This document provides an overview and outline of Chapter 18 which discusses international accounting issues. It examines factors that influence the development of accounting practices in different countries and the global convergence of standards. It also discusses how companies account for and translate foreign currency transactions and financial statements. Performance evaluation of foreign operations is complicated by issues like transfer pricing and foreign exchange rates. The balanced scorecard framework is introduced as an approach to evaluate performance from multiple perspectives.

1. CHAPTER EIGHTEEN
INTERNATIONAL ACCOUNTING ISSUES
Objectives
• To examine the major factors influencing the development of accounting practices in
different countries and the worldwide convergence of accounting standards
• To explain how companies account for foreign-currency transactions and translate
foreign-currency financial statements
• To illustrate how companies issue environmental reports
• To discuss different forms of performance evaluation of foreign operations and how
foreign exchange can complicate the budget process
• To explain how arbitrary transfer pricing can complicate performance evaluation and
control
• To introduce the balanced scorecard as an approach to evaluating performance
Chapter Overview
The international accounting and taxation functions comprise great challenges for today’s
global business managers. Chapter Eighteen presents the key accounting and taxation
issues confronting firms that do business abroad. First, the chapter examines the ways in
which national accounting systems differ and how today’s global capital markets force
countries to consider the harmonization of their accounting and reporting standards. It
then explores a number of unique issues MNEs face, such as the valuation and translation
of transactions and assets that are denominated in foreign currencies. The chapter
concludes with an examination of the impact of transfer pricing on business unit
performance evaluation and an explanation of the balanced scorecard approach to
performance evaluation.
Chapter Outline
OPENING CASE: Parmalat—Europe’s Enron
This case gives an overview of the accounting manipulations that were at the center of
one of Europe’s most massive corporate scandals. Parmalat, which started as a family
owned Italian dairy company, grew into large multinational with over 32,000 employees.
In the 1990s, Parmalat was reporting healthy profits that turned out to actually be created
by accounting fraud rather than real operations. The fraudulent practices included double
billing of Italian supermarkets and other retailers, “off-balance sheet financing” that
involved the creation of three phony shell companies based in the Caribbean, and the
issuance of bonds backed up by falsified assets. The schemes allowed the company to
report profits every year between 1990 and 2003, even though the company should have
reported operating losses for each of these years. The fraud was discovered when the
206

2. company’s auditor discovered that a bank account reported by the company did not exist.
Further investigations revealed the full extent of the fraud. The CEO resigned, was
arrested, and was sent to prison. The company filed for bankruptcy, and a flood of
lawsuits have been filed against the company, its former management, and auditors.
Teaching Tip: Review the PowerPoint slides for Chapter Eighteen and select those
you find most useful for enhancing your lecture and class discussion. For additional
visual summaries of key chapter points, also review the map, figures, and tables in
the text.
I. INTRODUCTION
International business managers cannot make informed decisions without relevant
and reliable accounting and taxation information. While the financial manager of any
firm is responsible for procuring and managing the company’s financial resources,
today’s corporate controller (accountant) is responsible for providing information to
the firm’s financial decision makers, and to a wide variety of other stakeholders as
well.
II. FACTORS INFLUENCING THE DEVELOPMENT OF ACCOUNTING
AROUND THE WORLD
Accounting origins and traditions are as individual as the languages of the nations
that produce them. As a result, financial statements in different countries appear
different from each other both in form (format) and in content (substance). While
some people argue differences in format are a minor problem, the fact that
companies can value assets and determine income differently in different countries is
not. Countries doing business in multiple countries must often produce financial
statement using the standards of the countries in which they operate. For example,
foreign companies operating in the United States usually issue financial statements
according to U.S. generally accepted accounting principles (GAAP).
A. Accounting Objectives [See Figure 18.4]
Accounting is defined as a service activity whose function is to provide
quantitative information, primarily financial in nature, which will be useful in
making strategic decisions and reasoned choices among alternative courses of
action. It is crucial that the accounting process identify, record, and interpret
economic events. The private sector body that establishes financial accounting
standards in the United States is the Financial Accounting Standards Board
(FASB). The FASB states that the external reporting of accounting information
should help investors (i) make investment and credit decisions, (ii) assess cash
flow prospects and (iii) evaluate enterprise resources. The international private-sector
organization that sets financial accounting standards for worldwide use is
the International Accounting Standards Board (IASB). The IASB and its
predecessor, the International Accounting Standards Committee (IASC),
identified the following key users of accounting information: investors,
employees, lenders, suppliers and other trade creditors, customers, governments
and their agencies, and the public. While equity markets are an important
207

3. influence on accounting standards in the United States and the United Kingdom,
banks are influential in Switzerland and Germany, and taxation is a major
influence in France and Japan. Differences in accounting practices around the
world have resulted in a move toward convergence—the process of bringing
different nationally generally accepted accounting principles into line with
International Accounting Standards issued by the IASB.
B. Cultural Differences in Accounting [See Figure 18.5]
Culture influences both measurement practices (how firms value assets) and
disclosure practices (how and what information firms provide and discuss).
From an accounting standpoint, secrecy and transparency refer to the degree to
which corporations disclose information to the public. Optimism and
conservatism refer to the degree of caution that companies exhibit in valuing
assets and recognizing income. Anglo-Saxon countries such as the United
Kingdom and the United States have accounting systems that tend to be
transparent and optimistic, while Germanic countries, among others, tend to be
secretive and conservative.
C. Classification of Accounting Systems [See Figure 18.6]
Although accounting standards and practices vary worldwide, systems can
nonetheless be classified according to common characteristics. While macro-uniform
accounting systems are shaped more by government influences (strong,
codified, tax-based legal systems), micro-based accounting systems rely on
pragmatic business practices. Because MNEs must adjust to different accounting
systems on a worldwide basis, the international accounting function becomes
increasingly complex and costly. Financial statements differ from one country to
another in six major ways: (i) language, (ii) currency, (iii) the type of statement
(income, statement, balance sheet, etc.), (iv) the financial statement format, (v)
the extent of footnote disclosures and (vi) the underlying GAAPs on which
financial statements are based. Firms must deal with all six issues. Major
approaches to dealing with accounting and reporting differences include mutual
recognition (a foreign registrant need only provide information prepared
according to the GAAPs of the home country), reconciliation to the local
GAAPs (a foreign registrant reconciles its home-country financial statement
with the local GAAPs), and recasting financial statements in terms of local
GAAPs. A Form 20-F is the document used to recast financial statements in the
United States.
D. International Accounting Standards and Global Convergence
Forces encouraging the harmonization of national accounting standards include:
investor orientation, the global integration of capital markets, the need for
MNEs to raise foreign capital, regional economic integration and the pressure
from MNEs to reduce their accounting and reporting costs. The most ambitious
regional harmonization efforts are occurring in the EU, which promotes, among
other things, the free flow of capital and the adoption of the International
Accounting Standards as set forth by the IASB by 2005. The key turning point
in the significance of the IAS standards came in 1995 when the International
Organization of Securities Commissions (IOSCO) announced it would
endorse IASC core standards if a set were developed that both organizations
208

4. could agree upon. Another major factor affecting the harmonization of
accounting standards worldwide was the reorganization of the IASC in 2000.
Trustees for the IASC foundation searched for and appointed members of the
IASB, representing all areas of the world, in 2001. When the IASB was
organized, all of the old International Accounting Standards were adopted, and
the board began to issue new standards called International Financial
Reporting Standards (IFRS). The IASB has expanded its influence and
effectiveness due to the decision of the EU, Australia, and New Zealand to
require all of their publicly listed companies to adopt IFRS and the decision of
the FASB and IASB to adopt a process of convergence of accounting standards.
LOOKING TO THE FUTURE:
Will IASB GAAP Become the Global Accounting Standard?
With the adoption of IFRSs by the EU, Australia and New Zealand, nearly 100 countries
in six continents will be requiring or permitting the use of IFRSs for some or all domestic
listed companies. IASB GAAP is being set by most of the major countries in the world
and is the product of a great deal of negotiation, compromise, and broad-based input. As
of 2007, companies listing on European exchanges are required to follow IASB GAAP.
The convergence project between FASB and IASB has led to a process where new
standards are written by both bodies together using the same wording. At some point,
there will be virtually no difference between U.S. GAAP and IASB GAAP.
III. TRANSACTIONS IN FOREIGN CURRENCIES
In addition to minimizing or eliminating foreign-exchange risk, firms must concern
themselves with the proper recording and subsequent accounting of transactions
resulting from the purchase or sale of products and the borrowing or lending of
foreign currency.
A. Recording of Transactions
When accounting for assets, liabilities, revenues and expenses, foreign-currency
receivables and payables result in gains and losses whenever the relevant
exchange rate changes. Such transaction gains and losses must be included on
the income statement in the accounting period in which they arise.
B. Correct Procedures for U.S. Companies
The Financial Accounting Standards Board Statement (FASB) No. 52 requires
U.S. firms to report foreign-currency transactions at the original spot exchange
rate in effect on the initial transaction date and to report receivables and
payables at the subsequent balance sheet date at the spot exchange rate on those
dates. Any foreign-exchange gains and losses associated with carrying
receivables or payables are taken directly to the income statement. Practices
vary in other countries, although the IASB procedure is somewhat similar to that
of the United States, except that it permits a firm to increase the value of an
asset by the amount of foreign-exchange loss and then write it off over the
209

5. useful life of the asset as part of the depreciation charge.
210

6. IV. TRANSLATION OF FOREIGN-CURRENCY FINANCIAL
STATEMENTS
An MNE must eventually develop one set of financial statements in its home-country
currency. Translation involves the process of restating foreign-currency financial
statements, and consolidation is the process of combining the translated financial
statements of a parent and its subsidiaries into a single set. In the United States,
translation is a two-step process: first, statements are recast according to U.S.
GAAPs; then all foreign currency amounts are translated into U.S. dollars.
A. Translation Methods
FASB No. 52 allows firms to use either of two methods when translating
foreign-currency financial statements into dollars. The method the firm chooses
depends on the functional currency of the foreign operation, which is the
currency of the primary economic environment in which the entity operates. If
the functional currency is that of the local operating environment, the firm must
use the current rate method, which provides that all assets and liabilities be
translated at the current exchange rate (the spot exchange rate on the balance
sheet date). All income statement items are translated at the average exchange
rate, and owner’s equity is translated at the rates in effect when the firm issued
capital stock and accumulated retained earnings. If the functional currency is the
parent’s currency, then the firm must use the temporal method, which provides
that only monetary assets such as cash, marketable securities and receivables
and liabilities be translated at the current exchange rate. Inventory and property,
plant and equipment are all translated at the historical exchange rates in effect
when the assets were acquired. In general, income statement accounts are
translated at the average exchange rate, but cost of goods sold and depreciation
expenses are reported at the appropriate historical exchange rates (not an
average for the period).
B. Disclosure of Foreign-Exchange Gains and Losses
Under the current-rate method of translating foreign-currency financial
statements, the gain or loss is called an accumulated translation adjustment and
is recognized in owners’ equity. Under the temporal method, the gain or loss is
taken directly to the income statement, thus affecting earnings per share.
V. ENVIRONMENTAL REPORTS
Environmental reports vary from firm to firm and country to country because they
provide voluntary information. These reports identify the impact of the firm on the
environment, focusing especially on the use of natural resources and efforts to
recycle waste. Typically, the environmental report is separate from the annual report
and is not part of the financial statements or footnotes.
VI. PERFORMANCE EVALUATION AND CONTROL
Different measures are used to evaluate performance of foreign operations, including
ROI, sales, cost reduction, quality targets, market share, profitability, and budget to
actual.
211

7. A. Foreign Exchange in the Budget Process
A complicating factor for MNEs is setting targets or budgets in different
currencies. Budgets are usually either set in the headquarters country’s currency
and translated into local currency, or set in local currency and translated to
headquarters’ currency. Since currency values will likely change during the
budgeting period, companies need to consider the actual exchange rate at time of
budget, the projected end of period exchange rate at time of budget, and the
actual exchange rate at the end of the budget period. Although companies rely
on all of these, the most frequently relied on seems to be the projected end of
period exchange rate at time of budget.
B. Budgeting and Currency Practices
Fewer than half of the firms surveyed in one study judged subsidiary
performance in terms of translated dollar amounts. Another study found that a
significant number of firms in the sample used both dollar and local currency
budgets compared to actual profits and actual sales.
POINT-COUNTERPOINT: Should Local Subsidiary Management Be Held
Responsible for Exchange Rate Changes?
POINT: Local subsidiary management must be held responsible for exchange rate
changes since they are best able to forecast the future value of the local currency. The
criticism that the local subsidiary cannot control currency fluctuations could be applied to
many other factors they are usually responsible for but are also out of their direct control
such as competitive pressures, supplier relationships, and labor relations. Earnings
forecasts must be consolidated at headquarters in the headquarters country’s currency,
therefore each subsidiary must be responsible for contributing to that forecast in the
headquarters country’s currency be held accountable for the impact of fluctuations in
currency values.
COUNTERPOINT: It is unrealistic to expect local management to forecast exchange
rates in the future since those rates are driven by factors such as inflation, interest rates,
trade balances, foreign currency reserves, political stability, government policies, and
other factors entirely out of the control of local subsidiaries. If local management cannot
accurately predict future values of local currency, how can they be expected to meet
foreign currency based earnings or profitability targets? All evaluation of local
management should be done in local currency, independent of international currency
exchange rates.
VII. TRANSFER PRICING AND PERFORMANCE EVALUATION
Transfer pricing refers to prices of goods and services that are bought and sold
(transferred) between members of a corporate family. International transfer prices
may be set with little consideration for market prices or production costs due to tax
212

8. policies, competitive purposes, to avoid dumping regulations, to lessen the impact of
national controls, to lower the apparent profitability of a subsidiary, and a host of
other reasons (see Table 18.8).
VIII.THE BALANCED SCORECARD
The balanced scorecard (BSC) is an approach to performance measurement that
closely links the strategic and financial perspectives of a business. It provides a
framework to look at the strategies giving rise to value creation from the following
perspectives: (i) financial, (ii) customer, (iii) internal business processes, and (iv)
learning and growth. A firm’s BSC is a proprietary strategic tool and is generally
not available to the public. It offers the advantages of logically connecting financial
performance with its nonfinancial drivers, but can be a challenge to create. In some
companies, the BSC concept has been refined into a strategic management system
that replaces the traditional focus on the budget as the center for the management
process.
WEB CONNECTION
Teaching Tip: Visit www.prenhall.com/daniels for additional information and
links relating to the topics presented in Chapter Eighteen. Be sure to refer your
students to the online study guide, as well as the Internet exercises for Chapter
Eighteen.
CLOSING CASE: Vivendi Universal [See Tables 18.9–18.11]
Vivendi Universal is a French-based global communications giant with diverse products in many countries
throughout the world. The company’s Canal + Group is the leader in digital and pay-TV in France and has
the world’s third largest film library. Universal Music Group is another division of Vivendi and is the
world’s largest music company, selling about one out of every four albums worldwide. Vivendi Universal
Games is a global developer, publisher, and distributor of interactive entertainment including popular
games such as Warcraft. The company also has a significant communications component with both fixed-line
and mobile offerings. The diversity of operations and their geographic scope creates accounting
challenges for the company. Changing accounting standards have also posed challenges for the company
in modifying its accounting practices.
[Note: information pertinent to this case is embedded throughout the chapter.]
QUESTIONS
1. Based on this short description, do you agree with Vivendi Universal’s acquisition
and diversification strategy?
It would be useful to see the mission statement that drove Vivendi’s acquisition and
213

9. diversification strategy. Firms the world over choose to expand via diversification in
order to offset economic fluctuations and the unpredictable dynamics of the
consumer marketplace. Some choose to so by moving into an attractive industry and
seeking specific opportunities there; others will choose to acquire an attractive firm
(or series of firms) and by default expand into the industry represented. Vivendi’s
expansion into the communications and media area seems to have been carefully
planned and executed; its holdings cover the breadth of the industry, and each entity
is a major player in its respective market. Whether Vivendi’s move away from
environmental services and into communications was deliberate or opportunistic is
not known. However, while Vivendi Environment contributes substantial strength
and stability to the firm, there appears to be little synergy between the two clusters.
2. Since Vivendi Universal listed its shares on the New York Stock Exchange, why
didn’t it just adopt U.S. GAAP as Seagrams did or as DaimlerChrysler does?
Vivendi, as a company of French origins, needed to continue to comply with the
more rigid French accounting system. More specifically, differences between the
U.S. GAAP and French accounting systems require different accounting for
proportional ownership, the recoding of certain transactions, and differences in the
adjustments column.
3. As Vivendi Universal began to adopt IFRS, the differences between its financial
statements and U.S. GAAP financial statements narrowed significantly. Why is that
the case?
This is due to the ongoing convergence between U.S. GAAP and IFRS. IFRS is
closer to U.S. GAAP than to French GAAP, which Vivendi had been using
previously.
4. What challenges face European companies that move from their own GAAP to
IFRS? What challenges do these moves create for Vivendi Universal’s investors in
France and abroad?
The major challenge is in understanding how the changes in standards impact the
actual business operations of the companies to which they apply. Even though no
substantive changes may have occurred in the operation of a given firm, statements
of profitability, asset levels, debt levels, and other factors can vary dramatically as
different accounting standards are adopted. This presents challenges for the
evaluation of subsidiary performance, as well as complicating issues of valuation for
investors. For Vivendi Universal’s investors in both France and abroad, the major
issue becomes the comparability of financial statements. It will be challenging for
investors to compare current and future results with past results within the company,
but hopefully comparability of Vivendi’s financial statements with those of other
companies around the world will become easier as accounting systems converge.
_________________________
CHAPTER TERMINOLOGY:
accounting, p. 639 Generally accepted accounting
214

10. principles (GAAP), p. 639
Financial Accounting Standards
Board (FASB), p. 639
International Accounting Standards
Board (IASB), p. 639
International Accounting Standards
Committee (IASC), p. 639
convergence, p. 640
culture, p. 642
mutual recognition, p. 645
International Organization of
Securities Commissions
(IOSCO), p. 646
International Financial Reporting
Standards (IFRS), p. 647
current-rate method, p. 651
translation, p. 651
consolidation, p. 651
temporal method, p. 651
functional currency, p. 651
transfer pricing, p. 657
balanced scorecard, p. 659
_________________________
ADDITIONAL EXERCISES: Multinational Accounting
Exercise 18.1. Ask the students to find the financial statements of a company
headquartered in Europe and one headquartered in the United States. Are these
statements comparable? What are the major differences in accounting standards that
one might want to be aware of when trying to compare the financial results as
reported by these two companies?
Exercise 18.2. Have students look at Coca-Cola’s most recent financial statements.
What impact do currency fluctuations have on Coca-Cola’s business results? Are
there any notes in the financial statements that explain the handling and/or impact of
currency fluctuations on reported results?
Exercise 18.3. Many transition economies such as China, Russia, and the former
Soviet satellite nations have not only different accounting standards from those
found in West Europe, North America, and Japan, but their accounting systems are
seriously underdeveloped, given the dynamics of today’s global business
environment. Ask the students to discuss the logic of those countries’ adopting the
International Accounting Standards as the basis of their national business accounting
systems.
215