COMPLIANCE W EEKTHE L E A D I N G I N F O R M A T I O N S .docx

COMPLIANCE W EEK
THE L E A D I N G I N F O R M A T I O N S E R V I C E
ON C O R P O R A T E G O V E R N A N C E , RI SK, A N
D C O M P L I A N C E
S hop Talk: M o v in g From
C o m p lia n c e t o ERM
November 2015 | www.complianceweek.com
By J a c ly n J a e g e r
More and more companies want to build their enterprise risk
man-agement programs, particularly as
emerging risks like cyber-security force their
way on to board agendas. The trick is in get-
ting from your compliance routines of today
to a more coherent ERM program tomorrow.
To debate the finer points of shifting from
a compliance program to ERM, Compli-
ance Week and Workiva recently hosted 10
compliance, risk, and audit professionals in
Orlando for an executive roundtable on the
subject. “Risk management is not a sequence
after compliance,” said Mike Rost, vice
president of vertical solution strategy with
Workiva. “It is its own thing, and every or
ganization is going to come at it differently.
The good news: Most participants said
that they are implementing ERM to some de-

A L S O INSIDE
gree, even if many are still in the early stages.
Some of that effort traces its origins back to
compliance with the Sarbanes-Oxley Act,
plus good internal auditing principles that
require an annual enterprise risk assessment.
Little surprise, then, that numerous partici-
pants said their internal audit departments
still drive their organization’s ERM efforts.
C o n tin u e d o n P ag e 4 6
U.S. Financial
Reporting: How
Are We Doing?
By R o b e r t H e r z
C o m p lia n c e W e e k C o lu m n is t
Earlier this year I gave a guest lecture to a major university,
and met with a group of accounting doctoral stu-
dents informally to discuss their areas of
research and current developments in finan-
cial reporting. I was rather startled (or better
said, taken aback) when student from abroad
asked me the following question: “Why is the
U.S. falling behind in financial reporting?”
N ot only was this stu-
dent questioning whether
the United States is the
leader in financial report-
ing, but doing so in a way
that implied that it is an
accepted fact that the U.S.

reporting system is lagging
behind those in other coun-
tries.
My instinctive reaction
was to correct the student
by stating that, of course
the United States is the leader in financial re-
porting. But instead, I took a deep breath and
decided that I should try to understand why
he believed that the U.S. is falling behind in
financial reporting. So I asked him.
He responded that he believed that we
have been slower than other counties to
adopt advances in financial and corporate
reporting, and cited three things: adoption
of International Financial Reporting Stan-
dards; expanded auditor reporting; and in-
tegrated reporting of financial and key non-
financial information, including information
on environmental, social, and governance
(ESG) issues.
I responded that though there would like-
ly be differing viewpoints among informed
and reasonable people as to whether the
matters he cited are indicative of the United
States falling behind in financial and corpo-
6 NEED TO KNOW
EU Safe H a rb o r in v a lid a te d — w h a t's n e x t fo r g lo
b a l d a ta tra n s fe r rules; a u d it fe e s rising
f o r p u b lic co m p a n ie s; a lo o k a t c h ie f c o m p lia n
c e o ffic e r sa laries; m o re .

2 4 ENFORCEMENT & LITIGATION
T ip s fo r th w a r tin g a Federal Trade C o m m issio n c y b
e r-s e c u rity a c tio n .
3 6 ACCOUNTING & AUDITING
A n in -d e p th lo o k a t th e SEC's n e w , b o ld e r ta k e
on a c c o u n tin g e n fo rc e m e n t.
96S900
eooood
66fr000
L000
.......... .
8 1 0 H O I C K
Robert
Herz
C olum nist
C o n tin u e d o n P a g e 4 0
http://www.complianceweek.com
— [ACCOUNTING & AUDITING}
U.S. Financial Reporting: How Are W e Doing?
Continued from Page 1
rate reporting, or indeed whether any or
all of these represented needed changes in
reporting. I also said that while I support
the goal of a single set of global account-
ing standards for at least listed companies

and favor continued convergence between
U.S. Generally Accepted Accounting
Principles and IFRS, I do not view IFRS
as superior to U.S. GAAP, or vice versa.
I also pointed out that the Public
Company Accounting Oversight Board
continues to consider requiring expand-
ed auditor reporting, and that while I
am proponent of integrated reporting,
many U.S. companies include key non-
financial performance measures in their
earnings releases and Securities and Ex-
change Commission filings, that many
also issue separate sustainability re-
ports, and that the San Francisco-based
Sustainability Accounting Standards
Boards is developing a set of industry-
based standards for voluntary reporting
of material ESG issues and metrics in
SEC filings.
Although I felt I had responded ap-
propriately to the student’s question, his
question and the way he stated it contin-
ued to haunt me a bit. I have been involved
in financial reporting for more than 40
years, both in the U.S. and internation-
ally. I have regarded the United States as
the clear leader in financial reporting. In
my view, we led in the development of
accounting and auditing standards and
corporate disclosure requirements, which
other countries and capital markets then
looked to as the gold standard. O ur SEC
is the largest, and I believe the most ca-

pable, capital markets regulator in the
world.
In my view these factors have contrib-
uted significantly to the United States
having the deepest, most liquid capital
markets in the world, and a place that
continues to be viewed as a safe haven for
investing in a turbulent world. Still, the
student’s question continued to bother
me. Might there be some truth that we
have been slow in recent years to embrace
potentially positive changes and in mod-
ernizing our reporting system, so much
so that we might be falling behind?
So I pondered it some more. Some
thoughts came to mind. First, I think it is
now widely accepted that vital aspects of
our national infrastructure, such as our
highways, bridges, airports, and passen-
ger rail system, are in critical need of re-
pair, rebuilding, and modernization; and
that we have fallen behind those of many
other countries. And while we continue
to have many of the finest universities
and hospitals in the world, I think evi-
dence abounds that the quality and effec-
tiveness of our education and healthcare
systems lag those in many other coun-
tries in terms of measured costs and out-
comes.
So if that is the case with other impor-
tant aspects of national infrastructure,

might it also be possible for our reporting
system? In that regard, I thought further
about whether the three matters cited by
the student, as well as other aspects of fi-
nancial and corporate reporting, might be
indicators of the United States falling be-
hind. And if so, why?
First, on IFRS: my view is that both
U.S. GAAP and IFRS are high-quality
sets of accounting standards, what I call
"capital markets” accounting standards.
Both the U.S. Financial Accounting
Standards Board and the International
Accounting Standards Board have com-
petent board members and staff who con-
duct standard setting through a thorough
and objective due process. While there
are some specific IFRS standards that
I feel are superior to the corresponding
U.S. GAAP standard, there are also cases
where I believe the U.S. GAAP standard
is better.
So overall, while I would like to see
continued convergence between the two
sets of standards-not just for the sake of
convergence, but also to improve both
the comparability and quality of financial
reporting worldwide. O ur not having ad-
opted IFRS is not at all evidence that U.S.
financial reporting is falling behind.
Second, on expanded auditor report-
ing, while it is true that certain other

countries (most notably Britain) have
led the way on this, and that the Interna-
tional Auditing and Assurance Standards
Board and the European Union have
been ahead of the PCAOB in promulgat-
ing requirements for expanded auditor
reporting, I think we will soon see this
in our country.
And finally, on integrated reporting:
Yes, it has become mandated in certain
other countries and voluntarily adopt-
ed by a growing number of companies
around the world. But as discussed in
my February 2015 column, I believe that
the SEC’s current initiative on disclosure
effectiveness provides a real opportu-
nity for enhancing and modernizing the
SEC reporting system through adopt-
ing more of an integrated reporting ap-
proach to organizing and presenting fi-
nancial and non-financial information,
and to incorporating material informa-
tion on ESG issues in SEC filings more
systematically.
We will have to see how this effort by
the SEC progresses, whether it results in
the kinds of changes necessary to improve
and modernize the SEC reporting sys-
tem, and how that will stack up against
those that are evolving in other parts of
the world. So on this important aspect of
our reporting system, I think the jury is
still out as to whether we might be falling

behind.
What about the many other aspects
of our reporting system compared those
in other parts of the world, such as the
quality of auditing and internal controls
over financial reporting, the performance
of audit committees, effective regulatory
In a world where other countries and regions are investing,
innovating, and advancing in critical components o f their
infrastructures, including their financial and corporate reporting
systems, we must be open to changes that improve the quality
and effectiveness of our national infrastructures, including our
reporting system. Otherwise, we do risk falling behind.
40 W W W.CO M PLIANCEW EEK.CO M » 8 8 8 . 5 1 9 .9 2 0
0 NOVEMBER 2015
http://WWW.COMPLIANCEWEEK.COM
review and enforcement, and scrutiny of
corporate information by investors and
financial analysts? Although I believe that
these continue to improve in other parts
of the world, I feel strongly that the U nit-
ed States leads the world in these critical
aspects of reporting.
My conclusion from this exercise is
that overall the United States has not
fallen behind in financial and corporate
reporting. Still, there are plenty of oppor-
tunities to improve and modernize our
reporting system.

At times we do seem to be slower to
adopt changes in reporting than certain
other countries and jurisdictions. I attri-
bute this, at least partly, to the extensive
due process and stakeholder engagement
that our standard setters and regulators
are required to conduct before adopting
major changes in our reporting system.
That is crucial to ensuring that proposed
changes are likely to prove positive and
cost beneficial. I also believe that concerns
by U.S. companies, audit committees, and
auditors over being second-guessed and
potentially becoming subject to enforce-
ment actions and litigation can some-
times, quite understandably, make them
resistant to proposed changes in our re-
porting system.
Similarly, although the enhanced fo-
cus on internal controls has been instru-
mental in raising the quality of financial
reporting in the United States, it has also
upped the cost of implementing changes
in accounting and financial reporting,
which affects both the overall receptivity
to change and the cost-benefit analysis of
proposed changes. And there are always
vested interests that want to maintain the
status quo.
But in a world where other countries
and regions are investing, innovating, and
advancing in critical components of their
infrastructures, including their finan-

cial and corporate reporting systems, we
must be open to changes that improve the
quality and effectiveness of our national
infrastructures, including our reporting
system. Otherwise, we do risk falling be-
hind. ■
Robert Herz was chairman o f the Financial Ac-
counting Standards Board (FASB), from July 2002 to
September 2010. Previously, he was a senior partner
w ith PricewaterhouseCoopers.
Prior to joining FASB, Herz was PricewaterhouseC-
oopers North America theater leader of Professional,
Technical, Risk & Quality and a member of the firm's
Global and U.S. Boards. Fie was also president o f the
PricewaterhouseCoopers Foundation which supports
college and university activities. Fie also served as a
part-tim e member o f the International Accounting
Standards Board. Herz is both a U.S. Certified Public
Accountant and a U.K. Chartered Accountant and a
gold medal w inner on the uniform CPA examination.
Herz joined Price Waterhouse in 1974 upon grad-
RECENT COLUMNS BY ROBERT HERZ
uating from the University of Manchester in England
w ith a B.A. first class honors degree in economics,
graduating top o f his class. He later joined Coopers &
Lybrand becoming its senior technical partner in 1996
and assumed a sim ilar position w ith the merged firm
o f PricewaterhouseCoopers in 1998.
During his distinguished career, Herz headed

Coopers & Lybrand's Corporate Finance Advisory Ser-
vices and served as audit partner on numerous major
clients including AT&T, Dun & Bradstreet, Goldman
Sachs, Shearson Lehman Bros, and Volvo.
He can be reached at [email protected]
com.
Below are recent columns by Compliance Week Columnist
Robert Herz. To read more from Herz, please go to
www.complianceweek.com and select "Columnists" from the
Compliance Week toolbar.
Gleaning Enforcement Insights From Accounting Missteps
A confession from CW colum n ist Robert Herz: He spends tim
e each sum mer reading A ccounting &
A u d itin g Enforcem ent Releases the SEC publishes as p a rt
o f its enforcem ent against corporate mis-
conduct. Herz looks over the various AAERs o f th e last 12
months to pluck o u t com mon them es: more
enforcem ent against individuals, more problem s w ith
revenue, more a tte n tio n to in ternal control.
Published online 08/25/15
Improving EITF to Improve Accounting Practice
FASB's Emerging Issues Task Force turns 30 th is year, and w
ith th a t comes its th ird 10-year review of
h ow th e EITF should consider new accounting issues.
Compliance W eek colum n ist Robert Herz offers
his th o u g h ts on w here the EITF can im prove, in cluding w
h a t issues it addresses and vo tin g practices
to make decisions.
Published online 0 6 /09/15
Tilting Toward IFRS Experiments in the U.S.
Last December, SEC officials raised yet again the idea o f le

ttin g U.S. companies file financial d a ta — ju st
a bit, on a vo lu n ta ry basis— according to Inte rna tional
Financial Reporting Standards. The proposal
was the latest in a long discussion a b o u t w h e th e r to let
U.S. businesses ado pt IFRS. Compliance Week
colum nist Robert Herz examines the current state o f IFRS
debates in corporate accounting and w h a t
m ig h t come next.
New Ideas on Disclosure Reform
Disclosure reform is one o f th e more in tra cta b le problem
s o f corporate re porting. The SEC says it w ill
w o rk to move th a t issue fo rw a rd this year, and inside,
Compliance W eek colum n ist Robert Herz offe rs
his vie w on ho w to reinvigorate th a t project: Aim fo r a
system o f one corporate "e verg ree n" file o f
in fo rm a tio n , w ith real-tim e updates as m aterial events
happen a fte r th a t.
The Ingredients for Good Non-Financial Reporting
Good disclosure begins w ith good standards. That has been
challenging enough fo r finan cial reporting,
and no w investors w a n t even m ore disclosure a b o u t im p
o rta n t non -fina ncial in fo rm a tio n . Compliance
W eek colum n ist Robert Herz ta lks a b o u t th e Su
stainability A ccounting Standards Board (disclosure: he
sits on SASB's board), its e ffo rt to develop disclosure
standards, and ho w th e y can be used to com ple-
m ent finan cial data and satisfy investors.
NOVEMBER 2015 WWW.COMPLIANCEWEEK.COM » 88 8
.519.9200 41

http://www.complianceweek.com
http://WWW.COMPLIANCEWEEK.COM
Copyright of Compliance Week is the property of Wilmington
Group plc and its content may
not be copied or emailed to multiple sites or posted to a listserv
without the copyright holder's
express written permission. However, users may print,
download, or email articles for
individual use.
FEATURE IFRS 16
There may be trouble ahead
A n e w lea se a c c o u n tin g s ta n d a rd is s e t t o b e b
o o n f o r in v e s to rs b u t le a ve s C F O s
w ith a h o s t o f b a la n c e s h e e t c h a lle n g e s , w rite
s Calum Fuller and Richard Crump
S
ir David Tweedie once remarked
that he had never flown on
an aircraft that was on an
airline’s balance sheet. So
irked was Tweedie, one of the
chief architects behind the creation of
international financial reporting standards,
by this that he once quipped that “one o f the
great ambitions before I die” is flying on an
on balance sheet aircraft.

Sixteen years after the IASB’s former
chairman voiced his complaint, the global
accounting standard setter has published
rules that will force companies around the
world to add close to $3tn (£2.07tn) of
leasing commitments to their balance sheets.
The new financial reporting standard,
IFRS 16, ends years of debate over off-
balance sheet finances and will see more
than one in two public companies around
the world recognising leases as new assets
and liabilities for the first time. Heralded as
“one of the most significant developments”
in the history o f IFRS, the new rules will
provide investors with more transparent
and reliable information about a company’s
leasing commitments, without having to
make difficult estimates about a company’s
true level of debt. It will also improve
comparability between companies that lease
and those that borrow to buy.
“These new accounting requirements bring
lease accounting into the 21st Century, ending
the guesswork involved when calculating a
company’s often-substantial lease obligations,”
says Hans Hoogervorst, chair of the LASB.
“The new standard will provide much-needed
transparency on companies’ lease assets and
liabilities, meaning that off balance sheet lease
financing is no longer lurking in the shadows.
Such landmark changes will alter the
balance sheet, income statement and

cashflow statements for companies with
material off balance sheet leases. Indeed,
research by PwC finds the new standard will
see a 13% increase in EBITDA and a 22%
increase in interest-bearing debt.
“For companies in some industries the
impact will be even more stark. For example,
the average expected increases for retail
business are 41% and 98% respectively,” says
James Chalmers, PwC’s UK assurance leader.
Entities that have significant operating
leases, such as lessees of real estate,
large equipment and machinery, and
transportation vehicles, will be most affected
by the standard, which is effective 1 January
2019. Worst hit will be airlines, retailers
and hotel companies which lease property
and aircraft over long periods. By its own
3 0 | financialdirector.co.uk | M a rch 2 0 1 6
calculations, the IASB estimates that future
payments for off-balance sheet leases could
equate to almost 30% of assets on average
(see table, page 33). Indeed, for some airlines,
the value of their off balance sheet leases is
equivalent to more than 100% of the value
of the airline’s total assets.
The negative impact the standard will have
on retailers can be seen instantly from the
impact on Tesco’s accounts with one analyst

suggesting the retailer’s liabilities will go from
£8.6bn to £17.6bn at a stroke (seepage 40).
Broader impacts
There are some exemptions. In particular,
short-term leases of less than 12 months
and leases of low-value assets, such
as personal computers, are exempt
from the requirements. Nevertheless,
finance functions dealing with big lease
commitments will have to commence the
process of collating the necessary data to
accurately reflect their liabilities.
“Companies should not overlook the
broader impact, including systems and data
requirements, loan covenants, distributable
profits and the effect on any targets for
remuneration purposes,” says Chalmers.
IASB sample: number of
companies with most significant
off balance sheet leases by region
The IASB compared the off balance sheet
leases to the total assets o f these 1,022
companies. That analysis indicated that the
prevalence o f off balance sheet leases is very
different for different industries.
The main challenge for finance functions
is ensuring long-term leasing commitments
are matched with economic substance
on the balance sheet, Stephen Herring of
the Institute of Directors’ policy unit tells
Financial Director.

“The loD position is we favour accounts
reflecting the reality of transactions,”
Herring says. Companies will now recognise
a front-loaded pattern of expense for
most leases, even when they pay constant
annual rentals. And the new requirements
introduce a stark dividing line between
leases and service contracts — the former will
be brought on-balance sheet, while service
contracts will remain off-balance sheet.
The accounting changes do not affect cash
flows directly. However, given the scale of
the accounting change, Brian O’Donovan,
UK partner in KPMG’s International
Standards Group, expects that companies
will be keen to understand the size of the
lease liabilities arising from transactions they
enter into between now and 2019.
“No one wants to see accounting drive
business behaviours - the tail shouldn’t wag
the dog. But if accounting consequences are
in the mix when a company is considering a
Leases: W h a t you need to know
What changes in a company's balance
sheet?
IFRS 16 eliminates the classification
of leases as either operating leases or
finance leases for a lessee. Instead all
leases are treated in a similar way to
finance leases applying IAS 17. Leases are
'capitalised' by recognising the present

value of the lease payments and showing
them either as lease assets (right-of-use
assets) or together with property, plant
and equipment.
If lease payments are made over time,
a company also recognises a financial
liability representing its obligation to make
future lease payments.
The most significant effect of the new
requirements in IFRS 16 will be an increase
in lease assets and financial liabilities.
Accordingly, for companies with material
off balance sheet leases, there will be a
change to key financial metrics derived
from the company's assets and liabilities
(for example, leverage ratios).
What does IFRS 16 mean for a
company's income statement?
For companies with material off balance
leases, IFRS 16 changes the nature of
expenses related to those leases.
IFRS 16 replaces the typical straight-
line operating lease expense for those
leases applying IAS 17 with a depreciation
charge for lease assets (included within
operating costs) and an interest expense
on lease liabilities (included within finance
costs). This change aligns the lease
expense treatment for all leases.
Although the depreciation charge
is typically even, the interest expense

reduces over the life of the lease as lease
payments are made. This results in a
reducing total expense as an individual
lease matures.
The difference in the expense profile
between IFRS 16 and IAS 17 is expected
to be insignificant for many companies
holding a portfolio of leases that start and
end in different reporting periods.
Are there any implications for cash
flows?
Changes in accounting requirements do
not change amount of cash transferred
between the parties to a lease.
Consequently, IFRS 16 will not have
any effect on the total amount of cash
flows reported. However, IFRS 16 is
expected to have an effect on the
presentation of cash flows related to
former off balance sheet leases.
IFRS 16 is expected to reduce operating
cash outflows, with a corresponding
increase in financing cash outflows,
compared to the amounts reported
applying IAS 17. This is because, applying
IAS 17, companies presented cash
outflows on former off balance sheet
leases as operating activities.
In contrast, applying IFRS 16, principal
repayments on all lease liabilities are
included within financing activities.

Interest payments can also be included
within financing activities applying IFRS.
March 2016 | financialdirector.co.uk | 31
deal, then the mix will change. For example,
this standard essentially kills sale-and-
leaseback as an ofF-balance-sheet financing
proposition,” he says.
Agree to disagree
CFOs working at companies listed both sides
o f the Atlantic will also likely need to manage
two sets o f accounts for subsidiaries that use
IFRS and US GAAP after the LASB failed to
agree a converged leasing standard w ith US
counterpart FASB.
FASB and the IASB spent ten years
locked in convergence efforts, yet ultimately
agreed to disagree about how corporate lease
customers should report lease expenses on
their income statements. FASB went its own
way — it will require a dual approach that
maintains the distinction between operating
and capital leases - and is due to publish its
own set o f rules in the coming months.
“I f you’re listed in both the US and the
UK, you’ll need to produce two sets of
numbers,” Eddy James, technical manager
at IC A EW ’s financial reporting faculty, tells
Financial Director. “W hat’s on the balance
sheet would be the same; it’s just what goes

into the profit and loss accounts will be
some o f the leases - the ones that used to be
operating leases under the old regime.”
The primary area of difference, he explains,
is on recognising expenses on certain leases.
The end effect is that US businesses are set to
continue w ith a straight-line expense profile,
while IFRS will now be a more front-loaded
expense, something the IASB predicts won’t
" T h e n e w IFR S a n d
U S G A A P s ta n d a r d s
w ill in tr o d u c e
d iffe r e n c e s in t h e
p r o file a n d
p r e s e n ta tio n o f
a n n u a l le a s e
e x p e n s e w h e r e n o n e
c u r r e n tly e x is t"
Brian O'Donovan, KPMG
make a drastic difference for companies,
particularly if they have a big portfolio of
leases at differing points in their lifespans.
The diverged standards will also likely harm
comparability. “It’s ironic that the outcome o f
this long-running convergence project will be
divergence in accounting for common lease
types,” says Donovan. “The new IFRS and US
GAAP standards will introduce differences in
the profile and presentation o f annual lease
expense where none currently exist.”
More widely, the convergence o f standards

between the IASB and FASB has been a
politically charged issue w ith some EU
standard setters and policymakers unhappy
with the LASB’s perceived focus on converging
with US standards. O ne concern for Nigel
Sleigh-Johnson, head of IC A EW ’s financial
reporting faculty, is the need for the EU to
formally endorse the standard before it can
be used by European companies. I would
urge the European Commission to get the
complex process o f endorsement underway as
soon as possible, especially considering that
some businesses may wish to adopt the new
standard early.”
The EU is currently mulling the
endorsement o f another significant reporting
standard, IFRS 9 (seepage 34), and while both
standards will likely be approved, and delay
could ham per companies efforts to adopt.
That, though, is not only a small price
to pay, but one that should not come as a
surprise, ICAS’ director o f technical policy
James Barbour says.
“This shouldn’t be a surprise to anyone
because it’s been so long in the pipeline,”
Barbour tells Financial Director. “We welcome
the fact the IASB has substantively achieved
the one model for dealing with leases. This
makes it more transparent for users o f
accounts, particularly investors, to see the true
level o f debt a company has and the true level
o f the assets.

“For companies, they’ll take the view that
this will come in. There will be a lot o f data
collection and there may even be consideration
as to whether they will still do business as they
currently do,” he adds. “Will they potentially
try to restructure transactions? There is a lot
they will have to consider, but they have until
2019 to get it right.” ■
In d u s try s e c to r N u m b e r o f
co m p an ies
To tal assets
($m )
F u tu re p a y m e n ts
fo r o f f b alan ce
s h e e t leases
( u n d is c o u n t e d )
($m )
F u tu re p a y m e n ts
fo r o ff b alan ce
le a s e s /to ta l
assets
P re sen t v a lu e o f
fu tu re p a y m e n ts
fo r o f f b alan ce
s h e e t leases
(e s tim a te ) ($m )

P re sen t v a lu e o f
fu tu r e p a y m e n ts
o ff b a lan ce
s h e e t lea ses /
to ta l assets
A ir lin e s 5 0 5 2 6 ,7 6 3 1 5 1 ,5 4 9 2 8 .8 % 1 1 9 ,3 8 4 2 2
:7 %
R e ta ile rs 2 0 4 2 , 0 1 9 , 9 5 8 5 7 1 ,8 1 2 2 8 .3 % 4 3 1 ,4 7
3 2 1 .4 %
T ra v e l a n d le is u r e 6 9 4 0 3 ,5 2 4 1 1 5 ,3 0 0 2 8 .6 % 8
3 ,4 9 1 2 0 .7 %
T r a n s p o r t 51 5 8 5 ,9 6 4 9 0 ,5 9 8 1 5 .5 % 6 8 ,1 7 5 1 1
.6 %
T e le c o m m u n ic a t io n s 5 6 2 ,8 4 7 ,0 6 3 2 1 9 ,1 7 8 7
.7 % 1 7 2 ,6 4 4 6 .1 %
E n e r g y 9 9 5 ,1 9 2 ,9 3 8 4 0 0 ,1 9 8 7 .7 % 2 8 7 ,8 5 8 5 .5
%
M e d ia 4 8 1 ,0 2 0 ,3 1 7 7 1 ,7 4 3 7 .0 % 5 5 ,7 6 4 5 .5 %
D is t r ib u to r s 2 6 5 8 1 ,5 0 3 3 1 ,4 1 0 5 .4 % 2 5 ,0 9 2 4
.3 %
I n f o r m a t io n t e c h n o lo g y 5 8 1 ,9 1 1 ,3 1 6 6 9 ,8 7
0 3 .7 % 5 6 ,8 0 6 3 .0 %
H e a lth c a r e 5 5 1 ,8 9 4 ,9 3 3 7 2 ,1 4 9 3 .8 % 5 4 ,3 6 5 2
.9 %

O t h e r s 3 0 6 1 3 , 9 5 9 ,2 2 3 4 0 1 ,7 0 3 2 .9 % 3 0 6 ,7 3 5
2 .2 %
Total 1 ,0 2 2 3 0 ,9 4 3 ,5 0 2 2 ,1 9 5 ,5 1 0 7 .1 % 1 ,6 6 1 ,7 8
7 5 .4 %
M a rc h 2 0 1 6 | financialdirector.co.uk | 33
S
ou
rc
e:
I
A
S
B
Copyright of Financial Director is the property of Contentive
and its content may not be
copied or emailed to multiple sites or posted to a listserv
without the copyright holder's
express written permission. However, users may print,
download, or email articles for
individual use.
FINANCIAL REPORTING
Don't let foreign

currency fluctuations
im pair performance
measurements
Companies need to determine the best approach for translating
financial statements to show true operating performance.
By Mark D. Mishler, CPA
60 I Journal o f Accountancy December 2015
T
he value o f the U.S. dollar rose significantly
from June 2014 to April 2015 compared
w ith other foreign currencies. For U.S.
companies with international operations, that
could have resulted in reduced reported sales and
net income. But the stronger dollar could also have
had an impact on the companies’ internal perfor
mance analyses.
ASC Topic 830, Foreign Currency Matters,
prescribes methods for translating foreign opera-
tions’financial statements into U.S. dollars for
consolidation. But drawing operating performance
conclusions from these U.S. GAAP-translated
financial statements may result in the wrong
conclusions and suboptimal decisions impacting
future financial performance.
For example, the U.S. dollar appreciated 17%
against the euro from an average $1.3695 in the
first quarter o f 2014 to an average $1.1320 in the
first quarter o f 2015. Quarterly averages are the
basis for translating foreign income statements

under U.S. G A A P (Topic 830).
This article ultimately shows that a constant-
dollar income statement presentation may best
illustrate true operating performance and disaggre-
gate the impact of fluctuating foreign currency.
U.S. d o lla rs to b u y o n e e u ro
Weekly and average quarterly exchange rates show
the trend o f the U.S. dollars required to buy one
euro from Jan. 1,2014, through April 1,2015 (see
the chart “Euro/Dollar Exchange Rate”).
Specific information for the income statement
is in ASC Paragraph 830-10-55-11 and ASC
Paragraph 830-30-45-3.
Topic 830 requires translating income statement
accounts at the foreign currency exchange rates on
the recognition date for revenues and expenses. Be-
cause it might be impractical to use the current ex-
change rate for the dates that the numerous income
statement elements are recognized, an appropriately
weighted average foreign currency exchange rate for
the period covered by the income statement may be
used to translate those elements. ►
journalofaccountancy.com December 2015 i 61
FINANCIAL REPORTING
The guidance also applies to accounting
allocations in the income statement, such as

depreciation, amortization, cost o f goods sold from
inventory, and deferred revenues and expenses.
Thus, these allocations are required to be translated
at the foreign currency exchange rates on the date
they are included in revenues and expenses, and
not the rates on the historical dates the related
items originate.
W hile Topic 830 is appropriate for financial
reporting, better tools are available for assessing
business performance.
PERFORMANCE MEASUREMENT
Consider a U.S. entity with operations in Europe.
This company would translate its income statement
using the average foreign currency exchange rate
over the period covered in the income statement.
Euro/dollar exchange rate
1.4500
1.4000
1.3500
1.3000
1.2500
1.2000
1.1500
1.1000

1.0500
1.0000
"x A A' A Ax A. A. A A A A Ado do do do
' V ' V ' V ' V ' V ' ' V , 'V, ' V ' V ' V ' V ' V
.s'
£>• $■ v- <r
v
Euro/U.S. dollar Quarterly average
Source: Mark D. Mishler.
IN BRIEF
■ U.S. GAAP requires U.S. companies
w ith international business to translate
their income statement using average
foreign currency exchange rates.
These translated income statements
are appropriate for financial reporting
purposes but not for measuring
operational performance.
■ income statements in the local
currency are of limited use for
measuring performance because
they make it difficult for the parent
company to calculate efficiency
and profitability metrics. Also, the
overseas business unit may combine
several regional currencies in the local
currency statement.

■ A constant-dollar income statement
is the best approach for measuring
performance because it provides true
operating performance and addresses
foreign currency fluctuations.
To comment on this article or to suggest an idea for another
article, contact Sabine Vollmer, senior editor, at
[email protected]
or 919-402-2304.
62 I Journal of Accountancy December 2015
mailto:[email protected]
U.S. G A A P -tra n s la te d P&L
The U.S. dollar income statement for the first
quarter ended March 31,2015, of a company’s
European operations prepared according to Topic
830 is appropriate for financial reporting purposes
(see the chart “European Operations P& L Trans
lated Into Dollars”).
The income statement in the chart “European
Operations P& L Translated Into Dollars” is not
appropriate for performance measurement because
it is not sufficient for reaching meaningful operat-
ing conclusions and, as a result, could lead to poor
decisions with unfavorable consequences.
The operating performance conclusions from
this income statement are that sales o f $15.2 mil-
lion are below both budget and prior year. Income

is relatively flat, coming in slightly above budget
but slightly below the prior year. It appears that
management may have positively reacted to the
sales decline by aggressively reducing expenses.
Because o f U.S. G A A P’s foreign currency
guidance limitations for operating performance
measurement, a more appropriate approach may
be to evaluate operating performance using local
foreign currency financial statements before transla-
tion into U.S. dollars.
P&L b e fo re tra n s la tio n
The income statement for the first quarter ended
March 31,2015, in euros appears much different
from the one measured in U.S. dollars (see the chart
Drawing operating performance
conclusions from U.S. GAAP-translated
financial statements may result in
suboptimal decisions impacting future
financial performance.
“European Operations P& L Before Translation
Into Dollars”).
Unlike the currency-translated income state-
ment, which showed poor performance, the
operating performance assessment in euros is very
favorable with sales higher than both budget and
the prior year and with gross margin improvement
from cost o f goods sold increasing at a lower rate
than sales. The European operations also achieved

operating leverage from smaller overall cost in-
creases versus revenues, despite operating expenses
growing faster than expectations and faster than
sales. There is not enough information to know
whether the gross margin improvement is due to
product mix or manufacturing expense control, but
it can be concluded that operating expenses are not
being controlled. ►
E u ro p e a n o p e ra tio n s P&L tra n s la te d in to d o lla
rs
First q u a rte r e n d e d M arch 3 1 ,2 0 1 5
(All d o lla r fig u re s in th o u s a n d s ).
$ Variance
fa v /(u n fa v )
% Variance
fa v /(u n fa v )
Actual B udget Prior year V Bud V P Y V Bud V P Y
Sales $ 1 5 ,1 6 8 $ 1 5 ,7 2 3 $ 1 7 ,803 $ (555) $(2,635)
(3.5)% (14.8)%
C ost o f g o o d s sold 12,559 13,160 14,996 601 2,437 4.6%
16.3%
Gross p r o fit 2,609 2,563 2,807 46 (198) 1.8% (7.1)%
% o f sales 17.2% 16.3% 15.8% 0.9% Pt 1.4% Pt
O p e ra tin g expenses 1,121 1,125 1,294 4 173 0.4% 13.4%

O p e ra tin g in c o m e $ 1,488 $ 1,438 $ 1,513 $ 42 $ (25)
3.5% (1.7)%
9.8% 9.1% 8.5% 0.7% Pt 1.3% Pt
Source: M a rk D. M ishler.
journalofaccountancy.com December 2015 i 63
FINANCIAL REPORTING
A constant-dollar income
statement presentation will provide
true operating performance
and disaggregate the impact of
fluctuating foreign currency.
It may appear that using a local currency income
statement for performance analysis would be ideal,
but the approach has the following shortcomings:
■ It can be difficult for the management o f a
parent company to put foreign currency financial
statements into perspective regarding magnitude
and proportion related to other operations and
to the overall business.
■ The income statement is not in U.S. GAAP,
which, in addition to this limitation outright,
could make it more difficult to calculate
efficiency and profitability metrics that rely
on income statement items tied to the balance
sheet and statement of cash flows. Examples are

return on assets, return on equity, and working
capital turns.
■ There could be subtranslations o f other foreign
currencies into euros, such as from Swiss or U.K.
operations, which reduce the purity o f what
appears to be a single currency.
■ It does not explain the overall impact o f foreign
currency changes on the consolidated income
statement, which is required for proper foot-
note disclosure and for public company SEC
management discussion & analysis (M D&A)
disclosure.
■ It would not provide functional department per
formance measurement, such as for the treasury
department that could be responsible for foreign
currency risk management.
CONSTANT-DOLLAR PRESENTATION FOR
PERFORMANCE MANAGEMENT
A performance management approach that will
provide true operating performance and disag-
gregate the impact of fluctuating foreign currency
is a constant-dollar income statement presentation.
In this approach, the comparable budget and
prior-year periods are all translated using the same
current-period foreign currency exchange rate.
Constant-dollar P&L
The constant-dollar income statement for the
period ended March 31,2015, was prepared by
European operations P&L before translation into dollars
First q u a rte r e n d e d M a rch 3 1 ,2 0 1 5

€ Variance
fav/(unfav)
% Variance
fav/(unfav)
Actual Budget Prior year V Bud VPY V Bud VPY
Sales € 1 3 ,4 0 0 € 1 2 ,5 7 5 € 1 3 ,0 0 0 € 825 € 40 0 6.6%
3.1%
C ost o f g o o d s sold 11,095 10,525 10,950 (570) (145)
(5.4)% (1.3)%
Gross p ro fit 2,305 2,050 2,050 255 255 12.4% 12.4%
% o f sales 17.2% 16.3% 15.8% 0.9% Pt 1.4% Pt
O p e ra tin g expenses 990 900 945 (90) (45) (10)% (4.8)%
O p e ra tin g in c o m e € 1,315 € 1,150 € 1,105 € 165 € 210
14.3% 19%
9.8% 9.1% 8.5% 0.7% Pt 1.3% Pt
Source: M a rk D. M ishler.
64 I Journal of Accountancy December 2015
translating all periods at the current quarterly
period foreign currency exchange rate. The rec-

onciliation is between the operating and currency
performance variances, and the reported budget
and prior-year variances are calculated according
to Topic 830 (see the chart “European Operations
P& L Using Constant Exchange Rate”).
The constant-dollar table shows the true operat-
ing performance and the impact o f foreign currency
fluctuations compared with budget and the prior
year. Although this is not U.S. GAAP, it does
provide a better performance measurement format.
Unlike the U.S. GAAP presentation that re-
ported decreasing sales and flat net income growth
compared with budget and the prior year (columns
1 and 2), this constant-dollar table shows strong
sales and net income growth. In addition, unlike
the local-currency income statement, operating
performance is measured in the parent entity’s
reporting currency, the U.S. dollar. Finally, the
impact of foreign currency fluctuation is quantified
in terms o f U.S. dollars.
It also reconciles the performance measurement
reported in the U.S. GAAP presentation translated
into U.S. dollars with the constant-dollar presenta-
tion. This analysis meets both internal operating
performance assessment and quantifies the foreign
currency impact o f SEC M D& A.
INCENTIVE PROGRAM IMPLICATIONS
In addition to measuring operating performance,
other reporting implications are affected by foreign
currency rate fluctuations. Companies design
management and employee incentive systems for

profit sharing contributions, annual bonus pay-
ments, and long-term, share-based awards. For ►
E u r o p e a n o p e r a t i o n s P & L u s i n g c o n s t a n t
e x c h a n g e r a t e
First q u a rte r e n d e d M arch 3 1 ,2 0 1 5
S ta te d a t 1 Q 1 5
a c tu a l FX
B u d g e t v a ria n c e
e x p la in e d b y
fa v /( u n f a v )
PY v a ria n c e
e x p la in e d by
f a v /( u n f a v )
A c tu a l B u d g e t P rio r y e a r O p e r a tio n s FX O p e r a
tio n s FX
Sales $ 1 5 ,1 6 8 $ 1 4 ,2 3 4 $ 1 4 ,7 1 5 $ 9 3 4 $ (1,4 8 9 ) $
4 5 3 $ (3,0 8 8 )
C ost o f g o o d s sold 1 2 ,5 5 9 1 1 ,9 1 4 1 2 ,3 9 5 (6 4 5 ) 1
,2 46 0 6 4 ) 2,601
Gross p ro fit 2 ,6 0 9 2 ,3 2 0 2 ,3 2 0 2 8 9 (2 4 3 ) 2 8 9 (4 8 7
)
% o f sales 17.2% 16.3% 15.8% 0 .9% Pt 1.4% Pt
O p e ra tin g expenses 1,121 1 ,019 1 ,0 7 0 0 0 2 ) 1 06 (51) 2
2 4

O p e ra tin g in c o m e $ 1 ,488 $ 1,301 $ 1 ,2 5 0 $ 187 $ 0 3
7 ) $ 2 3 8 $ (2 6 3 )
9 .8% 9 .1% 8 .5% 0 .7 % Pt 1.3% Pt
t t
R e p o rte d
b u d g e t
v a ria n c e
V a r ia n c e c o m p o n e n ts V a ria n c e c o m p o n e n ts
R e p o rte d
PY v a ria n c e
R e c o n c ilia tio n fa v /( u n f a v ) O p e r a tio n s FX O p e
r a tio n s FX fa v /( u n f a v )
Sales $ (5 5 5 ) $ 9 3 4 $ (1 ,4 8 9 ) $ 4 5 3 $ (3 ,0 8 8 ) $ (2,6 3
5 )
C ost o f g o o d s sold 601 (6 4 5 ) 1 ,246 (164) 2,601 2 ,4 3 7
Gross p r o fit 4 6 2 8 9 (2 4 3 ) 2 8 9 (4 8 7 ) (1 9 8 )
O p e ra tin g expenses 4 0 0 2 ) 106 (51) 2 2 4 173
O p e ra tin g in c o m e $ 5 0 $ 1 87 $ 0 3 7 ) $ 2 3 8 $ (2 6 3 )
$ (25)
Source: Mark D. Mishler.
jo u rn a lo fa c c o u n ta n c y .c o m D e ce m b e r 2015 I 6 5

F IN A N C IA L R E P O R T IN G
Since foreign currency fluctuations
are neither controllable nor
accountable (except for finance
departments and C-level executives
in certain situations), the currency
impact should be excluded from
incentive plans.
About the
author
Mark D. Mishler
([email protected]
edu) is a principal
at CFO Resource
Management in
Morristown, N.J.,
and an adjunct
professor of
accounting and
finance at Seton
Hall University in
South Orange, N.J.
long-term shareholder value, it is important that
incentive programs properly reward controllable
and accountable performance.
Since foreign currency fluctuations are neither
controllable nor accountable (except for finance
departments and C-level executives in certain
situations), the currency impact should be excluded
from incentive plans. These situations are largely
determined by corporate risk tolerance, operating

philosophy, and culture, because these character-
istics also play a role in incentive program design.
This article focuses on foreign currency fluctuation
impacts on measuring operating performance,
without debating the merits of different incentive
program designs.
Some companies structure incentive programs
based on overall consolidated results with the
philosophy that incentivizing internal cooperation
triumphs over separate business operating perfor-
mance that is more controllable at the country level.
Globally, however, there may be foreign country
statutory requirements for profit sharing that
would not coincide with this consolidated incentive
program design.
A potential pitfall o f excluding the impact
o f foreign currency fluctuations from incentive
programs is where country management has some
control and accountability for foreign currency
decisions, especially when the foreign entity can
elect to transact in other currencies. For example,
a German subsidiary that has significant sales to
Swiss customers in Swiss francs may have some
control over sales currency impact by purchasing
materials and entering into contracts where costs
are denominated in Swiss francs.
Lastly, finance and treasury departments may be
accountable for foreign currency hedging programs.
Thus, foreign currency exchange rate fluctuations
should impact their incentive programs. ■
AICPA RESOURCES
JofA a r tic le s

“T h r e e C o m m o n C u r re n c y -
A d ju s t m e n t P itfa lls," Feb. 2012,
p a g e 3 0
" C h e c k lis t: H o w t o M a n a g e
F lu c tu a tio n s in F o re ig n C u r re n c y
Rates," A p r il 2011, p a g e 19
" C u rr e n c y T ra n s la tio n
A d ju s tm e n ts ," J u ly 2 0 0 8 , p a g e 42
" F o u n d in T ra n s la tio n ," F eb. 2007,
p a g e 38
G o t o jo u r n a lo f a c c o u n t a n c y . c o m
t o f in d p a s t a rtic le s .
P u b lic a tio n
Special Issues Related to Foreign
Currency Translation, C e n te r fo r
Plain E n g lis h A c c o u n tin g , tin y u r l.
c o m / p h 5 8 v n k ( m e m b e r lo g in
r e q u ir e d )
CPE s e lf-s tu d y

F o re ig n C u r re n c y Risk
M a n a g e m e n t a n d T ra n s la tio n
(#165342, o n e -y e a r o n lin e access)
IFRS: T h e E ffe c ts o f C h a n g e s in
F o re ig n E x c h a n g e Rates (#159744,
o n e -y e a r o n lin e access)
F or m o r e in f o r m a t io n o r t o m a k e
a p u rc h a s e , g o t o c p a 2 b iz .c o m o r
c a ll t h e I n s titu te a t 8 8 8 -7 7 7 -7 0 7 7
PCPS In t e r n a t io n a l S e rv ic e
C e n te r
T h e P riv a te C o m p a n ie s P ra c tic e
S e c tio n (PCPS) In te r n a tio n a l
S e rv ic e C e n te r p r o v id e s p ra c tic a l
in fo r m a tio n , g u id a n c e , a n d to o ls
t o h e lp CPA fir m s a c h ie v e t h e ir
g o a l o f o b t a i n i n g a n d r e ta in in g
c lie n ts t h a t h a v e in t e r n a tio n a l
s e rv ic e n e e d s a n d a s p ira tio n s .

PCPS m e m b e r s c a n s ig n in t o t h e
In te r n a tio n a l S e rv ic e s C e n te r a t
t in y u r l.c o m /b y jd m a 7 .
6 6 i Journal o f A c c o u n ta n cy D e ce m b e r 2015
Copyright of Journal of Accountancy is the property of
American Institute of Ceritified Public
Accountants and its content may not be copied or emailed to
multiple sites or posted to a
listserv without the copyright holder's express written
permission. However, users may print,
download, or email articles for individual use.
MBA 6601, International Business 1
Course Learning Outcomes for Unit VII
Upon completion of this unit, students should be able to:
9. Compare the accounting concepts of Generally Accepted
Accounting Principles (GAAP) and
International Financial Reporting Standards (IFRS).
Reading Assignment

In order to access the following resource(s), click the link(s)
below:
Fuller, C., & Crump, R. (2016). There may be trouble ahead.
Financial Director, 30–33. Retrieved from
https://libraryresources.columbiasouthern.edu/login?url=http://s
earch.ebscohost.com/login.aspx?direc
t=true&db=bth&AN=113496250&site=ehost-live&scope=site
Herz, R. (2015). U.S. financial reporting: How are we doing?
Compliance Week, 12(142), 39–41. Retrieved
from
Mishler, M. D. (2015). Don’t let foreign currency fluctuations
impair performance measurements. Journal of
Accountancy, 220(6), 60–66.Retrieved from
Click here to view the Unit VII Presentation. Click here to
access a PDF of the presentation, which includes
slide images and audio transcript.

Unit Lesson
International Accounting Issues
In a corporation’s senior management, the finance and
accounting functions fall under the same person. Both
the treasurer and the controller report to the chief financial
officer (CFO). The treasurer is responsible for
finance, while the controller handles the accounting side.
So, what does the controller control? While they are responsible
for accounting standards and procedures,
their job duties go much further. They provide data to evaluate
potential acquisitions abroad, disposition of
assets, managing cash flow, hedging currency, internal auditing,
tax planning, preparation of financial
statements, and assistance in implementing corporate strategy.
A large combination of these duties may only
be found in large multinational enterprises (MNEs), but even
small companies that import or export will have
to occasionally handle foreign currency transactions or conduct
currency hedging strategies.
One of the big headaches that controllers have to deal with is
the differences in the presentation of the
financial information. Under normal conditions, each branch or
subsidiary is required to have a financial
statement completed on their operations so that local taxes are
computed and paid. Each country has its own
type of accounting procedures that an MNE must follow.
Financial statements written in the local language
show financial transactions stated in the local currency. Other
considerations include the statement layout and
the Generally Accepted Accounting Principles (GAAP) provided
by the local government’s comptroller’s office.

UNIT VII STUDY GUIDE
Managing International Operations, Part 2:
Accounting and Financial Issues
earch.ebscohost.com/login.aspx?direct=true&db=bth&AN=1134
96250&site=ehost-live&scope=site
https://online.columbiasouthern.edu/CSU_Content/Courses/Busi
ness/MBA/MBA6601/15L/UnitVII/UnitVII_Presentation.htm
https://online.columbiasouthern.edu/CSU_Content/Courses/Busi
ness/MBA/MBA6601/15L/UnitVII_SlideView_Transcript.pdf
UNIT x STUDY GUIDE

Title
It is important to note that both the United States and global
authorities have organizations that have issued
standardized accounting rules.
(FASB) is the organization that
establishes the accounting standards for the private sector in the
United States. Its rules are the
Generally Accepted Accounting Principles (U.S. GAAP).
Board (IASB) is the organization that
establishes accounting standards for the global community. Its
rules are the International Ffinancial
Reporting Standards (IFRS).
U.S. GAAP is to FASB as IFRS is to IASB. In a few
international countries, neither IFRS nor U.S. GAAP are
required; in a few other international countries, either IFRS or
U.S. GAAP is required. However, as many as
120 countries currently require or permit IFRS use
(Solomonzori, 2013).
Global Convergence to International Standards
Prior to the rise of global capital markets, many foreign
countries accepted U.S. accounting standards as a
qualified substitute. Both the U.S. and other global nations
mutually recognized accounting standards from
the other. Since the 1970s, efforts have been made to harmonize
accounting standards that anyone in the

world could use. Several trends have come together to push this
convergence:
evidenced by over 60 stock markets.
transaction costs in foreign countries.
purposes.
governments for more uniform standards in
financial reporting that are easier to understand.
In the early 2000s, FASB and IASB began working together to
eliminate differences in accounting standards.
While there is some similarity between the two accounting
standards, it is still felt by the U.S. Securities
Exchange Commission that FASB needs to be stringent and
transparent as it relates to U.S. corporations;
characteristics that IASB has yet to embrace for international
MNEs.
Transactions in Foreign Currencies
Subsidiaries and branches that operate in foreign countries must
convert all of their transactions in foreign
currencies to the currency of the home office at the end of the
accounting year. For example, an importer
purchases the service of a freight forwarder to assist with
freight going through customs in the foreign country.
The importer will sell its domestic currency to purchase the

foreign currency of the freight forwarder.
Depending on the fluctuations of the currency, the importer
might gain or lose on the transaction. Those gains
or losses translate into the net income of the importer (Financial
Accounting Standards Board, 1981).
The process of restating those gains or losses into the currency
of the importer is translation. In the United
States, translation is a two-step process. First, for each country
in which the importer was conducting
business, the importer would need to convert the foreign
financial statement to a GAAP financial statement in
U.S. dollars. Second, now that all of the financial statements are
in U.S. dollars, the importer would combine
them into one financial statement. This combination process is
consolidation of all individual operations
(Financial Accounting Standards Board, 1981).
Even in this process, there are similarities between FASB and
IASB. For U.S. companies, this process is
outlined in Financial Accounting Statement Number 52
(Financial Accounting Standards Board, 1981). This
same process is outlined for other global companies in the
International Accounting Standard Number 21
(Deloitte, 2015).
International Financial Issues
Earlier, we discussed the functions that fall under the
accounting side; the treasury side is no less important.
Treasury functions include capital budgeting, cash management,
and foreign exchange risk management.
Capital Budgeting in a Global Context

UNIT x STUDY GUIDE
Title
Every company, big or small, has projects that it would want to
complete if it had the resources to do so.
Some projects increase revenues, some decrease costs, and
some, like capital maintenance expenditures,
allow the company to keep operating. Companies may not have
enough money to pay for all of the projects,
thus they must prioritize them and only finance the top ones that
they can afford. Each project gets its ranking
in one of three ways.
Payback method: One method is to determine how long the
project will take to repay the initial investment.
For example, a project with an investment of $100,000 and an
estimated $20,000 return each year would
have a payback of five years. When compared with other similar
projects, the one with the shortest payback is
preferred. The disadvantages of this method are that it ignores
the benefits after year five and that it ignores
the time value of money.
Net present value method (NPR): This method estimates the free
cash flow for each accounting period of
the project’s economic life and discounts that cash flow by a
specified hurdle rate. The discounted cash flows
must exceed the initial cost of investment, or the project is not

economically viable. The hurdle rate or
discount rate is the expected rate of return for similar projects
with the same amount of risk. An example
would be a small machine costing $75,000 to get it up and
running with an expected free cash flow of $20,000
at the end of each year for five years. If the hurdle rate is 10%,
then NPV is $75,815 or $815 to the positive.
The disadvantages to this method lie in the forecasts.
Forecasting sales and costs is difficult—especially for
factories and plants and especially forecasting 10-20 years into
the future. There is more to forecast and more
to go wrong.
Internal rate of return method: The IRR method is similar to the
NPR method. The difference is the variable
being calculated is the discount rate. The initial investment is
known, and the free cash flow per accounting
period is known. What is not known is the discount rate that
will make the free cash flow equal to the initial
investment. For example, using the previous example, if a small
machine costing $75,000 will generate free
cash flows of $20,000 per year for five years, what is the
discount rate that makes the free cash flow equal to
the initial investment? The answer is 10.42%. Using this method
to compare capital projects will allow the
user to compare discount rates on capital. Higher discount rates
mean more return on your investment.
Again, the main problem with the method is forecasting
revenues and expenses far into the future.
As the methods pertain to global expenditures, it is difficult to
know whether foreign currencies will strengthen
or weaken. Capital projects usually span long periods, and while
domestic capital projects have economic
risk, foreign projects have economic and political risk.

Cash Management
One responsibility of the treasurer is to determine whether
capital project financing should come from internal
sources of funds or external sources of funds such as debt or
equity. Large companies can move resources
and assets between branches and subsidiaries. Internal funds
grow when deferring payment on expenses.
Taxes decline when payments to the parent company are loans
and not dividends. In other words, funds
become available by knowing how to legally declare and
transfer assets.
Foreign Exchange Risk Management
If foreign currencies did not constantly strengthen or weaken,
companies would not need risk management.
However, the movement of currencies in relation to a
company’s domestic currency constantly occurs. A
change in the exchange rate causes a currency risk. That is, a
company may lose money due to foreign
exchange losses. This risk exposure is broken down into three
categories:
Translation exposure: It is normal practice to create financial
statements in the subsidiary’s foreign location.
That means the financial statements post its value in foreign
currency. At the end of the accounting period,
the parent company has to consolidate all of the financial
statements, which means that the foreign currencies
convert into domestic currency. Generally, there is a gain or a
loss from currency translation. That gain or loss
is the translation exposure.

UNIT x STUDY GUIDE
Title
An example would be if a Japanese subsidiary sold some
products to another Japanese company and had a
profit of 1,133,530 yen. At the time of the transaction, the
exchange rate was 113.5300 yen to the dollar. The
parent company, in the United States, would need to consolidate
all financial statements at the end of the
accounting period. When the time came to consolidate, the
yen’s exchange rate was 118.0260 to the dollar.
The parent company would show $9,584.06 profit on its
operating statement and a currency loss of $414.94
under its expenses. In actual practice, the company still has the
original yen in the bank, so the loss is not an
actual loss; it does not become an actual loss until the yen
convert to dollars.
Transaction exposure: Actual transactions that occur between
businesses in the international market can
show losses when payment is made in a devaluing currency.
Transaction exposure is the risk incurred when
exchange rates change for the worse after the financial
obligation has occurred.
For example, a U.S. company sells product to a Japanese
company with payment to be in U.S. dollars upon
delivery. The sales contract calls for a $10,000 price, so the
Japanese company can immediately buy $10,000

in U.S. currency at an exchange rate of 113.530 yen per dollar
or it can wait until closer to delivery. As it turns
out, upon delivery, the exchange rate is 118.0260 yen per
dollar. If the Japanese company waited to buy the
U.S. currency, it would lose 44,960 yen or about $381.
Transaction exposure measures cash (realized) gains
and losses from a change in exchange rate.
Economic exposure: International companies have cash flows
from their different subsidiaries and
branches. These cash flows are subject over time to exchange-
rate fluctuations. For example, a company
with factories in countries with weak currencies will make more
money when it sells its product in countries
with strong currencies. However, if the countries with weak
currencies become strong, and its currency
becomes strong, the product costs will increase. Increasing
product cost will change the value of the cash
flow and even the value of the company itself.
An example of this comes from Volkswagen AG. To take
advantage of the strong euro versus the U.S. dollar,
in 2011, Volkswagen opened an automobile factory in
Chattanooga, TN. Volkswagen found that exporting
cars from Germany to the U.S. was costly. Manufacturing costs
were in euros while revenues were in dollars.
Manufacturing cars in the U.S. cut Volkswagen’s economic
exposure and boosted its earnings (Ramsey,
2011).
Exposure Management
International companies with exposure to foreign currency
exchange have developed sophisticated methods
to protect themselves. The steps are outlined below:

1. Forecast the degree of transaction exposure by currency.
2. Forecast the trend of exchange rates. Short-term trends
(weekly and monthly) are difficult to forecast,
but long-term forecasts (yearly) are easy.
3. Report all currency-exchange purchases when they occur.
This is an advantage of a centralized
organization structure. Have all subsidiaries report their
currency-exchange transactions to a
centralized point.
4. Have the strategic planning department share its plans to
expand subsidiaries in the international
market with the treasury department.
5. Formulate hedging strategies.
Transaction hedging strategies: Have sales contracts denominate
the price and payment in the subsidiary’s
home currency. A secondary plan would be to denominate any
purchases in a weak currency and
denominate any sales in a strong currency. If just the opposite
occurs, the corporate office can take out
forward contracts or spot agreements to balance the inflows and
outflows.
A lead strategy is another transaction hedging strategy that
includes providing incentives to pay early when
collecting receivables. A lag strategy is just the opposite. When
collecting receivables in a foreign currency
that is expected to strengthen, provide incentives to delay
payment. The lead and lag concepts work for
paying off payables as well.

UNIT x STUDY GUIDE
Title
Operational hedging strategies: As described previously in the
Volkswagen example, the strategy is to build
products in countries with weak currencies and sell the product
in countries with strong currencies. In that
manner, costs are lower but revenues are higher.
Another operational hedging strategy is the use of forward
contracts and options, as discussed in the Unit IV
lesson.
Exposure management is a form of risk management that
international companies use to protect themselves
from currency exchange losses.
References
Bank for International Settlements. (2013). Triennial central
bank survey. Retrieved from
http://www.bis.org/publ/rpfx13fx.pdf
Deloitte. (2015). IAS 21–The effects of changes in foreign

exchange rates. Retrieved from
http://www.iasplus.com/en/standards/ias/ias21
Financial Accounting Standards Board. (1981). Statement of
financial accounting standards No. 52. Retrieved
from
http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid
=1218220126851&acceptedDisclaime
r=trueRamsey, M. (2011, May 23). VW chops labor costs in
U.S. The Wall Street Journal. Retrieved
from
http://www.wsj.com/articles/SB10001424052748704083904576
335501132396440
Solomonzori. (2013). Who pays and who free rides?
International free rider reporting standards or
International Financial Reporting Standards. Retrieved from
http://governancexborders.com/tag/ifrs/
95
Journal of the International Academy for Case Studies, Volume
16, Special Issue, Number 1, 2010
ACCOUNTING FOR BUSINESS COMBINATIONS
AND THE CONVERGENCE OF INTERNATIONAL

FINANCIAL REPORTING STANDARDS WITH U.S.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES:
A CASE STUDY
Marianne L. James, California State University, Los Angeles
CASE DESCRIPTION
The primary subject matter of this case concerns changes in
accounting for business
combinations and the convergence of International Financial
Reporting Standards (IFRS) with U.S.
Generally Accepted Accounting Principles (GAAP). The case
focuses on the effect of the changes
on financial statements of global entities, as well as strategic
decisions made by company
executives.
Secondary, continuing significant differences between U.S.
GAAP and IFRS and future
potential developments in accounting for consolidated
multinational entities are explored. This case
has a difficulty level of three to four and can be taught in about
50 minutes. Approximately three
hours of outside preparation is necessary to fully address the
issues and concepts. This case can be
utilized in an Advanced Accounting course, either on the
graduate or undergraduate level to help
students understand changes in and differences between U.S.
GAAP and IFRS. Two sets of questions
address U.S. GAAP and IFRS and include researchable
questions that are especially useful for a
graduate level course. The case has analytical, critical thinking,
conceptual, and research

components. Utilizing this case can enhance students’ oral and
written communication skills.
CASE SYNOPSIS
Financial reporting in the U.S. is changing dramatically.
Consistent with the Securities and
Exchange Commission’s proposed “Roadmap” (SEC, 2008), the
U.S. likely will join the more than
100 nations worldwide that currently utilize International
Financial Reporting Standards (IFRS),
and require the use of IFRS in the U.S.
Because of the globally widespread use of IFRS, multinational
entities with subsidiaries that
prepare IFRS-based financial statements already have to be
knowledgeable about IFRS as well as
the current differences between U.S. GAAP and IFRS.
Fortunately, the Financial Accounting
Standards Board (FASB) and the International Accounting
Standards Board (IASB) are working
96
together to bring about convergence between the two sets of
accounting standards.
Recently, FASB and the IASB issued new and revised several
existing standards that
eliminate many differences between U.S. GAAP and IFRS with
respect to business combinations and

consolidated financial statements. However, some significant
differences persist. Until the SEC
makes a final decision regarding the mandatory use of IFRS,
and during the proposed multi-year
transition period, current and future accounting professionals
must continue to keep abreast of
changes in U.S. GAAP, be knowledgeable about differences
between U.S. GAAP and IFRS, and, at
the same time, prepare for the likely transition to IFRS. In
addition, company executives should be
cognizant of developments that may affect their strategic
decisions as the U.S. moves toward a likely
adoption of IFRS during the next five years.
This case focuses on the effect of changes in financial reporting
for business combinations.
Changes as well as continuing differences between U.S. GAAP
and IFRS are explored. Secondarily,
strategic decisions arising from the changes and the likely
future adoption of IFRS are addressed.
This case, which can be utilized in Advanced Accounting on
either the graduate or undergraduate
level can enhance students’ analytical, technical, critical
thinking, research, and communication
skills.
INTRODUCTION
Financial accounting and reporting in the U.S. is changing
rapidly. During the past six
months, the Financial Accounting Standards Board, the primary
accounting standard setter in the
U.S., issued twelve (12) new standards and launched its on-line
“Accounting Standards
Codification,” which organizes existing GAAP into 90 topics
(FASB, 2009). At the same time, a

significantly more dramatic change is on the horizon for
accounting professionals, company
executives, and financial statement users.
Consistent with the SEC’s 2008 proposal entitled, “Roadmap for
the Potential Use of
Financial Statements Prepared in Accordance With International
Financial Reporting Standards by
U.S. Issuers,” (Roadmap) in approximately five years, public
companies likely will have to utilize
IFRS, instead of U.S. GAAP (SEC, 2008). In fact, some large
global U.S.-based entities are
permitted to early-adopt IFRS starting in 2009. The SEC
expects to reach a final decision regarding
the mandatory adoption of IFRS in 2011 (SEC, 2008).
If the U.S. indeed adopts IFRS as the required standard for
financial accounting and
reporting, the U.S. will join the more than 100 nations
worldwide that currently permit or mandate
the use of IFRS. For example, starting with the 2005 reporting
period, all European public
companies listed on any European stock exchange must prepare
IFRS-based financial statements.
Other nations, such as Canada, are planning to adopt IFRS in
the near future.
Currently, U.S. GAAP and IFRS are not identical. However,
since signing their
Memorandum of Understanding, commonly referred to as the
“Norwalk Agreement,” in 2002, FASB
and the IASB have been working together to develop a set of
high-quality globally acceptable

97
financial accounting standards and to bring about convergence
of U.S. GAAP and IFRS. Since the
Norwalk Agreement was signed, many new and revised
standards issued by FASB and the IASB
have served the purpose of eliminating existing differences.
However, while many differences have
been eliminated, others persist.
Accounting for and reporting by global entities is quite
complex. U.S., as well as
international accounting rules require that a parent company
consolidates its subsidiaries’ financial
statements with the parent company’s financial statements.
Recent standards issued by the IASB
and FASB have eliminated many differences between U.S.
GAAP and IFRS in accounting for
business combinations and financial reporting for consolidated
entities. However, some significant
differences continue to exist.
KLUGEN CORPORATION
Irma Kuhn, CPA, CMA holds the position of Chief Financial
Officer (CFO) of Klugen
Corporation, a global telecommunications company. Klugen is
a consolidated entity headquartered
in the U.S. with four majority-owned European subsidiaries.
The company has expanded primarily
by acquiring majority interest in European companies and holds
between 51% and 70% of the
outstanding voting stock of its subsidiaries. Three of these

subsidiaries were acquired in stages and
consolidated once the company achieved majority ownership.
Consistent with current accounting rules, Klugen consolidates
all four of its subsidiaries. In
addition, Klugen also holds financial interests in several
unconsolidated entities and accounts for
those as investments.
Klugen’s European subsidiaries currently prepare their financial
statements consistent with
International Financial Reporting Standards (IFRS), which are
promulgated by the International
Accounting Standards Board (IASB). Klugen, the parent
company, issues consolidated financial
statements, which include the results of its majority-owned
subsidiaries in conformity with U.S.
GAAP. Preparation of Klugen’s consolidated financial
statements requires that Irma and her staff
convert the subsidiaries’ IFRS-based financial statements into
U.S. GAAP prior to consolidating the
numbers. This process is quite complex and requires many of
the accounting departments’ resources.
Irma is well aware of efforts between the FASB and the IASB to
bring about convergence
between U.S. GAAP and IFRS. She expects that consistent with
the SEC’s “Roadmap,” (SEC, 2008)
within the next five years, U.S. public companies likely will
have to apply IFRS, rather than U.S.
GAAP. Irma welcomes this development and believes that in the
long-run, use of IFRS by the parent
company as well as its subsidiaries will preserve and strengthen
the company’s global financial
competitiveness. In addition, she believes that it will simplify
the accounting and consolidation

process significantly and, in the long-run, reduce financial
reporting costs. She is aware, however,
that in the short-run many challenges, such as conversion of the
accounting and IT systems and
extensive staff training will increase costs. Knowing that the
SEC’s Roadmap proposes a phased-in
98
adoption by public companies between 2014 and 2016, Irma
plans to recommend adoption of IFRS
at the earliest permitted time.
As the person who ultimately is responsible for financial
reporting, Irma is very
knowledgeable about current and proposed changes in U.S.
GAAP as well as IFRS. She knows that
the IASB and FASB have issued new and revised standards
applicable to business combinations that
affect the company’s consolidated financial statements. After in
depths analysis of the new and
revised standards, she determined that many of the past
differences between U.S. GAAP and IFRS
where eliminated when the FASB issues FAS 141 R “Business
Combinations” and FAS 160 “Non-
controlling interest in consolidated financial statements”
(FASB, 2007) and the IASB revised IFRS
3 “Business Combinations” and IAS 27 “Consolidated and
Separate Financial Statements” (IASB,
2008). She also realizes that some significant differences still
persist. Klugen Corporation has

properly adopted FAS 141R and FAS 160 (now codified in
sections 805 and 810 of FASB’s 2009
Standards Codification) for the 2009 fiscal period and its
forthcoming annual report will reflect
those changes.
Irma regularly conducts in-house seminars to instruct her
accounting staff regarding new
developments in financial reporting. In fact, her seminars meet
the Continuing Professional
Education (CPE) sponsor requirements set forth by the National
Association of State Boards of
Accountancy (NASBA) and the Quality Assurance Service
(QAS), which is required by State
Boards of Accountancy and other licencing organizations for the
renewal of CPA, CMA and other
professional certifications.
Irma’s CPE seminars entitled “Financial Reporting Updates” are
always well received by
her staff. During the past six months, Irma already has held
several seminars to inform her staff
regarding IFRS. Those who attended all her seminars are
already familiar with the SEC’s Roadmap
that proposes adoption of IFRS starting in 2014, and also know
about some of the most significant
differences between U.S. GAAP and IFRS.
Since in about five (5) months, Klugen Corporation will issue
its consolidated financial
statements, which will, for the first time, incorporate FAS 160
and FAS 141R, Irma decides to
schedule a seminar on “Business Combinations - Consolidated
Financial Statements” for October
15, 2009. The following is a brief agenda for Irma’s Seminar:

Business Combinations - Consolidated Financial Statements -
Financial Reporting Update
October 15, 2009 - Agenda
1. Review of fundamental concepts of business combinations
and consolidated financial
statements
2. Changes to U.S. GAAP (FAS 141R and FAS 160)
3. Significant continuing differences between U.S. GAAP and
IFRS
4. Developments with potential impact on future fiscal periods
99
5. Questions
The seminar will be highly beneficial for staff members who are
currently involved or
planning to become involved in critical aspects of financial
reporting and also for those who want
to develop their knowledge of IFRS. During the seminar, Irma
distributes several handouts,
including the company’s prior year income statement and
balance sheet for reference.
Table 1
Klugen Corporation
Consolidated Statement of Income
for the year ended December 31, 2008

Numbers are in million (except share amounts)
Operating Revenues
Business service $15,500
Residential service 10,200
Wireless service 18,000 $ 43,700
Operating Expenses
Cost of services (excludes depreciation & amortization) $
15,200
Selling, general, administrative expenses 11,100
Depreciation and amortization 7,150 $ 33,450
Operating Income $ 10,250
Other Income (Expense)
Interest expense (820)
Minority interest (1,010)
Investment income 405 (1,425)
Income Before Income Taxes $ 8,825
Income Tax 3,250
Net Income 5,575

Basic Earnings Per Share $2.08
Diluted Earnings Per Share $1.92
The accompanying notes are an integral part of the consolidated
financial statements
100
Table 2
Klugen Corporation
Consolidated Balance Sheet
December 31, 2008
(Numbers are in millions)
Assets
Current Assets
Cash and cash equivalents $ 519
Accounts receivables (net of allowances of $310) 4,200
Prepaid expenses 400
Other current assets 520
Total Current Assets $ 5,639

Non-Current Assets
Property, plant & equipment (net) 25,600
Goodwill 18,500
Licenses 12,900
Customer relationships (net) 3,100
Investments in non-consolidated entities 1,000
Dividends receivables 300
Other assets 1,200
Total Non-Current Assets $62,600
Total Assets $68,239
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts payable and accrued liabilities 5,200
Advanced billings and deposits 920
Accrued taxes 420
Total Current Liabilities $ 6,540
Non-Current Liabilities
Long-term debt 25,500

Post-retirement benefits 2,300
Deferred taxes 3,200
Total Non-Current Liabilities $31,000
Total Liabilities $37,540
Minority Interest 5,000
101
Table 2
Klugen Corporation
Consolidated Balance Sheet
December 31, 2008
(Numbers are in millions)
Stockholders’ Equity
Common stock ($1 par, 100,000,000 authorized, 60,000,000
issued)
60
Additional paid in capital 13,095
Retained earnings 14,588

Accumulated other comprehensive income (2,044)
Total Stockholders’ Equity 25,699
Total Liabilities and Stockholders’ Equity $68,239
The accompanying notes are an integral part of the consolidated
financial statements.
The Seminar
Agenda Item 1 Fundamental Concepts of Business Combinations
- Consolidated
Financial Statements
During the first part of the seminar, Irma reviews several
fundamental concepts
relating to accounting for business combinations. She
emphasizes that these concepts are
common to both U.S. GAAP and IFRS.
Fundamental Concepts common to both U.S. GAAP and IFRS
‚ The parent company issues consolidated financial statements
that include the results
for all subsidiaries that the company controls.
‚ Control is usually assumed when the parent holds a controlling
financial interest
(generally, more than 50% ownership of the outstanding voting
common stock.
‚ Consolidated financial statements include 100% of the
subsidiaries’ assets, liabilities,
revenue, expense, gains, and losses, even if the subsidiary is
only partially owned.

‚ Subsidiaries’ previously unrecognized assets are identified at
time of business
combination and are recognized in the consolidated financial
statements.
‚ Goodwill is recognized on the consolidated balance sheet if
the acquisition cost
exceeds the fair value of the subsidiaries’ identifiable net
assets.
‚ Goodwill is not amortized, but periodically tested for
impairment.
‚ Non-controlling interest (formerly called minority interest) is
recognized on the
consolidated balance sheet.
102
Agenda Item 2 Changes in U.S. GAAP
Irma discusses the most important changes in accounting and
financial reporting for
consolidated entities consistent with FAS 141R and FAS 160.
She prepares a handout for
the seminar participants, consisting of a comparative table that
contrast the new rules
(effective for the 2009 financial statements) with the prior
rules.

Table 3
Recent Changes to U.S. GAAP - effective 2009 - FAS 141R and
FAS 160
Issue E f f e c t i v e 2 0 0 9 F i n a n c i a l
Statements
Pre-2009 Financial Statements
Subsidiaries’ assets and liabilities All assets and liabilities are
revalued to fair market value at
acquisition date (100%
revaluation).
Assets and liabilities were
revalued based on the parent’s
ownership percentage
Negative goodwill Recognized as gain for year of
acquisition.
Recognized as a proportionate
reduction of long-term assets.
Balance sheet classification of non-
controlling interest (NCI)
NCI is classified as equity. NCI is recognized as liability,
equity, or between liabilities and
equity.
Income statement presentation of
NCI’s share of income
Presented as a separate deduction
from consolidated income to

derive income to controlling
stockholders.
NCI was presented as part of
“Other income, expenses, gains,
and losses.”
NCI valuation Is carried at fair market value of
subsidiaries’ net assets, multiplied
by NCI percentage.
Carried at book value of
subsidiaries’ net assets, multiplied
by NCI percentage.
Cost of business combinations Direct costs are expensed during
year of acquisition
Direct costs were capitalized as
part of acquisition cost.
In process research and development
(R&D)
Are capitalized at time of
acquisition.
Could be expensed at time of
acquisition.
Acquisition in stages Previously acquired equity interest
is remeasured when acquiring
company achieves control; gain or
loss is recognized in the income
statement.

Measurement was based on
values at time of individual equity
acquisition
Terminology Minority interest is now referred
to as “non-controlling interest.”
The commonly used term was
“minority interest.”
103
Agenda Item 3 Significant Continuing Differences Between
U.S. GAAP and IFRS
Irma highlights continuing significant differences between U.S.
GAAP and IFRS.
This information is particularly important for those staff
members who are involved in the
consolidation process and those who wish to prepare for the
future adoption of IFRS. The
following table represents a handout based on Irma’s
PowerPoint presentation:
Table 4
Summary of Current Differences Between U.S. GAAP and IFRS
Issue U.S. GAAP IFRS
Definition of control Defined as “controlling financial
interest” (ARB 51).

Usually interpreted as majority
voting interest.
Focuses on “power to govern
financial and operating policies”
(IFRS 3, par. 19); The goal is that
activities generate “benefits” for
controlling entity.
Shares considered for determining
control
Only existing voting rights are
considered.
May include exercisable shares.
Calculation of non-controlling
interest (NCI)
NCI interest is measured at fair
value of total net assets and
includes share of goodwill.
Choice between (1) fair value
and (2) proportionate share of fair
value of identifiable net assets.
Calculation of goodwill at time of
acquisition
Goodwill (if it exists) also includes
share attributed to NCI.
If second option is chosen,
goodwill is only attributed to

controlling interest (parent).
Contingencies - initial measurement Contractual contingent
assets or
liabilities are valued at fair market
value. Non-contractual contingent
assets and liabilities that meet the
‘more likely than not’ test are
accounted for consistent with SFAC
6.
Non-contractual assets and
liabilities: If they do not meet ‘more
likely than not test’ are accounted
for consistent with FAS 5.
Recognition of contingent liability:
Contingent liability is recognized
even if it is does not meet the
‘probable’ test if the present
obligation
arises from a past event and is
reliably measured.
104
Table 4
Summary of Current Differences Between U.S. GAAP and IFRS
Issue U.S. GAAP IFRS
Goodwill impairment test Two-step approach: (1) compare

book value of reporting unit to fair
market value of reporting unit; (2) if
book value is larger, impairment is
equal to book value less implied
fair value of goodwill.
One-step approach
Compare book value to larger of
cash generating unit’s (a) fair value
less selling cost and (b) value in use
[value in use = PV of expected
future cash flows].
Agenda Item 4 Developments with Potential Impact on Future
Fiscal Periods
Irma briefly mentions other developments in the consolidation
area. She mentions
that in June 2009, FASB issued FAS 166, “Accounting for
Transfers of Financial Assets,”
and FAS 167, “Amendments to FASB Interpretation No. 46R”
(FASB, 2009). FAS 166
eliminates the concept of qualifying special purpose entities
(SPE); FAS 167 deals with the
consolidation aspects of this elimination. Specifically,
companies with formerly classified
qualifying SPEs must now assess these entities for possible
consolidation.
FAS 167 focuses on control and the primary beneficiary of the
SPE in determining
whether a company, such as Klugen Corp., must consolidate its
SPE. A primary beneficiary
is (1) able to direct activities of the SPE and is required to
absorb significant gains and
losses. A company is assumed to have control if (1) it has the

power to direct activities, (2)
has the most significant impact on the entity’s performance, and
(3) is required to absorb
losses, and benefit from gains (FAS 167, par. 14A-G). Irma
reminds her staff that currently
Klugen Corporation does not have investments in qualifying
SPE’s; thus, the new standards
will not affect the company.
Irma also mentions that in December 2008, the IASB issued
Exposure Draft 10 (ED
10) “Consolidated Financial Statements,” (IASB, 2008), which
proposes a single definition
of control that is very similar to the FAS 167 definition. Once
this exposure draft is finalized,
convergence between U.S. GAAP and IFRS likely will be
further enhanced. Irma promises
to keep her staff informed about developments in that area.
Agenda Item 5 Questions
At the end of the seminar, many questions arise from the staff
and some from the
CEO, who attended the second half of the seminar. Irma
answers as many questions as
possible and promises to prepare a short question/answer
briefing sheet for all those who
105
were present at the seminar. During the seminar she summarizes

the following questions as
shown in the Assignments section.
ASSIGNMENTS
Answer the questions specifically assigned by your instructor.
U.S. GAAP Questions
1. How will adoption of the new accounting standards (FAS
141R and FAS 160) affect Klugen
Corporation’s financial statements in the forthcoming reporting
period?
2. Utilizing the 2008 numbers, prepare (1) a partial income
statement starting at income from
operations and (2) the equity section of the balance sheet
consistent with the requirements
of FAS 141R and FAS 160 (FASB Accounting Standards
Codification sections 805 and
810).
3. How will adoption of FAS 141R and FAS 160 affect Klugen
Corporation’s financial
statements in the long-run?
4. What key financial ratios will be affected by the adoption of
FAS 141R and FAS 160? What
will be the likely effect?
5. What additional estimates have to be made consistent with
the new accounting standards?
6. Could any of the recent and forthcoming changes affect the
company’s acquisition strategies
and potentially its growth?

7. What were FASB’s primary reasons for issuing FAS 141R
and FAS 160? (Research
question)
8. What are qualifying SPEs? Do they exist under IFRS? What
is the effect of FAS 166
eliminating the concept of qualifying SPEs on the convergence
of accounting standards?
9. FASB and IASB recently issued an updated Memorandum of
Understanding. Retrieve the
updated memorandum and identify several issues that the two
standard setting boards are
jointly focusing on to facilitate convergence. (Research
Question)
106
IFRS Questions
1. From the consolidation perspective, what would be the likely
overall effect of adopting IFRS
on the company’s financial statements?
2. What potential effect would arise if Klugen were to select the
option under IFRS 3 to value
non-controlling interest at the proportionate share of its
subsidiaries’ net identifiable assets?
3. Do you believe that an impairment of goodwill would be

more likely under IFRS or under
U.S. GAAP? Why, or why not?
4. What challenges would arise for the accounting staff if the
company adopts IFRS? Do you
believe that he company is making progress toward meeting
some of these challenges?
5. What opportunities would arise for the accounting staff if the
company adopts IFRS?
6. What other (non-staff related) factors should Klugen
Corporation consider prior to adopting
IFRS? Differentiate between advantages and disadvantages.
7. Two of Klugen’s non-consolidated entities regularly grant
stock options to its employees.
How could this affect Klugen’s accounting for these entities
under IFRS?
8. As indicated in the case, Irma previously highlighted some
other significant differences
between IFRS and U.S. GAAP. Research the issue and find
three (3) differences other than
those related to business combinations. You may want to
consider accounting for inventory,
extraordinary items, property, plant and equipment, and
research and development.
9. Assume that the SEC provides a choice in the timing of the
adoption of IFRS. What ethical
issues could arise for the CFO in deciding whether to adopt
IFRS at the earliest possible, or
at a later required date? (Research question)
10. Review comment letters received by the SEC regarding its

Roadmap. List two concerns
mentioned by those offering comments. (Research question)
REFERENCES
Committee on Accounting Procedures (1959). Accounting
Research Bulletin No. 51. Consolidated Financial Statements.
Original Pronouncement. Financial Accounting Standards
Board: Stamford: CT.
107
Financial Accounting Standards Board (2009). FASB
Accounting Standards Codification. Http://www.fasb.org.
Financial Accounting Standards Board (2009). FASB Statement
No. 167. Amendments to FASB Interpretation 46R.
Retrieved on July 7, 2009, from http://www.fasb.org.
No. 166. Accounting for the Transfer of Financial
Assets - an amendment of FASB Statement No. 140. Retrieved
on July 7, 2009, from http://www.fasb.org.
No. 160. Non-Controlling Interest in Consolidated
Financial Statement. Retrieved on January 5, 2008, from
http://www.fasb.org.
No. 141R. Business Combinations. Retrieved on

January 5, 2008, from http://www.fasb.org.
Financial Accounting Standards Board (2002). Memorandum of
Understanding. The Norwalk Agreement. September
18. Retrieved on June 18, 2008, from
fasb.org/newsmemoradum.pdf.
International Accounting Standards Board (2008). ED 10
Consolidated Financial Statements. December 2008. Retrieved
on March 30, 2009, from http://www.iasb.org.
International Accounting Standards Board (2008). International
Financial Reporting Standard No. 3. Business
Combinations. London, England: IASB.
International Accounting Standards Board (2008). International
Accounting Standard No. 27. Consolidated and Separate
Financial Statements. London, England: IASB.
Securities and Exchange Commission (2008). Roadmap for the
Potential Use of Financial Statements Prepared in
Accordance With International Financial Reporting Standards
by U.S. Issuers. Release No.: 33-8982, File No.
S7-27-08. Retrieved on November 19, from
http://www.sec.gov.
108
AUTHOR’S NOTE
This is a fictitious case. Any similarities with real companies,

individuals, and situations are solely
coincidental.
Copyright of Journal of the International Academy for Case
Studies is the property of Dreamcatchers Group,
LLC and its content may not be copied or emailed to multiple
sites or posted to a listserv without the copyright
holder's express written permission. However, users may print,
download, or email articles for individual use.

COMPLIANCE W EEKTHE L E A D I N G I N F O R M A T I O N S .docx

Recommended

Recommended

More Related Content

Similar to COMPLIANCE W EEKTHE L E A D I N G I N F O R M A T I O N S .docx

Similar to COMPLIANCE W EEKTHE L E A D I N G I N F O R M A T I O N S .docx (16)

More from donnajames55

More from donnajames55 (20)

Recently uploaded

Recently uploaded (20)

COMPLIANCE W EEKTHE L E A D I N G I N F O R M A T I O N S .docx