Assignment Question
I’m working on a accounting writing question and need a reference to help me learn. “Consider the following scenario: You are the new chief financial officer of ABC Corp., a company in the United Kingdom, and you’ve been asked to help with the consolidation of your new U.S. subsidiary. ABC Corp. uses International Financial Reporting Standards (IFRS) accounting practices, while the subsidiary used U.S. Generally Accepted Accounting Principles (GAAP). In your initial post, describe and compare the process when a subsidiary is consolidated under IFRS versus U.S. GAAP. Also, explain how goodwill is determined under each practice. Post a response to at least two of your classmates’ comments, and compare and contrast your post with theirs.” 2 replies to the following attached posts
Answer
Introduction
Consolidating subsidiaries is a complex process, and the choice between International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP) can significantly impact how this process is carried out. It’s essential to delve deeper into the nuances of these accounting standards and their impact on financial reporting, especially when it comes to determining goodwill.
Under IFRS, the consolidation process focuses on substance over form. This means that the primary consideration is whether the parent company has control over the subsidiary. Control is not merely determined by owning the majority of voting shares; it can also arise from other factors such as board representation or contractual arrangements.
Once control is established, IFRS requires the parent company to combine the financial statements of both entities, making adjustments for any intercompany transactions. This approach is more flexible and principle-based, allowing for a more holistic assessment of control.
Determining goodwill under IFRS involves comparing the cost of investment (the price paid for acquiring the subsidiary) with the fair value of the subsidiary’s identifiable net assets at the acquisition date. Identifiable net assets include items like tangible assets and intangible assets that can be separately identified and measured reliably. If the cost of investment exceeds the fair value of identifiable net assets, the excess is recognized as goodwill.
It’s worth noting that under IFRS, a bargain purchase gain may arise if the fair value of the subsidiary’s net assets exceeds the cost of investment. However, such gains are recognized immediately in profit or loss, emphasizing the conservative approach of IFRS.
Under U.S. GAAP, the consolidation process is more prescriptive and rule-based. The primary criterion for consolidation is whether the parent company holds a majority voting interest in the subsidiary. Control, in this case, is more focused on ownership of shares with voting rights.
Goodwill determination under U.S. GAAP differs from IFRS in several ways. Firstly, U.S. GAAP includes all identifiable intangible assets in the calculation of the subsidiary’s net assets’ fair value. This includes items like patents, trademarks, and customer relationships. Consequently, the potential for recognizing goodwill is often higher under U.S. GAAP.
Secondly, U.S. GAAP does not recognize bargain purchase gains, which is a notable distinction from IFRS. If the fair value of the subsidiary’s net assets exceeds the cost of investment, U.S. GAAP requires reassessment of the assets and liabilities to ensure accuracy but does not recognize a gain.
One significant difference in the subsequent treatment of goodwill is impairment testing. Under both standards, goodwill is tested for impairment at least annually. However, IFRS provides the option to test a group of assets, including goodwill, for impairment before testing individual assets. U.S. GAAP does not offer this option and requires the immediate testing of goodwill at the reporting unit level. If impairment is identified, U.S. GAAP includes an impairment loss on goodwill, potentially reducing the carrying amount on the balance sheet.
In conclusion, the choice between IFRS and U.S. GAAP for consolidating subsidiaries involves considering factors like control criteria, treatment of identifiable intangible assets, and the recognition of bargain purchase gains. Understanding these differences is essential for CFOs and finance professionals, as it directly impacts financial reporting and the portrayal of a company’s financial health. The process of consolidating subsidiaries is nuanced and requires a deep understanding of both accounting standards to ensure accurate and compliant financial reporting.
References
Ewert, R., & Wagenhofer, A. (2016). Economic effects of tightening accounting standards to restrict earnings management. Journal of Accounting Research, 54(2), 389-431.
Daske, H., Hail, L., Leuz, C., & Verdi, R. (2008). Mandatory IFRS reporting around the world: Early evidence on the economic consequences. Journal of Accounting Research, 46(5), 1085-1142.
Herz, R. H. (2010). The role of fair value measurement in the current financial crisis. The Accounting Review, 85(2), 519-525.
FAQs
- What are the key differences between consolidating subsidiaries under IFRS and U.S. GAAP, and why do these differences exist?
- How does the determination of control in the consolidation process vary between IFRS and U.S. GAAP, and what are the implications of this difference?
- Can you provide examples of identifiable net assets under IFRS and U.S. GAAP, and explain how they impact the calculation of goodwill?
- What is the treatment of bargain purchase gains under IFRS and U.S. GAAP, and why does IFRS recognize such gains while U.S. GAAP does not?
- How do impairment testing requirements differ for goodwill under IFRS and U.S. GAAP, and what are the implications of these differences for financial reporting?
