1. Chapter 19 Accounting in International Business

2. “The language of business”
Accounting
“The language of business”
Accounting information is the means by which firms communicate their financial position to the providers of capital (investors, creditors and government)
Accounting standards differ from country to country which make it difficult for investors, creditors, and governments to evaluate firms

3. Accounting Information and Capital Flows

4. Country Differences in Accounting Standards
Accounting systems in every country has evolved in response to the demands for accounting information
The International Accounting Standards Board (IASB) has made some attempts to establish common accounting and auditing standards across countries
Despite attempts to harmonize standards by developing internationally acceptable accounting conventions, differences between national accounting systems still remain

5. Country Differences in Accounting Standards
Five Main Variables
relationship between business and the providers of capital
political and economic ties with other countries
level of inflation
level of a country’s economic development
prevailing culture in a country

6. Country Differences in Accounting Standards

7. Relationship Between Business and Providers of Capital
Three main external sources of capital for firms are:
Individual investors
Banks
Government
A country’s accounting system tends to reflect the relative importance of each constituency as a provider of capital

8. Relationship Between Business and Providers of Capital
Accounting systems in:
U.S. and Great Britain are oriented toward individual investors
Switzerland, Germany, and Japan focus on providing information to banks
France and Sweden prepare financial documents with the government in mind

9. Political and Economic Ties with Other Nations
Similarities in accounting systems of countries may be due to close political and/or economic ties
U.S. accounting system influences the systems in Canada and Mexico
In the European Union, countries are harmonizing their accounting practices

10. Inflation Accounting
The historic cost principal assumes the currency unit used to report financial results is not losing its value due to inflation
There are no adjustments to sales, purchases, etc at a later date due to inflation
This principle affects asset valuation
If inflation is high, assets will be undervalued

11. Level Of Development Developed nations tend to have:
large, complex organizations
more sophisticated capital markets
more sophisticated accounting systems
Many developing nations have accounting systems:
that were inherited from former colonial powers
that may not apply to small businesses

12. Culture
The extent to which a culture is characterized by uncertainty avoidance (extent to which cultures socialize their members to accept ambiguous situations and tolerate uncertainty) impacts the country’s accounting system
Countries with low uncertainty avoidance cultures have strong independent auditing professions

13. National and International Standards

14. National and International Standards
Accounting Standards
rules for preparing financial statements—they define useful accounting information
Auditing standards
specify the rules for performing an audit
technical process by which an independent person gathers evidence for determining if financial accounts conform to required accounting standards and also reliable

15. Lack Of Comparability
National differences in accounting and auditing standards limit the comparability of financial reports from one country to another
Growth of transnational financing and transnational investment has been accompanied by the growth of transnational financial reporting
But the lack of comparability between accounting standards in different nations can lead to confusion

16. International Standards
Substantial efforts have been made recently to harmonize accounting standards across countries
Global capital markets are adding urgency to the issue
Common accounting standards will facilitate the development of global capital markets
The International Accounting Standards Board (IASB) is a major proponent of standardization
The IASB currently has 45 standards, but compliance is voluntary
About 100 nations have adopted IASB standards or permitted their use in reporting financial results

17. International Standards
International Accounting Standards Board (IASB)
Major proponent of standardization
Currently has 45 standards
Compliance is voluntary
About 100 nations have adopted IASB standards or permitted their use in reporting financial results

18. International Standards
International Accounting Standards Board (IASB)
Most IASB standards are consistent with standards already in place in the United States
European Union has mandated harmonization of accounting principles in its member countries
By 2010, there could be only two major accounting bodies with substantial influence on global reporting
FASB in the United States and IASB elsewhere

19. Multinational Consolidation and Currency Translation

20. Consolidated Financial Statement
Combines the separate financial statements of two or more companies to yield a single set of financial statements as if the individual companies were one
Multinational firms typically issue consolidated financial statements for the parent company which includes the merging of subsidiaries

21. Consolidated Financial Statements
Most multinational firms consists of a parent company and a number of subsidiary companies that are:
separate legal entities
interdependent economic entities
Consolidated financial statements provide accounting information about a group of companies that recognize the economic interdependence
Transactions among members of a corporate family are not included in consolidated financial statements, only assets, liabilities, revenues, and expenses with external third parties
Since separate legal entities are required to keep their own accounting records, they record transactions with other members of the corporate group in separate statements

22. Currency Translation
Foreign subsidiaries usually keep accounting records and prepare financial statements in the local currency
Consolidated financial statements require all local financial statements be converted to the home currency
Two methods to determine what exchange rate should be used when translating financial currencies:
the current rate method
the temporal method

23. Current Rate Method
Exchange rate at the balance sheet date is used to translate the financial statements of a foreign subsidiary into the home currency of the multinational firm
Incompatible with the historic cost principle and might provide a misleading financial picture

24. Temporal Method
Translates assets valued in a foreign currency into the home currency using the exchange rate that exists when assets are purchased
Avoids the problems associated with the current rate method
But still problematic because different exchange rates are used to translate foreign assets and the multinational firm’s balance sheet may not balance

25. FASB 52 Requirement for US Multinationals
Current U.S. Practice
FASB 52 Requirement for US Multinationals
The functional currency is the local currency of each self-sustaining foreign subsidiary
Balance sheets should be translated into the home currency using the exchange rate in effect at the end of the firm’s financial year
Income statements are translated using the average exchange rate for the firm’s financial year

26. Accounting Aspects of Control Systems
Control process in most firms is usually conducted annually and involves three steps:
1. subunit goals are jointly determined by the head office and subunit management
2. the head office monitors subunit performance throughout the year
3. the head office intervenes if the subsidiary fails to achieve its goal, and takes corrective actions if necessary
Two factors that can complicate the control process
exchange rate changes
transfer pricing practices

27. Exchange Rate Changes And Control Systems
Most international firms require all budgets and performance data to be expressed in the “corporate currency” (normally the home currency)
This facilitates comparisons between subsidiaries
However, it also allows exchange rate changes during the year to introduce substantial distortions

28. Exchange Rate Changes And Control Systems
Lessard-Lorange Model
Firms can use three exchange rates to translate foreign currencies in the corporate currency
Initial Rate
spot exchange rate when the budget is adopted
Projected Rate
spot exchange rate forecast for the ends of the budget picture
Ending Rate
spot exchange rate when the budget and performance are being compared

29. Lessard-Lorange Model

30. Lessard-Lorange Model
Suggests that firms use the projected spot exchange rate (usually the forward exchange rate) to translate budget and performance figures into the corporate currency
Firms can also use the internal forward rate which is the company-generated forecast of future spot rates

31. Transfer Pricing And Control Systems
Transfer price is the price at which goods and services are transferred within the firm:
can significantly influence the performance of subsidiaries
must be considered when evaluating a subsidiary’s performance
Firms often manipulate transfer prices to:
minimize tax liability
minimize import duties
avoid government restrictions on capital flows

32. Separation of Subsidiary and Manager Performance
Since foreign subsidiaries do not operate in uniform environments, the evaluation of a:
subsidiary should be kept separate from the evaluation of its manager
manager should consider the country’s environment for business
manager should be in the local currency and allow for the consideration of those items over which they have no control