1. Accounting in the International Business
Chapter 19
Accounting in the International Business

2. Introduction
Accounting is the language of business – it is the way firms communicate their financial positions
Accounting standards differ from country to country
These differences make it difficult for investors, creditors, and governments to evaluate firms
The International Accounting Standards Board (IASB) has made some attempts to establish common accounting and auditing standards across countries

3. Introduction
Figure 19.1

4. Country Differences In Accounting Standards
A country’s accounting system evolves in response to local demands for accounting information
While there have been efforts to harmonize accounting practices across countries, significant differences remain
One study found that among 22 countries, there were 76 ways to assess the cost of goods sold, 65 differences in the calculation of return on assets, and 20 ways to calculate net profits
The differences make it challenges to compare financial performance of firms from different countries

5. Country Differences In Accounting Standards
Five main variables influence the development of a country’s accounting system:
1. the relationship between business and the providers of capital
2. political and economic ties with other countries
3. the level of inflation
4. the level of a country’s economic development
5. the prevailing culture in a country

6. Country Differences In Accounting Standards
Figure 19.2

7. Relationship Between Business And Providers Of Capital
The three main external sources of capital for firms are:
Individual investors
Banks
Government
A country’s accounting system reflects the relative importance of each constituency as a provider of capital
So, accounting systems in the U.S. and Great Britain are oriented toward individual investors; Switzerland, Germany, and Japan focus on providing information to banks; and France and Sweden prepare financial documents with the government in mind
Three external sources of capital:
Individual investors
Buying shares and bonds
Banks
Loan capital
Government
Make loans or investment

8. Political And Economic Ties With Other Nations
Similarities in accounting systems across countries can reflect political or economic ties
The U.S. accounting system influences the systems in Canada and Mexico
In the European Union, countries are moving toward common standards

9. Inflation Accounting
The historic cost principal assumes the currency unit used to report financial results is not losing its value due to inflation
This principle affects asset valuation
If inflation is high, assets will be undervalued

10. Level Of Development
Developed nations tend to have more sophisticated accounting systems than developing countries
Many developing nations have accounting systems that were inherited from former colonial powers

11. Culture
The extent to which a culture is characterized by uncertainty avoidance (the extent to which cultures socialize their members to accept ambiguous situations and tolerate uncertainty) impacts the country’s accounting system
Countries with low uncertainty avoidance cultures have strong independent auditing professions

12. National And International Standards
Accounting standards are rules for preparing financial statements—they define useful accounting information
Auditing standards specify the rules for performing an audit—the technical process by which an independent person gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable
Management Focus: The Consequences Of Different Accounting Standards
Summary
This feature explores the consequences of different accounting standards. When firms from different countries merge, their accounting systems also merge. This can be a complicated process! Discussion of the feature can revolve around the following questions:
1. What do differences in accounting standards mean for companies? Use examples from the feature to illustrate your response. How should companies communicate with investors about the differences?
Discussion Points: Most students will quickly realize the complexities involved in merging accounting systems from different countries. Educating investors on the implications of the differences could be crucial to the success of the merger. Many students will probably recommend that firms communicate directly with existing shareholders via direct mail, and with potential shareholders through the media.
2. Consider the challenges involved in merging accounting departments from different countries. What problems might occur? What are some of the decisions that will have to be made?
Discussion Points: Merging companies from different countries can be challenging even when they have similar corporate cultures, strategies, and so on. One area that can be especially difficult to bring together is the accounting department. Accountants are trained to prepare financial documents according to the system that prevails in that country. As the feature clearly illustrates, the accounting system used in one country can be very different from the accounting system used in another. Companies will have to decide which system to follow, and where it should be followed. In addition, firms will have decide how to handle accounting personnel.

13. Lack Of Comparability
Because of national differences in accounting and auditing standards, comparability of financial reports from one country to another is difficult
The growth of transnational financing and transnational investment is promoting the growth of transnational financial reporting

14. International Standards
There has been a substantial effort recently to harmonize accounting standards across countries
Many companies obtain capital from foreign providers who are demanding greater consistency
Common accounting standards will facilitate the development of global capital markets
The International Accounting Standards Board (IASB) is a major proponent of standardization
The IASB currently has 45 standards, but compliance is voluntary
About 100 nations have adopted IASB standards or permitted their use in reporting financial results

15. International Standards
Most IASB standards are consistent with standards already in place in the United States
The European Union has mandated harmonization of accounting principles in its member countries
By 2010, there could be only two major accounting bodies with substantial influence on global reporting – FASB in the United States and IASB elsewhere
Management Focus: Novartis Joins the International Accounting Club
Summary
This feature explores the pressure felt by Swiss firms to adopt international accounting standards. Switzerland’s accounting system has been criticized for obscuring as much as it revealed, and foreign investors have been pushing for better information. Discussion of the feature can revolve around the following questions:
1. Why did Ciba move to adopt IASC guidelines? What did the company hope to achieve with this move? In your opinion, was it successful?
Discussion Points: Ciba, Switzerland’s largest pharmaceuticals and chemicals firm, now called Novartis, announced that in 1994, its financial statements would be prepared according to IASC guidelines. The company made the decision in an effort to respond to foreign stockholders, and to open the door to the possibility of listing on the New York and London stick exchanges.
2. Reflect on the implications of Ciba’s decision to adopt IASC standards. What does this decision mean to other Swiss companies?
Discussion Points: Many students will probably focus on the additional pressure Ciba’s decision will put on other Swiss firms to also adopt IASC guidelines. Other students might also point out that Ciba’s decision, if it is followed by other companies, will help the push towards a more harmonized international accounting system.
Another Perspective: For additional information on Novartis’ accounting system, go to the company web site at { and click on Investors. Ciba’s website is {

16. Multinational Consolidation And Currency Translation
A consolidated financial statement combines the separate financial statements of two or more companies to yield a single set of financial statements as if the individual companies were really one
Multinational firms typically issue consolidated financial statements

17. Consolidated Financial Statements
The typical multinational company is made up of a parent company and a number of subsidiary companies
Economically, all the companies are interdependent
The consolidated financial statement provides accounting information about the group of companies
Transactions among members of a corporate family are not included in consolidated financial statements, however, because separate legal entities are required to keep their own accounting records they record transactions with other members of the corporate family in separate statements
The IASB requires firms to prepare consolidated financial statements, as do most industrialized nations

18. Currency Translation
Foreign subsidiaries usually keep accounting records and prepare financial statements in the local currency
To prepare consolidated financial statements, all local financial statements must be converted to the home currency
There are two methods to determine what exchange rate should be used when translating financial statement currencies:
1. the current rate method
2. the temporal method

19. The Current Rate Method
Under the current rate method, the exchange rate at the balance sheet date is used to translate the financial statements of a foreign subsidiary into the home currency of the multinational firm
The current rate method is incompatible with the historic cost principle

20. The Temporal Method
The temporal method translates assets valued in a foreign currency into the home currency using the exchange rate that exists when assets are purchased
So, while the temporal method avoids the problems associated with the current rate method, it is still problematic because different exchange rates are used to translate foreign assets

21. Current U.S. Practice
U.S. multinationals are required to follow FASB 52 which states:
the functional currency is the local currency of each self-sustaining foreign subsidiary
balance sheets should be translated into the home currency using the exchange rate in effect at the end of the firm’s financial year
income statements are translated using the average exchange rate for the firm’s financial year
Statement 52 “Foreign Currency Translation”
Self-sustaining autonomous subsidiary:
Functional currency is local currency
Balance sheet uses exchange rate at
end of financial year
Income statement is financial year average
Integral subsidiary:
Functional currency is US currency
Financial statements use the
temporal method
Dangling credit or debit increases or
Decreases consolidated earnings
for the period

22. Accounting Aspects Of Control Systems
The control process in most firms is usually conducted annually and involves three steps:
1. subunit goals are jointly determined by the head office and subunit management
2. the head office monitors subunit performance throughout the year
3. the head office intervenes if the subsidiary fails to achieve its goal, and takes corrective actions if necessary
Two factors that can complicate the control process are exchange rate changes and transfer pricing practices

23. Exchange Rate Changes And Control Systems
Most international firms require budgets and performance data to be expressed in the corporate currency-normally the home currency
While this facilitates comparisons between subsidiaries, it can also create distortions in financial statements

24. The Lessard-Lorange Model
Donald Lessard and Peter Lorange suggest that firms can deal with the problems of exchange rates and control in three ways:
1. the initial rate - the spot exchange rate when the budget is adopted
2. the projected rate - the spot exchange rate forecast for the ends of the budget picture
3. the ending rate - the spot exchange rate when the budget and performance are being compared

25. The Lessard-Lorange Model
Figure 19.3

26. The Lessard-Lorange Model
Lorange and Lessard suggest that firms use the projected spot exchange rate (usually the forward exchange rate) to translate budget and performance figures into the corporate currency
Firms can also use the internal forward rate (company-generated forecast of future spot rates)

27. Transfer Pricing And Control Systems
The price at which goods and services transferred within the firm is the transfer price
The choice of transfer price can significantly influence the performance of subsidiaries
Transfer prices should be considered when evaluating a subsidiary’s performance
Companies can manipulate transfer prices to minimize tax liability, minimize import duties, and avoid government restrictions on capital flows

28. Separation Of Subsidiary And Manager Performance
The evaluation of a subsidiary should be kept separate from the evaluation of its manager
A manager’s evaluation should consider the country’s environment for business, and should take place after making allowances for those items over which managers have no control