Question

Consider the following scenario: You have been promoted to the role of controller at the Multi Co. holding company where you work. The financial statements have been translated from using U.S. Generally Accepted Accounting Principles (GAAP) to using International Financial Reporting Standards (IFRS).

In your initial discussion post, explain how you would make your financial comparison. Ensure you cover the term functional currency and how it is determined. Also, address the following: If Multi Co. has a subsidiary in a highly inflationary environment, what method would be used under U.S. GAAP?

Answer 1

A.

Converting from US GAAP to IFRS is a significant finance transformational event for a company. The long-term effects on a company go beyond accounting and if planned right can improve various aspects of the organization. There are five different aspects which need to be considered in financial comparison vis a vis US GAAP vs IFRS:

1. The first consideration in is to perform an accounting gap assessment. This can take anywhere from 4-8 weeks depending on the size and complexity of business – but it is vital to identify areas where differences will arise and help to focus any future implementation.
2. Any IFRS adopter for the purpose of external financial reporting needs to apply IFRS 1,First-time Adoption of IFRS. This requires retrospective application of IFRS with some required exceptions and elective exemptions, and specific disclosures.
3. Like US GAAP, IFRS has significant new standards for revenue recognition, leases and financial instruments. These standards aren’t fully aligned with their US GAAP counterparts. For example, if we have already begun our lease assessment in anticipation of ASC 842, Leases, we will need to rethink the process under IFRS due to the differences between the two standards, although the information gathered to inventory all leases will still be useful.
4. In contrast, the new revenue recognition standards are largely converged, so any work done to date to prepare for US GAAP adoption should largely carry over. However, there remain some challenging differences in the detail. Each applicable regulatory framework may bring additional complexities in areas such as pro forma financial information, separate acquiree’s financial reporting, and accounting reconciliations.
5. Finally, converting to IFRS was more than an accounting exercise. It has impacted systems, processes, people and other business areas – and all of these areas will have to be considered when moving forward with the reporting requirements for the year.

How to determine the functional currency? (IFRS vs US GAAP)

• As per IFRS (IAS 21) the functional currency is the currency of the primary economic environment in which the entity operates.In most cases, it is crystal clear.Normally, it’s the currency in which the company makes and spends money. And, in most cases it will be just the currency of the country where you operate. But, not in all cases. One good example are factories owned by Western countries, operating in low labor cost countries like India, Cambodia or so – such a subsidiary in India makes sales mostly in Western currency, like USD. People are paid in INR, but the materials are again purchased in USD. In this case, the functional currency is USD despite the fact that the subsidiary is incorporated in India.The most important, top priority factors to consider while determining functional currency are two:

1. The currency of your sales; and
2. The currency of your cost of sales and other expenses.

• As per ASC 830, a number of indicators must be considered to determine the entity's functional currency. Those indicators are not setup in the hierarchical structure. The same indicators are also used to assess whether the currency of a foreign operation is the same as that of the parent; there are no additional indicators

B.

In situation of Hyper inflationary economies (IFRS vs US GAAP)

• As per IAS 21 when economy qualifies as hyper inflationary the functional currency is retained. However if there are any amounts in the financial statements that are not already measured, at current rate at the end of reporting period, those amounts should be restated using a general price index. and then translated into reporting currency at current rate.
• As per ASC 830, if the economy qualifies as hyper inflationary, the financial statements are remeasured as if the reporting parent's reporting currency were the functional currency. Any exchange differences are reported in income.