Chapter 1:�Introduction to International Accounting

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Learning Objectives

• Discuss the nature and scope of international accounting
• Describe accounting issues confronted by companies involved in international trade (import and export transactions)
• Explain the reasons for, and the accounting issues associated with, foreign direct investment
• Describe the practice of cross-listing on foreign stock exchanges
• Explain the notion of global accounting standards
• Examine the importance of international trade, foreign direct investment, and multinational corporations in the global economy

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International Accounting

• Includes study of various functional areas of accounting
• Focuses on the accounting issues unique to multinational corporations
• Can be defined at three different levels
• Supranational accounting
• Standards, guidelines, and rules issued by supranational organizations
• Company level
• Followed by company in international business activities and foreign investments
• International accounting
• Study of the standards, guidelines, and rules of accounting, auditing, and taxation existing within each country and comparison across countries

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Accounting Issues Related to International Business—Sale to Foreign Customer

• First encounter with international business occurs as sales to foreign customers
• Credit sales are made to foreign customers who will pay in their own currency
• Gives rise to foreign exchange risk

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Accounting Issues Related to International Business—Sale to Foreign Customer

• Suppose that on February 1, 2014, Joe Inc., a U.S. company, makes a sale and ships goods to Jose SA, a Mexican customer, for $100,000 (U.S.)
• However, it is agreed that Jose will pay in pesos on March 2, 2014. The exchange rate as of February 1, 2014 is U.S.$1 = 10 pesos. How many pesos does Jose agree to pay?

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Accounting Issues Related to International Business—Sale to Foreign Customer

• Even though Jose 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, 2014, as follows:

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Dr. Accounts Receivable

Cr. Sales Revenue

100,000

100,000

Accounting Issues Related to International Business—Sale to Foreign Customer

• Suppose that on March 2, 2014, the exchange rate for pesos is U.S.$1=11 pesos. Joe Inc. will receive 1,000,000 pesos, which are now worth $90,909

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Dr. Cash

Cr. Accounts Receivable

90,909

100,000

Dr. Loss on Foreign Exchange

9,091

Hedges of Foreign Exchange Risk

• Techniques to manage exposure
• Foreign currency option
• Right to sell foreign currency at a predetermined exchange rate and time
• Forward contract
• Obligation to exchange foreign currency at a future date

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Foreign Direct Investment

• Ownership and control of foreign assets
• Two ways
• Acquisition
• Investment in existing operations in foreign countries
• Greenfield investment
• New operation in foreign countries

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Reasons for Foreign Direct Investment

• Increase sales and profits
• Enter rapidly growing or emerging markets
• Reduce costs
• Gain a foothold in economic blocs
• Protect domestic markets
• Protect foreign markets
• Acquire technological and managerial know-how

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Financial Reporting for Foreign Operations

• Steps in reporting for Foreign Operations
• Conversion from local to U.S. GAAP
• Records prepared using local GAAP
• Translate from local currency to U.S. dollars
• Records are prepared using local currency

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International Income Taxation

• Double taxation
• 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

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International Transfer Pricing

• 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 companies pay their fair share of local taxes

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Performance Evaluation of Foreign Operations

• Evaluation is through periodic reports on individual unit’s performance
• Issues in evaluation
• Translation from one currency to another
• Inflated price paid in transfer pricing
• Issues unique to foreign operations

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International Auditing

• Internal auditing is an important component of a management’s control process
• Issues faced by internal and external auditors
• Differences in language and culture
• Differences accounting standards and auditing standards

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Cross-Listing on Foreign Stock Exchanges

• Cross-listing: stock listed and traded on several foreign stock exchanges
• Issues
• Listing regulations differ for foreign companies

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Global Accounting Standards

• Requires countries to adopt a common set of accounting rules
• Advantages
• Avoids GAAP conversion
• Easier to evaluate foreign investment opportunities

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The Global Economy

• International trade constitutes a significant portion of the world economy
• Largest exporters are China, the United States and Germany
• Largest importers are United States, Germany, and China
• Foreign direct investment to retain advantage over competition
• Multinational companies
• International capital markets:
• Help companies find capital at a reasonable cost
• Help in having an “acquisition currency” for acquiring firms through stock swaps

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End of Chapter 1

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