Chapter 8

1. Chapter 8 International Business Combinations, Goodwill, and Intangibles

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

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

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

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

6. Purchase Accounting • Pooling-of-interests method (merger method) • Assets are not revalued • No goodwill • Precombination earnings are included • Investment recorded at nominal value International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

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

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

9. Corporate Group Share Ownership Patterns International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

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

11. 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 and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

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

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

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

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

16. Funds and Cash Flow Statements • 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) International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

17. Funds and Cash Flow Statements • 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 International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

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

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

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

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

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

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

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

25. Brands, Trademarks, Patents, and Related Intangibles • 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. International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

26. Brands, Trademarks, Patents, and Related Intangibles • 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 and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

27. Brands, Trademarks, Patents, and Related Intangibles • 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 International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

28. Brands, Trademarks, Patents, and Related Intangibles • 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 International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

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

30. 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 and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

31. Research and Development • 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 International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black

32. Research and Development • 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 International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black