Accounting in the International Business Chapter 19 Mc

Accounting in the International Business Chapter 19 © Mc. Graw Hill Companies, Inc. , 2000

Accounting Information and Capital Flows $ Resource Users Business Enterprise Resource Providers of Capital (investors, Creditors and Government) Information Users Information Providers Financial Accounting Information © Mc. Graw Hill Companies, Inc. , 2000 Figure 19. 1 19 -1

Determinants of National Accounting Standards Relationship Between Business and Providers of Capital Level of Inflation © Mc. Graw Hill Companies, Inc. , 2000 National Accounting System National Culture Political and Economic Ties with Other Countries Level of Economic Development Figure 19. 2 19 -2

Relationship Between Business and Providers of Capital ¥External sources of capital: ¤Individual investors. • Buying shares and bonds. ¤Banks. • Loan capital. ¤Government. Importance of each varies from country to country • Make loans or investment. © Mc. Graw Hill Companies, Inc. , 2000 19 -3

Political and Economic Ties with Other Countries ¥Accounting convergence: ¤Influence of NAFTA. ¤Influence of the former British Empire. ¤Influence of the European © Mc. Graw Hill Companies, Inc. , 2000 Union. 19 -4

Inflation Accounting ¥Historic cost principle: ¤Assumes currency is not losing value to inflation. ¤Most significant impact = asset valuation. ¤ Appropriateness varies with inflation. ¥ Current cost accounting: ¤Factors out inflation. ¤Used in Great Britain until inflation rate declined. © Mc. Graw Hill Companies, Inc. , 2000 19 -5

Level of Development ¥Developed countries have more sophisticated accounting procedures. ¤Accounting problems are more complex. ¤Sophisticated capital markets. ¤Lenders require comprehensive reports. ¤Educated workforce can perform complex accounting functions. © Mc. Graw Hill Companies, Inc. , 2000 19 -6

Culture ¥Hofstede’s uncertainty avoidance has an impact on accounting systems. ¤Low uncertainty avoidance - these countries tend to have strong independent accounting professions that ensure a firm’s compliance with rules. © Mc. Graw Hill Companies, Inc. , 2000 19 -7

Accounting Clusters British-American-Dutch Group Firms raise capital from investors. Accounting systems designed to inform investors Europe-Japan Group Have close ties to banks. Accounting practices meet bank’s needs. South American Group Countries have experienced persistent and rapid inflation. Accounting principles reflect the inflation. © Mc. Graw Hill Companies, Inc. , 2000 19 -8

© Mc. Graw Hill Companies, Inc. , 2000 Map 19. 1 19 -9

International Accounting Standards Committee ¥Members represent 79 countries. ¥Responsible formulating international accounting standards (IAS). ¥Has issued over 30 IAS. ¤Difficult to get requisite votes. ¤Voluntary compliance. ¥Recognition is growing. © Mc. Graw Hill Companies, Inc. , 2000 19 -10

Multinational Consolidation and Currency Translation Consolidated Financial Statements Cash Receivables Payables Revenues Expenses Parent $1, 000 300 3, 000 2, 000 Parent $1, 000 300 7, 000 2, 000 Foreign Subsidiary $250 *Subsidiary owes Parent $300 900 *Subsidiary pays Parent $1000 500 in royalties for products 900 licensed from Parent 3, 000 Eliminations Foreign Subsidiary $250 900 500* 5, 000 3, 000** Debit $300 1, 000 Credit $300 1, 000 Consolidated $1, 250 3, 600 500 11, 000 4, 000 *Subsidiary owes Parent $300. **Subsidiary pays Parent $1, 000 in royalties for products licensed from Parent. © Mc. Graw Hill Companies, Inc. , 2000 19 -11

Currency Translation ¥The current rate method: the exchange rate at the balance sheet’s date is used to translate foreign subsidiary financial statements into home country currency. ¤Incompatible with ‘historic cost principle’. ¥The temporal method: translates foreign subsidiary assets into home-country currency at the time the asset is purchased. ¤Changing exchange rates may mean the balance sheet may not balance! © Mc. Graw Hill Companies, Inc. , 2000 19 -12

U. S. Practice ¥Statement 52 “Foreign Currency Translation” ¥ Self-sustaining autonomous subsidiary: ¤Functional currency is local currency. ¤Balance sheet uses exchange rate at end financial year. ¤Income statement is financial year average. Firms using multidomestic of or international strategies. ¥ Integral subsidiary: ¤Functional currency is US currency. ¤Financial statements use the temporal ¤Dangling credit or debit increases or decreases consolidated earnings for the period. © Mc. Graw Hill Companies, Inc. , 2000 method. Firms using global or transnational strategies. 19 -13

Accounting Aspects of Control Systems ¥Annual control process involves three steps: ¤Head office and suibunit management jointly determine subunit goals for the coming year. ¤Throughout year, head office monitors subunit performance against agreed goals. ¤If subunit fails to achieve goals, head office intervenes to determine why the shortfall occurred, taking corrective action when appropriate. © Mc. Graw Hill Companies, Inc. , 2000 19 -14

Importance of Financial Criteria Used to Evaluate Performance of Foreign Subsidiaries and Their Managers Item Subsidiary Manager Return on investment (ROI) 1. 9 2. 2 Return on equity (ROE) Return on assets (ROA) Return on sales (ROS) Residual income Budget compared to actua. L sales Budget compared to actual profit Budget compared to actua. L ROI Budget compared to actual ROA Budget compared to actua. L ROE 3. 0 2. 3 2. 1 3. 4 1. 9 1. 5 2. 3 2. 7 3. 1 3. 0 2. 3 2. 1 3. 3 1. 7 1. 3 2. 4 2. 5 3. 0 Importance of criteria ranked on a scale from 1=very important to 5=unimportant. © Mc. Graw Hill Companies, Inc. , 2000 Table 19. 1 19 -15

Exchange Rate Changes and Control Systems ¥Lessard-Lorange Model: ¤Three exchange rates used to translate foreign currency into corporate currency for budget and performance purposes. • The initial rate, the spot exchange rate when the budget is adopted. • The projected rate, the spot exchange forecast for the end of budget period (I. e. , the forward rate) • The ending rate, the spot exchange rate when the budget and performance are being compared. © Mc. Graw Hill Companies, Inc. , 2000 19 -16

Possible Combinations of Exchange Rates in the Control Process Rates Used to Translate Actual Performance for Comparison with Budget Initial (I) Projected (P) Ending (E) (II) Budget at Initial (IE) Actual at Budget at Initial (I) Budget at Initial Actual at Initial Projected Actual at Ending Rates Budget at (PP) (PE) Used Budget at Projected (P) for Actual at Initial Actual at Projected Actual Translating at Ending Budget Actual at (EE) Ending (E) Initial Figure 19. 3 © Mc. Graw Hill Companies, Inc. , 2000 Projected Budget at Ending Actual at Ending 19 -17

Transfer Pricing and Control Systems Before Change in Transfer Price After 20% Increase in Transfer Price Revenues per unit $230 Cost of component per unit 100 Revenues per unit 100 Profit per unit 30 10 © Mc. Graw Hill Companies, Inc. , 2000 19 -18