International versus U.S. Standards

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16th Jun 2020 Business Assignment Reference this

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Abstract

This paper will describe the differences in the way property, plant, and equipment are reported under U.S GAAP and IFRS. U.S. GAAP requires property, plant, and equipment to be reported at historical cost net of accumulated depreciation. Whereas, IFRS permits the revaluation of property, plant, and equipment to their current cost as of the balance sheet date. This paper will discuss the depreciation methodologies prescribed by both U.S. GAAP and IFRS in an attempt to determine which of the two has more comparable, reliable, and relevant traits. In conclusion, this paper will provide personal recommendations as a solution to the case.

International versus U.S. Standards

Case 3-5 describes the differences in the way property, plant, and equipment are reported under U.S GAAP and IFRS. Specifically, U.S. GAAP requires property, plant, and equipment to be reported at historical cost net of accumulated depreciation. Whereas, IFRS permits the revaluation of property, plant, and equipment to their current cost as of the balance sheet date (Schroeder, Clark, & Cathey, 2014). Proponents of the IFRS depreciation methodology state that the historical cost of assets purchased ten, twenty, or more years ago is not meaningful. Proponents for the U.S. GAAP methodology state that the IFRS depreciation methodology lacks objectivity in arriving at current cost estimates, specifically older assets that cannot be replaced or there are no similar assets available for purchase. The following paper will discuss these two depreciation methodologies in an attempt to determine which of the two has more comparable, reliable, and relevant traits. In conclusion, this paper will provide personal recommendations as a solution to the case.

The qualitative concept of comparability is defined as a concept that “enables users to identify and understand similarities in, and differences among, items” (Schroeder, Clark, & Cathey, 2014, p. 52). Companies are regarded as having the qualitative concept of comparability if they produce similar financial statements given the same set of economic events (Chen, Collins, Kravet, & Mergenthaler, 2018). The qualitative concept of comparability is intended for the use of end-users, which are shareholders and possible investors. According to the Financial Accounting Standards Board (FASB), the usefulness of information “depends to a great extent on the user’s ability to relate it to some benchmark” (Chen, Collins, Kravet, & Mergenthaler, 2018). Investors are able to evaluate the financial performance of companies when financial statements are more comparable with those of industry peers because these peers serve as a benchmark. Therefore, financial statement comparability should help investors to extract and process information from financial statements such that they are better able to predict future earnings. The differences in the way property, plant, and equipment are recorded prevents end-users from easily comparing financial statements of foreign and U.S. companies.  Because of this, financial statements of companies operating in foreign countries that record property, plant, and equipment in the manner mandated by the IFRS would not be comparable to U.S. companies who record property, plant, and equipment in the manner mandated by U.S. GAAP policies.

The concept of reliability is concerned with the question, how accurate is the information. The reliability of financial statements is measured by the “degree to which it represents the conditions or situations it claims to represent” (Rayburn & Tosh, p. 324, 1991). Accounting depreciation requires one to use due diligence, the best data available, and a reasonable basis for making their decisions (Rayburn & Tosh, 1991). The reliability of the model chosen for analysis is just as important as the reliability of the information used to derive the accounting judgments. U.S. companies reporting under U.S. GAAP, use the historical cost net of accumulated depreciation for reporting assets.  The U.S. GAAP requirements for recording depreciation are well structured and limit variables since they cite the amount initially invested and depreciate the cost over the lifetime of the asset.Foreign Companies who follow IFRS guidance are allowed to reevaluate assets citing the current fair market value.  The variables that make this method less reliable include the inaccurate assessments of fair value pertaining to an asset, the ease of manipulation of fair value, and the determination of fair value, as it depends on the date of acquisition (Cristea, 2017). The amounts reported by U.S. companies for property, plant, and equipment are more reliable than the current cost amounts reported by companies in England, Mexico, and elsewhere due to the reduction of judgment variables and enhanced structure of the U.S. GAAP accounting depreciation methodology.

The concept of relevance is concerned with information that may influence a decision. Relevant information could “reveal potential outcomes of past or present events, predict or assist in the prediction of future events, or support current expectations (Rayburn & Tosh, p. 323, 1991). The information does not have to change a user’s decision to be considered relevant; it must only change the degree of uncertainty associated with the decision (Rayburn & Tosh, 1991). The depreciation methodology prescribed under U.S. GAAP provides more relevant information that the depreciation methodology prescribed under IFRS because companies following U.S. GAAP depreciation methodologies use a standard formula, which in turn allows users to forecast the cost of the asset in the future. Foreign companies following IFRS depreciation guidance cannot easily forecast future costs regarding assets because the future valuations are unpredictable.

“The objective of financial statements is to provide useful information to a wide range of users for decision-making purposes. The information provided should contain the qualitative characteristics of relevance, reliability, comparability, and understandability” (Schroeder, Clark, & Cathey, 2014, p. 27). When comparing the depreciation methodologies prescribed in both U.S. GAAP and IFRS, I feel that the U.S. GAAP depreciation methodology of reporting assets at historical cost net of accumulated depreciation more accurately represents the qualitative characteristics mentioned above. The differences in the depreciation of assets among U.S. GAAP and IFRS financial statements prevent these financial statements from being comparable given the same set of economic events. The reduction of judgment variables and the enhanced structure of the U.S. GAAP accounting depreciation methodology allows it to be more reliable than the IFRS depreciation methodology. Lastly, the depreciation methodology prescribed under U.S. GAAP provides more relevant information by using a standard formula, which in turn allows users to forecast the cost of an asset in the future.

References

  • Chen, C., Collins, D.W., Kravet, T.D., & Mergenthaler, R.D. (2018). Financial Statement Comparability and the Efficiency of Acquisition Decisions. Contemporary Accounting Research, 35(1), 164-202. Retrieved from https://doi.org/10.1111/1911-3846.12380.
  • Cristea, V.G. (2017). Fair Value Accounting or Historical Cost Accounting for Property, Plant, and Equipment? Valahian Journal of Economic Studies, 8(4), 23-30. Retrieved from https://search.ebscohost.com.
  • Mangala, D., & Dhanda, M. (2018). Earnings Management: Conceptual Framework and Research Developments. IUP Journal of Accounting Research & Audit Practices, 17(4), 7-20. Retrieved from https://search.ebscohost.com
  • Schroeder, R, Clark, M., & Cathey, J. (2014). Financial accounting theory and analysis: Textand cases (11th ed.). Hoboken, NJ: John Wiley & Sons.
  • Rayburn, W.B., & Tosh, D.S. (1991). FASB Concept Statement 2: A framework for more useful appraisal reporting. Appraisal Journal, 59(3), 319. Retrieved from https://search.ebscohost.com.

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