INTRODUCTION TOINTERNATIONAL ACCOUNTING

International Accounting, 5e Timothy Doupnik, Hector Perera

(Solutions Manual All Chapters)

• / 4

Chapter 01 - Introduction to International Accounting 1-1 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

CHAPTER 1

INTRODUCTION TOINTERNATIONAL ACCOUNTING

Chapter Outline

• International accounting is an extremely broad topic.
• At a minimum it focuses on the accounting issues unique to multinational corporations,

especially with respect to international transactions and foreign investments.

• At the other extreme it encompasses the study of the various functional areas of

accounting in all countries of the world, as well as the activities of a number of supranational organizations.

• This book provides an overview of the broadly defined area of international accounting,

including certain supranational guidelines, but focusing on the accounting issues related to international business activities and foreign investments. In other words, this book focuses on international accounting issues at the company level that are specifically relevant to multinational corporations.

II. There are several accounting issues encountered by companies involved in international trade.

• One issue is the accounting for foreign currency-denominated export sales and import

purchases.An important issue is how to account for changes in the value of the foreign currency-denominated account receivable (payable) that occur as exchange rates fluctuate.

• A related issue is the accounting for derivative financial instruments, such as forward

contracts and foreign currency options, used to hedge the foreign exchange risk associated with foreign currency transactions.

III. There is an even greater number of accounting issues encountered by companies that have made a direct investment in a foreign operation.These issues primarily result from the fact that accounting rules, tax laws, and other regulations differ across countries, and

include:

• Figuring out how to make sense of the financial statementsofa foreign acquisition

target prepared in accordance with an unfamiliar GAAP when making a foreign direct investment decision.

• Determining the correct amounts to include in consolidated financial statements for the

assets, liabilities, revenues, and expenses of foreign operations.The consolidation of a foreign subsidiary involves a two-step process: (1) restate foreign GAAP financial statements into parent company GAAP and (2) translate foreign currency amounts into parent company currency.Determining the appropriate translation method and deciding how to report the resulting translation adjustment are important questions.

• Complying with host country income tax laws, as well as home country tax laws related

to income earned in a foreign country (foreign source income).Double taxation of income is a potential problem, and foreign tax credits are the most important relief from this problem.

• Establishing prices for intercompany transactions that cross national borders

(international transfer prices) toachieve corporate objectives and at the same time comply with governmental regulations. 2 / 4

Chapter 01 - Introduction to International Accounting 1-2 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

• Evaluating the performance of both a foreign operating unit and its

management.Decisions must be made with respect to issues such as the currency in which a foreign operation should be evaluated and whether foreign management should be held responsible for items over which they have little control.

• Establishing an effective internal audit function to help maintain control over foreign

operations.Differences in culture, customs, and language must be taken into consideration.

• Deciding whether to cross-list securities on foreign stock exchanges, and complying

with local stock exchange regulations to do so.This could involve the preparation of financial information in accordance with a GAAP different from that used by the company.

IV. As companies have become more multinational, so have their external auditors.The Big 4 public accounting firms are among the most multinational business organizations in the world.

• Problems encountered by MNCs when confronted with different local GAAP in different

countries leads to the desire for a single set of global accounting standards.There would be significant advantages to MNCs if all countries used the same GAAP.

VI. The world economy is becoming increasingly more integrated.International trade (imports and exports) has grown substantially in recent years and has become a normal part of business for relatively small companies.The number of U.S. exporting companies has increased four-fold over the last three decades.

VII. The tremendous growth in foreign direct investment (FDI) over the last several decades is partially attributable to the liberalization of investment laws in many countries specifically aimed at attracting FDI.The aggregate revenues generated by foreign operations are more than twice as large as the revenues generated through exporting.

VIII. There were more than 82,000 multinational companies in the world in 2009 with810,000 foreign subsidiaries.The 100 largest multinationals generatedapproximately 4% of global GDP.A disproportionate number of multinational corporations are headquartered in the United States, China, Japan, and the European Union.

IX. According to one definition of multinationality used by the United Nations, nine of the ten most multinational companies in the world in 2016 were headquartered in Europe, including four companies based in the United Kingdom.

• In addition to establishing operations overseas, many companies also cross-list their

shares on stock exchanges outside of their home countries.There are a number of reasons for doing this including having access to a larger pool of capital.

• / 4

Chapter 01 - Introduction to International Accounting 1-3 Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Answers to Questions

• In 2016, companies worldwide exported over $15.9 trillion worth of merchandise. Although

international trade has existed for thousands of years, recent growth in trade has been phenomenal.Over the period 2006-2016, U.S. exports increased from $1,026 billion to $1,455 billion per year, a 42% increase.During the same period, Chinese exports more than doubled to $2,098 billion in 2016.

• Companies engaged in international trade with imports and exports denominated in foreign

currencies are faced with the accounting issue of translating foreign currency amounts into the company’s reporting currency and reporting the effects of changes in exchange rates in the financial statements. Many of these companies also engage in hedging activities to reduce the risk of changes in exchange rates.The accounting for derivative financial instruments used to hedge foreign exchange risk can be quite complicated.

• As listed in Exhibit1-1, following are several reasons why companies might want to invest

overseas:

 Increase sales and profits  Enter rapidly growing or emerging markets  Reduce costs  Gain an foothold in economic blocs  Protect domestic markets  Protect foreign markets  Acquire technological and managerial know-how

• FDI is playing a larger and more important role in the world economy.Global sales of foreign

affiliates were more than twice as large as global exports in 2016, compared to almost parity about three decades earlier.Global sales of foreign affiliates comprise about one half of worldwide gross domestic product.

• Financial reporting issues that result from foreign direct investment are (a) conversion of

foreign GAAP to parent company GAAP and (b) translation of foreign currency to parent company reporting currency to prepare consolidated financial statements.

• Two major taxation issues related to a foreign direct investment are (a) taxation of the

investee’s income by the host country in which the investment is located and (b) taxation of the investee’s income by the investor’s home country.Companies with foreign direct investments need to develop an expertise in the host country’s income tax rules, as well as in the home country’s tax rules with respect to foreign source income.

• Companies must make several decisions in designing the system for evaluating the

performance of foreign operations.Two of these are (a) deciding whether to evaluate performance on the basis of foreign currency or parent company reporting currency and (b) deciding whether to factor out of the performance measure those items over which the foreign operation’s managers have no control.

• Two reasons to have stock listed on the stock exchange of a foreign country are (a) to

obtain capital in that country, perhaps at a more reasonable cost than is available at home, and (b) to have an “acquisition currency” for acquiring firms in that country through stock swaps.

• / 4