Part Six Managing International Operations Chapter Eighteen International

Part Six Managing International Operations Chapter Eighteen International Accounting Issues 1 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Chapter Objectives • To examine the major factors influencing the development of accounting practices in different countries • To examine the global convergence of accounting standards • To explain how companies account foreign-currency transactions and translate foreign-currency financial statements • To discuss different forms of performance evaluation of foreign operations and how foreign exchange can complicate the budget process • To explain how arbitrary transfer pricing can complicate performance evaluation and control • To introduce the balanced scorecard as an approach to evaluating performance 2 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Accounting for International Differences • Accounting standards and practices vary around the world • Both the form and the content of financial statements are different in different countries 3 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Accounting Objectives • The accounting process identifies, records, and interprets economic events. • The Financial Accounting Standards Board (FASB) sets accounting standards in the United States. • The International Accounting Standards Board (IASB) is an international privatesector organization that sets accounting standards. 4 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Cultural Differences in Accounting • Culture can have a strong influence on the accounting dimensions of measurement and disclosure • The cultural values of secrecy and transparency refer to the degree of disclosure of information • The cultural values of optimism and conservatism refer to the valuation of assets and the recognition of income 5 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Financial Statements • Financial statements differ in terms of: § § § language currency type of statements (income statement, balance sheet, etc. ) financial statement format extent of footnote disclosures the underlying GAAP on which the financial statements are based • Major approaches to dealing with accounting and reporting differences: § Mutual recognition. § Reconciliation to local GAAP. § Recasting of financial statements in terms of local GAAP. 6 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

International Accounting Standards and Global Convergence • Convergence is the process of bringing different national Generally Accepted Accounting Principles (GAAP) into line with International Financial Reporting Standards (IFRS) issued by the IASB. 7 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Major forces leading to convergence • • Investor orientation. Global integration of capital markets. MNEs’ need foreign capital. Regional political and economic harmonization. • MNEs’ desire to reduce accounting and reporting costs. • Convergence efforts of standards-setting bodies. 8 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

International Financial Reporting Standards (IFRS) • The IASB is attempting to harmonize accounting standards through issuing International Financial Reporting Standards (IFRS). • The EU and other countries have agreed to require IFRS for publicly listed companies. • FASB and IASB are trying to converge their standards through a variety of different activities. • Enforcement of IFRS is a major concern. • The SEC may soon allow U. S. -listed firms to report financial results using IFRS. 9 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Recording Foreign Currency Transactions • Foreign-currency receivables and payables give rise to gains and losses whenever the exchange rate changes. Transaction gains and losses must be included in the income statement in the accounting period in which they arise. • The FASB requires that U. S. companies report foreign currency transactions at the original spot exchange rate and that subsequent gains and losses on foreign-currency receivables or payables be put on the income statement. The same procedure must be followed according to IFRS. 10 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Translating Foreign-Currency Financial Statements • Translation: the process of restating foreign-currency financial statements. • Consolidation: the process of combining the translated financial statements of a parent and its subsidiaries into one set of financial statements. 11 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Translation Methods • The functional currency is the currency of the primary economic environment in which the entity operates. • The current-rate method applies when the local currency is the functional currency. • The temporal method applies when the parent’s reporting currency is the functional currency. 12 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Disclosing Foreign-Exchange Gains and Losses • With the current-rate method, the translation gain or loss is recognized in comprehensive income rather than net income, and therefore it goes to owners’ equity. • With the temporal method, the translation gain or loss is recognized in the income statement. 13 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Management Accounting Issues • Performance evaluation and control • The impact of transfer pricing on performance evaluation • The use of the balanced scorecard 14 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Performance Evaluation And Control • Different measures are used to evaluate performance of foreign operations, including ROI, sales, cost reduction, quality targets, market share, profitability, and budget to actual. • When using a budget, management must select a currency to set the budget and a currency to evaluate performance. • The most widely used approaches to translate budgets and compare with performance use forecasts of the exchange rate. 15 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Transfer Pricing And Performance Evaluation • Transfer pricing refers to prices on intracompany transfers of goods, services, and capital. • There are conflicting reasons for setting transfer prices that make it difficult for top management to select the correct price. 16 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

The Balanced Scorecard • The balanced scorecard is an approach to performance measurement that closely links the strategic and financial perspectives of a business. • Using the balanced scorecard helps management avoid using only one measure of performance. 17 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Corporate Governance • The external and internal factors designed to safeguard the assets of a company and protect the rights of shareholders. • Corporate governance practices worldwide are partly a function of the legal environment in the countries where companies operate. • The Sarbanes-Oxley Act of 2002 was passed in the United States to improve financial reporting and strengthen internal controls. 18 Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall