Solution Manual For International Accounting, 4th Edition

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Chapter 01-Introduction to International Accounting1-1CHAPTER 1INTRODUCTION TOINTERNATIONAL ACCOUNTINGChapter OutlineI.International accounting is an extremely broad topic.A.Ataminimumitfocusesontheaccountingissuesuniquetomultinationalcorporations, especially with respect to foreign operations.B.At the other extreme it encompasses the study of the various functional areas ofaccounting in all countries of the world, as well as the activities of a number ofsupranational organizations.C.Thisbookprovidesanoverviewofthebroadlydefinedareaofinternationalaccounting, with a focus on the accounting issues encountered by multinationalcompanies engaged in international trade andinvested inforeign operations.II.There are several accounting issues encountered by companies involved in internationaltrade.A.One issue is the accounting for foreign currency-denominated export sales andimport purchases.An important issue is how to account for changes in the value oftheforeigncurrency-denominatedaccountreceivable(payable)thatoccurasexchange rates fluctuate.B.A related issue is the accounting for derivative financial instruments, such as forwardcontracts and foreign currency options,used to hedge the foreign exchange riskassociated with foreign currency transactions.III.Thereisan even greater number of accounting issues encountered by companiesthathave made a direct investment in aforeign operation.These issues primarily result fromthe fact that GAAP, tax laws, and other regulations differ across countries.A.Figuring out how to make sense ofthe financial statementsofaforeign acquisitiontargetpreparedin accordance with an unfamiliar GAAP when makingaforeign directinvestment decision.B.Determining the correct amounts to include in consolidated financial statements fortheassets,liabilities,revenues,andexpensesofforeignoperations.Theconsolidation of a foreign subsidiary involves a two-step process:(1) restateforeignGAAP financial statements intoparent company GAAP and (2) translateforeigncurrencyamountsinto parentcompanycurrency.Determiningtheappropriatetranslation method anddeciding how to report the resulting translation adjustmentare importantquestions.C.Complying with host country income tax laws, as well as home country taxlawsrelated toincome earned in a foreign country(foreign source income).Doubletaxation of income is a potential problem, and foreign tax credits are the mostimportant relief from this problem.D.Establishingpricesforintercompanytransactionsthatcrossnationalborders(international transfer prices)toachieve corporate objectives and at the same timecomply with governmental regulations.

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Chapter 01-Introduction to International Accounting1-2E.Evaluating the performance of both a foreign operating unit and its management.Decisions must be made with respect toissues such asthe currency in which aforeign operation should be evaluated and whether foreign management should beheld responsible for items over which they have little control.F.Establishing an effective internal audit function to help maintain control over foreignoperations.Differences in culture, customs, and language must be taken intoconsideration.G.Deciding whether to cross-list securities on foreign stock exchanges, and complyingwith local stock exchange regulations to do so.This could involve the preparation offinancial information in accordance with a GAAPdifferentfrom that used by thecompany.IV.As companies have become more multinational, so have their external auditors. The Big 4public accounting firms are among the most multinational business organizations in theworld.V.Problems encountered by MNCs when confronted with different local GAAP in differentcountries leads to the desire for accounting harmonization.There would be significantadvantages to MNCs if all countries used the same GAAP.VI.The world economy is becoming increasingly more integrated. International trade (importsand exports) has grown substantially in recent years andhasbecomea normal part ofbusiness for relatively small companies.The number of U.S. exporting companies morethan doubled in the 1990s.VII.The tremendous growth inforeign direct investment (FDI)over the last two decades ispartially attributable to the liberalization of investment laws in many countries specificallyaimed at attracting FDI.The aggregate revenues generated by foreign operationsaretwice as large asthe revenues generated through exporting.VIII.There are more than82,000 multinational companies in the worldin 2009with810,000foreign subsidiaries.The 100 largest multinationals generateapproximately4% of globalGDP.A disproportionate number of multinational corporations are headquartered in thetriad 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 toone definition ofmultinationality used bythe United Nations, the two most multinational companies in theworld in2011werebased inSwitzerland(Nestlé SA)andthe United Kingdom(AngloAmerican plc).X.In addition to establishing operations overseas, many companies also cross-list theirshares on stock exchanges outside of their home country.There are a number ofreasons for doing this includinghavingaccess to a larger pool of capital.

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Chapter 01-Introduction to International Accounting1-3Answers to Questions1.In 2011, companies worldwide exported over $18.3trillion worth of merchandise. Althoughinternational trade has existed for thousands of years, recent growth in trade has beenphenomenal.Over the period 1996-2011, U.S. exports increased from $625billion to$1,480billion per year, a137% increase.During the same period, Chinese exportsincreasedeight-foldto $1,898billionin 2011.2.Companies engaged in international trade with imports and exports denominated in foreigncurrencies are faced with the accounting issue of translating foreign currency amounts intothe company’s reporting currency and reporting the effects of changes in exchange rates inthe financial statements.3.As listed inExhibit1-1, following are several reasons why companies might want to investoverseas:•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-how4.FDI is playing a larger and more important role in the world economy.Global sales offoreign affiliates were about1.5 timesas high as global exports in2011,compared to almostparity aboutthreedecades earlier.Global sales of foreign affiliates comprises about onetenth of worldwide gross domestic product.5.Financial reporting issues that result from foreign direct investment are (a) conversion offoreign GAAP to parent company GAAP and (b) translation of foreign currency to parentcompany 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 theinvestee’s income by the host country in which the investment is located and (b) taxation ofthe investee’s income by the investor’s home country.Companies with foreign directinvestments need to develop an expertise in the host country’s income tax rules so as tominimize the amount of taxes paid to the host country, as well as in the home country’s taxrules with respect to foreign source income.7.Companiesmustmakeseveraldecisionsindesigningthesystemforevaluatingtheperformance of foreign operations.Two of these are (a) deciding whether to evaluateperformance 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 theforeign operation’s managers have no control.8.Two reasons to have stock listed on the stock exchange of a foreign country are (a) toobtain 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 stockswaps.

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Chapter 01-Introduction to International Accounting1-49.The United Nations measures the multinationality of companies based on the average ofthree factors: the ratio of foreign sales to total sales, the ratio of foreign assets to totalassets, and the ratio of foreign employees to total employees.Information about foreignsales,foreignassets,andthenumberofforeignemployeesmightbeprovidedinacompany’sannualreportorotherpublicationsthroughwhichacompanyprovidesinformation to the public.10.A single set of accounting standards used worldwide would have the following benefits formultinational corporations:•Reduce the cost of preparing consolidated financial statements•Reduce the cost of gaining access to capital in foreign countries•Facilitatetheanalysisandcomparisonoffinancialstatementsofcompetitorsandpotential acquisitionsSolutions to Exercises and Problems1.Sony uses the following procedures to translate the foreign currency financial statements ofits 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 thetransaction date•The resulting translation adjustment is included in accumulated other comprehensiveincome (stockholders’ equity)[StudentsfamiliarwithU.S.GAAPwillrecognizethisapproachasbeingproceduresrequired by FASB Statement No. 52 for foreign subsidiaries with a foreign currency as theirfunctional currency.]Sony uses the following procedure to translate foreign currency payables and receivablesinto Japanese yen:•All foreign currency receivables and payables are translated into Japanese yen at theyear-end exchange rate•Changes in the Japanese yen value of foreign currency receivables and payables arereported as gains and losses in income[Students familiar with U.S. GAAP will recognize this as being the approach requiredinaccounting for foreign currency payables and receivables.]2.Sony has intercompany transactions that result in one affiliatepaying foreign currencyto (orreceivingforeign currency from) another affiliate.The company uses foreign exchangeforward contracts and foreign currency option contracts tofix the local currency value of theforeign currency that will be paidto(or receivedfrom) the affiliate.Sony does this fortransactionsthathavealreadyoccurred(receivablesandpayables),aswellasfortransactions that are expected to occur (forecasted).For example, assume that SonyMexicopurchases goods from the parent company inJapanon February 1 with payment of50 million Japanese yento 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 topay to acquire 50 million Japaneseyen on March 31.Alternatively, Sony Mexico couldpurchase aforeign currencyoptionon February 1that expires on March 31 that would givethe company the option to purchase yen on that date at a predetermined price.

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Chapter 01-Introduction to International Accounting1-5In addition, Sony uses forward contracts to fix the amount of local currency it will need toexpend to be able to repay foreign currency loans (debt). For example, assume Sony has aloan of 10 million Swiss francs that comes in six months, and the company is concerned thatthe Swiss franc might appreciate against the Japanese yen during thatperiod.Thecompany could buy 10 million Swiss francs six-months forward thereby fixing the Japaneseyen 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 aretranslated at different exchange rates.Specifically, Sales are translated at an exchangerateofUSD0.30/BRLandExpensesaretranslatedatanexchangerateofUSD0.347368/BRL.b.The question is whether Acme Brush should use BRL income or USD income toevaluate Cooper Grant’s performance.There is no unequivocally correct answer to thisquestion. Issues that might be discussed include:•WhatistheBraziliansubsidiary’sobjective?Togenerateprofitsthatcanbedistributed 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 economicsense?4.The New York Stock Exchange (NYSE) provides aPDF file titled “CurrentList ofAllNon-U.S. Listed Issuers” on its website under Investor Relations>Financial.This document canbe accessed either by using a web browser to search for “NYSE List of Non-U.S. ListedIssuers”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 ofDecember31, 2012.Theinstructor should update these answers to the current date.a.A total of 525non-U.S.companiesrepresenting 46different countries werelisted on theNYSE, NYSEMKTexchanges.b.OnDecember 31, 2012, the foreign countries with the most companies listed on theNYSE were: Canada (157);China (82);Brazil (26);U.K. (29);andBermuda (19).c.Companies in Canada,China,Brazil,andBermuda probably have listed on the NYSE totap into the much larger U.S. capital market.The reasons for U.K. companies to list onthe NYSE are less clear.One reason a foreign company might want to list its shares inthe United States is to enhance the company’s ability to acquire U.S. companies throughan exchange of shares of stock.U.S. stockholders are more likely to trade in theirshares of stock in a U.S. company in exchange for shares of a foreign company if thatforeign company’s shares are traded on a U.S. stock exchange.5.The London Stock Exchange (LSE) provides an Excel file containing alist ofallcompanieslisted on the exchange on itswebsite(www.londonstockexchange.com).In 2013, this couldbe foundby searching for“List ofAllCompanies”in the LSE website.Note: The answers below come from an Excel spreadsheet “AllCompanies on theLondon Stock Exchange–At 31December2012.”The instructor should update theseanswers to the current date.a.The Excel spreadsheet lists583non-U.K.companies.These companies represent65different countries.b.Australia (31), Brazil (0), Canada (32),China (5),France (3), Germany (7), Mexico (0),and the United States (43).Four reasons why there are more companies listed on theLSE from Australia and Canada than from France and Germany might be:

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Chapter 01-Introduction to International Accounting1-6•Language–the LSE might require information filed with it to be in English, arequirement easier for Australian and Canadian companies to meet.•Number of publicly traded companies–even though there are more people inFrance and Germany, there might be more publicly traded companies in Canada andAustralia.The percentage of publicly traded companies listed on the LSE mightactuallybethesameacrossthefourcountries.Forexample,28Australiancompanies might be the same percentage of total publicly traded companies inAustralia as is8companies in Germany.•Size of local capital market–large firms in France and Germany might have noproblemobtainingsufficientcapitallocally;AustraliaandCanadamighthaverelatively small capital markets and large companies might need to obtain financingin international markets.6.Based onthegeographical distribution ofRevenues (NetSales)andNon-current (Long-term)Assets,AstraZeneca has amultinationalityindex(MNI)of 0.86andAbbott Labshas amultinationalityindex of 0.58.AstraZenecaSalesNon-currentAssetsMNIUnited Kingdom8,7822,743Continental Europe11,2643,673The Americas15,82225,767Asia, Africa, Australasia6,534803Total42,40232,986Foreign33,62030,243Foreign/Total79.3%91.7%85.5%Abbott LaboratoriesNet SalesLong-termAssetsMNIUnited States16,78415,244Japan2,4411,169Germany1,7406,173the Netherlands1,883532Italy1,127222Canada1,253352France1,167220Spain942314United Kingdom1,0491,345India9333,467All Other Countries10,5556,874Consolidated39,87435,912Foreign23,09020,668Foreign/Consolidated57.9%57.6%57.7%

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Chapter 01-Introduction to International Accounting1-7Case 1-1:Besserbrau AGBesserbrau AG is faced with international accounting issues related to four different types ofactivities:1.International Trade:Imports from Czech Republic;exports to China•Translation of foreign currency payables and receivable resulting from import and exporttransactions.•Account for foreign currency forward contracts and foreign currency options used tohedge foreign exchange risk related to foreign currency payables and receivables2.Foreign direct investment in China•Conversion of BB Pijio’s profit from Chinese GAAP to German GAAP.•Translation 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 performance3.Pricing of intercompany sales made by Besserbrau (Germany) to BB Pijio (China)•Compliance with German and Chinese transfer pricing regulations.4.Cross-listing on London Stock Exchange•Compliance with London Stock Exchange financial reporting requirements.Case 1-2:Vanguard International Growth Fund1.Individual investors can diversify the risk associated with investing in companies in only onecountry 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 issubject to:•Investment style risk, which is the chance that returns from the types of stocks in which itinvests will trail returns from the overall stock market.•Stock market risk, which is the chance that stock prices overall will decline over short oreven long periods.•Country/regionalrisk, which is the chance that domestic events–such as politicalupheaval, financial troubles, or natural disasters–willadversely affect the value ofsecurities issued by companies in foreign countries or regions.•Currency risk, which is the chance that investments in a foreign country will decrease invalue if the U.S. dollar rises in value against that country’s currency.•Manager risk, which is the chance that the advisers will do a poor job of selecting thesecurities, sectors,orgroups of companiesin which the Fund invests.Investment style, stock market,andmanagerrisksare common to both domestic andinternational funds.International fundsalsoare subject to country/regionaland currencyrisks:

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Chapter 01-Introduction to International Accounting1-83.The Plain Talk About International Investing box discusses the fact thatbecauseforeigncompaniesarenotsubjecttothesameaccounting,auditing,andfinancialreportingstandards and practices as U.S. companies, there exists a riskthat the information madeavailable by foreign companies is not as reliable or as useful in making investment decisionsas information provided by U.S. companies.4.Thefund’sassets are distributedbyregion asfollows:Europe(55%),Pacific(17%),Emerging Markets (23%), North America (3.8%), and Middle East (1.3%).Other than NorthAmerica, this allocation might be affected by the number of firms listed on stock exchangesin those regions; relative risks–country and currency–across regions; relative growthpotentials across regions; and/or differences in the quality and quantity of informationprovided by companies for making investment decisions.5.ThefundismostheavilyinvestedintheU.K.(20%),Japan(8.9%),China(8.1%).Switzerland (7.8%),andFrance (7.6%).The reasons why these countries are so heavilyrepresented are similar to those listed in4above.One might have expected more investment inemerging markets likeBraziland India.Also,one might expect the percentage invested in the U.K., France, and Germany to be moresimilar.The fundhas a very small amount of investment in Canadianoperations,andapparentlynothing inMexican companies.One might have expected more investment in companieslocated in these countries.6.Thefundismostheavilyinvestedinthefollowingsectors:financials,consumerdiscretionary, andindustrials.These industries might be the most profitable or have thehighest growth potential. As a regulated industry, financials mightbe perceived asprovidingmore reliable information for making investment decisionsthan other sectors.

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Chapter 02-Worldwide Accounting Diversity2-1CHAPTER 2WORLDWIDE ACCOUNTING DIVERSITYChapter OutlineI.Considerable differences exist across countries in the accounting treatment of many items.These differences can result in significantly different amounts being reported in the financialstatements preparedby companies usingdifferent GAAP.II.Avariety of factors influencea country’s accounting system.A.Legal system–in code law countries, accounting rules tend to be legislated; commonlaw countries tend to have a non-legislative organization that develops accountingstandards.B.Taxation–financial statements serve as the basis for taxation in many countries.Inthose countries with a close linkage between accounting and taxation, accountingpractice tends to be more conservative so as to reduce the amount of income subjectto taxation.C.Providers of financing–in those countries in which family members, banks, and thegovernment are the major providers of business finance, there tends to be lessdemand for public accountability and information disclosure.In countries whereshareholders are a major provider of financing, the demand for information madeavailable outside the company becomes greater.D.Inflation–countries with chronic high inflation adopt accounting principles in whichtraditional historical cost accounting is abandoned in favor of inflation adjusted figures.E.Politicalandeconomicties–throughpreviouscolonization,aBritishstyleofaccounting is used throughout most of the former British Empire.Ties betweencountriesalsohelptoexplainsimilaritiesbetweentheU.S.andCanada,andincreasingly, the U.S. and Mexico.III.Differences in accounting across countries cause several problems.A.Consolidating foreign subsidiaries requires that the financial statements prepared inaccordance with foreign accounting rules must be converted intoparent companyGAAP.B.Companies interested in obtaining capital in foreign countriesmay berequired toprovide financial statements prepared in accordance with accounting rules in thatcountry, which are likely to differ from rules in the home country.C.Investors interested in investing in foreign companies may have a difficult time inmakingcomparisonsacrosspotentialinvestmentsbecauseofdifferencesinaccounting rules across countries.D.There is a lack of quality accounting standards in some parts of the world.The 1997East Asian financial crisis was at least partially attributable to a lack of high qualityaccounting in the region.IV.There are two major classes of accounting systems, the micro-based class and the macro-uniform class.A.The micro-basedclass of accounting is found incommon law countries, where there isaseparation of accounting from taxation, andshareholders are an important source offinancing.Information is developed primarily forequity investors,with adequatedisclosure serving as a major objective.

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Chapter 02-Worldwide Accounting Diversity2-2B.The macro-uniformclass exists incode law countries, whereaccounting serves as thebasis for taxation, andfamilies, banks and government are the major providers ofcapital. Income measurement is more conservative and disclosure is lower than in themicro-basedclass of countries.V.National culture is anotherfactor long thought to influence a country’s accounting system.Using Hofstede’s (1980) societal value dimensions, Gray (1988) developed the followinghypotheses:A.Conservatismhypothesis–countries highonuncertainty avoidance and long-termorientation, and low on individualism and masculinity will foster a more conservativeapproach to measurement.B.Secrecyhypothesis–countries high in power distance, uncertainty avoidance, andlong-term orientation, and low on individualism and masculinity will exhibit more secrecy(less disclosures)in accounting reports.C.Research results provide some support for these hypotheses, especially the hypothesisthat culture affects the level of disclosure in accounting reports.VI.Nobesintroduced asimplified model of the reasons for international differences in financialreportingin 1998.In this model,the class (A or B) of accounting used in a country is afunction of the strength of the equity-outsider financing system, which is a function of anation’s culture,includingitsinstitutional structures.A.ClassAaccountingsystemsare oriented towardprovidinginformationtooutsideshareholders (less conservative, more disclosure).This is consistent with the micro-based class of accounting.B.Class Baccountingsystems aregeared 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 forequity capital will adopt a Class A accounting system if allowed to do so.VII.Differences in accounting across countries exist in several areas.A.Differences in the financial statements included in an annual report–for example, cashflows statements are not required in all countries.B.Differences in the format used to present financial statements–for example, assets arepresented in order of liquidity in the U.S.,but in reverse order of liquidity in mostcountries.C.Differences in the level of detail provided in the financial statements–for example, anItalian 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 extensivedisclosures related to their employees.F.Recognition and measurement differences–for example, differences exist acrosscountries with respect to the accounting for goodwill, development costs, and leases.

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Chapter 02-Worldwide Accounting Diversity2-3Answers to Questions1. Companies in North America commonly present assets in order of liquidity, beginning withcash; companies in Europe commonly present assets in reverse order of liquidity, beginningwith “fixed assets.”2. The two major types of legal system are “code law” and “common law.” Code law countriestend to have an accounting law, which is rather general and does not provide much detail. Incommonlawcountries,anon-legislativeorganizationgenerallydevelopsaccountingstandards, which tend to provide much more detail than is found in the accounting laws ofcode law countries.3. In those countries in which published financial statements form the basis for taxation, there isan incentive for companies to minimize financial statement income so as to also minimizeincome taxes.This incentive does not exist in those countries in which expenses taken fortax 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 thedisclosure of information available to the public.It is not feasible for a company to allowhundreds and thousands of investors access to internal accounting records.5. Worldwide accounting diversity causes additional complexity for MNCs in the preparation ofconsolidated financial statements on the basis of parent company GAAP.Each foreignsubsidiary must either keep two sets of books–one in local GAAP and one in parentcompany GAAP–or the foreign subsidiary’s local GAAP financial statement mustbereconciled to parent company GAAP.Accounting diversity also complicates MNCs gainingaccess to foreign capital markets, as investors and lenders in foreign countries might requirefinancial statements prepared in local GAAP. A third problem for MNCs caused by worldwideaccounting diversity relates to a lack of comparability of financial statements when makingforeign acquisition decisions.The MNC might need financial statements for the potentialacquisition target prepared in accordance with a set of accounting standards with which theMNCs managers are familiar and that fairly present operating performance and financialposition.6. Comparisons of companies across countries for making portfolio investment decisions arecomplicated 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 companythat uses one set of accounting standards to measure income and report financial positionwith another company that uses a different set of accounting standards.7.Strong uncertainty avoidance countries are hypothesized to favor conservative measures ofprofit and assets following from a concern with security and a perceived need to adopt acautious approach to cope with uncertainty of future events.They are also hypothesized toprefer secrecy (less disclosure) following from a need to restrict information so as to avoidconflict and competition and to preserve security.8.The Anglo cultural area is expected to favor less conservatism and more disclosure and theLessdevelopedLatinculturalareaisexpectedtofavormoreconservatismandlessdisclosure.

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Chapter 02-Worldwide Accounting Diversity2-49.Nobes(1998)arguesthatthetwomostimportantfactorsinfluencingdifferencesinaccounting systems across countries are (a) nature of culture and (b) type of financingsystem.Nobes’ notion of culture appears to go beyond the rather narrow notion in Gray’sframework to include institutional structures found in a country.Countries that are culturallydominated by a country with a self-sufficient culture are expected to have an accountingsystemsimilartothedominantcountry.Someculturesleadtostrongequity-outsideshareholder financing systems, and other cultures lead to weak equity-outside shareholderfinancing systems.Countries with a strong equity-outside shareholder financing system useaClassAaccountingsysteminwhichmeasurementpracticesarelessconservative,disclosure is extensive, and accounting practice differs from tax rules. Countries with a weakequity-outside shareholder financing system use a Class B accounting system in whichmeasurement is more conservative, disclosure is not as extensive, and accounting practicemore 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; andf. recognition and measurement rules.11.Cost of goods sold is comprised of materials, labor, and overhead.In a type of expenditureformat income statement, such as that presented by Südzucker AG in Exhibit2.10, separateline items forcost of materials,personnel expenses, anddepreciationare presented in theincome statement. In addition, the line itemchange in work in process and finished goodsinventoriesadjusts for the manufacturing costs included incost of materials,personnelexpenses, anddepreciationthat are not part of the cost of the inventory that was sold in thecurrent year.12.A statement ofaddedvalue added presents information on the wealth created by thecompany and the distribution of this wealth to employees, banks, stockholders, and thegovernment.Valueaddediscalculatedas incomebefore deduction oftheamountsdistributedtoemployees(wages,salaries,pensions,etc.),banks(interest),andthegovernment (taxes).13.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/orc.fair value.

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Chapter 02-Worldwide Accounting Diversity2-5Solutions to Exercises and Problems1. a.CallawaySudzückerCemexSol MeliaThai AirwaysGross profit marginGross profit343,763N/A58,129N/AN/ASales950,7995,718.2197,8011,148.7*161,602,742,485***36.2%N/A29.4%N/AN/AOperating profitmarginOperating profit(30,534)392.415,840105.2**13,844,815,818Sales950,7995,718.2197,8011,148.7161,602,742,485(3.2%)6.9%8.0%9.2%8.6%Net profit marginNet profit(15,260)276.41,64943.57,415,827,014Sales950,7995,718.2197,8011,148.7161,602,742,485(1.6%)4.8%0.8%3.8%4.6%*Weuse Total revenues.** We assume that “EBIT” is an approximation of operating profit for Sol Melia.*** We use Total Revenuefrom Sale or Revenues from Services.Gross profit margin cannot be calculated forSudzücker, Sol Melia, or Thai Airwaysbecausegross profit is not disclosed separately.Thesecompanies use a type of expenditure formatincome statement.b.In addition to the obvious caveat about comparing profitmarginsacross companiesoperating in different industries, an analystalsomust be careful in directly comparingprofit margins across countries because of differences in the rules governing therecognition 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 want to forewarn students that depending upon the companies selected itmight not be possible to identify five differences for parts c. and d.

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Chapter 02-Worldwide Accounting Diversity2-63.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, highLTOPDUAINDMASCLTO#High SecrecyHighHighLowLowHighBelgiumHighHighHighHighLow2BrazilHighHighMediumHighHigh3KoreaHighHighLowLowHigh5NetherlandsLowMediumHighLowHigh2SwedenLowLowHighLowLow1ThailandHighMediumLowLowHigh3Assuming that each cultural dimension is equally important in influencing the accountingvalue of secrecy, the number of dimensions on which each country’s index is consistent witha high level of secrecy could be summed as shown in the far right column above. Using thisapproach, Korea would be expected to have the highest level of secrecy, followed by Braziland Thailand, then Belgium and the Netherlands.Sweden would be rated as having thelowest level of secrecy.Note that there could be some disagreement with respect to rating each country’s level oneach cultural dimension as high, medium, or low, but the overall conclusions should not besubstantially different from those presented above.5.Completing this assignment requires students to integrate the information in the chapter onfactors 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 Exhibit2.7.Finland–Sweden family–Scandinavian culture, former Swedish possession, economicties to Sweden.Ivory Coast–Spain, Belgium, France, Italy family–former French colony–perhaps part ofa Francophone African family of accounting comprised of former French colonies inAfrica.Russia–unclear as to where Russia would fit in–historically it would have been in acompletely separate class of accounting based on the soviet system.South Africa–U.K. influence family–former British colony–possibly with Netherlands, asSouth Africa was Dutch prior to becoming British.6.The response to this exercise will depend upon the student’s home country.U.S. studentsshould mention(1)the importance of the equity market(strong equity-outside shareholderfinancing system),(2)the separation of taxation and financial reporting, and(3)the fact thataccounting standards are developed by a non-governmental entity as important factorsinfluencing accounting in the United States.Historical ties to the U.K. also could bementioned.

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Chapter 02-Worldwide Accounting Diversity2-77.There are no correct answers to these questions.Different opinions among students cangenerate 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 highquality financial reporting in some countries.b.Possible answers include: international investors, international lenders, MNCs.c.ItmightbeeasierforMNCstodealwiththeproblemofpreparingworldwideconsolidated financial statements than for international investors and creditors to dealwith issues of non-comparability or low quality financial statements.The reason is thatMNCshavetheinternalinformationneededtoreconciletheirforeignsubsidiariesfinancial statements to a common GAAP, whereas investors and creditors generally donothaveaccesstointernalinformationtobeabletomakefinancialstatementscomparable or of higher quality.8.There are no correct answers to these questions.Different opinions among students cangenerate an interesting debate.Two issues to consider are (1) how strong is the influence each factor exerts on accountingand (2) how likely is it that these factors will change over time.For example, if taxationexerts a very strong influence on financial reporting in some countries and it is highlyunlikelythatthegovernmentsinthosecountrieswillseparatetaxationfromfinancialreporting, then taxation represents a relatively large impediment toconvergencein thosecountries.

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Chapter 02-Worldwide Accounting Diversity2-8Case2-1The Impact of Culture on ConservatismPart I.If cultural values affect the development of financial reporting rules, and countries differ withrespect to cultural values, then financial reporting rules will differ across countries.If financialreporting rules are strongly influenced by culture and cultural values do not change significantlyover time, culture acts as an impediment to reducing differences in financial reporting rules thatexist across countries.Part II.Even if all countries agreed to use the same financial reporting standards (harmonization), tothe extent that application of those standards involves judgment, cultural differences could leadto differences in the application of those standards.For example, in applying a rule thatrequires recognition of a contingent loss when its realization is “probable,” accountants in morehighly conservative countries might err on the side of conservatism by establishing a lowerprobability threshold than would accountants in less conservative countries.Other areas in which culture might lead to differences in the application of financial reportingrules include areas in which estimation and judgment are involved: warranty expense, bad debtexpense, revenue recognition, asset impairment tests, obsolete inventories, etc.Part III.Cancan’s internal auditors need to be aware that accountants in these different countries mighthave 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) inapplying 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 impairmenttests, and obsolete inventories are all areas that require considerable judgment. In addition, theaccountants in Brazil and Korea may be less willing to provide information requested by theinternal auditors because of a higher level of secrecy.

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Chapter 02-Worldwide Accounting Diversity2-9Case2-2SKD Limited1.Goodwilla.There is no goodwill amortization expense in Country A, so the goodwill amortizationexpense recognized by SKD must be added back to determine income under Country AGAAP.SKD amortizes goodwill over a longer period (20 years) than is allowed in Country B (5years), so an additional amount of goodwill amortization expense must be recognized todetermine income under Country B GAAP, which reduces Country B GAAP income.b.The goodwill adjustment affects the retained earnings in stockholders’ equity.Theincrease in Country A GAAP income results in an increase in retained earnings and thedecrease 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 aslarger as the income adjustment implies that the goodwill was purchased three year ago.2.Capitalized Interesta.The adjustment labeled “Capitalized interest” relates to the interest that is not expensedbut instead is capitalized under Country A GAAP.The adjustment labeled “Depreciationrelatedtocapitalizedinterest”relatestothedepreciationoftheinterestthatwascapitalized as part of the cost of the asset.b.Thefirstadjustmentincreasesincomebecauseinterestisnotbeingexpensedimmediately 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 towhichinterestis capitalizedhas a larger costand therefore a largerdepreciationexpense.c.Both income adjustments are closed out to retained earnings and partially offset oneanother. The increase to income of $50 and the decrease of $20 result in a net increasein retained earnings of $30.3.Fixed Assetsa.When fixed assets are revalued to a higher amount, there is an increase in their carryingvalue with an offsetting increase in stockholders’ equity to keep the balance sheet inbalance.The amount by which the assets are revalued is subject to depreciation, whichresults in a larger depreciation expense.The adjustment to recognize this additionaldepreciation expense decreases income under Country B GAAP.It also decreasesstockholders’equity(retainedearnings).Thedecreaseinretainedearningsfromadditionaldepreciationissmallerthantheincreaseinstockholders’equityfromrevaluation of assets, which results in a net increase in stockholders’ equity.Note: if weknew when the fixed assets were revalued, we could determine the amount by whichthey were revalued.For example, if revaluation occurred at the end of the previousyear, then the revaluation amount must have been $64 ($64–8 = $56) because onlyoneyearofadditionaldeprecationwouldbeincludedinthestockholders’equityadjustment.

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Chapter03-International Convergenceof Financial Reporting3-1CHAPTER3INTERNATIONALCONVERGENCEOFFINANCIAL REPORTINGChapter OutlineI.Accounting harmonization is a process that reduces alternatives while retaining a highdegree of flexibility in accounting practices.A.Harmonization is different from standardization (or uniformity) which implies theelimination of alternatives in accounting practices.B.The objective of accounting harmonization is to have comparable financial statementsfrom companies in different countries.C.Harmonization of regulations (de jureharmonization) does not necessarily produceharmonizationof practices (de factoHarmonization).II.There are many arguments forinternationalharmonization of accounting standards. Thearguments include that it would:A.Make financial statements of companies in different countriesmorecomparable,andhence make it easier for investors to evaluate foreign firms.B.Simplify for MNCs the evaluation of possible foreign takeover targets.C.Reduce thecost for MNCs to consolidateforeign 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 accountingpersonnel to other countries.F.Raise the quality level of accounting practices internationally.III.Therealsoareseveralargumentsagainstinternationalharmonizationofaccountingstandards.A.Considering the differences among countries in terms of socio-politico-economicsystems, it would be almost impossible to arrive at a set of accounting standards thatwould satisfy all of the parties involved.B.Nationalism–internationalstandards would beperceived as a set of standardsdevelopedto suitthe requirementsofothercountries, andhencewouldnotbereceived 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 Accounting Standards Committee (IASC) was established in 1973 byprofessional accounting bodies in ten countries (Australia, Canada, France, Germany,Ireland, Japan, Mexico, the Netherlands, the United Kingdom, and the United States) withthe broad objective of formulating “international accounting standards.”A.Initsfirst15years,theIASC’smainactivitywastheissuanceofInternationalAccounting Standards (IASs), many of which allowed multiple options to accommodateexisting accounting practices in various countries.B.The IASC undertook a Comparability Project duringthe period 1989-1993to eliminatemost of the choices of accounting treatment permitted under IASs.

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Chapter03-International Convergenceof Financial Reporting3-2C.The final phase in the work of the IASC began with the IOSCO agreement in 1993 andended with the creation of the IASB in 2001.The main activity during this phase wasthe development of a “core set” of international standards that could be endorsed byIOSCO for cross-listing purposes.V.TheInternational Accounting Standards Board (IASB)has the primary responsibility forinternational harmonization/convergence of accounting standards.A.TheIASB was formed in 2001 to replacetheIASC with the objective of developingaset of high quality accounting standards to be used through out the world.B.TheIASB follows a due process procedure andusesa principles-based approachindeveloping international standards.C.The IASB has 14 members–12 full-time and 2 part-time.Seven full-time membersserveasliaison with national standard setters.Technical competence is themostimportant criterion for selection as a Board member.D.In addition to the IASB itself, the other main components of international standardsetting include the IASC Foundation and its Trustees, the International FinancialReporting Interpretations Committee (IFRIC), andtheStandards Advisory Council(SAC).E.International Financial Reporting Standards (IFRS) consist of IFRSs issued by theIASB, IASs issued by the IASC(and adopted by the IASB), andInterpretationsdeveloped by IFRIC.F.As of March2008, 41 IASs and8IFRSs hadbeen issued, but only30IASs were still ineffect.G.TheIASBhasaconceptualframework(FrameworkforthePreparationandPresentation of Financial Statements) that servesas the basis for developingIFRS.Subsequently,theIASBandFASBattemptedtodevelopacommonconceptualframeworkfor financial reporting. More recently, the IASBhas launched an IASB onlyconceptual framework project.H.TheIASBalsohas issued a set of guidelines for first time adoptersof IFRS(IFRS 1).VI.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 consolidatedfinancial statements.C.Require stock exchange listed companies to use IFRS in preparing consolidatedfinancial statements.D.Require foreign companies listed ona domestic stock exchange to use IFRS.E.Require domestic companies listing onaforeign stock exchange to use IFRS.VII.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.SomeIFRS,forexample,thoserelatedtofinancialinstrumentsandfairvalueaccounting, are controversial.D.Guidance for first-time adopters is inadequate.E.In countries which do not have well-developed capital markets,and where the usersare 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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Chapter03-International Convergenceof Financial Reporting3-3VIII.Despite the difficulties, thereisa worldwide trend towards convergencewith or adoption ofIFRS, 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, forexample,by issuingguidelines for first-time adopters,holding public round tableforums,andhavingdirect liaison with some national standard setters.C.The European Union requiring the use of IFRS by publicly traded companies inpreparing consolidated financial statements.D.TheFASB/IASB convergence project (the so-calledNorwalk agreement).E.More recently, the IASB seems to havetaken a new direction to itsconvergenceproject.

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Chapter03-International Convergenceof Financial Reporting3-4Answers to Questions1.Theultimategoalofbothharmonizationandconvergenceistoachieveinternationalcomparability in financial reporting, and both are processes that take place over time.However, while harmonization refers to the reduction of alternative accounting practices indifferent countries, convergence refers to the process of developing a set of high qualityfinancial 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 achieveinternational harmonization in accounting standards. Accordingly, the focus was to achieveconsensus among different countries with regard to accounting standards. In this processdifferent countries were allowed to have different accounting standards as long as they didnot conflict, for example, the harmonization program of the European Union. On the otherhand, convergence implies the adoption of one set of standards internationally.2.The potential benefits for a multinational corporation from convergence of financial reportingstandards are derived mainly as a result of international comparability of financial reportingstandards and practices. Examples of such benefits include: reduction of financial reportingcosts for multinational corporations that seek to list their stocks on foreign stock exchanges;reduction of cost of preparing worldwide consolidated financial statements; and ability totransfer accounting staff to other subsidiaries overseas more easily.3.The EU Directives were not completely effective in generating comparability across EUmember nations because the Directives:a. allowed countries to choose among available options in many areas andb. did not cover many accounting issues, such as leases and translation of foreign currencyfinancial statements.4.The three phases in the life of the IASC were:a. 1973-1988–lowest common denominator approach to standard settingb. 1988-1993–reduction of existing options in IASs through the Comparability of FinancialStatements Projectc. 1993-2001–development of core set of standards under the IOSCO Agreement5.IOSCO’s endorsement of IASs legitimized the IASC’s claim as “the” international accountingstandard setter. This also helped in addressing, at least partly, the problem of IASC’s lack ofenforcement power.6.Twelve of 14 members of the IASB are full-time. They are required to sever all ties to formeremployers to establish their independence.The most important criterion for selection ofIASB members is technical competence. These aspects of the Board’s structure confirm theIASB’s commitment to develop the highest quality standards possible.In addition, the IASBfollows an open process in which constituents are able to provide input and feedback onIASBprojectsandproposedstandards.Thegeographicalrepresentationisachievedthrough the method of appointing the IASC Foundation Trustees.7.A principles-based approach to accounting standard setting refers to the development ofstandards that provide the basic guidelines for accounting in a particular area without gettingbogged down in detailed rules.The IASB uses a principles-based approach in developing

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Chapter03-International Convergenceof Financial Reporting3-5IFRS. Traditionally, the U.K. and the member countries of the British Commonwealth haveadopted this approach.8.IFRS appear to cover most of the major accounting issues.With the issuance ofIFRS 2,“Share-based Payments,” IFRS even provide guidance with respect to the accounting forstock options.Other than banks and financial institutions (IAS 30), IFRS do not providerules for specific industries. On the other hand,IAS 41,“Agriculture,” provides guidelines fora particular sector of the economy for which rules are lacking in many countries.9.TheIASBhasadoptedaprinciples-basedapproachtodevelopasetofaccountingstandards that constitute the “highest common denominator” of financial reporting.Thisapproach 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 the14 Board members have a direct liaison relationship with influential national standard settersand the IASB has entered into a formal agreement to converge its standards with those ofthe U.S. FASB. The major change is in the emphasis of the role of the IASB, fromharmonization 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; nationalGAAP 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.Domesticcompanies use national GAAP.•Required of domestic companies with foreign operations and/or foreign stock exchangelistings. Domestic companies without a foreign presence use national GAAP.•Instead of requiring the use of IFRS in each example above, a country couldallowtheuse ofIFRSin lieu of domestic GAAP in each situation.11. There are several factors that might inhibit worldwide comparability of financial statementseven if IFRS are required in every country.First, even though the Comparability Project ofthe 1990s reduced the number of alternative methods allowed, several IFRS continue toallow companies to choose between a benchmark and an allowed alternative treatment.Ifthebenchmarkisadoptedbyonecompanyandtheallowedalternativebyanothercompany, strict comparability will not exist.(It should be noted that this is also true within acountry if domestic GAAP allows choice among alternatives, for example, in depreciationand inventory valuation methods.) Second, even if the same treatments are selected, cross-national comparability could be harmed if accountants apply the principles-based IFRSdifferently.Differences in cultural values across countries could cause accountants to havebiases, for example, with respect to conservatism that could influence their judgment inapplying IFRS.12.Theobjective of developingasetof high qualitystandards forfinancialreportingbycompanies internationally is commendable. There are many potential benefits associatedwith it. For example, it would increase the level of comparability of information contained infinancial statements prepared by companies from different countries, and this would benefitinvestors when using those statements to assess the performance of companies as the

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Chapter03-International Convergenceof Financial Reporting3-6basis for their investment decisions. Currently, about one hundred and twenty countries areadopting IFRS and some other countries, including the U.S., are taking steps so that theycan use those standards in future.However, adoption of IFRS is different from their implementation on a consistent basis. If thestandardsarenotimplementedconsistentlybycompaniesindifferentcountries,theobjective of international comparability of information contained in financial statementswould not be achieved. There are many factors that are likely to influence theconsistencywithwhichIFRSareimplementedindifferentcountries.IFRSareprinciples-basedstandards. To start with, arriving at principles that satisfy all of the parties involved indifferent countries seems an almost impossible task. Further,accountants’ professionaljudgments play an important role in implementing principles-based standards, as there aremany principles and uncertainty expressions that need interpretation. But, accountants’professional judgments can be influenced by factors such as cultural values and the level ofprofessionalism in a particular country. Onecan argue that it is unnecessary to force allcompanies worldwide to follow a common set of rules requiring to comply with a set ofstandards which may not be relevant to them as it would be unnecessarily costly and wouldlead to a situation of standards overload. Furthermore, not only is convergence difficult toachieve,buttheneedforsuchstandardsisnotuniversallyaccepted.Finally,globalconvergence may not be necessary as the international capital market will force thosecompanies that can benefit from accessing the market to provide the required accountinginformation without convergence.13.IAS1indicatesthat,ifexistingIFRSdonotprovideguidanceinaspecificarea,management should refer to the definitions, and recognition and measurement criteria forassets, liabilities, income and expenses set out in the Framework.14.TheamendmentstoIFRS1First-timeAdoptionofIFRSaddresstheretrospectiveapplication of IFRS to particular situations and are aimed at ensuring that entities applyingIFRS will not face undue cost or effort in the transition process.15.Nearly 120 countrieshave either adopted or allowed the use of IFRS.16.The SEC has ruled that beginning in 2007, foreign companies which have prepared theirfinancial statements on the basis of IFRS need not include a reconciliation to U.S. GAAP infiling the Form 20-F. A possible reason for this rule is that it would help better serveinvestors. The AICPA, FASB and senior finance professional supported this view. Taking astep further, the SEC has considered allowing U.S. domestic companies also to use IFRSanddeveloped a“Roadmap for the Potential Use of Financial Statements Prepared inAccordance with International Financial Reporting Standards by US Issuers”.Solutions to Exercises and Problems

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Chapter03-International Convergenceof Financial Reporting3-71.A major concern particularly in continental Europe is that the IASB is attempting to impose acertain style of accounting on every country. The reason for this concern is the fact thatIFRSarebasedonAnglo-Saxonaccountingprinciples,whicharenotthebasisofaccounting systems in most continental European countries. There is also a concern thatthe IASB standard setting process is dominated by representatives from Anglo-Saxoncountries. Recognizing these and other similar concerns, the IASC Foundation ConstitutionCommittee is currently undertaking a review of its constitution, and has identified as one ofthe key areas for consideration the appropriateness of the IASB’s existing formal liaisonrelationships. The Committee recognizes that the IASB should liaise with a broad range ofnational standard-setters, beyond the ones currently recognized in the Constitution. Inaddition, the IASB has attempted to make the standard setting process more transparent, byholding public meetings to discuss accounting issues, and increasing the opportunities forinterested parties to contribute to the standard setting process.2.a.TheultimateobjectiveofadoptingIFRSistoensurethatfinancialstatementsprepared by firms in different countries are comparable.b.There are several issues that might hamper the EU from achieving the objective offinancial statement comparability through the use of IFRS:•Thepreparersoffinancialstatementsneedtointerpretandunderstandtherequirementsincludedinfinancialreportingstandardsinaconsistentmanner.Language will be a major issue in this regard. The IFRS are written in English andneed to be translated into different languages. It is possible that the meanings ofsome of the terms used may be lost in translation, because of the absence of anyequivalent terms in a particular language. This would be an impediment to achievingcomparable financial statements.•The decision to adopt IFRS in EU member countries involves a change in accountingvalues (especially conservatism and secrecy) in most EU countries.The main focusof accounting in these countries has been either taxation or providing information togovernment,whereasIFRSare aimed atprovidinginformation fortheefficientworking of the capital market. Eight of the ten countries which gained membership ofEU in May 2004 were former Soviet Union countries. Changing the accountingculture 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 financialreporting in many EU countries.Using professional judgment within the principles-basedsystemofIFRStocomplywithIAS1’soverridingprincipleof“fairpresentation” might be something that EU accountants will need to learn how to doover time.•Another major challenge is the absence of an adequate accounting infrastructure,particularly in most of the new member countries. Successful adoption of IFRSrequires, among other things, a well-developed accounting profession, a businesssector that supports IFRS, and an effective enforcement mechanism. The EU willhave challenges in all these areas given the backgrounds of its member countries.

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Chapter03-International Convergenceof Financial Reporting3-83.Some of the key points to include in your report include:•Make sure thatIFRSaretranslated intoeach of the EU’slocal languageswithoutaltering the substanceof 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 onmarket based economic imperatives.•Emphasize the need for an effective enforcement mechanismin each EU membernationwith appropriate disciplinary procedures to deal with non-compliance.•Ensurethattheaccountingoversightbodyremainsindependentfromoutsideinterference.•Request adequate funding to allow the oversight body to discharge its responsibilitieseffectively.•Propose setting up a web page for the accounting oversight body to respond to on-goingissues.•Introduce measures such as seminars to convince the business community of thebenefits of adopting IFRS.4.Examples of countries that might have their own, different reasons for not permitting the useof IFRS include the United States, Mexico, and Japan. Thereasons can be summarized asfollows:United States:U.S. GAAP is considered to be better-suited (superior) for the U.S. capitalmarket environment than IFRS. Permission for U.S. companies to use IFRS would amountto lowering the quality of the standards.Mexico:Mexico’s business activities are strongly influenced by U.S. investmentand tradethrough NAFTA.For Mexican companies, it is more important to follow U.S.GAAP thanIFRSto be able toaccess the U.S. capital market.Japan:Traditionally,Japanese financial reportinghas beenbased on tax rules, and themain source of finance for businesshas beenbank credit. Cross-ownership is alsocommonamongJapanese companies. Theoutsideequity capital market has not been amajorsource of financing or a majorinfluencein developing financial reporting standards in Japan.An outside equity market-oriented set of accounting standards like IFRS might not berelevant for the Japanese environment.5.The purpose of this exercise is to encourage students to use the Internet to search forrelevant information about the various initiatives taken by the IASB from time totime.Theinformation 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 informationindependently.They can select theirhomecountry oranother countryoftheirchoice.Incompleting this exercise,students will become familiar with how a particular professionalaccounting body responds to the global trend toward convergence in financial reportingstandards.7.There are several reasons why Anglo-Saxon accounting might be of interest to Chineseaccounting regulators.First, China has expressed a commitment to adoptIFRS.To besuccessfulinadoptingIFRS,aclearunderstandingofAnglo-Saxonaccountingisnecessary,asIFRSarebasedonAnglo-Saxonaccounting.Second,Anglo-Saxonaccounting hasevolved over a long period of time in a particular socio-economic and

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Chapter03-International Convergenceof Financial Reporting3-9political environment, focused on capitalism, whereas in China, the focus has been oncommunism.Adopting capitalistmeasuresinacommunistenvironmentisamajorchallenge for the Chinese regulators. Translating some of the fundamental concepts ofAnglo-Saxon accounting, such as true and fair view, intotheChinese language would beanother challenge. Further, the main purpose of Anglo-Saxon accounting is to facilitatetheefficient working of the capital market, which is self-regulated.8.Honda Company raises a large proportion of its funding from overseas markets, particularlyfrom the United States. The Company’s shares are listed on the New YorkStock Exchange.As a condition of listing, itmustsubmit a set of annual financial statements based on USGAAP. As the U.S. financial reporting standards are generally considered to be of highquality, financial statements prepared by using them are also accepted in other overseasstock exchanges. IfHonda Company used IFRS in preparing its consolidated financialstatementsthen it would have to submit a separate reconciliation to the U.S. SEC. So, thecompany’s desire to access the U.S. market easily could be the possible reason forpreparing 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 differentpieces of information can be extracted from different sources and usedto address a givenissueconcerning international harmonization of accounting standards.For this exercise,students needto log on to the NYSE website atwww.nyse.com, anddeterminethe countryorigins of foreign companieslisted on the exchange.Students might find the IASPLUSwebsite (www.iasplus.com) to be a useful source of information to solve part b. of thisexercise.10. The ultimate objective of the efforts at setting global standards for accounting and financialreporting is to make corporate financial reports comparable, regardlessof their geographicalorigin. However, setting global standards alone is not sufficient to achieve this objective.Some commentators argued that the rules-based approach to setting accounting standardswas responsible for the accounting scandals in the U.S.However, the Parmalat scandal inItaly showed that this was not necessarily correct, and that scandals can happen anywhere,because thereasons are much more complicated than just the nature of the accountingstandards used. The lesson referred to in theFinancial Timesstatement is that effectiveenforcement is equally important as the type of regulation or accounting standard used, andthat enforcement effectiveness is influenced byfactorssuchas the availability of adequateresources for the enforcement agencies, and their levelofindependence from politicalinterference.11.The purpose of this exercise is to encourage students to look beyond the text book tosearch for the relevant material. The chapter provides the structure for this exercise.Whatis required is to expand on the material that is already in the textbook.

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Chapter03-International Convergenceof Financial Reporting3-1012.The IASB’s main objective is to develop a set ofHigh quality standards for financialreporting by companies at international level. Towards achieving this objective, the IASBhas taken several initiatives including consulting with the professional accounting bodies indifferent countries, and launching a convergence project. However, there seems to be anumber of challenges in this process. First, different countries seem to have different viewsonwhatshouldbetheprimarypurposeoffinancialstatements.Second,fairvalueaccounting is not universally acceptable. Third, there is great deal of variability in theeffectivenessofenforcementofIFRSindifferentcountries.Fourth,takingpropercognizance of the fundamentally different ways in which business is conducted in differentcountries seems to be almost impossible. Fifth, there is an ongoing debate concerning theeffectiveness of mandating high quality accounting standards in unsuitable contexts withinadequate institutional infrastructures.13.In accordance withIFRS 1,First Time Adoption ofIFRS,thefollowing steps must be takenby the fixed assets accounting department manager in preparing IFRS-based financialstatements.•Identify the IFRS effective as of December 31, 2007 that are relevant in accounting forfixed assets.•Determine the amounts related to fixed assets that will appear on the January 1, 2006IFRS opening balance sheetbased on IFRS in effect at December 31, 2007.•Preparation of theIFRS opening balance sheetwill require:•Determining whether any costsexpensedunder previous GAAP should have beencapitalized as a fixed asset under IFRS and, conversely, whether any costscapitalizedas a fixed asset under previous GAAP should have been expensed under IFRS.If so,make necessary adjustments.•Determiningwhether any assetsclassifiedas a fixed asset under previous GAAP wouldnot 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 timeadopters of IFRS.15.In November 2007, the SEC removed the requirement that foreign issuers using IFRSreconcilethefinancialstatementstoUSGAAPforseveralreasons.First,theSECrecognized that IFRS is of high quality and is capable of ensuring adequate disclosures forthe protection of investors and the promotion of efficient markets. Second, the adoption ofIFRS by the European Union in 2005 had not caused any market disruption or loss ofinvestorconfidence.Third,manyUScompanieshadalreadyinvestedinEuropeancompanies which reported under IFRS, and they had been satisfied that IFRS was of highquality.16.Recently, IASB chairman Hans Hoogervoorst suggested that the IASB would no longer seekto converge with the US GAAP. The reason for this change of direction would probably bethe view that unlike before, under the current circumstances the risk of going alone would beminimal. Currently, as there are about 120 countries which have either adopted or permittedtheuse of IFRS, IASB has reached a critical mass. It needs tolisten to the concerns ofthese diverse set of countries. Pursuing convergence with the US GAAP at the expense ofignoring concerns raised by this growing constituency was becoming an increasingly costlyexercise.

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Chapter03-International Convergenceof Financial Reporting3-11However, given the importance of the U.S. as the major capital market of the world, thiswould not be unproblematic. Further, as a consequence of this change, two or more sets ofslightly different standardsare likely to co-exist in future,Case 3-1: Jardine Matheson GroupAs required byIAS 1,Jardine presents a consolidated income statement (profit and lossaccount), balance sheet, cash flow statement, and statement of changes in equity in its annualreport.Presentation of Profit and Loss AccountJardine uses the “function of expenses” format in its income statement as allowed byIAS 1.The company does present the minimum items required as shown in the illustrative IFRSincome statement in Exhibit3-3.Presentation of Balance SheetJardine does classify assets and liabilities as current and non-current as required by IAS 1. Theformat used by Jardine is considerably different from the illustrative IFRS balance sheet inExhibit3-4, but the minimum items required byIAS 1are presented, with the possible exceptionthat Jardine does not separate “retained earnings” from “other reserves,” but instead combinesthese in the line item “revenue and other reserves.”There are considerable terminologydifferences such as:IAS 1JardineMathesonProperty, plant and equipmentTangible assetsInventoriesStocks and work in progressCash and cash equivalentsBank balance and other liquid fundsTrade and other payablesCreditors and accrualsRetained earningsRevenue and other reserves

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Chapter 04-International Financial Reporting Standards: Part I4-1CHAPTER4INTERNATIONAL FINANCIAL REPORTING STANDARDS:PART IChapter OutlineI.The International Accounting Standards Board (IASB) had28International AccountingStandards (IAS) and13International Financial Reporting Standards (IFRS) in forcein2013.A.In 2002, the IASB and U.S. Financial Accounting Standards Board (FASB) agreed towork together to reduce differences betweenIFRSand U.S. GAAP.II.There are several types of differences between IFRS and U.S. GAAP.A.Definition differences.Differences in definitionscan occureven though concepts aresimilar.Definitiondifferencescanleadtodifferencesinrecognitionand/ormeasurement.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 isrecognized (timing difference).C.Measurementdifferences.Differencesinapproachfordeterminingtheamountrecognized resulting from either (a) a difference in the method required, or (b) adifference in the detailed guidance for applying a similar method.D.Alternatives.One set of standards allows a choice between two or more alternativemethods; the other set of standards requires one specific method to be used.E.Lack of requirements or guidance.IFRSdo not cover an issue addressed by U.S.GAAP, and vice versa.F.Presentation differences.Differences in the presentation of items in the financialstatements.G.Disclosure differences.Differences in information presented in the notes to financialstatements related to (a) whether a disclosure is required and/or (b) the manner inwhich a disclosure is required to be made.III.A variety of differences exist betweenIFRSand U.S. GAAP with respect to the recognitionand measurement of assets.A.Inventory–IFRSrequire inventory to be reported on the balance sheet at the lower ofcost 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 profitmargin as the floor. U.S. GAAP allows the use of LIFO;IFRSdo not.B.Property, plant and equipment–subsequent to acquisition,IFRSallow fixed assets tobe reported on the balance sheet using a cost model (historical cost less accumulateddepreciation and impairment losses) or a revaluation model (fair value at the balancesheetdatelessaccumulateddepreciationandimpairmentlosses);U.S.GAAPrequires the use of the cost model.Component depreciation must be applied underIFRS 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 I4-2C.Impairment of assets–an asset is impaired underIFRSwhen its carrying amountexceeds its recoverable amount, which is the greater of net selling price and value inuse. Value in use is calculated as the present value of future cash flows expected fromcontinued use of the asset and from its disposal. An asset is impaired under U.S.GAAP when its carrying amount exceeds theundiscountedfuture cash flows expectedfrom the asset’s continued use and disposal.1.Measurementofimpairmentloss–theimpairmentlossunderIFRSisthedifference 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, therecoverable amount of an asset is determined to exceed its new carrying amount,IFRSrequire the original impairment loss to be reversed; U.S. GAAP does notallow the reversal of a previously recognized impairment loss.D.Development costs–when certain criteria are met,IFRSrequire development costs tobe capitalized as an asset and then amortized over their useful life; U.S. GAAPrequires development costs to be expensed as incurred.An exception exists in U.S.GAAP for software development costs.E.Borrowingcosts–similartoU.S.GAAP,IFRSrequiresborrowingcoststobecapitalizedtotheextenttheyareattributabletotheacquisition,construction,orproduction of a qualifying asset.Other borrowing costs are expensed as incurred.However, the amount of borrowing costs to be capitalized differs between IFRS andU.S. GAAP.F.Leases–under standards in effect at the time this book went to pressbothIFRSandU.S. GAAPdistinguishedbetween operating and finance (capitalized) leases.U.S.GAAP provides “bright line” tests to determine when a lease must be capitalized;IFRSdo not.Note: In 2013, the IASB and FASB jointly issued a revised Exposure Draft thatwouldsubstantiallyconvergetheaccountingforleases.TheEDprovidesnoinformation 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 insome cases requirements differ from U.S. GAAP.A.In thestatement ofcash flows,IAS 7allows interestand dividends received tobeclassified as operatingorinvesting, whereasthese arealwaysclassified as operatingunder U.S. GAAP.IAS 7 allows interest and dividends paid to be classified asoperatingorfinancing,whereasinterestpaidisoperatinganddividendspaidisfinancing under U.S. GAAP.B.IAS 10requires financial statements to be adjusted for so-called adjusting events thatoccur 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 beissued as the cutoff date for adjusting events.C.IAS 8establishes a hierarchy of authoritative pronouncements to be considered inselecting an accounting policy.The lowest level in the hierarchy would allow the use ofU.S.GAAP.Once selected, accounting policies must be applied consistently unless achange is required by IFRS or would result in more relevant information being reportedin the financial statements.D.IFRS 5provides a more liberal definition of what qualifies as a discontinued operationthan does U.S. GAAP.E.IAS 34requires interim periods to be treated as discrete accounting periods, whereasU.S. GAAP treats interim periods as an integral part of the full year.

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