Encyclopedic Dictionary of International Finance and Banking Phần 1 pdf

Each country has a strong “accounting nationalism.” It requires business companiesoperating within its borders to follow its own accounting standards and practices.Consequently, a foreig

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No claim to original U.S Government works International Standard Book Number 1-57444-291-0 Library of Congress Card Number 2001001297 Printed in the United States of America 1 2 3 4 5 6 7 8 9 0

Printed on acid-free paper

Library of Congress Cataloging-in-Publication Data

Shim, Jae K.

Encyclopedic dictionary of international finance and banking / Jae

K Shim and Michael Constas.

p cm.

ISBN 1-57444-291-0 (alk paper)

1 International finance—Encyclopedias 2 Banks and banking, International—Encylopedias 3 International economic

relations—Encyclopedias I Constas, Michael, 1952- II Title.

HG3880 S55 2001

disclaimer Page 1 Tuesday, May 15, 2001 3:54 PM

P REFACE

WHAT THIS BOOK WILL DO FOR YOU

for working professionals engaged in the fields of international finance, global trade, foreigninvestments, and banking It may be used for day-to-day practice and for technical research.The Encyclopedic Dictionary is a practical reference of proven techniques, strategies, andapproaches that are successfully used by professionals to diagnose multinational finance andbanking problems The book covers virtually all important topics dealing with multinationalbusiness finance, investments, financial planning, financial economics, and banking It alsocovers such topics as computers, quantitative techniques and models, and economics as

prac-ticing financial analysts, CFOs, controllers, financial managers, treasurers, money managers,fund managers, investment analysts, and professional bankers, among others

The subjects are explained with

• Clear definitions and explanations, including step-by-step instructions

• Exhibits and statistical data, as needed

• Charts, exhibits, and diagrams, where appropriate

medium, or small multinational companies It will help you to make smart decisions in allareas of international finance and banking It should be used as an advanced guide for workingprofessionals, rather than as a reference guide for laymen or a glossary of international financeand banking terms

The Encyclopedic Dictionary is a handy reference for today’s busy financial executive It

is a working guide to help you quickly pinpoint

• What to look for

• How to do it

• What to watch out for

• How to apply it in the complex world of business

• What to do

You will find ratios, formulas, examples, applications, exhibits, charts, and rules of thumb

to help you analyze and evaluate any business-related situation New, up-to-date methods and

comprehensive, quick, and useful In short, this is a veritable cookbook of guidelines, trations, and how-to’s for you, the modern decision maker The uses of this handbook are asvaried as the topics presented Keep it handy for easy reference throughout your busy day

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There are approximately 570 major topics in international finance, banking, and investments

there is a cross-reference to another entry to explain the topic in greater detail The entries arelisted in alphabetical order for easy reference There are approximately 120 examples and

that almost any subject area of interest to financial executives, as well as other interestedparties, can be found

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A BOUT T HE A UTHORS

Jae K Shim, Ph.D., is Professor of Business at California State University, Long Beach Hereceived his M.B.A and Ph.D degrees from the University of California at Berkeley (HaasSchool of Business) He is also Chief Financial Officer (CFO) of a Los Angeles–basedmultinational firm

of Financial Analysis, Forecasting, and Modeling; Managerial Accounting; Financial agement; Strategic Business Forecasting; Barron’s Accounting Handbook; Financial

Management, Advances in Accounting, Corporate Controller, The CPA Journal, CMA azine, Management Accounting, Econometrica, Decision Sciences, Management Science, Long Range Planning, OMEGA, Journal of Operational Research Society, Journal of Business

Michael Constas, Ph.D., J.D., is a Professor of Business at California State University, LongBeach Before teaching, he was a partner in a major California law firm Dr Constas receivedhis Ph.D., J.D., and M.B.A from U.C.L.A He has published numerous articles in the area of

Syndications, which is part of the collections at the libraries of our nation’s leading universities

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N OTES AND A BBREVIATIONS

KEY NOTES

1 This book has the following features:

• Plenty of examples and illustrations

• Useful strategies and checklists

• Ample number of exhibits (tables, figures, and graphs)

Indirect quotes are used more widely in examples throughout the book

3 Selling forward means “buy a forward contract to sell a given currency,” and buying forward means “buy a forward contract to buy a given currency.” As a matter of

For example, a contract to deliver dollars for British pounds in 180 days might be

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A

ABSOLUTE PURCHASING POWER PARITY

See PURCHASING POWER PARITY

See TRANSLATION EXPOSURE

ACCOUNTING FOR MULTINATIONAL OPERATIONS

At the beginning of the 21st century, the world economy has become truly internationalizedand globalized Advances in information technology, communications, and transportationhave enabled businesses to service a world market Many U.S companies, both large andsmall, are now heavily engaged in international trade The foreign operations of many largeU.S multinational corporations now account for a major percentage (10 to 50%) of theirsales and/or net income

The basic business functions (i.e., finance/accounting, production, management, ing) take on a new perspective when conducted in a foreign environment There are differentlaws, economic policies, political framework, and social/cultural factors that all have an effect

market-on how business is to be cmarket-onducted in that foreign country From an accounting standpoint,global business activities are faced with three realities:

1 Accounting standards and practices differ from country to country Accounting is

a product of its own economic, legal, political, and sociocultural environment.Because this environment changes from country to country, the accounting system

of each country is unique and different from all others

2 Each country has a strong “accounting nationalism.” It requires business companiesoperating within its borders to follow its own accounting standards and practices.Consequently, a foreign company operating within its borders must maintain itsbooks and records and prepare its financial statements in the local language, usethe local currency as a unit of measure, and be in accordance with local accountingstandards and procedures In addition, the foreign company must comply with thelocal tax laws and government regulations

3 Cross-border business transactions often involve receivables and payables inated in foreign currencies During the year, these foreign currencies must betranslated (converted) into the local currencies for recording in the books andrecords At year-end, the foreign currency financial statements must be translated(restated) into the parent’s reporting currency for purposes of consolidation Boththe recording of foreign currency transactions and the translation of financial state-ments require the knowledge of the exchange rates to be used and the accountingtreatment of the resulting translation gains and losses

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The biggest mistake a company can make in international accounting is to not be aware

of, or even worse, to ignore these realities It should know that differences in accountingstandards, tax laws, and government regulations do exist and that these differences need to

be an integral part of formulating its international business plan

A Accounting for Foreign Currency Transactions

International business transactions are cross-border transactions; therefore, two national rencies are usually involved For example, when a United States corporation sells to acorporation in Germany, the transaction can be settled in U.S dollars (the seller’s currency)

cur-or in German marks (the buyer’s currency)

A.1 Transactions Denominated in U.S Currency

When the foreign transaction is settled in U.S dollars, no measurement problems occur forthe U.S corporation As long as the U.S corporation receives U.S dollars, the transactioncan be recorded in the same way as a domestic transaction

EXAMPLE 1

A U.S firm sells on account equipment worth $100,000 to a German company If the German company will pay the U.S firm in U.S dollars, no foreign currency is involved and the transaction

is recorded as usual:

A.2 Transactions Denominated in Foreign Currency

If the transaction above is settled in German marks, however, the U.S corporation will receiveforeign currency (German marks) that must be translated into U.S dollars for purposes ofrecording on the U.S company’s books Thus, a foreign currency transaction exists when thetransaction is settled in a currency other than the company’s home currency

A foreign currency transaction must be recorded in the books of accounts when it isbegun (date of transaction), then perhaps at interim reporting dates (reporting date), andfinally when it is settled (settlement date) On each of these three dates, the foreign currencytransaction must be recorded in U.S dollars, using the spot rate on that date for translation

A.3 Accounting at Transaction Date

Before any foreign currency transaction can be recorded, it must first be translated into thedomestic currency, using the spot rate on that day For the U.S company, this means thatany receivable and payable denominated in a foreign currency must be recorded in U.S.dollars

EXAMPLE 2

Assume a U.S firm purchases merchandise on account from a French company on December 1, 20X1 The cost is 50,000 French francs, to be paid in 60 days The exchange rate for French francs on December 1 is $.20 Using the exchange rate on December 1, the U.S firm translates the FFr 50,000 into $10,000 and records the following entry:

[To record purchase of merchandise on account (FFr 50,000 × $.20 = $10,000).]

ACCOUNTING FOR MULTINATIONAL OPERATIONS

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A.4 Accounting at Interim Reporting Date

Foreign currency receivables and payables that are not settled at the balance sheet date areadjusted to reflect the exchange rate at that date Such adjustments will give rise to foreignexchange gains and losses that are to be recognized in the period when exchange rates change

EXAMPLE 3

Assume the same facts as in Example 2 and that the U.S corporation prepares financial statements

as of December 31, 20X1 when the exchange rate for the French franc is $0.22 The U.S firm will make the following adjusting entry:

A.5 Accounting at Settlement Date

When the transaction is settled, if the exchange rate changes again, the domestic value of theforeign currency paid on the settlement date will be different from that recorded on the books.This difference gives rise to translation gains and losses that must be recognized in thefinancial statements

two-B Translation of Foreign Currency Financial Statements

When the U.S firm owns a controlling interest (more than 50%) in another firm in a foreigncountry, special consolidation problems arise The subsidiary’s financial statements are usu-ally prepared in the language and currency of the country in which it is located and inaccordance with the local accounting principles Before these foreign currency financialstatements can be consolidated with the U.S parent’s financial statements, they must first be

Dec 31 Foreign Exchange Loss 1,000

[To record payment of accounts payable (FrF 50,000 × $0.21 = $10,500)

and foreign exchange gain.]

ACCOUNTING FOR MULTINATIONAL OPERATIONS

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B.1 The Functional Currency

SFAS 52 defines the functional currency of the subsidiary as the currency of the primaryeconomic environment in which the subsidiary operates It is the currency in which thesubsidiary realizes its cash flows and conducts its operations To help management determinethe functional currency of its subsidiary, SFAS 52 provides a list of six salient economicindicators regarding cash flows, sales price, sales market, expenses, financing, and intercom-pany transactions Depending on the circumstances:

• The functional currency can be the local currency For example, a Japanese sidiary manufactures and sells its own products in the local market Its cash flows,revenues, and expenses are primarily in Japanese yen Thus, its functional currency

sub-is the local currency (Japanese yen)

• The functional currency can be the U.S dollar For foreign subsidiaries that areoperated as an extension of the parent and integrated with it, the functional currency

is that of the parent For example, if the Japanese subsidiary is set up as a salesoutlet for its U.S parent, i.e it takes orders, bills and collects the invoice price,and remits its cash flows primarily to the parent, then its functional currency would

be the U.S dollar

The functional currency is also the U.S dollar for foreign subsidiaries operating in highlyinflationary economies (defined as having a cumulative inflation rate of more than 100% over

a three-year period) The U.S dollar is deemed the functional currency for translation purposesbecause it is more stable than the local currency

Once the functional currency is determined, the specific conversion procedures are selected

as follows:

• If foreign currency is the functional currency, use translation procedures

• If U.S dollar is the functional currency, use remeasurement procedures

B.2 Translation Procedures

If the local currency is the functional currency, the subsidiary’s financial statements are lated using the current rate method Under this method:

trans-• All assets and liabilities accounts are translated at the current rate (the rate in effect

at the financial statement date);

• Capital stock accounts are translated using the historical rate (the rate in effect atthe time the stock was issued);

• The income statement is translated using the average rate for the year; and

• All translation gains and losses are reported on the balance sheet, in an accountcalled “Cumulative Translation Adjustments” in the stockholders’ equity section.The purpose of these translation procedures is to retain, in the translated financial state-ments, the financial results and relationships among assets and liabilities that were created

by the subsidiary’s operations in its foreign environment

ACCOUNTING FOR MULTINATIONAL OPERATIONS

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EXAMPLE 5

Assume that the following trial balance, expressed in the local currency (LC) is received from

a foreign subsidiary, XYZ Company The year-end exchange rate is 1 LC = $.1.50, and the average exchange rate for the year is 1 LC = $1.25 Under the current rate method, XYZ Company’s trial balance would be translated as in Exhibit 1 which shows the translation proce- dures applied to XYZ Company’s trial balance Note that the translation adjustment is reflected

as an adjustment of stockholders’ equity in U.S dollars.

B.3 Remeasurement Procedures

If the U.S dollar is considered to be the functional currency, the subsidiary’s financialstatements are then remeasured into the U.S dollar by using the temporal method Underthis method:

• Monetary accounts, such as cash, receivables, and liabilities, are remeasured at thecurrent rate on the date of the balance sheet;

• Nonmonetary accounts, such as inventory, fixed assets, and capital stock, areremeasured using the historical rates;

• Revenues and expenses are remeasured using the average rate, except for cost ofsales and depreciation expenses that are remeasured using the historical exchangerates for the related assets; and

• All remeasurement gains and losses are recognized immediately in the incomestatement

The objective of these remeasurement procedures is to produce the same U.S dollarfinancial statements as if the foreign entity’s accounting records had been initially maintained

in the U.S dollar Exhibit 2 shows these remeasurement procedures applied to XYZ Company’strial balance Note that the translation gain/loss is included in the income statement

ACCOUNTING FOR MULTINATIONAL OPERATIONS

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C Interpretation of Foreign Financial Statements

To evaluate a foreign corporation, we usually analyze its financial statements However, theanalysis of foreign financial statements needs special considerations:

1 We often have the tendency of looking at the foreign financial data from a homecountry perspective For example, a U.S businessman has the tendency of usingU.S GAAP to evaluate the foreign financial statements However, U.S GAAP arenot universally recognized and many differences exist between U.S GAAP andthe accounting principles of other countries (industrialized or nonindustrialized)

2 Because of the diversity of accounting principles worldwide, we have to overcomethe tendency of using our home country GAAP to evaluate foreign financialstatements Instead, we should try to become familiar with the foreign GAAP used

in the preparation of these financial statements and apply them in our financialanalysis

3 Business practices are culturally based Often they are different from country tocountry and have a significant impact on accounting measurement and disclosurepractices Therefore, local economic conditions and business practices should betaken into consideration to correctly analyze foreign financial statements

D Harmonization of Accounting Standards

The diversity of accounting systems is an obstacle in the development of international tradeand business and in the efficiency of the global capital markets Many concerted efforts havebeen made to reduce this diversity through the harmonization of accounting standards Also,

as international business expands, there is a great need for international accounting standardsthat can help investors make decisions on an international scale The agencies working towardthe harmonization of accounting standards are:

ACCOUNTING FOR MULTINATIONAL OPERATIONS

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