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Chapter 11 - Worldwide Accounting Diversity and International Standards

ADVANCE ACCOUNTING
ACCT 462

CHAPTER 11 WORLDWIDE ACCOUNTING DIVERSITY AND INTERNATIONAL STANDARDS


Question Answers to Questions
1.

The five factors most often cited as affecting a country's accounting system are: (1) legal system, (2) taxation, (3) providers of financing, ( ) inflation, and (!) political and economic ties. The legal system is primarily related to ho" accounting principles are esta#lished$ code la" countries generally having legislated accounting principles and common la" countries having principles esta#lished #y non% legislative means. &n some countries, financial statements serve as the #asis for taxation and in other countries they do not. &n those countries "ith a close lin'age #et"een accounting and taxation, accounting practice tends to #e more conservative so as to reduce the amount of income su#(ect to taxation. )hareholders are a ma(or provider of financing in some countries. *s shareholder financing increases in importance, the demand for information made availa#le outside the company #ecomes greater. &n those countries in "hich family mem#ers, #an's, and the government are the ma(or providers of #usiness finance, there tends to #e less demand for pu#lic accounta#ility and information disclosure. +hronic high inflation has caused some countries, especially in ,atin *merica, to develop accounting principles in "hich traditional historical cost accounting is a#andoned in favor of inflation ad(usted figures. -olitical and economic ties can explain the usage of a .ritish style of accounting throughout most of the former .ritish empire. They also help to explain similarities #et"een the /.). and +anada, and increasingly, the /.). and 0exico. +ulture also is vie"ed as a factor that has significant influence on the development of a country1s accounting system. This influence is descri#ed in more detail in the ans"er to 2uestion 3. -ro#lems caused #y accounting diversity for a company li'e 3estle include: (a) the additional cost associated "ith converting foreign 4**- financial statements of foreign su#sidiaries to parent company 4**- to prepare consolidated financial statements, (#) the additional cost associated "ith preparing 3estle financial statements in foreign 4**- (or reconciling to foreign 4**-) to gain access to foreign capital mar'ets, and (c) difficulty in understanding and comparing financial statements of potential foreign ac2uisition targets.

2.

3.

4ray developed a model that hypothesi5es that societal values, i.e., culture, affect the development of accounting systems in t"o "ays: (1) societal values help shape a country1s institutions, such as legal system and financing system, "hich in turn influences the development of accounting, and (2) societal values influence accounting values held #y mem#ers of the accounting su#%culture, "hich in turn influences the development of the accounting system. 4ray provides specific hypotheses "ith respect to the manner in "hich specific cultural dimensions "ill influence specific accounting values. 6or example, he hypothesi5es that in countries in "hich avoiding uncertainty is important, accountants "ill have a preference for more conservative measurement of profit.

*ccording to 3o#es, the purpose for financial reporting determines the nature of a country1s financial reporting system. The most relevant factor for determining the purpose of financial reporting is the nature of the financing system. )ome countries have a culture, and accompanying institutional structure, that leads to a strong e2uity financing system "ith large num#ers of outside shareholders.

* country "ith a self%sufficient Type & culture "ill have a strong e2uity%outsider financing system "hich in turn "ill lead that country developing a +lass * accounting system oriented to"ard providing information for outside shareholders. * self%sufficient Type && culture "ill have a "ea' e2uity%outsider financing system "hich results in a +lass . accounting system oriented to"ard protecting creditors and providing a #asis for taxation.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

!. )everal of the &*)+1s original standards "ere critici5ed for allo"ing too many alternative methods of accounting for a particular item. *s a result, through the selection of different accepta#le options, the financial statements of t"o companies follo"ing &nternational *ccounting )tandards still might not have #een compara#le. To enhance the compara#ility of financial statements prepared in accordance "ith &nternational *ccounting )tandards, and at the urging of the &nternational 7rgani5ation of )ecurities +ommissions, the &*)+ systematically revie"ed its existing standards (in the so%called +ompara#ility -ro(ect) and revised ten of them #y eliminating previously accepta#le alternatives. 8.

* ma(or difference #et"een the &*). and the &*)+ is the composition of the .oard and the manner in "hich .oard mem#ers are selected. &*). has at least 12 and as many as 1 full%time mem#ers, the &*)+ had 5ero. 6ull%time &*). mem#ers must sever their employment relationships "ith former employers and must maintain their independence. )even of the full%time mem#ers have a liaison relationship "ith a national standard setter. *t least five mem#ers must have #een auditors, three must have #een financial statement preparers, three must have #een users of financial statements, and at least one must come from academia. The most important criterion for appointment to the &*). is technical competence. (*lthough not stated in the #ody of the chapter, there "as a perception that some appointments to the &*)+ "ere #ased on politic connections and not competence.) 9)ome of the common features of the &*)+ and &*). are that #oth (a) issue:d ;international standards,< (#) have:had their head2uarters in ,ondon, and (c) use:d =nglish as the "or'ing language.> This statement is true in that =/ publicly traded companies are re2uired to use &6@) in preparing consolidated financial statements. &t is false in that non-public companies are not re2uired to use &6@) and pu#licly traded companies do not use &6@) in preparing their parent company only financial statements.

?.

A.

The #ottom panel of =xhi#it 11.8 sho"s the countries as of Buly 2CCD that (after 2C12) do not allo" domestic companies to use &6@) in preparing consolidated financial statements. The three most economically important countries in this group are +hina, Bapan, and the /nited )tates. The &*). and 6*). have agreed to ;use their #est efforts to (a) ma'e their existing financial reporting standards fully compati#le as soon as is practica#le and (#) coordinate their "or' program to ensure that once achieved, compati#ility is maintained.<

D.

1C. The six 'ey initiatives are: )hort%term convergence pro(ect to eliminate differences "here convergence is li'ely in the short%term. Boint pro(ects on #roader issues in "hich 6*). and &*). share resources and "or' on a similar time schedule. +onvergence research pro(ect to identify all su#stantive differences #et"een &6@) and /.). 4**-. ,iaison &*). mem#er on site at 6*). offices. 0onitoring of &*). pro(ects. =xplicit consideration of convergence potential in 6*). agenda decisions.

11. +onvergence implies a (oint effort #et"een t"o standard setters to reduce differences in the sets of standards for "hich they are responsi#le. +onvergence could result in one standard setter adopting an existing standard developed #y the other standard setter or #y the t"o standard setters (ointly developing a ne" standard. +onvergence does not necessarily mean the t"o sets of standards that result from the convergence process "ill #e the same. &ndeed, the 6*). and &*). ac'no"ledge that differences #et"een &6@) and /.). 4**- "ill continue to exist even after convergence. &n contrast to the approach ta'en #y the 6*). to influence future &*). standards, the =uropean /nion simply adopted &6@) as the national 4**- in mem#er nations.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

12. )ince 2CC?, foreign companies listed on /.). stoc' exchanges may file &6@) financial statements "ith the /.). )=+ "ithout providing any reconciliation to /.). 4**-. The )=+1s &6@) @oadmap proposes the phased%in use of &6@) #y /.). pu#licly%traded domestic companies #eginning in 2C1 . The )=+ "ill monitor progress on several milestones and ma'e a decision on mandatory &6@) adoption in 2C11. 13. Ehen adopting &6@), a company must prepare an ;&6@) opening #alance sheet< at the date of transition. The date of transition is the #eginning of the earliest period for "hich comparative information must #e presented, i.e., t"o years prior to the ;reporting date.< * company must follo" five steps in preparing its &6@) opening #alance sheet: 1. Fetermine applica#le &6@) accounting policies #ased on standards that "ill #e in force on the reporting date. 2. @ecogni5e assets and lia#ilities re2uired to #e recogni5ed under &6@) that "ere not recogni5ed under prior 4**-, and derecogni5e assets and lia#ilities recogni5ed under prior 4**- that are not allo"ed to #e recogni5ed under &6@). 3. 0easure assets and lia#ilities recogni5ed on the &6@) opening #alance sheet in accordance "ith &6@) (that "ill #e in force on the reporting date). . @eclassify items previously classified in a different manner from "hat is accepta#le under &6@). !. +omply "ith all disclosure and presentation re2uirements. 1 . The extreme approaches that a company might follo" in determining appropriate accounting policies for preparing its initial set of &6@) financial statements are: 1. *dopt accounting policies accepta#le under &6@) that minimi5e change from existing accounting policies used under current 4**-. 2. Ta'e a fresh start, clean slate approach and develop accounting policies accepta#le under &6@) that "ill result in financial statements that reflect the economic su#stance of transactions and present the most economically meaningful information possi#le.

1!. *ccording to the accounting policy hierarchy in IAS 8, if a company is faced "ith an accounting issue for "hich (a) there is no specific &*). standard that applies, (#) there are no &*). standards on related issues, and (c) reference to the &*).1s 6rame"or' does not help in determining an appropriate accounting treatment, then the company should consider the most recent pronouncements of other standard%setting #odies that use a similar conceptual frame"or'. The 6*).1s conceptual frame"or' is similar to the &*).1s, so reference to 6*). pronouncements "ould #e accepta#le under IAS 8 "hen conditions (a), (#), and (c) exist.18. -otentially significant differences #et"een &6@) and /.). 4**related to asset recognition and measurement are: *ccepta#le use of ,&67 under /.). 4**-, #ut not &6@). Fefinition of ;mar'et< in the lo"er of cost or mar'et rule for inventory G replacement cost under /.). 4**-$ net reali5a#le value under &6@). @eversal of inventory "ritedo"ns allo"ed under &6@), #ut not under /.). 4**-. -ossi#le revaluation of property, plant, and e2uipment under &6@) (allo"ed alternative), #ut not under /.). 4**-. +apitali5ation of development costs as an intangi#le asset under &6@), "hich is not accepta#le under /.). 4**- (except for computer soft"are development costs). Fifference in the determination of "hether an asset is impaired. )u#se2uent reversal of impairment losses allo"ed #y &6@), #ut not /.). 4**-. 1?. =ven if all countries adopt a similar set of accounting standards, t"o o#stacles remain in achieving the goal of "orld"ide compara#ility of financial statements. 6irst, &6@) must #e translated into languages other than =nglish to #e usa#le #y non%=nglish spea'ing preparers of financial statements. &t is difficult to translate some "ords and phrases found in &6@) into non%=nglish languages "ithout a distortion of meaning. )econd, culture can affect the manner in "hich accountants interpret and apply accounting standards. Fifferences in culture can lead to differences in ho" the same standard is applied across countries.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

Answers to Prob e!s 1" &" '" (" )" *" +" ," -" # $LO1% C $LO&% D $LO&% C $LO'% D $LO(% D $LO)% C $LO)% # $LO)% D $LO)%

1." # $LO*% 11" C $LO*% 1&" A $LO*% 1'" A $LO)% 1(" C $LO)% Prob e!s 1)/1- 0re b0se1 on t2e 3o!4re2ensi5e i ustr0tion"

Note to instru3tors6 Prob e!s 1)/1- 205e 320n7e1 8ro! Prob e!s 11/1) in t2e Nint2 E1ition o8 t2e boo9 in t20t t2e: now 0s9 8or t2e 01;ust!ents to re3on3i e 8ro! U"S" GAAP to I<RS= w2ere0s in t2e 4re5ious e1ition t2e re3on3i i0tion w0s 8ro! I<RS to U"S" GAAP" T2is 320n7e is 3onsistent wit2 t2e n0ture o8 t2e re3on3i i0tion t20t U"S" 3o!40nies wi !09e i8 t2e SEC re>uires t2e I<RS 0s 4ro4ose1 un1er t2e I<RS Ro01!04" 1)" C0rr:in7 in5entor: 0t t2e ower o8 3ost or ?!0r9et@ $LO+% $1) !inutes% a. 1. /nder /.). 4**-, the company reports inventory on the #alance sheet at the lo"er of cost or mar'et, "here mar'et is defined as replacement cost ("ith net reali5a#le value as a ceiling and net reali5a#le value less a normal profit as a floor). &n this case, inventory "ill #e "ritten do"n to replacement cost and reported on the Fecem#er 31, 2C11 #alance sheet at HD!,CCC. * H!,CCC loss "ill #e included in 2C11 income. 2. &n accordance "ith IAS 2, the company reports inventory on the #alance sheet at the lo"er of cost and net reali5a#le value. *s a result, inventory "ill #e reported on the Fecem#er 31, 2C11 #alance sheet at its net reali5a#le value of HDA,CCC and a loss on "ritedo"n of inventory of H2,CCC "ill #e reflected in 2C11 net income.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

#. *s a result of the differing amounts of inventory loss recogni5ed under /.). 4**- and &6@), ,isali "ill add H3,CCC to /.). 4**- income to reconcile to &6@) income, and "ill add H3,CCC to /.). 4**- stoc'holders1 e2uity to reconcile to &6@) stoc'holders1 e2uity. 1*" Ae0sure!ent o8 4ro4ert:= 4 0nt= 0n1 e>ui4!ent subse>uent to 03>uisition $LO+% $&) !inutes% a. 1. /nder /.). 4**-, the company "ould report the e2uipment at its depreciated historical cost. )traight%line deprecation expense is HA,CCC per year 9(H1CC,CCC G H2C,CCC) : 1C years>. The e2uipment "ould #e reported at HD2,CCC, HA ,CCC, and H?8,CCC, respectively, on the Fecem#er 31, 2C11, 2C12, and 2C13 #alance sheets.

2. /nder &6@), the e2uipment "ould #e depreciated #y HA,CCC in 2C11 9(H1CC,CCC % H2C,CCC) : 1C years>, resulting in a #oo' value of HD2,CCC at Fecem#er 31, 2C11. /nder IAS 161s allo"ed alternative treatment, the e2uipment "ould #e revalued on Banuary 1, 2C12 to its fair value of H1C1,CCC. The (ournal entry to record the revaluation on Banuary 1, 2C12 "ould #e: Fr. =2uipment HD,CCC +r. @evaluation surplus (stoc'. e2uity) HD,CCC (To revalue e2uipment from carrying value of HD2,CCC to appraisal value of H1C1,CCC.) Fepreciation expense on a straight%line #asis in 2C12, 2C13, and #eyond "ould #e HD,CCC per year 9(H1C1,CCC G H2C,CCC) : D years>. The e2uipment "ould #e reported on the Fecem#er 31, 2C12 #alance sheet at HD2,CCC 9H1C1,CCC G HD,CCC>, and on the Fecem#er 31, 2C13 #alance sheet at HA3,CCC 9HD2,CCC G HD,CCC>. The differences can #e summari5ed as follo"s: De4re3i0tion eB4ense &6@) /.). 4**Fifference #oo9 50 ue o8 e>ui4!ent &6@) /.). 4**Fifference &.11 HA,CCC HA,CCC HC 1&C'1C11 HD2,CCC HD2,CCC HC &.1& HD,CCC HA,CCC H1,CCC 1&C'1C1& HD2,CCC HA ,CCC H A,CCC &.1' HD,CCC HA,CCC H1,CCC 1&C'1C1' HA3,CCC H?8,CCC H ?,CCC

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Chapter 11 - Worldwide Accounting Diversity and International Standards

#. There is no difference in net income #et"een &6@) and /.). 4**- in 2C11, so no reconciliation ad(ustments are necessary in 2C11.

&n 2C12, the additional amount of depreciation expense of H1,CCC related to the revaluation surplus under &6@) must #e su#tracted from /.). 4**- income to reconcile to &6@) net income. The additional depreciation ta'en under &6@) causes &6@) retained earnings to #e H1,CCC less than /.). 4**- retained earnings at Fecem#er 31, 2C12. /nder &6@), the revaluation surplus causes &6@) stoc'holders1 e2uity to #e HD,CCC larger than /.). 4**stoc'holders1 e2uity. The ad(ustment to reconcile /.). 4**- stoc'holders1 e2uity to &6@) is HA,CCC, the difference #et"een the original amount of the revaluation surplus (HD,CCC) and the accumulated depreciation on that surplus (H1,CCC). HA,CCC "ould #e added to /.). 4**stoc'holders1 e2uity to reconcile to &6@).

&n 2C13, H1,CCC again is added to &6@) net income to reconcile to /.). 4**- net income, and H?,CCC is no" su#tracted from &6@) stoc'holders1 e2uity to reconcile to /.). 4**stoc'holders1 e2uity. H?,CCC is the original amount of revaluation surplus (HD,CCC) less accumulated depreciation on that surplus for t"o years (H2,CCC). 1+" Rese0r32 0n1 1e5e o4!ent 3osts $LO+% $1) !inutes% a. 1. /nder /.). 4**-, H!CC,CCC of research and development costs "ould #e expensed in 2C11. 2. &n accordance "ith IAS 38, H3!C,CCC 9H!CC,CCC x ?CI> of research and development costs "ould #e expensed in 2C11, and H1!C,CCC 9H!CC,CCC x 3CI> of development costs "ould #e capitali5ed as an intangi#le asset. The intangi#le asset "ould #e amorti5ed over its useful life of ten years, #ut only #eginning in 2C12 "hen the ne"ly developed product is #rought to mar'et. #. &n 2C11, H1!C,CCC "ould #e added to /.). 4**- net income to reconcile to &6@) and the same amount "ould #e added to /.). 4**- stoc'holders1 e2uity. &n 2C12, the company "ould recogni5e H1!,CCC 9H1!C,CCC : 1C years> of amorti5ation expense on the deferred development costs under &6@) that "ould not #e recogni5ed under /.). 4**-. &n 2C12, H1!,CCC "ould #e su#tracted from /.). 4**- net income to reconcile to &6@) net income. The net ad(ustment to reconcile from /.). 4**- stoc'holders e2uity to &6@) at Fecem#er 31, 2C12 "ould #e H13!,CCC, the sum of the H1!C,CCC smaller expense under &6@) in 2C11 and the H1!,CCC larger expense under &6@) in 2C12. H13!,CCC "ould #e added to /.). 4**- stoc'holders1 e2uity at Fecem#er 31, 2C12 to reconcile to &6@).

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Chapter 11 - Worldwide Accounting Diversity and International Standards

1," G0in on s0 e 0n1 e0seb039 tr0ns03tion $LO+% $1) !inutes% a. 1. /nder /.). 4**-, the gain of H!C,CCC on the sale and lease#ac' transaction of is deferred and amorti5ed to income over the life of the lease. Eith a lease period of five years, H1C,CCC of the gain "ould #e recogni5ed in 2C11. 2. &n accordance "ith IAS 17, the entire gain of H!C,CCC on the sale and lease#ac' "ould #e recogni5ed in income in the year of the sale "hen the lease is an operating lease. #. &n 2C11, &6@) net income exceeds /.). 4**- net income #y H C,CCC, the difference in the amount of gain recogni5ed on the sale and lease#ac' transaction. * positive ad(ustment of H C,CCC "ould #e made to reconcile /.). 4**- net income and /.). 4**- stoc'holders1 e2uity to &6@). &n 2C12, a gain of H1C,CCC "ould #e recogni5ed under /.). 4**- that "ould not exist under &6@). *s a result, H1C,CCC "ould #e su#tracted from /.). 4**- net income to reconcile to &6@). .y Fecem#er 31, 2C12, H2C,CCC of the gain "ould have #een recogni5ed under /.). 4**- and included in retained earnings, "hereas retained earnings under &6@) includes the entire H!C,CCC gain. Thus, H3C,CCC "ould #e added to /.). 4**- stoc'holders1 e2uity at 12:31:12 to reconcile to &6@). 1-" I!40ir!ent o8 4ro4ert:= 4 0nt= 0n1 e>ui4!ent $LO+% $&. !inutes% a. 1. /nder /.). 4**-, an asset is impaired "hen its carrying value exceeds the expected future cash flo"s (undiscounted) to #e derived from use of the asset. =xpected future cash flo"s are HA!,CCC, "hich exceeds the carrying value of HAC,CCC, so the asset is not impaired. Fepreciation expense for the year is H2C,CCC 9H1CC,CCC : ! years>, and the e2uipment "ill carried #e on the Fecem#er 31, 2C11 #alance sheet at HAC,CCC. 2. &n accordance "ith IAS 36, an asset is impaired "hen its carrying value exceeds its recovera#le amount, "hich is the greater of (a) value in use (present value of expected future cash flo"s), and (#) net selling price, less costs to dispose. The carrying value of the e2uipment at Fecem#er 31, 2C11 is HAC,CCC$ original cost of H1CC,CCC less accumulated depreciation of H2C,CCC 9H1CC,CCC : ! years>. The asset1s recovera#le amount is H?!,CCC (the higher of value in use of H?!,CCC and fair value of H?2,CCC), so the asset is impaired. *n impairment loss of H!,CCC 9HAC,CCC % H?!,CCC> "ould #e recogni5ed at the end of 2C11, in addition to depreciation expense for the year of H2C,CCC. The e2uipment "ill #e carried on the Fecem#er 31, 2C11 #alance sheet at H?!,CCC.

#. *n impairment loss of H!,CCC "as recogni5ed in 2C11 under &6@) #ut not under /.). 4**-. Therefore, H!,CCC must #e su#tracted from /.). 4**- net income to reconcile to /.). 4**net income in 2C11. The same amount "ould #e su#tracted from /.). 4**- stoc'holders1 e2uity at Fecem#er 31, 2C11 to reconcile to &6@). &n 2C12, depreciation under &6@) "ill #e H1A,?!C 9H?!,CCC : years>, "hereas depreciation under /.). 4**- is H2C,CCC. H1,2!C "ould #e added to /.). 4**- net income to reconcile to &6@) net income in 2C12. To reconcile stoc'holders1 e2uity to &6@) at Fecem#er 31, 2C12, H3,?!C must #e su#tracted from /.). 4**- stoc'holders1 e2uity. This is the difference #et"een the impairment loss of H!,CCC in 2C11 ta'en under &6@) and the difference in depreciation expense recogni5ed under the t"o sets of standards in 2C12. &t also is e2ual to the difference in the carrying value of the e2uipment at Fecem#er 31, 2C12 under the t"o sets of accounting rules: +ost Fepreciation, 2C11 I<RS H1CC,CCC (2C,CCC)
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U"S" GAAP H1CC,CCC (2C,CCC)

Chapter 11 - Worldwide Accounting Diversity and International Standards

&mpairment loss, 2C11 +arrying value, 12:31:11 Fepreciation, 2C12 +arrying value, 12:31:12

(!,CCC) H?!,CCC (1A,?!C) H!8,2!C

C HAC,CCC (2C,CCC) H8C,CCC

T2is 3o4: o8 stu1: 7ui1e is e1ite1 b:D Vin3ent o uo32 o12i0!bo Senior stu1ent &.11 Uni5ersit: o8 E0stern A8ri30 #0r0ton= S32oo o8 #usiness De40rt!ent o8 A33ountin7D ##A$A33ountin7% ##A$<in0n3e% E!0i 65ino uoE:02oo"3o!

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