International Business
8e
By Charles W.L. Hill
Chapter 19
Accounting in
the International
Business
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
What Is Accounting?
Accounting is the language of business – it is the
way firms communicate their financial positions
Accounting is more complex for international
firms because of differences in accounting
standards from country to country
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
How Is Accounting
Information Used?
Accounting Information and Capital Flows
19-4
Why Do Countries Use
Different Accounting Systems?
A country’s accounting system evolves in response
to local demands for accounting information
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 challenging to compare
financial performance of firms from different
countries
While there have been efforts to harmonize
accounting practices across countries, significant
differences remain
19-5
What Determines National
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
What Determines National
Accounting Standards?
Determinants of National Accounting Standards
19-7
How Do Providers Of Capital
Influence Accounting?
 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
 accounting systems in the U.S. and Great Britain are oriented
toward individual investors
 Switzerland, Germany, and Japan focus on providing information to
banks
 France and Sweden prepare financial documents with the
government in mind
19-8
How Do Political And Economic
Ties Influence Accounting?
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
the British system of accounting is used by
many former colonies
19-9
How Does Inflation
Influence Accounting?
The historic cost principal assumes the
currency unit used to report financial
results is not losing its value due to inflation
affects asset valuation
if inflation is high, assets will be undervalued
19-10
How Do Levels of Development
Influence Accounting?
Developed nations tend to have more
sophisticated accounting systems than developing
countries
larger, more complex firms create accounting challenges
providers of capital require detailed reports
Many developing nations have accounting systems
that were inherited from former colonial powers
lack of trained accountants
19-11
How Does Culture
Influence Accounting?
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
19-12
What Are Accounting And
Auditing 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
It is difficult to compare financial reports from
country to country because of national differences
in accounting and auditing standards
19-13
Why Are International
Accounting Standards Important?
The growth of transnational financing and
transnational investment has created a need for
transnational financial reporting
many companies obtain capital from foreign providers
who are demanding greater consistency
The International Accounting Standards Board
(IASB) is a major proponent of standardization of
accounting standards
common accounting standards will facilitate the
development of global capital markets
most IASB standards are consistent with standards
already in place in the United States
19-14
Why Are International
Accounting Standards Important?
About 100 nations have adopted IASB
standards or permitted their use in
reporting financial results
the EU has mandated harmonization of
accounting principles for members
By 2010, there could be only two major
accounting bodies with substantial
influence on global reporting – FASB in the
United States and IASB elsewhere
19-15
What Is A Consolidated
Financial Statement?
 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
 used by multinational firms
 Transactions among members of a corporate family are not
included in consolidated financial statements
 they are recorded in separate statements
 The IASB requires firms to prepare consolidated financial
statements, as do most industrialized nations
19-16
How Do MNCs Handle
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
19-17
What Is 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
can present a misleading picture of the financial
situation
method is incompatible with the historic cost
principle
19-18
What is 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
avoids the problems associated with the
current rate method
is still problematic because different exchange
rates are used to translate foreign assets
19-19
What System Do
U.S. Firms Use?
U.S. multinationals are required to follow
FASB 52 which states
the functional currency is the local currency of
each self-sustaining 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
19-20
How Does Accounting
Influence 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
19-21
How Do Exchange Rates
Influence Control?
 Budgets and performance data are usually expressed in
the corporate currency-normally the home currency
 facilitates comparisons between subsidiaries
 but, can create distortions in financial statements
 Donald Lessard and Peter Lorange - 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 end of the budget picture
3. The ending rate - the spot exchange rate when the budget
and performance are being compared
19-22
What Is The
Lessard-Lorange Model?
Possible Combinations of Exchange Rates in the Control Process
19-23
How Does Transfer Pricing
Influence Control?
The price at which goods and services are
transferred within the firm is the transfer
price
Transfer prices can be manipulated to
minimize tax liability
minimize import duties
avoid government restrictions on capital flows
19-24
Why Separate Subsidiary and
Managerial Performance?
Subsidiaries operate in different environments
which influence profitability
So, 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
19-25
Review Question
_______ has an accounting system that was
developed with the government in mind.
a) France
b) Japan
c) Great Britain
d) Germany
19-26
Review Question
Which organization is responsible for formulating
international accounting standards?
a)
b)
c)
d)
the Global Federation of Accountants
the World Bank
the International Accounting Standards Board
the International Panel of Accounting Standards
and Ethics
19-27
Review Question
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
19-28
Review Question
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
19-29
Review Question
Financial statements of U.S. firms must be
prepared according to
a) FASB
b) IASB
c) IFAC
d) EUAC
19-30