How Bitcoins May Change the Global Economy, Research Paper Example

Introduction

International finance is continuously contributing to the economic development of nations around the world. Just about all of a nation’s resources are dependent on their financial situation as well as the financial situations of other nations. For this reason, the US multi-national corporations’ financial and accounting systems should adopt the International Financial Reporting Standards (IFRS). So this leaves us with the question of the subject matter: Why should US public companies adopt international regulations, practices, and concepts of finance?

Policies

Foreign currency translations in international finance are primarily governed under two comparable yet contrasting concepts, International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP).  There is an ever increasing drive for the globalization of a single set of universal accounting and financial reporting regulations, otherwise known as convergence. Over 100 countries currently translate foreign currencies under the guidance of IFRS. This is why it is important for any business desiring global expansion to learn how IFRS will impact their business. (Lemus, 2014)

The Securities and Exchange Commission (SEC) focuses on regulating whether the adoption of IFRS by US registrants should be permitted or even required. Although the SEC has not solidified any decisions on the use of IFRS by any US registrants, such activity is still in development. (Lemus, 2014)

Foreign currency matters related to GAAP are guided primarily guided under the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) Topic 830, titled Foreign Currency Matters. The IFRS issues guidance for foreign currency matters under its’ International Accounting Standards (IAS) 21 and 29. IAS 21 deals with the effects of changes in foreign exchange rates, while IAS 29 deals with the financial reporting in hyper-inflation economies. (McGladrey, 2012) (Lemus, 2014)

In the actual determination of functional currency, GAAP and IFRS use different indicators as stated above. Under IFRS, such indicators of functional currency are structured in a hierarchy; where primary and secondary indicators are considered. Contrasting, GAAP does not structure its’ indicators in a hierarchy matter. (McGladrey, 2012)

Hyperinflationary economies carry other major differences under GAAP versus IFRS. Under GAAP, the financial statements of hyperinflationary economies are pre-measured as if the parent company’s reporting currency was considered the functional currency. Any differences resulting from exchange rates are reported as income. Under IFRS however, the functional currency is retained in hyperinflationary economies. If there are any amounts in the financial statements that were not pre-measured using the current rate at the end of the reporting period, then those amounts are indexed under a general pricing index, which are then converted into the reporting currency at the current rate. (Lemus, 2014)

Let’s first discuss how entities measure their assets, liability, income, and expenses under each concept. These accounts are measured in the entity’s functional currency under both IFRS and GAAP. However, IFRS uses slightly different indicators to determine their functional currency. For both concepts, transactions not denominated by functional currency of the entity are considered foreign currency transactions. In such cases of foreign currency transactions, exchange differences emerging on currency translation are primarily recognized in profits or loss. (KPMG, 2013)

For purposes of consolidation, financial reports from foreign operations are translated under the same methods for both IFRS and GAAP. First, both assets and liabilities are converted at the closing rate. Income and expenses are converted at the actual rates, where in some cases, the applicable average rate is used. Finally, equity components are converted using historical rates; this does not included current-year movements. Current-year movements are converted through actual rates. (KPMG, 2013)

Under both concepts, exchange differences that emerge from the conversion of financial statements from foreign operations are recognized through other comprehensive income or (OCI); and then accumulated in separate components of equity, which is called accumulated OCI.  Attributable amounts recognized as part of any non-controlling interests (NCI) are then allocated to it. (KPMG, 2013)

The entity can present financial statements in currencies other than the functional currency, which is known as a presentation currency. When the entity translates such financial statements into a presentation currency, they make use of the same method from translating financial statements from foreign currencies. (KPMG, 2013)

If the entity makes willing of an interest from a foreign operation that includes loss of control over a foreign subsidiary, then the cumulative exchange differences recognized in the OCIs are averted to either profit or loss. Partial disposals of foreign subsidiaries can lead to proportionate reclassification into NCI; this is without loss of control of the foreign subsidiary. This happens while other partial disposals lead to proportionate reclassifications to profits or losses. However, under GAAP, the proportionate reclassifications to profits or losses when business subsidiaries are in substance real-estate or oil & gas, or the entire OCI which was accumulated is reclassified to profits or losses when control is lost, may cause differences in results from IFRS. In such cases, the loss of control is considered a disposal, even if the entity maintains interest in their investees, similar to IFRS. Only unlike IFRS, a loss of adequate influence or joint control is considered a partial disposal when the entity maintains interest in the investee. (KPMG, 2013)

Entities may present supplementary financial data in currencies other than the presentation currency if applicable disclosures are presented. This is also true under GAAP, only the SEC requires more authoritative regulations than from IFRS. (KPMG, 2013)

If US companies adopt IFRS, the major impacts will be on the reporting of the balance sheets, income statements, and financial ratios. For example, in the reporting of inventory on the balance sheet, the first-in first-out (FIFO) or the last-in first-out (LIFO) methods are normally used. IFRS prohibits the use of LIFO in reporting inventory, so US companies following currently using the LIFO method of reporting inventory would have to convert to using the FIFO method. This would impact the cost of goods sold (COGS) which would affect the results of profit from sales revenue, thus having a major impact on the income statements. (Dumont, 2014)

The adoption of IFRS by US companies would have an impact on a few of the financial ratios. The current ratio and quick ratio are impacted due to the change in inventory reporting methods as stated above. The interest coverage ratio is affected because earnings before interest & taxes (EBIT) are changed by the difference in COGS. The return on assets ratio is also affected by the difference in COGS. Financial analysts must be aware of these differences when evaluating US companies. (Dumont, 2014)

The differences in GAAP and IFRS are highly complex, especially in regards to foreign currency translations; but this report gives the basic rundown of how converting from GAAP to IFRS will impact the US. Progress continues for the adoption of IFRS by US companies as more countries already us it. The pro for IFRS is that once the US fully adopts it, the translation of foreign currencies will become universally regulated by a single concept and less complicated for multi-national corporations to comprehend. Thus, it is strongly recommended that all US based companies using GAAP start to learn the concepts of IFRS for a good head start. (Leonidas Sandoval Junior, 2015)

In international finance and accounting, rules and regulations must be periodically maintained in order for business to function adequately at an acceptable level. This is where the Financial Accounting Standards Boards (FASB) does their job. The FASB is designated by the Security and Exchange Commission (SEC) to uphold accounting standards for public companies in the US. Although they establish GAAP, the FASB is not a Governmental entity, but rather a private, not-for-profit organization.

There are various sections under the FASB codification, all pertaining to every area of accounting standards among public companies. Every codification is essential to a functional set of GAAP, but in terms of multi-national corporations (MNC), one of the most important codifications to be adopted is that of foreign currency matters.  When US companies conduct business abroad, they are subject to market risks such as fluctuations in foreign exchange rates and tax jurisdictions on their sales revenue.

FASB statement No. 8 was issued in October 1975, and became effective the following year. This statement deals with financial statement translations based on foreign subsidiaries. It was necessary because US based multi-national corporations needed an adequate method of translating their financial statements from foreign countries in which they operated, into US dollars. When this statement was established, it rendered previous methods of foreign currency translations used among accounting firms obsolete. (Shank, 1976)

The method of converting foreign income statements is the least complicated section of FASB statement no. 8. Income statements required the conversions of all revenues and expenses based on what the foreign currency exchange rate was at the time of the transaction, into US dollars. However, depreciation and cost of goods sold were subject to slightly different terms. For these accounts, the amount of expense is converted into US dollars based on the historical foreign exchange rate that was current at the time the pertaining asset was acquired. Because it would be impractical for an accounting firm to calculate the foreign exchange conversions of revenues and expenses on a daily basis, FASB statement no. 8 allows for the use of average foreign exchange rates over the year. However, if there is a significant fluctuation in foreign exchange rates across the four quarters of the year, then firms may use the averages of those exchange rates in accordance with the pertaining quarter. (Shank, 1976)

The method of converting balance sheets is based on the temporal method of accounting, which is the method of foreign currency conversion which uses the exchange rate based on the time that assets and liabilities were incurred. Under this conversion method, all monetary accounts in the balance sheet are converted at the foreign exchange rate that existed on the balance sheet date, while all non-monetary accounts are converted based on the historical exchange rates that existed when the items were acquired. Monetary items represent cash or claims on or against fixed amounts of cash. Owner’s equity is not converted because it acts as a balancing account in the balance sheet after conversion. (Shank, 1976)

In accounting for foreign exchange gains and losses, FASB statement no. 8 requires all foreign exchange gains and losses to be defined as an income or expense as soon as it is incurred, on a quarterly basis. When FASB statement no. 8 was established, it no longer permitted the deferral of gains and losses. Because all gains and losses must immediately be recognized, deferrals must invert the net deferred balance by renewing the financial statements for all previous years shown in the annual report.  (Shank, 1976)

In the translation of foreign financial statements, the US used three primary methods of conversion. The first method is referred to as the monetary/nonmonetary method, and has been required by all firms since FASB no. 8 was established. (Shank, 1976)

The second method, the current/noncurrent method, translates all current assets/liabilities with current foreign exchange rates, and all noncurrent assets/liabilities at the historical exchange rates. The formula for this method is that gain or loss translation equals current assets minus current liabilities or net working capital. This method caused significant shifts in gains and losses to firms who changed from this method. (Shank, 1976)

The third method is called the all current except plant method, and is sometimes referred to as the modified monetary/nonmonetary method. This is because this method is in fact identical to the monetary/nonmonetary method, but in this modified version, inventories are translated at current exchange rates as opposed to historical exchange rates. Again, this exception for inventories is due to FASB statement no. 8. (Shank, 1976)

In December of 1981, FASB statement no. 52 was issued, which was titled Foreign Currency Translation. This was anticipated to reduce fluctuations in businesses reported earnings caused from cycles of foreign exchange rates. Because FASB statement no. 8 was surrounded with controversy for a number of reasons, statement no. 52 was established with intent to replace it. (FASB, 1982)

Functional currency is currency of the primary economic environment where subsidiaries, divisions, or joint ventures generate and expend cash. FASB statement no. 52 mandated the use of current exchange rates in converting from foreign functional currency to US dollars for foreign operations consolidated in a particular country. These conversions are adjusted specifically in stockholders’ equity as oppose to income, in which case cash flows are no included in net income. Thus, the local currency is used for many foreign operations. (FASB, 1982)

However, for some US companies with operations abroad, economic effects of foreign exchange rate fluctuations would affect the company’s cash flow directly. This is because their cash flows are related to individual assets and liabilities which directly affect the parent company’s cash flows based on the US dollar on a current basis. So, foreign exchange gains and losses from conversions of that foreign operation would need to be included when calculating net income. (FASB, 1982)

According to the FASB website, the functional currency translation approach adopted in statement no. 52 encompasses:

1. Identifying the functional currency of the entity’s economic environment
2. Measuring all elements of the financial statements in the functional currency
3. Using the current exchange rate for translation from the functional currency to the reporting currency, if they are different
4. Distinguishing the economic impact of changes in exchange rates on a net investment from the impact of such changes on individual assets and liabilities that are receivable or payable in currencies other than the functional currency

In 2010, the FASB issued six accounting standards updates to amend the FASB codification. One of those updates (update 2010-19) was in relation to foreign currency. The FASB topic no. 830, titled Foreign Currency Issues: Multiple Foreign Currency Exchange Rates, provided accounting guidance for reporting balances in a business entity’s financial statements that were different from their US dollar values. (Coville, Fitzsimons, & Tesher, 2010)

Restrictions of foreign exchange in Venezuela provide entities use of the official exchange rate to convert funds. The update notes that the official rate is established by the Venezuelan Government, and that an entity is required to obtain the ability to use Venezuela’s official exchange rate from the Venezuela Commissions for Administration of Foreign Currency. The SEC noted in update 2010-19 that instead of using official foreign exchange rates, an entity may legally use parallel rates which provide more exchange rates that are more liquid. This could be done by having the entity use a circuit of transactions through a broker. (Coville, Fitzsimons, & Tesher, 2010)

The SEC stated that when reported balances for financial reports were different from the actual balances set by the US dollar, then disclosures are required to inform users of financial statements about such differences. When such differences are material, disclosures in the annual and interim financial statements consist of a set of disclosures. These disclosures are summarized as follows:

• Disclose rates used for re-measurement and translation
• Reason for differences between actual balances based on the US dollar and amounts reported
• Disclosure of relevant line items on financial statements for amounts reports for financial reporting purpose are different from the values based on the US dollar
• Disclosure of amounts that are recognized through income statements, including the effect on other financial statements, per high inflationary accounting

Under topic no. 830 on Foreign Currency Matters, every issue related to foreign currency is addressed on the FASB website, with their corresponding subtopics. These subtopics include foreign currency transactions, translation of financial statements, statements of cash flows, income taxes, and financial services for investment companies. Each of these subtopics is divided into more detailed subtopics, but all of which relate to foreign currency matters. An accounting standards update was added in early 2010 in regards to not-for-profit entities under the general status of foreign currency matters. Maintenance is constantly being done on certain updates themselves, such as a maintenance update done to update 2014-07 earlier in 2014. All accounting standards updates related to foreign currency matters, in addition to other topics set by FASB, are added to their website as each action is amended.

In March of 2013, the FASB issued another accounting standards update to topic no. 830, titled update 2013-05, under Foreign Currency Matters. This was issued in order to address diversity in accounting practice in regards for releasing cumulative translation adjustments (CTA) into earnings in the occurrences of events. (Rashty, 2014)

According to a report from Deloitte, update 2013-05 indicates that CTA is attached to the parent company’s investment in a foreign entity and should be released in consistence with derecognition guidance on investments in entities. This would mean the entire amount of the CTA related to foreign currency would be released under the following conditions:

• Sale of a subsidiary or group of net assets within a foreign entity and the sale represent the substantially complete liquidation of the investment in the foreign entity.
• Loss of a controlling financial interest in an investment in a foreign entity (i.e., the foreign entity is deconsolidated).
• Step acquisition for a foreign entity (i.e., when an entity has changed from applying the equity method for an investment in a foreign entity to consolidating the foreign entity).

Deloitte’s report notes that entities with foreign subsidiaries for foreign investments are primarily affected by update 2013-05. The status is effective for public entities for fiscal years which began on or after December 15, 2013. The current status in regards to nonpublic entities is that the update is effective for the first annual periods beginning on or after December 14, 2014. However, early adoption of this update is permitted for public and nonpublic entities. (Orrell & Tian-Lee, 2013)

Foreign currency matters is probably the most complex topic that FASB has ever established, due to the fact that it needs to cover concepts beyond those of GAAP. Foreign exchange rates are constantly fluctuating which makes operating abroad a risk, because the fluctuations can either be favorable or unfavorable, depending on the status of the economy in which the US based MNC is operating. As updates are constantly being made to FASB 830, it is important for anyone dealing with foreign currency matters of any business to understand how accounting is translated from business done abroad. (Mohsen Bahmani-Oskooee, 2015)

Global Capital Investments

The strong economic development of the BRICS countries is not due to any disregard of the Washington Consensus. Although the BRICS countries are not fully governed by every component of the Washington Consensus, they have integrated a great deal of it into their economic structure. In the past couple of decades, concepts and policies related with the Washington Consensus have gained attention from political economists. The systematic effects following the 2008 recession stimulated concern about the convergence of the on-going economic development throughout the BRICS countries and their presumed accord with the Washington Consensus paradigm of policies. Now, we believe that such concern from political economists has brought forth the question of whether the BRICS countries have branched off from both the concepts and the policies proposed for them by the Washington Consensus. However this does not suggest that the BRICS countries have completely disregarded it.

The BRICS Development Bank may act as a pressure mechanism to get World Bank and the International Monetary Fund back in a position of financial and economic sound. The following data, presented in millions, represents the official reserve assets of global nations in convertible foreign currencies. As we can see, the emerging and developing nations carry higher numbers in their official reserve assets than even the advanced economics. The BRICS countries role in their Development Bank is a significant factor when considering these statistics.

Initially, the World Bank and IMF were established in Washington with objectives to stimulate employment growth, as well as financial and economic security. Gallagher points out however that this initial objective was disrupted in in the 1980’s throughout the 1990’s when they launched the ploy of the Washington Consensus. He states that the Washington Consensus disrupted global economic stability because while it provided financial resources, it was done under the condition of deregulation. The times of the Washington Consensus are frowned upon due to their imposed financial costs throughout developing countries. The World Bank and IMF are viewed as if the institutions were fabricated specifically against the emerging markets as well as developing nations. Gallagher supports such a speculative claim on the grounds of an unwritten rule. That unwritten rule he believes is that the IMF head has always been a European citizen while the World Bank head has always been American. He also supports his claims by stating that the voting network of both IMF and World Bank are bias and rule in favor of better industrialized countries. While this is just his speculation, he does point out that the voting network of these institutions does allocate veto power for the United States should they disagree on an economic policy. Furthermore, IMF and World Bank failed to predict the recession of 2008 while the BRICS countries continued their economic development. (Gallagher, 2014) (Payne, 2015)

Now in an analysis of a contrasting article from Pepe Escobar about how BRICS stands against the Washington Consensus, we will evaluate their perspective while maintain our position in the argument. Escobar uses a situation about the BRICS Development Bank to support his position. The Brazilian economy use utilizing a financial model in which they are making investment across Latin America. It is predicted that in the next few years, their capital will amount to about 350 billion USD. They are receiving extra funding from China and Russia and this new institutionalized bank may far surpass the World Bank. Additionally, the Contingents Arrangement Agreement establishes a pool of reserve currencies amounting to 100 billion USD. To generate the currencies pool the BRICS countries will all contribute to it. 18 billion USD will be contributed from Brazil, Russia, and India. China will contribute 41 billion USD and South Africa will contribute 5 billion USD. Escobar argues that this BRICS Development Bank situation is considered “non-Washington Consensus” and is a circuit to counter-act with it. (Escobar, 2014) (Leonidas Sandoval Junior, 2015)

The Future of Currency

Innovations in information technology are constantly surfacing in the world. Such technological advances are driving the economy forward in making business enterprises run more sufficiently. The financial markets are always trending towards investments that will increase their stock shares and sustain their marks on global stock exchanges. None of this is possible without currency. Whether it is the US dollar, British pounds, Japanese yen, or Mexican pesos, currency is the blood of business that is in a never-ending circulation. As information technology has continued to advance in the world, currency has gone digital. Digital currency is use by virtually all parties public and private. Credit cards, electronic checks, and even mobile money via smartphones are the most popular forms of digital currency among individual parties. Major financial institutions such as Bank of America and Wells Fargo manage clients’ bank accounts and host their digital currency balances. Trade debtors or cash handling organizations such PayPal and Western Union manage cash on hand accounts and are often used for online shopping. Though these trade debtors do not distribute loans or pay interest on accounts such as public financial institutions. Such digital currencies are government regulated however, and subject to accounting audits as well as taxes in pertaining tax jurisdictions. A new form of digital currency however, is on the rise. This currency is not regulated by any government, not subject to taxes or audits, and can even be transacted anonymously. It is a single unit of currency and does not need to be converted when transacted among differing countries. This rising digital and universally traded currency is called Bit Coin.

The Bit Coin currency is not centralized by any bank, and no form of government has established or even approves any financial value it may carry. They can be viewed as an unofficial form of currency, because despite not being supported by any government or financial institution, enough parties trade, spend, and accept them as a form of payment for goods or services. Bit Coins will remain a part of the global economy for as long as holders of them continue to believe that they may be used to acquire goods or services. (Yellin, 2014)

On the technical component of how the Bit Coin is operated, it uses a method of cryptology known as encryption. Encryption in information technology is a type of digital signature that maintains privacy between the trading parties. It was originally developed for the use of private messaging in electronic messages that contained sensitive or classified information. This digital signature in the form of encryption gave verification to the recipient that the message had truly originated from the given sender and that it had not been manipulated or tampered with during transit. Then in 2009 this same software was integrated into the digital currency that is now Bit Coin. Assurance that Bit Coins are not duplicated or reused by the same spender all rely on the mathematics of the computer code that operate it. When a user spends Bit Coins on the internet, they use a unique pass key to authorize a transaction to the web of the other Bit Coin users showing that given amount of Bit Coins have been spent to a seller. The Bit Coin software then authenticates this transaction showing all users that the amount has been deducted from the spender’s account and credited to the seller’s account.

Bit Coin continues to make its trend-setting impact on the global economy, but its role will have the greatest effect on the international working force. Having a current value of $247 USD to 1 Bit Coin, transactions are not laced with any transaction or conversion fees. Workers living abroad, both blue and white collar, are able to transfer money to any country in the world without having to deal with the fees imposed by what Western Union would charge. Within the next few years, people living in third world countries will be able to make use of Bit Coins as it gives them a form of a bank account that they can use to globally interact with other parties for purposes of business. To take matters even further, Bit Coin may even set the new benchmark for central banks and financial institutions, as they would have to conform to the value and transaction fees of Bit Coin in order to sustain their position in the economy. (Carmody, 2013)

Conclusion

With international finance being an ongoing subject, efforts towards universal convergence are becoming more agreeable due to the desires of simplifications. In order for this to happen, the US MNC’s currently using the GAAP system of finance and the FASB No. 8 statement explains why this would help. The BRICS countries demonstrate in their Development Bank that the convergence of multiple nations makes for stronger financial standing. The prospect of Bit Coin, a universal currency, might be more effective if the model was actually adopts by the United Nations as a global currency. In any case, the primary efforts in international finance should be convergence.

References

Carmody, T. (2013, October 15). Money 3.0: How Bitcoins May Change the Global Economy. Retrieved April 2, 2015, from National Geographic: http://news.nationalgeographic.com/news/2013/10/131014-bitcoins-silk-road-virtual-currencies-internet-money/

Coville, T., Fitzsimons, A., & Tesher, A. (2010, November). FASB Issues Guidance on Foreign Currency, Credit Quality and Health Care. Commercial Lending Review, 25(6), 45-48.

Dumont, C. (2014). International Financial Reporting Standards: What You Need To Know. Retrieved from Investopedia: http://www.investopedia.com/articles/fundamental-analysis/12/international-financial-reporting-standards.asp

Escobar, P. (2014, July 15). BRICS against Washington consensus. Retrieved from Asia Times: http://www.atimes.com/atimes/World/WOR-01-150714.html

FASB. (1982, Janurary ). FASB replaces standard on foreign currency translation. Journal of Accountancy , 153(1), 9-10.

Gallagher, K. (2014, July 14). BRICS: Toward a Rio Consensus. Retrieved from The Globalist: http://www.theglobalist.com/brics-toward-a-rio-consensus/

KPMG. (2013, November). IFRS Compared to US GAAP: An Overview . Retrieved from KPMG: http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/IFRS-compared-to-US-GAAP-An-overview-O-201311.pdf

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Leonidas Sandoval Junior, A. M. (2015). Dependency Relations among International Stock Market Indices. J. Risk Financial Manag. , 8(2), 227-265.

McGladrey. (2012). US GAAP vs IFRS: Foreign Currency Translation issues at a glance. Retrieved from McGradrey: http://mcgladrey.com/content/dam/mcgladrey/pdf/ifrs_foreign_currency_translation.pdf

Mohsen Bahmani-Oskooee, T. C.-P. (2015). Purchasing Power Parity in Transition Countries: Panel Stationary Test with Smooth and Sharp Breaks. Int. J. Financial Stud, 3(2), 153-161.

Orrell, M., & Tian-Lee, J. (2013). Accounting Roundup. Deloitte & Touche LLP.

Payne, N. A. (2015). Special Issue: Recent Developments in Finance and Banking after the 2008 Crisis. Int. J. Financial Stud, 3(2), 151-152.

Rashty, J. (2014, March). Foreign Currency Matters. CPA Journal, 54-56.

Shank, J. K. (1976, July/August). FASB Statement 8 Resolved Foreign Currency Accounting – Or Did It? Financial Analysts Journal, 32(4), 55-61.

Yellin, T. (2014). What is Bitcoin? Retrieved April 2, 2015, from CNN Money: http://money.cnn.com/infographic/technology/what-is-bitcoin/