Accounting in the International Business

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

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Introduction

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Country Differences In Accounting Standards

A countrys 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

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Country Differences In Accounting Standards

Five main variables influence the development of a countrys 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 countrys economic development 5. the prevailing culture in a country

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Relationship Between Business And Providers Of Capital

The three main external sources of capital for firms are: Individual investors Banks Government

A countrys 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
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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

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Inflation Accounting
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 If inflation is high, assets will be undervalued

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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

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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 countrys accounting system Countries with low uncertainty avoidance cultures have strong independent auditing professions

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National And International Standards

Accounting standards are rules for preparing financial statementsthey define useful accounting information Auditing standards specify the rules for performing an auditthe 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

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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 The growth of transnational financing and transnational investment is promoting the growth of transnational financial reporting

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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
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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

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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 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 industrialized nations
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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 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

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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 (companygenerated forecast of future spot rates)

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