564 Wk 2 Hw 3p21d

Chapter 3, Exercise 5 Lists of pronouncements: On May 19, 2004, the International ing Standards Board (IASB) published a single volume of its official pronouncements. These pronouncements would be applicable from 1 January, 2005. The International Financial Reporting Standards (IFRS) Bound Volume 2004 provides the complete consolidated text of the latest version of the IFRS. International ing Standards (IASs) and interpretations and ing documents published by IASB. IFRS 1 IFRS 2 IFRS 3 IFRS 4 IFRS 5

First-Time Adoption of International Financial Reporting Standards Share-based Payment Business Combinations Insurance Contracts Non-current Assets Held for Sale and Discontinued Operations

Chapter 4, Exercises 1 and 4 Exercise 1. A company incurred the following costs related to the production of inventory in the current year:

The cost of materials included abnormal waste of $10,000. What is the cost of inventory in the current year?

a.

$190,000.

b.

$205,000.

c.

$215,000.

d.

$217,000. (Doupnik 158)

Answer B ($100,000 - $10,000) + $60,000 + $30,000 + $25,000 = $205,000. Exercise 4. On January 1, Year 1, an entity acquires a new machine with an estimated useful life of 20 years for $100,000. The machine has an electrical motor that must be replaced every five years at an estimated cost of $20,000. Continued operation of the machine requires an inspection every four years after purchase; the inspection cost is $10,000. The company uses the straight-line method of depreciation. What is the depreciation expense for Year 1?

a.

$5,000.

b.

$5,500.

c.

$8,000.

d.

$10,000. (Doupnik 159)

D is the answer. Total $100,000 Motor = $20,000/5 years =

$4,000

Inspection $ 10,000 / 4 years = $2,500 Machine $70,000 / 20 years = TOTAL =

$3,500 $10,000

Chapter 5, Case 5-1 (S.A. Harrington Co.)

Case 5–1: S. A. Harrington Company S.A. Harrington Company is a U.S.-based company that prepares its consolidated financial statements in accordance with U.S. GAAP. The company reported income in 2011 of $5,000,000 and stockholders’ equity at December 31, 2011, of $40,000,000. The CFO of S. A. Harrington has learned that the U.S. Securities and Exchange Commission is considering requiring U.S. companies to use IFRS in preparing consolidated financial statements. The company wishes to determine the impact that a switch to IFRS would have on its financial statements and has engaged you to prepare a reconciliation of income and stockholders’ equity from U.S. GAAP to IFRS. You have identified the following five areas in which S. A. Harrington’s ing principles based on U.S. GAAP differ from IFRS. 1.

Restructuring

2.

Pension plan

3.

Stock options

4.

Revenue recognition

5.

Bonds payable

The CFO provides the following information with respect to each of these ing differences.

Restructuring Provision

The company publicly announced a restructuring plan in 2011 that created a valid expectation on the part of the employees to be terminated that the company will carry out the restructuring. The company estimated that the restructuring would cost $300,000. No legal obligation to restructure exists as of December 31, 2011.

Pension Plan In 2009, the company amended its pension plan, creating a past service cost of $60,000. Half of the past service cost was attributable to already vested employees who had an average remaining service life of 15 years, and half of the past service cost was attributable to nonvested employees who, on average, had two more years until vesting. The company has no retired employees.

Stock Options Stock options were granted to key officers on January 1, 2011. The grant date fair value per option was $10, and a total of 9,000 options were granted. The options vest in equal installments over three years: one-third vest in 2010, one-third in 2011, and one-third in 2012. The company uses a straight-line method to recognize compensation expense related to stock options.

Revenue Recognition The company entered into a contract in 2011 to provide engineering services to a long-term customer over a 12-month period. The fixed price is $250,000, and the company estimates with a high degree of reliability that the project is 30 percent complete at the end of 2011.

Bonds Payable On January 1, 2010, the company issued $10,000,000 of 5 percent bonds at par value that mature in five years on December 31, 2014. Costs incurred in issuing the bonds were $500,000. Interest is paid on the bonds annually.

Required Prepare a reconciliation schedule to reconcile 2011 net income and December 31, 2011 stockholders’ equity from a U.S. GAAP basis to IFRS. Ignore income taxes. Prepare a note to explain each adjustment made in the reconciliation schedule. 1

“The IASC-US Comparison Project: A Report on the Similarities and Differences between IASC

Standards and US GAAP: 2nd Edition,” published by the FASB, 1999. 2

Ernst & Young, “The Evolution of IAS 39 In Europe,” Eye on IFRS Newsletter, November 2004, pp. 1–

4. (Doupnik 231)

2011 $5,000,0 Income under U.S. GAAP Adjustments: Restructuring charge Additional past service cost Compensation cost (stock options) Recognition of service revenue Interest expense on bonds payable Income under IFRS

00 (300,000) (6,000) 5,000 75,000 6194 4,780,194

2011 $40,000, Stockholders’ equity under U.S. GAAP Adjustments: Restructuring charge Accumulated additional past service cost Accumulated compensation cost (stock options) Recognition of service revenue Interest expense on bonds payable

000 (300,000) (42,000) (20,000) 75,000 17,859

Stockholders’ equity under IFRS

39,730,859

Restructuring. Under U.S. GAAP, the restructuring is not recognized in 2011 because a legal obligation does not yet exist. Under IAS 37, a restructuring provision and offsetting expense in the amount of $300,000 would be recognized in 2011 because a constructive obligation does exist. IFRS income would be $300,000 less that U.S. GAAP income in 2011, and stockholders’ equity at year-end 2011 under IFRS would be less than under U.S. GAAP by the same amount. Pension Plan. Under U.S. GAAP, the prior service cost is amortized over the remaining service life of the employees. Expense recognized in 2011 is $4,000 [$60,000 / 15 years]. The cumulative expense recognized since the plan was changed in 2010 is $8,000 [$4,000 x 2 years] Under IAS 19, the prior service cost attributable to the vested employees would have been expensed in 2010 – $30,000 [50% x $60,000]. The prior service cost attributable to non-vested employees would be expensed over the three remaining years until vesting. Expense recognized in 2011 would be $10,000 [$30,000 / 3 years]. The cumulative expense recognized since the plan was changed is $50,000 [$30,000 + ($10,000 x 2 years). IFRS income in 2011 would be $6,000 less than U.S. GAAP income, and stockholders’ equity at year-end 2011 under IFRS would be $42,000 less than under U.S. GAAP. Stock Options. The total compensation cost related to the stock options is $90,000. Under U.S. GAAP, compensation expense would be recognized at the rate of $30,000 per year, for a total cumulative expense at year-end 2011 of $60,000. Under IFRS, compensation expense would be recognized as follows: Installment Compensation Cost per Installment Compensation Expense 2010 Compensation Expense 2011 Compensation Expense 2011 1 $30,000 $30,000 $ – $ – 2 $30,000 15,000 15,000 – 3 $30,000 10,000 10,000 10,000 $90,000 $55,000 $25,000 $10,000

Compensation expense in 2011 would be $25,000 and cumulative compensation expense would be $80,000. IFRS income would be $5,000 larger than U.S. GAAP income in 2011, but IFRS stockholders’ equity would be $20,000 smaller. Revenue Recognition. No revenue would be recognized on this service contract under U.S. GAAP because the services have not yet been completed. Under IFRS, the company would use the stage of completion method to recognize service revenue of $75,000 [$250,000 x 30%] in 2011. In 2011, IFRS income would be $75,000 larger than under U.S. GAAP; at December 31, 2011, IFRS stockholders’ equity also will be $75,000 larger than under U.S. GAAP. Bonds Payable. Under U.S. GAAP, $600,000 would be recognized as expense in 2010 and 2011 related to the bonds payable: $500,000 interest expense [$10,000,000 x 5%] and $100,000 bond issuance expense [$500,000 / 5 years]. The total reduction in retained earnings as of December 31, 2011 would be $1,200,000. Under IFRS, the bond issuance costs reduce the carrying amount of the bonds to $9,500,000, and the effective interest rate is determined to be 6.193% [$9,500,000 cash inflow on January 1, 2010; $500,000 cash outflow on December 31, 2010 – 2014; and $10,000,000 cash outflow on December 31, 2014]. Interest expense in 2010 is $588,335 [$9,500,000 x 6.193%]. Interest expense in 2011 is $593,806 [($9,500,000 + ($588,335 - $500,000)) x 6.193%]. The total reduction in retained earnings as of December 31, 2011 would be $1,182,141. In 2011, IFRS income would be $6,194 [$600,000 - $593,806] larger than U.S. GAAP income. Stockholders’ equity at December 31, 2011 is $17,859 [$1,200,000 - $1,182,141] larger under IFRS than U.S. GAAP. Note: The adjustments related to interest expense on bonds payable will differ depending on rounding of the effective interest rate. For example, if the effective interest rate is rounded to 6.2%, interest expense under IFRS would be $589,000 [$9,500,000 x 6.2%] in 2010 and $594,518 [($9,500,000 + ($589,000 - $500,000)) x 6.2%] in 2011. In 2011, IFRS income would be $5,482 [$600,000 - $594,518] larger than U.S. GAAP income. Stockholders’ equity at December 31, 2011 would be $16,482 [$1,200,000 - $1,183,518] larger under IFRS than U.S. GAAP