McGraw Hill Companies, Inc.

, 2000
Accounting in the International
Business
Chapter 19
McGraw Hill Companies, Inc., 2000
Accounting Information and
Capital Flows
Business
Enterprise
Providers of Capital
(investors, Creditors
and Government)
Resource
Users
Resource
Providers
Information
Providers
Information
Users
Financial Accounting Information
$
Figure 19.1
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Determinants of National
Accounting Standards
National
Accounting
System
Political and
Economic Ties
with Other
Countries
National
Culture
Level of
Inflation
Relationship
Between
Business and
Providers
of Capital
Figure 19.2
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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.
Importance of
each varies from
country to
country
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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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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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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
Hofstedes uncertainty avoidance has an
impact on accounting systems.
Low uncertainty avoidance - these countries
tend to have strong independent accounting
professions that ensure a firms compliance
with rules.
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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
banks needs.
South American Group
Countries have experienced
persistent and rapid inflation.
Accounting principles reflect
the inflation.
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Map 19.1
McGraw Hill Companies, Inc., 2000
International Accounting
Standards Committee
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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Multinational Consolidation and
Currency Translation
Consolidated Financial Statements
Parent Foreign Subsidiary
Cash $1,000 $250
Receivables 3,000 900
Payables 300 500
Revenues 3,000 900
Expenses 2,000 3,000
*Subsidiary owes Parent $300
*Subsidiary pays Parent $1000
in royalties for products
licensed from Parent
Eliminations
Parent Foreign Subsidiary Debit Credit Consolidated
Cash $1,000 $250 $1,250
Receivables 3,000 900 $300 3,600
Payables 300 500* $300 500
Revenues 7,000 5,000 1,000 11,000
Expenses 2,000 3,000** 1,000 4,000
*Subsidiary owes Parent $300.
**Subsidiary pays Parent $1,000 in royalties for products licensed from Parent.
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Currency Translation
The current rate method: the exchange rate at
the balance sheets 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.
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 period.

Firms using
multidomestic
or international
strategies.
Firms using
global or
transnational
strategies.
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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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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) 3.0 3.0
Return on assets (ROA) 2.3 2.3
Return on sales (ROS) 2.1 2.1
Residual income 3.4 3.3
Budget compared to actuaL sales 1.9 1.7
Budget compared to actual profit 1.5 1.3
Budget compared to actuaL ROI 2.3 2.4
Budget compared to actual ROA 2.7 2.5
Budget compared to actuaL ROE 3.1 3.0
Importance of criteria ranked on a scale from
1=very important to 5=unimportant.
Table 19.1
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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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Possible Combinations of Exchange
Rates in the Control Process
Rates Used to Translate Actual Performance for
Comparison with Budget
Rates
Used
for
Translating
Budget
(II)
Budget at Initial
Actual at Initial
Budget at Initial
Actual at
Projected
(IE)
Budget at Initial
Actual at Ending
Budget at
Projected
Actual at Initial
(PP)
Budget at Projected
Actual at Projected
(PE)
Budget at
Projected
Actual at Ending
Budget at
Ending
Actual at
Initial
Budget at
Ending
Actual at
Projected
(EE)
Budget at Ending
Actual at Ending
Initial (I) Projected (P) Ending (E)
Initial (I)
Projected (P)
Ending (E)
Figure 19.3
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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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