international finance environment

8/18/2019 International Finance Environment

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International Finance EnvironmentToward Accounting Harmonization

Session 1

Ferry Jaolis

Marketing Evangelist

These are confidential sessions. Please refrain from redistributing without written permission from the university.

International Finance #FIN

Monday, March 21, 16


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Directions

International finance environment and MNCs

Accounting diversity and harmonisation (Europe, East Asia)

Conceptual framework for financial reporting

Presentation of financial statements under standards (IFRS)



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Readings

Textbooks

• International Financial Management, 10th Ed. (Madura)

• Comparative International Accounting, 10th Ed. (Nobes & Parker)

• Intermediate Accounting, 15th Ed. (Kieso, Weygandt, & Warfield)

• IFRS: Practical Implementation Guide & Workbook, 2nd Ed. (Mirza, Orrell, & H

• Financial Accounting, 14th Ed. (Elliot & Elliot)

Online

• www.iasplus.com (Deloitte.)

• www.ifrs.org/Use-around-the-world/Education


http://www.ifrs.org/Use-around-the-world/Educationhttp://www.ifrs.org/Use-around-the-world/Educationhttp://www.ifrs.org/Use-around-the-world/Educationhttp://www.iasplus.com/http://www.ifrs.org/Use-around-the-world/Educationhttp://www.ifrs.org/Use-around-the-world/Educationhttp://www.iasplus.com/http://www.iasplus.com/


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Structure

Five lectures

Two students’ group presentations — 50%

One final exam (multiple choice) — 50%



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Group Presentations

Causes and examples of international differences (NP 2)

Harmonization in Europe (NP 5.3+13.2)

Conceptual Framework (KWW ch. 2; MHO ch. 2)

Presentation of financial statements IAS 1 (MHO/E ch.3) Accounting on a cash flow basis (Elliott ch. 1)

Accounting on an accrual accounting basis (Elliott ch. 2)

International Auditing (NP ch. 20)

Fraud and internal control (Weygandt et al., ch. 7)



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Agenda

Multinational Corporations (MNCs)

• Goal

• Organizational Structure

• Key Theories

• Common Conduct Methods

• Valuation

Accounting Harmonization



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MNC

Maximize shareholder wealth (stock price)

Shareholder vs. firm’s managers gap (agency problem)

Agency costs (Rubin, 1978)

• Larger in MNCs than purely domestic firms

• Sheer size of the MNC

• Scattering of distant subsidiaries

• Culture of foreign managers

• Subsidiary value versus overall MNC value

Goal and Gap



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Agency Costs

Parent control

• Centralized

• Decentralized

• Mixed

Management



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Agency Costs

Parent control

• Centralized

• Decentralized

• Mixed

Corporate control

• Stock compensation for board members/executives

• Threat of hostile takeover

• Monitoring, intervention by large shareholders

Management



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Agency Costs

SOX (Sarbanes-Oxley Act) – U.S. in 2002

• The critical case of Enron 2001

• Transparency on productivity and financial condition

• Centralized database of information

• Consistent data reporting among subsidiaries

• Automation system to check data discrepancies from norms

• Personal verification toward accountable actions

• Can deter foreign firms from listing in U.S.

Management



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Agency Costs

Environmental

Regulatory

Ethical

Constraints Facing MNCs Managers



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Why Firms Pursue Business Internationally

Comparative Advantage

Imperfect Markets

Product Cycle

Key International Business Theories



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Comparative AdvantageDavid Ricardo (1772 – 1823)



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Specialization increases production efficiency (better job, lower c

Apple, Hasbro, Sony, Volkswagen

U.S. — innovation-led specialization

Germany, Japan — engineering-led specialization

China — manufacture-led specialization

India — innovation-led specialization

Indonesia — manufacture-led specialization



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Imperfect Markets TheoryHymer (1976)

Imperfect = anything that interferes with trade

Factors of productions (e.g. labors, resources) are immobile

There is no perfect competition in the final product market

• Exclusive, permanent control of proprietary tech

• Privileged access to inputs

• Scale of economies

• Control of distribution systems

• Product differentiation (branding, positioning)



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Imperfect Markets TheoryCase: Indonesia for Luxury Goods

Restrictions and barriers to entry issues

Domestic market protection

Decrease luxury products consumptions (consumerism)

Indonesia, luxury cars:

• Whether you produce or import

• 10 – 200% tax on the product price

• Luxury cars (e.g. Ferrari) — 150%

• If you are exporting luxury products, 0% tax



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Product Cycle TheoryHymer (1976)

Market saturation in home base country (primary reason for MNCs)

Information are easily and readily available in home country

Cycle:

• Foreign demand will be first served by exporting

• Foreign market competitions arise as function of others’ learning curve

• CA is retained by offshoring, subsidiaries, birth of MNCs

• Competitions rise again due to learning curve

• MNCs practiced “differentiation” or “positioning”

• First-mover advantage (e.g. the 1st in bringing new techs/innovationsabroad or the 1st entering or creating a market)



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World Wide WebLife cycle is shortened


I i l E M d


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International Entry Modes

Export/importLicensing

Franchising

Joint ventures Acquisitions

Subsidiaries


I t ti l T d


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International Trade

Minimal risk due to no capital placement

Walmart mostly import goods from China (low cost)

Online stores

Compare:

• How much is it a piece of Kingston USB stick from Amazon.com?

• How much is it from Walmart?



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Li i


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Licensing

A firm allows usages of tech (copyrights, patents, TM, brands)

In exchange for some fees

Usually non-exclusive (multiple firms serving same market)

Doesn’t control licensees’ business operations

Starbucks licensing with SSP (F&B operator in Europe)

Sprint Nextel Corp. in the UK

Mostly pharmaceuticals and softwares


F hi i


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Franchising

A firm allows usages of brand name and business practices

In exchange for intial fees and on going royalties

Usually non-exclusive (multiple firms serving same market)

Does control franchisees’ business operations

Initial opening, market-geographic assessment, trainings, suppor

McD, KFC, Pizza Hut, Domino’s, …

Dessange, Bocage, Celio, De Neuville, La Vie Claire, …


Global Franchise Brand Share 2009


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Global Franchise Brand Share 2009

Asia Europe N. America L. America Pacific Africa


Franchise Brand Share By Country 2009


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Franchise Brand Share By Country 2009

France Germany Spain Italy UK Netherland

*

* As of 2014Monday, March 21, 16

Joint Ventures


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Joint Ventures

A venture jointly owned and operated by two or more firms

Allows them to marry respective comparative advantages

Mostly because foreign country place restrictions for full subsidia

Must select local firm(s) as partner(s)

Must share technologies, and certain ownership

PMI and Swedish Match AB (boost sales of snus)

General Mills and Nestlé (allowed GM to take advantage of Nestléoverseas sales distribution network)

Xerox and Fuji (Xerox enter Japanese market)


Acquisitions


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Acquisitions

Great way of penetrating foreign markets

Quickly gain control over foreign operations and market shares

Pfizer (U.S.) acquired Allergan (Irish) – $191 B

Anheuser-Busch InBev (Belgian) acquired SABMiller (UK) – $120 B

Shell (Dutch) acquired BG (British) –$81 B

PMI (U.S.) acquired Sampoerna (INA) – $5.2 B


PMI Acquired Sampoerna Tbk (INA)


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PMI Acquired Sampoerna Tbk. (INA)




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PM has only 4% share in Indonesia




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Sampoerna has 31% share




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87% in clove market (15% CAGR)




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Enormous distribution network




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49% tobacco taxes (crisis-proof)




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• 65M Indonesians smoke (13.3% CAGR)




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• 2nd largest after Russia




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• 70% labors are female (low costs)




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• Smoking is associated with stress reliever

• Smoking “facilitates” communal relationship




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cqu ed Sa poe a b ( )









• Smoking is associated with stress reliever

• Smoking “facilitates” communal relationship


Subsidiaries


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Similar to acquisitions, requires large investmentsPreferred (can be tailored to the firm’s needs)

However, must adapt with local preferences and laws

No rewards until subsidiary is built and customer base establishe


International Entry Modes


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y

Export/importLicensing

Franchising – semi DFI

Joint ventures – semi DFI

Acquisitions – DFI

Subsidiaries – DFI


Degree of International Business by MNCs


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g y

18 %

35 %

53 %

70 %

Campbell's Soup Dow Chemical IBM Motorola Nike

Foreign Sales as a % of Total SalesForeign Assets as a % of Total Assets



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Value Management


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g

Domestic + foreign projects involve investment + financing decisiGoal is to maximize overall PV of future cash flows

Maximize the firm’s value

Hence, shareholder wealth


International Monetary System


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1945 – 1972• Bretton Woods Agreement

• Fixed exchange rates with periodic devaluations

Since 1973

• Floating exchange rates

1999

• EU enacted single currency ( ! )

• Concern with hedging activities

• Concern with other transactions in foreign currency


Di"erences in Financial Reporting


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Accountants from a country/different countries won’t produceidentical statements

No set of rules covers every event or prescriptive to smallest deta

Judgments (e.g. whether the main users are tax authorities, etc.)

Group of companies (domestic or MNCs) differ in rules


Di"erences in Financial Reporting


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IASB (International Accounting Standards Board)• IFRS (International Financial Reporting Standards)

European Union

• Directives and Regulations on accounting and financial reporting

U.S.

• GAAP (Generally Accepted Accounting Principles)

Towards Similarity Attempts



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Globalization of Accounting Rules


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Major political issues (dominance of U.S., expansion of EU)Economic globalization

Emergence of global financial markets

Patterns of share ownership (state or private-owned)

Changes in International monetary system

Growth of MNCs


Accounting and World Politics


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Dominance of U.S. GAAP• Enron case (2001)

• Andersen as accounting firm

Development of International Accounting Standards

• IASC, London, by Lord Benson

Accounting in developing countries

• Strongly influenced by former colonial powers

• Former British colonies – Institute of Chartered Accountants

• French colonies – government based (double entry to published)


Accounting and Globalization of Economy


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Freer and faster transfer of goods, services, people, tech, ...Foreign Direct Investment (FDI)

• Equity interest in a foreign firm held with the intention of acquiringcontrol or significant influence (i.e. usually consolidated or for thepurpose of acquiring more shares of stocks – >50% to gain control)

• In most cases, securities investment are made with the intention tosell them in the near future

• However, other investments are made with the intent of holding themto extended period (held-to-maturity approach)



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Accounting and Global Financial Markets


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Globalization of stock markets is possible due to• Deregulations of leading national financial markets (e.g. “Big Bang”

the London Stock Exchange in 1986)

• Innovation speed (e.g. new trading tech, new financial instruments)

• Dramatic advances in electronic techs of communication• Growing links between domestic and world financial markets



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Accounting and Global Financial MarketsP bl


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Precise measure of world’s stock market Internationalization are h• Firms need to translate reports for foreign investors

• French firms are listed on Australia, Belgium, Canada, Germany,Luxembourg, the Netherlands, Spain, Sweden, Switzerland, UK, U.S

• New York has the largest number of foreign listings

• Tokyo has the smallest in that regard

• Rise of listing requirements in London, Berlin, Paris, New York

Translations

• Finland: Nokia reports in Finnish+Swedish (2 local language), & Eng• Problem: translating accounting terms

Problems


Accounting and Share of Ownership


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The nature of investors in listed firms has implications on financiareporting styles

> owner-manager split, > the need for publicly available andindependently audited financial statements

Financial/non-financial controlled (36%) – UK, JPN, US, AUS, IRECAN, FRA, SWZ

Family controlled (30%) – MEX, HKG, ARG

State controlled (18%) – AUSTRIA, SGP, ISR, ITA, FIN, NOR


Accounting & International Monetary Syste


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1945 – 1972

• Bretton Woods Agreement• Fixed exchange rates with periodic devaluations

Since 1973

• Floating exchange rates

1999• EU enacted single currency ( ! ) – currency is “politically” stable

• Concern with hedging activities (more positive going concern in accreports ) – Hedging=insurance policy (invest in a position that offsets(bets against) former investment, lost on one means gain on others

• Concern with other transactions in foreign currency ( going concern )


Accounting and MNCs


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Rise of the need for auditingIssues such as translations of foreing subsidiaries finstatements to prepare for consolidated statements

Most MNCs produce consolidated stats in accord w/US GAAP, IFRS



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Comparative & Internationalization of AccThree Major Reasons


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1. Reminds that US or Anglo-Saxon isn’t the only contributors• The Romans (not double entry)

• Muslims (arithmetic and bookkeeping)

• Italian (double entry, spread first across Europe then the world)

• Loanwords: bank, capital, cash, debit, credit, folio, journal• Britain (19th century) – imported Italian double entry, exported

professional accountancy to the rest of the world and EU

• US (20th century) – lead the concepts & practices of management ac

• Japan (20th century) – management acc and control

• English reporting became then mostly universal

Three Major Reasons



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What the Table doesn’t Show


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Rates of growth• Chinese Institute of CPA grown the third largest in the world

Worldwidely, not just national memberships

• Two UK bodies (ACCA, CIMA)

Ratio of accountant per head of population• France (population 60 M, accountants 18,000)

• New Zealand (population 4 M, accountants 29,000)




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2. Means to learn from each other (preparers, users, regulators)• Improvement motifs

• Achievements and failures to avoid accounting ethnocentrism

• History in economic, legal, and social are differences that should nodelay harmonization

• UK accepted European ideas on greater layout uniformity in financiastatements

• France, Germany accepted UK and US approach to consolidatedstatements

• US, learned hard from 2001’s Enron case, willing to consideraccounting standards accord to UK and by the IASB

Three Major Reasons




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3. Harmonization deemed desirable yet difficult to achieve• Consolidation acc and foreign currency translation have been tackle

significantly in different countries

• One plausible, mostly accepted is FASB (since they are not US GAA

• FASB close to US GAAP, however, and acceptable to most stock-exchange regulators

• IASB is adopted by the EU (to avoid use of US GAAP)

• IASB and FASB race to the top

• Keywords: compromises on both political and technical nature

Three Major Reasons


Quick Recap


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Clearly, accounting differs from country to countryThe presence of accountancy bodies help unify those differences

Some causes and examples of international differences


Causes and Examples of Int’l Di"erences


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International cultural differences and acc differences


Factors A "ecting International Di"erences


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CultureLegal systems

Providers of finance

Taxation

Other external influences


Culture


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Accounting is affected by its environment, including cultureCulture contains values, affect how society is structured

And how they interact with its substructure

Accounting may be seen as on of those structure


CultureHofstede (1980)


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Individualism vs. collectivism• Group goals vs. individual freedoms

Large vs. small power distance

• Low trust in younger professionals (high hierarchical manner)

Strong vs. weak uncertainty avoidance• Relaxed vs. paranoid

Masculinity vs. femininity

• Masculine (assertive, achievement, material success)

• Feminine (relationship, harmony, modesty, caring for the weak)

( )


The 5 PillarsCollectivism vs. Individualism


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Collectivism Individualism

Origins of human rights Gift from government Intrinsic to human being

Supremacy Group Individual

Responsibilities Coercion Freedom to choose

Law mechanism Inequality Equality

State rolePositive (aggressive,

leading, providing)

Negative (defensive,

protecting)


Individualism vs. CollectivismHofstede (1980)


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Collectivism can be associated with more prudent/conservatist accapproach (i.e. everything is “managed” the state; tax, profit margin,etc.)

• Germany – accounting rules is tax rules

Individualists tend to be more fair and fully disclosure statements, mo

often than not, is required• US – making its own acc standards (GAAP)

( )




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Individualism vs. collectivism• Group goals vs. individual freedoms






• Feminine (relationship, harmony, modesty, caring for the weak)

( )



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Larger power distance

• Senior acc bodies / firms

• Pricewaterhouse Coopers, Deloitte, Ernst & Young, KPMG

Shorter power distance

• Mostly professional services, irrespective of brand names• However, more often than not, public have higher trust on bigger firm




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Individualism vs. collectivism

• Group goals vs. individual freedoms




• Strong uncertainty avoidance demand full disclosure fin statements




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Individualism vs. collectivism

• Group goals vs. individual freedoms






• Feminine (relationship, harmony, modesty, caring for the weak)• Indonesia: beware, rare transparency, weak law, high corruption


CultureGray (1998)


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Applied Hofstede’s cultural dimensions to explain Int’l differencesin accountants’ behaviour, hence, the nature of acc practices

Pairs of accounting values

• Professionalism vs. statutory control (authority)—Anglo

• Uniformity vs. flexibility (enforcement)—Asian

• Conservatism/prudent vs. optimism (measurement)—Anglo

• Secrecy vs. transparency (disclosure)—Latin, Germany

• Transparency increased as uncertainty avoidance decreased




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Culture

Legal systems


Taxation



Legal systems


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Legal systems


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Common law emanates from England and spreaded out

Influences commercial law (traditionally doesn’t prescribe rules tocover behaviours of companies and how to prepare fin statement

Accounting within such context is not specified in detail in law

Accountants establish rules for acc practices (standards)


Legal systems


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Legal systems


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Based on the Roman ius civile (compiled by Justinian 6th century)

Taught in European universities from 12th century onwards

Accounting rules established from this law

Germany’s company accounting is under domestic rules, andtreated as a branch of law


Legal systemsImplications on Accounting Practices


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The nature of acc regulation is affected by its general system of la

Companies in common law countries

• Have higher levels of disclosures (Jaggi & Low, 2000)

• Greater incentives to report losses quickly (Bushman & Piotroski, 2006

Legal systems have weaker effect because some countries mightadopt IFRS for some or all purposes, irrespective of its legal syste




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Culture

Legal systems


Taxation



Providers of FinanceImplications on Accounting Practices


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Germany, France, Italy, capital is provided by banks (credit)–”insiders”

• Bankers, governments, founding families (have “natural” or “forced” accesto internal information)

• Thus requires less auditing process on the financial reporting

• Dominated by gov’s need of taxable income calculation in the report

UK, US, is by private shareholders (capital market) – “outsiders”

• Often don’t have access to internal information

• Thus emphasize disclosure, audit, and “fair” information

• Two acc rules: one for financial reporting, one for taxable income calculatio

Nevertheless, countries with few listed companies (lower requirement to

publish financial data) move to emphasize audited fin statements




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Culture

Legal systems


Taxation



TaxationImplications on Accounting Practices


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Taxation regulations determine acc measurements

UK, US – tax rules are different with acc treatment for taxation

• Fixed asset’s depreciation follows as fairly as possible in which the asset’seconomic benefits are consumed by the entity

France, Germany – tax rules are the acc rules

• Fixed asset’s depreciation follows declining balance method, with a changto straight-line depreciation when this results in higher depreciation amou

For UK, US, tax charge against profit isn’t “fair”

For France, Germany, it’s a minor problem




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Culture

Legal systems


Taxation



Other External InfluencesImplications on Accounting Practices


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Economic events

Economic crisis in US (late 1920s and early 1930s) emphasizeextensive disclosure and state control of acc standards

Level of inflation

• Very high in some South American countries (~100% per year)

• The use of general price-level adjustment (Tweedie & Whittington, 1984)




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Influence of theory

• Microeconomics in Netherlands + Dutch law and tax requirements arerelatively loose

• Led to the present diversity of practice

• Allowing accountants to emphasize fairness through judgment (i.e. to

select and present acc figures)• Experimentation with replacement cost accounting




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Accountancy profession

• Lower amount of public companies or private shareholders in somecountries means smaller needs for an auditor

• This is in opposite to those in UK or US (auditors needed)

Adoption of standards of the IASB (mostly by EU)


Some Examples of Di"erencesConservatism and Accruals


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Conservatism has two meanings

• Tendency to understate profit and assets

• Associated with state’s desire to limit dividends to protect creditors

• Company’s desire to limit taxable income

• The speed with which losses are reported (e.g. in accrual basis–account

payable)

In Germany, bankers are interested in ‘rock-bottom’ figures so they fethat long-term loans are safe (i.e. profits and assets are not reported accrual basis)

Accrual acc basis called ‘prudence’ by IFRS (careful statement, sinceaccruals tend to reflect only prediction, not reality like in cash basis a


Some Examples of Di"erencesFinancial Statement Formats


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Balance sheets vary in two main ways under domestic rules

• In some countries, Assets are displayed in order of decreasing liquidity(cash first) – countries influenced by US GAAP

• In others, increasing order of liquidity (intangible fixed assets come first)countries influenced by EU Directives

• Other variations is shape of financial statement format• Some combine together all debits and then all credits (two-sided, asse

the left),

• Or in a report form a single page (asset at the top)

• Other companies arrange the items in order to calculate TOTALS of Ne

Current Assets and Net Assets (called financial position format)


ChinaIndia

GDP Composition 2012


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-15

0

15

30

45

60

Consumption Government Investment Net Exports

Indonesia


Valuation ModelPurely Domestic


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E (CF$,t ) = expected cash flows to be received at the end of

period t n = the number of periods into the future in which cas

flows are received k = the required rate of return by investors/WACC


Valuation ModelInternational Cash Flow


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E (CF j,t ) = expected cash flows denominated in currency j to

be received by the U.S. parent at the end of period t E (S j,t ) = expected exchange rate at which currency j can be

converted to dollars at the end of period t k = the weighted average cost of capital of the U.S. paren

company

m

=

the number of multiple currencies from multiple foreigoperationsMonday, March 21, 16

Valuation ModelInternational Cash Flow: MNC Uses Two/More Currencie

C li C h t d h fl f $100 000 f l l b i


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Carolina Co. has expected cash flows of $100,000 from local business

and 1 million Mexican pesos from business in Mexico at the end ofperiod t. Assuming that the peso’s value is expected to be $.09 whenconverted into dollars, the expected dollar cash flows are:


Uncertainty Surrounding an MNC’s CFExposure to foreign economies Exchange rate risk


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Exposure to FE (e.g. weak PPP) — if [CF j,t < E (CF j,t )] = Value decl

Exposure to PR (e.g. high taxes) — if [CF j,t < E (CF j,t )] = Value dec

Exposure to ERR — if [S j,t < E (S j,t )] = Value declines


international finance environment

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