In business, record-keeping is essential for the planning of prospects and analysis of past performance. The need to have international accounting practices brought about the International Financial Reporting Standards. The paper would discuss IFRS, GAAP, and transfer price.
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GAAP and IFRS
After the formation of the European Union, there was an urgent need to harmonize accounting principles among the member states. They formed the International Accounting Standards Committee, which developed the International Accounting Standards in 1973. It comprised of only ten countries (Gebhardt, Mora & Wagenhofer, 2014).
The Convergence Project between US GAAP and IFRS
The standards of the IAS became attractive around the world since many Multinational Corporations had dealings with foreign countries. IASC’s successor, the International Accounting Standards Board, continued with the process of setting the International Accounting Standards. It also set the Standing Interpretation Committee standards (Gebhardt et al., 2014). The board renamed the rules as International Financial Reporting Standards. IFRS is an Anglo-Saxon accounting system that serves the interest of investors. It is decision-based and not under the influence of legal rules. It involves intensive management judgment. All listed companies in Europe must adhere to this rule.
GAAP also gives the accounting standards for financial accounting in certain countries including the US (Singleton-Green, 2012). The guidelines are usually known as the accounting standards or the standard accounting practices. The accountants use them to record, summarize and prepare financial statements. But most businesses do not use this accounting standard because it operates on a cash basis while IFRS allows treatment on an accruals basis.
Countries that have used GAAP principles include the United Kingdom and China. Others are now moving towards using the IFRS. The world governing bodies passed a resolution to adapt to the IFRS standards because they are the most acceptable all over the world. The US and a handful of countries are still lagging behind. But the US has already passed the resolution.
Differences between IFRS and GAAP
IFRS is a principle-based accounting standard while GAAP is rule-based. IFRS accommodates the economics of trade better than GAAP. The treatment of acquired intangible assets under GAAP is on the fair value while IFRS recognizes such assets if only they would have a future economic benefit.
IFRS uses FIFO and the weighted average cost for inventory records. GAAP does not use them for inventory purposes. GAAP prohibits reversals of written down inventory (Singleton-Green, 2012). The IFRS allows the reversal of stock in future as they meet certain criteria. GAAP is mainly useful in the US while most of the countries use IFRS. GAAP has not developed comprehensive policies on the “going concern”. IFRS uses the underlying assumptions of accruals and “going concern” with specific rules.
Countries that have Adopted IFRS
Countries that are using IFRS include Armenia, Australia, Austria, Azerbaijan, Belarus, Belgium, Bulgaria, and Canada. China, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, and France are using it. Others include Georgia, Germany, Greece, Hungary, Iceland, India, Ireland, Italy, Japan, Kazakhstan, Kyrgyzstan, and Latvia. Lithuania, Luxembourg, Moldova, Netherlands, Norway, Poland, Portugal, Romania, Russia, and Serbia have also adapted them. The list also includes Slovakia, Slovenia, South Korea, Spain, Sweden, Tajikistan, Turkey, Turkmenistan, United Kingdom, United States, and Uzbekistan (Jackling, Howieson & Natoli, 2012).
Cultural Differences Interpretation
Most of the countries had traditional accounting methods that slightly differed from IFRS principles. The treatment of assets as accruals or cash basis is one of the challenges. There are also challenges on financial instruments, revenue recognition, and leasing. Some countries are mixing the traditional methods with a few of the IFRS regulations. Other countries like the US believe that the GAAP principles are working well among all its states. But the IAS board has allowed the states to adopt the rules in phases until they can meet all the requirements.
It is the setting of prices of goods and services between related entities within a firm (Martin & Vandekerckhove, 2013). The transactions occur within the MNC and its branches outside the country of origin. An example of transfer pricing is when a company’s office from another country sells goods to the parent company. The price that the parent company pays for the goods or services to its branch is called the transfer price. Businesses can also use it to allocate profit or loss to its subsidiaries. As a result of a transfer price, the enterprise may set prices among divisions from within the firm.
Corporate tax rates differ from country to country. Most corporations use the transfer prices to allocate most of their profits in countries where taxes are low. They set the process for tax avoidance. Some states impose penalties to MNCs that deny them taxes. The Organization for Economic Cooperation and Development considers transfer prices to be necessary for both the taxpayer and the tax administrator (Martin & Vandekerckhove, 2013). Therefore, it is logical for countries with higher taxes to work on their tax figures in such a manner that they would attract more investments. Fewer than 100 countries have initiated the transfer pricing rules. The rules allow the corporations to set their prices. However, taxation rules allow for adjustment of the taxes if they are outside the arm’s length rule.
How MNCs can Use Transfer Pricing
When goods move across national frontiers, the MNC has to calculate transfer prices for tax payments (Taylor, 2011). But when the corporate tax in both nations differs, then the MNC has to determine how to file its returns on revenue. The MNC would choose the country which charges lower taxes so that it can decrease its tax liabilities.
For instance, a Canadian multinational may want to sell high-margin Japanese products to US customers (Blouin, 2012). The multinational would put its IP in a tax haven, and require its Japanese manufacturing affiliate to pay royalties. The profits would make the company a US Haven as compensation for assuming inventory risk. Canada won’t charge any taxes. But the MNC would pay little taxes in the US.
Translation of Foreign Currency Financial Statements
The accounting standards require the foreign currency translation to be consistent and give the actual picture of the underlying economic view (Taylor, 2011). IAS 11 and Rule 52 of the FASB require that the functional currency becomes the one that predominates in the foreign subsidiary’s books of accounts. Currency translation comprises of the conversion of the functional currency into the presentation currency.
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The current rate method becomes useful when the functional currency is the same as the local currency. Assets and liabilities use the current exchange rate existing at the date of translation. The temporal rate translation method becomes useful when the foreign currency differs from the functional one. A company may also use the monetary and nonmonetary translation method when a foreign subsidiary has high integration with the parent company.
The IFRS brings about a common broad-based global language in business. They have united many enterprises and governments across the globe to have similar accounting standards. It makes it easy to compare and contrast companies’ records without having to adjust them afresh. Many MNCs have benefited from the transfer price rules. Countries have to make their taxes attractive to MNCs operations.
Blouin, J. (2012). Taxation of multinational corporations. Boston, MA: Now.
Gebhardt, G., Mora, A., & Wagenhofer, A. (2014). Revisiting the fundamental concepts of Ifrs. Abacus, 50(1), 107-116.
Jackling, B., Howieson, B., & Natoli, R. (2012). Some implications of Ifrs adoption for accounting education. Australian Accounting Review, 22(4), 331-340.
Martin, S., & Vandekerckhove, J. (2013). Market performance implications of the transfer price rule. Southern Economic Journal, 80(2), 466-487.
Singleton-Green, B. (2012). Commentary: The US and IFRS: Which way ahead?. Australian Accounting Review, 22(1), 51-53.
Taylor, V. (2011). The transfer price conundrum. International Business & Economics Research Journal (IBER), 5(11).