Chapter 11 - Worldwide Accounting Diversity and International Standards

ADVANCE ACCOUNTING
ACCT 462

CHAPTER 11
WORLDWIDE ACCOUNTING DIVERSITY
AND INTERNATIONAL STANDARDS
Question
Answers to Questions
1. The five factors most often cited as affecting a country's accounting system are: (1) legal system, (2)
taxation, (3) providers of financing, (4) inflation, and (5) political and economic ties. The legal system is
primarily related to how accounting principles are established; code law countries generally having
legislated accounting principles and common law countries having principles established by non-
legislative means. In some countries, financial statements serve as the basis for taxation and in other
countries they do not. In those countries with a close linkage between accounting and taxation,
accounting practice tends to be more conservative so as to reduce the amount of income subject to
taxation. Shareholders are a major provider of financing in some countries. As shareholder financing
increases in importance, the demand for information made available outside the company becomes
greater. In those countries in which family members, banks, and the government are the major
providers of business finance, there tends to be less demand for public accountability and information
disclosure. Chronic high inflation has caused some countries, especially in Latin America, to develop
accounting principles in which traditional historical cost accounting is abandoned in favor of inflation
adjusted figures. Political and economic ties can explain the usage of a British style of accounting
throughout most of the former British empire. They also help to explain similarities between the U.S. and
Canada, and increasingly, the U.S. and Mexico.
Culture also is viewed as a factor that has significant influence on the development of a country’s
accounting system. This influence is described in more detail in the answer to question 3.
2. Problems caused by accounting diversity for a company like Nestle include: (a) the additional cost
associated with converting foreign GAAP financial statements of foreign subsidiaries to parent company
GAAP to prepare consolidated financial statements, (b) the additional cost associated with preparing
Nestle financial statements in foreign GAAP (or reconciling to foreign GAAP) to gain access to foreign
capital markets, and (c) difficulty in understanding and comparing financial statements of potential
foreign acquisition targets.
3. Gray developed a model that hypothesizes that societal values, i.e., culture, affect the development of
accounting systems in two ways: (1) societal values help shape a country’s institutions, such as legal
system and financing system, which in turn influences the development of accounting, and (2) societal
values influence accounting values held by members of the accounting sub-culture, which in turn
influences the development of the accounting system. Gray provides specific hypotheses with respect
to the manner in which specific cultural dimensions will influence specific accounting values. For
example, he hypothesizes that in countries in which avoiding uncertainty is important, accountants will
have a preference for more conservative measurement of profit.
4. According to Nobes, the purpose for financial reporting determines the nature of a country’s financial
reporting system. The most relevant factor for determining the purpose of financial reporting is the nature
of the financing system. Some countries have a culture, and accompanying institutional structure, that
leads to a strong equity financing system with large numbers of outside shareholders.

A country with a self-sufficient Type I culture will have a strong equity-outsider financing system which in
turn will lead that country developing a Class A accounting system oriented toward providing information
for outside shareholders. A self-sufficient Type II culture will have a weak equity-outsider financing
system which results in a Class B accounting system oriented toward protecting creditors and providing a
basis for taxation.

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Chapter 11 - Worldwide Accounting Diversity and International Standards

5. Several of the IASC’s original standards were criticized for allowing too many alternative methods of
accounting for a particular item. As a result, through the selection of different acceptable options, the
financial statements of two companies following International Accounting Standards still might not have been
comparable. To enhance the comparability of financial statements prepared in accordance with International
Accounting Standards, and at the urging of the International Organization of Securities Commissions, the
IASC systematically reviewed its existing standards (in the so-called Comparability Project) and revised ten of
them by eliminating previously acceptable alternatives.
6. A major difference between the IASB and the IASC is the composition of the Board and the manner in
which Board members are selected. IASB has at least 12 and as many as 14 full-time members, the
IASC had zero. Full-time IASB members must sever their employment relationships with former
employers and must maintain their independence. Seven of the full-time members have a liaison
relationship with a national standard setter. At least five members must have been auditors, three must
have been financial statement preparers, three must have been users of financial statements, and at
least one must come from academia. The most important criterion for appointment to the IASB is
technical competence. (Although not stated in the body of the chapter, there was a perception that
some appointments to the IASC were based on politic connections and not competence.)
[Some of the common features of the IASC and IASB are that both (a) issue/d “international standards,”
(b) have/had their headquarters in London, and (c) use/d English as the working language.]
7. This statement is true in that EU publicly traded companies are required to use IFRS in preparing
consolidated financial statements. It is false in that non-public companies are not required to use IFRS
and publicly traded companies do not use IFRS in preparing their parent company only financial
statements.
8. The bottom panel of Exhibit 11.6 shows the countries as of July 2009 that (after 2012) do not allow
domestic companies to use IFRS in preparing consolidated financial statements. The three most
economically important countries in this group are China, Japan, and the United States.
9. The IASB and FASB have agreed to “use their best efforts to (a) make their existing financial reporting
standards fully compatible as soon as is practicable and (b) coordinate their work program to ensure that
once achieved, compatibility is maintained.”
10. The six key initiatives are:
• Short-term convergence project to eliminate differences where convergence is likely in the short-term.
• Joint projects on broader issues in which FASB and IASB share resources and work on a similar time
schedule.
• Convergence research project to identify all substantive differences between IFRS and U.S. GAAP.
• Liaison IASB member on site at FASB offices.
• Monitoring of IASB projects.
• Explicit consideration of convergence potential in FASB agenda decisions.
11. Convergence implies a joint effort between two standard setters to reduce differences in the sets of
standards for which they are responsible. Convergence could result in one standard setter adopting an
existing standard developed by the other standard setter or by the two standard setters jointly developing
a new standard. Convergence does not necessarily mean the two sets of standards that result from the
convergence process will be the same. Indeed, the FASB and IASB acknowledge that differences
between IFRS and U.S. GAAP will continue to exist even after convergence.
In contrast to the approach taken by the FASB to influence future IASB standards, the European Union
simply adopted IFRS as the national GAAP in member nations.

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12. Since 2007, foreign companies listed on U.S. stock exchanges may file IFRS financial statements with
the U.S. SEC without providing any reconciliation to U.S. GAAP. The SEC’s IFRS Roadmap proposes
the phased-in use of IFRS by U.S. publicly-traded domestic companies beginning in 2014. The SEC will
monitor progress on several milestones and make a decision on mandatory IFRS adoption in 2011.
13. When adopting IFRS, a company must prepare an “IFRS opening balance sheet” at the date of
transition. The date of transition is the beginning of the earliest period for which comparative information
must be presented, i.e., two years prior to the “reporting date.” A company must follow five steps in
preparing its IFRS opening balance sheet:
1. Determine applicable IFRS accounting policies based on standards that will be in force on the
reporting date.
2. Recognize assets and liabilities required to be recognized under IFRS that were not recognized under
prior GAAP, and derecognize assets and liabilities recognized under prior GAAP that are not allowed
to be recognized under IFRS.
3. Measure assets and liabilities recognized on the IFRS opening balance sheet in accordance with IFRS
(that will be in force on the reporting date).
4. Reclassify items previously classified in a different manner from what is acceptable under IFRS.
5. Comply with all disclosure and presentation requirements.

14. The extreme approaches that a company might follow in determining appropriate accounting policies for
preparing its initial set of IFRS financial statements are:
1. Adopt accounting policies acceptable under IFRS that minimize change from existing accounting
policies used under current GAAP.
2. Take a fresh start, clean slate approach and develop accounting policies acceptable under IFRS that
will result in financial statements that reflect the economic substance of transactions and present the
most economically meaningful information possible.

15. According to the accounting policy hierarchy in IAS 8, if a company is faced with an accounting issue for
which (a) there is no specific IASB standard that applies, (b) there are no IASB standards on related
issues, and (c) reference to the IASB’s Framework does not help in determining an appropriate
accounting treatment, then the company should consider the most recent pronouncements of other
standard-setting bodies that use a similar conceptual framework. The FASB’s conceptual framework is
similar to the IASB’s, so reference to FASB pronouncements would be acceptable under IAS 8 when
conditions (a), (b), and (c) exist.16. Potentially significant differences between IFRS and U.S. GAAP
related to asset recognition and measurement are:
• Acceptable use of LIFO under U.S. GAAP, but not IFRS.
• Definition of “market” in the lower of cost or market rule for inventory – replacement cost under U.S.
GAAP; net realizable value under IFRS.
• Reversal of inventory writedowns allowed under IFRS, but not under U.S. GAAP.
• Possible revaluation of property, plant, and equipment under IFRS (allowed alternative), but not under
U.S. GAAP.
• Capitalization of development costs as an intangible asset under IFRS, which is not acceptable under
U.S. GAAP (except for computer software development costs).
• Difference in the determination of whether an asset is impaired.
• Subsequent reversal of impairment losses allowed by IFRS, but not U.S. GAAP.
17. Even if all countries adopt a similar set of accounting standards, two obstacles remain in achieving the
goal of worldwide comparability of financial statements. First, IFRS must be translated into languages
other than English to be usable by non-English speaking preparers of financial statements. It is difficult
to translate some words and phrases found in IFRS into non-English languages without a distortion of
meaning. Second, culture can affect the manner in which accountants interpret and apply accounting
standards. Differences in culture can lead to differences in how the same standard is applied across
countries.

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Answers to Problems
1. B (LO1)
2. C (LO2)
3. D (LO2)
4. C (LO3)
5. D (LO4)
6. D (LO5)
7. C (LO5)
8. B (LO5)
9. D (LO5)
10. B (LO6)
11. C (LO6)
12. A (LO6)
13. A (LO5)
14. C (LO5)
Problems 15-19 are based on the comprehensive illustration.
Note to instructors: Problems 15-19 have changed from Problems 11-15 in the Ninth Edition
of the book in that they now ask for the adjustments to reconcile from U.S. GAAP to IFRS,
whereas in the previous edition the reconciliation was from IFRS to U.S. GAAP. This change
is consistent with the nature of the reconciliation that U.S. companies will make if the SEC
requires the IFRS as proposed under the IFRS Roadmap.
15. Carrying inventory at the lower of cost or “market” (LO7) (15 minutes)

a. 1. Under U.S. GAAP, the company reports inventory on the balance sheet at the lower of cost
or market, where market is defined as replacement cost (with net realizable value as a
ceiling and net realizable value less a normal profit as a floor). In this case, inventory will
be written down to replacement cost and reported on the December 31, 2011 balance
sheet at $95,000. A $5,000 loss will be included in 2011 income.

2. In accordance with IAS 2, the company reports inventory on the balance sheet at the lower
of cost and net realizable value. As a result, inventory will be reported on the December
31, 2011 balance sheet at its net realizable value of $98,000 and a loss on writedown of
inventory of $2,000 will be reflected in 2011 net income.

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b. As a result of the differing amounts of inventory loss recognized under U.S. GAAP and IFRS,
Lisali will add $3,000 to U.S. GAAP income to reconcile to IFRS income, and will add $3,000
to U.S. GAAP stockholders’ equity to reconcile to IFRS stockholders’ equity.

16. Measurement of property, plant, and equipment subsequent to acquisition (LO7) (25
minutes)

a. 1. Under U.S. GAAP, the company would report the equipment at its depreciated historical
cost. Straight-line deprecation expense is $8,000 per year [($100,000 – $20,000) / 10
years]. The equipment would be reported at $92,000, $84,000, and $76,000, respectively,
on the December 31, 2011, 2012, and 2013 balance sheets.

2. Under IFRS, the equipment would be depreciated by $8,000 in 2011 [($100,000 - $20,000)
/ 10 years], resulting in a book value of $92,000 at December 31, 2011. Under IAS 16’s
allowed alternative treatment, the equipment would be revalued on January 1, 2012 to its
fair value of $101,000.

The journal entry to record the revaluation on January 1, 2012 would be:
Dr. Equipment $9,000
Cr. Revaluation surplus (stock. equity) $9,000
(To revalue equipment from carrying value of $92,000 to appraisal value of $101,000.)

Depreciation expense on a straight-line basis in 2012, 2013, and beyond would be $9,000
per year [($101,000 – $20,000) / 9 years]. The equipment would be reported on the
December 31, 2012 balance sheet at $92,000 [$101,000 – $9,000], and on the December
31, 2013 balance sheet at $83,000 [$92,000 – $9,000].

The differences can be summarized as follows:

Depreciation expense 2011 2012 2013

IFRS $8,000 $9,000 $9,000
U.S. GAAP $8,000 $8,000 $8,000
Difference $0 $1,000 $1,000

Book value of equipment 12/31/11 12/31/12 12/31/13

IFRS $92,000 $92,000 $83,000
U.S. GAAP $92,000 $84,000 $76,000
Difference $0 $ 8,000 $ 7,000

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b. There is no difference in net income between IFRS and U.S. GAAP in 2011, so no
reconciliation adjustments are necessary in 2011.

In 2012, the additional amount of depreciation expense of $1,000 related to the revaluation
surplus under IFRS must be subtracted from U.S. GAAP income to reconcile to IFRS net
income. The additional depreciation taken under IFRS causes IFRS retained earnings to be
$1,000 less than U.S. GAAP retained earnings at December 31, 2012. Under IFRS, the
revaluation surplus causes IFRS stockholders’ equity to be $9,000 larger than U.S. GAAP
stockholders’ equity. The adjustment to reconcile U.S. GAAP stockholders’ equity to IFRS is
$8,000, the difference between the original amount of the revaluation surplus ($9,000) and the
accumulated depreciation on that surplus ($1,000). $8,000 would be added to U.S. GAAP
stockholders’ equity to reconcile to IFRS.

In 2013, $1,000 again is added to IFRS net income to reconcile to U.S. GAAP net income, and
$7,000 is now subtracted from IFRS stockholders’ equity to reconcile to U.S. GAAP
stockholders’ equity. $7,000 is the original amount of revaluation surplus ($9,000) less
accumulated depreciation on that surplus for two years ($2,000).

17. Research and development costs (LO7) (15 minutes)

a. 1. Under U.S. GAAP, $500,000 of research and development costs would be expensed in
2011.

2. In accordance with IAS 38, $350,000 [$500,000 x 70%] of research and development costs
would be expensed in 2011, and $150,000 [$500,000 x 30%] of development costs would
be capitalized as an intangible asset. The intangible asset would be amortized over its
useful life of ten years, but only beginning in 2012 when the newly developed product is
brought to market.

b. In 2011, $150,000 would be added to U.S. GAAP net income to reconcile to IFRS and the
same amount would be added to U.S. GAAP stockholders’ equity.

In 2012, the company would recognize $15,000 [$150,000 / 10 years] of amortization expense
on the deferred development costs under IFRS that would not be recognized under U.S.
GAAP. In 2012, $15,000 would be subtracted from U.S. GAAP net income to reconcile to
IFRS net income. The net adjustment to reconcile from U.S. GAAP stockholders equity to
IFRS at December 31, 2012 would be $135,000, the sum of the $150,000 smaller expense
under IFRS in 2011 and the $15,000 larger expense under IFRS in 2012. $135,000 would be
added to U.S. GAAP stockholders’ equity at December 31, 2012 to reconcile to IFRS.

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18. Gain on sale and leaseback transaction (LO7) (15 minutes)

a. 1. Under U.S. GAAP, the gain of $50,000 on the sale and leaseback transaction of is
deferred and amortized to income over the life of the lease. With a lease period of five
years, $10,000 of the gain would be recognized in 2011.
2. In accordance with IAS 17, the entire gain of $50,000 on the sale and leaseback would be
recognized in income in the year of the sale when the lease is an operating lease.

b. In 2011, IFRS net income exceeds U.S. GAAP net income by $40,000, the difference in the
amount of gain recognized on the sale and leaseback transaction. A positive adjustment of
$40,000 would be made to reconcile U.S. GAAP net income and U.S. GAAP stockholders’
equity to IFRS.

In 2012, a gain of $10,000 would be recognized under U.S. GAAP that would not exist under
IFRS. As a result, $10,000 would be subtracted from U.S. GAAP net income to reconcile to
IFRS. By December 31, 2012, $20,000 of the gain would have been recognized under U.S.
GAAP and included in retained earnings, whereas retained earnings under IFRS includes the
entire $50,000 gain. Thus, $30,000 would be added to U.S. GAAP stockholders’ equity at
12/31/12 to reconcile to IFRS.

19. Impairment of property, plant, and equipment (LO7) (20 minutes)

a. 1. Under U.S. GAAP, an asset is impaired when its carrying value exceeds the expected
future cash flows (undiscounted) to be derived from use of the asset. Expected future
cash flows are $85,000, which exceeds the carrying value of $80,000, so the asset is not
impaired. Depreciation expense for the year is $20,000 [$100,000 / 5 years], and the
equipment will carried be on the December 31, 2011 balance sheet at $80,000.
2. In accordance with IAS 36, an asset is impaired when its carrying value exceeds its
recoverable amount, which is the greater of (a) value in use (present value of expected
future cash flows), and (b) net selling price, less costs to dispose. The carrying value of
the equipment at December 31, 2011 is $80,000; original cost of $100,000 less
accumulated depreciation of $20,000 [$100,000 / 5 years]. The asset’s recoverable
amount is $75,000 (the higher of value in use of $75,000 and fair value of $72,000), so the
asset is impaired. An impairment loss of $5,000 [$80,000 - $75,000] would be recognized
at the end of 2011, in addition to depreciation expense for the year of $20,000. The
equipment will be carried on the December 31, 2011 balance sheet at $75,000.
b. An impairment loss of $5,000 was recognized in 2011 under IFRS but not under U.S. GAAP.
Therefore, $5,000 must be subtracted from U.S. GAAP net income to reconcile to U.S. GAAP
net income in 2011. The same amount would be subtracted from U.S. GAAP stockholders’
equity at December 31, 2011 to reconcile to IFRS.
In 2012, depreciation under IFRS will be $18,750 [$75,000 / 4 years], whereas depreciation
under U.S. GAAP is $20,000. $1,250 would be added to U.S. GAAP net income to reconcile
to IFRS net income in 2012. To reconcile stockholders’ equity to IFRS at December 31, 2012,
$3,750 must be subtracted from U.S. GAAP stockholders’ equity. This is the difference
between the impairment loss of $5,000 in 2011 taken under IFRS and the difference in
depreciation expense recognized under the two sets of standards in 2012. It also is equal to
the difference in the carrying value of the equipment at December 31, 2012 under the two sets
of accounting rules:

IFRS U.S. GAAP

Cost $100,000 $100,000
Depreciation, 2011 (20,000) (20,000)

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Impairment loss, 2011 (5,000) 0

Carrying value, 12/31/11 $75,000 $80,000
Depreciation, 2012 (18,750) (20,000)
Carrying value, 12/31/12 $56,250 $60,000

This copy of study guide is edited by;

Vincent oluoch odhiambo
Senior student 2011
University of Eastern Africa Baraton,
School of Business
Department of Accounting;
BBA(Accounting)
BBA(Finance)
Email:vinoluo@yahoo.com

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