International Business 9e
By Charles W.L. Hill
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 20
Accounting and Finance in the International
Business
20-3
What Is Financial Management?
Financial management involves1. Investment decisions –what to finance2. Financing decisions –how to finance those
decisions3. Money management decisions –how to
manage the firm’s financial resources most efficiently
20-4
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 countrydifferences 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
20-5
What Determines National Accounting Standards?
Several variables influence the development of a country’s accounting system including the relationship between business and the
providers of capital political and economic ties with other
countries the level of inflation the level of a country’s economic
development the prevailing culture in a country
20-6
How Do Providers Of Capital Influence Accounting?
A country’s accounting system reflects the relative importance of each constituency as a provider of capital accounting systems in the U.S. and Great
Britain are oriented toward individual investorsSwitzerland and Germany focus on providing
information to banks
20-7
How Do Political And Economic Ties Influence Accounting?
Similarities in accounting systems across countries can reflect political or economic tiesthe U.S. accounting system influences the
systems in the Philippinesin the European Union, countries are moving
toward common standardsthe British system of accounting is used by
many former colonies
20-8
How Do Levels of Development Influence Accounting?
Developed nations tend to have more sophisticated accounting systems than developing countries larger, more complex firms create accounting
challengesproviders of capital require detailed reports
Many developing nations have accounting systems that were inherited from former colonial powers lack of trained accountants
20-9
What Are Accounting And Auditing Standards?
Accounting standards are rules for preparing financial statementsthey define useful accounting information
Auditing standards specify the rules for performing an auditthe technical process by which an
independent person gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable
20-10
Why Are International Accounting Standards Important? The growth of transnational financing and
transnational investment has created a need for transnational financial reportingmany 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 economywill facilitate the development of global capital
markets
20-11
Why Are International Accounting Standards Important? The International Accounting Standards Board
(IASB) is a major proponent of standardization of accounting standardsmost IASB standards are consistent with standards
already in place in the U.S.by 2011, 100 nations have adopted IASB standards
or permitted their use in reporting financial results the EU has mandated harmonization of accounting
principles for members there soon could be only two major accounting bodies
with substantial influence on global reporting FASB in the U.S. and IASB elsewhere
20-12
How Does Accounting Influence Control Systems?
The control process in most firms is usually conducted annually and involves three steps1. Subunit goals are jointly determined by the
head office and subunit management2. The head office monitors subunit
performance throughout the year3. The head office intervenes if the subsidiary
fails to achieve its goal, and takes corrective actions if necessary
20-13
How Do Exchange Rates Influence Control?
Budgets and performance data are usually expressed in the corporate currency normally the home currency
facilitates comparisons between subsidiaries
but, can create distortions in financial statements
20-14
How Do Exchange Rates Influence Control?
The Lessard-Lorange Model firms can deal with the problems of exchange
rates and control in three ways1. The initial rate
the spot exchange rate when the budget is adopted2. 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
20-15
What Is The Lessard-Lorange Model?
Possible Combinations of Exchange Rates in the Control Process
20-16
Why Separate Subsidiary and Managerial Performance?
Subsidiaries operate in different environments which influence profitabilitythe evaluation of a subsidiary should be kept
separate from the evaluation of its managerA manager’s evaluation should
consider the country’s environment for business
take place after making allowances for those items over which managers have no control
20-17
What Is Financial Management?
Good financial management can create a competitive advantage reduces the costs of creating value and adds
value by improving customer service Decisions are more complex in
international business different currencies, tax regimes, regulations
on capital flows, economic and political risk, etc.
20-18
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
20-19
Why Is Capital Budgeting More Difficult For International Firms?Capital budgeting is more complicated in
international businessbecause a distinction must be made between
cash flows to the project and cash flows to the parent company
because of political and economic riskbecause the connection between cash flows
to the parent and the source of financing must be recognized
20-20
What Is The Difference Between Project And Parent Cash Flows?
Cash flows to the project and cash flows to the parent company can be quite different
Parent companies are interested in the cash flows they will receive, not the cash flows the project generates received cash flows are the basis for dividends, other
investments, repayment of debt, and so on Cash flows to the parent may be lower because of
host country limits on the repatriation of profits, host country local reinvestment requirements, etc.
20-21
How Does Political 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 businesshigher in countries with social unrest or disorder, or
where the nature of the society increases the chance for social unrest
Political change can result in the expropriation of a firm’s assets, or complete economic collapse that renders a firm’s assets worthless
20-22
How Does Economic Risk Influence Investment Decisions?
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
The biggest economic risk is inflationreflected in falling currency values and lower
project cash flows
20-23
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
20-24
How Do Firms Make Financing Decisions?
Firms must consider two factors 1. How the foreign investment will be
financed the cost of capital is usually lowest in the
global capital market but, some governments require local debt or
equity financing firms that anticipate a depreciation of the
local currency, may prefer local debt financing
20-25
How Do Firms Make Financing Decisions?
2. How the financial structure (debt vs. equity) of the foreign affiliate should be configured
need to decide whether to adopt local capital structure norms or maintain the structure used in the home country
Most experts suggest that firms adopt the structure that minimizes the cost of capital, whatever that may be
20-26
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 notes payable and unexpected demands
cash reserves are usually invested in money market accounts that offer low rates of interest
when firms invest in money market accounts they have unlimited liquidity, but low interest rates
when they invest in long-term instruments they have higher interest rates, but low liquidity
20-27
What Is Global Money Management?
2. Reduce transaction costs - the cost of exchange
every time a firm changes cash from one currency to another, they face transaction costs
Most banks also charge a transfer fee for moving cash from one location to another
Multilateral netting can reduce the number of transactions between subsidiaries and the number of transaction costs
20-28
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
20-29
How Can Firms Limit Their Tax Liability?
Taxes can be minimized through1. 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
20-30
How Do Firms Move Money Across Borders?
Firms can transfer liquid funds across border via1. Dividend remittances2. Royalty payments and fees3. Transfer prices4. Fronting loans
20-31
What Are Dividend Remittances?
Paying dividends is the most common method of transferring funds from subsidiaries to the parent
The relative attractiveness of paying dividends varies according to tax regulations – high tax rates make this less attractive foreign exchange risk – dividends might speed up in
risky countries the age of the subsidiary – older subsidiaries remit a
higher proportion of their earning in dividends the extent of local equity participation – local owners’
demands for dividends come into play
20-32
What Are Royalty Payments And Fees?
Royalties - 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 namescan be levied as a fixed amount per unit or as a
percentage of gross revenuesmost parent companies charge subsidiaries royalties
for the technology, patents or trade names transferred to them
20-33
What Are Royalty Payments And Fees?
A fee is compensation for professional services or expertise supplied to a foreign subsidiary by the parent company or another subsidiaryroyalties and fees are often tax-deductible
locally
20-34
What Are Transfer Prices? Transfer prices - the price at which goods and
services are transferred between entities within the firm
Transfer prices can be manipulated to1. Reduce tax liabilities by shifting earnings from high-
tax countries to low-tax countries2. Move funds out of a country where a significant
currency devaluation is expected3. Move funds from a subsidiary to the parent when
dividends are restricted by the host government4. Reduce import duties when ad valorem tariffs are in
effect
20-35
What Makes Transfer Prices Unattractive?
But, using transfer pricing can be problematic because1. Governments think they are being cheated
out of legitimate income2. Governments believe firms are breaking the
spirit of the law when transfer prices are used to circumvent restrictions of capital flows
3. It complicates management incentives and performance evaluation
20-36
What Are Fronting Loans?
Fronting loans are loans between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank
Firms use fronting loansto circumvent host-country restrictions on the
remittance of funds from a foreign subsidiary to the parent company
to gain tax advantages
20-37
What Are Fronting Loans?An Example of the Tax Aspects of a Fronting Loan
