Multinational Accounting

The U.S. treats foreign branches as U.S. residents for tax purposes and taxes foreign branch income currently. Foreign subsidiaries are not considered to be U.S. residents and foreign subsidiary income is taxes in the U.S. only when dividends are paid to the U.S. parent.

How are foreign branch income and foreign subsidiary income taxed differently by a company's home country?

All derivative financial instruments must be recognized as assets or liabilities on the balance sheet, measured at fair value

How are foreign currency derivatives such as forward contracts and options reported on the balance sheet?

The gains and losses arising from financial instruments used to hedge balance sheet exposure are treated in a similar manner as the item the hedge is intended to cover. If the foreign currency is the functional currency, gains and losses on hedging instruments will be taken to other comprehensive income. If the parent's reporting currency is the functional currency, gains and losses on the hedging instruments will be offset against the related remeasurement gains and losses.

How are gains and losses on foreign currency borrowings used to hedge the net investment in a foreign subsidiary reported in the consolidated financial statements?

MNCs can finance their foreign operations by making capital contributions (equity) or through loans (debt). Cash flows generated by a foreign operation can be repatriated back to the MNC either by making dividend payments (on equity financing) or interest payments (on debt financing). Countries often impose a withholding tax on dividend and interest payments made to foreigners. Withholding tax rates within a country can differ by type of payment. When this is the case, the MNC may wish to use more of one type of financing than the other because of the positive impact on cash flows back to the MNC.

How can a country's tax system affect the manner in which an operation in that country is financed by a foreign investor?

To determine the appropriate translation method under both IFRS and U.S. GAAP, the functional currency of a foreign subsidiary must be identified. The functional currency is the primary currency of the foreign entity's operating environment. It can be either the parent's reporting currency or a foreign currency (generally the local currency). The functional currency orientation results in the following rule: Functional Currency Translation Method Translation Adjustment Parent's currency Temporal method Gain (loss) in net income Foreign currency Current rate method Separate component of stockholders' equity (other comprehensive income)

How does a parent company determine the appropriate method for translating the financial statements of a foreign subsidiary?

In applying the lower of cost and market rule for inventories, AIS 2 defines market as net realizable value (NRV) and US GAAP defines market as replacement cost (with NRV as a ceiling and NRV less normal profit margin as a floor). In addition, the rule generally is applied on a item basis under AIS 2, whereas it may be applied on an item by item, group of items, or total inventory basis under U.S GAAP.

How does application of the lower of cost or market rule for inventories differ between IFRS and U.S. GAAP?

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.

How does harmonization differ from convergence?

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.

How does the relationship between financial reporting and taxation affect the manner in which income is measured for financial reporting purposes?

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".

How has the U.S. SEC policy toward IFRS changed?

One of the distinct Japanese cultural values is collectivism or group consciousness. This has directly affected the Japanese attitude towards external auditors and the audit function. Prior to the American occupation of Japan after the Second World War, there was no external auditing profession. When it was introduced in 1949, Japanese corporations often considered it as unnecessary. Because of the cultural value orientation of not trusting someone from outside the group, independent auditors had difficulty being accepted by clients.

How have cultural factors influenced accounting practices in Japan?

When an item of property, plant and equipment is comprised of significant parts that have different useful lives, such as an airplane, the asset must be split into components and each component must be depreciated separately.

How is depreciation determined for an item of property, plant, and equipment that is comprised of significant parts, such as an airplane?

Features of the accounting profession in China, which are different from those of Anglo-American countries: a. Following the revolution in 1949, the Chinese accounting profession was under bureaucratic control rather than market control. Consequently, accounting was focused on reporting compliance with state economic plans. b. Education of accountants has not been well developed in China. For example, it was particularly disrupted during the cultural revolution in the 1960-70s. c. Unlike in Anglo-American countries, accounting and auditing in China took different paths in their development processes. Traditionally, auditing firms in China mainly audited domestic companies, whereas accounting firms focused on companies using foreign investments. Further, accountants and auditors had their own rules issued by different government departments. d. There are some differences in the evolution of the accounting profession in China compared to that in Anglo-American countries. For example, in the United Kingdom, auditors enjoyed good legislation and judicial environment during the early stages of development, whereas such an environment is yet to be developed in China.

Identify three features of the Chinese accounting profession that are different from its counterparts in Anglo-American countries.

Foreign currency receivables resulting from export sales are revalued at the end of accounting periods using the current spot rate. An increase in the value of a receivable will be offset by reporting a foreign exchange gain in net income, and a decrease will be offset by a foreign exchange loss. Foreign exchange gains and losses are accrued even though they have not yet been realized.

A company makes an export sale denominated in a foreign currency and allows the customer one month to pay. Under the two-transaction perspective accrual approach, how does the company account for fluctuations in the exchange rate for the foreign currency?

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.

What accounting issues arise for a company as a result of engaging in international trade (imports/exports)?

Commercial databases tend not to include notes to financial statements, which are an important source of information about a company. They also tend to force different country formats for financial statements into a common format and thereby run the risk of misclassification and loss of information. Data entry errors are also a potential problem

What are potential problems in using commercial databases as the source of financial statement information for foreign companies?

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.

What are some of the issues that arise in evaluating and maintaining control over foreign operations?

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.

Are there any major accounting issues that have not yet been covered by IFRS?

Recent amendment to Mexico's MFRS B-10 requires corporations to include the effects of inflation in financial statements only if such inflation exceeds 26% (the combined inflation of the last three years). Inflation continues to be taken into account in the determination of taxes to be paid.

Briefly describe the current requirement for companies in Mexico to account for the effect of inflation in their annual financial statements.

IAS 27 states that control exists when the investor owns more than 50 of the stock of another company. However, control also can exist for an investor owning less than 50% of the stock of another company when the investor has power: • Over more than half of the voting rights through agreements with other shareholders, • To set the company's financial and operating policies because of existing statutes or agreements, • To appoint or remove majority of the members of the governing body (board of directors or equivalent group), or • To cast the majority of votes at meetings of the company's governing body.

Define "control". When does control exist in accordance with IAS 27?

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.

What are the potential benefits that a multinational corporation could derive from the international convergence of accounting standards?

IAS 38, states 3 major types of intangible assets are: 1) Purchased intangible assets, 2) Intangible assets acquired in a Business Combination (Goodwill is under this category) 3) Internally generated intangible assets Assets under 1) and 2) are classified as having finite or Indefinite useful life 3) can only be classified as finite-lived. Finite-lived intangibles are amortized on a systematic basis over their useful lives. All Intangibles are subject to Impairment testing. Indefinite-lived intangibles must be tested for impairment at least annually.

What are the three major types of intangible asset, and how does the accounting for them differ?

Monetary assets (cash and receivables) give rise to purchasing power losses and monetary liabilities (payables) give rise to purchasing power gains

Which balance sheet accounts give rise to purchasing power gains, and which accounts give rise to purchasing power losses?

Ford might want to include the following companies in a benchmarking study: U.S. - General Motors, Chrysler Japan - Honda, Toyota, Nissan, Subaru Germany - Daimler, BMW, Volkswagen, Audi Korea - Hyundai, Kia France - Renault, Peugeot

Which companies might Ford Motor Company include in a benchmarking study of the automobile industry, and in which countries are those companies located?

Any item of property, plant, and equipment may be accounted for under the revaluation model. However, all other items within that class of PPE must be revalued at the same time. Revaluation must occur frequently enough that the difference between the revalued assets' carrying amount and fair values is not material.

Which items of property, plant, and equipment may be accounted for under the revaluation model, and how frequently must revaluation occur?

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.

Who are the major providers capital (financing) for business enterprises? What influence does the relative importance of equity financing in a country have on financial statement disclosure?

In Germany, tax law has a strong influence on accounting and financial reporting. The reason for this link between taxation and financial reporting is historical. When corporate income taxation was introduced in Germany in 1874, the requirement for annual accounting had already been codified in the Commercial Code in 1862. It was convenient to link corporate income taxation to existing financial statements.

Why does the tax law have a strong influence on German accounting?

Nearly 120 countries have either adopted or allowed the use of IFRS

To what extent has IFRS been adopted around the world?

U.S. companies are allowed either to (1) deduct all foreign taxes paid or (2) take a credit for foreign income taxes paid. "Income" taxes include both income taxes and withholding taxes, but would exclude sales, excise, and other types of taxes not based on income. If taxes other than income taxes are substantial, it is more advantageous for a company to take a tax deduction for all foreign taxes paid rather than a tax deduction for income taxes only.

Under what circumstances is it advantageous to take a deduction rather than a credit for taxes paid in a foreign country?

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.

Were the EU directives effective in generating comparability of financial statements across companies located in member nations? Why or Why not?

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?

A condensed income statement for Acme Brush of Brazil for the most recent year shows: In BRL Sales BRL 10,000 Exp 9,500 PTxInc BRL 500 After translation into US dollars: Sales 3,000 Exp 3,300 PTxInc (300) a. Explain how Brazil's income became a pretax loss in US Dollars b. Discuss whether Cooper Grant should be paid a bonus or not

If an analyst is unable to read a company's annual report, they will be less likely to feel that they have sufficient information to make an informed investment decision. This would be analogous to making an internet purchase of an electronic product manufactured by a company with which you are unfamiliar and the only description of the product is in a language you do not read

A foreign company prepares its financial statements in a foreign language and does not provide any convenience translations. How might this affect an analyst's decision to invest in this company?

IFRS 8 defines an operating segment as a component of a company that (a) engages in activities from which it earns revenues and incurs expenses, (b) is regularly reviewed by the chief operating decision maker to assess performance and make resource allocation decisions, and (c) for which discrete financial information available. An operating segment is a reportable segment if it meets any one of the following three significance tests: • Revenue test. Segment revenues, both external and intersegment, are 10% or more of the combined revenue, internal and external, of all segments. • Profit or loss test. Segment result (profit or loss) is 10% or more of the greater (in absolute value terms) of the combined profit of segments with a profit or combined loss of segments with a loss. • Asset test. Segment assets are 10% or more of the combined assets of all segments. If total external revenue attributable to reportable segments constitutes less than 75% of the total consolidated revenue, additional segments should be reported even if they do not meet the 10% threshold. All segments that are neither separately reported nor combined should be included in the segment reporting disclosures as an unallocated reconciliation item or in an "all other" category.

In accordance with IFRS 8, how does a company determine which operating segments to report separately?

A unique feature in the development of accounting and auditing in China is that, unlike in many other countries, until recently (1998), these two areas developed as two rival disciplines competing with each other, supported by two separate government agencies.

In what way has the development of accounting and auditing in China differed from that of other countries?

A provision is a Liability of uncertain timing or amount. It must be recognized when a) there is a present obligation, b) an outflow of resources to settle the obligation is probable, and c) the obligation can reliably estimated.

What is a provision, and when must a provision be recognized?

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

What are the different ways IFRS might be used within a country?

There are three main external factors that have influenced financial reporting in Mexico in recent years. First, NAFTA required Mexico, among other things, to remove barriers to trade with partner countries (the U.S. and Canada). One of the barriers was the use of incompatible financial reporting standards by Mexican companies. Second, the IMF/U.S. Treasury bail-out plan in the mid-1990s after the "Tequila" crisis also included specific requirements concerning information disclosure by Mexican companies. Finally, the efforts of the IASB as global standard setter have also influenced financial reporting by Mexican companies.

What are the main external factors that have influenced Mexican financial reporting in recent years?

There are two main external factors that have influenced financial reporting in Germany in recent years. They are, EU Directives and the forces of globalization. The 1985 Accounting Act implemented the Fourth, Seventh, and Eighth Directives and transformed them into German Commercial Law. The EU's decision to adopt IFRS from January 1 2005, was in recognition of the global trends in financial reporting. Even before the EU's decision, large German companies like Daimler-Chrysler that had their shares listed on foreign stock exchanges were already using internally acceptable accounting standards.

What are the main external factors that have influenced financial reporting in Germany in recent years?

The pressures arise from the need to change from an accounting system designed to provide information to government for planning purposes to a system that is capable of providing useful information for economic decision making. China has expressed a commitment to adopt IFRS. This is particularly important to China because of the requirement under WTO membership and the need to attract foreign investment. The ultimate objective of accounting regulation is to achieve a high level of compliance with the mandated reporting standards. This requires an adequate number of professionals who are willing and able to implement the standards. However, the accounting profession in China is still at the early stage of development, and a lack of skilled professionals will create problems for regulators. IFRS are based on western cultural values. Some of the concepts that are fundamental to IFRS, such as true and fair view or fair presentation and transparency, may not be clearly understood by Chinese accountants.

What are the main pressures for accounting regulation in modern China?

For foreign entities that report in the currency of a hyperinflationary economy, IAS 21 requires the parent first to restate the foreign financial statements for inflation using IAS 29 rules and then translate the statements into parent company currency using the current rate method. U.S. GAAP, on the other hand, requires financial statements of such foreign entities to be translated using the temporal method. U.S. GAAP specifically defines hyperinflation as cumulative three-year inflation greater than 100%. IAS 29 provides no specific definition for hyperinflation, but suggests that a cumulative three-year inflation rate approaching or exceeding 100% is evidence that an economy is hyperinflationary

What are the major differences between IFRS and U.S. GAAP in the translation of foreign currency financial statements?

Only three substantive differences exist in the segment reporting required by IFRS and U.S. GAAP: a. IFRS requires the disclosure of operating segment liabilities, and U.S. GAAP does not. b. For geographic areas, U.S. GAAP requires disclosure of "long-lived assets," which many companies interpret as fixed assets only. IFRS requires disclosure of "non-current assets," which specifically includes intangibles. c. Companies with a matrix form of organization may identify operating segments either by products and services or geographic areas under IFRS. U.S. GAAP requires segments to be defined on the basis of products and services in this situation.

What are the major differences in the segment information required to be reported in accordance twith IFRS and in accordance with U.S. GAAP?

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.

What are the major problems caused by worldwide accounting diversity for a multinational corporation?

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.

What are the major problems caused by worldwide accounting diversity for international portfolio investment?

Three mechanisms that countries can use to provide companies relief from double taxation are: • exempt foreign source income from taxation, in effect, adopt a territorial approach, • allow the parent company to deduct the taxes paid to the foreign government from its taxable income, and • provide the parent company with a credit for taxes paid to the foreign government

What are the mechanisms used by countries to provide relief from double taxation?

The two major issues related to the translation of foreign currency financial statements are: (a) which method should be used and (b) where should the resulting translation adjustment be reported in the consolidated financial statements. The first issue relates to determining the appropriate exchange rate (historical, current, or average for the current period) for the translation of foreign currency balances. Those items translated at the current exchange rate are exposed to translation adjustment. The second issue relates to whether the translation adjustment should be treated as a gain or loss in income, or should be deferred as a separate component of stockholders' equity.

What are the two major conceptual issues that must be resolved in translating foreign currency financial statements?

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.

What are the two major types of legal systems used in the world? How does the type of legal system affect accounting?

The two models allowed by AIS 16 are the cost model and the revaluation model. Under the revaluation model, property, plant, and equipment is reported on the Balance Sheet at a revalued amount, measured as fair value at the date of remeasurement, less accumulated depreciation and any accumulated impairment losses

What are the two models allowed for measuring property, plant, and equipment at dates subsequent to original acquisition?

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."

What are the two most common methods used internationally for the order in which assets are listed on the balance sheet? Which of these methods is used in North America? In Europe?

The functional currency is the currency of the subsidiary's primary economic environment. It is usually identified as the currency in which the company generates and expends cash. U.S. GAAP stipulates that several factors such as the location of primary sales markets, sources of materials and labor, the source of financing, and the amount of intercompany transactions should be evaluated in identifying an entity's functional currency. U.S. GAAP does not provide any guidance as to how these factors are to be weighted (equally or otherwise) when identifying an entity's functional currency. IAS 21 also provides factors to be considered in determining the functional currency of a foreign subsidiary. Unlike U.S. GAAP, IAS 21 provides a hierarchy of factors to consider. Two primary factors are first to be considered. If evaluation of these primary factors does not clearly indicate a foreign subsidiary's functional currency, then a group of six secondary factors should be considered.

What does the term "functional currency" mean? How is the functional currency determined under IFRS and under U.S. GAAP?

Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid potential losses from fluctuations in exchange rates. In addition to avoiding possible losses, companies hedge foreign currency transactions and commitments so as to introduce an element of certainty into the future cash flows resulting from foreign currency activities. Hedging involves establishing a price today at which foreign currency can be sold or purchased at a future date

What does the word hedging mean? Why do companies hedge foreign exchange risk?

Balance sheet exposure arises when a foreign currency balance is translated at the current exchange rate. By translating at the current exchange rate, the foreign currency item in essence is being revalued in U.S. dollar terms on the consolidated financial statements. There will be either a net asset balance sheet exposure or net liability balance sheet exposure depending upon whether assets translated at the current rate are greater or less than liabilities translated at the current rate. Balance sheet exposure generates a translation adjustment, which does not result in an inflow or outflow of cash. Transaction exposure, which results from the receipt or payment of foreign currency, generates foreign exchange gains and losses that are realized in cash.

What factors create a balance sheet (or translation) exposure to foreign exchange risk? How does balance sheet exposure compare with transaction exposure?

Foreign exchange gains and losses are created by two factors: having foreign currency exposures (foreign currency receivables and payables) and changes in exchange rates. Appreciation of the foreign currency will generate foreign exchange gains on receivables and foreign exchange losses on payables. Depreciation of the foreign currency will generate foreign exchange losses on receivables and foreign exchange gains on payables.

What factors create a foreign exchange gain on a foreign currency transaction? What facgtors create a foreign exchange loss?

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.

What financial reporting issues arise as a result of making a foreign direct investment?

Membership in the EU has had a profound effect on accounting regulation in the U.K. The U.K. pioneered private-sector regulation of accounting where legislation provides broad principles and the accounting profession determines specific rules for financial reporting. However, this approach was changed with the 1981 amendments to the U.K. Companies act that introduced the EU Fourth Directive. These amendments were prescriptive in that they stated exactly how certain matters should be treated, such as the format of financial statements. Another significant change was introduced in the 1989 Companies Act, which for the first time referred to accounting standards. It requires that companies must state whether the financial statements have been prepared in accordance with applicable accounting standards.

What has been the impact of EU membership on accounting regulation in the United Kingdom?

A Contingent Liability is a possible obligation or a present obligation that is not recognized as a provision because a) an outflow or resources to settle the obligation is not probable or b) the obligation cannot be reliably estimated. Contingent Liability are disclosed unless the likelihood of an outflow of resources is remote.

What is a contingent liability? What is the financial reporting treatment for contingent liabilities?

Tax havens are tax jurisdictions with abnormally low corporate income tax rates or no corporate income tax at all. Tax havens include the Bahamas, which has no corporate income tax, and Liechtenstein, which has tax rates ranging from 7.5% - 15%. A company involved in international business might establish an operation in a tax haven to avoid paying taxes in one or more countries in which the company operates. For example, assume a Spanish company manufactures a product for $70 per unit that it exports to a customer in Mexico at a sales price of $100 per unit. The $30 of profit earned on each unit is subject to the Spanish corporate tax rate of 30%. The Spanish manufacturer could take advantage of the fact that there is no corporate income tax in the Bahamas by establishing a sales subsidiary there that it uses as a conduit for export sales. The Spanish parent company would then sell product to its Bahamian sales subsidiary at a price of, say, $80 per unit, and the Bahamian sales subsidiary would turn around and sell the product to the customer in Mexico at $100 per unit. In this way, only $10 of the total profit is earned in Spain and subject to Spanish income tax; $20 of the $30 total profit is recorded in the Bahamas upon which no income tax is paid.

What is a tax haven? How might a company use a tax haven to reduce income taxes?

An important contribution that Mexican accounting has made to international accounting is in the treatment of the effects of inflation for accounting purposes by using General Price-level Accounting. The introduction of the "integral cost of financing" as an income statement item was particularly innovative. This is the net result of three different costs: nominal interest expense, the gain or loss due to price level changes on the net monetary position, and foreign exchange gains and losses on monetary assets and liabilities denominated in foreign currencies arising from variations in exchange rates.

What is an important contribution that Mexican accounting has made to international accounting?

Hedge accounting is defined as recognition of gains and losses on the hedging instrument in the same period as the recognition of gains and losses on the underlying hedged asset or liability (or firm commitment

What is hedge accounting?

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 IFRS. Traditionally, the U.K. and the member countries of the British Commonwealth have adopted this approach.

What is the IASB's principle-based approach to accounting standard setting?

The Professional Mutual Recognition Agreement (PMRA) signed by NAFTA participants (United States, Canada and Mexico) in September 2002 allows accountants in one participant country to practice in another participant country. For example, the Mexican CPCs are allowed to practice accounting in the United States subject to passing examinations on national legislation and standards. The implementation of NAFTA - PMRA is an example of converging national licensing requirements into an international framework

What is the Professional Mutual Recognition Agreement (PMRA) signed by NAFTA participants in September 2002?

Under the two-transaction perspective, an export sale (import purchase) and the subsequent collection (payment) of cash are treated as two separate transactions to be accounted for separately. The idea is that management has made two decisions: (1) to make the export sale, and (2) to extend credit in foreign currency to the foreign customer. The income effect from each of these decisions should be reported separately.

What is the concept underlying the two-transaction perspective to accounting for foreign currency transactions?

Under the worldwide approach to taxation, all income of a resident of a country or a company incorporated in a country is taxed by that country regardless of where the income is earned. In other words, foreign source income is taxed by the country of residence. Under the territorial approach, only the income earned within the borders of the country (domestic source income) is taxed

What is the difference between the worldwide and territorial approaches to taxation?

The maximum amount of foreign tax credit a U.S. company will be allowed to take related to income earned by a foreign operation is the lesser of the amount of actual taxes paid to the foreign government or the amount of U.S. income tax that would have been if the income had been earned in the United States.

What is the maximum amount of foreign tax credit that a company will be allowed to take with respect to the income earned by a foreign operation?

The significance of Bulletin A-8 is that it requires Mexican companies to apply international accounting standards for issues that are not covered by Mexican GAAP

What is the significance of Buletin A-8 of the Mexican Institute of Public Accountants?

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.

What taxation issues arise as a result of making a foreign direct investment?

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

What were the three phases on the life of IASC?

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

What would be the advantages of having a single set of accounting standards used worldwide?

Historical cost accounting causes assets to be significantly understated in a country experiencing high inflation. Understated assets, such as inventory and fixed assets, leads to understated expenses, such as cost of goods sold and depreciation, which in turn leads to overstated income and stockholders' equity. Understated asset values can have a negative impact on a company's ability to borrow because the collateral is understated. Understated asset values also can be an invitation for a hostile takeover to the extent that the current market price of a company's stock does not reflect the current value of assets. Overstated income results in more taxes being paid to the government than would otherwise be paid, and could lead to stockholders demanding a higher level of dividend than would otherwise be expected. Through the payment of taxes on inflated income and the payment of dividends out of inflated net income, both of which result in cash outflows, a company may find itself in a liquidity crisis. To the extent that companies are exposed to different rates of inflation, the understatement of assets and overstatement of income will differ across companies; this can distort comparisons across companies. For example, a company with older fixed assets will report a higher return on assets than a company with newer assets because income is more overstated and assets are more understated than for the comparison company. Because inflation rates tend to vary across countries, comparisons made by a parent company across its subsidiaries located in different countries can be distorted

Why is it important that,in countries with high inflation, financial statements be adjusted for inflation?

The principle of prudence is firmly established in the German law mainly because of the heavy losses suffered by creditors of German companies during the Great Depression in the late 1920s and early 1930s. The accounting system at the time allowed companies to revalue assets as they wished, and was blamed for the losses as it failed to protect the creditors from becoming victims of companies, which adopted highly optimistic methods to value their assets. The objective of establishing the principle of prudence in the 1937 Stock Corporations Law was to ensure that the events of the 1920s and 1930s would not happen again. This is reflected in the strict adherence to the use of historical cost for measuring asset values.

Why is the principle of prudence clearly established in the German law?

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

Why might a company be interested in investing overseas (foreign direct investment)?

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.

Why might a company want its stock listed outside its home country?

Although balance sheet exposure does not result in cash inflows and outflows, it does nevertheless affect amounts reported in consolidated financial statements. If the foreign currency is the functional currency, translation adjustments will be reported in stockholders' equity. If translation adjustments are negative and therefore reduce total stockholders' equity, there is an adverse (inflationary) impact on the debt to equity ratio. Companies with restrictive debt covenants requiring them to stay below a maximum debt to equity ratio, may find it necessary to hedge their balance sheet exposure so as to avoid negative translation adjustments being reported. If the U.S. dollar is the functional currency or an operation is located in a high inflation country, remeasurement gains and losses are reported in income. Companies might want to hedge their balance sheet exposure in this situation to avoid the adverse impact remeasurement losses can have on consolidated income and earnings per share. The paradox in hedging balance sheet exposure is that, by agreeing to receive or deliver foreign currency in the future under a forward contract, a transaction exposure is created. This transaction exposure is speculative in nature, given that there is no underlying inflow or outflow of foreign currency that can be used to satisfy the forward contract. By hedging balance sheet exposure, a company might incur a realized foreign exchange loss to avoid an unrealized negative translation adjustment or unrealized remeasurement loss.

Why might a company want to hedge its balance sheet exposure? What is the paradox associated with hedging balance sheet exposure?

Investors can diversify their risk by including shares of foreign companies in their investment portfolio. Correlations in the returns (increases and decreases in stock prices) earned across stock markets are relatively low. The high degree of independence across capital markets affords investors diversification opportunities.

Why might individual investors wish to include foreign companies in their investment portfolio?

Much financial statement analysis is conducted using ratios or percentage changes (comparing one year with another). Ratios and percentages are not expressed in currency amounts. In fact, in analyzing year-to-year percentage changes, analysts must be careful in translating from a foreign currency to their own currency as changes in exchange rates can distort underlying relationships

Why should the fact that a foreign company presents its financial statements in a foreign currency present no significant problems in analyzing those statements?

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.

Would the worldwide adoption of IFRS result in worldwide comparability of financial statements? Why or why not?