CHAPTER 18
INTERNATIONAL ISSUES IN
MANAGEMENT ACCOUNTING
QUESTIONS FOR WRITING AND DISCUSSION
1. Differences among countries in terms of the
political, legal, and cultural environment can
all affect the firm. The management accoun-
tant may find that practices that work well in
the home country do not work as well (or at
all) in other countries. It is necessary for the
management accountant to be aware of all
facets of business and to be knowledgeable
and creative in applying accounting con-
cepts in various business environments.
2. A foreign trade zone is an area that is physi-
cally on U.S. soil but is considered to be
outside U.S. commerce. As a result, goods
imported into a foreign trade zone are free of
tariff or duty until they leave the zone.
Therefore, companies located in a foreign
trade zone can postpone payment of tariff
and the associated loss of working capital.
Additionally, the company does not pay duty
on defective materials or inventory that has
not been included in the finished product.
3. Outsourcing is the payment by a company
for a business function that was formerly
done in-house. In an international context,
outsourcing refers to the location of busi-
ness functions in another country. Frequent-
ly, the work outsourced is to a lower-wage
country. The company receives a compara-
ble quality of work but at a lower cost.
4. Joint ventures are partnerships between two
or more companies. The enterprise is co-
owned. A company may find joint ventures
advantageous when another company has
expertise that the first company lacks. In ad-
dition, restrictions by certain countries on
foreign ownership of business may mean
that a joint venture is the only avenue open
to a company wishing to expand into the
foreign country.
5. Maquiladoras are manufacturing plants lo-
cated in Mexico that process imported mate-
rials and reexport them to the United States.
Maquiladoras are exempt from Mexican
laws governing ownership, and the U.S.
government grants exemptions from or re-
ductions in custom duties levied on reex-
613
ported goods. Many U.S. firms have em-
braced the maquiladora because of the low-
cost labor, the flexible ownership structure,
and the opportunity to locate close to an in-
creasingly important Mexican market.
6. The exchange rate is the amount for which
one currency can be traded for another. The
spot rate is the exchange rate in effect at the
current time. There are also future exchange
rates, which describe the rates in effect for
future delivery.
7. These three types of risk relate to the impact
on the firm of changing exchange rates.
Transaction risk refers to the possibility that
future cash transactions will be affected by
changing exchange rates. Economic risk re-
fers to the possibility that a firm’s present
value of future cash flows can be affected by
exchange fluctuations. Translation risk is the
degree to which a firm’s financial statements
are exposed to exchange rate fluctuations.
8. Currency appreciation means that the home
country’s currency strengthens against anoth-
er currency. In other words, one unit of the
home currency purchases more units of
another currency than it did previously. Cur-
rency appreciation makes the products of a
foreign country cheaper than before, and
thus, it is easier for a company in the home
country to import goods.
9. Currency appreciation makes the home
country currency more expensive to foreign
customers, thereby making the products of
the home country firm more expensive than
they were before. For example, if the ex-
change rate is one home country unit to one
foreign country unit and the currency appre-
ciates, then the exchange rate might be-
come one home country unit to two foreign
units. That is, the home country unit buys
more foreign currency as it appreciates. Put
differently, the foreign currency buys less as
the home country currency appreciates.
10. If Mexico devalues the peso, a dollar will buy
relatively more pesos, making the cost of
 Mexican labor cheaper. As the controller,
you will revise your estimates of labor costs
in the maquiladora downward. The proposed
12.
new production facility will be more attrac-
tive.
As a local labor union leader, you would be
displeased by the potential devaluation. If
Mexican wages go down relative to U.S.
wages, Mexican labor will be relatively more
attractive, and more jobs may be outsourced
13.
to Mexico.
11. Hedging is a way of insuring against gains
and losses on foreign currency exchange.
The company that imports the material may
14.
be afraid that the exchange rate will change
in 90 days and that the home currency will
weaken against the foreign currency. In that
case, the company may hedge by purchas-
ing a forward contract for the foreign curren-
cy, thereby locking in the exchange rate and
614
insuring against adverse exchange rate fluc-
tuations.
Disagree. The manager of a subsidiary
should not be evaluated on the basis of fac-
tors over which he or she has no control.
These factors may include transfer prices,
currency fluctuations, local taxes, and so on.
The subsidiary manager should be eva-
luated on the basis of revenues and costs.
Environmental factors that may affect the
performance of divisional managers include
economic, legal, political, social, and educa-
tional variables.
Internal Revenue Code Section 482 outlines
the transfer pricing methods acceptable for
income tax purposes. The four acceptable
methods are the comparable uncontrolled
price method, the resale price method, the
cost-plus method, and any method jointly
acceptable to the IRS and the company.
 EXERCISES

18–1

Your friend will take the traditional accounting and business courses required for
a major in accounting. Naturally, these would include international business
courses, such as international accounting and international finance. In addition,
she/he would be well advised to take classes relating to other cultures, including
history, philosophy, literature, and foreign language(s). No individual class is crit-
ical; instead, it is the sum of the classes that is important. In other words, your
friend will learn a little about other countries in each class. Over time, that little bit
will add up, giving your friend the background to understand business practices
overseas and to fit business transactions into a cultural context.

Suppose your friend is just about to graduate and cannot afford to spend more
time in college? Then she/he should do what all management accountants need
to do—stay up to date by reading books and articles in a variety of international
business areas, including information systems, marketing, management, politics,
and economics.

Note to Instructors: Your students may want to read Daniel M. Hrisak’s “Global
Challenges Call for More CMAs and CFMs,” Strategic Finance (June 2001): pp.
44–49.

18–2

1. e 4. c
2. b 5. a
3. d

18–3

1. e 4. b
2. c 5. a
3. d

615
18–4

1. $14,200,000 × 0.30 = $4,260,000

2. $4,260,000 × 9/12 × 0.10 = $319,500

18–5

1. $14,200,000 × 0.85 × 0.30 = $3,621,000

2. Savings = ($4,260,000 – $3,621,000) + $319,500

= $639,000 + $319,500 = $958,500

18–6

Tariff savings = ($3,750,000 × 0.06 × 0.25) = $56,250 per year

Because broken items will never be sold outside the foreign trade zone, Bulwar
will not owe a tariff on them.

18–7

1. 70,100 pesos/10.9 = $6,431

2. 70,100 pesos/11.4 = $6,149

3. There is an exchange gain of $282 ($6,431 – $6,149).

616
18–8

1. 75,000/10.9 = $6,881

2. 75,000/11.4 = $6,579

3. Exchange loss = $6,881 – $6,579 = $302

4. Hedging contract = 75,000/11.1 = $6,757

Premium expense = $6,881 – $6,757 = $124

5. Net savings = $302 – $124 = $178

18–9

1. The dollar weakened against the euro (€) from June 1 to September 1. On
June 1, one dollar would buy €0.833 (1/1.20). On September 1, one dollar
would buy €0.794 (1/1.26).

2. On June 1, Basu would need $720,000 to pay for the purchase.

€600,000 × 1.20 = $720,000
On September 1, Basu would need $756,000 to pay for the purchase.
€600,000 × 1.26 = $756,000

18–10

There was an exchange loss of $36,000, calculated as follows:

Liability in dollars on June 1 $ 720,000
Payment in dollars on September 1 (756,000)
Exchange loss $ 36,000

617
18–11

1. Persephone Company engaged in a forward contract to buy Canadian dollars

for U.S. dollars. In other words, on September 30, Persephone expects to pay
120,000 Canadian dollars. Therefore, it needs to exchange U.S. dollars for Ca-
nadian dollars on September 30. The forward contract allows it to buy the
120,000 Canadian dollars at a specified forward rate of Canadian dollars for
U.S. dollars.
Had Persephone Company expected to receive Canadian dollars from the Ca-
nadian company, it would have engaged in a forward contract to sell Cana-
dian dollars on September 30 instead.

2. Because Persephone hedges all currency exchanges, the forward rate is the
applicable exchange rate. Persephone will buy 120,000 Canadian dollars on
September 30 for $92,308.
120,000/1.30 = Canadian $ 92,308

18–12

You are delighted—the dollar has appreciated and now buys more euros than it
did before. The car costs € 90,000, which translates to $107,143 at the € 0.84 to $1
rate (90,000/0.84 = $107,143). At the new exchange rate, only $102,273
(90,000/0.88) is required to purchase € 90,000. Have a good trip!

18–13

Market price $45.00

Add: Shipping, duties 12.20
Less: Marketing costs (4.50)
Transfer price $52.70

618
18–14

$80 = Cost + 0.25 Cost

$80 = 1.25 Cost
Cost = $64
Therefore, the transfer price is $64

18–15

1. Mexican division’s ROI = $150,000/$1,500,000 = 10.0%

British division’s ROI = $230,000/$2,000,000 = 11.5%

2. No, we cannot directly compare the two divisions’ ROIs without knowing
more about the cultural and environmental factors faced by each.

18–16

1. The maximum transfer price is $200, because the Singapore plant could pur-
chase the motor externally for that price.

2. The minimum transfer price is $195, because that is equal to the total variable
cost of $195.

3. The environmental factor most important to this decision is the governmental

prohibition against layoffs. This could turn direct labor into a strictly fixed
cost. This particular prohibition is a serious one.
Some Spanish plants have been virtually closed for years, yet the firms must
continue to pay the workers because the government has refused permission
to lay off the workers.

619
18–17

1. The comparable uncontrolled price method should be used because a market

price exists.

2. Market price $30.00

Add: Shipping, duties 5.05
Less: Marketing costs (4.00)
Transfer price $31.05

18–18

1. c 5. d
2. a 6. e
3. b 7. e
4. a

620
 PROBLEMS

18–19

1. a. Factors that generally determine the degree of decentralization in an or-

ganization include the following:
• Physical proximity of the organization’s divisions.
• Philosophy of top-level management to commit to delegating authority
and allowing decentralized decision making.
• Importance, materiality, time constraints, and risk level of decisions.

b. Benefits to be derived from decentralization include:

• Increased growth of the organization because decisions can be made by
more individuals closer to the operations, thus reducing pressure on
and allowing ample time for top-level management to deal with strategic
and long-range planning issues.
• More flexibility and timelier decision making in a rapidly changing envi-
ronment.

c. Disadvantages of decentralization include:

• More control features required at company headquarters to monitor di-
visions/subsidiaries.
• Loss of some control as central authority is reduced.
• Greater pressure in allocating pooled resources.
• Duplication of support functions.

2. The factory currently owned and operated by LSI in Nuevo Laredo is a maqui-
ladora. LSI is already well acquainted with the customs of doing business in
Mexico and should have relatively little difficulty expanding its operations.
The passage of the North American Free Trade Agreement makes LSI’s ex-
pansion simpler by further easing Mexican laws governing foreign ownership.
It also means that the current special U.S. customs treatment of reimported
goods would continue. In general, NAFTA creates a more hospitable envi-
ronment for U.S. companies expanding production in Mexico.

621
18–20

Alternative 1:
Advantages: This alternative involves working with a well-understood
process in a well-understood environment. Beryl is completely familiar with
the legal and social environment in Minnesota. Morale may increase because
all workers will receive the higher wages. The factory is already set up, sup-
pliers are in line, and the company knows just how long it takes to produce
the fax machines.
Disadvantages: Additional workers who are not trained in Paladin’s process
would need to be hired. Heavier use of plant facilities will wear out plant and
equipment faster. The addition of a second shift may cause labor problems
because those workers assigned to the second shift may want to work on the
more desirable first shift.

Alternative 2:
Advantages: Wages are much lower in Mexico. The burgeoning Mexican mar-
ket would provide demand for Paladin’s product. Production in Mexico would
satisfy Mexican demands for locally produced goods.
Disadvantages: Paladin has no experience in Mexico. There is considerable
uncertainty regarding the training of Mexican workers and the start-up costs
of building a new plant. Language and cultural differences may cause difficul-
ties.

Alternative 3:
Advantages: Location of a new plant in a foreign trade zone would save on
duty-related costs. There is no language difference in Dallas. The opening of
a plant in the Southwest would give Paladin easier access to markets in the
southern and southwestern United States. Wages would be lower than those
in Minnesota.
Disadvantages: The Dallas plant is a considerable distance from the Minneso-
ta plant, requiring another layer of management. Beryl may find it difficult to
run both plants herself.

622
18–21

1. Using the spot rates in effect on July 1, the following prices can be set in
francs and yen:
Swiss order: $64,000 × 1.2360 = 79,104 Swiss francs
Japanese order: $124,000 × 117.70 = 14,594,800 yen

2. On October 1, the Swiss customer should pay Custom Shutters 79,104 Swiss
francs. If the 90-day forward rate anticipated on July 1 holds, Custom Shut-
ters will receive $62,831 (79,104/1.2590).
On October 1, the Japanese customer should pay Custom Shutters
14,594,800 yen. If the 90-day forward rate anticipated on July 1 holds, Custom
Shutters will receive $124,000.
Will Lee actually receive $186,831 ($62,831 + $124,000) on October 1? We
don’t know. It depends on the exchange rates in effect on October 1. Current-
ly, it is expected that the dollar will weaken against the Swiss franc and stay
unchanged against the yen. However, this could change. If Lee is bothered by
the uncertainty, he could hedge by locking in the exchange rates now. That
would guarantee the $186,831 on October 1. He might want to do that since
the anticipated trend is steadily upward for Swiss francs and the Swiss cus-
tomer could very well pay late.

623
18–22

Your objective in meeting with the IRS representative is to demonstrate that the
$10 transfer price negotiated between the European and U.S. divisions is accept-
able under Internal Revenue Code Section 482.

Comparable uncontrolled price method:

Market price (U.S.) $14.00
Add: Landing costs 2.50
Less: Variable marketing costs (1.80)
Transfer price $14.70

Clearly, your problem is that the comparable uncontrolled price method gives a
higher transfer price than the one negotiated. The problem with the above compu-
tation, of course, is that it assumes that you can sell additional units of the com-
ponent for $14 within the United States. You can’t. If there were a buyer for addi-
tional units at $14 per unit, the U.S. division would gladly sell them. As it is, the
U.S. division has substantial excess capacity. The $10 transfer price covers all
incremental costs of production plus the landing costs. Thus, a more valuable
computation would be the following:
Negotiated transfer price $ 10.00
Less:
Variable costs of production (7.00)
Landing costs (2.50)
Profit per unit $ 0.50

You can also point out that there is a market for this component in Europe, and
that given this fact, the negotiated transfer price has the feel of an arm’s-length
transaction. That is, both the U.S. and the European divisions are acting in their
own best interests.

624
18–23

1. Comparable uncontrolled price method:

Belgium Canada
Market price $430 $430
Add: Shipping 30 25
Less: Avoidable marketing cost (40) (40)
Transfer price $420 $415

2. No, the IRS will have no problem with the $430 charged to the Belgian and
Canadian divisions. This price exceeds the comparable uncontrolled price.
One might wonder why Audio-Tech has set such a high transfer price to the
foreign divisions. The reason is that both Canada and Belgium have higher
corporate income tax rates than the United States. Therefore, Audio-Tech
wants to take as much profit as possible in the United States and as little
profit as possible in the two foreign countries. Currently, the tax departments
in Canada and Belgium have not targeted transfer pricing as an important
problem.

625
 MANAGERIAL DECISION CASES

18–24

1. Some might argue that the company has an obligation to pay no more than its
minimum legal tax. The actions taken by the company were clearly intended
to escape taxation. Avoidance of taxes is acceptable, evasion is not. And
perhaps auditors would not find anything that would signal any deviation
from the legal guidelines. After all, this had been done in the past with great
success. Nonetheless, the propriety of the actions taken by the firm is ques-
tionable. It was made quite clear that under normal operating conditions,
transfer prices were set by divisional managers. Thus, the incentive for tam-
pering with the transfer prices appears to be motivated by expected losses
for the U.S. operations. The only purpose of increasing the transfer prices
was to reduce European taxes that normally would be owed and paid. This
creates some suspicion about the ethical content of the transfer pricing deci-
sion. This suspicion is strengthened by the act of reassigning so-called legi-
timate costs to support the planned increase in transfer prices. If the costs
are really that legitimate, why were they not discovered until the prospect of
losses appeared? The behavior displayed by the top executives is not ethical.
Debbie is not directly involved in the decision but should consider whether
she wants to continue working for a company that engages in this kind of
manipulation.

2. Accountants have a responsibility to “perform professional duties in accor-

dance with relevant laws, regulations, and technical standards.” (I-2) Fur-
thermore, they have a responsibility to “abstain from engaging in or support-
ing any activity that would discredit the profession.” (III-3) Finally, they must
“disclose all relevant information that could reasonably be expected to influ-
ence an intended user’s understanding of the reports, analyses, or recom-
mendations presented.” (IV-2) One wonders how willing and how comfortable
the management and accountants responsible for the scheme would be in re-
vealing the reassignment of costs and the reasons thereof. If tax accountants
are asked to be involved in a questionable scheme, they should clearly refuse
to do so.

626
18–25

1. The price is unacceptable because it is less than the adjusted market price of
$12.00 ($10 + $2.50 – $0.50). By setting a transfer price lower than the IRS
guideline, revenues recognized in the United States are lower than they
should be, and less taxes are paid than required. The IRS could reallocate in-
come (by requiring a transfer price of $12). If the transfer price were greater
than $12, the IRS would have no concern, since the company would be paying
more taxes than expected.

2. Resale price – Cost = 0.25(Resale price)

$8.00 – Cost = 0.25($8.00)
Cost = $6.00
Thus, if the normal markup is 25 percent, the allowable cost without adjust-
ment is $6.00. Adding to this the landing cost of $1.20, the allowable transfer
price is $7.20. Thus, the price of $4.50 is certainly unacceptable as far as the
U.S. taxing authorities would be concerned. The transfer price should be in-
creased to $7.20.

3. Minimum: $6.00 + $2.00 – $1.25 = $6.75

Maximum: $12.00 (local price for the European division)
The maximum transfer price is less than the Internal Revenue Code Section
482 comparable uncontrolled price ($12.75 = $12.00 + $2.00 – $1.25). If the
joint benefit of $5.25 ($12.00 – $6.75) is split equally, the transfer price would
be $9.38 ($2.63 + $6.75). The company could justify the $9.38 transfer price by
arguing that the company has idle capacity, which would otherwise produce
no revenues. This argument would be strengthened if the buying division
does not normally buy this component from the selling division or if the price
concession is necessary to induce the internal acquisition. The presence of
decentralized decision making could also strengthen the argument. If divi-
sional managers are free to set prices and free to buy from whichever source
is best and evidence exists that they do both, then the company could argue
that the negotiated outcome is an arm’s-length transaction.

RESEARCH ASSIGNMENT

18–26

Answers will vary.

627
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