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CHAPTER 18 INTERNATIONAL ISSUES IN MANAGEMENT ACCOUNTING

1. Management Accounting in the International Environment Doing business in a global environment requires management to shift perspective. The job of the management accountant in the international firm is made more challenging by the ambiguous and ever-changing nature of global business.

2. Levels of Involvement in International Trade A multinational corporation (MNC) is one that does business in more than one country in such a velume that its well-being and growth rest in more than one country. The involvement of MNC in international trade may take many forms. a. Importing and Exporting

A company may import materials for use in production. An imported part may have a tariff, or duty, in addition to freight-in costs. The US government has set up foreign trade zones, which are areas near a customs port of entry that are physically on US soil but are considered to be outside US commerce. Goods imported into foreign trade zone are duty-free until they leave the zone. Exporting is the sale of a companys products in foreign countries. Foreign countries have a variety of import and tariff regulations. Trade treaties between countries affect tariff charged. Management accountants must be aware of the custom regulations and ensure that adequate record keeping and internal control mechanisms exist. b. Wholly Owned Subsidiaries

A company may choose to purchase an existing foreign company, making the purchased company a wholly owned subsidiary of the parent. Outsourcing is the payment by a company for a business function formerly done in-house.The management accountant must be aware of numerous costs and benefits of outsourcing that would not be available in the US. c. Joint Ventures

A joint venture is a type of partnership in which investors co-own the enterprise. A special case of joint venture cooperation is the maquiladora. A maquiladora is a manufacturing plant located in Mexico which processes imported materials and re-exported them to the US.

3. Foreign Currency Exchange The management accountant plays an important role in managing the companys exposure to currency risk. Currency risk management refers to the compamys management of its transaction, economic, and translation risks due to exchange risk fluctations. a. Managing Transaction Risk

Transaction risk refers to the possibility that future cash transactions will be affected by changing exchange rates. Spot rate is the exchange rate of one currency for another for immediate delivery (today). When ones country currency strengthens relative to another countrys currency, currency appreciation occurs. Currency depreciation is the opposite. One way of insuring against gains or losses on foreign currency transactions is hedging. The forward contract requires the buyer to exchange a specified amount of a currency at a specified rate (forward rate) on a specified future date. b. Managing Economic Risk

Economic risk referes to the possibility that a firms present value of future cash flows will be affected by exchange rate fluctuations. To manage a companys exposure to economic risk the accountant must be aware of it by understanding the position of the firm in global economy. c. Managing Translation Risk

Translation (or accounting) risk is the degree to which a firms financial statements are exposed to exchange rate fluctuation.

4. Decentralization a. Advantages of Decentralization in the MNC

The quality of information is better at the local level, and that can improve the quality of decisions. As a result, local managers are often in a position to make better decisions. Local managers in the MNC are capable of a more timely response in decision making. Just as decentralization gives the lower-level managers in the home country a chance to develop managerial skills, foreign subsidiaries also gain valuable experience. The chance for learning from each other is much greater in a decentralized MNC. b. Creation of Divisions

The MNC has great flexibility in creating types of divisions. Product lines may afford a rationale for the creation of divisions. Many MNCs are diversified, manufacturing and selling a number of different products.

5. Measuring Performance in the Multinational Firm

It is important for the MNC to separate the evaluation of the manager of a division from the evaluation of the division. Managers should be evaluated on the basis or revenues and costs incurred. It is particularly difficult to compare the performance of a manager of a division (or subsidiary) in one country with the performance of a manager of a division in another country. a. Political and Legal Factors Affecting Performance Evaluation

The management accountant in the MNC must be aware of more than business and finance. Political and legal systems have important implications for the company. b. Multiple Measures of Performance

Both EVA (economic value added) and ROI are important measures of managerial performance. However, they are both short-term measures. In addition, top management could look look at such factors such as market share, customer complaints, personnel turnover ratios, and personnel development.

6. Transfer Pricing and Multinational Firm a. Performance Evaluation

Divisions are frequently evaluated on the basis of income and return on investment. But they are frequently set by parent company, so they can no longer serve as indicators of managemen performance in this case. b. Income Taxes and Transfer Pricing

The IRS allows three pricing methods that approximate arms length pricing. The comparable uncontrolled price method essentially uses the market price. The resale price method is equal to the sales price received by the reseller less an appropriate markup. The cost-plus method is simply the cost-based transfer price. Recently the IRS authorized the issuance of advance pricing agreements (APAs) to assist taxpaying firms in determining whether or not a proposed transfer price is acceptable to the IRS in advance of tax filing.

7. Ethics in the International Environment MNCs face ethical issues that do not arise for domestic companies. Other countries have business customs and laws that differ from those of the home country. A strong underlying system is important for enforcing contracts and provides the basis for confidence in ethical dealings.