Location: AICPA Washington Office

(Reference: AICPA International Practices Task Force - December 2, 1997 meeting)

Historically, there has been diverse practice among Mexican companies that consolidate foreign operations. Most of these foreign operations are located in the United States, but a small number of companies have operations in other countries around the world.

The Mexican Accounting Principles Commission has recently issued a new standard Bulletin B-15 that addresses consolidation of foreign subsidiaries. This standard addresses among other items how prior year amounts should be recasted. While the standard presents a methodology that allows the use of averages for simplicity, conceptually, the amounts are recast using the inflation rate of the foreign (non Mexican) country and translated into pesos using the year end exchange rate. Prior to the issuance of this standard, some companies had historically used this method in filings with the Commission. Most companies, however, simply updated all amounts in the current year by the rate of inflation in Mexico - amounts in pesos of equivalent purchasing power.

This issue was discussed at length last year and the Task Force reached a conclusion that would prohibit in Commission filings the method that is now required by Bulletin B-15. Attached is a copy of the discussion paper that was distributed last year that was used to reach a consensus at the AICPA Task Force Meeting on August 15, 1996. This conclusion was based on the belief that the method used by these Mexican companies violated Rule 3-20(e) of Regulation S-X. This section of the rule requires all amounts to be stated in a constant currency for all periods. This conclusion was supported by the staff and the staff's support was reconfirmed at the AICPA conference with the following statement -

There is also diversity in practice on presenting corresponding amounts from the prior year that are attributable to foreign operations. Most Mexican registrants recast prior year amounts by applying the general Mexican inflation index. Some Mexican registrants, however, have developed an alternative methodology in which the amounts reported by the foreign subsidiaries in the prior year are "re-translated" into pesos using the most recent balance sheet exchange rate. The staff and the Task Force concluded that this methodology is inconsistent with Rule 3-20(e) of Regulation S-X. This rule states that the financial statements should be presented using the same reporting currency for all periods. In preparing price level adjusted financial statements, the registrant is defining their reporting currency as pesos of equivalent purchasing power as of the most recent date. This alternative methodology of re-translating prior year balances using the current exchange rate effectively results in changing amounts that were previously reported, and thus, the prior year amounts are not stated in pesos of equivalent purchasing power. This alternative method should not be used in future Commission filings.

The methodology in Bulletin B-15 effectively results in the company changing amounts that were previously reported and are not expressed in pesos of equivalent purchasing power. To further illustrate the application of B-15, assume a company reported sales of NP 1,000 in 1995 which were evenly divided 500 from Mexican operations and 500 from US operations. Further assume that all sales, including those in Mexico, were denominated in US dollars and the rate of inflation in the subsequent year is 25% in Mexico and 0% in the US and devaluation is 5%. If the amounts were reported in constant pesos of equivalent purchasing power the relationship would never change. All amounts would be updated by a constant rate of inflation - both the Mexican and US operation would report sales of 625 (500* 1.25). Under the methodology required by B15, the Mexican operation would report sales of 625 but the US operation would report sales of 525 (500* 1.05).

It is my understanding that one of the reasons that this standard was adopted was that several companies with significant US operations were concerned about the negative trends in US dollars because the peso was not devaluing at the same rate as inflation. As sales in dollar terms were not increasing as fast as Mexican inflation, when the prior year amounts were expressed in constant pesos of equivalent purchasing power - the reporting currency, the result would be declining sales in constant pesos. This scenario is no different from a US company reporting in dollars with significant operations in the UK. Sales in the UK in terms of pounds could be the same between years, but in dollar terms if the dollar strengthens against the pound the result will be declining sales.

ISSUES:

1. As a result of the issuance of Bulletin B-15, should the Task Force reconsider its conclusion?

2. Does the SEC staff believe the conclusion should be reconsidered?

In evaluating these issues, the following should be considered:

• There will be consistent application with respect to prior years under Mexican GAAP. Previously, one of the concerns was diverse practice.
  
  
• Technically, if the Task Force and SEC staff continue to believe that the method required by Bulletin B-15 violates Rule 3-20, the rule could be interpreted as requiring the primary financial statements to be changed - i.e., not a reconciliation issue. Even if a reconciliation issue this would make the reconciliation to US GAAP very difficult as virtually every number would be different. A similar issue was addressed by the SEC staff in prior years with respect to the Canadian methodology of translation prior year balances if there is a change in reporting currency. The staff provided the following guidance on that issue:

Canadian issuers that elect to change reporting currency are strongly encouraged to discuss their particular facts and circumstances with the staff. Rule 3-20 of Regulation S-X states that the primary financial statements should be recast as if the new reporting currency had always been used. As indicated in the proposing release, this method differs from the Canadian method described in EIC 1I that uses a convenience translation to recast prior periods.-[7]-. The level of additional information that will be necessary to comply with the Commission's requirements will depend on the differences in exchange rates that would be used to recast prior periods. The additional information could range from addressing differences in the methodology as part of the reconciliation to US GAAP to complete restatement of prior year financial statements using the methodology required by Rule 3-20. Additional information in management's discussion and analysis using the US GAAP balances may also be necessary.

The methodology of translating foreign operations for the current year under B-15 is consistent with the methodology used to recast prior years. That is, the amounts are adjusted for inflation in the foreign (non-Mexican) country and translated into pesos using the year end exchange rate. Should this methodology be acceptable for filings with the Commission? If the methodology relating to the prior years is not acceptable, but the methodology for the current year is considered acceptable, there could be a significant difference in presenting a transaction on December 31 vs January 1 of the following year. There are two opposing views:

• The staff has historically not objected to different methodologies of translating foreign subsidiaries - part of the compressive basis of presenting price level adjusted financial statements.
  
  
• The same reason why the Task Force concluded in prior years that the methodology now required by B-15 for prior years is not appropriate would appear to be equally applicable to the method of consolidating in the current year.

If a full reconciliation would not be required should alternative disclosure be provided such as -

• selected financial information in methodology that presents all amounts in a constant currency (recasted in constant currency).
  
  
• selected financial information in the foreign currency relating to the foreign operations.