dowling int business ppt chapter 18
TRANSCRIPT
Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a International Business by Dowling et al. 18-1
CHAPTER 18
Global accounting and international business
Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a International Business by Dowling et al.
Opening case – Adopting international accounting standards
• The opening case examines the trend toward a more harmonised international accounting system. The European Union has been especially active in promoting a more harmonised system, and now some 65 other countries have also adopted IASB standards.
• Where differences in accounting system prevail, comparability across borders is difficult.
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Discussion questions
What are the benefits of adopting international accounting standards for a) investors, and b) for business enterprises?
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Learning objectives
After you have read this chapter, you should:
• Be able to discuss the source of country differences in accounting standards.
• Be aware of the consequences of national differences in accounting standards.
• Understand the accounting implication of currency translation.
• Be able to explain how accounting systems impact upon control systems within the multinational enterprise.
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Introduction• Accounting is the language of business—it is the way
firms communicate their financial positions to the providers of capital, creditors and government.
• Accounting enables the providers of capital to assess the value of their investments or the security of their loans, and to make decisions about future resource allocations.
• Accounting standards differ from country to country, making 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.
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Figure 18.1 Accounting information and capital flows
Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a International Business by Dowling et al.
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 harmonise accounting practices across countries, significant differences remain.
• The differences make it challenges to compare financial performance of firms from different countries.
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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.
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Figure 18.2 Determinants of national accounting standards
Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a International Business by Dowling et al.
Relationship between business and providers of capital
• The three main external sources of capital for firms are:
– individual investors (through selling shares and bonds)
– banks (by acquiring loans)
– government (by acquiring loans for priority initiatives).
• A country’s accounting system reflects the relative importance of each constituency as a provider of capital.
• So, accounting systems in Australia and the U.K. are oriented toward individual investors; Switzerland, Germany and Japan focus on providing information to banks; and China, France and Sweden prepare financial documents with the government in mind.
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Political and economic ties with other countries
• Similarities in accounting systems across countries can reflect political or economic ties.
• The British accounting system influences the systems in former colonies of the British Commonwealth.
• The accounting practices in the U.S. Canada and Mexico show signs of convergence due to NAFTA.
• In the European Union, member countries are moving toward common standards.
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Price changes and inflation
• The historic cost principle assumes the currency unit used to report financial results is not losing its value due to inflation.
• This principle affects asset valuation most significantly.
• If inflation is high, assets will be undervalued.
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Level of development
• Developed nations tend to have more sophisticated capital markets, and hence accounting systems, than developing countries.
• Many developing nations have accounting systems that were inherited from former colonial powers.
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Culture
The extent to which a culture is characterised by:
power distance
individualism
uncertainty avoidance
masculinity,
is likely to have an impact on accounting systems because of the impact of these cultural dimensions accounting values.
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Culture
• For example, cultures with a high degree of individualism and lower uncertainty avoidance will tend to have a high value on professionalism (i.e. a preference for the exercise of individual professional judgment).
• Countries with a higher uncertainty avoidance orientation and higher power distance, such as Japan, will tend to prefer uniformity in accounting practices.
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National and international standards
• Accounting standards are the basis for preparing financial statements—they define what is useful accounting information.
• Auditing standards specify the criteria for performing an audit—the technical process by which an independent person (the auditor) gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable.
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Lack of comparability
• Because of national differences in accounting and auditing standards, comparability of financial reports from one country to another is difficult.
• However, the growth of global capital markets have spurred the growth of transnational financing and transnational investment activities.
• Thus, transnational financial reporting has attracted much interest in recent years, and the problem of the lack of comparability of accounting reports is changing.
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International standards
• There have been substantial efforts to harmonise 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 standardisation.
• The IASB develops a set of standards, but compliance is voluntary.
• By 2006, more than 100 nations adopted IASB standards or permitted their use in reporting financial results.
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International standards
• Most IASB standards are consistent with standards already in place in the United States articulated by the U.S. Financial Accounting Standards Board (FASB).
• The European Union has mandated harmonisation of accounting principles in its member countries.
• Because of the significant efforts towards harmonisation, major differences in accounting standards across countries may very well soon disappear.
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Different accounting standards – classroom question
Why do the accounting systems of different countries differ? Why do these differences matter?
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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 composed of a parent company and a number of subsidiary companies located in various countries typically issue consolidated financial statements.
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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 industrialised nations.
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Sample financial statements: parent company and subsidiary
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Sample balance sheets: parent company and subsidiary
Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a International Business by Dowling et al.
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.
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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.
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The temporal method
• The temporal method translates assets valued in a foreign currency into the home currency using the exchange rate that existed when the assets were 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.
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Current Australian practice
Standards pertaining to transactions affected by foreign exchange rate changes are covered in the Australian Accounting Standards Board’s AASB 121 (The effects of changes in foreign exchange rates):•These are consistent with IFRS.
•The company is required to translate a transaction done in a foreign currency into Australian dollars by applying the foreign currency-Australian dollar spot exchange rate at the date of the transaction.
•All monetary items need to be reflected in Australian dollars at the reporting date.
•This means that there will be some loss or gain that may arise from the currency translation.
•The company is required to reflect this profit or loss accordingly.
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Discussion question
When a firm uses the exchange rate at the balance sheet date to translate financial statements of a foreign subsidiary into the home currency, the firm is using:
A.the temporal method.
B.the current rate method.
C.AASB 121.
D.the historic cost principle.
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Discussion question
Financial statements of Australian firms must be prepared according to:
A.AASB.
B.IASB.
C.IFAC.
D.EUAC.
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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.
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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.
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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.
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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).
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Figure 18.3 Possible combinations of exchange rates in the control process
Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a International Business by Dowling et al.
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 minimise tax liability, minimise import duties, and avoid government restrictions on capital flows.
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Choice of transfer price: subsidiary company
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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.
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