FROM PRINCIPLES TO PLANNING International Accounting Issues FROM PRINCIPLES TO PLANNING

International Accounting Issues Joel Mitchell, Plante Moran PLLC Randy Janiczek, Plante Moran PLLC Frank Kacsandi, MNP LLP

Session Topics Income Tax Accounting (ASC 740) Foreign Currency Translation and Transaction Accounting (ASC 830) IFRS Canadian and U.S. Tax Accounting International Accounting Issues

Income Tax Accounting ASC 740 Objectives of ASC 740 Recognize the amount of taxes payable or refundable for the current year Recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in a company’s financial statement or tax returns International Accounting Issues

Basic Principles A current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year A deferred tax liability or asset is recognized for estimated future taxes created by temporary differences and carry forwards The measurement of current and deferred taxes is based on the provisions of the enacted tax law Measurement of deferred tax assets is reduced if they will not be recognized International Accounting Issues

Components of Income Tax Expense Current income tax expense (benefit) + Deferred income tax expense (benefit) Total income tax expense (benefit) International Accounting Issues

Applicability Domestic federal income taxes Foreign, state and local taxes based on income Domestic and foreign operations that are consolidated, combined or accounted for by the equity method Foreign enterprises in preparing financial statements under US GAAP International Accounting Issues

Temporary Differences The difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable or deductible amounts in future years when the reported amount of the asset or liability is recovered or settled, respectively. International Accounting Issues

ASSETSLIABILITIES Taxable temporary difference Book carrying value > tax basis Tax basis > book carrying value Deductible temporary difference Tax basis > book carrying value Book carrying value > tax basis International Accounting Issues

Calculation DTL = Taxable temporary differences * applicable tax rate DTA = [(Deductible temporary differences + loss and deduction carryforwards) * applicable federal rate] + tax credit carryforwards International Accounting Issues

Tax Rates Used U.S. Federal Income Tax Rate State Income Taxes Foreign Income Taxes Foreign deferred is difference between US GAAP and Foreign Tax Law International Accounting Issues

Tax Rates Used Change in Tax Rate A change in the tax rate imposed in a jurisdiction will require a revaluation of existing DTAs and DTLs The change in value of the deferred tax items is recognized as a current benefit or expense in the period in which the tax rate change was enacted International Accounting Issues

Deferred Tax Expense/Benefit Net DTA or DTL at end of year Less: Net DTA or DTL at beginning of year Deferred income tax expense (benefit) International Accounting Issues

Presentation of DTAs and DTLs Classified as Current or Noncurrent based on the financial accounting classification of the underlying liability or asset to which the temporary difference relates If not specifically related to an asset or liability, a DTA or DTL is classified based on its expected reversal date Each tax paying component within each tax jurisdiction should: net all current DTAs and DTLs to present as a single amount net all noncurrent DTAs and DTLs to present as a single amount There should be no offsetting of DTAs and DTLs attributable to different tax paying components or to different tax jurisdictions International Accounting Issues

Valuation Allowance Impairment Approach A valuation allowance is required if the deferred tax asset is “impaired” Realization Test A probability level of more than 50% A single criterion “more likely than not” All available evidence is considered, with the greatest weight given to objectively verifiable information Future taxable income is required Cumulative loss over recent years is a common basis for valuation allowances International Accounting Issues

Valuation Allowance Examples of Future Taxable Income Existing taxable temporary differences that will reverse in the future Refunds available by carryback of losses to offset taxable income in prior years Tax planning strategies Future taxable income exclusive of reversing temporary differences and carry forwards It may be necessary to schedule out future income to illustrate ability to utilize DTAs based on expected reversals or expiration International Accounting Issues

Application to Foreign Subsidiaries Measure temporary differences separately for each foreign sub – jurisdictional approach US GAAP v. Tax Basis under foreign law Valuation allowances determined in light of foreign law Review of uncertain foreign tax positions Taxpayer must generally record the tax impact of fully liquidating foreign subsidiaries – impact of outside basis differences, including foreign currency translation amounts International Accounting Issues

Investment in Foreign Corporations First tier CFCs generally result in an outside basis difference caused by the increase in investment in subsidiary account as earnings are recognized for book purposes but not for tax purposes Under ASC 740, this basis difference generally requires the recognition of a DTL and related tax expense A company can avoid recognition of such a DTL if its investment of the foreign earnings is essentially permanent in duration and it meets the indefinite reversal criteria International Accounting Issues

Application to Foreign Branches Branch income subject to both foreign and US tax Additional set of temporary differences US GAAP v. US Tax US tax recorded net of US foreign tax credit Review of uncertain foreign tax positions International Accounting Issues

Recognition Criteria (a.k.a. FIN 48) Applies to all income tax positions A tax position is defined as a position taken in a previously filed return or expected to be taken in a future return A position can result in a permanent reduction of taxes (permanent differences), a deferral of taxes (temporary differences), or a change in the expected realizability of deferred tax assets FIN 48 also encompasses decisions not to file an income tax return, jurisdictional allocations (i.e., transfer pricing) and characterization of income International Accounting Issues

“More Likely Than Not” Recognition Threshold Greater than 50% Matter of judgment Based on facts and circumstances Consider all available evidence A positive assertion that the reporting enterprise believes that it is entitled to the economic benefits of the tax position Presumption of examination by taxing authority includes resolution of appeal or litigation process, if any Technical merits of a tax position are derived from sources of authority Legislation & statutes Legislative intent Regulations, rulings, case law International Accounting Issues

Measurement For a tax position that meets the more-likely-than-not recognition threshold Measure initially and subsequently as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information Consider the amounts and probabilities of the outcomes that could be realized upon ultimate settlement Based on facts, circumstances, and information available at the reporting date Cumulative Probability Assessment International Accounting Issues

Foreign Currency Matters (ASC 830) Session Goals Gain a practical understanding of foreign currency transactions and translation Highlight tax accounting and reporting considerations International Accounting Issues

Overview and Objectives The standards for foreign currency translation are designed to Provide information that is generally compatible with the expected economic effects of a rate change on an enterprise’s cash flows and equity Reflect in consolidated statements the financial results and relationships as measured in the primary currency in which each entity conducts its business (referred to as its “functional currency”) International Accounting Issues

Overview and Objectives Foreign Currency Matters are addressed in a 3 Step Process 1.Determine the Functional Currency of the foreign entity 2.Remeasure foreign currency items into the foreign entity’s functional currency 3.Translate functional currency amounts into the reporting currency of the parent International Accounting Issues

Functional Currency Functional Currency – is the currency of the primary economic environment in which the entity operates The currency in which an entity primarily generates and expends cash Key indicators include cash flow, sales price, sales market, expenses, financing, intra-entity transactions and agreements Determining a foreign entity’s functional currency requires management’s judgment Once the functional currency is determined, it shall be used consistently unless significant changes in economic facts and circumstances indicate clearly that it has changed International Accounting Issues

Functional Currency A currency in a highly inflationary environment (3-year inflation rate of approximately 100 percent or more) is not considered stable enough to serve as a functional currency and the more stable currency of the reporting parent is to be used instead A highly inflationary economy is one that has a cumulative inflation of approximately 100 percent or more over a 3 year period Qualitative factors such as the trend of inflation must be taken into account International Accounting Issues

Foreign Currency Transactions May produce receivables or payables that are fixed in terms of the foreign currency that will be received or paid Common transactions include: Buy/sell goods on credit in a foreign currency Borrow/lend money denominated in a foreign currency Party to an unperformed forward exchange contract Acquire/dispose of assets denominated in a foreign currency Incur/settle liability denominated in a foreign currency International Accounting Issues

Foreign Currency Transactions Initial Measurement At the date a foreign currency transaction is recognized, each item arising from the transaction shall be recorded in the functional currency of the reporting entity The Initial Measurement in functional currency is made by using the foreign exchange rate in effect on the date of the transaction An average or a method of approximation may be used International Accounting Issues

Foreign Currency Transactions Subsequent Measurement – the change in foreign exchange rates between the functional currency and the transaction currency increase or decrease the expected functional currency cash flow upon settlement and must be recognized Gains and losses on those foreign currency transactions are generally included in determining net income for the period in which exchange rates change Exceptions include hedges of a foreign currency commitment or a net investment in a foreign entity where the gains and losses are included in Other Comprehensive Income From a tax perspective, the gains and losses recognized during a subsequent measurement period are considered Unrealized and generally create a temporary difference on which deferred taxes must be provided International Accounting Issues

Foreign Currency Transactions Derecognition – the transaction gain or loss realized upon the settlement of a foreign currency transaction is measured from the most recent of the transaction date or the most recent intervening balance sheet date As with gains and losses recognized on subsequent measurement dates, these foreign currency transaction amounts are generally included in determining net income for the period in which the settlement occurs From a tax perspective, the gains and losses recognized at the Derecognition event are considered Realized and generally become taxable at such time International Accounting Issues

Foreign Currency Transactions Other Income Tax Accounting Matters When an entity has DTAs or DTLs in nonfunctional currency, remeasurement from a change in FX rate results in transaction gain or loss recognized in Net Income Any income taxes associated with transaction gains or losses reported in Other Comprehensive Income also need to be allocated to Other Comprehensive Income International Accounting Issues

Foreign Currency Translation Translate P&L on the dates the elements are recognized or by using an appropriately weighted average exchange rate for the period (daily, weekly, monthly, or annually) Translating foreign exchange rates on the specific date of each transaction is generally impractical Translate Balance Sheet using period end spot rate, except Accounts denominated in a currency other than functional currency are remeasured into functional currency using the spot rate for monetary accounts and historical exchange rates for nonmonetary accounts Capital Accounts – translated at historical rates in order to eliminate with investment in subsidiary accounts International Accounting Issues

Foreign Currency Translation Translation adjustments are an inherent result of the process of translating a foreign entity’s financial statements of the functional currency to U.S dollars Translation adjustments are NOT included in determining net income for the period but are disclosed and accumulated in a separate component of consolidated equity until sale or until substantially complete liquidation of the net investment in the foreign entity takes place Translation adjustments are accounted for in the same way as temporary adjustments under ASC 740 and deferred taxes must be provided for unremitted earnings unless the indefinite reversal criteria are met (permanent reinvestment) International Accounting Issues

Basic Translation Adjustment - Example International Accounting Issues XYZ Company 12/31/2012 Income Statement (CDN)Ave Rate Income Statement (USD) Balance Sheet (CDN)Spot Rate Balance Sheet (USD) Sales (30,000) 1.02 (30,600)12/31/2012 COGS 20, ,400Cash Office Expense 9, ,180A/R 1, ,785 Net Income (1,000) 1.02 (1,020)A/P (300) 1.05 (315) Loans (700) 1.05 (735) Common Stock (500) 1.00 (500) Net (Income)/Loss (1,000) 1.02 (1,020) Year End Spot Rate 1.05 Average Rate 1.02 FX Translation Adjustment - (55) Historical Rate 1.00 Balance to Zero - -

Intraperiod Allocations Transaction gains/losses on other items are generally recorded as income/loss amounts in the Income Statement Translation gains/losses on equity investments are recorded as Other Comprehensive Income (“OCI”) as part of the Cumulative Translation Account (“CTA”) International Accounting Issues

Mitigation for companies To help reduce the risk of misapplying rules for foreign currency translations and, in the end, misstating the financial statements Adopt understandable accounting policies Scrutinize the system Implement adequate internal controls (to detect misstatements in foreign-currency gains and losses) International Accounting Issues

U.S. GAAP v.s. IFRS Convergence IFRS Adoption Approximately 120 nations and reporting jurisdictions permit or require IFRS for domestic listed companies Approximately 90 countries have fully conformed with IFRS International Accounting Issues

IFRS Adoption CountryDate of AdoptionListed Companies Required Private Companies Required Canada1/1/2011Yes, certain listed companies are deferred from adoption IFRS for SMEs is prohibited Germany2005Yes, some exceptions for subs of foreign parents No, but can be permitted as long as local GAAP is prepared Mexico1/1/2013Yes, foreign listed issues are allowed to use US GAAP No, but can use IFRS or Mexican FRS USPossibly in 2015No, cannot issue in IFRS yet No, but Foreign private issuers may use IFRS International Accounting Issues

U.S. GAAP vs. IFRS Convergence List of Projects that FASB and IASB are working to make US GAAP and IFRS compatible Financial instruments Revenue recognition Leases Statement of comprehensive income Fair value measurement Derecognition Consolidations Post-employment benefits Balance sheet - Netting Financial statement presentation Discontinued operations Financial instruments with characteristics of equity Insurance Contracts Emissions trading schemes International Accounting Issues

Areas with Significant Differences Financial statement presentation Consolidations, joint venture accounting and equity method investees Business combinations Intangible assets Inventory Long-lived assets Lease Financial Instruments Foreign currency matters Income taxes Provisions and contingencies Revenue recognition Share-based payments Employee benefits other than share-based payments Segment reporting Earnings per share Interim financial reporting Subsequent events Related parties International Accounting Issues

Canadian and U.S. Tax Accounting Unrealized foreign exchange gain & losses Main differences between Canadian and U.S. tax accounting Canadian parent with U.S. subsidiaries U.S. parent with Canadian subsidiaries International Accounting Issues

Unrealized Foreign Exchange Gain & Losses Monetary Asset or Liability Current income tax – permanent and temporary difference adjustments Deferred income tax – corresponding temporary difference movements Non monetary Asset or Liability Translation temporary difference International Accounting Issues

Main Differences in Canadian and U.S. Tax Accounting Classification Recognition Uncertain tax positions Translation temporary difference International Accounting Issues

Main Differences in Canadian and U.S. Tax Accounting Initial recognition exemption Subsequent changes Undistributed earnings on investments Tax consequences of intercompany sales International Accounting Issues

Canadian Parent with U.S. Subsidiaries Translation temporary differences from the non monetary assets The outside basis difference International Accounting Issues

U.S. Parent with Canadian Subsidiaries Intercompany sales consideration International Accounting Issues

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. IRS Circular 230 Disclosure

Questions?

Contact Information Joel Mitchell, Plante Moran PLLC Randy Janiczek, Plante Moran PLLC Frank Kacsandi, MNP LLP