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International
Issues in Cost
Management
Prepared by
Douglas Cloud
Pepperdine University
11-1
Objectives
1. Explain the role
the accountant
Afterofstudying
this in the
internationalchapter,
environment.
you should
2. Discuss the varying
levels
be able
to:of involvement
that firms can take in international trade.
3. List the ways accountants can manage foreign
currency risk.
4. Tell why multinational firms choose to
decentralize.
Continued
11-2
Objectives
5. Explain how environmental factors can affect
performance evaluation in the multinational
firm.
6. Describe the role of transfer pricing in the
multinational firm.
7. Discuss ethical issues that affect firms
operating in the international environment.
11-3
Where does the
management accountant
fit into the global
Business looks to the
business environment?
management accountant for
international financial and
business expertise.
11-4
Management Accounting in the
International Environment
Skills needed by cost accountants
 Politics
 Economics
 Marketing
 Management
 Information systems
technology
11-5
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.”
11-6
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.
11-7
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.
Example:
Example:
San
New
Antonio
Orleans
11-8
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.
11-9
Example (continued)
Roadrunner Wilycoyote
Duty paid at purchase
Carrying costs of duty
Duty paid at sale
$
0
0
16,800
$24,000
1,920
0
Wilycoyote
pays
at
Totalduty
dutytherelated
point of
Roadrunner payspurchase (6%
carrying costs
duty at point of sale
of $400,000).
(0.12
x 8/12 x
because it is in a
$24,000)
foreign trade zone.
11-10
Example (continued)
Roadrunner Wilycoyote
Duty paid at purchase
Carrying costs of duty
Duty paid at sale
Total duty and dutyrelated costs
$
0
0
16,800
$24,000
1,920
0
$16,800
$25,920
Clearly the
advantage
approach
11-11
A If
company
the lawsmay
of the
choose
country
to purchase
permit, aan
existing
multinational
foreign
corporation
company, can
making
simply
the
purchased
set up a wholly
company
owned
a wholly
subsidiary
owned
or
branch office
subsidiary.
in the country.
11-12
Outsourcing is the payment by a
Outsourcing
technical
and
company
for a of
business
function
professional
is becoming
formerly
donejobs
in-house,
such as
an important
issue
forneeds
resourcepayment for
legal
to
conscious
firms.
outsideU.S.
firms.
11-13
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 that
processes imported
materials and reexports
them, tariff-free, to the
United States.
11-14
Foreign Currency Exchange
Kinds of risks:
 Currency risk
management
 Transaction risk
 Economic risk
 Translation (accounting )
risk
11-15
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
francs on March 15. The exchange rate on January 15 is
six francs per dollar or 600,000 francs. Suppose that on
March 15 the exchange rate is 6.1 francs per dollar. A
$1,639 loss is experienced by SuperTubs, Inc.
Receivable in dollars on Jan. 15 $100,000
Received in dollars on March 15
(600,000/6.1)
98,361
Exchange loss
$ 1,639
11-16
A Transaction Risk Example
If the franc had strengthened against the dollar to a rate
of 5.9 francs per dollar, a $1,695 gain would occur:
Receivable in dollars on Jan. 15 $100,000
Received in dollars on March 15
(600,000/5.9)
101,695
Exchange gain
$ 1,695
11-17
Hedging
One way of ensuring against gains and losses
on foreign currency exchanges is hedging.
11-18
Hedging
On March 15, Bonbain pays SuperTubs 600,000
francs. SuperTub pays the exchange dealer
600,000 francs, and the exchange dealer pays
SuperTub $99,668 (600,000/6.02).
$100,000 – $99,668
= $332
Premium expense
11-19
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.
11-20
Managing Transaction Risk
Example
Multinational, Inc., has a foreign division, FD, which has
been experiencing eroding sales. Multinational directs FD
managers to increase research and development
expenditures over the following four quarters:
Quarter
1
2
3
4
Expenditures in Local Currency
LC
LC
LC
LC
100,000
110,000
121,000
133,100
A 10%
increase
each
quarter
11-21
Managing Transaction 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 Dollars
$100,000
91,667
89,630
88,733
It looks like FD
has decreased
expenditures.
11-22
Advantages of Decentralization
in the MNC
 The quality of information is better at the local
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.
11-23
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.
11-24
Environmental Variables Facing
Local Managers of Divisions
Economic
 Inflation
 Foreign currency
exchange rates
 Income taxes
 Transfer prices
11-25
Environmental Variables Facing
Local Managers of Divisions
Legal and Political
 Country may not
allow cash
outflows
 Country may forbid
the import of
certain items
11-26
Environmental Variables Facing
Local Managers of Divisions
Social and Educational
 Certain systems, like JIT,
may not work in all cultures
 Roads and communication
may be inadequate
 Training centers may need to
be established
11-27
Comparison of Divisional ROI
An example of misleading results:
Assets
Brazil
Canada
Spain
$10
18
15
Revenues Net Income Margin Turnover
$6
13
10
$3
10
6
0.50
0.77
0.60
0.60
0.72
0.67
ROI
0.30
0.56
0.40
However, the
Analysis:
Oninflation
the basisrate
of ROI,
in Brazil
it appears
was 100%
that the
formanager
the year.
of the adjusting
After
Canadianthe
subsidiary
asset base
didfor
theinflation,
best job while
the ROI
thewould
manager
be
60% for
of the Brazilian manager.
subsidiary did the worst job.
11-28
Other Factors Affecting
Performance Evaluation
Economic Factors:
Organization of central banking system
Economic stability
Existence of capital markets
Currency restrictions
Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management
Accounting (October 1986): pp. 33-36.
11-29
Other Factors Affecting
Performance Evaluation
Political and Legal Factors:
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.
11-30
Other Factors Affecting
Performance Evaluation
Educational Factors:
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.
11-31
Other Factors Affecting
Performance Evaluation
Sociological Factors:
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.
11-32
Transfer Pricing and the
Multinational Firm
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
11-33
Transfer Pricing and the
Multinational Firm
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.
Tax Impact
0% tax rate
$200 revenue – $100
cost = $100
Taxes paid = $0
11-34
Transfer Pricing and the
Multinational Firm
Income Taxes and Transfer Pricing
Action
U.S. subsidiary sells component
to external company at $200 each.
Tax Impact
35% tax rate
$200 revenue – $200
cost = $0
Taxes paid = $0
11-35
Transfer Pricing and the
Multinational Firm
Income Taxes and Transfer Pricing
Division B (in the United States) of ABC, Inc.,
purchases a component from Division C (in Canada).
The component can be purchased eternally for $38.
The freight and insurance on the item amount to $5;
however, commissions of $3.80 need not be paid.
Market price
Plus: Freight and insurance
Less: Commissions
Transfer price
$38.00
5.00
-3.80
$39.20
11-36
Transfer Pricing and the
Multinational Firm
Income Taxes and Transfer Pricing
If there is no outside market for the component that
Division C transfers to Division B, the resale price method
is used. If Division B sells the component for $42 and
normally receives a 40 percent markup on cost of goods
sold, then the transfer price is calculated as follows:
Resale price = Transfer price + .40 Transfer price
$42 = 1.40 x Transfer price
Transfer price = $42/1.40
= $30
11-37
Questions to Ask Concerning Ethics
in the International Environment
Is the action right legally?
Is the action right morally?
11-38
End of
Chapter
11-39
11-40