Chapter 20 – Accounting and Finance in the International Business
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Accounting and Finance in the
International Business
Learning objectives
• Discuss the national differences
in accounting standards.
• Explain the implications of the
rise of international accounting
standards.
• Explain how accounting
systems impact upon control
systems within the
multinational enterprise.
• Discuss how operating in
different nations impacts
investment decisions within the
multinational enterprise.
• Discuss the different financing
options available to the
subsidiary of a multinational
enterprise.
• Understand how money
management in the international
business can be used to
minimize cash balances,
transaction costs, and taxation.
• Understand the basic techniques
for global money management.
This chapter deals with accounting and financial
management in international business. It illustrates and
explains how accounting decisions, investment decisions,
financing decisions, and money management decisions are
complicated by different currencies, different tax regimes,
different levels of political and economic risk, and so on.
Accounting, the language of business, provides the means
for firms to communicate their financial positions to
investors, creditors, and the government. Financial
information also is used in making resource allocations.
International businesses are confronted with a number of
accounting challenges that do not arise in the case of
domestic businesses. They must prepare reports for
international constituencies and translate and consolidate
information across countries and currencies.
Financial managers must also account for all of these
factors when deciding which activities to finance, how
best to finance those activities, how best to manage the
firm’s financial resources, and how best to protect the firm
from political and economic risks, including foreign
exchange risk. Good financial management can be a
source of competitive advantage because it can lower the
cost of activities and enhance the value of activities of a
firm.
The opening case, Chinese Accounting, illustrates some of
the issues accountants address in the international sphere.
The closing case describes how Brazil’s successful, no
frills airline, Gol, has been able to expand its capital
opportunities by listing on the New York Stock Exchange.
20
Chapter 20 – Accounting and Finance in the International Business
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OUTLINE OF CHAPTER 20: ACCOUNTING AND FINANCE IN THE
INTERNATIONAL BUSINESS
Opening Case: Chinese Accounting
Introduction
National Differences in Accounting Standards
Management Focus: The Consequences of Different Accounting Standards
International Accounting Standards
Accounting Aspects of Control Systems
Exchange Rate Changes and Control Systems
The Lassard-Lorange Model
Transfer Pricing and Control Systems
Separation of Subsidiary and Manager Performance
Financial Management: The Investment Decision
Capital Budgeting
Project and Parent Cash Flows
Adjusting for Political and Economic Risk
Risk and Capital Budgeting
Management Focus: Black Sea Energy Ltd.
Financial Management: The Financing Decision
Financial Management: Global Money Management
Minimizing Cash Balances
Reducing Transaction Costs
Managing the Tax Burden
Moving Money across Borders
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: Brazil’s Gol Airlines
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CLASSROOM DISCUSSION POINT
Ask students about the accounting system in the United States. Why is it mandatory for
companies to abide by the system? Then, ask students to take the perspective of an
investor. How does the system in the United States help investors? Try to focus on
issues like reliability and comparability. Then, ask students how they might assess a
company from another country that follows a different accounting system. What happens
to reliability and comparability? Finally, ask students to consider the need for an
international accounting system. What issues could emerge in the development of such a
system? Next, ask students to consider the role of international finance in building and
sustaining a competitive advantage in global markets. Set up an example of a
multinational firm with multiple cash flows in various currencies. Then, ask students
how to manage all of the accounts payable and receivable. Challenge students to
consider the costs involved in converting currencies and the foreign exchange exposure
incurred.
OPENING CASE: Chinese Accounting
The opening case describes the evolving nature of the accounting system in China, and
the challenges that this creates for Western firms. Discussion of the case can revolve
around the following questions:
1. What factors have shaped the accounting system currently in use in China?
2. What problems does the accounting system currently in use in China present to foreign
investors in joint ventures with Chinese companies?
3. If the evolving Chinese system does not adhere to IASC standards, but instead to
standards that the Chinese government deems appropriate to China’s “special situation,”
how might this affect foreign firms with operations in China?
Another Perspective: To learn more about China’s Accounting System for Business
Enterprises go to
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LECTURE OUTLINE FOR CHAPTER
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The PPT slides include additional notes that can be viewed by
clicking on “view”, then on “notes”. The following provides a brief overview of each
Power Point slide along with teaching tips, and additional perspectives.
Slides 20-3 What is Financial Management?
Financial management focuses on three types of decisions: investment, financing, and
money management. In international business, currencies, tax regimes, regulations on
capital flows, norms for the financing of business, levels of economic and political risk
all influence these decisions.
Slides 20-4 What is Accounting?
Accounting is the language of business – it is the way firms communicate their financial
positions.
Slides 20-5 Determinants of National Accounting Standards
Accounting is shaped by the environment in which it operates. In each country the
accounting system has evolved in response to the nature of the demands for accounting
information.
Slide 20-6 Relationship between Business and Providers of Capital
Three main external sources of capital for business enterprises are: (1) individual
investors, (2) banks, and (3) government.
Slide 20-7 Political and Economic Ties with Other Countries
Similarities in accounting systems across countries can reflect political or economic ties.
Slide 20-8 Level of Development
Developed nations tend to have more sophisticated accounting systems than developing
countries.
Slide 20-9 Accounting and Auditing Standards
Accounting standards are rules for preparing financial statements—they define useful
accounting information.
Auditing standards specify the rules for performing an audit—the technical process by
which an independent person gathers evidence for determining if financial accounts
conform to required accounting standards and if they are reliable.
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Slides 20-10 International Standards
Because of national differences in accounting and auditing standards, comparability of
financial reports from one country to another is difficult.
There has been a substantial effort recently to harmonize accounting standards across
countries. The International Accounting Standards Board (IASB) is a major
proponent of standardization.
Slide 20-12 Accounting Aspects of 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
Slide 20-13 Exchange Rate Changes and Control Systems
Most international firms require budgets and performance data to be expressed in the
corporate currency-normally the home currency.
Slides 20-14-20-15 The Lessard- Lorange Model
Lorange and Lessard suggest that firms use the projected spot exchange rate (usually
the forward exchange rate) to translate budget and performance figures into the corporate
currency.
Slide 20-16 Separation of Subsidiary and Manager Performance
The evaluation of a subsidiary should be kept separate from the evaluation of its
manager.
Slide 20-17-20-19 Investment Decisions
Financial managers must quantify the benefits, costs, and risks associated with an
investment in a foreign country.
Capital budgeting quantifies the benefits, costs, and risks of an investment.
Slide 20-20 Project and Parent Cash Flows
For the parent company, the key figure is the cash flows it will receive, not the cash flows
Slides 20-21-20-23 Adjusting for Political and Economic Risk
The analysis of a foreign investment opportunity includes an assessment of political and
economic risk.
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Political risk is 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.
Economic risk is 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.
Slides 20-24-20-27 Global Money Management
Firms must consider two factors when considering financing options:
The cost of capital is typically lower in the global capital market than in many domestic
markets.
The mix of debt and equity used to finance a business varies across countries. Japanese
firms rely far more on debt financing than do most U.S. firms.
Money management decisions attempt to manage global cash resources efficiently.
Slides 20-28-20-29 Global Money Management: The Tax Objective
Double taxation occurs when the income of a foreign subsidiary is taxed by the host-
country government and by the home-country government.
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.
A deferral principle specifies that parent companies are not taxed on foreign source
income until they actually receive a dividend.
A tax haven is a country 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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Another Perspective: To extend this discussion consider the iGLOBE IRS Ends Amnesty
For Use Of Overseas Tax Havens which explores the U.S. government’s recent
crackdown on the use of tax havens.
Slide 20-30 Moving Money Across Borders: Attaining Efficiencies and Reducing Taxes
Slide 20-31 Dividend Remittances
The most common method of transferring funds from subsidiaries to the parent is through
dividends.
Slide 20-32 Royalty Payments and Fees
Royalties represent the remuneration paid to the owners of technology, patents, or trade
A fee is compensation for professional services or expertise supplied to a foreign
subsidiary by the parent company or another subsidiary.
Slides 20-33-20-34 Transfer Prices
Transfer prices can be used to position funds within an international business.
Slide 20-36-30-37 Fronting Loans
Fronting loans circumvent host government restrictions on the remittance of funds and
have certain tax advantages.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: Why do the accounting systems of different countries differ? Why do
these differences matter?
ANSWER 1: Accounting systems are shaped by the environment of the country, and
have evolved to meet the nature of demand for accounting information in that country.
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affect the way financial reports are created and interpreted, and make comparisons across
borders difficult.
QUESTION 2: Why might an accounting-based control system provide headquarters
management with biased information about the performance of a foreign subsidiary?
How can these biases be corrected?
ANSWER 2: There are three primary reasons why accounting based control systems
may provide headquarters management with biased information about the performance of
a subsidiary: exchange rate changes, transfer prices, and general economic conditions.
Because exchange rates can change over the course of a budget, translated financial data
can be misleading – an increase in domestic sales could actually show up as a decrease
QUESTION 3: You are the CFO of a U.S. firm with a wholly owned subsidiary in
Mexico that manufactures component parts for your U.S. assembly operations. The
subsidiary has been financed by bank borrowings in the United States. One of your
analysts told you that the Mexican peso is expected to depreciate by 30% against the U.S.
dollar on the foreign exchange markets over the next year. What actions, if any, should
you take?
ANSWER 3: This issue suggests that some interest and principal will have to be repaid
in U.S. dollars in the near future, but the plan was likely to pay this off out of earnings
from the Mexican subsidiary. Paying off the entire loan in advance before the peso
depreciates would be a good option. At least the peso funds could be transferred out of
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QUESTION 4: You are the CFO of a Canadian firm that is considering building a $10
million factory in Russia to produce milk. The investment is expected to produce net
cash flows of $3 million every year for the next 10 years, after which the investment will
have to close down due to technological obsolescence. Scrap values will be zero. The
cost of capital will be is 6% if financing is arranged through the Eurobond market.
However, you have an option to finance the project by borrowing funds from a Russian
bank at a 12 percent. Analysts tell you that due to high inflation in Russia, the Russian
ruble is expected to depreciate against the Canadian dollar. Analysts also rate the
probability of violent revolution occurring in Russia within the next ten years as high.
How would you incorporate these factors into your evaluation of the investment
opportunity? What would you recommend that the firm do?
ANSWER 4: In considering these investments there are three basic steps:
• make a basic analysis
(1) Make a basic analysis of the investment:
(2) Adjust for risk
In the case of Russia, the likelihood of violent revolution, which could damage
the plant irreparably or cause the firm to lose ownership is probably as likely to
(3) Determine whether it would be better to fund the project from Canada or Russia or
not at all.
(i) Russian funds: If we assume that if there is a violent revolution, we would
neither earn money nor have to pay back the bank. (Let them have the plant if
Chapter 20 – Accounting and Finance in the International Business
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The net present value of these cash flows in Canadian dollars could then be calculated.
(ii) Eurobond Funds: Eurobond investors would still want to be paid even if the
plant goes out of production. They will also want to be paid most likely in US
After more careful analysis both choices would likely yield a positive net present value,
although which one is higher is not obvious. While one can make estimates for the risks
and include them as suggested, it is clear that the Eurobond option exposes the firm to
CLOSING CASE: Brazil’s Gol
The closing case describes the financial approach Gol took to raising capital to fund its
expansion. Gol is Brazil’s version of JetBlue Airways. In 2004, the company made an
offering of nonvoting preferred stock on Brazil’s stock exchange, the Sao Paulo Bovespa,
and on the New York Stock Exchange. Discussion of the case can revolve around the
following questions:
QUESTION 1: What were the benefits to Gol of a listing on the New York stock
exchange in addition to the San Paulo Bovespa?
ANSWER 1: By listing on the NYSE, Gol was able to build recognition of its business
QUESTION 2: Why do you think the Gol stock offering was oversubscribed?
ANSWER 2: Most students will probably suggest that Gol’s position of being one of the
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QUESTION 3: Do you think Gol would have raised as much money if it had just listed
on the New Sao Paulo exchange?
ANSWER 3: By listing its stock on both the New York Stock Exchange and the
QUESTION 4: How might the joint listing of the New York and San Paulo stock
exchanges affect Gol’s ability to raise additional capital in the future?
ANSWER 4: Gol’s successful stock offering helped propel the company into a tier one
airline in company with other successful firms like Southwest, Ryanair, and JetBlue. Gol
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented
in this chapter. In particular, you might consider the following:
Title: Greek Debt Crisis Adds New Gravity To U.S. Deficit Debate
Run Time: 8:27
Abstract: This video explores the continued protests against austerity measures
implemented by Greece to help get the country back on track, and the implications of the
situation for other European Union countries and the future of the euro.
Key Concepts: European Union, euro, globalization, political economy, global capital
markets, exchange rates, economic integration
Notes: Protests against government imposed austerity measures in Greece continued
recently as the country grappled with finding a solution to its decades of overspending
and now inability to repay its debts. Greece now finds itself in the unpleasant and rather
precarious position in which its position as a member of the European Union and
Eurozone is in question. In other European Union countries there is growing anger about
the situation and support for those who believe Greece should no longer be a part of its
common currency arrangement. Greece has been forced to ask the European Central
Bank for help, and many citizens particularly in Great Britain and Germany are angry
Chapter 20 – Accounting and Finance in the International Business
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that they are being asked to pay for what they believe was irresponsible behavior by the
Greek government. Moreover, the European Union is deeply concerned about the
potential for contagion. In addition, some elected officials are worried that their position
on the situation in Greece could have significant implications for their bids for reelection.
In 2010, Greece implemented a series of highly unpopular austerity policies designed to
help the country overcome its debt problems. The country found itself deeply in the hole
after years of overspending. The austerity policies were part of a bailout package
requested by Greece designed to help the country get back on track. However, as the
recent protests indicate, the situation was not resolved as planned and deteriorated even
further. Now, economic growth in the country has stalled, the country has been unable to
successfully restructure its debts and is paying interest rates as high as 30 percent, and the
country is asking for additional assistance.
Discussion Questions:
1. Why has it been so difficult to resolve the problems in Greece? How does the situation
affect the value of the euro and its role in global capital markets?
2. What do the austerity measures implemented in Greece mean for the country? Do the
policies actually limit the country’s economic growth?
3. What are the long term implications of pushing Greece out of the Eurozone? What
message would such a move send to other European Union countries? How might it
affect future membership considerations?
4. Discuss the situation in Greece from the perspective of the United States. Should U.S.
companies be concerned? Why or why not?
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material
presented in this chapter. In particular, you might consider the following from
International Business DVD Volume 6:
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Title: Bank Launches Partnership for ‘Green Accounting’
Learning Objectives
The purpose of this video is to help you:
❖ Understand the nature of natural capital and environmental sustainability.
❖ Examine the concept of ‘green accounting’.
❖ Explore how multinational companies have and are destroying valuable ecosystems
in developing countries.
❖ Recognize the importance of managing resources to promote economic growth.
Key Words
❖ Globalization
❖ Environmental sustainability
❖ Social responsibility
❖ Levels of economic development
❖ Impact of multinational companies on host countries
❖ Ethics
❖ World Bank
Synopsis
The World Bank is launching a new program designed to help developing countries
better manage their natural capital. The World Bank is concerned that without the proper
knowledge of how to value natural resources, these countries could lose their ecosystems,
and with them potential economic benefits. In many developing countries, valuable
forests, wetlands, coral reefs, and other ecosystems have been damaged irreversibly by
multinational companies that invested in the countries hoping to make a quick profit.
Now, however, the World Bank wants to ensure that developing countries recognize the
true economic potential of their biodiversity and what the possible loss could be if their
ecosystems are destroyed.
The World Bank’s new program, which is being offered in partnership with the United
Nation’s Environmental Program, involves providing developing countries with the tools
for ‘green accounting.’ The goal is to ensure that a country’s finance minister has a full
understanding of the economic implications of decisions that involve the nation’s natural
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Discussion Questions
1. Explain the concept of natural capital. Why is the World Bank concerned about
protecting the natural capital of developing countries?
2. What is “green accounting’? How is the World Bank working to identify the necessary
tools for the task? Why is it so difficult to value natural capital?
3. What role do multinational companies play in the environmental degradation taking
place in many developing countries? Why do developing countries permit investments
by the companies? What responsibilities do these companies have to the host countries?
4. Discuss how companies can use ‘green accounting’ methods and tools to incorporate
social and environmental goals with their business strategies. How might promoting a
greener approach to strategy help companies be more profitable in the long run?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following
exercises:
Exercise 1
The inflation rate of a country can impact the valuation of multinational corporation’s
assets. In fact, your U.S.-based company has operations in the following countries:
Belarus, Costa Rica, Egypt, Finland, Ghana, Iceland, Paraguay, Thailand, and Zimbabwe.
Based on the most recent inflation data available, categorize each country’s asset
devaluation from highest to lowest. Be sure to use the globalEDGE™ website’s “country
comparator” tool that allows investigators to compare countries based on statistical
indicators.
Exercise 2
Country risk is an important issue for international investors to consider. As your firm is
looking to invest in the Middle East, use the @rating resource to identify and present the
country ratings for each of the following Middle Eastern countries: Egypt, Israel,
Lebanon, Qatar, and the United Arab Emirates. Which country would you recommend
for investment? Justify your position thoroughly.
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Answers to the Exercises
Exercise 1
The Country Comparator section is located under the “Country Insights” and “Country
Tools & Games” section of the globalEDGE website. The countries specified in the
Exercise 2
The report can be accessed by searching for the term “@rating” at
http://globaledge.msu.edu/ResourceDesk/. Using this search, the link will lead the user to
this report. This resource is found under the globalEDGE category “Research: Rankings”.
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End of Part Case Notes
Part Six:
Building the Boeing 787
1. What are the benefits to Boeing of outsourcing so much work on the 7878 to foreign
suppliers? What are the potential risks? Do the benefits outweigh the risk?
Answer: Boeing made the decision to outsource much of the production of the 787
because of the potential gains this strategy could realize. By outsourcing, Boeing hoped
to achieve significant costs savings, generate additional sales in the countries where
2. In 2007 and 2008 Boeing ran into several publicized issues with regard to its
management of globally dispersed supply chain. What are the causes of these problems?
What can a company like Boeing do to make sure that such problems do not occur in the
future?
Answer: In 2007-2008, Boeing announced that delivery of the 787 would be delayed by
as much as 12 months. The delay was the result of problems with Boeing’s partners.
Companies that had been hired to produce various parts were behind schedule, producing
inferior parts, and even outsourcing themselves. Many students will probably suggest
3. Some critics have claimed that by outsourcing so much work, Boeing has been
exporting American jobs overseas. Is this criticism fair? How should the company
respond to such criticism?
Answer: The question of whether jobs are being shipped abroad is likely to generate
significant debate among students. Some students will probably suggest that through its
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outsourcing program, Boeing is indeed taking jobs away from U.S. citizens. Other
students however, may note that cost savings were a critical issue for Boeing in its
Adopting International Accounting Standards
1. What are the benefits of adopting international accounting standards for a) investors
and b) for business enterprises?
Answer: For investors, the adoption of a common set of international accounting
standards is the key to facilitating comparisons of companies across borders. When
2. What are the potential risks associated with a move in a nation towards the adopting of
international accounting standards?
Answer: There are a number of risks associated with adopting international accounting
standards. Some students will probably point out that in a nation with an accounting
system that tends to overstate the value of a company as compared to the value IASB
3. In which nation is the move to adoption of IASB standards likely to cause revisions in
the reported financial performance of business enterprises, the United States or China?
Why?
Answer: Most students will probably suggest that the adoption of IASB standards would
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Li & Fung
1. What are the benefits to Li & Fung’s customers of working with the company? Why
do companies like The Limited outsource the coordination of manufacturing to Li &
Fung, rather than do it themselves?
Answer: Li & Fung has positioned itself as an expert in supply chain management. The
company, which maintains a network of independent suppliers in 40 different countries,
2. Li & Fung does no manufacturing itself. What then is its role? How does the
company create value?
Answer: Li & Fung’s expertise in global logistics has helped become one of the fastest
growing trading companies in the developing world. Key elements of the company’s
3. What do you think drives the choices that Li & Fung makes about who should produce
what for its clients?
Answer: One of Li & Fung’s selling points is its ability to quickly provide fulfillment
services to its customers. Clients like the clothing chain, The Limited for example,
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4. What is the source of Li & Fung’s competitive advantage in the global economy?
Answer: Most students will probably agree that the source of Li & Fung’s competitive