International Accounting Practices

(Getting the numbers right)

Chapter 2

Firm in Homeserve foreign markets / source from abroad?

Stay domestic

Export

Export or local production?

Import or local production?

ImportMultinational activity:

horizontalMultinational activity:

vertical

no

yes, serve foreign market

yes, source from abroad

exportlocal

productionimportlocal

production

Two types of trade: intra-firm and inter-firmConsisting of trade in final goods, services, and intermediate goods

Two types of multinational activity: horizontal and verticalMultinational = firm owning and controlling value adding activities in two or more countries

triggers intra-firm trade

Figure 2.1 Home firm decision tree

Country A Country B

Market A Market B

Multinational(producer)

Multinational(producer, marketer)

Foreign subsidiary (producer)

Foreign subsidiary (assembler)

FDI

FDI

Finished products

Finished products

Finished products

Finished products

Components

Horizontal multinational

(market seeking)

Vertical multinational

(efficiency seeking)

Fig. 2.2 Horizontal and vertical multinational activity

Figure 2.3 US export shares in 2010

Source: US census Bureau, own calculations

US export shares (%), 2010

S+C America, 10.8

European Union, 18.8

Pacific Rim, 25.5

Canada+Mexico, 32.2

Other, 6.1

Africa, 2.2 OPEC, 4.3

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.1 US imports and exports ($ billion), 2010

Imports Exports Difference % of total (a) (b) (b)-(a) )/()(100 abab

World total 1,912 1,278 -634 -20

Canada 276 249 -28 -5 Mexico 230 163 -66 -17 Brazil 24 35 11 19 Norway 7 3 -4 -38 Netherlands 19 35 16 30

Switzerland 19 21 2 4 Germany 83 48 -34 -26 Nigeria 31 4 -26 -77 OPEC 150 54 -96 -47 Cyprus 0.01 0.13 0.12 85 Source: US Census Bureau

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.2 A firm’s statement of income1

Revenue Cost of sales Gross profit Selling, administrative, and other expenses Research and development Other income Other expenses Operating profit Interest income Interest expenses Currency exchange gains or losses Income before taxation Taxation Minority interests Income after taxation Income from discontinued operation (net of taxes) Income on disposal of discontinued operations (net of taxes) Cumulative effects of changes in accounting principles Net income 1 Neither the terminology nor the complete set-up need be similar across countries, firms and periods. For example, gross profit is often referred to as gross margin, and many firms list special items (such as merger or reorganization costs). In this table we list a “common denominator”.

Micro-level accounting: A firm’s annual report

• Rules of double-entry bookkeeping

• Complications1. How should the firm account for foreign-currency

transactions?

2. Cross-country financial management (exchange rate risk management, fiscal optimizations,...).

3. Diverging country-specific accounting regulations.

Balance of payments: Records all economic transactions between the residents of the country and residents of the rest of the world.

Each transaction or exchange results in two opposite flows of value.

Double-entry bookkeeping.A credit or positive item is the flow for which the country is

paid—it is the item that the country gives up in the transaction, and it sets up a claim on the foreign resident, so that funds (or "money") flow into the country.

A debit or negative item is the flow that the country must pay for—it is the item that the country receives in the transaction, and it sets up a foreign claim on a resident of the country, so that funds (or "money") flow out of the country.

If we add up all items for the country's balance of payments, it must add up to zero

Macro-level accounting: A country’s balance of payments

Figure 2.4 A country’s balance of payments

The balance of payments

Goods

Services

Income

Current transfers

Current account

Capital and financial account

Reserve assets

Direct investment

Trade balance

Portfolio investment

Other investment

Capital account

Financial account

The balance of payments

Goods

Services

Income

Current transfers

Current account

Capital and financial account

Reserve assets

Direct investment

Trade balance

Portfolio investment

Other investment

Capital account

Financial account

Source: van Marrewijk (2012, p. 411)

Figure 2.5 Current account balance; % of GDP, 1980-2012

Source: based on data from World Development Indicators online (1980-2010) and The Economist, June 9, 2012, “Trade, exchange rates, budget balances, and interest rates” (2012 estimate).

-8

-6

-4

-2

0

2

4

6

1980 1985 1990 1995 2000 2005 2010

United States Japan

-15

-10

-5

0

5

10

15

20

1980 1985 1990 1995 2000 2005 2010

Malaysia Philippines

-8

-6

-4

-2

0

2

4

6

8

10

12

1980 1985 1990 1995 2000 2005 2010

Netherlands Australia

-6

-4

-2

0

2

4

6

8

10

12

1980 1985 1990 1995 2000 2005 2010

Germany China

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.3 Funding options for multinationals

Source

Location Internal External

Parent country Retained earning of the multinational parent

Equity or debt raised by the multinational parent

Local (host country) Retained earnings of local subsidiary

Equity or debt raised by multinational parent or by local subsidiary

Third country Retained earnings of the third country based subsidiary

Equity or debt raised by multinational parent or by 3rd country based subsidiary

Source: Root (1994, p. 584); the shaded box is excluded in FDI statistics.

FDI data and the capital account

• US government’s definition of foreign direct investment (FDI): ‘Ownership or control of 10% or more of an enterprise’s voting securities, or equivalent interest in unincorporated business’ (2004, M5-6).

• FDI and foreign portfolio investment (FPI)

• World Investment Report (by UNCTAD - http://unctad.org/en/PublicationsLibrary/wir2014_en.pdf) is the most important source of information on FDI flows.

a. FDI inflows; US $ bn, 2006-2011

0

500

1000

1500

2000

2006 2007 2008 2009 2010 2011

developed

developing

transition

b. FDI outflows; US $ bn, 2006-2011

0

500

1000

1500

2000

2006 2007 2008 2009 2010 2011

developing

developed

transition

c. FDI flows into developing economies; US $ bn, 2005-2011

0

50

100

150

200

250

300

350

400

450

2005 2006 2007 2008 2009 2010 2011

greenfield

M&A

Figure 2.6 FDI flows, 2005-2011

Source: based on data from UNCTAD, World Investment Report 2012; developed = developed economies; developing = developing economies; transition = transition economies.

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.4 Inward FDI stock; US $ bn, 2009

a. USA inward FDI stock b. Germany inward FDI stock Total 2,253 % Total 909 %

United Kingdom 454 20.1 Netherlands 230 25.3 Japan 264 11.7 Luxembourg 127 14.0 Netherlands 238 10.6 United States 98 10.7 Canada 226 10.0 France 96 10.5 Germany 218 9.7 Switzerland 75 8.2 Switzerland 189 8.4 United Kingdom 73 8.1 France 189 8.4 Italy 47 5.1 Luxembourg 128 5.7 Austria 25 2.8 Australia 46 2.0 Japan 20 2.2 Spain 44 1.9 Sweden 18 2.0

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers right

c. Japan inward FDI stock d. Australia inward FDI stock Total 189 % Total 224 %

United States 75 39.7 United States 66 29.5 Netherlands 36 19.1 United Kingdom 42 18.6 Cayman Islands 17 9.0 Japan 25 11.1 France 15 8.0 Netherlands 17 7.7 Singapore 11 5.6 Switzerland 14 6.0 United Kingdom 7 3.9 Germany 10 4.2 Germany 7 3.8 France 9 4.1 Switzerland 5 2.6 Canada 7 3.1 Luxembourg 4 2.3 Singapore 7 3.1 Hong Kong 3 1.4 Hong Kong 7 2.9 Source: OECD Foreign Direct Investment Position database; German and Australian data for 2008.

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.5 Foreign Direct Investment (FDI), stocks and flows; $ bn (%), 2011

FDI in FDI out Flows Stock Flows Stock

World 1,524 (100)

20,438 (100)

1,694 (100)

21,168 (100)

Developed economies 748 (49.1)

13,056 (63.9)

1,238 (73.0)

17,056 (80.6)

Europe 425 (27.9)

8,081 (39.5)

651 (38.4)

10,444 (49.3)

North America 268 (17.6)

4,104 (20.1)

446 (26.3)

5,170 (24.4)

Other developed ec. 55 (3.6)

870 (4.3)

140 (8.3)

1,442 (6.8)

Developing economies 684 (44.9)

6,625 (32.4)

384 (22.6)

3,705 (17.5)

Africa 43 (2.8)

570 (2.8)

4 (0.2)

126 (0.6)

Asia 423 (27.8)

3,991 (19.5)

280 (16.6)

2,573 (12.2)

Latin America 217 (14.2)

2,048 (10.0)

10 (0.6)

1,006 (4.8)

Oceania 2 (0.1)

17 (0.1)

0 (0.0)

1 (0.0)

Source: based on data from UNCTAD (2012), World Investment Report 2012; % in parentheses.

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.6 Analytic presentation: balance of payments, 2007 (billion US dollars)

Germany USA A current account 255.53 -731.21 goods: exports fob 1,354.12 1,152.57 goods: imports fob -1,075.43 -1,967.87 balance on goods 278.69 -815.30 services: credit 214.96 493.16 services: debit -254.23 -378.11 balance on goods and services 239.41 -700.26 income: credit 318.01 817.78 income: debit -260.12 -736.03 balance on goods, services, and income 297.31 -618.50 current transfers: credit 25.43 22.33 current transfers: debit -67.21 -135.03 B capital account .24 -1.84 capital account: credit 4.75 1.8 capital account: debit -4.51 -3.65 total: groups A plus B 255.77 -733.05 C financial account -301.46 774.47 direct investment abroad -169.37 -333.27 direct investment in Germany/USA 50.94 237.54 portfolio investment assets -178.42 -294.57 portfolio investment liabilities 370.43 1,145.14 financial derivatives .. .. other investment assets -440.27 -661.89 other investment liabilities 164.39 675.02 total: groups A through C -45.69 41.42 D net errors and omissions 46.93 -41.29 total: groups A through D 1.24 0.13 E reserves and related items -1.23 -0.13 overall balance 0.00 0.00 Source IMF Balance of Payments Statistics Yearbook

Some meanings of the current account balance

1. Current account (CA) equals the value of the country's net flow of foreign investments (both private and official).

2. CA equals the difference between national saving and domestic real investment (S I).

3. CA is approximately equal to the difference (X M) implies that CA is approximately equal to the difference between domestic production of goods and services and national expenditures on goods and services (Y E).

4. Surplus current account <=> net capital (and financial) outflow

Official international reserves include financial assets denominated in readily accepted foreign currencies, the country's holdings of Special Drawing Rights (SDRs), the country's reserve position at the International Monetary Fund (IMF), and gold.

A line called "statistical discrepancy" is added to make the accounts on the BOP add to zero. It represents the net of many items that are measured incorrectly or missed (net errors and omissions).

Limitations of FDI data

• Criticizing FDI data: See Box 2.3

• FDI data are still useful when comparing groups of countries (Table 2.7)

• Significant observations about FDI flows:– FDI flows are to a large part from and to

developed economies– FDI from developing countries (emerging

economies) is on the rise

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.7 FDI inflows and outflows, as % of total flows

Developed economies Developing economies Transition economies

Period In Out In Out In Out

1980-89

1990-99

2000-09

74.7

68.1

65.1

94.0

88.0

85.0

25.3

30.8

31.3

6.0

11.7

13.2

0.0

1.0

3.9

0.0

0.4

1.8

Source: UNCTAD

Sales and value added

• Tax havens and FDI• Value added is the “best indicator of overall or

sectoral economic significance of multinational activity” (John Dunning, 1993, p. 7)

• World Input Output Database (http://www.wiod.org/new_site/home.htm)

• Box 2.4: Transnationality index (UNCTAD) = (unweigthed average) of

foreign assets/total assets + foreign sales/total sales + foreign employment/total employment

• Table 2.9

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers right

Table 2.8: U.S. outward multinational activity in 2010

Ranking FDI Affiliate sales Affiliate value added 1 2 3 4 5 6 7 8 9 10

Netherlands United Kingdom Canada Luxemburg Bermuda Ireland UK Island, Caribbean Switzerland Australia Japan

United Kingdom Canada Germany Singapore Switzerland Ireland Japan Netherlands France Mexico

United Kingdom Canada Germany Japan France Ireland Australia Brazil Switzerland China

Source: BEA. The value added and sales data refer to majority owned all foreign affiliates in 2009. The FDI data reflect the direct investment position in 2010 based on a historical costs basis.

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.9 Top 10 non-financial multinationals 2011, ranked according to TNI

Rank Corporation Home country Sector TNI*

1 Nestlé SA Switzerland Food, beverages and tobacco 96.9

2 Anglo American plc UK Mining & quarrying 93.9

3 Xstrata PLC Switzerland Mining & quarrying 93.5

4 Anheuser-Busch InBev NV Belgium Food, beverages and tobacco 92.4

5 British American Tobacco PLC UK Food, beverages and tobacco 91.7

6 Nokia OYJ Finland Electrical & electronic equipment 91.4

7 ABB Ltd. Switzerland Engineering services 91.2

8 ArcelorMittal Luxembourg Metal and metal products 90.5

9 Linde AG Germany Chemicals 90.2

10 Vodafone Group Plc UK Telecommunications 90.2

Source: UNCTAD World Investment Report 2012; * TNI = TransNationality Index

Value added export (VAX) to GDP ratio; 1995 and 2008 (%)

-10 0 10 20 30 40 50

United StatesBrazil

GreeceTurkeyJapanIndia

SpainFranceMexico

PortugalAustria

ItalyUnited Kingdom

IndonesiaRussia

CanadaPoland

South KoreaFinland

DenmarkGermany

ChinaSweden

AustraliaTaiwan

NetherlandsBelgiumHungary

Czech RepublicIreland

VAX/GDP 1995

change 1995-2008

Figure 2.7 Value added export (VAX) as a share of GDP; 1995 and 2008 (%)

Source: based on World input output Database (WIOD), see wiod.org.

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.10: Country of origin of Global 500 between 2005-2010

Country 2005 2006 2007 2008 2009 2010 United States Japan France Germany Britain

176 81 39 37 35

170 70 38 38 35

162 67 38 37 33

153 64 39 37 34

140 68 40 39 26

139 71 39 37 29

China Netherlands Canada BRIC total Other Total

16 14 13 27 78

500

20 14 14 35 86

500

24 14 16 39 94

500

29 13 14 46

100 500

37 12 14 58

103 500

46 13 11 67 94

500

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.11: GDP, sales and profits in 2009 (in US$ bn)

Country GDP Firm sales Firm profits

Sweden: 406

Honduras: 14.3

Walmart (1): 408

Dai Nippon Printing (500): 17

Walmart (1): 14.3

Dai Nippon Printing (500): 0.3

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2.12 Size of net capital flows; selected countries, 1870-2010

Period Arg Aus Can Fr Ger It Jap UK USA

1870-1889 18.7 9.7 7.2 2.9 1.9 1.8 0.5 4.5 1.5

1890-1913 6.2 6.3 7.6 2.3 1.4 1.9 2.2 4.5 0.8

1914-1918 2.7 7.6 3.5 3.1 - 11.7 6.6 2.9 3.5

1919-1926 4.9 8.8 2.3 1.1 2.2 4.2 2.1 2.9 1.7

1927-1931 3.7 12.8 3.6 1.8 1.8 1.5 0.6 2.0 0.8

1932-1939 1.6 3.7 1.6 3.7 0.4 0.7 1.1 1.1 0.6

1940-1946 4.8 7.1 6.5 1.8 - 3.4 1.0 7.3 1.0

1947-1959 3.1 3.4 2.3 2.0 2.0 1.4 1.3 1.2 0.6

1960-1973 1.0 2.3 1.2 1.5 1.0 2.1 1.0 0.8 0.5

1974-1989 1.7 3.7 2.6 0.8 1.9 1.4 2.0 1.4 1.3

1990-2000 2.9 4.5 2.3 1.1 1.3 1.9 2.3 1.9 1.8

2001-2010 3.3 4.9 1.8 1.1 4.6 1.8 3.4 2.3 4.6

Source: Obstfeld (1998), update Obstfeld and Taylor (2004), Table 2.2. Updated for the period 2001-2010 using World Bank Development Indicators data. Size of net capital flows measured as mean absolute value of current account as a percentage of GDP, annual data; - = data not available; Arg = Argentina, Aus = Australia, Can = Canada; Fr = France, Ger = Germany It = Italy, Jap = Japan, UK = United Kingdom, and USA = United States of America.

How is international capital mobility measured?

• Current account balance as an indicator of the degree of international capital mobility– CA surplus (deficit) net capital outflow (inflow)

• Size of net capital flows (1870-2001): Table 2.12 and Figure 2.9

Figure 2.9 Global net capital flows; average for 15 countries, 1870-2010

Net capital flows; current account (% of GDP, abs. value)

0

1

2

3

4

5

6

1870-1889

1890-1913

1914-1918

1919-1926

1927-1931

1932-1939

1940-1946

1947-1959

1960-1973

1974-1989

1990-2000

2001-2010

Source: see Table 2.11; average includes countries listed in Table 2.11 plus Denmark, Finland, the Netherlands, Norway, Spain, and Sweden.

Degree of international capital mobility: Historical perspective

• Main observations: 1. International capital mobility was already high during

1870-1914 and it is only recently that capital mobility started rising (after the significant decline that lasted until 1973)

2. There are considerable changes in the degree of international capital mobility over time which weakens the argument that ‘one of the key features of the present global economy is a high and rising degree of cross-border capital mobility.’

Figure 2.10 Capital outflows; selected countries (% of national savings

Capital outflows (% of national savings)

-10

0

10

20

30

40

50

60

1850 1860 1870 1880 1890 1900 1910year

capi

tal o

utflo

w

United Kingdom

Germany

France

United Kingdom

Source: O’Rourke and Williamson (1999).

Figure 2.11 Evolution of British and American share in foreign assets

Foreign assets; UK and USA share of total

0

0.2

0.4

0.6

0.8

1825 1850 1875 1900 1925 1950 1975 2000year

shar

e of

ass

ets

USA

UK

USA

UK

Source: see Table 2.14

Net private financial flows to emerging and developing economies; $ bn, 1992-2009

C&E Eur

CISCIS

D Asia

D Asia

L Am

SSA

-100

-50

0

50

100

150

200

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Figure 2.12 Net private financial flows to developing economies; $ bn, 1992-2009

Source: IMF, World Economic Outlook database; D Asia = Developing Asia; L Am = Latin America & Caribbean; C&E Eur = Central & Eastern Europe; CIS = Commonwealth of Independent States; SSA = Sub-Saharan Africa.

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2A.1 Overview of tax havens:

The Caribbean and Africa Europe Americas Liberia Aldernay Anguilla Mauritius Andorra Antigua and Barbados Melila Belgium Aruba the Seychelles Campione d'Italia the Bahamas Soa Tome e Principe City of London Barbados Somalia Cyprus Belize South Africa Gibraltar Bermuda Guernsey British Virgin Islands Middle East and Asia Hungary Costa Rica Bahrain Iceland Domini Dubai Ireland (Dublin) Grenada Hong Kong Ingushetia Montserrat Labuan Isle of Man Netherlands Antilles Lebanon Jersey New York Macau Liechtenstein Panama Singapore Luxembourg Saint Lucia Tel Aviv Madeira St. Kitts & Nevis Taipei Malta Saint Vincent and the Monaco Grenadines Indian and Pacific Ocean Netherlands Turks and Calcos Islands The Cook Islands Sark Uruguay The Maladives Switzerland US Virgin Islands The Marianas Trieste Marshall Islands Turkish Republic of Nothern Nauru Cyprus Niue Frankfurt Samoa Tonga Vanuatu Source: offshore business magazine (20 Sep 2006, pp. 66-7) and Tax Justice network "tax us if you can".

Beugelsdijk, Brakman, Garretsen, and van Marrewijk International Economics and Business© Cambridge University Press, 2013 Chapter 2 – Getting the numbers rightTable 2A.2 Global 500: Top 20 largest firms of the world; in US $ bn,,2010

Rank Company Country Revenues Profits

1 Wal-Mart Stores U.S. 408 14.3 2 Royal Dutch Shell Netherlands 285 12.5 3 Exxon Mobil U.S. 285 19.3 4 BP Britain 246 16.6 5 Toyota Motor Japan 204 2.3

6 Japan Post Holdings Japan 202 4.8 7 Sinopec China 188 5.8 8 State Grid China 184 -0.3 9 AXA France 175 5.0 10 China National Petroleum China 165 10.3

11 Chevron U.S. 164 10.5 12 ING Group Netherlands 163 -1.3 13 General Electric U.S. 157 11.0 14 Total France 156 11.7 15 Bank of America Corp. U.S. 150 6.3

16 Volkswagen Germany 146 1.3 17 ConocoPhillips U.S. 140 4.9 18 BNP Paribas France 131 8.1 19 Assicurazioni Generali Italy 126 1.8 20 Allianz Germany 126 6.0

Source: Fortune Global 500

The importance of distinguishing between micro and macro

1. A micro-level investment (shown on the firm’s annual accounts) does not necessarily translate into a macro-level investments (in the country’s BOP).

2. M&As are firm-level investment but are neutral from a macro perspective.

3. A multinational’s sales cannot be compared with a country’s GDP

Box 2.7Why accounting is useful but it is not explaining.

• C + M + S = I + X + C

or• S – I = X – M

This implies that the national saving surplus must be equal to the current account (CA) surplus.

However, accounting cannot explain whether

a trade deficit is good or bad or why we have

trade deficit.