1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter One Introduction to International Accounting Copyright © 2012 The McGraw-Hill Companies, All Rights Reserved

2. 1-2 Learning Objectives 1. Understand the nature and scope of international accounting. 2. Describe accounting issues created by international trade. 3. Explain reasons for, and accounting issues associated with, foreign direct investment (FDI).

3. 1-3 Learning Objectives 4. Describe the practice of cross-listing on foreign stock exchanges. 5. Explain the notion of global accounting standards. 6. Examine the importance of international trade, FDI, and multinational corporations (MNCs) in the global economy.

4. 1-4 International Accounting can be described at three different levels: The influence on accounting by international political groups such as the OECD, UN, etc. The accounting practices of companies in response to their own international business activities. The differences in accounting, auditing and taxation standards and practices between countries. Learning Objective 1

5. 1-5 Sale to foreign customer 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). Learning Objective 2

6. 1-6 Sale to foreign customer 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). Learning Objective 2

7. 1-7 Sale to foreign customer Suppose that on February 1, 2011, 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, 2011. The exchange (spot) rate as of February 1, 2011 is 10 pesos per U.S. dollar. How many pesos does Jose agree to pay? Learning Objective 2

8. 1-8 Sale to foreign customer 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 Learning Objective 2

9. 1-9 Sale to foreign customer Suppose that on March 2, 2011, the spot 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: Dr. Cash (+) 90,909 Dr. Loss on foreign exchange (+) 9,091 Cr. Accounts receivable 100,000 Learning Objective 2

10. 1-10 Hedging 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. Learning Objective 2

11. 1-11 Hedging Forward contract – this is an obligation to exchange foreign currency at a date in the future, which is typically 30, 60 or 90 days. Learning Objective 2

12. 1-12 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/or exporting from suppliers in a foreign country. Two types of FDI are greenfield investment and acquisition. Learning Objective 3

13. 1-13 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. Learning Objective 3

14. 1-14 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 local currency. Learning Objective 3

15. 1-15 Foreign income taxes – the foreign government will tax the company’s profits at applicable rates. U.S. income taxes – the U.S. will tax the company’s foreign- based income. Learning Objective 3

16. 1-16 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. Learning Objective 3

17. 1-17 These exchanges are not arms-length transactions, thus giving rise to certain problems in an international context:  Taxation – governments in the various countries often scrutinize transactions to assure that sufficient profits are being recorded in that country. Learning Objective 3

18. 1-18 Performance evaluation issues – to the extent that division managers are evaluated based on divisional profits, transfer prices influence division manager performance evaluation. Learning Objective 3

19. 1-19 Both internal and external auditors encounter differ- ences that arise between auditing in an international vs. domestic context. These include: Language and cultural differences Different accounting standards (GAAP) and auditing standards (GAAS) Learning Objective 3

20. 1-20 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. Learning Objective 4

21. 1-21 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 accounting standards is the elimination of the need to convert from local GAAP when preparing consolidated financial statements. Learning Objective 5

22. 1-22 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 by 106% in volume. Foreign Direct Investment – Between 1982 and 2008 worldwide FDI inflows increased from $58 billion to $1.7 trillion. Learning Objective 6

23. 1-23 Several indicators demonstrate the extent of business globalization: Multinational corporations (MNCs) – Companies that have headquarters in one country and operate in one or more other countries. Currently, MNCs account for approximately 10% of the world’s Gross Domestic Product (GDP). Learning Objective 6

24. 1-24 Several indicators demonstrate the extent of business globalization: International capital markets – As of January 31, 2010 there were 499 companies representing 47 countries cross-listed on the New York Stock Exchange (NYSE). In addition, over 50 U.S. companies are cross-listed on the London Stock Exchange, for example. Learning Objective 6