© mcgraw hill companies, inc., 2000 accounting in the international business chapter 19
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© McGraw Hill Companies, Inc., 2000
Accounting in the International Business
Chapter 19
© McGraw Hill Companies, Inc., 2000
Accounting Information and Capital Flows
Business Enterprise
Providers of Capital (investors, Creditors
and Government)
Resource Users
Resource Providers
Information Providers
Information Users
Financial Accounting Information
$
Figure 19.1
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Determinants of National Accounting Standards
National Accounti
ng System
Political and Economic Ties
with Other Countries
Level of Economic
DevelopmentNational Culture
Level of Inflation
Relationship Between
Business and Providers of Capital
Figure 19.219-2
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Relationship Between Business and Providers of Capital
External sources of capital: Individual investors.
• Buying shares and bonds.
Banks.• Loan capital.
Government.• Make loans or investment.
Importance of each varies from country to country
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Political and Economic Ties with Other Countries
Accounting convergence: Influence of NAFTA. Influence of the former
British Empire. Influence of the European
Union.
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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.
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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.
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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.
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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
GroupCountries have experienced persistent and rapid inflation. Accounting principles reflect
the inflation.
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International Accounting Standards Committee
Members represent 79 countries. Responsible for formulating international
accounting standards (IAS). Has issued over 30 IAS.
Difficult to get requisite votes. Voluntary compliance.
Recognition is growing.
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Multinational Consolidation and Currency Translation
Consolidated Financial Statements Parent Foreign
SubsidiaryCash $1,000 $250Receivables 3,000 900 Payables 300 500Revenues 3,000 900
Expenses 2,000 3,000
*Subsidiary owes Parent $300*Subsidiary pays Parent $1000 in royalties for products licensed from Parent
EliminationsParent Foreign Subsidiary Debit Credit ConsolidatedCash $1,000 $250
$1,250Receivables 3,000 900 $300 3,600 Payables 300 500* $300 500Revenues 7,000 5,000 1,000
11,000Expenses 2,000 3,000** 1,000 4,000
*Subsidiary owes Parent $300.**Subsidiary pays Parent $1,000 in royalties for products licensed from Parent.
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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!
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U.S. Practice Statement 52 “Foreign Currency Translation” Self-sustaining autonomous subsidiary:
Functional currency is local currency. Balance sheet uses exchange rate at end
of financial year. Income statement is financial year average.
Integral subsidiary: Functional currency is US currency. Financial statements use the temporal
method. Dangling credit or debit increases or
decreases consolidated earnings for the period.
Firms using multidomestic or international strategies.
Firms using global or transnational strategies.
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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.
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Importance of Financial Criteria Used to Evaluate Performance of Foreign Subsidiaries
and Their ManagersItem Subsidiary Manager
Return on investment (ROI) 1.9 2.2
Return on equity (ROE) 3.0 3.0Return on assets (ROA) 2.3 2.3Return on sales (ROS) 2.1 2.1Residual income 3.4 3.3Budget compared to actuaL sales 1.9 1.7Budget compared to actual profit 1.5 1.3Budget compared to actuaL ROI 2.3 2.4Budget compared to actual ROA 2.7 2.5Budget compared to actuaL ROE 3.1 3.0
Importance of criteria ranked on a scale from 1=very important to 5=unimportant. Table 19.1
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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.
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Possible Combinations of Exchange Rates in the Control Process
Rates Used to Translate Actual Performance for Comparison with Budget
Rates Used
for Translating
Budget
(II) Budget at
Initial Actual at Initial
Budget at Initial Actual at Projected
(IE) Budget at
Initial Actual at Ending Budget at
Projected Actual at Initial
(PP) Budget at Projected Actual at Projected
(PE) Budget at Projected Actual at
Ending Budget at Ending Actual at
Initial
Budget at Ending Actual at
Projected
(EE) Budget at
Ending Actual at Ending
Initial (I) Projected (P) Ending (E)
Initial (I)
Projected (P)
Ending (E)
Figure 19.3
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Transfer Pricing and Control Systems
Before Change in Transfer Price
After 20% Increase in Transfer Price
Revenues per unit $230 $230
Cost of component per unit 100 100
Revenues per unit 100 100
Profit per unit 30 10
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