1. 11-1 International Issues in Cost Management Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University

2. 11-2 1.Explain the role of the accountant in the international environment. 2.Discuss the varying levels of involvement that firms can take in international trade. 3.List the ways accountants can manage foreign currency risk. 4.Tell why multinational firms choose to decentralize. ObjectivesObjectives After studying this chapter, you should be able to: ContinuedContinued

3. 11-3 5.Explain how environmental factors can affect performance evaluation in the multinational firm. 6.Describe the role of transfer pricing in the multinational firm. 7.Discuss ethical issues that affect firms operating in the international environment. ObjectivesObjectives

4. 11-4 Where does the management accountant fit into the global business environment? Business looks to the management accountant for international financial and business expertise.

5. 11-5 Management Accounting in the International Environment Skills needed by cost accountants Politics Economics Marketing Management Information systems technology

6. 11-6 Multinational Corporation (MNC) A multinational corporation (MNC) is one that “does business in more than one country in such a volume that its well-being and growth rest in more than one country.”

7. 11-7 Importing and Exporting  Importing is the process of bringing product in from a foreign country.  Exporting is the process of shipping product to a foreign country.

8. 11-8 Foreign trade zones are areas near a customs port of entry that are physically on U.S. soil but considered to be outside U.S. commerce. Foreign Trade Zones Example: San Antonio Example: New Orleans

9. 11-9 Example of the Advantages of Operating a Plant in a Foreign Trade Zone Roadrunner, Inc., operates a petrochemical plant in a foreign trade zone. Wilycoyote, Inc., operates an identical plant just outside the foreign trade zone. Both plants purchase $400,000 of crude oil from Venezuela.

10. 11-10 Roadrunner Wilycoyote Duty paid at purchase$ 0$24,000 Carrying costs of duty 01,920 Wilycoyote pays duty at the point of purchase (6% of $400,000). Total duty- related carrying costs (0.12 x 8/12 x $24,000) Duty paid at sale 16,8000 Roadrunner pays duty at point of sale because it is in a foreign trade zone. Example (continued)

11. 11-11 Roadrunner Wilycoyote Duty paid at purchase$ 0$24,000 Carrying costs of duty 01,920 Duty paid at sale 16,800 0 Example (continued) Total duty and duty- related costs$16,800$25,920 Clearly the advantage approach

12. 11-12 A company may choose to purchase an existing foreign company, making the purchased company a wholly owned subsidiary. If the laws of the country permit, a multinational corporation can simply set up a wholly owned subsidiary or branch office in the country.

13. 11-13 Outsourcing of technical and professional jobs is becoming an important issue for resource- conscious U.S. firms. Outsourcing is the payment by a company for a business function formerly done in-house, such as payment for legal needs to outside firms.

14. 11-14 A joint venture is a type of partnership in which investors co-own the enterprise. A special case of joint venture cooperation is the maquiladora—a manufacturing plant located in Mexico that processes imported materials and reexports them, tariff-free, to the United States.

15. 11-15 Foreign Currency Exchange  Currency risk management  Transaction risk  Economic risk  Translation (accounting ) risk Kinds of risks:

16. 11-16 A Transaction Risk Example SuperTubs, Inc., a U.S. firm, sells its line of whirlpool tubs to Bonbain, a French distributor. On January 15, Bonbain orders 100 tubs at $1,000 per tub to be paid with francs on March 15. The exchange rate on January 15 is six francs per dollar or 600,000 francs. Suppose that on March 15 the exchange rate is 6.1 francs per dollar. A $1,639 loss is experienced by SuperTubs, Inc. Receivable in dollars on Jan. 15$100,000 Received in dollars on March 15 (600,000/6.1) 98,361 Exchange loss$ 1,639

17. 11-17 A Transaction Risk Example If the franc had strengthened against the dollar to a rate of 5.9 francs per dollar, a $1,695 gain would occur: Receivable in dollars on Jan. 15$100,000 Received in dollars on March 15 (600,000/5.9) 101,695 Exchange gain$ 1,695

18. 11-18 Hedging One way of ensuring against gains and losses on foreign currency exchanges is hedging.

19. 11-19 On March 15, Bonbain pays SuperTubs 600,000 francs. SuperTub pays the exchange dealer 600,000 francs, and the exchange dealer pays SuperTub $99,668 (600,000/6.02). $100,000 – $99,668 = $332 Premium expense $100,000 – $99,668 = $332 Premium expense Hedging

20. 11-20 Economic risk is the impact of exchange rate fluctuations on the present value of a firm’s future cash flows. Managing Economic Risk Example A U.S. consumer can choose to purchase heavy equipment from either Caterpillar (U.S.) or Komatsu (Japan). A piece of equipment is $80,000 from either maker. At an exchange rate of $1 equals 130 yens, the price is set. Assume the dollar strengthens so the exchange rate becomes $1 equals 140 yens. This lowers Katmatsu’s price to $74,286.

21. 11-21 Managing Transaction Risk Example Multinational, Inc., has a foreign division, FD, which has been experiencing eroding sales. Multinational directs FD managers to increase research and development expenditures over the following four quarters: Quarter Expenditures in Local Currency 1LC100,000 2LC110,000 3LC121,000 4LC133,100 A 10% increase each quarter

22. 11-22 Managing Transaction Risk Example (continued) Suppose that the dollar has strengthened against the local currency and the quarterly exchange rates of $1 for units of local currency are 1.00, 1.2, 1.35, and 1.50, respectively. Quarter Expenditures in Dollars 1$100,000 291,667 389,630 488,733 It looks like FD has decreased expenditures.

23. 11-23 Advantages of Decentralization in the MNC  The quality of information is better at the local level.  Local managers in the MNC are capable of a more timely response in decision making.  Social, legal, and language barriers are minimized.  Valuable training grounds for foreign subsidiary managers.

24. 11-24 Measuring Performance in the Multinational Firm It is particularly difficult to compare the performance of a manager of a division in one country with the performance of a manager of a division in another country.

25. 11-25 Environmental Variables Facing Local Managers of Divisions Economic  Inflation  Foreign currency exchange rates  Income taxes  Transfer prices

26. 11-26 Environmental Variables Facing Local Managers of Divisions Legal and Political  Country may not allow cash outflows  Country may forbid the import of certain items

27. 11-27 Environmental Variables Facing Local Managers of Divisions Social and Educational  Certain systems, like JIT, may not work in all cultures  Roads and communication may be inadequate  Training centers may need to be established

28. 11-28 An example of misleading results: Assets Revenues Net Income Margin Turnover ROI Brazil $10$ 6$ 30.500.600.30 Canada 1813100.770.720.56 Spain 151060.600.670.40 Analysis: On the basis of ROI, it appears that the manager of the Canadian subsidiary did the best job while the manager of the Brazilian subsidiary did the worst job. Comparison of Divisional ROI However, the inflation rate in Brazil was 100% for the year. After adjusting the asset base for inflation, the ROI would be 60% for the Brazilian manager.

29. 11-29 Other Factors Affecting Performance Evaluation Economic Factors: Organization of central banking system Economic stability Existence of capital markets Currency restrictions Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

30. 11-30 Political and Legal Factors: Quality, efficiency, and effectiveness of legal structure Effect of defense policy Impact of foreign policy Level of political unrest Degree of governmental control of business Other Factors Affecting Performance Evaluation Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

31. 11-31 Educational Factors: Literacy rate Extent and degree of formal education and training systems Extent and degree of technical training Extent and quality of management development programs Other Factors Affecting Performance Evaluation Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

32. 11-32 Sociological Factors: Social attitude toward industry and business Cultural attitude toward authority and persons in subordinate positions Cultural attitude toward productivity and achievement (work ethic) Social attitude toward material gain Cultural and racial diversity Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36. Other Factors Affecting Performance Evaluation

33. 11-33 Action Tax Impact Action Tax Impact Belgian subsidiary of Parent42% tax rate Company produces a component$100 revenue – $100 at a cost of $100 per unit. Title tocost = $0 the component is transferred to aTaxes paid = $0 reinvoicing center in Puerto Rico at a transfer price of $100 per unit. Transfer Pricing and the Multinational Firm Income Taxes and Transfer Pricing

34. 11-34 Action Tax Impact Action Tax Impact Reinvoicing center in Puerto Rico,0% tax rate also a subsidiary of Parent Company, $200 revenue – $100 transfers title of component to U.S.cost = $100 subsidiary of Parent Company at aTaxes paid = $0 transfer price of $200 per unit. Transfer Pricing and the Multinational Firm Income Taxes and Transfer Pricing

35. 11-35 Action Tax Impact Action Tax Impact U.S. subsidiary sells component35% tax rate to external company at $200 each.$200 revenue – $200 cost = $0 Taxes paid = $0 Transfer Pricing and the Multinational Firm Income Taxes and Transfer Pricing

36. 11-36 Transfer Pricing and the Multinational Firm Income Taxes and Transfer Pricing Division B (in the United States) of ABC, Inc., purchases a component from Division C (in Canada). The component can be purchased eternally for $38. The freight and insurance on the item amount to $5; however, commissions of $3.80 need not be paid. Market price$38.00 Plus: Freight and insurance5.00 Less: Commissions -3.80 Transfer price$39.20

37. 11-37 Transfer Pricing and the Multinational Firm Income Taxes and Transfer Pricing If there is no outside market for the component that Division C transfers to Division B, the resale price method is used. If Division B sells the component for $42 and normally receives a 40 percent markup on cost of goods sold, then the transfer price is calculated as follows: Resale price = Transfer price +.40 Transfer price $42= 1.40 x Transfer price Transfer price= $42/1.40 = $30

38. 11-38 Questions to Ask Concerning Ethics in the International Environment Is the action right legally? Is the action right morally?

39. 11-39 Chapter End of

40. 11-40