Chap 19

Griffin and Pustay Third Edition
INTERNATIONAL
BUSINESS
A MANAGERIAL PERSPECTIVE
Chapter 19
International Accounting and Taxation
1
Prentice
Prentice
Hall ©Hall
2002©International
2002 International
Business
Business
3e 3e
Chapter Objectives
After studying this chapter you should be able to:
• Discuss the various factors that influence the

accounting systems countries adopt.
• Describe the impact these national accounting
differences have on international firms.
• Analyze the benefits to international firms of
harmonizing differences in national accounting
systems.
• Describe the accounting procedures used by U.S.
firms engaged in international business.
2
Prentice Hall © 2002 International Business 3e
Chapter Objectives (cont.)
After studying this chapter you should be able to:
• Identify the major international taxation issues

affecting international businesses.
• Discuss the taxation of foreign income by the
U.S. government.
• Assess the techniques available to resolve
tax conflicts among countries.
3
Mr. Anchovy Was Wrong
• The accounting industry is dominated by five

firms, collectively referred to as the Big Five.
• Megamergers are nothing new in this
industry. This trend toward consolidation can
be explained in part by the growth of
international business. As their clients have
globalized, accounting firms have felt
compelled to expand their operations in order
to meet their client’s needs—as well as to
retain their business.
4
Mr. Anchovy Was Wrong
(cont.)
• By merging with existing accounting firms, the
Big Five have gained quick access to many
domestic markets as well as to the existing
client bases of the acquired firms.
• That doesn’t mean, however, that the
managers of the Big Five can afford to relax.
They must manage their explosive growth,
maintain the quality of services they offer their
clients, and keep their employees happy.
5
The Roots of Differences in
Accounting
• A country’s accounting standards and
practices reflect the influence of legal,
cultural, political, and economic factors.
• The difference between common law and
code law is one example.
• A country’s accounting system may reflect its
national culture. The detailed accounting
procedures laid down by the French
government mirror France’s statist tradition.
6
The Roots of Differences in
Accounting (cont.)
• Capital markets may also affect national accounting
standards. U.S. firms have historically raised capital
by relying on public investors. U.S. accounting
standards therefore emphasize the provision of
accurate and useful information to help outsiders
make appropriate investment decisions.
• Most Japanese firms have large debt-to-equity ratios
by Western standards. Thus Japanese accounting
standards are geared toward meeting the needs of
the firm’s lenders and keiretsu partners, both of which
already have privileged access to the firm’s financial
records, rather than those of outside investors.
7
Differences in Accounting
Practices
• Some of the more important national

accounting differences that affect
international business are:
– Valuation and revaluation of assets
– Valuation of inventories
– Dealing with the tax authorities
– Use of accounting reserves
8
Impact on Capital Markets
• Australia’s accounting practices used to allow firms to

appear more profitable than identically performing
U.S. firms, an advantage that helped Aussie
entrepreneurs gain favorable access to additional
capital.
• Many foreign bankers believe that the United States
is the easiest foreign locale in which to lend because
of U.S. public disclosure policies. Those policies
result in reliable numbers for assessing the riskiness
of potential loans.
9
Impact on Corporate Financial
Controls
• National differences in accounting procedures
also complicate an MNC’s ability to manage
its foreign operations.
• In practice, there is no uniform answer to the
question of which currency to use for
performance evaluation: some MNCs choose
the host currency and others the home
currency, but most appear to use both.
10
Efforts at Harmonization
• Differences in accounting systems are

confusing and costly to international
businesses. To help solve such problems, many
accounting professionals and national
regulatory bodies are attempting to harmonize
the various national accounting practices.
• One of the most important of these efforts was
the creation of the International Accounting
Standards Committee (IASC) in 1973.
11
Efforts at Harmonization (cont.)
• The EU has undertaken a separate

initiative to harmonize the accounting
systems of its member states as part of
its drive to complete the formation of its
internal market.
• Other groups, such as the World Trade
Organization and IOSCO, have also
lobbied for the adoption of international
accounting standards.
12
Accounting for International
Business Activities
• Most international firms must deal with
two types of specific accounting
problems that routinely develop when
business is conducted internationally:
– Accounting for transactions denominated in
foreign currencies
– Reporting the operating results of foreign
subsidiaries in the firm’s consolidated
financial statements
13
Accounting for Transactions in
Foreign Currencies
• Under the existing flexible exchange-rate
system, it is very likely that the exchange rate
will change between the time a firm enters
into an international transaction and the time
it receives payment or pays for the goods,
services, or assets in question. In accordance
with FASB Statement 52, issued in 1981,
U.S. firms must account for such international
transactions by using the two-transaction
approach in their financial statements.
14
Foreign Currency Translation
• The process of transforming a subsidiary’s

reported operations denominated in a
foreign currency into the parent’s home
currency is called translation.
• Consolidated financial statements report
the combined operations of a parent and
its subsidiaries in a single set of
accounting statements denominated in a
single currency.
15
Foreign Currency Translation
(cont.)
• A U.S. firm that has a portfolio investment in a

foreign firm (less than 10 percent ownership)
must use the cost method of accounting.
• A U.S. firm that owns between 10 and 50
percent of a foreign firm’s stock must use the
equity method.
• If a U.S. firm owns more than 50 percent of a
foreign firm, the U.S. firm must use the
consolidation method.
16
International Taxation Issues
• Two common means international

businesses adopt to reduce their overall
tax burden are:
– Transfer pricing
– Tax havens
17
Transfer Pricing
• Transfer prices are calculated in one of two ways:

– Market-based method
– Nonmarket-based methods
• The market-based method utilizes prices determined
in the open market to transfer goods between units of
the same corporate parent.
• The market-based approach has two main benefits:
– It reduces conflict between the two units over the
appropriate price.
– It promotes the MNC’s overall profitability by encouraging
the efficiency of the selling unit.
18
Transfer Pricing (cont.)
• Transfer prices may also be established using

nonmarket-based methods.
• One disadvantage of using nonmarket-based
pricing is that the managers of the buying and
selling units may waste time and energy
arguing over the appropriate transfer price.
• However, creative rearranging of
intracorporate prices may allow the parent to
lower its overall tax bill.
19
Arm’s Length Test
A transaction is said to be
‘at arm’s length’ if the terms
are what two unrelated firms
would have agreed upon.
20
Tax Havens
• For a relatively small fee, an MNC may set up

a wholly owned subsidiary in a tax haven.
• To attract MNCs, a tax haven must not only
refrain from imposing income taxes but also
provide a stable political and business
climate.
• Being a tax haven can create a thriving
economy. The firms create demand for highly
paid professionals such as accountants.
21
Taxation of Exports
• Ordinarily, the U.S. tax code treats the profits
associated with the export of goods and services the
same as domestically generated income.
• However, to encourage firms to increase their export
activities, the U.S. tax code allowed firms to establish
foreign sales corporations (FSC).
• In early 2000, the WTO, acting on a complaint filed by
the European Union, determined that the tax breaks
offered FSCs violated its rules against unfair
subsidization of exports. The United States is in the
process of adjusting its tax code to bring it in
compliance with the WTO’s rules.
22
Taxation of Foreign Subsidiary
Income
• In general, for U.S. tax purposes, a U.S. parent
corporation does not need to include the earnings of
its foreign subsidiaries in reporting its profits to the
IRS.
• The deferral rule in the U.S. tax code allows such
earnings to be taxed only when they are remitted to
the parent in the form of dividends.
• A controlled foreign corporation (CFC) is a foreign
corporation in which U.S. shareholders—each of
which holds at least 10 percent of the firm’s share—
together own a majority of its stock.
23
Taxation of Foreign Subsidiary
Income (cont.)
• According to U.S. tax code, the income of CFCs is
divided into two types:
– Active income
– Passive income (also called Subpart F income)
• The U.S. government, by treating active and
passive earnings of foreign subsidiaries
differently, is walking a fine line between
stimulating U.S. firms’ international business
activities and limiting their ability to evade U.S.
taxes through the creation of subsidiaries in tax
havens.
24
Tax Credits
• The U.S. tax code allows U.S. firms to reduce

their federal corporate income taxes by the
amount of foreign income taxes paid by their
foreign branches or subsidiaries, subject to
certain limitations.
• International firms generally hire
professionals knowledgeable about the
intricacies of the tax code’s treatment of
foreign tax credits.
25
Tax Treaties
• To promote international commerce,

many countries sign treaties that
address taxation issues affecting
international business.
• While details vary, many of these
treaties contain provisions for reducing
withholding taxes imposed on firms’
foreign branches and subsidiaries.
26
Chapter Review
• The accounting tasks international businesses confront
are more complex than those purely domestic firms face.
• To reduce the costs that differing national accounting
systems impose on international businesses and
international investors, several efforts are underway to
harmonize the accounting systems of the major trading
nations.
• Firms engaged in international business typically face
two specific accounting challenges: accounting for
transactions in foreign currencies and translating the
reported operations of foreign subsidiaries into the
currency of the parent firm for purposes of consolidation.
27
Chapter Review (cont.)
• International businesses are also challenged in
dealing with various countries’ taxation policies.
MNCs try to maximize their after-tax profitability by
taking advantage of tax breaks and avoiding punitive
taxes.
• Like many countries, the United States offers
favorable tax incentives to encourage its firms to
participate in international business.
• Because of the revenue needs of governments,
international businesses often find themselves in
conflict with foreign governments.
28

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Griffin and Pustay Third Edition

• Discuss the various factors that influence the

• Identify the major international taxation issues

• The accounting industry is dominated by five

• Some of the more important national

• Australia’s accounting practices used to allow firms to

• Differences in accounting systems are

• The EU has undertaken a separate

• The process of transforming a subsidiary’s

• A U.S. firm that has a portfolio investment in a

• Two common means international

• Transfer prices are calculated in one of two ways:

• Transfer prices may also be established using

• For a relatively small fee, an MNC may set up

• The U.S. tax code allows U.S. firms to reduce

• To promote international commerce,

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