Chapter 12: International accounting Contemporary issue 12.1 Adopting IFRS in Asian countries vital Questions Outline the benefits of adoption of IFRSs in Sri Lanka. What are the challenges expected to be faced by a country in adopting IFRSs? 1. Benefits of IFRS adoption in Sri Lanka include the following: A commonly understood financial reporting framework; Support foreign investment through provision of comparable and credible financial information; Enhanced business environment; Promote access to finance. 2. Challenges might include: An inconsistency with legal, environmental or political systems, where IFRSs are designed to meet the needs of a western society based on a strong capital market; May be the need to educate local accountants on IFRSs; Need to educate investors and other users on the differences from local GAAP; Enforcement of accounting rules will need to be considered. Contemporary issue 12.2 Survey finds multinationals facing new tax challenges Questions How can multinationals use transfer pricing to minimise their taxation burden? Why do you think taxation authorities would get involved in transfer pricing? 1. Transfer pricing relates to the pricing of goods and services transferred between members of a corporate family. At an international level transferring goods and services internally may mean that the entity is not impacted by a range of taxed such as goods and services taxes and sales taxes in countries where they may need resources. Entities may be able to transfer goods and services to other entities in the corporate group which operate in countries with more lenient tax practices and rules. 2. Taxation authorities are likely to wish to get involved, as the more MNEs transfer goods internally to other corporate members internationally to avoid paying taxes it means the governments are going to miss out on potential revenue sources gained from sales in the country of origin. Review questions 12.1 Outline and differentiate the various definitions of international accounting. International accounting, or international financial reporting, refers to a description or comparison of accounting in different countries and the accounting dimensions of international transactions. International financial reporting can be defined at three levels – universal or world accounting; company level standards and practices; and comparative accounting. Universal accounting relates to standards, guidelines and rules issued by supranational organisations such as the International Federation of Accountants. Company level accounting, on the other hand, focuses on accounting processes required to account for a range of international transactions at the corporate level. These might include accounting for foreign investments or transactions, and parent-foreign subsidiary consolidations. It is the definition with the narrowest focus. Comparative accounting studies the rules, standards and guidelines that exist in different countries and a comparison between these. It considers the diversity of accounting practices across the globe. 12.2 Explain the environmental factors that lead to national differences in accounting. There are a range of environmental factors that can influence accounting on an international level. They can generally be classified as ‘cultural’ attributes, and can include such factors as: The taxation system – can affect accounting practice in countries where financial reports are used to determine an entity’s tax liabilities, such as Japan, France and Germany. Sources of finance – these may differ across countries where some rely on banks as major sources of finance, in others equity markets and shareholders provide funds for corporate operations, and in others entities can be owned primarily by families or government. The political system – the accounting system may reflect political philosophies or objectives. Economic growth and development and the nature of the economic system – whether the economy is primarily industrial or agricultural will affect they nature of the accounting system in place. The legal system – common law or codified Roman (or civil) law can impact the extent to which accounting rules and regulations are codified in legislation. 12.3 What are the two main legal systems operating worldwide? How might these affect accounting? The two main legal systems operating across the world are referred to as common law and codified Roman law, otherwise referred to as code law or civil law. Common law, which originated in England, relies on a limited amount of statute law, which is interpreted by the courts. Civil law, on the other hand, was developed in non-English speaking countries and originated in Europe. These countries tend to rely more heavily on statute law, without the extent of court interpretation found in common law. Common law countries are likely to have non-legislative organisations developing accounting standards. The accounting profession is likely to have less of an influence in civil law countries. 12.4 Countries that rely on capital markets for finance, as opposed to banks and governments, are likely to expect greater levels of public disclosure in their accounting systems. Evaluate this argument and provide examples. Where entities operate in countries that rely more on capital markets and external investors for finance, rather than banks or government, there is going to be higher levels of information asymmetry between investors and the entity. Banks and government are in a position to demand specific information from an entity so there is less likely to be onerous public disclosure requirements as there is not the same need to reduce information asymmetry between external users and the entity. 12.5 Outline and discuss three cultural aspects that can differ across countries. How do these cultural differences relate to differences in accounting systems? Hofstede identified a total of five cultural dimensions on which countries can differ. These include: Individualism versus collectivism – individualism relates to a preference for a loosely knit social framework, while collectivism refers to a preference for a tightly knit social framework. In an individualist society there is a preference for self-regulation rather than compliance with prescriptive legal requirements. This leads to the development of strong professional organisations. In collectivist societies statutory control is stronger, so professional bodies are less prevalent and they do not have the same level of input to accounting standard development. Power distance –refers to the extent to which members of society view power entities as distributed unequally. Where entities prefer an unequal distribution of power they have a preference for uniformity of accounting requirements also. Uncertainty avoidance – refers to how comfortable members of society are with uncertainty and ambiguity. In countries where there is a preference for high uncertainty avoidance there would also be a preference for accounting systems that avoid any ambiguity, meaning a rules-based approach to accounting regulation rather than a principles-based approach. Masculinity versus femininity – masculinity refers to a preference for assertiveness, achievement and material success, while societies with feminine traits have a preference for caring for the weak and nurturing. Long-term versus short-term orientation – long-term focus on social and status obligations, a thrifty approach to resources etc. A short-term orientation engenders social pressure to overspend and is concerned with appearances. 12.6 What does accounting harmonisation mean? Differentiate harmonisation from convergence or adoption. Accounting harmonisation implies reconciling different points of view and reducing diversity, while allowing countries to have different sets of accounting standards. Convergence or adoption is a process that takes place over time, and implies the adoption of one set of standards across the globe. This can also be referred to as standardisation. 12.7 Explain the bene¬fits of global adoption of IFRSs. Many countries, and developing nations in particular, do not have well codified accounting standards. Adoption of IFRSs is a cost effective way to institute a comprehensive system of accounting standards. Adoption of IFRSs would also enhance the operation and globalisation of capital markets. 12.8 What are advantages of having one set of accounting standards worldwide? Financial statements would be more comparable, making it easier for investors to evaluate a range of investment opportunities, thus leading to reduced risk to investors. Adoption of IFRSs would also reduce the cost of financial statement preparation by MNEs or those seeking to cross-list on multiple exchanges around the world, and would increase the ability of MNEs to access less expensive capital in other countries. 12.9 What are the limitations of global adoption of IFRSs? It may be difficult to achieve international comparability of accounting practices through IFRS adoption due to differences in business, financial and accounting culture from one country to another. The costs involved in overcoming the sometimes vast difference in legal and political systems across the globe may be too great. Religion can also be a factor that impacts on accounting practices in some jurisdictions, leading to difficulties in applying IFRS which can conflict with the purpose of financial reporting in countries, such as Islamic countries, where religion and culture can play a significant role in business operations. 12.10 Outline the key challenges of US GAAP and IFRS convergence. There are a number of key challenges to US GAAP and IFRS convergence. One is the different underlying philosophies of the two standards. While the IASB standards are ‘principles-based’ the FASB has taken a ‘rules-based’ approach to standard setting. The support of the US government and a number of business constituents is going to be essential to any changes to the US GAAP regime. There have been delays in the agenda due to the large number of draft standards which have been produced over a short period of time. 12.11 What is transfer pricing and how does it affect the operation of MNEs? Transfer pricing relates to the pricing of goods and services transferred between members of a corporate family. At an international level transferring goods and services internally may mean that the entity is not impacted by a range of taxed such as goods and services taxes and sales taxes in countries where they may need resources. Entities may be able to transfer goods and services to other entities in the corporate group which operate in countries with more lenient tax practices and rules Application questions 12.12 Visit the website of the IASB and FASB and read the documents relating to US GAAP and IASB convergence. Prepare a summary of the process to date, and the timelines for future convergence. This summary has been prepared as at October 2017. 2002 – both signed the Norwalk Agreement –g aimed at removing any differences between IFRSs and US GAAP 2006 – bodies issued a Memorandum of Understanding (MoU) which included milestones and priorities to be completed by 2008 2007 – the SEC in the US permits foreign entities listed on US securities exchanges to use IFRS in preparing financial reports, with no need to also present comparative reports in accordance with US GAAP 2008 – the MoU is updated with priorities outlined to 2011 2011 – progress report issued, which confirms that the bodies are giving priority to three main projects on their MoU – revenue recognition, leasing and financial instruments. Priority is also being given to insurance contracts. The Scope of the project has changed over time, and there is a view that it was overly ambitious, due to the fundamentally different perspectives on rules versus principles of both bodies. The most successful project to have been completed was the revenue recognition project, where a converged standard was issued, effective from 2016. The projects on leases, insurance and financial assets have not been successful and both bodies have decided to work on their own projects in this regard, without issuing joint standards. The following minor projects have been completed: Share-based payments Segment reporting Non-monetary assets Inventory Fair value option Accounting changes Borrowing costs Non-controlling interests Business combinations Research costs derecognition The convergence project is now coming to an end, and no new projects are being added to the convergence agenda. 12.13 The New York Stock Exchange (NYSE) is the largest exchange in the U.S. Visit the website of the NYSE, www.nyse.com, and determine the number of foreign companies listed on it. Choose ten of these companies and analyse their latest financial reports, available from the companies’ websites. Document how the companies have addressed the difference, if any, between their reporting requirements for United States purposes and those for their home jurisdiction. Why would foreign companies have gone to the effort of listing their shares on the NYSE and the expense of preparing separate financial statements in some cases? Answers will vary depending upon the companies selected. International companies listed on the NYSE are available on the NYSE website by clicking on: International Listings Documents and Reports: International Listing Company Directory The report outlining the current list of companies is available at the following link: https://www.nyse.com/publicdocs/nyse/data/CurListofallStocks.pdf As at 30 September 2017 there were 490 foreign companies from 46 countries listed on the NYSE. For the purposes of demonstration only, Westpac Banking Corporation is selected. A review of the website of Westpac (https://www.westpac.com.au/about-westpac/investor-centre/financial-information/annual-reports/) indicates that two separate annual reports are available for 2016: the 2016 Annual Report containing the full Annual Report including audited financial statements (272 pages) The 2016 Annual Report on Form 20-F filed with the US Securities Exchange Commission to meet US listing requirements (306 pages). Westpac’s ordinary shares are primarily listed (trading under code WBC) on the Australian Securities Exchange (ASX) and, with ordinary shares also being listed on the New Zealand Stock Exchange (NZX). Westpac also has an American Depositary Receipts (ADR) program listed on the New York Stock Exchange under code WBK, which have been trading since 1989. There are a number of reasons foreign companies might list on the NYSE. Some of these reasons are provided by the NYSE (https://www.nyse.com/network/article/10-reasons-companies-list-on-nyse), and include: lower stock price volatility; a larger, more diverse market that spans all industries and sectors; access to a world-wide market and platform, thereby increasing access to investors. 12.14 Find the financial report available on the websites of one domestic company, and one foreign company that operates in the same industry and complete the following: Document what accounting principles the foreign and domestic companies used to prepare their financial report. Document any differences between the formats of the report or the accounting principles used between your two companies. Document any differences in the directors’ report for each company. Prepare a table which outlines the similarities and differences you have observed. For the purposes of demonstration only, the following points relate to Qantas Ltd and Emirates Ltd, a company listed in the United Arab Emirates. (a) The financial statements of Qantas comply with Australian accounting standards, and also with IFRSs. The financial statements of Emirates are prepared in accordance with IFRSs. (b) The accounting principles are the same. There are no fundamental differences in the formats of the reports of both companies. (c) Emirates does not provide a directors report in its financial report. This means there is no presentation of information concerning corporate governance, including the roles of directors, meetings attended, how the company adheres to a code of corporate governance principles and directors’ and executives’ remuneration. These issues are all addressed in the Qantas report. (d) Accounting rules Both use IFRSs. Qantas reports also comply with Australian accounting standards issued by the AASB Format The format of all financial reports is the same for both companies Directors report Emirates does not include a directors report. There is no discussion of the role of directors, and corporate governance practices or directors’ and executives’ remuneration in the Emirates annual report. These are all included in the Qantas report 12.15 Form small teams and have each team select two countries from different cultural areas. Identify and compare each country’s environmental, cultural and accounting values. An example of two countries could include, but is not limited to: Australia, and China. For the purposes of illustration these countries will be compared. Australia is a western democratically run country, while China is an eastern country where there is an extensive amount of control by the government. This has impacted on accounting and business operations in a number of ways. Until relatively recently China was not open to foreign investment, and most entities were government controlled or owned. This is now changing, with an increase in foreign and private ownership. This has not changed to the extent of Australia, however, where there is an active capital market with many entities being owned by shareholders who buy and sell shares on the stock exchange. Australia has a common law system while the legal system is China is a code law system. If you refer to page 346-47 of the text Hofstede’s cultural dimensions are discussed. China tends towards collectivism while Australia tends towards individualism. China has a large power distance, while Australia’s is smaller. In Australia, society is happy to tolerate uncertainty, while in China it tends towards strong uncertainty avoidance. In terms of Gray’s accounting dimensions, Australia tends towards professionalism, while China favours statutory control. The countries also differ on uniformity versus flexibility, with China favouring more uniformity. Finally, in China there is a high degree of secrecy while in Australia transparency is favoured. 12.16 Visit the website of the Australian Stock Exchange, www.asx.com.au. Select a large company that is listed on the securities exchange that also has operations in different countries – a MNE. You may need to refer to the company website or annual report for this information. Access the latest annual report and evaluate the impact of operating across countries on the company’s financial reporting requirements For the purposes of demonstration only, ANZ Bank has been selected. ANZ Bank has major operations in Australia, New Zealand, Asia and the Pacific regions. In the annual report, Segment Analysis is presented as part of the notes to the financial statements, which outlines revenues, expenses and assets across each segment. In the 2016 financial statements, this analysis is presented in Note 9. Segments include: Australia, New Zealand, Asia Pacific. Case study questions Case study 12.1 US accounting switch to aid multinationals Questions Outline some reasons the US regulators are likely to accept financial reports prepared under IFRSs rather than US GAAP for listing purposes. What would you perceive to be negative aspects of convergence between the FASB and IASB? Explain your answer. How do you think the agreement to accept IFRSs will impact on US companies? 1. There has been evidence that IFRSs were better at uncovering problems during the GFC, thus are likely to be reliable. The US regulators have signed an agreement to move towards convergence, so have changed some US standards to align with IRFSs. In this case there is alignment between the two types of standards. If the standard setters in the US are looking at IFRSs as quality standards that are informing their own accounting standard setting then they need to be seen to be embracing IFRS. The US regulators are keen to attract foreign investment, and accepting financial reports based on IFRSs is one way to encourage this. 2. The standards are formulated using two different underlying philosophies – US GAAP are rules based while IFRS are principles based. Convergence will likely mean substantial changes to IFRS to reflect a greater emphasis on rules rather than principles, which will not necessarily align with the needs of users in other countries. 3. US companies which operate internationally will likely not be affected by this requirement as they may also be using IFRS to prepare reports in other countries. They will need to look closely at how their financial procedures compare with competitors which use IFRS as there are likely to be differences in accounting methods. For instance, in the US, LIFO is commonly used for inventory accounting, while it is not permitted under IFRS. Accounting for research and development will also be different. In the US all R&D must be expensed, while under IFRS it can be capitalized if certain criteria are met. Solution Manual for Contemporary Issues in Accounting Michaela Rankin, Kimberly Ferlauto, Susan McGowan, Patricia McGowan 9780730343530
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