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Chapter 8

International Business
Combinations, Goodwill, and
Intangibles

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,

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,

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,

Purchase versus Pooling-ofInterests 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,

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,

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,

The Treatment of
Nonconsolidated Subsidiaries
Equity

Reported earnings will be higher because MNEs


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

Cost

Method

Method

MNEs share of dividends is included in reported


earnings
Used in Australia, Sweden, and Switzerland

International Accounting and Multinational Enterprises Chapter 8 Radebaugh,

Corporate Group Share


Ownership Patterns

International Accounting and Multinational Enterprises Chapter 8 Radebaugh,

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,

Accounting for Goodwill

Most countries treat goodwill as an asset subject to


systematic amortization

U.S. and IASB treatment is an annual impairment


test of goodwill
Some countries use immediate write-off method
against reserves

Maximum amortization periods of 5 to 40 years apply in


some countries

Not permitted in U.S., Australia, Japan

Some countries retain goodwill as a permanent


asset

International Accounting and Multinational Enterprises Chapter 8 Radebaugh,

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,

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,

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,

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,

Funds and Cash Flow


Statements
Countries

Brazil, Canada, Philippines, Australia, NZ


All countries adopting IFRS

Countries

where statement is required

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,

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,

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
venturers perspective

International Accounting and Multinational Enterprises Chapter 8 Radebaugh,

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,

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,

Goodwill and Intangibles


The

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

Stock Market Perspective

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,

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,

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,

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,

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,

Brands, Trademarks, Patents,


and Related Intangibles
U.S.

combination of asset-withoutamortization method and asset-withsystematic-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,

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,

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,

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,

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,

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,

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,