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International
Business
Fourth Edition
CHAPTER 19
Accounting in the International
Business
19-3
Chapter Focus
Examine the problems arising when an
international business with operations in more than
one country must produce consolidated financial
statements.
Look at control (from an accounting perspective) in
international business.
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19-4
Accounting Information and Capital Flows
$
Resource
Users
Business
Enterprise
Resource
Providers
Providers of Capital
(investors, Creditors
and Government)
Information
Users
Information
Providers
Financial Accounting Information
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Figure 19.1
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19-5
Country Differences in Accounting Standards
5 variables that influence a country’s accounting system:
The relationship between business and the providers of
capital.
The political and economic ties with other countries.
The level of inflation.
The level of a country’s economic development.
The prevailing culture in a country.
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19-6
Determinants of National Accounting Standards
Relationship
Between
Business and
Providers
of Capital
Level of
Inflation
National
Accounting
System
Political and
Economic Ties
with Other
Countries
National
Culture
Figure 19.2
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19-7
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.
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Importance of
each varies from
country to
country
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19-8
Political and Economic Ties with Other
Countries
Accounting convergence:
Impact of political ties between/among nations.
U.S.
Influence of NAFTA.
U.S. role as Philippine protectorate.
Influence of the former British Empire.
Influence of the European Union.
Probable convergence by 2005.
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19-9
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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19-10
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.
Developing countries:
Tend to use systems inherited from colonial powers.
May not work for small businesses in poorly developed
economies.
Lack of trained accountants.
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19-11
Culture
Hofstede’s uncertainty avoidance has an impact on
accounting systems.
Refers to the extent to which cultures socialize their
members to accept ambiguous situations and tolerate
uncertainty.
High uncertainty avoidance – countries have strong need for
rules and regulations. (Mexico, Japan)
Low uncertainty avoidance – Greater readiness to take risks
and less emotional resistance to change (U.S., U.K.)
These countries tend to have strong independent
accounting professions that ensure a firm’s compliance
with rules.
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19-12
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.
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19-13
National and International Standards
lack of comparability
firm reports results
in one country to
citizens of another
fueled by
growth
transnational transnational
financing
investment
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international standards
International Accounting
Standards Committee
European Union
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19-14
International Accounting Standards
Committee
Members represent 79 countries.
Responsible for formulating international
accounting standards (IAS).
Has issued over 40 IAS.
Difficult to get requisite votes.
Voluntary compliance.
Recognition is growing.
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19-15
Multinational Consolidation and
Currency Translation
Consolidated Financial
Statements
Currency Translation
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19-16
Consolidated Financial Statements
Consolidated Financial Statements
Cash
Receivables
Payables
Revenues
Expenses
Cash
Receivables
Payables
Revenues
Expenses
Parent
$1,000
3,000*
300
7,000**
2,000
Parent
$1,000
3,000
300
7,000
2,000
Foreign Subsidiary
$250
*Subsidiary owes Parent $300
900
*Subsidiary pays Parent $1000
500
5,000 in royalties for products
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.
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19-17
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.
19-18
Firms using
multidomestic or
international
strategies.
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
McGraw-Hill/Irwin
Firms using
global or
transnational
strategies.
period.
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19-19
The Temporal Method
Yen
Exchange
Rate
U.S. Dollars
Cash
10,000,000
($1 =Yen 100)
100,000
Owner’s
Equity
10,000,000
($1 =Yen 100)
100,000
Yen
Exchange
Rate
U.S. Dollars
Fixed Assets
5,000,000
($1=Yen 95)
52,632
Inventory
5,000,000
($1=Yen90)
55,556
Total
10,000,000
Owner’s
Equity
10,000,000
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108,188
($1=Yen100)
100,000
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19-20
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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19-21
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 actuaL sales
Budget compared to actual profit
Budget compared to actuaL ROI
Budget compared to actual ROA
Budget compared to actuaL 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.
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Table 19.1
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19-22
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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19-23
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
Initial (I) Budget at Initial
Actual at Initial
Projected
Actual at Ending
Rates
Budget at
Used
Projected
Projected
(P)
for
Actual at Initial
Translating
Budget at
Budget
Ending
Ending (E)
Figure 19.3
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Actual at
Initial
(PP)
(PE)
Budget at Projected
Budget at
Actual at Projected
Projected
Actual at Ending
Budget at
Ending
(EE)
Actual at
Budget at Ending
Projected
Actual at Ending
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19-24
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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19-25
Separation of Subsidiary and Manager
Performance
Suggested that manager and subsidiary
performance be kept separate.
Consider how hostile or benign the country’s
environment.
Evaluation should be in local currency terms.
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