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International Issues in Managerial Accounting

CHAPTER. International Issues in Managerial Accounting. Objectives. 1. Explain the role of the management accountant in the international environment. 2. Identify the varying levels of involvement that firms can undertake in international trade.

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International Issues in Managerial Accounting

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  1. CHAPTER International Issues in Managerial Accounting

  2. Objectives 1.Explain the role of the management accountant in the international environment. 2. Identify the varying levels of involvement that firms can undertake in international trade. 3. List the ways management accountants can manage foreign currency risk. 4. Explain why multinational firms choose to decentralize.

  3. Objectives 5.Describe how environmental factors can affect performance evaluation in the multinational firm. 6. Discuss the role of transfer pricing in the multinational firm. 7. Discuss ethical issues that affect firms operating in the international environment.

  4. Where does the management accountant fit into the global business environment?

  5. Business looks to the management accountant for international financial and business expertise.

  6. Management Accounting in the International Environment Skills needed by management accountants • Politics • Economics • Marketing • Management • Information Systems Technology

  7. Multinational Corporation (MNC) • Amultinational corporation (MNC)is onethat “does business in more than one country in such a volume that its well-being and growth rest in more than one country.”

  8. Importing and Exporting • Importingis the process of bringing product in from a foreign country. • Exporting is the process of shipping product to a foreign country.

  9. Foreign Trade Zones • Foreign trade zones are areas near a customs port of entry that are physically on U.S. soil but considered to be outside U.S. commerce. Example: San Antonio Example: New Orleans

  10. Example of the Advantages of Operating a Plant in a Foreign Trade Zone Roadrunner, Inc. operates a petrochemical plant in a foreign trade zone. Wilycoyote, Inc. operates an identical plant just outside the foreign trade zone. Both plants purchase $400,000 of crude oil from Venezuela.

  11. Example (continued) RoadrunnerWilycoyote Duty paid at purchase $ 0 $24,000 Wilycoyote pays duty at the point of purchase (6% of $400,000). Carrying costs of duty 0 1,920 Duty paid at sale 16,800 0 Total duty-related carrying costs (0.12 x 8/12 x $24,000) Roadrunner pays duty at point of sale because it is in a foreign trade zone.

  12. RoadrunnerWilycoyote Duty paid at purchase $ 0 $24,000 Carrying costs of duty 0 1,920 Duty paid at sale 16,800 0 Example (continued) Total duty and duty- related costs $16,800 $25,920 Clearly the advantage approach

  13. A company may choose to purchase an existing foreign company, making the purchased company a wholly owned subsidiary. If the laws of the country permit, an multinational corporation can simply set up a wholly owned subsidiary or branch office in the country.

  14. Outsourcing is the payment by a company for a business function formerly done in-house, such as payment for legal needs to outside firms. Outsourcing of technical and professional jobs is becoming an important issue for cost-conscious U.S. firms.

  15. A joint venture is a type of partnership in which investors co-own the enterprise. A special case of joint venture cooperation is the maquiladora—a manufacturing plant located in Mexico which processes imported materials and reexports them to the United States.

  16. Foreign Currency Exchange Currency risk management Transaction risk Economic risk Translation (accounting ) risk Kinds of risks:

  17. A Transaction Risk Example SuperTubs, Inc., a U.S. firm, sells its line of whirlpool tubs to Bonbain, a French distributor. On January 15, Bonbain orders 100 tubs at $1,000 per tub to be paid with French francs on March 15. The exchange rate on on January 15 is seven francs per dollar or 700,000 francs. Suppose that on March 15 the exchange rate is 7.1 francs per dollar. A $1,408 loss is experienced by SuperTubs, Inc. Receivable in dollars on Jan. 15 $100,000 Received in dollars on March 15 (700,000/7.1) 98,592 Exchange loss $ 1,408

  18. A Transaction Risk Example If the franc had strengthened against the dollar to a rate of 6.9 francs per dollar, a $1,449 gain would occur: Receivable in dollars on Jan. 15 $100,000 Received in dollars on March 15 (700,000/6.9) 101,449 Exchange gain $ 1,449

  19. One way of insuring against gains and losses on foreign currency exchanges is hedging.

  20. Managing Economic Risk Economic risk is the impact of exchange rate fluctuations on the present value of a firm’s future cash flows. Example A U.S. consumer can choose to purchase heavy equipment from either Caterpillar (U.S.) or Komatsu (Japan). A piece of equipment is $80,000 from either maker. At an exchange rate of $1 equals 130 yens, the price is set. Assume the dollar strengthens so the exchange rate becomes $1 equals 140 yens. This lowers Katmatsu’s price to $74,286.

  21. Quarter Expenditures in Local Currency 1 LC10,000 2 LC11,000 3 LC12,100 4 LC13,310 Managing Translation Risk Example Multinational, Inc., has a foreign division, FD, which has been experiencing eroding sales. Multinational directs FD managers to increase marketing expenditures over the following four quarters: A 10% increase each quarter

  22. Quarter Expenditures in Local Currency 1 $10,000 2 9,167 3 8,963 4 8,873 Managing Translation Risk Example (continued) Suppose that the dollar has strengthened against the local currency and the quarterly exchange rates of $1 for units of local currency are 1.00, 1.2, 1.35, and 1.50, respectively. It looks like FD has decreased expenditures.

  23. Advantages of Decentralizationin the MNC The quality of information is better at the local level. Local managers in the MNC are capable of a more timely response in decision making. Social, legal, and language barriers are minimized. Valuable training grounds for foreign subsidiary managers.

  24. Measuring Performance in the Multinational Firm It is particularly difficult to compare the performance of a manager of a division in one country with the performance of a manager of a division in another country.

  25. Measuring Performance in the Multinational Firm An example of misleading results: Assets Revenues Net Income Margin Turnover ROI Brazil $10 $ 6 $ 3 0.50 0.60 0.30 Canada 18 13 10 0.77 0.72 0.55 Spain 15 10 6 0.60 0.67 0.40 Analysis: On the basis of ROI, it appears that the manager of the Canadian subsidiary did the best job, while the manager of the Brazilian subsidiary did the worst job. However, the inflation rate in Brazil was 100% for the year. After adjusting the asset base for inflation, the ROI would be 60% for the Brazilian manager.

  26. Environmental Factors Affecting Performance Evaluation in the MNC • Economic Factors: • Organization of central banking system • Economic stability • Existence of capital markets • Currency restrictions Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

  27. Environmental Factors Affecting Performance Evaluation in the MNC • Political and Legal Factors: • Quality, efficiency, and effectiveness of legal structure • Effect of defense policy • Impact of foreign policy • Level of political unrest • Degree of governmental control of business Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

  28. Environmental Factors Affecting Performance Evaluation in the MNC • Educational Factors: • Literacy rate • Extent and degree of formal education and training systems • Extent and degree of technical training • Extent and quality of management development programs Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

  29. Environmental Factors Affecting Performance Evaluation in the MNC • Sociological Factors: • Social attitude toward industry and business • Cultural attitude toward authority and persons in subordinate positions • Cultural attitude toward productivity and achievement (work ethic) • Social attitude toward material gain • Cultural and racial diversity Adapted from Wagdy M. Abdallah, “Change the Environment or Change the System,” Management Accounting (October 1986): pp. 33-36.

  30. Income Taxes and Transfer Pricing Action Tax Impact Belgian subsidiary of parent 42% tax rate company produces a component $100 revenue – $100 at a cost of $100 per unit. Title to cost = $0 the component is transferred to a Taxes paid = $0 reinvoicing center in Puerto Rico at a transfer price of $100 per unit.

  31. Action Tax Impact U.S. subsidiary sells a component 35% tax rate to external company at $200 each. $200 revenue – $200 cost = $0 Taxes paid = $0 Income Taxes and Transfer Pricing Action Tax Impact Reinvoicing center in Puerto Rico, 0% tax rate also a subsidiary of parent company $200 revenue – $100 transfers title of component to U.S. cost = $100 subsidiary of parent company at a Taxes paid = $0 transfer price of $200 per unit.

  32. Comparable uncontrolled price method Resale price method Cost-plus method The IRS allows three pricing methods that approximate arm’s-length pricing (shown in the order of preference):

  33. Questions to Ask Concerning Ethics in the International Environment Is the action right legally? Is the action right morally?

  34. Chapter Fourteen The End

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