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To examine the major factors influencing the development of accounting practices in
different countries and the worldwide convergence of accounting standards
To explain how companies account for foreign-currency transactions and translate
foreign-currency financial statements
To illustrate how companies issue environmental reports
To discuss different forms of performance evaluation of foreign operations and how
foreign exchange can complicate the budget process
To explain how arbitrary transfer pricing can complicate performance evaluation and
To introduce the balanced scorecard as an approach to evaluating performance
Chapter Overview
The international accounting and taxation functions comprise great challenges for todays
global business managers. Chapter Eighteen presents the ey accounting and taxation
issues confronting firms that do business abroad. !irst" the chapter examines the ways in
which national accounting systems differ and how todays global capital marets force
countries to consider the harmoni#ation of their accounting and reporting standards. $t
then explores a number of uni%ue issues &'Es face" such as the valuation and translation
of transactions and assets that are denominated in foreign currencies. The chapter
concludes with an examination of the impact of transfer pricing on business unit
performance evaluation and an explanation of the balanced scorecard approach to
performance evaluation.
Chapter Outline
OPENING CASE Par!alat"Eur#pe$s Enr#n
This case gives an overview of the accounting manipulations that were at the center of
one of Europes most massive corporate scandals. (armalat" which started as a family
owned $talian dairy company" grew into large multinational with over )*"+++ employees.
$n the ,--+s" (armalat was reporting healthy profits that turned out to actually be created
by accounting fraud rather than real operations. The fraudulent practices included double
billing of $talian supermarets and other retailers" .off-balance sheet financing/ that
involved the creation of three phony shell companies based in the Caribbean" and the
issuance of bonds baced up by falsified assets. The schemes allowed the company to
report profits every year between ,--+ and *++)" even though the company should have
reported operating losses for each of these years. The fraud was discovered when the
companys auditor discovered that a ban account reported by the company did not exist.
!urther investigations revealed the full extent of the fraud. The CE1 resigned" was
arrested" and was sent to prison. The company filed for banruptcy" and a flood of
lawsuits have been filed against the company" its former management" and auditors.
Teachin% Tip 2eview the (ower(oint slides for Chapter Eighteen and select those
you find most useful for enhancing your lecture and class discussion. !or additional
visual summaries of ey chapter points" also review the map" figures" and tables in
the text.
$nternational business managers cannot mae informed decisions without relevant
and reliable accounting and taxation information. 3hile the financial manager of any
firm is responsible for procuring and managing the companys financial resources"
todays corporate controller 4accountant5 is responsible for providing information to
the firms financial decision maers" and to a wide variety of other staeholders as
6ccounting origins and traditions are as individual as the languages of the nations
that produce them. 6s a result" financial statements in different countries appear
different from each other both in form 4format5 and in content 4substance5. 3hile
some people argue differences in format are a minor problem" the fact that
companies can value assets and determine income differently in different countries is
not. Countries doing business in multiple countries must often produce financial
statement using the standards of the countries in which they operate. !or example"
foreign companies operating in the 7nited 8tates usually issue financial statements
according to 7.8. generally accepted accounting principles (GAAP).
A' Acc#untin% Objectives [See Figure 18.4]
Accounting is defined as a service activity whose function is to provide
%uantitative information" primarily financial in nature" which will be useful in
maing strategic decisions and reasoned choices among alternative courses of
action. $t is crucial that the accounting process identify" record" and interpret
economic events. The private sector body that establishes financial accounting
standards in the 7nited 8tates is the Financial Accounting Standards Board
(FASB). The !689 states that the external reporting of accounting information
should help investors 4i5 mae investment and credit decisions" 4ii5 assess cash
flow prospects and 4iii5 evaluate enterprise resources. The international private-
sector organi#ation that sets financial accounting standards for worldwide use is
the International Accounting Standards Board (IASB). The $689 and its
predecessor" the International Accounting Standards Committee (IASC),
identified the following ey users of accounting information: investors"
employees" lenders" suppliers and other trade creditors" customers" governments
and their agencies" and the public. 3hile e%uity marets are an important
influence on accounting standards in the 7nited 8tates and the 7nited <ingdom"
bans are influential in 8wit#erland and =ermany" and taxation is a major
influence in !rance and >apan. ?ifferences in accounting practices around the
world have resulted in a move toward convergence@the process of bringing
different nationally generally accepted accounting principles into line with
$nternational 6ccounting 8tandards issued by the $689.
B. Cultural &i,,erences in Acc#untin% [See Figure 18.5]
Culture influences both measurement practices 4how firms value assets5 and
disclosure practices 4how and what information firms provide and discuss5.
!rom an accounting standpoint" secrecy and transparency refer to the degree to
which corporations disclose information to the public. 1ptimism and
conservatism refer to the degree of caution that companies exhibit in valuing
assets and recogni#ing income. 6nglo-8axon countries such as the 7nited
<ingdom and the 7nited 8tates have accounting systems that tend to be
transparent and optimistic" while =ermanic countries" among others" tend to be
secretive and conservative.
C. Classi,icati#n #, Acc#untin% S-ste!s [See Figure 18.6]
6lthough accounting standards and practices vary worldwide" systems can
nonetheless be classified according to common characteristics. 3hile macro-
uniform accounting systems are shaped more by government influences 4strong"
codified" tax-based legal systems5" micro-based accounting systems rely on
pragmatic business practices. 9ecause &'Es must adjust to different accounting
systems on a worldwide basis" the international accounting function becomes
increasingly complex and costly. !inancial statements differ from one country to
another in six major ways: 4i5 language" 4ii5 currency" 4iii5 the type of statement
4income" statement" balance sheet" etc.5" 4iv5 the financial statement format" 4v5
the extent of footnote disclosures and 4vi5 the underlying =66(s on which
financial statements are based. !irms must deal with all six issues. &ajor
approaches to dealing with accounting and reporting differences include mutual
recognition 4a foreign registrant need only provide information prepared
according to the =66(s of the home country5" reconciliation to the local
=66(s 4a foreign registrant reconciles its home-country financial statement
with the local =66(s5" and recasting financial statements in terms of local
=66(s. 6 !orm *+-! is the document used to recast financial statements in the
7nited 8tates.
&' Internati#nal Acc#untin% an. Gl#bal C#nver%ence
!orces encouraging the harmoni#ation of national accounting standards include:
investor orientation" the global integration of capital marets" the need for
&'Es to raise foreign capital" regional economic integration and the pressure
from &'Es to reduce their accounting and reporting costs. The most ambitious
regional harmoni#ation efforts are occurring in the E7" which promotes" among
other things" the free flow of capital and the adoption of the $nternational
6ccounting 8tandards as set forth by the $689 by *++A. The ey turning point
in the significance of the IAS standards came in ,--A when the International
Organiation o! Securities Commissions (IOSCO) announced it would
endorse $68C core standards if a set were developed that both organi#ations
could agree upon. 6nother major factor affecting the harmoni#ation of
accounting standards worldwide was the reorgani#ation of the $68C in *+++.
Trustees for the $68C foundation searched for and appointed members of the
$689" representing all areas of the world" in *++,. 3hen the $689 was
organi#ed" all of the old $nternational 6ccounting 8tandards were adopted" and
the board began to issue new standards called International Financial
"eporting Standards (IF"S). The $689 has expanded its influence and
effectiveness due to the decision of the E7" 6ustralia" and 'ew Cealand to
re%uire all of their publicly listed companies to adopt $!28 and the decision of
the !689 and $689 to adopt a process of convergence of accounting standards.
+ill IAS0 GAAP 0ec#!e the Gl#bal Acc#untin%
3ith the adoption of $!28s by the E7" 6ustralia and 'ew Cealand" nearly ,++ countries
in six continents will be re%uiring or permitting the use of $!28s for some or all domestic
listed companies. $689 =66( is being set by most of the major countries in the world
and is the product of a great deal of negotiation" compromise" and broad-based input. 6s
of *++;" companies listing on European exchanges are re%uired to follow $689 =66(.
The convergence project between !689 and $689 has led to a process where new
standards are written by both bodies together using the same wording. 6t some point"
there will be virtually no difference between 7.8. =66( and $689 =66(.
$n addition to minimi#ing or eliminating foreign-exchange ris" firms must concern
themselves with the proper recording and subse%uent accounting of transactions
resulting from the purchase or sale of products and the borrowing or lending of
foreign currency.
A' #, Transacti#ns
3hen accounting for assets" liabilities" revenues and expenses" foreign-currency
receivables and payables result in gains and losses whenever the relevant
exchange rate changes. 8uch transaction gains and losses must be included on
the income statement in the accounting period in which they arise.
0' C#rrect Pr#ce.ures ,#r U'S' C#!panies
The !inancial 6ccounting 8tandards 9oard 8tatement 4!6895 'o. A* re%uires
7.8. firms to report foreign-currency transactions at the original spot exchange
rate in effect on the initial transaction date and to report receivables and
payables at the subse%uent balance sheet date at the spot exchange rate on those
dates. 6ny foreign-exchange gains and losses associated with carrying
receivables or payables are taen directly to the income statement. (ractices
vary in other countries" although the $689 procedure is somewhat similar to that
of the 7nited 8tates" except that it permits a firm to increase the value of an
asset by the amount of foreign-exchange loss and then write it off over the
useful life of the asset as part of the depreciation charge.
6n &'E must eventually develop one set of financial statements in its home-country
currency. #ranslation involves the process of restating foreign-currency financial
statements" and consolidation is the process of combining the translated financial
statements of a parent and its subsidiaries into a single set. $n the 7nited 8tates"
translation is a two-step process: first" statements are recast according to 7.8.
=66(sD then all foreign currency amounts are translated into 7.8. dollars.
A' Translati#n *eth#.s
!689 'o. A* allows firms to use either of two methods when translating
foreign-currency financial statements into dollars. The method the firm chooses
depends on the !unctional currency of the foreign operation" which is the
currency of the primary economic environment in which the entity operates. $f
the functional currency is that of the local operating environment" the firm must
use the current rate met$od, which provides that all assets and liabilities be
translated at the current exchange rate 4the spot exchange rate on the balance
sheet date5. 6ll income statement items are translated at the average exchange
rate" and owners e%uity is translated at the rates in effect when the firm issued
capital stoc and accumulated retained earnings. $f the functional currency is the
parents currency" then the firm must use the temporal met$od, which provides
that only monetary assets such as cash" maretable securities and receivables
and liabilities be translated at the current exchange rate. $nventory and property"
plant and e%uipment are all translated at the historical exchange rates in effect
when the assets were ac%uired. $n general" income statement accounts are
translated at the average exchange rate" but cost of goods sold and depreciation
expenses are reported at the appropriate historical exchange rates 4not an
average for the period5.
0' &iscl#sure #, (#rei%n2E4chan%e Gains an. L#sses
7nder the current-rate method of translating foreign-currency financial
statements" the gain or loss is called an accumulated translation adjustment and
is recogni#ed in owners e%uity. 7nder the temporal method" the gain or loss is
taen directly to the income statement" thus affecting earnings per share.
Environmental reports vary from firm to firm and country to country because they
provide voluntary information. These reports identify the impact of the firm on the
environment" focusing especially on the use of natural resources and efforts to
recycle waste. Typically" the environmental report is separate from the annual report
and is not part of the financial statements or footnotes.
?ifferent measures are used to evaluate performance of foreign operations" including
21$" sales" cost reduction" %uality targets" maret share" profitability" and budget to
A' (#rei%n E4chan%e in the 0u.%et Pr#cess
6 complicating factor for &'Es is setting targets or budgets in different
currencies. 9udgets are usually either set in the head%uarters countrys currency
and translated into local currency" or set in local currency and translated to
head%uarters currency. 8ince currency values will liely change during the
budgeting period" companies need to consider the actual exchange rate at time of
budget" the projected end of period exchange rate at time of budget" and the
actual exchange rate at the end of the budget period. 6lthough companies rely
on all of these" the most fre%uently relied on seems to be the projected end of
period exchange rate at time of budget.
0' 0u.%etin% an. Currenc- Practices
!ewer than half of the firms surveyed in one study judged subsidiary
performance in terms of translated dollar amounts. 6nother study found that a
significant number of firms in the sample used both dollar and local currency
budgets compared to actual profits and actual sales.
POINT2COUNTERPOINT Sh#ul. L#cal Subsi.iar- *ana%e!ent 0e Hel.
Resp#nsible ,#r E4chan%e Rate Chan%es1
POINT: Eocal subsidiary management must be held responsible for exchange rate
changes since they are best able to forecast the future value of the local currency. The
criticism that the local subsidiary cannot control currency fluctuations could be applied to
many other factors they are usually responsible for but are also out of their direct control
such as competitive pressures" supplier relationships" and labor relations. Earnings
forecasts must be consolidated at head%uarters in the head%uarters countrys currency"
therefore each subsidiary must be responsible for contributing to that forecast in the
head%uarters countrys currency be held accountable for the impact of fluctuations in
currency values.
COUNTERPOINT: $t is unrealistic to expect local management to forecast exchange
rates in the future since those rates are driven by factors such as inflation" interest rates"
trade balances" foreign currency reserves" political stability" government policies" and
other factors entirely out of the control of local subsidiaries. $f local management cannot
accurately predict future values of local currency" how can they be expected to meet
foreign currency based earnings or profitability targetsF 6ll evaluation of local
management should be done in local currency" independent of international currency
exchange rates.
#rans!er pricing refers to prices of goods and services that are bought and sold
4transferred5 between members of a corporate family. $nternational transfer prices
may be set with little consideration for maret prices or production costs due to tax
policies" competitive purposes" to avoid dumping regulations" to lessen the impact of
national controls" to lower the apparent profitability of a subsidiary" and a host of
other reasons 4see Table ,B.B5.
The %alanced scorecard (BSC) is an approach to performance measurement that
closely lins the strategic and financial perspectives of a business. $t provides a
framewor to loo at the strategies giving rise to value creation from the following
perspectives: 4i5 financial" 4ii5 customer" 4iii5 internal business processes" and 4iv5
learning and growth. 6 firms 98C is a proprietary strategic tool and is generally not
available to the public. $t offers the advantages of logically connecting financial
performance with its nonfinancial drivers" but can be a challenge to create. $n some
companies" the 98C concept has been refined into a strategic management system
that replaces the traditional focus on the budget as the center for the management
Teachin% Tip Gisit &&&.pren$'daniels for additional information and
lins relating to the topics presented in Chapter Eighteen. 9e sure to refer your
students to the online study guide" as well as the $nternet exercises for Chapter
CLOSING CASE )iven.i Universal [See Tables 18.918.11]
Givendi 7niversal is a !rench-based global communications giant with diverse products in many countries
throughout the world. The companys Canal H =roup is the leader in digital and pay-TG in !rance and has
the worlds third largest film library. 7niversal &usic =roup is another division of Givendi and is the
worlds largest music company" selling about one out of every four albums worldwide. Givendi 7niversal
=ames is a global developer" publisher" and distributor of interactive entertainment including popular
games such as 3arcraft. The company also has a significant communications component with both fixed-
line and mobile offerings. The diversity of operations and their geographic scope creates accounting
challenges for the company. Changing accounting standards have also posed challenges for the company in
modifying its accounting practices.
I'ote: information pertinent to this case is embedded throughout the chapter.J
1. Based on this short description, do you agree with Vivendi niversal!s ac"uisition
and diversification strategy#
$t would be useful to see the mission statement that drove Givendis ac%uisition and
diversification strategy. !irms the world over choose to expand via diversification in
order to offset economic fluctuations and the unpredictable dynamics of the
consumer maretplace. 8ome choose to so by moving into an attractive industry and
seeing specific opportunities thereD others will choose to ac%uire an attractive firm
4or series of firms5 and by default expand into the industry represented. Givendis
expansion into the communications and media area seems to have been carefully
planned and executedD its holdings cover the breadth of the industry" and each entity
is a major player in its respective maret. 3hether Givendis move away from
environmental services and into communications was deliberate or opportunistic is
not nown. Kowever" while Givendi Environment contributes substantial strength
and stability to the firm" there appears to be little synergy between the two clusters.
$. Since Vivendi niversal listed its shares on the %ew &or' Stoc' (xchange, why didn!t
it just adopt .S. )AA* as Seagrams did or as +aimler,hrysler does#
Givendi" as a company of !rench origins" needed to continue to comply with the
more rigid !rench accounting system. &ore specifically" differences between the
7.8. =66( and !rench accounting systems re%uire different accounting for
proportional ownership" the recoding of certain transactions" and differences in the
adjustments column.
-. As Vivendi niversal .egan to adopt I/0S, the differences .etween its financial
statements and .S. )AA* financial statements narrowed significantly. 1hy is that
the case#
This is due to the ongoing convergence between 7.8. =66( and $!28. $!28 is
closer to 7.8. =66( than to !rench =66(" which Givendi had been using
2. 1hat challenges face (uropean companies that move from their own )AA* to
I/0S# 1hat challenges do these moves create for Vivendi niversal!s investors in
/rance and a.road#
The major challenge is in understanding how the changes in standards impact the
actual business operations of the companies to which they apply. Even though no
substantive changes may have occurred in the operation of a given firm" statements
of profitability" asset levels" debt levels" and other factors can vary dramatically as
different accounting standards are adopted. This presents challenges for the
evaluation of subsidiary performance" as well as complicating issues of valuation for
investors. !or Givendi 7niversals investors in both !rance and abroad" the major
issue becomes the comparability of financial statements. $t will be challenging for
investors to compare current and future results with past results within the company"
but hopefully comparability of Givendis financial statements with those of other
companies around the world will become easier as accounting systems converge.
accounting" p. 0)-
=enerally accepted accounting
principles 4=66(5" p. 0)-
!inancial 6ccounting 8tandards
9oard 4!6895" p. 0)-
$nternational 6ccounting 8tandards
9oard 4$6895" p. 0)-
$nternational 6ccounting 8tandards
Committee 4$68C5" p. 0)-
convergence" p. 0M+
culture" p. 0M*
mutual recognition" p. 0MA
$nternational 1rgani#ation of
8ecurities Commissions
4$18C15" p. 0M0
$nternational !inancial 2eporting
8tandards 4$!285" p. 0M;
current-rate method" p. 0A,
translation" p. 0A,
consolidation" p. 0A,
temporal method" p. 0A,
functional currency" p. 0A,
transfer pricing" p. 0A;
balanced scorecard" p. 0A-
A&&ITIONAL E6ERCISES *ultinati#nal Acc#untin%
()ercise *+.*. 6s the students to find the financial statements of a company
head%uartered in Europe and one head%uartered in the 7nited 8tates. 6re these
statements comparableF 3hat are the major differences in accounting standards that
one might want to be aware of when trying to compare the financial results as
reported by these two companiesF
()ercise *+.,. Kave students loo at Coca-Colas most recent financial statements.
3hat impact do currency fluctuations have on Coca-Colas business resultsF 6re
there any notes in the financial statements that explain the handling andNor impact of
currency fluctuations on reported resultsF
()ercise *+.-. &any transition economies such as China" 2ussia" and the former
8oviet satellite nations have not only different accounting standards from those
found in 3est Europe" 'orth 6merica" and >apan" but their accounting systems are
seriously underdeveloped" given the dynamics of todays global business
environment. 6s the students to discuss the logic of those countries adopting the
International Accounting Standards as the basis of their national business accounting