©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter 11 International Accounting Standards; Accounting for Foreign Currency Transactions

2 Scope of Chapter Recent political and economic events have focused on the pressing need for more uniformity in international accounting standards. Two organizations in the forefront of attempts to achieve such uniformity are: 1. The International Accounting Standards Board (IASB). 2. The International Organization of Securities Commissions (IOSCO).

3 International Accounting Standards Committee (IASC) The IASC was formed in 1973 by professional accounting organizations of 10 countries. Currently more than 140 groups from more than 100 countries are members of the ISAC. ISAC is headquartered in London and its business is conducted by an International Accounting Standards Board.

4 International Accounting Standards Committee (IASC) Through 2001 the IASC has issued/revised 41 International Accounting Standards. Four of these Standards dealt in this book are: – IAS 31: Financial Reporting of Interests in Joint Ventures. – IAS 22: Accounting for Business Combinations. – IAS 27: Consolidated Financial Statements and Accounting for Investment in Subsidiaries. – IAS 28: Accounting for Investment in Associates

5 IAS 31: Financial Reporting of Interests in Joint Ventures IASB permits the Proportionate Consolidation method or the Equity method for venturer’s investment in a jointly controlled entity. US accounting standards require: 1. Equity method of accounting for investments in corporate joint ventures. 2. Permit either proportionate Consolidation method or the Equity method method in unincorporated joint ventures.

6 IAS 22: Accounting for Business Combinations IASC requires purchase-type accounting for all Business Combinations except those deemed a uniting in interests – a combinantion in which stockholders of the constituent companies combine into one entity and share the risks and benefits as one entity. In uniting of interest-type combination, pooling of interests accounting is required. Goodwill in a purchase-type combination must be amortized over a period not exceeding 20 years unless a longer period can be justified.

7 IAS 27: Consolidated Financial Statements and Accounting for Investments in Subsidiaries Consolidated policy is based on control rather than ownership. Intercompany transactions, gains or loss are eliminated in full regardless of minority interest. Minority interests in assets and income are shown separately in consolidated statements. Thus there is no parent company or economic unit concept. Equity Method (required by the SEC) or Cost method may be used to account for investment in subsidiary by the parent company.

8 IAS 28: Accounting for Investments in Associates Apart from using the term “Associate” for an “Influenced Investee”, the provisions of IAS 28 resemble those of APB Opinion No. 18 – “The Equity Method of Accounting for Investments in Common Stock”.

9 International Organization of Securities Commissions (IOSCO) The IOSCO includes securities regulators from 50 countries. Their goal is to reduce the impact of differences in securities trading regulations among its members.

10 SEC’s Eased Requirements for Foreign Issuers of Securities in US Adoption of multi-jurisdictional disclosure system for eligible Canadian issuers to permit them to register securities and report to the SEC using Canadian registration and reporting requirements. Acceptance of foreign issuer’s statement of cash flows in accordance with IAS 7 – “Cash Flow Statements”. Elimination of requirements for reconciliation of differences between financial statements prepared under certain IAS and US generally accepted accounting principles. Elimination of eight previously required financial statement schedules, as discussed in chapter 13.

11 Accounting for Foreign Currency Transactions In most countries foreign currency is treated as a commodity or a money-market instrument. The buying and selling of foreign currency as commodity results in variation in its exchange rate.

12 Accounting for Foreign Currency Transactions Different Exchange Rates: 1. Selling spot rate: The rate charged by the bank for current sales in the foreign country. 2. Buying spot rate: The rate charged to dispose of a foreign currency, typically lower than selling spot rate. 3. Agio: Spread between the selling and the buying spot rates represents gross profit to a trader in foreign currency. 4. Forward Rates: Rates applied to foreign currency transactions to be consummated at a future date. Contd.

13 Accounting for Foreign Currency Transactions 5. Nation’s balance of payments, fluctuations in money market such a interest rate in individual countries, differing global inflation rates, capital investment levels and monetary actions of various central banks have major impact on fluctuations prevailing in the exchange rates. Notes: 1. Foreign currencies have “Forward rates” which apply to “Forward contracts” at a future date. 2. FSAB Statements 52 and 133 were issued to establish accounting standards regarding foreign currency.

14 Transactions Involving Foreign Currencies A “Multi-National Company” is one that conducts its business in more that one country via branches, joint ventures, subsidiaries etc. If all its transactions are accounted for in one currency, no problem arises, however often local currencies are used which must be denominated in some other currency – the country where the company is headquartered.

15 Transactions Involving Foreign Currencies: Accounting Treatment The transactions engaged into by the multinational company must be recorded in the reporting currency in the accounting records of the enterprise. The appropriate spot rate is used for this purpose. If the spot exchange rate for the foreign currency changes on the date of financial statement preparation prior to settlement of the transaction, or on the settlement date itself, a foreign currency transaction gain or loss is recognized for display in the income statement of the enterprise for the accounting period in which the rate changes.

16 The Euro The Euro is the currency of the 11 members of the European Union. For purchase of merchandise form a foreign supplier, the selling spot rate is used to determine the local currency denomination.

17 Forward Contracts A forward contract is an agreement to exchange currencies of different countries on a specified future date at the forward rate in effect when the contract was made. Forward rates may be smaller or larger than the spot rates for a foreign currency based on expectations regarding fluctuations in the exchange rates for the currency.

18 Forward Contracts as Derivative Instruments Defined by the FASB as follows: A derivative instrument is a financial instrument with all three of the following characteristics: 1. It has one or more underlying and one or more notional amounts or payment provisions or both. 2. It requires no initial net investment or an initial investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. 3. Its terms require or permit net settlement, it can readily be settled net by a means outside the contract, or it provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement.

19 Underlying, Notional Amount and Payment Provision Underlying: 1. A specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates or other variable. 2. May be a price/rate of an asset/liability but not the asset/liability itself. Notional Amount: A number of currency units, shares, bushels, pounds or other units specified in the contract. Payment provision: Specified a fixed or determinable settlement to be made if the underlying behaves in a specified manner.

20 Forward Contracts Specified by FASB Statement No. 133 FASB Statement No. 133 “Accounting for Derivative Instrument and Hedging Activities” established accounting standards for the following types of forward contracts: 1. Forward contract not designated as a hedge. 2. Forward contract designated as a hedge of a foreign-currency- denominated firm commitment. 3. Forward contract designated as a hedge of an investment in an available-for-sale security. 4. Forward contract designated as a hedge of a forecasted foreign- currency-denominated transaction. 5. Forward contract designated as a hedge of a net investment in a foreign operation.

21 Disclosures Regarding Foreign Currency Transactions FASB Statement No. 52 requires disclosure in the financial statements or notes thereto of the aggregate foreign currency transaction gains and losses included in the measurement of net income. FASB Statement No. 133 requires numerous quantitative and qualitative disclosures regarding all derivative instruments, including those designated as hedges of foreign currency exchange risks. SEC requires disclosure outside the financial statements and notes thereto, of both qualitative and quantitative information about market risk inherent in derivative instruments.