Chapter 20

Accounting and Finance

in the International
Business
 What Is Accounting?
 Accounting is the language of business
 it is the way firms communicate their financial
positions
 Accounting is more complex for international
firms because of differences in accounting
standards from country to country
 differences make it difficult for investors, creditors,
and governments to evaluate firms
 It is difficult to compare financial reports from
country to country because of national
differences in accounting and auditing standards

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 What Determines National
Accounting Standards?
 Accounting standards are rules for preparing
financial statements
 variables influencing accounting systems include
 the relationship between business and the
providers of capital
 political and economic ties

 Auditing standards specify the rules for

performing an audit

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 Why Are International
Accounting Standards Important?
 The growth of transnational financing and
transnational investment has created a need for
transnational financial reporting
 many companies obtain capital from foreign providers
who are demanding greater consistency
 Standardization of accounting practices across
national borders is probably in the best interests
of the world economy
 The International Accounting Standards Board
(IASB) is a major proponent of standardization of
accounting standards

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 How Does Accounting
Influence 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
 Budgets and performance data are usually
expressed in the corporate currency

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 How Do Exchange Rates
Influence Control?
 The Lessard-Lorange Model -
 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 end of the
budget picture
3. The ending rate
 the spot exchange rate when the budget and
performance are being compared

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 What Is The
Lessard-Lorange Model?
Possible Combinations of Exchange Rates in the Control Process

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Transfer Pricing

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 Separation of Manager and
Subsidiary Performance
 Indicators of profitability
 Environments have widely different
economic, political, and social conditions,
all of which influence the costs of doing
business in a country and hence the
subsidiaries' profitability

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 What Is
Financial Management?
 Financial management involves
1. Investment decisions –what to finance
2. Financing decisions –how to finance those decisions
3. Money management decisions –how to manage the
firm’s financial resources most efficiently
 Decisions are more complex in international
business because of different currencies, tax
regimes, regulations on capital flows, economic
and political risk, etc.

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 How Do Managers Make
Investment Decisions?
 Financial managers must quantify the benefits,
costs, and risks associated with an investment in
a foreign country
 To do this, managers use capital budgeting
 involves estimating the cash flows associated with the
project over time, and then discounting them to
determine their net present value
 If the net present value of the discounted cash
flows is greater than zero, the firm should go
ahead with the project

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 Why Is Capital Budgeting More
Difficult For International Firms?
 Capital budgeting is more complicated in
international business
because a distinction must be made between
cash flows to the project and cash flows to the
parent company
because of political and economic risk
because the connection between cash flows
to the parent and the source of financing must
be recognized

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 How Does Risk Influence
Investment Decisions?
 Political risk - the likelihood that political forces will
cause drastic changes in a country’s business
environment that hurt the profit and other goals of
a business
 higher in countries with social unrest or disorder, or
where the nature of the society increases the chance
for social unrest
 Example, Tax rates, Political/social unrest, Price
controls, govt interference in contracts, Outright or
defacto expropriation of assets etc
 Country risk rating eg by Euromoney
 Many political risks cannot be foreseen at all

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 Economic risk - the likelihood that
economic mismanagement will cause
drastic changes in a country’s business
environment that hurt the profit and other
goals of a business
 Eg inflation

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 How Can Firms Adjust For
Political And Economic Risk?
 Firms analyzing foreign investment
opportunities can adjust for risk
1. By raising the discount rate in countries
where political and economic risk is high
2. By lowering future cash flow estimates to
account for adverse political or economic
changes that could occur in the future

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 How Do Firms Make
Financing Decisions?
 Firms must consider two factors
1. How the foreign investment will be
financed
2. How the financial structure (debt vs.
equity) of the foreign affiliate should be
configured
 Most experts suggest that firms adopt
the structure that minimizes the cost of
capital, whatever that may be

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 What Is Global
Money Management?
 Money management decisions attempt to manage
global cash resources efficiently
 Firms need to
1. Minimize cash balances - need cash balances on hand
for payables and unexpected demands
Pooling has 3 benefits:
 Greater funds (eg Overnight money market account
balances)
 Greater access to information about investment
options
 Reduction of total size of cash pool

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1. Reduce transaction costs - the cost of
exchange (transaction fee and transfer
fee)
 Bilateral netting and multinational netting

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 How Can Firms Limit
Their Tax Liability?
 Every country has its own tax policies
 most countries feel they have the right to tax
the foreign-earned income of companies
based in the country
 Double taxation occurs when the income
of a foreign subsidiary is taxed by the
host-country government and by the
home-country government

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 How Can Firms Limit
Their Tax Liability?
 Taxes can be minimized through
1. Tax credits - allow the firm to reduce the taxes paid to
the home government by the amount of taxes paid to
the foreign government
2. Tax treaties - agreement specifying what items of
income will be taxed by the authorities of the country
where the income is earned
3. Deferral principle - specifies that parent companies
are not taxed on foreign source income until they
actually receive a dividend
4. Tax havens - countries with a very low, or no, income
tax – firms can avoid income taxes by establishing a
wholly-owned, non-operating subsidiary in the country

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 How Do Firms Move
Money Across Borders?
 Firms can transfer liquid funds across border via
1. Dividend remittances - the most common
method of transferring funds from subsidiaries
to the parent
2. Royalty payments and fees -the remuneration
paid to the owners of technology, patents, or
trade names for the use of that technology or
the right to manufacture and/or sell products
under those patents or trade names; Fees for
professional services, expertise, or advice.
They are tax deductible.

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 How Do Firms Move
Money Across Borders?
3. Transfer prices -the price at which goods and
services are transferred between entities within the
firm
a) To gain tax benefit
b) Move out of the country where currency
devaluation is expected
c) when financial transfers in the form of dividends are
restricted or blocked by host-country government
policies
d) To reduce the import duties by charging low
transfer price of goods being imported

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 Fronting loans -loans between a parent
and its subsidiary channeled through a
financial intermediary, usually a large
international bank
 fronting loans can circumvent host country
restrictions on the remittance of funds from
a foreign subsidiary to the parent
company.

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