International Accounting Standards IAS
Introduction:
In 1973, the accountancy bodies of the United States of America, Canada, Germany, United Kingdom, France, Japan, Australia, the Netherlands, Ireland, and Mexico made an agreement to establish an independent organisation known as The International Accounting Standard Committee (IASC). Since that time, accounting rules and standards are issued by this committee in order to organise accounting practices in these countries (Deloitte, 2010). In 1997, the IASC realised that to maintain efficient performance, national accounting systems should strive to attain high-quality international accounting standards. The IASC formed a team to review its structure and scheme. Once the review was complete, this team submitted their report to the IASC board. The final report and proposal was delivered to the IASC board in November 1998 for approval and was subsequently published by the board. In 2000, the new reform of the International Accounting Standard Board (IASB) worked under the International Accounting Standard Committee Foundation (IASCF). See Figure 1 (ibid).
From April 2001 onwards, the IASB became the body responsible for setting new rules and accounting standards under the International Financial Reporting Standards (IFRS). At the same time, International Accounting Standards (IASs) that were issued by the International Accounting Standard Committee (IASC) were still accepted by the IASB. (Ball, 2005, p3).
The European Union recommended that all listed firms in EU countries adopt IFRS no later than 2005. Since 2001, at least 120 countries have adopted IFRS (IASB 2010). In 2005, about 7000 European listed companies in 25 countries changed to IFRSs at the same time. Figure 2 shows the present level of IFRS adoption. Blue regions indicate countries that require or permit IFRSs. Grey regions are countries seeking convergence with the International Accounting Standards Board (IASB) or pursuing adoption of IFRSs.
IASB Framework
The IASB has a framework for the preparation and presentation of financial statements. This framework assists the IASB:
- In the development of future IFRSs and in its review of existing IFRSs.
- In promoting harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs.
This framework may also assist:
* Preparers of financial statements in applying IFRSs and in dealing with topics which have yet to form the subject of standard or an interpretation.
* Auditors in forming an opinion as to whether financial statements conform to IFRSs.
* Users of financial statements in interpreting the information contained in financial statements that are prepared in conformity with IFRSs.
� Those who are interested in the work of the IASB by providing them with information about its approach to the formulation of IFRSs (IFRS 2004).
IAS 2: Inventories (ISAB, 2010).
IAS 2 (Inventories) was issued by the International Accounting Standards Committee in December 1993. It replaced the IAS 2 Valuation and Presentation of Inventories in the Context of the Historical Cost System, which were originally issued in October 1975.
Objective of IAS 2:
“The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides guidance for determining the cost of inventories and for subsequently recognising an expense, including any write-down to net realisable value. It also provides guidance on the cost formulas that are used to assign costs to inventories” (Deloitte, 2010).
Definitions: According to (Alexander, et al 2005, p285).
Inventory:
IAS 2, paragraph 6 defines Inventories as assets:
a) held for sale in the ordinary course of business;
b) in the process of production for such sale; or
c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.
Net realisable value: is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale.
Fair value: is the amount for which an asset could be exchanged, or a liability settled between knowledgeable, willing parties in an arm’s length transaction.
Measurement:
Inventory is one of the items that is listed in the balance sheet of a company. In some companies, this item is one of the most important items that the company relies on in its operations. As a result, it should be measured and recorded accurately in order to show the exact value of cost of goods sold. This value will determine the net income for the firm. (ibid, p279).
According to IAS2, inventories are measured at the lower of cost and net realisable value. To make this inventory ready for trade, this cost must include all of the expenses (direct and indirect), as well as the costs that incur as a result of the decommissioning and restoration of production of inventories (IAS 2, IASB 2010).
The methods used in determining the cost of inventories under IFRS are first-in, first-out (FIFO) and the weighted average method; the use of the last-in, first-out (LIFO) method is not allowed any more (Deloitte 2004; Mirza et al 2008). US GAAP uses the same methods in addition to the LIFO method, which is not permitted by IAS 2. Nevertheless, U.S. GAAP requires firms using the LIFO method to report their inventory using FIFO. As a result, it is possible to adjust the U.S. financial reports for comparison between firms that use LIFO with those that use FIFO only. Taking the above mentioned requirements into consideration, the value of inventories for the year ending October 31, 2009 of John Deere’s Group using the FIFO method is $ 3,764 million, whereas the value for the same inventories when adjusted to use LIFO method is $2,397 million (John Deere group annual report 2009 p,50).
Both the IFRS and the US GAAP requirement are to write down any declines in the value of goods, as well as stating the lower of cost or market value of goods. IFRS allows these written-downs to be reversed when the value of the inventories has risen; U.S. GAAP does not allow these written-downs to be reversed even if the inventory subsequently rises in value (financial education, 2010).
Another example of differences is the value of the inventories of ASML Company for the year ended December 31, 2009. Under IFRS, the value is �986,341.00 while under US GAAP, the value is �963,382.00. This affects the net income of the company. Hence the net loss of income recorded under IFRS is �83,492.00 and under US GAAP is �153,023.00 (ASML HOLDING N.V., 2009, annual report).
Presentation:
The inventory is presented on the balance sheet under the current assets in both standards, the IFRS and the US GAAP. This item is presented under the IFRS at lower of cost or net realisable value (NRV) (para. 9, IAS 2). The US GAAP requires this item to be presented at lower of cost or market (LCM) (ARB 43, Chapter 4, para 8). Under IFRS, the adjustments to lower of cost or market can be reversed under defined conditions; the US GAAP does not allow that (IFRS Accounting, 2010). US GAAP does not require any specific layout for the financial statements as long as revenues, expenses, gains, losses, and reclassifications are properly classified by net asset class and the change in net assets is presented both by net asset class and in total. This is applied to IFRS too since there is no particular layout, but the IFRS should include a list of minimum items which are less regulatory than the requirements in regulations S-X (Ernst & Young LLP 2009; Larkin & DiTommaso 2004).
Disclosure:
According to the IASB, the financial statements should disclose the accounting strategies that are adopted by the company for assessing inventories, as well as the method used (cost formula). The company should also disclose the total book value of any inventories carried at fair value, less the cost to sell, as well as amounts classified as suitable to the company. The amount of inventories recorded as an expense during the period and the amount of any write-down should also be disclosed under the IFRS. This applies to amounts of any reversal of write-down to NRV and the conditions that led to that reversal. The book value of inventories guaranteed as security for debts should also be disclosed under IFRS (Mirza et al 2008).
Under US GAAP (ARB 43, Chapter 4, paras 14-15), companies should disclose in their financial statements the basis for stating inventories, method of measuring costs, and the abnormal losses resulting from lower of cost or market adjustments or losses on company purchase commitments. If material, the losses should be disclosed separately from the cost of goods sold in the statement of activities (Larkin & DiTommaso 2004 p, 277). In its annual report in 2009, ASML Holding N.V prepared its main financial statements under US GAAP. They did mention in the required disclosure that the inventories were stated at the lower of cost or market value assessed by the first-in first-out method. Cost includes the following items: net prices for purchases, cost of freight and customs duties, labour cost, and production overhead. It also discloses the allowances made for stagnant and obsolete goods. These allowances are established on the basis of sales forecasting and the expected market value of the goods.
Discussion and conclusion:
There are some differences between both standards, as well as some similarities between them. IFRS prohibit the inclusion of the idle capacity and spoilage in inventory, whereas under US GAAP this is not prohibited. Also when measuring the cost of inventories, US GAAP allows for the use of LIFO, FIFO, and weighted average. In IFRS, LIFO is not permitted. Unlike the IFRS, the US GAAP does not allow for the reversal of the write-downs of inventories. An inventory measured at net realisable value is permitted according to IFRS but only for producers’ inventories of agricultural and forest products, mineral ores, and for broker-dealers’ inventories of commodities. US GAAP permits the same measurement but does not limit it to producers and broker-traders (Deloitte 2004).
References:
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