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Chapter 1 _Introduction to International Accounting
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McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 1
Introduction to International Accounting
1-2
Introduction to International Accounting
Learning Objectives
1. Understand the nature and scope of international accounting
2. Describe accounting issues created by international trade
3. Explain reasons for, and accounting issues associated with, foreign direct investment (FDI)
1-3
Introduction to International Accounting
Learning Objectives
4. Describe the practice of cross-listing on foreign stock exchanges
5. Explain the notion of international harmonization of accounting standards
6. Examine the importance of international trade, FDI, and multinational enterprises (MNEs) in the global economy
1-4
What is International Accounting?
International Accounting can be described at three different levels: The influence on accounting by international
political groups such as the OECD, UN, etc. The accounting practices of companies in
response to their own international business activities
The differences in accounting standards and practices between countries.
Learning Objective 1
1-5
What is International Accounting?
Domestic accounting: an information system providing information about a firm to users of that information as a basis for economic decisions.
International accounting (defined): same as above except that the firm being reported on is a multinational company with operations and transactions that cross national boundaries or an entity with reporting obligations to non-domestic readers.
1-6
International Transactions, FDI and Related Accounting Issues
Sale to foreign customer Most companies’ first encounter with
international business occurs as sales to foreign customers.
Often, the sale is made on credit and it is agreed that the foreign customer will pay in its own currency (e.g., Mexican pesos).
Learning Objective 2
1-7
International Transactions, FDI and Related Accounting Issues
Sale to foreign customer
This gives rise to foreign exchange risk as the
value of the foreign currency is likely to change in
relation to the company’s home country currency
(e.g., U.S dollars).
Learning Objective 2
1-8
International Transactions, FDI and Related Accounting Issues
Sale to foreign customer
Suppose that on February 1, 2006, Joe Inc., a U.S.
company, makes a sale and ships goods to Jose,
SA, a Mexican customer, for $100,000 (U.S.).
However, it is agreed that Jose will pay in pesos
on March 2, 2006. The exchange (spot) rate as of
February 1, 2006 is 10.00 pesos per U.S. dollar.
How many pesos does Jose agree to pay?
Learning Objective 2
1-9
International Transactions, FDI and Related Accounting Issues
Sale to foreign customerEven though Jose SA agrees to pay 1,000,000 pesos ($100,000 x 10.00 pesos/U.S. $), Joe, Inc. records the sale (in U.S. dollars) on February 1, 2006 as follows:Dr. Accounts receivable (+) 100,000
Cr. Sales revenue (+) 100,000
Learning Objective 2
1-10
International Transactions, FDI and Related Accounting Issues
Sale to foreign customerSuppose that on March 2, 2006, the spot rate for pesos is 11 pesos/U.S. $). Joe Inc. will receive 1,000,000 pesos, which are now worth $90,909. Joe makes the following journal entry:Dr. Cash (+) 90,909Dr. Loss on foreign exchange (+) 9,091
Cr. Accounts receivable 100,000
Learning Objective 2
1-11
International Transactions, FDI and Related Accounting Issues
Foreign Direct Investment (FDI) – occurs when a
company invests in a business operation in a
foreign country.
This represents an alternative to importing to customers and/or exporting from suppliers
in a foreign country.
Two types of FDI are Greenfield investment and acquisition.
Learning Objective 3
1-12
International Transactions, FDI and Related Accounting Issues
Foreign Direct Investment (FDI)
Greenfield investment – the establishment of a
new operation in the foreign country
Acquisition – investment in an existing operation
in the foreign country.
Learning Objective 3
1-13
International Transactions, FDI and Related Accounting Issues
FDI creates two primary issues: The need to convert from local to U.S. GAAP
since accounting records are usually prepared using local GAAP.
The need to translate from local currency to U.S. dollars since accounting records are usually prepared using local currency.
Learning Objective 3
1-14
International Income Taxation
Foreign income taxes –the foreign government will tax the company’s profits at applicable rates.
U.S. income taxes – the U.S. will tax the
company’s foreign-based income.
Learning Objective 3
1-15
International Transfer Pricing
Transfer pricing – setting prices on goods and services exchanged between separate divisions within the same firm. These prices have a direct impact on the profits of the different divisions.
Learning Objective 3
1-16
International Transfer Pricing
These exchanges are not arms-length
transactions, thus giving rise to the certain
problems in an international context:
Taxation – governments in the various countries
often scrutinize transactions to assure that
sufficient profits are being recorded in that country.
Learning Objective 3
1-17
International Transfer Pricing
Performance evaluation issues – to the extent that division managers are evaluated based on divisional profits, transfer prices influence division manager performance evaluation.
Learning Objective 3
1-18
International Auditing
Both internal and external auditors encounter
differences that arise between auditing in an
international vs. domestic context. These
include: Language and cultural differences Different accounting standards (GAAP) and
auditing standards (GAAS) Generally Accepted Auditing Standards
Learning Objective 3
1-19
Cross-listing on Foreign Stock Exchanges
MNEs (Multinational enterprises ) frequently raise capital outside their home country. When a company offers its shares on an exchange outside of its home country, this is referred to as Cross-Listing.
Learning Objective 4
1-20
International Harmonization of Accounting Standards
The international movement towards a single set of worldwide accounting rules is referred to as Harmonization.
International Accounting Standards (IAS) and U.S. GAAP are currently the two most important sets of accounting
rules.
Learning Objective 5
1-21
International Harmonization of Accounting Standards
The Norwalk Agreement Published in 2002. Is a promise of cooperation in standard-setting
between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB).
Represents a significant step toward international harmonization.
Learning Objective 5
1-22
The Global Economy
Several indicators demonstrate the extent of
business globalization: International trade – In 2001 exports worldwide
topped $6 trillion. Between 1987 and 1999, U.S. exporters increased by 233% in number.
Foreign Direct Investment – Between 1982 and 1999 worldwide FDI inflows increased from $58 billion to $865 billion.
Learning Objective 6
1-23
The Global Economy
Several indicators demonstrate the extent of
business globalization: Multinational enterprises (MNEs) –
Companies that have headquarters in one country and operate in one or more other countries. Currently, MNEs account for over one-quarter of the world’s Gross Domestic Product (GDP).
Learning Objective 6
1-24
The Global Economy
Several indicators demonstrate the extent of
business globalization: International capital markets – In 2001 there
were 462 companies representing 53 countries cross-listed on the New York Stock Exchange (NYSE). In addition, over 60 U.S. companies are cross-listed on foreign exchanges…
Learning Objective 6