International Business 9 e By Charles W L

Chapter 20 Accounting and Finance in the International Business

What Is Accounting? Ø Accounting is the language of business Ø it is the way firms communicate their financial positions Ø Accounting is more complex for international firms because of differences in accounting standards from country to country Ø differences make it difficult for investors, creditors, and governments to evaluate firms Ø It is difficult to compare financial reports from country to country because of national differences in accounting and auditing standards 20 -3

What Determines National Accounting Standards? Ø Accounting standards are rules for preparing financial statements Ø variables influencing accounting systems include Ø the relationship between business and the providers of capital Ø political and economic ties Ø the level of inflation Ø the level of economic development Ø the prevailing culture in a country Ø Auditing standards specify the rules for performing an audit 20 -4

Why Are International Accounting Standards Important? Ø The growth of transnational financing and transnational investment has created a need for transnational financial reporting Ø many companies obtain capital from foreign providers who are demanding greater consistency Ø Standardization of accounting practices across national borders is probably in the best interests of the world economy Ø The International Accounting Standards Board (IASB) is a major proponent of standardization of accounting standards 20 -5

How Does Accounting Influence Control Systems? Ø 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 Ø Budgets and performance data are usually expressed in the corporate currency 20 -6

How Do Exchange Rates Influence Control? Ø The Lessard-Lorange Model Ø firms can deal with the problems of exchange rates and control in three ways 1. The initial rate Ø the spot exchange rate when the budget is adopted 2. The projected rate Ø the spot exchange rate forecast for the end of the budget picture 3. The ending rate Ø the spot exchange rate when the budget and performance are being compared 20 -7

What Is The Lessard-Lorange Model? Possible Combinations of Exchange Rates in the Control Process 20 -8

What Is Financial Management? Ø Financial management involves 1. Investment decisions –what to finance 2. Financing decisions –how to finance those decisions 3. Money management decisions –how to manage the firm’s financial resources most efficiently Ø Decisions are more complex in international business because of different currencies, tax regimes, regulations on capital flows, economic and political risk, etc. 20 -9

How Do Managers Make Investment Decisions? Ø Financial managers must quantify the benefits, costs, and risks associated with an investment in a foreign country Ø To do this, managers use capital budgeting Ø involves estimating the cash flows associated with the project over time, and then discounting them to determine their net present value Ø If the net present value of the discounted cash flows is greater than zero, the firm should go ahead with the project 20 -10

Why Is Capital Budgeting More Difficult For International Firms? Ø Capital budgeting is more complicated in international business Øbecause a distinction must be made between cash flows to the project and cash flows to the parent company Øbecause of political and economic risk Øbecause the connection between cash flows to the parent and the source of financing must be recognized 20 -11

How Does Risk Influence Investment Decisions? Ø Political risk - the likelihood that political forces will cause drastic changes in a country’s business environment that hurt the profit and other goals of a business Ø higher in countries with social unrest or disorder, or where the nature of the society increases the chance for social unrest Ø Economic risk - the likelihood that economic mismanagement will cause drastic changes in a country’s business environment that hurt the profit and other goals of a business 20 -12

How Can Firms Adjust For Political And Economic Risk? Ø Firms analyzing foreign investment opportunities can adjust for risk 1. By raising the discount rate in countries where political and economic risk is high 2. By lowering future cash flow estimates to account for adverse political or economic changes that could occur in the future 20 -13

How Do Firms Make Financing Decisions? Ø Firms must consider two factors 1. How the foreign investment will be financed 2. How the financial structure (debt vs. equity) of the foreign affiliate should be configured Ø Most experts suggest that firms adopt the structure that minimizes the cost of capital, whatever that may be 20 -14

What Is Global Money Management? Ø Money management decisions attempt to manage global cash resources efficiently Ø Firms need to 1. Minimize cash balances - need cash balances on hand for notes payable and unexpected demands 2. Reduce transaction costs - the cost of exchange Ø multinational netting 20 -15

How Can Firms Limit Their Tax Liability? Ø Every country has its own tax policies Ø most countries feel they have the right to tax the foreign-earned income of companies based in the country Ø Double taxation occurs when the income of a foreign subsidiary is taxed by the host -country government and by the homecountry government 20 -16

How Can Firms Limit Their Tax Liability? Ø Taxes can be minimized through 1. Tax credits - allow the firm to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government 2. Tax treaties - agreement specifying what items of income will be taxed by the authorities of the country where the income is earned 3. Deferral principle - specifies that parent companies are not taxed on foreign source income until they actually receive a dividend 4. Tax havens - countries with a very low, or no, income tax – firms can avoid income taxes by establishing a wholly-owned, non-operating subsidiary in the country 20 -17

How Do Firms Move Money Across Borders? Ø Firms can transfer liquid funds across border via 1. Dividend remittances - the most common method of transferring funds from subsidiaries to the parent 2. Royalty payments and fees -the remuneration paid to the owners of technology, patents, or trade names for the use of that technology or the right to manufacture and/or sell products under those patents or trade names 20 -18

How Do Firms Move Money Across Borders? 3. Transfer prices -the price at which goods and services are transferred between entities within the firm 4. Fronting loans -loans between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank 20 -19