Solution Manual For International Accounting, 4th Edition
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Chapter 01 - Introduction to International Accounting 1 - 1 C HAPTER 1 I NTRODUCTION TO INTERNATIONAL ACCOUNTING C hapter Outline I. International accounting is an extremely broad topic. A. At a minimum it focuses on the accounting issues unique to multinational corporations, especially with respect to foreign operations. B. At the other extreme it encompasses the study of the various functional areas of accounting in all countries of the world, as well as the activities of a number of supranational organizations. C. This book provides an overview of the broadly defined area of international accounting, with a focus on the accounting issues encountered by multinational companies engaged in international trade and invested in foreign operations. II. There are several a ccounting issues encountered by companies involved in international trade. A. One issue is the a ccounting for foreign currency - denominated export sales and import purchases. An important issue is how to account for changes in the value of the foreign currency - denominated account receivable (payable) that occur as exchange rates fluctuate. B. A related issue is the a ccounting for derivative financial instruments , such as forward contracts and foreign currency options, used to hedge the foreign exchange risk associated with foreign currency transactions. III. There is an even greater number of a ccounting issues encountered by companies that have made a direct investment in a foreign operation. These issues primarily result from the fact that GAAP, tax laws, and other regulations differ across countries. A. Figuring out how to make sense of the financial statements of a foreign acquisition target prepared in accordance with an unfamiliar GAAP when making a foreign direct investment decision. B. Determining the correct amounts to include in consolidated financial statements for the assets, liabilities, revenues, and expenses of foreign operations. The consolidation of a foreign subsidiary involves a two - s tep process : (1) restat e foreign GAAP financial statements in to parent company GAAP and (2) translat e foreign currency amounts into parent company currency. Determining the appropriate translation method and deciding how to report the resulting translation adjustment are important questions . C . Complying with host country income tax laws, as well as home country tax laws related to income earned in a foreign country (foreign source income) . Double taxation of income is a potential problem, and foreign tax credits are the most important relief from this problem. D . Establishing prices for intercompany transactions that cross national borders (international transfer prices) to achieve corporate objectives and at the same time comply with governmental regulations.
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Chapter 01 - Introduction to International Accounting 1 - 2 E . Evaluating the performance of both a foreign operating unit and its management. Decisions must be made with respect to issues such as the currency in which a foreign operation should be evaluated and whether foreign management should be held responsible for items over which they have little control. F . Establishing an effective internal audit function to help maintain control over foreign operations. Differences in culture, customs, and language must be taken into consideration. G. Deciding whether to cross - list securities on foreign stock exchanges, and complying with local stock exchange regulations to do so. This could involve the preparation of financial information in accordance with a GAAP different from that used by the company . I V . As companies have become more multinational, so have their external auditors. The Big 4 public accounting firms are among the most multinational business organizations in the world. V . Problems encountered by MNCs when confronted with different local GAAP in different countries leads to the desire for accounting harmonization. There would be significant advantages to MNCs if all countries used the same GAAP. V I . The world economy is becoming increasingly more integrated. International trade (imports and exports) has grown substantially in recent years and has becom e a normal part of business for relatively small companies. The number of U.S. exporting companies more than doubled in the 1990s. V II . The tremendous growth in foreign direct investment ( FDI ) over the last two decades is partially attributable to the liberalization of investment laws in many countries specifically aimed at attracting FDI. The aggregate revenues generated by foreign operations are twice as large as the revenues generated through exporting. VI II . There are more than 82 ,000 multinational companies in the world in 2009 w ith 810 ,000 foreign subsidiaries . The 100 largest multinationals generate approximately 4 % of global GDP. A disproportionate number of multinational corporations are headquartered in the triad countries of the United States, Japan, and the European Union. IX . The largest companies in the world are not necessarily the most multinational. Indeed, many large U.S. companies have no foreign operations. According to one definition of multinationality used by the United Nations, the two most multinational companies in the world in 20 11 were based in Switzerland ( Nestlé SA) and the United Kingdom ( Anglo American plc ). X . In addition to establishing operations overseas, many companies also cross - list their shares on stock exchanges outside of their home country. There are a number of reasons for doing this including having access to a larger pool of capital.
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Chapter 01 - Introduction to International Accounting 1 - 3 Answers to Questions 1. In 20 11 , companies worldwide exported over $ 1 8.3 trillion worth of merchandise. Although international trade has existed for thousands of years, recent growth in trade has been phenomenal. Over the period 199 6 - 20 11 , U.S. exports increased from $ 625 billion to $ 1, 480 billion per year, a 1 37 % increase. During the same period, Chinese exports increased eight - fold to $ 1, 898 billion in 20 11 . 2. Companies engaged in international trade with imports and exports denominated in foreign currencies are faced with the accounting issue of translating foreign currency amounts into the company’s reporting currency and reporting the effects of changes in exchange rates in the financial statements. 3. As listed in Exhibit 1 - 1, following are several reasons why companies might want to invest overseas: • Increase sales and profits • Enter rapidly growing or emerging markets • Reduce costs • Gain an foothold in economic blocs • Protect domestic markets • Protect foreign markets • Acquire technological and managerial know - how 4. FDI is playing a larger and more important role in the world economy. Global sales of foreign affiliates were about 1.5 times as high as global exports in 20 11 , compared to almost parity about three decades earlier. Global sales of foreign affiliates comprises about one tenth of worldwide gross domestic product. 5. Financial reporting issues that result from foreign direct investment are (a) conversion of foreign GAAP to parent company GAAP and (b) translation of foreign currency to parent company reporting currency to prepare consolidated financial statements. In addition, supplementary disclosures about foreign operations might be required. 6. Two major taxation issues related to a foreign direct investment are (a) taxation of the investee’s income by the host country in which the investment is located and (b) taxation of the investee’s income by the investor’s home country. Companies with foreign direct investments need to develop an expertise in the host country’s income tax rules so as to minimize the amount of taxes paid to the host country, as well as in the home country’s tax rules with respect to foreign source income. 7. Companies must make several decisions in designing the system for evaluating the performance of foreign operations. Two of these are (a) deciding whether to evaluate performance on the basis of foreign currency or parent company reporting currency and (b) deciding whether to factor out of the performance measure those items over which the foreign operation’s managers have no control. 8. Two reasons to have stock listed on the stock exchange of a foreign country are (a) to obtain capital in that country, perhaps at a more reasonable cost than is available at home, and (b) to have an “acquisition currency” for acquiring firms in that country through stock swaps.
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Chapter 01 - Introduction to International Accounting 1 - 4 9. The United Nations measures the multinationality of companies based on the average of three factors: the ratio of foreign sales to total sales, the ratio of foreign assets to total assets, and the ratio of foreign employees to total employees. Information about foreign sales, foreign assets, and the number of foreign employees might be provided in a company’s annual report or other publications through which a company provides information to the public. 10. A single set of accounting standards used worldwide would have the following benefits for multinational corporations: • Reduce the cost of preparing consolidated financial statements • Reduce the cost of gaining access to capital in foreign countries • Facilitate the analysis and comparison of financial statements of competitors and potential acquisitions Solutions to Exercises and Problems 1. Sony uses the following procedures to translate the foreign currency financial statements of its foreign subsidiaries into Japanese yen: • All assets and liabilities are translated at the year - end exchange rate • All income and expense accounts are translated at the exchange rate prevailing on the transaction date • The resulting translation adjustment is included in accumulated other comprehensive income (stockholders’ equity) [Students familiar with U.S. GAAP will recognize this approach as being procedures required by FASB Statement No. 52 for foreign subsidiaries with a foreign currency as their functional currency.] Sony uses the following procedure to translate foreign currency payables and receivables into Japanese yen: • All foreign currency receivables and payables are translated into Japanese yen at the year - end exchange rate • Changes in the Japanese yen value of foreign currency receivables and payables are reported as gains and losses in income [Students familiar with U.S. GAAP will recognize this as being the approach required in accounting for foreign currency payables and receivables .] 2. Sony has intercompany transactions that result in one affiliate paying foreign currency to (or receiving foreign currency from ) another affiliate. The company uses foreign exchange forward contracts and foreign currency option contracts to fix the local currency value of the foreign currency that will be paid to ( or received from) the affiliate . Sony does this for transactions that have already occurred (receivables and payables), as well as for transactions that are expected to occur (forecasted). For example, assume that Sony Mexico purchases goods from the parent company in Japan on February 1 with payment of 50 million Japanese yen to be made on March 31. Sony Mexico could enter into a two - month forward contract on February 1 that fixes the number of Mexican pesos it will need to pay to acquire 50 million Japanes e yen on March 31. Alternatively, Sony Mexico could purchase a foreign currency option on February 1 that expires on March 31 that would give the company the option to purchase yen on that date at a predetermined price.
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Chapter 01 - Introduction to International Accounting 1 - 5 In addition, Sony uses forward contracts to fix the amount of local currency it will need to expend to be able to repay foreign currency loans (debt). For example, assume Sony has a loan of 10 million Swiss francs that comes in six months, and the company is concerned that the Swiss franc might appreciate against the Japanese yen during that period. The company could buy 10 million Swiss francs six - months forward thereby fixing the Japanese yen price that will be paid when the debt matures. 3. a. The BRL pre - tax income becomes a USD pre - tax loss because Sales and Expenses are translated at different exchange rates. Specifically, Sales are translated at an exchange rate of USD0.30/BRL and Expenses are translated at an exchange rate of USD0 .347368/BRL. b. The question is whether Acme Brush should use BRL income or USD income to evaluate Cooper Grant’s performance. There is no unequivocally correct answer to this question. Issues that might be discussed include: • What is the Brazilian subsidiary’s objective? To generate profits that can be distributed to U.S. stockholders? • Does Cooper Grant have the ability to “control” USD income? • Do the translation procedures that result in a USD pre - tax loss make economic sense? 4. The New York Stock Exchange (NYSE) provides a PDF file titled “ Current List of All Non - U.S. Listed Issuers” on its website under Investor Relations > Financial . This document can be accessed either by using a web browser to search for “NYSE List of Non - U.S. Listed Issuers” or by searching for “List of Non - U.S. Listed Issuers” within the NYSE website ( www.nyse.com ). Note: The answers to a. and b. provided below were as of December 3 1 , 201 2 . The instructor should update these answers to the current date. a. A total of 5 25 n on - U.S. c ompanies representing 4 6 different countries were listed on the NYSE , NYSE MKT exchanges. b. On December 31, 2012 , the foreign countries with the most companies listed on the NYSE were: Canada ( 1 57 ); China ( 8 2 ); Brazil ( 2 6 ); U.K. ( 2 9 ); and Bermuda ( 19 ) . c. Companies in Canada, China, Brazil, and Bermuda probably have listed on the NYSE to tap into the much larger U.S. capital market. The reasons for U.K. companies to list on the NYSE are less clear. One reason a foreign company might want to list its shares in the United States is to enhance the company’s ability to acquire U.S. companies through an exchange of shares of stock. U.S. stockholders are more likely to trade in their shares of stock in a U.S. company in exchange for shares of a foreign company if that foreign company’s shares are traded on a U.S. stock exchange. 5. The London Stock Exchange (LSE) provides a n Excel file containing a list of all companies listed on the exchange on its website ( www.londonstockexchange.com ) . In 20 1 3 , this could be found by searching for “List of All Companies” in the LSE website. Note: The answers below come from an Excel spreadsheet “ All Companies on the London Stock Exchange – At 3 1 December 20 1 2 . ” The instructor should update these answers to the current date. a. The Excel spreadsheet lists 5 83 non - U.K. companies. T hese companies represent 6 5 different countries. b. Australia ( 31 ), Brazil (0), Canada ( 3 2 ), China (5), France ( 3 ), Germany ( 7 ), Mexico (0), and the United States ( 4 3 ). Four reasons why there are more companies listed on the LSE from Australia and Canada than from France and Germany might be:
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Chapter 01 - Introduction to International Accounting 1 - 6 • Language – the LSE might require information filed with it to be in English, a requirement easier for Australian and Canadian companies to meet. • Number of publicly traded companies – even though there are more people in France and Germany, there might be more publicly traded companies in Canada and Australia. The percentage of publicly traded companies listed on the LSE might actually be the same across the four countries. For example, 28 Australian companies might be the same percentage of total publicly traded companies in Australia as is 8 companies in Germany. • Size of local capital market – large firms in France and Germany might have no problem obtaining sufficient capital locally; Australia and Canada might have relatively small capital markets and large companies might need to obtain financing in international markets. 6. Based on the geographical distribution of Revenues (Net Sales ) and Non - current (Long - term) Assets, AstraZeneca has a multinationality index (MNI) of 0. 86 and Abbott Labs has a multinationality index of 0. 58 . AstraZeneca Sales Non-current Assets MNI United Kingdom 8,782 2,743 Continental Europe 11,264 3,673 The Americas 15,822 25,767 Asia, Africa, Australasia 6,534 803 Total 42,402 32,986 Foreign 33,620 30,243 Foreign/Total 79.3% 91.7% 85.5% Abbott Laboratories Net Sales Long-term Assets MNI United States 16,784 15,244 Japan 2,441 1,169 Germany 1,740 6,173 the Netherlands 1,883 532 Italy 1,127 222 Canada 1,253 352 France 1,167 220 Spain 942 314 United Kingdom 1,049 1,345 India 933 3,467 All Other Countries 10,555 6,874 Consolidated 39,874 35,912 Foreign 23,090 20,668 Foreign/Consolidated 57.9% 57.6% 57.7%
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Chapter 01 - Introduction to International Accounting 1 - 7 C ase 1 - 1: Besserbrau AG Besserbrau AG is faced with international accounting issues related to four different types of activities: 1. International Trade: Imports from Czech Republic; e xports to China • Translation of foreign currency payables and receivable resulting from import and export transactions . • Account for foreign currency forward contracts and foreign currency options used to hedge foreign exchange risk related to foreign currency payables and receivables 2. Foreign direct investment in China • Conversion of BB Pijio’s profit from Chinese GAAP to German GAAP . • T ranslation of BB Pijio’s profit from Chinese currency (renminbi) to German currency (euro) . • Chinese taxation of income earned in China . • German taxation of income earned in China . • Evaluation of BB Pijio’s performance 3. Pricing of intercompany sales made by Besserbrau (Germany) to BB Pijio (China) • Compliance with German and Chinese transfer pricing regulations . 4. Cross - l isting on London Stock Exchange • Compliance with London Stock Exchange financial reporting requirements . C ase 1 - 2: Vanguard International Growth Fund 1 . Individual investors can diversify the risk associated with investing in companies in only one country by investing in mutual funds that invest in the stock of foreign companies. 2 . According to information provided in the fund’s prospectus, the International Growth Fund is subject to: • I nvestment style risk, which is the chance that returns from the types of stocks in which it invests will trail returns from the overall stock market. • S tock market risk, which is the chance that stock prices overall will decline over short or even long periods. • C ountry /regional risk, which is the chance that domestic events – such as political upheaval, financial troubles, or natural disasters – will adversely affect the value of securities issued by companies in foreign countries or regions . • C urrency risk, which is the chance that investments in a foreign country will decrease in value if the U.S. dollar rises in value against that country’s currency. • M anager risk, which is the chance that the advisers will do a poor job of selecting the securities , sectors, or groups of companies in which the Fund invests. I nvestment style, stock market, and manager risks are common to both domestic and international funds. International funds also are subject to country /regional and currency risks:
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Chapter 01 - Introduction to International Accounting 1 - 8 3 . The Plain Talk About International Investing box discusses t he fact that because foreign companies are not subject to the same accounting, auditing, and financial reporting standards and practices as U.S. companies , there exists a risk that the information made available by foreign companies is not as reliable or as useful in making investment decisions as information provided by U.S. companies. 4 . The fund’s assets are distributed by region as follows: Europe ( 5 5 %), Pacific ( 17 %), Emerging Markets ( 2 3 %) , North America (3.8%), and Middle East (1.3%) . Other than North America, t his allocation might be affected by the number of firms listed on stock exchanges in those regions; relative risks – country and currency – across regions; relative growth potentials across regions; and/or differences in the quality and quantity of information provided by companies for making investment decisions. 5 . The fund is most heavily invested in the U.K. ( 20 %), Japan ( 8.9 %), China (8.1%). Switzerland ( 7.8 %), and France ( 7.6 %). The reasons why these countries are so heavily represented are similar to those listed in 4 above. One might have expected more investment in emerging markets like Brazil and India. Also, one might expect the percentage invested in the U.K., France, and Germany to be more similar. The fund has a very small amount of investment in Canadian operations, and apparently nothing in Mexican companies. One might have expected more investment in companies located in these countries. 6 . The fund is most heavily invested in the following sectors : financials, consumer discretionary , and industrials . These industries might be the most profitable or have the highest growth potential. As a regulated industry, financials might be perceived as provid ing more reliable information for making investment decisions than other sectors .
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C hapter 02 - Worldwide Accounting Diversity 2 - 1 CHAPTER 2 WORLDWIDE ACCOU N TING DIVERSITY C hapter Outline I. Considerable differences exist across countries in the accounting treatment of many items. These differences can result in significantly different amounts being reported in the financial statements prepared by companies using different GAAP. II. A variety of factors influenc e a country’s accounting system. A. Legal system – in code law countries, accounting rules tend to be legislated; common law countries tend to have a non - legislative organization that develops accounting standards. B. Taxation – financial statements serve as the basis for taxation in many countries. In those countries with a close linkage between accounting and taxation, accounting practice tends to be more conservative so as to reduce the amount of income subject to taxation. C. Providers of financing – in those countries in which family members, banks, and the government are the major providers of business finance, there tends to be less demand for public accountability and information disclosure. In countries where shareholders are a major provider of financing, the demand for information made available outside the company becomes greater. D. Inflation – c ountries with chronic high inflation adopt accounting principles in which traditional historical cost accounting is abandoned in favor of inflation adjusted figures. E. Political and economic ties – through previous colonization, a British style of accounting is used throughout most of the former British Empire. Ties between countries also help to explain similarities between the U.S. and Canada, and increasingly, the U.S. and Mexico. I II. Differences in accounting across countries cause several problems. A. Consolidating foreign subsidiaries requires that the financial statements prepared in accordance with foreign accounting rules must be converted into parent company GAAP. B. Companies interested in obtaining capital in foreign countries may be required to provide financial statements prepared in accordance with accounting rules in that country, which are likely to differ from rules in the home country. C. Investors interested in investing in foreign companies may have a difficult time in making comparisons across potential investments because of differences in accounting rules across countries. D. There is a lack of quality accounting standards in some parts of the world. The 1997 East Asian financial crisis was at least partially attributable to a lack of high quality accounting in the region. I V . There are two major classes of accounting systems , the micro - based class and the macro - uniform class . A. The m icro - based class of accounting is found in common law countries , where there is a separation of accounting from taxation , and shareholders are an important source of financing. Information is developed primarily for equity investors, with adequate disclosure serving as a major objective.
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C hapter 02 - Worldwide Accounting Diversity 2 - 2 B. The m acro - uniform class exists in code law countries , where accounting serves as the basis for taxation , and families, banks and government are the major providers of capital. Income measurement is more conservative and disclosure is lower than in the micro - based class of countries. V. National culture is an other factor long thought to influence a country’s accounting system. Using Hofstede’s (1980) societal value dimensions, Gray (1988) developed the following hypotheses: A. Conservatism hypothesis – countries high on uncertainty avoidance and long - term orientation, and low on individualism and masculinity will foster a more conservative approach to measurement. B. Secrecy hypothesis – countries high in power distance, uncertainty avoidance, and long - term orientation, and low on individualism and masculinity will exhibit more secrecy (less disclosures) i n accounting reports. C. Research results provide some support for these hypotheses, especially the hypothesis that culture affects the level of disclosure in accounting reports. V I . Nobes i ntroduced a simplified model of the reasons for international differences in financial reporting in 1998. In this model, the class (A or B) of accounting used in a country is a function of the strength of the equity - outsider financing system , which is a function of a nation’s culture, including its institutional structures. A . Class A accounting systems are oriented to ward providing information to outside shareholders (less conservative, more disclosure) . This is consistent with the micro - based class of accounting. B. Class B accounting systems are geared to taxation and creditors (more conservative, less disclosure, accounting follows tax rules). C. Nobes suggests that countries in Class B countries that are interested in competing for equity capital will adopt a Class A accounting system if allowed to do so. VI I . Differences in accounting across countries exist in several areas. A. Differences in the financial statements included in an annual report – for example, cash flows statements are not required in all countries. B. Differences in the format used to present financial statements – for example, assets are presented in order of liquidity in the U.S. , but in reverse order of liquidity in most countries. C. Differences in the level of detail provided in the financial statements – for example, an Italian balance sheet can comprise up to five pages of the annual report. D. Terminology differences – for example, sales revenue in the U.K. is called “turnover,” and inventory is called “stock.” E. Disclosure differences – for example, companies in some countries provide extensive disclosures related to their employees. F. Recognition and measurement difference s – for example, differences exist across countries with respect to the accounting for goodwill, development costs, and leases.
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C hapter 02 - Worldwide Accounting Diversity 2 - 3 Answers to Questions 1. Companies in North America commonly present assets in order of liquidity, beginning with cash; companies in Europe commonly present assets in reverse order of liquidity, beginning with “fixed assets.” 2. The two major types of legal system are “code law” and “common law.” Code law countries tend to have an accounting law, which is rather general and does not provide much detail. In common law countries, a non - legislative organization generally develops accounting standards, which tend to provide much more detail than is found in the accounting laws of code law countries. 3. In those countries in which published financial statements form the basis for taxation, there is an incentive for companies to minimize financial statement income so as to also minimize income taxes. This incentive does not exist in those countries in which expenses taken for tax purposes are not required to be recognized in the financial statements. 4. The major providers of financing are equity investors (shareholders), banks, family members, and government. As equity financing becomes more important in a country so does the disclosure of information available to the public. It is not feasible for a company to allow hundreds and thousands of investors access to internal accounting records. 5. Worldwide accounting diversity causes additional complexity for MNCs in the preparation of consolidated financial statements on the basis of parent company GAAP. Each foreign subsidiary must either keep two sets of books – one in local GAAP and one in parent company GAAP – or the foreign subsidiary’s local GAAP financial statement must be reconciled to parent company GAAP. Accounting diversity also complicates MNCs gaining access to foreign capital markets, as investors and lenders in foreign countries might require financial statements prepared in local GAAP. A third problem for MNCs caused by worldwide accounting diversity relates to a lack of comparability of financial statements when making foreign acquisition decisions. The MNC might need financial statements for the potential acquisition target prepared in accordance with a set of accounting standards with which the MNCs managers are familiar and that fairly present operating performance and financial position. 6. Comparisons of companies across countries for making portfolio investment decisions are complicated by the diversity in accounting practice that exists worldwide. There is a so - called “apples and oranges” problem associated with trying to directly compare a company that uses one set of accounting standards to measure income and report financial position with another company that uses a different set of accounting standards. 7. Strong uncertainty avoidance countries are hypothesized to favor conservative measures of profit and assets following from a concern with security and a perceived need to adopt a cautious approach to cope with uncertainty of future events. They are also hypothesized to prefer secrecy (less disclosure) following from a need to restrict information so as to avoid conflict and competition and to preserve security. 8. The Anglo cultural area is expected to favor less conservatism and more disclosure and the Less developed Latin cultural area is expected to favor more conservatism and less disclosure.
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C hapter 02 - Worldwide Accounting Diversity 2 - 4 9. Nobes (1998) argues that the two most important factors influencing differences in accounting systems across countries are (a) nature of culture and (b) type of financing system. Nobes’ notion of culture appears to go beyond the rather narrow notion in Gray’s framework to include institutional structures found in a country. Countries that are culturally dominated by a country with a self - sufficient culture are expected to have an accounting system similar to the dominant country. Some cultures lead to strong equity - outside shareholder financing systems, and other cultures lead to weak equity - outside shareholder financing systems. Countries with a strong equity - outside shareholder financing system use a Class A accounting system in which measurement practices are less conservative, disclosure is extensive, and accounting practice differs from tax rules. Countries with a weak equity - outside shareholder financing system use a Class B accounting system in which measurement is more conservative, disclosure is not as extensive, and accounting practice more closely follows tax rules. 10. Financial statements can differ across countries in terms of: a. which financial statements are included in an annual report ; b. the format used to present individual financial statements; c. the level of detail provided in financial statements; d. terminology; e. disclosure requirements; and f. recognition and measurement rules. 11. Cost of goods sold is comprised of materials, labor, and overhead. In a type of expenditure format income statement, such as that presented by Südzucker AG in Exhibit 2.1 0 , separate line items for cost of materials , personnel expenses , and depreciation are presented in the income statement. In addition, the line item change in work in process and finished goods inventories adjusts for the manufacturing costs included in cost of materials , personnel expenses , and depreciation that are not part of the cost of the inventory that was sold in the current year. 1 2 . A statement of added value added presents information on the wealth created by the company and the distribution of this wealth to employees, banks, stockholders, and the government. Value added is calculated as income before deduction of the amounts distributed to employees (wages, salaries, pensions, etc.), banks (interest), and the government (taxes). 1 3 . Fixed assets can be reported on the balance sheet subsequent to acquisition at: a. historical cost, b. historical cost adjusted for changes in the general purchasing power of the currency, and/or c. fair value .
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C hapter 02 - Worldwide Accounting Diversity 2 - 5 Solutions to Exercises and Problems 1. a. Callaway Sudz ü cker Cemex Sol Melia Thai Airways Gross profit margin Gross profit 343,763 N/A 58,129 N/A N/A Sales 950,799 5,718.2 197,801 1,148.7 * 161,602,742,485*** 3 6 . 2 % N/A 29.4% N/A N/A Operating profit margin Operating profit (30,534) 392.4 15,840 105.2 ** 13,844,815,818 Sales 950,799 5,718.2 197,801 1,148.7 161,602,742,485 ( 3. 2 % ) 6.9% 8.0% 9.2% 8.6% Net profit margin Net profit (15,260) 276.4 1,649 43.5 7,415,827,014 Sales 950,799 5,718.2 197,801 1,148.7 161,602,742,485 (1.6 % ) 4.8% 0.8% 3.8% 4.6% * W e use Total revenues. ** We assume that “EBIT” is an approximation of operating profit for Sol Melia. *** We use Total Revenue from Sale or Revenues from Services . Gross profit margin cannot be calculated for Sudz ü cker, Sol Melia, or Thai Airways because gross profit is not disclosed separately. The se companies use a type of expenditure format income statement. b. In addition to the obvious caveat about comparing profit margins across companies operating in different industries, a n analyst also must be careful in directly comparing profit margins across countries because of differences in the rules governing the recognition and measurement of revenues and expenses in calculating profit (income). 2 . The solution to this exercise will depend upon the companies selected for examination. Instructors might wa nt to forewarn students that depending upon the companies selected it might not be possible to identify five differences for parts c. and d.
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C hapter 02 - Worldwide Accounting Diversity 2 - 6 3 . The solution to this exercise will depend upon the companies selected for examination. 4 . Gray’s secrecy hypothesis – high secrecy = high PD, high UA, low IND, low MASC, high LTO PD UA IND MASC LTO # High Secrecy High High Low Low High Belgium High High High High Low 2 Brazil High High Medium High High 3 Korea High High Low Low High 5 Netherlands Low Medium High Low High 2 Sweden Low Low High Low Low 1 Thailand High Medium Low Low High 3 Assuming that each cultural dimension is equally important in influencing the accounting value of secrecy, the number of dimensions on which each country’s index is consistent with a high level of secrecy could be summed as shown in the far right column above. Using this approach, Korea would be expected to have the highest level of secrecy, followed by Brazil and Thailand, then Belgium and the Netherlands . Sweden would be rated as having the lowest level of secrecy. Note that there could be some disagreement with respect to rating each country’s level on each cultural dimension as high, medium, or low, but the overall conclusions should not be substantially different from those presented above. 5 . Completing this assignment requires students to integrate the information in the chapter on factors affecting accounting development. There are no absolutely correct responses. Some of the factors that might be relevant are presented below: Austria – Japan, Germany family – Germanic culture, influenced by Germany . Brazil – Spain, Belgium, France, Italy family – former Portuguese colony, Latin cultural area – actually belongs in a separate Latin American family of accounting as shown in Exhibit 2.7 . Finland – Sweden family – Scandinavian culture, former Swedish possession, economic ties to Sweden . Ivory Coast – Spain, Belgium, France, Italy family – former French colony – perhaps part of a Francophone African family of accounting comprised of former French colonies in Africa . Russia – unclear as to where Russia would fit in – historically it would have been in a completely separate class of accounting based on the soviet system . South Africa – U.K. influence family – former British colony – possibly with Netherlands, as South Africa was Dutch prior to becoming British . 6 . The response to this exercise will depend upon the student’s home country. U.S. students should mention (1) the importance of the equity market (strong equity - outside shareholder financing system) , (2) the separation of taxation and financial reporting, and (3) the fact that accounting standards are developed by a non - governmental entity as important factors influencing accounting in the United States. Historical ties to the U.K. also could be mentioned.
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C hapter 02 - Worldwide Accounting Diversity 2 - 7 7 . There are no correct answers to these questions. Different opinions among students can generate an interesting debate. a. Possible answers include: lack of comparability of financial statements across countries, additional work for MNCs to prepare consolidated financial statements, lack of high quality financial reporting in some countries. b. Possible answers include: international investors, international lenders, MNCs. c. It might be easier for MNCs to deal with the problem of preparing worldwide consolidated financial statements than for international investors and creditors to deal with issues of non - comparability or low quality financial statements. The reason is that MNCs have the internal information needed to reconcile their foreign subsidiaries financial statements to a common GAAP, whereas investors and creditors generally do not have access to internal information to be able to make financial statements comparable or of higher quality. 8 . There are no correct answers to these questions. Different opinions among students can generate an interesting debate. Two issues to consider are (1) how strong is the influence each factor exerts on accounting and (2) how likely is it that these factors will change over time. For example, if taxation exerts a very strong influence on financial reporting in some countries and it is highly unlikely that the governments in those countries will separate taxation from financial reporting, then taxation represents a relatively large impediment to convergence in those countries.
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C hapter 02 - Worldwide Accounting Diversity 2 - 8 C ase 2 - 1 The Impact of Culture on Conservatism Part I. If cultural values affect the development of financial reporting rules, and countries differ with respect to cultural values, then financial reporting rules will differ across countries. If financial reporting rules are strongly influenced by culture and cultural values do not change significantly over time, culture acts as an impediment to reducing differences in financial reporting rules that exist across countries. Part II. Even if all countries agreed to use the same financial reporting standards (harmonization), to the extent that application of those standards involves judgment, cultural differences could lead to differences in the application of those standards. For example, in applying a rule that requires recognition of a contingent loss when its realization is “probable,” accountants in more highly conservative countries might err on the side of conservatism by establishing a lower probability threshold than would accountants in less conservative countries. Other areas in which culture might lead to differences in the application of financial reporting rules include areas in which estimation and judgment are involved: warranty expense, bad debt expense, revenue recognition, asset impairment tests, obsolete inventories, etc. Part III. Cancan’s internal auditors need to be aware that accountants in these different countries might have culturally - determined biases in the way that they apply the company’s accounting policies. Accountants in Brazil and Korea are likely to be more conservative (higher UA, lower IND) in applying Cancan’s accounting policies than the accountant in Sweden (lower UA, higher IND). The internal auditor needs to plan to conduct tests to determine whether this bias is operating. Contingencies, warranty expense, bad debt expense, revenue recognition, asset impairment tests, and obsolete inventories are all areas that require considerable judgment. In addition, the accountants in Brazil and Korea may be less willing to provide information requested by the internal auditors because of a higher level of secrecy.
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C hapter 02 - Worldwide Accounting Diversity 2 - 9 C ase 2 - 2 SKD Limited 1 . Goodwill a . There is no goodwill amortization expense in Country A, so the goodwill amortization expense recognized by SKD must be added back to determine income under Country A GAAP. SKD amortizes goodwill over a longer period (20 years) than is allowed in Country B (5 years), so an additional amount of goodwill amortization expense must be recognized to determine income under Country B GAAP, which reduces Country B GAAP income. b . The goodwill adjustment affects the retained earnings in stockholders’ equity. The increase in Country A GAAP income results in an increase in retained earnings and the decrease in Country B GAAP income results in a decrease in retained earnings. c . The adjustment to income is for the current year only. The adjustment to stockholders’ equity is cumulative. The fact that the stockholders’ equity adjustment is three times as larger as the income adjustment implies that the goodwill was purchased three year ago. 2 . Capitalized Interest a . The adjustment labeled “Capitalized interest” relates to the interest that is not expensed but instead is capitalized under Country A GAAP. The adjustment labeled “Depreciation related to capitalized interest” relates to the depreciation of the interest that was capitalized as part of the cost of the asset. b . The first adjustment increases income because interest is not being expensed immediately but instead is capitalized as part of the cost of the asset to which it relates. The second adjustment decreases income because under Country A GAAP, the asset to which interest is capitalized has a larger cost and therefore a larger depreciation expense. c . Both income adjustments are closed out to retained earnings and partially offset one another. The increase to income of $50 and the decrease of $20 result in a net increase in retained earnings of $30. 3 . Fixed Assets a . When fixed assets are revalued to a higher amount, there is an increase in their carrying value with an offsetting increase in stockholders’ equity to keep the balance sheet in balance. The amount by which the assets are revalued is subject to depreciation, which results in a larger depreciation expense. The adjustment to recognize this additional depreciation expense decreases income under Country B GAAP. It also decreases stockholders’ equity (retained earnings). The decrease in retained earnings from additional depreciation is smaller than the increase in stockholders’ equity from revaluation of assets, which results in a net increase in stockholders’ equity. Note: if we knew when the fixed assets were revalued, we could determine the amount by which they were revalued. For example, if revaluation occurred at the end of the previous year, then the revaluation amount must have been $64 ($64 – 8 = $56) because only one year of additional deprecation would be included in the stock holders’ equity adjustment.
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 1 C HAPTER 3 I NTERNATIONAL CONVERGENCE OF FINANCIAL REPORTING C hapter Outline I. Accounting harmonization is a process that reduces alternatives while retaining a high degree of flexibility in accounting practices. A. Harmonization is different from standardization (or uniformity) which implies the elimination of alternatives in accounting practices. B. The objective of accounting harmonization is to have comparable financial statements from companies in different countries. C. Harmonization of regulations ( de jure harmonization) does not necessarily produce harmonization of practices ( de facto Harmonization). II. There are many arguments for international harmonization of accounting standards. The arguments include that it would: A. Make financial statements of companies in different countries more comparable , and hence make it easier for investors to evaluate foreign firms. B. Simplify for MNCs the evaluation of possible foreign takeover targets. C. Reduce the cost for MNCs to consolidate foreign listed companies. D. Make it easier for companies to access foreign capital markets. E. Make it easier for MNCs and international accounting firms to transfer accounting personnel to other countries. F. Raise the quality level of accounting practices internationally. III. There also are several arguments against international harmonization of accounting standards. A. Considering the differences among countries in terms of socio - politico - economic systems, it would be almost impossible to arrive at a set of accounting standards that would satisfy all of the parties involved. B. Nationalism – i nternational standards would be perceived as a set of standards developed to suit the requirements of other countries, and hence would not be received favorably. C. It is unnecessary to force all companies worldwide to follow a common set of rules. D. Today’s global capital market has evolved without harmonized accounting standards. E. It would lead to a situation of standards overload. IV. The International Acco u nting Standards Committee (IASC) was established in 1973 by professional accounting bodies in ten countries (Australia, Canada, France, Germany, Ireland, Japan, Mexico, the Netherlands, the United Kingdom, and the United States) with the broad objective of formulating “international accounting standards.” A. In its f irst 15 years, the IASC’s main activity was the issuance of International Accounting Standards (IASs), many of which allowed multiple options to accommodate existing accounting practices in various countries. B. The IASC undertook a Comparability Project during the period 1989 - 1993 to eliminate most of the choices of accounting treatment permitted under I ASs .
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 2 C. The final phase in the work of the IASC began with the IOSCO agreement in 1993 and ended with the creation of the IASB in 2001. The main activity during this phase was the development of a “core set” of international standards that could be endorsed by IOSCO for cross - listing purposes. V. The I nternational Accounting Standards Board (IASB) has the primary responsibility for international harmonization/convergence of accounting standards. A. The IASB was formed in 2001 to replace the IASC with the objective of developing a set of high quality accounting standards to be used through out the world. B . The IASB follows a due process procedure and uses a principles - based approach in developing international standards. C . The IASB has 14 members – 12 full - time and 2 part - time . S even full - time members serve a s liaison with national standard setters. Technical competence is the most important criterion for selection as a Board member. D. In addition to the IASB itself, the other main components of international standard setting include the IASC Foundation and its Trustees, the I nternational Financial Reporting Interpretations Committee (I FRIC ), and the Standards Advisory Council ( SAC ) . E. International Financial Reporting Standards ( IFRS ) consist of IFRSs issued by the IASB, IASs issued by the IASC (and adopted by the IASB) , and Interpretation s developed by IFRIC. F. As of Ma rch 200 8 , 41 IASs and 8 IFRSs ha d been issued , but only 30 IASs were still in effect. G. The IASB has a conceptual framework (Framework for the Preparation and Presentation of Financial Statements) that serves as the basis for developing IFRS . Subsequently, the IASB and FASB attempted to develop a common conceptual framework for financial reporting . More recently, the IASB has launched an IASB only conceptual framework project. H. The IASB also has issued a set of guidelines for first time adopters of IFRS (IFRS 1). V I . There are a number of ways in which a country might adopt IFRS. A. Replace national GAAP with IFRS. B. Require parent companies to use IFRS in preparing consolidated financial statements. C. Require stock exchange listed companies to use IFRS in preparing consolidated f inancial statements. D. Require foreign companies listed on a d omestic stock exchange to use IFRS. E. Require domestic companies listing on a foreign stock exchange to use IFRS. VI I . There are some concerns about adopting IFRS. A. They are too complicated for some companies. B. Using them as the basis for taxation could be a problem. C. Some IFRS, for example, those related to financial instruments and fair value accounting, are controversial. D. Guidance for first - time adopters is inadequate. E. In countries which do not have well - developed capital markets, and where the users are satisfied with the local standards, the adoption of IFRS would be of little benefit. F. There could be language translation issues.
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 3 VII I . Despite the difficulties, there is a worldwide trend towards convergence with or adoption of IFRS , as evidenced by: A. Support for the IASB structure and its highest common denominator approach. B . The IASB’s initiatives to facilitate and enhance its role as a global standard - setter, for example, by issuing guidelines for first - time adopters, holding public round table forums , and having direct liaison with some national standard setters. C. The European Union requiring the use of IFRS by publicly traded companies in preparing consolidated financial statements. D . The FASB/IASB convergence project (the so - called Norwalk agreement ) . E. More recently, the IASB seems to have taken a new direction to its convergence p roject.
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 4 Answers to Questions 1. The ultimate goal of both harmonization and convergence is to achieve international comparability in financial reporting, and both are processes that take place over time. However, while harmonization refers to the reduction of alternative accounting practices in different countries, convergence refers to the process of developing a set of high quality financial reporting standards for use internationally (the process of global standard setting). Until the establishment of the IASB in 2001, the main objective of the IASC was to achieve international harmonization in accounting standards. Accordingly, the focus was to achieve consensus among different countries with regard to accounting standards. In this process different countries were allowed to have different accounting standards as long as they did not conflict, for example, the harmonization program of the European Union. On the other hand, convergence implies the adoption of one set of standards internationally. 2. The potential benefits for a multinational corporation from convergence of financial reporting standards are derived mainly as a result of international comparability of financial reporting standards and practices. Examples of such benefits include: reduction of financial reporting costs for multinational corporations that seek to list their stocks on foreign stock exchanges; reduction of cost of preparing worldwide consolidated financial statements; and ability to transfer accounting staff to other subsidiaries overseas more easily. 3. The EU Directives were not completely effective in generating comparability across EU member nations because the Directives: a. allowed countries to choose among available options in many areas and b. did not cover many accounting issues, such as leases and translation of foreign currency financial statements. 4. The three phases in the life of the IASC were: a. 1973 - 1988 – lowest common denominator approach to standard setting b. 1988 - 1993 – reduction of existing options in IASs through the Comparability of Financial Statements Project c. 1993 - 2001 – development of core set of standards under the IOSCO Agreement 5. IOSCO’s endorsement of IASs legitimized the IASC’s claim as “the” international accounting standard setter. This also helped in addressing, at least partly, the problem of IASC’s lack of enforcement power. 6. Twelve of 14 members of the IASB are full - time. They are required to sever all ties to former employers to establish their independence. The most important criterion for selection of IASB members is technical competence. These aspects of the Board’s structure confirm the IASB’s commitment to develop the highest quality standards possible. In addition, the IASB follows an open process in which constituents are able to provide input and feedback on IASB projects and proposed standards. The geographical representation is achieved through the method of appointing the IASC Foundation Trustees. 7. A principles - based approach to accounting standard setting refers to the development of standards that provide the basic guidelines for accounting in a particular area without getting bogged down in detailed rules. The IASB uses a principles - based approach in developing
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 5 IFRS. Traditionally, the U.K. and the member countries of the British Commonwealth have adopted this approach. 8. IFRS appear to cover most of the major accounting issues. With the issuance of IFRS 2 , “Share - based Payments,” IFRS even provide guidance with respect to the accounting for stock options. Other than banks and financial institutions ( IAS 30 ), IFRS do not provide rules for specific industries. On the other hand, IAS 41, “Agriculture,” provides guidelines for a particular sector of the economy for which rules are lacking in many countries. 9. The IASB has adopted a principles - based approach to develop a set of accounting standards that constitute the “highest common denominator” of financial reporting. This approach is in sharp contrast to the approach adopted by the IASC in its early years. Also, unlike the IASC, the IASB is now formally linked to national standard setters. Seven of the 14 Board members have a direct liaison relationship with influential national standard setters and the IASB has entered into a formal agreement to converge its standards with those of the U.S. FASB. The major change is in the emphasis of the role of the IASB, from harmonization to global standard setting. 10. The different ways in which IFRS might be used within a country include: • Required of all companies domiciled within the country. • Required of parent companies in preparing consolidated financial statements; national GAAP used in parent company - only financial statements. • Required of all companies (both domestic and foreign) publicly traded within the country; non - listed companies use national GAAP. • Required of foreign companies that are publicly traded within the country. Domestic companies use national GAAP. • Required of domestic companies with foreign operations and/or foreign stock exchange listings. Domestic companies without a foreign presence use national GAAP. • Instead of requiring the use of IFRS in each example above, a country could allow the use of IFRS in lieu of domestic GAAP in each situation. 11. There are several factors that might inhibit worldwide comparability of financial statements even if IFRS are required in every country. First, even though the Comparability Project of the 1990s reduced the number of alternative methods allowed, several IFRS continue to allow companies to choose between a benchmark and an allowed alternative treatment. If the benchmark is adopted by one company and the allowed alternative by another company, strict comparability will not exist. (It should be noted that this is also true within a country if domestic GAAP allows choice among alternatives, for example, in depreciation and inventory valuation methods.) Second, even if the same treatments are selected, cross - national comparability could be harmed if accountants apply the principles - based IFRS differently. Differences in cultural values across countries could cause accountants to have biases, for example, with respect to conservatism that could influence their judgment in applying IFRS. 12. The objective of developing a set of high quality standards for financial reporting by companies internationally is commendable. There are many potential benefits associated with it. For example, it would increase the level of comparability of information contained in financial statements prepared by companies from different countries, and this would benefit investors when using those statements to assess the performance of companies as the
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 6 basis for their investment decisions. Currently, about one hundred and twenty countries are adopting IFRS and some other countries, including the U.S., are taking steps so that they can use those standards in future. However, adoption of IFRS is different from their implementation on a consistent basis. If the standards are not implemented consistently by companies in different countries, the objective of international comparability of information contained in financial statements would not be achieved. There are many factors that are likely to influence the consistency with which IFRS are implemented in different countries. IFRS are principles - based standards. To start with, a rriving at principles that satisfy all of the parties involved in different countries seems an almost impossible task. Further, accountants’ professional judgments play an important role in implementing principles - based standards, as there are many principles and uncertainty expressions that need interpretation. But, accountants’ professional judgments can be influenced by factors such as cultural values and the level of professionalism in a particular country. One can argue that it is unnecessary to force all companies worldwide to follow a common set of rules requiring to comply with a set of standards which may not be relevant to them as it would be unnecessarily costly and would lead to a situation of standards overload. Furthermore, not only is convergence difficult to achieve, but the need for such standards is not universally accepted. Finally, global convergence may not be necessary as the international capital market will force those companies that can benefit from accessing the market to provide the required accounting information without convergence. 13. IAS 1 indicates that, if existing IFRS do not provide guidance in a specific area, management should refer to the definitions, and recognition and measurement criteria for assets, liabilities, income and expenses set out in the Framework. 14 . The amendments to IFRS 1 First - time Adoption of IFRS address the retrospective application of IFRS to particular situations and are aimed at ensuring that entities applying IFRS will not face undue cost or effort in the transition process. 15. Nearly 120 countries have either adopted or allowed the use of IFRS. 1 6 . The SEC has ruled that beginning in 2007, foreign companies which have prepared their financial statements on the basis of IFRS need not include a reconciliation to U.S. GAAP in filing the Form 20 - F. A possible reason for this rule is that it would help better serve investors. The AICPA, FASB and senior finance professional supported this view. Taking a step further, the SEC has considered allowing U.S. domestic companies also to use IFRS and developed a “Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by US Issuers”. Solutions to Exercises and Problems
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 7 1. A major concern particularly in continental Europe is that the IASB is attempting to impose a certain style of accounting on every country. The reason for this concern is the fact that IFRS are based on Anglo - Saxon accounting principles, which are not the basis of accounting systems in most continental European countries. There is also a concern that the IASB standard setting process is dominated by representatives from Anglo - Saxon countries. Recognizing these and other similar concerns, the IASC Foundation Constitution Committee is currently undertaking a review of its constitution, and has identified as one of the key areas for consideration the appropriateness of the IASB’s existing formal liaison relationships. The Committee recognizes that the IASB should liaise with a broad range of national standard - setters, beyond the ones currently recognized in the Constitution. In addition, the IASB has attempted to make the standard setting process more transparent, by holding public meetings to discuss accounting issues, and increasing the opportunities for interested parties to contribute to the standard setting process. 2. a. The ultimate objective of adopting IFRS is to ensure that financial statements prepared by firms in different countries are comparable. b. There are several issues that might hamper the EU from achieving the objective of financial statement comparability through the use of IFRS: • The preparers of financial statements need to interpret and understand the requirements included in financial reporting standards in a consistent manner. Language will be a major issue in this regard. The IFRS are written in English and need to be translated into different languages. It is possible that the meanings of some of the terms used may be lost in translation, because of the absence of any equivalent terms in a particular language. This would be an impediment to achieving comparable financial statements. • The decision to adopt IFRS in EU member countries involves a change in accounting values (especially conservatism and secrecy) in most EU countries. The main focus of accounting in these countries has been either taxation or providing information to government, whereas IFRS are aimed at providing information for the efficient working of the capital market. Eight of the ten countries which gained membership of EU in May 2004 were former Soviet Union countries. Changing the accounting culture in these countries in particular will be a major challenge facing the EU. • In addition, there is lack of a tradition in exercising professional judgment in financial reporting in many EU countries. Using professional judgment within the principles - based system of IFRS to comply with IAS 1’s overriding principle of “fair presentation” might be something that EU accountants will need to learn how to do over time. • Another major challenge is the absence of an adequate accounting infrastructure, particularly in most of the new member countries. Successful adoption of IFRS requires, among other things, a well - developed accounting profession, a business sector that supports IFRS, and an effective enforcement mechanism. The EU will have challenges in all these areas given the backgrounds of its member countries.
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 8 3. Some of the key points to include in your report include: • Make sure that IFRS are translated into each of the EU’s local language s without altering the substance of the financial reporting requirements. • Develop an educational and training program to educate accountants about IFRS. • Propose reorientation of the system of professional accounting education focusing on market based economic imperatives. • Emphasize the need for an effective enforcement mechanism in each EU member nation with appropriate disciplinary procedures to deal with non - compliance. • Ensure that the accounting oversight body remains independent from outside interference. • Request adequate funding to allow the oversight body to discharge its responsibilities effectively. • Propose setting up a web page for the accounting oversight body to respond to on - going issues. • Introduce measures such as seminars to convince the business community of the benefits of adopting IFRS . 4. Examples of countries that might have their own, different reasons for not permitting the use of IFRS include the United States, Mexico, and Japan. The reasons can be summarized as follows: United States: U.S. GAAP is considered to be better - suited (superior) for the U.S. capital market environment than IFRS. Permission for U.S. companies to use IFRS would amount to lowering the quality of the standards. Mexico: Mexico’s business activities are strongly influenced by U.S. investment and trade through NAFTA. For Mexican companies, it is more important to follow U.S.GAAP than IFRS to be able to access the U.S. capital market. Japan: Traditionally , Japanese financial reporting has been based on tax rules, and the main source of finance for business has been bank credit. Cross - ownership is also c ommon among Japanese companies. The outside equity capital market has not been a major source of financing or a major influence in developing financial reporting standards in Japan. An outside equity market - oriented set of accounting standards like IFRS might not be relevant for the Japanese environment. 5. The purpose of this exercise is to encourage students to use the Internet to search for relevant information about the various initiatives taken by the IASB from time to time. T he information required for this exercise is directly available from the IASB website. 6. The purpose of this exercise is to encourage students to find the necessary information independently. They can select their home country or another country of their choice. In completing this exercise, students will become familiar with how a particular professional accounting body responds to the global trend toward convergence in financial reporting standards. 7. There are several reasons why Anglo - Saxon accounting might be of interest to Chinese accounting regulators. First, China has expressed a commitment to adopt IFRS. To be successful in adopting IFRS, a clear understanding of Anglo - Saxon accounting is necessary, as IFRS are based on Anglo - Saxon accounting. Second, Anglo - Saxon accounting has e volved over a long period of time in a particular socio - economic and
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 9 political environment, focused on capitalism, whereas in China, the focus has been on communism. Adopting capitalist measures in a communist environment is a major challenge for the Chinese regulators. Translating some of the fundamental concepts of Anglo - Saxon accounting, such as true and fair view, into the Chinese language would be another challenge. Further, the main purpose of Anglo - Saxon accounting is to facilitate the efficient working of the capital market, which is self - regulated. 8. Honda Company raises a large proportion of its funding from overseas markets, particularly from the United States. The Company’s shares are listed on the New York Stock Exchange. As a condition of listing, it must submit a set of annual financial statements based on US GAAP. As the U.S. financial reporting standards are generally considered to be of high quality, financial statements prepared by using them are also accepted in other overseas stock exchanges. If Honda Company used IFRS in preparing its consolidated financial statements then it would have to submit a separate reconciliation to the U.S. SEC. So, the company’s desire to access the U.S. market easily could be the possible reason for preparing its consolidated statements in conformity with U.S.GAAP. 9. The purpose of this exercise is to provide students with an opportunity to learn how different pieces of information can be extracted from different sources and used to address a given issue concerning international harmonization of accounting standards. For this exercise, students need to log on to the NYSE website at www.nyse.com , and determine the country origins of foreign companies listed on the exchange. Students might find the IASPLUS website ( www.iasplus.com ) to be a useful source of information to solve part b. of this exercise. 10. The ultimate objective of the efforts at setting global standards for accounting and financial reporting is to make corporate financial reports comparable, regardless of their geographical origin. However, setting global standards alone is not sufficient to achieve this objective. Some commentators argued that the rules - based approach to setting accounting standards was responsible for the accounting scandals in the U.S. However, the Parmalat scandal in Italy showed that this was not necessarily correct, and that scandals can happen anywhere, because the reasons are much more complicated than just the nature of the accounting standards used. The lesson referred to in the Financial Times statement is that effective enforcement is equally important as the type of regulation or accounting standard used, and that enforcement effectiveness is influenced by f actors such as the availability of adequate resources for the enforcement agencies, and their level of independence from political interference. 11. The purpose of this exercise is to encourage students to look beyond the text book to search for the relevant material. The chapter provides the structure for this exercise. W hat is required is to expand on the material that is already in the textbook.
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 10 12. The IASB’s main objective is to develop a set of High quality standards for financial reporting by companies at international level. Towards achieving this objective, the IASB has taken several initiatives including consulting with the professional accounting bodies in different countries, and launching a convergence project. However, there seems to be a number of challenges in this process. First, different countries seem to have different views on what should be the primary purpose of financial statements. Second, fair value accounting is not universally acceptable. Third, there is great deal of variability in the effectiveness of enforcement of IFRS in different countries. Fourth, taking proper cognizance of the fundamentally different ways in which business is conducted in different countries seems to be almost impossible. Fifth, there is an ongoing debate concerning the effectiveness of mandating high quality accounting standards in unsuitable contexts with inadequate institutional infrastructures. 13. In accordance with IFRS 1, First Time Adoption of IFRS , the following steps must be taken by the fixed assets accounting department manager in preparing IFRS - based financial statements. • Identify the IFRS effective as of December 31, 2007 that are relevant in accounting for fixed assets. • Determine the amounts related to fixed assets that will appear on the January 1, 2006 IFRS opening balance sheet based on IFRS in effect at December 31, 2007. • Preparation of the IFRS opening balance sheet will require: • Determining whether any costs expensed under previous GAAP should have been capitalized as a fixed asset under IFRS and, conversely, whether any costs capitalized as a fixed asset under previous GAAP should have been expensed under IFRS. If so, make necessary adjustments. • Determin ing whether any assets classified as a fixed asset under previous GAAP would not be under IFRS, and vice versa. If so, make necessary adjustments. 14. Recently, IFRS 1 has been amended mainly to provide further assistance to first time adopters of IFRS. 15. In November 2007, the SEC removed the requirement that foreign issuers using IFRS reconcile the financial statements to US GAAP for several reasons. First, the SEC recognized that IFRS is of high quality and is capable of ensuring adequate disclosures for the protection of investors and the promotion of efficient markets. Second, the adoption of IFRS by the European Union in 2005 had not caused any market disruption or loss of investor confidence. Third, many US companies had already invested in European companies which reported under IFRS, and they had been satisfied that IFRS was of high quality. 16. Recently, IASB chairman Hans Hoogervoorst suggested that the IASB would no longer seek to converge with the US GAAP. The reason for this change of direction would probably be the view that unlike before, under the current circumstances the risk of going alone would be minimal. Currently, as there are about 120 countries which have either adopted or permitted the use of IFRS, IASB has reached a critical mass. It needs to listen to the concerns of these diverse set of countries. Pursuing convergence with the US GAAP at the expense of ignoring concerns raised by this growing constituency was becoming an increasingly costly exercise.
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Chapter 0 3 - International Convergence o f Financial Reporting 3 - 11 However, given the importance of the U.S. as the major capital market of the world, this would not be unproblematic. Further, as a consequence of this change, two or more sets of slightly different standards are likely to co - exist in future, C ase 3 - 1 : Jardine Matheson Group As required by IAS 1, Jardine presents a consolidated income statement (profit and loss account), balance sheet, cash flow statement, and statement of changes in equity in its annual report. Presentation of Profit and Loss Account Jardine uses the “function of expenses” format in its income statement as allowed by IAS 1. The company does present the minimum items required as shown in the illustrative IFRS income statement in Exhibit 3 - 3. Presentation of Balance Sheet Jardine does classify assets and liabilities as current and non - current as required by IAS 1. The format used by Jardine is considerably different from the illustrative IFRS balance sheet in Exhibit 3 - 4, but the minimum items required by IAS 1 are presented, with the possible exception that Jardine does not separate “retained earnings” from “other reserves,” but instead combines these in the line item “revenue and other reserves.” There are considerable terminology differences such as: IAS 1 Jardine Matheson Property, plant and equipment Tangible assets Inventories Stocks and work in progress Cash and cash equivalents Bank balance and other liquid funds Trade and other payables Creditors and accruals Retained earnings Revenue and other reserves
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Chapter 04 - International Financial Reporting Standards: Part I 4 - 1 C HAPTER 4 I NTERNATIONAL FINANCIAL REPORTING STANDARDS : PART I C hapter Outline I. The International Accounting Standards Board (IASB) ha d 2 8 International Accounting Standards (IAS) and 13 International Financial Reporting Standards (IFRS) in force in 201 3 . A. In 2002, the IASB and U.S. Financial Accounting Standards Board (FASB) agreed to work together to reduce differences between IFRS and U.S. GAAP. II. There are several types of differences between IFRS and U.S. GAAP. A. Definition differences. Differences in definitions can occur even though concepts are similar. Definition differences can lead to differences in recognition and/ or measurement . B. Recognition differences. Differences in recognition criteria and/or guidance related to (a) whether an item is recognized, (b) how it is recognized, and/or (c) when it is recognized (timing difference). C. Measurement differences. Differences in approach for determining the amount recognized resulting from either (a) a difference in the method required, or (b) a difference in the detailed guidance for applying a similar method. D. Alternatives. One set of standards allows a choice between two or more alternative methods; the other set of standards requires one specific method to be used. E. Lack of requirements or guidance. IFRS do not cover an issue addressed by U.S. GAAP, and vice versa. F. Presentation differences. Differences in the presentation of items in the financial statements. G. Disclosure differences. Differences in information presented in the notes to financial statements related to (a) whether a disclosure is required and/or (b) the manner in which a disclosure is required to be made. III. A variety of d ifferences exist between IFRS and U.S. GAAP with respect to the recognition and measurement of assets. A. Inventory – IFRS require inventory to be reported on the balance sheet at the lower of cost or net realizable value; U.S. GAAP requires the lower of cost or replacement cost, with net realizable value as a ceiling and net realizable value less a normal profit margin as the floor. U.S. GAAP allows the use of LIFO; IFRS do not. B . Property, plant and equipment – subsequent to acquisition, IFRS allow fixed assets to be reported on the balance sheet using a cost model (historical cost less accumulated depreciation and impairment losses) or a revaluation model (fair value at the balance sheet date less accumulated depreciation and impairment losses); U.S. GAAP requires the use of the cost model. Component depreciation must be applied under IFRS when items of property, plant and equipment are comprise of significant parts; this is not the case under U.S. GAAP
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Chapter 04 - International Financial Reporting Standards: Part I 4 - 2 C . Impairment of assets – an asset is impaired under IFRS when its carrying amount exceeds its recoverable amount, which is the greater of net selling price and value in use. Value in use is calculated as the present value of future cash flows expected from continued use of the asset and from its disposal. An asset is impaired under U.S. GAAP when its carrying amount exceeds the undiscounted future cash flows expected from the asset’s continued use and disposal. 1. Measurement of impairment loss – the impairment loss under IFRS is the difference between carrying amount and recoverable amount; under U.S. GAAP, the impairment loss is the amount by which carrying amount exceeds fair value. Recoverable amount and fair value are likely to be different. 2. Reversal of impairment loss – if subsequent to recognizing an impairment loss, the recoverable amount of an asset is determined to exceed its new carrying amount, IFRS require the original impairment loss to be reversed; U.S. GAAP does not allow the reversal of a previously recognized impairment loss. D . Development costs – when certain criteria are met, IFRS require development costs to be capitalized as an asset and then amortized over their useful life; U.S. GAAP requires development costs to be expensed as incurred. An exception exists in U.S. GAAP for software development costs. E. Borrowing costs – similar to U.S. GAAP, IFRS requires b orrowing costs to be capitalized to the extent they are attributable to the acquisition, construction, or production of a qualifying asset. Other borrowing costs are expensed as incurred. However, the amount of borrowing costs to be capitalized differs between IFRS and U.S. GAAP. F. Leases – under standards in effect at the time this book went to press both IFRS and U.S. GAAP distinguish ed between operating and finance (capitalized) leases . U.S. GAAP provides “bright line” tests to determine when a lease must be capitalized; IFRS do not. Note: In 2013, the IASB and FASB jointly issued a revised Exposure Draft that would substantially converge the accounting for leases. The ED provides no information about a possible effective date if a new standard should become approved. IV. A number of IASB standards deal primarily with disclosure and presentation issues, and in some cases requirements differ from U.S. GAAP. A. In the statement of cash flows , IAS 7 allows interest and dividends received to be classified as operating or investing, whereas these are always classifi ed as operating under U.S. GAAP. IAS 7 allows interest and dividends paid to be classified as operating or financing, whereas interest paid is operating and dividends paid is financing under U.S. GAAP. B. IAS 10 requires financial statements to be adjusted for so - called adjusting events that occur up to the point that the financial statements have been authorized for issuance. U.S. GAAP uses the date the financial statements are issued or are available to be issued as the cutoff date for adjusting events. C . IAS 8 establishes a hierarchy of authoritative pronouncements to be considered in selecting an accounting policy. The lowest level in the hierarchy would allow the use of U.S.GAAP. Once selected, accounting policies must be applied consistently unless a change is required by IFRS or would result in more relevant information being reported in the financial statements. D . IFRS 5 provides a more liberal definition of what qualifies as a discontinued operation than does U.S. GAAP. E . IAS 34 requires interim periods to be treated as discrete accounting periods, whereas U.S. GAAP treats interim periods as an integral part of the full year.
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