International Accounting and International Business

Chapter One

Introduction The basic purpose of accounting is to

provide useful information to prudent users…creditors, investors, and those how advise them.

Useful information is reliable and relevant. It should be neutral, verifiable, representationally faithful, and have predictive value, feedback value, and be timely.

This becomes difficult when dealing with a multinational enterprise…a corporation with foreign operations, foreign transactions, and/or users of the financial information that are in a different domicile than the reporting entity.

How many accounting systems do companies use in the US?

External reporting Tax reporting Internal decision-making,

including JIT, CPV, make/buy decisions, NPV of investments, performance evaluations…

So how many accounting systems do you think there are internationally?

Who Uses Accounting Information? Government Creditors Management Owners (private and public) Neighbors Employees Social and environmental activists Unions Others

Why is understanding International Accounting important?

Increasingly internationalized world of business

Language and currency are different (even terminology!)

Types and amount of information disclosed are likely to be different

Procedures followed to determine figures are likely to be different and may not be explained…valuation…(i.e., historical cost, fair market value, discounted cash flows) recognition and timing of recognition, and even realization

Why would we expect these differences? Differences in culture, business

practices, political and regulatory structures, legal systems, currency value, foreign exchange rates, local inflation rates, business risk, sources of finance, and tax codes all affect how the MNE conducts its operations and how it reports the results of those operations…that is, the company’s financial reporting..around the world.

To think about as we begin this course… Why are international accounting

issues important? Who has access to what information?

Is the access to governments, creditors, stockholders, neighbors, unions, different?

Who has the ability to request and receive information that might not otherwise be readily available?

What difference does form of business make when considering information users and information needs? Corporation, sole proprietorship, partnership…

How are financing needs, financing sources, and business form related? Where do businesses get capital? Family, friends, banks, investors…

What does this have to do with accounting information?

World Capital MarketsNorth America New York, San Francisco, Chicago, TorontoAsia Hong Kong, TokyoAustralia SydneyEurope London, Zurich, Frankfurt, Brussels, Milan, Paris,

Amsterdam, Stockholm, MadridSouth America Buenos Aires, Santiago, Mexico CityAfrica Johannesburg

As we become a global economy… World capital markets compete

for listings Companies increasingly use

multiple sources of capital Diversify risk Greater access to funds

How did we get to “where we are today?”

Historical Development of AccountingAncient World Mesopotamia, Egypt, India, China,

Rome

Middle Ages – Rise of Double Entry Bookkeeping, which seems to have evolved independently in different places, responding to the changing nature of business transactions and the need to record them properly

Genoa, Florence, Venice

National Differences in Accounting Systems

Historical developments did not lead to uniformity in international accounting practice

Despite similarities, no two systems are exactly alike

Reasons for Differences: Economic, Educational, Legal, Political, and Social/ Cultural Factors

Implications of National Differences in Accounting

Acts as a barrier to the free-flow of international business information

Potential to inhibit efficient allocation of resources

Potential to increase the cost of capital

Evolution and Significance of International Business

Greek Period First international sales of mass-produced

products through Greece in 5 B.C.

Roman Period First open market with political stability,

better transportation, and few tariffs or restrictions

Middle Ages Banking, Insurance, and trade fairs in

Byzantium

The Preindustrial Period

Europe: Rise of Mercantilism Right to trade regulated by the state, Colonialism driven by state’s direct

investment in colonies and near-monopolistic control of trade, and

Dominated by Western European Nations.

The Industrialization Period: 1780-1945

Technological inventions led to unprecedented mass production and standardization,

Implementation of large-scale infrastructure between historically separate markets, and

Birth of large multinational corporations such as: Singer, Ford, Dunlop, and Lever Brothers.

The mass production of goods encouraged (or perhaps required) companies to look for new markets to take advantage of these economies of scale.

The Post-World War II Period

Great Depression and WWII stunted international trade

Following the end of the war, demand for products and services, trade and investment sharply increased.

The Multinational Era

Involvement in International trade is essential for developing nations, and

For the continued economic growth of developed nations.

What is International Business? All business transactions involving

two or more countries.

Reasons for International Involvement Expand sales, Gain access to raw materials and

other factors of production, and Obtain information, technical

expertise (i.e. patents, licenses, “know-how”).

Forms of International Involvement Exporting and Importing of goods

and services, Strategic alliances including

licensing agreements, franchises, and joint ventures, (McDonalds, Holiday Inn, Pizza Hut), and

Direct investment.

Global Enterprises

Multinational enterprises are those which:

Have a world-wide view of production, materials, components and final markets;

Have over 10% of sales, assets, earnings, and employees abroad.

Large MNE’s

Indicators: Sales and Market Value, Profits and Return on Shareholders

Equity, and Worldwide stock market

valuations.

The Decision to Become Global:

The decision to become global depends on how effectively management assesses two different but interactive dimensions: the external environment and the internal capabilities of the firm.

The Decision to Become Global: External Environment v. Internal Capabilities

Environmental Constraints-Domestic:

Educational, Sociological

(Sociocultural), Political/ Legal, and Economic.

Environmental Constraints-International:

May differ from domestic constraints and mostly concerned with nationalism

Firm Specific Advantages

Intangibles that provide a unique firm advantage,

Examples include market-niche capabilities and personnel advantages.

Accounting Aspects of International Business

Accounting requirements differ with each successive stage of international involvement,

For example, import-export stage would require investigation of potential buyer or seller for purposes of determining credit-worthiness and capacity to perform.

Initial Issues may include: statements written in foreign language, amounts in foreign currencies, and information produced using different standards.

Establishing an Internal International Accounting Capability

Increased international involvement requires: Internal accounting resources, Creation of separate organization to handle international trade, and Creation of a foreign operation of some kind.

Degrees of Involvement: International accounting knowledge may be necessary even with no

direct international business involvement (i.e. company needs to borrow money or sell stock internationally).

The Field of International Accounting

Increased need for accountants who understand the international accounting environment,

International certification possibilities, and Fascinating career opportunities.

Capital Markets Accounting plays a critical role in the efficient

functioning of capital markets (and Enron has given us a taste of just how important it is to have reliable accounting information if capital markets are going to function efficiently)

The needs of capital market participants have strongly shaped the development of accounting practice.

The dollar value of cross-border equity listings almost tripled between 1995 and 1999, with over US$500 billion raised during that 5-year period. International offerings in bonds, syndicated loans, and other debt instruments also grew dramatically during the 1990s.

From 1998 through 2001, for example, 405 non-U.S. firms listed on Nasdaq, raising an average of $125.5 million each.

One of the biggest constraints to growth is access to capital.

In previous decades, companies typically listed on their home country's stock exchange Firms in places such as the United States and Germany had an advantage because those two countries had the richest capital markets. A company with a good product or service and a potentially hefty pool of customers was likely to get funded.

In contrast, firms in entrepreneurially energetic places with smaller stock markets such as Israel and India operated at a disadvantage. Simply put, there was less money to go around.

In a survey, Amit and Zott discovered multiple reasons for cross-border listings, although fundraising predominated. Every firm they surveyed listed money as a motive. But about two-thirds also wanted to increase their international visibility, and a third wanted to broaden the geographic distribution of their shareholders.

Companies that list abroad also make useful foreign contacts and improve their familiarity with foreign consumers and competitors, Amit and Zott point out. That, in turn, can help them boost their foreign sales and market share. That's especially important for, say, an Israeli firm listing on Nasdaq because Israel's economy is dwarfed by the United States'.

Hundreds of foreign issuers have had their equity listed on European, North American, and Japanese equity markets for years.

WHY?

At the same time, there is a growth in listings on some of Europe’s “new markets”…markets designed to meet the needs of young, high-growth companies seeking new capital.

More flexible listing standards, but their financial reporting and corporate governance standards are often more STRINGENT…why? RISK!

Major Equity Markets North America, especially NYSE and NASDAQ Asia…Japan, PRC, :Asian Tigers” of Singapore, Hong Kong,

Taiwan, Thailand Market meltdown of July, 1997 Critics suggest that Asian accounting and political practices

deter potential investors.

Western Europe is now the second largest equity market in terms of market capitalization and trading volume. There was dramatic growth of many Western European markets in the second half of the 1990s.

Economic growth Shift toward equity financing (as opposed to government

ownership or debt)

The growth of an equity culture in Europe has encouraged the equity markets in the European countries to become more similar.

This convergence is one step toward market integration, when location is no longer a relevant variable

However, European markets are still fragmented, and cross-border trading is still expensive, which is a barrier to integration.

Fragmentation Decreased by technology and competition Increased by language, culture, legal, tax, and market

regulation differences In Europe, the threat and the promise of the

European Union…nationalism, vs. integration and the power of size

Reasons for cross-border listings Broaden the shareholder base Promote awareness of products Promote awareness of the company Are these goals met? Not usually Thinly traded listings, few local

shareholders, and decreasing number of listings

Stock Exchange Alliances and Mergers Alliances and mergers have made the European capital market

interactions complex Alliances involve the sharing of various stock exchange

functions including marketing, listing, order routing, information dissemination, order execution, matching, clearing, settlement, and administration

The impetus is cost containment, which would lead to a competitive advantage

The alliances are to benefit each participant, but the participants are rivals, which is a barrier to cooperation

What are the current issues?

International accounting standards (IFRS) Formerly called IASs.

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