International business

Angela gomez

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International Business

Sixteenth Edition

Chapter 19

International Accounting and Finance Issues

Learning Objectives (1 of 2)

19-1 Explain the crossroads of accounting and finance

19-2 Identify the major factors affecting the development of accounting objectives, standards, and practices

19-3 Describe international accounting standards and the process of global convergence

19-4 Demonstrate how companies account for foreign-currency transactions

Learning Objectives for the chapter.

Learning Objectives (2 of 2)

19-5 Determine how companies can translate foreign-currency financial statements

19-6 List some of the key international finance functions

19-7 Show how companies protect against foreign- exchange risk

Learning Objectives for the chapter.

Accounting and Finance

Objective 19-1

The role of the CFO

Controller

Global Financial Challenges

Learning Objective 1: Explain the crossroads of accounting and finance.

As noted in Chapter 11, the Chief Financial Officer (CFO) of a company is responsible for overseeing the financial activities of a company.2 Working under the CFO, the controller has responsibility for accounting-related activities, providing management with relevant and reliable information, and preparing information for the external users of financial information.

The accounting and finance functions are closely related, with each relying on the other to fulfill its responsibilities. The CFO relies on the controller, or chief accountant, to provide the right information for making decisions, while the internal audit staff ensures that corporate policies and procedures are followed. The internal auditors, the controller, and the CFO work closely with the external auditor to try to safeguard the assets of the business.

Today’s controller is engaged in a variety of activities outside the typical accounting and reporting functions that support the firm’s general strategy such as evaluating potential acquisitions abroad, disposing of a subsidiary or a division, managing cash flow, hedging currency and interest-rate risks, tax planning, internal auditing, and helping to plan corporate strategy.

The types of financial information required in different countries can differ, while companies also have to consider who their audience is: Are they providing financial information only for the local market, or also for users from the broader global capital markets?

Major reporting issues:

Language

Currency

Underlying GAAP on which the financial statements are based

Influences on Accounting Standards

Objective 19-2

Figure 19.1 Sources of Influence on Accounting Standards and Practices

Learning Objective 2: Identify the major factors affecting the development of accounting objectives, standards, and practices.

Figure 19.1 shows the influences on accounting standards and practices.

Factors Affecting Accounting

Objective 19-2

Cultural Differences in Accounting

Secrecy-Transparency/Optimism-Conservatism Matrix

Figure 19.2 A Disclosure/Assessment Matrix for National Accounting Systems

Source: Based on Lee H. Radebaugh, Sidney J. Gray, and Ervin L. Black, International Accounting and Multinational Enterprises, 6th ed.(New York: John Wiley & Sons, 2002): 51.

Learning Objective 2: Identify the major factors affecting the development of accounting objectives, standards, and practices.

Cultural Differences in Accounting The differences in measurement and disclosure practices among countries are of special interest to international investors. Measurement means how companies value assets, including inventory and fixed assets, whereas disclosure refers to how and what information companies provide and the level of detail and transparency.

The Secrecy–Transparency/Optimism–Conservatism Matrix Figure 19.2 depicts the accounting practices of various groupings of countries within a matrix of the cultural values of secrecy–transparency and optimism–conservatism. With respect to accounting, secrecy and transparency indicate the degree to which companies disclose information to the public. In the past, countries such as Germany, Switzerland, and Japan tended to have less disclosure (illustrating the cultural value of secrecy) than did more transparent U.S. and British companies (Anglo-Saxon in Figure 19.2) due to their reliance on stock markets.

Mutual Recognition and Reconciliation

Objective 19-3

Mutual Recognition

Reconciliation

Forces for Global Standards

Learning Objective 3: Describe international accounting standards and the process of global convergence.

Before the rise in importance of global capital markets and the move to a common set of accounting standards, it was common for many countries to apply the principle of mutual recognition, whereby a regulator, such as the German Stock Exchange, would accept financial statements provided in U.S. GAAP of a U.S. company wanting to list securities in Germany.

The United States uses two approaches: adoption of U.S. standards or the use of IFRS as established by the International Accounting Standards Board. If a foreign company prefers to list according to their home-country GAAP instead of U.S. GAAP or IFRS, they must provide a statement of reconciliation

Major forces for Global Accounting Standards Despite the many differences in accounting standards and practices around the world, a number of forces are leading to convergence:

A movement to provide information compatible with the needs of investors.

The global integration of capital markets, which means easier and faster access to investment opportunities around the world and, therefore, the need for more comparable financial data.

The need of MNEs to raise capital outside their home-country capital markets while generating as few different financial statements as possible.

Regional political and economic harmonization, such as the efforts of the EU, which affect accounting as well as trade and investment issues.

Pressure from MNEs for more uniform standards to allow greater ease and reduced costs in general reporting in each country.

International Accounting Standards

Objective 19-3

Drivers of the development of core standards globally

Learning Objective 3: Describe international accounting standards and the process of global convergence.

Established in 1973, the International Accounting Standards Committee (IASC), the forerunner of the IASB, began working toward harmonizing standards by issuing a set of International Accounting Standards (IAS) that they hoped anyone in the world could use The turning point in the significance of IAS came in 1995, when the International Organization of Securities Commissions (IOSCO) announced publicly it would endorse IAS if the IASC developed a set of core standards acceptable to it.

FASB and IASB are trying to converge their standards through removing differences in existing standards and engaging in joint projects to develop new standards.

International Financial Reporting Standards (IFRS) When the IASB was organized, all of the old standards from the IASC were adopted, and the Board began to go through each one to upgrade them. Then the Board began to issue the new International Financial Reporting Standards; thus, when we use the term IFRS, we refer to the new standards as well as the old IAS.

The Relationship Between the FASB and the IASB The U.S. Financial Accounting Standards Board (FASB) and IASB have been working closely to achieve a convergence of accounting standards. In 2002, they issued the Norwalk Agreement, pledging their best efforts to remove individual differences between U.S. GAAP and IFRS and undertake joint projects to develop future standards.

Accounting for Foreign Currency Transactions

Objective 19-4

Receivables and Payables

FASB Reporting

Learning Objective 4: Demonstrate how companies account for foreign-currency transactions.

Foreign-currency receivables and payables give rise to gains and losses whenever the exchange rate changes. Transaction gains and losses must be included in the income statement in the accounting period in which they arise.

The FASB requires that U.S. companies report foreign currency transactions at the original spot exchange rate and that subsequent gains and losses on foreign-currency receivables or payables be put on the income statement. The same procedure must be followed according to IFRS.

Translating Financial Statements

Objective 19-5

Translation

Consolidation

Current Rate/Temporal Methods

Learning Objective 5: Determine how companies can translate foreign-currency financial statements.

The process of restating foreign-currency financial statements into U.S. dollars is called translation. The combination of all of these translated financial statements into one is consolidation.

Two Methods: Current-Rate and Temporal Both standards allow companies to use either of two methods in the translation process: the current-rate method (called the closing rate method under IFRS) or the temporal method. The one the company chooses depends on the functional currency of the foreign operation, which is the currency of the primary economic environment in which that entity operates. Whichever method a company uses, it has to determine the proper exchange rate to translate the foreign-currency balances into U.S. dollars.

Selecting a Translation Method

Objective 19-5

Figure 19.3 Selecting a Translation Method

Learning Objective 5: Determine how companies can translate foreign-currency financial statements.

This figure shows a way to determine financial translation method.

International Finance Functions

Objective 19-6

Capital Budgeting

Internal Sources of Funds

Global Cash Management

Learning Objective 6: List some of the key international finance functions.

Capital budgeting: is the technique that helps the MNE determine which projects and countries will receive its capital investment funds. The parent company must compare the net present value or internal rate of return of a potential foreign project with that of its other projects around the world to determine the best place to invest resources.

Internal Source of Funds: Although the term funds usually means “cash,” it is used in a much broader sense in business and generally refers to working capital—that is, current assets minus current liabilities. From a general perspective, funds come from the normal operations of a business (selling merchandise or services) as well as from financing activities, such as borrowing money, issuing bonds, or issuing shares. They are used to purchase fixed assets, pay employees, buy materials and supplies, and invest in marketable securities or long-term investments.

Global Cash Management answers the following questions

What are the local and corporate system needs for cash?

How can the cash be withdrawn from subsidiaries and centralized?

Once the cash has been centralized, what should be done with it?

Risk Exposure

Objective 19-7

Types of Risk Exposure

Strategies for Exposure Management

Learning Objective 7: Show how companies protect against foreign-exchange risk.

Translation exposure occurs because exposed accounts—those translated at the current exchange rate—either gain or lose value in dollars when the exchange rate changes.

Denominating a transaction in a foreign currency gives rise to transaction exposure because the company has accounts receivable or payable in foreign currency that must be settled eventually.

Economic exposure, also known as operating exposure, is the potential for change in expected cash flows that arises from the pricing of products, the sourcing and cost of inputs, and the location of investments.

Exposure-Management Strategy To adequately protect assets against the risks from translation, transaction, and economic exposure to exchange-rate fluctuations, management must do the following:

Define and measure exposure.

Organize and implement a reporting system that monitors exposure and exchange-rate movements.

Adopt a policy assigning responsibility for minimizing—or hedging—exposure.

Formulate strategies for hedging exposure.