Chapter 18 Issues in International Accounting

Learning Objectives: After reading this chapter, you should be able to: Understand why the Financial Accounting Standards Board (FASB) moved from the temporal method of Statement of Financial Accounting Standards (SFAS) No. 8 to the functional currency approach of SFAS No. 52. Understand why different countries have different approaches to financial accounting and reporting. Know what the Anglo-American and continental models of financsial reporting are. Note the role the Europan Union (UE) toward harmonization. Understand the emergence of the International Accounting Standards Board as a major player in the setting of the accounting standards.

International trade and investment have grown at a stagering rate over the last quarter century. This type of firm is known as a multinational or a transactional coorporation. In addition, crossborder financings have also increased dramatically. Even more important than crossborder financings is the listing of equity securities of foreign coorporations for trading on domestic securities exchange. We then examine attempts to measure harmonization among the accounting standards of different countries and national groupings. Finally, we emphasize the growth and development of the IASB in the quest for harmonization now called convergence of accounting standards. TRANSLATION OF FOREIGN OPERATIONS Translation of foreign-based operations and holdings into U.S. dollars has been addressed by all three standard-setting bodies. 1. CAP (Committee in Accounting Procedure) 2 Accounting Research Bulletins (ARBs) on the subject (4 and 43) 2. APB (accounting Principles Board) APB opinion No. 6 and discussed the subject at length in 1971 but did not issues a pronouncement 3. FASB SFAS No 1, 8, and 52. What determines the exchange rate between currencies of different countries? 1. Exchange Rate are assumed to be the result of two factors: a. Different nominal interest rates arising from differences in expected inflation rates occurring in different countries and, b. the ratio of the relative prices of a common market basket of goods and services. 2. Instability in foreign exchange rates that has the potential to create large translation gains and losses.

There are numerous approaches to the translation of foreign operations, but all stem the basic orientation one addopts: 1. U.S. dollar orientation requires an enterprise to account for foreign operations as if those operations actually occured in U.S. Dollars 2. Foreign currency orientation recognizes that the foreign operations occured in a foreign currency and that those operations may not affect U.S. Dollars; therefore, accounting should be consistent with the foreign-currency economic impact of the operations. SFAS no. 8 SFAS No. 8 and previous standards were consistent with the U.S. Dollar orientation. The temporal method of translation was required by SFAS No. 8: All balance sheet items that were carried at current or future exchange prices (for example, monetary assets and liabilities inventories at market price, and investments at market price) were translated at the current exchange rate, while items carried at past prices (for example, fixed assets) were translated at exchange rates existing at the time the item was acquired (that is, the historical exchange rate). Income statement items were translated at the average exchange rate for the reporting period except that items related to balance sheet accounts that were translated at historical exchange rate (for example, cost of goods sold and depreciation) were also translated at the historical rates. The exchange adjustment, the amount required to balance the statements due to different translation rates, was reported each period on the income statement as an exchange gain or loss. This complex translation was necessary to convert foreign currency account balances to their U.S. Dollar equivalent; that is, to arrive at the same dollar amount as if dollars had been used as the accounting basis all along. A number of empirical studies were made of the economic impact of SFAS No. 8 on American Multinational enterprises. Foreign currency exposure may be defined as either accounting or economic exposure: 1. Accounting exposure is the exposure to exchange gains and losses resulting from translating foreign-currency-denominated financial statements into U.S. Dollars (for example, the $10 million we have just been considering). 2. Economic Exposure is the exposure to cash flow change resulting from dealings in foreigndenominated transactions and commitments (for example, the need to use more U.S. Dollars to settle a foreign currency-denominated debt). SFAS no 52 May 1978, FASB requested comments from constituents regarding the first twelve SFASs 1. 88% of the comments received requested that the board reconsider SFAS No. 8 2. primary complaints about SFAS No. 8: exchange gains and losses are reported, when from an economic viewpoint the reverse had occurred SFAS No. 52 adopts a functional currency orientation rather than a U.S. dollar orientation. The functional currency is the currency of the subsidiarys primary economic environment where cash is primarily received and spent.

If the foreign entitys currency is the functional currency, net income is measured in the foreign currency and then restated into dollars at the average exchange rate for the period. All Balance sheet items are translated at the current exchange rate at the end of the period. The Objective of translation under SFAS No. 52, then, is to avoid reporting 1. accounting exchange gains and losses when an economic gain or loss has not occurred 2. foreign-currency-denominated operations as if they had occurred in U.S. dollars Functional Currency Determination. The six guidelines or economic factors do have, as the discussion in the standard indicates, a differential cash flow orientation: 1. 2. 3. 4. 5. 6. Cash flow indicators Sales price indicators Sales market indicators Expense indicators Financing indicators Intercompany transactions and arrangements indicators