Chapter Nineteen

Accounting in the
International Business
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Case: Adoption of International

Accounting Standards in Germany

• In Germany, market for debt is expensive; limited

possibility for raising additional equity
• German firms begin to raise equity on international capital
markets only in 1990
• Major German firms apply for listing on the US Securities
and Exchange commission (SEC)
• SEC was not responsive because German accounting
standards were not comparable to those in the US. Not
enough information to investors
• Adhering to generally accepted accounting principles
(GAAP) has its positives and negatives
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 19 - 4

Accounting Information and

Capital Flows

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Determinants of National
Accounting Standards

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 19 - 6

Relationship Between
Business and Providers of Capital

• Three external sources of capital:

- Individual investors
• Buying shares and bonds
- Banks
• Loan capital Importance of each
- Government varies from country
• Make loans or investment to country

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 19 - 7

Political and Economic

Ties With Other Countries

• Accounting convergence:
- Influence of NAFTA
- Influence of the former British Empire
- Influence of the European Union

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 19 - 8

Inflation Accounting

• Historic cost principle:

- Assumes currency is not losing value to inflation
- Most significant impact in the area of 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 - 9

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

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Culture

• Hofstede’s uncertainty avoidance has an impact on

accounting systems
- Low uncertainty avoidance - these countries tend to have
strong independent auditing professions that ensure a
firm’s compliance with rules

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 19 - 11

National and
International Standards

• Diverse accounting practices are enshrined in national

accounting and auditing standards
• Accounting standards: Rules for preparing financial
statements
• Auditing standards: Specify rules for performing an
audit

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 19 - 12

Lack of Comparability

• One result of national differences in auditing and

accounting standards is lack of comparability of
financial reports
• With growth of global capital markets both
transnational financing and transnational investment
have grown
• Firm has to explain to investors why its financial
position looks different in two accountings

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 19 - 13

International Standards

• Efforts to harmonize accounting standards across

countries
• Formation of International Accounting Standards
Board
• Members represent 79 countries
• Responsible for formulating international accounting
standards (IAS)
• Has issued over 30 IAS
- Difficult to get requisite votes
- Voluntary compliance
• Recognition is growing
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 19 - 14

Multinational Consolidation and

Currency Translation

• Subsidiaries of multinationals are separate legal entities but not

separate economic entities
• Transactions among members of a corporate family not
included in consolidated financial statements. Only assets,
liabilities, revenues, and expenses statements with external
trade parties are shown
• Purpose is to provide accounting info about a group of
companies that recognizes economic interdependence
(subsidiaries)
• Financial statements of subsidiaries are prepared in the local
currency
• For the consolidated accounts of a multinational, these accounts
then have to be converted into currency of multinational’s
home country
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 19 - 15

Currency Translation

• The current rate method:

- Exchange rate at the date on the balance sheet 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 of purchase of the asset
- Changing exchange rates may mean the balance sheet
may not balance!

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 19 - 16

Current US Practice

• Statement 52 “Foreign Currency Translation”

• Self-sustaining autonomous subsidiary: Firms using
- Functional currency is local currency
multidomestic or
- Balance sheet uses exchange rate at
international
end of financial year
- Income statement is financial year average strategies.
• Integral subsidiary:
- Functional currency is US currency
- Financial statements use the
temporal method
- Dangling credit or debit increases or Firms using
- Decreases consolidated earnings global or
for the period transnational
strategies.
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 19 - 17

Accounting Aspects of
Control Systems

• Annual control process involves three steps:

- Head office and sub-unit management jointly determine
sub-unit goals for the coming year
- Throughout year, head office monitors sub-unit
performance against agreed goals
- If sub-unit fails to achieve goals, head office intervenes to
determine why the shortfall occurred, taking corrective
action when appropriate

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 19 - 18

Exchange Rate Combinations in the

Control Process

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 19 - 19

Accounting Aspects of
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 - 20

Transfer Pricing and

Control Systems

• Transfer prices introduce significant distortions into

the control process
• Transfer price must be taken into account when setting
budgets and evaluating a subsidiary’s performance

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 19 - 21

Separation of Subsidiary and

Manager Performance

• Valuation of a subsidiary should be separate from the

evaluation of the subsidiary manager
• Manager’s evaluation should take into consideration
how hostile or benign the country’s environment is for
business and make allowances over items for which
the manager has no control, e.g. inflation rates, interest
rates, exchange rates

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 19 - 22

Looking Ahead to Chapter 20

• Financial Management in the International Business

- Investment Decisions
- Financing Decisions
- Global Money Management: The efficiency Objective
- Global Money Management: The Tax Objective
- Moving Money Across Borders: Attaining Efficiencies and
Reducing Taxes
- Techniques for Global Money Management

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