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CHAPTER 15
Accounting and Taxation in Global Business
Chapter Outline
• Introduction
• Accounting and Financial Reporting in Global Business
o Management Accounting
o Financial Accounting
• Generally Accepted Accounting Principles (GAAP)
o U.S. GAAP
o International GAAP
o Differences Between U.S. and International GAAP
o Differences Between U.S. GAAP and Selected Countries
• International Financial Reporting Standards
• The Role of Auditing and the Sarbanes-Oxley Act
• Financial Statement Analysis
o Financial Ratios
o Evaluating Trends
• Global Tax Matters
o Tax Rates Among Selected Countries
o Transfer Pricing
Teaching Objectives
After covering this chapter, the student should be able to:
• Explain briefly the function of accounting and describe the two parts of the accounting
information system.
• Describe briefly the function of GAAP.
• Recount the goal of the IASB and describe why IFRS are important to global business
operations.
• Explain how auditing contributes to the usefulness of financial reporting.
• Explain how financial statement analysis can be used to evaluate a company’s financial
situation and compare it to other companies.
• Describe briefly tax issues that MNCs face.
COMPREHENSIVE LECTURE OUTLINE
I. Introduction. Accounting is the recording, summarizing, and reporting of the
economic activities and events of an organization. Accounting generates information
used by people inside and outside the firm. The most important reports produced by
the accounting information system are the set of four financial statements. Exhibit
15.1 • Fundamental Financial Questions and Answers. Together, the four
financial statements represent a business in financial terms:
• Income statement answers the question: How much income did the firm
earn or lose during the period? It summarizes the revenues earned and the
expenses incurred over a period of time.
• Balance sheet lists the balances of the asset, liability, and owners’ equity
accounts of a business on a specific date. A balance sheet answers the
question: What is the firms’ financial position at a designated point in
time?
• Statement of retained earnings shows the starting balance for retained
earnings, additions and reductions to retained earnings, and the ending
balance of retained earnings. Retained earnings refers to the part of the
stockholders’ equity generated from operations and kept for use in future
operations. It’s the stockholder’s claim to assets earned from company
operations and reinvested into the company.
• Statement of cash flows shows the company’s cash receipts and cash
payments—inflows and outflows of cash. The statement of cash flows
answers the question: How much cash was taken in and paid out during
the period?
CLASS ACTIVITY: Use the Cultural Perspective case as an opportunity to allow students to
explore the impact of a well-designed accounting system on a company’s ability to detect and
resolve electronic crimes.
II. Accounting and Financial Reporting in Global Business. The accounting
Information System (AIS) has specific objectives: to provide all the financial information
internally needed by management for business decision-making, known as management
accounting; and to provide financial information to various external users concerned with the
financial activities of the organization, known as financial accounting.
• Management Accounting. The component of the accounting information system that
provides information to management is referred to as management accounting.
Management accounting in most firms includes similar kinds of financial analysis.
Specific steps in performing these types of analyses are standardized. There are widely
accepted guidelines on how these internal documents should be prepared. Technological
innovation has had a profound effect on how management accounting tasks are
performed: specialized software is available to assist management accountants. For
example, specialized hardware devices such as bar code readers may be used to help keep
track of inventory, etc.
• Financial Accounting. The component of the AIS that supplies information to external
users is financial accounting. External users of accounting information fall into two
major categories: organizations that require or expect information to be reported, and
organizations that receive information on an as needed basis. Exhibit 15.2 • External
Users of Accounting Information.
DISCUSSION STARTER: REALITY CHECK 1.
Have you filed a federal tax return? The tax authorities require taxpayers to submit very
specific tax-related information on the appropriate forms on a regular basis. During the year,
do you keep track of the information needed to prepare your tax return?
III. Generally Accepted Accounting Principles (GAAP). The financial statements of
publicly traded companies must be prepared according to generally accepted accounting
principles (GAAP). GAAP provides guidelines by which financial statements are prepared.
Differences in culture and business environments have led to differences in GAAP among
different countries. In the 1970s, a movement was started to create one set of GAAP that could
be used in all countries. In the past decade this movement has gained momentum.
• U.S. GAAP. The FASB issues Statements of Financial Accounting Standards that
provide the procedures for dealing with specific accounting matters. Additional
accounting guidance is provided in a number of places. Exhibit 15.3 • Authoritative
Accounting Literature. There are three primary fields of work for accountants: in the
AIS of a business firm, in a public accounting firm, and in the AIS of a government
entity. Accountants who work in the public accounting field need to be licensed by the
state in which they work. The license is designated Certified Public Accountant (CPA).
CPA firms provide three basic types of services: auditing, tax, and consulting.
Accountants in industry, government, or public accounting may attain the CPA
designation. Other notable professional designations are the CMA (Certified
Management Accountant), CIA (Certified Internal Auditor), and CFE (Certified Fraud
Examiner).
• International GAAP. GAAP used by companies based in other countries is determined
by the governments of those countries. GAAP in one country could be significantly
different from GAAP in another country. Different GAAPs made it difficult for investors
and other financial statement users to meaningfully compare financial reports of
companies from different countries. The solution to this problem would be to develop one
set of GAAP, an “international” GAAP that would be used by all companies around the
world. In the 1970s a movement began to develop an international GAAP. The
international GAAP is now used in many countries. The international GAAP is
developed by the International Accounting Standards Board (IASB). It is called
International Financial Reporting Standards (IFRS).
• Differences Between U.S. and International GAAPs. GAAPs are different among
countries due to the factors that influence development of accounting and financial
reporting: political and legal systems, sources of capital, inflation, taxation, culture, etc.
IFRS are different from U.S. GAAP in a variety of ways. IFRS are regarded as being
more principles-based and U.S. GAAP as being more rules-based. Detailed rules of U.S.
GAAP may be a result of extreme business complexity and a high rate of litigation. There
are many areas of difference between U.S. GAAP and IFRS, but there are more
similarities than differences. In October 2002, the FASB and the IASB issued a
memorandum formally announcing their commitment to converging the two systems.
• Differences Between U.S. GAAP and Selected Countries. Due to the global movement
to adopt or require IFRS, there are fewer countries that maintain their own GAAP. In
2003, fewer than 30 countries required or accepted IFRS. By 2015, more than 120
countries required or accepted IFRS. Consequently, comparing GAAPs in different
countries is becoming less necessary. What is more important is comparing U.S. GAAP
to IFRS.
DISCUSSION STARTER: REALITY CHECK 2.
Have you ever encountered a difficulty due to different measurement scales such as hand tools
based on English standards (one inch, ½ inch, 3/8 inch, etc.) versus metric standards (10mm,
9mm, 8mm, etc.) or container capacity (e.g., converting ounces to liters)? Different accounting
standards create a similar problem.
IV. International Financial Reporting Standards. The International Accounting Standards
Board (IASB) issues IFRS. The IASB is an independent, privately funded accounting standard-
setter based in London. IFRS is a set of international accounting standards stating how particular
types of transactions and other events should be reported in financial statements. IFRS is
designed to provide a single set of GAAP that can be used around the globe. The IASB
cooperates with national accounting standard setters to achieve convergence in accounting
standards around the world. It represents more than 100 worldwide accounting and financial
organizations from more than 80 countries. The objectives of the IASB include:
• Increasing harmonization of accounting standards and disclosures to meet the
needs of the global market
• Providing an accounting basis for underdeveloped or newly industrialized
countries
• Increasing the compatibility of domestic and international accounting
requirements
The rapid growth in international capital markets, cross-border mergers and acquisitions, and
other international developments have created pressures for harmonization of accounting
standards beyond those that were contemplated when IASB was formed. MNCs will benefit if
they must prepare financial reports based only on IFRS, in all countries where they conduct
business. Financial statements users will benefit if all financial reports of all companies use
IFRS. Among other advantages, this would greatly enhance the comparability of financial
statements from one firm to another.
DISCUSSION STARTER: REALITY CHECK 3.
Have you studied a foreign language? If so, you know how difficult it can be to translate a
story from one language into another. The same is true for accounting information.
Translating accounting information from one GAAP to another GAAP is a challenging
process.
V. The Role of Auditing and the Sarbanes-Oxley Act. People who rely upon financial
statements are very concerned about the validity of the reports they receive. In the case of a
publicly traded company, users of its annual financial statements need some form of assurance
that they do not contain material misstatements, either intentional or unintentional.
• Assurance is provided by the independent external auditor who examines the firm’s
financial statements and provides an audit opinion. The two major categories of auditing
are external auditing and internal auditing. In the U.S. external audits of financial
statement audits must be conducted by independent Certified Public Accountants.
• Audits are characterized by several common steps. Planning an audit involves gaining an
understanding of the company being audited—the company’s management, goals and
objectives, key personnel, financial information from prior years, etc. At this stage, the
auditor will specify what audit procedures will be done and select the people who will be
carrying out those procedures. Obtaining evidence to support the audit opinion involves
the application of a series of audit procedures to verify the accuracy of assertions being
made by the company. After evaluating the evidence, the auditor reaches an opinion. In
the U.S. the auditor’s opinion is included in the annual report that a publicly traded
company files with the SEC.
• Internal audits, also called management or operational audits, are generally concerned
with evaluating the economy and the efficiency with which scarce resources are used.
Internal auditors often review all aspects of operations to determine whether any
improvements can be made. Internal audits can also evaluate internal controls. One key
objective of an internal control audit is to ensure that the internal control structure is
sound and provides a reasonable degree of assurance about the integrity of information
output.
ETHICAL PERSPECTIVES: Can Government Regulators Prevent Financial Crises? Use the
Ethical Perspectives case as an opportunity to discuss the new rules proposed by the SEC to
prevent another financial crisis.
Questions:
1. Do you think the U.S. SEC will be able to ensure that there will not be another financial
crisis like the one in 2008? Do you think that real-time surveillance of market behavior
2. Do you think that with enough regulations, people’s ethical failings can be prevented?
3. Why do you think the ACCA report recommended setting the right tone at the top?
• When the Sarbanes-Oxley Act was passed in 2002, it established the Public Company
Accounting Oversight Board to oversee auditors of publicly traded companies. In
addition, SOX increased prison sentences for fraud. The PCAOB sets auditing,
attestation, quality control, and ethical standards for auditors. As a result of SOX the U.S.
auditing profession moved from a self-regulatory environment under the American
Institute of Certified Public Accountants’ peer review system to the regulatory
framework under the PCAOB.
DISCUSSION STARTER: REALITY CHECK 4.
English historian Lord Acton is famous for this quote: “Power tends to corrupt, and absolute
power corrupts absolutely.” In a country with no checks and balances on the power of
government officials, do you think citizens are more concerned about corruption there than in
a country like the United States, which has a checks and balances system? If there were no
audits of financial statements of publicly traded companies, do you think stockholders would
be concerned about the accuracy and reliability of those statements?
VI. Financial Statement Analysis. Financial Statement Analysis is an evaluation of
financial statements to identify significant trends or relationships among the items contained
within them. Financial Statement Analysis begins with the information directly provided on
financial statements and builds upon that information to provide a more comprehensive
understanding of a company’s financial situation.
• Financial Ratios. A financial ratio shows the relationship of one number on a financial
statement to another number. Financial ratios enable meaningful comparisons among
companies of different sizes. When comparing two companies, the total dollar amount of
debt is less important than the ratio of total debt to total assets.
o One of the most frequently used financial ratios is called the current ratio, which
is calculated as current assets divided by current liabilities. The current ratio
shows the firm’s ability to pay its current liabilities using current assets.
• Evaluating Trends. Positive trends in financial performance are indicators that the
company has positive future prospects. Negative trends suggest a negative future for the
firm.
DISCUSSION STARTER: REALITY CHECK 5.
If you had a half million dollars to invest, would you prefer to invest in a company that has
made steadily increasing profits year after year? Or would you prefer instead to invest in a
company that has experienced dramatic ups and downs in profitability, some years with huge
profits and other years with huge losses? Explain the reasons for your preference.
VII. Global Tax Matters. Tax rates and types of taxes vary greatly from one country to
another.
• Tax Rates Among Selected Countries. Almost every country imposes a corporate
income tax. Countries that have little or no corporate income tax are referred to as tax
havens. Conducting business in tax havens does not mean that there are no taxes. The
company will still have to pay other taxes such as property taxes, payroll taxes, and sales
taxes. The amount of the other taxes may be higher in tax-haven countries than in
countries where there are income taxes. The total amount of taxes paid may be about the
same in a country that is a tax haven and in a country that is not a tax haven. Corporate
income tax rates vary from a high of 35% in the U.S. to a low of 12.5% in Ireland.
Exhibit 15.4 • Corporate Income Tax rates in OECD Countries.
ECONOMIC PERSPECTIVES: Corporate Income Tax Rates and Economic Activity. Use
the Economic Perspectives case as an opportunity to discuss the impact of corporate income tax
rates on the economic activity in a country.
Suggestion: You could ask students to do this case as individuals or in teams as a class activity.
Have the students read the case presented in the text and answer the questions at the end of the
case.
Questions:
1. Why do you think government expenditures as a percentage of GDP have increased in the
2. Why do you think a lower corporate income tax rate would be associated with more
favorable economic activity such as an increase in GDP? Answer: Companies will be
3. If you were a CEO making a decision upon where to locate future business operations,
would you locate in a low-tax or high-tax country, all other factors being equal? As a
• Transfer Pricing. The majority of MNCs use transfer pricing. Transfer pricing refers to
the pricing of goods and services that are transferred internally between members of a
corporate family. Internal transfers can involve a variety of goods and services, such as
raw materials, semi-finished and finished goods, allocation of fixed costs, loans, fees,
etc. When the members of a corporate family are located in different countries, transfer
pricing affects taxes owed and company profits. This makes transfer pricing a matter of
operational importance and creates a significant tax issue. The consolidated corporation
potentially can lower taxes as a result of a transfer pricing arrangement between the
parent and its subsidiary. Exhibit 15.5 • Transfer Pricing Scenarios. Transfer pricing
has this potential benefit, at least in situations in which a company has the ability to set
the transfer price as it chooses. In many countries, a company cannot arbitrarily set the
transfer price. A country may have laws and regulations that specify how transfer prices
are determined.
DISCUSSION STARTER: REALITY CHECK 6.
Are corporate taxes in the United States too high? Search the Internet for an economist’s or
other expert’s opinion on the subject. Why would multinational corporations compare tax
rates among countries before setting up business operations in a specific country?
Assignments
End-of-Chapter Discussion Questions
1. What is the difference between management accounting and financial
accounting? Answer: Providing financial information internally needed by
2. Describe U.S. GAAP and why it differs from GAAP in other countries.
3. What are the benefits of every country using the same GAAP; that is, IFRS?
Why haven’t all countries adopted IFRS? Answer: Different GAAPs made it
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170
compare financial reports of companies from different countries. The
solution to this problem would be to develop one set of GAAP, an
“international” GAAP that would be used by all companies around the
world. MNCs would benefit if they could prepare financial reports based
only on IFRS in all countries where they conduct business. Financial
statements users would benefit if all financial reports of all companies use
IFRS. Among other advantages, this would greatly enhance the
comparability of financial statements from one firm to another. With
globalization, fewer countries choose to maintain their own GAAP.
4. How does auditing contribute to better financial reporting? Answer: People
5. How does financial ratio analysis enable an investor to compare two
companies? Answer: A financial ratio shows the relationship of one
6. Before locating operations in a country, why should a MNC evaluate that
country’s tax system? Answer: Part of international operations is paying
Mini-Case Synopsis and Questions
McDonald’s Corporation operates in more than 100 countries. As a multinational
business, McDonald’s must comply with the rules and regulations of the countries
where it operates. The UN is concerned that globalization of business makes it
difficult for external stakeholders, including governments, to verify a multinational
firm’s data. IFRS has been developed and can be used for financial reporting by
companies in countries around the world.
Questions:
1. Why is it difficult to compare the financial statements of a U.S. company
with those of a company in India or Germany? Financial reporting in the
2. How would McDonald’s benefit if IFRS were adopted for use in all
Point/Counterpoint, Interpreting Global Business News, and Portfolio Projects
Students’ answers to these assignments will vary widely. Their writing should
reflect an understanding of the chapter’s basic concept, thorough research, and
logic and critical thinking skills.
