Palmerston Company

 

 

 

Contents Issues 2 Facts 3 Analysis 4 Conclusions 9

 

 

 

 

 

Issues 

1. How the company should treat the record of buying materials with different currencies? 

2. How the company should treat the record of sales with different currencies? 

3. What risk have this company associates with their direct sale in a foreign country with different currency? 

4. Why might a company want its stock listed on a stock exchange outside of its home country? 

5. Why might a company be interested in investing in an operation in a foreign country (foreign direct investment)? 

Facts 

Besserbrau AG is a German beer producer headquartered in Ergersheim, Bavaria. The company, which was founded in 1842 by brothers Hans and Franz Besser, is publicly traded, with shares listed on the Frankfurt Stock Exchange. Manufacturing in strict accordance with the almost 500-year-old German Beer Purity Law, Besserbrau uses only four ingredients in making its products: malt, hops, yeast, and water. While the other ingredients are obtained locally, Besserbrau imports hops from a company located in the Czech Republic. Czech hops are considered to be among the world’s finest. Historically, Besserbrau’s products were marketed exclusively in Germany. To take advantage of a potentially enormous market for its products and expand sales, Besserbrau began making sales in the People’s Republic of China three years ago. The company established a wholly owned subsidiary in China (BB Pijio) to handle the distribution of Besserbrau products in that country. In the most recent year, sales to BB Pijio accounted for 20 percent of Besserbrau’s sales, and BB Pijio’s sales to customers in China accounted for 10 per-cent of the Besserbrau Group’s total profit. In fact, sales of Besserbrau products in China have expanded so rapidly and the potential for continued sales growth is so great that the company recently broke ground on the construction of a brewery in Shanghai, China. To finance construction of the new facility, Besserbrau negotiated a listing of its shares on the London Stock Exchange to facilitate an initial public offering of new shares of stock. 

 

Analysis  

1- How the company should treat the record of buying materials with different currencies? 

The company on this study case use materials from another country and this situation make the company keep certain accounting records that could help them describe this reality.

The company should record the account payable of the hops in Euros if that is possible an the dilemma associated to the exchange in the foreign country currency will be out of the picture but since maybe this could not be the case the company should record the account payable for the value of the invoice at the present currency exchange rates and by the time of the contract payment adjust the journal entry adding the loss or gain in foreign currency exchange.

An important rule of accounting is that your balance sheet and income statement must be reported in your home currency. So, you will record all the foreign-currency expenses incurred by your business as well as invoices created in Euros using the exchange rate that is current on the date when you log the transaction.

2- How the company should treat the record of sales with different currencies? 

Companies can use a variety of techniques to manage, or hedge, their exposure to foreign exchange risk. A popular way to hedge foreign exchange risk is through the purchase of a foreign currency option that gives the option owner the right, but not the obligation, to sell foreign currency at a predetermined exchange rate known as the strike price. But could also be treated as we explain in the prior question recording the account receivable of the sale amount per the rate at the date of the transaction and after receiving the payment adjusting the journal with the gain or loss in the foreign exchange transactions.

3. What risk have this company associates with their direct sale in a foreign country? 

Every country presents its own opportunities. But before expanding your company overseas, however, be aware of the additional risks of the foreign trade market. In general, the risks of conducting international business can be segmented into four main categories: country, political, regulatory and currency risk.

Higher Transaction Costs

Likely the biggest barrier to selling in international markets are the transaction costs. Although we live in a relatively globalized and connected world, transactions costs can still vary greatly depending on which foreign market you are selling in.

In addition, there are frequently additional charges that are piled on top of exchange rates that are specific to the local market, which can include stamp duties, levies, taxes and clearing fees.

Country Risk

Weigh the benefits of your company doing business abroad against the potential pitfalls. Poor infrastructure such as roads, bridges and telecommunications networks can make it expensive to operate a business in another country. Economic conditions such as high unemployment or a largely unskilled labor force can be barriers to entry. Rogue nations may have untapped potential, but may also pose risks such as terrorism, internal conflict and civil unrest. Anti-foreign sentiment among citizens, workers and government officials may also make doing business abroad especially challenging. Other country risks include crime and corruption.

Political Risk

Determine the political climate of the country you hope to enter. An unstable or ineffective government will be unable to protect your business interests. Lack of a strong foreign trade policy means that your business will have to navigate through the nuances of allying with government officials who may fall from power. An incoming government may not be business-friendly and may decide to increase tariffs or impose quotas.

Regulatory Risk

A sudden change in trade laws or a poor legal system exposes your business to regulatory risk. For example, a country without clearly defined intellectual property laws make it difficult for foreign software companies to protect their investments. Changes in banking laws may limit your company's ability to repatriate money to your home country or may limit access to funding.

Currency Risk

Fluctuations of a foreign country's currency can diminish profits when converting back to the home currency. Analyze the risk and rewards of making an investment in another country. The currencies of stable governments are less volatile than those of less-developed countries. Hedging strategies could mitigate some of the currency risk; however, your business is still at the mercy of the vagaries of the local currency market. Sudden changes in monetary policy will also affect currency rates.

4. Why might a company want its stock listed on a stock exchange outside of its home country? 

Companies list on the stock exchange to raise capital. There are two methods that companies can raise capital - equity and debt. When a company take the decision of listing in a foreign stock exchange could be to gain access to more financial resources than are available in its home country

When a company lists on the stock exchange, they are raising equity by making shares open for the public to buy.

Raising capital through equity is less risky because investors aren’t entitled to receiving a specific return for their investment. For this reason, companies seek to find a favorable balance between debt and equity funding in order to manage a firm’s risk.

As a publicly traded company in two different stock exchange this company is required to prepare consolidated financial statements in which the assets, liabilities, and income of its subsidiaries (domestic and foreign) are combined with those of the parent company. The consolidated financial statements must be presented in the regulatory currencies of those stock exchanges and prepared using the required accounting standards of those countries.

5. Why might a company be interested in investing in an operation in a foreign country (foreign direct investment)? 

Increase Sales and Profits

International sales may be a source of higher profit margins or of additional profit through additional sales. Unique products or technological advantages may provide a comparative advantage that a company wishes to exploit by expanding sales in foreign countries.

Enter Rapidly Growing or Emerging Markets

Some international markets are growing much faster than others. Foreign direct investment is a means for gaining a foothold in a rapidly growing or emerging market. The ultimate objective is to increase sales and profits.

Reduce Costs

A company sometimes can reduce the cost of providing goods and services to its customers through foreign direct investment. Significantly lower labor costs in some countries provide an opportunity to reduce the cost of production. If materials are in short supply or must be moved a long distance, it might be less expensive to locate production close to the source of supply rather than to import the materials. Transportation costs associated with making export sales to foreign customers can be reduced by locating production close to the customer.

Gain a Foothold in Economic Blocs

To be able to sell its products within a region without being burdened by import taxes or other restrictions, a company might establish a foothold in a country situated in a major economic bloc. The three major economic blocs are the North American Free Trade Association (NAFTA), the European Union, and an Asian bloc that includes countries such as China, India, Indonesia, Malaysia, the Philippines, South Korea, Taiwan, and Thailand.

Protect Domestic Markets

To weaken a potential international competitor and protect its domestic market, a company might enter the competitor’s home market. The rationale is that a potential competitor is less likely to enter a foreign market if it is preoccupied with protecting its own domestic market. Protect Foreign Markets Additional investment in a foreign country is sometimes motivated by a need to protect that market from local competitors. Companies generating sales through exports to a particular country sometimes find it necessary to establish a stronger presence in that country over time to protect their market.

Acquire Technological and Managerial Know-How

In addition to conducting research and development at home, another way to acquire technological and managerial know-how is to set up an operation close to leading competitors. Through geographical proximity, companies find it easier to more closely monitor and learn from industry leaders and even hire experienced employees from the competition.

 

Conclusions

There are several issues the Besserbrau AG will face. With the expansion into China, Besserbrau AG will need to account for Foreign Direct Investment (FDI). They can do this by adapting their accounting standards to meet the requirements in China. The profits made by BB Pijio will need to be converted from Chinese GAAP to German GAAP. These profits will also need to be translated between the two currencies and the overall performance of BB Pijio.

Besserbrau AG would face an issue with the sales to foreign customers. Since both of the countries have different currency, in order to account for their export sales, they will need to convert the Chinese Yuan into the German Euros for both the sale and the receivable.

Besserbrau AG would also face an issue with foreign exchange risk. To reduce their risk to foreign exchange risk, Besserbrau AG could set the requirement that all foreign customers pay for products in Euros.

Cross listing on foreign stock exchanges is another issue Besserbrau AG would face. Since Besserbrau AG negotiated a listing on the London Stock Exchange to help finance their new facility, they must stay in compliance with the regulations pertaining to the London Stock Exchange. In order to stay in compliance, they will need to fully understand the financial reporting requirements. In order to minimize taxation Besserbrau AG could use discretionary transfer pricing. This would give them the ability to shift their profits between China and Germany. By doing this, they need to follow the laws for regulating international transfer pricing for each country.

It is obvious that Besserbrau AG has a number of issues they will face with their expansion into China. I believe the issues listed above are the major issues they will have to face and conquer in order to be successful in this endeavor.

 

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