International Accounting 6th

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Timothy Doupnik
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 Page i

International Accounting

Sixth Edition

Timothy Doupnik
University of South Carolina

Mark Finn
Northwestern University

Giorgio Gotti
University of Texas Rio
Grande Valley
 Page ii

INTERNATIONAL ACCOUNTING

Published by McGraw Hill LLC, 1325 Avenue of the Americas, New York, NY 10019.
Copyright ©2024 by McGraw Hill LLC. All rights reserved. Printed in the United States of
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To my wife, Birgit, and children, Stephanie and Alexander Page iii

—TSD

To Kaori, Alisa, Monica, and George

—MF

To my parents, and to Alan, Martina, Maurizio, Nicola, and Sara2

—GG
About the Authors
Timothy S. Doupnik University of South Carolina Page iv

Timothy S. Doupnik is a Distinguished Professor Emeritus of Accounting at the University

of South Carolina, where he joined the faculty in 1982. He served as director of the School
of Accounting from 2003 until 2010, and then as Vice Provost for international affairs until
2013. He has an undergraduate degree from California State University–Fullerton and
received his master’s and PhD from the University of Illinois.

Professor Doupnik has published exclusively in the area of international accounting in

various academic journals, including The Accounting Review; Accounting, Organizations, and
Society; Abacus; Journal of International Accounting Research; Journal of Accounting Literature;
International Journal of Accounting; and Journal of International Business Studies.

Professor Doupnik is a past president of the International Accounting Section of the

American Accounting Association, and he received the section’s Outstanding International
Accounting Educator Award in 2008. He has taught or conducted research in international
accounting at universities in a number of countries around the world, including Austria,
Brazil, China, Dominican Republic, Finland, Germany, and Mexico.

Mark Finn Northwestern University

Mark Finn is a Clinical Professor of Accounting at the Kellogg School of Management,
Northwestern University, having served on the Kellogg faculty since 1996. Prior to Kellogg,
Professor Finn was on the faculty of the University of Chicago’s Booth School of Business.
He has been affiliated with the Sasin School of Management, Chulalongkorn University
(Bangkok, Thailand) since 2003 and the Birla Institute of Technology and Science’s School
of Management (Mumbai) since 2020. Professor Finn has also served as a visiting professor
at the Indian School of Business (Hyderabad and Mohali) and Keio University (Hiyoshi,
Japan). From 2001 to 2008 he was director of Kellogg’s Global Initiatives in Management
(GIM) program. He received a PhD from Cornell University and a BA with honors from
Stanford University.

Professor Finn teaches core financial accounting and advanced classes in financial
reporting, taxation, international accounting, and sustainability reporting. He received
Kellogg’s Chairs’ Core Teaching Award in 1999, 2005, 2008, 2012, 2014, and 2021 and the
Indian School of Business’s Teacher of the Year award in 2003, 2008, and 2009. Within the
GIM program, he served as a faculty adviser to classes on China, Japan, India, and South
Africa. His primary research interests are related to the quality and credibility of financial
disclosures, especially in non-U.S. settings. His research articles include “Market Rewards
for Increasing Earnings Patterns,” published in the Journal of Accounting Research.

Giorgio Gotti University of Texas Rio Grande Valley

Giorgio Gotti is the Director of the School of Accountancy and Professor at the Robert C.
Vackar College of Business & Entrepreneurship, University of Texas Rio Grande Valley. He
received his PhD in Business Administration and his Master of Accountancy from the
University of Tennessee and a Laurea in Economics from Bocconi University, Italy. He is a
Chartered Accountant and Statutory Auditor in Milan, Italy.

Professor Gotti’s research and teaching interests are in international and financial
accounting. His papers have been published in the International Journal of Accounting;
Journal of Accounting, Auditing & Finance; Journal of International Accounting Research;
Management International Review; Journal of Business Ethics; Research in Accounting
Regulation; Journal of Management and Governance; Management Decision; and Review of
Accounting and Finance. He has taught international accounting to graduate students at
various universities in Italy, Brazil, and the United States.

Professor Gotti is Director focusing on International in the Board of Directors of the Page v
American Accounting Association, and past president of the International Accounting
Section of the American Accounting Association. He is a member of the Editorial Board of
the International Journal of Accounting and Associate Editor of the Journal of International
Accounting, Auditing & Taxation. He has been a member of the Scientific Committee of the
European Accounting Association Annual Congress since 2016. He served as Associate
Editor of the Journal of International Accounting Research in 2014–2017 and is now a
member of the Editorial Board.
Preface
Page vi

ORIENTATION AND UNIQUE FEATURES

International accounting can be viewed in terms of the accounting issues uniquely
confronted by companies involved in international business. It also can be viewed more
broadly as the study of how accounting is practiced in each and every country around the
world, learning about and comparing the differences in financial reporting, taxation, and
other accounting practices that exist across countries. More recently, international
accounting has come to be viewed as the study of rules and regulations issued by
international ­organizations—most notably International Financial Reporting Standards
(IFRS) issued by the International Accounting Standards Board (IASB). This book is
designed to be used in a course that attempts to provide an overview of the broadly defined
area of international accounting. It focuses on the accounting issues related to international
business activities and foreign operations and provides substantial coverage of the IASB and
IFRS.

The unique benefits of this textbook include its up-to-date coverage of relevant material;
extensive numerical examples provided in most chapters; two chapters devoted to the
application of IFRS; and coverage of nontraditional but important topics such as
management accounting issues in multinational companies, international corporate
governance, and corporate social reporting. This book contains several important
distinguishing features:
Numerous excerpts from recent annual reports to demonstrate differences in financial
reporting practices across countries and financial reporting issues especially relevant for
multinational corporations.
Incorporation of research findings into the discussion of many issues.
Extensive end-of-chapter assignments that help students develop their analytical,
communication, and research skills.
Detailed discussion on the most recent developments in the area of international
convergence of financial reporting standards.
Two chapters on IFRS that provide detailed coverage of a wide range of standards and
topics. One chapter focuses on the financial reporting of assets, and the second chapter
focuses on liabilities, financial instruments, and revenue recognition. (IFRS related to
foreign currency translation is covered in other chapters.) The IFRS chapters also include
numerical examples demonstrating major differences between IFRS and U.S. GAAP and
their implications for financial statements.
Separate chapters for foreign currency transactions and hedging foreign exchange risk,
and translation of foreign currency financial statements. The first of these chapters
includes detailed examples demonstrating the accounting for foreign currency derivatives
used to hedge a variety of types of foreign currency exposure.
Separate chapters for international taxation and international transfer pricing, with
detailed examples based on U.S. tax law. The chapter on international taxation covers the
international tax provisions in the new U.S. tax law (Tax Cuts and Jobs Act of 2017).
A chapter devoted to a discussion of the management accounting issues facing
multinational corporations, with a focus on issues important for strategy formulation and
implementation.
Coverage of the importance of corporate governance in an international context and the
role of auditing (external and internal) in enhancing it.
A chapter on sustainability reporting, which is becoming increasingly more common
among global enterprises and is now a mandatory part of the corporate reporting model
in many countries.

Page vii
CHAPTER-BY-CHAPTER CONTENT
Chapter 1 introduces the accounting issues related to international business by following
the evolution of a fictional company as it grows from a domestic company to a global
enterprise. This chapter provides the context into which the topics covered in the remaining
chapters can be placed.

Chapters 2 and 3 focus on differences in financial reporting across countries and the
efforts at converging accounting standards internationally.
Chapter 2 presents evidence of the diversity in financial reporting that exists around
the world, explores the reasons for that diversity, and describes the problems that are
created by differences in accounting practice across countries. In this chapter, we also
describe several major models of accounting used internationally, discuss the potential
impact that culture has on the development of national accounting systems, and present a
simplified model of the reasons for international differences in financial reporting. The
next to last section of this chapter uses excerpts from recent annual reports to present
additional examples of some of the differences in accounting that exist across countries.
The final section introduces the facts that some countries require parent company-only
financial statements in addition to consolidated financial statements, and that most
companies in the world are privately held. In both cases, local GAAP often is required to
be followed.
Chapter 3 focuses on the major efforts worldwide to converge financial reporting
practices, with an emphasis on the activities of the IASB. We explain the meaning of
convergence, identify the arguments for and against convergence, and discuss the use of
the IASB’s IFRS internationally.

The universal recognition of IFRS as a set of global accounting standards is one of the most
important trends in modern accounting. IFRS are used as the primary set of reporting
standards in a majority of the world’s economies. In countries that continue to use national
standards, including the U.S. and India, IFRS provide a set of benchmarks toward which the
national standards converge over time. The chapter surveys the status of IFRS adoption or
convergence in each of the world’s major economies: the European Union, China, India,
Japan, and the United States. Chapters 4 and 5 introduce financial reporting under
IFRS for a wide range of accounting issues.
 Chapter 4 summarizes the major differences between IFRS and U.S. GAAP. It
provides detailed information on selected IFRS, concentrating on standards that relate to
the recognition and measurement of assets—including inventories; property, plant, and
equipment; investment properties; biological assets; and intangible assets. The chapter
also provides a discussion of accounting for business combinations and the scope of
consolidation. Numerical examples demonstrate the application of IFRS, differences
between IFRS and U.S. GAAP, and the implications for financial statements.
Chapter 5 focuses on current liabilities, provisions, employee benefits, share-based
payment, income taxes, revenue recognition, financial instruments, and leases, including
major differences between IFRS and U.S. GAAP. This chapter also describes the
requirements of IFRS in a variety of disclosure and presentation standards.

Chapters 6 and 7 deal with financial reporting issues that are of particular importance
to multinational corporations. Two different surveys of business executives indicate that the
most important topics that should be covered in an international accounting course are
related to the accounting for foreign currency.1 Because of its importance, this topic is
covered in two separate chapters ( Chapters 6 and 7).
Chapter 6 begins with a description of the foreign exchange market and then Page viii
illustrates the accounting for foreign currency transactions. Much of this chapter
deals with the accounting for derivatives used in foreign currency hedging activities. We
first describe how foreign currency forward contracts and foreign currency options can be
used to hedge foreign exchange risk. We then explain the concepts of cash flow hedges,
fair value hedges, and hedge accounting. Finally, we present examples of accounting for
forward contracts and options used as cash flow hedges and fair value hedges to hedge
foreign currency assets and liabilities, foreign currency firm commitments, and forecasted
foreign currency transactions.
Chapter 7 focuses on the translation of foreign currency financial statements for the
purpose of preparing consolidated financial statements. We begin by examining the
conceptual issues related to translation, focusing on the concept of balance sheet
exposure and the economic interpretability of the translation adjustment. Only after a
thorough discussion of the concepts and issues do we then describe the manner in which
these issues have been addressed by the IASB and by the U.S. FASB. We then illustrate
application of the two methods prescribed by both standard-setters and compare the
results. We discuss the hedging of balance sheet exposure and provide examples of
 disclosures related to translation. The appendix to this chapter covers the translation of
foreign currency financial statements in hyperinflationary environments.

In terms of importance, business executives rank international taxation second only to

foreign currency as a topic to be covered in an international accounting course.2
International taxation and tax issues related to international transfer pricing are covered in ­-
Chapters 8 and 9.
Chapter 8 begins with a discussion of the types of taxes and different tax rates imposed
on corporations by countries around the world. We describe different approaches
countries take with respect to tax jurisdiction, the problem of double taxation due to
overlapping tax jurisdictions, and mechanisms through which countries provide relief
from double taxation, focusing on foreign tax credits. We summarize the U.S. approach to
taxing income earned by foreign operations of U.S. corporations and provide an example
to demonstrate application of this approach. We also discuss benefits of tax treaties and
the translation of foreign currency amounts for tax purposes. The appendix to this
chapter describes several issues related to U.S. taxation of expatriate individuals.
Chapter 9 covers the topic of international transfer pricing, focusing on tax
implications. We explain how discretionary transfer pricing can be used to achieve
specific cost minimization objectives and how the objectives of performance evaluation
and cost minimization can conflict in determining international transfer prices. We also
describe government reactions to the use of discretionary transfer pricing by
multinational companies, focusing on the U.S. rules governing intercompany pricing.

Chapter 10 covers management accounting issues of particular relevance to multinational

corporations. This chapter covers multinational capital budgeting as a vital component of
strategy formulation and operational budgeting as a key ingredient in strategy
implementation, and it discusses issues that must be addressed in designing a process for
evaluating the performance of foreign operations.

Chapter 11 explains the importance of corporate governance internationally and the role
of auditing in enhancing it. This chapter discusses the meaning of corporate governance and
both external and internal auditing issues as they relate to corporate governance.
Chapter 11 also describes international diversity in external auditing and the
international harmonization of auditing standards.
Page ix
Chapter 12 introduces sustainability reporting, a system of measuring and
disclosing an entity’s social and environmental performance using well-defined,
internationally agreed-upon standards. Sustainability reporting is now required of all large
companies in the European Union. Elsewhere, most large companies voluntarily publish
annual sustainability reports that are analogous to traditional financial reports.
Chapter 12 describes the structure of the sustainability reporting system, including the
Global Reporting Initiative at the international level and the Sustainability Accounting
Standards Board in the United States.

CHANGES IN THE SIXTH EDITION

Chapter 1
Updated statistics in the section titled “The Global Economy.”
Updated end-of-chapter assignments based on annual reports and replaced other dated
material with the most current information available.
Added two end-of-chapter exercises and problems related to the sections titled
“International Income Taxation” and “International Auditing.”

Chapter 2
Updated excerpts from corporate annual reports in the section titled “Evidence of
Accounting Diversity” and added to the discussions of those excerpts.
Updated and reworded some of the explication and discussion in the “National Culture”
subsection of “Reasons for Accounting Diversity.” For example, in the interest of clarity,
Hofstede’s original use of the term “masculinity” as a cultural dimension is now described
as “competitiveness.”
Updated excerpts from corporate annual reports in the section titled “Further Evidence
of Accounting Diversity” and added to the discussions of those excerpts.
Added a section titled “Parent Company-Only Financial Statements and Private Company
Financial Reporting” with a new, related learning objective.
Added a new question in the end-of-chapter assignments related to private company
financial reporting.
Replaced one exercise in the end-of-chapter assignments related to accounting families
with a new exercise related to identifying financial reporting differences across countries.
 Chapter 3
Updated annual reports excerpts from various companies.
Added a discussion of convergence with IFRS in India and China.
Added a discussion of the expansion of IFRS in Japan.
Added a discussion of IFRS for Small and Medium Size Entities.
Added a new questions and new exercises and problems to the end-of-chapter material to
reflect the updated focus on convergence in large economies.
Replaced Case 3-1 to examine the difference between Indian Accounting Standards
(Ind AS) and IFRS at Dr. Reddy’s Laboratories.

Chapter 4
Updated annual reports excerpts from various companies.
Revised the discussion of biological assets to present the financial statements of Stora
Enso Oyj.
Revised and updated the discussion of capitalized development costs in the German auto
industry.
Added and/or modified problems to reflect the above changes.
Revised and updated the Jaguar Land Rover plc case.
Page x

Chapter 5
Updated annual reports excerpts from various companies.
Added a comparison of IFRS 9 and ASC Topic 326 covering the current expected credit
loss model (CECL).

Chapter 6
Updated statistics, annual report excerpts and the related discussions.
Updated Exhibits 6.1 and 6.2 and related discussions to provide recent exchange rates.
Added information on IFRS 9, Financial Instruments.
Updated Case 6-2 to be based on more recent exchange rates.
Updated Case 6-3, Jaguar Land Rover, related to 2020 Brexit.
Introduced 2020 Brexit example and discussed the consequences for UK firms related to
sudden devaluation of the British pound without proper hedging.

Chapter 7
Updated corporate annual report excerpts and related discussions.
Updated information about hyperinflationary countries in the appendix.
Added an exhibit to the appendix containing an excerpt from a company’s annual report
disclosing its treatment of foreign currency financial statements in countries with
hyperinflationary economies.
Changed the facts provided in several end-of-chapter exercises and problems.

Chapter 8
Updated information related to income tax, withholding tax, and tax treaty rates in
several exhibits and also updated related discussions.
Changed the source of information in the exhibit on tax havens in the section “Types of
Taxes and Tax Rates.”
Added anecdotal information on the impact of the deemed repatriation of foreign
earnings tax for several companies in “U.S. Tax Reform 2017: Other International Tax
Provisions.”
Updated the amounts that may be excluded from U.S. taxable income in the sections
titled “Foreign Earned Income Exclusion” and “Foreign Housing Cost Exclusion” in the
appendix to this chapter.
Changed the facts provided in several end-of-chapter exercises and problems.

Chapter 9
Updated statistics related to the incidence of cross-border intercompany transfers, the
implementation of country-by-country reporting, and the use of advance pricing
agreements.
Added anecdotal information on the “Enforcement of Transfer Pricing Regulations” in
the United States.

Chapter 10
Added a footnote referencing recent professional journal articles that provide further
insights into budgeting in a multinational corporation.
Streamlined the discussion of culture and management control.

Page xi

Chapter 11
Updated corporate annual report excerpts and related discussions.
Added a discussion and end-of-chapter problems on Germany’s Corporate Governance
Code.
Added a discussion of reforms outside the United States that were inspired by the
Sarbanes-Oxley Act.
Added a short discussion of the PCAOB’s framework for inspecting auditors in non-U.S.
settings and the controversy over inspections in China.
Revised and expanded Cases 11-1 and 11-2.

Chapter 12
Updated corporate annual and sustainability report excerpts and related discussions.
Added a discussion of the Global Sustainability Standards Board, its merger with the
Sustainability Accounting Standards Board, and the future direction of IFRS
Sustainability Disclosure Standards.
Added a discussion of the Task Force on Climate-related Financial Disclosure and the
ESG rating system introduced by Institutional Shareholder Services.
Expanded the discussion of the SEC’s climate reporting rules.
Added and/or modified problems to reflect the above changes.

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Acknowledgments
We extend our sincere thanks to Hector Perera—gentleman, scholar, and true world Page xiv
citizen. As an original author of this text, Hector was instrumental in making International
Accounting the market leader that it is today. We want to thank the many people who
participated in the review process and offered their helpful comments and suggestions:
Wagdy Abdallah
Seton Hall University
Kristine Brands
Regis University
Bradley Childs
Belmont University
Teresa Conover
University of North Texas
Burak Dolar
Western Michigan University
Orapin Duangploy
University of Houston–Downtown
Gertrude Eguae-Obazee
Albright College
Emmanuel Emmenyonu
Southern Connecticut State University
Christine Errico
Champlain College
Charles Fazzi
Saint Vincent College
Leslie B. Fletcher
Georgia Southern University
Paul Foote
California State University–Fullerton
Mohamed Gaber
State University of New York at Plattsburgh
Julie E. Glittelman
Salisbury University
Shiv Goyal
University of Maryland University College
Rita H. Grant
Grand Valley State University
Robert Gruber
University of Wisconsin
Andrew Holt
Metropolitan State University of Denver
Marianne James
California State University–Los Angeles
Agatha E. Jeffers
Montclair State University
Cynthia Jeffrey
Iowa State University
Craig Keller
Missouri State University
Victoria Krivogorsky
San Diego State University
Junghun (Jay) Lee
University of Massachusetts Boston
Daphne Main
Loyola University New Orleans
John R. McGowan
St. Louis University
Britton McKay
Georgia Southern University
Jamshed Mistry
Suffolk University
James N. Mohs
University of New Haven
Gregory Naples
Marquette University
Cynthia Nye
Bellevue University
Randon C. Otte
Clarion University
Obeua Persons
Rider University
Felix Pomeranz
Florida International University
Grace Pownall
Emory University
Juan Rivera
University of Notre Dame
Kurt Schulzke
Kennesaw State University
Mary Sykes
University of Houston–Downtown
Elaine (Ying) Wang
University of Massachusetts Amherst
Sung Wook Yoon
California State University–Northridge

We also pass along many thanks to all the people at McGraw-Hill Education who
participated in the creation of this book. In particular, we extend our thanks to Executive
Portfolio Manager Rebecca Olson, Product Developer Destiny Hadley, and Marketing
Manager Lauren Schur.
 Page xv

Brief Contents
About the Authors iv

Preface vi

Chapter
1 Introduction to International Accounting 1
2 Worldwide Accounting Diversity 21
3 International Convergence of Financial Reporting 61
4 International Financial Reporting Standards: Part I 93
5 International Financial Reporting Standards: Part II 147
6 Foreign Currency Transactions and Hedging Foreign Exchange Risk 205
7 Translation of Foreign Currency Financial Statements 267
8 International Taxation 318
9 International Transfer Pricing 358
10 Management Accounting Issues in Multinational Corporations 390
11 Auditing and Corporate Governance: An International Perspective 429
12 International Sustainability Reporting 472

Index 503

DIGITAL EDITION
 Page xvi

Contents
About the Authors iv

Preface vi

Chapter 1
Introduction to International Accounting 1
Introduction 1
Evolution of a Multinational Corporation 2
Sales to Customers 2
Hedges of Foreign Exchange Risk 3
Foreign Direct Investment 4
Financial Reporting for Foreign Operations 5
International Income Taxation 6
International Transfer Pricing 6
Performance Evaluation of Foreign Operations 7
International Auditing 7
Cross-Listing on Foreign Stock Exchanges 8
Sustainability Reporting 8
Global Financial Reporting Standards 9

The Global Economy 9

International Trade 9
Foreign Direct Investment 10
Multinational Corporations 11
International Capital Markets 12

Outline of the Book 13

Summary 14
Questions 15
Exercises and Problems 15
Case 1-1: Besserbrau AG 18
Case 1-2: Vanguard International Growth Fund 18

Chapter 2
Worldwide Accounting Diversity 21
Introduction 21
Evidence of Accounting Diversity 22
Reasons for Accounting Diversity 26
Legal System 26
Taxation 27
Providers of Financing 28
Inflation 28
Political and Economic Ties 28
National Culture 29

Problems Caused by Accounting Diversity 33

Preparation of Consolidated Financial Statements 33
Access to Foreign Capital Markets 33
Comparability of Financial Statements 34
Lack of High-Quality Accounting Information 35

Classification of Accounting Systems 35

A Judgmental Classification of Financial Reporting Systems 36

A Simplified Model of the Reasons for International Differences in Financial Reporting

37
Examples of Countries with Class A Accounting 39
Accounting Change in Europe 39

Further Evidence of Accounting Diversity 39

Financial Statements 40
 Format of Financial Statements 40
Level of Detail 44
Terminology 46
Disclosure 46
Recognition and Measurement 49

Parent Company-Only Financial Statements and Private Company Financial Reporting

50
Summary 51
Appendix to Chapter 2
The Case of Daimler-Benz 52
Questions 54
Exercises and Problems 55
Case 2-1: The Impact of Culture on Conservatism 58
Case 2-2: SKD Limited 59

Chapter 3
International Convergence of Financial Reporting 61
Introduction 61
International Harmonization of Accounting Standards 62
Harmonization Efforts through the International Accounting Standards Committee
(IASC) 62
The “Lowest-Common-Denominator” Approach 63
The Comparability Project 63
The IOSCO Agreement 63

Other Harmonization Efforts 64

International Organization of Securities Commissions 64
International Federation of Accountants 64
European Union 65
The International Forum on Accountancy Development (IFAD) 66
Creation of the IASB 67
The Structure of the IASB 67

From Harmonization to Convergence of Financial Reporting Standards 71 Page xvii

Presentation of Financial Statements (IAS 1/IFRS 1) 72
A Principles-Based Approach to International Financial Reporting Standards 73
Arguments for and against International Convergence of Financial Reporting Standards
74
Arguments for Convergence 74
Arguments against Convergence 75

The IASB Conceptual Framework 75

The Need for a Framework 75
Objective of Financial Statements and Underlying Assumptions 76
Qualitative Characteristics of Financial Statements 76
Elements of Financial Statements: Definition, Recognition, and Measurement 76
Concepts of Capital Maintenance 77

International Financial Reporting Standards (IFRS) 77

Adoption of IFRS 77
IFRS in the European Union 78
IFRS in China and India 79
IFRS in Japan 79
IFRS in the United States 81

IFRS for SMES 85

Summary 86
Appendix to Chapter 3
What Is This Thing Called “Anglo-Saxon” Accounting? 87
Questions 89
Exercises and Problems 90
Case 3-1: Comparing Ind AS and IFRS at Dr. Reddy’s Laboratories 92
Chapter 4
International Financial Reporting Standards: Part I 93
Introduction 93
Types of Differences Between IFRS and U.S. GAAP 94
Inventories 95
Lower of Cost or Net Realizable Value 96

Property, Plant, and Equipment 97

Recognition of Initial and Subsequent Costs 97
Measurement Subsequent to Initial Recognition 98
Depreciation 103
Derecognition 103

Investment Property 103

Biological Assets 106
Fair Value Appraisals and the Relevance-Reliability Trade-Off 107

Impairment of Assets 108

Definition of Impairment 108
Measurement of Impairment Loss 109
Reversal of Impairment Losses 110

Intangible Assets 111

Purchased Intangibles 112
Intangibles Acquired in a Business Combination 113
Internally Generated Intangibles 113
Revaluation Model 119
Impairment of Intangible Assets 119

Business Combinations and Consolidated Financial Statements 119

The Acquisition Method 121
Impairment of Goodwill 124
 The Convergence of Goodwill Impairment Testing Rules 126

Borrowing Costs 126

Summary 128
Questions 129
Exercises and Problems 130
Case 4-1: Jaguar Land Rover PLC 144
Case 4-2: Telco Ltd. 145

Chapter 5
International Financial Reporting Standards: Part II 147
Introduction 147
Current Liabilities 147
Provisions, Contingent Liabilities, and Contingent Assets 148
Contingent Liabilities and Provisions 148
Onerous Contract 150
Restructuring 151
Contingent Assets 151
Additional Guidance 152

Employee Benefits 152

Short-Term Benefits 153
Post-Employment Benefits 153
Other Long-Term Employee Benefits 156

Share-Based Payment 156

Equity-Settled Share-Based Payment Transactions 156
Cash-Settled Share-Based Payment Transactions 158
Choice-of-Settlement Share-Based Payment Transactions 158

Income Taxes 160 Page xviii

Tax Laws and Rates 160

 Recognition of Deferred Tax Asset 161
Disclosures 162
IFRS versus U.S. GAAP 162
Financial Statement Presentation 163

Revenue Recognition 164

Customer Loyalty Programs 167

Financial Instruments 169

Definitions 169
Liability or Equity 170
Compound Financial Instruments 171
Classification and Measurement of Financial Assets and Financial Liabilities 171
Impairment 175
Derivatives 176
Sales of Receivables 177

Leases 178
Disclosure and Presentation Standards 182
Statement of Cash Flows 182
Events after the Reporting Period 183
Accounting Policies, Changes in Accounting Estimates, and Errors 184
Related Party Disclosures 185
Earnings per Share 185
Interim Financial Reporting 185
Noncurrent Assets Held for Sale and Discontinued Operations 185
Operating Segments 186

Summary 186
Questions 188
Exercises and Problems 189
Case 5-1: Accounting for BP PLC’s Deepwater Horizon Oil Spill 202
Chapter 6
Foreign Currency Transactions and Hedging Foreign Exchange Risk 205
Introduction 205
Foreign Exchange Markets 206
Exchange Rate Mechanisms 207
Foreign Exchange Rates 207
Spot and Forward Rates 208
Option Contracts 209

Foreign Currency Transactions 210

Accounting Issue 210
Accounting Alternatives 211

Hedging Foreign Exchange Risk 214

Accounting for Derivatives 215
Fundamental Requirement of Derivatives Accounting 216
Determining the Fair Value of Derivatives 216
Accounting for Changes in the Fair Value of Derivatives 217

Hedge Accounting 217

Nature of the Hedged Risk 217
Hedge Effectiveness 218
Hedge Documentation 220
Statement of Cash Flows 220

Hedging Combinations 220

Hedges of Foreign-Currency-Denominated Assets and Liabilities 221
Forward Contract Used To Hedge a Recognized Foreign-Currency-Denominated Asset
222
Forward Contract Designated as Cash Flow Hedge 224
Forward Contract Designated as Fair Value Hedge 227
 Foreign Currency Option Used to Hedge a Recognized Foreign-Currency-Denominated
Asset 229
Option Designated as Cash Flow Hedge 230
Spot Rate Exceeds Strike Price 232
Option Designated as Fair Value Hedge 233

Hedges of Unrecognized Foreign Currency Firm Commitments 234

Forward Contract Used as Fair Value Hedge of a Firm Commitment 234
Option Used as Fair Value Hedge of Firm Commitment 236

Hedge of Forecasted Foreign-Currency-Denominated Transaction 238

Option Designated as a Cash Flow Hedge of a Forecasted Transaction 239

Use of Hedging Instruments 240

Summary 242
Appendix A to Chapter 6
Illustration of the Accounting for Foreign Currency Transactions and Hedging Activities by
an Importer 243
Appendix B to Chapter 6
Foreign Currency Borrowing 254
Questions 255
Exercises and Problems 256
Case 6-1: Zorba Company 264
Case 6-2: Portofino Company 265
Case 6-3: 2020 Brexit—Jaguar Land Rover 265
Case 6-4: Better Food Corporation 266
Page xix
Chapter 7
Translation of Foreign Currency Financial Statements 267
Introduction 267
Two Conceptual Issues 268
Example 268
 Balance Sheet Exposure 271

Translation Methods 272

Temporal Method 272
Current Rate Method 273
Translation of Retained Earnings 274
Complicating Aspects of the Temporal Method 275

Disposition of Translation Adjustment 277

U.S. GAAP 278
FASB ASC 830 278
Functional Currency 279
Highly Inflationary Economies 279

International Financial Reporting Standards 281

The Translation Process Illustrated 282
Translation of Financial Statements: Current Rate Method 284
Translation of the Balance Sheet 284
Computation of Translation Adjustment 286

Remeasurement of Financial Statements: Temporal Method 286

Remeasurement of Income Statement 287
Computation of Remeasurement Gain 289

Nonlocal Currency Balances 289

Comparison of the Results from Applying the Two Different Translation Methods
290
Underlying Valuation Method 291
Underlying Relationships 291

Hedging Balance Sheet Exposure 292

Disclosures Related to Translation 294
Summary 296
Appendix to Chapter 7
Translation of Foreign Currency Financial Statements in Hyperinflationary Economies
297
Questions 305
Exercises and Problems 305
Case 7-1: Columbia Corporation 315
Case 7-2: Palmerstown Company 316

Chapter 8
International Taxation 318
Introduction 318
Investment Location Decision 318
Legal Form of Operation 318
Method of Financing 319

Types of Taxes and Tax Rates 319

Income Taxes 319
Tax Havens 321
Withholding Taxes 323
Value-Added Tax 324

Tax Jurisdiction 325

Worldwide versus Territorial Approach 325
Source, Citizenship, and Residence 326
Double Taxation 327

Tax Treaties 328

Model Tax Treaties 328
U.S. Tax Treaties 329
Treaty Shopping 330

OECD Base Erosion and Profit Shifting Action Plan 331

Controlled Foreign Corporations 332
Subpart F Income 332
Determination of the Amount of CFC Income Currently Taxable 332
Safe Harbor Rule 333

Foreign Tax Credits 333

Calculation of Foreign Tax Credit 334
Excess Foreign Tax Credits 335
FTC Baskets 336

U.S. Tax Treatment of Foreign Operation Income 337

Example: U.S. Taxation of Foreign Income 337

U.S. Tax Reform: Other International Tax Provisions 340

Deemed Repatriation of Accumulated Foreign Earnings 340
Global Intangible Low-Taxed Income 341
Base Erosion Anti-Abuse Tax 342

Translation of Foreign Operation Income 343

Translation of Foreign Currency Income 343
Foreign Currency Transactions 344

Summary 345
Appendix to Chapter 8
U.S. Taxation of Expatriates 346
Questions 348
Exercises and Problems 349
Case 8-1: Worldwide United Corporation 357

Chapter 9
International Transfer Pricing 358
Introduction 358
Decentralization and Goal Congruence 359
Transfer Pricing Methods 360
Objectives of International Transfer Pricing 361
Performance Evaluation 361
Cost Minimization 363
Other Cost-Minimization Objectives 363 Page xx
Interaction of Transfer Pricing Method and Objectives 365

Government Reactions 366

OECD Guidelines 366

U.S. Transfer Pricing Rules 366

Sale of Tangible Property 367
Licenses of Intangible Property 372
Intercompany Loans 374
Intercompany Services 374
Arm’s-Length Range 375
Correlative Relief 375
Penalties 376
Contemporaneous Documentation 376
Reporting Requirements 377

Advance Pricing Agreements 378

Enforcement of Transfer Pricing Regulations 379
Worldwide Enforcement 381

Summary 382
Questions 382
Exercises and Problems 383
Case 9-1: Litchfield Corporation 388
Case 9-2: International Lamp Company 389

Chapter 10
Management Accounting Issues in Multinational Corporations 390
Introduction 390
Capital Budgeting 391
Capital Budgeting Techniques 391
Multinational Capital Budgeting 392
Illustration: International Wire Company 394

Management Control Systems 399

Management Control Issues in MNCs 399

Performance Evaluation 402

Evaluating the Performance of Foreign Operations 404
Performance Measures 404
Responsibility Centers 407
Separating Managerial and Unit Performance 409
Choice of Currency in Measuring Profit 411
Foreign Currency Translation 411

Operational Budgeting 411

Choice of Currency in Operational Budgeting 412
Incorporating Economic Exposure into the Budget Process 415

Culture and Management Control 417

Summary 419
Questions 420
Exercises and Problems 420
Case 10-1: Felix Machine Company 426

Chapter 11
Auditing and Corporate Governance: An International Perspective 429
Introduction 429
Corporate Governance Principles 430
 Auditing and Corporate Governance 432
Rules vs Principles in Auditing 434
Professional Accountants’ Role 435
The International Response to Sarbanes-Oxley 436

International Diversity in External Auditing 438

Purpose of Auditing 439
Audit Environments 440
Regulation of Auditors and Audit Firms 442
Audit Reports 444

International Standards on Auditing (ISA) and Generally Accepted Auditing Standards

(GAAS) in The United States 444
Audit Expectation Gap 445

International Harmonization of Auditing Standards 447

Ethics and International Auditing 450
A More Communitarian View of Professional Ethics 451

Additional International Auditing Issues 451

Auditors’ Liability 452
Limiting Auditors’ Liability 452
Auditor Independence 454
Audit Committees 458

Internal Auditing 459

The Demand for Internal Auditing in MNCs 461
U.S. Legislation against Foreign Corrupt Practices 461

Future Directions 464

Consumer Demand 464
Increased Competition in the Audit Market 465
Continued High Interest in the Audit Market 465
 Increased Exposure of the International Auditing Firms 465

Summary 466
Questions 467
Exercises and Problems 467
Case 11-1: Mazda Motor Company 470
Case 11-2: Mercedes-Benz Group 470
Page xxi
Chapter 12
International Sustainability Reporting 472
Introduction 472
Theories to Explain the Emergence of Sustainability Reporting 474
Investors’ Demand for Sustainability Information 475

The Structure of the Sustainability Reporting System 477

The Global Reporting Initiative 477
Other Sustainability Reporting Frameworks 480

Toward Mandatory Sustainability Reporting 481

Mandatory Sustainability Reporting in the European Union 482
Sustainability Reporting Required by the Hong Kong Stock Exchange 482
Mandatory Sustainability Reporting in the United States 483

Carbon Emissions Reporting 486

Measuring Carbon Emissions 487
Sustainability Reporting Practices of MNCs 489
Mazda’s 2020 Sustainability Report 490
IKEA Group’s 2021 Sustainability Report 492
Baxter International’s 2020 Sustainability Report 494
Climate Change Disclosures in ExxonMobil’s 2021 Form 10-K 494

Summary 496
Questions 497
Exercises and Problems 497
Case 12-1: The Case of Modco Inc. 501

Index 503

Page xxii
Chapter One
Introduction to International Accounting
Page 1

Learning Objectives
After reading this chapter, you should be able to
Discuss the nature and scope of international accounting.
Describe accounting issues confronted by companies involved in international
trade (import and export transactions).
Explain the reasons for, and the accounting issues associated with, foreign direct
investment.
Describe the practice of cross-listing on foreign stock exchanges.
Explain the notion of global accounting standards.
Understand the importance of international trade, foreign direct investment, and
multinational corporations in the global economy.
INTRODUCTION
Most accounting students are familiar with financial accounting and managerial accounting,
but many have only a vague idea of what international accounting is. Defined broadly, the
accounting in international accounting encompasses the functional areas of financial
reporting, managerial accounting, auditing, and taxation.

The word international in international accounting can be defined at three different levels.1
At the first level, international accounting can be viewed as the study of the standards,
guidelines, and rules of accounting, auditing, and taxation that exist within each country as
well as comparison of those items across countries. Examples would be cross-country
comparisons of rules related to the financial reporting of property, plant, and equipment;
income and other tax rates; and the requirements for becoming a member of the national
accounting profession.

At the second level is supranational accounting, which denotes standards, guidelines, Page 2
and rules of financial reporting, auditing, and taxation issued by supranational
organizations. Such organizations include the International Accounting Standards Board
(IASB), the International Federation of Accountants (IFAC), and the Organization for
Economic Cooperation and Development (OECD).

At the third level, the company level, international accounting can be viewed in terms of the
accounting standards, guidelines, and practices that a company follows that are specifically
related to its international business activities and foreign investments. These would include
standards for accounting for transactions denominated in a foreign currency, tax rules
related to international transfer pricing, and techniques for evaluating the performance of
foreign operations.

Clearly, international accounting encompasses an enormous amount of territory—both

geographically and topically. It is not feasible or desirable to cover the entire discipline in
one course. This book is designed to be used in a course that provides an overview of the
broadly defined area of international accounting, including certain supranational guidelines,
but that focuses on the accounting issues related to international business activities and
foreign investments. In other words, this book focuses on international accounting issues at
the company level that are specifically relevant to multinational corporations.2
The next section of this chapter introduces accounting issues that are important to
multinational corporations by describing the evolution of a fictitious company as it becomes
increasingly more multinational. To provide justification for the importance of these issues,
the following section highlights the importance of international trade, foreign direct
investment, and multinational corporations in the global economy. The final section of this
chapter summarizes the major topics covered in this book.
EVOLUTION OF A MULTINATIONAL
CORPORATION
To gain an appreciation for the accounting issues related to international business, let us
follow the evolution of Magnum Corporation, a fictional auto parts manufacturer
headquartered in Detroit, Michigan.3 Magnum was founded in the early 1950s to produce
and sell rearview mirrors to automakers in the United States. For the first several decades,
all of Magnum’s transactions occurred in the United States. Raw materials and machinery
and equipment were purchased from suppliers located across the United States, finished
products were sold to U.S. automakers, loans were obtained from banks in Michigan and
Illinois, and the common stock was sold on the New York Stock Exchange. At this stage, all
of Magnum’s business activities were carried out in U.S. dollars, its financial reporting was
done in compliance with U.S. generally accepted accounting principles (GAAP), and taxes
were paid to the U.S. federal government and the state of Michigan.

Sales to Customers
In the 1980s, one of Magnum’s major customers, Normal Motors Inc., acquired a
production facility in the United Kingdom, and Magnum was asked to supply this operation
with rearview mirrors. The most feasible means of supplying Normal Motors UK (NMUK)
was to manufacture the mirrors in Michigan and then ship them to the United Kingdom,
thus making export sales to a foreign customer. If the sales had been invoiced in U.S.
dollars, accounting for the export sales would have been no different from accounting for
domestic sales. However, Normal Motors required Magnum to bill the sales to NMUK in
British pounds (£), thus creating foreign currency sales for Magnum. The first shipment of
mirrors to NMUK was invoiced at £100,000 with credit terms of 2/10, net 30. If Magnum
were a British company, the journal entry to record this sale would have been:
Page 3

Dr. Accounts Receivable (+ Assets) £100,000

Cr. Sales Revenue (+ Equity) £100,000
However, Magnum is a U.S.-based company that keeps its accounting records in U.S. dollars
(US$). To account for this export sale, the British-pound sales revenue and account
receivable must be translated into US$. Assuming that the exchange rate between the £ and
the US$ at the time of this transaction was £1 = US$1.35, the journal entry would have
been:

Dr. Accounts Receivable (£) (+ Assets) US$135,000

Cr. Sales Revenue (+ Equity) US$135,000

This was the first time since its formation that Magnum had found it necessary to account
for a transaction denominated (invoiced) in a currency other than the U.S. dollar. The
company added to its chart of accounts a new account indicating that the receivable was in
a foreign currency, “Accounts Receivable (£),” and the accountant had to determine the
appropriate exchange rate to translate £ into US$.

As luck would have it, by the time NMUK paid its account to Magnum, the value of the £
had fallen to £1 = US$1.30, and the £100,000 received by Magnum was converted into
US$130,000. The partial journal entry to record this would have been:

Dr. Cash (+ Assets) US$130,000

Cr. Accounts Receivable (£) (− Assets) US$135,000

This journal entry is obviously incomplete because the debit and the credit are not equal and
the balance sheet will be out of balance. A question arises: How should the difference of
US$5,000 between the original US$ value of the receivable and the actual number of US$
received be reflected in the accounting records? Two possible answers would be (1) to treat
the difference as a reduction in sales revenue or (2) to record the difference as a separate
loss resulting from a change in the foreign exchange rate. This is an accounting issue that
Magnum was not required to deal with until it became involved in export sales. Specific
rules for accounting for foreign currency transactions exist in the United States, and
Magnum’s accountants had to develop an ability to apply those rules.

Through the British-pound account receivable, Magnum became exposed to foreign

exchange risk—the risk that the foreign currency will decrease in US$ value over the life of
the receivable. The obvious way to avoid this risk is to require foreign customers to pay for
their purchases in US$. Sometimes foreign customers will not or cannot pay in the seller’s
Another random document with
no related content on Scribd:
based on space experiments to the extent that they affected national
security. But even he could not find a means to extend a security
blanket to cover a theory of extra-galactic origin of the moon.
He raged at Jim, however. "You'll make a laughing stock of us in
every scientific center of the world! You can't publish a ridiculous
thing like this!"
"No one will laugh if he reads the data I've got to present," said Jim.
"Every member of our staff who knows the subject has verified that
the data are correct. The conclusion is inescapable."
"I can't forbid publication, Cochran," said Hennesey, "but I think it is
very unwise for you to go ahead. Very unwise."
"I'll take that risk," said Jim.
He sent the paper to the Journal of Astro-physics. At the same time
he sent an announcement to the major news services.
He had expected some sensationalism in the reporting. There was
more than he bargained for. Some of the headlines that followed
were:
"Savant Says Moon is Messenger from Outer Space."
"Moon Will Poison Earth."
"Moon Trip—One Way only."
The reactions in the upper echelons of NASA were almost as bad—in
their own way. No thought had ever been given to a need for
complete decontamination of astronauts and equipment after
exposure on the moon. The requirement, if admitted, would threaten
the entire program in the minds of some of the engineers. Others
admitted it was tough, but thought they could solve it in an extra year
or so. Rumblings were heard echoing down from Congressional halls.
Why hadn't the stupid scientists known in the beginning that this was
necessary? Always bungling things—
In the end, it was Alan himself who came up with a proposal that kept
the project from bogging down and still provided some measure of
protection against the possible menace. He suggested a plastic outer
suit to be fitted over the space-suit and discarded as the astronaut re-
entered the space vehicle. With care, such a procedure could prevent
direct contact with moondust. In the meantime, it was hoped that
robot vehicles could bring back moon samples before the Apollo was
sent out.
This rather mild proposal did much to calm the furor in NASA and
contractor engineering circles and soon the press had abandoned it
for other, more sensational stories. But Hennesey and a number of
other officials didn't forget. Some of them believed Jim Cochran was
a charlatan at worse and an incompetent at best. They considered he
had degraded American science with his fantastic theory.
Scientific judgement was being held in abeyance until actual moon
samples were available on earth. For the present, at least one of
Jim's predictions had come true. The hypothesis was becoming
known as Cochran's Theory. That it was also called Cochran's Idiocy
by a few didn't matter.
Jim continued his own sixteen-hour stints at the analyzer controls,
probing in a wide pattern over the floor of the Sea of Rains, and
striking deeper toward the heart of the moon with each probe.
Probing to such great depths was made possible by a development
that didn't even exist when the Prospector design was begun. Then, it
was hoped that penetration to a foot and a half of the moon's surface
might be possible. Five-hundred-foot holes were only a madman's
nightmare. How could you carry such drilling equipment all the way to
the moon?
Then, in the last months of Prospector design, laser devices had
been produced, capable of burning holes in a diamond. It was only a
small step, then, to the design of a drilling head which mounted a
cluster of laser beams. These would literally burn their way toward
the heart of the moon.

The laser drilling head was lowered on five hundred feet of minute
cable, which had tremendous tensile strength. The vaporized moon
substance boiled out of the hole and condensed above the surface,
settling as fine dust. As the hole deepened, the condensation
products coated the upper portions of the hole and the cable. To keep
the hole from thus being closed, the cable was vibrated at a
frequency that shook loose the condensing rock products, and the
laser head was raised with beams shooting upward to clear the hole.
Jim found that a very special technique was required to raise and
lower the head at the proper intervals to keep the hole clear and
prevent loss of the drilling head. A spare was carried, but he didn't
want to face the loss of even one. After three weeks, he felt confident
in his operation and began lowering the drilling head to depths of two
hundred and three hundred feet.
As he had expected, along with the lunar geologists who were
participating, the moon showed a definite pattern of stratification. But
the differences between the layers seemed slight. Chalky, calcium
compounds were abundant. Some were powdery; others were
pressed into brittle limestone formations. No really hard rocks such as
granite were encountered, however. The boundaries between layers
were ill-defined. No one knew what to make of it. The observations
were interesting. Explanations were wholly lacking.
Then, after five weeks of probing, on the edge of the four-hundred-
foot level, Jim found something new. He sought out Sam at the end of
the day.
"A few years ago," he said, "scientists were startled to find chemicals
that were the product of life, inside meteors from outer space."
"I understand they've even found bacteria which they have been able
to bring to life," said Sam.
Jim nodded. "More than four hundred feet deep on the moon I've
found the same kind of chemicals—hydrocarbons that must be the
product of living cells."
"Four hundred feet deep on the moon—" said Sam musingly. "And
maybe the moon came from billions of billions of light years across
space. So wherever it came from there was something living. What is
it? Traces of bacteria, or chemical remains of plant life like our coal
mines?"
Jim shook his head. "I don't know yet. I'm not sure we can find out
until we go there. But, as you say, it means the moon was once the
scene of life—wherever it came from."
"One thing I haven't understood," said Sam, "is why the moon
stopped here if it had been traveling through space for so long. Why
didn't it keep on going?"
"It was just a combination of factors," said Jim. "The moon happened
to be traveling at just the right speed. The earth was in just the right
place at the right time. As a result, the moon fell into an orbit around
the earth. Pure accident."
"A lucky accident!" said Sam.
Jim looked up at the pale moon above their heads as they walked
toward the parking lot. "I hope so," he said. "We will soon know
whether it was a lucky or an unlucky accident."

The moon laboratory had not been designed for extensive organic
chemical analysis. There were only a few things it could do with
organic compounds. But these were sufficient to convince Jim that
the moon had once been the scene of life.
Why so deep? he wondered. Nothing had been found in the upper
levels, unless he had missed it—he would have to check that out
later.
As the drilling head moved slowly downward, the evidence of fossil
hydrocarbons increased. There seemed to be an almost geometric
increase in concentration after he passed the four-hundred-foot level.
He was certain the drill was penetrating a bed of fossil remains of
some form of life that flourished the little planet that the moon must
have been incalculable eons ago.
The more he thought about his theory, however, the more difficult it
became to explain all the factors. If the moon had actually been a
planet of some far distant system, what had torn it loose from its
parent sun and sent it careening through space? Had its sun
exploded, blasting whatever planets the system held into the depths
of space? Such an occurrence might explain the sterility of the
moon's surface, but why was the evidence of life buried so deep?
Perhaps the upper layers of the moon's surface consisted of debris
blasted from the exploding sun. Such debris would have been molten,
flowing about the moon's surface, cremating everything living. Finally,
it would have shrunk in the cold depths of space and wrinkled into the
vast mountains and cracks that laced the moon's surface.
It was one way it could have happened, but it seemed so fantastic
that Jim had difficulty in convincing himself that it was true.
He doubted the accuracy of his analyses. There were so many
tenuous links between the substance on the moon and his own
senses that an error in any one of them could destroy the accuracy of
the results. But he had no reason to doubt.
He began making calibration checks before and after every analysis.
It added scores of hours to his work. Sam sat beside him, checking
and verifying the accuracy of the telemetering circuits constantly. The
operation was as foolproof as their science could make it.
"You've got to believe what you find," said Sam. "There's no other
answer."
And then, one day, Jim found an answer that was utterly impossible
to believe. His mind balked and closed up completely at the thought.
Sam had been watching him for almost three hours, aware that
something had perturbed Jim exceedingly. Sam kept his mouth shut
and leaned quietly against the desk of his own console, keeping
check on the circuits while he watched Jim grow more and more
distressed. Sam didn't understand the processes, but he was aware
that Jim had been going over and over the same analysis for almost
two hours. At last Jim's face seemed to go utterly white, and his
hands became motionless on the console.
Sam waited a long time. Then he asked, "What is it, Jim? What's the
matter?"
Jim continued to stare at the panels of the console, then answered as
if from some far nightmare distance. "Two chemicals, Sam," he said.
"One of them a big molecule, something like hemoglobin. And neither
of them could exist as fossils. Their structure would have broken
down long ago. They could exist only in live tissue!"
He continued staring. Neither of them moved. Sam felt as if he had
just heard something in a nightmare and had only to wait a minute
until he woke up. Then it would be gone.
Jim turned his head at last and faced Sam. He gave a short, harsh
bark of a laugh that sounded half-hysterical.
"We'd be off our rockers, wouldn't we Sam? Clear off our rockers to
believe there could be something alive five hundred feet inside the
moon!"
"Sure—and if it were alive, it wouldn't be sitting still while the laser
beams drilled a hole into it. Besides, we just couldn't be lucky enough
to lower the drill right smack into some cave where a moon bear was
hibernating. All the circuits must have busted down at the same time.
We'll fix it tomorrow. Let's get the girls and have a night on the town."

It was a very unsuccessful night on the town. Jim and Mary, and Sam
and his wife went to a show and a nightclub.
"You're moving like a zombie. What's the matter?" said Mary as she
and Jim danced together.
"Feel like a zombie. Why don't we give it up and go home? I want to
get down to the lab by five in the morning."
"That's the trouble. You've done nothing but live in the lab since the
Prospector landed. So we're not going home. Sam and Alice are
having a good time. You dance with Alice next, and make her think
you're enjoying it!"
So Jim didn't go to bed at all, but he was at the lab by five in the
morning. The night crew were still at work. He had steered them
away from the analyses he was doing so they were unaware of the
shattering results he had found.
He took over the controls, and resumed work alone.
There was no doubt about it. If any of the methods they were using
were accurate, then he had discovered almost indisputable proof that
some living tissue existed five hundred feet below the surface of the
moon.
Since the laser drilling head sealed the walls of the hole with a
coating of frozen lava, it was necessary to probe horizontally for
samples. Small extension drills, capable of reaching five feet on
either side of the hole, were carried in the head for this purpose.
Jim lowered the head through the last twenty feet of its drilling limit.
Every six inches he sent the horizontal probes to their limits. The tell-
tale chemicals existed at every point. He computed the volume he
had probed, and felt numb.
By the time Sam had shown up, Jim had withdrawn the probe to the
surface and was moving the Prospector slowly across the moon's
surface.
Sam saw the motion on the television screen. "Where are you going?
I thought we were going to check out the hole we were in."
"It's been checked," said Jim. He hesitated. His original plan had
been to move the Prospector a distance of fifty feet and probe again
to the five-hundred-foot level. Then, decisively, he pressed the control
that kept the Prospector moving. He stopped it a hundred feet from
the previous hole and began the long, tedious job of drilling again to
the limits of the Prospector's equipment.

Sam spelled him off during the day. By evening, they had hit the four-
hundred-and-fifty-foot level. Jim took his first analysis in this hole. The
chemicals were there. In greater concentration than at the same level
in the previous hole.
Jim turned to Sam. "We have circuits for measuring potential
differences on the lunar landscape. Could we make a reading at the
bottom of this hole?"
Sam considered. "It'll take some doing, but I think we can manage it.
What do you expect to find from that?"
Jim didn't dare tell him what was in his mind. "I don't know," he said.
"But it might be worth trying—if there is anything living down there—"
By the following afternoon, Sam had made the necessary equipment
arrangements so that potential readings could be obtained in the
mass from which the chemical samples were being removed. The
telemetered report was connected to a recorder that plotted the
variations against a time scale.
As soon as the circuit was set up and calibrated, the recording meter
showed a response. A very slow, rhythmic pulsation showed in the
inked line on the paper.
Jim felt as if his breathing must have stopped for an infinite length of
time. "That's what I thought we'd find," he said at last.
"What?" said Sam. "I don't understand what you're talking about.
What do you think those pulsations mean?"
"Did you ever hear of an electroencephalograph?" said Jim, gravely.
"Electro—Sure, brain wave recordings. Jim! You don't think these
waves—!"
In silence, the two men stared at the wavering pen and the sheet of
recording paper that slowly unrolled beneath it.

Dr. Thomas Banning had been a class mate of Jim Cochran when
they were both in their first couple of years of college. Banning had
gone on into medicine, specializing in brain studies, while Jim had
turned to chemistry. The two had been out of touch for several years.
Tom Banning was the first one Jim thought of, not only because of
their old friendship, but because he had read recent papers
describing some of Tom's new work on the frontier of
electroencephalography. He called first on the phone, then arranged
for a personal visit. Sam went with him. They had closed down all
Prospector work while they were to be away.

Tom met them and was introduced to Sam as he ushered them into
his own modest laboratory. "This isn't the plush sort of surroundings
you've become used to," he said as he showed them around. "The
Government isn't spending billions these days trying to find out how
the human mind works."
Jim could well understand Tom's bitterness. Doing research on the
frontiers of the mind, he was forced to spend his own money for much
of his laboratory equipment.
"I can sympathize, but that's about all," said Jim. "I just work here
myself."
"Tell me about your problem. On the phone, that sounded interesting
enough to make a man's day brighter. You said something about an
unknown life form with electrical pulses that might be related to brain
waves?"
Jim nodded. "That's the way it looks to me."
"But where does this life form exist? Surely it can be identified!"
"If I told you, you'd throw me out or call the paddy wagon. Look at
these, first."
Jim and Sam spread out the long folds of chart they had accumulated
through days of recording. "Does it look like anything to you?" asked
Jim.
Tom Banning frowned. "Well, it certainly could be an EEG record of
some kind. The apparatus—"
"The apparatus was nothing but a single electrical probe, and the
signal was transmitted under very unsatisfactory conditions."
"Signal transmitted, you say? Just where did this come from, Jim?
You didn't come all this way just to pull my leg."
"No," said Jim wearily. "If anybody's leg is being pulled, it's mine. I
wanted to see if you could recognize it as having any similarity to an
EEG. Then I wanted to ask about your work you reported in your last
paper. The one on 'EEG as a Brain Stimulus and Communication
Medium'."
"Yes? What did you want to know about that?"
"You've had some success in taking the EEG waves of one person
and applying them to the brain of another person so that the latter
understood some of the thoughts of the first person while being
stimulated by his brain waves."
"Yes."
"Would it be possible to do that with this record?"
Tom studied the record silently. "Any cyclic electric impulse can be
applied as a stimulus to the brain. Certainly, this one can. My
question still remains, however, what kind of a creature generated
these pulses? If it is so alien you can't even identify it, we can't really
be sure that these are brain waves. I can only say they may be."
"That's good enough for me," said Jim. "How about setting it up so
that we can see if these tell us anything."
"I think I ought to make you tell me where you got these, first."
"Afterwards, please, Tom."

It took the rest of the day to transcribe the record to the format
required by Tom's light-intensity reader. They set the following day for
the experiment.
Both Sam and Jim were to participate. Tom applied eight electrodes
to the skull of each man. They reclined in deep sleep-back chairs,
and Tom suggested they close their eyes.
Jim began to feel a sense of apprehension as he heard the first faint
whine of the equipment. He knew the transcribed tape was unreeling
slowly beneath the photo-electric scanner. The resulting fluctuating
current was being amplified, filtered, gated to the proper level, and
applied to the electrodes on his skull. He felt nothing.
"Just like a ride on the merry-go-round," he said in disappointment.
Then it struck.
Like a fearful, billowing blackness rising out of the depths of Hell
itself, it washed over him. It sucked at his very soul, corroding,
destroying, a wind of darkness where the very concept of light was
unknown.
He was not conscious of his screaming until he heard his own dying
voice and grew slowly aware of the sudden rawness of his throat. He
heard another screaming and it sounded like Sam. Dimly, he
wondered what had happened to Sam.
Tom was bending over him, patting his face with a cold towel and
murmuring, "Wake up, Jim! You're all right now. You're all right."
He opened his eyes and saw Tom, white-faced. He turned and looked
at Sam, whose head lolled sluggishly while a low whimpering came
from his lips.
"I'm all right," said Jim weakly. "Take care of Sam."
Exhausted, he leaned back and closed his eyes another moment.
Sweat oozed from every pore of his skin, cold, fear-inspired sweat.

An hour later, he felt completely recovered from the experience,

except that his knees were still a little wobbly when he tried his legs.
"We've got to try it again," Jim said. "Can you cut down the intensity a
little? Better still, how about rigging up an intensity control that we can
operate for ourselves?"
"Nobody is trying that thing again in my lab," said Tom Banning. "Do
you think I want a couple of corpses on my hands? Not to mention
the droves of police that your screaming will bring down."
"We've got to know," Jim said. "Listen, Tom, I'll tell you where we got
this record. Then you can judge for yourself."
Rapidly, he told Tom all that had happened since their first experience
with the Prospector. The brain specialist listened impassively until the
end of the story.
"So you conclude there's something monstrous on the moon, and this
experience you've just had would indicate that it's highly inimical to
human life," said Tom.
"That's about it," said Jim.
"What do you expect to do about it?"
"I want to finish what we started here. Then I've got to show the
authorities that the moon project has got to stop. We can't go ahead
with our moon landings now. If we do, that thing will be stirred out of
dormancy into life—and, somehow, it will make its way to earth. I
wouldn't be surprised if it could navigate space alone, its own naked
being."
Tom turned back to his equipment. "All right, let's go. I want to get a
sampling of that before we're through, too."
With a control that he could operate himself, Jim found it endurable.
With the control at minimum intensity, he tensed for that first terrible
impact of the alien impulses pouring into his own mind.
They were weaker, but still he felt as if the shroud of death had
settled over him. He heard a moan from Sam and knew his
companion was experiencing the same sensations.
The impulses of evil poured on through the electrodes into his mind.
He sensed the immensity and purpose of the thing that had
generated them. He sensed that out of some far reach of space,
where time and dimension were not the same, the thing had acquired
an eternal nature of a kind that knew no birth and could experience
no death in the dimensions of man.
He sensed that its nature and its purpose were pure destruction.
Destruction of life in any form. It was a thing of death, and life and it
could not exist in the same universe.
He sensed how it had come and why it had come, and the partial
defeat that had sent it into dormancy because there was no life of the
kind it knew in the universe through which it hurtled.
Now—it was once again aware of life.

The three of them went back to the tracking station laboratory

together. Jim managed to obtain a clearance for Tom to see what
they were doing. "I want to move the Prospector a long distance and
try one more hole," he told Sam.
"What do you mean by a long distance?"
"A hundred miles."
"A hun—! You think you'll still find this thing that far away?"
"We'll find out. Can the Prospector travel that far?"
"Sure. If you wait long enough. Its maximum speed is two miles an
hour."
"A little better than two days. Let's pick the direction of the flattest and
lowest terrain. I don't want to get it up into the mountains."
During the following two days, Jim considered what his next move
should be. He had to present his data and evidence to a conference
of men who mattered, who could make the necessary decisions. It
had to be brought to the attention of the top levels of NASA. The
Department of Defense and the Presidential advisors should be in on
it, too.
His thoughts came to a stop and he felt more than a little hysterical.
Who was he? A third-string chemical researcher on one of dozens of
current NASA projects. Who was going to let him call a conference of
the nation's brass and instruct them to close down the moon
program?
Nobody.
In the Civil Service hierarchy to which he belonged there was
absolutely no way on earth by which he could bring his story to the
attention of the people who could act on it.
No way at all. But he had to try.
He tried to reach the Director of NASA. The Director's secretary told
Jim the Director was out of town and could not be reached except for
emergency or other top-priority communications. Jim said that was
exactly the nature of his message. The Secretary told him to get his
Project Director to approve the message and an effort could be made
to get it through.
That meant Hennesey.
Hennesey laughed in his face, and told him that one more fantasy like
that would get him fired.
Jim had known that's the way it would be, but he had to try.
By this time, the Prospector had traveled more than ninety miles from
the last probe. It was far enough, Jim decided. They'd put down one
more probe, then—he didn't know where he'd go from there.
Sam saw the bleakness and bitterness on his face when he came
into the tracking station. "No luck?" said Sam.
"What do you think? Have you ever realized that there is no way
whatever for the ordinary citizen to get through with a message that
requires action at the top? Channels, supervisors' approvals, okays
by supervisors' supervisors—the only communication the top level
has is with itself; generals talk to other generals, Bureau Directors
talk to generals and other Bureau Directors, the President talks to his
advisors who talk only to each other. The communication barrier is
complete and absolute."
"I could have told you that," said Sam. "I've been here longer than
you have. But some of them may still read a newspaper now and
then."
"What do you mean by that?"
"Call a news conference of the science editors and reporters of the
major press services and big-city newspapers. Your reputation is big
enough that they'll listen to you."
"You saw what they did to me last time!"
Sam shrugged. "Maybe you know a better way."

Jim took his seat at the console and watched the slow progress of the
Prospector across the moon's surface. It was winding its way through
an area of small, low crags. Ahead was a smooth, level plain. Jim
determined to halt there and make the next probe.
Out of the corner of his eye he saw Hennesey moving toward them.
He could think of nothing that would make the day more unpleasant
than Hennesey's presence.
The Project Director scanned the panels and the meters that showed
the distance traveled by the Prospector.
"Why have you moved the machine so far?" Hennesey demanded.
"You've used up valuable machine time that could have been used in
additional probes. We may be approaching the end of the useful life
of the Prospector very rapidly."
"I am aware of that," said Jim icily. "The stock of reagents aboard is
nearly exhausted. I wanted to make at least one comparison probe at
a considerable distance from our original site."
Hennesey grunted and remained silent, watching. Then, suddenly he
cried out, "Look out! You fool—!"
Jim had seen it, too. At the edge of the crags was a ten-foot wide
fissure spreading darkly on either side of the Prospector. The drives
of the machine were upon it before he realized it was there. In fact,
the crazy thought echoed in the back of his mind that it wasn't there
an instant before.
He slammed his hand against the switches that sent out a reversing
signal to the drives of the Prospector. But it was too late. The worm
drives bit into nothingness as the machine toppled slowly at the edge
of the crevasse. And in that moment, as the image on the television
screen teetered crazily, Jim had the impression that he was looking
into the black depths of utter horror. There was a blackness oozing
and writhing faintly in the depths—that could have been thirty or a
hundred feet deep. But he had seen just such a black horror once
before.
When the EEG signals from the moon first smashed into his brain!
He glanced at Sam. Sam was staring in a kind of intense horror that
told Jim he recognized it, too.
The image tilted abruptly against the black moon sky. Then the
screen went dark. And Jim had the feeling that the blackness had
closed over him.
But Hennesey had sensed nothing of this. He was cursing and raging
beside Jim. "You blind, brainless fool! You wiped out a billion-dollar
experiment because you weren't looking! You're through, Cochran!
Get everything that's yours and be out of here in ten minutes!"
Hennesey whirled and strode away, his rage reeking through the
atmosphere of the room.
Jim stood up and moved to the back of the panel. He opened the
plastic doors and clipped the last ten feet from the spool of TV
recording tape and slipped it in his pocket. When he returned to the
other side of the console, Sam was waiting for him.
"Where are you going?" said Jim.
"With you."
"Where's that?"
"I don't think you know, but I do. I'll tag along and see if I'm right."
"You're crazy. Didn't you just hear Hennesey fire me?"
"Yeah. I quit at the same time."
"You're really crazy."
Jim had a few textbooks and scientific papers in his desk. He
arranged for one of his men to clean them out. He didn't feel that he
could endure remaining in the station any longer.
Tom Banning followed them out into the sunshine of the parking lot.
"I'm sorry," he said, "but it looked as if what happened back there was
rather inevitable."
"It was," said Jim. "I'd have kicked his teeth in sooner or later. It's
better this way."
"What will you do now?"
"Ask Sam. He seems to think he has some crazy idea of what I'm
going to do next. I sure don't."
"The news conference," said Sam. "You'd better call it right away
before news of your dismissal gets out. They may think you just want
to unload some sour grapes if they hear of that first."
"Yeah, I guess you're right. Will you back me up in the conference,
Tom?"
The doctor nodded. "Gladly. It's pretty hard to believe, but you've got
me believing."

Jim was personally acquainted with most of the newsmen who

showed up for his conference. He had met them and helped them get
stories on the Prospector during the past two years. They were
sympathetic toward him.
He began his story by reviewing his initial discovery of the difference
in moon elements. He explained the analysis and showed them
samples of the telemetry record. Then he eased slowly into his
discovery of fossil hydrocarbons and finally the living hydrocarbons.
He watched carefully as he moved deeper into the story. He didn't
want to lose them here.
They stayed with him, incredulous but confident that he knew what he
was talking about. It was when he spoke of the fluctuating potential
measurements, that proved to be interpretable as EEG recordings
that he almost lost them. But he introduced Tom Banning quickly to
verify his statements. And Tom introduced the EEG machine itself. He
offered to demonstrate. A half dozen of the reporters tried it. They
had no doubts, afterward.
"You can almost draw your own conclusions," said Jim in winding up
the conference. "That thing is out there in our sky. There's no doubt
about it. I've shown you what we know. Now let me tell you what I
believe:
"There is some form of life in the moon. It is not merely in the moon. It
is the moon. I believe its bulk occupies almost the entire volume of
the moon. I believe this nemesis was spawned incalculable eons ago
in a time and a space that is literally outside our own. It was driven
out of that time and space by intelligent beings who could not destroy
it, but who could at least exile it in a state of dormancy. Or perhaps
they thought they had destroyed it and wanted not even the remains
in their own domain. Perhaps the craters of the moon were caused by
bombardment intended to destroy the thing.
"But it is not dead. It was dormant. Now, our laser probings have
stirred it to feeble life. It made a deliberate effort to capture or destroy
the Prospector by opening a fissure beneath it. My TV film recording
proves that the fissure was not there previously.
"What are we to do about it? That is why I have called you here.
Consider that the science of the intelligences in the domain that
spawned this thing could not destroy it. What chance has our feeble
science and powers against such a force? Hydrogen bombs would
probably serve only to feed it the energy for which it is starved.
"We must cease our lunar exploration program at once. We can hope
that it is not too late. If it is not, this thing may relapse into the
dormancy from which it has been shaken. We can only hope.
"But if we persist in our explorations and our probings of the moon we
are certain to loose upon ourselves a living force that our entire world
of science will be helpless to overcome.
"We must stop the moon program now!"

They kept him for another two hours with questions and demands for
further information. He gave them everything he knew, and when they
finally left, he felt that a sane and correct story of his findings would
be published. He waited for whatever results would be published by
the news services the following morning.
He waited.
There was nothing.
Eddie Fry called him two days later. Eddie was the reporter who knew
him best. "They killed the story," said Eddie. "We had to clear it with
government sources, and they persuaded every press association
and newspaper that knew about it to kill it. They said it would destroy
the national economy that was being built up on the space program.
We tried to make them believe it, Jim, but we couldn't do it. It was
hard enough to be convinced when we were listening to you. Second
hand, it just wouldn't go over. You really can't blame them.
"They're doing something else, too. They're really going to nail you for
this thing. A story is being released about your dismissal. It is said
that you were released for fantastic and unreliable theories and for
incompetence that resulted in the loss of the Prospector. I'm sorry as
hell, Jim. I wish we could kill that one, but there's not a thing we can
do for you."
"It's o.k., Eddie," said Jim. "I know how it is."
Crackpot. He was finished.
He called Allan at his base that night. His brother-in-law's voice was
icy as he answered. "What do you want, Jim?"
"Come down over the weekend, can you, Allan? I've got something
important I want to talk to you about."
"Listen, Jim. Stay away from me! Don't call; don't try to see me. Don't
send me letters or telegrams. Nothing! Do you understand that?"
"What the devil—?"
"They're investigating me. Because of you. They want to know how
much I've been listening to your crackpot notions. They're afraid
maybe it will produce an instability that will make me unfit for the
moon trip. If I lose out, it will be because of you!"
"That's what I want to talk to you about. Allan, you've got to listen to
me! You won't get off the moon alive—"
The phone went dead. Jim hung up slowly and went back to the living
room where Mary sat in tense, white fear. She had heard Jim's side of
the conversation. She guessed what Allan had said.
"It's no use," said Jim. "Don't try to reach him. He'll hate you forever."