Found in Translation

A guide to using foreign financial statements.

by Susan M. Sorensen and Donald L. Kyle

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 sorensen@uhcl.edu and kyle@uhcl.edu, respectively.

our 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.

Behind the Numbers Common approaches foreign businesses take when providing financial statements to U.S. investors/creditors. Approach Language Currency Accounting principles Selected items reconciled to U.S. GAAP Statements reconciled to U.S. GAAP Do nothing Foreign* Foreign* Foreign No No Primary statements prepared under U.S. GAAP English U.S. U.S. GAAP N/A N/A Convenience translations English Foreign Foreign No No Convenience statements English U.S. Foreign No No Limited restatements English U.S./Foreign U.S./Foreign Yes No Reconciliation to U.S. GAAP (Minimum required by SEC–Form 20-F) English U.S./Foreign U.S./Foreign Yes Yes 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 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.

KNOW COMMON APPROACHES
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.

Volvo Group Balance Sheet for 2005 Consolidated balance sheet December 31       Volvo Group SEK M 2004 2005 Assets     Intangible assets 17,612 20,421 Property, plant and equipment 31,151 35,001 Assets under operating leases 19,534 20,839 Shares and participations 2,003 751 Long-term customer-financing receivables 25,187 31,184 Long-term interest-bearing receivables 1,741 1,433 Other long-term receivables 6,100 7,021 Inventories 28,598 33,937 Short-term customer-financing receivables 26,006 33,282 Short-term interest-bearing receivables 1,643 464 Other short-term receivables 29,647 35,855 Marketable securities 25,955 28,834 Cash and cash equivalents 8,791 8,113 Total Assets 223,968 257,135       Shareholders’ equity and liabilities     Shareholders’ equity1 70,155 78,768 Provisions for post-employment benefits 14,703 11,986 Other provisions 14,993 18,556 Loans 61,807 74,885 Other liabilities 62,310 72,940 Shareholders’ equity and liabilities 223,968 257,135       Shareholders’ equity and minority interests as percentage of total assets 31.3% 30.6% 1Whereof minority interests SEK 260 M (229).

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.”)

DETERMINE THE APPROACH
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.

WATCH FOR PRESENTATION DIFFERENCES
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.K. terminology U.S. equivalent or definition Accounts Financial statements Debtors Accounts receivable Hire charges Rent Stocks Inventories Turnover Sales and other operating income Source: BP’s 2004 Annual Report.

DETERMINE THE CURRENCY
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 Methods and Rates Used for Asset Accounts Current rate method: Assets are translated at the current rate. Current/Noncurrent method: Current assets are translated using current rates and noncurrent assets are translated using historical rates. Monetary/Nonmonetary method: Monetary assets are translated using current rates and nonmonetary assets are translated using historical rates. Temporal method: Monetary assets such as cash and receivables are translated using current rates. Nonmonetary assets such as inventory and long-term investments are translated using current rates if they are carried on the books at current value. Other assets are translated using historical rates.

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/).

» Practical Tips

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.