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Solution Manual

to accompany

Contemporary Issues in
Accounting
Michaela Rankin, Patricia
Stanton, Susan McGowan,
Kimberly Ferlauto & Matt Tilling
PREPARED BY:

Michaela Rankin

John Wiley & Sons Australia, Ltd 2012


Chapter 12: International accounting

CHAPTER 12
INTERNATIONAL ACCOUNTING

Contemporary Issue 12.1: Adopting IFRS in Asian countries vital

1. Outline the benefits of adoption of IFRSs in Sri Lanka. (J, K)


Benefits of IFRS adoption in Sri Lanka include the following:
 A commonly understood financial reporting framework;
 Support foreign investment through provision of comparable and
credible financial information;
 Enhanced business environment;
 Promote access to finance.
2. What are the challenges expected to be faced by the country in adopting
IFRSs from 2011? (J)
Challenges might include:
 An inconsistency with legal, environmental or political systems, where
IFRSs are designed to meet the needs of a western society based on a
strong capital market;
 May be the need to educate local accountants on IFRSs;
 Need to educate investors and other users on the differences from local
GAAP;
 Enforcement of accounting rules will need to be considered.
Contemporary Issue 12.2: Survey finds multinationals facing new
tax challenges

1. How can multinationals use transfer pricing to minimize their taxation


burden? (K)
Transfer pricing relates to the pricing of goods and services transferred
between members of a corporate family. At an international level transferring
goods and services internally may mean that the entity is not impacted by a
range of taxed such as goods and services taxes and sales taxes in countries
where they may need resources. Entities may be able to transfer goods and
services to other entities in the corporate group which operate in countries
with more lenient tax practices and rules.
2. Why do you think taxation authorities would get involved in transfer
pricing? (J, K)
Taxation authorities are likely to wish to get involved, as the more MNEs
transfer goods internally to other corporate members internationally to avoid
paying taxes it means the governments are going to miss out on potential
revenue sources gained from sales in the country of origin.

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Solution manual to accompany: Contemporary Issues in Accounting

Review questions

1. Outline and differentiate the various definitions of international accounting.


International accounting, or international financial reporting, refers to a
description or comparison of accounting in different countries and the accounting
dimensions of international transactions. International financial reporting can be
defined at three levels – universal or world accounting; company level standards
and practices; and comparative accounting. Universal accounting relates to
standards, guidelines and rules issued by supranational organisations such as the
International Federation of Accountants.
Company level accounting, on the other hand, focuses on accounting processes
required to account for a range of international transactions at the corporate level.
These might include accounting for foreign investments or transactions, and
parent-foreign subsidiary consolidations. It is the definition with the narrowest
focus.
Comparative accounting studies the rules, standards and guidelines that exist in
different countries and a comparison between these. It considers the diversity of
accounting practices across the globe.
2. Explain the environmental factors that lead to national differences in
accounting.
There are a range of environmental factors that can influence accounting on an
international level. They can generally be classified as ‘cultural’ attributes, and
can include such factors as:

 The taxation system – can affect accounting practice in countries where


financial reports are used to determine an entity’s tax liabilities, such as
Japan, France and Germany;
 Sources of finance – these may differ across countries where some rely on
banks as major sources of finance, in others equity markets and
shareholders provide funds for corporate operations, and in others entities
can be owned primarily by families or government;
 The political system – the accounting system may reflect political
philosophies or objectives;
 Economic growth and development and the nature of the economic system
– whether the economy is primarily industrial or agricultural will affect
they nature of the accounting system in place;
 The legal system – common law or codified Roman (or civil) law can
impact the extent to which accounting rules and regulations are codified in
legislation.
3. What are the two main legal systems operating worldwide? How might these
affect accounting?
The two main legal systems operating across the world are referred to as common
law and codified Roman law, otherwise referred to as code law or civil law.
Common law, which originated in England, relies on a limited amount of statute

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Chapter 12: International accounting

law, which is interpreted by the courts. Civil law, on the other hand, was
developed in non-English speaking countries and originated in Europe. These
countries tend to rely more heavily on statute law, without the extent of court
interpretation found in common law. Common law countries are likely to have
non-legislative organisations developing accounting standards. The accounting
profession is likely to have less of an influence in civil law countries.

4. Countries that rely on capital markets for finance, as opposed to banks and
governments, are likely to expect greater levels of public disclosure in their
accounting systems. Evaluate this argument and provide examples.
Where entities operate in countries that rely more on capital markets and external
investors for finance, rather than banks or government, there is going to be higher
levels of information asymmetry between investors and the entity. Banks and
government are in a position to demand specific information from an entity so
there is less likely to be onerous public disclosure requirements as there is not the
same need to reduce information asymmetry between external users and the
entity.
5. Outline and discuss three cultural aspects that can differ across countries.
How do these cultural differences relate to differences in accounting
systems?
Hofstede identified a total of five cultural dimensions on which countries can
differ. These include:
a. Individualism versus collectivism – individualism relates to a
preference for a loosely knit social framework, while collectivism
refers to a preference for a tightly knit social framework. In an
individualist society there is a preference for self-regulation rather than
compliance with prescriptive legal requirements. This leads to the
development of strong professional organisations. In collectivist
societies statutory control is stronger, so professional bodies are less
prevalent and they do not have the same level of input to accounting
standard development.
b. Power distance –refers to the extent to which members of society view
power entities as distributed unequally. Where entities prefer an
unequal distribution of power they have a preference for uniformity of
accounting requirements also.
c. Uncertainty avoidance – refers to how comfortable members of society
are with uncertainty and ambiguity. In countries where there is a
preference for high uncertainty avoidance there would also bee a
preference for accounting systems that avoid any ambiguity, meaning a
rules-based approach to accounting regulation rather than a principles-
based approach.
d. Masculinity versus femininity – masculinity refers to a preference for
assertiveness, achievement and material success, while societies with
feminine traits have a preference for caring for the weak and nurturing.

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Solution manual to accompany: Contemporary Issues in Accounting

e. Long-term versus short-term orientation – long-term focus on social


and status obligations, a thrifty approach to resources etc. A short-term
orientation engenders social pressure to overspend and is concerned
with appearances.
6. What does accounting harmonisation mean? Differentiate harmonisation
from convergence or adoption.
Accounting harmonisation implies reconciling different points of view and
reducing diversity, while allowing countries to have different sets of accounting
standards.
Convergence or adoption is a process that takes place over time, and implies the
adoption of one set of standards across the globe. This can also be referred to as
standardisation.

7. Explain the benefits of global adoption of IFRSs.


Many countries, and developing nations in particular, do not have well codified
accounting standards. Adoption of IFRSs is a cost effective way to institute a
comprehensive system of accounting standards. Adoption of IFRSs would also
enhance the operation and globalisation of capital markets.

8. What are advantages of having one set of accounting standards worldwide?


Financial statements would be more comparable, making it easier for investors to
evaluate a range of investment opportunities, thus leading to reduced risk to
investors. Adoption of IFRSs would also reduce the cost of financial statement
preparation by MNEs or those seeking to cross-list on multiple exchanges around
the world, and would increase the ability of MNEs to access less expensive
capital in other countries.

9. What are the limitations of global adoption of IFRSs?


It may be difficult to achieve international comparability of accounting practices
through IFRS adoption due to differences in business, financial and accounting
culture from one country to another. The costs involved in overcoming the
sometimes vast difference in legal and political systems across the globe may be
too great. Religion can also be a factor that impacts on accounting practices in
some jurisdictions, leading to difficulties in applying IFRS which can conflict
with the purpose of financial reporting in countries, such as Islamic countries,
where religion and culture can play a significant role in business operations.

10. Outline the key challenges of US GAAP and IFRS convergence.


There are a number of key challenges to US GAAP and IFRS convergence. One
is the different underlying philosophies of the two standards. While the IASB
standards are ‘principles-based’ the FASB has taken a ‘rules-based’ approach to
standard setting. The support of the US government and a number of business
constituents is going to be essential to any changes to the US GAAP regime.
There have been delays in the agenda due to the large number of draft standards
which have been produced over a short period of time.

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Chapter 12: International accounting

11. What is transfer pricing and how does it affect the operation of MNEs?
Transfer pricing relates to the pricing of goods and services transferred between
members of a corporate family. At an international level transferring goods and
services internally may mean that the entity is not impacted by a range of taxed
such as goods and services taxes and sales taxes in countries where they may
need resources. Entities may be able to transfer goods and services to other
entities in the corporate group which operate in countries with more lenient tax
practices and rules

Application questions

12.1 Visit the website of the IASB and FASB and read the documents relating
to US GAAP and IASB convergence. Prepare a summary of the process to
date, and the timelines for future convergence. (K)
This summary has been prepared as at April 2012.
2002 – both signed the Norwalk Agreement –g aimed at removing any
differences between IFRSs and US GAAP
2006 – bodies issued a Memorandum of Understanding (MoU) which
included milestones and priorities to be completed by 2008
2007 – the SEC in the US permits foreign entities listed on US securities
exchanges to use IFRS in preparing financial reports, with no need to also
present comparative reports in accordance with US GAAP
2008 – the MoU is updated with priorities outlined to 2011
2011 – progress report issued, which confirms that the bodies are giving
priority to three main projects on their MoU – revenue recognition, leasing
and financial instruments. Priority is also being given to insurance contracts.
The following projects have been completed:
 Share-based payments
 Segment reporting
 Non-monetary assets
 Inventory
 Fair value option
 Accounting changes
 Borrowing costs
 Non-controlling interests
 Business combinations
 Research costs
 derecognition
Work on the priority projects is to be completed over the next few years

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Solution manual to accompany: Contemporary Issues in Accounting

12.2 The New York Stock Exchange (NYSE) is the largest exchange in the U.S.
Visit the website of the NYSE, www.nyse.com, and determine the number
of foreign companies listed on it. Choose ten of these companies and
analyse their latest financial reports, available from the companies’
websites. Document how the companies have addressed the difference, if
any, between their reporting requirements for United States purposes and
those for their home jurisdiction. Why would foreign companies have
gone to the effort of listing their shares on the NYSE and the expense of
preparing separate financial statements in some cases? (J, SM)

12.3 Find the financial report available on the websites of one domestic
company, and one foreign company that operates in the same industry
and complete the following: (J, K, AS, SM)
For the purposes of demonstration only, the following points relate to Qantas
Ltd and Emirates Ltd, a company listed in the United Arab Emirates.
(a) Document what accounting principles the foreign and domestic
companies used to prepare their financial report.
The financial statements of Qantas comply with Australian accounting
standards, and also with IFRSs. The financial statements of Emirates are
prepared in accordance with IFRSs.

(b) Document any differences between the formats of the report or the
accounting principles used between your two companies.
The accounting principles are the same. There are no fundamental differences
in the formats of the reports of both companies.

(c) Document any differences in the directors’ report for each company.
Emirates does not provide a directors report in its financial report. This means
there is no presentation of information concerning corporate governance,
including the roles of directors, meetings attended, how the company adheres
to a code of corporate governance principles and directors’ and executives’
remuneration. These issues are all addressed in the Qantas report.

(d) Prepare a table which outlines the similarities and differences you have
observed.

Accounting rules Both use IFRSs. Qantas reports also comply with
Australian accounting standards issued by the
AASB

Format The format of all financial reports is the same for


both companies

Directors report Emirates does not include a directors report. There


is no discussion of the role of directors, and

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Chapter 12: International accounting

corporate governance practices or directors’ and


executives’ remuneration in the Emirates annual
report. These are all included in the Qantas report

12.4 Form small teams and have each team select two countries from different
cultural areas. Identify and compare each country’s environmental,
cultural and accounting values. (J, K, CT)
An example of two countries could include, but is not limited to: Australia,
and China. For the purposes of illustration these countries will be compared.
Australia is a western democratically run country, while China is an eastern
country where there is an extensive amount of control by the government. This
has impacted on accounting and business operations in a number of ways.
Until relatively recently China was not open to foreign investment, and most
entities were government controlled or owned. This is now changing, with an
increase in foreign and private ownership. This has not changed to the extent
of Australia, however, where there is an active capital market with many
entities being owned by shareholders who buy and sell shares on the stock
exchange.
Australia has a common law system while the legal system is China is a code
law system.
If you refer to page 346-47 of the text Hofstede’s cultural dimensions are
discussed. China tends towards collectivism while Australia tends towards
individualism. China has a large power distance, while Australia’s is smaller.
In Australia, society is happy to tolerate uncertainty, while in China it tends
towards strong uncertainty avoidance.
In terms of Gray’s accounting dimensions, Australia tends towards
professionalism, while China favours statutory control. The countries also
differ on uniformity versus flexibility, with China favouring more uniformity.
Finally, in China there is a high degree of secrecy while in Australia
transparency is favoured.
12.5 Visit the website of the Australian Stock Exchange, www.asx.com.au.
Select a large company that is listed on the securities exchange that also
has operations in different countries – a MNE. You may need to refer to
the company website or annual report for this information. Access the
latest annual report and evaluate the impact of operating across countries
on the company’s financial reporting requirements (J, K, SM)

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Solution manual to accompany: Contemporary Issues in Accounting

Case Study Questions

Case study 12.1: US accounting switch to aid multinationals


1. Outline some reasons the US regulators are likely to accept financial
reports prepared under IFRSs rather than US GAAP for listing purposes.
(J, K)
There has been evidence that IFRSs were better at uncovering problems
during the GFC, thus are likely to be reliable. The US regulators have signed
an agreement to move towards convergence, so have changed some US
standards to align with IRFSs. In this case there is alignment between the two
types of standards. If the standard setters in the US are looking at IFRSs as
quality standards that are informing their own accounting standard setting then
they need to be seen to be embracing IFRS.
The US regulators are keen to attract foreign investment, and accepting
financial reports based on IFRSs is one way to encourage this.

2. What would you perceive to be negative aspects of convergence between


the FASB and IASB? Explain your answer. (J, K)
The standards are formulated using two different underlying philosophies –
US GAAP are rules based while IFRS are principles based. Convergence will
likely mean substantial changes to IFRS to reflect a greater emphasis on rules
rather than principles, which will not necessarily align with the needs of users
in other countries.

3. How do you think the agreement to accept IFRSs will impact on US


companies? (J, K)
US companies which operate internationally will likely not be affected by this
requirement as they may also be using IFRS to prepare reports in other
countries. They will need to look closely at how their financial procedures
compare with competitors which use IFRS as there are likely to be differences
in accounting methods. For instance, in the US, LIFO is commonly used for
inventory accounting, while it is not permitted under IFRS. Accounting for
research and development will also be different. In the US all R&D must be
expensed, while under IFRS it can be capitalized if certain criteria are met.

Case study 12.2: Making the most of IFRS


1. Outline the arguments both for and against full adoption rather than
harmonization with IFRSs. (J, K)
Arguments in favour of full adoption: Financial statements would be more
comparable, making it easier for investors to evaluate a range of investment
opportunities, thus leading to reduced risk to investors. Adoption of IFRSs
would also reduce the cost of financial statement preparation by MNEs or
those seeking to cross-list on multiple exchanges around the world, and would

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Chapter 12: International accounting

increase the ability of MNEs to access less expensive capital in other


countries.
Arguments against full adoption: It may be difficult to achieve international
comparability of accounting practices through IFRS adoption due to
differences in business, financial and accounting culture from one country to
another. The costs involved in overcoming the sometimes vast difference in
legal and political systems across the globe may be too great. Religion can
also be a factor that impacts on accounting practices in some jurisdictions,
leading to difficulties in applying IFRS which can conflict with the purpose of
financial reporting in countries, such as Islamic countries, where religion and
culture can play a significant role in business operations. Adoption instead of
convergence would result in countries giving up significant control of the
standard setting process.

2. What are the benefits to India of convergence? (J, K)


The benefit to India of convergence is the ability to attract foreign investment
where investors are able to understand the financial reports. Reporting costs
for companies operating internationally will be reduced. At the same time,
convergence rather than adoption ensures the Indian standard setters maintain
control of the standard setting process, and are able to incorporate those
standards that reflect the business environment and culture in the country.
3. As an investor looking to invest in the Indian market, what do you see as
the obstacles to investment? (J, K)

The fact that the Indian government is considering convergence rather than
adoption of IFRS means that an investor will need to look closely at the
financial reports to recognize the differences in financial reporting practices
when comparing potential investments in other countries. Investors would
perceive greater risk of investing in Indian firms as the financial reports will
not align fully with those of alternative investment opportunities in other
nations.

© John Wiley and Sons Australia, Ltd 2012 12.9