International Business 8e

By Charles W.L. Hill

Chapter 19

Accounting inthe International

Business

Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

19-3

What Is Accounting?

Accounting is the language of business – it is the way firms communicate their financial positions

Accounting is more complex for international firms because of differences in accounting standards from country to countrydifferences make it difficult for investors, creditors, and

governments to evaluate firms The International Accounting Standards Board

(IASB) has made some attempts to establish common accounting and auditing standards across countries

19-4

How Is Accounting Information Used?

Accounting Information and Capital Flows

19-5

Why Do Countries Use Different Accounting Systems?A country’s accounting system evolves in response

to local demands for accounting informationOne study found that among 22 countries, there were

76 ways to assess the cost of goods sold, 65 differences in the calculation of return on assets, and 20 ways to calculate net profits

The differences make it challenging to compare financial performance of firms from different countries

While there have been efforts to harmonize accounting practices across countries, significant differences remain

19-6

What Determines National Accounting Standards?

Five main variables influence the development of a country’s accounting system

1. The relationship between business and the providers of capital

2. Political and economic ties with other countries

3. The level of inflation

4. The level of a country’s economic development

5. The prevailing culture in a country

19-7

What Determines National Accounting Standards?

Determinants of National Accounting Standards

19-8

How Do Providers Of Capital Influence Accounting?

The three main external sources of capital for firms are individual investors banks government

A country’s accounting system reflects the relative importance of each constituency as a provider of capital accounting systems in the 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

19-9

How Do Political And Economic Ties Influence Accounting?

Similarities in accounting systems across countries can reflect political or economic tiesthe U.S. accounting system influences the

systems in Canada and Mexicoin the European Union, countries are moving

toward common standardsthe British system of accounting is used by

many former colonies

19-10

How Does Inflation Influence Accounting?

The historic cost principal assumes the currency unit used to report financial results is not losing its value due to inflationaffects asset valuation

if inflation is high, assets will be undervalued

19-11

How Do Levels of Development Influence Accounting?

Developed nations tend to have more sophisticated accounting systems than developing countrieslarger, more complex firms create accounting

challengesproviders of capital require detailed reports

Many developing nations have accounting systems that were inherited from former colonial powers lack of trained accountants

19-12

How Does Culture Influence Accounting?

Uncertainty avoidance - the extent to which cultures socialize their members to accept ambiguous situations and tolerate uncertainty - impacts the country’s accounting systemcountries with low uncertainty avoidance

cultures have strong independent auditing professions

19-13

What Are Accounting And Auditing Standards?

Accounting standards are rules for preparing financial statementsthey define useful accounting information

Auditing standards specify the rules for performing an auditthe technical process by which an independent person

gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable

It is difficult to compare financial reports from country to country because of national differences in accounting and auditing standards

19-14

Why Are International Accounting Standards Important?The growth of transnational financing and

transnational investment has created a need for transnational financial reportingmany companies obtain capital from foreign providers

who are demanding greater consistencyThe International Accounting Standards Board

(IASB) is a major proponent of standardization of accounting standardscommon accounting standards will facilitate the

development of global capital marketsmost IASB standards are consistent with standards

already in place in the United States

19-15

Why Are International Accounting Standards Important?About 100 nations have adopted IASB

standards or permitted their use in reporting financial resultsthe EU has mandated harmonization of

accounting principles for membersBy 2010, there could be only two major

accounting bodies with substantial influence on global reporting – FASB in the United States and IASB elsewhere

19-16

What Is A Consolidated Financial Statement?

A 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 really one used by multinational firms

Transactions among members of a corporate family are not included in consolidated financial statements they are recorded in separate statements

The IASB requires firms to prepare consolidated financial statements, as do most industrialized nations

19-17

How Do MNCs Handle Currency Translation?

Foreign subsidiaries usually keep accounting records and prepare financial statements in the local currency

To prepare consolidated financial statements, all local financial statements must be converted to the home currency

There are two methods to determine what exchange rate should be used when translating financial statement currencies

1. The current rate method2. The temporal method

19-18

What Is The Current Rate Method?

Under the current rate method, the 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 firmcan present a misleading picture of the financial

situationmethod is incompatible with the historic cost

principle

19-19

What is The Temporal Method?

The temporal method translates assets valued in a foreign currency into the home currency using the exchange rate that exists when assets are purchasedavoids the problems associated with the

current rate methodis still problematic because different exchange

rates are used to translate foreign assets

19-20

What System Do U.S. Firms Use?

U.S. multinationals are required to follow FASB 52 which statesthe 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

19-21

How Does Accounting Influence Control Systems?

The 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

19-22

How Do Exchange Rates Influence Control?

Budgets and performance data are usually expressed in the corporate currency-normally the home currency facilitates comparisons between subsidiaries but, can create distortions in financial statements

Donald Lessard and Peter Lorange - firms can deal with the problems of exchange rates and control in three ways

1. The initial rate - the spot exchange rate when the budget is adopted

2. The projected rate - the spot exchange rate forecast for the end of the budget picture

3. The ending rate - the spot exchange rate when the budget and performance are being compared

19-23

What Is The Lessard-Lorange Model?

Possible Combinations of Exchange Rates in the Control Process

19-24

How Does Transfer Pricing Influence Control?

The price at which goods and services are transferred within the firm is the transfer price

Transfer prices can be manipulated tominimize tax liabilityminimize import dutiesavoid government restrictions on capital flows

19-25

Why Separate Subsidiary and Managerial Performance?

Subsidiaries operate in different environments which influence profitability

So, the evaluation of a subsidiary should be kept separate from the evaluation of its manager

A manager’s evaluation should consider the country’s environment for business, and should take place after making allowances for those items over which managers have no control

19-26

Review Question

_______ has an accounting system that was

developed with the government in mind.

a) France

b) Japan

c) Great Britain

d) Germany

19-27

Review Question

Which organization is responsible for formulating

international accounting standards?

a) the Global Federation of Accountants

b) the World Bank

c) the International Accounting Standards Board

d) the International Panel of Accounting Standards and Ethics

19-28

Review Question

By 2010, which two accounting bodies are expectedto dominate accounting practices?

a) The historic cost principle and FSABb) FSAB and the IASBc) The IASB and the historic cost principled) The current rate method and the historic cost

principle

19-29

Review Question

When a firm uses the exchange rate at thebalance sheet date to translate financial statementsof a foreign subsidiary into the home currency, thefirm is using

a) the temporal methodb) the current rate methodc) FASB 52d) the historic cost principle

19-30

Review Question

Financial statements of U.S. firms must be

prepared according to

a) FASB

b) IASB

c) IFAC

d) EUAC