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The information that was in the additional information section directly impacted the balance sheet for Jaunty Coffee Company. Below is a comprehensive analysis of how converting the financial statements that were prepared under US GAAP standards over to International Financial Reporting Standards would affect the 2012 Jaunty Coffee balance sheet. This analysis includes the short-term investments, LIFO inventory method, contingent liabilities, intangible asset impairment, depreciation, extraordinary items, and income taxes.
In 2012 there were $4,000 in short-term investments, which were recognized as a gain in the exchange rate; this amount was included in the beginning value of $15,001.
The IFRS recognizes foreign exchange gains and losses on available for sale in the income statement as to where GAAP recognizes them in other comprehensive income. The FASB states that available for sale securities, gains and losses, that are unrealized are to be omitted from earnings; until they are realized they are to be reported in other comprehensive income. The SEC supported the FASB requirement by stating that the scope of gains and losses from available for sale that are unrealized would result in adjustments and that if the gains or losses were realized the balance sheet amount would need to be adjusted with accurately corresponding credits or debits to other comprehensive income. The FASB had also established that the method of reporting unrealized gains or losses for available for sale securities used by the IFRS could have the probability for earnings to be unpredictable, causing there to be misrepresentation of the way enterprises conduct their business and the effect that economic events have on those enterprises. Because of this, the FASB determined that the changes should be omitted from earnings.
|Stockholders’ Equity – Accumulated OCI||2600|
|Currency Exchange Rate Gain||4000|
This adjustment extracts the $4000 gain in exchange rate that had been posted to the balance sheet under GAAP. On account of other comprehensive income being recorded net of taxes, $2600 is taken from other comprehensive income, and $1400 is taken from taxes payable. Under IFRS the $4000 gain in exchange rate is posted to Foreign Exchange Gain/(Loss). The $4000 is subject to a tax rate of 35%, which results in a net increase in net income of $2600, which is then posted to retained earnings, and an increase of $1400 recorded to taxes payable. The effect on the balance sheet would $0 because, despite the fact that the IFRS approach to the exchange rate gain effects the income statement, both the GAAP and IFRS approaches have the same effect on the balance sheet.
Jaunty Coffee Company uses the last in first out (LIFO) method for their inventory assessment. At the end of 2011 the inventory reserves were $35,000, and at the end of 2012 the reserves were $45,000. The IFRS forbids enterprises from using the LIFO inventory method but is allowed under U.S. GAAP. IAS 2 allows FIFO or WAC formulas for items that are interchangeable, as to where the LIFO formula was no longer permitted after the 2003 revision. Because of this, Jaunty coffee would need to change their implementation of LIFO to either FIFO or WAC. Unfortunately, the process of changing methods can be costly and time consuming. The IRS’s LIFO Conformity Rule causes this issue to be even more complicated. Based on the LIFO conformity rule, if LIFO is implemented on a taxpayer’s tax return then other methods may not be used to value inventory in order to calculate income, profit, or loss in any report or statement pertaining to that same tax year which is provided to shareholders or to creditors. What this means for Jaunty Coffee is if they were to change their inventory methods, they would be unable to reap the tax benefits resulting from the use of LIFO any longer, which would result in a higher tax liability than prior years.
In order to translate this account to FIFO from the existing LIFO inventory the adjusting entry would be:
Inventory is increased by a total of $45,000, the amount of the reserve at the end of 2012. In order for this transaction, the entry decreases COGS by $10,000, which is the difference between the beginning and the ending reserves. This $10,000 increase is then subjected to the 35% tax rate, culminating an increase in net income of $6500, which is then posted into retained earnings. The adjusting entry also takes into account that if FIFO had been used in prior years, net income and taxes would have been higher. This is achieved by increasing retained earnings by $22,750 and taxes payable by $12,250. This subsequent taxation shows the effect of losing the LIFO tax benefit. The total effect on the balance sheet is an increase of $45,000 to inventory, $15,750 to taxes payable, and $29,250 to retained earnings.
It is stated that the long-term contingencies lawsuit most likely will be awarded for $10,000. Both US GAAP and IFRS regulations call for the contingent liabilities to be recorded when it is determined that the contingency is probable, but the US GAAP and the IFRS definitions of probable differ. The IFRS characterizes probable as being more likely than not and the US GAAP characterizes it as likely to happen. Since Jaunty Coffee has deemed this contingency as most likely, US GAAP and IFRS both require that it be recorded as a long-term contingency; thus, there is no adjustment to be made on the balance sheet.
On the additional information provided, the fair market value of goodwill was $15,000, the copyright value was $10,000, the trademark value was $20,000. It was also stated that there were impairments of the 2010 Copyright in the amount of $4,400, the 2011 Goodwill in the amount of $5,400, and the 2009 Trademark in the amount of $6,400. Both the IFRS and the US GAAP authorize adjustment for the impairment of intangible assets annually, but only the IFRS authorizes the impairment to be reversed if the fair market value is higher than the book value. Goodwill is the only exception to the rule; according to both the IFRS and the US GAAP. With the exception of goodwill, any reversal of impairment loss for an asset is to be recognized right away in profit or loss.
No journal entry is necessary for goodwill. The proper adjusting journal entry to reverse the impairment loss on the trademark and the copyright would be:
|Reversal of Impairment loss||3000|
|Reversal of Impairment loss||3000|
This adjustment reflects the increase of the book value of the trademark and the copyright to the fair market value and the gain is posted to reversal of impairment loss. The $6000 is subjected to the 35% tax rate, which results in an increase in net income of $3900 that is posted to retained earnings. The effect on the balance sheet would be an increase of $6000 to intangible assets, an increase of $3900 to retained earnings, and an increase of $2100 to taxes payable.
According to the additional information provided, thePPE & Intangible assets have a straight-line depreciation/amortization method, 10 years useful life, and no salvage value.
The proper adjusting journal entry to recognize prior year amortization expense on the trademark and the copyright would be:
This entry demonstrates the $1500 increase in both amortization expense and accumulated amortization. $600 of this is related to the copyright ($3000 impairment reversal divided by the 10-year useful life using straight line amortization then multiplied by two years of lost amortization) and $900 is related to the trademark ($3000 impairment reversal divided by the 10-year useful life using straight line amortization method then multiplied by three years of lost amortization). The $1500 decrease in net income is subjected to the 35% tax rate, which results in a decrease in net income of $975, which is then posted to retained earnings. The effect on the balance sheet would be an increase of $1500 to accumulated amortization, a decrease of $975 to retained earnings, and a decrease of $525 to taxes payable.
The extraordinary item listed on the additional is flood damage, which resulted in a loss of $15,000. The US GAAP permits the recognition of expenses that are both rare and atypical in the course of business as extraordinary items. But, the IFRS does not allow for extraordinary items, resulting in these expenses being recognized as non-operating income or loss on the income statement.
The proper adjusting journal entry to reclassify the extraordinary expense is as follows.
This adjusting entry just moves the expense from within the income statement. Since the extraordinary item was recorded net of taxes, the balance sheet is not affected.
On the additional information provided,it is stated that the tax rate is 35%. The effect the tax had on the previous adjustments is detailed above within each adjustments detail. All previously stated adjustments that have an effect on net income also have an effect on taxes, save that the original balance sheet entry was recorded net of taxes. The net effect on taxes payable would be:
|Short term investments (AFS)||0|
|Net Effect on Taxes Payable||+17325|
In conclusion, the outcome of using of the IFRS in Jaunty Coffee’s 2012 financial statements would be higher net income and higher retained earnings. Although, this can be indicative of increased income statement unpredictability. For instance, the income statement and balance sheet benefits that are seen from the IFRS approach to available for sale short term investments and impairment reversal, not to mention the initial adjustment for LIFO, are not inevitably exhibitive of the ordinary course of business. For this reason, it would be in the best interest for Jaunty Coffee to continue the use of the US GAAP.
- Adams, M. T., & Troutman, C. S. (2012, July 31). Avoiding missteps in the LIFO conformity rule. Retrieved from http://www.journalofaccountancy.com/issues/2012/aug/20125571.html
- IAS 2 — inventories. (n.d.). In Deloitte. Retrieved from https://www.iasplus.com/en/standards/ias/ias2
- IFRS. (n.d.). IAS 37. Retrieved from http://www.ifrs.org/IFRSs/Pages/IFRS.aspx.
- PWC. (2014, October). IFRS and US GAAP: similarities and differences. In IFRS and US GAAP: similarities and differences. Retrieved from https://www.pwc.com/us/en/issues/ifrs-reporting/publications/assets/ifrs-and-us-gaap-similarities-and-differences-2014.pdf
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