McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Topics
 Current Liabilities
 Provisions, Contingent Liabilities, and Contingent Assets
 Employee Benefits
 Share-Based Payment
 Income Taxes
 Revenue Recognition
 Financial Instruments

5-2
Learning Objectives
1. Describe and apply the requirements of IFRS related to the
financial reporting of current liabilities, provisions,
employee benefits, share-based payment, income taxes,
revenue, and financial instruments.

2. Explain and analyze the effect of major differences between

IFRS and U.S. GAAP related to the reporting of current
liabilities, provisions, employee benefits, share-based
payment, income taxes, revenue, and financial instruments.

5-3
 IAS 1, Presentation of Financial Statements:
Requires liabilities to be classified as current or noncurrent
Current:
 Expects to settle in its normal business cycle
 Holds primarily for the purpose of trading
 Expects to settle within 12 months of the balance sheet
date
 Does not have the right to defer until 12 months after the
balance sheet date

Learning Objective 1
5-4
 IFRS is similar but differences may relate to:
Refinanced short-term debt– only long-term if completed prior to
balance sheet date vs. U.S. GAAP which allows long-term if an
agreement has been reached prior to balance sheet date, even if
not completed by then.

Accounts payable on demand due to violation of debt covenants—

must be current unless lender issues waiver of at least 12 months by
balance sheet date. The waiver must be obtained, under U.S.
GAAP, by annual report issuance date.

Bank overdrafts—netted against cash if an integral part of cash

management—otherwise current liabilities. U.S. GAAP always
treats as current liabilities.

Learning Objective 2
5-5
  Liabilities and assets of uncertain timing, amount, or
existence.

 Onerous contracts and restructuring costs.

 Examples of environmental costs and nuclear

decommissioning costs.

Learning Objective 1
5-6
 Contingent Liabilities and Provisions
Contingent liability is either:

 Possible obligation from past events to be confirmed by presence or

absence of future event OR
 Present obligation not recognized because no probable outflow of
resources or amount can’t be measured reliably

Learning Objective 1
5-7
 Contingent Liabilities and Provisions
Contingent liability is not recognized on balance sheet while
a provision is.

Provision is a liability of uncertain timing or amount:

 Present legal or constructive obligation resulting from past event
(constructive—e.g. manufacturer announces will honor defunct
retailer rebates).
 Probable (more likely than not) outflow of resources.
 Can be estimated reliably.

Learning Objective 1
5-8
  U.S. GAAP doesn’t recognize constructive obligations—only
legal.

 For contingencies U.S. GAAP does not define probable,

although research shows most accountants use 70%-90%
probability. IAS 37 uses “more likely than not”, which
implies a threshold of just over 50%.

Learning Objective 2
5-9
 Onerous Contract
Unavoidable costs of meeting the obligation exceed
economic benefits to be realized.

Recognize lower of cost of fulfillment or penalty from non-

fulfillment.

If onerous from entity's own action--no recognition until that

action happens.

Learning Objective 1
5-10
 Restructuring
A program planned and controlled by management that
materially changes either scope of business or manner in which
business is conducted.

Such as sale or termination of line of business, closure of

location, change in management structure, material
reorganization which changes nature and focus of operations.

U.S. GAAP doesn’t allow restructuring provision until liability

incurred, so may occur later than under IFRS.

Learning Objective 1, 2
5-11
 Contingent Assets
Probable asset arising from past events whose existence will be
confirmed by occurrence or non-occurrence of future event.

Don’t recognize—disclose when probable inflow of economic

benefits.

Recognize as asset when virtually certain.

Earlier recognition of contingent asset and related gain than U.S.

GAAP, which generally requires realization before recognition.

Learning Objective 1, 2
5-12
 Proposed Amendments to IAS 37
Criterion of “probable outflow of resources” for provision
would be removed---i.e.—recognize as long as reasonably
measurable.

 “Best estimate” rule would be replaced with liability

measurement at what would be a rational expectation of
payment to relieve present obligation---in many cases the
present value of required resources.

Learning Objective 1
5-13
  Covers all forms of employee compensation and benefits
other than share-based compensation (e.g. stock options).

 Four types:
 Short-term (compensated absences and bonuses).

 Post-employment ( pensions, medical benefits, etc.).

 Other long-term benefits (deferred compensation and disability).

 Termination benefits (severance and early retirement).

Learning Objective 1
5-14
 Short-term
Recognize expense and liability at time services provided—
undiscounted.

Accrue compensated absences (sick/vacation pay) only if

accumulate over time and can be carried over—otherwise
expense as incurred.

Profit sharing and bonus plans—accrue only if legal or

constructive obligation from past events and can be
reasonably measured or estimated.

Learning Objective 1
5-15
 Post-employment benefits
Distinguishes between defined benefit and defined
contribution plans.
Defined contribution—accrue when services rendered for
amount required to be contributed and reduce liability when
contributions are made.
Defined benefit (and medical and life insurance benefits)
more complicated issues---same or similar to U.S. GAAP:
 Calculation of net current pension expense or revenue.
 Calculation of net pension liability or asset for balance sheet.

Learning Objective 1, 2
5-16
 Post-employment benefits—Income statement
recognition and measurement
Up to 6 components:
+ Current service cost + interest cost – expected return on plan assets +/-
actuarial gains and losses (recognized currently) + past service cost
(recognized in current period) +/- curtailment of settlement gains or
losses.
Actuarial gains/losses—corridor approach used to smooth impact
—recognize currently if > 10% of greater of present value of previous
year end defined benefit obligation or fair value of previous year end
plan assets.
Current actuarial g/l is recognizable amount divided by average
remaining working lives of covered employees.

Learning Objective 1
5-17
 Post-employment benefits—Income statement
recognition and measurement
Actuarial g/l re: inactive or retired employees expensed
immediately.
Similar corridor approach under U.S. GAAP except amortize
expense of inactive/retired employees over life expectancy.
Also permitted– any systematic method of amortization
resulting in faster recognition of actuarial g/l (even immediate)
if applied to both g/l consistently each period.
If recognize immediately—either in net income or separate
component of shareholders’ equity (U.S. GAAP must report
only in net income).

Learning Objective 1, 2
5-18
 Post-employment benefits—Income statement
recognition and measurement
Past service cost—from improvement to benefits from defined
benefit plan. PSC to retired employees and vested employees
expensed immediately .
PSC to non-vested employees amortized straight-line over
remaining vesting period.
U.S. GAAP says past service cost (called prior service cost) for
retired employees amortized over remaining life expectancy while
active employees amortized over remaining service period.

Learning Objective 1, 2
5-19
 Post-employment benefits—Income statement
recognition and measurement
Curtailments and settlements—when material reduction in
covered employees (e.g. from closure or restructuring) or when
future service by current employees will no longer qualify for
pension benefits or only qualify for reduced pension benefits.

Gains/losses recognized in income when entity is demonstrably

committed and curtailment or settlement is announced.

U.S. GAAP is different—losses generally recognized earlier than

gains and curtailment gain not recognized until related employees
terminate or the plan has been adopted.

Learning Objective 1, 2
5-20
 Post-employment benefits—Balance sheet recognition
and limitation re: defined benefit pension plan
Can either be net liability or asset.
• + Present value of defined benefit obligation (PVDBO) – fair
value of plan assets +/- unrecognized actuarial gains and losses
– unrecognized past service cost.
• If result is negative (i.e. net asset) report the lesser of:
• PVDBO +/- unrecognized actuarial gains/losses – unrecognized past service
costs – fair value of plan assets or
 Sum of unrecognized actuarial losses and past service cost and the present
value of available plan refunds and available future reductions in employer
contributions.

Learning Objective 1, 2
5-21
 • PVDBO assumptions re: turnover, life expectancy and
future salary levels.
• Discount rate refers to end of period yield on high-quality
corporate bonds.
• U.S. GAAP recognizes difference between PVDBO and fair
value of plan assets (i.e. “funded status”)—no adjustment
for unrecognized actuarial g/l and psc—also no limitation
on recognized amount of pension asset.

Learning Objective 1, 2
5-22
 Other post-employment benefits
No separate guidance provided for medical and life insurance
benefits.

U.S. GAAP provides much more guidance re: assumptions and

measurement for post-employment medical benefits.

IFRS allows reference to U.S. GAAP guidance for post-employment

measurement for other than pensions.

IFRS says liability should be recognized for difference between

present value of defined benefit obligation and fair value of any plan
assets.

Learning Objective 1, 2
5-23
 Termination benefits
Recognize as expense and liability when demonstrable
commitment to either terminating the employee or group of
employees or providing termination benefits as a result of offer to
encourage voluntary termination (based on # of affected employees
expected to accept offer discounted to present value if benefits to
be paid > 12 months after balance sheet date (U.S. GAAP based on
actual # who accept and no discounting required).

U.S. GAAP—3 types of termination benefits—different timing

recognition criteria for each:
 Recognize special termination benefits when accepted.
 Recognize contractual obligations when entitlement is probable.
 Termination benefits under restructuring recognized when
management approves plan.
Learning Objective 1, 2
5-24
  IASB and FASB worked closely on standards.

 # of minor differences, but both standards substantially

similar

 IFRS 2 sets out measurement principles and specific

guidance for three types of transactions:
 Equity-settled—entity receives goods or services in exchange for
equity instruments (e.g. stock options).
 Cash-settled—entity receives goods or services by incurring liability
to supplier based on price or value of shares or other equity
instruments (e.g. share appreciation rights).
 Choice of settlement of above two options.

Learning Objective 1, 2
5-25
 Equity-settled
Non-employees– if fair value of goods or services can’t be
determined—use fair value of the equity instrument as of each date
goods or services are received vs. U.S. GAAP where fair value of
instrument used and measured at earlier of commitment for
performance or when performance completed.
Employees—use fair value of instrument since fair value of services
not reliably measurable—value at date of grant—need to estimate #
of options expected to vest multiplied by fair value to determine
compensation expense over vesting period (offset is paid-in capital).
 If single vesting date (cliff vesting)—straight-line over service period.
 If installments (graded vesting)—amortize each installment (tranche)
over their vesting period.
 U.S. GAAP re: graded vesting—choice of accelerated or straight-line
recognition.

Learning Objective 1, 2
5-26
 Equity-settled
Modification of stock option plans—length or price may
change—recognize, at minimum, original compensation cost at
grant date.
 If fair value reduced---no change in compensation deduction.
 If fair value increased—increase compensation by the like amount.

U.S. GAAP—if modifications—fair value at modification date

determines compensation expense---no minimum
compensation as under IFRS.

Learning Objective 1, 2
5-27
 Cash-settled
Stock appreciation rights—recognize liability for future cash
outflow at fair value of appreciation rights using an option
pricing model.

Remeasure at each balance sheet date until settled.

U.S. GAAP—certain cash-settled payments classified as

equity, whereas liability under IFRS.

Learning Objective 1, 2
5-28
 Choice-of-settlement
Treat as cash-settled only if present obligation to settle in
cash—otherwise, treat as equity-settled.

Remeasure at each balance sheet date until settled.

If supplier can choose—entity has compound instrument

with debt and equity components:
 Debt component measured at each balance sheet date (recognize
change in value in income).
 Equity component remains in equity and if supplier chooses debt
settlement in equity—transfer debt piece to equity.

Learning Objective 1
5-29
  Similar approach with U.S. GAAP.

 Both have deferred tax assets and liabilities re: timing

differences and operating loss and tax credit carryovers.

 March 2009 IASB exposure draft “Income Tax” intended to

eliminate differences with U.S. GAAP.

 Final standard replacing IAS 12 still not published as of Spring

2011.

Learning Objective 1, 2
5-30
 Tax Laws and Rates
Current and deferred taxes based on rates enacted or
substantively enacted (when future steps can’t change
outcome) by balance sheet date.

U.S. GAAP must use actually enacted rates.

To minimize double taxation some countries apply lower rate

to distributed profits vs. retained profits.

Learning Objective 1, 2
5-31
 Recognition of Deferred Tax Asset
If future realization probable (undefined) vs. U.S. GAAP
where realization takes place if more likely than not ---IAS 12 is
more stringent if probability interpreted to mean greater than
“more likely than not”.

Disclosures
IAS 12 requires extensive disclosures, including current and
deferred components of tax expense and relationship between
hypothetical expense based on statutory vs. effective tax rates
using 2 approaches (statutory rate in home country or
weighted average statutory rate between jurisdictions).

Learning Objective 1, 2
5-32
 IFRS vs. U.S. GAAP
IFRS can cause temporary differences not existing under U.S.
GAAP (e.g. revaluation model for p, p & e under IAS 16).

Differences in impairment standards.

Financial Statement Presentation

Under U.S. GAAP—deferred tax assets and liabilities current
or non-current based on underlying asset or liability or, if for
loss or credit carryforwards, timing of expected realization.

IAS 1, Presentation of Financial Statements”—only

noncurrent.

Learning Objective 1, 2
5-33
  Single standard covering most revenues (sale of goods,
rendering of services, interest, royalties and dividends).

 U.S. GAAP has no single standard—instead over 200

different authoritative pronouncements, so difficult to
compare IAS 18 and U.S. GAAP .

 Revenue must be measured at fair value of consideration

received or receivable.

 May need to split transaction into multiple elements (e.g.

sale of software and maintenance contract) or may need to
combine multiple transactions into one for true economic
substance.
Learning Objective 1, 2
5-34
 Sale of Goods—5 Criteria
•Transfer of significant risks and rewards to buyer (IAS has various examples
of how seller may retain risks).
•No effective control maintained or management involvement.
•Can measure revenue reliably.
•Probable future economic benefits flow to seller.
•Selling costs can be measured reliably.

Rendering of Service
Estimate reliably amount of revenue, costs incurred or to be incurred, and
stage of completion (see IAS 11, Construction Contracts, which can also apply
to service contracts).
Probable benefits will flow to enterprise.
U.S. GAAP doesn’t allow percentage-of-completion for service contracts.
If outcome can’t be measured reliably, only estimate revenue to extent
expenses are probably recoverable—otherwise, recognize only expense
and not revenue.

Learning Objective 1, 2
5-35
 Interest, Royalties and Dividends (if reliably measurable)
Interest recognized on effective yield basis.
Royalties recognized on accrual basis based on relevant
agreement.
Dividends recognized when shareholder’s right to receive
payment is established.

Exchange of Goods or Services—no gain or loss if similar—if

dissimilar—recognize fair value of what is received adjusted for
cash paid or received

Learning Objective 1
5-36
 IASB-FASB Revenue Recognition Project
Both boards working since 2002.
June 2010—joint Exposure Draft “Revenue from Contracts
with Customers”.
5 steps:
 Identify the contract.
 Identify separate performance obligations in the contract.
 Determine the transaction price.
 Allocate the transaction price to the separate performance
obligations.
 Recognize the revenue allocated to each performance obligation
when the entity satisfies each performance obligation.

Learning Objective 1, 2
5-37
 Three Standards
IAS 32, Financial Instruments: Presentation.
IAS 39, Financial Instruments: Recognition and Measurement.
IFRS 7, Financial Instruments: Disclosure.

Also—IFRS 9, Financial Instruments—issued in November 2009

to replace IAS 39—effective November 2013

Definitions
IAS 32 says a financial instrument is any contract that gives
rise to both a financial asset of one entity and a financial
liability or equity instrument of another entity.

Learning Objective 1
5-38
 Definitions (continued)
Financial asset (e.g. cash, receivables, loans to others, etc.):
 Cash
 Contractual right to:
 Receive cash or other financial asset
 Exchange financial assets or financial liabilities under potentially favorable conditions
 An equity instrument of another entity
 A contract that will or may be settled in the equity’s own equity
instruments and is not classified as an equity instrument of the entity
Financial liability (e.g. payables, loans from other entities, bonds,
etc.):
 A contractual obligation to:
 Deliver cash or another financial asset
 Exchange financial assets or financial liabilities under potentially unfavorable conditions
 A contract that will or may be settled in the equity’s own equity
instruments.

Learning Objective 1
5-39
 Definitions (continued)
Equity instrument—any contract that evidences a residual
interest in the assets of an entity after deducting all its
liabilities.

Compound Financial Instruments

Both a liability and equity element (e.g. convertible bond).
Split accounting required using with and without method.

Learning Objective 1
5-40
 Classification of Financial Assets and Liabilities
Financial asset:
 Fair value through profit or loss (FVPL)
 Held-to-maturity investments
 Loans and receivables
 Available-for-sale financial assets
Financial liabilities:
 Fair value through profit or loss (FVPL)
 Financial liabilities measured at amortized cost

Measurement of Financial Instruments

Initial—fair value (normally = amount paid or received).
Subsequent—cost, amortized cost, or fair value.

Learning Objective 1
5-41