The financial statements of entities - Part 35
However, the application Of either IIS GAP or FIRS may be nevertheless significantly different - The financial statements of entities introduction. Consequently, the differences between US GAP and IF-RSI may impact the figures presented in the financial statements of entities and lead to significant variances in financial ratios computed under US GAP and FIRS. FIRS and US GAP differ in the classification of short-term obligations that are expected to be refinanced. Under SEAS No. , a short-term obligation may be excluded from current liabilities and classified as nonoccurrence obligation if the entity intends to refinance it on a long-term basis and the intent is sustained by the ability to do so as evidence either by: (1) actual refinancing prior to the issuance of the financial statements or (2) an existence of a unconscionable financing agreement from a lender having the financial resources to complete the refinancing (FAST).
Contrary, under provision of AS 1 , the long-term obligation must be classified as current when due to be settled within twelve months of the end of the reporting period, despite that its original term was for a period of more than twelve months; and that the agreement to refinance, on a long-term basis is completed subsequent to the reporting period and before the financial statements are authorized for issuance Epstein). Classifying liabilities as either current or nonoccurrence is very significant for financial reporting presentation and financial ratio analysis.
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The difference in classification between FIRS and US GAP has a direct impact in liquidity ratios, such as current ratio, working capital, quick ratio and cash ratio, which include current liabilities and current assets. For example, in determining the working capital, an entity using US GAP, which meets the criteria to exclude from current liabilities a short-term obligation, will have a have a different ratio than an entity that uses FIRS.
Now, these ratios are very important for entities because they provide information about the entity ability to meet its short-term financial obligations and allow financial institutions to determine the extension or provision of short-term credit to entities. Another important difference between FIRS and US GAP that has an effect on the financial statements and financial ratios is the treatment of changes in accounting estimates. A change in accounting estimate is a necessary consequence of the assessment of the present status and expected torture benefits and obligations associated with assets and liabilities.
Both FIRS and US GAP agree that the change in accounting estimate shall be recognized prospectively (AS). Nonetheless, they differ in the timing of review for reasonableness of the residual value and useful life estimates of depreciable assets. AS 8, accounting policies, changes in accounting estimates and errors, states that the residual value and the useful life of an asset shall be reviewed at least at each fiscal year end. Contrary, ASS 250, accounting changes and errors, does not state an explicit requirement.
The view of residual value and useful life of depreciable assets under US GAP is required only when events or changes in circumstances indicate that the estimate is no longer applicable (PWS). This will impact the net realizable value Of assets and the depreciation expense reported in the financial statements of the entities. For example, if at year end, an entity using IF-RSI determines that the reasonableness of the residual value or the useful life of an asset differs from prior year, the value of the asset and the depreciation amount recognized in the financial statements will be impacted.
Contrary, an entity using US GAP might determine that the residual value and the useful life of the same asset were still appropriate, presenting a difference in the amounts reported under both FIRS and US GA_AP. As a consequence, activity ratios, such as total asset turnover, profitability ratios, such as return on total assets, or long-term debt-paying ratio, such as debt ratio, from an entity that follows FIRS may differ significantly from those presented under US GAP. Further differences might exist between FIRS and US GAP in such areas as research and development costs.
AS 38, Intangible Assets, requires the capitalization of development costs once certain criteria are met. Criteria such as technological feasibility, intention to complete the intangible, the ability to use or sell the intangible asset, if it will generate future economic benefits, the existence of resources to complete it and sell it, and the ability to measure the expenses attributable to the intangible, should be met before a development cost can be capitalized. Costs incurred before the criteria are met (including research costs) are expensed as incurred and cannot be epitomized in subsequent periods (AS 38).
ASS Topic 730 generally requires that research and development costs are expensed as incurred, except for which capitalization is allowed once criteria similar to those found in AS 38 are met (Dolomite). This difference has a direct impact in the classification of research and development costs. Under US GAP research and development costs will have a direct effect in the profitability of an entity. Contrary, under FIRS, development cost, if certain criteria are met, could potentially be part of the statement of financial position of an entity.
The difference in classification could impact profitability ratios, such as net profit margin, return on total assets, return on common equity, and long-term debt-paying ratios, such as debt to equity ratio and debt ratio. For example, under US GAP an entity will probably have a lower return on equity than a firm that uses FIRS, because research and development expense will reduce the entity’s net income. Now, for an entity using FIRS, if the same development costs qualified to be capitalized, it will have no impact on return on equity ratio.
Reporting uncial statements under both FIRS and US GAP can be a difficult task for entities now days. Even a seemingly simple area, like the timing of evaluation for reasonableness of residual value of an asset, the classification of a short- term obligation as nonoccurrence if certain criteria are met, or capitalization or expense of research and development costs, is more complicated than one might consider. Differences in terminology, classification, presentation, or timing can add up and affect the comparability of financial statements and the financial position determined by the financial rations.