Chapter 20

International Business
11e
By Charles W.L. Hill
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 20
Accounting and Finance

in the
International
Business
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
What Is
Financial Management?
 Financial management involves
1. Investment decisions – what to finance
2. Financing decisions – how to finance those
decisions
3. Money management decisions – how to
manage the firm’s financial resources most
efficiently
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 20-3
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 country
 differences 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
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
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 United States and
Great Britain are oriented toward individual
investors
 Switzerland and Germany focus on providing
information to banks
How Do Political and Economic
Ties Influence Accounting?
 Similarities in accounting systems across
countries can reflect political or
economic ties
 the U.S. accounting system influences the
systems in the Philippines
 in the European Union, countries are moving
toward common standards
 the British system of accounting is used by
many former colonies
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
challenges
 providers of capital require detailed reports
 Many developing nations have accounting
systems that were inherited from former colonial
powers
 lack of trained accountants
What Are 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
also reliable
required accounting standards and if they are
Why Are International
Accounting Standards Important?
 The growth of transnational financing and
transnational investment has created a need for
transnational financial reporting
 many 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 economy
 will facilitate the development of global capital
markets
Why Are International
Accounting Standards Important?
 The International Accounting Standards Board
(IASB) is a major proponent of
standardization of accounting standards
 most IASB standards are consistent with standards
already in place in the U.S.
 by 2012, 100 nations had 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
How Does Accounting
Influence 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
2. The head office monitors subunit
performance throughout the
year
3. The head office intervenes if the subsidiary
fails to achieve its goal and takes corrective
actions if necessary
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
How Do Exchange Rates
Influence Control?
 The Lessard-Lorange Model
 firms can deal with the problems of exchange
rates and control in three ways
1. The initial rate
 the spot exchange rate when the budget is adopted
2. 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
What Is the
Lessard-Lorange Model?
Possible Combinations of Exchange Rates in the Control
Process
Why Separate Subsidiary and
Managerial Performance?
 Subsidiaries operate in different
environments, which influence profitability
 the evaluation of a subsidiary should be kept
separate from the evaluation of its manager
 A 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
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.
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
Why Is Capital Budgeting More
Difficult for International Firms?
 Capital budgeting is more complicated in
international business
 because a distinction must be made between
cash flows to the project and cash flows to
the parent company
 because of political and economic risk
 because the connection between cash flows
to the parent and the source of financing
must be recognized
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.
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 business
 higher 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
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 inflation
 reflected in falling currency values and lower
project cash flows
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
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
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
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
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
How Can Firms Limit
Their Tax Liability?
 Every country has its own tax policies
 most countries feel that 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
How Can Firms Limit
Their Tax Liability?
 Taxes can be minimized through
1. 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 - agreements 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
Some of today’s top companies, including Apple, Google,
and Microsoft, seek to minimize their tax burden by storing
significant amounts of cash in foreign countries with low
corporate tax rates. Some view this as a shrewd business
practice, while others call it unethical tax avoidance.
As the chief financial officer of a multinational enterprise

with an expected $10 billion in profits for the upcoming
fiscal year, would you advise that the company follow
Apple, Google, Microsoft, and others in storing cash in
Ireland, the Cayman Islands, or another tax haven? Why or
why not?
How Do Firms Move
Money Across Borders?
 Firms can transfer liquid funds across
border via
1. Dividend remittances
2. Royalty payments and fees
3. Transfer prices
4. Fronting loans
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 reduce
attractiveness
 foreign exchange risk – dividends might be sped up
in risky countries
 the age of the subsidiary – older subsidiaries remit
a
higher proportion of their earning in dividends
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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 names
 can be levied as a fixed amount per unit or as a
percentage of gross revenues
 most parent companies charge subsidiaries royalties
for the technology, patents, or trade names
transferred to them
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 subsidiary
 royalties and fees are often tax-deductible
locally
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 to
1. reduce tax liabilities by shifting earnings from high-
tax countries to low-tax countries
2. move funds out of a country where a significant
currency devaluation is expected
3. move funds from a subsidiary to the parent when
dividends are restricted by the host government
4. reduce import duties when ad valorem tariffs are in
effect
What Makes
Transfer Prices Unattractive?
 Using transfer pricing can be problematic
because
1. governments think they are being cheated
out of legitimate income
2. 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
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 loans
 to circumvent host-country restrictions on
the remittance of funds from a foreign
subsidiary to the parent company
 to gain tax advantages
What Are Fronting Loans?
An Example of the Tax Aspects of a Fronting Loan

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International Business

By Charles W.L. Hill

Accounting and Finance

As the chief financial officer of a multinational enterprise

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