Chapter 1 international accounting

Foreign Direct Investment FDI – occurs whena company invests in a business operation in a foreign country.This represents an alternative to importing to customers and/orexporting from su

5 Explain the notion of global accounting standards.

6 Examine the importance of international trade, FDI,

and multinational corporations (MNCs) in the global economy

• Includes study of various functional areas of accounting

– Focuses on the accounting issues unique to multinational corporations

• Can be defined at three different levels

• Study of the standards, guidelines, and rules of

accounting, auditing, and taxation existing within each country and comparison across countries

• Most companies’ first encounter with international

business occurs as sales to foreign customers

• Often, the sale is made on credit and it is agreed that the foreign customer will pay in its own currency (e.g., Mexican pesos)

 This gives rise to foreign exchange risk as the value

of the foreign currency is likely to change in relation to the company’s home country currency (e.g., U.S dollars

Suppose that on February 1, 2011, Joe Inc., a U.S company,makes a sale and ships goods to Jose, SA, a Mexicancustomer, for $100,000 (U.S.).

However, it is agreed that Jose will pay in pesos on March 2,

2011 The exchange rate as of February 1, 2011 is 10 pesosper U.S dollar How many pesos does Jose agree to pay?

LO 2

Even though Jose SA agrees to pay 1,000,000 pesos

($100,000 x 10 pesos/U.S $), Joe, Inc records the sale (in U.S dollars) on February 1, 2011 as follows:

Dr Accounts receivable (+) 100,000

Cr Sales revenue (+) 100,000

Sale to foreign customer

Suppose that on March 2, 2011, the exchange rate for pesos is

11 pesos/U.S $ Joe Inc will receive 1,000,000 pesos, which are now worth $90,909 Joe makes the following journal entry:

Joe can hedge (i.e., protect itself) against a loss from an

exchange rate fluctuation Hedging can be accomplished by

various means, including:

Foreign currency option – the right (but not the obligation) to

sell foreign currency at a specific exchange rate for a specified period of time

Forward contract – this is an obligation to exchange foreign

currency at a date in the future, which is typically 30, 60 or 90 days

Foreign Direct Investment (FDI) – occurs when

a company invests in a business operation in a foreign country.This represents an alternative to importing to customers and/orexporting from suppliers in a foreign country Two types of FDI

are greenfield investment and acquisition.

LO 3

Foreign Direct Investment (FDI)

Greenfield investment – the establishment of a new operation

in the foreign country

Acquisition – investment in an existing operation in the foreign

country

REASONS FOR FOREIGN DIRECT INVESTMENT

• Increase Sales and Profits

• Enter Rapidly Growing or Emerging Markets

• Reduce Cost

• Protect Domestic Markets

• Protect Foreign Markets

• Acquire Technological and Managerial Know-How

FDI creates two primary issues:

• The need to convert from local to U.S GAAP since

accounting records are usually prepared using local GAAP

• The need to translate from local currency to U.S dollars

since accounting records are usually prepared using localcurrency

– Foreign income taxes

• The company’s profits taxed at foreign rates

– U.S income taxes

• The U.S will tax the company’s foreign-based income

• Tax treaties provide relief from double taxation

• Objectives

– Legally minimize taxes in foreign countries and home

country– Maximize after-tax cash flows

LO 3

INTERNATIONAL TRANSFER PRICING

• Transfer pricing – setting prices on goods and services

exchanged between separate divisions within the same firm These prices have a direct impact on the profits of the

different divisions

• Issue for multinational companies making intercompany

sales

• Companies use of discretionary transfer pricing

– Price negotiation between buyer and seller not feasible due to tax rate differences

• Companies shift profits from countries with high-tax rates to countries with low tax-rates

• Countries regulate international transfer pricing to ensure

These include:

• Language and cultural differences

• Different accounting standards (GAAP) and auditingstandards (GAAS)

LO 3

CROSS-LISTING ON FOREIGN STOCK EXCHANGES

MNCs frequently raise capital outside their home country When

a company offers its shares on an exchange outside of its

home country, this is referred to as Cross-Listing.

GLOBAL ACCOUNTING STANDARDS

• There is an international movement towards adopting a set

of global accounting standards These standards are

known as “International Financial Reporting Standards”

or “IFRS”

• Countries adopting these standards, will, for example, be in

a better position to evaluate FDI

• Another advantage of the adoption of global accountingstandards is the elimination of the need to convert from localGAAP when preparing consolidated financial statements

LO 5

THE GLOBAL ECONOMY

Several indicators demonstrate the extent of business globalization:

• International trade – In 2008 exports worldwide topped $16

trillion Between 1996 and 2008, U.S exports increased by106% in volume

• Foreign Direct Investment – Between 1982 and 2008

worldwide FDI inflows increased from $58 billion to $1.7trillion

• Multinational corporations (MNCs) – Companies that have

headquarters in one country and operate in one or moreother countries Currently, MNCs account for approximately

10% of the world’s Gross Domestic Product (GDP).

LO 6

THE GLOBAL ECONOMY

Several indicators demonstrate the extent of business globalization:

• International capital markets – As of January 31, 2010

there were 499 companies representing 47 countries listed on the New York Stock Exchange (NYSE) In addition,over 50 U.S companies are cross-listed on the London StockExchange, for example

1 What accounting issues arise for a company as a result

of engaging in international trade (imports and exports)?

2 What financial reporting issues arise as a result of

making a foreign direct investment?

1 What accounting issues arise for a company as a result

of engaging in international trade (imports and exports)?

 companies do in international trade with imports and

exports denominated in foreign currencies are faced with the accounting issue of translating foreign currency

amounts into the company's reporting currency and

reporting the effects of exchange rates in the financial

statements

2 What financial reporting issues arise as a result of

making a foreign direct investment?

Financial reporting issues that result from foreign direct investment are:

1) conversion of foreign GAAP to parent company GAAP 2) Translation of foreign currency to parent company

reporting currency to prepare consolidated financial

statements, in additional supplementary disclosure

about foreign operations might be required