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CHAPTER

International Issues in Managerial Accounting

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Objectives
1. Explain the role of the management After studying this accountant in the international environment. chapter, you should 2. Identify the varying levels of involvement be able to: that firms can undertake in international trade. 3. List the ways management accountants can manage foreign currency risk. 4. Explain why multinational firms choose to decentralize.

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Objectives
5. Describe how environmental factors can affect performance evaluation in the multinational firm. 6. Discuss the role of transfer pricing in the multinational firm. 7. Discuss ethical issues that affect firms operating in the international environment.

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Where does the management accountant fit into the global business environment?

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Business looks to the management accountant for international financial and business expertise.

Management Accounting in the International Environment
Skills needed by management accountants  Politics  Economics  Marketing  Management  Information Systems Technology

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Multinational Corporation (MNC)
A multinational corporation (MNC) is one that “does business in more than one country in such a volume that its well-being and growth rest in more than one country.”

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Importing and Exporting
Importing is the process of bringing product in from a foreign country. Exporting is the process of shipping product to a foreign country.

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Foreign Trade Zones
Foreign trade zones are areas near a customs port of entry that are physically on U.S. soil but considered to be outside U.S. commerce.

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San New Antonio Orleans

Example: Example:

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Example of the Advantages of Operating a Plant in a Foreign Trade Zone
Roadrunner, Inc. operates a petrochemical plant in a foreign trade zone. Wilycoyote, Inc. operates an identical plant just outside the foreign trade zone. Both plants purchase $400,000 of crude oil from Venezuela.

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Example (continued) Roadrunner Wilycoyote Duty paid at purchase $ 0 $24,000 Carrying costs of duty 0 1,920 Duty paid at sale 16,800 0 Wilycoyote pays duty at Total dutythe point of related Roadrunner pays purchase (6% carrying costs duty at point of sale $400,000). of (0.12 x 8/12 x because it is in a $24,000) foreign trade zone.

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Example (continued) Roadrunner Wilycoyote $ 0 $24,000 0 1,920 16,800 0 $16,800 Clearly the advantage approach $25,920

Duty paid at purchase Carrying costs of duty Duty paid at sale Total duty and dutyrelated costs

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A the laws of the choose to purchase If company may country permit, an an existing foreign company, making multinational corporation can simply set up a wholly owned subsidiary or the purchased company a wholly branch office in the country. owned subsidiary.

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Outsourcing is the payment by Outsourcing of technical and a company for a business professional jobs is becoming function formerly done inan important as payment for house, such issue for costconscious outside firms. legal needs toU.S. firms.

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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 manufacturing plant located in Mexico which processes imported materials and reexports them to the United States.

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Foreign Currency Exchange
Kinds of risks:
 Currency risk management  Transaction risk  Economic risk  Translation (accounting ) risk

A Transaction Risk Example
SuperTubs, Inc., a U.S. firm, sells its line of whirlpool tubs to Bonbain, a French distributor. On January 15, Bonbain orders 100 tubs at $1,000 per tub to be paid with French francs on March 15. The exchange rate on on January 15 is seven francs per dollar or 700,000 francs. Suppose that on March 15 the exchange rate is 7.1 francs per dollar. A $1,408 loss is experienced by SuperTubs, Inc. Receivable in dollars on Jan. 15 $100,000 Received in dollars on March 15 (700,000/7.1) 98,592 Exchange loss $ 1,408

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A Transaction Risk Example
If the franc had strengthened against the dollar to a rate of 6.9 francs per dollar, a $1,449 gain would occur: Receivable in dollars on Jan. 15 $100,000 Received in dollars on March 15 (700,000/6.9) 101,449 Exchange gain $ 1,449

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One way of insuring against gains and losses on foreign currency exchanges is hedging.

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Managing Economic Risk
Economic risk is the impact of exchange rate fluctuations on the present value of a firm’s future cash flows. Example
A U.S. consumer can choose to purchase heavy equipment from either Caterpillar (U.S.) or Komatsu (Japan). A piece of equipment is $80,000 from either maker. At an exchange rate of $1 equals 130 yens, the price is set. Assume the dollar strengthens so the exchange rate becomes $1 equals 140 yens. This lowers Katmatsu’s price to $74,286.

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Managing Translation Risk
Example
Multinational, Inc., has a foreign division, FD, which has been experiencing eroding sales. Multinational directs FD managers to increase marketing expenditures over the following four quarters: Quarter 1 2 3 4 Expenditures in Local Currency LC10,000 LC11,000 LC12,100 LC13,310 A 10% increase each quarter

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Managing Translation Risk
Example (continued)
Suppose that the dollar has strengthened against the local currency and the quarterly exchange rates of $1 for units of local currency are 1.00, 1.2, 1.35, and 1.50, respectively. Quarter 1 2 3 4 Expenditures in Local Currency $10,000 9,167 8,963 8,873 It looks like FD has decreased expenditures.

Advantages of Decentralization in the MNC
 The quality of information is better at the local

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level.
 Local managers in the MNC are capable of a

more timely response in decision making.
 Social, legal, and language barriers are

minimized.
 Valuable training grounds for foreign

subsidiary managers.

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Measuring Performance in the Multinational Firm It is particularly difficult to compare the performance of a manager of a division in one country with the performance of a manager of a division in another country.

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Measuring Performance in the Multinational Firm
An example of misleading results:
Assets Revenues Net Income Margin Turnover ROI

Brazil Canada Spain

$10 18 15

$6 13 10

$3 10 6

0.50 0.77 0.60

0.60 0.72 0.67

0.30 0.55 0.40

Analysis: On the basis of ROI, it appears that the manager of the Canadian subsidiary did the best job, while the manager of the Brazilian subsidiary did the worst job. However, the inflation rate in Brazil was 100% for the year. After adjusting the asset base for inflation, the ROI would be 60% for the Brazilian manager.

Environmental Factors Affecting Performance Evaluation in the MNC
Economic Factors:
Organization of central banking system Economic stability Existence of capital markets Currency restrictions

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Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

Environmental Factors Affecting Performance Evaluation in the MNC
Political and Legal Factors:

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Quality, efficiency, and effectiveness of legal structure Effect of defense policy Impact of foreign policy Level of political unrest Degree of governmental control of business
Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

Environmental Factors Affecting Performance Evaluation in the MNC
Educational Factors:

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Literacy rate Extent and degree of formal education and training systems Extent and degree of technical training Extent and quality of management development programs
Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

Environmental Factors Affecting Performance Evaluation in the MNC
Sociological Factors:

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Social attitude toward industry and business Cultural attitude toward authority and persons in subordinate positions Cultural attitude toward productivity and achievement (work ethic) Social attitude toward material gain Cultural and racial diversity
Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

Income Taxes and Transfer Pricing
Action Belgian subsidiary of parent company produces a component at a cost of $100 per unit. Title to the component is transferred to a reinvoicing center in Puerto Rico at a transfer price of $100 per unit. Tax Impact 42% tax rate $100 revenue – $100 cost = $0 Taxes paid = $0

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Income Taxes and Transfer Pricing
Action Reinvoicing center in Puerto Rico, also a subsidiary of parent company transfers title of component to U.S. subsidiary of parent company at a transfer price of $200 per unit. Action U.S. subsidiary sells a component to external company at $200 each. Tax Impact 0% tax rate $200 revenue – $100 cost = $100 Taxes paid = $0

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Tax Impact 35% tax rate $200 revenue – $200 cost = $0 Taxes paid = $0

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The IRS allows three pricing methods that approximate arm’s-length pricing (shown in the order of preference):
 Comparable uncontrolled

price method
 Resale price method  Cost-plus method

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Questions to Ask Concerning Ethics in the International Environment

Is the action right legally? Is the action right morally?

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Chapter Fourteen

The End

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