Ch14 International Issues 2

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International International Issues in Issues in

Managerial Managerial AccountingAccounting

CHAPTERCHAPTER

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1. Explain the role of the management accountant in the international environment.

2. Identify the varying levels of involvement that firms can undertake in international trade.

3. List the ways management accountants can manage foreign currency risk.

4. Explain why multinational firms choose to decentralize.

ObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

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5. Describe how environmental factors can affect performance evaluation in the multinational firm.

6. Discuss the role of transfer pricing in the multinational firm.

7. Discuss ethical issues that affect firms operating in the international environment.

ObjectivesObjectives

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Where does the management accountant

fit into the global business environment?

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Business looks to the management accountant

for international financial and business

expertise.

14 -6 Management Accounting in the International Environment

Skills needed by management accountants

Politics Economics Marketing Management Information Systems

Technology

14 -7 Multinational Corporation (MNC)

A multinational corporation (MNC)

is one that “does business in more

than one country in such a volume that its well-being and

growth rest in more than one country.”

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Importing and ExportingImporting and Exporting

Importing is the process of bringing product in from a foreign country.

Exporting is the process of shipping product to a foreign country.

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Foreign trade zones are areas near a customs port of entry that are

physically on U.S. soil but considered to be

outside U.S. commerce.

Foreign Trade ZonesForeign Trade Zones

Example:

San Antonio

Example:

New Orleans

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Example of the Advantages of Operating a Plant in a Foreign Trade Zone

Roadrunner, Inc. operates a petrochemical plant in a

foreign trade zone. Wilycoyote, Inc. operates an identical plant just outside

the foreign trade zone. Both plants purchase $400,000 of crude oil from Venezuela.

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Roadrunner WilycoyoteDuty paid at purchase $ 0 $24,000Carrying costs of duty 0 1,920

Wilycoyote Wilycoyote pays duty at pays duty at the point of the point of

purchase (6% purchase (6% of $400,000).of $400,000).

Total duty-Total duty-related related

carrying costs carrying costs (0.12 x 8/12 x (0.12 x 8/12 x

$24,000)$24,000)

Duty paid at sale 16,800 0

Roadrunner pays Roadrunner pays duty at point of sale duty at point of sale

because it is in a because it is in a foreign trade zone.foreign trade zone.

Example (continued)

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Roadrunner WilycoyoteDuty paid at purchase $ 0 $24,000Carrying costs of duty 0 1,920Duty paid at sale 16,800 0

Example (continued)

Total duty and duty- related costs $16,800 $25,920

Clearly the Clearly the advantage advantage approachapproach

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A company may choose to purchase an existing foreign company, making

the purchased company a wholly owned subsidiary.

If the laws of the country permit, an multinational corporation can simply set up a wholly owned subsidiary or

branch office in the country.

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Outsourcing of technical and professional jobs is becoming an important issue for cost-

conscious U.S. firms.

Outsourcing is the payment by a company for a business

function formerly done in-house, such as payment for legal needs to outside firms.

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A joint venture is a type of partnership in which investors co-own the

enterprise. A special case of joint venture

cooperation is the maquiladora—a

manufacturing plant located in Mexico which

processes imported materials and reexports

them to the United States.

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Foreign Currency Exchange

Currency risk management Transaction risk Economic risk Translation (accounting ) risk

Kinds of risks:

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A Transaction Risk ExampleA Transaction Risk ExampleSuperTubs, Inc., a U.S. firm, sells its line of whirlpool tubs to Bonbain, a French distributor. On January 15, Bonbain orders 100 tubs at $1,000 per tub to be paid with French francs on March 15. The exchange rate on on January 15 is seven francs per dollar or 700,000 francs. Suppose that on March 15 the exchange rate is 7.1 francs per dollar. A $1,408 loss is experienced by SuperTubs, Inc.

Receivable in dollars on Jan. 15

$100,000Received in dollars on March 15

(700,000/7.1)

98,592 Exchange loss

$ 1,408

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One way of insuring against gains and losses

on foreign currency exchanges is hedging.

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Economic risk is the impact of exchange rate fluctuations on the present

value of a firm’s future cash flows.

Managing Economic RiskManaging Economic Risk

ExampleA U.S. consumer can choose to purchase heavy

equipment from either Caterpillar (U.S.) or Komatsu (Japan). A piece of equipment is $80,000 from either maker. At an exchange rate of $1 equals 130 yens, the

price is set. Assume the dollar strengthens so the exchange rate becomes $1 equals 140 yens. This

lowers Katmatsu’s price to $74,286.

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Managing Translation RiskManaging Translation Risk

ExampleMultinational, Inc., has a foreign division, FD, which has been experiencing eroding sales. Multinational

directs FD managers to increase marketing expenditures over the following four quarters:

Quarter Expenditures in Local Currency

1 LC10,0002 LC11,0003 LC12,1004 LC13,310

A 10% increase

each quarter

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Managing Translation RiskManaging Translation Risk

Example (continued)Suppose that the dollar has strengthened against

the local currency and the quarterly exchange rates of $1 for units of local currency are 1.00,

1.2, 1.35, and 1.50, respectively. Quarter Expenditures in Local Currency

1 $10,0002 9,1673 8,9634 8,873

It looks like FD has decreased expenditures.

14 -22 Advantages of Decentralizationin the MNC

The quality of information is better at the local level.

Local managers in the MNC are capable of a more timely response in decision making.

Social, legal, and language barriers are minimized.

Valuable training grounds for foreign subsidiary managers.

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Measuring Performance in the Multinational Firm

It is particularly difficult to compare the

performance of a manager of a division in one

country with the performance of a manager

of a division in another country.

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An example of misleading results:Assets Revenues Net Income Margin Turnover ROI

Brazil $10 $ 6 $ 3 0.50 0.600.30

Canada 18 13 10 0.77 0.720.55

Spain 1510 6 0.60 0.67 0.40Analysis: On the basis of ROI, it appears that the manager of the Canadian subsidiary did the best job, while the manager of the Brazilian subsidiary did the worst job. However, the inflation rate in Brazil was 100% for the year. After adjusting the asset base for inflation, the ROI would be 60% for the Brazilian manager.

Measuring Performance in the Multinational Firm

14 -25 Environmental Factors Affecting Performance Evaluation in the MNC

Economic Factors:Organization of central banking system

Economic stability

Existence of capital markets

Currency restrictions

Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

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Political and Legal Factors:

Quality, efficiency, and effectiveness of legal structure

Effect of defense policy

Impact of foreign policy

Level of political unrest

Degree of governmental control of business

Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

Environmental Factors Affecting Performance Evaluation in the MNC

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Educational Factors:

Literacy rate

Extent and degree of formal education and training systems

Extent and degree of technical training

Extent and quality of management development programs

Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

Environmental Factors Affecting Performance Evaluation in the MNC

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Sociological Factors:

Social attitude toward industry and business

Cultural attitude toward authority and persons in subordinate positions

Cultural attitude toward productivity and achievement (work ethic)

Social attitude toward material gain

Cultural and racial diversity

Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

Environmental Factors Affecting Performance Evaluation in the MNC

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Action Tax Impact Action Tax Impact

Belgian subsidiary of parent 42% tax ratecompany produces a component $100 revenue – $100 at a cost of $100 per unit. Title to cost = $0the component is transferred to a Taxes paid = $0reinvoicing center in Puerto Ricoat a transfer price of $100 per unit.

Income Taxes and Income Taxes and Transfer PricingTransfer Pricing

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Action Tax Impact Action Tax Impact

Reinvoicing center in Puerto Rico, 0% tax ratealso a subsidiary of parent company $200 revenue – $100 transfers title of component to U.S. cost = $100subsidiary of parent company at a Taxes paid = $0transfer price of $200 per unit.

Income Taxes and Income Taxes and Transfer PricingTransfer Pricing

Action Tax Impact Action Tax Impact

U.S. subsidiary sells a component 35% tax rateto external company at $200 each. $200 revenue – $200

cost = $0Taxes paid = $0

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Comparable uncontrolled price method

Resale price method

Cost-plus method

The IRS allows three pricing methods that approximate

arm’s-length pricing (shown in the order of preference):

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Questions to Ask Concerning Ethics in the International Environment

Is the action right legally?

Is the action right morally?

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The EndThe End

Chapter FourteenChapter Fourteen