International Business Chapter 19

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International BusinessChapter 19

• Multinational Accounting and Tax Function

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Introduction

• Accounting is defined as
• A service activity whose function is to provide
  quantitative information, primarily financial in
  nature about economic entities that is intended
  to be useful in making economic decisions in
  making reasoned choices among alternative courses
  of action.

Assets Liabilities Owners Equity
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Accounting Standards

• The Financial Accounting Standards Board (FASB)
  establishes accounting standards in the United
  States. The Accounting information should
  consist of
• Investment and credit decisions
• Assessment of cash flow prospects
• Evaluation of enterprise resources, claims to
  those resources, and changes in them

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Accounting Standards (cont.)

• The International Accounting Standards Committee
  (IASC) is an international private sector
  organization that sets accounting standards.
  They identify the major users of financial
  information as

• Investors
• Employees
• Lenders
• Suppliers

• Customers
• Government and their agencies
• Public

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Accounting Standards (cont.)

• Generally Accepted Accounting Principles (GAAP)
  are those standards established in each country
  that must be followed by companies in generating
  their financial statements.
• Counties differ on the level of secrecy and
  transparency in which companies are required to
  disclose financial information to the public.

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Cultural Differences

• Countries differ greatly on the degree of
  optimism vs. conservatism in valuing assets and
  recognizing income.
• German companies are very conservative
• British and U.S. companies are optimistic

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Cultural Differences (cont.)

• Major reporting issues faced by Multitnational
  firms include
• Differences in language and currency
• Types of statements
• Format of the financial statements
• Extent of footnote disclosures
• Underlying GAAP on which the financial statements
  are based

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Cultural Differences (cont.)

• Ways to deal with accounting and reporting
  differences
• Mutual recognition
• Reconciliation to local GAAP
• Recast financial statements in terms of local GAAP

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Harmonization

• Major forces leading to harmonization
• A movement to provide information compatible with
  the needs of investors
• The global integration of capital markets
• The need for MNEs to raise capital outside the
  home-country
• Regional political and economic harmonization

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Translation

• Translation is the process of restating
  foreign-currency financial statements
• FASB Statement No. 52 describes how companies
  must translate their foreign-currency financial
  statements into dollars
• All U.S. companies and those that are listed on a
  U.S. exchange must use Statement No. 52

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Translation (cont.)

• Translation is done by either of two methods
• depending on the function currency of the
  foreign operation
• Current-rate method
• Temporal method
• Functional currency is the currency of the
  primary economic environment in which the entity
  operates

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Translation (cont.)

• The Current-rate method is used when the local
  currency is the functional currency.
• Translate all assets and liabilities at the
  current exchange rate, which is the spot exchange
  rate on the balance sheet date
• All income items are translated at the average
  exchange rate
• Owners equity is translated at the rates in
  effect when the company issued capital stock and
  accumulated retained earnings

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Translation (cont.)

• The temporal method is used when the parents
  reporting currency is the functional currency
• Only monetary assets and liabilities are
  translated at the current exchange rate
• Inventory and property, plant, and equipment are
  translated at the historical exchange rates
• Most income statement accounts are translated at
  average exchange rates with the exception of cost
  of goods sold and depreciation, which are
  translated at the appropriate historical exchange
  rates

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Translation (cont.)

• A translation adjustment will need to be made
  due to the changes in exchange rates.
• With the current-rate method the translation gain
  or loss is recognized in owners equity
• With the temporal method the translation gain or
  loss is recognized in the income statement

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Taxes

• Taxes influence a companys profitability and
  cash flow therefore tax planning is a critical
  dimension for any business. Taxation can
  influence business decision in the following
  areas
• Location of the initial investment
• Choice of operating form
• Legal form of the new enterprise
• Method of financing
• Method of setting transfer prices

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Taxes (cont.)

• Companys should become familiar with the tax
  practices of the countries in which they operate
• Separate entity approach income is taxed when
  earned, both company and individual
• Integrated system dividend credit given to
  shareholders

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Taxes (cont.)

• Exporting companies seek to set up a Foreign
  Sales Corporation (FSC) to shelter some of its
  income from taxation. To qualify, a substantial
  economic activity must occur outside the United
  States.
• Maintain a foreign office
• Operate under foreign management
• Keep a permanent set of books at the foreign
  office
• Conduct foreign economic processes
• Be a foreign corporation

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Taxes (cont.)

• Tax strategies include
• Companies should set up branches in early years
  to recognize losses
• Companies should set up subsidiaries in later
  years to shield profits