Comparison between IFRS 17 and US GAAP

Fair Value Option

A fair value option is an option to recognize an equity method investment at fair value at the time of initial recognition. Under IFRS, the fair value option is only available to venture capitalists and unit trusts. On the other hand, it is available to all entities under U.S. GAAP.

Impairment

Equity method investments require periodic reviews for impairment. Impairment occurs when the carrying amount is greater than the fair value. Impairment needs to be indicated by at least one loss event under IFRS. Under U.S. GAAP, if the fair value of the investment is less than the carrying value, the investment is written down to fair value, and a loss is recognized on the income statement. The reversal of permanent impairment losses is prohibited.

The assets cannot be written up under both IFRS and U.S. GAAP.

Joint Ventures

Joint ventures have different definitions under IFRS and U.S. GAAP. IFRS classifies joint ventures as jointly controlled operations, jointly controlled assets, and jointly controlled entities. The preferred accounting treatment is proportionate consolidation.

On the contrary, U.S. GAAP views joint ventures as jointly controlled separate entities. The preferred accounting treatment is the equity method. 

Business Combinations

Under IFRS and U.S. GAAP, business combinations must be accounted for using the acquisition method.

Goodwill

The previous LOS defines goodwill as an unidentifiable asset that cannot be separated from the business. IFRS recognizes it as partial goodwill, whereas U.S. GAAP recognizes it as full goodwill.

Where:

$$\text{Partial goodwill}=\text{Purchase price}-(\%\ \text{owned}\times \text{Fair value of net identifiable assets of the subsidiary})$$

$$\text{Full goodwill}=\text{Fair value of equity of whole subsidiary}-(\text{Fair value of net identifiable assets of the subsidiary})$$

More on Goodwill

Goodwill is not amortized but tested for impairment. Under IFRS, goodwill is impaired when the recoverable value of a business unit is less than the carrying value (one-step approach). On the other hand, goodwill is impaired when the carrying value of a business unit exceeds its fair value under U.S. GAAP. An impairment loss is a difference between the implied fair value of the reporting unit’s goodwill and the carrying amount (two-step approach).

Non-Controlling (Minority) Interest

A non-controlling interest is the portion of the subsidiary’s equity not owned by the parent when the acquirer holds less than a 100% stake in the target.

$$\text{Minority Interest}=\text{Percentage of a subsidiary not owned by the parent}\times\text{Subsidiary’s equity}$$

It is reported as a separate component of stockholder’s equity under both IFRS and US GAAP. 

Property, Plant, and Equipment (PPE)

IFRS allows PPE to be reported either at historical cost or fair value. However, U.S. GAAP allows companies to only use the historical model. 

Under the historical cost model, PPE is reported at historical cost as follows:

$$\text{Historical cost} – \text{Accumulated Depreciation or Amortization} – \text{Impairment loss}$$

Under the revaluation cost model, long-lived assets are reported at fair value as follows:

$$\text{Fair value} – \text{Accumulated depreciation or Amortization} – \text{Impairment losses}$$

VIEs and SPEs

Under IFRS, an SPE must be consolidated if the substance of the relationship indicates control. Under U.S. GAAP, the primary beneficiary of a VIE (which is often the sponsor) must consolidate it as its subsidiary regardless of how much of an equity investment it has in the VIE.

Question

Company P forms a special purpose entity (SPE) and contributes $20 million in cash. Company P will provide all the services to build and maintain a new commercial property that the SPE will own.

Other capital providers contribute $100 million and, between them, will have 85% voting interest in the SPE. Company P will absorb some of the profits and the majority of the losses. Under U.S. GAAP, Company P’s SPE is most likely to be:

1. Consolidated as Company P is considered the primary beneficiary.
2. Held off the balance sheet as Company P does not have majority voting control.
3. Consolidated since Company P provides the majority of the services to the SPE.

Solution

The correct answer is A.

P Inc. is required to consolidate the SPE regardless of its voting interest and is considered the primary beneficiary as it absorbs the most of losses. The primary beneficiary must consolidate.

Further explanation

The primary beneficiary is identified as the entity expected to take up most of the SPE’s expected losses and receive most of the SPE’s profits or both.

In a case where one entity absorbs the most of the SPE’s expected losses while the other entity receives a most of the SPE’s expected profits, the entity absorbing a majority of the losses must consolidate the SPE.

Non-controlling interests in the SPE are recorded in the primary beneficiary’s consolidated balance sheet and income statement.

Reading 11:  Intercorporate Investment

LOS 11 (b) Compare and contrast IFRS and US GAAP in the classification, measurement, and disclosure of investment in financial assets, investments in associates, joint ventures, business combinations, and special purpose variable interest entities.