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Previous Lecture • • • • • Remaining Part of Chapter # 22 Comprehensive Cash Budget The Budgeted Income Statement The Budgeted Balance Sheet Flexible Budgeting: Performance evaluation is difficult when actual activity differs from the activity originally budgeted. • Flexible Budgeting Performance Report Chapter 15 GLOBAL BUSINESS AND ACCOUNTING Globalization The process of managers assessing the impact of international activities on the future of their company. Globalization typically progresses through an outward growth path. Exporting Licensing & Joint Venture Wholly Owned Subsidiaries Global Sourcing Globalization People around the globe are more connected to each other than ever before. Information and money flow more quickly than ever. Goods and services produced in one part of the world are increasingly available in all parts of the world. International travel is more frequent. International communication is commonplace. This phenomenon has been titled "globalization." Environmental Forces Shaping Globalization Political/Legal Cultural Globalization Economic Technological Environmental Forces Shaping Globalization Political/Legal Cultural •Businesses •Transfer Risk •Control Risk Globalization •Reporting •Individuals •Tax Laws Economic •Policies Technological Environmental Forces Shaping Globalization Political/Legal Cultural Globalization Economic Economic System Obtaining Capital Industrial Organization Exchange Rate Fluctuation Technological Environmental Forces Shaping Globalization Political/Legal Cultural Individualism vs. Collectivism Globalization Uncertainty Avoidance Short vs. Long Horizon Economic Power Distance Technological Environmental Forces Shaping Globalization Political/Legal Cultural Globalization Economic Technological Education Level Infrastructure Knowledge Transfer Foreign Currencies and Exchange Rates Each country uses its own currency for internal economic transactions. To make transactions in another country, units of that country’s currency must be acquired. The cost of those currencies is called the exchange rate. Exchange Rates Exchange rates fluctuate daily. Daily exchange rates are published in the financial press, such as the Wall Street Journal. The process of restating a foreign currency amount into a domestic currency amount is called “translation”. Exchange Rate Country Currency (in US $) Britain Pound (£) 1.6295 France French Franc (FF) 0.1576 Japan Yen (¥) 0.0106 Mexico Peso ($) 0.1058 Germany Deutche Mark (DM) 0.5283 Exchange Rates When the US $ price of a foreign currency unit rises, we say that the US $ is “weaker”. When the US $ price of a foreign currency unit falls, we say that the US $ is “stronger”. I noticed that the $ is stronger against the Yen today. Yes. Yesterday, Yen cost $0.0106, but today, Yen only cost $0.0100! Accounting for Transactions with Foreign Companies When a transaction is denominated in a foreign currency . . . And the transaction occurs on one date (for example a credit sale) . . . . . . but the cash flow is at a later date . . . . . . fluctuating exchange rates can result in exchange rate gains or losses. 12/10/02 1 DM = $.55 US 1/9/03 1 DM = $.53 US ? Exchange Rate Issues Example On 9/10/02, BobCo (a US firm) sells inventory to Knight Corp. (a UK firm) on credit. Knight will pay BobCo 10,000 British pounds in 3 months. The current exchange rate is $1 = .6093 £. On 9/10/02, what is the expected US $ value of the 10,000 £ that BobCo expects to collect on 12/10/02? On September 10, BobCo would expect to be able to convert the 10,000 £ into $16,412.27 on December 10, 2002 based on the current exchange rate. 10,000£ ÷ .6093 = $16,412.28 Exchange Rate Issues Example By 12/10/02, the foreign exchange rate has changed to $1 = .6115 £. After receiving the British £ from Knight, and exchanging them into US $, how much will BobCo have actually received? On December 10, 2002, BobCo would actually collect $16,353.23, an exchange loss of of $59.05 since September 10! 10,000£ ÷ .6115 = $16,353.23 Adjustment of Foreign Currency Transaction at the Balance Sheet Date Occasionally, a transaction occurs in one fiscal period, but cash is not received or paid until the next fiscal period. At the balance sheet date, any outstanding foreign currency receivables or payables must be “remeasured” using the spot rate available on the balance sheet date. Adjustment of Foreign Currency Transaction at the Balance Sheet Date On 12/1/02, Balloon Co., a US balloon manufacturer sells balloons to Maison Rue., a french company, for 20,000 french francs on credit. Payment is due in 90 days. The current exchange rate is $0.1575 per FF. Prepare Balloon Co.’s 12/1/02 journal entry. BALLOON CO. GEN'L JOURNAL Date Description Page Debit 18 Credit Adjustment of Foreign Currency Transaction at the Balance Sheet Date On 12/1/02, Balloon Co., a US balloon manufacturer sells balloons to Maison Rue., a french company, for 20,000 french francs on credit. Payment is due in 90 days. The current exchange rate is $0.1575 per FF. Prepare Balloon Co.’s 12/1/02 journal entry. BALLOON CO. GEN'L JOURNAL Date Dec Description 1 Accounts Receivable (FF) Sales Page Debit 18 Credit 3,150 3,150 Adjustment of Foreign Currency Transaction at the Balance Sheet Date On 12/31/02, the value of the foreign currency receivable must be adjusted based on the 12/31/02 spot rate of $0.1500 per FF. Adjust the original receivable: BALLOON CO. GEN'L JOURNAL Date Description Page Debit 25 Credit Adjustment of Foreign Currency Transaction at the Balance Sheet Date On 12/31/02, the value of the foreign currency receivable must be adjusted based on the 12/31/02 spot rate of $0.1500 per FF. Adjust the original receivable: BALLOON CO. GEN'L JOURNAL Date Description Dec 31 Loss on Fluctuation of Exch. Rates Accounts Receivable (FF) $3,150 - $3,000 = $150 Page Debit 25 Credit 150 150 Strategies to Avoid Losses from Rate Fluctuations Insist that the transaction is consumated in your own currency (US $). Hedging! Hedging The practice of minimizing or eliminating risk of loss associated with foreign currency fluctuations by using forward exchange rates to offset changes in spot rates. Spot Rates The exchange rates that are available today. Forward Exchange Rates The exchange rates that can be locked in today for expected future exchange transactions. Hedging A forward contract requires the purchase of currency units at a future date at the contracted exchange rate. This forward contract allows us to purchase 1,000,000 ¥ at a price of $.0080 US in 30 days. Good. If the spot rate is $.0090 US in 30 days, we only have to pay $.0080 US, and we avoid a $1,000 loss! Foreign Corrupt Practices Act of 1977 Record and disclose all payments, proper or improper. Bribery of government officials is illegal. Influence peddling is illegal. (1986 Amendment) Maintain an adequate system of internal controls. Facilitating payments are not illegal. (1986 Amendment) International Accounting? International Accounting can be described at three different levels: • The influence on accounting by international political groups such as the OECD, UN, etc. • The accounting practices of companies in response to their own international business activities • The differences in accounting standards and practices between countries International Transactions, FDI and Related Accounting Issues Sale to foreign customer • Most companies’ first encounter with international business occurs as sales to foreign customers. • Often, the sale is made on credit and it is agreed that the foreign customer will pay in its own currency (e.g., Mexican pesos). International Transactions, FDI and Related Accounting Issues Sale to foreign customer This gives rise to foreign exchange risk as the value of the foreign currency is likely to change in relation to the company’s home country currency (e.g., U.S dollars). International Transactions, FDI and Related Accounting Issues Sale to foreign customer Suppose that on February 1, 2006, Joe Inc., a U.S. company, makes a sale and ships goods to Jose, SA, a Mexican customer, for $100,000 (U.S.). However, it is agreed that Jose will pay in pesos on March 2, 2006. The exchange (spot) rate as of February 1, 2006 is 10.00 pesos per U.S. dollar. How many pesos does Jose agree to pay? International Transactions, FDI and Related Accounting Issues Sale to foreign customer Even though Jose SA agrees to pay 1,000,000 pesos ($100,000 x 10.00 pesos/U.S. $), Joe, Inc. records the sale (in U.S. dollars) on February 1, 2006 as follows: Dr. Accounts receivable (+) Cr. Sales revenue (+) 100,000 100,000 International Transactions, FDI and Related Accounting Issues Sale to foreign customer Suppose that on March 2, 2006, the spot rate for pesos is 11 pesos/U.S. $). Joe Inc. will receive 1,000,000 pesos, which are now worth $90,909. Joe makes the following journal entry: Dr. Cash (+) 90,909 Dr. Loss on foreign exchange (+) 9,091 Cr. Accounts receivable 100,000 International Transactions, FDI and Related Accounting Issues Hedging Joe can hedge (i.e., protect itself) against a loss from an exchange rate fluctuation. Hedging can be accomplished by various means, including: Foreign currency option – the right (but not the obligation) to purchase foreign currency at a specific exchange rate for a specified period of time. International Transactions, FDI and Related Accounting Issues Hedging Forward contract – this is an obligation to exchange foreign currency at a date in the future, typically 30, 60 or 90 days. International Transactions, FDI and Related Accounting Issues Foreign Direct Investment (FDI) – occurs when a company invests in a business operation in a foreign country. This represents an alternative to importing to customers and/or exporting from suppliers in a foreign country. Two types of FDI are Greenfield investment and acquisition. International Transactions, FDI and Related Accounting Issues Foreign Direct Investment (FDI) Greenfield investment – the establishment of a new operation in the foreign country Acquisition – investment in an existing operation in the foreign country. International Transactions, FDI and Related Accounting Issues FDI creates two primary issues: • The need to convert from local to U.S. GAAP since accounting records are usually prepared using local GAAP. • The need to translate from local currency to U.S. dollars since accounting records are usually prepared using local currency. International Income Taxation • Foreign income taxes – the foreign government will tax the company’s profits at applicable rates. • U.S. income taxes – the U.S. will tax the company’s foreign-based income. International Transfer Pricing • Transfer pricing – setting prices on goods and services exchanged between separate divisions within the same firm. These prices have a direct impact on the profits of the different divisions. International Transfer Pricing These exchanges are not arms-length transactions, thus giving rise to the certain problems in an international context: Taxation – governments in the various countries often scrutinize transactions to assure that sufficient profits are being recorded in that country. International Transfer Pricing • Performance evaluation issues – to the extent that division managers are evaluated based on divisional profits, transfer prices influence division manager performance evaluation. International Auditing Both internal and external auditors encounter differences that arise between auditing in an international vs. domestic context. These include: • Language and cultural differences • Different accounting standards (GAAP) and auditing standards (GAAS) Cross-listing on Foreign Stock Exchanges MNEs frequently raise capital outside their home country. When a company offers its shares on an exchange outside of its home country, this is referred to as Cross-Listing. International Harmonization of Accounting Standards The international movement towards a single set of worldwide accounting rules is referred to as Harmonization. International Accounting Standards (IAS) and U.S. GAAP are currently the two most important sets of accounting rules. International Harmonization of Accounting Standards The Norwalk Agreement • Published in 2002. • Is a promise of cooperation in standard-setting between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB). • Represents a significant step toward international harmonization. The Global Economy Several indicators demonstrate the extent of business globalization: • International trade – In 2001 exports worldwide topped $6 trillion. Between 1987 and 1999, U.S. exporters increased by 233% in number. • Foreign Direct Investment – Between 1982 and 1999 worldwide FDI inflows increased from $58 billion to $865 billion. The Global Economy Several indicators demonstrate the extent of business globalization: • Multinational enterprises (MNEs) – Companies that have headquarters in one country and operate in one or more other countries. Currently, MNEs account for over one-quarter of the world’s Gross Domestic Product (GDP). The Global Economy Several indicators demonstrate the extent of business globalization: • International capital markets – In 2001 there were 462 companies representing 53 countries cross-listed on the New York Stock Exchange (NYSE). In addition, over 60 U.S. companies are cross-listed on foreign exchanges… End of Chapter 15 When the ad said, “Job with a hot future!” this isn’t exactly what I expected.