1. International Businessby
Daniels and Radebaugh
Chapter 19
Multinational
Accounting and Tax
Functions
© 2001 Prentice Hall

2. Objectives
To examine the major factors influencing the development of accounting practices in different countries and the worldwide harmonization of accounting principles
To explain how companies account for foreign-currency transactions and translate foreign-currency financial statements
To describe the impact of accounting methods on the evaluation of foreign operations
To investigate the U.S. taxation of foreign-source income
To examine some of the major non–U.S. tax practices and to show how international tax treaties can alleviate some of the impact of double taxation
© 2001 Prentice Hall

3. Introduction Accounting and finance functions are closely related
Financial manager—responsible for procuring and managing financial resources
relies on accountants to provide financial information
flow of assets across national boundaries complicates both functions
Controller—collects and analyzes data for internal and external uses
must be concerned about different currencies and accounting systems
engaged in many activities associated with international business
foreign managers and subsidiaries usually evaluated based on data provided by controller
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4. Accounting in International Business
EXTERNAL INFLUENCES
COMPETITIVE
ENVIRONMENT
PHYSICAL AND
SOCIETAL FACTORS
OPERATIONS
OBJECTIVES
STRATEGY
MEANS
Overlaying
Alternatives
Modes
Functions
Marketing
Exporting and importing
Global manufacturing
Supply chain
management
ACCOUNTING
Finance
Human resources
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5. Factors influencing the development of accounting around the world
Both the form and substance of financial statements are different in different countries
Statements differ in format—relatively minor matter
Terms differ
companies can measure assets and determine income differently in different countries
Some companies present only consolidated financial statements
others present separate statements for parent and subsidiaries
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6. Accounting Objectives
Accounting—provides quantitative information about economic entities for making economic decisions
Financial Accounting Standards Board (FASB)—sets accounting standards in the U.S.
Financial reporting provides information for:
investment and credit decisions
assessment of cash flow prospects
evaluation of enterprise resources, claims to those resources, and changes in them
International Accounting Standards Committee (IASC)—private sector group that sets accounting standards
Users have different foci
Creditors—focus on the balance sheet
Investors—focus on the income statement
Generally accepted accounting principles (GAAP)—local standards that must be followed by companies when preparing financial statements
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7. Environmental Influences on Accounting Practices
Other external
users
Enterprise
users
Nature of the
enterprise
Development of
Accounting Objectives, Standards, and Practices
Accounting
profession
Characteristics of
the local environment
International
influences
Academic
influences
Government
© 2001 Prentice Hall

8. Cultural Differences in Accounting
Culture influences:
Measurement—how companies value assets
Disclosure—how and what information companies provide in reports for external users of financial data
Countries differ with respect to:
Secrecy and transparency—indicate the degree to which companies disclose information to the public
Optimism and conservatism—degree of caution companies exhibit in valuing assets and recognizing income
Countries moving toward greater optimism and transparency
reflects influence of capital markets that require disclosures consistent with Anglo-Saxon model
© 2001 Prentice Hall

9. Cultural Differences in Measurement and
Disclosure in Accounting Systems
Secrecy
Less developed
Latin
Germanic
Near Eastern
Japan
Less developed
Asian
More developed
Latin
African
Less public disclosure
Asian
colonial
Nordic
Anglo-Saxon
Transparency
Optimism
Conservatism
Greater caution in assessment
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10. Cultural Differences in Accounting (cont.)
Classification of accounting systems—group systems according to common characteristics
Macrouniform systems—shaped by governmental influence
Strong legal systems
Tax law
Tend to be more conservative and secretive
Microbased systems—support pragmatic business practice
Exhibit more optimism and transparency
Rely less on legal and tax requirements
Accounting for IB more complex and costly
Financial statements differ across countries
- language financial statement format
- currency extent of footnote disclosure
- statement type underlying GAAP
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11. Classification of Accounting Systems of Developed
Western Countries
Class
Subclass
Family
Species
Government,
economics
Sweden
Macro-uniform
Law-based
Japan
Germany
Developed
Western
Countries
Continental:
government,
tax legal
Spain
Belgium
France
Italy
Tax-based
United States-
influenced
Canada
United States
Pragmatic
business practices,
British origin
Ireland
United Kingdom
New Zealand
Australia
United Kingdom-
influenced
Microbased
Business
economics, theory
Netherlands
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12. Harmonization of Differences in Accounting Standards
Major forces leading to harmonization
Investor orientation
Global integration of capital markets
MNEs’ needs for foreign capital
Regional political and economic harmonization
Desire to reduce accounting and reporting costs
EU—harmonizing accounting to promote the free flow of capital
Has identified the:
type and format of financial statements
measurement bases for financial statements
importance of consolidated financial statements
Improved the comparability of financial statements
© 2001 Prentice Hall

13. Harmonization of Differences in Accounting Standards (cont.)
International Accounting Standards Committee (IASC)
Comprises 143 professional accounting organizations from 104 countries
Has worked toward harmonizing standards
Standards endorsed by the International Organization of Securities Commissions (IOSCO)
U.S. GAAP standards are dominant in the world
challenge IASC standards
International Accounting Standards (IAS)
Convergence increasing among national standards and IASs
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14. Transactions in Foreign Currencies
Recording of transactions—importer must keep track of transactions when it trades its own currency for that of the exporter to make payment
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
Correct procedures for U.S. companies
Spelled out in Financial Accounting Standards Board (FASB) Statement No. 52
FASB requires U.S. firms to report foreign-currency transactions at the original spot exchange rate and to record subsequent gains and losses for foreign-currency receivables (or payables) on the income statement
Procedures vary in other countries
© 2001 Prentice Hall

15. Translation of Foreign-Currency Financial Statements
Translation—process of restating foreign-currency financial statements into a common currency
Consolidation—process of combining the financial statements of a parent and its subsidiaries
Translation methods—firm chooses the method most appropriate for a particular foreign subsidiary
Functional currency—the currency of the primary economic environment in which the firm operates
Current-rate method—selected if functional currency is the local currency
firms translate all assets and liabilities at the current exchange rate
Temporal method—functional currency is that of the parent company
only monetary assets and liabilities are translated at the current exchange rate
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16. Selection of Translation Method
Functional
currency
Local
currency
Reporting currency
of parent
Current-rate
method
Temporal
method
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17. Balance Sheet, December 31, 1999
TEMPORAL METHOD
CURRENT-RATE METHOD
POUNDS
RATE
DOLLARS
RATE
DOLLARS
Cash , , ,960
Accounts receivable , , ,920
Inventories , , ,920
Fixed assets , , ,800
Accumulated dep (20,000) (30,000) (33,960)
Total , , ,640
Accounts payable , , ,940
Long-term debt , , ,712
Capital stock , , ,000
Retained earnings , * , * ,481
Accum. trans. adj _____ ______ ,507
© 2001 Prentice Hall

18. Income Statement, 1999 TEMPORAL METHOD CURRENT-RATE METHOD POUNDS RATE
DOLLARS
Sales , , ,191
Expenses
CGS (110,000) (171,600) (171,787)
Depreciation (10,000) (15,000) (15,617)
Other (80,000) (124,936) (124,936)
Taxes (6,000) (9,370) (9,370)
24, , ,481
Transl. gain (Loss) (9,633)
Net income , , ,481
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19. Translation of Foreign-Currency Financial Statements (cont.)
Disclosure of foreign-exchange gains and losses
Current-rate method—translation gain or loss is recognized in owner’s equity
Temporal method—translation gain or loss is recognized in the income statement
Environmental reports
Identify the impact of the company on the environment
Reports not required
vary substantially from company to company and from country to country
Focus on the use of natural resources and efforts to recycle waste
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20. Taxation Exports of goods and services
Foreign sales corporation (FSC)—used to shelter some of its export income from taxation
qualifications to become an FSC include:
maintain a foreign office
operate under foreign management
keep a permanent set of books at foreign office
conduct foreign economic processes
be a foreign corporation
a portion of the income of foreign corporations that qualify as FSCs is exempt from U.S. corporate income tax
Foreign branch—extension of the parent company
Income is directly included in the parent’s taxable income
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21. Taxation (cont.)
Foreign subsidiary—a foreign corporation established in a country as an independent legal entity
Subsidiary—a foreign corporation purchased or established by an MNE
Income is taxable to the parent or tax deferred
tax deferred income—not taxed until it is remitted to the parent company as a dividend
Controlled foreign corporation (CFC)—foreign corporation of which more than 50% of its voting stock is held by U.S. shareholders
CFC income classified as either:
active income—derived from the direct conduct of a trade or business
passive income—usually derived from operations in a tax-haven country
Tax haven—country with low or no taxes on foreign-source income
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22. A Tax-Haven Subsidiary as a Holding Company
Parent Company in
the United States
Grandchild
Subsidiary
Tax-Haven
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23. Taxation (cont.)
Transfer price—price on goods and services sold by one member of a corporate family to another
Price is arbitrary due to:
differences in taxation between countries
competitive reasons
restrictions on currency flows
Arbitrary pricing makes evaluating subsidiary and management performance difficult
Arm’s-length price—price between two companies that do not have ownership interest in each other
Tax credit—dollar-for-dollar reduction of tax liability by the amount of foreign tax already paid
Must coincide with the recognition of income
Intended to avoid double taxation
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24. A Tax-Haven Subsidiary as a Holding Company
U.S. Stockholder
(parent company)
Foreign Corporation
(non-CFC)
Income is taxable to the
parent when declared as
a dividend, regardless
of whether the income
is active or Subpart F.
Deferral applies
CFC
Active income is
tax-deferred
Subpart F. income is
taxable to the parent
when earned by the CFC
Foreign Branch
All income is taxable to
the parent when earned
by the branch
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25. Taxation (cont.) Taxation of U.S. citizens abroad
Governments treat overseas compensation in a variety of ways
U.S. policy has changed over the years
U.S. citizens working abroad can exclude $74,000 of their income from U.S. taxation and can claim a housing exclusion for housing expenses in excess of a base amount determined by the Internal Revenue Service
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26. Non–U.S. Tax Practices
Differences in tax practices around the world cause problems for MNEs
Different GAAPs lead to differences in the determination of taxable income
Taxation of corporate income differs
separate entity approach—each separate unit is taxed when it earns income
results in double taxation
integrated system—tries to avoid double taxation of corporate income through split tax rates or tax credits
Value-added tax (VAT)—each independent company is taxed only on the value it adds at each stage in the production process
EU is narrowing differences among members’ VAT practices
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27. Non–U.S. Tax Practices (cont.)
Tax treaties—intended to prevent international double taxation or to provide remedies when it occurs
Several similar treaties and protocols were signed between the U.S. and foreign countries
Planning the Tax Function
Taxes are a consideration in MNEs’ investment decisions
Branches or foreign subsidiaries typically are used to establish a foreign operation
if losses are expected at the start, branch is the advisable form
parent can deduct branch losses against parent income
as operation becomes profitable, subsidiary form is advisable
tax deferral applies to subsidiary income
© 2001 Prentice Hall