Solution Manual For International Accounting, 4th Edition
Solution Manual For International Accounting, 4th Edition is the ultimate guide for understanding and solving textbook problems.
Scarlett Anderson
Contributor
4.9
161
about 2 months ago
Preview (31 of 309)
Sign in to access the full document!
Chapter 01 - Introduction to International Accounting
1-1
CHAPTER 1
INTRODUCTION TO INTERNATIONAL ACCOUNTING
Chapter 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 accounting issues encountered by companies involved in international
trade.
A. One issue is the accounting 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 accounting 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 accounting 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-step process: (1) restate foreign
GAAP financial statements into parent company GAAP and (2) translate 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.
1-1
CHAPTER 1
INTRODUCTION TO INTERNATIONAL ACCOUNTING
Chapter 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 accounting issues encountered by companies involved in international
trade.
A. One issue is the accounting 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 accounting 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 accounting 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-step process: (1) restate foreign
GAAP financial statements into parent company GAAP and (2) translate 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.
Chapter 01 - Introduction to International Accounting
1-1
CHAPTER 1
INTRODUCTION TO INTERNATIONAL ACCOUNTING
Chapter 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 accounting issues encountered by companies involved in international
trade.
A. One issue is the accounting 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 accounting 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 accounting 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-step process: (1) restate foreign
GAAP financial statements into parent company GAAP and (2) translate 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.
1-1
CHAPTER 1
INTRODUCTION TO INTERNATIONAL ACCOUNTING
Chapter 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 accounting issues encountered by companies involved in international
trade.
A. One issue is the accounting 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 accounting 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 accounting 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-step process: (1) restate foreign
GAAP financial statements into parent company GAAP and (2) translate 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.
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.
IV. 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.
VI. The world economy is becoming increasingly more integrated. International trade (imports
and exports) has grown substantially in recent years and has become a normal part of
business for relatively small companies. The number of U.S. exporting companies more
than doubled in the 1990s.
VII. 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.
VIII. There are more than 82,000 multinational companies in the world in 2009 with 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 2011 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.
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.
IV. 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.
VI. The world economy is becoming increasingly more integrated. International trade (imports
and exports) has grown substantially in recent years and has become a normal part of
business for relatively small companies. The number of U.S. exporting companies more
than doubled in the 1990s.
VII. 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.
VIII. There are more than 82,000 multinational companies in the world in 2009 with 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 2011 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.
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.
IV. 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.
VI. The world economy is becoming increasingly more integrated. International trade (imports
and exports) has grown substantially in recent years and has become a normal part of
business for relatively small companies. The number of U.S. exporting companies more
than doubled in the 1990s.
VII. 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.
VIII. There are more than 82,000 multinational companies in the world in 2009 with 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 2011 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.
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.
IV. 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.
VI. The world economy is becoming increasingly more integrated. International trade (imports
and exports) has grown substantially in recent years and has become a normal part of
business for relatively small companies. The number of U.S. exporting companies more
than doubled in the 1990s.
VII. 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.
VIII. There are more than 82,000 multinational companies in the world in 2009 with 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 2011 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.
Chapter 01 - Introduction to International Accounting
1-3
Answers to Questions
1. In 2011, companies worldwide exported over $18.3 trillion worth of merchandise. Although
international trade has existed for thousands of years, recent growth in trade has been
phenomenal. Over the period 1996-2011, U.S. exports increased from $625 billion to
$1,480 billion per year, a 137% increase. During the same period, Chinese exports
increased eight-fold to $1,898 billion in 2011.
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 2011, 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.
1-3
Answers to Questions
1. In 2011, companies worldwide exported over $18.3 trillion worth of merchandise. Although
international trade has existed for thousands of years, recent growth in trade has been
phenomenal. Over the period 1996-2011, U.S. exports increased from $625 billion to
$1,480 billion per year, a 137% increase. During the same period, Chinese exports
increased eight-fold to $1,898 billion in 2011.
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 2011, 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.
Loading page 4...
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 Japanese 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.
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 Japanese 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.
Loading page 5...
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 31, 2012. The
instructor should update these answers to the current date.
a. A total of 525 non-U.S. companies representing 46 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 (157); China (82); Brazil (26); U.K. (29); 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 an Excel file containing a list of all companies
listed on the exchange on its website (www.londonstockexchange.com). In 2013, 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 31 December 2012.” The instructor should update these
answers to the current date.
a. The Excel spreadsheet lists 583 non-U.K. companies. These companies represent 65
different 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 the
LSE from Australia and Canada than from France and Germany might be:
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 31, 2012. The
instructor should update these answers to the current date.
a. A total of 525 non-U.S. companies representing 46 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 (157); China (82); Brazil (26); U.K. (29); 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 an Excel file containing a list of all companies
listed on the exchange on its website (www.londonstockexchange.com). In 2013, 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 31 December 2012.” The instructor should update these
answers to the current date.
a. The Excel spreadsheet lists 583 non-U.K. companies. These companies represent 65
different 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 the
LSE from Australia and Canada than from France and Germany might be:
Loading page 6...
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%
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%
Loading page 7...
Chapter 01 - Introduction to International Accounting
1-7
Case 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; exports 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.
• 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 performance
3. 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 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:
• Investment 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.
• Stock market risk, which is the chance that stock prices overall will decline over short or
even long periods.
• Country/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.
• Currency 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.
• Manager 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.
Investment 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:
1-7
Case 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; exports 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.
• 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 performance
3. 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 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:
• Investment 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.
• Stock market risk, which is the chance that stock prices overall will decline over short or
even long periods.
• Country/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.
• Currency 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.
• Manager 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.
Investment 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:
Loading page 8...
Chapter 01 - Introduction to International Accounting
1-8
3. The Plain Talk About International Investing box discusses the 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 (55%), Pacific (17%),
Emerging Markets (23%), North America (3.8%), and Middle East (1.3%). Other than North
America, this 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 providing
more reliable information for making investment decisions than other sectors.
1-8
3. The Plain Talk About International Investing box discusses the 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 (55%), Pacific (17%),
Emerging Markets (23%), North America (3.8%), and Middle East (1.3%). Other than North
America, this 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 providing
more reliable information for making investment decisions than other sectors.
Loading page 9...
Chapter 02 - Worldwide Accounting Diversity
2-1
CHAPTER 2
WORLDWIDE ACCOUNTING DIVERSITY
Chapter 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 influence 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 – countries 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.
III. 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.
IV. There are two major classes of accounting systems, the micro-based class and the macro-
uniform class.
A. The micro-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.
2-1
CHAPTER 2
WORLDWIDE ACCOUNTING DIVERSITY
Chapter 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 influence 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 – countries 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.
III. 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.
IV. There are two major classes of accounting systems, the micro-based class and the macro-
uniform class.
A. The micro-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.
Loading page 10...
Chapter 02 - Worldwide Accounting Diversity
2-2
B. The macro-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 another 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) in accounting reports.
C. Research results provide some support for these hypotheses, especially the hypothesis
that culture affects the level of disclosure in accounting reports.
VI. Nobes introduced 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 toward 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.
VII. 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 differences – for example, differences exist across
countries with respect to the accounting for goodwill, development costs, and leases.
2-2
B. The macro-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 another 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) in accounting reports.
C. Research results provide some support for these hypotheses, especially the hypothesis
that culture affects the level of disclosure in accounting reports.
VI. Nobes introduced 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 toward 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.
VII. 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 differences – for example, differences exist across
countries with respect to the accounting for goodwill, development costs, and leases.
Loading page 11...
Chapter 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.
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.
Loading page 12...
Chapter 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 2.10, 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.
12. 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).
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/or
c. fair value.
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 2.10, 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.
12. 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).
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/or
c. fair value.
Loading page 13...
Chapter 02 - Worldwide Accounting Diversity
2-5
Solutions to Exercises and Problems
1. a.
Callaway Sudzücker 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***
36.2% 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%
* We 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 Sudzücker, Sol Melia, or Thai Airways because
gross profit is not disclosed separately. These 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, an 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 want to forewarn students that depending upon the companies selected it
might not be possible to identify five differences for parts c. and d.
2-5
Solutions to Exercises and Problems
1. a.
Callaway Sudzücker 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***
36.2% 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%
* We 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 Sudzücker, Sol Melia, or Thai Airways because
gross profit is not disclosed separately. These 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, an 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 want to forewarn students that depending upon the companies selected it
might not be possible to identify five differences for parts c. and d.
Loading page 14...
Chapter 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.
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.
Loading page 15...
Chapter 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.
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.
Loading page 16...
Chapter 02 - Worldwide Accounting Diversity
2-8
Case 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.
2-8
Case 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.
Loading page 17...
Chapter 02 - Worldwide Accounting Diversity
2-9
Case 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 stockholders’ equity
adjustment.
2-9
Case 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 stockholders’ equity
adjustment.
Loading page 18...
Chapter 03 - International Convergence of Financial Reporting
3-1
CHAPTER 3
INTERNATIONAL CONVERGENCE
OF FINANCIAL REPORTING
Chapter 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 – international 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 Accounting 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 first 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 IASs.
3-1
CHAPTER 3
INTERNATIONAL CONVERGENCE
OF FINANCIAL REPORTING
Chapter 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 – international 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 Accounting 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 first 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 IASs.
Loading page 19...
Chapter 03 - International Convergence of 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 International 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. Seven full-time members
serve as 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 International Financial
Reporting Interpretations Committee (IFRIC), 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 Interpretations
developed by IFRIC.
F. As of March 2008, 41 IASs and 8 IFRSs had 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).
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 consolidated financial statements.
C. Require stock exchange listed companies to use IFRS in preparing consolidated
financial statements.
D. Require foreign companies listed on a domestic stock exchange to use IFRS.
E. Require domestic companies listing on a foreign 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. 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.
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 International 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. Seven full-time members
serve as 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 International Financial
Reporting Interpretations Committee (IFRIC), 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 Interpretations
developed by IFRIC.
F. As of March 2008, 41 IASs and 8 IFRSs had 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).
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 consolidated financial statements.
C. Require stock exchange listed companies to use IFRS in preparing consolidated
financial statements.
D. Require foreign companies listed on a domestic stock exchange to use IFRS.
E. Require domestic companies listing on a foreign 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. 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.
Loading page 20...
Chapter 03 - International Convergence of Financial Reporting
3-3
VIII. 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
project.
3-3
VIII. 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
project.
Loading page 21...
Chapter 03 - International Convergence of 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
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
Loading page 22...
Chapter 03 - International Convergence of 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
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
Loading page 23...
Chapter 03 - International Convergence of 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, arriving 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.
16. 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
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, arriving 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.
16. 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
Loading page 24...
Chapter 03 - International Convergence of 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.
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.
Loading page 25...
Chapter 03 - International Convergence of 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 languages 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 common
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. The
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 evolved over a long period of time in a particular socio-economic and
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 languages 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 common
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. The
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 evolved over a long period of time in a particular socio-economic and
Loading page 26...
Chapter 03 - International Convergence of 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 factors 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. What
is required is to expand on the material that is already in the textbook.
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 factors 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. What
is required is to expand on the material that is already in the textbook.
Loading page 27...
Chapter 03 - International Convergence of 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.
• Determining 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.
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.
• Determining 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.
Loading page 28...
Chapter 03 - International Convergence of 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,
Case 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
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,
Case 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
Loading page 29...
Chapter 04 - International Financial Reporting Standards: Part I
4-1
CHAPTER 4
INTERNATIONAL FINANCIAL REPORTING STANDARDS:
PART I
Chapter Outline
I. The International Accounting Standards Board (IASB) had 28 International Accounting
Standards (IAS) and 13 International Financial Reporting Standards (IFRS) in force in
2013.
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 differences 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
4-1
CHAPTER 4
INTERNATIONAL FINANCIAL REPORTING STANDARDS:
PART I
Chapter Outline
I. The International Accounting Standards Board (IASB) had 28 International Accounting
Standards (IAS) and 13 International Financial Reporting Standards (IFRS) in force in
2013.
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 differences 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
Loading page 30...
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 borrowing 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 distinguished 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 classified 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.
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 borrowing 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 distinguished 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 classified 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.
Loading page 31...
28 more pages available. Scroll down to load them.
Preview Mode
Sign in to access the full document!
100%
Study Now!
XY-Copilot AI
Unlimited Access
Secure Payment
Instant Access
24/7 Support
AI Assistant
Document Details
Subject
Accounting