Accounting for Business Combinations and the Convergence of International Financial Reporting Standards with U.S. Generally Accepted Accounting Principles: A Case Study

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INTRODUCTION

Financial accounting and reporting in the U.S. is changing rapidly. During the past six months, the Financial Accounting Standards Board, the primary accounting standard setter in the U.S., issued twelve (12) new standards and launched its on-line "Accounting Standards Codification," which organizes existing GAAP into 90 topics (FASB, 2009). At the same time, a significantly more dramatic change is on the horizon for accounting professionals, company executives, and financial statement users.

Consistent with the SEC's 2008 proposal entitled, "Roadmap for the Potential Use of Financial Statements Prepared in Accordance With International Financial Reporting Standards by U.S. Issuers," (Roadmap) in approximately five years, public companies likely will have to utilize IFRS, instead of U.S. GAAP (SEC, 2008). In fact, some large global U.S.-based entities are permitted to early-adopt IFRS starting in 2009. The SEC expects to reach a final decision regarding the mandatory adoption of IFRS in 2011 (SEC, 2008).

If the U.S. indeed adopts IFRS as the required standard for financial accounting and reporting, the U.S. will join the more than 100 nations worldwide that currently permit or mandate the use of IFRS. For example, starting with the 2005 reporting period, all European public companies listed on any European stock exchange must prepare IFRS-based financial statements. Other nations, such as Canada, are planning to adopt IFRS in the near future.

Currently, U.S. GAAP and IFRS are not identical. However, since signing their Memorandum of Understanding, commonly referred to as the "Norwalk Agreement," in 2002, FASB and the IASB have been working together to develop a set of high-quality globally acceptable financial accounting standards and to bring about convergence of U.S. GAAP and IFRS. Since the Norwalk Agreement was signed, many new and revised standards issued by FASB and the IASB have served the purpose of eliminating existing differences. However, while many differences have been eliminated, others persist.

Accounting for and reporting by global entities is quite complex. U.S., as well as international accounting rules require that a parent company consolidates its subsidiaries' financial statements with the parent company's financial statements. Recent standards issued by the IASB and FASB have eliminated many differences between U.S. GAAP and IFRS in accounting for business combinations and financial reporting for consolidated entities. However, some significant differences continue to exist.

KLUGEN CORPORATION

Irma Kuhn, CPA, CMA holds the position of Chief Financial Officer (CFO) of Klugen Corporation, a global telecommunications company. Klugen is a consolidated entity headquartered in the U.S. with four majority-owned European subsidiaries. The company has expanded primarily by acquiring majority interest in European companies and holds between 51% and 70% of the outstanding voting stock of its subsidiaries. Three of these subsidiaries were acquired in stages and consolidated once the company achieved majority ownership.

Consistent with current accounting rules, Klugen consolidates all four of its subsidiaries. In addition, Klugen also holds financial interests in several unconsolidated entities and accounts for those as investments.

Klugen's European subsidiaries currently prepare their financial statements consistent with International Financial Reporting Standards (IFRS), which are promulgated by the International Accounting Standards Board (IASB). Klugen, the parent company, issues consolidated financial statements, which include the results of its majority-owned subsidiaries in conformity with U.S. GAAP. Preparation of Klugen's consolidated financial statements requires that Irma and her staff convert the subsidiaries' IFRS-based financial statements into U.S. GAAP prior to consolidating the numbers. This process is quite complex and requires many of the accounting departments' resources. …