Chapter 8
International Business
Combinations, Goodwill, and
Intangibles
Strategic Decision Point

How should we consolidate financial results?
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Use 50% rule or some other method?
Example – Vodafone owns 47% of Verizon

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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
Consolidated Financial
Statements

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Controversy exists on how results for MNEs should
be reported
Current method – consolidation
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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
Consolidation Methods

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“Line-by-line” for approach
Proportionate ownership method
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“One-line basis” - equity method
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Considered appropriate for joint ventures
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
Purchase versus Pooling-ofInterests Accounting

Purchase method (acquisition method)
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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
Purchase Accounting

Pooling-of-interests method (merger method)
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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
Pooling-of-Interests
Accounting

What method is most appropriate?

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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
The Treatment of
Nonconsolidated Subsidiaries

Equity Method

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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
Corporate Group Share
Ownership Patterns
International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black
Fair Value Adjustments

Fair value of assets acquired is determined
using the current market value
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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

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FV>BV, earnings overstated and assets understated
FV<BV, earnings understated and assets overstated
International Accounting and Multinational Enterprises – Chapter 8 – Radebaugh, Gray, Black
Accounting for Goodwill

Most countries treat goodwill as an asset subject to
systematic amortization
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U.S. and IASB treatment is an annual impairment
test of goodwill
Some countries use immediate write-off method
against reserves

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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, Gray, Black
International Accounting
Standards

IFRS 3 on Business Combinations superceded IAS
22 in March 2004
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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
Problems and Prospects
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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
Problems and Prospects

Different groups want different consolidation
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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
Funds and Cash Flow
Statements

“Funds” does not necessarily mean cash

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Provides insight into the financial
performance, stability, and liquidity of MNEs
May be useless without additional
disaggregated information

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Could also mean working capital
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
Funds and Cash Flow
Statements
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Countries where statement is required
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Countries where statement is not required
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Brazil, Canada, Philippines, Australia, NZ
All countries adopting IFRS
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
Funds and Cash Flow
Statements
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Problems and Prospects
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Regulation is highly flexible in this area
Some confusion about the purpose, presentation,
and use of the statement
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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
Joint Venture Accounting
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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
Joint Venture Accounting
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Three types of joint ventures exist
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Jointly controlled operations
Jointly controlled assets
Jointly controlled entities
IAS 31 requirements for venturers
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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
Goodwill and Intangibles
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Major international importance
Academic research and cooperation between
standard-setting agencies are needed in this
area
Intangible Assets and the Balance Sheet
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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
Goodwill and Intangibles

The Stock Market Perspective
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If the market is efficient
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If the market is inefficient
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The nature and treatment of intangible assets should
be sufficiently disclosed to help users assess the
treatment used
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
Goodwill
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Only an issue when purchase method is used
Controversies
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Should goodwill be included as an asset?
Should goodwill be amortized?
Accounting Methods
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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
Goodwill

Comparative National Practices
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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
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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
Brands, Trademarks, Patents,
and Related Intangibles

Should brands be capitalized?

Brand capitalization would
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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
Brands, Trademarks, Patents,
and Related Intangibles
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Methods of Accounting
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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
Brands, Trademarks, Patents,
and Related Intangibles
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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, Gray, Black
Brands, Trademarks, Patents,
and Related Intangibles
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International Accounting Standards

IAS 38
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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
Brands, Trademarks, Patents,
and Related Intangibles

Conclusions
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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
Research and Development
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R & D expenditures include all costs related
to the creation and development of new
processes, techniques, applications, and
products
Three categories of expenditure
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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
Research and Development
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Insert Exhibit 8.4
Tendency towards conservative asset recognition
and assessment of future benefits
Accounting Methods
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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
Research and Development

International Accounting Standards

IAS 38
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Requires immediate write-off method for research
expenditures
Development costs should be immediately written off
unless project meets specific criteria

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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
Research and Development

Conclusions
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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