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International
Business 7e
by Charles W.L. Hill
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 19
Accounting in the International
Business
Introduction
Accounting is the language of business – it is the way
firms communicate their financial positions
Accounting standards differ from country to country
These differences make it difficult for investors, creditors,
and governments to evaluate firms
The International Accounting Standards Board (IASB)
has made some attempts to establish common accounting
and auditing standards across countries
19-3
Introduction
Figure 19.1
19-4
Country Differences In
Accounting Standards
A country’s accounting system evolves in response to
local demands for accounting information
While there have been efforts to harmonize accounting
practices across countries, significant differences remain
One study found that among 22 countries, there were 76
ways to assess the cost of goods sold, 65 differences in the
calculation of return on assets, and 20 ways to calculate
net profits
The differences make it challenges to compare financial
performance of firms from different countries
19-5
Country Differences In
Accounting Standards
Five main variables influence the development of a
country’s accounting system:
1. the relationship between business and the providers of
capital
2. political and economic ties with other countries
3. the level of inflation
4. the level of a country’s economic development
5. the prevailing culture in a country
19-6
Country Differences In
Accounting Standards
Figure 19.2
19-7
Relationship Between Business
And Providers Of Capital
The three main external sources of capital for firms are:
Individual investors
Banks
Government
A country’s accounting system reflects the relative
importance of each constituency as a provider of capital
So, accounting systems in the U.S. and Great Britain are
oriented toward individual investors; Switzerland, Germany,
and Japan focus on providing information to banks; and
France and Sweden prepare financial documents with the
government in mind
19-8
Classroom Performance System
_______ has an accounting system that was developed
with the government in mind.
a) France
b) Japan
c) Great Britain
d) Germany
19-9
Political And Economic
Ties With Other Nations
Similarities in accounting systems across countries can
reflect political or economic ties
The U.S. accounting system influences the systems in
Canada and Mexico
In the European Union, countries are moving toward
common standards
19-10
Inflation Accounting
The historic cost principal assumes the currency unit
used to report financial results is not losing its value due to
inflation
This principle affects asset valuation
If inflation is high, assets will be undervalued
19-11
Level Of Development
Developed nations tend to have more sophisticated
accounting systems than developing countries
Many developing nations have accounting systems that
were inherited from former colonial powers
19-12
Culture
The extent to which a culture is characterized by
uncertainty avoidance (the extent to which cultures
socialize their members to accept ambiguous situations
and tolerate uncertainty) impacts the country’s accounting
system
Countries with low uncertainty avoidance cultures have
strong independent auditing professions
19-13
National And International Standards
Accounting standards are rules for preparing financial
statements—they define useful accounting information
Auditing standards specify the rules for performing an
audit—the technical process by which an independent
person gathers evidence for determining if financial
accounts conform to required accounting standards and if
they are also reliable
19-14
Lack Of Comparability
Because of national differences in accounting and
auditing standards, comparability of financial reports from
one country to another is difficult
The growth of transnational financing and transnational
investment is promoting the growth of transnational
financial reporting
19-15
International Standards
There has been a substantial effort recently to harmonize
accounting standards across countries
Many companies obtain capital from foreign providers
who are demanding greater consistency
Common accounting standards will facilitate the
development of global capital markets
The International Accounting Standards Board (IASB) is
a major proponent of standardization
The IASB currently has 45 standards, but compliance is
voluntary
About 100 nations have adopted IASB standards or
permitted their use in reporting financial results
19-16
Classroom Performance System
Which organization is responsible for formulating
international accounting standards?
a) the Global Federation of Accountants
b) the World Bank
c) the International Accounting Standards Board
d) the International Panel of Accounting Standards and
Ethics
19-17
Classroom Performance System
The IASB currently has about ____ standards.
a) 10
b) 25
c) 45
d) 95
19-18
International Standards
Most IASB standards are consistent with standards
already in place in the United States
The European Union has mandated harmonization of
accounting principles in its member countries
By 2010, there could be only two major accounting
bodies with substantial influence on global reporting –
FASB in the United States and IASB elsewhere
19-19
Classroom Performance System
By 2010, which two accounting bodies are expected to
dominate accounting practices?
a) The historic cost principle and FSAB
b) FSAB and the IASB
c) The IASB and the historic cost principle
d) The current rate method and the historic cost principle
19-20
Multinational Consolidation
And Currency Translation
A consolidated financial statement combines the
separate financial statements of two or more companies to
yield a single set of financial statements as if the individual
companies were really one
Multinational firms typically issue consolidated financial
statements
19-21
Consolidated Financial Statements
The typical multinational company is made up of a parent
company and a number of subsidiary companies
Economically, all the companies are interdependent
The consolidated financial statement provides accounting
information about the group of companies
Transactions among members of a corporate family are
not included in consolidated financial statements, however,
because separate legal entities are required to keep their
own accounting records they record transactions with other
members of the corporate family in separate statements
The IASB requires firms to prepare consolidated financial
statements, as do most industrialized nations
19-22
Currency Translation
Foreign subsidiaries usually keep accounting records and
prepare financial statements in the local currency
To prepare consolidated financial statements, all local
financial statements must be converted to the home
currency
There are two methods to determine what exchange rate
should be used when translating financial statement
currencies:
1. the current rate method
2. the temporal method
19-23
The Current Rate Method
Under the current rate method, the exchange rate at the
balance sheet date is used to translate the financial
statements of a foreign subsidiary into the home currency
of the multinational firm
The current rate method is incompatible with the historic
cost principle
19-24
The Temporal Method
The temporal method translates assets valued in a
foreign currency into the home currency using the
exchange rate that exists when assets are purchased
So, while the temporal method avoids the problems
associated with the current rate method, it is still
problematic because different exchange rates are used to
translate foreign assets
19-25
Current U.S. Practice
U.S. multinationals are required to follow FASB 52 which
states:
the functional currency is the local currency of each selfsustaining foreign subsidiary
balance sheets should be translated into the home
currency using the exchange rate in effect at the end of the
firm’s financial year
income statements are translated using the average
exchange rate for the firm’s financial year
19-26
Classroom Performance System
When a firm uses the exchange rate at the balance sheet
date to translate financial statements of a foreign subsidiary
into the home currency, the firm is using
a) the temporal method
b) the current rate method
c) FASB 52
d) the historic cost principle
19-27
Classroom Performance System
Financial statements of U.S. firms must be prepared
according to
a) FASB
b) IASB
c) IFAC
d) EUAC
19-28
Accounting Aspects Of Control Systems
The control process in most firms is usually conducted
annually and involves three steps:
1. subunit goals are jointly determined by the head office
and subunit management
2. the head office monitors subunit performance throughout
the year
3. the head office intervenes if the subsidiary fails to
achieve its goal, and takes corrective actions if necessary
Two factors that can complicate the control process are
exchange rate changes and transfer pricing practices
19-29
Exchange Rate Changes
And Control Systems
Most international firms require budgets and performance
data to be expressed in the corporate currency-normally
the home currency
While this facilitates comparisons between subsidiaries, it
can also create distortions in financial statements
19-30
The Lessard-Lorange Model
Donald Lessard and Peter Lorange suggest that firms can
deal with the problems of exchange rates and control in
three ways:
1. the initial rate - the spot exchange rate when the budget
is adopted
2. the projected rate - the spot exchange rate forecast for
the ends of the budget picture
3. the ending rate - the spot exchange rate when the
budget and performance are being compared
19-31
The Lessard-Lorange Model
Figure 19.3
19-32
The Lessard-Lorange Model
Lorange and Lessard suggest that firms use the
projected spot exchange rate (usually the forward
exchange rate) to translate budget and performance figures
into the corporate currency
Firms can also use the internal forward rate (companygenerated forecast of future spot rates)
19-33
Transfer Pricing And Control Systems
The price at which goods and services transferred within
the firm is the transfer price
The choice of transfer price can significantly influence the
performance of subsidiaries
Transfer prices should be considered when evaluating a
subsidiary’s performance
Companies can manipulate transfer prices to minimize
tax liability, minimize import duties, and avoid government
restrictions on capital flows
19-34
Separation Of Subsidiary
And Manager Performance
The evaluation of a subsidiary should be kept separate
from the evaluation of its manager
A manager’s evaluation should consider the country’s
environment for business, and should take place after
making allowances for those items over which managers
have no control
19-35