Format of Balance Sheet and Income Statement

There are differences in the names of the balance sheets used by the three companies. L'Oreal is entitled 'Comparative Balance Sheet'; Caterpillar 'Consolidated Financial Position as of December 31'; GSK is titled 'Consolidated Balance Sheet'. The balance sheets of GSk and Caterpillar are consolidated. That is, the results of subsidiaries are included, but L'Oreal excludes them. L'Oreal includes his balance sheet for three years, GSK and Caterpillar for two years. The second major difference is the order of total assets. Caterpillar Inc. Starting with current assets and finally fixed assets and other assets.L’Oréal and GSK include the non-current assets first with the current and other assets coming after. In this case, the US GAAP adopted by Caterpillar does not prescribe a specific format while IFRS and the French Accounting specify the line items are to be presented (Grant Thornton 2016, p.11). Caterpillar’s current assets are in order of liquidity; cash is first while inventory is last. However, GSK and L’Oréal start with the inventory and ends with cash and cash equivalents and the implication is that U.S GAAP requires the ordering of current assets in order of liquidity while this is not a requirement under French Accounting or IFRS.

The Income Statement

L’Oréal presents a single income statement while both GSK and Caterpillar present two separate statements: the income statement and statement of comprehensive income. GSK presents the expenses by the function where the cost of sales is matched with sales to get gross profit while L’Oréal and Caterpillar include the cost of sales as part of operating expenses to get operating profit. Caterpillar Inc. includes basic and diluted eps and weighted average number of shares outstanding as well as the cash dividend declared per year. L’Oréal does not have to include the earnings per share information while GSK only includes the basic and diluted eps, excluding to indicate the cash dividend declared. A point to note is that French Accounting requires companies to exclude the results of the subsidiaries and therefore, L’Oreal does not present the profit attributable to the common stockholders and the non-controlling interest.

Inventories

company

inventory valuation method

inventory turnover

Caterpillar

LIFO

=33742/[(9700+12205)/2]=3.08

L’Oreal

-Weighted average cost method

=209.3/[(36.2+34.3)/2]=5.94

GSK

-FIFO

=8853/[4716+4231)/2)=1.98

Lam (2015 p.66) points out that IFRS prohibits the use of LIFO, US GAAP allows companies to either choose FIFO or LIFO while French GAAP permit the use of WAM. A central assumption under the LIFO method is that over time, the cost of inventory increases. The result is that the ending inventory includes the earlier costs while the cost of goods sold includes the higher, most recent costs. Therefore, companies using LIFO report lower ending inventory costs and importantly, reduced profits because they include the higher cost inventory into the cost of goods sold. For instance, Caterpillar points out that if it used the FIFO method, the inventory would have been higher by $2,498 million in 2014 and $2,430 for the year 2014. Robinson et al. (2015 p. 96) point out that US companies such as prefer LIFO during inflationary periods because the income is lower reducing taxes, and Caterpillar proves this because it has no tax expense for the year 2015.

FIFO assumes that the first goods sold were the ones that were first purchased. IFRS adopts this method because it matches the actual flow of goods in a business where the oldest are sold first, reducing obsolescence. The implication is that the ending inventory includes the items purchased most recently meaning GSK’s inventory is valued at the most recent market prices. Since prices rise over time, the cost of goods sold reduces because it includes the oldest cheaper inventory, resulting in a higher net income.

On the other hand, by using WAM, L’Oreal values its inventory using the weighted average cost per unit calculated by dividing the costs of goods available for sale by the number of units available for sale. WAM results in a valuation in-between that derived in FIFO and LIFO, and it is considered a safe approach to valuing inventory. WAM avoids the understatement or overstatement of inventory, and many individuals regard it as a conservative approach.

The inventory turnover ratio for Caterpillar is higher than that of GSK. LIFO results in a higher ratio because the average cost of inventory is lower since it includes the oldest items purchased. Under FIFO, the cost of inventory is higher because it consists of the recent items purchased at higher prices (Zhang et al. 2014, p.351) leading to a lower ratio.

Depreciation

company

depreciation principle

Caterpillar

straight line method

GSK

straight line method

L’Oreal

straight line and declining balance

GSK depreciates its plant, property, and equipment using the straight-line method over their expected useful life. The company has four categories of PP&E: equipment and vehicles, plant and machinery, leasehold land and buildings, and freehold buildings. Equipment has a useful life of between 3 to 10 years, machinery’s useful life is between 10 to 20 years, while both leasehold and freehold hold buildings life is between 20 to 50 years. Under the straight line basis, the depreciation expense is the same every year meaning that profit is a reduction by the same amount every year (Radu 2013 p. 254). Caterpillar also uses straight line method to depreciate its plant, property, and equipment. The PP&E are in four categories: buildings and land improvement, machinery and equipment, software, and leased equipment. The useful life of buildings and land improvement is 20-45 years, machinery and equipment 3-10, software 3-7, and equipment leased 1-10 years.

On the other hand, L’Oreal has four categories of tangible assets: buildings, fixtures and fittings, industrial machinery and equipment, and other tangible assets. Their useful lives are buildings 20-50 years, fixtures and fittings 5-10 years, industrial machinery 10 years, and others 3-10 years. Industrial machinery is depreciated using the straight-line basis while the other three is the declining balance method. The double declining balance method is a form of the accelerated depreciation, and it is twice the straight line depreciation rate. The result is a higher depreciation expense in the early years of the asset and reduces as the asset ages. In such a situation, the net profit is lower in the beginning years, and increases as the expense reduce over the years.

Intangible Assets

company

recognition

GSK

cost less provision for impairment and amortization

Caterpillar

cost less accumulated amortization

L’Oreal

purchase cost, including acquisition costs

GSK intangible assets include licenses, patents, know-how, and marketing rights are amortized over their estimated life of 20 years. An individual asset is then recognized at cost less the amortization expense. On the other hand, Caterpillar intangibles include customer relationships, intellectual property, and others. The company records its intangible assets at their cost less the accumulated amortization expense. On the other hand, include records them at purchase cost including all the acquisition costs. The French Accounting GAAP does not require the amortization of some intangible assets as well as recognizing items which do not meet the definition of an intangible asset (Nobes and Parker 2008, p.318). Both GSK and L’Oreal are allowed to revalue their intangible assets, and as a result, they recognize an impairment cost which reduces the value of the asset. However, Caterpillar does not record an impairment charge because, under US GAAP, revaluation is not allowed.

A significant difference is that GSK capitalizes the developmental costs, Caterpillar expenses them while L'Oreal amortizes them using the straight-line method. An example of a developmental cost is the acquisition and development of software for internal use, and according to Ernst & Young (2011, p.16) they are expensed under US GAAP and capitalized under IFRS. However, IFRS requires that certain criteria be met for capitalization to occur, for instance, the demonstration of technical feasibility and ability to sell the asset in the future.

Goodwill

Goodwill arises when a company acquires another for a price that exceeds the fair market value of the net assets acquired.

company

treatment of goodwill

GSK

cost less impairments

Tested for impairment annually.

does not include goodwill: does not give results of subsidiaries

Caterpillar

tested for impairment annually

GSK considers its goodwill to have an indefinite life which means that it is expected to generate benefits for the company for the foreseeable future. Indefinite life assets are not amortized, but rather, it is tested for impairment at least on an annual basis. It uses the one-step approach where the impairment is recognized when the recoverable amount is less than the fair value of the assets. The company allocates its goodwill to a cash generating unit which refers to the lowest level under which monitoring is carried out for internal management purposes.

On the other hand, Caterpillar allocates the goodwill to a reporting unit which refers to an operating segment. Testing for impairment is performed annually, primarily through the two-step process. The first step involves comparing the carrying values of the reporting unit with the sum of future discounted cash flows to be generated (fair value). Impairment exists when the carrying value is higher than the fair value and in such a situation and we move to the second stage. Implied value is calculated in this process as the excess of fair value over a unit’s assets and liabilities, and an impairment loss is if the implied value of goodwill is less than the carrying value.

Capitalization of Financial Leases

company

capitalized

Caterpillar

capitalization based on a specific detailed criteria

GSK

Finance leases are capitalized but not based on a detailed criteria used in US GAAP.

L’Oreal

finance leases not capitalized

L’Oreal under the French GAAP is prevented from capitalizing a lease because its results are unconsolidated (Nobes and Parker 2008, p.319) while Caterpillar uses specific criteria for categorizing an asset as a financial lease. US GAAP requires that a capital lease must meet a set of four criterion while for IFRS, it depends on the substance of an item. For instance, GAAP requires that the lease term should be equal or greater than 75% of the economic life while IFRS states that the term of the lease should be a major part of the economic life of the asset.

The main difference is that GSK separately assesses the land and buildings element separately while Caterpillar assesses them as a single group. It is important to note that Caterpillar conducts a 25% test on the fair value of land to confirm that it is less than 25% of the fair value of the lease. If the land’s fair value exceeds 25% of the total value of the lease, the land and buildings components are assessed separately. GSK, which follows IFRS carries out a separate assessment of the elements rather than the 25%. However, since the value of the land is immaterial for the year ended 31st December 2015, land and buildings is treated as a single unit.

Contract Accounting

company

method

caterpillar

percentage of completion method

L’Oreal

does not offer contracts but French GAAP requires the use of completed contract

GSK

not involved in contracts with customers but IFRS requires the use of percentage of completion method

Caterpillar accounts the sale of some turbine machinery, draglines, and longwall roof contracts as construction type contracts. L’Oreal does not report any sale contracts, but in case they were present; the completed contract method would be used. GSK also does not report entering into sale contracts with customers, but if existent, IFRS requires the use of the percentage of completion method.

US GAAP allows the use of either completed contract or percentage of contract method to account for contracts (Seay 2014, p.119). Caterpillar continually estimates the progress of the completion of the various contracts and provides for loss or profit in each accounting period. The method gives a relatively accurate picture of the financial position because it shows the expected income or losses and related costs as at a particular period.

Pension

company

GSK

defined benefit plan: costs determined using the projected unit method

L’Oreal

costs measured using the actuarial valuation method

Caterpillar

defined benefit and contribution: immediate recognition in earnings

L’Oreal under the French Accounting GAAP is not required to recognize a provision for unfunded pension obligations in the balance sheet, but the company may disclose such details in the notes program. Caterpillar operates both the defined contribution and benefit plans while GSK only provides the defined benefits plan. Since 1st January 2016, Caterpillar started immediately recognizing actuarial gains and losses in its earnings on an interim basis. On the other hand, GSK recognizes any actuarial movements within the year in the statement of comprehensive income.

There exist differences in recognition of plan assets or liability in the balance sheet (Ernst & Young 2016, p.42). Caterpillar recognizes a liability which is the amount expected to be paid in the next 12 months. The liability is the difference between the fair values of the plan assets and the benefit obligation. On the other hand, GSK identifies a liability which is equal to the present value of the defined benefit obligation, plus or minus any actuarial gains and losses, less unrecognized past service costs, less the fair value of any plan assets.

Currency Translation

company

translation

GSK

foreign currency assets and liabilities are translated using the balance sheet’s exchange rates

Caterpillar

Functional currency is the U.S dollar and all foreign items are re-measured into the functional currency.

L’Oreal

translates all receivables and payables in foreign currencies at the rate prevailing at end of year

Under the U.S GAAP, the functional currency used is the U.S dollar, and the foreign monetary items are re-measured using the dollar as the reporting currency. The gains and losses from the translation of asset and liability are included in other comprehensive income or losses. On the other hand, GSK books the foreign currency transactions using its functional currency, the sterling pound. Translation of these foreign monetary items into the functional currency is at the exchange rate prevailing as at the balance sheet date. Any losses or gains from the translation are reported in the consolidated income statement. L’Oreal translates its assets and liabilities using the rate prevailing at the end of the financial year with any difference reported as unrealized exchange losses or gains

Other Differences

There is different of disclosures made by the three companies. US GAAP is rule based meaning that Caterpillar provides extensive disclosures on the financial statements. GSK adopts IFRS which is principle based meaning that it has fewer exceptions and allows for clarification by the standard-setting board and therefore, requires less extensive disclosures. The French GAAP requires the least disclosures in the financial statements because the French system applies the concepts of regularity and sincerity.

Conclusion

There exist significant differences between IFRS and US GAAP standards. Such differences are most prominent in the valuation of inventory and goodwill hinder the global comparability of companies across borders. Wilmore (2015, p.1) points out that there is a huge debate on whether American companies should converge its accounting standards with those used by the majority of the world. Convergence between US GAAP and IFRS will provide a global set of standards which will improve the comparability of financial reporting across borders.

References

Comparison between U.S. GAAP and IFRS® Standards. (2016). [online] Grant Thornton, pp.4-60. Available at: https://www.grantthornton.com/issues/library/.../comparison-US-GAAP-IFRS.aspx [Accessed 6 Mar. 2017]

Lam, H., 2015. Why does the US Continue to Use GAAP and Will it Ever Converge to IFRS? Available at: http://www.scholarship.claremont.edu/cgi/viewcontent.cgi?article=2018&context=cmc_theses

Nobes, C. and Parker, R.H., 2008. Comparative international accounting. Pearson Education

Robinson, T.R., Henry, E., Pirie, W.L. and Broihahn, M.A., 2015. International financial statement analysis

Seay, S.S., 2014. The economic impact of IFRS-a financial analysis perspective. Academy of Accounting and Financial Studies Journal, 18(2), p.119

US GAAP versus IFRS. (2011). The Basics. [online] Ernst & Young, pp.1-40. Available at: http://www.ey.com/...US-GAAP-vs-IFRS-the.../EY-US-GAAP-vs-IFRS-the-basics-2013.pd [Accessed 6 Mar. 2017]

Willmore, A., 2015. The Implication of US GAAP and IFRS Convergence on American Business. Bridges, 9, p.1

Zhang, Y., Shi, C., Gao, P. and Wang, F. (2014). Repealing the LIFO Inventory Accounting Choice? A Review of LIFO and Inventory Management. American Journal of Operations Research, 04(06), pp.351-364