Third Edition Third Edition I N T E INTERNATIONAL R N Capture the Exciting and Vibrant Nature of International Accounting A ACCOUNTING T I O N A L Key Features: A C M D C D A O L I M U #1 1 3 3 6 N 0 4 2 /2 T 8 /1 1 I C www.mhhe.com/doupnik3e Y N A N M G A G Y E L O Doupnik B L K Perera Timothy Doupnik Hector Perera TM Confirming Pages International Accounting Third Edition Timothy Doupnik University of South Carolina Hector Perera Macquarie University ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd ii 22//2244//1111 22::5533 PPMM Rev. Confirming Pages INTERNATIONAL ACCOUNTING, THIRD EDITION Published by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY 10020. Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Previous editions © 2009 and 2007. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on recycled, acid-free paper containing 10% postconsumer waste. 1 2 3 4 5 6 7 8 9 0 QDB/QDB 1 0 9 8 7 6 5 4 3 2 1 ISBN 978-0-07-811095-5 MHID 0-07-811095-5 Vice President & Editor-in-Chief: Kimberly Meriwether David Editorial Director: Stewart Mattson Publisher: Tim Vertovec Executive Editor: Richard T. Hercher, Jr. Senior Administrative Assistant: Janice Hansen Marketing Manager: Dean Karampelas Project Manager: Erin Melloy Design Coordinator: Brenda A. Rolwes Cover Designer: Studio Montage, St. Louis, Missouri Cover Image: © Getty Images RF Buyer: Susan K. Culbertson Media Project Manager: Balaji Sundararaman Compositor: Laserwords Private Limited Typeface: 10/12 Palatino Printer: Quad/Graphics All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Doupnik, Timothy S. International accounting/Timothy Doupnik, Hector Perera.—3rd ed. p. cm. ISBN 978-0-07-811095-5 (alk. paper) 1. International business enterprises—Accounting. I. Perera, M. H. B. II. Title. HF5686.I56D68 2012 657’.96—dc22 2011001155 www.mhhe.com ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd iiii 33//1177//1111 99::4422 AAMM Confirming Pages To my wife Birgit and children Stephanie and Alexander —TSD To my wife Sujatha and daughter Hasanka —HBP ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd iiiiii 22//2244//1111 22::5533 PPMM Confirming Pages About the Authors Timothy S. Doupnik University of South Carolina Timothy S. Doupnik is a Professor of Accounting at the University of South Caro- lina, where he has been on the faculty since 1982, and primarily teaches financial and international accounting. He served as director of the School of Accounting from 2003 until 2010, when he assumed the position of Vice Provost for interna- tional affairs. He has an undergraduate degree from California State University– Fullerton, and received his master’s and Ph.D. from the University of Illinois. P rofessor Doupnik has published exclusively in the area of international accounting in various journals, including T he Accounting Review; Accounting, Orga- nizations, and Society; Abacus; Journal of International Accounting Research; Journal of Accounting Literature; International Journal of Accounting; and Journal of International Business Studies. Professor Doupnik is a past president of the International Accounting Section of the American Accounting Association, and he received the section’s Outstand- ing International Accounting Educator Award in 2008. He has taught or con- ducted research in the area of international accounting at universities in a number of countries around the world, including Brazil, China, Dominican Republic, Fin- land, Germany, and Mexico. Hector B. Perera Macquarie University E meritus Professor Hector Perera is at Macquarie University, Australia. Prior to joining Macquarie University in January 2007, he was at Massey University, New Zealand, for 20 years. He has an undergraduate degree from University of Sri Lanka, Peradeniya, and received his Ph.D. from the University of Sydney, Australia. Professor Perera’s research has dealt mainly with international accounting issues and has been published in various journals, including J ournal of Inter- national Accounting Research; Journal of Accounting Literature; International Jour- nal of Accounting; Advances in International Accounting; Journal of International Financial Management and Accounting; Abacus; Accounting and Business Research; Accounting, Auditing and Accountability Journal; Accounting Education; Aus- tralian Accounting Review; International Journal of Management Education; and Pacific Accounting Review. In an article appearing in a 1999 issue of the Interna- tional Journal of Accounting, he was ranked fourth in authorship of international accounting research in U.S. journals over the period 1980–1996. P rofessor Perera served as chair of the International Relations Committee of the American Accounting Association’s International Accounting Section in 2003 and 2004. He is currently an associate editor for the J ournal of International Accounting Research and on the editorial boards of several other journals. P rofessor Perera has been a visiting professor at a number of universities, including the University of Glasgow in Scotland; NewSouth Wales University, Wollongong University, and Northern Territory University in Australia; Turku School of Economics and Business Administration, and Åbo Akademi University in Finland; Unversiti Teknologi Mara, Malaysia; and University of Shahjah. iv ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd iivv 22//2244//1111 22::5533 PPMM Confirming Pages Preface ORIENTATION AND UNIQUE FEATURES International accounting can be viewed in terms of the accounting issues uniquely confronted by companies involved in international business. It also can be viewed more broadly as the study of how accounting is practiced in each and every country around the world, learning about and comparing the differences in financial reporting, taxation, and other accounting practices that exist across countries. More recently, international accounting has come to be viewed as the study of rules and regulations issued by international organizations—most nota- bly International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). This book is designed to be used in a course that attempts to provide an overview of the broadly defined area of international accounting, but that focuses on the accounting issues related to international busi- ness activities and foreign operations and provides substantial coverage of the IASB and IFRS. T he unique benefits of this textbook include its up-to-date coverage of relevant material; extensive numerical examples provided in most chapters; two chapters devoted to the application of International Financial Reporting Standards (IFRS); and coverage of nontraditional but important topics such as strategic account- ing issues of multinational companies, international corporate governance, and corporate social reporting. This book contains several important distinguishing features: • Numerous excerpts from recent annual reports to demonstrate differences in financial reporting practices across countries and to demonstrate financial reporting issues especially relevant for multinational corporations. • Incorporation of research findings into the discussion on many issues. • Extensive end-of-chapter assignments that help students develop their analyti- cal, communication, and research skills. • Detailed discussion on the most recent developments in the area of interna- tional harmonization/convergence of financial reporting standards. • Two chapters on International Financial Reporting Standards that provide detailed coverage of a wide range of standards and topics. One chapter focuses on the financial reporting of assets, and the second chapter focuses on liabilities, financial instruments, and revenue recognition. (IFRS related to topics such as business combinations, foreign currency, and segment reporting are covered in other chapters.) The IFRS chapters also include numerical examples demon- strating major differences between IFRS and U.S. GAAP and their implications for financial statements. • Separate chapters for foreign currency transactions and hedging foreign exchange risk and translation of foreign currency financial statements. The first of these chapters includes detailed examples demonstrating the accounting for foreign currency derivatives used to hedge a variety of types of foreign cur- rency exposure. • Separate chapters for international taxation and international transfer pricing, with detailed examples based on provisions in U.S. tax law. v ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd vv 22//2244//1111 22::5533 PPMM Confirming Pages vi Preface • A chapter devoted to a discussion of the strategic accounting issues facing mul- tinational corporations, with a focus on the role accounting plays in strategy formulation and implementation. • Use of a corporate governance framework to cover external and internal audit- ing issues in an international context, with substantial coverage of the Sarbanes- Oxley Act of 2002. • A new chapter on corporate social responsibility reporting, which is becoming increasingly more common among global enterprises. CHAPTER-BY-CHAPTER CONTENT C hapter 1 introduces the accounting issues related to international business by following the evolution of a fictional company as it grows from a domestic com- pany to a global enterprise. This chapter provides the context into which the top- ics covered in the remaining chapters can be placed. Chapters 2 and 3 focus on differences in financial reporting across countries and the international convergence of accounting standards. • C hapter 2 presents evidence of the diversity in financial reporting that exists around the world, explores the reasons for that diversity, and describes the problems that are created by differences in accounting practice across coun- tries. In this chapter, we also describe and compare several major models of accounting used internationally. We discuss the potential impact that culture has on the development of national accounting systems and present a simpli- fied model of the reasons for international differences in financial reporting. The final section of this chapter uses excerpts from recent annual reports to present additional examples of some of the differences in accounting that exist across countries. • C hapter 3 focuses on the major efforts worldwide to converge financial report- ing practices with an emphasis on the activities of the International Account- ing Standards Board (IASB). We explain the meaning of convergence, identify the arguments for and against convergence, and discuss the use of the IASB’s International Financial Reporting Standards (IFRS), including national efforts to converge with those standards. T he almost universal recognition of IFRS as a high-quality set of global account- ing standards is arguably the most important development in the world of inter- national accounting. Chapters 4 and 5 introduce financial reporting under IFRS for a wide range of accounting issues. • Chapter 4 summarizes the major differences between IFRS and U.S. GAAP. It provides detailed information on selected IFRS, concentrating on standards that relate to the recognition and measurement of assets—including inventories; property, plant, and equipment; intangible assets; and leased assets. Numeri- cal examples demonstrate the application of IFRS, differences between IFRS and U.S. GAAP, and the implications for financial statements. This chapter also describes the requirements of IFRS in a variety of disclosure and presentation standards. • C hapter 5 focuses on current liabilities, provisions, employee benefits, share- based payment, income taxes, revenue, and financial instruments, including major differences between IFRS and U.S. GAAP. ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd vvii 22//2244//1111 22::5533 PPMM Confirming Pages Preface vii Chapter 6 describes the accounting environment in five economically signifi- cant countries—China, Germany, Japan, Mexico, and the United Kingdom—that are representative of major clusters of accounting system. The discussion related to each country’s accounting system is organized into four parts: background, accounting profession, accounting regulation, and accounting principles and practices. Exhibits throughout the chapter provide detailed information on dif- ferences between each country’s GAAP and IFRS, as well as reconciliations from local GAAP to U.S. GAAP. Chapters 7, 8, and 9 deal with financial reporting issues that are of particular importance to multinational corporations. Two different surveys of business exec- utives indicate that the most important topics that should be covered in an inter- national accounting course are related to the accounting for foreign currency. 1 Because of its importance, this topic is covered in two separate chapters (Chapters 7 and 8). Chapter 9 covers three additional financial reporting topics of particular importance to multinational corporations—inflation accounting, business combi- nations and consolidated financial statements, and segment reporting. Emphasis is placed on understanding IFRS related to these topics. • Chapter 7 begins with a description of the foreign exchange market and then demonstrates the accounting for foreign currency transactions. Much of this chapter deals with the accounting for derivatives used in foreign currency hedging activities. We first describe how foreign currency forward contracts and foreign currency options can be used to hedge foreign exchange risk. We then explain the concepts of cash flow hedges, fair value hedges, and hedge accounting. Finally, we demonstrate the accounting for forward contracts and options used as cash flow hedges and fair value hedges to hedge foreign cur- rency assets and liabilities, foreign currency firm commitments, and forecasted foreign currency transactions. • C hapter 8 focuses on the translation of foreign currency financial statements for the purpose of preparing consolidated financial statements. We begin by examining the conceptual issues related to translation, focusing on the concept of balance sheet exposure and the economic interpretability of the translation adjustment. Only after a thorough discussion of the concepts and issues do we then describe the manner in which these issues have been addressed by the IASB and by the U.S. FASB. We then illustrate application of the two methods prescribed by both standard-setters and compare the results. We discuss the hedging of balance sheet exposure and provide examples of disclosures related to translation. • Chapter 9 covers three additional financial reporting issues. The section on inflation accounting begins with a conceptual discussion of asset valuation and capital maintenance through the use of a simple numerical example and then summarizes the inflation accounting methods used in different countries. The second section focuses on International Financial Reporting Standards related to business combinations and consolidations, covering issues such as the deter- mination of control, the acquisition method, proportionate consolidation, and 1 T. Conover, S. Salter, and J. Price, “International Accounting Education: A Comparison of Course Syllabi and CFO Preferences,” Issues in Accounting Education, Fall 1994; and T. Foroughi and B. Reed, “A Survey of the Present and Desirable International Accounting Topics in Accounting Education,” International Journal of Accounting, Fall 1987, pp. 64–82. ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd vviiii 22//2244//1111 22::5533 PPMM Confirming Pages viii Preface the equity method. The final section of this chapter focuses on International Financial Reporting Standard 8, O perating Segments. C hapter 10 introduces issues related to the analysis of foreign financial state- ments. We explore potential problems (and possible solutions to those problems) associated with using the financial statements of foreign companies for decision- making purposes. This chapter also provides an example of how an analyst would reformat and restate financial statements from one set of GAAP to another. B usiness executives rank international taxation second only to foreign currency in importance as a topic to be covered in an international accounting course. 2 International taxation and tax issues related to international transfer pricing are covered in Chapters 11 and 12. • C hapter 11 focuses on the taxation of foreign operation income by the home- country government. Much of this chapter deals with foreign tax credits, the most important mechanism available to companies to reduce double taxation. This chapter provides a comprehensive example demonstrating the major issues involved in U.S. taxation of foreign operation income. We also discuss benefits of tax treaties, translation of foreign currency amounts for tax pur- poses, and tax incentives provided to attract foreign investment. • C hapter 12 covers the topic of international transfer pricing, focusing on tax implications. We explain how discretionary transfer pricing can be used to achieve specific cost minimization objectives and how the objectives of per- formance evaluation and cost minimization can conflict in determining inter- national transfer prices. We also describe government reactions to the use of discretionary transfer pricing by multinational companies, focusing on the U.S. rules governing intercompany pricing. C hapter 13 covers strategic accounting issues of particular relevance to mul- tinational corporations. This chapter discusses multinational capital budgeting as a vital component of strategy formulation and operational budgeting as a key ingredient in strategy implementation. Chapter 13 also deals with issues that must be addressed in designing a process for evaluating the performance of foreign operations. Chapter 14 covers comparative international auditing and corporate gov- ernance. This chapter discusses both external and internal auditing issues as they relate to corporate governance in an international context. Chapter 14 also describes international diversity in external auditing and the international harmo- nization of auditing standards. Chapter 15 introduces the current trend toward corporate social reporting (CSR) by multinational corporations (MNCs). We describe theories often used to explain CSR practices by companies and the motivations for them to engage in CSR practices. We also examine the implications of climate change for CSR. Fur- ther, we discuss some issues associated with regulation of CSR at the international level and identify international organizations that promote CSR, such as Global Reporting Initiative (GRI). Finally, we provide examples of actual CSR practices by MNCs. 2 Ibid. ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd vviiiiii 22//2244//1111 22::5533 PPMM Rev. Confirming Pages Preface ix SUPPLEMENTARY MATERIAL International Accounting is accompanied by supplementary items for both students and instructors. The Online Learning Center ( www.mhhe.com/doupnik3e ) is a book-specific website that includes the following supplementary materials. For Students: • Chapter Summaries • Learning Objectives • Links to Relevant Sites • Online Quizzing For Instructors: • Access to all supplementary materials for students • Instructor’s Manual • Solutions Manual • PowerPoint Presentations • Test Bank ddoouu1100995555__ffmm__ii--xxvviiiiii..iinndddd iixx 0022//0033//1111 33::0011 PPMM