Foreign Subsidiary Consolidation under FASB 52: The Case of the Fading Honduran Plant during Periods of Moderate Inflation and Devaluation

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INTRODUCTION

In the modern global economy it is common for US corporations to have subsidiaries in other nations. Operating across national borders greatly increases the complexity of business operations. Clearly, issues like culture (e.g., Hofstede, 1980, 1994; House, Hanges, Javidan, Dorfman, & Gupta, 2004; Schwartz, 1990) and language (e.g., Marschan-Piekkari, Welch, & Welch, 1999; Marschan, Welch, & Welch, 1997) complicate things for the managers running the operations. However, with only two exceptions, under US generally accepted accounting principles (GAAP) if the parent owns over 50% of the voting stock of the foreign corporation the parent must prepare consolidated financial statements (Holt, 2004). This increases the complexity for the accountants because conducting business in multiple currencies and under different accounting standards also complicates financial reporting as the accountants must convert the financial statements of foreign subsidiaries to first comply with US generally accepted accounting principles (GAAP) and then convert the foreign currency amounts to US dollars unless the foreign currency is US dollars as is the rare case in Panama Ecuador, and El Salvador. At this point, the term convert is used to avoid confusion with translation and remeasurement that have specific meanings in this context.

Although the conversion of foreign subsidiary would seem straight forward at first glance, the process is complicated and researchers and practitioners argue that the converted financial information, in compliance with US GAAP, does not accurately reflect foreign subsidiary value (e.g., Aliber & Stickney, 1975; Duangploy & Owings, 1997; Hall, 1983; Holt, 2004, 2006; Ruland & Doupnik, 1988; Ziebart, 1985; Ziebart & Choi, 1998). As the fixed exchange rate system went away, Shapiro (1975) demonstrated that exchange rates, inflation, and the sector that the subsidiary operated in made determining value more complex than the "balance sheet" (p. 485) approach taken by accountants. After discussing the importance of understanding the particular business environment in which the foreign subsidiary operates, Holt (2004) states that "In fact, recasting from foreign GAAP to US GAAP is likely to destroy or distort relationships that are meaningful in the foreign environment" (p. 160).

This issue is not immaterial. There are many US corporations that have a significant portion of their operations outside of the US and a considerable number that derive the majority of their income through foreign subsidiaries. For example, a review of the financial statements of both McDonalds and Coca Cola indicates that international operations contribute more to shareholder value than US operations do. According to PriceSmart's (PSMT:NSDQ) 2013 10-K, 99% of its revenue from external customers came from its warehouse clubs in the Caribbean Islands and Latin America from Guatemala to Colombia. As US corporations increasingly look to emerging market economies in Asia, Latin America, and Africa for growth this trend will accelerate. In this paper we demonstrate how currency devaluation and moderate inflation, below the three-year cumulative 100% level that triggers remeasurement, effect asset valuation over time under the current rate method of translation.

We use the context of Central America to demonstrate. US MNCs have been operating in the region for over a century (Acker, 1988; Chapman, 2007; Valentine, 1916) and the region experienced a significant amount of foreign direct investment in many industry segments over the last 25 years. Several US corporations operating in the apparel and automotive components sectors have wholly owned manufacturing subsidiaries, called maquillas locally, in Honduras and other Central American nations. These factories exist solely to access the low-cost labor to manufacture products for export to sell in the US or other nations, not in the local market. …