Introduction to International Accounting Chapter 1 Introduction to International Accounting

Introduction to International Accounting Learning Objectives 1. Understand the nature and scope of international accounting 2. Describe accounting issues created by international trade 3. Explain reasons for, and accounting issues associated with, foreign direct investment (FDI)

Introduction to International Accounting Learning Objectives 4. Describe the practice of cross-listing on foreign stock exchanges 5. Explain the notion of international harmonization of accounting standards 6. Examine the importance of international trade, FDI, and multinational enterprises (MNEs) in the global economy

What is International Accounting? International Accounting can be described at three different levels: The influence on accounting by international political groups such as the OECD, UN, etc. The accounting practices of companies in response to their own international business activities The differences in accounting standards and practices between countries Learning Objective 1

International Transactions, FDI and Related Accounting Issues Sale to foreign customer Most companies’ first encounter with international business occurs as sales to foreign customers. Often, the sale is made on credit and it is agreed that the foreign customer will pay in its own currency (e.g., Mexican pesos). Learning Objective 2

International Transactions, FDI and Related Accounting Issues Sale to foreign customer This gives rise to foreign exchange risk as the value of the foreign currency is likely to change in relation to the company’s home country currency (e.g., U.S dollars). Learning Objective 2

International Transactions, FDI and Related Accounting Issues Sale to foreign customer Suppose that on February 1, 2006, Joe Inc., a U.S. company, makes a sale and ships goods to Jose, SA, a Mexican customer, for $100,000 (U.S.). However, it is agreed that Jose will pay in pesos on March 2, 2006. The exchange (spot) rate as of February 1, 2006 is 10.00 pesos per U.S. dollar. How many pesos does Jose agree to pay? Learning Objective 2

International Transactions, FDI and Related Accounting Issues Sale to foreign customer Even though Jose SA agrees to pay 1,000,000 pesos ($100,000 x 10.00 pesos/U.S. $), Joe, Inc. records the sale (in U.S. dollars) on February 1, 2006 as follows: Dr. Accounts receivable (+) 100,000 Cr. Sales revenue (+) 100,000 Learning Objective 2

International Transactions, FDI and Related Accounting Issues Sale to foreign customer Suppose that on March 2, 2006, the spot rate for pesos is 11 pesos/U.S. $). Joe Inc. will receive 1,000,000 pesos, which are now worth $90,909. Joe makes the following journal entry: Dr. Cash (+) 90,909 Dr. Loss on foreign exchange (+) 9,091 Cr. Accounts receivable 100,000 Learning Objective 2

International Transactions, FDI and Related Accounting Issues Hedging Joe can hedge (i.e., protect itself) against a loss from an exchange rate fluctuation. Hedging can be accomplished by various means, including: Foreign currency option – the right (but not the obligation) to purchase foreign currency at a specific exchange rate for a specified period of time. Learning Objective 2

International Transactions, FDI and Related Accounting Issues Hedging Forward contract – this is an obligation to exchange foreign currency at a date in the future, typically 30, 60 or 90 days. Learning Objective 2

International Transactions, FDI and Related Accounting Issues Foreign Direct Investment (FDI) – occurs when a company invests in a business operation in a foreign country. This represents an alternative to importing to customers and/or exporting from suppliers in a foreign country. Two types of FDI are Greenfield investment and acquisition. Learning Objective 3

International Transactions, FDI and Related Accounting Issues Foreign Direct Investment (FDI) Greenfield investment – the establishment of a new operation in the foreign country Acquisition – investment in an existing operation in the foreign country. Learning Objective 3

International Transactions, FDI and Related Accounting Issues FDI creates two primary issues: The need to convert from local to U.S. GAAP since accounting records are usually prepared using local GAAP. The need to translate from local currency to U.S. dollars since accounting records are usually prepared using local currency. Learning Objective 3

International Income Taxation Foreign income taxes – the foreign government will tax the company’s profits at applicable rates. U.S. income taxes – the U.S. will tax the company’s foreign-based income. Learning Objective 3

International Transfer Pricing Transfer pricing – setting prices on goods and services exchanged between separate divisions within the same firm. These prices have a direct impact on the profits of the different divisions. Learning Objective 3

International Transfer Pricing These exchanges are not arms-length transactions, thus giving rise to the certain problems in an international context: Taxation – governments in the various countries often scrutinize transactions to assure that sufficient profits are being recorded in that country. Learning Objective 3

International Transfer Pricing Performance evaluation issues – to the extent that division managers are evaluated based on divisional profits, transfer prices influence division manager performance evaluation. Learning Objective 3

International Auditing Both internal and external auditors encounter differences that arise between auditing in an international vs. domestic context. These include: Language and cultural differences Different accounting standards (GAAP) and auditing standards (GAAS) Learning Objective 3

Cross-listing on Foreign Stock Exchanges MNEs frequently raise capital outside their home country. When a company offers its shares on an exchange outside of its home country, this is referred to as Cross-Listing. Learning Objective 4

International Harmonization of Accounting Standards The international movement towards a single set of worldwide accounting rules is referred to as Harmonization. International Accounting Standards (IAS) and U.S. GAAP are currently the two most important sets of accounting rules. Learning Objective 5

International Harmonization of Accounting Standards The Norwalk Agreement Published in 2002. Is a promise of cooperation in standard-setting between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB). Represents a significant step toward international harmonization. Learning Objective 5

Several indicators demonstrate the extent of business globalization: The Global Economy Several indicators demonstrate the extent of business globalization: International trade – In 2001 exports worldwide topped $6 trillion. Between 1987 and 1999, U.S. exporters increased by 233% in number. Foreign Direct Investment – Between 1982 and 1999 worldwide FDI inflows increased from $58 billion to $865 billion. Learning Objective 6

Several indicators demonstrate the extent of business globalization: The Global Economy Several indicators demonstrate the extent of business globalization: Multinational enterprises (MNEs) – Companies that have headquarters in one country and operate in one or more other countries. Currently, MNEs account for over one-quarter of the world’s Gross Domestic Product (GDP). Learning Objective 6

Several indicators demonstrate the extent of business globalization: The Global Economy Several indicators demonstrate the extent of business globalization: International capital markets – In 2001 there were 462 companies representing 53 countries cross-listed on the New York Stock Exchange (NYSE). In addition, over 60 U.S. companies are cross-listed on foreign exchanges… Learning Objective 6