|EXECUTIVE SUMMARY |
| More CPAs are finding themselves working with foreign statements. As progress is made in convergence and harmonization between FASB and the IASB, the interpretation of foreign financial statements should become easier. CPAs in the United States should watch these developments carefully and familiarize themselves with IFRSs.
Users should be ready to adjust their expectations about language, currency, accounting practices, methods and presentation when working with foreign statements.
Even if a company’s statements have been audited, CPAs should be aware that the sophistication and enforcement of accounting rules vary significantly by country.
Approximately half of the countries in the world have adopted international standards for publicly listed companies. Although the United States is not one of them, FASB and the IASB are working on convergence projects.
Many domestic CPA firms can, through their international alliances and networks, help U.S.-based CPAs in business and industry understand foreign financial statements.
Cultural differences often make foreign statements prepared using U.S. GAAP quite different from statements of U.S.-based companies. CPAs should not accept anything at face value.
Susan M. Sorensen, CPA, PhD, has 30 years of public accounting experience and is an assistant professor of accounting, and Donald L. Kyle, CPA, PhD, is a professor of accounting, both at the University of Houston—Clear Lake. Their e-mail addresses are firstname.lastname@example.org and email@example.com , respectively.
Your Monday is off to a reasonably good start. The improvements you made last year to your company’s financial reporting system are paying off. You’re getting data faster and your boss, the president, is delighted with the new reports you created. But this morning’s call is not a request for yet another report.
“Did you see what we’re paying for bearings for the new 800s?” blurts your boss. “Every time we turn around, our domestic supplier hikes prices. I’ve found a new supplier, and it’s for sale.”
“Good,” you reply. “Where is it located?”
“Ukraine,” he says. “And I want you to take a look at its financials. They’re in English.”
If you have not already experienced this situation, you may soon. Globalization, once the exclusive realm of America’s largest companies, is now a reality for companies of all sizes—so all financial managers and CPAs must be prepared to work with foreign financial statements. You may need to include information from foreign statements in your own statements or tax returns, or to rely upon foreign financials when making investment decisions, securing credit or using foreign outsourcing firms. CPAs in industry may find themselves dealing with foreign subsidiaries or working for a subsidiary of a foreign company.
As CPAs, you have expectations about language, currency, accounting practices, methods and presentation when reading and analyzing U.S. GAAP statements. When dealing with foreign or transnational statements—even if they are presumed to be prepared using U.S. GAAP—be ready to adjust your expectations.
When providing statements to foreign users, companies adopt a variety of approaches based on factors such as language, currency and accounting practices. These cover the spectrum from not changing the primary foreign statement at all to preparing primary statements using U.S. GAAP (see exhibit 1). The specific approach may not be obvious and may vary from year to year. The options include:
Doing nothing. If a company chooses to provide its primary statements without making any changes, it often will be apparent because the statements will be written in a foreign language.
Primary statements under U.S. GAAP. Many foreign companies choose to prepare primary statements using U.S. GAAP.
Convenience translation. Companies may translate the language into English, but provide no information about the accounting practices and currency. Volvo’s balance sheet in exhibit 2 is an example of a convenience translation. The currency is the Swedish krona (SEK) and the format does not follow U.S. GAAP.
|| Behind the Numbers |
|Common approaches foreign businesses take when providing financial statements to U.S. investors/creditors.
||Selected items reconciled to U.S. GAAP
||Statements reconciled to U.S. GAAP |
|Primary statements prepared under U.S. GAAP
|Reconciliation to U.S. GAAP (Minimum required by SEC–Form 20-F)
|Secondary statements—country-specific for U.S.**/ Secondary statements—universal
||English/Commonly in English
||U.S./ U.S. or foreign
||U.S. GAAP/ May use IFRS/IAS
||N/A/ No |
*The term foreign does not preclude the possibility that English may be spoken, the company’s primary reporting language may be English, the primary reporting currency may be the U.S. dollar or the foreign company’s statements may be prepared using U.S. GAAP.
**Meets SEC requirements.
Convenience statements. These contain translated language and, often, converted currency. They still lack information CPAs need about accounting practices, the translation method and how the currency was converted. Do not assume they are in or comparable with U.S. GAAP. Even large companies may choose to use convenience statements. Suzuki Motor Corp., for example, prepares statements that show both Japanese yen and U.S. dollars. Amounts are converted to U.S. dollars at the year-end exchange rate.
Limited restatements. These attempt to provide more information by reconciling some significant items to U.S. GAAP. Critics argue they allow companies to selectively choose items that improve their financial picture.
Reconciling to U.S. GAAP. Companies that cross-list their stock on foreign and U.S. exchanges must, at a minimum, prepare a reconciliation of their home-country statements to U.S. GAAP. These companies file Form 20-F in lieu of Form 10-K with the SEC; the filings are available on the SEC Web site at www.sec.gov/edgar.shtml .
Secondary statements. These may be country-specific or universal. A U.S. country-specific secondary statement would be prepared using U.S. GAAP; universal statements may use International Accounting Standards/International Financial Reporting Standards (IASs/IFRSs). (See “ Understanding IASs and IFRSs. ”)
|| Volvo Group Balance Sheet for 2005 |
|Consolidated balance sheet December 31
||Volvo Group |
|Property, plant and equipment
|Assets under operating leases
|Shares and participations
|Long-term customer-financing receivables
|Long-term interest-bearing receivables
|Other long-term receivables
|Short-term customer-financing receivables
|Short-term interest-bearing receivables
|Other short-term receivables
|Cash and cash equivalents
|Shareholders’ equity and liabilities
|Shareholders’ equity 1
|Provisions for post-employment benefits
|Shareholders’ equity and liabilities
|Shareholders’ equity and minority interests as percentage of total assets
1 Whereof minority interests SEK 260 M (229).
||Understanding IASs and IFRSs
International Accounting Standards (IASs) were issued by the International Accounting Standards Committee (IASC) from 1973 to 2000. Although the IASC Foundation continues as the parent body of the International Accounting Standards Board (IASB), in 2001 the IASB took over the IASC’s standard-setting activities. The IASB has amended some IASs and proposed to amend others, proposed to replace some IASs with new International Financial Reporting Standards (IFRSs) and adopted or proposed certain new IFRSs on topics for which there were no previous IASs. Through committees, both the IASC and the IASB also have issued interpretations of standards. Financial statements may not be described as complying with IFRSs unless they comply with all the requirements of each applicable standard and interpretation.
Source: Deloitte’s IAS Plus Web site, www.iasplus.com/standard/standard.htm .
If the reporting approach is not disclosed in the notes or referred to in the auditor’s report, CPAs can contact the company and make a detailed inquiry. The lack of notes to the financial statements explaining how they were prepared may show a lack of accounting sophistication on the foreign company’s part.
Even if the statements have been audited, be aware that the sophistication and enforcement of accounting rules vary significantly by country. Some foreign accounting firms register with the Public Company Accounting Oversight Board (PCAOB) so they may conduct or participate in audits of companies filing with the SEC; they therefore are subject to PCAOB rules and oversight. About one-third of the more than 1,500 public accounting firms listed on the PCAOB Web site (www.pcaobus.org) are foreign.
More than 90 countries permitted or required their domestic-listed companies to report under IFRSs in 2005, and the list is growing rapidly. Summaries of IFRSs are available at www.iasplus.com/standard/standard.htm. Although the summaries are inherently incomplete, they offer a quick read for the beginner. Be cautious, since implementation and enforcement of IFRSs vary from country to country. An updated list of adoption status by country is available at www.iasplus.com/country/useias.htm.
Although Japan and the United States have not yet adopted IFRSs, both have committed significant resources toward international convergence. For the United States, progress is being made on harmonization under an agreement between FASB and the IASB. Significant differences, however, remain between IFRS and U.S. GAAP.
||Bridging the Culture GAAP
The foreign financial statements you’re examining may have been prepared using U.S. GAAP, but was it applied in the same way it would have been in the United States?
“In a lot of cases, probably not,” says Gregory S. Miller, CPA, a professor at Harvard Business School. “Conservatism [in financial reporting] is driven by the litigation environment.” Even if a foreign company is cross-listed on a U.S. exchange, it does not run the same risk of investor lawsuits as a U.S.-based company. Furthermore, research suggests there are country-specific biases, Miller says. For example, a company in Germany is far more likely than a company in Italy to interpret the same results negatively.
Paul Neubelt, CPA, chairman of BDO International’s China region, agrees that accounting principles are applied differently according to the culture of the country where the statements are prepared. “Anyone looking to invest in another country needs to know something about the cultures of the country,” he says. That caution extends to choosing your own translators, who can explain the meaning behind the words.
Changes to U.S. GAAP may present other problems with financial statements of foreign companies. “A company may say it knows U.S. GAAP and may have someone on staff who has lived in the United States, but it’s often not up to date,” Neubelt says.
Even if you hire an expert in the country in question, ultimately you’ve got to have the courage and conviction that you understand the numbers yourself, Miller says. “The same [cultural] factors that make it difficult to understand the accounting can make it difficult to understand a local consultant.”
—Matthew G. Lamoreaux is a senior editor of the JofA . Mr. Lamoreaux is an employee of the AICPA, and his views, as expressed in this article, do not necessarily reflect the views of the Institute. Official positions are determined through certain specific committee procedures, due process and deliberation.
Some countries present items differently. For example, the Volvo balance sheet in exhibit 2 lists long-term assets before short-term assets and shareholders’ equity before liabilities. This format is consistent with the IAS-compliant model financial statements for 2005 available at www.iasplus.com/fs/2005modelfs.pdf. CPAs also should seek information about accounting practices such as the grouping or netting of accounts and the definition of current vs. noncurrent. These types of differences make it important to read the footnotes and to obtain country-specific information.
Information about doing business in specific foreign countries can be obtained from sources such as HLB International (www.hlbi.com/DBI_list.asp) and the Tax and Accounting Sites Directory (www.taxsites.com). HLB International is a global network of accounting firms and business advisers whose Web site includes information on currency and languages, investment factors, business organizations and taxation. The Tax and Accounting Sites Directory provides links to a variety of other international information Web sites.
It’s also important to know whether a company’s foreign statements reflect historical cost or contain inflation adjustments. Two common models for inflation adjustment are the general price-level-adjusted (GPLA) model and the current cost-adjusted (CCA) model. Information about the accounting methods and presentation rules may be disclosed in the supplemental information included with the statements. If the information is difficult to locate, a source of last resort may be the accounting principle disclosures or the reconciliation to U.S. GAAP in the statements of multinational corporations based in that country.
Do not assume common accounting terms have the same meaning outside the United States. For example, although some companies in the United Kingdom have adopted IFRSs, many continue to use terminology that can be confusing to CPAs in the United States (see exhibit 3).
|| U .K. vs. U.S. Reporting Terminology |
||U.S. equivalent or definition |
||Financial statements |
||Accounts receivable |
||Sales and other operating income |
Source: BP’s 2004 Annual Report.
The currency used in the financial statements may not be obvious, as shown in exhibit 2 . The SEK M above the “Assets” caption shows the statements are in the Swedish krona. Remember that Canada, Australia and Jamaica also call their currency “dollars” and many currencies use the familiar $ symbol.
Translated financial statements are meaningful only if the reader knows the method used to convert foreign currencies to U.S. dollars. A basic convenience statement may be prepared by multiplying all the amounts on the income statement and balance sheet by the translation rate in effect at the balance sheet date. In that case there would not be any translation gains or losses, and the statements would not provide any information about the effects of rate changes over time.
Multinational enterprises have been dealing with translation issues for many years because their foreign divisions and subsidiaries often keep records in the local currency. Exhibit 4 lists four common methods of translation. Each uses a different combination of the following three rates: the historical rate in effect on the date of the transaction, the rate in effect at the end of the current year and the weighted average rate for the period.
Translation rules are addressed by FASB Statement no. 52 in the United States and by IAS 21 in the international standards. Current and historical exchange rate information is available from Web sites such as the Federal Reserve Bank (www.federalreserve.gov/releases/H10/hist) or the Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2/).
| Understand the common approaches foreign companies take when they provide statements to users in the United States.
Understand the effects of currency translation on financial statements and the common conversion methods.
Become familiar with IASs/IFRSs, since more than 90 countries have adopted these international standards.
Line up sources of help in advance.
Many accounting firms belong to international networks or alliances to expand their resources. Your domestic CPA firm may be able to help arrange for an accounting firm in the foreign country to provide assistance in interpreting the financial statements. Exhibit 5, contains a list of some of the larger networks and alliances that provide international resources to accounting firms.
|| CPA Firm Networks and Alliances |
| Baker Tilly International, www.bakertillyinternational.com |
BDO International, www.bdointernational.com
BKR International, www.bkr.com
CPA Associates International, www.cpaai.com
CPAmerica International, www.cpamerica.org
DFK International, www.dfkintl.com
GMN Enterprise, www.gmnen.com
HLB International, www.hlbi.com
IGAF Worldwide, www.igafworldwide.org
Moores Rowland International, www.mri-world.com
NACPAF, National Associated CPA Firms, www.nacpaf.com
PKF North American Network, www.pkfnan.org
RSM McGladrey Network, www.rsmi.com
The global integration of national economies is well under way and will accelerate over the next two decades. The result is that U.S.-based CPAs will see more financial statements originating in foreign countries. Foreign investment in the United States also is likely to increase, and many financial executives in the United States may soon be required to report results in compliance with IFRSs. As progress is made in convergence and harmonization between FASB and the IASB, the interpretation of foreign financial statements should become easier. CPAs who develop expertise in the international reporting arena will be in increasingly high demand.