International Accounting and Finance

CHAPTER ONE
OVERVIEW INTERNATIONAL FINANCE AND ACCOUNTING
INTRODUCTION TO INTERNATIONAL FINANCE
International finance, sometimes known as international macroeconomics, is the study of

monetary interactions between two or more countries, focusing on areas such as foreign direct
investment and currency exchange rates.
International Finance is a branch of economics which studies the dynamics of foreign exchange.
It is a monetary system which transcends national borders. The activities involved in international
finance helps organizations to engage in cross-border transactions.
International finance covers all procedures, techniques, and tools that financial institutions, such
as banks and insurance companies, provide to clients.
An initiative known as the Bretton Woods system emerged from a 1944 conference attended by
40 nations and aims to standardize international monetary exchanges and policies in a broader
effort to nurture post World War II economic stability.
International finance deals with the economic interactions between multiple countries, rather than
narrowly focusing on individual markets. International finance research is conducted by large
institutions such as the International Finance Corp. (IFC), and the National Bureau of Economic
Research (NBER).
ADVANTAGES OF INTERNATIONAL FINANCE:

Due to the current changes brought about by globalization of industrial activities and liberalization
of trade among nations, international finance has become useful in the following ways:
 It helps us to understand the consumption pattern of different economies

 It aids our understanding of production pattern of different nations
 It guides us to know where and how to invest.
1
THE BALANCE OF PAYMENTS
A country’s balance of payments is commonly defined as the record of transactions over a

specified period between its residents and foreign residents. These transactions include exports
and imports of goods and services, cash receipts and payments, gifts, loans, and investments.
Residents may include business firms, individuals, and government agencies.
The balance of payments helps business managers and government officials to analyze a country’s
competitive position and to forecast the direction of pressure on exchange rates. The ability of
multinational firms to move money across national boundaries is critical. Multinational companies
depend on this ability for exports, imports, payment of foreign debts, and dividend remittances.
Many factors affect a firm’s ability to move funds from one country to another. In particular, a
country’s balance of payments affects the value of its currency, its ability to obtain currencies of
other countries, and its policy toward foreign investment.
BALANCE-OF-PAYMENT ACCOUNTS
The balance of payments identifies transactions along functional lines. We may classify balance-
of-payments transactions into four major groups:
1. Current Account: Merchandise, services, and unilateral transfers

2. Capital Account: Long-term capital and short-term capital.
The Current Account
The current account includes merchandise exports and imports, earnings, and expenditures for
invisible trade items (services), and unilateral transfer items. Entries in this account are “current”
in nature because they do not give rise to future claims. The balance of payments on the current
account is the broadest measure of a country’s international trade because it includes financial
transactions as well as trade in goods and services. A surplus on the current account represents an
inflow of funds, while a deficit represents an outflow of funds.
Balance of Merchandise Trade: The balance of merchandise trade refers to the balance between
exports and imports of physical goods such as automobiles, machinery, and farm products. A
favorable balance-of-merchandise trade (surplus) occurs when exports are greater in value than
imports. An unfavorable balance-of-merchandise trade (deficit) occurs when imports exceed
2
exports. Merchandise exports and imports are the largest single components of total international
payments for most countries.
The Capital Account
Unlike current account entries, entries in the capital account indicate changes in future claims, for
instance, loans and their interests should be paid, or dividends on investments should be paid. The
capital account covers long-term capital and short-term capital.
MEASURING DEFICIT OR SURPLUS IN BALANCE OF PAYMENTS
If the total debits are more than total credits in the current and capital accounts, including errors
and omissions, the net debit balance measures the deficit in the balance of payments of a country.
This deficit can be settled with an equal amount of net credit balance in the official settlements
account.
In the contrary, if total credits are more than total debits in the current and capital accounts,
including errors and omissions, the net debit balance measures the surplus in the balance of
payments of a country. This surplus can be settled with an equal amount of net debit balance in
the official settlements account.
The relationship between these balances is summarized in Table below.
3
CONCLUSION
As discussed in the text, the balance of payments summarizes all international transactions
between residents of a country and residents of foreign countries during a specified period. The
systematic recording of these international transactions requires pre-established principles. These
principles include rules or procedures, such as the double-entry accounting rule, and definitions of
terminology, such as the current account.
We noted that the balance of payments deficit can be corrected by means of freely fluctuating
exchange rates, changes in income, and government controls. Government controls, such as
exchange and trade controls, can be used to alleviate or control the balance of payments deficit.
SUMMARY
In this unit, we noted that the balance of payments identifies transactions according to functional
lines. For this reason, balance of payments transactions can be classified into four broad groups.
The current account mainly includes merchandize exports and imports, earnings and expenditures
for invisible trade items and services. In the next unit, we shall be looking at Foreign Exchange
Market.
TUTOR-MARKED ASSIGNMENT
* Explain the four major groups into which balance of payment can be classified.
* Why is balance of payments regarded as a flow concept?
REFERENCE/FURTHER READING
Bodie, Z. et al. (2001) Essentials of Investment (Fourth Edition)
Published by McGraw-Hill Company Inc., 1221 Avenue, New York, U.S.A.
Cohen, J. (1977) Investment Analysis & Portfolio Management (Third Edition)
Richard D. Irwin Inc. New York, U.S.A.
Gitman, L.J and Joehnk, M.D. (1998). Fundamentals of Investment (Seventh Edition)
4
INTRODUCTION TO INTERNATIONAL ACCOUNTING
International accounting as a concept can be defined as the process of identifying, collecting,

recording, measuring, classifying, verifying, summarizing, interpreting and communicating
financial information to various users globally for meaningful financial decision making. The use
of the financial statements globally separate international accounting from domestic accounting.
The system of international accounting primarily connotes accounting in different types of
environments.
HISTORY OF ACCOUNTING
The history of accounting and international accounting are intertwined, although accounting begat
international accounting. Generally it is believed that accounting history can be traced to Luca
Pacioli in 1494, however, the history of accounting dates back to period before the advent of the
concept of money which is before Luca Pacioli Era (Jayeoba&Ajibade, 2016). The formal book
keeping and accounting process was first documented by Luca Pacioli in 1494. The evidence of
accounting’s existence before the advent of the concept of money was supported by archaeologists
and historians who discovered the oldest city of Jericho as a trade centre for salt. It was evidenced
in this city that no complete accounting was there but the artifacts revealed remains of a temple
priest taking inventory of the village livestock using tokens to keep track of the herd size and count
the grain harvest (Mattessich, 1989). It can be deduced from the fossils and records discovered not
only in Jericho but other parts of the world, that before men knew the concept of money, the
process of stewardship was known.
Accounting therefore, can be said to be as old as civilization itself, as writing developed over 5,000
years ago and archaeological findings revealed that writing was in fact developed by accountants
(Salisu, 2011). Further look into the history, the development of the science of accounting has
itself driven the evolution of commerce since it was only through the use of more precise
accounting methods that modern business was able to grow, flourish and respond to the needs of
its owners and the public (John, 2002).
5
FACTORS INFLUENCING INTERNATIONAL ACCOUNTING DEVELOPMENT
Just as nations differ in their histories, values, and political systems, they also have different
patterns of financial accounting development. Basically, this environment is expressed by shaping
factors that influence the development of accounting. Therefore, it is in the light of this to discuss
further those factors that influence accounting development.
 External Finance
The source of finance to organizations differs in various countries and this influence their
accounting profession. In situation where a company grows from private ownership to public
ownership due to the need for capital increase, the first observation is that the shareholder group
becomes large and diverse. The second observation is that ownership is separated from
management. Owners of the business (shareholders) become essentially uninvolved in the day-to-
day management of the companies they owned. In such situation, in order to know how well a
company is doing, financial accounting information becomes an important source of information.
This was how the industrial revolution in the United States and Britain aided the development of
accounting.
Another point in external financing is the credit system. Where banks are primarily the source of
capital, financial accounting is oriented toward creditor protection. There are close ties between
companies and banks. The information needs of the resource providers are satisfied in a relatively
straightforward way through personal contacts and direct visits. Since the business enterprises have
to deal with only a few creditors and sometimes even one, direct access in an efficient and practical
way to have the company’s financial health monitored.
 Legal System
A major factor that influences the development of accounting is the legal system that operates in
that country. Many dissect the accounting world into those countries with a ‘legalistic’ orientation
toward accounting and those with a ‘non legalistic’ orientation. They explained that the legalistic
approach to accounting is predominantly represented by the so-called code law countries while the
non-legalistic approach is the so-called common law countries.
6
 Political and Economic ties with other Countries
One factor that has shaped accounting development is the political and economic ties that exist
among nations. The United States has influenced accounting in Canada due to geographic
proximity and friendly economic ties and because a number of Canadian companies routinely sell
shares of common stock or borrow money in the United States. The United States is Mexico’s
principal trading partner: and also because of proximity, accounting in Mexico is very much like
that in the United States.
Another significant force in international accounting has been the United Kingdom. Almost every
former British colony has an accounting profession and financial accounting practices patterned
after the UK model. These countries include Australia, New Zealand, Malaysia, Pakistan, India,
South Africa, and Nigeria. The British did not only export their brand of accounting but also
exported many accountants. Most early US accountants also came from Britain, seeking the job
opportunities associated with the economic expansion that was occurring in the United States
around the turn of the 20th century.
The political and economic ties among nations have forced accounting practices to become more
similar. Consequently, this has led to the rise of the International Accounting Standards Committee
(IASC) which has become the driving force globally to develop international financial accounting
standards and sought for their widest possible acceptance and use. Similarly, the International
Federation of Accountants Committee (IFAC), among many other activities, develops and issues
international auditing standards which were accepted in 1992 for financial reporting in
international financial market.
 Level of Inflation
Another factor that influences the development of accounting development is the level of inflation.
Accounting in many countries is based on the historical cost principle. The principle is based on
an assumption that the currency unit used to report financial results is reasonably stable. The
historical cost principle holds that the recording of transactions at prices when they occur should
be done and there should not be changes in the prices at later date. Generally, historical cost
principle affects accounting most significantly in the area of assets values that the company keeps
7
for a long time such as land and buildings. The reasonableness of the historical cost principle varies
inversely with the level of inflation.
Germany and Japan hold strictly to historical cost principle because they have historically
experienced very little inflation. However, some South American countries, ravaged by inflation
problem for years, long age abandoned any attachment to strict historical cost. Companies in these
countries routinely write up the values of their assets based on changes in general price levels.
 Size and Complexity of Organizations
The size and complexity of businesses in a country determine the country’s accounting
sophistication. Larger and more complex business enterprises have more difficult accounting
problems. Highly trained accountant are needed to handle these more difficult problems,
accounting cannot be highly developed in a country where general education levels are low, unless
that country imports accounting talent or sends bright citizens elsewhere for the necessary training.
At the same time, the users of a company’s financial reports must themselves be sophisticated- or
else there will be no demand for sophisticated accounting reports.
Most multinational corporations are headquartered in the wealthy, industrialized nations (e.g
Japan, Germany, Great Britain and the United States). These countries have sophisticated
accounting systems and highly qualified professional accountants. In contrast, education levels in
most developing countries are low and businesses are small.
CONCLUSION
The evolution of accounting has been traced to a period before civilization, from the singular
purpose of rendering reports to the owners of the business in the same environment to more
complicated purposes. The concept of international accounting becomes important where
accounting reports are used by diverse users in various countries. Diverse users in various countries
consequently have an impact on the development of their respective accounting standards and
rules. This is due to the fact that accounting development is very much a function of external
finance, legal system, political and economic ties with other countries, and levels ofinflation, size
and complexity of organizations in the country in which the accounting system exists. The
objectives of the accounting system are often linked from an historical perspective to goals and
objectives of the perceived users of the financial statements.
8
SUMMARY
In this unit, the history of accounting was traced to the period pre-lucapacioli era. Further emphases
were placed on distinguishing domestic accounting from international accounting. Subsequently,
various factors influencing accounting development globally were discussed.
1. Distinguish between the concept of accounting and international accounting
2. Trace the history of accounting with emphasis on periods before and after Luca Pacioli.
3. List and explain five factors influencing accounting development globally.
7.0 REFERENCES/FURTHER READINGS
Geijsbeek, J. B. (1914). Ancient double-entry bookkeeping: Lucas Pacioli’s treatise. Denver:

University of Colorado
9
CHAPTER TWO
INTERNATIONAL FINANCIAL INSTITUTION
INTRODUCTION
The centre for Global Development (CGD) research examines how the International Financial
Institutions or IFIs – the IMF, World Bank, multilateral development banks, and other international
development agencies – can become more responsive to the need of developing countries and
ensures that growth opportunities they promote reach the world’s poorest people. Publish what
you pay (PWYP) calls for International Financial Institutions (IFIs) to require public disclosure of
revenues and contracts for all extractive industry investment projects development policy lending
and technical assistance programmes. In addition, PWYP request IFIs to ensure the development,
implementation and monitoring of the transparency program includes meaningful civil society
participation.By International Financial Institutions, we mean recognize international economic
organizations established primarily to provide adjustments, financing of external balances,
creating and distribution of liquidity of their members. However, the discussion below
encapsulates all recognized bodies that are of international status.
DEFINITION AND MEANING OF INTERNATIONAL FINANCIAL INSTITUTIONS (IFIS).
International Financial Institutions can refer to any of the following:
 International Bank for Reconstruction and Development (IBRD). Recognized international

economic organizations established primarily to provide adjustments, financing of external
imbalances, creating and distributions of liquidity to their members. (Bakare, 2003).
 International development association (IDA)
 International Finance Corporation etc.
IFIs offer loans, grants, and policy reforms mainly in low-income and middle-income countries.
The specific mission of each IFI varies, but typically includes elements ranging from poverty
reduction to economic development, to promotion of international trade. The World Bank group
and the major regional development banks directly finance, to varying degrees, extractive industry
projects, investing a total of & 2.2 billion in 2006 and $2.6billion in 2007, according to Bank
information centre statistics.
10
Two institutions, the international finance corporation (IFC) and the European investment Bank
(EIB) have dominated IFI financing of European investment together accounting for almost three-
fourth of total financing for 2009- 2011.
INTERNATIONAL MONETARY FUND
Following the breakdown, International Gold Standard in the thirties.Countries embarked on

policies aimed at increasing their exports and reducing their imports, such as currency
depreciation. Foreign exchange and trade controls, currency devaluation, thus generating
retaliatory action from other countries. As a result of which led to total international money
disorder. In short, this acute commercial rivalry resulted in straining of political relations with one
another, which was one of the remote causes of the Second World War. (Bakare, 2003). After the
Second World War, there was therefore the need for reconstruction and development, thus an
international institution was needed for the orderly international monetary cooperation as well as
reconstruction. Therefore, in July 1944, some leads national of the world met as a conference in
Bretton Wood, New Hampshire in the USA and decided to from the twin institutions namely.
(Andy C.E. 2001).
INTERNATIONAL MONETARY FUND FORMATIONS
The United Nations Monetary and Financial Conference held at Breton Woods in USA in July
1944 decided to establish the International Monetary Fund to help the countries to tide their
temporary difficulties in their balance of payments and maintain their rates of exchange fairly at
stable level. 44 countries and its currency operation in March 1947 signed the articles of agreement
in December 27, 1945.
OBJECTIVES/PURPOSE
The objectives of the fund as contained in paragraph one of its Articles of Agreement are as
follows:
1. To promote international Monetary cooperation among member countries, through

the establishment of a permanent institution.
2. To pursue with vigour, the expansion and balance growth of world trade so as to
improve the standard of living of mankind.
11
3. To provide means of international payments (i.e. promotion of multilateral method
of payment).
4. To assist in the promotion of exchange stability of the effective maintenance of
orderly exchange relations among member countries and to avoid competitive devaluation
that characterized the pre-Bretton Wood era.
5. To provide financial resources to member countries in order to enable them clear
their fundamental dis-equilibrium evident in the balance of payment.
6. To promote investment of capital in backward and underdeveloped countries by
means of exporting capital from the richer to the poorer countries so that the latter could
develop their economic resources for achieving higher living standard.
MEMBERSHIP
Every member of the UNO is free to become a member of the IMF. It should be note that the
defunct USSR although played a major role in the establishment of the institutions is not a member.
As at September 1981, the fund had 141 members subscribing to its shares China became member
of the IMF only in April 1980.
Capital
The financial resources of the fund consist of the aggregate of the quotas to member countries.
Contributions to the IMF pool are partly in gold or US Dollars and partly in the members ‘local
currencies. Member’s gold contribution is normally 25 percent while the local currency is 75
percent. The IMF might decide to keep the national currency of the member with the country’s
Central Bank. The contribution of a member’s quota start from strength especially in such areas as
the volume of the country’s international trade fluctuations in it balance of payments and the level
of its international reserves. Among the Central banks appointed by IMF as its gold depositories
for members to deposit gold are Federal Reserve Bank of New York, the Bank of England, Bank
of France and Reserve Bank of India.
12
Organization and Management
Two bodies run the IMF. These bodies are:
a. Board of Governors
It is the highest of the authority of fund, consisting of one person from each member country
normally appointed for a term of 5 years. Each participant has 250 votes plus one vote.
b. Board of directors
There are 21 members in the board of directors. Seven of them are permanent members appointed
by the seven member nations with the highest quota holdings while 14 are elected from among the
remaining members. One of the directors is designated as the Managing Directors of the Fund. He
is the chief executive of IMF and control the day-to-day affairs of the fund.
THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT (IBRD).
The International Bank for Reconstruction and development (IBRD) otherwise known as the
World Bank was established at a conference in Breton Woods in 1945 along with International
Monetary Fund (IMF). They are expected to complement one another. The need for international
finance at the end of the Second World War for reconstruction of infrastructures destroyed during
the war and to enhance and increases productivity and living standards of the underdeveloped areas
of the world was in the minds of the participants of the Breton Wood Conference. As they felt that
private capital alone could not cope with these problems (Andy C.E. 2001).
AIMS AND OBJECTIVES
The primary aim of the bank is to guide international investment into productive channels.
To assist the member countries in the reconstruction and development of their economies
through facilitation of capital for productive purpose. Since the bank provides such capital for
restoration of the destroyed economies during the Second World War. It is called bank for
reconstruction and since it also provide finance for the development.
To promote private foreign investment by means of guarantees or direct participation in loans
in less developed countries either from its capital or borrowed funds.
13
To promote long range balanced growth of international trade and consequently indirect
maintenance of balance of payments equilibrium through deliberate encouragement of
international investments for the development of the productive resources of nation.
To provide technical assistance to the less developed countries which in most cases have less
experts available in the field of investment projects.
CAPITAL OF THE WORLD BANK
The bank capital was $10billion made up of shares of $100 each. The actual amount subscribed
by the members amounted to $9.4billion, which the USA subscribing the highest amount of
more than 30 percent. The bank capital is divided into two parts.
Loan fund made up of 20 percent of all contributions. 20 percent of which is payable in gold
or US Dollars and the remaining 18 percent payable in the currencies with the consent of
contributing member.
Guarantee fund, which made up 80 percent of the subscription that is subject to call whenever
the bank requires it to meet its obligations.
The other resources of the bank are borrowed on special resources. Members can always contribute
to the resources of the bank especially when bank is sourcing for funds for specified project of a
member nation of the IMF are equally members of the World Bank.
Organization of the Bank
The board of governors is the highest authority of the bank like that case of the IMF. Consisting
of one governor and another alternate governor appointed by each member nation. The board meets
annually to deliberate many of its power to board of executive directors consisting of 21 directors,
six appointed by the six members with the largest capital subscription and the remaining 15 elected
from among other members. The board of executive directors meets regularly once in a month to
carry out routine working of the bank. The president of the bank is the chairman of the board and
executive directors. He is the chief executive and its responsible for the day-today business of the
bank. Other structures of the bank include, its committee comprising of seven members on playing
advisory role on banking concerns, industry, agriculture and labour. There is also a loan
committee, which advises on loan matters.
14
Banks Operations
For the purpose of efficiency the World Bank and its affiliate, the international development
association (IDA) has divided the member nations into the following groups:
 Eastern African
 Western Africa
 East Asia
 Latin American and Caribbean
 South Asia
 Europe, Middle East and North Africa.
Each office is responsible for planning and supervising of the execution of the banks development
assistance programme within its assigned countries.
Functionally, the World Bank investments are mainly for agriculture, transportation water supply
telecommunication, power generation, industry education urban development and finance etc.
The banks loans are commercial in nature with its own interest and period of amortization.
However, it is worthy to note that the bank is to empower to give soft loans or grants. Its loans are
granted to private investors in member country. The bank lends for project, which cannot be
financed by private investors either because of the low rate of return or magnitude of resources
required for such a project. Besides granting of loans, the banks give technical assistance member
countries in form of:
 Feasibility studies for projects

 Setting of industrial or development banks.
 Supplement private investment in agriculture productivity etc.
PROCEDURES FOR LENDING
There are four stages involved in the granting of loan by the bank, which are:
 Exploratory Discussion and Preliminary Investigations: under this stage, discussions

between the bank and the intending borrower are held, basically on the latter ability to repay.
In case of a first time borrows, experts are sent to make a detailed study of its economy and its
ability for repayment.
15
 Investigation of the specific project: Based on satisfactory recommendation of the bank
under the first stage, the bank then proceeds to investigate the specific project in all its aspect,
technical financial and administrative.
 Negotiation of term of Loan: If the second phase is successful, the bank proceeds further to
determine the amount of loan and securing assurances and guarantees for safe guarding the
bank’s interest.
 Administration of Loan: This is the final phase of the bank’s representatives at this stage
continue to visit the borrowing country to check whether the fund is being used as agreed upon.
Regular progress reports are also demanded by the bank to keep abreast and monitor the
project.
INTERNATIONAL DEVELOPMENT ASSOCIATION (IDA)
The need to provide development finance on more lenient terms and bearing less heavily on the
balance of payments of developing countries than the World Bank’s loan gave both the
International Association in September 1960. It is worthy to note that borrowing countries were
allowed longer period of repayment say 50 years or these about 10 years of grace, and loans can
be repaid in borrower’s currencies instead of gold or US Dollars as is the case with the World
Bank. Based on this, the IDA is often regarded as the “Soft Loan Window” of the World Bank.
OBJECTIVES OF THE IDA
 The main objectives of IDA are to expand loan to the poorer member nations on terms,
which are more favourable to them.
 To extend its credit its facility to the private sectors and also on projects which aimed at
developing the economics of the member countries?
THE MULTINATIONAL INVESTMENT GUARANTEE AGENCIES (MIGA).
This body was established in April 1988. It has been created to supplement the World Bank and
the IFC to assist where the Bank and the IFC do not reach. It is a joint venture with the international
finance Corporation. The MIGA has an authorized capital of $1.08 billion.
16
OBJECTIVES OF MIGA
The MIGA has the following objectives:
1. Its primary objective is to encourage the flow of direct foreign investment into developing
member countries.
2. It provides insurance cover to investors against political risks.
3. The MIGA’s guarantee programme to protect investors against four types of non-commercial
risks. They are: any danger involved in currency transfer, expropriation, war and civil
disturbance and breach of contract by governments.
4. It insures only few investments including the expansion of existing investment. Privatization
and financial restricting.
5. It provides promotional and advisory services to the governments of developing countries to
enable them to increase the attractiveness of their investment climate.
6. Another objective of the MIGA is to establish among global banking and finance markets of
its members.
Membership and its operations
It order to become a full-fledge member of the MIGA, a country has to ratify the convention and
pay its capital subscription. By 30 June 1996, 152countries had signed the MIGA convention of
these, 128 countries had become it’s full-fledge members. Before the investments are made,
projects are to be registered with the MIGA 90 percent of the investments amount can be insured.
By the MIGA subject to equity loans made or guarantee by equity holders, and certain other types
of extended to 20 years in exception cases. It also insures eligible investment in cooperation with
national insurance agencies and private insurers. All projects insured by the MIGA have to support
the environmental and development objectives of the World Bank. The MIGA provides
promotional advisory services to its developing member’s countries to help them attract more
foreign direct investments. These services include the organization of investment promotion
conferences; executive development programmes foreign investment advisory services in policy
institutional and legal matter relating to direct foreign investment. It also gives advice on such
policies and programme, which promote backward linkages between foreign investors and local
investors. (Andy C. E. 2001).
17
AFRICAN DEVELOPMENT BANK (ADB)
In international financial system made up of the World Bank Group. The international bank for
Reconstruction and Development (IBRD), the International Development Finance Corporation
(IFC) and the international Monetary Fund (IMF). Third world countries have only a minority
voice in the manner in which economic assistance is being provided and used. These financial
institutions focus little or no attention on problems peculiar to the third world countries of which
the African states from the largest percentage.
The African continent with about 240 million population covers almost one quarter of the earth’s
land mass. Though vast, the continent’s resources are yet to be adequately exploited due mainly to
lack of capital and shortage of technicians and identifiable projects. As a result of this situation,
the Africans resolve to create an effective instrument, which would help to spread up development
of its vast resources. It was decided that the best instrument for this purpose would be a financial
institution common to all African countries. This idea originated in Tunis (Tunisia) in 1960 during
the All People’s Conference (Bakare, 2003). Thus the adoption of resolution 2711/on February 16,
1961 by the United Nations Economic Commission for Africa (UNECA) at its meeting was the
genesis of the ABD. A nine-nation committee made up Nigeria, Ghana, Cameroon, Liberia, Mali,
Sudan, Tanzania, Ethiopia and Tunisia made far reaching recommendations, which were the basis
of the agreement for its establishment. On August 4, 1963, the agreement establishing ABD was
signed in Khartoum, Sudan by 30 independent African countries. In November 1964, the member
countries participated in the inaugural meeting of the Board of Governors held in Lagos. Election
of the President, Vice-President and Board of Directors took place, and Abidjan in Ivory Coast
was chosen as the site for its headquarters. It commenced business in July 1966 with representative
offices in London and Nairobi, and its authorized capital was initially fixed at 250 million units of
account. (One unit of account $ is 115060). Membership of the bank is restricted to independent
African nations. However, in May 1978, the Board of Governors passed a resolution to admit non-
African nations as members with the provision that the
President of the bank should always be an African. The main objectives of the ADB include:
a) Financing of investment projects with potential for social and economic development of
member (African) states.
b) Preparing, studying and identifying project for development of member states.
18
c) Mobilization of resources for financial of development of selected projects inside and outside
Africa.
d) Providing technical assistance for project preparation, study and execution.
THE ORGANIZATION OF PETROLEUM EXPORTING COUNTRIES (OPEC)
5 oil-producing countries of Venezuela, Iran, Iraq, Kuwait and Saudi Arabia formed the body in
1960. The membership increased to 13 with the admission of Qatar, Indonesia and Libya in 1962,
UAE (1967), Algeria (1969) Nigeria (1971). Equador and Gabon (1973). (Andy C. E 2001). The
main aim of the member countries is to coordinate the production, development and pricing of
crude petroleum resources among them. Its formation has helped.
OBJECTIVES OF OPEC
1. To adopt a uniform policy towards oil importing countries

2. To maintain stability of price of oil in the international market.
3. To ensure steady and effective supply of petroleum products to importing countries.
4. To fix and allocate production quota to each member state.
5. To assess and examine the effects of the involvement of foreign companies in oil exploitation
and exploration vis-à-vis the OPEC and exploitation.
ACHIEVEMENTS OF OPEC
The Organization has been able to attain some levels of achievements in the area of:
1) Regulation of oil prices, to a large extent, ensuring stability of prices in the international
markets.
2) Adoption of uniform policies towards importing countries.
3) Curbing the exploitative tendencies of foreign multinational companies that are involved in oil
exploration.
4) Participation of its member nations in oil exploration.
5) Protection of the interest of the member states by provision of financial assistance in times if
need.
19
PROBLEMS OF OPEC
1. The activities of non-OPEC member oil producing countries such as Norway, Mexico etc. tend
to negate the rules, regulations and expectations of OPEC in the international oil market.
2. Dishonesty on the part of member countries would act deviance of the directive of the
organization.
3. The rivalry for the leadership of the organization between Saudi Arabia and Iran is a big
problem to OPEC.
4. World economic depression has brought about a fall in oil prices.
5. The emergence in the international oil market in the 1980s of the North Sea oil producers of
the UK and Norway added to the problems of the organization.
6. The activities of most oil importing countries in stockpiling oil, most of the time creates
fluctuation in the international oil market.
7. Declining loyalty by member countries in another problem confronting OPEC.
8. Political disagreements, which sometimes lead to war between member nations, have a
destabilizing on the organization.
CONCLUSION
This unit has succinctly taken you round the operation and existence of International Financial
Institutions. You have learnt about the meaning, formation and structure of the World Bank and
International Monetary Fund. The unit has also introduced you to the international bank for
reconstruction and development, the organization of OPEC and its criticisms etc.
SUMMARY
International Financial Institutions (IFIs) are financial institutions that have been established (or
chartered) by more than one country, and hence are subjects of international law. Their owners or
shareholders are generally national governments, although other International Institutions and
other organizations occasionally figure as shareholders. The regional development banks consist
of several regional institutions that have function similar to the world bank group’s activities, but
with particular focus on a specific region. The best known of these regional banks – African
development bank, inter-American development bank, European bank for reconstruction and
20
development etc. Several regional groupings of countries have established international financial
institutions to finance various projects.
TUTOR–MARKED ASSIGNMENT
Examine the comprehensive objectives of Multinational Investment Guarantee Agencies

(MIGA).
Answers to Self Assessment Exercise
The purpose for the establishment of OPEC is thwarted by reasons such as:
1. The activities of non-OPEC member oil producing countries such as Norway, Mexico etc,
tend to negate the rules, regulations and expectations of OPEC in the international oil
market.
2. Dishonesty on the part of member countries of OPEC. Most of the time some of the
member countries would act in deviance of the directives of the organization.
problem to OPEC.
4. World Economic depression has brought about a fall in oil prices.
fluctuation in the international oil markets.
Andy, C.E. (2001): Essential Economics, Tonad Publishers.
Bakare I. O. (2003): Fundamental And Principles Of Macro Economics,
Giitbak Publishers, Fadeyi, Lagos.http://www.deginvest.de, http://www.nib.int.
21
CHAPTER THREE
INTERNATIONAL HARMONIZATION OF ACCOUNTING STANDARDS
INTRODUCTION
To bridge the gap of diversity in accounting practices as discussed in the previous unit, the project
to harmonize accounting practice was set up by the International Accounting Standards’ Board
(IASB) through the implementation of International Financial Reporting Standards (IFRS). This
unit discusses the nature, reasons, obstacles, and measurement of harmonization of accounting
standards; the role of IASB and other bodies in the harmonization; and Political lobbying on
accounting standards.
International Accounting Standards (IAS) are older accounting standards issued by the
International Accounting Standards Board (IASB); an independent international standard-setting
body based in London.
International Accounting Standards (IAS) were the first international accounting standards that
were issued by the International Accounting Standards Committee (IASC), formed in 1973. The
goal then, as it remains today, was to make it easier to compare businesses around the world,
increase transparency and trust in financial reporting, and foster global trade and investment.
NATURE OF HARMONIZATION OF ACCOUNTING STANDARDS
Harmonization simply implies uniformity. As a result of the existing diversity in financial

reporting styles all over the world, harmonization of accounting standards become important. This
harmonization is tailored towards breaking the barriers of national differences so that financial
reports prepared across the globe can be easily comparable, understandable, and relevant for
economic decision making. Nobes and Parker (2008) explained that ‘Harmonization’ is a process
of increasing the compatibility of accounting practices by setting bounds to their degree of
variation. Thus, harmonization of accounting standards implies the development of accounting
standards to be used across the globe to promote uniformity and quality financial reporting.
22
REASONS FOR HARMONIZATION OF ACCOUNTING STANDARDS
The resulting effect of use of various accounting practices all of over the world otherwise called
consequences are the reasons for the harmonization of accounting standards. These are discussed
below:
1. Corporate management of Multi-national Corporations: the managers of MNCs face global

competition and crave for uniformity in accounting practices. Not only to reduce the cost
of re-preparing subsidiaries’ financial statements but also to enhance ease of comparability.
Thus, a major reason for harmonization of accounting standards is higher cost involved in
re-preparing subsidiaries financial statements by the MNCs.
2. Investors: financial analysts and investors experience difficulties with accounting diversity
due to information asymmetry and lack of uniformity. Foreign investors crave to
understand and compare financial reports from different countries.
3. Stock market and regulators: To protect investors, most stock markets require listed
companies to disclose sufficient information so that investors can assess their past
performance and future prospect. Market quality is achieved by fair and efficient trading
and by the availability of investment opportunities for market participants. Stock markets
and regulators interpret these goals differently around the world. For example, accounting
and disclosure requirements for listing shares vary extensively. Research shows that MNCs
consider these requirements to be an important cost when they choose where to list their
common stock shares. Indeed, MNCs are less likely to choose stock exchanges that require
them to make extensive new disclosures over and above those that they are already making
at home.
4. Accounting Professionals and Standard Setters: Some have suggested that accounting
professionals like diversity because it generates fees for them all the way from assisting in
setting up new business units for their clients in different GAAP territories to restating
financial reports from one set of GAAP to another. GAAP diversity also makes cross-
border auditing more costly and therefore raises auditing fees. Although, another school of
thought argues that when there is diversity, accounting professionals are expected to train
and re-train staff when dealing with foreign clients. This leads to additional cost on the part
of the client and the accounting professional.
23
5. Analysis and Comparison: Differences in the treatment of the same type of transactions’
makes it difficult to analyze and compare financial statements among the countries.
6. Reliability: National accounting standards especially in emerging economies are often seen
to be less reliable and low in quality since they are not generally acceptable across
countries. Implying that, harmonization of accounting standards will lead to more reliable
financial reports.
OBSTACLES FOR HARMONIZATION OF ACCOUNTING STANDARDS
The following are the obstacles of accounting standards’ harmonization:
1. Size of the national differences: it has been identified earlier that there exist differences in the
accounting practices of different countries, the size of these differences mitigate the
harmonization of accounting standards.
2. Lack of international regulatory agency: the regulatory agency assist in ensuring the
compliance of accounting standards, however there is no international regulatory agency to
ensure the compliance of countries to harmonized accounting standards.
3. Unwillingness of countries: Due to peculiar national differences, some countries may not want
to lose their sovereignty by accepting compromises that involve changing accounting practices
towards those of other countries.
4. Lack of expertise: lack of technical know-how on the part of accounting professional in
accepting different accounting practice.
ADVANTAGES OF HARMONIZATION
The first and most important advantage of harmonization of reporting standards is to achieve
comparability in financial statements. Due to different sets of financial reporting standards, the
way financial statements prepared and presented are different from each other which make it
complicated to compare them. This is even more noticeable in multinational companies when they
operate in more than just one country. If international harmonization is achieved, the level of
international comparability also increases making it easier for companies to prepare the financial
statements under one set of rules; investors who understand the financial statements due to the
nature of IFRS and make well thought investment decisions.
24
There will be increased auditing efficiency and money saving as companies has to use only one
set of reporting standards. This also serves to reduce trade barriers among countries allowing more
access to international capital markets.
Another advantage worth noting is the consistency to be achieved under IFRS as it was one of the
objectives of IFRS as a single reporting standard. The consistency also contributes to better
understanding between investors, lenders, and other businesses as there will be the nature of
predictability in place. Moreover, companies operating in different countries also can use their
expertise and systems in all countries they are operating due to consistency of the reporting
standards. Another benefit that derives from consistency is the time scale needed to implement in
new countries as there will be no need to learn and adapt to new county specific rules except minor
adjustments.
MEASUREMENT OF HARMONIZATION OF ACCOUNTING STANDARDS
In order to measure the level of accounting standards’ harmonization, the comparability levels of
the published financial reports are determined. The comparability index is used to determine areas
of uniformity of accounting treatment of various financial reports from different countries.
ROLE OF IASB AND OTHER BODIES IN ACCOUNTING STANDARDS

HARMONIZATION
The most successful body involved in harmonization has been the International Accounting
Standards Committee (IASC) and its successor, the International Accounting Standards Board
(IASB). The International Accounting Standards’ Board (IASB) through the implementation of
International Financial Reporting Standards (IFRS) has encouraged accounting standards
harmonization. Another professional body that has played significant role in the harmonization of
accounting standards is the International Federation of Accountants (IFAC). The history and roles
of IASC, IASB and IFAC will be discussed in the next module.
The governmental bodies concerned with harmonization of accounting standards around the world
are: United Nations (UN), (OECD), and (IOSCO).
25
POLITICAL LOBBYING ON ACCOUNTING STANDARDS
Accounting standard-setters such as the International Accounting Standards Board (IASB) are
often challenged with the issue of political lobbying driven by preparer or governmental self-
interest. This is done by those who have vested interest in certain treatments of transactions mount
pressure on the standard-setter not to approve the standard containing an objectionable feature.
This usually includes lobbying, writing letters, giving oral testimony at a hearing arranged by a
standard-setter to expose its tentative views to public comment. It is usually a complaint against a
specific standard in its proposal states. This is the reason for stalling some standards on certain
issues. Issues such as share-based payment, pensions, insurance, leases and performance reporting
have caused controversy in the past. This may cause the standard-setters to modify their positions
and run the risk of diluting or abandoning the principles implicit in their standards (Nobes &
Parker, 2009). The likelihood of political lobbying would increase in some countries if the
proposed standard were either to lower companies’ earnings or make their trend of earnings.
CONCLUSION
Although there is a universal purpose of financial reporting, there exists diversity in reporting
processes. Accounting practices all over the world are influenced by national environmental
factors and conditions as discussed in this unit. However, when accounting practices between
countries are far apart there will be problems of understandability of these reports. As such, the
focus of global harmonization of accounting practices.
SUMMARY
In this unit, we discussed the concept of international and universal accounting under the following
sub-units: origin of national differences in accounting, the causes of these differences, and some
existing practices in accounting.
1. Explain the origin of national differences in accounting
2. List and explain five causes of international accounting practices
3. What does conservatism and accruals imply in accounting?
26
REFERENCES/FURTHER READINGS
Nobes, C. & Parker, R. (2008). Comparative international accounting.10th Edition. UK: Prentice
Hall.
D. Alexander and C Nobes, 2008, “International Financial Reporting Standards: Context, Analysis
and Comment”, Routladge, London.
27
CHAPTER FOUR
INTERNATIONAL FINANCIAL INSTITUTION
INTRODUCTION
The centre for Global Development (CGD) research examines how the International Financial
Institutions or IFIs – the IMF, World Bank, multilateral development banks, and other international
development agencies – can become more responsive to the need of developing countries and
ensures that growth opportunities they promote reach the world’s poorest people. Publish what
you pay (PWYP) calls for International Financial Institutions (IFIs) to require public disclosure of
revenues and contracts for all extractive industry investment projects development policy lending
and technical assistance programmes. In addition, PWYP request IFIs to ensure the development,
implementation and monitoring of the transparency program includes meaningful civil society
participation.By International Financial Institutions, we mean recognize international economic
organizations established primarily to provide adjustments, financing of external balances,
creating and distribution of liquidity of their members. However, the discussion below
encapsulates all recognized bodies that are of international status.
DEFINITION AND MEANING OF INTERNATIONAL FINANCIAL INSTITUTIONS (IFIS).
International Financial Institutions can refer to any of the following:
 International Bank for Reconstruction and Development (IBRD). Recognized international

economic organizations established primarily to provide adjustments, financing of external
imbalances, creating and distributions of liquidity to their members. (Bakare, 2003).
 International development association (IDA)
 International Finance Corporation etc.
IFIs offer loans, grants, and policy reforms mainly in low-income and middle-income countries.
The specific mission of each IFI varies, but typically includes elements ranging from poverty
reduction to economic development, to promotion of international trade. The World Bank group
and the major regional development banks directly finance, to varying degrees, extractive industry
projects, investing a total of & 2.2 billion in 2006 and $2.6billion in 2007, according to Bank
information centre statistics.
28
Two institutions, the international finance corporation (IFC) and the European investment Bank
(EIB) have dominated IFI financing of European investment together accounting for almost three-
fourth of total financing for 2009- 2011.
INTERNATIONAL MONETARY FUND
Following the breakdown, International Gold Standard in the thirties.Countries embarked on

policies aimed at increasing their exports and reducing their imports, such as currency
depreciation. Foreign exchange and trade controls, currency devaluation, thus generating
retaliatory action from other countries. As a result of which led to total international money
disorder. In short, this acute commercial rivalry resulted in straining of political relations with one
another, which was one of the remote causes of the Second World War. (Bakare, 2003). After the
Second World War, there was therefore the need for reconstruction and development, thus an
international institution was needed for the orderly international monetary cooperation as well as
reconstruction. Therefore, in July 1944, some leads national of the world met as a conference in
Bretton Wood, New Hampshire in the USA and decided to from the twin institutions namely.
(Andy C.E. 2001).
INTERNATIONAL MONETARY FUND FORMATIONS
The United Nations Monetary and Financial Conference held at Breton Woods in USA in July
1944 decided to establish the International Monetary Fund to help the countries to tide their
temporary difficulties in their balance of payments and maintain their rates of exchange fairly at
stable level. 44 countries and its currency operation in March 1947 signed the articles of agreement
in December 27, 1945.
OBJECTIVES/PURPOSE
The objectives of the fund as contained in paragraph one of its Articles of Agreement are as
follows:
7. To promote international Monetary cooperation among member countries, through

the establishment of a permanent institution.
8. To pursue with vigour, the expansion and balance growth of world trade so as to
improve the standard of living of mankind.
29
9. To provide means of international payments (i.e. promotion of multilateral method
of payment).
10. To assist in the promotion of exchange stability of the effective maintenance of
orderly exchange relations among member countries and to avoid competitive devaluation
that characterized the pre-Bretton Wood era.
11. To provide financial resources to member countries in order to enable them clear
their fundamental dis-equilibrium evident in the balance of payment.
12. To promote investment of capital in backward and underdeveloped countries by
means of exporting capital from the richer to the poorer countries so that the latter could
develop their economic resources for achieving higher living standard.
MEMBERSHIP
Every member of the UNO is free to become a member of the IMF. It should be note that the
defunct USSR although played a major role in the establishment of the institutions is not a member.
As at September 1981, the fund had 141 members subscribing to its shares China became member
of the IMF only in April 1980.
Capital
The financial resources of the fund consist of the aggregate of the quotas to member countries.
Contributions to the IMF pool are partly in gold or US Dollars and partly in the members ‘local
currencies. Member’s gold contribution is normally 25 percent while the local currency is 75
percent. The IMF might decide to keep the national currency of the member with the country’s
Central Bank. The contribution of a member’s quota start from strength especially in such areas as
the volume of the country’s international trade fluctuations in it balance of payments and the level
of its international reserves. Among the Central banks appointed by IMF as its gold depositories
for members to deposit gold are Federal Reserve Bank of New York, the Bank of England, Bank
of France and Reserve Bank of India.
30
Organization and Management
Two bodies run the IMF. These bodies are:
a. Board of Governors
It is the highest of the authority of fund, consisting of one person from each member country
normally appointed for a term of 5 years. Each participant has 250 votes plus one vote.
b. Board of directors
There are 21 members in the board of directors. Seven of them are permanent members appointed
by the seven member nations with the highest quota holdings while 14 are elected from among the
remaining members. One of the directors is designated as the Managing Directors of the Fund. He
is the chief executive of IMF and control the day-to-day affairs of the fund.
THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT (IBRD).
The International Bank for Reconstruction and development (IBRD) otherwise known as the
World Bank was established at a conference in Breton Woods in 1945 along with International
Monetary Fund (IMF). They are expected to complement one another. The need for international
finance at the end of the Second World War for reconstruction of infrastructures destroyed during
the war and to enhance and increases productivity and living standards of the underdeveloped areas
of the world was in the minds of the participants of the Breton Wood Conference. As they felt that
private capital alone could not cope with these problems (Andy C.E. 2001).
AIMS AND OBJECTIVES
The primary aim of the bank is to guide international investment into productive channels.
To assist the member countries in the reconstruction and development of their economies
through facilitation of capital for productive purpose. Since the bank provides such capital for
restoration of the destroyed economies during the Second World War. It is called bank for
reconstruction and since it also provide finance for the development.
To promote private foreign investment by means of guarantees or direct participation in loans
in less developed countries either from its capital or borrowed funds.
31
To promote long range balanced growth of international trade and consequently indirect
maintenance of balance of payments equilibrium through deliberate encouragement of
international investments for the development of the productive resources of nation.
To provide technical assistance to the less developed countries which in most cases have less
experts available in the field of investment projects.
CAPITAL OF THE WORLD BANK
The bank capital was $10billion made up of shares of $100 each. The actual amount subscribed
by the members amounted to $9.4billion, which the USA subscribing the highest amount of
more than 30 percent. The bank capital is divided into two parts.
Loan fund made up of 20 percent of all contributions. 20 percent of which is payable in gold
or US Dollars and the remaining 18 percent payable in the currencies with the consent of
contributing member.
Guarantee fund, which made up 80 percent of the subscription that is subject to call whenever
the bank requires it to meet its obligations.
The other resources of the bank are borrowed on special resources. Members can always contribute
to the resources of the bank especially when bank is sourcing for funds for specified project of a
member nation of the IMF are equally members of the World Bank.
Organization of the Bank
The board of governors is the highest authority of the bank like that case of the IMF. Consisting
of one governor and another alternate governor appointed by each member nation. The board meets
annually to deliberate many of its power to board of executive directors consisting of 21 directors,
six appointed by the six members with the largest capital subscription and the remaining 15 elected
from among other members. The board of executive directors meets regularly once in a month to
carry out routine working of the bank. The president of the bank is the chairman of the board and
executive directors. He is the chief executive and its responsible for the day-today business of the
bank. Other structures of the bank include, its committee comprising of seven members on playing
advisory role on banking concerns, industry, agriculture and labour. There is also a loan
committee, which advises on loan matters.
32
Banks Operations
For the purpose of efficiency the World Bank and its affiliate, the international development
association (IDA) has divided the member nations into the following groups:
 Eastern African
 Western Africa
 East Asia
 Latin American and Caribbean
 South Asia
 Europe, Middle East and North Africa.
Each office is responsible for planning and supervising of the execution of the banks development
assistance programme within its assigned countries.
Functionally, the World Bank investments are mainly for agriculture, transportation water supply
telecommunication, power generation, industry education urban development and finance etc.
The banks loans are commercial in nature with its own interest and period of amortization.
However, it is worthy to note that the bank is to empower to give soft loans or grants. Its loans are
granted to private investors in member country. The bank lends for project, which cannot be
financed by private investors either because of the low rate of return or magnitude of resources
required for such a project. Besides granting of loans, the banks give technical assistance member
countries in form of:
 Feasibility studies for projects

 Setting of industrial or development banks.
 Supplement private investment in agriculture productivity etc.
PROCEDURES FOR LENDING
There are four stages involved in the granting of loan by the bank, which are:
 Exploratory Discussion and Preliminary Investigations: under this stage, discussions

between the bank and the intending borrower are held, basically on the latter ability to repay.
In case of a first time borrows, experts are sent to make a detailed study of its economy and its
ability for repayment.
33
 Investigation of the specific project: Based on satisfactory recommendation of the bank
under the first stage, the bank then proceeds to investigate the specific project in all its aspect,
technical financial and administrative.
 Negotiation of term of Loan: If the second phase is successful, the bank proceeds further to
determine the amount of loan and securing assurances and guarantees for safe guarding the
bank’s interest.
 Administration of Loan: This is the final phase of the bank’s representatives at this stage
continue to visit the borrowing country to check whether the fund is being used as agreed upon.
Regular progress reports are also demanded by the bank to keep abreast and monitor the
project.
INTERNATIONAL DEVELOPMENT ASSOCIATION (IDA)
The need to provide development finance on more lenient terms and bearing less heavily on the
balance of payments of developing countries than the World Bank’s loan gave both the
International Association in September 1960. It is worthy to note that borrowing countries were
allowed longer period of repayment say 50 years or these about 10 years of grace, and loans can
be repaid in borrower’s currencies instead of gold or US Dollars as is the case with the World
Bank. Based on this, the IDA is often regarded as the “Soft Loan Window” of the World Bank.
OBJECTIVES OF THE IDA
 The main objectives of IDA are to expand loan to the poorer member nations on terms,
which are more favourable to them.
 To extend its credit its facility to the private sectors and also on projects which aimed at
developing the economics of the member countries?
THE MULTINATIONAL INVESTMENT GUARANTEE AGENCIES (MIGA).
This body was established in April 1988. It has been created to supplement the World Bank and
the IFC to assist where the Bank and the IFC do not reach. It is a joint venture with the international
finance Corporation. The MIGA has an authorized capital of $1.08 billion.
34
OBJECTIVES OF MIGA
The MIGA has the following objectives:
7. Its primary objective is to encourage the flow of direct foreign investment into developing
member countries.
8. It provides insurance cover to investors against political risks.
9. The MIGA’s guarantee programme to protect investors against four types of non-commercial
risks. They are: any danger involved in currency transfer, expropriation, war and civil
disturbance and breach of contract by governments.
10. It insures only few investments including the expansion of existing investment. Privatization
and financial restricting.
11. It provides promotional and advisory services to the governments of developing countries to
enable them to increase the attractiveness of their investment climate.
12. Another objective of the MIGA is to establish among global banking and finance markets of
its members.
Membership and its operations
It order to become a full-fledge member of the MIGA, a country has to ratify the convention and
pay its capital subscription. By 30 June 1996, 152countries had signed the MIGA convention of
these, 128 countries had become it’s full-fledge members. Before the investments are made,
projects are to be registered with the MIGA 90 percent of the investments amount can be insured.
By the MIGA subject to equity loans made or guarantee by equity holders, and certain other types
of extended to 20 years in exception cases. It also insures eligible investment in cooperation with
national insurance agencies and private insurers. All projects insured by the MIGA have to support
the environmental and development objectives of the World Bank. The MIGA provides
promotional advisory services to its developing member’s countries to help them attract more
foreign direct investments. These services include the organization of investment promotion
conferences; executive development programmes foreign investment advisory services in policy
institutional and legal matter relating to direct foreign investment. It also gives advice on such
policies and programme, which promote backward linkages between foreign investors and local
investors. (Andy C. E. 2001).
35
AFRICAN DEVELOPMENT BANK (ADB)
In international financial system made up of the World Bank Group. The international bank for
Reconstruction and Development (IBRD), the International Development Finance Corporation
(IFC) and the international Monetary Fund (IMF). Third world countries have only a minority
voice in the manner in which economic assistance is being provided and used. These financial
institutions focus little or no attention on problems peculiar to the third world countries of which
the African states from the largest percentage.
The African continent with about 240 million population covers almost one quarter of the earth’s
land mass. Though vast, the continent’s resources are yet to be adequately exploited due mainly to
lack of capital and shortage of technicians and identifiable projects. As a result of this situation,
the Africans resolve to create an effective instrument, which would help to spread up development
of its vast resources. It was decided that the best instrument for this purpose would be a financial
institution common to all African countries. This idea originated in Tunis (Tunisia) in 1960 during
the All People’s Conference (Bakare, 2003). Thus the adoption of resolution 2711/on February 16,
1961 by the United Nations Economic Commission for Africa (UNECA) at its meeting was the
genesis of the ABD. A nine-nation committee made up Nigeria, Ghana, Cameroon, Liberia, Mali,
Sudan, Tanzania, Ethiopia and Tunisia made far reaching recommendations, which were the basis
of the agreement for its establishment. On August 4, 1963, the agreement establishing ABD was
signed in Khartoum, Sudan by 30 independent African countries. In November 1964, the member
countries participated in the inaugural meeting of the Board of Governors held in Lagos. Election
of the President, Vice-President and Board of Directors took place, and Abidjan in Ivory Coast
was chosen as the site for its headquarters. It commenced business in July 1966 with representative
offices in London and Nairobi, and its authorized capital was initially fixed at 250 million units of
account. (One unit of account $ is 115060). Membership of the bank is restricted to independent
African nations. However, in May 1978, the Board of Governors passed a resolution to admit non-
African nations as members with the provision that the
President of the bank should always be an African. The main objectives of the ADB include:
e) Financing of investment projects with potential for social and economic development of
member (African) states.
f) Preparing, studying and identifying project for development of member states.
36
g) Mobilization of resources for financial of development of selected projects inside and outside
Africa.
h) Providing technical assistance for project preparation, study and execution.
THE ORGANIZATION OF PETROLEUM EXPORTING COUNTRIES (OPEC)
5 oil-producing countries of Venezuela, Iran, Iraq, Kuwait and Saudi Arabia formed the body in
1960. The membership increased to 13 with the admission of Qatar, Indonesia and Libya in 1962,
UAE (1967), Algeria (1969) Nigeria (1971). Equador and Gabon (1973). (Andy C. E 2001). The
main aim of the member countries is to coordinate the production, development and pricing of
crude petroleum resources among them. Its formation has helped.
OBJECTIVES OF OPEC
6. To adopt a uniform policy towards oil importing countries

7. To maintain stability of price of oil in the international market.
8. To ensure steady and effective supply of petroleum products to importing countries.
9. To fix and allocate production quota to each member state.
10. To assess and examine the effects of the involvement of foreign companies in oil exploitation
and exploration vis-à-vis the OPEC and exploitation.
ACHIEVEMENTS OF OPEC
The Organization has been able to attain some levels of achievements in the area of:
6) Regulation of oil prices, to a large extent, ensuring stability of prices in the international
markets.
7) Adoption of uniform policies towards importing countries.
8) Curbing the exploitative tendencies of foreign multinational companies that are involved in oil
exploration.
9) Participation of its member nations in oil exploration.
10) Protection of the interest of the member states by provision of financial assistance in times if
need.
37
PROBLEMS OF OPEC
1. The activities of non-OPEC member oil producing countries such as Norway, Mexico etc. tend
to negate the rules, regulations and expectations of OPEC in the international oil market.
2. Dishonesty on the part of member countries would act deviance of the directive of the
organization.
problem to OPEC.
4. World economic depression has brought about a fall in oil prices.
5. The emergence in the international oil market in the 1980s of the North Sea oil producers of
the UK and Norway added to the problems of the organization.
fluctuation in the international oil market.
7. Declining loyalty by member countries in another problem confronting OPEC.
8. Political disagreements, which sometimes lead to war between member nations, have a
destabilizing on the organization.
CONCLUSION
This unit has succinctly taken you round the operation and existence of International Financial
Institutions. You have learnt about the meaning, formation and structure of the World Bank and
International Monetary Fund. The unit has also introduced you to the international bank for
reconstruction and development, the organization of OPEC and its criticisms etc.
SUMMARY
International Financial Institutions (IFIs) are financial institutions that have been established (or
chartered) by more than one country, and hence are subjects of international law. Their owners or
shareholders are generally national governments, although other International Institutions and
other organizations occasionally figure as shareholders. The regional development banks consist
of several regional institutions that have function similar to the world bank group’s activities, but
with particular focus on a specific region. The best known of these regional banks – African
development bank, inter-American development bank, European bank for reconstruction and
38
development etc. Several regional groupings of countries have established international financial
institutions to finance various projects.
TUTOR–MARKED ASSIGNMENT
Examine the comprehensive objectives of Multinational Investment Guarantee Agencies

(MIGA).
Answers to Self Assessment Exercise
The purpose for the establishment of OPEC is thwarted by reasons such as:
6. The activities of non-OPEC member oil producing countries such as Norway, Mexico etc,
tend to negate the rules, regulations and expectations of OPEC in the international oil
market.
7. Dishonesty on the part of member countries of OPEC. Most of the time some of the
member countries would act in deviance of the directives of the organization.
problem to OPEC.
9. World Economic depression has brought about a fall in oil prices.
fluctuation in the international oil markets.
Andy, C.E. (2001): Essential Economics, Tonad Publishers.
Bakare I. O. (2003): Fundamental And Principles Of Macro Economics,
Giitbak Publishers, Fadeyi, Lagos.http://www.deginvest.de, http://www.nib.int.
39
CHAPTER FIVE
EXCHANGE RATES
INTRODUCTION
the foreign exchange market, currencies of different nations are traded. While exchanging one
currency for another, an exchange rate is established. This exchange rate determines how much of
one country's currency should be exchanged for that of another. This activity is of particular
interest to the government of every nation and to the business community, especially those that
deal with the international market. Based on this, business managers would be able to design better
policies for their firms when they possess knowledge of the exchange rate. In this section of the
work, we will be examining the concept of exchange rate and the types of exchange rates. Now if,
in considering the movement in the exchange rate of the naira against foreign currencies, your
friend asks you, 'When does a currency gain value or lose value in the exchange market?' What
would be your reply?
DEFINITION OF EXCHANGE RATE
The exchange rate is simply the price of one currency in terms of another. That is to say, how much
of one currency can be given up obtaining another (e.g., $1 = SH.25K). Here, we can say that the
exchange rate of the US dollar in Somalia is $1 to SH.25K.
An exchange rate represents the price of a national currency valued as a foreign currency. The
exchange rate plays a significant role in the economy. Because exchange rate fluctuations
influence the whole economy, the exchange rate is a major economic factor for growth, stability,
and economic development. In addition, the exchange rate directly influences the unemployment
rate and the inflation level, and it is an indicator of external competitiveness (Madura 2003). The
exchange rate also affects trade flows and investments, which in turn influence the balance of
payments. Generally, the exchange rate is considered the most important price in the economy.
The exchange rate has direct practical importance to those engaged in foreign transactions, whether
for trade or investment. It affects the price of imports when expressed in domestic currency, as
well as the price of exports when converted into a foreign currency.
40
TYPES OF EXCHANGE RATE
The following are the types of exchange rates commonly used around the globe:
 Flexible exchange rate
This is a system whereby exchange rates are determined by the forces of demand and supply. Since
the forces of demand and supply purely determine the exchange rate under this system, there is no
government intervention in the market.
The demand for US dollars and supply of the Sh.so. are linked, as are the demand for the Sh.so.
and supply of US dollars. Suppose an American wants to buy Somali1s groundnuts, before he
purchases Somali`s groundnuts, he must buy the Sh.so., hence the Sh.so is demanded. But the
American will buy the sh.so with dollars; that is, he supplies dollars to the foreign exchange market
in order to demand Sh.so. We then conclude that the American's demand for Somali`s goods has
led to a demand for the sh.so and to a supply of U.S. dollars in the foreign exchange market. The
process is the same if a Somali importer wants to buy goods from the U.S. He must buy dollars
first, hence U.S. dollars are demanded. He buys the dollar with the sh.so. It can be concluded that
the Somali’s demand for American goods has led to the demand for U.S. dollars and to the supply
of the naira in the foreign exchange market. At the equilibrium exchange rate, the demand for
dollars equals the supply of the Sh.so. There is no shortage or surplus of dollars. At any other
exchange rate, however, either an excess demand for the dollar or excess supply of the Sh.so exists.
The factors that can cause a change in the equilibrium flexible exchange rate include a difference
in income growth rates, differences in the relative inflation rate, and change in real interest rates.
ADVANTAGE OF FLOATING EXCHANGE RATES:
Floating exchange rates have the following advantages:
 Automatic Stabilization:
Any disequilibrium in the balance of pay-ments would be automatically corrected by a change in

the exchange rate. For example, if a country suffers from a deficit in the balance of payments, then,
other things being equal, the country’s currency should depreciate.
This would make the country’s exports cheaper, thus increasing demand, while at the same time
making imports expensive and decreasing demand. The balance of payments equilibrium would
41
therefore be restored. On the contrary, a balance of payments surplus would be automatically
eliminated through a change in the exchange rate.
 Freeing Internal Policy:
Under the floating exchange rate system the balance of payments deficit of a country can be
rectified by changing the external price of the currency. On the country if a fixed exchange rate
policy is adopted, then reducing a deficit could involve a general deflationary policy for the whole
economy, resulting in unpleasant consequences such as unemployment and idle capacity.
Thus, a floating exchange rate allows a government to pursue internal policy objectives such as
full employment growth in the absence of demand-pull inflation without external con-straints
(such as debt burden or shortage of foreign exchange).
 Absence of Crisis:
The periods of fixed exchange rates were frequently characterised by crisis as too much pressure
was put on central bank to devalue or revalue the country’s currency. However, the central bank
that devalued a currency by giving out too much of it would soon either stop or run out of it.
Similarly the central banks that revalued a currency by giving out too little of it in exchange for
other currencies would soon be flooded with that currency as it would get relatively large amounts
of other curren-cies. Under floating exchange rate system such changes occur automatically. Thus,
the possibility of international monetary crisis originating from ex-change rate changes is
automatically eliminated.
 Avoiding Inflation:
John Beardshaw has argued that, “A floating exchange rate helps to insulate a country from
inflation elsewhere. In the first place, if a country were on a fixed exchange rate then it would
‘import’ inflation by way of higher import prices. Secondly, a country with a payments surplus
and a fixed exchange rate would tend to ‘import’ inflation from deficit countries.”
 Fixed exchange rate
This is a system where a nation's currency is set at a fixed rate relative to all other currencies and
central banks intervene in the foreign exchange market to maintain the fixed rate. The major
42
alternative to the flexible exchange rate system is the fixed exchange rate system. This system
works the way it sounds: exchange rates are fixed or pegged; they are not allowed to fluctuate
freely in response to the forces of supply and demand.
For instance if the naira price of dollars is above its equilibrium level (which, for example, is the
case at the official price of $1 = Sh.so 25k), the Sh.so is said to be overvalued. It follows that if
the Sh.so is overvalued, the dollar is undervalued. Similarly, if the Sh.so price of the dollar is
below the equilibrium level, the Sh.so is undervalued. It follows that if the Sh.so is undervalued,
the dollar must be overvalued.
 Managed Float Exchange Rate
In a managed float (or dirty float) exchange rate regime, the monetary authority influences the
movements of the exchange rate through active intervention in the foreign market without
specifying, or recommitting to, a preannounced path for the exchange rate. Although market
conditions determine the exchange rate, this type of exchange rate regime also involves certain
less-specified central bank interventions with various objectives. A managed float exchange rate
regime belongs with the so-called intermediate methods because it stands between the extremes of
perfectly flexible and fixed regimes. It resembles the freely floating exchange rate in the sense that
exchange rates can fluctuate on a daily basis and official boundaries do not exist. The difference
is that the government can intervene in order to prevent the currency rate from fluctuating too
much in a certain direction. Under a managed float, the goal of intervention is to prevent sharp
fluctuations in the short run, but intervention does not target any particular rate over the long run.
Generally, the central bank intervenes only to smooth fluctuations. Some governments impose
bands within which the exchange rate can fluctuate, which is one of the reasons for calling this
approach “dirty.”
FACTORS AFFECT EXCHANGE RATES
One of the most common questions about exchange rates is “why do exchange rates change so
frequently?” This is because they depend on several factors, such as interest rates, money supply,
and financial stability.
43
Interest rates
Interest rates, inflation, and exchange rates are closely related because they directly influence each
other. When financial institutions change the interest rate, this impacts currency values. Higher
interest rates mean that lenders receive a higher return compared to other economies, which then
motivates them to spend more money in that country. This leads to an influx in foreign capital,
which causes the exchange rate to increase.
Decreasing interest rates have the opposite effect. As interest rates go down, so do exchange rates.
In short, higher interest rates make a country’s currency more valuable, which drives investors to
exchange their local currency for the higher-paying one.
Money supply
Money supply, or how much cash a country has on hand, influences both inflation and exchange
rates. This is the money that the country’s central bank creates. If there is too much money in
circulation, this causes inflation. This also means that the country’s currency isn’t worth as much
because there is more of it.
When that currency is exchanged internationally, it’s not worth as much because there’s an excess,
resulting in a decreasing exchange rate. This is what economists mean when they talk about how
“strong” a currency is.
Financial stability
The country’s economic health plays a role in determining its exchange rate. If a country has a
strong economy, people will buy its goods and services. This results in more international currency
being injected into the local economy. On the flip side, things like financial instability or political
turmoil can make international investors nervous and they may move their capital to more stable
countries.
44
CALCULATE EXCHANGE RATES
Currency conversion calculations can be tricky at first, but it really only requires a simple
calculation. Here is a step-by-step guide on how to calculate exchange rates:
1. Know the country’s exchange rate. You can find this information online or on the Western
Union app. If you’re traveling, the exchange rates are usually posted at places like banks,
airports, or currency exchange shops.
2. If you know the exchange rate, divide your current currency by the exchange rate. For
example, suppose that the USD/EUR exchange rate is 0.631 and you’d like to convert 100
USD into EUR. To accomplish this, simply multiply the 100 by 0.631 and the result is the
number of EUR that you will receive: 63.10 EUR. Converting EUR to USD involves reversing
that process. Using the same example, if you took your 63.10 EUR and multiplied it by 0.631,
you end up with the 100 USD you started with.
3. If you don’t know the exchange rate, you can use the following currency conversion calculation
to find it:
For example,
if you exchange 100 USD for 80 EUR, the exchange rate would be 1.25.
Examples Exchange rates from £1
The currency of the United Kingdom is the British pound, or pound sterling. When we refer to
foreign currency, we mean the money that a different country uses such as baht in Thailand or
rupees in India.
Not all currencies have the same value. We use exchange rates to convert from one currency to
another.
Exchange rates are published in newspapers and online where the pound is matched against various
currencies. This table shows examples of exchange rates, but they change constantly to reflect the
current economy.
45
To convert from British pounds to a foreign currency, you multiply by the exchange rate.
Question
Emma is going to South Africa and wants to exchange £250. Based on the table above, how many
rand should she get?
Answer
The exchange rate for South African rand is 19.33.
250 × 19.33 = 4,832.50 rand.
Question
Emma returns from South Africa with 85 rand. How much is this worth in British pounds?
Answer
85 ÷ 19.33 = 4.397309.
This answer needs to be rounded to two decimal places.
85 rand is worth £4.40.
46
CONCLUSION
The significance of exchange rates to business decisions cannot be ignored. Firms and their
managers as well as government representatives must be informed of changes in the foreign
exchange market so as to reap maximum benefits from this variable.
SUMMARY
This unit has examined exchange rates and has tried to link up the analysis to business firms.
Managers with knowledge of the exchange rate may have an upper hand among competitors in
making business decisions.
TUTOR -MARKED ASSIGNMENT
1. What are exchange rates?
2 Explain in detail how flexible and managed exchange rate’s function.
REFERENCES AND OTHER RESOURCES
Lipsey, R.G. and K.A. Crystal (1997) An Introduction to Positive Economics, Oxford, Oxford
Press.
Lipsey, R.G. and K.A. Crystal (1987) Economics, London: Harper and Row Publishers.
Dwivedi, D.N. (1987) Managerial Economics, New Delhi: Vikas Publishing House Pvt Limited.
47
CHAPTER SIX
FINANCE AND MANAGEMENT OF FOREIGN OPERATIONS.
INTRODUCTION
Many companies that have significant foreign operations derive a high percentage of their sales
overseas. Financial manager of the company requires an understanding of the complexities of
international finance to make sound financial and investment decisions. International operations
in the finance aspect or perspective involve consideration of managing working capital, financing
the business, control of foreign exchange and political risks, foreign direct investments. Most
importantly, the financial manager must consider the value of the US dollar relative to the value
of the currency of the foreign country in which business activities are being conducted. Currency
exchange rates may materially affect receivables and payables, and imports and exports of the US
Company in its multinational operations. The effect is more pronounced with increasing activities
abroad.
MANAGEMENT OF FOREIGN OPERATIONS AND INTERNATIONAL TRADE
The efficient and cost-effective production and delivery of goods and services to customers is
essential for business to flourish. Achieving this in the global marketplace poses unique and
exciting challenges, and international companies require skilled operations manages to deliver
these goals.
TYPES OF FOREIGN OPERATIONS
Companies, nations involved in foreign operations business may structure their activities in the
following three ways.
1. Wholly Owned Subsidiaries
A large, well-established company with much international experience may eventually have
wholly owned subsidiaries.
2. Imports/Exports Activities
A small company with limited foreign experience operating in “risky areas” may be restricted to
export and import activity. If the company’s sales force has minimal experience in export sales, it
48
is advisable to use foreign brokers when specialized knowledge of foreign markets is needed.
When sufficient volume exists, the company may establish a foreign branch sales office, including
sale people and technical services staff.
3. Joint Ventures
A joint venture with a foreign company is another way to proceed international and share the risk.
Some foreign governments require this to be the path to follow to operate in their countries. The
foreign company may have local goodwill to assure success. A drawback is less control over
activities and a conflict of interests.
ISSUE OF NATIONS/ ORGANIZATIONS WITH FOREIGN OPERATION
Nations involved in foreign operations are to take cognizance of the three key issues below:
a) Multiple-currency problem: sales revenues may be collected in one currency, assets

denominate in another, and profits measured in a third.
b) Various legal, institutional, and economic constraints: There are variations in such things
as tax, labour practices, balance of payment policies, and government controls with respect to
the types and sizes of investment, types and amount of capital raised, and repatriation of profits.
c) Internal control problem: When the parent office of a foreign operation company and its
affiliates are widely located, international organization difficulties arise.
THE CONCEPT OF CURRENCY RISK MANAGEMENT
Foreign exchange rate exists when a contract is written in terms of the foreign currency or
denominated in the foreign currency. The exchange rate fluctuations increase the riskness of the
investment, incur cash loses. The financial manager must not only seek the highest return on
temporary investments but must also be concerned about changing values of the currencies
invested. You at this point do not necessarily eliminate foreign exchange risk.
FINANCIAL STRATEGIES
In countries where currency values are likely to drop financial managers of the subsidiaries should:
 Avoid paying advances on purchases orders unless the sellers pays interest on the
advances sufficient to cover the loss of purchasing power.
49
 Not have excess idle cash. Excess cash can be used to buy inventory or other real
assets.
 Buy materials and supplies on credit in the country in which the foreign subsidiary
is operating, extending the final payment date as long as possible.
 Avoid, giving excessive trade credit. If accounts receivable balances are
outstanding for an extended time period, interest should be changed to absorb the loss in
purchasing power.
 Borrow local currency funds when the interest rate charged does not exceed US
rates after taking into account expected devaluation in the foreign country.
TYPES OF FOREIGN EXCHANGE EXPOSURE (RISK)
National and companies with foreign operations are faced with the dilemma of three different types
of foreign exchange risk. They are.
Translation Exposure
It is often called accounting exposure, measures the impact of an exchange rate change on the
firm’s financial statements. An example would be the impact of a Euro devaluation on a US firms
reported income statement and balance sheet. A major purpose of translation is to provide data of
expected income statement and balance sheet. A major purpose of transaction is to provide data of
expected impacts of rate changes on cash flow and equity. In the transaction of the foreign
subsidiary’s financial statements into the US parent’s financial statements, the following steps are
involved.
The foreign financial statements are put into US generally accepted accounting principles.
The foreign currency is translated into US dollars. Balance sheet account are translated using
the current exchange rate at the balance sheet date. If a current exchange rate is not available
at the balance sheet date, use the first exchange rate available after that date. Income statement
accounts are translated using the weighted average exchange rate for the period.
Translation gains and losses are only included in net income when there is a sale or liquidation
of the entire investment in a foreign entity.
50
Transaction Exposure
This measures potential gains or losses on the future settlement of outstanding obligations that are
denominated in a foreign currency. An example would be a US dollar loss after the European
devaluates, on payments received for an export involved in francs before that devaluation. Foreign
currency transactions may result in receivables or payables fixed in terms of the amount of foreign
currency to be received or paid. Transaction gains and losses are reported in the income statement.
Foreign currency transacted are those transactions whose terms are denominated in a currency
other than the entities functional currency.
Operating Exposure
It is often called economic exposure. It is the potential for the change in the present value of future
cash flows due to an unexpected change in the exchange rate. Operating or economic exposure is
the possibility that an unexpected change in exchange rates will cause a change in the future cash
flows of a firm and its market value. It differs from translation and transaction exposure in that it
is subjective and thus not easily quantified. Note the best strategy to control operation exposure is
to diversify operations and financing internationally.
CONCLUSION
This unit has introduced you to the various types of foreign operations that we have, the issues of
nations and organizations in foreign operations management. You have also learnt about the
concept of currency risk management.
SUMMARY
The foreign exchange market (forex, fx or currency market) is a global worldwide–decentralized

financial market for trading currencies. Financial centres around the world function as anchors of
trading between a wide range of different types of buyers and sellers around the clock, with the
exception of weekend. The foreign exchange market determines the relative values of different
currencies. The foreign exchange market assists international trade and investment, by enabling
currency conversion.
Discuss the financial strategies that are involved in currency risk management.
51
Answer to Self-Assessment Exercise
Translation exposure has it that.
The foreign financial statements are put into US generally accepted accounting principles.
The translation gains and losses are only included in net income when there is a sale or
liquidation of the entire investment in a foreign entity.
REFERENCES/FURTHER READING
Bakare I. O. A. (2003): Fundamental Macro Economic Giittbak Pushes, Fadeyi, Lagos.
Lawrence S. Welch & Co (2007): Foreign Operations Methods: Theory, Analysis Sis and Strategy.
Edward Eldgar Publishing, Business & Economics – 462.
Zemel E. (2006): Managing Business Process Flows (MBPF), Prentic.
52
CHAPTER SEVEN
FOREIGN INVESTMENT ANALYSIS
INTRODUCTION
Foreign investment analysis is the procedure for analyzing expected cash flows for a proposed
direct foreign investment to determine if the potential investment is worth undertaking. In finance
literature, foreign investment analysis is also called capital budgeting. Foreign investment analysis
is concerned with direct (as distinct from portfolio) investments. The overall foreign investment
decision has two components: the quantitative analysis of available data (“capital budgeting”
proper) and the decision to invest abroad as part of the firm’s strategic plans.
This chapter deals with the quantitative aspects of foreign investment analysis. It treats, first, the
general methodology of capital budgeting, second, the international complexities of that
procedure, and third, the implications of international accounting for conclusions reached by that
methodology.
OBJECTIVES OF FOREIGN DIRECT INVESTMENT (FDI)
The major objective of FDI is to provide the investing company the opportunity to actively manage
and control the host nation’s activities.
The following are the identified reasons for FDI: -
 Increase sales and profit: most of the largest and best-known multinationals earn millions of
dollars each year through overseas sales, for example General Electric a US MNE held $448.9
billion dollars in foreign assets in 2010 (World Investment Report 2011). Small and medium
scale enterprises (SMEs) also benefit from the growth of operation of large MNEs in the aspect
of local suppliers; if their productivity is high there is a possibility that the MNE will extend
the contract and allow them supply other world-wide locations. SMEs are interested in FDI
because it helps them increase their sales and profits.
 Reduction in Cost: An MNE can achieve lower cost of production by going abroad to operate
than by producing in its home country. Some cost to be considered are; transportation cost,
cost of energy, access to raw materials and labour cost. However some critics argued that this
can have an adverse effect as the case of US top sport brand NIKE in 1992, their business
model was to outsource all manufacturing to low cost areas in the world such as Indonesia
which had a labour cost of 4% of those prevailing in US and re-invest the money saved into
53
R&D and marketing. Nike was accused of using child labourers, sexually abusing female
workers and also unreasonable working hours for their workers. This had a dent on their public
image and in 1999 they recorded a sales loss of $67.7 million (Barboza 2006).
 Protect domestic markets: a major reason the domestic market. Some MNEs enter
international markets in order to bout out potential competitors and thus prevent them from
expanding their operations overseas. For example, Airtel Nigeria overtook Glo Mobile as the
second largest player in the mobile market after its rebranding exercise in 2008.
 To enter emerging markets: some foreign economies have a faster economic growth pace
than others and FDI provides MNCs a possibility to take advantage of this opportunity.
Benefits of Foreign Portfolio Investment
Foreign portfolio investment increases the liquidity of domestic capital markets, and can help
develop market efficiency as well. As markets become more liquid, as they become deeper and
broader, a wider range of investments can be financed. New enterprises, for example, have a
greater chance of receiving start-up financing. Savers have more opportunity to invest with the
assurance that they will be able to manage their portfolio, or sell their financial securities quickly
if they need access to their savings. In this way, liquid markets can also make longer-term
investment more attractive.
Foreign portfolio investment can also bring discipline and know-how into the domestic capital
markets. In a deeper, broader market, investors will have greater incentives to expend resources in
researching new or emerging investment opportunities. As enterprises compete for financing, they
will face demands for better information, both in terms of quantity and quality. This press for fuller
disclosure will promote transparency, which can have positive spill-over into other economic
sectors. Foreign portfolio investors, without the advantage of an insider’s knowledge of the
investment opportunities, are especially likely to demand a higher level of information disclosure
and accounting standards, and bring with them experience utilizing these standards and a
knowledge of how they function.
Foreign portfolio investors may also help the domestic capital markets by introducing more
sophisticated instruments and technology for managing portfolios. For instance, they may bring
with them a facility in using futures, options, swaps and other hedging instruments to manage
portfolio risk. Increased demand for these instruments would be conducive to developing this
54
function in domestic markets, improving risk management opportunities for both foreign and
domestic investors.
In the various ways outlined above, foreign portfolio investment can help to strengthen domestic
capital markets and improve their functioning. This will lead to a better allocation of capital and
resources in the domestic economy, and thus a healthier economy. Open capital markets also
contribute to worldwide economic development by improving the worldwide allocation of savings
and resources. Open markets give foreign investors the opportunity to diversify their portfolios,
improving risk management and possibly fostering a higher level of savings and investment
GENERAL METHODOLOGY FOR ONE-COUNTRY CAPITAL BUDGETING.
Capital budgeting is essentially concerned with three types of data: (1) cash outflows (i.e., project
costs) and (2) project cash inflows, both of which are measured over a period of time, and (3) the
marginal cost of capital. This chapter will follow the typical procedure of using annual time
periods, but an analysis could be based on cash flows for quarters, months, or even days.
a. Project Cash Outflows (Costs). Project cash outflows refers to the cash cost paid
out to start the project. Usually the outflow for an investment occurs at the time when the
investment is made, which is to say in “year 0” if the project is to be analyzed in annual
time periods. However, other time squences are possible; for example, the cash outlay
could occur over several years, as when a very large hydroelectric plant is being
constructed.
Cash outflows include:
• Cash paid for all new assets purchased.
• Cash paid to prepare a new site. These outlays might be for such costs as grading, building
access roads, or installing utilities.
• Cash paid to dispose of, remove, or destroy old equipment or other assets, or, alternatively,
net cash received from the sale of old assets. Cash disbursed or received, net of any tax effect,
is the relevant flow.
• Cash cost of additional storage and/or transportation facilities needed because of the new
investment. If the new venture necessitates additional warehousing space or additional
transportation equipment (e.g., a new fleet of trucks), these additional costs must be included
as part of the required supporting investment for the project.
55
b. Project Cash Inflows. The relevant cash inflows for any project are those that will
be received by the firm in each future year from the investment. This set of cash flows must
be identified by specific year. Each annual cash inflow differs from net income for that
same period for two general reasons:
1. The cash inflows are calculated ignoring noncash expenses, such as depreciation of assets, or
amortization of earlier costs, such as research and development (R&D) or prior-service
pension costs.
2. The calculation is usually made on the hypothetical assumption that the entire venture is
financed with equity (stockholder) funds and that taxes are thus based upon such an “all-
equity” assumption. Consequently, the income tax calculation is a hypothetical amount,
unless the firm is, in fact, financed without any debt. (The tax shelter consequences of interest
payments are incorporated into the cost-of-capital calculation.)
A simplified view of a single year’s cash flow calculations is illustrated below.
56
The top-down or bottom-up simplification is important, because, in practice, one or the other is
often applied to pro forma income statements for a project as the fastest way to estimate likely
cash flows. Hence, the person doing the calculations is often an unconscious slave to the
accounting methods used in the pro forma analysis, and, when those methods differ from home
country methods, errors are made.
APPENDIX A: ILLUSTRATIVE INTERNATIONAL CAPITAL BUDGETING EXAMPLE
To illustrate complexities than can arise in the analysis of a foreign investment proposal, a capital
budgeting analysis for Cacau do Brasil, S.A., a proposed investment in a chocolate factory in
Belém, Brazil. is presented. The U.S. parent will invest the entire equity of R$56,000,000, or
57
US$20,000,000 at the current exchange rate of R$2.80 = US$1.00. (“R$” is the symbol for Brazil’s
currency, the real.) If established, Cacau do Brasil, S.A. will have an initial balance sheet as shown
in Exhibit 5A.1.
Cacau do Brasil is expected to operate as follows:
• Sales. Unit sales will grow at 3% per annum. Initial unit sales will be 25,000 tons, and the initial
sales price will be R$5,000 per ton. Initial labor cost is R$2,000 per ton and initial local material
will cost R$200 per ton. Cacau do.
58
SUMMARY
International investment analysis is based on analysis of expected future cash flows from a foreign
direct investment. The database for estimating future cash flows is often current and recent past
financial statements. In addition, future cash flows depend on local accounting and tax treatment
of profits and expenses. The essential difference between domestic and international investment
analysis is that estimates of future cash flows are in different currencies and depend on local
accounting methods. Those methods often differ from one country to another.
In this unit, you have learnt the Meaning of Foreign Direct Investment, Objectives of Foreign
Direct Investment (FDI), the different theories of Foreign Direct Investment, the Benefits of FDI
to host country, the adverse effects of FDI to host country, the definition of Foreign Portfolio
Investment (FPI), the benefits of Foreign Portfolio Investment, the Shared attributes and
complementarity of the benefits as well as the Policy differences and complements.
59
CHAPTER EIGHT
INTERNATIONAL ACCOUNTING STANDARD SETTING BODIES AND ORGANS
INTRODUCTION
This unit discusses the major international accounting setting bodies in the world. There are two
main international accounting setting bodies; these are the IASB and the FASB. While the IASB
sets accounting standards that are globally acceptable, the FASB sets accounting standards for the
United States. Thus, the IASB and FASB are discussed and the IFAC is also discussed here.
ABBREVIATIONS IN ACCOUNTING STANDARDS
Certain abbreviations are used in the discussion of accounting standards, some of this include:
1. IAS: International Accounting Standards

2. IASC: International Accounting Standards Committee
3. IASB: International Accounting Standards Board
4. IFRS: International Financial Reporting Standards
5. SAS: Statement of Accounting Standards
6. NASB: Nigerian Accounting Standards Board
7. FRCN: Financial Reporting Council of Nigeria
8. IFAC: International Federation of Accountants
9. FASB: Financial Accounting Standards Board
INTERNATIONAL FEDERATION OF ACCOUNTANTS (IFAC).AND AFFILIATES
The International Federation of Accountants (IFAC) is the global organization for the accountancy
profession dedicated to serving the public interest by strengthening the profession and contributing
to the development of strong international economies. IFAC is comprised of over 175 members
and associates in more than 130 countries and jurisdictions, representing almost 3 million
accountants in public practice, education, government service, industry, and commerce. Their
members and associates are representatives from various professional accountancy bodies from
different countries including developing, emerging, and developed countries. IFAC was
established in 1977 and perform the following roles:
60
1. Provides the structures and processes that support the development of high-quality
international standards.
2. The standards it supports, in the areas of auditing, assurance, and quality control; public
sector accounting; accounting education; and ethics, are an important part of the global
financial infrastructure and contribute to economic stability around the world.
3. Through its member bodies, IFAC provides tools and guidance to facilitate the adoption
and support implementation of standards and support professional accountants in business
and small and medium practices.
4. Supports the development of the accountancy profession in emerging economies.
5. Speaks out on public interest issues where the profession’s voice is most relevant; and
6. Promotes its values of integrity, transparency, and expertise
FINANCIAL ACCOUNTING STANDARD BOARD (FASB) OF U.S.A
The Financial Accounting Standards Board (FASB) is the primary standard setting body in the
United States. It is a private organization that is non-profit making with the main responsibility of
establishing and improving already established accounting standards with the US. The FASB was
established in 1973 to replace the American Institute of Certified Public Accountants' (AICPA)
Accounting Principles Board (APB). The Securities and Exchange Commission (SEC) saddled the
FASB with the responsibility of setting accounting standards for public companies in the U.S. The
FASB and its predecessor organizations have been issuing accounting standards in the United
States since the 1930s (Robinson, Hennie, Elaine, & Michael, 2009).
INTERNATIONAL FINANCIAL REPORTING STANDARD FOUNDATION (IFRS

FOUNDATION) AND AFFILIATES INCLUDING IASB
The International Accounting Standards Committee (IASC) was formed in the year 1973 and was
the first international standards-setting body. In 2001, the IASC was reorganized into the
International Accounting Standards Board (IASB). The IASB is the independent standard-setting
body of the International Financial Reporting Standards (IFRS) foundation. While the IASC
formulated the International Accounting Standards (IAS), IASB formulates IFRS and enforce
IASs that the substitutes are not yet available in IFRS. This implies that both IAS and IFRS are
still relevant under the IASB. The IFRS foundation is an independent private organization that is
61
non-profit making working in the public interest and charged with the following objectives
according to Olanrewaju (2012):
1. To develop a single set of high quality, understandable, enforceable and globally accepted
IFRSs through its standard setting body, IASB.
2. To promote the use and rigorous application of those standards.
3. To take account of the financial reporting needs of emerging economies and SMEs; and
4. To bring about convergence of national accounting standards and IFRSs to high quality
solutions.
The IASB is responsible for developing, in the public interest, a single set of high quality,
understandable and enforceable global accounting standards (IFRSs) that require transparent and
comparable information in general purpose financial statements and other financial reporting to
help participants in the various capital markets of the world and other users of the information to
make economic decisions. The IASB objective is to require like transactions and events to be
accounted for and reported in like way and unlike transactions and events to be accounted for and
reported differently, both within an entity over time and among entities throughout the world. The
choices in accounting treatment are continuously being reduced. Consequently, the IASB has,
since its inception, issued a number of IFRSs and interpretations, and amended several IASs
including interpretations issued under the previous Constitutions of IASC. In pursuit of its
objectives, the IASB cooperates with national accounting standards setters to achieve convergence
in accounting standards around the world.
IFRSs are developed through an international due process that involves accountants, financial
analysts and other users of financial statements, the business community, Stock Exchanges,
regulatory and legal authorities, academics and other interested individuals and organizations from
around the world. This due process is conducted by the IASB, which has complete responsibility
for all technical matters including the publication and issuing of standards and interpretations
(Josiah, Okoye, & Adediran, 2013). The IFRSs were first adopted in 2005 by many countries and
as at 2017; over 100 countries around the world have adopted IFRS.
62
CONCLUSION
The IFAC acts as a check on both the accounting profession and the standard providers. Although,
the FASB still formulates standards for the US, the IFRS have since been adopted by more than
100 countries around the world. By adopting IFRS, countries.
SUMMARY
This unit explained the key terms used in accounting standards globally; gave background
information of IFAC, FASB and IFRS foundation.
1. What is the full meaning of FASB?
2. Explain the roles of IFAC.
3. What are the functions of IFRS foundation?
Josiah, M., Okoye, A. E., &Adediran, O. S. (2013).Accounting standards in Nigeria, the journey
so far.Research Journal of Business Management and Accounting, 2(1), 001-010
Olanrewaju, O. O. (2012). IFRS pal – handy approach. Lagos; Dimkem Publications Limited.
Robinson, T. R.,Hennie, V. G., Elaine, H., &Michael, A. B. (2009). Financial reporting standards:
International financial statement analysis. CFA Institute Investment Series
63
CHAPTER NINE
PERFORMANCE EVALUATION IN MNCS
INTRODUCTION
Within multinational corporations, there is need to measure the performance of the various
branches. This unit discusses the meaning of performance evaluation, financial measures used by
MNCS to evaluate domestic and foreign subsidiaries, issues to consider when developing MNC
evaluation systems, responsibility accounting and performance evaluation in MNCS.
MEANING OF PERFORMANCE EVALUATION
Performance evaluation is the periodic review of operations to ensure that the objectives of the
enterprise are being accomplished. It is a multi-purpose tool used to measure actual performance
against expected performance, provide an opportunity for the employee and the supervisor to
exchange ideas and feelings about job performance, identify employee training and development
needs, and plan for career growth. Performance evaluations are important tools used by
management to review and discuss employees' performances.
Several types of performance evaluations exist, including 360-degree feedback, management by

objectives and ratings scale evaluations. Regardless of the type of performance evaluation system
used, managers perform evaluations to benefit employees and the employer. However,
implementing performance evaluations offer advantages and disadvantages. Companies who
recognize the disadvantages can make the necessary adjustments to receive the full benefits of
implementing performance evaluations.
Benefits result from the Performance Evaluation process:
 Control of the work that needs to be done

 Enhancement of employee motivation, commitment, and productivity
 Identification of goals and objectives for the employee
 Satisfaction of the basic human need for recognition
 Identification of process improvement opportunities
 Identification of employee development opportunities
64
FINANCIAL MEASURES USED BY MNCS TO EVALUATE DOMESTIC AND
FOREIGN SUBSIDIARIES
MNCs use various measures to evaluate the results of their operations at home and abroad. Let us
discuss some of the measures.
1. Profitability Measures
A fundamental measure of operating success is profitability. This can be expressed as gross profit,
net income, or return on investment (ROI). Gross profit (or gross margin) is the difference between
revenues and the cost of products sold or services provided. Net income is the “bottom line” profit
figure of an operation. Expressed as a rate of return, ROI relates profitability to invested capital. It
is said that since shareholders are profit oriented, manager should be as well. Profitability measures
imply a level of decentralization that does not always exist in multinational operations.
2. Sales Growth and Cost Reduction
The ability to reach customers is vital to company’s long-run success. Customer acceptance of
company’s products or services translates directly into the sales (or revenue) figure. Sales growth
may also indicate increased market share. Because of an increase in globalization leading to high
competition in the 1990s, cost reduction intensified. Cost reduction is the minimization of
associated cost using certain techniques, an example is outsourcing functions such as accounting
and information technology. Sales growth and cost reductions should also improve profitability.
3. Budgets as a Success Indicator
Sometime, budgeting has been accepted as a management tool for controlling operations and
forecasting future operations of domestic companies. One purpose of the budget is to clearly set
out the objectives of the entity. A budget generally provides a forecast and a means of comparing
the actual results, of operations to the budget. This comparison produces variances that can be
analyzed to evaluate performance and improve the efficiency of future operations.
When a budget is used for a foreign subsidiary, the budget should be developed by that subsidiary.
The experience of the local manager is extremely important, in that, it produces a deep knowledge
of the specific business situation. Thus, the subsidiary manager should fully participate in
establishing the subsidiary’s goals and in developing its budget. A budget developed on this level
65
will help control the operations and make achievement of goals possible. This budget can be used
by the local manager on a daily basis.
Budgeting gives local managers the opportunity to set their own performance standards. In
international operations, top management is not as familiar with what the standards should be.
Headquarters must rely to a greater extent on good local or regional budgets, which help facilitate
the strategic planning process.
The subsidiaries’ budgets are approved at the parent-company level and often require the
endorsement of the president and/or the board of directors. Presumably, headquarters uses the
budget to consider the circumstances peculiar to each subsidiary. All of this should ensure a two-
way flow of communication between the subsidiary and headquarters, which in turn, will improve
the overall budgeting process.
ISSUES TO CONSIDER WHEN DEVELOPING MNC EVALUATION SYSTEMS
From previous studies and literatures, it can be concluded that MNCs and their subsidiaries operate
in different international environments, and the performance of the foreign subsidiaries is affected
by some variables and factors such as: environmental factors (economic, legal, political,
technological, cultural, and social), transfer pricing, foreign currencies, and inflation. If the MNC
want to evaluate the real performance of the foreign subsidiaries and their managers, it must
consider these factors and variables at performance evaluation process of foreign subsidiaries and
their managers. But the MNC faces some problems and difficulties when it deals with these issues
in the performance evaluation of foreign subsidiaries and their managers as the following:
1. Transfer Pricing
The transfer price (internal price) is the price at which goods and services are transferred (bought
or sold) between members of MNC, for example, from parent to subsidiaries, between subsidiaries,
and from subsidiaries to parent. The MNC often sets the transfer prices to maximize the global
after-tax income or otherwise manoeuvre profits to lower tax rate countries. This may however,
conflict with the real performance evaluation of foreign subsidiaries and their managers. The issue
of transfer pricing in MNC is complicated by the fact that tax and custom authorities of different
countries take an active interest in the methods employed. Furthermore, MNCs can use transfer
prices in a similar manner to reduce the impact of tariffs. Tariffs increase import prices and apply
66
to inter-corporate transfers as well as to sales to unaffiliated buyers. Although no company can do
much to change tariffs, the effect of tariffs can be lessened, if the selling company underprices the
goods it exports to the buying company. Under-pricing inter-corporate transfers can also be used
to get more products into a country that is rationing its currency or otherwise limiting the value of
goods that can be imported. The subsidiary can import twice as many products if they can be
bought at half the price.
2. Foreign Currencies
The accounting records and financial statements of the foreign subsidiaries are generally
maintained in the subsidiary’s local currency. The parent company must be able to translate these
foreign currency financial statements to the currency of the parent company. The choice of
currency, in which to evaluate the performance, is one of the problems of performance
measurement and evaluation of foreign subsidiaries and their managers. What is the best method
for the MNC in evaluating the real performance of the foreign subsidiaries and their managers in
the local currency results or the results translated into the currency of the parent company? The
MNC needs to translate the financial statements of its foreign subsidiaries for many reasons: (1)
to record the transactions that are measured in a foreign currency, (2) to prepare consolidated
financial statements which report on the economic entity as a whole, (3) to evaluate the operations
of a foreign business segment, (4) to evaluate the performance of the management of the foreign
subsidiaries, (5) to direct and control the foreign operations, and (6) for the convenience of users
whether they are internal or external users.
The multinational companies use the current exchange rate method to translate the accounts of
foreign subsidiaries from the currency of the host country into the currency of the parent company,
because this method provides information, which reflect economic facts and the real performance
of foreign subsidiaries and their managers
3. Inflation
Inflation is one of the environmental factors, which affecting the performance of multinational
companies. It is considered as one of the variables (problems) that are out of control of subsidiary
management. During inflation periods, the figures and information in the financial statements and
reports are misrepresentative and may mislead the decision makers; consequently, they affect the
67
performance of the company. Thus, the multinational company must consider the effect of inflation
on the financial statements and reports of the company, if it wants to measure and evaluate the real
performance of foreign subsidiaries in the host countries. Doubtless, high inflation rates render
accounting numbers fairly useless for performance evaluation. Without adjustments, realistic
evaluations of units and management would be very difficult. Thus, a number of companies find
it beneficial to adjust their financial statements for inflation and to discuss with their owners and
shareholders the related impact on dividend policy and capital requirements. While other
companies find it not beneficial to adjust their financial statements for inflation.
4. The effect of the environmental factors
The foreign subsidiaries operate in different international environments. Each environment may
have economic, legal, political, cultural and social factors different from those in other
environments. Because of these environmental factors it is possible to have a good management
performance despite poor subsidiary performance, and vice-versa. Thus, if the MNC want to
evaluate the real performance of foreign subsidiaries and their managers, it must eliminate the
effect of these environmental factors from the performance of the foreign subsidiaries and their
managers.
RESPONSIBILITY ACCOUNTING AND PERFORMANCE EVALUATION IN MNCs
The concepts of responsibility accounting are devised to place performance evaluation into
manageable contexts. Responsibility accounting merely defines spheres of reference
(responsibility centers) that had control over costs and / or revenues and to which inputs (resources)
and outputs (products, services, or revenues) could be traced. These responsibility centers varied
in complexity of control, structure, and purpose. The responsibility centers can be classified below:
Cost Centers: whenever controls and objectives are concerned, the cost centers are the simplest
spheres of the responsibility centers. Control is exercised over incurred costs. Objectives normally
call for the maximization of outputs, in quantity and quality, within the constraints on inputs
specified by time and effort, standard cost, flexible budget, and similar systems. Structures vary
from a single person, operation, or machine to the function of an entire plant. In practice, control
and evaluation are enhanced by breaking down structures into smallest components exercising
control over costs.
68
Performance evaluations of cost centers are primarily financial and focus upon variances from
predetermined standards. The better systems are based upon reasonably attainable standards,
tailored to suit the responsibility centers, and revised as conditions change. Other quantitative,
non-financial measures are often employed as well: number of reject products, machine
breakdowns, employee turnovers, and alike. Qualitative assessment may be made by product
engineers by using surrogate measures (such as using the numbers of grievances to judge employee
attitudes), or all too often, by relegating assessments to consumers where products are concerned.
Revenue Centers: By definition, revenue centers can affect output levels (revenues) in relation to
the inputs (resources represented in expense budgets), but no direct control is exercised over the
costs of the products or services to be sold. Motivation and control are sought by means of
budgeted revenues and expenses. The twin objectives are to maximize revenues while spending
within authorized levels. Sales offices are typical revenue centers, often with further segmentation
into product lines, territories, salesmen, and so on.
Performance evaluation usually begins with financial comparisons of actual and budgeted levels
of revenues and expenses, after variable portion of the latter have been adjusted to reflect actual
activity levels. Since the costs and qualities of the sold items are not controllable, appropriate
adjustments should be made for any favorable or unfavorable effects caused by changes in these
factors that are not recognized by budget revisions. Non-financial measures are also employed,
although not necessarily in a systematic fashion (market shares, changes in sales mix, repeat sales,
numbers of customers, quotas, calls made by salesmen, complaints, and others). The non-financial
measures become increasingly important as inflation, which affects revenues expressed in
monetary units.
Profit centers: The profit centers are units or divisions that have control over both costs and
revenues. Performance evaluations relate outputs (revenues) with inputs (costs and expenses) by
focusing on profits (revenues minus identifiable expenses). Profit is an absolute measure that in
itself can be assessed as a subjective representation of the firm’s financial health. At such, it
becomes a more meaningful measure when relative comparisons are possible with budget, results
of prior periods and profit of other divisions of the firm.
69
CONCLUSION
Multinational corporations usually measure the performance of its branches in order to determine
their overall performance. Different performance evaluation techniques are used depending on the
peculiarity of the business. Issues such as inflation, exchange rates fluctuations, transfer pricing
and other environmental factors affect performance evaluation of MNCs.
SUMMARY
This unit discussed the meaning of performance evaluation, financial measures used by MNCs to
evaluate domestic and foreign subsidiaries, issues to consider when developing MNC evaluation
systems, responsibility accounting and performance evaluation in MNCs.
1. Define the concept of performance evaluation
2. List and explain five financial measures used by MNCs to evaluate domestic and foreign
subsidiaries
3. Why consider inflation an issue when developing MNC evaluation systems?
4. Discuss performance evaluation of responsibility centers in MNCs.
70
CHAPTER TEN
MULTINATIONAL CORPORATIONS
Contents
 Introduction
 Objectives
 Main Content
 Meaning of Multinational Corporations
 Characteristics of Multinational Companies (Mncs)
 Advantages of Multinational Companies (Mncs)
 Disadvantages of Multinational Companies (Mncs)
 Mn’s and Consolidated Financial Statements
 Accounting Issues of Multinational Corporations
 Conclusion
 Summary
 Tutor-Marked Assignment
 References/Further Readings
INTRODUCTION
World history suggests that the growth in cross border trade led foreign investors to invest in
countries and further establish branches across the globe especially in environments that have
cheaper labour. This led to the establishment of Multinational corporations, the focus of this unit.
MEANING OF MULTINATIONAL CORPORATIONS
Multinational Corporation (MNC) is a business organization operating in more than one country.
MNC can be defined as an undertaking which owns or controls productive or service facilities in
more than one country, thus excluding mere exporters, even those with established sales
subsidiaries abroad, as it does more licensers of technology. MNC is also referred to as
“Multinational Company” or “International Company” or“Transnational corporation”.
71
Therefore, it can be defined as a main company (a parent company) manages a group of branches
or subsidiaries in different countries to achieve certain objectives, by working together through a
world managerial strategy under the constraints and laws in the home and host countries.
According to this definition of the MNC we can conclude the following facts about the MNC:
 There is a parent company in the home country where the Headquarter is.
 There are branches or subsidiaries in different countries (host countries).
 The branches or subsidiaries operate not only to achieve special objectives for themselves, but
also for general objectives of the MNC as a whole, according to a certain international strategy.
 The parent company works under the laws of the home country, while the foreign branches or
subsidiaries work under the applied laws in the host countries.
 The company must be controlling foreign offices, production, policies, quality, deadline and
procedures.
 The product being produced must sooth the region where the company/branch is located.
The first multinational business organization was the Knights Templar, founded in 1120. After
that came the British East India Company in 1600 and then the Dutch East India Company,
founded March 20, 1602, which became the largest company in the world for nearly 200 years
(Nobes& Parker, 2008).
CHARACTERISTICS OF MULTINATIONAL COMPANIES (MNCS)
1. Geographical Spread: This geographical spread of MNCs places them in a considerable

flexible position, because of the wide range of the multi-options in some decision areas, such
as sourcing, pricing, financing, cash flow etc. The best MNC is able to take the advantage of
changes in the economic environment internationally. The existence of networks of foreign
affiliates within MNC gives the possibility of integrated production and marketing on a global
basis. So, this may give rise to extensive intra-firm trade, such as various stages in the
production process which are located in different countries or affiliates which specialize in a
particular part of the total product line. The intra-transfers of MNC constitute a very significant
part of the total volume of international trade.
2. The Efficiency: The magnitude of the available resources of MNCs enables it to distribute
these resources wherever they want in different countries in the world. MNC can transport
72
investments, money, people, machines, materials, goods, special technical knowledge and
cleverness, and other services. All these are managed from a global and national perspective.
This attitude of globalization in management thinking means that all affiliates are managed
and controlled by the headquarters of the MNCs, but with a certain degree of the
decentralization in some decision making areas. From this vantage point, the MNC is capable
of tapping and manipulating its resources on a worldwide basis, using them in the locations
considered to offer the best opportunities and/or the lowest risks. In other words, the MNC can
generally obtain financing and produce its products at the lowest possible total costs, and also
select the most promising available markets in which to sell.
3. The Power: The power attribute of the MNC is a result of its size, geographical spread, scope
of operations, and efficiency. Today it is normal that the MNC records annual sales greater
than GNP in some countries where it operates. Consequently, the MNC, as a giant among local
firms, in general, has the power (at least in the economic sense) to dominate and control the
local markets. Because the MNC lacks the protection of the international law, it relies upon
itself to compete and win. For this, the MNC transcends the national boundaries and controls
to have the potential to influence the world affairs and course of events in the host countries in
very significant ways.
4. The Flexibility: According to its size and scope, the MNC is certainly the most flexible of the
economic enterprises. The excellent communication systems enable the widely decentralized
operations to serve the local needs, and also permit the centralized direction to assure the goal
congruence. Thus, the headquarters can manipulate the mobile resources of the MNC on a
global basis, based upon the best overall interests for MNC. It can produce, assemble, and
market in the locations offering the best opportunity. This kind of flexibility often enables the
MNC to offset or escape from restrictive regulations or controls in certain sections of the world.
Transfer prices, credit terms, loans, and other points are examples of devices available to the
MNC.
ADVANTAGES OF MULTINATIONAL COMPANIES (MNCS)
1. They ensure optimum utilization of resources both in their domestic and foreign companies.
2. They represent risk-taking enterprise for advancement, development and the provision of
services.
73
3. They provide capital investments where urgently needed.
4. They assist the development of emerging nations and distant regions, by generating
investment-multiplier effects and invisible trade.
5. They are leaders in innovation, business methods and financial practices.
6. They prove the validity of international cooperation and regional schemes.
7. They provide advanced training of staffs and opportunity for employment and career
development.
8. They allow a wide participation on their investments, thereby contributing support democracy.
9. They assist in the balance of payments between developed and developing regions.
10. They lead to international mobility and trade.
11. They launch nations on a path of the self-sufficiency.
12. They provide a framework of interlocking operations and financial strategies.
DISADVANTAGES OF MULTINATIONAL COMPANIES (MNCS)
1. They tend to exploit national resources.

2. They create tensions in the host countries in the political, social and economic aspects.
3. They foster excessive nationalism and anti-company feelings.
4. They exercise arbitrary control over their operations in the host countries to the exclusion of
local factors.
5. They constitute crippling competition to the local enterprise.
6. They possess strong economic power and thereby exert unfair pressures and gain unfair
advantages.
7. They tend to achieve economic domination over smaller economies.
8. They sometimes practice unethical business methods, such as pricing speculations, excessive
royalties, loss accounting.
9. They tend to aggravate the host country’s currency situation.
10. They have adverse effects on the motivation of their own staff, by the impersonal stratification
of controls, thus stifle initiative and encourage risk avoidance.
11. They export capital and thereby jobs to the foreign countries.
12. They build up profits abroad at the expense of the home country.
13. They are insensitive to the local social and cultural values.
74
MNCS AND CONSOLIDATED FINANCIAL STATEMENTS
Consolidated financial statements combine 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. Multinationals are often required by the countries in which they do business to set up a
separate corporation in each country. The point is that a legal entity is not necessarily the same as
an economic entity. From an economic point of view, the activities of these various legal entities
are centrally administered from corporate headquarters. Thus, the intent of consolidated financial
statements is to provide financial accounting information about the group of companies from an
overall perspective.
Consolidated financial statements first appeared around the turn of the 20th century in the United
States. This was a time of great economic expansion during which a number of corporations grew
into economic giants. The era witnessed a wave of corporate mergers. It is said that J.P. Morgan
was so proud of his US steel company (the first billion-dollar company in the world) that he
insisted on preparing and disseminating consolidated financial statements since the company’s
inception in 1901. Since holding companies first became important in the United States, it is not
surprising that US accountants were the first to experiment with consolidated financial statements.
Holding companies became important in Great Britain and Netherlands in the 1920s, so
consolidated financial statements appeared there somewhat later than in the United States. Today,
they are required in both countries. The practice moves much more slowly in the other European
and non-European countries.
ACCOUNTING ISSUES OF MULTINATIONAL CORPORATIONS
The accounting issues of MNCs become numerous because of the complexity involved in
managing and accounting for transactions in more than one country. These issues are discussed as
follows:
1. Various accounting standards issues: accounting standards vary from one country to another
and this influence significantly the overall financial reporting system of the MNCs. Although,
Nigeria as adopted IFRS, not all countries have adopted as such there are differences in the
recognition of intangible assets, asset measurement, financial instruments, provisions,
employee benefits, deferred tax, revenue recognition, comprehensive income, and others. All
75
these affect the consistency of the report being produced, for instance, the Last-In-First-Out
(LIFO) method of inventory valuation is allowed under US GAAP and other local standards
while this method is not allowed under the IFRS.
2. Foreign exchange fluctuations and translation issues: the issues of more than one country
implies more than one currency, as such, there is need for the financial statements of
subsidiaries in other countries to be translated to the parent’s currency. The translation process
sometimes can be in the form of transaction or the entire financial statements (will be discussed
in module 4) which is influenced by the fluctuation in the exchange rates. These fluctuations
affect the treatment of transactions in the translated financial statements.
3. Diversity in economic factors: an important macro-economic factor is level of inflation. The
level of inflation in different countries influences their accounting treatments and procedures.
Also, accounting systems are further influenced by tax laws which determine the treatment of
financial transactions in the financial reports. These make consolidation of financial reports
difficult for the MNCs.
4. Capital budgeting issues: in MNCs capital budgeting is seen to be complicated due to
associated risk with future cashflows. These risks include: political, economic and financial.
The political risk is the probability that unexpected political events will affect the business
such as, political unrest, unfavorable changes in labour laws, etc. Economic risks include the
macro-economic factors that can influence the business such as inflation, etc. Financial risk
involves the undesirable changes in financial factors that will affect the business. Such factors
are interest rates, exchange rate, etc. The level of risk is usually country specific.
CONCLUSION
As discussed in the previous unit, one of the reasons for adopting IFRS in Nigeria is to reduce cost
of preparing consolidated financial statements of Multinational corporations. MNCs are
corporations with branches in more than one country and are required to provide consolidated
financial statements irrespective of each individual country’s accounting standards. These
statements are prepared using the accounting standards of parent’s country.
SUMMARY
This unit discussed meaning of MNCS, its characteristics, its pros and cons, its relationship with
consolidated financial statements and its accounting issues.
76
1. What are the key elements in defining MNCs?
2. List at least five pros and cons of MNCs
3. Discuss five characteristics of MNCs
4. What is the relationship between MNCs and Consolidated financial statements?
5. State 4 accounting issues of MNCs.
Nobes, C., & Parker, R. (2008).Comparative International Accounting.10th Edition. UK: Prentice
Hall.
77
CHAPTER ELEVEN
NATURE OF CAPITAL
CONTENT
 Introduction
 Objectives
 Main Content
 Relations of Capital
 Features of Capital
 Types of Capital
 Theories of Capital Structure
 Conclusion
 Summary
 References/Further Reading
INTRODUCTION
Capital itself does not exist until it is produced. Then, to create wealth, capital must be combined
with labor, the work of individuals who exchange their time and skills for money. When people
invest in capital by foregoing current consumption, they can enjoy greater future prosperity.
Capital has value because of property rights. Individuals or companies can claim ownership to
their capital and use it as they please. They can also transfer ownership of their capital to another
individual or corporation and keep the sale proceeds. Government regulations limit how capital
can be used and diminish its value; the tradeoff is supposed to be some benefit to society. For
example, when you sell a stock that has increased in value since you purchased it, you must pay
tax on the capital gains. Those taxes are used for public purposes, such as national defense.
Different subjects like Book-keeping, organization of commerce (O.C) and secretarial practice
(S.P) in commerce, economics, etc., indicate different meaning of the term Capital.
In book-keeping, capital means amount invested by businessman in the business .In commerce
subjects like O.C and S.P, capital means finance or company's capital. But, in economics, capital
78
is that part of wealth which is used for production. This unit shall consider meaning of term capital
from economic point of view.
Relations of Capital
The word Capital is related with the following three terms, viz.
1. Wealth,
2. Money, and
3. Income.
The relation of capital with wealth, money and income is explained below:-
1. Relation with Wealth:-Capital is that part of wealth which is used for production. So,
wealth is a broad concept and capital is a narrowed concept.
Relation of Capital and Wealth is explained with the help of following items. (A) Car (B)
furniture’s.
If a commodity is having features like scarcity, utility, externality and transferability, it
becomes wealth. A motor car has all above features, so it is a wealth. (This is related to
item 'A' above ). When wealth is used in production process, it becomes capital. If that car
is used for taxi (cab) business, it becomes capital. (As per item 'B' above). Therefore, any
commodity as a wealth becomes the capital, if it is used for production. Thus, all capital is
wealth but all wealth is not capital.
1. Relation with Money:-The relation between Capital and Money is explain below.
Normally, capital means investment of money in business. But in economics money
becomes capital only when it is used to purchase real capital goods like plant, machinery,
etc. When money is used to purchase capital goods, it becomes Money Capital. But money
in the hands of consumers to buy consumer goods or money hoarded does not constitute
capital. Money by itself is not a factor of production, but when it acquires stock of real
capital goods, it becomes a factor of production. For production we need real capital and
money capital but money capital acquires real capital.
2. Relation with Income: - Capital generates income. So, capital is a source and
income is a result. E.g. refrigerator is a capital for an ice-cream parlour owner. But, the
79
profit which he gets out of his business is his income. So, Capital is a FUND concept and
Income is a FLOW concept.
SELF ASSESSMENTS EXERCISE
Explain the relation between capital, income, money and wealth.
Define capital in line with difference discipline.
Features of Capital
The characteristics or features of capital are:-
1. Man-made Factor: Capital is not a gift of nature. So it is not a primary or natural factor, it is
made by man in capital goods industry. It is secondary as well as an artificial factor of
production.
2. Productive Factor: Capital helps in increasing level of productivity and speed of production.
3. Elastic Supply: Supply of capital depends upon capital formation process. Capital formation
depends upon savings and investment. By accelerating capital formation, capital supply can be
increased. But it is a long term process.
4. Durable: Capital is not perishable like labour. It has a long life subject to periodical
depreciation.
5. Easy Mobility: Movement of capital from one place to another is easily possible.
6. Is a Wealth: Since capital has all features of wealth viz. utility, scarcity, transferability and
externality, capital is a wealth but wealth doesn't necessarily become capital.
7. Derived demand: As a factor of production, capital has a derived demand to produce finished
goods which have a direct demand. e.g. demand for raw cotton is derived from demand for
cotton cloth.
8. Round about production: Capital goods do not satisfy our wants directly. But resources
should be diverted towards production of capital goods first. And thereafter such produced
mean can be used to produce consumer goods having direct demand.
9. Social Cost: Resources have alternative uses. Either they can be put to production of capital
goods or consumer goods. When resources are used for producing capital goods, it means
society has sacrificed enjoyment of consumer goods. This is called social cost.
80
Types of Capital
The forms, classification or types of capital are:-
1. Fixed capital: It refers to durable capital goods which are used in production again
and again till they wear out. Machinery, tools, means of transport, factory building, etc are
fixed capital. Fixed capital does not mean fixed in location. Since the money invested in
such capital goods is fixed for a long period, it is called Fixed Capital.
2. Working capital: Working capital or variable capital is referred to the single use
produced goods like raw materials. They are used directly and only once in production.
They get converted into finished goods. Money spend on them is fully recovered when
goods made out of them are sold in the market.
3. Circulating capital: It is referred to the money capital used in purchasing raw
materials. Usually the term working capital and circulating capital are used synonymously.
4. Sunk capital: Capital goods which have only a specific use in producing a
particular commodity are called Sunk capital. E.g. A textile weaving machine can be used
only in textile mill. It cannot be used elsewhere. It is sunk capital.
5. Floating capital: Capital goods which are capable of having some alternative uses
are called floating capital. For e.g. electricity, fuel, transport vehicles, etc are the floating
capital which can be used anywhere.
6. Money capital: Money capital means the money funds available with the enterprise
for purchasing various types of capital goods, raw material or for construction of factory
building, etc. it is also called liquid capital. At the beginning the money capital is required
for two purposes one for acquiring fixed assets i.e. fixed capital goods and another for
purchasing raw materials, payment of wages and meeting certain current expenses i.e.
working capital.
7. Real capital: On the other hand, real capital is referred to the capital goods other
than money such as machinery, factory buildings, semi-finished goods, raw materials,
transport equipment, etc.
8. Private capital: All the physical assets (other than land), as well as investments,
which bring income to an individual are called private capital.
81
9. Social capital: All the assets owned by a community as a whole in the form of non-
commercial assets are called social capital e.g. roads, public parks, hospitals, etc.
10. National capital: Capital owned by the whole nation is called national capital. It
comprises private as well as public capital. National capital is that part of national wealth
which is employed in the reproduction of additional wealth.
11. International capital: Assets owned by international organizations like UN,
WTO, World Bank, etc., constitutes an International Capital.
THEORIES OF CAPITAL STRUCTURE
1st Theory of Capital Structure
The Net Income Theory of Capital Structure
This theory gives the idea for increasing market value of firm and decreasing overall cost
of capital. A firm can choose a degree of capital structure in which debt is more than equity
share capital. It will be helpful to increase the market value of firm and decrease the value
of overall cost of capital. Debt is cheap source of finance because its interest is deductible
from net profit before taxes. After deduction of interest company has to pay less tax and
thus, it will decrease the weighted average cost of capital. For example if you have equity
debt mix is 50:50 but if you increase it as 20: 80, it will increase the market value of firm
and its positive effect on the value of per share. High debt content mixture of equity debt
mix ratio is also called financial leverage. Increasing of financial leverage will be helpful
to for maximize the firm's value.
2nd Theory of Capital Structure
The Net Operating income Theory of Capital Structure
Net operating income theory or approach does not accept the idea of increasing the
financial leverage under NI approach. It means to change the capital structure does not
affect overall cost of capital and market value of firm. At each and every level of capital
structure, market value of firm will be same.
82
3rd Theory of Capital Structure
The Traditional Theory of Capital Structure
This theory or approach of capital structure is mix of net income approach and net operating
income approach of capital structure. It has three stages which you should understand:
1st Stage
In the first stage which is also initial stage, company should increase debt contents in its
equity debt mix for increasing the market value of firm.
2nd Stage
In second stage, after increasing debt in equity debt mix, company gets the position of
optimum capital structure, where weighted cost of capital is minimum and market value of
firm is maximum. So, no need to further increase in debt in capital structure.
3rd Stage
Company can gets loss in its market value because increasing the amount of debt in capital
structure after its optimum level will definitely increase the cost of debt and overall cost of
capital.
4th Theory of Capital Structure
The Modigliani and Miller
MM theory or approach is fully opposite of traditional approach. This approach says that
there is not any relationship between capital structure and cost of capital. There will not
effect of increasing debt on cost of capital.
Value of firm and cost of capital is fully affected from investor's expectations. Investors'
expectations may be further affected by large numbers of other factors which have been
ignored by traditional theorem of capital structure.
Financial Leverage And Capital Structure Policy - Modigliani And Miller's Capital
Structure Theories
83
Modigliani and Miller, two professors in the 1950s, studied capital-structure theory
intensely. From their analysis, they developed the capital-structure irrelevance proposition.
Essentially, they hypothesized that in perfect markets, it does not matter what capital
structure a company uses to finance its operations. They theorized that the market value of
a firm is determined by its earning power and by the risk of its underlying assets, and that
its value is independent of the way it chooses to finance its investments or distribute
dividends.
The basic M and M proposition is based on the following key assumptions:
 No taxes
 No transaction costs
 No bankruptcy costs
 Equivalence in borrowing costs for both companies and investors
 Symmetry of market information, meaning companies and investors has the same
information
 No effect of debt on a company's earnings before interest and taxes
Of course, in the real world, there are taxes, transaction costs, and bankruptcy costs,
differences in borrowing costs, information asymmetries and effects of debt on earnings.
To understand how the M&M proposition works after factoring in corporate taxes,
however, we must first understand the basics of M&M propositions I and II without taxes.
Modigliani and Miller's Capital-Structure Irrelevance Proposition
The M and M capital-structure irrelevance proposition assumes no taxes and no bankruptcy

costs. In this simplified view, the weighted average cost of capital (WACC) should remain
constant with changes in the company's capital structure. For example, no matter how the
firm borrows, there will be no tax benefit from interest payments and thus no changes or
benefits to the WACC. Additionally, since there are no changes or benefits from increases
in debt, the capital structure does not influence a company's stock price, and the capital
structure is therefore irrelevant to a company's stock price.
84
However, as we have stated, taxes and bankruptcy costs do significantly affect a company's
stock price. In additional papers, Modigliani and Miller included both the effect of taxes
and bankruptcy costs.
Modigliani and Miller's Tradeoff Theory of Leverage
The tradeoff theory assumes that there are benefits to leverage within a capital structure up
until the optimal capital structure is reached. The theory recognizes the tax benefit from
interest payments - that is, because interest paid on debt is tax deductible, issuing bonds
effectively reduces a company's tax liability. Paying dividends on equity, however, does
not. Thought of another way, the actual rate of interest companies’ pay on the bonds they
issue is less than the nominal rate of interest because of the tax savings. Studies suggest,
however, that most companies have less leverage than this theory would suggest is optimal.
(Learn more about corporate tax liability in How Big Corporations Avoid Big Tax Bills
and Highest Corporate Tax Bills by Sector.)
In comparing the two theories, the main difference between them is the potential benefit
from debt in a capital structure, which comes from the tax benefit of the interest payments.
Since the MM capital-structure irrelevance theory assumes no taxes, this benefit is not
recognized, unlike the tradeoff theory of leverage, where taxes, and thus the tax benefit of
interest payments, are recognized.
In summary, the MM I theory without corporate taxes says that a firm's relative proportions
of debt and equity don't matter; MM I with corporate taxes says that the firm with the
greater proportion of debt is more valuable because of the interest tax shield.
MM II deals with the WACC. It says that as the proportion of debt in the company's capital
structure increases, its return on equity to shareholders increases in a linear fashion. The
existence of higher debt levels makes investing in the company more risky, so shareholders
demand a higher risk premium on the company's stock. However, because the company's
capital structure is irrelevant, changes in the debt-equity ratio do not affect WACC. MM II
with corporate taxes acknowledges the corporate tax savings from the interest tax
deduction and thus concludes that changes in the debt-equity ratio do affect WACC.
Therefore, a greater proportion of debt lowers the company's WACC.
85
CONCLUSION
Capital means investment of money in business. But in economics money becomes capital
only when it is used to purchase real capital goods like plant, machinery, etc. When money
is used to purchase capital goods, it becomes Money Capital. Capital itself does not exist
until it is produced. Then, to create wealth, capital must be combined with labor, the work
of individuals who exchange their time and skills for money. When people invest in capital
by foregoing current consumption, they can enjoy greater future prosperity.
But money in the hands of consumers to buy consumer goods or money hoarded does not
constitute capital. Money by itself is not a factor of production, but when it acquires stock
of real capital goods, it becomes a factor of production. For production we need real capital
and money capital but money capital acquires real capital.
SUMMARY
Capital is that part of wealth which is used for production. It is a portion of wealth which
is used for production. So, wealth is a broad concept and capital is a narrowed concept.
This unit focused on economics Interpretations of capital, its relates capital with money,
wealth and income. The nature of capital consist types, characteristics and relation of
capital as explain above. We shall extend the analysis on nature of capital in the next unit
by considering international capital flow or foreign capital flow as preferred by different
writers.
1) Discuss the various types of capital?
2) List and explain the four theories of capital structure?
REFERENCES/FURTHER READING
Guidelines for Public Debt Management, Prepared by the Staffs of the International
Monetary Fund and the World Bank, March 21, 2001.4.
Nigeria’s debt guardian February 14, 2014 | Filed under: The Executives | Author: Phillip
Isakpa
86
IMF studies, Debt- and Reserve-Related Indicators of External Vulnerability, March 23,
2000; Debt Sustainability in Low-Income Countries—Proposal for an Operational
Framework and Policy Implications, February 3, 2004.
87
CHAPTER TWELVE
IAS 21 AND REPORTING FOREIGN CURRENCY TRANSACTIONS IN THE

FUNCTIONAL CURRENCY
Content
 Introduction
 Objectives
 Main Content
 Terminologies
 Foreign Currency Translation of Direct
 Business Transactions
 Conclusion
 Summary
INTRODUCTION
Activities of home companies with foreign companies are generally divided into two categories,
firstly, it can be on transaction basis and secondly, the home company can be a branch or
subsidiary of the foreign company. Accounting guidelines for these two scenarios are treated by
the IAS 21, however, the first scenario is considered in this unit while the second is considered in
units 2 and 3. Thus, this unit provides in details the treatment a business considers on how to
translate foreign currency amounts into its accounts when direct business transactions are
involved.
TERMINOLOGIES
Closing Rate: this is the exchange rate at the reporting date which is end of the reporting period.
Opening Rate: this is the exchange rate at the beginning of the reporting period.
Average Rate: this is derived by adding the opening rate and the closing rate divided by two
88
Monetary Items: are units of currency held and assets and liabilities to be received or paid in a
fixed or determinable number of units of currency
Foreign currency is a currency other than the functional currency of the entity.
Spot exchange rate is the exchange rate for immediate delivery.
Exchange difference is the difference resulting from translating a given number of units of one
currency into another currency at different exchange rates.
Net investment in a foreign operation is the amount of the reporting entity’s interest in the net
assets of that operation.
Reporting Currency: The improvement project to IAS 21 removed the notion of ‘reporting
currency’ and replaced it with two further definitions of currency provided as follows:
1. Functional currency: this is the currency of the primary economic environment in which the
entity operates
2. Presentation currency: this is the currency in which the financial statements are presented.
A foreign subsidiary: is a subsidiary whose activities are based and conducted in a country
other than the country of the parent. Such as subsidiary may not constitute a foreign entity.
A Foreign Entity: is a foreign operation whose activities are not in integral part of those of the
parent.
Exchange Rate: This could be defined a ratio at which the currencies of two countries are
exchanged at a particular date.
Forward Rate: The exchange rate available by the terms of an agreement for the exchange of
two currencies at a future date.
Closing Date: This is the spot rate that exists at the reporting date.
Foreign Currency: A currency other than the functional currency of the entity.
Monetary Items: Units of currency held and assets and liabilities to be received or paid in a fixed
or determinable number of units of currency.
89
FOREIGN CURRENCY TRANSLATION OF DIRECT BUSINESS TRANSACTIONS
There are situations where a business enters into a contract with a foreign currency and there
arise the need to translate such transaction into the functional currency of the business for
presentation purpose. Examples of such transactions are: Imports of raw materials, Exports of
finished goods, Importation of non-current assets, Investments on foreign securities, Obtaining
foreign loan, etc.
Such transactions may be required to be translated at more than one time in the accounts, for
instance, the credit purchase of raw materials will affect the books and the subsequent payment
will also affect the books especially in the era of exchange rate fluctuations. Also, the domestic
value of an overseas long-term loan is likely to fluctuate from period to another.
The method of translation is as follows:
I. Transactions during Accounting Period: These should be translated and recorded at the
rate of exchange ruling at the date of the transaction. In practice, an average rate might be
used.
II. Monetary Items at reporting date: Where these items such as receivables, payables, bank
balances or loans are denominated in a foreign currency they should be translated and
recorded at the closing rate or, if appropriate, at the rate at which the transaction is contracted
to be settled that is at an agreed forward rate.
III. Non-monetary items at reporting date: where these items are carried at cost less
depreciation, they should be translated and recorded at the exchange rate at the date of
acquisition. Where these items are carried at fair value less depreciation, they should be
translated and recorded at the exchange rate at the date of revaluation.
Exchange difference: All exchange difference should be reported as part of profit for the year.
It is also important to differentiate between functional currency and presentation currency. IAS
21 suggests that when determining its functional currency, the entity has to consider the primary
economic environment where an entity operates in which it primarily generates and expends
cash.
90
ILLUSTRATION I
An entity operating in Nigeria has various buildings in Ghana that are determined in US Dollars
and payments can be made in US dollars or cedes. Determine the entity’s functional currency.
Solution
The functional currency is Cedes because.
1. The local circumstances in Ghana determine the rental yield.

2. Presumably labour and other expenses are paid in Cedes.
ILLUSTRATION 2
On 20 October 2016 an entity with a functional currency of Naira buys raw materials from a
supplier on credit for $1,000. At the end of the accounting period the entity is yet to pay the debt.
The entity has a financial year-end of 31 December 2016.
The spot exchange rates are as follows:
 20 October 2016: ₦250/$1

 31 December 2016: ₦280/$1
Required: show the journal entries for the above transactions at initial recognition and end of the
year.
91
CONCLUSION
Specific business transactions of home companies with foreign companies usually require special
treatment as highlighted in IAS 21. This is as a result of exchange rate fluctuation because an
entity that obtains foreign loan of $1,000 in January of 2016 with an expectation to pay back the
same $1,000 in December of the same year will not be paying back the same naira value
especially where there is no specific agreed rate.
SUMMARY
This unit provides in details the treatment of translation of direct business transactions and
exchange difference arising therefrom.
92
1. An entity operating in Nigeria has majority of his clients in Dubai and transactions are usually
made in US dollars or Dirham. Determine the entity’s functional currency.
2. On 1/1/2015 an entity with a functional currency of Naira obtained a foreign loan of £750. At
the end of the accounting period the entity is yet to pay the debt. The entity has a financial year-
end of 31 December 2015.The spot exchange rates are as follows:
1/1/2015: ₦450/£1
31/12/2015: ₦580/£1
Required: show the journal entries for the above transactions at initial recognition and end of the
year.
IAS 21: The effect of changes in foreign exchange rates.
93
CHAPTER THIRTEEN
IAS 21 AND FINANCIAL STATEMENT TRANSLATION OF FOREIGN
OPERATIONS: FOREIGN BRANCHES
Content
 Introduction
 Objectives
 Main Content
 Methods Of Translation
 Determination Of Method to Adopt
 Conclusion
 Summary
INTRODUCTION
As discussed in the previous unit, the home company can be a subsidiary or branch of the foreign
company. Both scenarios require for the home company to prepare their accounts in their
functional currency and there exist the need to subsequently translate the financial statements to
the presentation currency of the foreign company. The procedures for translating the financial
statements of foreign branches are discussed in this unit.
METHODS OF TRANSLATION
The IAS 21 does not give an enterprise the freedom to choose which method of translation should
be used. It lays down the circumstances in which each particular method must be used. There are
basically three methods as provided in the standards and these are explained as follows:
I. Closing rate method:
This method is to be used when the foreign operations do not form an integral part of the activities
of home company. Under this method:
94
The method is also referred to as current rate method. Arising exchange difference will be adjusted
to reserves.
II. Temporary method:
This method is used when foreign operations form an integral part of the activities of home country
company. Here:
This method is sometimes referred to as current-non-current method. Arising exchange difference

will be adjusted to statement of Comprehensive Income.
III. Monetary and non-monetary:
Under this method, monetary assets and liabilities are translated to the rate ruling at the Reporting
date and non-monetary assets and liabilities at the historical rate at the date they were acquired or
incurred. Assets and liabilities are regarded as monetary if their nominal values are fixed.
DETERMINATION OF METHOD TO ADOPT
The method to be used will be determined by the business of the home country in association with
the foreign operations. Some of the cluesinclude:
 When goods sent to the branch by the head office constitute a high proportion of goods by the
branch, then the temporal method is used while closing method will be suitable if otherwise.
 If the branch relies on funding from the head office, the temporal method is suitable while the
closing method should be used if the branch is independent in terms of funding. (Shiyanbola,
2015).
95
ILLUSTRATION I
Shugarine Enterprise operates in Nigeria with a branch in Ghana, Dudu Enterprise. The financial
statements prepared in Cede (Ghana Currency) were as follows:
96
97
98
CONCLUSION
Financial statements of foreign branches usually require translation whether the branches are
integral parts of the head office or not. The procedures for translation usually result to exchange
difference as highlighted in this unit.
SUMMARY
This unit discussed theprocedures for translating the financial statements of foreign branches and
subsequent treatment of exchange difference arising.
In Accordance with IAS 21 and relevant IFRS, translate the financial statements of God is Able
Bank LTD for the year ended 31/12/2012 below to dollars($) using the following assumptions:
Opening exchange rate: $1= ₦150 Closing exchange rate: $1= ₦165.
99
100
IAS 21: The effect of changes in foreign exchange rates.
Siyanbola, T. T. (2015). Advanced financial accounting (IFRS compliant).Nigeria, Lagos:

Gastos Consults.
101

International Accounting and Finance

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

International Accounting and Finance

Uploaded by

Copyright:

Available Formats

CHAPTER ONE

OVERVIEW INTERNATIONAL FINANCE AND ACCOUNTING

INTRODUCTION TO INTERNATIONAL FINANCE

International finance, sometimes known as international macroeconomics, is the study of

ADVANTAGES OF INTERNATIONAL FINANCE:

 It helps us to understand the consumption pattern of different economies

A country’s balance of payments is commonly defined as the record of transactions over a

1. Current Account: Merchandise, services, and unilateral transfers

The Current Account

The Capital Account

MEASURING DEFICIT OR SURPLUS IN BALANCE OF PAYMENTS

The relationship between these balances is summarized in Table below.

* Why is balance of payments regarded as a flow concept?

Bodie, Z. et al. (2001) Essentials of Investment (Fourth Edition)

Published by McGraw-Hill Company Inc., 1221 Avenue, New York, U.S.A.

Cohen, J. (1977) Investment Analysis & Portfolio Management (Third Edition)

Richard D. Irwin Inc. New York, U.S.A.

International accounting as a concept can be defined as the process of identifying, collecting,

 Size and Complexity of Organizations

1. Distinguish between the concept of accounting and international accounting

3. List and explain five factors influencing accounting development globally.

7.0 REFERENCES/FURTHER READINGS

Geijsbeek, J. B. (1914). Ancient double-entry bookkeeping: Lucas Pacioli’s treatise. Denver:

INTERNATIONAL FINANCIAL INSTITUTION

DEFINITION AND MEANING OF INTERNATIONAL FINANCIAL INSTITUTIONS (IFIS).

International Financial Institutions can refer to any of the following:

 International Bank for Reconstruction and Development (IBRD). Recognized international

INTERNATIONAL MONETARY FUND

Following the breakdown, International Gold Standard in the thirties.Countries embarked on

INTERNATIONAL MONETARY FUND FORMATIONS

1. To promote international Monetary cooperation among member countries, through

Two bodies run the IMF. These bodies are:

THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT (IBRD).

AIMS AND OBJECTIVES

CAPITAL OF THE WORLD BANK

Organization of the Bank

 Feasibility studies for projects

PROCEDURES FOR LENDING

 Exploratory Discussion and Preliminary Investigations: under this stage, discussions

INTERNATIONAL DEVELOPMENT ASSOCIATION (IDA)

OBJECTIVES OF THE IDA

THE MULTINATIONAL INVESTMENT GUARANTEE AGENCIES (MIGA).

The MIGA has the following objectives:

Membership and its operations

THE ORGANIZATION OF PETROLEUM EXPORTING COUNTRIES (OPEC)

1. To adopt a uniform policy towards oil importing countries

Examine the comprehensive objectives of Multinational Investment Guarantee Agencies

Answers to Self Assessment Exercise

Andy, C.E. (2001): Essential Economics, Tonad Publishers.

Bakare I. O. (2003): Fundamental And Principles Of Macro Economics,

Giitbak Publishers, Fadeyi, Lagos.http://www.deginvest.de, http://www.nib.int.

INTERNATIONAL HARMONIZATION OF ACCOUNTING STANDARDS

NATURE OF HARMONIZATION OF ACCOUNTING STANDARDS

Harmonization simply implies uniformity. As a result of the existing diversity in financial

1. Corporate management of Multi-national Corporations: the managers of MNCs face global

OBSTACLES FOR HARMONIZATION OF ACCOUNTING STANDARDS

The following are the obstacles of accounting standards’ harmonization:

MEASUREMENT OF HARMONIZATION OF ACCOUNTING STANDARDS

ROLE OF IASB AND OTHER BODIES IN ACCOUNTING STANDARDS

1. Explain the origin of national differences in accounting

2. List and explain five causes of international accounting practices

3. What does conservatism and accruals imply in accounting?

INTERNATIONAL FINANCIAL INSTITUTION