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 Preface vii

Chapter 6 describes the accounting environment in five economically signifi-

cant countries—China, Germany, Japan, Mexico, and the United Kingdom—that
are representative of major clusters of accounting systems. The discussion related
to each country’s accounting system is organized into four parts: background,
accounting profession, accounting regulation, and accounting principles and prac-
tices. Exhibits throughout the chapter provide detailed information on differences
between each country’s GAAP and IFRS, as well as reconciliations from local
GAAP to U.S. GAAP.
Chapters 7, 8, and 9 deal with financial reporting issues that are of particu-
lar importance to multinational corporations. Two different surveys of business
executives indicate that the most important topics that should be covered in an
international accounting course are related to the accounting for foreign currency.1
Because of its importance, this topic is covered in two separate chapters (Chapters
7 and 8). Chapter 9 covers three additional financial reporting topics of particular
importance to multinational corporations—inflation accounting, business combi-
nations and consolidated financial statements, and segment reporting. Emphasis
is placed on understanding IFRS related to these topics.
Chapter 7 begins with a description of the foreign exchange market and then
demonstrates the accounting for foreign currency transactions. Much of this
chapter deals with the accounting for derivatives used in foreign currency
hedging activities. We first describe how foreign currency forward contracts
and foreign currency options can be used to hedge foreign exchange risk. We
then explain the concepts of cash flow hedges, fair value hedges, and hedge
accounting. Finally, we demonstrate the accounting for forward contracts and
options used as cash flow hedges and fair value hedges to hedge foreign cur-
rency assets and liabilities, foreign currency firm commitments, and forecasted
foreign currency transactions.
Chapter 8 focuses on the translation of foreign currency financial statements
for the purpose of preparing consolidated financial statements. We begin by
examining the conceptual issues related to translation, focusing on the concept
of balance sheet exposure and the economic interpretability of the translation
adjustment. Only after a thorough discussion of the concepts and issues do we
then describe the manner in which these issues have been addressed by the
IASB and by the U.S. FASB. We then illustrate application of the two methods
prescribed by both standard-setters and compare the results. We discuss the
hedging of balance sheet exposure and provide examples of disclosures related
to translation.
Chapter 9 covers three additional financial reporting issues. The section on
inflation accounting begins with a conceptual discussion of asset valuation
and capital maintenance through the use of a simple numerical example and
then summarizes the inflation accounting methods used in different countries.
The second section focuses on International Financial Reporting Standards
related to business combinations and consolidations, covering issues such as

1
T. Conover, S. Salter, and J. Price, “International Accounting Education: A Comparison of Course Syllabi
and CFO Preferences,” Issues in Accounting Education, Volume 9, Issue 2, Fall 1994; and T. Foroughi and
B. Reed, “A Survey of the Present and Desirable International Accounting Topics in Accounting Educa-
tion,” International Journal of Accounting, Volume 23, Number 1, Fall 1987, pp. 64–82.
viii Preface

the determination of control, the acquisition method, proportionate consolida-

tion, and the equity method. The final section of this chapter focuses on Inter-
national Financial Reporting Standard 8, Operating Segments.
Chapter 10 introduces issues related to the analysis of foreign financial state-
ments. We explore potential problems (and possible solutions to those problems)
associated with using the financial statements of foreign companies for decision-
making purposes. This chapter also provides an example of how an analyst would
reformat and restate financial statements from one set of GAAP to another.
Business executives rank international taxation second only to foreign currency
in importance as a topic to be covered in an international accounting course.2
International taxation and tax issues related to international transfer pricing are
covered in Chapters 11 and 12.
Chapter 11 focuses on the taxation of foreign operation income by the home-
country government. Much of this chapter deals with foreign tax credits, the
most important mechanism available to companies to reduce double taxation.
This chapter provides a comprehensive example demonstrating the major
issues involved in U.S. taxation of foreign operation income. We also discuss
benefits of tax treaties, translation of foreign currency amounts for tax purposes,
and tax incentives provided to attract foreign investment.
Chapter 12 covers the topic of international transfer pricing, focusing on tax
implications. We explain how discretionary transfer pricing can be used to
achieve specific cost minimization objectives and how the objectives of per-
formance evaluation and cost minimization can conflict in determining inter-
national transfer prices. We also describe government reactions to the use of
discretionary transfer pricing by multinational companies, focusing on the U.S.
rules governing intercompany pricing.
Chapter 13 covers strategic accounting issues of particular relevance to multi-
national corporations. This chapter discusses multinational capital budgeting as
a vital component of strategy formulation and operational budgeting as a key in-
gredient in strategy implementation. Chapter 13 also deals with issues that must
be addressed in designing a process for evaluating the performance of foreign
operations.
Chapter 14 covers comparative international auditing and corporate gover-
nance. This chapter discusses both external and internal auditing issues as they re-
late to corporate governance in an international context. Chapter 14 also describes
international diversity in external auditing and the international harmonization of
auditing standards.
Chapter 15 introduces the current trend toward corporate social reporting
(CSR) by multinational corporations (MNCs). We describe theories often used to
explain CSR practices by companies and the motivations for them to engage in
CSR practices. We also examine the implications of climate change for CSR. Fur-
ther, we discuss some issues associated with regulation of CSR at the international
level and identify international organizations that promote CSR, such as Global
Reporting Initiative (GRI). Finally, we provide examples of actual CSR practices
by MNCs.

2
Ibid.
 Preface ix

CHANGES IN THE FOURTH EDITION

Chapter 1
Updated statistics provided in the section titled “The Global Economy”
Updated End-of-Chapter (EOC) assignments based on annual reports and other dated
material to the most current information available

Chapter 2
Noted that inflation is no longer as important in explaining accounting diversity as it
once was and that European accountants need to develop an expertise in both local
GAAP and IFRS

Chapter 3
Updated exhibits on excerpts from annual reports of various companies
Added two new sections at the end of the chapter titled “Challenges to International
Convergence of Financial Reporting Standards” and “New Direction to the IASB”
Added three new Exercises and Problems to the EOC material

Chapter 4
Noted that the discussion in the section on “Leases” is based on guidance in effect at
the time of publication, and that a revised IASB-FASB exposure draft issued in 2013
was likely to substantially change and converge lease accounting at some unknown
future date

Chapter 5
Deleted the subsection on “Proposed Amendments to IAS 37”
Rewrote the subsection on “Post-Employment Benefits” to reflect the new guidance
provided in IAS 19 (Revised), which was issued in 2011
Rewrote several Exercises and Problems in the EOC material related to post-
employment benefits to reflect the changes in IAS 19 (Revised)
Deleted the subsection on “Termination Benefits”
Removed reference to a 2009 IASB Exposure Draft from the section on “Income Taxes”
In the subsection titled “IASB-FASB Revenue Recognition Project,” removed some of
the specific discussion and an example based upon the 2011 IASB-FASB joint Expo-
sure Draft, and noted that a new standard, if approved, would not become effective
any earlier than 2017

Chapter 6
Updated annual report excerpts
Added new material incorporating the latest developments with regard to financial
reporting in China, Germany, Japan, Mexico, and the United Kingdom
Added three new Questions and one new Exercise and Problem to the EOC material

Chapter 7
Updated annual report excerpts and the related discussion
Updated Exhibit 7.1 to provide recent exchange rates and the related discussion
x Preface

Enhanced explanation of several journal entries related to the accounting for a

“Forward Contract Designated as Cash Flow Hedge”
Deleted the subsection titled “The Euro”
Updated Case 7-2 to be based on more recent exchange rates

Chapter 8
Updated annual report excerpts and the related discussion
Updated the U.S dollar-to-euro exchange rates used in the example provided in
“Translation Process Illustrated” to more current levels

Chapter 9
Updated annual report excerpts and the related discussion
Added a subsection on “Identification of Highly Inflationary Countries”
Deleted the subsection on “Proportionate Consolidation” and removed the require-
ments in EOC Exercise and Problem 6 related to proportionate consolidation
Added discussion of IFRS 11 in the section titled “Equity Method”
Updated EOC Exercise and Problem 10 to be based on the most current annual report
disclosures available

Chapter 10
Deleted the discussion related to leases in the subsection titled “Extent of Disclosure”

Chapter 11
Updated information in several Exhibits providing income, withholding, and treaty
tax rates and updated Case 11-1 to reflect changes in these rates

Chapter 12
Updated statistics related to the extent of international intercompany transfers, the
use of various transfer pricing methods, the use of advance pricing agreements, and
the enforcement of transfer pricing regulations

Chapter 13
Replaced Exhibit 13.14, “Rockwater’s Balanced Scorecard,” with “Use of Balanced
Scorecard at Veolia Water”
Revamped Case 13-2, Lion Nathan Limited, in the EOC material

Chapter 14
Updated Exhibits 14.5 and 14.6, and “Appendix to Chapter 14” on excerpts from
annual reports of various companies.

Chapter 15
Added new material incorporating GRI’s fourth-generation guidelines issued in 2013
Updated Exhibits 15.4, 15.5, and 15.6
Added a new Case 15-1, Modco Inc., to the EOC material
 Preface xi

SUPPLEMENTARY MATERIAL
International Accounting is accompanied by supplementary items for both students
and instructors. The Online Learning Center (www.mhhe.com/doupnik4e) is a
book-specific website that includes the following supplementary materials.
For Students:
PowerPoint Presentation
For Instructors:
Access to all supplementary materials for students
Instructor’s Manual
PowerPoint Presentation
Test Bank
Acknowledgments
We want to thank the many people who participated in the review process and
offered their helpful comments and suggestions:
Wagdy Abdallah Marianne James
Seton Hall University California State University–Los Angeles
Kristine Brands Cynthia Jeffrey
Regis University Iowa State University
Bradley Childs Craig Keller
Belmont University Missouri State University
Teresa Conover Victoria Krivogorsky
University of North Texas San Diego State University
Orapin Duangploy Britton McKay
University of Houston–Downtown Georgia Southern University
Gertrude Eguae-Obazee Jamshed Mistry
Albright College Suffolk University
Emmanuel Emmenyonu Gregory Naples
Southern Connecticut State University Marquette University
Charles Fazzi Cynthia Nye
Saint Vincent College Bellevue University
Mark Finn Randon C. Otte
Northwestern University Clarion University
Leslie B. Fletcher Obeua Persons
Georgia Southern University Rider University
Paul Foote Felix Pomeranz
California State University–Fullerton Florida International University
Mohamed Gaber Grace Pownall
State University of New York at Plattsburgh Emory University
Giorgio Gotti Juan Rivera
University of Massachusetts–Boston University of Notre Dame
Shiv Goyal Kurt Schulzke
University of Maryland University College Kennesaw State University
Robert Gruber Mary Sykes
University of Wisconsin University of Houston–Downtown

We are also thankful to Gary Blumenthal, chief financial officer of The Forbes
Consulting Group and instructor at Stonehill College, who revised the PowerPoint
slides and Test Bank to accompany the third edition of the text.
We also pass along many thanks to all the McGraw-Hill Education who partici-
pated in the creation of this book. In particular, Executive Brand Manager James
Heine, Development Editor Gail Korosa, and Senior Marketing Manager Kathleen
Klehr.

xii
Brief Contents
About the Authors iv
Preface v Financial Statements 403
Chapter
1 Introduction to International
Accounting 1
2 Worldwide Accounting Diversity 23
3 International Convergence of
Financial Reporting 65
4 International Financial Reporting
Standards: Part I 118
5 International Financial Reporting
Standards: Part II 179
6 Comparative Accounting 232
7 Foreign Currency Transactions
and Hedging Foreign Exchange
Risk 339
8 Translation of Foreign Currency
9 Additional Financial Reporting
Issues 448
10 Analysis of Foreign Financial
Statements 492
11 International Taxation 541
12 International Transfer Pricing 586
13 Strategic Accounting Issues in
Multinational Corporations 621
14 Comparative International Auditing
and Corporate Governance 674
15 International Corporate Social
Reporting 739
xiii
Contents
About the Authors iv Access to Foreign Capital Markets 31
Comparability of Financial Statements 32
Preface v Lack of High-Quality Accounting Information 33
Accounting Clusters 33
Chapter 1 A Judgmental Classification of Financial Reporting
Introduction to International Systems 34
Accounting 1 An Empirical Test of the Judgmental
What Is International Accounting? 1 Classification 35
Evolution of a Multinational Corporation 2 The Influence of Culture on Financial
Sales to Foreign Customers 2
Reporting 37
Hofstede’s Cultural Dimensions 37
Hedges of Foreign Exchange Risk 4
Gray’s Accounting Values 37
Foreign Direct Investment 4
Religion and Accounting 39
Financial Reporting for Foreign Operations 6
International Income Taxation 7
A Simplified Model of the Reasons for
International Transfer Pricing 7
International Differences in Financial
Performance Evaluation of Foreign Operations 8
Reporting 41
Examples of Countries with Class A
International Auditing 8
Accounting 42
Cross-Listing on Foreign Stock Exchanges 9
Recent Changes in Europe 42
Global Accounting Standards 10
The Global Economy 10 Further Evidence of Accounting Diversity 43
Financial Statements 43
International Trade 10
Format of Financial Statements 43
Foreign Direct Investment 11
Level of Detail 47
Multinational Corporations 12
Terminology 47
International Capital Markets 14
Disclosure 49
Outline of the Book 14
Recognition and Measurement 53
Summary 15
Questions 16 Summary 54
Exercises and Problems 17 Appendix to Chapter 2
Case 1-1: Besserbrau AG 19 The Case of Daimler-Benz 55
Case 1-2: Vanguard International Growth Questions 57
Fund 20 Exercises and Problems 58
References 22 Case 2-1: The Impact of Culture on
Conservatism 60
Case 2-2: SKD Limited 62
Chapter 2 References 63
Worldwide Accounting Diversity 23
Chapter 3
Introduction 23
International Convergence of
Evidence of Accounting Diversity 24
Financial Reporting 65
Reasons for Accounting Diversity 28
Legal System 28 Introduction 65
Taxation 29 International Accounting Standard-
Providers of Financing 29 Setting 66
Inflation 30 Harmonization Efforts 68
Political and Economic Ties 30 International Organization of Securities
Correlation of Factors 30 Commissions 68
Problems Caused by Accounting Diversity 31 International Federation of Accountants 69
Preparation of Consolidated Financial Statements 31 European Union 69
xiv
 Contents xv

The International Forum on Accountancy Chapter 4

Development (IFAD) 72 International Financial Reporting
The International Accounting Standards
Standards: Part I 118
Committee (IASC) 72
Creation of the IASB 75 Introduction 118
The Structure of the IASB 77 Types of Differences between IFRS and
Arguments for and against International U.S. GAAP 119
Convergence of Financial Reporting Inventories 120
Standards 82 Lower of Cost or Net Realizable Value 121
Arguments for Convergence 82 Property, Plant, and Equipment 122
Arguments against Convergence 82 Recognition of Initial and Subsequent Costs 123
A Principles-Based Approach to International Measurement at Initial Recognition 123
Financial Reporting Standards 83 Measurement Subsequent to Initial Recognition 124
The IASB Framework 84 Depreciation 130
The Need for a Framework 84 Derecognition 130
Objective of Financial Statements and Investment Property 131
Underlying Assumptions 84 Impairment of Assets 131
Qualitative Characteristics of Financial Definition of Impairment 131
Statements 85 Measurement of Impairment Loss 132
Elements of Financial Statements: Definition, Reversal of Impairment Losses 133
Recognition, and Measurement 85 Intangible Assets 134
Concepts of Capital Maintenance 86 Purchased Intangibles 135
International Financial Reporting Intangibles Acquired in a Business
Standards 86 Combination 136
Presentation of Financial Internally Generated Intangibles 136
Statements (IAS 1) 86 Revaluation Model 141
First-Time Adoption of International Financial Impairment of Intangible Assets 141
Reporting Standards (IFRS 1) 90 Goodwill 141
International Convergence toward IFRS 92 Impairment of Goodwill 142
The Adoption of International Financial Goodwill Not Allocable to Cash-Generating Unit
Reporting Standards 94 under Review 144
IFRS in the European Union 96 Borrowing Costs 146
IFRS in the United States 98 Leases 147
Support for a Principles-Based Approach 98 Lease Classification 147
The SEC and IFRS Convergence 99 Finance Leases 149
Challenges to International Convergence 100 Operating Leases 150
New Direction for the IASB 102 Sale–Leaseback Transaction 150
The FASB and IFRS Convergence 103 Disclosure 151
The Norwalk Agreement 103 IASB/FASB Convergence Project 153
AICPA and IFRS Convergence 105 Other Recognition and Measurement Standards 153
Revision of the Conceptual Framework 106 Disclosure and Presentation Standards 154
Some Concluding Remarks 108 Statement of Cash Flows 154
Summary 109 Events after the Reporting Period 155
Appendix to Chapter 3 Accounting Policies, Changes in Accounting
What Is This Thing Called Anglo-Saxon Estimates, and Errors 156
Accounting? 110 Related Party Disclosures 157
Questions 112 Earnings per Share 157
Exercises and Problems 113 Interim Financial Reporting 158
Case 3-1: Jardine Matheson Group Noncurrent Assets Held for Sale and
(Part 1) 115 Discontinued Operations 158
References 116 Operating Segments 158
xvi Contents

Summary 159 Classification of Financial Assets and

Questions 161 Financial Liabilities 206
Exercises and Problems 162 Measurement of Financial Instruments 208
Case 4-1: Bessrawl Corporation 177 Available-for-Sale Financial Asset Denominated
References 178 in a Foreign Currency 210
Impairment 211
Derecognition 211
Chapter 5 Derivatives 213
International Financial Reporting Receivables 213
Standards: Part II 179 Summary 215
Questions 217
Introduction 179 Exercises and Problems 218
Current Liabilities 179 Case 5-1: S. A. Harrington Company 230
Provisions, Contingent Liabilities, and
Contingent Assets 180 Chapter 6
Contingent Liabilities and Provisions 180
Comparative Accounting 232
Onerous Contract 182
Restructuring 183 Introduction 232
Contingent Assets 183 People’s Republic of China (PRC) 234
Additional Guidance 184 Background 234
Employee Benefits 185 Accounting Profession 236
Short-Term Benefits 185 Accounting Regulation 241
Post-employment Benefits 185 Accounting Principles and Practices 246
Other Long-Term Employee Benefits 188 Germany 257
Share-Based Payment 188 Background 257
Equity-Settled Share-Based Payment Transactions 189 Accounting Profession 258
Cash-Settled Share-Based Payment Transactions 190 Accounting Regulation 259
Choice-of-Settlement Share-Based Payment Accounting Principles and Practices 263
Transactions 191 Issues Related to the Adoption of IFRS
Income Taxes 193 in Germany 267
Tax Laws and Rates 193 Japan 277
Recognition of Deferred Tax Asset 194 Background 277
Disclosures 195 Accounting Profession 278
IFRS versus U.S. GAAP 195 Accounting Regulation 281
Financial Statement Presentation 196 Accounting Principles and Practices 284
Revenue Recognition 197 Mexico 291
General Measurement Principle 197 Background 291
Identification of the Transaction Generating Accounting Profession 293
Revenue 197 Accounting Regulation 294
Sale of Goods 197 Accounting Principles and Practices 297
Rendering of Services 199 United Kingdom 303
Interest, Royalties, and Dividends 200 Background 303
Exchanges of Goods or Services 200 Accounting Profession 303
IAS 18, Part B 200 Accounting Regulation 305
Customer Loyalty Programs 201 Accounting Principles and Practices 309
Construction Contracts 202 Summary 325
IASB–FASB Revenue Recognition Project 203 Questions 327
Financial Instruments 204 Exercises and Problems 328
Definitions 204 Case 6-1: China Petroleum and Chemical
Liability or Equity 205 Corporation 329
Compound Financial Instruments 205 References 336

Chapter 7
Foreign Currency Transactions
and Hedging Foreign
Exchange Risk 339
Introduction 339
Foreign Exchange Markets 340
Exchange Rate Mechanisms 340
Foreign Exchange Rates 341
Spot and Forward Rates 343
Option Contracts 344
Foreign Currency Transactions 344
Accounting Issue 345
Accounting Alternatives 345
Balance Sheet Date before Date of Payment
Hedging Foreign Exchange Risk 349
Accounting for Derivatives 350
Fundamental Requirement of Derivatives
Accounting 351
Determining the Fair Value of Derivatives 351
Accounting for Changes in the Fair Value
of Derivatives 351
Hedge Accounting 352
Nature of the Hedged Risk 352
Hedge Effectiveness 353
Hedge Documentation 353
Hedging Combinations 353
Hedges of Foreign-Currency-Denominated
Assets and Liabilities 354
Forward Contract Used to Hedge a Recognized
Foreign-Currency-Denominated Asset 355
Forward Contract Designated as Cash
Flow Hedge 357
Forward Contract Designated as Fair
Value Hedge 361
Foreign Currency Option Used to Hedge a
Recognized Foreign-Currency-Denominated
Asset 363
Option Designated as Cash Flow Hedge 365
Spot Rate Exceeds Strike Price 367
Option Designated as Fair Value Hedge 368
Hedges of Unrecognized Foreign Currency
Firm Commitments 368
Forward Contract Used as Fair Value Hedge
of a Firm Commitment 368
Option Used as Fair Value Hedge of
Firm Commitment 371
Hedge of Forecasted Foreign-Currency-
Denominated Transaction 373
Option Designated as a Cash Flow Hedge of a
Forecasted Transaction 374
Contents xvii
Use of Hedging Instruments 375
Foreign Currency Borrowing 377
Foreign Currency Loan 379
Summary 379
Appendix to Chapter 7
Illustration of the Accounting for Foreign
Currency Transactions and Hedging
Activities by an Importer 380
Questions 392
Exercises and Problems 393
Case 7-1: Zorba Company 401
Case 7-2: Portofino Company 402
Case 7-3: Better Food Corporation 402
References 402
347
Chapter 8
Translation of Foreign Currency Financial
Statements 403
Introduction 403
Two Conceptual Issues 404
Example 404
Balance Sheet Exposure 407
Translation Methods 408
Current/Noncurrent Method 408
Monetary/Nonmonetary Method 408
Temporal Method 409
Current Rate Method 410
Translation of Retained Earnings 411
Complicating Aspects of the Temporal Method 413
Disposition of Translation Adjustment 414
U.S. GAAP 415
FASB ASC 830 416
Functional Currency 416
Highly Inflationary Economies 417
International Financial Reporting
Standards 418
The Translation Process Illustrated 420
Translation of Financial Statements: Current
Rate Method 421
Translation of the Balance Sheet 422
Computation of Translation Adjustment 424
Remeasurement of Financial Statements:
Temporal Method 424
Remeasurement of Income Statement 424
Computation of Remeasurement Gain 426
Nonlocal Currency Balances 427
Comparison of the Results from Applying the
Two Different Methods 428
Underlying Valuation Method 428
Underlying Relationships 429
xviii Contents

Hedging Balance Sheet Exposure 429 Foreign Portfolio Investment 494

Disclosures Related to Translation 432 International Mergers and Acquisitions 494
Summary 434 Other Reasons 495
Questions 435 Potential Problems in Analyzing Foreign
Exercises and Problems 436 Financial Statements 495
Case 8-1: Columbia Corporation 443 Data Accessibility 495
Case 8-2: Palmerstown Company 445 Language 496
References 447 Currency 498
Terminology 499
Format 500
Chapter 9 Extent of Disclosure 500
Additional Financial Reporting Timeliness 502
Issues 448 Differences in Accounting Principles 503
International Ratio Analysis 506
Introduction 448
Restating Financial Statements 508
Accounting for Changing Prices (Inflation
Explanation of Reconciling Adjustments 513
Accounting) 449
Comparison of Local GAAP and U.S.
Impact of Inflation on Financial Statements 449
GAAP Amounts 518
Purchasing Power Gains and Losses 450
Summary 519
Methods of Accounting for Changing Prices 450
Appendix to Chapter 10
General Purchasing Power (GPP) Accounting 452
Morgan Stanley Dean Witter: Apples
Current Cost (CC) Accounting 453
to Apples 520
Inflation Accounting Internationally 454
Questions 523
International Financial Reporting Standards 457
Exercises and Problems 523
Translation of Foreign Currency Financial Statements
Case 10-1: Swisscom AG 535
in Hyperinflationary Economies 460
References 539
Identification of High Inflation Countries 463
Business Combinations and Consolidated
Financial Statements 463 Chapter 11
Determination of Control 464 International Taxation 541
Scope of Consolidation 467
Introduction 541
Full Consolidation 467
Investment Location Decision 541
Equity Method 472
Legal Form of Operation 542
Segment Reporting 474
Method of Financing 542
Operating Segments—The Management Approach 475
Types of Taxes and Tax Rates 542
Example: Application of Significance Tests 476
Income Taxes 542
Operating Segment Disclosures 478
Tax Havens 544
Entity-Wide Disclosures 478
Withholding Taxes 546
Summary 482
Tax-Planning Strategy 547
Questions 483
Value-Added Tax 547
Exercises and Problems 483
Tax Jurisdiction 548
References 491
Worldwide versus Territorial Approach 548
Source, Citizenship, and Residence 549
Chapter 10 Double Taxation 550
Analysis of Foreign Financial Foreign Tax Credits 551
Credit versus Deduction 551
Statements 492
Calculation of Foreign Tax Credit 552
Introduction 492 Excess Foreign Tax Credits 553
Overview of Financial Statement Analysis 492 FTC Baskets 555
Reasons to Analyze Foreign Financial Indirect Foreign Tax Credit (FTC
Statements 494 for Subsidiaries) 556
 Contents xix

Tax Treaties 557 Advance Pricing Agreements 607

Model Treaties 558 Enforcement of Transfer Pricing
U.S. Tax Treaties 558 Regulations 609
Treaty Shopping 560 Worldwide Enforcement 610
Controlled Foreign Corporations 561 Summary 611
Subpart F Income 561 Questions 612
Determination of the Amount of CFC Income Exercises and Problems 613
Currently Taxable 562 Case 12-1: Litchfield Corporation 618
Safe Harbor Rule 562 Case 12-2: Global Electronics Company 619
Summary of U.S. Tax Treatment of Foreign References 620
Source Income 562
Example: U.S. Taxation of Foreign Source Income 562 Chapter 13
Translation of Foreign Operation Income 565 Strategic Accounting Issues in
Translation of Foreign Branch Income 566 Multinational Corporations 621
Translation of Foreign Subsidiary Income 567
Foreign Currency Transactions 568 Introduction 621
Tax Incentives 568 Strategy Formulation 622
Tax Holidays 569 Capital Budgeting 622
U.S. Export Incentives 570 Capital Budgeting Techniques 626
Summary 572 Multinational Capital Budgeting 629
Appendix to Chapter 11 Illustration: Global Paper Company 631
U.S. Taxation of Expatriates 573 Strategy Implementation 637
Questions 576 Management Control 637
Exercises and Problems 576 Operational Budgeting 640
Case 11-1: U.S. International Corporation 584 Evaluating the Performance of
References 585 Foreign Operations 641
Designing an Effective Performance Evaluation
Chapter 12 System for a Foreign Subsidiary 642
Performance Measures 643
International Transfer Pricing 586
Financial Measures 643
Introduction 586 Nonfinancial Measures 643
Decentralization and Goal Congruence 587 Financial versus Nonfinancial Measures 644
Transfer Pricing Methods 588 The Balanced Scorecard (BSC): Increased Importance
Objectives of International Transfer Pricing 589 of Nonfinancial Measures 646
Performance Evaluation 589 Responsibility Centers 648
Cost Minimization 591 Foreign Operating Unit as a Profit Center 649
Other Cost-Minimization Objectives 591 Separating Managerial and Unit Performance 650
Survey Results 593 Uncontrollable Items 650
Interaction of Transfer Pricing Method Choice of Currency in Measuring Profit 652
and Objectives 594 Foreign Currency Translation 652
Government Reactions 595 Choice of Currency in Operational Budgeting 653
U.S. Transfer Pricing Rules 595 Incorporating Economic Exposure into the
Sale of Tangible Property 596 Budget Process 656
Licenses of Intangible Property 601 Implementing a Performance Evaluation System 659
Intercompany Loans 603 Culture and Management Control 660
Intercompany Services 604 Summary 661
Arm’s-Length Range 604 Questions 663
Correlative Relief 604 Exercises and Problems 663
Penalties 606 Case 13-1: Canyon Power Company 665
Contemporaneous Documentation 606 Case 13-2: Lion Nathan Limited 667
Reporting Requirements 607 References 672
xx Contents
Chapter 14
Comparative International Auditing
and Corporate Governance 674
Introduction 674
International Auditing and Corporate
Governance 676
International Diversity in External
Auditing 680
Purpose of Auditing 680
Audit Environments 682
Regulation of Auditors and Audit Firms 684
Audit Reports 687
International Harmonization of Auditing
Standards 688
Ethics and International Auditing 693
A More Communitarian View of Professional
Ethics 694
Additional International Auditing Issues
Auditor’s Liability 695
Limiting Auditor’s Liability 695
Auditor Independence 697
Audit Committees 701
Internal Auditing 702
The Demand for Internal Auditing in MNCs 704
U.S. Legislation against Foreign
Corrupt Practices 705
Legislation in Other Jurisdictions 708
Future Directions 710
Consumer Demand 711
Reporting on the Internet 711
Increased Competition in the Audit Market 712
Continued High Interest in the
Audit Market 712
Increased Exposure of the International
Auditing Firms 712
Tendency toward a Checklist Approach 713
Auditing No Longer Only the Domain of the
External Auditor 713
Different Corporate Governance Models 713
Summary 713
Appendix to Chapter 14
Examples of Audit Reports from
Multinational Corporations 714
Questions 722
Exercises and Problems 723
Case 14-1: Honda Motor Company 725
Case 14-2: Daimler AG 732
References 736
Chapter 15
International Corporate Social
Reporting 739
Introduction 739
Theories to Explain CSR Practices 741
695
Drivers of CSR Practices by Companies 741
Implications of Climate Change for CSR 743
Climate Change at a Glance 743
Some Related Key Concepts 744
Regulating CSR Practices 745
Regulation of CSR in the United States 746
Regulation of CSR in Other Countries
and Regions 748
International Arrangements to Regulate CSR 748
Global Reporting Initiative (GRI) 749
CSR Practices by MNCs 754
Concluding Remarks 764
Summary 766
Questions 767
Exercises and Problems 767
Case 15-1: The Case of Modco Inc. 767
References 769
Index 772
Chapter One

Introduction to
International
Accounting
Learning Objectives
After reading this chapter, you should be able to

• Discuss the nature and scope of international accounting.

• Describe accounting issues confronted by companies involved in international
trade (import and export transactions).
• Explain the reasons for, and the accounting issues associated with, foreign direct
investment.
• Describe the practice of cross-listing on foreign stock exchanges.
• Explain the notion of global accounting standards.
• Examine the importance of international trade, foreign direct investment, and
multinational corporations in the global economy.

WHAT IS INTERNATIONAL ACCOUNTING?

Most accounting students are familiar with financial accounting and managerial
accounting, but many have only a vague idea of what international accounting
is. Defined broadly, the accounting in international accounting encompasses the
functional areas of financial accounting, managerial accounting, auditing, taxa-
tion, and accounting information systems.
The word international in international accounting can be defined at three dif-
ferent levels.1 The first level is supranational accounting, which denotes standards,
guidelines, and rules of accounting, auditing, and taxation issued by supranational
organizations. Such organizations include the United Nations, the Organization
for Economic Cooperation and Development, and the International Federation of
Accountants.

1
This framework for defining international accounting was developed by Professor Konrad Kubin in the
preface to International Accounting Bibliography 1982–1994, distributed by the International Accounting
Section of the American Accounting Association (Sarasota, FL: AAA, 1997).
1
2 Chapter One

At the second level, the company level, international accounting can be viewed
in terms of the standards, guidelines, and practices that a company follows related
to its international business activities and foreign investments. These would in-
clude standards for accounting for transactions denominated in a foreign currency
and techniques for evaluating the performance of foreign operations.
At the third and broadest level, international accounting can be viewed as the
study of the standards, guidelines, and rules of accounting, auditing, and taxa-
tion that exist within each country as well as comparison of those items across
countries. Examples would be cross-country comparisons of (1) rules related to
the financial reporting of plant, property, and equipment; (2) income and other tax
rates; and (3) the requirements for becoming a member of the national accounting
profession.
Clearly, international accounting encompasses an enormous amount of
territory—both geographically and topically. It is not feasible or desirable to cover
the entire discipline in one course, so an instructor must determine the scope of
an international accounting course. This book is designed to be used in a course
that attempts to provide an overview of the broadly defined area of international
accounting, but that also focuses on the accounting issues related to international
business activities and foreign operations.

EVOLUTION OF A MULTINATIONAL CORPORATION

To gain an appreciation for the accounting issues related to international business,
let us follow the evolution of Magnum Corporation, a fictional auto parts manu-
facturer headquartered in Detroit, Michigan.2 Magnum was founded in the early
1950s to produce and sell rearview mirrors to automakers in the United States.
For the first several decades, all of Magnum’s transactions occurred in the United
States. Raw materials and machinery and equipment were purchased from suppli-
ers located across the United States, finished products were sold to U.S. automak-
ers, loans were obtained from banks in Michigan and Illinois, and the common
stock was sold on the New York Stock Exchange. At this stage, all of Magnum’s
business activities were carried out in U.S. dollars, its financial reporting was done
in compliance with U.S. generally accepted accounting principles (GAAP), and
taxes were paid to the U.S. federal government and the state of Michigan.

Sales to Foreign Customers

In the 1980s, one of Magnum’s major customers, Normal Motors Inc., acquired a
production facility in the United Kingdom, and Magnum was asked to supply this
operation with rearview mirrors. The most feasible means of supplying Normal
Motors UK (NMUK) was to manufacture the mirrors in Michigan and then ship
them to the United Kingdom, thus making export sales to a foreign customer. If the
sales had been invoiced in U.S. dollars, accounting for the export sales would have
been no different from accounting for domestic sales. However, Normal Motors
required Magnum to bill the sales to NMUK in British pounds (£), thus creating
foreign currency sales for Magnum. The first shipment of mirrors to NMUK was

2
The description of Magnum’s evolution is developed from a U.S. perspective. However, the international
accounting issues that Magnum is forced to address would be equally applicable to a company head-
quartered in any other country in the world.
 Introduction to International Accounting 3

invoiced at £100,000 with credit terms of 2/10, net 30. If Magnum were a British
company, the journal entry to record this sale would have been:

Dr. Accounts Receivable (1 Assets) . . . . . . . . . . . . . . . . . . . . . . . . . . . £100,000

Cr. Sales Revenue (1 Equity) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . £100,000

However, Magnum is a U.S.-based company that keeps its accounting records in

U.S. dollars (US$). To account for this export sale, the British pound sale and re-
ceivable must be translated into US$. Assuming that the exchange rate between
the £ and the US$ at the time of this transaction was £1 5 US$1.60, the journal
entry would have been:

Dr. Accounts Receivable (£) (1 Assets) . . . . . . . . . . . . . . . . . . . . . . US$160,000

Cr. Sales Revenue (1 Equity) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$160,000

This was the first time since its formation that Magnum had found it necessary to
account for a transaction denominated (invoiced) in a currency other than the U.S.
dollar. The company added to its chart of accounts a new account indicating that
the receivable was in a foreign currency, “Accounts Receivable (£),” and the accoun-
tant had to determine the appropriate exchange rate to translate £ into US$.
As luck would have it, by the time NMUK paid its account to Magnum, the
value of the £ had fallen to £1 5 US$1.50, and the £100,000 received by Magnum
was converted into US$150,000. The partial journal entry to record this would
have been:

Dr. Cash (1 Asset) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$150,000

Cr. Accounts Receivable (£) (− Asset). . . . . . . . . . . . . . . . . . . . . . . US$160,000

This journal entry is obviously incomplete because the debit and the credit are not
equal and the balance sheet will be out of balance. A question arises: How should
the difference of US$10,000 between the original US$ value of the receivable and
the actual number of US$ received be reflected in the accounting records? Two
possible answers would be (1) to treat the difference as a reduction in sales rev-
enue or (2) to record the difference as a separate loss resulting from a change in the
foreign exchange rate. This is an accounting issue that Magnum was not required
to deal with until it became involved in export sales. Specific rules for accounting
for foreign currency transactions exist in the United States, and Magnum’s accoun-
tants had to develop an ability to apply those rules.
Through the British-pound account receivable, Magnum became exposed to
foreign exchange risk—the risk that the foreign currency will decrease in US$
value over the life of the receivable. The obvious way to avoid this risk is to require
foreign customers to pay for their purchases in US$. Sometimes foreign customers
will not or cannot pay in the seller’s currency, and to make the sale, the seller will
be obliged to accept payment in the foreign currency. Thus, foreign exchange risk
will arise.
4 Chapter One

Hedges of Foreign Exchange Risk

Companies can use a variety of techniques to manage, or hedge, their exposure to
foreign exchange risk. A popular way to hedge foreign exchange risk is through
the purchase of a foreign currency option that gives the option owner the right,
but not the obligation, to sell foreign currency at a predetermined exchange rate
known as the strike price. Magnum purchased such an option for US$200 and was
able to sell the £100,000 it received for a total of US$155,000 because of the option’s
strike price. The foreign currency option was an asset that Magnum was required
to account for over its 30-day life. Options are a type of derivative financial instru-
ment,3 the accounting for which can be quite complicated. Foreign currency for-
ward contracts are another example of derivative financial instruments commonly
used to hedge foreign exchange risk. Magnum never had to worry about how to
account for hedging instruments such as options and forward contracts until it
became involved in international trade.

Foreign Direct Investment

Although the managers at Magnum at first were apprehensive about international
business transactions, they soon discovered that foreign sales were a good way to
grow revenues and, with careful management of foreign currency risk, would allow
the company to earn adequate profit. Over time, Magnum became known through-
out Europe for its quality products. The company entered into negotiations and
eventually landed supplier contracts with several European automakers, filling or-
ders through export sales from its factory in the United States. Because of the com-
bination of increased shipping costs and its European customers’ desire to move
toward just-in-time inventory systems, Magnum began thinking about investing
in a production facility somewhere in Europe. The ownership and control of for-
eign assets, such as a manufacturing plant, is known as foreign direct investment.
Exhibit 1.1 summarizes some of the major reasons for foreign direct investment.
Two ways for Magnum to establish a manufacturing presence in Europe were
to purchase an existing mirror manufacturer (acquisition) or to construct a brand-
new plant (greenfield investment). In either case, the company needed to calculate
the net present value (NPV) from the potential investment to make sure that the
return on investment would be adequate. Determination of NPV involves fore-
casting future profits and cash flows, discounting those cash flows back to their
present value, and comparing this with the amount of the investment. NPV calcu-
lations inherently involve a great deal of uncertainty.
In the early 1990s, Magnum identified a company in Portugal (Espelho Ltda.) as
a potential acquisition candidate. In determining NPV, Magnum needed to fore-
cast future cash flows and determine a fair price to pay for Espelho. Magnum had
to deal with several complications in making a foreign investment decision that
would not have come into play in a domestic situation.
First, to assist in determining a fair price to offer for the company, Magnum
asked for Espelho’s financial statements for the past five years. The financial state-
ments had been prepared in accordance with Portuguese accounting rules, which
were much different from the accounting rules Magnum’s managers were familiar
with. The balance sheet did not provide a clear picture of the company’s assets,

3
A derivative is a financial instrument whose value is based on (or derived from) a traditional security
(such as a stock or bond), an asset (such as foreign currency or a commodity like gold), or a market index
(such as the S&P 500 index). In this example, the value of the British-pound option is based on the price
of the British pound.
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