UNIT-V

INTERNATIONAL ACCOUNTING AND REPORTING

Book keeping: It is the Means of recording transactions and keeping records.

Accounting: It is an information system that measures, processes, and communicates

financial information about and identifiable economic entity to interested parties for making
economic decisions.

Causes of differences between national accounting systems

 Provision of finance
 Legal system
 Link between accounting and taxation
 Accounting profession (Example: International Federation of Accountants)
 Cultural differences
 Geographical position

Accounting standard setting process at National, Regional and International Level

 National Level: Generally Accepted Accounting Principles: Example: IGGAP,

US GAAP
 Regional Level: European Community, Asian& Pacific region, Africa, South
America
 International Level: International Accounting Standards Committee Foundation
(IASCF), International Federation of Accountants (IFAC), International Organization
of Securities Commissions (IOSCO) and Organization for Economic Cooperation and
Development (OECD)

Currently in global perspective there are two organizations who provide guidance and issue
Accounting and financial reporting standards. Those are International Accounting standard
board (IASB) and Financial Accounting Standard Board (FASB). In particular most of the
countries such as UK European countries Asian countries Canada use the financial reporting
standards issued by IASB while USA is using its own financial reporting standards published
by FASB. However IASB and FASB are currently working in a joint project of convergence
of financial reporting standards.

FOREIGN CURRENCY TRANSACTIONS (International Financial Management by

Vyuptakesh Sharan, Page No: 196-196) Web Link: https://smallbusiness.chron.com/foreign-
exchange-accounting-rules-77779.html

A foreign currency transaction is a transaction that is denominated in foreign currency or is

settled in a foreign currency [IAS 21:20] including the transactions involving sale or purchase
of goods and services in a foreign currency, borrowing and lending in a foreign currency,

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forward contract, and acquisition and disposal of assets/settlement of liabilities in a foreign
currency. A foreign currency transaction needs to be recorded in the reporting currency after
translation at the exchange rate applicable to the date of transaction.

For example, an entity may:

 Buy or sell goods or services at a price denominated in a foreign currency;

 Borrow or lend funds such that the amounts payable or receivable are denominated in
a foreign currency; and/or
 Acquire or dispose of assets, or incur or settle liabilities, denominated in a foreign
currency.

When the transactions are reported at subsequent balance sheet dates, a clear-cut distinction is
made between monetary items and non-monetary items. Cash, receivables, and payables are
the examples of monetary items. Fixed assets, inventories and investment in equity shares are
examples of non-monetary items. As per the rule, foreign currency monetary items should be
reported using the closing date. When the closing date is not realistic, particularly when there
are restrictions on remittances, the relevant monetary item should be reported in the reporting
currency at the amount which is likely to be realised from, or required to disburse, such item
at the balance sheet date.

Non-monetary items, which are carried in terms of historical cost denominated in a foreign
currency, should be reported using the exchange rate at the date of the transaction. Again
non-monetary items, which are carried at fair value or other similar valuation denominated in
a foreign currency should be reported using the exchange rates that existed when the values
were determined.

Exchange differences arising on the settlement of monetary items or on reporting an

enterprise’s monetary items at rates different from the originally recorded ones should be
treated as income/expense in the period when they arise. if exchange difference arising in
respect of monetary items forms a part of the net investment of an enterprise in a non-integral
foreign operation, it should be accumulated in a foreign currency translation reserve until the
disposal of the net investment. Thereafter it should be treated as income/expense.

INTER-CORPORATE FUNDS FLOW (International Financial Management by

V.A.Avadhani Page No: 321-330)

The MNC has the flexibility of funds flowing as between firms and between subsidiaries and
the parent company. The transfer can take the form of inputs, including financial inputs
followed by corresponding flow of funds. They include inter-company loans, dividends,
royalty charges, the timing of which is adjusted to suit the companies after complying with
government law and rules.

Factors influencing the flows of inter-firm

 To determine the optimum debt equity ratio

 To decide the mix of sources for borrowing funds
 To fix the prices of such borrowing in the form of costs.

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  The extent of borrowing, inter-firm and for outside agencies, including the domestic
source of the firm.
 To decide on the transfer price for inter-firm transfers and lay down guidelines for
transfer pricing, as required generally by the tax authorities in the host countries.
 To fix the dividend payment, royalty and other payments.

The above are some of the financial decisions to be initially taken by the finance manager
based on the information supplied by the local affiliate or the subsidiary and their own
information on the various countries, in which they have affiliates and the international
markets. Finally these decisions are to be approved by the parent company’s board of
directors and by the local board before their implementation.

The real flow of goods and services among the parent and affiliates are as follows:

 Market information system and sharing of it

 Sharing of R&D results
 Technology transfers
 Right to use patents or brand names
 Raw material or intermediate products
 Finished goods for assembly or sale
 Capital goods, plant, machinery etc.
 Transfer of skilled personnel and management talent

Technique of inter-corporate funds flow

 Transfer pricing: Transfer pricing is the setting of the price for goods and services
sold between controlled (or related) legal entities within an enterprise. For example, if
a subsidiary company sells goods to a parent company, the cost of those goods paid
by the parent to the subsidiary is the transfer price.
Or
The transfer price is the price that one division of a company charges another division
of the same company for a product transferred between the two divisions.

Example:

- Parentco, a fictional U.S. based pen company, manufactures pens in the U.S. at the
cost of 10 cents per pen.
- Parentco’s Canadian subsidiary, Subco, sells the pens to Canadian customers for $1
(or 100 cents) per pen and spends 10 cents per pen in distribution and marketing costs.
- The group's total profit on the sale of each pen is 80 cents (revenue of 100 cents, less
cost of 20 cents).
- Transfer price is the price charged by Parentco to Subco and is likely to somewhere
between 20 cents (which will leave all of the profit in Canada) and 80 cents (which
will leave all of the profit in the US).

Motivations/ Objectives of Transfer Pricing

Reference: International Financial Management by Vyuptakesh Sharan,Page No: 482-491)

The existing literature on the subject mentioned broadly three factors that motivate a firm to
employ transfer pricing.

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 1. Huge amount of money is spent on research and development for the creation of an
intermediate product. Thus the transfer of that product must be charged at a high price
so that the cost could be recovered.
2. There are various market imperfections. Different national markets are segmented on
account of tax rate, tariff rate, exchange rate control, currency risk, restrictions on
investment, etc. transfer pricing is used for doing away with these imperfections and
there by maximizing the profits of a firm.
3. Transfer pricing is used for liquidity adjustment among different units of a firm. It
helps the liquidity-deficit units to get funds from liquidity-surplus units. The working
capital management becomes smooth.

Some of the motivations or the objectives need further explanations

 Reducing tax burden: Minimization of income-tax liability for the maximization of

overall profit is a pressing factor behind transfer pricing. The MNC transfers a good
part of profit before tax from a unit facing higher rate of taxes to a unit subjected to
lower rate of taxes. This is done through over-invoicing of import of the former unit
from the latter or under-invoicing of export to the latter.
 Reduction of tariff burden: Lowering of tariff burden is another factor motivating
for transfer pricing. A survey made by Kim and Miller reveals this factor being more
significant than reducing of tax burden.
 Controlling currency risk: Transfer pricing cannot prevent changes in exchange rate
between currencies, but it can minimize the adverse impact of such changes through
reshuffling cash balances and profits among different units of a firm located in weak
and strong currency countries.
 Joint venture constraints: Sometimes the host government imposes restrictions on
foreign participation in corporate equity. in such cases, the parent company charges
greater prices for the transfer of technology or for other supplies if such supplies are
translated into equity shares. Similarly when the host government puts restrictions on
the remittances of dividend and other payments, the parent company uses transfer
pricing so as to effect such remittances.
 Liquidity adjustments: When the different units of firm are well-knit, the parent unit
maintains a centralized control on the management of cash. Surplus cash of one unit is
either sent to the cash-deficit unit or to a centralized pool for the purpose of its
investment in the near-cash assets. When the government of the cash-surplus unit
imposes restrictions on such movement of cash, the parent company uses the transfer
pricing technique.
 Fostering competition: The parent unit likes its subsidiary to possess an edge over
the local firms and, to this end; it supplies the intermediate product at much lower
than the arms’s-length price or without any charge. It enables the subsidiary to sell the
final product at a lower price and compete with the local firms.

Advantages

 Decisions are better and timelier because of the manager’s proximity to local
conditions.
 Top managers are not distracted by routine, local decision problems.

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  Managers’ motivation increases because they have more control over results.
 Increased decision making provides better training for managers for higher level
positions in the future.

Disadvantages

 Lack of goal congruence among managers in different parts of the organization.

 Insufficient information available to top management; increased costs of obtaining
detailed information.
 Lack of coordination among managers in different parts of the organization.

Purposes of Transfer Pricing

Let us go through some important reasons for which the transfer pricing scheme can be
applied:

 The transfer pricing method allows the company to generate profit figures for each
division in separate manner.
 The sales, pricing and the production departments can be coordinated through this
method. The managers can also get aware of the value of the services and the products
in other segments of the firm.
 It helps in generating not only the reported profits of the entire center but also the
resource allocation of the organization.
 Performance evaluation of each department becomes easy as it can generate separate
profits.
Performance Measurement

Transfer pricing is the price at which one segment of an organization sells a product or
service to another segment of the same organization. The most widely used transfer pricing
system is the market-based transfer price, cost-based transfer price, and negotiated transfer
price

Example

Methods of transfer pricing

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 1. Negotiated transfer pricing: a negotiated transfer pricing results from discussions
between the selling and buying divisions. Negotiated transfer prices have many
important advantages. First, this approach preserves the autonomy of the divisions
and is consistent with the spirit of decentralization. Second, the managers of the
divisions are likely to have much better information. About the potential costs and
benefits of the transfer than others in the company.

2. Cost based transfer pricing: Cost-based pricing is a pricing method that is based on
the cost of production, manufacturing, and distribution. Essentially, the price of a
product is determined by adding a percentage of the manufacturing costs to the
selling price to make a profit.
3. Market-based transfer pricing: Market-based transfer pricing is perhaps the easiest
form of transfer pricing when it comes to determining the price that will be paid
between divisions of the same company. It uses the normal market rate that would be
paid if the goods were bought on the open market.

Performance measurement

 Performance measure –Net income: Net income is generally defined as the

revenues of the investment center less the costs of the investment center. Where the
costs include the allocated costs or overhead
 Performance measure- ROI: Return on Investment is generally defined as the net
income of the investment center divided by some measure of assets (typically total
assets or net assets)
 Performance Measures – Residual Income: Residual Income is a variant of ROI.
Residual income is calculated as the investment center’s Net income less a targeted
return times assets (or net assets).

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  Performance Measures – EVA: EVA is basically the same as residual income.
There are two adjustments: 1. Accounting earnings are adjusted. 2. They use WACC,
weighted average cost of capital.

CONSOLIDATED FINANCIAL REPORTING/ CONSOLIDATED FINANCIAL

STATEMENTS

(International Financial Management by Vyuptakesh Sharan, Page No: 473-477)

If a firm sets up its network abroad through opening up of subsidiaries, it will like to evaluate
its overall performance. It is done through combining the financial statements of the
subsidiaries along with its own. The process of combining of financial statements is known as
consolidation.

Techniques of consolidation

There are two ways for consolidating financial statements. One is known as gross
consolidation. The other is known as net consolidation.

 Gross Consolidation: Gross consolidation refers to all the assets and liabilities of the
subsidiary are added to the respective values of the balance sheet of the parent
company irrespective of the share of the parent company in the equity of the
subsidiary. However, the value of the minority interest is shown on the liabilities side
of the consolidated balance sheet. The entire profit of the subsidiary is added to the
profit of the parent company. In simple gross consolidation refers to adding up of
liabilities and assets of various units and then making adjustment for the minority
interest.
 Net consolidation: Under the net consolidation method, the long procedure of adding
up of the whole of the subsidiary’s value and then making adjustments for the
minority interest is avoided. Instead, the net figures, which depend upon the parent
company’s share in the subsidiary’s equity, are added. This means that the minority
interest is excluded from the very beginning. In simple net consolidation involves
adding up of only the net figures excluding the minority interest from the very
beginning.

Note:

 Minority Interest: In accounting, minority interest is the portion of a subsidiary

corporation's stock that is not owned by the parent corporation.
 Residual income: Residual income is income that one continues to receive after the
completion of the income-producing work. Examples of residual income include
royalties, rental/real estate income, interest and dividend income, and income from the
ongoing sale of consumer goods (such as music, digital art, or books), among others.
 EVA: EVA = NOPAT – (Capital x cost of capital). In this formula, NOPAT stands
for net operating profit after taxes. The figure used for cost of capital is often the
weighted average cost of capital, or WACC.

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