written put options on the issuer’s own equity wouldcontinue to exist.

However, the Interpretations Committee noted that many respondents to the draft interpretation think that either the

Interpretations Committee or the IASB should address the accounting for NCI puts —or all derivatives written on an entity’s ownequity—more comprehensively. Those respondents believe that the requirements, which are to measure particular derivatives written on an entity’s own equity instruments on a gross basis at the present value of the redemption amount, do not result in usefulinformation. Consequently, before nalizing the draft interpretation, the Interpretations Committee decided to ask the IASB toreconsider the requirements in paragraph 23 of IAS 32 for put options and forward contracts written on an entity’s own equity. As aresult, the IASB tentatively decided in its March 2013 meeting to re-consider the requirements in paragraph 23 of IAS 32, including whether all or particular put options and forward contracts written on an entity’s own equity should be measured on a net basis atfair value.



Derivatives and hedging



146 PwC



Derivatives and hedging represent one of the more complex and nuanced topical areas within both US GAAP and IFRS. While IFRSgenerally is viewed as less rules-laden than US GAAP, the difference is less dramatic in relation to derivatives and hedging, whereinboth frameworks embody a signi cant volume of detailed implementation guidance.

In the area of derivatives and embedded derivatives, the de nition of derivatives is broader under IFRS than under US GAAP; there -fore, more instruments may be required to be accounted for at fair value through the income statement under IFRS. On the other hand,the application of the scope exception around “own use”/“normal purchase normal sale” may result in fewer derivative contracts at fair value under IFRS, as these are scoped out of IFRS while elective under US GAAP. Also, there are differences that should be carefully

considered in the identi cation of embedded derivatives within nancial and non nancial host contracts. In terms of measurementof derivatives, day one gains or losses cannot be recognized under IFRS unless supported by appropriate observable current markettransactions or if all of the inputs into the valuation model used to derive the day one difference are observable. Under US GAAP, dayone gains and losses are permitted where fair value is derived from unobservable inputs.

Although the hedging models under IFRS and US GAAP are founded on similar principles, there are a number of application differ -ences. Some of the differences result in IFRS being more restrictive than US GAAP, whereas other differences provide more exibilityunder IFRS.

Areas where IFRS is more restrictive than US GAAP include the nature, frequency, and methods of measuring and assessing hedgeeffectiveness. As an example, US GAAP provides for a shortcut method that allows an entity to assume no ineffectiveness and, hence,bypass an effectiveness test as well as the need to measure quantitatively the amount of hedge ineffectiveness. The US GAAP shortcutmethod is available only for certain fair value or cash ow hedges of interest rate risk using interest rate swaps (when certain stringent

criteria are met). IFRS has no shortcut method equivalent. To the contrary, IFRS requires that, in all instances, hedge effectiveness bemeasured and any ineffectiveness be recorded in pro t or loss. IFRS does acknowledge that in certain situations little or no ineffective -ness could arise, but IFRS does not provide an avenue whereby an entity may assume no ineffectiveness.

Because the shortcut method is not accepted under IFRS, companies utilizing the shortcut method under US GAAP will need to preparethe appropriate level of IFRS-compliant documentation if they want to maintain hedge accounting. The documentation will need to bein place no later than at the transition date to IFRS if hedge accounting is to be maintained on an uninterrupted basis. For example, fora company whose rst IFRS-based nancial statements will be issued for the three years ended December 31, 2013, hedging documen -tation needs to be in place as of the opening balance sheet date. Hence, documentation needs to be in place as of January 1, 2011, if theentity wants to continue to apply hedge accounting on an uninterrupted basis.

Another area where IFRS is more restrictive involves the use of purchased options as a hedging instrument. Under IFRS, when hedgingone-sided risk in a forecasted transaction under a cash ow hedge (e.g., for foreign currency or price risk), only the intrinsic value of apurchased option is deemed to re ect the one-sided risk of the hedged item. As a result, for hedge relationships where the critical termsof the purchased option match the hedged risk, generally, the change in intrinsic value will be deferred in equity while the change intime value will be recorded in the income statement. However, US GAAP permits an entity to assess effectiveness based on the entirechange in fair value of the purchased option. There is also less exibility under IFRS in the hedging of servicing r ights because they areconsidered non nancial interests.



147


PwC

IFRS is also more restrictive than US GAAP in relation to the use of internal derivatives. Restrictions under the IFRS guidance maynecessitate that entities desiring hedge accounting enter into separate, third-party hedging instruments for the gross amount of foreigncurrency exposures in a single currency, rather than on a net basis (as is done by many treasury centers under US GAAP).

At the same time, IFRS provides opportunities not available under US GAAP in a number of areas. Such opportunities arise in aseries of areas where hedge accounting can be accomplished under IFRS, whereas it would have been precluded under US GAAP. Forexample, under IFRS an entity can achieve hedge accounting in relation to the foreign currency risk associated with a rm commitmentto acquire a business in a business combination (whereas US GAAP would not permit hedge accounting). At the same time, IFRS allowsan entity to utilize a single hedging instrument to hedge more than one risk in two or more hedged items (this designation is precludedunder US GAAP). That difference may allow entities under IFRS to adopt new and sometimes more complex risk management strate -gies while still achieving hedge accounting. IFRS is more exible than US GAAP with respect to the ability to achieve fair value hedgeaccounting in relation to interest rate risk within a portfolio of dissimilar nancial assets and in relation to hedging a portion of a

speci ed risk and/or a portion of a time period to maturity (i.e., partial-term hedging) of a given instrument to be hedged. A series offurther differences exists as well.

As companies work to understand and embrace the new opportunities and challenges associated with IFRS in this area, it is importantthat they ensure that data requirements and underlying systems support are fully considered.

Moreover, the FASB and the IASB are reconsidering accounting for nancial instruments, including hedge accounting. Once nalized,the new guidance will replace the FASB’s and IASB’s respective nancial instruments guidance. Despite starting as a joint initiative, theFASB and IASB so far have reached different conclusions. Refer to the Recent/proposed guidance section for further discussion.

The following table provides further details on the foregoing and other selected current differences (pre-IFRS 9).



148 PwC


Impact US GAAP IFRS

Derivative denition and scope

Net settlement provisions

More instruments will qualify asderivatives under IFRS.

Some instruments, such as option andforward agreements to buy unlistedequity investments, are accounted foras derivatives under IFRS but not underUS GAAP.

To meet the de nition of a derivative, anancial instrument or other contract

must require or permit net settlement.

US GAAP generally excludes from thescope of ASC 815 certain instrumentslinked to unlisted equity securities whensuch instruments fail the net settlementrequirement and are, therefore, notaccounted for as derivatives.

An option contract between an acquirerand a seller to buy or sell stock of anacquiree at a future date that results in abusiness combination may not meet thede nition of a derivative as it may failthe net settlement requirement(e.g., the acquiree’s shares are not listedso the shares may not be readily convert-ible to cash).

IFRS does not include a requirement fornet settlement within the de nition of aderivative. It only requires settlement at afuture date.

There is an exception under IAS 39 forderivatives whose fair value cannot bemeasured reliably (i.e., instrumentslinked to equity instruments that are notreliably measurable), which could resultin not having to account for such instru-ments at fair value. In practice, however,this exemption is very narrow in scopebecause in most situations it is expectedthat fair value can be measured reliablyeven for unlisted securities.

Effective January 1, 2010, an optioncontract between an acquirer and aseller to buy or sell stock of an acquireeat a future date that results in a busi-

ness combination would be considered aderivative under IAS 39 for the acquirer;however, the option may be classi ed asequity from the seller’s perspective.

Own use versus normalpurchase normal sale (NPNS)

The “own use” exception is mandatoryunder IFRS but the “normal purchasenormal sale” exception is elective underUS GAAP.

There are many factors to consider indetermining whether a contract relatedto non nancial items can qualify for theNPNS exception.

If a contract meets the requirement of theNPNS exception, then the reporting entitymust document that it quali es in order toapply the NPNS exception—otherwise, it will be considered a derivative.

Similar to US GAAP, there are manyfactors to consider in determining whether a contract related to non -nancial items quali es for the “ownuse” exception.

While US GAAP requires documenta -tion to apply the NPNS exception (i.e.,it is elective), IFRS requires a contractto be accounted for as own use (i.e., notaccounted for as a derivative) if the ownuse criteria are satis ed.



149


PwC

Impact US GAAP IFRS

Embedded derivatives

Reassessment of embeddedderivatives

Differences with respect to the reassess-ment of embedded derivatives may resultin signi cantly different outcomes underthe two frameworks. Generally, reassess -ment is more frequent under US GAAP.

If a hybrid instrument contains anembedded derivative that is not clearlyand closely related at inception, and it isnot bifurcated (because it does not meetthe de nition of a derivative), it mustbe continually reassessed to determine

whether bifurcation is required at a laterdate. Once it meets the de nition of aderivative, the embedded derivative isbifurcated and measured at fair value with changes in fair value recognizedin earnings.

Similarly, the embedded derivative ina hybrid instrument that is not clearlyand closely related at inception and isbifurcated must also be continually reas-sessed to determine whether it subse-quently fails to meet the de nition of a

derivative. Such an embedded derivativeshould cease to be bifurcated at the pointat which it fails to meet the requirementsfor bifurcation.

An embedded derivative that is clearlyand closely related is not reassessedsubsequent to inception for the “clearlyand closely related” feature. For non -nancial host contracts, the assessment of whether an embedded foreign currencyderivative is clearly and closely relatedto the host contract should be performedonly at inception of the contract.

IFRS precludes reassessment of embeddedderivatives after inception of the contractunless there is a change in the terms ofthe contract that signi cantly modi esthe expected future cash ows that wouldotherwise be required under the contract.

Having said that, if an entity reclassi es anancial asset out of the held-for-trading

category, embedded derivatives must beassessed and, if necessary, bifurcated.



150 PwC


Impact US GAAP IFRS

Calls and puts in debtinstruments

IFRS and US GAAP have fundamentallydifferent approaches to assessing whethercall and puts embedded in debt hostinstruments require bifurcation.

Multiple tests are required in evaluating whether an embedded call or put is clearlyand closely related to the debt host.The failure of one or both of the belowoutlined tests is common and typicallyresults in the need for bifurcation.

Test 1— If a debt instrument is issued at

a substantial premium or discount anda contingent call or put can acceleraterepayment of principal, the call or put isnot clearly and closely related.

Test 2— If there is no contingent callor put that can accelerate repaymentof principal, or if the debt instrumentis not issued at a substantial premiumor discount, then it must be assessed whether the debt instrument can besettled in such a way that the holder would not recover substantially all of its

recorded investments or the embeddedderivative would at least double theholder’s initial return and the resultingrate would be double the then currentmarket rate of return. However, this ruleis subject to certain exceptions.

Calls, puts, or prepayment optionsembedded in a hybrid instrument areclosely related to the debt host instru-ment if either (1) the exercise priceapproximates the amortized cost on eachexercise date or (2) the exercise priceof a prepayment option reimburses thelender for an amount up to the approxi-mate present value of the lost interest forthe remaining term of the host contract.Once determined to be closely relatedas outlined above, these items do notrequire bifurcation.



151


PwC

Impact US GAAP IFRS

Nonnancial host contracts—currencies commonly used

Although IFRS and US GAAP have similarguidance in determining when to separateforeign currency embedded derivativesin a non nancial host, there is more ex -ibility under IFRS in determining that thecurrency is closely related.

US GAAP requires bifurcation of a foreigncurrency embedded derivative from anon nancial host unless the paymentis (1) denominated in the local currencyor functional currency of a substan-tial party to the contract, (2) the pricethat is routinely denominated in thatforeign currency in internationalcommerce (e.g., US dollar for crude oiltransactions), or (3) a foreign currencyused because a party operates in ahyperin ationary environment.

Criteria (1) and (2) cited for US GAAPalso apply under IFRS. However, bifur -cation of a foreign currency embeddedderivative from a non nancial host isnot required if payments are denomi-nated in a currency that is commonlyused to purchase or sell such items in theeconomic environment in which the trans-action takes place.

For example, Company X, in Russia(functional currency and local currencyis Russian ruble), sells timber to anotherRussian company (with a ruble func-tional currency) in euros. Because theeuro is a currency commonly used inRussia, bifurcation of a foreign currencyembedded derivative from the non nan -cial host contract would not be requiredunder IFRS.

Measurement of derivatives

Day one gains and losses

Day one gains and losses occur when theentity uses a model to measure the fair value of the instrument and the modelprice at initial recognition is differentfrom the transaction price.

The ability to recognize day one gains andlosses is different under both frameworks, with gain/loss recognition more commonunder US GAAP.

In some circumstances, the transactionprice is not equal to fair value, usually when the market in which the transac-tion occurs differs from the market wherethe reporting entity could transact. Forexample, banks can access wholesale andretail markets; the wholesale price mayresult in a day one gain compared to thetransaction price in the retail market.

In these cases, entities must recognizeday one gains and losses even if someinputs to the measurement model arenot observable.

Day one gains and losses are recognizedonly when the fair value is evidenced bycomparison with other observable currentmarket transactions in the same instru-ment or is based on a valuation technique whose variables include only data fromobservable markets.



152 PwC


Impact US GAAP IFRS

Hedge qualifying criteria

When to assess effectiveness

Non-SEC-listed entities may see greaterexibility in the frequency of required

effectiveness testing under IFRS.

Although the rules under IFRS allow less-frequent effectiveness testing in certainsituations, SEC-listed entities will stillbe required to assess effectiveness on aquarterly basis in conjunction with theirinterim reporting requirements.

US GAAP requires that hedge effective -ness be assessed whenever nancialstatements or earnings are reported andat least every three months (regard-less of how often nancial statementsare prepared).

IFRS requires that hedges be assessed foreffectiveness on an ongoing basis and thateffectiveness be measured, at a minimum,at the time an entity prepares its annual orinterim nancial reports.

Therefore, if an entity is required toproduce only annual nancial state -ments, IFRS requires that effectivenessbe tested only once a year. An entity may,of course, choose to test ef fectivenessmore frequently.

Hedge accounting practices allowed under US GAAP that are not acceptable under IFRS

Effectiveness testing andmeasurement of hedgeineffectiveness

IFRS requires an increased level of hedgeeffectiveness testing and/or detailed

measurement compared to US GAAP.There are a number of similaritiesbetween the effectiveness-testing methodsacceptable under US GAAP and thoseacceptable under IFRS. At the same time,important differences exist in areas suchas the use of the shortcut method and thecritical matched-terms method.

US GAAP does not specify a single methodfor assessing hedge effectiveness prospec-

tively or retrospectively. The method anentity adopts depends on the entity’s riskmanagement strategy and is included inthe documentation prepared at the incep-tion of the hedge.

IFRS does not specify a single method forassessing hedge effectiveness prospec-

tively or retrospectively. The method anentity adopts depends on the entity’s riskmanagement strategy and is includedin the documentation prepared at theinception of the hedge. The most commonmethods used are the critical-termsmatch, the dollar-offset method, andregression analysis.



153


PwC

Impact US GAAP IFRS

Effectiveness testing and measurementof hedge ineffectiveness (continued)

Shortcut method

US GAAP provides for a shortcut methodthat allows an entity to assume noineffectiveness (and, hence, bypass aneffectiveness test) for certain fair valueor cash ow hedges of interest rate riskusing interest rate swaps (when certainstringent criteria are met).

Critical terms match

Under US GAAP, for hedges that do notqualify for the shortcut method, if thecritical terms of the hedging instrumentand the entire hedged item are the same,the entity can conclude that changes infair value or cash ows attributable tothe risk being hedged are expected tocompletely offset. An entity is not allowedto assume (1) no ineffectiveness when itexists or (2) that testing can be avoided.Rather, matched terms provide a simpli-

ed approach to effectiveness testing incertain situations.

The SEC has clari ed that the criticalterms have to be perfectly matched toassume no ineffectiveness. Additionally,the critical-terms-match method is notavailable for interest rate hedges.

Shortcut method

IFRS does not allow a shortcut methodby which an entity may assumeno ineffectiveness.

IFRS permits portions of risk to be desig-nated as the hedged risk for nancialinstruments in a hedging relationshipsuch as selected contractual cash ows ora portion of the fair value of the hedgeditem, which can improve the effectiveness

of a hedging relationship. Nevertheless,entities are still required to test effec-tiveness and measure the amount ofany ineffectiveness.

Critical terms match

IFRS does not speci cally discuss themethodology of applying a critical-terms-match approach in the level of detailincluded within US GAAP. However, ifan entity can prove for hedges in whichthe critical terms of the hedging instru-ment and the hedged items are the samethat the relationship will always be 100percent effective based on an appro-priately designed test, then a similarqualitative analysis may be suf cient forprospective testing.

Even if the critical terms are the same,retrospective effectiveness must beassessed, and ineffectiveness mustbe measured in all cases becauseIFRS precludes the assumption ofperfect effectiveness.



154 PwC


Impact US GAAP IFRS

Credit risk and hypotheticalderivatives

In a cash ow hedge, an entity’s assess -ment of hedge effectiveness may beimpacted by an entity’s own credit risk orby the credit risk of the hedging deriva-tive’s counterparty. When using the hypo -thetical derivative method, a differencebetween IFRS and US GAAP may arisedepending on (1) whether the derivativeis in an asset or a liability position and(2) the method used for valuing liabilities.

Under US GAAP, a hypothetical deriva -tive will re ect an adjustment for thecounterparty’s (or an entity’s own)credit risk. This adjustment will bebased upon the credit risk in the actualderivative. As such, no ineffectiveness will arise due to credit risk, as the samerisk is re ected in both the actual andhypothetical derivative.

If, however, the likelihood that thecounterparty will perform ceases to beprobable, an entity would be unable toconclude that the hedging relationship ina cash ow hedge is expected to be highlyeffective in achieving offsetting cash

ows. In those instances, the hedgingrelationship is discontinued.

Under IFRS, a hypothetical derivativeperfectly matches the hedged risk of thehedged item. Because the hedged item would not contain the derivative counter-party’s (or an entity’s own) credit risk, thehypothetical derivative would not re ectthat credit risk. The actual derivative,however, would re ect credit risk. Theresulting mismatch between changes inthe fair value of the hypothetical deriva-tive and the hedging instrument wouldresult in ineffectiveness.

Servicing rights

Differences exist in the recognition andmeasurement of servicing rights, whichmay result in differences with respect tothe hedging of servicing rights. This isespecially relevant for nancial institu -tions that originate mortgages and retainthe right to service them.

US GAAP speci cally permits servicingrights to be hedged for the benchmarkinterest rate or for overall changes in fair value in a fair value hedge.

An entity may, however, avoid the needto apply hedge accounting by electingto measure servicing rights at fair valuethrough pro t or loss as both the hedginginstrument and the hedged item wouldbe measured at fair value through pro tor loss.

Under IFRS, servicing rights are considerednon nancial items. Accordingly, they canonly be hedged for foreign currency riskor hedged in their entirety for all risks(i.e., not only for interest rate risk).

Furthermore, IFRS precludes measurementof servicing rights at fair value throughpro t or loss because the fair value option isapplicable only to nancial items and there -fore cannot be applied to servicing rights.



155


PwC

Impact US GAAP IFRS

Cash ow hedges withpurchased options

For cash ow hedges, US GAAP providesmore exibility than IFRS with respectto designating a purchased option as ahedging instrument.

As a result of the difference, there may bemore income statement volatility for IFRSentities using purchased options in their

hedging strategies.

US GAAP permits an entity to assesseffectiveness based on total changes inthe purchased option’s cash ows (that is,the assessment will include the hedginginstrument’s entire change in fair value). As a result, the entire change in theoption’s fair value (including time value)may be deferred in equity based on thelevel of effectiveness.

Alternatively, the hedge relationship canexclude time value from the hedginginstrument such that effectiveness isassessed based on intrinsic value.

Under IFRS, when hedging one-sidedrisk via a purchased option in a cash owhedge of a forecasted transaction, onlythe intrinsic value of the option is deemedto be re ective of the one-sided risk ofthe hedged item. Therefore, in order toachieve hedge accounting with purchasedoptions, an entity will be required toseparate the intrinsic value and time valueof the purchased option and designate asthe hedging instrument only the changesin the intrinsic value of the option.

As a result, for hedge relationships wherethe critical terms of the purchased optionmatch the hedged risk, generally, thechange in intrinsic value will be deferredin equity while the change in time value will be recorded in the income statement.

Foreign currency risk and

internal derivativesRestrictions under the IFRS guidancerequire that entities with treasury centersthat desire hedge accounting eitherchange their designation or enter intoseparate third-party hedging instru-ments for the gross amount of foreigncurrency exposures.

US GAAP permits hedge accounting forforeign currency risk with internal deriva-tives, provided speci ed criteria are metand, thus, accommodates the hedgingof foreign currency risk on a net basis bya treasury center. The treasury centerenters into derivatives contracts withunrelated third parties that would offset,on a net basis for each foreign currency,the foreign exchange risk arising frommultiple internal derivative contracts.

Under IFRS, internal derivatives donot qualify for hedge accounting inthe consolidated nancial statements(because they are eliminated in consoli-dation). However, a treasury center’snet position that is laid off to an externalparty may be designated as a hedge of agross position in the consolidated nan -cial statements. Careful consideration ofthe positions to be designated as hedgeditems may be necessary to minimize the

effect of this difference. Entities may useinternal derivatives as an audit trail ora tracking mechanism to relate externalderivatives to the hedged item.

The internal derivatives would qualifyas hedging instruments in the separate

nancial statements of the subsidiariesentering into internal derivatives with agroup treasury center.



156 PwC


Impact US GAAP IFRS

Hedge accounting practices not allowed under US GAAP that are acceptable under IFRS

Hedges of a portion of the timeperiod to maturity

IFRS is more permissive than US GAAP with respect to a partial-term fair value hedge.

US GAAP does not permit the hedgedrisk to be de ned as a portion of the timeperiod to maturity of a hedged item.

IFRS permits designation of a derivativeas hedging only a portion of the timeperiod to maturity of a nancial hedgeditem if effectiveness can be measuredand the other hedge accounting criteriaare met. For example, an entity with a

10 percent xed bond with remainingmaturity of 10 years can acquire a ve- year pay- xed, receive- oating swapand designate the swap as hedging thefair-value exposure of the interest ratepayments on the bond until the fth yearand the change in value of the principalpayment due at maturity to the extentaffected by changes in the yield curverelating to the ve years of the swap. Thatis, a ve-year bond is the imputed hedgeditem in the actual 10-year bond; theinterest rate risk hedged is the ve-yearinterest rate implicit in the 10-year bond.

Designated risks for nancialassets or liabilities

IFRS provides opportunities with respectto achieving hedge accounting for aportion of a speci ed risk.

Those opportunities may reduce theamount of ineffectiveness that needs to berecorded in the income statement underIFRS (when compared with US GAAP).

The guidance does not allow a portion ofa speci c risk to qualify as a hedged riskin a hedge of nancial assets or nancialliabilities. US GAAP speci es that thedesignated risk be in the form of changesin one of the following:

• Overall fair value or cash ows

• Benchmark interest rates

• Foreign currency exchange rates

• Creditworthiness and credit risk

The interest rate risk that can be hedged isexplicitly limited to speci ed benchmarkinterest rates.

The guidance allows a portion of a speci crisk to qualify as a hedged risk (so long aseffectiveness can be reliably measured).Designating a portion of a speci c riskmay reduce the amount of ineffective-ness that needs to be recorded in theincome statement under IFRS comparedto US GAAP.

Under IFRS, portions of risks can be viewed as portions of the cash ows(e.g., excluding the credit spread froma xed-rate bond in a fair-value hedgeof interest rate risk) or different types of

nancial risks, provided the types of riskare separately identi able and effective -ness can be measured reliably.



157


PwC

Impact US GAAP IFRS

Fair value hedge of interest raterisk in a portfolio of dissimilaritems

IFRS is more exible than US GAAP with respect to the ability to achievefair value hedge accounting in relationto interest rate risk within a portfolio ofdissimilar items.

That difference is especially relevant

for nancial institutions that use suchhedging as a part of managing overallexposure to interest rate risk and mayresult in risk management strategiesthat do not qualify for hedge accountingunder US GAAP being re ected as hedgesunder IFRS.

US GAAP does not allow a fair valuehedge of interest rate risk in a portfolio ofdissimilar items.

IFRS allows a fair value hedge of interestrate risk in a portfolio of dissimilar items whereby the hedged portion may bedesignated as an amount of a currency,rather than as individual assets (orliabilities). Furthermore, an entity is able

to incorporate changes in prepaymentrisk by using a simpli ed method set outin the guidance, rather than speci callycalculating the fair value of the prepay-ment option on a (prepayable) item-by-item basis.

In such a strategy, the change in fair valueof the hedged item is presented in a sepa-rate line in the balance sheet and does nothave to be allocated to individual assetsor liabilities.

Firm commitment to acquire abusinessIFRS permits entities to hedge, withrespect to foreign exchange risk, a rmcommitment to acquire a business in abusiness combination, which is precludedunder US GAAP.

US GAAP speci cally prohibits a rmcommitment to enter into a businesscombination, or acquire or dispose of asubsidiary, minority interest, or equitymethod investee, from qualifying asa hedged item for hedge accountingpurposes (even if it is with respect toforeign currency risk).

An entity is permitted to hedge foreignexchange risk to a rm commitment toacquire a business in a business combina-tion only for foreign exchange risk.



158 PwC


Impact US GAAP IFRS

Foreign currency risk andlocation of hedging instruments

In hedging forecasted transactions andnet investments for foreign currencyexposure, IFRS provides an opportunityfor a parent to hedge the exposures ofan indirect subsidiary regardless of thefunctional currency of intervening entities within the organizational structure.

Under the guidance, either the operatingunit that has the foreign currency expo-sure is a party to the hedging instrumentor another member of the consolidatedgroup that has the same functionalcurrency as that operating unit is a partyto the hedging instrument. However,for another member of the consolidatedgroup to enter into the hedging instru-ment, there may be no intervening subsid-iary with a different functional currency.

For foreign currency hedges of forecastedtransactions, IFRS does not require theentity with the hedging instrument tohave the same functional currency asthe entity with the hedged item. At thesame time, IFRS does not require that theoperating unit exposed to the r isk beinghedged within the consolidated accountsbe a party to the hedging instrument.

As such, IFRS allows a parent company with a functional currency differentfrom that of a subsidiary to hedgethe subsidiary’s transactional foreigncurrency exposure.

The same exibility regarding locationof the hedging instrument applies to netinvestment hedges.

Hedging more than one risk

IFRS provides greater exibility withrespect to utilizing a single hedginginstrument to hedge more than one risk intwo or more hedged items.

That difference may allow entities toadopt new and sometimes more complexstrategies to achieve hedge accounting while managing certain risks.

US GAAP does not allow a single hedginginstrument to hedge more than one riskin two or more hedged items. US GAAPdoes not permit creation of a hypotheticalcomponent in a hedging relationship todemonstrate hedge effectiveness in thehedging of more than one risk with asingle hedging instrument.

IFRS permits designation of a singlehedging instrument to hedge more thanone risk in two or more hedged items.

A single hedging instrument may bedesignated as a hedge of more than onetype of risk if the risks hedged can beidenti ed clearly, the effectiveness ofthe hedge can be demonstrated, and it ispossible to ensure that there is speci cdesignation of the hedging instrumentand different risk positions. In the appli -cation of this guidance, a single swap may

be separated by inserting an additional(hypothetical) leg, provided that eachportion of the contract is designated as ahedging instrument in a qualifying andeffective hedge relationship.



159


PwC

Impact US GAAP IFRS

Cash ow hedges and basisadjustments on acquisition ofnonnancial items

In the context of a cash ow hedge,IFRS permits more exibility regardingthe presentation of amounts that haveaccumulated in equity (resulting froma cash ow hedge of non nancial assetsand liabilities).

Therefore, the balance sheet impacts maybe different depending on the policy elec-tion made by entities for IFRS purposes.The income statement impact, however, isthe same regardless of this policy election.

In the context of a cash ow hedge,US GAAP does not permit basis adjust -ments. That is, under US GAAP, an entityis not permitted to adjust the initialcarrying amount of the hedged item bythe cumulative amount of the hedging

instruments’ fair value changes that wererecorded in equity.

US GAAP does refer to “basis adjustments”in a different context wherein the termis used to refer to the method by which,in a fair value hedge, the hedged itemis adjusted for changes in its fair valueattributable to the hedged risk.

Under IFRS, “basis adjustment”commonly refers to an adjustment of theinitial carrying value of a non nancialasset or non nancial liability that resultedfrom a forecasted transaction subjectto a cash ow hedge. That is, the initial

carrying amount of the non nancial itemrecognized on the balance sheet (i.e., thebasis of the hedged item) is adjusted bythe cumulative amount of the hedginginstrument’s fair value changes that wererecorded in equity.

IFRS gives entities an accounting policychoice to either basis adjust the hedgeditem (if it is a non nancial item) orrelease amounts to pro t or loss as thehedged item affects earnings.


IFRS IAS 39, IFRS 7, IFRIC 9, IFRIC 16

US GAAP ASC 815, ASC 815-15-25-4 through 25-5, ASC 815-20-25-3, ASC 815-20-25-94 through 25-97, ASC 830-30-40-2 through 40-4

Note




160 PwC



FASB Proposed Accounting Standards Update, Accounting for Financial Instruments and Revisions to the Accountingfor Derivative Instruments and Hedging Activities

The FASB and IASB are reconsidering the accounting for nancial instruments, including hedge accounting. Among other things,the boards expect the project to result in simpli cation of the accounting requirements for hedging activities, resolve hedgeaccounting practice issues that have arisen under the current guidance, and make the hedge accounting model and associateddisclosures more useful and understandable to nancial statement users.

In this regard, on May 26, 2010, the FASB issued its exposure draft on nancial instruments. Comments were due by September 30,2010. The FASB proposes to carry forward many of its ideas contained in the 2008 exposure draft on hedge accounting. However, incontrast with the 2008 exposure draft, the FASB proposes to continue with the bifurcation-by-risk approach as contained in Topic

815 for nancial instruments classi ed at fair value with changes in fair value recognized in other comprehensive income (OCI).The 2010 exposure draft:

• Lowers the threshold to qualify for hedge accounting. The hedging relationship must be “reasonably effective” instead of “highlyeffective.” A company would need to demonstrate and document at inception that (1) an economic relationship exists betweenthe derivative and the hedged item, and (2) the changes in fair value of the hedging instrument would be reasonably effectivein offsetting changes in the hedged item’s fair value or variability in cash ows of the hedged transaction. While this assess -ment would need to be performed only qualitatively, the proposal notes that a quantitative assessment might be necessary incertain situations.

• Replaces the current requirement to quantitatively assess hedge effectiveness each quarter with a qualitative assessment atinception and limited reassessments in subsequent periods. The proposal also would eliminate the shortcut and critical-termsmatch method. Under the proposal, a subsequent hedge effectiveness assessment would be required only if circumstancessuggest that the hedging relationship may no longer be effective. Companies would need to remain alert for circumstances

that indicate that their hedging relationships are no longer effective. Under current guidance, it is not unusual for companiesto determine that a hedging relationship is highly effective in one period but not highly effective in the next period. In thosecircumstances, companies are unable to consistently apply hedge accounting from period to period. The board believes that bylowering the effectiveness threshold to reasonably effective, the frequency of these occurrences should diminish.

• Prohibits the discretionary de-designation of hedging relationships. The proposed model no longer would allow an entity todiscontinue fair value or cash ow hedge accounting by simply revoking the designation. A company would only be able todiscontinue hedge accounting by entering into an offsetting derivative instrument or by selling, exercising, or terminating thederivative instrument. As a result, once a company elects to apply hedge accounting, it would be required to keep the hedgerelationship in place throughout its term, unless the required criteria for hedge accounting no longer are met (e.g., the hedge isno longer reasonably effective) or the hedging instrument is sold, expired, exercised, or terminated.

• Requires recognition of the ineffectiveness associated with both over- and under-hedges for all cash ow hedging relationships(i.e., the accumulated OCI balance should represent a “perfect” hedge). This represents a signi cant change since under current

US GAAP, only the effect of over-hedging is recorded as ineffectiveness during the term of the hedge.• The FASB’s proposal would simplify certain key aspects of hedge accounting that many companies have found challenging.

However, it also would limit or eliminate other aspects of the current model that some companies found bene cial. The proposedhedge accounting has the potential to create signi cant differences when compared with that proposed by IFRS.

In May 2012, the FASB indicated that it will not start redeliberating hedge accounting until after completing the nancial instru -ments classi cation and measurement project.



161


PwC

In its February 2013 proposed Accounting Standards Update, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities , the FASB proposed that, similar to the approach adopted by the IASB underIFRS 9, embedded derivatives or other features which cause a nancial asset to fail the contractual cash ow characteristics test willnot be bifurcated. The corresponding nancial assets will be measured at fair value through the income statement. For nancialliabilities, the FASB proposed to adopt the IFRS 9 approach where there will be bifurcation based on the current embedded deriva -tive guidance.

IASB draft of forthcoming new hedge accounting requirements

In September 2012, the IASB posted to its website a draft of the forthcoming general hedge accounting requirements that will beadded to IFRS 9 Financial Instruments. The draft proposes changes to the general hedge accounting model and is expected to be

nalized in the second half of 2013.

The macro hedge accounting principles will be addressed as a separate project. In May 2012, the IASB tentatively decided to movetoward a discussion paper (instead of an exposure draft) as the next due process step relating to macro hedge accounting, which isexpected to be released by the end of 2013.

The proposed IFRS model is more principle-based than the current IASB and US GAAP models and the US GAAP proposal, and aimsto simplify hedge accounting. It would also align hedge accounting more closely with the risk management activities undertaken bycompanies and provide decision-useful information regarding an entity’s risk management strategies.

The following key changes to the IAS 39 general hedge accounting model are proposed by the IASB draft:

• Replacement of the “highly” effective threshold as the qualifying criteria for hedging. Instead, an entity’s designation of thehedging relationship should be based on the economic relationship between the hedged item and the hedging instrument, whichgives rise to offset. An entity should not designate a hedging relationship such that it re ects an imbalance between the weight -ings of the hedged item and hedging instrument that would create hedge ineffectiveness (irrespective of whether recognized or

not) in order to achieve an accounting outcome that is inconsistent with the purpose of hedge accounting. The objective of theIASB is to allow greater exibility in qualifying for hedge accounting but also to ensure that entities do not systematically under-hedge to avoid recording any ineffectiveness.

• Ability to designate risk components of nonnancial items as hedged items. The IASB’s draft would permit entities to hedge riskcomponents for nonnancial items, provided such components are separately identi able and reliably measurable.

• More exibility in hedging groups of dissimilar items (including net exposure). The IASB’s draft would allow hedges of(1) groups of similar items without a requirement that the fair-value change for each individual item be proportional to theoverall group (e.g., hedging a portfolio of S&P 500 shares with an S&P 500 future) as well as (2) groups of offsetting exposures(e.g., exposures resulting from forecast sale and purchase transactions). Additional qualifying criteria would be required forsuch hedges of offsetting exposures.

• Accounting for the time value component as “cost” of buying the protection when hedging with options in both fair value andcash ow hedges. The IASB’s draft introduces signi cant changes to the guidance related to the accounting for the time value of

options. It analogizes the time value to an insurance premium. Hence, the time value would be recorded as an asset on day oneand then released to net income based on the type of item the option hedges. The same accounting should apply for forwardpoints in a forward contract.

• Prohibition of voluntary de-designation of the hedging relationship unless the risk management objective for such relation -ship changes. The IASB’s draft allows termination of the hedging relationship only if it is no longer viable for r isk managementpurposes, or the hedging instrument is sold, expired, exercised, or terminated.

• Introduction of incremental disclosure requirements to provide users with useful information on the entity’s riskmanagement practices.



162 PwC


Subsequently, during the period of January to April 2013 the IASB discussed further issues on IFRS 9 Hedge Accounting based oncomments received on the review draft. As a result, the following was agreed:

• Broadening the concept of ‘cost’ of hedging (applicable to the time value of options and forward points in forward contracts) toalso incorporate the currency basis spread. This will help to reduce income statement volatility mainly in cash ow hedges offoreign currency risk.

• Clarifying in the IFRS 9 Basis for Conclusions the relevance of the IAS 39 Implementation Guidance not carried forward to IFRS 9.

• Providing a one-time accounting policy choice on the hedge accounting model to be applied. Entities may elect to continueapplying the hedging model as per IAS 39 or to adopt IFRS 9. The accounting model must be applied as a whole (no cherrypicking allowed) and cannot be changed until the IASB Macro Hedging project is nalized.

IFRS Amendments to IAS 39, Financial Instruments and Measurement: Novation of Derivatives and Continuation of Hedge Accounting

In June 2013 the IASB published amendments to IAS 39 on novation of derivatives; such amendments will also be incorporated inIFRS 9. These are the result of recent legislative changes requiring entities to novate Over the Counter derivative contracts to centralcounterparties (CCPs) in an effort to reduce counterparty credit risk. The IASB was concerned about the nancial reporting effectsthat would arise from these novations (discontinuation of hedge accounting) under current guidance and therefore, the amend-ments clarify that changes to a contract will not result in the expiration or termination of the hedging instrument (and therefore will not result in the termination of any related hedge designation) if:

• as a consequence of laws or regulations, the parties to the hedging instrument agree that a CCP, or an entity (or entities) actingas a counterparty in order to effect clearing by a CCP (‘the clearing counterparty’), replaces their original counterparty; and

• other changes, if any, to the hedging instrument are limited to those that are necessary to effect such replacement of the coun-terparty. These changes include changes in the contractual collateral requirements, rights to offset receivables and payables

balances, and charges levied.

The amendments will apply for annual periods beginning on or after 1 January 2014. Earlier application is permitted.

In the United States, the SEC staff provided similar relief. In a letter to the International Swaps and Derivative Association (ISDA)dated May 2012, the SEC staff agreed that it would not object to the continuation of an existing hedging relationship where there isa novation of a derivative contract under speci c circumstances. However, those speci c circumstances differ somewhat from thoseproposed by the IASB and therefore, could lead to application differences.

Balance sheet netting of derivatives and other nancial instruments

Further details on the balance sheet netting of derivatives and other nancial instruments are described in the Assets— nancialassets chapter.



Consolidation



164 PwC


Consolidation

IFRS is a principles-based framework, and the approach to consolidation re ects that structure. IFRS provides indicators of control,some of which individually determine the need to consolidate. However, where control is not apparent, consolidation is based on anoverall assessment of all of the relevant facts, including the allocation of risks and bene ts between the parties. The indicators providedunder IFRS help the report ing entity in making that assessment. Consolidation in nancial statements is required under IFRS when anentity has the ability to govern the nancial and operating policies of another entity to obtain bene ts.

US GAAP has a two-tier consolidation model: one focused on voting rights (the voting interest model) and the second focused on aqualitative analysis of power over signi cant activities and exposure to potentially signi cant losses or bene ts (the variable interest

model). Under US GAAP, all entities are evaluated to determine whether they are variable interest entities (VIEs). Consolidation of allnon-VIEs is assessed on the basis of voting and other decision-making rights.

Even in cases for which both US GAAP and IFRS look to voting r ights to drive consolidation, differences can arise. Examples includecases in which de facto control exists and how the two frameworks address potential voting rights. As a result, careful analysis isrequired to identify any differences.

Differences in consolidation under US GAAP and IFRS may also arise when a subsidiary’s set of accounting policies differs from that ofthe parent. While under US GAAP it is acceptable to apply different accounting policies within a consolidation group to address issuesrelevant to certain specialized industries, exceptions to the requirement to consistently apply standards in a consolidated group do notexist under IFRS. In addition, potential adjustments may occur in situations where a parent company has a scal year-end differentfrom that of a consolidated subsidiary (and the subsidiary is consolidated on a lag). Under US GAAP, signi cant transactions in thegap period may require disclosure only, whereas IFRS may require recognition of transactions in the gap period in the consolidated

nancial statements.

The current IFRS consolidation standard, IFRS 10, Consolidated Financial Statements , and joint arrangements standard, IFRS 11, Joint Arrangements , became effective for annual periods beginning on or after January 1, 2013. The related disclosure standard IFRS 12,Disclosure of Interests in Other Entities, has the same effective date.




165

Consolidation

PwC

Impact US GAAP IFRS

General requirements

Requirements toprepare consolidatednancial statementsIFRS does not provide industry-speci cexceptions (e.g., investment companiesand broker/dealers) to the requirementfor consolidation of controlled entities.

However, IFRS is, in limited circum -stances, more exible with respect to theability to issue nonconsolidated nan -cial statements (IAS 27, Separate FinancialStatements ). In addition, on adoptionof the amendment to IFRS 10, entitiesthat meet the de nition of an investmententity would be prohibited from consoli-dating controlled investments except forcertain circumstances.

The guidance applies to legal structures.

Industry-speci c guidance precludesconsolidation of controlled entities bycertain types of organizations, such as

registered investment companies orbroker/dealers.

Consolidated nancial statements arepresumed to be more meaningful and arerequired for SEC registrants.

There are no exemptions for consoli-dating subsidiaries in general-purpose

nancial statements.

Parent entities prepare consolidatednancial statements that include all

subsidiaries. An exemption applies to aparent entity when all of the followingconditions apply:

• It is a wholly owned subsidiary and theowners of the minority interests havebeen informed about and do not objectto the parent not presenting consoli-dated nancial statements

• The parent’s debt or equity securi -ties are not publicly traded and theparent is not in the process of issuingany class of instruments in publicsecurities markets

• The ultimate or any intermediateparent of the parent publishes consoli-dated nancial statements available forpublic use that comply with IFRS

A subsidiary is not excluded from consoli-dation simply because the investor is a venture capital organization, mutualfund, unit trust, or similar entity.However, note that an exception, whichis effective from 2014 with early adoptionpermitted, is provided for an investmententity from consolidating certain of itssubsidiaries. Instead, the investmententity measures those investments at fair

value through pro t or loss.



166 PwC


Impact US GAAP IFRS

Consolidation model

Differences in consolidation can arise as aresult of:

• Differences in how economic bene tsare evaluated when the consolidationassessment considers more than just voting rights(i.e., differences in methodology)

• Speci c differences or exceptions,

such as: - The consideration of

variable interests

- De facto control

- How potential voting rightsare evaluated

- Guidance related to de facto agentsand related parties

- Reconsideration events

All consolidation decisions are evalu-ated rst under the VIE model. US GAAPrequires an entity with a variable interestin a VIE to qualitatively assess the deter -mination of the primary bene ciary ofthe VIE.

In applying the qualitative model, anentity is deemed to have a controlling

nancial interest if it meets both of thefollowing criteria:

• Power to direct activities of the VIEthat most signi cantly impact the VIE’seconomic performance(power criterion)

• Obligation to absorb losses from orright to receive bene ts of the VIE thatcould potentially be signi cant to the VIE (losses/bene ts criterion)

In assessing whether an enterprise has acontrolling nancial interest in an entity,

it should consider the entity’s purpose anddesign, including the risks that the entity was designed to create and pass throughto its variable interest holders.

Only one enterprise, if any, is expected tobe identi ed as the primary bene ciary ofa VIE. Although more than one enterprisecould meet the losses/bene ts criterion,only one enterprise, if any, will have thepower to direct the activities of a VIEthat most signi cantly impact the entity’seconomic performance.

IFRS focuses on the concept of control indetermining whether a parent-subsidiaryrelationship exists.

An investor controls an investee when ithas all of the following:

• Power, through rights that give itthe current ability, to direct theactivities that signi cantly affect (the

relevant activities that affect) theinvestee’s returns.

• Exposure, or rights, to variable returnsfrom its involvement with the investee(returns must vary and can be positive,negative, or both)

• The ability to use its power over theinvestee to affect the amount of theinvestor’s returns.

In assessing control of an entity, aninvestor should consider the entity’spurpose and design to identify therelevant activities, how decisions aboutthe relevant activities are made, who hasthe current ability to direct those activi-ties, and who is exposed or has rights tothe returns from those activities. Onlysubstantive rights can provide power.



167

Consolidation

PwC

Impact US GAAP IFRS

Consolidation model (continued) Increased skepticism should be givento situations in which an enterprise’seconomic interest in a VIE is dispropor -tionately greater than its stated power todirect the activities of the VIE that mostsigni cantly impact the entity’s economicperformance. As the level of disparityincreases, the level of skepticism aboutan enterprise’s lack of power is expectedto increase.

All other entities are evaluated under the voting interest model. Unlike IFRS, onlyactual voting rights are considered. Underthe voting interest model, control canbe direct or indirect. In certain unusualcircumstances, control may exist with lessthan 50 percent ownership, when contrac-tually supported. The concept is referredto as effective control.

De facto control concept

No de facto control concept exists.Effective control as described above islimited to contractual arrangements.

The greater an investor’s exposure to vari -ability of returns, the greater its incentiveto obtain rights to give it power, i.e., it isan indicator of power and is not by itselfdeterminative of having power.

When an entity is controlled by votingrights, control is presumed to exist whena parent owns, directly or indirectly,more than 50 percent of an entity’s votingpower. Control also exists when a parent

owns half or less of the voting power buthas legal or contractual rights to controleither the majority of the entity’s votingpower or the board of directors. Controlmay exist even in cases where an entityowns little or none of a structured equity.The application of the control conceptrequires, in each case, judgment in thecontext of all relevant factors.

De facto control concept

An investor can control an entity whereit holds less than 50 percent of the votingrights of the entity and lacks legal orcontractual rights by which to controlthe majority of the entity’s voting poweror board of directors (de facto control). An example of de facto control is when amajor shareholder holds an investmentin an entity with an otherwise dispersedpublic shareholding. The assertion of defacto control is evaluated on the basisof all relevant facts and circumstances,including the legal and regulatory envi-ronment, the nature of the capital market,

and the ability of the majority owners of voting shares to vote together.



168 PwC


Impact US GAAP IFRS

Consolidation model (continued) Potential voting rights

No speci c guidance exists requiring theconsideration of potential voting rights.

Shared powerCurrent US GAAP for VIEs notes thatpower is shared, and consequently no partyconsolidates, when two or more unrelatedparties together have power to direct theentity’s activities that most signi cantlyimpact the entity’s economic performanceand decisions about those activities requirethe consent of each party sharing the power.

Agent versus principal analysis

Current US GAAP for VIEs includesspeci c guidance to determine whetherthe remuneration of a decision makeris considered a variable interest inthe entity. For limited partnershipsor similar entities that are not VIEs,US GAAP presumes that the generalpartner controls the entity, although thatpresumption of control can be overcomeif the limited partners possess substantiverights to remove the general partner orliquidate the entity.

The FASB issued a proposal in November2011 to incorporate an agent versus prin -cipal analysis in US GAAP for VIEs andlimited partnership entities that would bebroadly consistent with IFRS 10. However,the FASB is re-deliberating many of thekey aspects of the proposal. Signi cantchanges may be made before the standardis nalized.

Potential voting rights

IFRS requires potential voting rights tobe considered in the assessment of powerif they are substantive. Sometimes rightscan be substantive even though notcurrently exercisable. To be substantive,rights need to be exercisable when deci-sions about the direction of the relevantactivities need to be made.

Shared powerIFRS includes the concept of shared powerby noting that two or more investors collec-tively control an entity and do not individu-ally control when they must act togetherto direct the relevant activities. Note thatif there is joint control (which is differentfrom collective control) then the standardon joint arrangements (IFRS 11) applies.

Agent versus principal analysis

IFRS includes guidance on agent/principal relationships. An agent maybe engaged to act on behalf of a singleparty or a group of investors (princi-pals). Certain power is delegated by theprincipals to the agent. An agent doesnot consolidate the entity instead, theprincipal shall treat the decision-makingrights delegated to the agent as held bythe principal directly. Where there ismore than one principal, each shall assess whether it has power over the investee.

Four key factors need to be considered when determining whether the investor is

acting as an agent, as follows:Indicators relating to power:

1. the scope of its decision-makingauthority,

2. the rights held by other parties,

Indicators relating to exposure to variablereturns:

3. the remuneration it receives, and

4. exposure to variability of returns fromother interests that it holds in the entity.



169

Consolidation

PwC

Impact US GAAP IFRS

Consolidation model (continued) Related parties and de facto agents

US GAAP includes speci c guidanceon interests held by related parties. Arelated party group includes the reportingentity’s related parties and de facto agents(e.g., close business advisors, partners,employees) whose actions are likelyto be in uenced or controlled by thereporting entity.

Individual parties within a relatedparty group (including de facto agencyrelationships) are required to rstseparately consider whether they meetboth the power and losses/bene tscriteria. If one party within the relatedparty group meets both criteria, it is theprimary bene ciary of the VIE. If no party within the related party group on its ownmeets both criteria, the determination ofthe primary bene ciary within the relatedparty group is based on an analysis ofthe facts and circumstances, with the

objective of determining which party ismost closely associated with the VIE.

Reconsideration events

Determination of whether an entity isa VIE gets reconsidered either when aspeci c reconsideration event occurs or, inthe case of a voting interest entity, when voting interests or rights change.

However, the determination ofa VIE’s primary bene ciary is anongoing assessment.

Related parties and de facto agents

IFRS requires that an investor considerthe nature of rights and exposures heldby related parties and others to deter-mine if they are acting as de facto agents.Rights and exposures held by de factoagents would need to be consideredtogether with the investor’s own rightsand exposures in the consolidationanalysis. However, there is no related

party tiebreaker guidance as containedin US GAAP to address situations whereno party in a related party group controlsan entity on a stand-alone basis but therelated party group as a whole controlsthe entity.

Reconsideration events

There is no concept of a tr iggering eventin the current literature. IFRS 10 requiresthe consolidation analysis to be reassessed when facts and circumstances indicatethat there are changes to one or more ofthe elements of the control de nition.



170 PwC


Impact US GAAP IFRS

Consolidation model (continued) Silos

Although US GAAP applies to legal struc -tures, guidance is provided to addresscircumstances in which an entity witha variable interest shall treat a portionof the entity as a separate VIE if speci cassets or activities (a silo) are essentiallythe only source of payment for speci edliabilities or speci ed other interests. Aparty that holds a variable interest in the

silo then assesses whether it is the silo’sprimary bene ciary. The key distinctionis that the US GAAP silo guidance appliesonly when the larger entity is a VIE.

Silos

IFRS incorporates guidance for silos thatis similar to US GAAP; however, the siloguidance under IFRS applies regardless of whether the larger entity is a VIE.

Accounting policies andreporting periods

In relation to certain specialized indus-tries, US GAAP allows more exibilityfor use of different accounting poli-cies within a single set of consolidated

nancial statements.

In the event of nonuniform reportingperiods, the treatment of signi cant trans -actions in any gap period varies under thetwo frameworks, with the potential forearlier recognition under IFRS.

Consolidated nancial statements areprepared by using uniform accountingpolicies for all of the entities in a group.Limited exceptions exist when a subsid -iary has specialized industry accountingprinciples. Retention of the specializedaccounting policy in consolidation ispermitted in such cases.

The consolidated nancial statements ofthe parent and the subsidiary are usuallydrawn up at the same reporting date.However, the consolidation of subsidiaryaccounts can be drawn up at a differentreporting date, provided the differ-ence between the reporting dates is nomore than three months. Recognitionis given, by disclosure or adjustment,to the effects of intervening events that would materially affect consolidated

nancial statements.

Consolidated nancial statements areprepared by using uniform accountingpolicies for like transactions and events insimilar circumstances for all of the entitiesin a group.

The consolidated nancial statements ofthe parent and the subsidiary are usuallydrawn up at the same reporting date.However, the subsidiary accounts as of adifferent reporting date can be consoli-dated, provided the difference betweenthe reporting dates is no more than threemonths. Adjustments are made to the

nancial statements for signi cant trans -actions that occur in the gap period.



171

Consolidation

PwC

Impact US GAAP IFRS

Equity investments/investments in associates and joint ventures

Potential voting rights

The consideration of potential voting rights might lead to differ-ences in whether an investor hassigni cant in uence.

Potential voting rights are generally notconsidered in the assessment of whetheran investor has signi cant in uence.

Potential voting rights are considered indetermining whether the investor exertssigni cant in uence over the investee.Potential voting rights are importantin establishing whether the entity is anassociate. Potential voting rights are not,however, considered in the measure-

ment of the equity earnings recorded bythe investor.

Denition and types of joint ventures

Differences in the de nition or types of joint ventures may result in differentarrangements being considered joint ventures, which could affect reported

gures, earnings, ratios, and covenants.

The term joint venture refers only to jointly controlled entities, where thearrangement is carried on through aseparate entity.

A corporate joint venture is de ned asa corporation owned and operated bya small group of businesses as a sepa-

rate and speci c business or project forthe mutual bene t of the members ofthe group.

Most joint venture arrangements giveeach venturer (investor) participatingrights over the joint venture (withno single venturer having unilateralcontrol), and each party sharing controlmust consent to the venture’s operating,investing, and nancing decisions.

A joint arrangement is a contractualagreement whereby two or more partiesundertake an economic activity that issubject to joint control. Joint control is thecontractually agreed sharing of controlof an economic activity. Unanimousconsent is required of the parties sharingcontrol, but not necessarily of all partiesin the venture.

IFRS classi es joint arrangements intotwo types:

• Joint operations, which give parties tothe arrangement direct rights to theassets and obligations for the liabilities

• Joint ventures, which give the partiesrights to the net assets or outcome ofthe arrangement



172 PwC


Impact US GAAP IFRS

Accounting for jointarrangements

Under IFRS, classi cation of joint arrange -ment as a joint venture or a joint opera-tion determines the accounting by theinvestor. Under US GAAP, the propor -tional consolidation method is allowed forentities in certain industries.

Prior to determining the accountingmodel, an entity rst assesses whether the joint venture is a VIE. If the joint ventureis a VIE, the accounting model discussedearlier is applied. Joint ventures oftenhave a variety of service, purchase, and/or sales agreements, as well as fundingand other arrangements that may affectthe entity’s status as a VIE. Equity inter -ests are often split 50-50 or near 50-50,making nonequity interests (i.e., any vari -able interests) highly relevant in consoli-dation decisions. Careful considerationof all relevant contracts and governingdocuments is critical in the determinationof whether a joint venture is within thescope of the variable interest model and,if so, whether consolidation is required.

If the joint venture is not a VIE, venturersapply the equity method to recognize the

investment in a jointly controlled entity.Proportionate consolidation is generallynot permitted except for unincorporatedentities operating in certain industries. A full understanding of the rights andresponsibilities conveyed in management,shareholder, and other governing docu-ments is necessary.

The classi cation of a joint arrangementas a joint venture or a joint operationdetermines the investor’s accounting. Aninvestor in a joint venture must accountfor its interest using the equity method inaccordance with IAS 28.

An investor in a joint operation accounts

for its share of assets, liabilities, incomeand expenses based on its direct rightsand obligations.



173

Consolidation

PwC

Impact US GAAP IFRS

Accounting for contributions toa jointly controlled entity

Gain recognition upon contribution toa jointly controlled entity is more likelyunder IFRS.

As a general rule, a venturer records itscontributions to a joint venture at cost(i.e., the amount of cash contributed andthe carrying value of other nonmonetaryassets contributed).

When a venturer contributes appreciatednoncash assets and others have invested

cash or other hard assets, it might beappropriate to recognize a gain for aportion of that appreciation. Practice andexisting literature vary in this area. As aresult, the speci c facts and circumstancesaffect gain recognition and requirecareful analysis.

A venturer that contributes nonmonetaryassets—such as shares; property, plant,and equipment; or intangible assets—toa jointly controlled entity in exchange foran equity interest in the jointly controlledentity generally recognizes in its consoli-dated income statement the portion ofthe gain or loss attributable to the equityinterests of the other venturers, except when:

• The signi cant risks and rewards ofownership of the contributed assetshave not been transferred to the jointlycontrolled entity,

• The gain or loss on the assets contrib-uted cannot be measured reliably, or

• The contribution transaction lackscommercial substance

Note that where the nonmonetary asset

is a business, a policy choice is currentlyavailable for full or partial gain or lossrecognition, the IASB has proposedan amendment to IFRS 10 and IAS28 (Amended 2011) to clarify whenfull or partial gain or loss recognitionis appropriate.

IAS 28 (Amended 2011) provides anexception to the recognition of gains orlosses only when the transaction lackscommercial substance.



174 PwC


Impact US GAAP IFRS

Equity method of accounting—exemption from applying theequity method

An exemption from applying the equitymethod of accounting (i.e., use of thefair value through pro t or loss option)is available to a broader group of entitiesunder US GAAP.

Equity method investments are consid-ered nancial assets and therefore areeligible for the fair value accountingoption. An entity can measure an invest -ment in associates or joint ventures atfair value through pro t or loss, regard -less of whether it is a venture capital orsimilar organization.

An entity can elect fair value throughpro t or loss accounting when equitymethod investments are held by venturecapital organizations, mutual funds, unittrusts, and similar entities, includinginvestment-linked insurance funds.

Equity method of accounting—classication as held for sale

Application of the equity method ofaccounting may cease before signi cantin uence is lost under IFRS (but notunder US GAAP).

Under US GAAP, equity method invest -ments are not classi ed as held forsale. An investor applies equity methodaccounting until signi cant in uenceis lost.

If an equity method investment meets theheld for sale criteria in accordance withIFRS 5, an investor records the investmentat the lower of its (1) fair value less coststo sell or (2) carrying amount as of thedate the investment is classi ed as heldfor sale.

Equity method of accounting—acquisition date excess ofinvestor’s share of fair valueover cost

IFRS may allow for day one gain recogni-tion (whereas US GAAP would not).

Any acquisition date excess of the inves-tor’s share of the net fair value of the asso -ciate’s identi able assets and liabilitiesover the cost of the investment is includedin the basis differences and is amortized—if appropriate—over the underlyingasset’s useful life. If amortization is notappropriate, the difference is included inthe gain/loss upon ultimate disposition ofthe investment.

Any acquisition date excess of the inves-tor’s share of net fair value of the associ -ates’ identi able assets and liabilities overthe cost of the investment is recognized asincome in the period in which the invest-ment is acquired.



175

Consolidation

PwC

Impact US GAAP IFRS

Equity method of accounting—conforming accounting policies

A greater degree of conformity is requiredunder IFRS.

The equity investee’s accounting policiesdo not have to conform to the inves-tor’s accounting policies if the investeefollows an acceptable alternativeUS GAAP treatment.

An investor’s nancial statements areprepared using uniform accountingpolicies for similar transactions andevents. This also applies to equitymethod investees.

Equity method of accounting—impairment

Impairment losses may be recognizedearlier under IFRS.

An investor should determine whethera loss in the fair value of an investmentbelow its carrying value is a temporarydecline. If it is other than temporary,the investor calculates an impairment asthe excess of the investment’s carryingamount over the fair value.

An investor should assess whether impair-ment indicators exist, in accordance with IAS 39. If there are indicators thatthe investment may be impaired, theinvestment is tested for impairment inaccordance with IAS 36. The conceptof a temporary decline does not existunder IFRS.

Equity method of accounting—losses in excess of aninvestor’s interest

Losses may be recognized earlier underUS GAAP.

Even without a legal or constructiveobligation to fund losses, a loss in excessof the investment amount (i.e., a negativeor liability investment balance) shouldbe recognized when the imminent returnto pro table operations by an investeeappears to be assured.

Unless an entity has incurred a legal orconstructive obligation, losses in excessof the investment are not recognized. Theconcept of an imminent return to pro t -able operations does not exist under IFRS.



176 PwC


Impact US GAAP IFRS

Equity method of accounting—loss of signicant inuence or

joint control

The potential for greater earnings vola-tility exists under IFRS.

Upon the loss of signi cant in uenceor joint control, any retained interestis measured at the carrying amount ofthe investment at the date of the changein status.

If an entity loses signi cant in uenceor joint control over an equity methodinvestment and the retained interest is a

nancial asset, the entity should measurethe retained interest at fair value. Theresultant gain or loss is recognized in theincome statement.

In contrast, if an investment in anassociate becomes an investment in a joint venture, or vice versa, such that theequity method of accounting continues toapply, no gain or loss is recognized in theincome statement.

Disclosure

Disclosures

US GAAP and IFRS both require extensivedisclosure about an entity’s involvement

in VIEs/ structured entities, includingthose that are not consolidated.

Guidance applies to both nonpublic andpublic enterprises.

The principal objectives of VIE disclosuresare to provide nancial statement users with an understanding of the following:

• Signi cant judgments and assumptionsmade by an enterprise in determining whether it must consolidate a VIEand/or disclose information about itsinvolvement in a VIE

• The nature of restrictions on a consoli-dated VIE’s assets and on the settle -ment of its liabilities reported by anenterprise in its statement of nan -cial position, including the carryingamounts of such assets and liabilities

• The nature of, and changes in, the risksassociated with an enterprise’s involve -ment with the VIE

• How an enterprise’s involvement withthe VIE affects the enterprise’s nan -cial position, nancial performance,and cash ows

IFRS has disclosure requirements forinterests in subsidiaries, joint arrange-

ments, associates, and unconsolidatedstructured entities which includethe following:

• Signi cant judgments and assump -tions in determining if an investorhas control or joint control overanother entity, and the type of joint arrangement

• The composition of the group andinterests that non-controlling inter-ests have in the group’s activities andcash ows

• The nature and extent of any signi -cant restrictions on the ability of theinvestor to access or use assets, andsettle liabilities

• The nature and extent of an inves-tor’s interest in unconsolidatedstructured entities



177

Consolidation

PwC

Impact US GAAP IFRS

Disclosures (continued) The level of disclosure to achieve theseobjectives may depend on the facts andcircumstances surrounding the VIE andthe enterprise’s interest in that entity.

Additional detailed disclosure guidanceis provided for meeting the objectivesdescribed above.

Speci c disclosures are required for (1)a primary bene ciary of a VIE and (2) anentity that holds a variable interest in a VIE (but is not the primary bene ciary).

• The nature of, and changes in, the risksassociated with an investor’s interestin consolidated and unconsolidatedstructured entities

• The nature, extent and nancialeffects of an investors’ interests in joint arrangements and associates,and the nature of the risks associated with those interestsThe consequencesof changes in ownership interest of a

subsidiary that do not result in lossof control

• The consequences of a loss of controlof a subsidiary during the period

An entity is required to consider the levelof detail necessary to satisfy the disclosureobjectives of enabling users to evaluatethe nature and associated risks of its inter-ests, and the effects of those interests onits nancial statements.

Additional detailed disclosure guidanceis provided for meeting the objectivesdescribed above.

If control of a subsidiary is lost, the parentshall disclose the gain or loss, if any, and:

1. Portion of that gain or loss attributableto recognizing any investment retainedin former subsidiary at its fair value atdate when control is lost

2. Line item(s) in the statement ofcomprehensive income in which gainor loss is recognized (if not presentedseparately in the statement of compre-

hensive income) Additional disclosures are required ininstances when separate nancial state -ments are prepared for a parent that electsnot to prepare consolidated nancialstatements, or when a parent, venturer with an interest in a jointly controlledentity, or investor in an associate preparesseparate nancial statements.



178 PwC


Impact US GAAP IFRS


IFRS IAS 1, IAS 27 (Amended 2011), IAS 28, IAS 28 (Amended 2011), IAS 36, IAS 39, IFRS 5, IFRS 10, IFRS 11, IFRS 12, SIC 13

US GAAP ASC 205, ASC 323, ASC 323–10–15–8 through 15-11, ASC 325–20, ASC 360, ASC 810, ASC 810–10–25–1 through 25–14, ASC 810–10–60–4, SAB Topic 5H, SAB Topic 5–H (2)–(6)

Note


Recent/proposed guidanceIn May 2011, the IASB issued IFRS 10, Consolidated Financial Statements , IFRS 11, Joint Arrangements , IFRS 12, Disclosure of Interests in Other Entities , IAS 27 (Amended), Separate Financial Statements, and IAS 28 (Amended), Investments in Associates and Joint Ventures . These standards are effective for annual periods beginning on or after January 1, 2013, with earlier applicationpermitted. Please note that IFRS 10, IFRS 11, IFRS 12, IAS 27, and IAS 28 have been endorsed for application in the European Unionfor annual periods beginning on or after 1 January 2014 with early adoption allowed.

IASB amendments to IFRS 10, Consolidated Financial Statements, IFRS 12, Disclosure of Interests in Other Entities ,and IAS 27 (Amended), Separate Financial Statements—Investment Entities

In October 2012, the IASB issued a nal standard de ning an investment entity. This de nition was developed jointly with the

FASB although some differences exist. That standard provides an exception to the consolidation requirements in IFRS 10 for certaincontrolled investments held by an investment entity, and instead requires the investment entity to measure those investments at fair value through pro t or loss. New disclosures are also required. Note that the exception from consolidation only applies to the nan -cial reporting of an investment entity and that exception does not carry over for the nancial reporting by a non-investment entityparent. The amendments are effective from January 1, 2014 with early adoption permitted.

FASB Accounting Standards Update No, 2013-08, Financial Services—Investment Companies (Topic 946)

In June 2013, the FASB issued its standard de ning an investment company. The standard amends the current de nition andfurther speci es that entities registered under the Investment Company Act of 1940 would qualify as investment companies.Investment companies would continue to measure their investments at fair value, including any investments in which they have acontrolling nancial interest. The amendments are effective for interim and annual reporting periods in scal years that begin afterDecember 15, 2013. Early adoption is prohibited.

While the FASB and the IASB standards are substantially converged in most areas, there are several key differences. In contrast tothe IASB standard, the FASB guidance retains the specialized investment company accounting in consolidation by a non-investmentcompany parent. Further, while all portfolio investments will be accounted for at fair value through net income under the FASB’srequirements, the IASB only provides an exception from the consolidation requirement for controlled investments with all otherinvestments being subject to other applicable guidance. In addition to other differences, the IASB standard also does not have aspeci c inclusion for entities under the Investment Company Act of 1940 or other similar legislation.

IASB proposed amendments to IAS 28 (Amended), Investments in Associates and Joint Ventures—Equity Method:Share of Other Net Asset Changes

In November 2012, the IASB issued an exposure draft to provide additional guidance on how an investor should recognize its



179

Consolidation

PwC

share of the changes in the net assets of an investee that are not recognized in pro t or loss or other comprehensive income of theinvestee, or that are not distributions received. The exposure draft proposes that the investor should recognize its share of theseother net asset changes in its own equity. A nal standard is expected in the fourth quarter of 2013.

IASB proposed amendments to IFRS 10, Consolidated Financial Statements, and IAS 28(Amended), Investments in Associates and Joint Ventures

In December 2012, the IASB issued an exposure draft to address the inconsistency between the requirements in IFRS 10Consolidated Financial Statements , and IAS 28 Investments in Associates and Joint Ventures , in dealing with the loss of control of asubsidiary that is contributed to an associate or a joint venture. IAS 28 (2011) restricts gains and losses arising from contributionsof non-monetary assets to an associate or a joint venture to the extent of the interest attributable to the other equity holders in theassociate or joint venture. IFRS 10 requires full pro t or loss recognition on the loss of control of the subsidiary. The proposal would

amend IAS 28 so that the current requirements regarding the partial gain or loss recognition for transactions between an investorand its associate or joint venture only apply to the gain or loss resulting from the sale or contribution of assets that do not constitutea business as de ned in IFRS 3; and the gain or loss resulting from the sale or contribution of assets that constitute a business asde ned in IFRS 3 between an investor and its associate or joint venture is recognized in full. Similarly, IFRS 10 would be amended toindicate that the gain or loss resulting from the sale or contribution of a subsidiary that does not constitute a business as de ned inIFRS 3 between an investor and its associate or joint venture is recognized only to the extent of the unrelated investors’ interests inthe associate or joint venture. A full gain or loss would be recognized on the loss of control of a subsidiary that constitutes a businessas de ned in IFRS 3, including cases in which the investor retains joint control of, or signi cant in uence over, the investee. A nalstandard is expected in the fourth quarter of 2013.

IASB proposed amendments to IFRS 11, Joint Arrangements—Acquisition of an Interest in a Joint Operation

In December 2012, the IASB issued a proposal to amend IFRS 11 to address the accounting for the acquisition of an interest in a joint operation that constitutes a business. The IASB proposes that acquirers of such interests apply the relevant principles on busi -

ness combination accounting contained in IFRS 3, Business Combinations and other standards, and disclose the related informationrequired under those standards. A nal standard is expected in the fourth quarter of 2013.

FASB Proposed Accounting Standards Update, Consolidation (Topic 810)—Agent/Principal Analysis

In 2011 the FASB issued an exposure draft proposing changes to the consolidation guidance for VIEs and partnerships that arenot VIEs. The proposal provided that a reporting entity t-hat has a variable interest in a VIE and decision-making authority wouldneed to assess whether it uses its decision-making authority to act in a principal or an agent capacity. A decision maker determinedto be an agent would not consolidate the entity. The principal versus agent analysis would also apply in determining if the entityis a VIE. In addition, the presumption that a general partner controls a partnership that is a voting interest entity could be over -come by applying the same principal versus agent assessment and determining that the general partner is using its power in anagent capacity.

The proposal would rescind ASU 2010-10, Consolidation (Topic 810), Amendments for Certain Investment Funds , which deferredapplication of the VIE model in ASC 810 for certain types of investment entities. If an entity meets the conditions for the deferral,the reporting enterprise currently continues to apply the previous VIE model that was based on a quantitative analysis of the r isksand rewards of the entity or other applicable consolidation guidance when evaluating the entity for consolidation. The proposalcould also impact the consolidation conclusion for other entities and partnerships that were not subject to the deferral. The effectivedate has not been determined.

The comment letter period ended in February 2012. The FASB is in the process of redeliberating many of the key aspects of theproposal. Signi cant changes may be made before the standard is nalized. In evaluating control, IFRS 10 also includes a principal versus agent analysis that is similar to the FASB proposal. Consequently, if the FASB changes are adopted as proposed, IFRS and USGAAP consolidation guidance would be broadly aligned for VIEs.



Business combinations



182 PwC



IFRS and US GAAP are largely converged in this area. The business combinations standards under US GAAP and IFRS are close inprinciples and language, with two major exceptions: (1) full goodwill and (2) the requirements regarding recognition of contingentassets and contingent liabilities. Signi cant differences also continue to exist in subsequent accounting. Different requirements forimpairment testing and accounting for deferred taxes (e.g., the recognition of a valuation allowance) are among the most signi cant.




183


PwC

Impact US GAAP IFRS

Costs of acquisitions

Contingent consideration

The accounting for contingent consider-ation is recorded at fair value. Other guid -ance within each framework may result indifferent initial classi cation (i.e., equity versus liability classi cation) of contin -gent consideration. Varying initial classi -cation also results in different subsequent

accounting.In addition, asset or liability classi edcontingent consideration that does notqualify as a nancial instrument underIFRS may not be subject to remeasure-ment at fair value.

Contingent consideration is recognizedinitially at fair value as an asset, liability,or equity according to the applicableUS GAAP guidance.

Contingent consideration classi ed asan asset or liability is remeasured to fair value at each reporting date until thecontingency is resolved. The changesin fair value are recognized in earningsunless the arrangement is a hedginginstrument. If so, ASC 815 requires thechanges to be initially recognized in othercomprehensive income.

Contingent consideration classi ed asequity is not remeasured at each reportingdate. Settlement is accounted for within equity.

Contingent consideration is recognizedinitially at fair value as an asset, liability,or equity according to the applicableIFRS guidance.

Contingent consideration classi ed asan asset or liability will generally be a

nancial instrument measured at fair value, with any gains or losses recognizedin pro t or loss (or other comprehensiveincome, as appropriate). Contingentconsideration classi ed as an asset orliability that is not a nancial instru -ment is subsequently accounted for inaccordance with IAS 37 or other IFRSas appropriate.

Contingent consideration classi ed asequity is not remeasured. Settlement isaccounted for within equity.

Acquired assets and liabilities

Acquired contingencies

There are signi cant differences relatedto the recognition of contingent liabilitiesand contingent assets.

Acquired assets and liabilities subjectto contingencies are recognized at fair value if fair value can be determinedduring the measurement period. If fair value cannot be determined, companiesshould typically account for the acquiredcontingencies using existing guidance. Ifrecognized at fair value on acquisition, anacquirer should develop a systematic andrational basis for subsequently measuringand accounting for assets and liabilitiesarising from contingencies depending ontheir nature.

The acquiree’s contingent liabilities arerecognized separately at the acquisi-tion date provided their fair values canbe measured reliably. The contingentliability is measured subsequently at thehigher of the amount initially recognizedless, if appropriate, cumulative amor-tization recognized under the revenueguidance (IAS 18) or the best estimate ofthe amount required to settle (under theprovisions guidance—IAS 37).

Contingent assets are not recognized.



184 PwC


Impact US GAAP IFRS

Assignment/allocation andimpairment of goodwill

The de nition of the levels at whichgoodwill is assigned/allocated and testedfor impairment varies between the twoframeworks and might not be the same.

Additional differences in the impair-ment testing methodologies could createfurther variability in the timing and extent

of recognized impairment losses.

Goodwill is assigned to an entity’sreporting units, as de ned within theguidance.

Goodwill is tested for impairment at leaston an annual basis and between annualtests if an event occurs or circumstanceschange that may indicate an impairment.

When performing the goodwill impair-ment test, an entity may rst assessqualitative factors to determine whetherthe two-step goodwill impairment test isnecessary. If the entity determines, basedon the qualitative assessment, that it ismore likely than not that the fair valueof a reporting unit is below its carryingamount, the two-step impairment test isperformed. An entity can bypass the quali -tative assessment for any reporting unit inany period and proceed directly to Step 1of the two-step goodwill impairment test:

1. In Step 1, the fair value and thecarrying amount of the reporting unit,including goodwill, are compared. Ifthe fair value of the reporting unit isless than the carrying amount, Step 2is completed to determine the amountof the goodwill impairment loss, if any.

2. Goodwill impairment is measured asthe excess of the carrying amount ofgoodwill over its implied fair value.The implied fair value of goodwill—calculated in the same manner thatgoodwill is determined in a businesscombination—is the differencebetween the fair value of the reportingunit and the fair value of the variousassets and liabilities included in thereporting unit.

Any loss recognized is not permitted toexceed the carrying amount of goodwill.The impairment charge is included inoperating income.

Goodwill is allocated to a cash-generatingunit (CGU) or group of CGUs, as de ned within the guidance.

Goodwill is tested for impairment at leaston an annual basis and between annualtests if an event occurs or circumstanceschange that may indicate an impairment.

Goodwill impairment testing is performedusing a one-step approach:

The recoverable amount of the CGU orgroup of CGUs (i.e., the higher of its fair value less costs of disposal and its valuein use) is compared with its carryingamount.

Any impairment loss is recognizedin operating results as the excessof the carrying amount over therecoverable amount.

The impairment loss is allocated rst togoodwill and then on a pro rata basisto the other assets of the CGU or groupof CGUs to the extent that the impair -ment loss exceeds the carrying valueof goodwill.



185


PwC

Impact US GAAP IFRS

Assignment/allocation and impairmentof goodwill (continued)

For reporting units with zero or negativecarrying amounts, Step 1 of the two-stepimpairment test is always qualitative. An entity must rst determine whetherit is more likely than not that a goodwillimpairment exists. An entity is requiredto perform Step 2 of the goodwill impair -ment test if it is more likely than not thatgoodwill impairment exists.

Contingent consideration—seller accounting

Entities that sell a business that includescontingent consideration might encountersigni cant differences in the manner in which such contingent considerations arerecorded.

Under US GAAP, the seller should deter -mine whether the arrangement meets thede nition of a derivative. If the arrange -ment meets the de nition of a derivative,the arrangement should be recorded atfair value. If the arrangement does notmeet the de nition of a derivative, theseller should make an accounting policyelection to record the arrangement ateither fair value at inception or at thesettlement amount when the consider-ation is realized or is realizable, which-ever is earlier.

Under IFRS, a contract to receive contin-gent consideration that gives the sellerthe right to receive cash or other nancialassets when the contingency is resolvedmeets the de nition of a nancial asset.When a contract for contingent consider-ation meets the de nition of a nancialasset, it is measured using one of themeasurement categories speci ed in the

nancial instruments guidance.

Other

Noncontrolling interests

Noncontrolling interests are measuredat full fair value under US GAAP whereas IFRS provides two valua-tion options, which could result indifferences in the carrying values ofnoncontrolling interests.

Noncontrolling interests are measured atfair value.

Entities have an option, on a transaction-by-transaction basis, to measure noncon-trolling interests at their proportionof the fair value of the identi able netassets or at full fair value. This optionapplies only to instruments that representpresent ownership interests and entitletheir holders to a proportionate share ofthe net assets in the event of liquidation. All other components of noncontrol-ling interest are measured at fair valueunless another measurement basis isrequired by IFRS. The use of the full fair value option results in full goodwill beingrecorded on both the controlling andnoncontrolling interest.



186 PwC


Impact US GAAP IFRS

Combinations involving entitiesunder common control

Under US GAAP, there are speci c rulesfor common-control transactions.

Combinations of entities under commoncontrol are generally recorded at prede-cessor cost, re ecting the transferor’scarrying amount of the assets and liabili-ties transferred.

IFRS does not speci cally address suchtransactions. In practice, entities developand consistently apply an accountingpolicy; management can elect to applypurchase method of accounting or thepredecessor value method to a businesscombination involving entities undercommon control. The accounting policycan be changed only when criteria fora change in an accounting policy aremet in the applicable guidance in IAS 8(i.e., it provides more reliable and morerelevant information).

Identifying the acquirer

Different entities might be determinedto be the acquirer when applyingpurchase accounting.

Impacted entities should refer to theConsolidation chapter for a more detaileddiscussion of differences related to theconsolidation models between the frameworks that might create signi cant differ -ences in this area.

The acquirer is determined by referenceto ASC 810-10, under which generally theparty that holds greater than 50 percentof the voting shares has control, unlessthe acquirer is the primary bene ciary of

a variable interest entity in accordance with ASC 810.

The acquirer is determined by referenceto the consolidation guidance, under which generally the party that holdsgreater than 50 percent of the votingrights has control. In addition, control

might exist when less than 50 percent ofthe voting rights are held, if the acquirerhas the power to most signi cantly affectthe variable returns of the entity in accor-dance with IFRS 10.

Push-down accounting

The lack of push-down accounting underIFRS can lead to signi cant differences ininstances where push down accounting was utilized under US GAAP.

The SEC’s push-down accounting guid -ance is applicable to public companiesapplying US GAAP. If a company becomessubstantially wholly owned, it is requiredto re ect the new basis of accountingrecorded by the parent arising from acqui-sition of the company in the company’sstandalone nancial statements.Nonpublic entities can also elect to applypush-down accounting.

IFRS 3 is silent on whether push-downaccounting is allowed or required. It maybe appropriate under IFRS when theregulator requires it and the country lawpermits it.



187


PwC

Impact US GAAP IFRS

Employee benet arrangements and income tax

Accounting for share-based payments and income taxes in accordance with separate standards not at fair value might result indifferent results being recorded as part of purchase accounting.


IFRS IAS 12, IAS 38, IAS 39, IFRS 2, IFRS 3, IFRS 10, IFRS 13

US GAAP ASC 205–20, ASC 350–10, ASC 350–20, ASC 350–30, ASC 360–10, ASC 805, ASC 810

PwC Guide A Global Guide to Accounting for Business Combinations and Noncontrolling Interests

Note


PWC on IFRS and US GAAP Similarities and Differences 2013

Documents

Transcript of PWC on IFRS and US GAAP Similarities and Differences 2013