Chapter 1

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 1

Introduction to International Accounting

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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)

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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

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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

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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

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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

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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

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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

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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

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International Transactions, FDI and Related Accounting Issues

Hedging

Joe can hedge (i.e., protect itself) against a loss

from an exchange rate fluctuation. Hedging can

be accomplished by various means, including:

Foreign currency option – the right (but not the

obligation) to purchase foreign currency at a

specific exchange rate for a specified period of

time.

Learning Objective 2

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International Transactions, FDI and Related Accounting Issues

Hedging

Forward contract – this is an obligation to

exchange foreign currency at a date in the future,

typically 30, 60 or 90 days.

Learning Objective 2

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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

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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

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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

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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

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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

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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

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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

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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)

Learning Objective 3

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Cross-listing on Foreign Stock Exchanges

MNEs 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

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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

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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

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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

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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

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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