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International Business

By Charles W.L. Hill

Chapter 19 Accounting in the International Business

McGraw-Hill/Irwin Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

What Is Accounting?
Accounting is the language of business it is the way firms communicate their financial positions Accounting is more complex for international firms because of differences in accounting standards from country to country
differences make it difficult for investors, creditors, and governments to evaluate firms

The International Accounting Standards Board (IASB) has made some attempts to establish common accounting and auditing standards across countries

How Is Accounting Information Used?

Accounting Information and Capital Flows


Why Do Countries Use Different Accounting Systems?

A countrys accounting system evolves in response to local demands for accounting information
One study found that among 22 countries, there were 76 ways to assess the cost of goods sold, 65 differences in the calculation of return on assets, and 20 ways to calculate net profits

The differences make it challenging to compare financial performance of firms from different countries While there have been efforts to harmonize accounting practices across countries, significant differences remain

What Determines National Accounting Standards?

Five main variables influence the development of a countrys accounting system 1. The relationship between business and the providers of capital 2. Political and economic ties with other countries 3. The level of inflation 4. The level of a countrys economic development 5. The prevailing culture in a country


What Determines National Accounting Standards?

Determinants of National Accounting Standards


How Do Providers Of Capital Influence Accounting?

The three main external sources of capital for firms are
individual investors banks government

A countrys accounting system reflects the relative importance of each constituency as a provider of capital
accounting systems in the U.S. and Great Britain are oriented toward individual investors Switzerland, Germany, and Japan focus on providing information to banks France and Sweden prepare financial documents with the government in mind


How Do Political And Economic Ties Influence Accounting?

Similarities in accounting systems across countries can reflect political or economic ties
the U.S. accounting system influences the systems in Canada and Mexico in the European Union, countries are moving toward common standards the British system of accounting is used by many former colonies

How Does Inflation Influence Accounting?

The historic cost principal assumes the currency unit used to report financial results is not losing its value due to inflation
affects asset valuation
if inflation is high, assets will be undervalued


How Do Levels of Development Influence Accounting?

Developed nations tend to have more sophisticated accounting systems than developing countries
larger, more complex firms create accounting challenges providers of capital require detailed reports

Many developing nations have accounting systems that were inherited from former colonial powers
lack of trained accountants


How Does Culture Influence Accounting?

Uncertainty avoidance - the extent to which cultures socialize their members to accept ambiguous situations and tolerate uncertainty - impacts the countrys accounting system
countries with low uncertainty avoidance cultures have strong independent auditing professions


What Are Accounting And Auditing Standards?

Accounting standards are rules for preparing financial statements
they define useful accounting information

Auditing standards specify the rules for performing an audit

the technical process by which an independent person gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable

It is difficult to compare financial reports from country to country because of national differences in accounting and auditing standards

Why Are International Accounting Standards Important?

The growth of transnational financing and transnational investment has created a need for transnational financial reporting
many companies obtain capital from foreign providers who are demanding greater consistency

The International Accounting Standards Board (IASB) is a major proponent of standardization of accounting standards
common accounting standards will facilitate the development of global capital markets most IASB standards are consistent with standards already in place in the United States


Why Are International Accounting Standards Important?

About 100 nations have adopted IASB standards or permitted their use in reporting financial results
the EU has mandated harmonization of accounting principles for members

By 2010, there could be only two major accounting bodies with substantial influence on global reporting FASB in the United States and IASB elsewhere

What Is A Consolidated Financial Statement?

A consolidated financial statement combines 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
used by multinational firms

Transactions among members of a corporate family are not included in consolidated financial statements
they are recorded in separate statements

The IASB requires firms to prepare consolidated financial statements, as do most industrialized nations


How Do MNCs Handle Currency Translation?

Foreign subsidiaries usually keep accounting records and prepare financial statements in the local currency To prepare consolidated financial statements, all local financial statements must be converted to the home currency There are two methods to determine what exchange rate should be used when translating financial statement currencies
1. The current rate method 2. The temporal method

What Is The Current Rate Method?

Under the current rate method, the exchange rate at the balance sheet date is used to translate the financial statements of a foreign subsidiary into the home currency of the multinational firm
can present a misleading picture of the financial situation method is incompatible with the historic cost principle

What is The Temporal Method?

The temporal method translates assets valued in a foreign currency into the home currency using the exchange rate that exists when assets are purchased
avoids the problems associated with the current rate method is still problematic because different exchange rates are used to translate foreign assets


What System Do U.S. Firms Use?

U.S. multinationals are required to follow FASB 52 which states
the functional currency is the local currency of each self-sustaining foreign subsidiary balance sheets should be translated into the home currency using the exchange rate in effect at the end of the firms financial year income statements are translated using the average exchange rate for the firms financial year

How Does Accounting Influence Control Systems?

The control process in most firms is usually conducted annually and involves three steps 1. Subunit goals are jointly determined by the head office and subunit management 2. The head office monitors subunit performance throughout the year 3. The head office intervenes if the subsidiary fails to achieve its goal, and takes corrective actions if necessary

How Do Exchange Rates Influence Control?

Budgets and performance data are usually expressed in the corporate currency-normally the home currency
facilitates comparisons between subsidiaries but, can create distortions in financial statements

Donald Lessard and Peter Lorange - firms can deal with the problems of exchange rates and control in three ways 1. The initial rate - the spot exchange rate when the budget is adopted 2. The projected rate - the spot exchange rate forecast for the end of the budget picture 3. The ending rate - the spot exchange rate when the budget and performance are being compared

What Is The Lessard-Lorange Model?

Possible Combinations of Exchange Rates in the Control Process


How Does Transfer Pricing Influence Control?

The price at which goods and services are transferred within the firm is the transfer price Transfer prices can be manipulated to
minimize tax liability minimize import duties avoid government restrictions on capital flows


Why Separate Subsidiary and Managerial Performance?

Subsidiaries operate in different environments which influence profitability So, the evaluation of a subsidiary should be kept separate from the evaluation of its manager A managers evaluation should consider the countrys environment for business, and should take place after making allowances for those items over which managers have no control


Review Question
_______ has an accounting system that was developed with the government in mind.

a) France b) Japan c) Great Britain d) Germany


Review Question
Which organization is responsible for formulating international accounting standards? a) b) c) d) the Global Federation of Accountants the World Bank the International Accounting Standards Board the International Panel of Accounting Standards and Ethics


Review Question
By 2010, which two accounting bodies are expected to dominate accounting practices? a) The historic cost principle and FSAB b) FSAB and the IASB c) The IASB and the historic cost principle d) The current rate method and the historic cost principle


Review Question
When a firm uses the exchange rate at the balance sheet date to translate financial statements of a foreign subsidiary into the home currency, the firm is using a) the temporal method b) the current rate method c) FASB 52 d) the historic cost principle

Review Question
Financial statements of U.S. firms must be prepared according to