INTERNATIONAL ACCOUNTING

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 INTERNATIONAL ACCOUNTING
A User Perspective

Fifth Edition

Shahrokh M. Saudagaran, PhD

University of Washington Tacoma

L. Murphy Smith, DBA, CPA

Texas A&M University – Corpus Christi

Carolina Academic Press

Durham, North Carolina

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 Copyright © 2020
Carolina Academic Press, LLC
All Rights Reserved

Library of Congress Cataloging-in-Publication Data

Names: Saudagaran, Shahrokh M., 1956– author. | Smith,
Lawrence Murphy, author.
Title: International accounting : a user perspective /
Shahrokh M. Saudagaran, Lawrence Murphy Smith.
Description: Fifth Edition. | Durham : Carolina Academic Press,
2020. | Revised edition of International accounting, [2013].
Identifiers: LCCN 2019058644 | ISBN 9781531018665 (paperback)
| ISBN 9781531018672 (ebook)
Subjects: LCSH: Comparative accounting. | International business
enterprises—Accounting.
Classification: LCC HF5635 .S27 2020 | DDC 657—dc23
LC record available at [Link]

Carolina Academic Press

700 Kent Street
Durham, North Carolina 27701
Telephone (919) 489-7486
Fax (919) 493-5668
[Link]

Printed in the United States of America

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 To My Family
— Shahrokh Saudagaran

To Kathy
— L. Murphy Smith

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 CONTENTS

Preface xiii
About the Authors xix

Chapter 1 • Financial Reporting in the Global Arena 3

Introduction 3
Interaction Between Accounting and Its Environment 5
Nature of Capital Markets 6
Type of Reporting Regime 7
Size and Complexity of Business Entities 8
Type of Legal System 8
Level of Enforcement of Regulations 9
Rate of Inflation 10
Political and Economic Ties 10
Stature of the Accounting Profession 12
Existence of a Conceptual Framework 13
Quality of Accounting Education 15
Diverse Roles of Accounting in Countries 16
Policy Choices in Accounting 18
Effects of Diversity on Capital Markets 22
Classification of Financial Accounting and Reporting Systems 26
Review of Selected Classification Studies 27
Major Challenges Facing Accounting Globally 30
Global Convergence 30
Quality of Financial Reporting in Developed and Emerging Economies 31
Social Responsibility Reporting 31
Financial Reporting in the High Technology Era 32
Summary 33
Questions 33
Exercises 34
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 viii Contents

Cases 36
References 39
Test Prepper Questions 43

Chapter 2 • The Move to International Financial Reporting Standards 47

Introduction 47
Rationale for Harmonization 48
Pressures for Harmonization 50
Investors 50
Multinational Companies 51
Regulators 51
The Securities Industry and Stock Exchanges 51
Emerging Economies 52
Obstacles to Harmonization 52
Measuring Harmonization 55
Supra-National Organizations Engaged in Accounting Harmonization 56
International Accounting Standards Committee 56
International Accounting Standards Board 57
International Federation of Accountants 58
International Organization of Securities Commissions 61
United Nations 62
Organization for Economic Cooperation and Development 63
Other Harmonization Efforts 64
Bilateral or Mutual Agreements 64
World-Class Issuer 66
The IASC/IOSCO Initiative 66
Transition to IFRS in the US 67
Evidence on Harmonization 68
Global 69
Regional 72
Summary 79
Questions 80
Exercises 81
Cases 82
References 85
Test Prepper Questions 89

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 Contents ix

Chapter 3 • Accounting for Fluctuations in Currency Exchange Rates 93

Introduction 93
Overview of Foreign Currency Markets and Exchange Rates 94
Foreign Exchange Exposure 96
Accounting for Exchange Rate Fluctuations 98
Foreign Currency Transaction Versus Translation 98
Translation methods 102
Foreign Currency Translation in the United States 106
FASB Statement No. 8 (SFAS No. 8) 107
FASB Statement No. 52 (SFAS No. 52) 109
SFAS No. 52 and the Functional Currency Concept 112
SFAS No. 52 —Translation in Highly Inflationary Economies 115
SFAS No. 133 —Accounting for Derivatives and Hedging Activities 116
SFAS No. 161—Disclosures About Derivative Instruments
and Hedging Activities 117
The International Accounting Standard on Foreign Currency Translation 118
Summary 120
Questions 120
Exercises 121
Cases 123
References 124
Test Prepper Questions 126

Chapter 4 • Selected Financial Reporting and Disclosure Issues

in the Global Context 129
Introduction 129
Accounting for Changing Prices 130
Inflation-Adjusted Accounting Models 133
General Price Level Adjusted (GPLA) Model 133
Current Cost-Adjusted (CCA) Model 138
Accounting for Intangible Assets 142
Goodwill 143
Brands, Patents, and Trademarks 145
Research and Development 148
Geographic Segment Reporting 149
Research Evidence on Geographic Segment Reporting 150

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 x Contents

Developments in Geographic Segment Reporting 156

Environmental and Social Reporting 158
Environmental Disclosures 158
Employee Disclosures 166
Global Reporting Initiative (GRI) 168
Survey of Corporate Responsibility Reporting 172
Value-Added Statement 174
Summary 177
Questions 178
Exercises 179
Cases 182
References 184
Test Prepper Questions 187

Chapter 5 • Using Corporate Financial Reports Across Borders 191

Introduction 191
Corporate Responses to Foreign Users of Financial Statements 192
Coping with Transnational Financial Reporting 204
Preparer Response to Transnational Financial Reporting 204
User Response to Transnational Financial Reporting 206
International Financial Statement Analysis 209
Depreciation and Revaluation of Long-Lived Assets 209
Goodwill 210
Foreign Exchange 210
Pension and Other Post-Employment Benefits 212
Consolidation and Group Reporting 212
Taxation 213
Additional Issues in International Financial Statement Analysis 217
Availability of Data 217
Reliability of Data 218
Timeliness of Data 219
Language, Terminology, and Format 219
Summary 222
Questions 222
Exercises 224
Cases 227

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 Contents xi

References 232
Test Prepper Questions 233

Chapter 6 • Financial Reporting in Emerging Capital Markets 237

Introduction 237
The Nature and Importance of Emerging Capital Markets 239
The Role of Financial Reporting in Emerging Capital Markets 242
Characteristics of Financial Reporting in Emerging Capital Markets 243
Availability 243
Reliability 246
Comparability 251
Financial Reporting Policy Issues in Emerging Capital Markets 252
Information Availability 253
Strengthening Enforcement Capability 254
Convergence of Accounting Standards 256
Caveats Based on Recent Developments 257
Accounting in Selected Emerging Capital Markets 258
Mexico 258
People’s Republic of China (PRC) 261
Summary 265
Questions 266
Exercises 268
Cases 270
References 272
Test Prepper Questions 276

Chapter 7 • Managerial Issues in International Accounting 279

Introduction 279
Budgeting and Performance Evaluation 280
Using Appropriate Performance Measures 280
Using Appropriate Currencies 281
Transfer Pricing Policies 282
Other Considerations 283
Distinguishing between Manager Performance and Subsidiary
Performance 283

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 xii Contents

Some Comparative Evidence on Budgets and Performance

Evaluation Systems 284
Global Risk Management 285
Multinational Capital Budgeting 285
Managing Foreign Exchange Risk 287
Transfer Pricing 291
Major Constituents Affected by Transfer Pricing Choices 291
Internal Constituents 292
External Constituents 293
Transfer Pricing Methods 294
Advance Pricing Agreements 297
Research Evidence on Determinants of International Transfer
Pricing Methods 298
A Transfer Pricing Illustration 300
Information Technology 301
Complexities Involving IT Systems For MNCS 302
Global IT Challenges and Strategies 303
Ethics and Culture 305
Summary 310
Questions 311
Exercises 311
Cases 314
References 316
Test Prepper Questions 320

List of Abbreviations 325

Directory of Relevant Web Sites 329
Index 335

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 PREFACE

Introduction
As business and capital markets have continued to grow more globalized, the need
for cross-border financial information has correspondingly increased. This has
brought international accounting to the forefront. As products, services, and capital
increasingly cross domestic borders, the likelihood that various parties to business
transactions are based in different countries increases. These parties must contend
with the reality that information on their business partners often exists in an
accounting language other than their own. In order to make informed decisions in
a global environment, one needs to be educated in international accounting. While
the required level of detailed knowledge of international accounting issues varies
between organizations, there are very few businesses in the twenty-first century
that are not impacted by globalization and hence by some aspect of international
financial reporting.

Target Audiences
The primary audiences for this book are upper-division undergraduate students,
graduate students, and participants in executive development and corporate
university programs globally. In undergraduate programs, most Advanced
Accounting books focus on business combinations with little or no coverage of
international accounting topics. The typical Advanced Accounting book has a
section on foreign currency translation as its ode to international accounting.
International Accounting: A User Perspective provides a much more comprehensive
coverage of international accounting issues than is available in Advanced Accounting
texts. Given the target audience, every effort has been made to present the material
completely yet succinctly and in a writing style that is easy to read for a global

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 xiv Preface

audience. In terms of its coverage of international accounting issues, this book is

placed somewhere between Advanced Accounting texts that cover very little and
traditional international accounting texts that are too long and expensive for most
undergraduate, graduate and executive programs. Similar to previous editions, the
fifth edition has been kept to a reasonable length, ensuring that most of the chapters
will be actually used in the programs and courses where the book is adopted.

User Perspective
This book is designed to provide an understanding of international accounting issues
to students in graduate and undergraduate business programs and for executives
involved either directly or indirectly in international business. As indicated in its
title, the book takes a user perspective (as opposed to a preparer perspective) to
international financial reporting. This approach makes sense because most business
executives are more likely to be users of transnational financial information
than preparers of it. Very few managers are ever called upon to prepare financial
statements in their domestic environment, let alone in another country. However,
many executives regularly find themselves making decisions based on financial
information that originates in another country. This can take the form of evaluating
the performance of a subsidiary, affiliated organization or joint venture in another
country, making credit decisions on customers located abroad, or making cross-
border investing and financing decisions based on opportunities in other countries.
Being educated in international accounting is an important asset in the portfolio of
skills required of managers in companies engaged in global business.

Research Component and Other

Distinguishing Features
An important feature of the book is that it facilitates the transfer of international
accounting research to students who typically would not access the academic
literature on their own. It does this by discussing research findings where appropriate
and by extensively citing scholarly work related to the subject matter. Since much
of the text is based directly or indirectly on research evidence it helps bring “state of
the art” international accounting material into the classroom.
The extensive coverage of Financial Reporting in Emerging Capital Markets
is another distinguishing feature of this book. As these countries continue to grow
in importance so does the need to learn of the special accounting issues facing
them. Other distinguishing features of the book are its coverage of accounting for
changing prices, and social reporting and the audit of social reports.

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 Preface xv

Summary of the Book

Based on feedback received from reviewers and other colleagues that have used
the book, the length and coverage has been kept similar to the earlier editions.
However, revisions have been made as necessitated by recent developments in the
business and research arenas as well as the move towards convergence of financial
reporting standards worldwide. The book is organized as follows:

• Chapter 1 examines the interaction between accounting and its environ-

ment, the diverse roles of accounting in countries, the effects of account-
ing diversity, and the major challenges facing accounting globally.

• Chapter 2 is about the global harmonization and convergence of account-

ing and auditing standards. It looks at various aspects of harmonization
including the reasons for and against harmonization, the measures of
harmonization, the organizations engaged in harmonization, and the var-
ious harmonization models and scenarios.

• Chapter 3 deals with accounting for currency exchange rate changes. It

looks at the various alternative accounting methods for currency transla-
tion and their impact on management decision.

• Chapter 4 delves into selected financial reporting and disclosure issues in

the global context including accounting for changing prices, accounting
for goodwill and intangible assets, geographic segment reporting, and the
significant attention to environmental and social reporting in recent
years. Updates in this chapter include a discussion of the state of Corpo-
rate Responsibility Reporting globally as well as the role and impact of the
Global Reporting Initiative (GRI).

• Chapter 5 covers various topics related to using corporate financial re-

ports across borders. It examines corporate responses to foreign users of
financial statements, and how preparers and users cope with transnation-
al financial reporting. It also covers a number of issues related to interna-
tional financial statement analysis. This chapter contains several new
exhibits as well as revisions in the discussion of cross-country analysis.

• Chapter 6 looks at financial reporting in emerging capital markets. The

coverage includes the role of financial reporting in emerging capital mar-
kets, and the characteristics and policy issues related to financial report-
ing in developing countries. This chapter contains updated sections on
accounting in China and Mexico and several new exhibits.

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 xvi Preface

• Chapter 7 deals with a number of managerial issues in international ac-

counting. These include budgeting and performance evaluation, global
risk management, transfer pricing, information technology, and ethics
and culture.

End of Chapter Materials

Each chapter ends with a summary of the main points contained therein, discussion
questions, exercises, test prepper questions, and where appropriate, cases. The
discussion questions are relatively straightforward applications of chapter materials.
In keeping with the user perspective of the book most of the exercises involve hands-
on application of domestic and foreign annual reports.

Instructors’ Material
The book is accompanied by instructors’ material that includes 1) an outline of each
chapter, 2) solutions for selected exercises and cases at the end of the chapter, 3) a
test bank consisting of true/false and multiple choice questions, and 4) PowerPoint
slides.

Acknowledgments
We thank the many colleagues all over the world who have used the previous edi-
tions of this book despite (or because of) its innovative and novel approach. The
positive feedback received from many of these colleagues was instrumental in the
decision to proceed with this edition. It has been heartening to see that the book has
had global appeal and is used at universities in over 20 countries on four continents.
We thank the students in our MBA, Master of Accounting and undergraduate
classes for their valuable feedback on previous editions of the book. We also appre-
ciate the input of participants in Dr. Saudagaran’s executive education courses taught
in a number of countries over the years.
We would also like to acknowledge a number of individuals who have helped in
a variety of ways in the production of this book. We are grateful to the professional
and friendly team at CAP for their assistance and support during the entire process.
In some sort of chronological order, we thank Keith Sipe, Ryland Bowman, Jennifer
Hill, Rachael Meier, Arthur Iannacone and Rachel Greene for the professionalism
and speed with which they managed the production process. Drake Chien provided
able research assistance.

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 Preface xvii

We also appreciate the comments and feedback provided by the following col-
leagues:

Jason Al-Ajmi, University of Bahrain

Donald L. Ariail, Kennesaw State University
Robert Bloom, John Carroll University
Todd Broker, Murray State University
Teresa Conover, University of South Florida
Orapin Duangploy, University of Houston—Downtown
David Durr, Murray State University
Hans J. Dykxhoorn, Western Michigan University
Teresa Gordon, University of Idaho
Mustafa Mohamed Hanefah, USIM, Malaysia
Don Herrmann, Oklahoma State University
Allan Hodgson, University of Queensland, Australia
Majidul Islam, Concordia University, Canada
Steven Kachelmeier, University of Texas at Austin
Alan Kilgore, Macquarie University, Australia
Il-Woon Kim, University of Akron
Indra Kusuma, Gadjah Mada University, Indonesia
John Christian Langli, Norwegian School of Management
Hyo Ik Lee, Sungkyunkwan University, Korea
Robert Larson, University of Dayton
Asheq Rahman, Massey University, New Zealand
Joseph R. Razek, University of New Orleans
Juan Rivera, University of Notre Dame
Lynn Rees, Texas A & M University
Michimasa Sato, Nagoya University
Joanne Tay, Singapore Management University
Kriengkrai Boonlert U-Thai, Chulalongkorn University, Thailand
Eamonn Walsh, University College Dublin
Liyan Wang, Peking University, China
Jeanne H. Yamamura, University of Nevada Reno
Shahrokh M. Saudagaran
L. Murphy Smith

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 xviii Preface

Special Thanks
Since joining the University of Washington Tacoma in 2004, I have been inspired
and touched by the vision and generosity of the Milgard family. Gary, Carol, Carolyn
and Jim Milgard have been amazingly gracious in their support of the students,
faculty and staff of the Milgard School. For that I will always be grateful.
Finally, I am grateful to my wife Unhi, and our daughters, Mina and Maryam for
their love and support.
Shahrokh Saudagaran

Moving to Texas A&M University-Corpus Christi in 2017, then to the RELLIS Cam-
pus in Bryan, Texas, in 2018 began a grand adventure. Like Tolkien’s Fellowship of
the Ring, so has been the fellowship of the RELLIS Islanders, my warm-hearted
colleagues, Larry Crumbley, John DeLeon, Swint Friday, Randall Harris, Sandy
Huang, Dimitros Koutmos, and Anita Reed. I am thankful to Dean John Gamble for
his leadership and vision. I am grateful to the A&M System Chancellor John Sharp
for his innovative idea of RELLIS, and to Director James Nelson and Provost Nancy
Jordan for their tone at the top at the unique campus.
For her love, inspiration and encouragement, I am forever grateful to my princess
bride and RELLIS colleague, Dr. Katherine Taken Smith.
Murphy Smith

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 ABOUT THE AUTHORS

SHAHROKH M. SAUDAGARAN
Shahrokh Saudagaran, PhD, served as the Gary E. and James A. Milgard Endowed
Dean at the University of Washington Tacoma’s Milgard School of Business from
2004 to 2015. He currently serves as Professor of Accounting and Director of the
Milgard School’s Center for Leadership and Social Responsibility. His previous
academic positions were the Arthur Andersen Professor and Head of the School
of Accounting at Oklahoma State University and Director of the International
Business Studies Institute and McCullough Professor of Accounting at Santa Clara
University. He is Secretary General of the Asian Academic Accounting Association
and Past-President of the American Accounting Association’s International
Accounting Section. In 2002, the Japanese Association of International Accounting
Studies awarded him a lifetime honorary membership in recognition of his
contributions to international accounting. In 2004, he received the American
Accounting Association’s Outstanding International Accounting Educator Award.
His research on the impact of international accounting diversity on global listing
decisions and on financial reporting in emerging capital markets, particularly those
in the Asia-Pacific region, has been published in the top accounting, finance and
international business journals. He has presented his research at conferences and
university colloquia in over 30 countries. Saudagaran has consulted and taught
executive seminars in international accounting and finance for corporations in
Asia, Europe, and the United States.
Saudagaran has also published The Asian Accounting Handbook: A User’s Guide to
the Accounting Environment in 16 Countries. He has served on the editorial boards
of several journals including the Accounting Review, Accounting Horizons, and
Issues in Accounting Education and international accounting journals worldwide.
Saudagaran obtained his PhD from the University of Washington, his MBA from
the Iran Center for Management Studies, and his Bachelor of Commerce from the
University of Bombay. He was also licensed as a CPA in Washington State. He is

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 xx About the Authors

a member of the Academy of International Business, the American Accounting

Association, the American Finance Association, the Asian Academic Accounting
Association, and the European Accounting Association. Before entering academia,
he worked as a management consultant with Ernst & Young and as Financial
Controller with Van Leeuwen Buizenhandel, a Dutch multinational.

L. MURPHY SMITH
L. Murphy Smith, DBA, CPA, is a Professor of Accounting at Texas A&M University–
Corpus Christi. He teaches on the RELLIS Campus in Bryan, Texas. His academic
record includes numerous research articles, books and monographs, academic
conference presentations, research grants, and awards for teaching and research. Dr.
Smith has been ranked in the top one percent of accounting scholars in the United
States according to published guides of research productivity among accounting
professors and in the top one percent of authors on Social Sciences Research
Network ([Link]) by downloaded articles. His work is highly referenced, with
over 3,000 citations per Google Scholar.
His major areas of research include: international accounting ethics, financial
reporting, and information technology. Among the journals in which he has
published are the following: Journal of Business Research; Advances in Accounting;
Contemporary Accounting Research; Accounting Horizons; Journal of Information
Systems; Journal of Business Ethics; Research on Professional Responsibility and
Ethics in Accounting; Critical Perspectives on Accounting; International Journal of
Economics and Accounting; Internal Auditing; and Journal of Accountancy. His work
has been cited in various news media, including National Public Radio, Fortune,
USA Today, and The Wall Street Journal.
Among his recognitions for teaching and research are the following: Outstanding
Researcher Award from the American Accounting Association Strategic and
Emerging Technologies Section, Outstanding Educator Award from the Texas
Society of CPAs, KPMG Outstanding Published Manuscript Award from the
American Accounting Association Gender Issues and Work-Life Balance Section,
Outstanding Paper in JATA Award from the American Taxation Association, and
the Authors Award from the Association of Government Accountants.

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