chapter 8 international business combinations, goodwill, and intangibles

Chapter 8

International Business Combinations, Goodwill, and

Intangibles

International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

Strategic Decision Point

How should we consolidate financial results? Use 50% rule or some other method? Example – Vodafone owns 47% of Verizon

Does percentage consolidation show exaggerated growth?

FASB and IASB are considering options in this area currently


Consolidated Financial Statements

Controversy exists on how results for MNEs should be reported

Current method – consolidation Consolidated reports are useful to external users and

management Segment information is also presented No treatment is given to differing areas of risk and return Consolidated information varies from country to country

U.S. requires consolidated financial statements German common practice – parent company statements

and worldwide statements


Consolidation Methods

“Line-by-line” for approach Proportionate ownership method

Considered appropriate for joint ventures “One-line basis” - equity method

Investment amount is adjusted to reflect MNEs share of equity

More conservative method involving only dividends and receivables Used in Australia and Sweden


Purchase versus Pooling-of-Interests Accounting

Purchase method (acquisition method) Assets revalued at “fair-value” Purchase price above fair value of net assets is

goodwill Acquired company contributes to earnings after

consolidation Investment recorded at market value


Purchase Accounting

Pooling-of-interests method (merger method) Assets are not revalued No goodwill Precombination earnings are included Investment recorded at nominal value


Pooling-of-Interests Accounting

What method is most appropriate? Purchase method for situations where full

ownership is transferred Pooling-of-interests method is considered

appropriate when a continuity of ownership through an exchange of shares exists

Pooling-of-interests method is used less often Not allowed in the U.S. – FAS 144 IASB requires purchase method


The Treatment of Nonconsolidated Subsidiaries

Equity Method Reported earnings will be higher because MNE’s

share of earnings is included instead of dividends Used in Japan, U.K., and U.S. Japanese keiretsu make comparability difficult

Cost Method MNE’s share of dividends is included in reported

earnings Used in Australia, Sweden, and Switzerland


Corporate Group Share Ownership Patterns


Fair Value Adjustments

Fair value of assets acquired is determined using the current market value U.S. and U.K.

Book value is retained even if greater than fair value in Japan and Switzerland If there is no restatement and

FV>BV, earnings overstated and assets understated FV<BV, earnings understated and assets overstated


Accounting for Goodwill

Most countries treat goodwill as an asset subject to systematic amortization Maximum amortization periods of 5 to 40 years apply in

some countries U.S. and IASB treatment is an annual impairment

test of goodwill Some countries use immediate write-off method

against reserves Not permitted in U.S., Australia, Japan

Some countries retain goodwill as a permanent asset


International Accounting Standards

IFRS 3 on Business Combinations superceded IAS 22 in March 2004 Pooling-of-interests method disallowed Impairment testing for goodwill required

Some countries still adopt a flexible approach and permit immediate write-off of goodwill

Asset-with-amortization and immediate write-off methods are both supported by evidence

Enhanced transparency is likely more important than uniformity


Problems and Prospects

In practice, consolidated financial statements have not increased with demand – Italy, India

Consolidated accounts are still not required in some countries – India, Saudi Arabia

Problems exist relating to group identification and the various techniques of consolidation


Problems and Prospects

Different groups want different consolidation Government and trade union – country level Investors – worldwide level

International consolidation may not be relevant because of inflation, exchange rates, and political risk


Funds and Cash Flow Statements

“Funds” does not necessarily mean cash Could also mean working capital

Provides insight into the financial performance, stability, and liquidity of MNEs

May be useless without additional disaggregated information Example – location of sources and uses of funds

Fairly new statement in regards to regulation



Countries where statement is required Brazil, Canada, Philippines, Australia, NZ All countries adopting IFRS

Countries where statement is not required Saudi Arabia, India

Many companies disclose voluntarily IAS 7 permits companies to use the direct or

indirect method (direct recommended)



Problems and Prospects Regulation is highly flexible in this area Some confusion about the purpose, presentation,

and use of the statement Confusion as to what “funds” are Difficulty in comparing statements

Cash flow statement could be more useful than a funds statement internationally Used in U.S. and U.K. and endorsed by the IASB


Joint Venture Accounting

Little is known about the control processes or performance measurement of joint ventures

Differences between current and former socialist economies and Western economies lead to potential problems

IAS 31 attempts to resolve issues from the venturer’s perspective


Joint Venture Accounting

Three types of joint ventures exist Jointly controlled operations Jointly controlled assets Jointly controlled entities

IAS 31 requirements for venturers Jointly controlled operations and assets – recognition

based on share in operations or assets Jointly controlled entities – two alternatives

Benchmark Treatment Allowed Alternative Treatment


Goodwill and Intangibles

Major international importance Academic research and cooperation between

standard-setting agencies are needed in this area

Intangible Assets and the Balance Sheet Balance sheet should show how well a company

can meet its obligations Should “relevance” or reliability” govern the value

of intangible assets?


Goodwill and Intangibles

The Stock Market Perspective If the market is efficient

The nature and treatment of intangible assets should be sufficiently disclosed to help users assess the treatment used

If the market is inefficient Skepticism exists concerning analysts adjustments Markets are affected by international and national

political and economic factors More disclosure means fairer stock prices


Goodwill

Only an issue when purchase method is used Controversies

Should goodwill be included as an asset? Should goodwill be amortized?

Accounting Methods Asset without Amortization Asset with Annual Impairment Testing Asset with Systematic Amortization Immediate Write-Off


Goodwill

Comparative National Practices Insert Exhibit 8.3 Conflict existed between U.S. and U.K. over benefits

derived from immediate write-off Problem magnified by increased merger activity

Conclusions Goodwill is not an asset under “separability” Goodwill meets the “reliability” criterion Goodwill meets the “relevance” criterion Accounting for goodwill should be flexible, but fully

disclosed within competitive limits


Brands, Trademarks, Patents, and Related Intangibles

Should brands be capitalized? Brand capitalization would

Restore equity Enhance borrowing capacity Facilitate takeovers without consultation with

shareholders (U.K.) Avoid undervaluation of firms



Methods of Accounting Asset without Amortization Asset with Systematic Amortization Immediate write-off

“Current Cost” approach – U.K. Capitalization without amortization if no limit

to useful life – France Brands are identified as intangible assets in

Australia, France, and the U.K.



U.S. – combination of asset-without-amortization method and asset-with-systematic-amortization method depending on estimate of useful life

IFRS requires recognition of intangible assets for consolidated statements

U.S. and Canada must write off internally developed intangibles immediately



International Accounting Standards IAS 38

Intangible assets only recognized if future benefits will flow to the enterprise and cost of asset can be measured reliably

Systematic amortization required for finite lives Impairment testing for assets with infinite lives



Conclusions Problems are linked with the goodwill issue Brand names qualify as assets under

“separability” Measurement of intangibles may not be “reliable” Value-oriented approach to brands and

intangibles should be used


Research and Development

R & D expenditures include all costs related to the creation and development of new processes, techniques, applications, and products

Three categories of expenditure Pure research – no specific aim or application Applied research – applying research to an area

of business interest Development – work toward introduction or

improvement of specific products or processes


Research and Development Insert Exhibit 8.4 Tendency towards conservative asset recognition

and assessment of future benefits Accounting Methods

Expense as incurred Germany and U.S. (software exception in U.S.)

Capitalize Development Costs Canada, India, U.K.

Capitalize all R&D Costs Greece, Italy, Japan, Sweden

Multiple methods allowed Brazil, Hong Kong, Spain, Thailand



International Accounting Standards IAS 38

Requires immediate write-off method for research expenditures

Development costs should be immediately written off unless project meets specific criteria If project meets criteria, capitalize and amortize Amortization periods are reviewed and recognition of

impairment losses apply



Conclusions R&D expenditure does not qualify under

“separability” unless specific assets are developed

If assets are developed, expenditure meets the “relevance” criterion

If future benefits can be assessed, “reliability” criterion is met

R&D expenditures should be capitalized to the extent of development costs, subject to periodic review and disclosure within competitive limits

chapter 8 international business combinations, goodwill, and intangibles

Documents

international accounting

ownership method

conservative method

black pooling

sweden slide

switzerland slide

market value slide

nominal value slide