MODULE 10

Accounting in International Business

Accounting information and capital flows

Need for Accounting Information

• Enables providers of capital to – access the value of their investment – Access security of their loan– Make decisions about future resource allocation

• Tax assessment• Performance evaluation of the firm• Control internal expenditure• Planning for future expenditure and income

Determinants of national accounting standards

Relationship between business and providers of capital

• Three external sources of capital:– Individual investors• Buying shares and bonds

– Banks.• Loan capital

– Government• Make loans or investment

Relationship between business and providers of capital : Individual investors

• E.g in US and UK – individual investors and major source of capital– stock and bond market – purchase small proportion of stocks and bonds– No desire to be involved in day to day

management of firms– Lack the ability to get information on demand

from management– Financial accounting system provide information

required by small investors to make decisions

Relationship between business and providers of capital : Banks.

• E.g Switzerland, Germany and Japan– Banks satisfy most of capital needs– Bank officials on board of firms – Information need satisfied through personal

contacts, direct visit, board meetings– Reports for public disclosure of financial

information– Assets and valued conservatively, and liabilities

are overvalued to provide cushion for banks

Relationship between business and providers of capital : Government

• E.g France and Sweden– Government major providers of capital– Financial information oriented towards need of

government planners

Political and economic ties with other countries

• Accounting convergence due to close political and economic ties between countries– US system influenced accounting practices in

Canada and Mexico : NAFTA– Former colonies of British Empire follow British

system– European Union attempting to harmonize

accounting practices in its member countries

Inflation accounting

• Historic cost principle:– Assumes currency is not losing value to inflation– Most significant impact in the area of asset

valuation• Current cost accounting:– Factors out inflation – Used in Great Britain until inflation rate

declined

Level of development

• Developed countries have more sophisticated accounting procedures– Accounting problems are more complex– Sophisticated capital markets– Lenders require comprehensive reports– Educated workforce can perform complex

accounting functions

Culture

• Hofstede’s uncertainty avoidance has an impact on accounting systems– Low uncertainty avoidance - these countries tend

to have strong independent auditing professions that ensure a firm’s compliance with rules

Accounting clusters

• Few countries have identical accounting systems.

• Similarities exist in clusters

British-American-Dutch GroupFirms raise capital from investors. Accounting systems designed to inform investors

Have close ties to banks. Accounting practices meet bank’s needs.

South American Group

Countries have experienced persistent and rapid inflation.

Accounting principles reflect the inflation.

Accounting clusters

Europe-Japan Group

National and international standards

• Diverse accounting practices are enshrined in national accounting and auditing standards

• Accounting standards: Rules for preparing financial statements

• Auditing standards: Specify rules for performing an audit

Lack of comparability

• One result of national differences in auditing and accounting standards is lack of comparability of financial reports– Dutch – current values for replacement assets –

Japan – prescribes historic cost– Germany – depreciation is liability, Britain –

depreciation is deducted from assets

Lack of comparability

• With growth of global capital markets both transnational financing and transnational investment have grown

• Firm has to explain to investors why its financial position looks different in two accountings

International standards

• Efforts to harmonize accounting standards across countries

• Formation of International Accounting Standards Board in March 2001

• Members represent 79 countries• Responsible for formulating international accounting

standards (IAS)• Has issued over 30 IAS– Difficult to get requisite votes– Voluntary compliance

• Recognition is growing

Accounting aspects of control systems

• Annual control process involves three steps:– Head office and subunit management jointly

determine subunit goals for the coming year.– Throughout year, head office monitors subunit

performance against agreed goals.– If subunit fails to achieve goals, head office

intervenes to determine why the shortfall occurred, taking corrective action when appropriate.

Exchange rate combinations in the control process

Fig19.3

Accounting aspects of control systems

• Lessard- Lorange Model:– Three exchange rates used to translate foreign

currency into corporate currency for budget and performance purposes.• The initial rate, the spot exchange rate when the

budget is adopted.• The projected rate, the spot exchange forecast for

the end of budget period (i.e., the forward rate)• The ending rate, the spot exchange rate when the

budget and performance are being compared.

Transfer pricing and control systems

• Transfer prices introduce significant distortions into the control process

• Transfer price must be taken into account when setting budgets and evaluating a subsidiary’s performance.

Separation of subsidiary and manager performance

• Valuation of a subsidiary should be separate from the evaluation of the subsidiary manager

• Manager’s evaluation should take into consideration how hostile or benign the countries environment is for business and make allowances over items the manager has no control e.g. inflation rates, interest rates exchange rates