© The McGraw-Hill Companies, Inc., 2004 Slide 11-1 McGraw-Hill/Irwin Chapter Eleven Worldwide Accounting Diversity and International Standards

© The McGraw-Hill Companies, Inc., 2004 Slide 11-2 McGraw-Hill/Irwin Examples of International Accounting Diversity Dutch companies report assets at current replacement cost. German companies amortize goodwill as a reduction of owners’ equity. Canada and France allow capitalization of R&D costs.

© The McGraw-Hill Companies, Inc., 2004 Slide 11-3 McGraw-Hill/Irwin Magnitude of Accounting Diversity 2/3 of foreign companies report material differences when compared to GAAP. Over 90% of British companies reported lower net income under US GAAP. 60% of British companies reported higher equity under US GAAP. Results of a 1993 SEC survey on the significance of the differences between GAAP and non- GAAP countries.

© The McGraw-Hill Companies, Inc., 2004 Slide 11-4 McGraw-Hill/Irwin Reasons for Accounting Diversity Legal System Taxatio n Providers of Financing Inflation Political & Economic Systems

© The McGraw-Hill Companies, Inc., 2004 Slide 11-5 McGraw-Hill/Irwin Problems Caused By Diverse Accounting Standards Problem Subs use the standards for the country where they are located. To gain access to a country’s capital market, financial statements must be in accordance with local standards. Statements are not comparable. Solution The parent must adjust the subs’ statements to be in accord with GAAP. The parent must restate their own statements in accord with local standards. Statements must be re-stated in common standards.

© The McGraw-Hill Companies, Inc., 2004 Slide 11-6 McGraw-Hill/Irwin Accounting Clusters One classification scheme identifies four major accounting models.  British-American  Continental  South American  Mixed economy Nobes’ micro- based/macro-based model.

© The McGraw-Hill Companies, Inc., 2004 Slide 11-7 McGraw-Hill/Irwin Exh Hypothetical Classification of Accounting Systems

© The McGraw-Hill Companies, Inc., 2004 Slide 11-8 McGraw-Hill/Irwin Major Deviations From GAAP Depreciation and amortization Deferred or capitalized costs Deferred taxes Pension costs Foreign currency translation Depreciation and amortization Deferred or capitalized costs Deferred taxes Pension costs Foreign currency translation Gain/loss on disposal of assets Business combinations Extraordinary Items, discontinued operations, and accounting changes Employee compensation Investments in associated entities Gain/loss on disposal of assets Business combinations Extraordinary Items, discontinued operations, and accounting changes Employee compensation Investments in associated entities 10 Accounting Issues Most Commonly Requiring Adjustment

© The McGraw-Hill Companies, Inc., 2004 Slide 11-9 McGraw-Hill/Irwin International Harmonization The process of reducing differences in financial reporting practices across countries. European Union  The Fourth Directive (1978)  The Seventh Directive (1983) International Accounting Standards Committee International Organization of Securities Commissions

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin European Union 1957 – European Economic Community (now called European Union) established free trade among member countries. EU issues “Directives” to assist with harmonizing accounting across member countries  1978 – 4 th Directive deals with valuation  1983 – 7 th Directive deals with preparation of consolidated financial statements.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin European Union – Examples of Changes in Germany Required inclusion of notes to the financial statements. Inclusion of foreign subsidiaries in consolidated financial statements. Elimination of unrealized intercompany losses on consolidation. Use of equity method for investments in associated companies. Accrual of deferred taxes and pension obligations.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin European Union – Unaddressed Differences Between Countries Lease Accounting Accounting Changes Foreign Currency Translation Income Taxes Contingencies Long-term Construction Contracts

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin International Accounting Standards Committee (IASC) Established 1973 Includes over 140 accounting bodies, representing over 100 nations.  The U.S. is represented by the AICPA and IMA Standards produced by a 14-member board.  Requires 11 of 14 members to issue a standard.  39 International Accounting Standards (IAS’s) issued as of January 2000.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin International Accounting Standards Committee (IASC) Very few countries have formally adopted the IAS’s as the national practice.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin The IOSCO Agreement In 1987, partnered with the IASC’s Comparability Project. Helped to rewrite IAS’s to eliminate unnecessary alternatives. The goal is to help make it easier for foreign companies to use IAS’s when reporting on different exchanges. International Organization of Securities Commissions (IOSCO)

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Support of Securities Exchange Regulators Since 1994, reconciliation to U.S. GAAP is not required for foreign registrants using IAS’s for:   Statement of cash flows.   Amortization of goodwill.   Translation of financial statements of subsidiaries in highly inflationary economies.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Support of Securities Exchange Regulators In 1996, the FASB compare GAAP to IASC standards. Significant differences were found.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Accounting Principles United Kingdom The Companies Acts (1989)  Legal foundation for accounting.  Requires a “true and fair view” of a company’s operating results and financial position. Professional accountants are called Chartered Accountants. The Accounting Standards Board (ASB) was established in  Replaced the Accounting Standards Committee

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Accounting Principles Germany Accounting principles set by the legislature.  The Third Book of the Commercial Code (Handelsgesetzbuch).  It is generally believed that strict adherence to the law provides a “true and fair view”. A professional accountant carries the designation “Wirtschaftsprufer”.  Requires passing an exam and 6 years of experience.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Accounting Principles Germany German accounting is greatly influenced by German banks. A Statement of Fixed Assets is often produced in addition to the other common statements. Income Statement is produced on one of two formats:  Cost of Sales Approach  Type-of-Cost Approach Current and noncurrent designations are generally not used.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Accounting Principles Japan Basic accounting principles are set by the government.  Some rules are set by the Japanese Commercial Code.  The Business Accounting Deliberation Council provides additional accounting rules in the Financial Accounting Standards for Business Enterprises. CPA’s in Japan are members of the JICPA.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Accounting Principles Japan Financial statements required include:  Balance sheet.  Income statement.  Proposal of appropriation of profit or disposition of loss.  Business report. Extensive cash flow information is required in supplemental disclosures.

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Specific Accounting Problems Reported Value of Assets

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Specific Accounting Problems Consolidation Accounting

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Specific Accounting Problems Accounting for Goodwill

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Specific Accounting Problems Translation of Foreign Currency Financial Statements

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin Specific Accounting Problems Inventory Valuation

© The McGraw-Hill Companies, Inc., 2004 Slide McGraw-Hill/Irwin When the ad said, “Job with a hot future!”, this isn’t exactly what I expected. End of Chapter 11