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

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International International Issues in Cost Issues in Cost ManagementManagement

Prepared by Douglas Cloud

Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

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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.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

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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.

ObjectivesObjectivesObjectivesObjectives

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Where does the management accountant

fit into the global business environment?

Where does the management accountant

fit into the global business environment?

Business looks to the management accountant

for international financial and business expertise.

Business looks to the management accountant

for international financial and business expertise.

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Management Accounting in the International Environment

Skills needed by cost accountantsSkills needed by cost accountants

Politics Economics Marketing Management Information systems

technology

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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.”

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Importing and ExportingImporting and ExportingImporting and ExportingImporting 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.

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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 ZonesForeign Trade ZonesForeign Trade ZonesForeign Trade Zones

Example:

San Antonio

Example:

New Orleans

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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.

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Roadrunner Wilycoyote

Duty paid at purchase $ 0 $24,000Carrying costs of duty 0 1,920

Wilycoyote Wilycoyote pays duty at pays duty at the point of the point of

purchase (6% purchase (6% of $400,000).of $400,000).

Total duty-Total duty-related related

carrying costs carrying costs (0.12 x 8/12 x (0.12 x 8/12 x

$24,000)$24,000)

Duty paid at sale 16,800 0

Roadrunner pays Roadrunner pays duty at point of sale duty at point of sale

because it is in a because it is in a foreign trade zone.foreign trade zone.

Example (continued)

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Roadrunner Wilycoyote

Duty paid at purchase $ 0 $24,000Carrying costs of duty 0 1,920Duty paid at sale 16,800 0

Example (continued)

Total duty and duty- related costs $16,800 $25,920

Clearly the Clearly the advantage advantage approachapproach

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A company may choose to purchase an existing foreign company, making

the purchased company a wholly owned subsidiary.

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.

If the laws of the country permit, a multinational corporation can simply set up a wholly owned subsidiary or

branch office in the country.

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Outsourcing of technical and professional jobs is becoming

an important issue for resource-conscious U.S. firms.

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.

Outsourcing is the payment by a company for a business

function formerly done in-house, such as payment for legal needs to outside firms.

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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.

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Foreign Currency ExchangeForeign Currency Exchange

Currency risk management

Transaction risk

Economic risk

Translation (accounting ) risk

Kinds of risks:

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A Transaction Risk ExampleA 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

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A Transaction Risk ExampleA 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

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HedgingHedging

One way of ensuring against gains and losses on foreign currency exchanges is hedging.

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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

HedgingHedging

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Economic risk is the impact of exchange rate fluctuations on the present

value of a firm’s future cash flows.

Managing Economic RiskManaging Economic RiskManaging Economic RiskManaging 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.

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Managing Transaction RiskManaging Transaction RiskManaging Transaction RiskManaging 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

1 LC 100,0002 LC 110,0003 LC 121,0004 LC 133,100

A 10% increase

each quarter

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Managing Transaction RiskManaging Transaction RiskManaging Transaction RiskManaging 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 $100,0002 91,6673 89,6304 88,733

It looks like FD has decreased expenditures.

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Advantages of DecentralizationAdvantages of Decentralizationin the MNCin the MNC

Advantages of DecentralizationAdvantages of Decentralizationin the MNCin 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.

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Measuring Performance in Measuring Performance in the Multinational Firmthe Multinational Firm

Measuring Performance in Measuring Performance in the Multinational Firmthe 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.

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Environmental Variables Facing Environmental Variables Facing Local Managers of DivisionsLocal Managers of Divisions


Economic

Inflation Foreign currency

exchange rates Income taxes Transfer prices

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Legal and Political

Country may not allow cash outflows

Country may forbid the import of certain items

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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

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An example of misleading results:

Assets Revenues Net Income Margin Turnover ROI

Brazil $10 $ 6 $ 3 0.50 0.600.30

Canada 18 13 10 0.77 0.720.56

Spain 15 10 6 0.60 0.670.40Analysis: 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 ROIComparison of Divisional ROIComparison of Divisional ROIComparison 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.

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Other Factors Affecting Other Factors Affecting Performance EvaluationPerformance EvaluationOther Factors Affecting Other Factors Affecting Performance EvaluationPerformance 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.

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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



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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



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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



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Action Tax Impact Action Tax Impact

Belgian subsidiary of Parent 42% tax rateCompany produces a component $100 revenue – $100 at a cost of $100 per unit. Title to cost = $0the component is transferred to a Taxes paid = $0reinvoicing center in Puerto Ricoat a transfer price of $100 per unit.

Transfer Pricing and the Transfer Pricing and the Multinational FirmMultinational Firm


Income Taxes and Transfer PricingIncome Taxes and Transfer Pricing

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Reinvoicing center in Puerto Rico, 0% tax ratealso a subsidiary of Parent Company, $200 revenue – $100 transfers title of component to U.S. cost = $100subsidiary of Parent Company at a Taxes paid = $0transfer price of $200 per unit.




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U.S. subsidiary sells component 35% tax rateto external company at $200 each. $200 revenue – $200

cost = $0Taxes paid = $0




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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 $38.00Plus: Freight and insurance 5.00Less: Commissions -3.80 Transfer price $39.20

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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

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Questions to Ask Concerning Ethics in the International Environment

Questions to Ask Concerning Ethics in the International Environment

Is the action right legally?

Is the action right morally?

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ChapteChapterr

End ofEnd of

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Documents

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