INTRODUCTION TO INTERNATIONAL

ACCOUNTING

Chapter 1

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Introduction to International Accounting

Learning Objectives
1.
Understand the nature and scope of
international accounting
2.
Describe accounting issues created by
international trade
3.
Explain reasons for, and accounting issues
associated with, foreign direct investment (FDI)

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Introduction to International Accounting

Learning Objectives
4.
Describe the practice of cross-listing on foreign
stock exchanges
5.
Explain the notion of international
harmonization of accounting standards
6.
Examine the importance of international trade, FDI,
and multinational corporations (MNCs) in the
global economy

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What is International Accounting?

International Accounting can be

described at three different levels:
The influence on accounting by international political
groups such as the OECD, UN, etc.
The accounting practices of companies in response to
their own international business activities
The differences in accounting standards and practices
between countries

Learning Objective 1

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Related

International Transactions, FDI and

Accounting Issues

Sale to foreign customer

Most companies first encounter with international
business occurs as sales to foreign customers.
Often, the sale is made on credit and it is agreed that
the foreign customer will pay in its own currency (e.g.,
Mexican pesos).

Learning Objective 2

1-5

Related

International Transactions, FDI and

Accounting Issues

Sale to foreign customer

This gives rise to foreign exchange risk as the
value of the foreign currency is likely to change in
relation to the companys home country currency
(e.g., U.S dollars).

Learning Objective 2

1-6

Related

International Transactions, FDI and

Accounting Issues

Sale to foreign customer

Suppose that on February 1, 2006, Joe Inc., a U.S.
company, makes a sale and ships goods to Jose,
SA, a Mexican customer, for $100,000 (U.S.).
However, it is agreed that Jose will pay in pesos
on March 2, 2006. The exchange (spot) rate as of
February 1, 2006 is 10 pesos per U.S. dollar.
How many pesos does Jose agree to pay?
Learning Objective 2

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Related

International Transactions, FDI and

Accounting Issues

Sale to foreign customer

Even though Jose SA agrees to pay 1,000,000
pesos ($100,000 x 10 pesos/U.S. $), Joe, Inc.
records the sale (in U.S. dollars) on February 1,
2006 as follows:
Dr. Accounts receivable (+)100,000
Cr. Sales revenue (+)
100,000

Learning Objective 2

1-8

Related

International Transactions, FDI and

Accounting Issues

Sale to foreign customer

Suppose that on March 2, 2006, the spot rate for
pesos is 11 pesos/U.S. $). Joe Inc. will receive
1,000,000 pesos, which are now worth $90,909.
Joe makes the following journal entry:
Dr. Cash (+)
90,909
Dr. Loss on foreign exchange (+)9,091
Cr. Accounts receivable
100,000
Learning Objective 2

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Related

International Transactions, FDI and

Accounting Issues

Hedging
Joe can hedge (i.e., protect itself) against a loss
from an exchange rate fluctuation. Hedging can
be accomplished by various means, including:
Foreign currency option the right (but not the
obligation) to sell foreign currency at a
specific exchange rate for a specified period of
time.
Learning Objective 2

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Related

International Transactions, FDI and

Accounting Issues

Hedging
Forward contract this is an obligation to
exchange foreign currency at a date in the future, which is
typically 30, 60 or 90 days.

Learning Objective 2

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Related

International Transactions, FDI and

Accounting Issues

Foreign Direct Investment (FDI) occurs when a

company invests in a business operation in a
foreign country. This represents an alternative to
importing to customers and/or exporting from
suppliers in a foreign country. Two types of FDI
are greenfield investment and acquisition.

Learning Objective 3

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Related

International Transactions, FDI and

Accounting Issues

Foreign Direct Investment (FDI)

Greenfield investment the establishment of a
new operation in the foreign country.
Acquisition investment in an existing operation
in the foreign country.

Learning Objective 3

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Related

International Transactions, FDI and

Accounting Issues

FDI creates two primary issues:

The need to convert from local to U.S. GAAP since
accounting records are usually prepared using local
GAAP
The need to translate from local currency to U.S.
dollars since accounting records are usually prepared
using local currency

Learning Objective 3

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International Income Taxation

Foreign income taxes the foreign government will tax

the companys profits at applicable rates.
U.S. income taxes the U.S. will tax the companys
foreign-based income.

Learning Objective 3

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International Transfer Pricing

Transfer pricing setting prices on goods and services

exchanged between separate divisions within the same
firm. These prices have a direct impact on the profits of
the different divisions.

Learning Objective 3

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International Transfer Pricing

These exchanges are not arms-length

transactions, thus giving rise to certain
problems in an international context:
Taxation governments in the various countries
often scrutinize transactions to assure that
sufficient profits are being recorded in that country.

Learning Objective 3

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International Transfer Pricing

Performance evaluation issues to the extent that

division managers are evaluated based on divisional
profits, transfer prices influence division manager
performance evaluation.

Learning Objective 3

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International Auditing

Both internal and external auditors encounter

differences that arise between auditing in an
international vs. domestic context. These
include:
Language and cultural differences
Different accounting standards (GAAP) and auditing
standards (GAAS)

Learning Objective 3

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Cross-listing on Foreign Stock

Exchanges

MNCs frequently raise capital outside their

home country. When a company offers its
shares on an exchange outside of its home
country, this is referred to as Cross-Listing.

Learning Objective 4

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International Harmonization of
Accounting
Standards
The international movement towards a single
set of worldwide accounting rules is referred to
as Harmonization. International Financial
Reporting Standards (IFRS) and U.S. GAAP are
the two most important sets of accounting
rules.

Learning Objective 5

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The Global Economy

Several indicators demonstrate the extent of

business globalization:
International trade In 2006 exports worldwide topped
$11.7 trillion. Between 1996 and 2006, U.S. exports
increased by 66% in volume.
Foreign Direct Investment Between 1982 and 2005
worldwide FDI inflows increased from $58 billion to $916
billion.

Learning Objective 6

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The Global Economy

Several indicators demonstrate the extent of

business globalization:
Multinational corporations (MNCs) Companies that
have headquarters in one country and operate in one or
more other countries. Currently, MNCs account for
approximately 10% of the worlds Gross Domestic
Product (GDP).

Learning Objective 6

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The Global Economy

Several indicators demonstrate the extent of

business globalization:
International capital markets As of the end of 2007
there were 422 companies representing 45 countries
cross-listed on the New York Stock Exchange (NYSE).
In addition, over 70 U.S. companies are cross-listed on
the London Stock Exchange, for example.

Learning Objective 6

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