Classification of foreign operations for financial reporting

Abstract

The New Zealand standard on foreign currency translation (FRS-21), similar to standards in the US, Australia, and Canada and the International Accounting Standard (IAS-21), requires the classification of foreign operations for translation purposes into two mutually exclusive types: integrated or independent. In judging whether a foreign operation is either integrated or independent, the accounting standard requires the evaluation of five qualitative factors. The standard neither describes the judgement process nor identifies the relative importance of the determining factors. It has been asserted that the lack of clarity in the standard on foreign currency translation may yield dissimilar results for firms whose circumstances are similar and consequently may reduce the comparability of financial statements across firms. Using a repeated measures design, this paper examines the judgement of preparers of financial statements (New Zealand financial controllers) in determining the designation of foreign operations for translation purposes. The results indicate that the relative importance of the determining factors is marginally unequal. No support is found for the assertion that the use of qualitative factors in accounting standards results in dissimilar judgements (lack of consensus) across respondents. Further, the results show that the subjects demonstrated consistency and self-insight in their judgements. Further, the results indicate that the judgements of respondents are not biased toward either classification of foreign operation. This may suggest that the observed bias may be motivated by economic factors rather than the outcome of using the qualitative cues in the accounting standard. When the respondents were debriefed, several of them identified ‘managerial independence’ as another determining factor that has not been included in the NZ standard.