国际会计案例集锦

E-CENTIVES, INC.---RAISING CAPITAL IN SWITZERLAND

On October 3, 2000, E-Centives, incorporated in the United States made an initial public offering on the Swiss Stock Exchange’s New Market. The company raised approximately US$40 million. E-Centives’s offering circular stated that no offers or sales of the company’s common stock would be made in the United States, and that there would be no public market for the common stock in the United States after the offering.

THE SMISS EXCHANGE’S NEW MARKET

The Swiss Exchange launched the New Market in 1999. The New Market is designed to mmet the financing needs of rapidly growing companies from Switzerland and abroad. It provides firms with simplified means of entry to the Swiss capital markets. Listing requirements for the New Market are simple. For example, companies must have an operating track record of 12 months, the initial public listing must involve a capital increase, and to ensure market liquidity, a bank must agree to make a market in the securities. E-Centives

E-Centives, Inc, is a leading online direct marketing infrastructure company. The company offers systems and technologies that enable businesses to build large, rich databases of consumer profiles and interests. In return, consumers receive a free promotional offers based on their interests. At the time of the public offering, E-Centives maintained over 4.4 million E-Centives online accounts for members. The company does not charge members a fee for its service. Instead, that company generates revenue primarily from marketers whose marketing matter is delivered to targeted groups of E-Centives members. E-Centives currently employs more than 100 people in its Bethesda, Maryland headquarters, and its offices in Redwood City, New York and Los Angeles. As of the offering date, the company had little revenue and had not been profitable. Revenue for the year ended December 31, 1999, was $740000, with a net loss about US$16 million. As of June 30,2000, about US$39 million. E-Centives ‘ growth strategy is to expand internationally. To date, the company has focused on pursuing opportunities in the United States. E-Centives intends to expand into Europe and other countries. The company is currently considering expanding into Switzerland, the United Kingdom, and Germany. REQUIRED:

1. Which factors relevant for choosing an overseas market for listing or raising capital. Which

factors might have been relevant in E-Centives’ decision to raise capital and list on the Swiss Exchange’s new market?

2. Why do you believe E-Centives choose not to raise public equity in the United States? What

are the potential drawbacks related to E-Centives decision not to raise capital in the U.S PUBLIC MARKETS?

3. What are the advantage and disadvantages to E-Centives of using U.S.GAAP?

4. Should the SWX Swiss Exchange require E-Centives to prepare its financial statements using

Swiss accounting standards?

5. Learn more about the New Market at the SWX Swiss Exchange’s Web site

(http://www.swx.com). What are the listing requirements for the New Market? What are the financial reporting requirements? Does E-Centives appear to fit the profile of the typical New Market company?

Case 1.2: Toyota’s Global Expansion

In November 2004, Hiroshi Okuda, Chairman of Toyota Motor Corp. of Japan, announced that the company was going to build another factory in North America, raising the number of factories producing parts or assembling cars and trucks in North America to 14. As of May 2004, Toyota manufactured parts and assembled cars in 51 overseas manufacturing companies in 26 countries/locations. In 1980, the company had only 11 production facilities in 9 countries, so it was essentially servicing the world market through exports from Japan. Since 1980, however, the company has committed more energy and resources into foreign production.

Toyota, the second largest auto manufacturer in the world, is moving aggressively to overtake leader General Motors in terms of volume. In 2004-2005, GM sold 7.4 million vehicles worldwide, and the company expects to increase sales to 8.5 million vehicles by 2006. Even though Toyota’s major manufacturing base is in Japan, with 12 plants located closely together around Toyota City in Aichi Prefecture, it is expanding its manufacturing capabilities to every corner of the world, including Russia. However, it is clear that Toyota is betting more on production in countries outside of Japan. Although Toyota hopes to produce 3.8 million vehicles in Japan by 2006, it plans on doubling its foreign output to 6 million vehicles sometime in the future. It currently produces more vehicles in Japan than it does in its overseas plants, and it exports more of its domestic production than is sold inside of Japan.

Toyota is known for its commitment to low cost, high quality, and just-in-time inventory, which implies that it must be close to its main suppliers. A major reason for the company’s success in Japan is its close proximity to key suppliers, such as Nippon Denso, which allows it to schedule the delivery of parts as soon as they are needed in the assembly operations.

One of Toyota’s major advantages is its strong cash position. Its cash and short-term investments totaled $30 billion in 2004, even though GM’s cash and short-term investments at the end of the 3rd quarter 2004 were nearly double that at $58.623 billion, down slightly from the same quarter a year earlier. However, Toyota’s strong earnings and cash positions are in contrast to GM, which is constrained by weak credit ratings, rising health-care and pension costs, and losses in its automotive division. Toyota expects to use its strong financial position to expand operations worldwide and increase its commitment to R&D, especially in safety, automation, and environmentally friendly vehicles, such as the Prius, one of its hybrid cars.

In spite of its strong commitment to future growth, Toyota has some challenges. Its net profits in the second quarter of 2004 dropped from ¥301.9 billion a year earlier to ¥297.4 billion. Toyota reports its financial information in yen, although it reports earnings according to U.S. generally

accepted accounting principles due to its active presence on global capital markets and the universal acceptability of U.S. GAAP.

Operating in global markets is a challenge for Toyota. Since it is a Japanese company that reports financial information in Japanese yen, it is subject to exchange rate fluctuations. In particular, the yen has been strong relative to the U.S. dollar, so earnings of its U.S. operations have fallen in yen terms in recent years when translated from dollars back to yen. In addition to the strong yen, Toyota and other companies operating in the U.S. market have struggled with high gasoline prices and high competition, which have cut into profit margins. Toyota has also suffered with high raw materials costs, both inside Japan and in its other operations worldwide. It is important for the company to do well in North America, because it accounts for about two-thirds of the Japanese car industry’s profits on an operating level. Given Japan’s rapidly aging population and the sluggish economy, Toyota and other Japanese car manufacturers will have to do well in the United States to survive.

Toyota services U.S. markets through significant exports from Japan as well as assembly inside North America. Because Canada, the United States, and Mexico are members of the North American Free Trade Agreement, parts and final vehicles can be moved from one country to the other duty-free, as long as the North American content is at least 62.5% of total cost. It has plans to assemble the Tacoma in Mexico; it assembles the Corolla, Matrix, and RX33 in Canada; and it assembles the Corolla, Tacoma, Avalon, Camry, Solera, Tundra, Sequoia, and Sienna in the United States. It is firmly committed to manufacturing cars and trucks in developing countries, especially Thailand, and it is making a big push to assemble in China. It also has plans to expand in South America, probably in Brazil where it already produces the Corolla, and it plans to expand into Russia, which would then join Poland and the Czech Republic as former members of the Soviet Union that have production facilities.

Another factor influencing Toyota’s growth abroad is the opening of the European Union. In 1999, the EU countries finally opened the doors to Asian car makers, and their market share rose from 14.8% to 17.4% at the expense of Ford, GM, Volkswagen, and other European manufacturers. Due to high wages in Europe, which have reached $40.68 per hour for average wages including health-care costs, Asian auto makers are increasingly establishing assembly operations in Eastern Europe, where wages are significantly lower. In Poland, for example, wages are only $8.63 per hour. Thus it appears that Toyota’s strategy of making vehicles in Poland, the Czech Republic, and Russia makes sense. If the sluggish European market can recover, Toyota may have a bright future there.

Questions 1. Why do you think Toyota is expanding so aggressively outside of Japan instead of

focusing more on manufacturing in Japan and exporting to other countries?

2. What are the risks it faces in expanding its overseas manufacturing? 3. Where do you think Toyota should put its next plant in North America, and what factors

should it consider in making that decision?

4.

What are some of the major accounting issues that Toyota faces as it expands its global reach? What are the pros and cons to Toyota of issuing its financial statements according to U.S. GAAP?

Case 1.3: Sinopec’s Global Expansion

Company Profile

China Petroleum & Chemical Corporation (Sinopec Corp) is a China-based energy and chemical company. The Company through its subsidiaries engages in oil and gas and chemical operations in the People's Republic of China (PRC). Oil and gas operations consist of exploring for, developing and producing crude oil and natural gas; transporting crude oil and natural gas by pipelines; refining crude

oil into finished petroleum products; and marketing crude oil, natural gas and refined petroleum

products. Chemical operations include the manufacture and marketing of a range of chemicals for industrial uses. The Company operates in four business segments: exploration and production segment, refining segment, marketing and distribution segment and chemicals segment, and corporate and others.

History

In 1998, the country carried out a great reform in the management of the petroleum and petrochemical industry. According to the principle of separating the government functions from enterprises management, competing in order, China set up two major oil corporations, China Petroleum Corporation and China petrochemical industry Corporation. With the support of state policies and enterprise's efforts, Chinese Government strived to turn these two oil Corporations into a world-famous

multinational corporation that would support the national economic construction with stronger competitiveness and higher prestige in the international market. These two corporations have continuously carried on a series of nationwide reform aiming for the above-mentioned goal since 1998. In October 2000, China petrochemical industry Corporation succeeded in being listed in Hong Kong, London, and New York at the same time after two years of reshuffle and preparation. In August 2001, Sinopec Corp. was successfully listed on the Shanghai Stock Exchange.China Petrochemical Industry was on the way to international capital market from then on.

The Company was incorporated on 25th February, 2000 by China Petrochemical Corporation (hereinafter referred to as \"Sinopec Group\") as the sole initiator, pursuant to the Company Law of the People's Republic of China. Sinopec issued 16.78 billion H shares in Hong Kong, New York and London Stock Exchanges on 18th and 19th October, 2000. The Company floated 2.8 billion A shares in Shanghai Stock Exchange on 16th July, 2001. As of end 2009, the Company's total number of shares were 86.7 billion, of which 75.84% were held by Sinopec Group, 19.35% were shares listed overseas and 4.81% were domestic public shares.

The following table contains the significant events about Sinopec Corp. from 2000 to 2008:

February 28, As the sole initiator, China Petrochemical Corporation (Sinopec Group) 2000 October 18, 2000 incorporated China Petroleum & Chemical Corporation (Sinopec Corp.). Sinopec Corp. made a successful global IPO at Hong Kong, New York and London Stock Exchanges with a total issuance of 16.78 billion H shares (including ADRs in the US). On July 16, 2001, Sinopec Corp. issued 2.8 billion A shares in the PRC market. July 16, 2001 On August 8, 2001, Sinopec Corp. was successfully listed on the Shanghai Stock Exchange. August 24, 2001 2004 October 10, 2006 October 11, 2006 Sinopec Corp. acquired China's New Star Petroleum Company. December 31, Sinopec Corp. acquired chemical assets, catalyst assets and service stations from Sinopec Group and sold down-hole operation assets as a swap. Reform on share-split for A-share was implemented. Capital was injected into Hainan Petrochemical Co., Ltd. to increase its registered capital. Upon the completion of the capital increase, Sinopec Corp. held 75% of the equity interests in Hainan Petrochemical Co., Ltd. Administration Bureau from Sinopec Group. December 31, Sinopec Corp. acquired the oil production assets of Shengli Petroleum 2006 April 17, 2007 Sinopec Corp. issued HK$11.7 billion convertible bonds overseas. December 31, Sinopec Corp. acquired five refineries including Zhanjiang Dongxing from 2007 2008 Sinopec Group. with warrants in PRC market. February 20, On February 20, 2008, Sinopec Corp. issued RMB30 billion convertible bonds On March 4, 2008, bonds and warrants went public on Shanghai Stock Exchange. 【1】 Shares and Bonds: Where They Come From and Where They Go

The Company was established on 25 February 2000 with a registered capital of 68.8 billion domestic state-owned shares with a par value of RMB 1.00 each. Such shares were issued to Sinopec Group Company in consideration for the assets and liabilities of the Predecessor Operations transferred to the Company.

Pursuant to the resolutions passed at an Extraordinary General Meeting held on 25 July 2000 and approvals from relevant government authorities, the Company is authorised to increase its share capital to a maximum of 88.3 billion shares with a par value of RMB 1.00 each and offer not more than 19.5 billion shares with a par value of RMB 1.00 each to investors outside the PRC. Sinopec Group Company is authorised to offer not more than 3.5 billion shares of its shareholdings in the Company to investors outside the PRC. The shares sold by Sinopec Group Company to investors outside the PRC would be converted into H shares.

In October 2000, the Company issued 15,102,439,000 H shares with a par value of RMB 1.00 each, representing 12,521,8,000 H shares and 25,805,750 American Depositary Shares (“ADSs”, each representing 100 H shares), at prices of HK$ 1.59 per H share and US$ 20.5 per ADS, respectively, by way of a global initial public offering to Hong Kong and overseas investors. As part of the global initial public offering, 1,678,049,000 domestic state-owned ordinary shares of RMB 1.00 each owned by Sinopec Group Company were converted into H shares and sold to Hong Kong and overseas investors.

【2】

The proceeds from the issuance of H shares of Sinopec Corp in 2000amounted to RMB 25.802 billion. After deducting the issuance expenses, the net proceeds from the issuance of H shares amounted to RMB 24.326 billion, of which RMB 4.5 billion was used in 2000 for repayment of loans, RMB 13.735 billion was used in 2001, RMB 2.818 billion was used in 2002. In the period convered by this report, RMB 3.273 billion was used, of which RMB 2.273 billion was used for exploration and development and building up production capacity, RMB 540 million was used for the BASF-Yangzi Integrated Site Project, whilst RMB 360 million for the Shanghai Secco Project. As at the date of 31 December 2003, the proceeds from the issuance of H shares were all used up.

【3】

In July 2001, the Company issued 2.8 billion domestic listed A shares with a par value of RMB 1.00 each at RMB 4.22 by way of a public offering to natural persons and institutional investors in the PRC.

【2】

On 25 September 2006, the shareholders of listed A shares accepted the proposal offered by the shareholders of state-owned A shares whereby the shareholders of state-owned A shares agreed to transfer 2.8 state-owned A shares to shareholders of listed A shares for every 10 listed A shares they held, in exchange for the approval for the listing of all state-owned A shares. In October 2006, the 67,121,951,000 domestic state-owned A shares became listed A shares.

【4】

In 2001, the proceeds from the issuance of A shares of Sinopec Corp. amounted to RMB 11.816 billion. Excluding issuance expenses, the net proceeds from the issuance of A shares amounted to RMB 11.8 billion, of which RMB 7.766 billion was used in 2001 mainly for the acquisition of Sinopec National Star and to supplement the Company’s working capital. In 2002, RMB 696 million was used mainly to cover the initial preparation costs of the southwest oil products pipeline project and to build the Ningbo-Shanghai-Nanjing crude oil pipeline. In 2003, RMB 1.514 billion was used, of which RMB

700 million was used for building the southwest oil products pipeline and RMB 814 million was used for building the Ningbo-Shanghai-Nanjing crude oil pipeline. RMB 1.061 billion was used in 2004 for the southwest oil products pipeline project. RMB 611 million was used during this reporting period for the southwest oil products pipeline project. As of 30 June 2005, the proceeds from issuance of A shares were exhausted.

【5】

On 10 May 2007, Sinopec Corp. issued RMB 5 billion 10-year term corporate bonds in the domestic market with a credit rating of AAA and a fixed coupon rate of 4.2% per annum. The proceeds from the issuance will be used to fund Tianjin 1 million tpa ethylene project, Zhenhai 1 million tpa ethylene project, Guangzhou 800 thousand tpa ethylene expansion project, and Jinling 600 thousand tpa PX and aromatics project.

On 13 November 2007, Sinopec Corp. issued RMB 20 billion corporate bonds including RMB 11.5 billion 10-year term corporate bonds with a fixed coupon rate of 5.68% per annum and RMB 8.5 billion 5-year term corporate bonds with a fixed coupon rate of 5.40% per annum. The proceeds from the issuance will be used to fund the Sichuan-to- East China Gas Project.

At the first extraordinary general meeting of shareholders of Sinopec Corp. for 2007 held on 22 January 2007, the proposal relating to the issuance of corporate bonds convertible into overseas shares of Sinopec Corp. was approved. On 24 April 2007, Sinopec Corp. issued HK$11.7 billion zero coupon convertible bonds with a term of 7 years. The proceeds from the issuance were used to repay the foreign currency loans of Sinopec Corp. incurred in connection with the privatization of former Beijing Yanhua Petrochemical Company Limited and former Sinopec Zhenhai Refining & Chemical Company Limited, both of which were previously listed on the Hong Kong Stock Exchange.MAEKET

【6】

ISSURANCE OF HK$11.7 BILLION ZERO CONPON CONVERTIBLE BONDS IN OVERSEA

Name of holder As at 31 December 2008 Number of Bonds held (unit:10,000) Euroclear Clearst ream [2] 7,578,700 4,121,300 On February 20, 2008, Sinope Corp. issued convertible bonds with warrants at amount of RMB 30 billion (“Bonds with Warrants”). The bonds were issued with a term of six years, fixed annual interest rate of 0.8% and 3.03 billion warrants. The warrants are valid for two years with an exercise ratio of 2:1 between warrants and A Share. On March 4, 2008, the bonds and warrants were listed in Shanghai Stock Exchange. The proceeds from issuing bonds will be used for Sichuan- East China Gas Project, Tianjin 1 million tonnes per annum (tpa) ethylene project, Zhenhai 1 million tpa ethylene project and repayment of bank loans. The proceeds from exercise of the warrants will be used for the projects of Tianjin 1 million tpa ethylene project, Zhenhai 1 million tpa ethylene project, Wuhan ethylene project, repayment of bank loans and replenishment of working capital of Sinopec Corp.

During the period of this report(2008), the company issued short-term financing debentures at the amount of RMB 15 billion, which were issued on December 22, 2008. The term was six months and the interest rate was 2.30%. The debentures are targeted on institutional investors on the bond market among Chinese banks (excluding investors prohibited by the law and relevant regulations).

Discussion Question:

1. Why did SNP Corp. choose to list in HongKong, London and New York in 2000?

2. What are possible incentives behind that SNP Corp. listed on the Shanghai Stock Exchange in

2001 since it was listed on three Stock Exchanges in 2000?

3. We know the company listed in HongKong London and New York in 2000, and in Shanghai

in 2001. What do you think the possible reason for company not listing in Shanghai in 2000? 4. How much did Corp raise during 2000 to2001 and where did the fund-raising go?

5. After company used up all the proceeds early from the issuance of H shares and A shares, We

know the company has listed overseas, but why did SNP Corp. only issue bonds in the domestic market? Discuss.

Chapter 2

Case 2.1 Volkswagen Group

The Volkswagen Group adopted International Accounting Standards (IAS, OR IFRS) for its 2001 fiscal year. The following is taken from Volkswagen’s 2001 annual report. It discusses major

differences between the German Commercial Code (HGB) and IAS, as they apply to Volkswagen. General

In 2001 Volkswagen AG has for the first time published its consolidate financial statements in accordance with IAS and the interpretations of the Standing Interpretations Committee (SIC). All mandatory International Accounting Standards applicable to the financial year 2001 were

complied with. The previous year’s figures are also based on those standards. IAS 12 and IAS 39, in particular, were already complied with in the year 2000 consolidated financial statements. The financial statements thus give a true and fair view of the net assets, financial position, and earning performance of the Volkswagen Group.

The consolidated financial statements were drawn up in Euros. Unless otherwise stated, all amounts are quoted in millions of Euros (million Euro currency sigh).

The income statement was produced in accordance with the internationally accepted cost of sales method.

Preparation of the consolidated financial statements in accordance with IAS requires assumptions regarding a number of line items that affect the amounts entered in the consolidated balance sheet and income statement as well as the disclosure of contingent assets and liabilities.

The conditions laid down in Section 292a of the German Commercial Code (HGB) for exemption from the obligation to draw up consolidated financial statements in accordance with German commercial law are met. Assessment of the said condition is based on German Accounting Standard No.1 (DSR 1) published by the German Accounting Standards Committee. In order to ensure equivalence with consolidated financial statements produced in accordance with German commercial law, all disclosures and explanatory notes required by German commercial law beyond the scope of those required by IAS are published.

TRANSTION TO INTERNATIONAL ACCOUNTING STANDARDS

The accounting valuation and consolidation methods previously applied in the financial statements of VOLKSWAGEN AG as produced in accordance with the German Commerical Code have been amended in certain cases by the application of IAS.

Amended accounting, valuation, and consolidation methods in accordance with the German Commercial Code.

I Tangible assets leased under finance leases are capitalized, and the corresponding liability is recognized under liabilities in the balance sheet, provided the risks and rewards of ownership are substantially attributable to the companies of the Volkswagen Group in accordance with IAS 17. II As a finance lease lessor, leased assets are not capitalized, but the discounted leasing installments are shown as receivables.

III Movable tangible assets are depreciated using the straight line method instead of the declining balance method; no half year or multishift depreciation is used. Furthermore, useful lives are now based on commercial substance and no longer on tax law. Special depreciation for tax reasons is not permitted with IAS.

IV Goodwill from capital consolidation resulting from acquisition of companies since 1995 is capitalized in accordance with IAS 22 and amortized over its respective useful life.

V In accordance with IAS 2, inventories must be valued at full cost. They were formerly capitalized only at direct cost within the Volkwagen Group.

VI Provisions are only created where obligations to third parties exist.

VII Difference from the translation of financial statements produced in foreign currencies are not recorded in the income statement.

VIII Medium and long term liabilities are entered in the balance sheet including capital take up costs applying the effective interest method.

Amended accounting , valuation, and consolidation methods that differ from the German Commercial Code.

I In accordance with IAS 38, development costs are capitalized as intangible assets provide it is likely that the manufacture of the developed products will be of future economic benefit to the Volkwagen Group.

II Pension provisions are determined according to the Projected Unit Credit Method as set out in IAS 19, taking account of future salary and pension increases. III Provisions for deferred maintenance may not be created.

IV Medium and long term provisions are shown at their present value.

V Securities are recorded at their fair value, even if this exceeds cost, with the corresponding effect in the income statement.

VI Deferred taxes are determined according to the balance sheet liability method. For losses carried forward deferred tax assets are recognized, provided it is likely that they will be usable. VII Derivative financial instruments are recognized at their fair value, even if it exceeds cost. Gains and losses arising from the valuation of financial instruments serving to hedge future cash flows are recognized by way of a special reserve in equity. The profit or loss from such contracts is not recorded in the income statement until the corresponding due date. In contrast, gains and losses arising from the valuation of derivative financial statements used to hedge balance sheet items are recorded in the income statement immediately. VIII Treasure shares are offset against capital and reserves.

IX Receivalbe and payables denominated in foreign currencies are valued at the middle rate on the balance sheet, and not according to the imparity principle.

X Minority interests of shareholders from outside the Group are shown separately from capital and reserves.

The adjustment of the accounting and valuation policies to IAS with effect from January 1,2000, was undertaken in accordance with SIC 8, with no entry in the income statement, as an

allocation to or withdrawal from revenue reserves, as if the accounts had always been produced in accordance with IAS.

The reconciliation of the capital and reserves to IAS is shown in the following table: Capital and reserves according to the German Commercial Code as at January 1,2000 Capitalization of development costs Million euro 9811 3982 Amended useful lives and depreciation methods in respect of tangible and intangible assets Capitalization of overheads in inventories Different treatments of leasing contracts as lessor Differing valuation of financial instruments Effect of deferred taxes Elimination of special items Amended valuation of pension and similar obligations Amended accounting treatment of provisions Classification of minority interests not as part of equity Other changes Capital and reserves according to IAS as at January 1,2000 3483 653 1962 7 -1345 262 -633 2022 -197 21 20918 Source: Volkwagen AG Annual Report 2001, pp.84-86

REQUIRED

1. Based on the information provided in the chapter, describe the basic features of German

accounting. What developmental factors cause these features?

2. What difference between the accounting requirements in the HGB and IAS are highlighted in

Volkwagen’s disclosure? Are the German requirements consistent with your characterizations in requirement 1?

3. What is the relevance of Volkwagen’s adoption of IAS to the classifications studied in this

chapter?

Case 2.2: General Motors and Japanese Convergence vs. Chinese Convergence

General Motors Corp. is the world’s largest automaker and has led the auto industry worldwide in sales since 1938. GM employs over 324,000 people worldwide, with manufacturing operations in 32 countries and sales operations in 200 countries.

GM operates its own facilities worldwide, but it also has global partners in Italy, Japan, South Korea, Germany, France, and China. In Japan, its global partners are Fuji Heavy Industries Ltd., Isuzu Motors Ltd. and Suzuki Motor Corporation. In China, it has a vehicle manufacturing venture with Shanghai Automotive Industry Corp.

A major challenge that GM faces in both Japan and China is that both have financial reporting and measurement practices that differ from both U.S. GAAP and IFRS issued by the IASB. Assume you have just been hired by GM as an intern, and your first assignment is to research the convergence of China’s financial reporting standards with U.S. or IAS GAAP since 1999. Compare China’s historical path of convergence with Japan’s over the same period of time. What societal values and economic goals have caused the two Asian countries to develop different financial reporting standards? What societal values and economic goals have caused the two Asian countries to develop similar financial reporting standards?

Suggested websites: www.iasplus.com www.asb.or.jp

Chapter 3

Case 3.1: Reporting Standards vs. Tax Standards

The Anglo-American countries tend to have substantial differences between their reporting standards and their tax standards. Yet, little has been done to reconcile these differences because tax law and reporting law have different objectives. However, having two sets of rules requires

that companies keep two sets of books, which is both time-consuming and costly.

Cardon Company, located in the United States, is frustrated with the costs of maintaining two sets of books. After some research, top management noticed that some other countries, such as Japan and Germany, have tax law and reporting standards that closely correlate with each other. Cardon Company does not understand why the United States does not try to adopt a similar system. Does the company have a valid argument? In discussing this question, consider the following questions:

Questions 1. What are the advantages of converging the two systems? 2. What are the disadvantages? 3. What difficulties are likely to arise if such a shift were to take place? 4. Should the Anglo-American countries adopt a similar system?

Case 3.2: Standing on principles

Recent U.S accounting scandals, such as Enron and WorldCom, have caused some to question whether current U.S. generally accepted accounting principles (GAAP) are really protecting

investors. Critics, including the U.S. Securities and Exchange Commission (SEC) , charge that the rule-based approach to U.S. GAAP encourages a check-the-box mentality that inhibits

transparency in financial reporting. Some observes express a preference for principles-based standard such as International Financial Reporting Standards Board (FASB) and the SEC have released reports on the feasibility of principles-based accounting standards in the United States. The following appeared in a leading British professional accounting journal:

Ever since the Enron debacle first hit the news, smug U.K. accountants have found a new excuse for feeling superior to their transatlantic cousins. The U.S. Financial Accounting Standards Board’s massive oeuvre have been scoffed at as being merely a whole bunch of rules that

International standards, by way of contrast, are asserted to be based on principles. This essential difference, it is argued, helps to explain why the U.S. profession has got itself into such deep trouble.

Perhaps. But probably not. It certainly seems true that the highly detailed American standards have tended to invite legalistic interpretations and loopholing, whereas the U.K.’s paramount

requirement to present a true and fair view has helped to remind us that accounting is more than a compliance activity. However, it is much too glib to characterize their accounting standards as lacking in principle compared to ours; in terms of their intellectual rigour, American accounting standards compare favourably with any others in the world----

How is it that the U.K. and International Accounting Standards Boards appear to have found

reliable principles on which to base their own standards, principles that have eluded FASB? After conceptual frameworks that are largely to follow them. The answer is that they haven’t. Our

standards aren’t really more principled than the American ones, they are simply less detailed. And even that is changing---both the U.K. and IASB rulebooks have swollen very considerably in recent years, often inspired by the content of the equivalent American standards---

REQUIRED

1. What is the difference between rules-based and principle-based accounting standards and

what are the advantages and disadvantages of each?

2. Why has U.S. GAAP evolved into a rule-based approach? Would principles-based standards

be effective in the United States? Why or why not?

3. What needs to change in the United States to make principles-based standards effective? 4. Are investors and analysts better served by rules-based or principles-based accounting

standards? Why or why not?

Chapter 4

4.1 Does Secrecy Pay?

SIGN OF THE TIMES: TRANSPARENCY AWARDS Prague:Czech Republic1 By Robert Patton

If the “ABN AMRO Signum Temporis Awords for disclosure” had been held in 1994, Seliko probably would not have walked off with a prize.

Back then, an analyst for Atlantik Financial Markets brokerage asked the managers of this Czech food producer to discuss their business plans. Sure, they said—for ＄200 an hour.

Several weeks of the analyst’s phone calls finally wore down Seliko’s top brass which eventually met with him free of charge.

Still, the episode is a particularly appalling example of an all-too-common problem: Czech managers are notoriously tight-fisted with company information.

Through events such as the bank’s Signum Temporis (“sign of the time”) awards for best

corporate disclosure, planned for Feb.27 at the Prague Stock Exchange (PSE) Ball, brokers are trying to persuade executives to be more open. Award officials say some Czech companies are finally realizing that to attract more investment, they must let investors know what they’re getting into.

But analysts say many Czech companies continue to frustrate investors’ attempts to obtain such information. Despite the progress made so far, regional rivals Poland an Hungary have left the Czechs in the dust.

Some Czech firms simply give out as little information as possible, analysts say, and others take months to release basic financial data. Still others fail to publicize results.

A company might release new financial data, “but unless you call them, you don't know about it,” said ING Barings analyst Vojtech Kraus. “They’ll just tell investors who happened to come see them that week.”

Some, Czech companies, particularly large conglomerates, may have good intentions but simply aren’t experienced at quickly compiling and disseminating their financial data. Financial-industrial giant Skoda Plzen is good example of this, said Patria Finance analyst Ondrej Datka.

Leaving aside the shady managers with something to hide, many others simply don’t believe it’s important to keep investors informed.

Secretive companies often have managers with attitudes forged during the ’70s and ’80s, said Pavel Kohout, a portfolio manager at ING Investment Management. Under communism, secrecy-not transparency-was the watchword.

The conglomerate Chemapol is the quintessential example of a company run by old dogs who can’t or simply won’t learn new capitalist tricks. They’ve been “used to being opaque since communism,” Kohout said.

Coupon privatization did little to change such attitudes. Many managers find themselves in publicly traded companies against their will.

Many Czech companies “didn’t come to the stock market,” said Datka, “They found themselves on the stock market as a result of privatization.”

By contrast, many Polish and Hungarian firms have issued initial public offerings (IPOs) of stock and so are more concerned with investor satisfaction.

Analysts typically want a balance sheet, profit/loss statement, a cash-flow statement, and basic information about corporate outlook and goals. Legislation and PSE regulations help investors by forcing companies to divulge key financial data.

Every company with tradable securities must publish annual and semiannual reports and send them to the Finance Ministry and Czech Statistical Office. And companies whose stock is traded on the PSE’s primary and secondary markets must also release quarterly financial reports.

But the PSE doesn’t enforce its deadlines strictly enough, said Datka. And some companies submit financial data to the PSE that is timely but “unconsolidated” ——that is, it does not incorporate data for subsidiaries.

That’s not very useful, because in many cases “unconsolidated data don’t mean anything.” Datka said, and consolidated figures often don’t appear until months later..

The semiannual reports to the Ministry of Finance, too, often linger “somewhere on the table of some clerk in the Finance Ministry” for as long as two months before becoming available to the public, complained Milon Miller, project manager for the Prague branch of Consultants PlanEcon.

Investors hope capital-markets reform will stimulate foreign strategic investment into Czech companies and help make them more transparent. Strategic investors are more likely to discipline managers, said Central Europe Privatization Fund President Howard Golden.

Under such owners, secretive executives “would be more transparent or they would be out,” Golden said.

The trend may have already begun. Komercni Banka, SPT Telecom and tram-maker CKD have become more generous, analysts say. In many cases, such firms are providing more information partly to attract investors.

Several analysts said the improvement is steady but incremental. Golden went so far as to say that Czech firms are “light-years ahead of where they were two to three years ago.”

Is Seliko riding this wave of increasing transparency? Well, sort of.

Now that it’s partly owned by the Olpran Group, Seliko wouldn’t try to charge for information, Olpran spokeswoman Marie Logrova insisted.

“We wouldn’t go that far, but the information we’d give out probably wouldn’t be that precise,” she said. “We’d have to check with the other shareholders of Seliko before providing more specific information.”

And who are Seliko’s other shareholders? “I’m not authorized to answer that.”

REQUIRED

1. Describe the financial reporting practices of Czech companies, as characterized in the

newspaper article.

2. What are the likely causes of these practices?

3. How do these practices compare to the reporting requirements identified in the chapter? 4. What are the consequences of these practices for investors, the reporting companies, and

the Prague Stock Exchange?

＿＿＿

1Does Secrecy Pay? By Robert Patton, The Prague Post(February 25,1998) www.praguepost.cz

4.2 Case 1: Small GAAP vs. Large GAAP

4.3

With countries around the world adopting IFRS, many argue that the IASB should tailor its standards to meet the needs of small enterprises. One view is that the board should create standards for SMEs, specifically those that do not have public accountability. Others, however, believe that full IFRS are suitable for all entities. The board also needs to determine which entities the IASB SME standards should be intended for. One view is that public accountability should be the distinguishing factor. Full IFRS, rather than SME IFRS, should be required for companies that are public. Others believe the IASB should set forth characteristics of SMEs and let individual countries determine whether the companies qualify as an SME. Another possibility would be to use a size test to determine the enterprise’s classification.

Questions 1. Should the IASB develop a separate set of standards for SMEs or are existing IFRS

suitable for all companies?

2.

If the IASB does create separate standards, how should the board distinguish between small companies and large companies? Discuss the pros and cons of each method described.

Chapter 5

Case 5 1: Information Access in Mexico

The following Wall Street Journal article discusses the limited access to information in Mexico. Source: The Wall Street Journal, September 10,1998. Reprinted in Emerging Financial Markets, David O.Beim and Charles W.Calomiris, New York, McGraw-Hill/Irwin,2001.p.196.

“MEXICO ISN’T FREE WITH INFORMATION”

In Mexico, information is power. And just try to get your hands on any, be it mundane or profound. Everything from the number of billboards in Mexico City to the details of past presidential lives is closely guarded by government and business. The first line of defense of a Mexican secretary is the phrase “No sabría decirle,”—“I wouldn’t know what to tell you.”

This frustrates everyone from bankers to travel agents. John Donnelly, head of Chase Manhattan Bank here, says the lack of credible credit information has stymied renewed lending growth since the 1994 peso collapse. Iris de Buendía, an agent at the Viajes Wilfer travel agency, says it is nearly impossible to get a straight answer from Mexican airlines on the timing of price promotions. “Everything is always top secret here,” she says, sighing.

This vagueness has deep roots in Mexican history. The Aztecs, who commanded the central valleys of this land from the twelfth century to the fifteenth, kept their vassals in awe with a changing cast of hard-to-understand and unpredictable, but powerful, deities. The Spànish who followed were big on bureaucratic minutiae but rarely shared the details with the people they ruled. For the past 70years, the reigning Institutional Revolutionary Party, or PRI, has worked hard to make sure inconvenient information doesn’t end up in the wrong hands.

In Mexico, powerful people have traditionally kidnapped information,” says historian and novelist Hector Aguilar Camin. “Part of the process of democratization is freeing it.” But, he adds, “there is still a tendency to want to hold it hostage for some kind of benefit.”

History, particularly when it damages the reputations of the living, is closely guarded. When researchers sought to confirm the details of a childhood shooting incident involving former president Carlos Salinas de Gortari, they found newspaper morgues purged of any reference to the event. Nor did they have better luck at the National Archives. The head of security there says a squad of government functionaries arrived to mop up Mr. Salinas’s personal files when he took office in1988.

The debate over access to information has become more explosive with the growth of a free press, the rise of opposition political paries and a big jump in the number of foreign investors doing business here who are demanding more transparency…

Lawmakers haven’t had much better luck, so far, clarifying exactly what happened during the post-1994 bailout of the banking system orchestrated by President Ernesto Zedillo and his team. Finance Ministry officials say they are reluctant to give sensitive information to Congress, citing the country’s bank-secrecy laws which, uniquely, protect not just data on deposits but also on loans. Lawmakers suspect the ministry is trying to protect hundreds of well-connected

businessmen whose bum debts ended up being bought by Mexico’s deposit insurance fund and which will, in the end, be borne by taxpayers.

REQUIRED

1. Discuss at least five characteristics that predict relatively low disclosure levels in Mexico.

Your response should be based on a review of material presented in Chapters 2 and 4 and this chapter, in addition to the previous article.

2. Discuss characteristics or features that predict relatively high disclosure levels in Mexico.

Again, refer to Chapters 2, 4, and 5 for relevant information.

3. Accounting measurement and disclosure practices are improving (from an investor

protection viewpoint) in many emerging market economies. What are some of the recent improvements in these areas in Mexico? Discuss the underlying factors that help explain why the improvements are occurring.

Case 5 2: Alcatel and Lucent (French/United States)

In April and May 2001, Alcatel SA and Lucent Technologies held merger talks which climaxed at an offer of $22.8 billion before falling apart. Alcatel is a longstanding French communications solution provider, focusing on telecommunications and broadband Internet solutions. Lucent Technologies, based in Delaware, is also a communications consulting company, providing solutions to government agencies and corporations. Both Lucent and Alcatel are traded on the NYSE.

Questions: 1. What is Alcatel’s conservatism index when compared with Lucent in 2003? What does it

mean?

2. What is Alcatel’s partial conservatism index for earnings per share? 3. Compare Alcatel’s current ratio and debt-to-equity ratio under French GAAP with the

same ratios under U.S. GAAP. Compare both of these ratios with Lucent’s ratios.

4. If Alcatel were to acquire Lucent in 2003 and record the transaction according to French

GAAP, what would the balance sheet look like? What would happen to the assets, liabilities, and unassigned positive goodwill in the first year of acquisition and in the

subsequent years? How would the balance sheet look different if the acquisition was done with stock instead of cash?

5. If Alcatel were to acquire Lucent in 2003 and record the transaction according to U.S.

GAAP, what would the balance sheet look like? What would happen to the assets, liabilities, and unassigned goodwill in the first year of acquisition and in the subsequent years? How would the balance sheet look different if the acquisition was done with stock instead of cash?

6.

Given the information in the exhibits, would the merger have been a good idea? Do you think $22.8 billion was too much to pay for Lucent? Was it too little?

From Consolidated Financials (French GAAP) Ordinary Shares Basic earnings per share.......................................... 2003($) 2003(€) 2002 (1.84) (1.46) 2001 (3.99) (4.29) From 20-F (US GAAP) Basic earnings per share: (1.84) (1.46) (1.42) (1.42) (3.99) (4.29) (7.31) (4.05) (9.67) (4.26) Net income (loss) before cumulative effect of adoption of ($1.79) new standards Net income (loss)

Alcatel according to French GAAP

($1.79)

Selected Notes to Financial Statements

Alcatel According to U.S. GAAP

LUCENT TECHNOLOGIES INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

September 30,

2003

ASSETS

Cash and cash equivalents $ 3,821 $ 2,4 September 30,

2002

Short-term investments

Receivables, less allowance of $246 in 2003 and $325 in 2002 Inventories

Contracts in process, net Other current assets Total current assets

Property, plant and equipment, net Prepaid pension costs

Goodwill and other acquired intangibles, net

of accumulated amortization of $925 in 2003 and $910 in 2002 Other assets Total assets

LIABILITIES Accounts payable

Payroll and benefit-related liabilities Debt maturing within one year Other current liabilities Total current liabilities

Postretirement and postemployment benefit liabilities

Pension liabilities Long-term debt

Company-obligated 7.75% mandatorily redeemable convertible

preferred securities of subsidiary trust Other liabilities Total liabilities

Commitments and contingencies

8.00% redeemable convertible preferred stock

686 1,511 632 33 1,150 7,833 1,593 4,659 188

1,492 15,765 1,072 1,080 3 2,474 5,015 4,669 2,494 4,439 1,152

1,367 19,136 868 1,526 1,7 1,363 10 1,715 9,155 1,977 4,355 224

2,080 17,791 1,298 1,094 120 3,814 6,326 5,246 2,752 3,236 1,750

1,535 20,845

1,680

$ $ $ $ SHAREOWNERS’ DEFICIT Preferred stock — par value $1.00 per — — share; authorized shares: 250; issued and outstanding: none

Common stock — par value $.01 per share; 42 35 Authorized shares: 10,000; 4,170 issued and 4,169 outstanding shares as of September 30, 2003, and 3,491 issued and 3,490 outstanding shares as of September 30, 2002 Additional paid-in capital 22,252 20,606 Accumulated deficit (22,795) (22,025) Accumulated other comprehensive loss (3,738) (3,350) Total shareowners’ deficit (4,239) (4,734) Total liabilities, redeemable convertible $ 15,765) $ 17,791 preferred stock and shareowners’ deficit

Case 5.3: Hanson and ICI (United Kingdom)

In May 1991, Hanson, the United Kingdom’s most notoriously acquisitive corporation, purchased a 2.8 percent stake in ICI, the United Kingdom’s largest manufacturer and the world’s fourth-largest chemical corporation. Amid speculation about the possibility of a takeover bid, the comparative performance of the two companies was a significant issue because of the claims of the respective management concerning their relative efficiency and success.

From an accounting perspective, it is possible to assess performance in terms of both U.S. and U.K. GAAP because Hanson and ICI are listed in the United States and are required by the SEC, under Form 20-F, to provide reconciliation data. The comparative data below show net income and shareholders’ equity data for the period 1998–2002 in accordance with both U.K. and U.S. GAAP, together with the data for long-term debt.

Questions 1. Calculate the “conservatism” index and returns on equity for Hanson and ICI for the

period 1998–2002 under both U.K. and U.S. GAAP.

2. Does it appear that U.S. GAAP is more or less conservative than U.K. GAAP? What

could be the main reasons for this?

3. To what extent do the results affect your assessments of comparative corporate

performance?

4. Calculate the debt-equity (leverage or gearing) ratio for both corporations under both

U.K. and U.S. GAAPs.

5. To what extent are the results likely to affect your assessment of the comparative riskiness

of investing in Hanson and ICI?

ICI and Hanson: Comparative Data Under U.K. and U.S. GAAP

(in £)

ICI

Net Income

U.K. GAAP U.S. GAAP Shareholders' Equity U.K. GAAP U.S. GAAP Long-term Debt

Hanson Net Income

U.K. GAAP U.S. GAAP Shareholders' Equity U.K. GAAP U.S. GAAP Long-term Debt

1998

83,000,000 (44,000,000)

149,000,000 3,557,000,000 3,144,000,000

338,500,000 365,100,000

1,592,300,000 2,520,600,000 1,007,000,000

1999

252,000,000 53,000,000

244,000,000 3,373,000,000 1,503,000,000

302,200,000 317,900,000

1,847,000,000 2,733,200,000 1,005,700,000

2000

(228,000,000) (456,000,000)

(216,000,000) 2,828,000,000 1,616,000,000

236,400,000 256,700,000

2,420,600,000 3,369,000,000 1,634,100,000

2001

80,000,000 13,000,000

(3,000,000) 2,568,000,000 1,304,000,000

278,800,000 302,300,000

2,720,800,000 3,556,500,000 1,599,300,000

2002

179,000,000 9,000,000

499,000,000 2,805,000,000 1,709,000,000

187,400,000 (628,600,000)

2,660,200,000 2,605,800,000 972,300,000

Chapter 6

Case 6.1: Coca-Cola (United States)

In its 1999 annual report, Coca-Cola describes the impact of foreign exchange on its operations as follows:

“Our international operations are subject to certain opportunities and risks, including currency fluctuations and government actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments and to fluctuations in foreign currencies. We use approximately 60 functional currencies. Due to our global operations, weaknesses in some of these currencies are often offset by strengths in others. In 1999, 1998, and 1997, the weighted-average exchange rates for foreign currencies, and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows:

Year Ended December 1999 31, All currencies Australian dollar British pound Canadian dollar French franc German mark Japanese yen

These percentages do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in exchange on our operating results. Our foreign currency management program mitigates over time a portion of the impact of exchange on net income and earnings per share. The impact of a stronger U.S. dollar reduced our operating income by approximately 4 percent in 1999 and by approximately 9 percent in 1998.

Exchange gains (losses)-net amounted to $87 million in 1999, ($34) million in 1998 and ($56) million in 1997, and were recorded in other income-net. Exchange gains (losses)-net includes the remeasurement of certain currencies into functional currencies and the costs of hedging certain exposures of our balance sheet.”

Questions

1. Which translation methodology or methodologies does Coca-Cola use?

2. Given the methodology it uses, would you expect it to have translation gains or losses in

1997? In 1998? In 1999? Can you find any information in the chapter to help determine its

even 3% (2%) even (2%) (2%) 15% 1998 (9%) (16%) 2% (7%) (3%) (3%) (6%) 1997 (10%) (6%) 4% (1%) (12%) (13%) (10%) actual gains or losses in those years? Were your answers consistent with what actually happened to Coca-Cola during those years?

3. Explain how Coca-Cola could use the translation methodology that it does and still have

exchange gains and losses that show up in income as explained in the last paragraph above.

Case6. 2: Kamikaze Enterprises (Japan)

Ray Addis, chairman of the board of Ace Inc., a medium-sized airplane manufacturing company, had called Frank Anderson into his office to talk about an investment made by Ace in Japan five years ago. Ray was very upset because Ace’s Japanese affiliate, Kamikaze Enterprises, was owned 40 percent by Ace and 60 percent by the Bansha Group, was not doing well. He expected Frank, the CFO of Ace, to explain what was going on. Ray had been involved in marketing all his life, unlike Frank who came up through the finance route.

“How are you doing, Frank?”

“Pretty good, I guess, Ray. I gather from your note that you’re not too pleased with Kamikaze Enterprises.”

“That’s an understatement. In our last set of statements, I noticed that we picked up a dollar loss from Kamikaze for the fifth year in a row. I wouldn’t mind it so much, but that loss reduced our earnings by nearly 40 percent. Why can’t we get that blasted operation in the black? I thought those Japanese were supposed to be cost-efficient. I feel like we’re tapping money down a rat hole.”

“I can understand your concern, Ray, but we’ve gotten a healthy yen dividend from Kamikaze every year since we’ve been in operation. Because the yen keeps strengthening, the dollar equivalent of that dividend goes up every year.”

“I realize that, Frank, but we report in dollars to our shareholders, and I have to explain those foreign exchange losses at the next annual meeting. What am I going to do? I understand that the book value of our investment has been written down to practically nothing because of those losses. Either that operation becomes profitable or we cut loose. Let me know in three weeks what our plan of action should be.”

“OK, Ray. I’ll see what I can do.”

“What a circus,” thought Frank as he walked back to his office. “There’s no way I can explain this situation so that he understands.”

Ace Inc. had entered into the minority joint venture with the Bansha Group to produce small corporate aircraft in Japan. Ace provided the technical expertise and some equity financing. However, the Bansha Group provided most of the funds through debt financing with its bank. The

investment was almost 90 percent debt financed.

Kamikaze Enterprises had actually been quite profitable, increasing yen profits by nearly 25 percent a year. Sales were growing at about the same rate. This growth and high profitability allowed Kamikaze to declare sizable dividends each year. When translated into dollars, however, the yen profits turned into losses, which reduced Ace’s equity investment in Kamikaze. Frank had spoken to the managers of Kamikaze, who did not appear to understand the problem or want to do anything about it. Ace had been offered $50 million for its investment in Kamikaze, which seemed ironic given that the book value on Ace’s books was close to zero.

Frank’s major concern was that he was afraid the problem stemmed from Ace’s accounting policies, not their finance strategies. He decided to talk to his controller to find out what the problem might be and how they could correct it.

Questions

1. Which translation methodology did Ace use to translate Kamikaze’s financial statements into

dollars? Explain how you know that.

2. Assume that Ace uses the other translation methodology allowed by FASB Statement No.52.

How would that change the facts in the case?

3. Which translation methodology do you think Ace should use, and why?

Case 6.3 Managing Offshore Investments: Whose Currency?1

The Offshore Investment Fund (OIF) was incorporated in Fairfield, Connecticut, for the sole purpose of allowing U.S. shareholders to invest in Spanish securities. The fund custodian is the Shady Rest Bank and Trust Company of Connecticut (“Shady Rest”), which keeps the fund’s accounts. The question of which currency to use in keeping the fund’s books in Spanish pesetas, since the fund was a country fund that invested solely in securities listed on the Madrid Stock Exchange. Subsequently, the fund’s auditors stated that, in their opinion, the functional currency should be the U.S. dollar.

EFFECTS OF THE DECISION

The decision to possibly adopt the U.S. dollar as the functional currency for the fund created considerable managerial headaches. For one thing, the work of rewriting and reworking the accounting transactions was a monumental task that delayed the publication of the annual accounts. The concept of the functional currency was a foreign concept in Spain, and the effects of the functional currency choice were not made clear to the managers. Consequently, they continued to manage the fund until late in November without appreciating the impact the currency choice had on the fund’s results.

Additional difficulties caused by the functional currency choice were: 1

This case is based on actual occurrence. The names have been changed to ensure anonymity.

a. Shady Rest, which some ＄300 billion in various funds under management, still had

not developed an adequate multicurrency accounting system. Whereas accounting for a security acquisition would normally be recorded in a simple bookkeeping entry, three entries were now required. In addition, payment for the purchase itself could impact the income statement in the current period.

b. More serious problems related to day-to-day operations. When a transaction was

initiated, the fund manager had no idea of its ultimate financial effect. As an example, during the first year of

Operations, the Fund manager was certain that his portfolio sales had generated a profit

of more than ＄1 million. When the sales finally showed up in the accounts, the transaction gain was offset by currency losses of some ＄7 million!

REASONS GIVEN FOR CHOOSING THE DOLLAR AS FUNCTIONAL

The auditors gave the following reasons for choosing the dollar as the fund’s functional currency:

a. Incorporation in the United States b. Funded with U.S. shareholder capital

c. Dividends determined and paid in U.S. dollars

d. Financial reporting under U.S. GAAP and in U.S. dollars

e. Administration and advisory fees calculated on U.S. net assets and paid in U.S. dollars f. Most expenses incurred and paid in U.S. dollars g. Accounting records kept in U.S. dollars

h. Subject to U.S. tax, S.E.C., and 1940 Exchange Act regulations

Since the fund was set up to invest in Spain, it is assumed that U.S. shareholders are interested in the impact of an exchange rate change on the fund’s cash flows and equity; that is ,the shareholders do not invest in Spanish securities only because of attractive yields, but also are making a currency play that directly affects the measurement of cash flow and equity.

MANAGEMENT’S VIEWPOINT

Management disagreed with the auditors. Following is its rebuttal:

a. Incorporation in the United States with U.S. shareholders. FAS 52 clearly states that

the functional currency should be determined by “the primary economic environment in which that entity operates rather than by the technical detail of incorporation.” Similaly, nowhere does FAS 52 state that the facts that the company has U.S. shareholders and pays dividends in U.S. dollars are relevant. In fact, FAS 52 concerns itself throughout with the firm and its management rather that its shareholders.

b. Financial reporting in U.S. dollars under U.S. GAAP. The auditors fail to

differentiate between reporting currency and functional currency. It is clear that the U.S. dollar should be the reporting currency, but that alone does not mean that the U.S. dollar is the functional currency.

c. Payment of certain expenses in dollars. The payment of expenses in U.S. dollars is

no reason to make the dollar the functional currency. While expenses of some ＄8 million for calendar year 20X3 were incurred in U.S. dollars, income of over ＄100 million was earned in Spanish pesetas.

d. U.S. tax and S.E.C. regulations. These considerations are relevant for the reporting

currency, not the functional currency.

The decisive argument against identifying the dollar as the functional currency is that doing so does not provide information that is, in the words of FAS 52, “generally compatible with the expected economic effect of a rate change on an enterprise’s cash flow and equity.” Specifically, the operating cash flow of the Fund is located entirely in Spain once the initial transfer of funds raised by the issue of capital is made. The Fund buys and sells investments in Spain, and receives all its income from Spain, then realized currency fluctuations are recognized only when money is repatriated to the U.S. The present practice of “realizing” an exchange profit or loss when, for example, cash in Spain is exchanged for an investment purchased in Spain is wrong and misleading.

Consider an example. Suppose that the fund deposits P100,000,000 in a Spanish bank when the exchange rate is P1=＄0.005682. One week later, when the exchange rate is P1=＄0.005618, the fund purchases and pays for an investment of P100,000,000, which it sells for cash on the same day, having decided the investment was unwise. Ignoring transaction costs, the fund has P100,000,000 in cash in Madrid at both the beginning and the end of the week. If the functional currency is Spanish pesetas, there is no realized gain or loss. However, translation to dollars generates an unrealized currency loss of $6,400, which would be realized only when the amount in question is repatriated to the United States. This is analogous to the purchase of a stock whose price later falls. If the U.S. dollar is the functional currency, the transaction in question would result in a realized loss on exchange of $6,400. This result is absurd in terms of any common sense view of cash flow; indeed, it highlights that, given the fund’s purpose, the effect on the reporting of income of adopting the U.S. dollars as the functional currency is equally absurd.

The net asset value of the fund is determined each week in U.S. dollars, and reported to stockholders in U.S. dollars. This is entirely consistent with having the U.S. dollars as the functional currency implies that there is a realistic and practical option on each transaction of moving between the dollar and the Spanish peseta. This assumption is patently wrong; the fund will only repatriate its base capital under two circumstances: (1) liquidation; or (2) as a temporary expedient if Spanish yields fall below U.S. yields.

GENERAL THRUST OF FAS 52

The language of FAS 52 indicates that its authors did not write it with direct reference to a situation such as that of the Offshore Investment Fund, that is, a company that raises money for the single purpose of investing it in a foreign country. FAS 52 seems rather to be written from the viewpoint of an operating holding company owning a separate, distinct foreign operating subsidiary.

FAS 52 defines the functional currency of an entity as the currency of the primary economic environment in which that entity operates. Had the fund been incorporated in Malta and, as a

separate entity, borrowed the funds from its U.S. parent, use of the local currency would have been automatic. If substance is to prevail over from, one must conclude that the Spanish pesetas should still be used.

Paragraph 6 of FAS 52 states, “for an entity with operation that are relatively self-contained and integrated within a particular country, the functional currency generally would be the currency of that country.” This statement reinforces the operational aspect that governs the choice of the functional currency; it is surely wrong to argue that the operations of the fund are conducted anywhere but in Spain.

Paragraph 8 reinforces the contention that “management’s judgment will be required to determine the functional currency in which financial results and relationships are measured with the greatest degree of relevance and reliability.”

Finally, paragraphs 80 and 81 draw a very clear distinction that reinforces our (management’s) contention. Paragraph 80 reads:

In the first class are foreign operations that are relatively self-contained and integrated

within a particular country or economic environment. The day-to-day operations are not dependent upon the economic environment of the parent’s functional currency; the foreign operation primarily generates and expends foreign currency. The foreign currency net cash flows that it generates may be reinvested and converted and distributed to the parent. For this class, the foreign currency is the functional currency.

This definition should be contrasted with paragraph 81, which states:

In the second class … the day-to-day operations are dependent on the economic

environment of the parent’s currency, and the changes in the foreign entity’s individual assets and liabilities impact directly on the cash flows of the parent company in the parent’s currency. For this class, the U.S. dollar is the functional currency.

Since the purpose of single country funds is to create entites of the first rather than the second class, Paragraph 80 precisely describes the operations of the Overseas Investment Fund.

REQUIRED

Based on the arguments presented, what do you think should be the functional currency in this case?

Chapter 7

Case 7 1: Fosters Brewing Group

Fosters Brewing Group, based in Australia, is adopting International Financial Reporting Standards (IFRS). By June 2006, the company must use the Australian equivalent to IFRS for external reporting. One of the major changes is related to recognizing internally generated brand names (see information below).

Note 35 International Financial Reporting Standards (excerpt)

Questions

1. Assuming that $1,700 million of Foster’s intangible assets are internally generated brand

names, how will the statement of financial position look after Fosters implements IFRS? 2. What impact will this revaluation have on Fosters’ financial ratios? Compare the

debt-to-equity and return on equity ratios before and after implementing IFRS.

3. How do you think the revaluation will impact Fosters’ ability to obtain international debt

financing? Equity financing?

Chapter 8

Case 8.1: European Adoption of IFRS

Recently, the European Commission approved a proposal for the members of the European Union to use IFRS for consolidated statements starting in January 2005. Bomfrader, a company in England, is concerned about implementing the new standards into its company. All of its accountants are masters in understanding English Accounting Standards, but do not know much about the new standards that will be implemented in 2005. Imagine you are the CEO of Bomfrader, Mr. Jackson. You call together a meeting with the CFO and the accounting department.

Questions 1. What is your agenda for the meeting? In other words, what issues do you feel are most

important to address?

2. Create a task plan for converging to IFRS. Be sure to include the following:

a. What are the most important things to do first?

b. How will you educate your employees on the new standards?

c. Should you converge to IFRS all at once, implement IFRS standards one by one, or

try to use both standards concurrently until you can switch?

d. What other problems are you likely to face and how can you mitigate them?

Case 8.2: IAS 39

For many, the European Union’s regulation to adopt IFRS as of January 2005 seemed too good to be true. Until this point, the IASB had experienced limited success with regard to actual implementation of their standards. Although most countries supported the efforts of the IASB, many insisted on abiding by their own standards. The European Union’s adoption of IFRS triggered other countries to follow suit and consider adopting IFRS as their national standards. Now, more than 90 countries will be adopting IFRS in 2005.

Although this appears to be a big step for the IASB, the harmonization is not perfect. The European Union has had problems approving all standards for implementation. Specifically, the French and the Italians will not approve IAS 39 unless certain changes are made to its rules. IAS 39, which addresses financial instruments, requires that banks mark their derivative hedge positions to market. The French and Italians argue that this requirement will introduce high levels of false volatility in their earnings because interest rates will be marked to market while the underlying assets will not. The other European nations were against the idea of creating a carved-out standard because they believe it undermines the international standardization project. In spite of these oppositions, the European Commission has created and approved a proposal to carve out two IAS 39 sections—the prohibition of hedge accounting for core deposits and the fair value option. Regarding the proposal, the EU said,

“IAS 39 does not sufficiently take into account the way in which many European banks operate their asset/liability management, particularly in a fixed interest rate environment. The limitation of hedges to either cash flow hedges or fair value hedges and the strict requirements concerning the effectiveness of those hedges make it impossible for those banks to hedge their core deposits on a portfolio basis and would force them to carry out important and costly changes both to their asset/liability management and to their accounting system.... Those provisions of IAS 39, which prevent portfolio hedging of core deposits on a fair value measurement basis, and which can be clearly identified, should not be adopted because they do not meet the conditions set out in Article 3(2) of Regulation (EC) No 1606/2002 and in particular the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions.”

IAS 39 introduces an option to record all financial assets and liabilities at fair value. However, the IASB has recently published an Exposure Draft (a consultation paper) which proposes an amendment to IAS 39 in order to restrict the fair value option contained in the standard. The proposed amendment is a direct response to concerns expressed by the European Central Bank, by prudential supervisors as well as by securities regulators which fear that the fair value option might be used inappropriately. This proposed amendment is currently debated in public and a final version will most likely not be available before the end of 2004. The provisions in IAS 39 relating to that fair value option, which are also distinct and separable from other parts of the standard, should not be considered applicable, because of the uncertainty surrounding the final version of those provisions. As soon as the IASB has completed its work on this issue, and normally no later

than by the end of 2005, the Commission will examine the resulting amendments to IAS 39 with a view to their endorsement, in the light of the conditions set out in Article 3(2).

The proposed “carve out” not only allows fair value hedging of core deposits, but also extends the range of items that can be designated as hedged items and relaxes the effectiveness test requirements for hedges.

Questions 1. Discuss the potential influence that the EU will have over the IASB because of their

decision to adopt IFRS. How does this undermine the goal of the IASB?

2. What are the arguments for the EU adopting IAS 39 as is? 3. What are the arguments for the EU adopting a modified version of IAS 39? 4. Discuss the relative importance of international convergence and country-specific

standards that meet the country’s needs.

5. Do an internet search to determine what the outcome of the situation was. Did the EU

adopt a modified version? Did the IASB modify the statement towards French preferences? (Helpful sites: www.iasb.org and europa.eu.int)