Revsine/Collins/Johnson/Mittelstaedt: Chapter 18 Overview of International Financial Reporting Differences and Inflation Revsine/Collins/Johnson/Mittelstaedt: Chapter 18 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, All Rights Reserved.

Learning objectives Why financial reporting philosophies and detailed GAAP procedures have differed across countries in the past. How globalization has relaxed cross-border barriers and prompted convergence of reporting standards across countries. Why the International Accounting Standards Board (IASB) has become important. Efforts by the FASB and IASB to converge their respective standards and facilitate cross-border securities transactions. How to cope with reporting differences that persist.

Learning objectives: Concluded SEC actions to ease rules for foreign registrants using IFRS. That companies in foreign countries with high inflation rates depart from the historical cost reporting model. The two major approaches for adjusting financial reports for changing prices—current cost accounting and general price level accounting.

Overview: Growth in cross-border securities transactions

Overview: Why international accounting is important U.S. companies do not dominate the global economy. The growth in global investing has been fueled by several factors: Relaxed security market regulatory rules have made it easier for foreign firms to meet listing requirements. Improvements in telecommunications and computer technology have given investors access to information on a global scale. Investors understand that portfolios based on a global investment strategy are less risky than are those composed exclusively of domestic companies.

International Financial Reporting: The IASC and the IASB Formed in 1973. Included professional accounting organizations in 10 countries. International Accounting Standards Committee (IASC) Establishes high quality, understandable and enforceable global accounting standards. Works to achieve convergence throughout the world. Includes more than 121 countries. Has issued 41 International Financial Reporting Standards (IFRS). International Accounting Standards Board (IASB)

International Financial Reporting: U.S. GAAP vs. IFRS Compared to U.S. GAAP, IASB standards allow firms more latitude. IFRS often permit different accounting treatments for similar economic events. IFRS frequently follow a more “broad brush” approach than does U.S. GAAP. Existing differences between U.S. GAAP and IFRS will be narrowed in the future. Benchmark treatment Allowed treatment Preferred May be used

International Financial Reporting: Some difference between U. S International Financial Reporting: Some difference between U.S. GAAP and IFRS U.S. GAAP IFRS Long-lived assets Historical cost minus depreciation and impairment loss Permits upward revaluation when replacement cost is above original cost Reversal of impairment losses Prohibited Permitted Joint ventures Equity method when ownership is not more than 50% Proportionate consolidation Research & development Expensed as incurred Separate rules for “research” phase and “development” phase Capitalized interest Requires capitalization in certain instances Benchmark treatment is to expense all interest

International Financial Reporting: Monitoring compliance Not only do financial reporting rules differ across countries, but also do the mechanisms for monitoring compliance with those rules. Different countries have different structures for determining whether the stated principles are actually being followed. External auditor Securities commission Accounting court Competence Independence SEC can challenge financial reports Adequate staff and budget remains an issue Enterprise chartered in the Netherlands

Specific price-change Inflation accounting Inflation—a decline in the purchasing power of a country’s currency—complicates the analysis of international financial reports. Financial reporting standards in countries with high rates of inflation (e.g., Mexico) mandate some form of inflation accounting for both tax and financial statement reporting. Two forms of inflation accounting are required by Mexican GAAP: Rate of price change for specific items like electronic components, coffee beans, or natural gas. Current cost accounting approach. Specific price-change adjustments General price-level adjustments General rate of inflation for the economy as a whole. General price-level accounting approach

Inflation accounting: Current cost approach Current cost refers to the market price that an individual firm would have to pay in order to replace the specific assets it owns. Current cost accounting is designed to accomplish two things: Reflect all nonmonetary assets (inventory, buildings, and equipment) at their current replacement cost as of the balance sheet date. Differentiate between: (a) current cost income from continuing operations, and (b) increases or decreases in current cost amounts (holding gains or losses).

Inflation accounting: General price-level accounting The real amount of goods and services that can be acquired at any moment is what determines the purchasing power of a currency like the U.S. dollar. General price-level accounting measures changes in purchasing power using a price index for a broad market basket of goods and services. Current cost accounting Purchasing powers changes linked to special nonmonetary assets (e.g. computer chips inventory). General price-level accounting Purchasing powers changes linked to general price index and broad market basket.

Summary The financial reporting rules in some countries like the United States, Canada, and the United Kingdom strive to reflect firms’ underlying economic performance. But reporting rules in many other countries—Germany, France, and Japan—merely complied with taxation or other statutory requirements. “Globalization” forced many countries using a commercial or tax law approach to seek foreign capital, and to move toward an economic performance approach to reporting. International reporting differences have narrowed, but differences still exist.

Summary concluded Various mechanisms for coping with cross-border reporting diversity have evolved—reconciliation to host country GAAP, required use of IASB standards, and so on. Mechanisms for monitoring compliance with GAAP also differ significantly from one country to another—both in terms of the form of monitoring and in its effectiveness. When inflation is a serious problem, historical cost accounting becomes less meaningful and inflation accounting is used. Current cost accounting measures changes in specific purchasing power. By contrast, general price-level accounting strives to reflect overall, average changes in purchasing power.