1. © 2001 Prentice Hall19-1 International Business by Daniels and Radebaugh Chapter 19 Multinational Accounting and Tax Functions

2. © 2001 Prentice Hall19-2 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

3. © 2001 Prentice Hall19-3 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

4. © 2001 Prentice Hall19-4 OPERATIONS OBJECTIVES STRATEGY EXTERNAL INFLUENCES COMPETITIVE ENVIRONMENT PHYSICAL AND SOCIETAL FACTORS Functions Marketing Exporting and importing Global manufacturing Supply chain management ACCOUNTING Finance Human resources Modes MEANS Overlaying Alternatives Accounting in International Business

5. © 2001 Prentice Hall19-5 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

6. © 2001 Prentice Hall19-6 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

7. © 2001 Prentice Hall19-7 Academic influences Government Other external users Development of Accounting Objectives, Standards, and Practices International influences Nature of the enterprise Accounting profession Enterprise users Characteristics of the local environment Environmental Influences on Accounting Practices

8. © 2001 Prentice Hall19-8 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

9. © 2001 Prentice Hall19-9 OptimismConservatism Greater caution in assessment Less public disclosure Secrecy Transparency Anglo-Saxon Nordic Asian colonial African Less developed Asian More developed Latin Japan Less developed Latin Near Eastern Germanic Cultural Differences in Measurement and Disclosure in Accounting Systems

10. © 2001 Prentice Hall19-10 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

11. © 2001 Prentice Hall19-11 Spain Belgium France Italy Tax-based Ireland United Kingdom New Zealand Australia United Kingdom- influenced Japan Germany Family Law-based Continental: government, tax legal Netherlands Business economics, theory Canada United States United States- influenced Pragmatic business practices, British origin Microbased Species Sweden Subclass Government, economics Class Macro-uniform Developed Western Countries Classification of Accounting Systems of Developed Western Countries

12. © 2001 Prentice Hall19-12 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

13. © 2001 Prentice Hall19-13 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

14. © 2001 Prentice Hall19-14 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

15. © 2001 Prentice Hall19-15 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

16. © 2001 Prentice Hall19-16 Functional currency Local currency Current-rate method Reporting currency of parent Temporal method Selection of Translation Method

17. © 2001 Prentice Hall19-17 Balance Sheet, December 31, 1999 TEMPORAL METHODCURRENT-RATE METHOD POUNDSRATEDOLLARSRATEDOLLARS Cash 20,000 1.6980 33,960 1.6980 33,960 Accounts receivable 40,000 1.6980 67,920 1.6980 67,920 Inventories 40,000 1.5606 62,424 1.6980 67,920 Fixed assets 100,000 1.5000 150,000 1.6980 169,800 Accumulated dep. (20,000) 1.5000 (30,000) 1.6980 (33,960) Total 180,000 284,304 305,640 Accounts payable 30,000 1.6980 50,940 1.6980 50,940 Long-term debt 44,000 1.6980 74,712 1.6980 74,712 Capital stock 60,000 1.5000 90,000 1.5000 90,000 Retained earnings 46,000 * 68,652 * 77,481 Accum. trans. adj. _____ ______ 12,507 Total 180,000 284,304 305,640

18. © 2001 Prentice Hall19-18 Income Statement, 1999 TEMPORAL METHODCURRENT-RATE METHOD POUNDSRATEDOLLARS RATEDOLLARS Sales 230,000 1.5617 359,191 1.5617 359,191 Expenses CGS (110,000) 1.5600 (171,600) 1.5617 (171,787) Depreciation (10,000) 1.5000 (15,000) 1.5617 (15,617) Other (80,000) 1.5617 (124,936) 1.5617 (124,936) Taxes (6,000) 1.5617 (9,370) 1.5617 (9,370) 24,000 8,285 37,481 Transl. gain (Loss) (9,633) Net income 24,000 28,562 37,481

19. © 2001 Prentice Hall19-19 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

20. © 2001 Prentice Hall19-20 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

21. © 2001 Prentice Hall19-21 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

22. © 2001 Prentice Hall19-22 Parent Company in the United States Grandchild Subsidiary Grandchild Subsidiary Tax-Haven Subsidiary Grandchild Subsidiary A Tax-Haven Subsidiary as a Holding Company

23. © 2001 Prentice Hall19-23 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

24. © 2001 Prentice Hall19-24 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 A Tax-Haven Subsidiary as a Holding Company

25. © 2001 Prentice Hall19-25 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

26. © 2001 Prentice Hall19-26 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

27. © 2001 Prentice Hall19-27 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