Chapter 18

1. Chapter 18 International Accounting and Financial Management

2. Learning Objectives • LO1 Identify the major international accounting issues that international firms face. • LO2 Describe the international accounting standards’ convergence process and its importance to international firms. • LO3 Explain the capital structure choices open to international firms and their significance. • LO4 Describe the process of cash flow management in the traditional firm.

3. Learning Objectives • LO5 Explain the capital structure choices open to international firms and their significance. • LO6 Describe why ICs move funds. • LO7 Explain the utility of an international finance center. • LO8 Describe multilateral netting and its benefits.

4. Learning Objectives • LO9 Categorize foreign exchange risks faced by the international firm into transaction exposure, translation exposure, and economic exposure. • LO10 Describe ways to hedge transaction exposure.

5. International Accounting Provides data for decision making: • Managers • External constituencies Investors Governments Lenders Suppliers What useful data is varies by country • Germany: creditors • U.S.: investors

6. Accounting Issues with Foreign Currencies Two situations raise accounting issues • When transactions are made in foreign currencies • When subsidiaries operate in foreign currencies

7. Accounting Issues with Foreign Currencies Transactions in foreign currencies • Recorded as revenue/expense, asset/liability • Translated at FX rate on payment date • If time lag, FX gain/loss in income statement

8. Accounting and Foreign Currency Foreign Subsidiary Results’ Report: Consolidation • The process of translating subsidiary results and aggregating them into one financial report • Two ways to value: current FX rate and historical FX rate

9. Accounting and Foreign Currency Translation Methods • Current Rate Method assets and liabilities are valued at current spot rates • Temporal Method monetary accounts are valued a the spot rate and accounts carried at historical cost are translated at their historic exchange rate

10. Please place Fig 18.1 here

11. Accounting and Culture • Accounting influenced by culture • Sidney Gray’s country classifications: Secrecy-transparency • Understated asset values and income Optimism-conservatism • Overstated asset values and income

12. Please place Fig 18.2 here

13. Convergence of Accounting Standards Two groups working toward harmonized international accounting standards • International Accounting Standards Board (IASB) International Financial Reporting Standards (IFRS: based on principles) • Financial Accounting Standards Board (FASB) U.S. Generally Accepted Accounting Principles (U.S.GAAP: based on rules and regulations)

14. Triple-Bottom-Line Accounting Triple-Bottom Line Accounting (3BL) A report on the environment, social, and financial impacts of the business 3BL advantages • Supports sustainability • Supports corporate social responsibility Objections to 3BL • Environmental and social performance cannot be measured objectively • No shared framework yet • Measurement will not reach desired state

15. International Financial Management Topics • Capital structure • Cash flow management across borders • Financial flows • Foreign exchange (FX) • Risk management • Non-monetary sales • Taxes

16. Capital Structure of the Firm Firms raise capital in various ways • Retained earnings • Equity American Depository Receipts (ADRs): Foreign shares held by a custodian in the issuer’s home market and traded in dollars on the U.S. exchange Debt

17. Raising Capital: Decisions • In which currency should the firm raise capital? • How should the firm structure between equity and debt? • Which sources of capital should the firm use? • Should the firm use world capital markets? • Are there alternative sources of money? • How much money does the firm need, for how long?

18. Cash Flow Management Goal: • Reduce risks • Position firm to benefit from opportunities

19. Cash Flow Management Why funds are moved • Dividends • Royalties • Fees from subsidiary • Transfer pricing • Reduce FX risk • Direct loans

20. Techniques for Transferring Funds Fronting loan: • Loan made through an intermediary, usually a bank, from parent to subsidiary Transfer price: • The bookkeeping cost of goods sold, intra-firm

21. International Finance Center Reasons for centralized IFC • Volatile floating FX rates • Larger capital and FX markets offer lower interest rates and lower FX costs • Changing inflation rates • Electronic cash management • Innovative management of idle cash • Growth of derivatives to protect against commodity, currency and interest rate risks

22. Multilateral Netting Multilateral Netting • subsidiaries transfer net intracompany cash flows through a centralized clearing center Benefits • Transaction cost • Opportunity cost

23. Please insert Fig. 18.4

24. Leading and Lagging Technique to minimize FX risk Lead: time payments as early as possible • Collect payments early when foreign currency expected to weaken • Fund payables early when foreign currency expected to strengthen Lag: time payments as late as possible • Collect receivables late when foreign currency expected to strengthen • Fund payables late when currency expected to weaken

25. FX Risk Management: 3 Exposures Transaction exposure Change in the value of a financial position created by FX changes between the establishment and settlement of a contract Translation exposure Potential change in value of a company’s financial position due to exposure created during the financial consolidation process Economic exposure Occurs at operations level; results from FX rate changes on projected cash flows

26. Hedging Transaction Exposure • 6 Approaches to hedging transaction exposure • Leading and lagging • Exposure netting • Forward market hedge • Currency option hedge • Money market hedge • Swap contract

27. Hedging Transaction Risk Exposure netting: centralized account that matches and nets out FX exposure (like multilateral netting) Forward market hedge: foreign currency contract bought/sold forward to protect against currency movement Currency option hedge: puts and calls on specific amount of currency at specific time with option to exercise transaction

28. Hedging Transaction Risk • Money market hedge: borrowing/lending in domestic currency market to hedge foreign currency exposure • Swap contract: spot sale/purchase of an asset against a future purchase/sale of an equal amount to hedge a financial position

29. Translation Exposure Potential change in firm’s financial position due to exposure created during consolidation • What currency exchange rate to use for translation and consolidation? • current rate method • temporal rate method • Translation exposure can increase transaction exposure

30. Economic Exposure • Occurs at the operational level • Results from exchange rate changes on projected cash slows • Is long-term • Goes across the firm • Includes fixed and financial assets

31. Taxation Income Tax Direct tax levied on earnings Value-Added Tax (VAT) Indirect tax collected as value added to product Withholding Tax Indirect tax paid by payor, usually on passive income