International business has traditionally been associated with foreign trade. This activity, rooted in antiquity, continues unabated. While trade in services has traditionally paled in comparison to trade in merchandise, the former is gaining in significance and growing at a faster rate than the latter. Current trends in exports and imports of both goods and services by region and selected economy are depicted.
To obtain a better picture of the pattern of global trade at the micro level, one could examine the foreign operations disclosures of any major MNC. The geographic distribution of sales of AKZO Nobel, a multinational company headquartered in the Netherlands and concentrating on healthcare products, coatings, and chemicals. As can be seen, the company’s sales literally blanket every continent in the world. Unisys, the U.S.-based information technology services company, provides its expertise to clients in over 100 countries, while Japan’s Cannon Inc. sells cameras and other professional and consumer imaging equipment in virtually every country of the world. An aggregation of such disclosures for all MNCs in all countries would confirm that trade today is neither bilateral nor regional, but truly global.
A major accounting issue associated with export and import activities relates to accounting for foreign currency transactions. Assume, for example, that Heineken exports a certain quantity of beer to a Brazilian importer and invoices the sale in Brazilian reals. Should the real devalue relative to the euro prior to collection, Heineken will experience a foreign exchange loss as reals will yield less euros upon conversion after the devaluation than before.
Today, international business transcends foreign trade and is increasingly associated with foreign direct investments, which involve operating production or distribution systems abroad by way of a wholly or majority-owned affiliate, a joint venture, or a strategic alliance. While there is clearly a developed country bias of foreign direct investors, the boom of foreign direct investment flows to developing countries since the early 1990s indicates that MNCs are increasingly finding these host countries to be attractive investment locations.
At the level of the firm, foreign direct investment activities are captured by a company’s segmental disclosures and its roster of shareholdings in affiliated companies. Provides operating statistics by region for AKZO Nobel. The extensive holdings in operating group companies of Nestle, one of the world’s largest food and beverage companies headquartered in Vevy, Switzerland. While both AKZO and Nestle’s foreign operations are extensive, the numbers relating to capital expenditures, invested capital, production sold locally, and number of foreign employees understate the extent of their foreign operations. They do not reflect the extent of either company’s joint venture, strategic alliance, or other cooperative arrangements.
Operations conducted in foreign countries expose both financial managers and accountants alike to an additional set of problems that they do not encounter when solely engaged in international trade. As one example, how should an MNC like Nestle report the results of its operations, both domestic and international, to its South Korean investors? As national financial reporting principles can vary significantly from country to country as they are shaped by different socio-economic environments. Environmental influences that impinge on accounting development are examined. Nestle’s domestic shareholders are used to seeing reports on the basis of Swiss reporting conventions. Examination of Nestle’s accounting policies on consolidation suggests that the company first restates all of its foreign accounts to the reporting framework of the parent company prior to consolidation.
The report of Nestle’s auditors state that the consolidated financial statements comply with Swiss Law and are in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) and with the Interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC). But in restating from one set of principles to another, does something get lost in the translation? To illustrate, Mexican companies adjust their financial statements for changing prices, owing to serious bouts of inflation in the past. Their adjustment for changing prices utilizes a methodology that incorporates changes in specific prices or replacement costs. Nestle, on the other hand, restates assets located in hyperinflationary countries for changes in the general purchasing power of the local currency prior to consolidation. Since general price changes seldom move in tandom with specific price changes, does Nestle’s ethodology reduce the information content of the Mexican subsidiary’s inflation-adjusted accounts? Yamaha, producer of world-renowned musical instruments and other lifestyle products, expresses this concern in the first footnote to its consolidated financial accounts.
Yamaha Corporation (the Company) and its domestic subsidiaries maintain their accounting records and prepare their financial statements in accordance with accounting principles and practices generally accepted in Japan, and its foreign subsidiaries maintain their books of account in conformity with those of their countries of domicile. The Company and all consolidated subsidiaries are referred to as the “Group.” The accompanying consolidated financial statements have been prepared from the financial statements filed with the Ministry of Finance as required by the Securities and Exchange Law of Japan. Accordingly, the accompanying consolidated financial statements may differ in certain significant respects from accounting principles and practices generally accepted in countries and jurisdictions other than Japan. Then there is the choice of exchange rate to use in converting foreign accounts to a single reporting currency. There are a variety of rates that an MNC can use. As foreign exchange rates are seldom constant,restating accounts using exchange rates that gyrate almost daily produces gains and losses that can have a significant effect on the reported profitability and perceived riskiness of multinational operations. As you might suspect, accounting treatments for these gains and losses are far from uniform internationally.
Domestic readers are not the only audience that reporting entities must address. What about statement readers that are domiciled abroad? Their information needs must be considered when a firm seeks access to foreign sources of capital and at reasonable costs. Market access and cost of capital considerations are, in turn, related to the nature and quality of a firm’s external financial communications. Should a company send the same set of accounts that it prepares for its domestic readers to its foreign readers? Or, should the reporting entity restate its reports according to the language, currency and/or accounting principles of the reader’s country? This is not a trivial consideration as foreign readers are generally unaccustomed to providing money capital on the basis of an unfamiliar currency, language, and measurement framework. Evidence suggests that some institutional investors tend to exhibit a home country bias in their portfolio choices and tend to invest in nondomestic firms whose accounting and re orting methods conform to the GAAP framework that they are accustomed to.4 Would you be interested in investing in the shares of a Chinese company if the numbers in the annual report you received were expressed in Renmenbi, the text written in Mandarin, and the accounting measurements based on Chinese GAAP?
Both AKZO and Nestle, mentioned earlier, have chosen to accommodate their foreign readers by restating their financial statements to International Financial Reporting Standards (IFRS). AKZO’s initiative is in compliance with a European Union (EU) directive that mandates all EU listed companies to follow IASB standards. Nestle’s decision is voluntary as its decision to conform to IFRS predates the EU requirement. Issues associated with management’s use of special disclosures for nondomestic financial statement readers are covered in Chapter 5. In addition to external reporting, a firm’s internal users of accounting information, that is, financial managers and accountants, must also understand the effects of environmental complexities of an MNE’s accounting measurements. For example, understanding the effects of changes in foreign exchange and inflation rates is critical in areas such as the preparation of short- and long-term budgets for parent companies and th ir subsidiaries (or branches), measuring and evaluating the performance of local business units and managers, and making corporate-wide decisions on the allocation of investment capital and retained earnings, among others. To make matters more complex, foreign exchange and inflation rates do not work in tandem. The effect on accounting measurements of changes in foreign exchange rates and foreign inflation is so pervasive that domestic financial control systems cannot serve managers well in the absence of appropriate environmental adaptation. Then there are issues of management control. While companies often expand operations abroad to take advantage of low-cost labor or untapped markets, productivity and decision-making styles can be so different that company expectations are often met with disappointment. Imposing culturally inappropriate control systems on foreign managers only magnifies such disappointments. 5 Managerial accounting from an international perspective includes possibly the most complex and etailed material in this book.
