Advanced Accounting, Third Edition 11 International Accounting and the Global Economy Advanced Accounting, Third Edition

Learning Objectives Describe how the changing world environment is leading to an increased focus on international accounting standards. Explain some differences in accounting methods as they are applied internationally. List five major classifications of accounting models used in different geographical regions. Describe the role of the International Accounting Standards Committee and the International Accounting Standards Board in establishing international accounting standards. 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)

Learning Objectives List the steps that a non-U.S. company must follow to list its shares on a U.S. stock market. Explain the role of form 20-F filed with the Securities and Exchange Commission. Indicate the role of American Depository Receipts in the issuing of securities of non-U.S. companies in the United States. 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)

The Increasing Importance of International Accounting Standards Beginning in 2005, the European Union (EU) mandated that accounting standards for companies listed in its securities markets conform to International Financial Reporting Standards. In 2006, the total value of cross-border transactions in bonds and equities was $90 trillion U.S. dollars annually. LO 1 Increased focus on International Accounting Standards.

Importance of International Accounting Standards FIGURE 11-1 Composition of the Global Equity and Debt Markets by Each Country’s Domestic Securities LO 1 Increased focus on International Accounting Standards.

Importance of International Accounting Standards FIGURE 11-1 Composition of the Global Equity and Debt Markets by Each Country’s Domestic Securities LO 1 Increased focus on International Accounting Standards.

Importance of International Accounting Standards FIGURE 11-2 Holdings of U.S. and Foreign Securities, 1994–2004 Market Value of Holdings of U.S. and Foreign Securities, 1994-2004 Foreign holdings of U.S. securities (1.2 to 6 trillion increase) U.S. holdings of foreign securities (870 billion to 3.5 trillion increase) LO 1 Increased focus on International Accounting Standards.

Importance of International Accounting Standards The demand for uniform international accounting standards has increased because: Investors seek comparable standards to evaluate investment opportunities, Managers seek to evaluate the performance of foreign subsidiaries and competitors, and Creditors and debt capital markets seek comparable standards to determine credit quality and bankruptcy risk. Technical Bulletins provide answers to specific questions related to the application and implementation of FASB Statement or Interpretations, APB Opinions, and ARBs. Technical Bulletins do not alter GAAP; they merely provide guidance on questions related to existing GAAP. LO 1 Increased focus on International Accounting Standards.

Harmonization of Worldwide Accounting Standards Financial accounting practices, required disclosures, and auditing requirements are not uniform across countries. Variations exist in the accounting for: Goodwill. Business combination methods. Tax allocation. LIFO inventory costing. Development costs. Use of reserves LO 1 Increased focus on International Accounting Standards.

Harmonization of Worldwide Accounting Standards The International Accounting Standards Committee (IASC) was founded in 1973. 41 standards were issued by January 2001. In 2001, the IASC announced formation of the International Accounting Standards Board (IASB). Goal is to develop high-quality internationally accepted accounting standards. Issues standards known as International Financial Reporting Standards (IFRS). To date six IFRSs have been issued. LO 1 Increased focus on International Accounting Standards.

Harmonization of Worldwide Accounting Standards Harmonization of accounting standards. The International Accounting Standards Committee (IASC) was founded in 1973. In 2002, the FASB and IASB agreed to begin converging U.S. GAAP and the IFRSs. By 2005, over 90 countries had announced they would be following IFRSs. In 2005, European Union requires publicly traded EU companies to follow IFRSs. LO 1 Increased focus on International Accounting Standards.

Comparative Accounting Models Differing accounting practices could result in the same economic event being reported differently. FIGURE 11-3 Differences in Net Income and Equity due to Differing GAAP = ROE LO 2 Differences in accounting methods.

Comparative Accounting Models Format and Terminology Differences Some non-U.S. companies prepare statements in: English still using their national GAAP. Their local currency with a column that is translated into U.S. dollars. English conforming to U.S. GAAP or the IFRS. The first step is to determine which GAAP is being used. LO 2 Differences in accounting methods.

Comparative Accounting Models Format and Terminology Differences Examples of terminology differences: LO 2 Differences in accounting methods.

Comparative Accounting Models Format and Terminology Differences Various formats are allowed in presenting financial statements in different countries. In the UK: Noncurrent assets are listed first in the balance sheets. Current assets listed second and in order of increasing liquidity (i.e., the most liquid assets are listed last). Assets and liabilities are combined to compute total net assets. LO 2 Differences in accounting methods.

Comparative Accounting Models Review: A company located in Japan prepares an annual report denominated in U.S. dollars. Any report denominated in U.S. dollars is always prepared in accordance with U.S. GAAP. Technical Bulletins provide answers to specific questions related to the application and implementation of FASB Statement or Interpretations, APB Opinions, and ARBs. Technical Bulletins do not alter GAAP; they merely provide guidance on questions related to existing GAAP. False LO 2 Differences in accounting methods.

Comparative Accounting Models Review: In the United Kingdom, stock refers to common stock. False, stock refers to inventory Technical Bulletins provide answers to specific questions related to the application and implementation of FASB Statement or Interpretations, APB Opinions, and ARBs. Technical Bulletins do not alter GAAP; they merely provide guidance on questions related to existing GAAP. LO 2 Differences in accounting methods.

Comparative Accounting Models Review: Since 2005, all European Union companies listed on a regulated market are required to prepare consolidated accounts in accordance IASB accounting standards. Technical Bulletins provide answers to specific questions related to the application and implementation of FASB Statement or Interpretations, APB Opinions, and ARBs. Technical Bulletins do not alter GAAP; they merely provide guidance on questions related to existing GAAP. True LO 2 Differences in accounting methods.

Classification of International Accounting Models Five Major Geographical Classifications: Type of Accounting Practice Region Anglo-Saxon United States Anglo-Saxon United Kingdom German Germany, Switzerland Latin France, Italy, Brazil Asia-Pacific Japan, China LO 5 Five major classifications of accounting methods.

Classification of International Accounting Models Accounting Standards in the United Kingdom Standards referred to as Financial Reporting Standards (FRS). Issued by the Accounting Standards Board (ASB). The ASB strongly supports the IASB. ASB is considering a full conversion to IFRS implementation that would require companies to comply completely by January 1, 2009. LO 5 Five major classifications of accounting methods.

Classification of International Accounting Models Accounting Standards in Germany Historically, standard setting has been the responsibility of the Federal Ministry of Justice (FMJ). In 1998, FMJ recognized a new independent body, the German Accounting Standards Board (GASB). As of 2005, preparation of financial statements according to IAS became mandatory for public companies. GASB is now relevant primarily for unlisted companies. LO 5 Five major classifications of accounting methods.

Classification of International Accounting Models Accounting Standards in Japan In February 2001, the Financial Accounting Standards Foundation (FASF) and Accounting Standards Board (ASB), were formed to develop accounting standards. Accounting Standards Board has been working with the IASB in a path toward standards convergence. It plans to reconcile these differences to IAS by 2008. LO 5 Five major classifications of accounting methods.

International Reporting Issues Treatment of Goodwill Since June 30, 2001, goodwill is only expensed if impaired under U.S. GAAP. Amortization of goodwill is required under the Japanese model, with a life of five years. Under IAS standard 38, internally generated goodwill is not capitalized.

International Reporting Issues Inventories LIFO is not acceptable under IAS. IASB recommends specific cost. If specific cost is not determinable, the benchmark is FIFO or weighted average.

International Reporting Issues Research and Development In the United States: Research and development (R&D) costs are expensed as incurred. In acquisitions, in-process R&D is recognized as an expense. IAS No. 38: Research costs are expensed as incurred. Development costs are capitalized when a product is determined to be commercially feasible. Purchased R&D costs are capitalized and amortized.

International Reporting Issues Business Combinations Purchase method required under U.S. GAAP. Purchase method required under International Accounting Standards (IAS). Pooling is not permitted in Japan and is used infrequently in other countries.

International Reporting Issues Fixed Assets and Depreciation In several countries, fixed assets are valued at depreciated historical cost (Japan and the United States). Under IAS 16, fixed assets are initially valued at cost. Subsequently, they can be valued under either the: Cost model, or the Revaluation model.

International Reporting Issues SEC Registration and U.S. Listing for Non-U.S. Companies Registration with the SEC under the 1934 Securities Act is mandatory for non-U.S. companies that intend to list on a U.S. stock market. Foreign companies are required to comply with the SEC continuous reporting requirements. U.S. companies file forms 10-K and 10-Q. Foreign companies file forms 20-F and 6-K. LO 5 U.S. listing for non-U.S. companies.

International Reporting Issues 20-F Statement The 20-F filing is similar to the 10-K filing. The 20-F allows the non-U.S. company to retain its local GAAP reporting, so long as it meets one of two alternative conditions. The firm may either reconcile net income and the shareholders’ equity, thus showing earnings based on U.S. GAAP; or fully disclose all financial information required of U.S. firms. LO 6 The role of form 20-F.

International Reporting Issues Statement F-1 First-time offer of securities by any non-U.S. company requires filing an F-1 statement as the principal registration statement. Prospectus contains: Financial statements (reconciled to U.S. GAAP). Nonfinancial information about the company.

International Reporting Issues Reconciliation to U.S. Accounting Principles The footnote reconciling GAAP between the U.S. and another country can be very informative in terms of highlighting differences in accounting between countries.

American Depository Receipts (ADRs) A Depository Receipt (DR) is a derivative instrument that usually represents a certain fixed number of publicly traded shares of a non-U.S. corporation. American Depository Receipt (ADR) – traded in the United States. Global Depository Receipt (GDR) - traded outside the United States. ADRs may trade freely like any U.S. security on one of the major exchanges.

American Depository Receipts (ADRs) Types of ADR Programs Level I: Depository banks create an ADR program based on the underlying shares that already trade on home markets. No capital raised. ADRs are not listed on U.S. markets. Trading confined to “pink sheet” market.

American Depository Receipts (ADRs) Types of ADR Programs Level II: Do not involve raising new capital. Issues are registered with the U.S. SEC and listed on a major U.S. stock exchange. Companies must file F-6 and 20-F.

American Depository Receipts (ADRs) Types of ADR Programs Rule 144A: Rule 144A ADRs are those ADRs placed privately among large institutional buyers (known as QIB firms) with restrictions on subsequent trading of these securities. Rule 144A ADRs are not publicly traded or listed on U.S. stock exchanges and can be exchanged only among QIBs.

International Reporting Issues Review Question In preparing a 20-F filing, a non-U.S. company can retain its local GAAP reporting as long as it meets certain conditions. Which of the following alternatives satisfies these conditions? The firm must reconcile net income and shareholders’ equity from the non-U.S. GAAP to U.S. GAAP. The firm must fully disclose all financial information required of U.S. firms, including segmental disclosures. The firm is allowed to retain local GAAP reporting if it meets either (a) or (b) above. The firm is allowed to retain local GAAP reporting only if it meets both (a) and (b) above.

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