78.
Which of the following is a disadvantage of pursuing a transfer pricing
policy?
A.
It is not useful in shifting earnings from a high-tax country to a low-tax
one.
B.
Transfer pricing does not treat each subsidiary as a profit center.
C.
It is not effective when significant currency devaluation is expected.
D.
A transfer price policy cannot be used to move funds when dividends are
restricted.
Another problem associated with transfer pricing is related to management
incentives and performance evaluation. Transfer pricing is inconsistent with
a policy of treating each subsidiary in the firm as a profit center.
79.
A _____ is a loan between a parent and its subsidiary channeled through a
financial intermediary, usually a large international bank.
A.
fronting loan
B.
equity loan
C.
direct loan
D.
security loan
A fronting loan is a loan between a parent and its subsidiary channeled
through a financial intermediary, usually a large international bank.
80.
Firms use fronting loans to _____.
A.
avoid host-country restrictions on the remittance of funds from a foreign
subsidiary
B.
implement a cost-based and fair pricing policy across an international
business
C.
increase the profit center revenue of a subsidiary functioning in another
country
D.
implement a market-driven and fair pricing policy across an international
business
Fronting loans can circumvent host-country restrictions on the remittance
of funds from a foreign subsidiary to the parent company.
Essay Questions
81.
Describe importance of accounting information in business.
Accounting has often been referred to as “the language of business.” This
language finds expression in profit-and-loss statements, balance sheets,
budgets, investment analysis, and tax analysis. Accounting information is
the means by which firms communicate their financial position to the
providers of capital (investors, creditors, and government). It enables the
providers of capital to assess the value of their investments or the security
of their loans and to make decisions about future resource allocations.
Accounting information is also the means by which firms report their income
to the government so the government can assess how much tax the firm
owes. It is also the means by which the firm can evaluate its performance,
control its internal expenditures, and plan for future expenditures and
income.
82.
Identify a key accounting problem that international businesses are
confronted with but that does not confront purely domestic businesses.
Substantiate with a suitable example.
International businesses are confronted with a number of accounting
problems that do not confront purely domestic businesses. One of these
problems is the lack of consistency in the accounting standards of different
countries. For example, the accounting rules currently used in China are not
the same as those used in more developed markets. This makes it very
difficult for international investors to accurately value Chinese firms, and it
opens up the possibility that firms that seem to be profitable and financially
strong are in fact not.
83.
Explain the three types of decisions in international business.
Financial management in an international business includes three sets of
related decisions: (1) investment decisions: decisions about what activities
to finance, (2) financing decisions: decisions about how to finance those
activities, and (3) money management decisions: decisions about how to
manage the firm’s financial resources most efficiently.
84.
How is a country’s accounting system affected by the providers of capital?
Explain with the help of suitable examples.
In countries where there were well-developed capital markets, such as the
United States and Britain, firms typically raised capital by issuing stock or
bonds to investors. Investors in these countries demanded detailed
accounting disclosures so that they could better assess the risk and likely
return on their investments. The accounting system evolved to
accommodate these requests. In contrast, in Germany and Switzerland the
banks emerged as the main providers of capital to enterprises. Bank
officers often sat on the boards of these companies and were privy to
detailed information about their operations and financial position. As a
consequence, there were fewer demands for detailed accounting
disclosures, and public accounts tended to reveal less information.
85.
Briefly differentiate accounting standards and auditing standards.
Accounting standards are rules for preparing financial statements. They
define what is useful accounting information. Auditing standards specify the
rules for performing an audit—the technical process by which an
independent person (the auditor) gathers evidence for determining if
financial accounts conform to required accounting standards and if they are
also reliable.
86.
Describe the structure of the International Accounting Standards Board
(IASB).
The International Accounting Standards Board (IASB) has emerged as a
major proponent of standardization. The IASB was formed in March 2001 to
replace the International Accounting Standards Committee (IASC), which
had been established in 1973. The IASB has 15 members who are
responsible for the formulation of new international financial reporting
standards. To issue a new standard, 75 percent of the 15 members of the
board must agree.
87.
What are the shortcomings of IASB?
To issue a new standard, 75 percent of the 15 members of the board must
agree. It can be difficult to get three-quarters agreement, particularly since
members come from different cultures and legal systems. Another
hindrance to the development of international accounting standards is that
88.
What are the main steps in the control process of a typical firm?
In a typical firm, the control process is annual and involves three main
steps: (1) head office and subunit management jointly determine subunit
goals for the coming year; (2) throughout the year, the head office monitors
subunit performance against the agreed goals; (3) if a subunit fails to
achieve its goals, the head office intervenes in the subunit to learn why the
shortfall occurred, taking corrective action when appropriate.
89.
Describe the three exchange rates that Lessard and Lorange pointed out.
Lessard and Lorange pointed out three exchange rates that can be used to
translate foreign currencies into the corporate currency in setting budgets
and in the subsequent tracking of performance: (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 period (i.e., the forward
rate). (3) The ending rate, the spot exchange rate when the budget and
performance are being compared.
90.
What are the nine possible combinations of the three exchange rates
proposed by Lessard and Lorange in the control process?
These three exchange rates imply nine possible combinations. Lessard and
Lorange ruled out four of the nine combinations as illogical and
unreasonable. Students should draw figure 20.1 to answer this question.
91.
Explain the concept of transfer pricing.
The volume of intra-firm transactions in such firms is very high. The firms
are continually shipping component parts and finished goods between
subsidiaries in different countries. The price at which such goods and
services are transferred is referred to as the transfer price.
92.
Explain why the evaluation of a subsidiary should be kept separate from the
evaluation of its manager.
In many international businesses, the same quantitative criteria are used to
assess the performance of both a foreign subsidiary and its managers.
Many accountants, however, argue that although it is legitimate to compare
subsidiaries against each other on the basis of return on investment (ROI)
or other indicators of profitability, it may not be appropriate to use these for
comparing and evaluating the managers of different subsidiaries. Foreign
subsidiaries do not operate in uniform environments; their 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. Thus, the manager of a subsidiary in an adverse
environment that has an ROI of 5 percent may be doing a better job than
the manager of a subsidiary in a benign environment that has an ROI of 20
percent. Although the firm might want to pull out of a country where its ROI
93.
What is capital budgeting?
Capital budgeting is the technique financial managers use to try to quantify
the benefits, costs, and risks of an investment. This enables top managers
to compare, in a reasonably objective fashion, different investment
alternatives within and across countries so they can make informed choices
about where the firm should invest its scarce financial resources.
94.
Describe three factors that complicate the process of an international
business.
Among the factors complicating the process for an international business
are these: (1) A distinction must be made between cash flows to the project
and cash flows to the parent company. (2) Political and economic risks,
including foreign exchange risk, can significantly change the value of a
foreign investment. (3) The connection between cash flows to the parent
and the source of financing must be recognized.
95.
Describe the problem of blocked earnings.
When evaluating a foreign investment opportunity, the parent should be
interested in the cash flows it will receive—as opposed to those the project
generates—because those are the basis for dividends to stockholders,
investments elsewhere in the world, repayment of worldwide corporate
debt, and so on. Stockholders will not perceive blocked earnings as
contributing to the value of the firm, and creditors will not count them when
calculating the parent’s ability to service its debt.
96.
What are the criticisms against adjusting discount rates to reflect a
location’s riskiness?
Adjusting discount rates to reflect a location’s riskiness seems to be fairly
widely practiced. However, critics of this method argue that it penalizes
early cash flows too heavily and does not penalize distant cash flows
enough. They point out that if political or economic collapse were expected
in the near future, the investment would not occur anyway. So for any
investment decisions, the political and economic risk being assessed is not
of immediate possibilities, but rather at some distance in the future.
97.
What are the considerations when seeking external financing for
international business?
If external financing is required, the firm must decide whether to tap the
global capital market for funds or borrow from sources in the host country.
If the firm is going to seek external financing for a project, it will want to
borrow funds from the lowest-cost source of capital available. The cost of
capital is typically lower in the global capital market, by virtue of its size and
liquidity, than in many domestic capital markets, particularly those that are
small and relatively illiquid. However, despite the trends toward
deregulation of financial services, in some cases host-country government
restrictions may rule out this option.
98.
Explain the impact of transaction costs in international business.
Transaction costs are the cost of exchange. Every time a firm changes cash
from one currency into another currency it must bear a transaction cost—
the commission fee it pays to foreign exchange dealers for performing the
transaction. Most banks also charge a transfer fee for moving cash from
one location to another; this is another transaction cost. The commission
and transfer fees arising from intra-firm transactions can be substantial.
99.
Define tax credit and tax treaty.
A tax credit allows an entity to reduce the taxes paid to the home
government by the amount of taxes paid to the foreign government. A tax
treaty between two countries is an agreement specifying what items of
income will be taxed by the authorities of the country where the income is
earned.
100.
What are the advantages of using royalties and fees to move money across
borders?
Royalties and fees have certain tax advantages over dividends, particularly
when the corporate tax rate is higher in the host country than in the
parent’s home country. Royalties and fees are often tax-deductible locally
(because they are viewed as an expense), so arranging for payment in
royalties and fees will reduce the foreign subsidiary’s tax liability. If the
foreign subsidiary compensates the parent company by dividend payments,
local income taxes must be paid before the dividend distribution, and
withholding taxes must be paid on the dividend itself.