1. © McGraw Hill Companies, Inc., 2000 Accounting in the International Business Chapter 19

2. © McGraw Hill Companies, Inc., 2000 Accounting Information and Capital Flows Business Enterprise Providers of Capital (investors, Creditors and Government) Resource Users Resource Providers Information Providers Information Users Financial Accounting Information $ Figure 19.1 19-1

3. © McGraw Hill Companies, Inc., 2000 Determinants of National Accounting Standards National Accounting System Political and Economic Ties with Other Countries Level of Economic Development National Culture Level of Inflation Relationship Between Business and Providers of Capital Figure 19.2 19-2

4. © McGraw Hill Companies, Inc., 2000 Relationship Between Business and Providers of Capital  External sources of capital:  Individual investors. Buying shares and bonds.  Banks. Loan capital.  Government. Make loans or investment. Importance of each varies from country to country 19-3

5. © McGraw Hill Companies, Inc., 2000 Political and Economic Ties with Other Countries  Accounting convergence:  Influence of NAFTA.  Influence of the former British Empire.  Influence of the European Union. 19-4

6. © McGraw Hill Companies, Inc., 2000 Inflation Accounting  Historic cost principle:  Assumes currency is not losing value to inflation.  Most significant impact = asset valuation.  Appropriateness varies with inflation.  Current cost accounting:  Factors out inflation.  Used in Great Britain until inflation rate declined. 19-5

7. © McGraw Hill Companies, Inc., 2000 Level of Development  Developed countries have more sophisticated accounting procedures.  Accounting problems are more complex.  Sophisticated capital markets.  Lenders require comprehensive reports.  Educated workforce can perform complex accounting functions. 19-6

8. © McGraw Hill Companies, Inc., 2000 Culture  Hofstede’s uncertainty avoidance has an impact on accounting systems.  Low uncertainty avoidance - these countries tend to have strong independent accounting professions that ensure a firm’s compliance with rules. 19-7

9. © McGraw Hill Companies, Inc., 2000 Accounting Clusters British-American-Dutch Group Firms raise capital from investors. Accounting systems designed to inform investors Europe-Japan Group Have close ties to banks. Accounting practices meet bank’s needs. South American Group Countries have experienced persistent and rapid inflation. Accounting principles reflect the inflation. 19-8

10. © McGraw Hill Companies, Inc., 2000 19-9 Map 19.1

11. © McGraw Hill Companies, Inc., 2000 International Accounting Standards Committee  Members represent 79 countries.  Responsible for formulating international accounting standards (IAS).  Has issued over 30 IAS.  Difficult to get requisite votes.  Voluntary compliance.  Recognition is growing. 19-10

12. © McGraw Hill Companies, Inc., 2000 Multinational Consolidation and Currency Translation Consolidated Financial Statements Parent Foreign Subsidiary Cash $1,000 $250 Receivables 3,000 900 Payables 300 500 Revenues 3,000 900 Expenses 2,000 3,000 *Subsidiary owes Parent $300 *Subsidiary pays Parent $1000 in royalties for products licensed from Parent Eliminations Parent Foreign Subsidiary Debit Credit Consolidated Cash $1,000 $250 $1,250 Receivables 3,000 900 $300 3,600 Payables 300 500* $300 500 Revenues 7,000 5,000 1,000 11,000 Expenses 2,000 3,000** 1,000 4,000 *Subsidiary owes Parent $300. **Subsidiary pays Parent $1,000 in royalties for products licensed from Parent. 19-11

13. © McGraw Hill Companies, Inc., 2000 Currency Translation  The current rate method: the exchange rate at the balance sheet’s date is used to translate foreign subsidiary financial statements into home country currency.  Incompatible with ‘historic cost principle’.  The temporal method: translates foreign subsidiary assets into home-country currency at the time the asset is purchased.  Changing exchange rates may mean the balance sheet may not balance! 19-12

14. © McGraw Hill Companies, Inc., 2000 U.S. Practice  Statement 52 “Foreign Currency Translation”  Self-sustaining autonomous subsidiary:  Functional currency is local currency.  Balance sheet uses exchange rate at end of financial year.  Income statement is financial year average.  Integral subsidiary:  Functional currency is US currency.  Financial statements use the temporal method.  Dangling credit or debit increases or decreases consolidated earnings for the period. Firms using multidomestic or international strategies. Firms using global or transnational strategies. 19-13

15. © McGraw Hill Companies, Inc., 2000 Accounting Aspects of Control Systems  Annual control process involves three steps:  Head office and suibunit management jointly determine subunit goals for the coming year.  Throughout year, head office monitors subunit performance against agreed goals.  If subunit fails to achieve goals, head office intervenes to determine why the shortfall occurred, taking corrective action when appropriate. 19-14

16. © McGraw Hill Companies, Inc., 2000 Importance of Financial Criteria Used to Evaluate Performance of Foreign Subsidiaries and Their Managers Item Subsidiary Manager Return on investment (ROI) 1.9 2.2 Return on equity (ROE) 3.0 3.0 Return on assets (ROA) 2.3 2.3 Return on sales (ROS) 2.1 2.1 Residual income 3.4 3.3 Budget compared to actuaL sales 1.9 1.7 Budget compared to actual profit 1.5 1.3 Budget compared to actuaL ROI 2.3 2.4 Budget compared to actual ROA 2.7 2.5 Budget compared to actuaL ROE 3.1 3.0 Importance of criteria ranked on a scale from 1=very important to 5=unimportant. Table 19.1 19-15

17. © McGraw Hill Companies, Inc., 2000 Exchange Rate Changes and Control Systems  Lessard-Lorange Model:  Three exchange rates used to translate foreign currency into corporate currency for budget and performance purposes. The initial rate, the spot exchange rate when the budget is adopted. The projected rate,the spot exchange forecast for the end of budget period (I.e., the forward rate) The ending rate, the spot exchange rate when the budget and performance are being compared. 19-16

18. © McGraw Hill Companies, Inc., 2000 Possible Combinations of Exchange Rates in the Control Process Rates Used to Translate Actual Performance for Comparison with Budget Rates Used for Translating Budget (II) Budget at Initial Actual at Initial Budget at Initial Actual at Projected (IE) Budget at Initial Actual at Ending Budget at Projected Actual at Initial (PP) Budget at Projected Actual at Projected (PE) Budget at Projected Actual at Ending Budget at Ending Actual at Initial Budget at Ending Actual at Projected (EE) Budget at Ending Actual at Ending Initial (I)Projected (P)Ending (E) Initial (I) Projected (P) Ending (E) Figure 19.3 19-17

19. © McGraw Hill Companies, Inc., 2000 Transfer Pricing and Control Systems Before Change in Transfer Price After 20% Increase in Transfer Price Revenues per unit $230 $230 Cost of component per unit 100 100 Revenues per unit 100 100 Profit per unit 30 10 19-18