Accounting 5140 Quiz 4

Corporate Income Tax and Withholding Tax Regimes

Corporate income taxes are direct taxes on business income (which is not necessarily Net Income). The tax rates vary from zero percent in tax havens to over fifty percent. As of the end of 2017, the United Arab Emirates (UAE) had the highest corporate tax rate (55%) and the U.S. was fourth (38.9%). As of the end of 2018, the United Arab Emirates (UAE) had the highest corporate tax rate (55%) and the U.S. was "in the middle of all tax jurisdictions" (there are over 200+ tax jurisdictions).

The Impact of Taxes on International Business Decisions

The location of international investments is affected by relative tax rates in the alternative countries. The decision about the legal form of the foreign operation, branch or a subsidiary, is dependent on differential tax treatments. A branch is simply an extension of the parent and not a legal separate entity. A subsidiary is a legal separate entity, even though it can be wholly owned by the parent. A branch will be taxed where the parent is taxed (as well as in the foreign country). A subsidiary will be taxed where......well, that depends Method of financing, debt or equity, is affected by the rules governing taxation of interest and dividends in the host country

Restatement overview - Step two of two

The second step involves restating the foreign GAAP amounts to U.S. GAAP amounts. This process is made easier when the company files a Form 20-F. Sometimes, companies will present a similar reconciliation without actually filing the Form 20-F. In any case, notes to the financial statements are very useful in completing this step.

Step two mechanics - Reformatting

The work in this step affects the debit and credit columns in the worksheet. The nature of these entries is essentially adjusting and reclassification entries. Some entries affect current net income or beginning retained earnings, while others affect both. Each entry reflects the adjustment needed to reconcile to U.S. GAAP from local GAAP.

Timeliness

Timeliness is one aspect of the relevance of information. This varies significantly internationally since filing deadlines differ from country to country. Among developed countries, the U.S. and Canada are the most timely, whereas continental Europe is the least. Requirements about the frequency of information also vary internationally from quarterly to annual reporting. There is very little investors can do to overcome these problems. It's up to the regulators.

Impact of inflation on financial statements

Understated asset values. Overstated income and overpayment of taxes. Demands for higher dividends. Differing impacts across companies resulting in lack of comparability. Historical cost ignores purchasing power gains and losses. - for example, purchasing power would say that $1 in 1950 is worth more than in 2014. Purchasing power losses result from holding monetary assets, such as cash and accounts receivable. Purchasing power gains result from holding monetary liabilities, such as accounts payable. The two most common approaches to inflation accounting are general purchasing power accounting and current cost accounting.

General Purchasing Power (GPP) Accounting

Updates historical cost accounting for changes in the general purchasing power of the monetary unit. Also referred to as General Price-Level-Adjusted Historical Cost Accounting (GPLAHC). Nonmonetary assets and liabilities, stockholders' equity and income statement items are restated using the General Price Index (GPI also referred to as the CPI- Consumer Price Index). Requires purchasing power gains and losses to be included in net income.

Current Cost (CC) Accounting

Updates historical cost of assets to the current cost to replace those assets. Also referred to as Current Replacement Cost Accounting (CRC). Nonmonetary assets are restated to current replacement costs and expense items are based on these restated costs. Holding gains and losses are included in equity.

Full Consolidation - Purchase Method

When one company purchases a majority of the voting shares of another company, the purchased assets and liabilities are stated at fair value. The excess of the purchase price over the fair value of the net assets is goodwill. IFRS 3, Business Combinations, measures the minority interest as the minority percentage multiplied by the fair value of the purchased net assets.

Tax Jurisdiction and Double Taxation

When two countries tax the same income, this is referred to as double taxation. This occurs when one country taxes the income earned by a foreign company in that country, and the same company's home government taxes its foreign source income.

Taxation approaches

Worldwide (nationality) approach - all income of a resident or company of a country is taxed by that country, regardless of where it is earned. This was the United States at the end of 2017. Territorial approach - only income earned in that country is taxed. This is more like the United States today.

U.S. GAAP Segmented REporting

differences exist between IFRS 8 and U.S. GAAP: U.S. GAAP does not require disclosure of segment liabilities. IFRS 8 explicitly includes intangibles in the definition of long-lived assets for geographic area disclosures.

Business environment differences 2

Debt ratios also tend to be higher in Japan and Korea because of the sources of financing. Lower profit margins in Japan in the late 1970s, relative to the U.S., can be partly explained by the Japanese companies having their focus on market share as opposed to profits. In summary, an investor needs to be aware of these differences and not forgo potentially profitable investments. An investor must have a good understanding of the business environment and how to identify the best companies in that environment. It isn't just about the $$$$ on the financial statementsq

Differences in accounting principles

Differences in accounting principles often result in significantly different income and other financial statement amounts. Some of the biggest problem areas are consolidations, fixed asset valuation and depreciation, and goodwill. These differences cause some investors to limit the scope of their investments!!!

Business environment differences

Differences in culture and economic environments have an impact on the relevance of ratios. A study of companies in Japan, Korea, and the U.S. found significant differences due to business environment. For example, Japanese and Korean companies borrow much more on a short-term basis than U.S. companies, leading to lower current ratios.

Terminology

Differences in terminology exist between countries using the same language. For example, "inventory" in the U.S. can be called "stocks" in the U.K. In cases of convenience translations, sometimes these include terminology unfamiliar to English speakers. Knowledge of the business and accounting environment, as well as a careful reading of the notes to the financial statements can help alleviate some of these problems. Much of the U.S. and U.K. differences were removed in 2005 when the U.K. adopted IFRS.

Extent of disclosure - remember that we are not just referring to IFRS countries. And even within IFRS countries - they alter the "rules"

Disclosure internationally tends to be limited compared to the U.S. where full disclosure is fundamental. Some of the most serious disclosure limitations are information on segments, asset valuation, foreign operations, interim statements, and reserves. Lack of disclosure contributes to the significance of format problems. Globalization of capital markets tends to enhance disclosure as companies attempt to attract investors.

Form 20-F

Foreign companies that file non-U.S. GAAP financial statements with the SEC are required to complete a Form 20-F, with the exception of those that use IFRS. The Form 20-F reconciles net income and stockholders' equity to U.S. GAAP. However, there is no requirement to reconcile assets and liabilities. In essence, this represents a partial restatement from foreign GAAP to U.S. GAAP. Some ratios, such as return on equity, can be computed as if under U.S. GAAP. Most other ratios cannot be computed as if under U.S. GAAP. The analyst can overcome this by performing the restatement of financial statement items.

Latin America Inflation ACCTG

Latin America has a long history of significant inflation. Brazil, Chile, and Mexico have developed sophisticated inflation accounting standards over time. Like the U.S. and U.K., Brazil has abandoned inflation accounting. Mexico's Bulletin B-10, Recognition of the Effects of Inflation in Financial Information, is a well-known example.

Language

Many international companies do not produce financial statements in English. The financial statement user could hire a translator or develop foreign language capability. Since English is the language of business, companies in many foreign countries produce "convenience translations" of their financial statements in English.

Currency MErgers

Many international companies produce their financial statements in a currency other than the U.S. dollar. These can be converted to U.S. dollars by translating all balances at the exchange rate at the end of the current year. Is that optional? Hmmm - haven't we dealt with this headache? But we were on the inside of the company (owners).....what can outsiders do? In order to avoid distortions, the current exchange rate should be used for all previous years. Analysis using ratios is not distorted by different currencies.

Data accessibility

Relative to the U.S., financial information is difficult to obtain in many countries. While databases of foreign financial statements do exist, these can contain errors and present information in a variety of formats. These databases also do not contain complete disclosure notes. Another approach is to obtain a copy of the foreign company's annual report. Annual Reports.com provides reports for companies listed on U.S., U.K., Canada and Australia stock exchanges by name, ticker symbol, stock exchange and industry.

International mergers and acquisitions

The frequency and size of international corporate mergers has increased in recent years. Examples include Ambev/Anheuser-Busch; BP/Amoco; and acquisitions by Ford Motor such as Volvo (of Sweden), who, in 2010, reached a deal to sell Volvo to China's Zhejiang Geely Holding Group. Ford purchased Volvo for $6.5b in 1999.....and sold it for $1.5b in 2010. The purchaser of an international company needs to analyze the target company's financial statements to determine the acquisition price. Sounds basic enough.....

December 20, 2017 U.S. passes Tax Cut and Jobs act effective Jan 1, 2018

2018 U.S. Federal Corporate income tax rates on taxable income. As of today...... 21% corporate flat tax...regardless of levels of income.

Business Combinations and Consolidated Financial Statements

Background and conceptual issues Business combinations are the primary mechanism used by MNEs for expansion. Sometimes the acquiree ceases to exist. In other cases, the acquiree remains a separate legal entity as a subsidiary of the acquirer (parent). Accounting for the parent and one or more subsidiaries is often called group accounting.

Step one mechanics - Reformatting

Begin with a four column worksheet in U.S. GAAP format. Columns are Local GAAP, debits, credits, and U.S. GAAP. Amounts are presented in the original currency. Prepare worksheets for income statement, statement of retained earnings, and balance sheet. Line items in the worksheet are presented in the terminology of U.S. account titles.

Group Accounting - Full Consolidation

Full consolidation involves aggregation of 100 percent of the subsidiary's financial statement elements. When the subsidiary is not 100 percent owned, the non-owned portion is presented in a separate item called minority interest. Full consolidation is accomplished using one method-- purchase method (IFRS 3, issued in 2004, allows the use of the purchase method only - same as the U.S.)

Disclosures Segment Reporting—IFRS and U.S. GAAP

General information about the operating segment (how identified and products and services). Segment profit or loss and the following line items: Revenues from external customers Intersegment revenues Interest revenue and expense Depreciation, depletion and amortization Other significant noncash items in segment profit or loss Unusual items (e.g. discontinued operations and extraordinary items) Income tax expense or benefit Total segment assets (and liabilities for IFRS). Expenditures for additions to long-lived assets (U.S. GAAP) and noncurrent assets (IFRS 8). Information about products and services. Information about major customers (if 10% or more of total entity revenue). Information about geographic areas.

Should we adjust financial statements for inflation?

Give a response where you justify saying "no". What are the positives to NOT adjusting? Give a response where you justify saying "yes". What adjusting rate would you use? What are the positives to adjusting for inflation? Adjust all financial statement items, or just some of them?

Business Combinations and Consolidated Financial Statements Group ACCTG

Group Accounting - Determination of control Control provides the basis for whether a parent and a subsidiary should be accounted for as a group. Legal control through majority ownership or legal contract is often used to determine control. Effective control can be achieved without majority ownership. IAS 27, Consolidated and Separate Financial Statements, uses the effective control definition.

International Financial Reporting Standards

IAS 29 includes guidelines for determining the environments where it must be used. Nonmonetary assets and liabilities and stockholders' equity are restated using a general price index. Income statement items are restated using a general price index from the time of the transaction. Purchasing power gains and losses are included in net income.

IFRS 8, Operating Segments - Significance Tests to Justify Disclosure

Must meet any of the following tests: Revenue test—segment revenue (external and intersegment) represents 10% or more of combined internal and external revenue. Profit or loss test—segment profit or loss is 10% or more of the higher of the combined reported profit of profitable segments or the combined loss of all segments reporting a loss. Asset test—segment assets are 10% or more of the combined assets of all operating segments. Notwithstanding the tests above, segments must be disclosed if less than 75% of total company sales are to outsiders.

Restatement overview - Step one of two

The first step, reformatting, involves transforming the financial statements into a U.S. format. One part of step one is transforming terminology differences. Presentation differences are also transformed. Item definitions and classifications are transformed.

Segment Reporting

Segments are defined both by line-of-business and geographic area. The AICPA and Association of Investment Management and Research (AIMR) recommend segment reporting consistent with how a business is managed. A significant point of resistance to segment reporting is concerns about competitive disadvantage

Financial Statement - Segmented Info

Should companies be required to give segmented information? If not, why not? If so, why? And what types of info do you want? What are the negatives of being required to give segmented information?

Full Consolidation - Goodwill

Significant variation exists internationally in accounting for goodwill. U.S., IFRS, and most other countries require goodwill to be capitalized as an asset. Some countries require amortization over a period of up to 40 years (Mexico, Brazil, Japan, etc.). U.S., Canada, and IFRS do not require amortization but do require an annual impairment test. Japan allows the option of immediate expensing of goodwill.

Corporate income tax rates

Significant variation in tax rates worldwide provides a distinct tax planning opportunity. Some countries tax at different rates based on the type of activity. In addition to variation in tax rates, there is also variation in how taxable income is computed. Expenses that are deductible in one country are not necessarily deductible in others.

Format

Some format differences are not problematic because the information is given, just in a different place. However, other format differences are a problem because the information is not provided. It is common in Europe to not provide cost of good sold. This prevents an analyst from determining gross margin percentage and inventory turnover.

Differences in accounting principles 2

Some investors attempt to reframe foreign financial statements to a more familiar GAAP. Another approach is to use a stripped down measure of earnings that excludes items most affected by diversity. EBIMABD???? We use EBIT, etc...but EBIMABD seems extreme! Some firms alleviate some of financial statement users' problems in their convenience translation. In summary, as the use of IFRS becomes more widespread, many of these problems will abate.

IFRS 8, Operating Segments

Substantially converges IFRS with U.S. GAAP. Adopts the management approach to segment reporting. Management disaggregates components to make operating decisions. An operating segment is an enterprise component if: It earns revenues and incurs expenses. Its operating results are regularly reviewed for performance and resource allocation. Discrete financial information is available for it.

Foreign Tax Credit (FTC)

The United States (at the end of 2017) would tax a MNC on all profits earned in the United States. Any profits earned internationally would be subject to the tax in that country. Then, when the MNC repatriated the profits to the U.S., the U.S. would give them a foreign tax credit for the amount they paid to that foreign country. Then those international profits would be subject to U.S. corporate tax laws. Once the U.S. passed the Tax Cut and Jobs Act (effective Jan 1, 2018), all cash held by U.S. Corporations overseas that had never been repatriated and taxed in the U.S., would be subject to a one time 15.5% tax rate