\

7.10 Reconciling IFRS with US GAAP in Relation to FCFF

First, it is mandatory for both US GAAP and IFRS to provide a cash flow statement and under IFRS revenue is recognized when all significant risks and rewards of ownership are transferred.  Under US GAAP there can be industry specific guidelines for revenue recognition. Revenue recognition in practice is a difficult area for both sets of standards and the SEC has expressed concern about revenue recognition problems including adding to their own staff accounting bulletin (SAB) series. For example, on December 3, 1999, the SEC issued SAB 101, “Topic 13: Revenue Recognition and Topic 13A: Views on Selected Revenue Recognition Issues.”   Here they emphasized two revenue recognition criteria: realized (or realizable) and earned.  They also emphasized the following criteria:

·         Strong evidence that an arrangement exists.

·         Delivery has taken place or services rendered.

·         The seller’s price is fixed.

·         Reasonable likelihood of collection.

As a result, this is one area that an analyst will focus attention on the discussion of critical accounting policies or related discussion in a 10-K or 20-F given abuses that have occurred with revenue recognition. 

Another difference is dividends and recall that the cash flow statement consists of three sub parts.  These are cash flows from operating activities, investing activities and financing activities.  Under IFRS dividends are reported in the income statement as an expense which is contrary to the US GAAP treatment.  From a cash flow statement perspective under IFRS dividends paid to providers of equity capital can be classified as either as an operating or financing activity. Similarly, for dividends received IFRS classifies this as either an operating or investing activity.  Under US GAAP, on the other hand, dividends paid to providers of equity capital are classified as a financing activity and dividends received are classified as an operating activity. 

Interest expense also has subtle differences between the two standards.  Again under IFRS interest received can be classified as either an operating or an investing activity whereas under US GAAP interest received is classified as an operating activity.  For the case of interest paid under IFRS this can be classified as either an operating or financing activity whereas for US GAAP it is classified as an operating activity.

Some other notable differences lie in the area of Goodwill,  Under IFRS it is amortized over an estimated life as an expense whereas under US GAAP it is subject to an annual impairment test.  Negative goodwill (the excess of the fair value of net assets acquired over the aggregate purchase price) under US GAAP is allocated to reduce proportionally the value assigned to non-current assets or considered as an extraordinary gain whereas under IFRS this can pass through the income statement.

If research and development is a significant line item then again IFRS and US GAAP vary in their treatment of this.  Most research costs are expensed under both models.  However, for the case of development costs significant differences arise.  Under IFRS these costs can be capitalized if certain criteria is met such as commercial feasibility and resources to proceed are met whereas generally under US GAAP Research and Development is generally expensed although some exceptions exist in the software industry.