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CHAPTER 1
INTRODUCTION TO INTERNATIONAL ACCOUNTING
Chapter Outline
I. International accounting is an extremely broad topic.
A. At a minimum it focuses on the accounting issues unique to multinational
corporations, especially with respect to foreign operations.
B. 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.
C. This book provides an overview of the broadly defined area of international
accounting, with a focus on the accounting issues encountered by multinational
companies engaged in international trade and invested in foreign operations.
II. There are several accounting issues encountered by companies involved in international
trade.
A. 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.
B. 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 GAAP, tax laws, and other regulations differ across countries.
A. Figuring out how to make sense of the financial statements of a foreign acquisition
target prepared in accordance with an unfamiliar GAAP when making a foreign direct
investment decision.
B. 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.
C. 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.
D. Establishing prices for intercompany transactions that cross national borders
(international transfer prices) to achieve corporate objectives and at the same time
comply with governmental regulations. E.
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.
F. Establishing an effective internal audit function to help maintain control over foreign
operations. Differences in culture, customs, and language must be taken into
consideration.
G. 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.
V. Problems encountered by MNCs when confronted with different local GAAP in different
countries leads to the desire for accounting harmonization. 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 more
than doubled in the 1990s.
VII. The tremendous growth in foreign direct investment (FDI) over the last two 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
twice as large as the revenues generated through exporting.
VIII. There are more than 82,000 multinational companies in the world in 2009 with 810,000
foreign subsidiaries. The 100 largest multinationals generate approximately 4% of global
GDP. A disproportionate number of multinational corporations are headquartered in the
triad countries of the United States, Japan, and the European Union.
IX. The largest companies in the world are not necessarily the most multinational. Indeed,
many large U.S. companies have no foreign operations. According to one definition of
multinationality used by the United Nations, the two most multinational companies in the
world in 2011 were based in Switzerland (Nestlé SA) and the United Kingdom (Anglo
American plc).
X. In addition to establishing operations overseas, many companies also cross-list their
shares on stock exchanges outside of their home country. There are a number of
reasons for doing this including having access to a larger pool of capital.
Answers to Questions
