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Accounting and Finance in the International Business LEARNING OBJECTIVES After reading this chapter, you will be able to:

LO20 -1 Discuss the national differences in accounting standards. LO20-2 Explain the implications of the rise of international accounting standards. LO20-3 Explain how accounting systems affect control systems within the multinational enterprise. LO20-4 Discuss how operating in different nations affects investment decisions within the multinational enterprise. LO20-5 Discuss the different financing options available to the foreign subsidiary of a multinational enterprise. LO20-6 Understand how money management in the international business can be used to minimize cash balances, transaction costs, and taxation. LO20-7 Understand the basic techniques for global money management. 20 ©Bloomberg/Bloomberg/ Getty Images part six International Business Functions Shoprite—Financial Success of a Food Retailer in Africa Building on these financial and nonfinancial metrics, The Shoprite Group’s primary business is food retailing, but the Group’s financial success also depends on offering a broad range of products and services. For example, these include household products, furniture, pharmaceuti- cals, and financial services. In all endeavors, Shoprite has an unwavering dedication to providing the lowest prices to customers of all income levels across the 15 countries it serves in Africa and the Indian Ocean Islands.

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The financial success depends as much on repeat cus – tomers as it does on pursuing efficiency in everything that the company does. Shoprite’s advanced distribution cen – ters and sophisticated supply chain infrastructure provide greater control over operations. This empowers Shoprite to overcome eventual economic challenges without com – promising on quality. By setting the conditions for enduring success, Shoprite can provide affordable food to all com – munities, invest in social initiatives that help the communi- ties in which they operate, and contribute to the African economy—all while creating value for all stakeholders. The Shoprite Group of companies have created tremendous financial success in what many other companies consider a weak buying power market while also helping to socially develop the local African communities. Sources: Shoprite Holdings Ltd., March 27, 2017, shopriteholdings.; “Global Powers of Retailing 2017,” March 27, 2017, za/en/pages/consumer-industrial-products/articles/global-powers- of-retailing-2017.html ; “Supermarkets in Africa: The Grocers Great Trek,” The Economist , September 21, 2013; “Is It Worth It?” The Econo – mist, April 14, 2016; Liezel Hill, “Shoprite Jumps Most Since 1997 as Afri – can Sales Growth Rises,” Bloomberg Businessweek , July 20, 2016; Memory Mataranyika, “Shoprite Expands into West Africa as Urbanization Gathers Pace,” FIN 24, November 25, 2016; Janice Kew, “Christo Wiese Says He’ll Learn from Failed Merger Talks,” FIN 24, February 21, 2017. OPENING CASE The Shoprite Group is Africa’s largest food retailer, operat- ing more than 2,300 stores in 15 countries across Africa and the Indian Ocean Islands. The company began in 1979, has 143,000 employees, has revenue of R130 billion rand (about $11 billion U.S. dollars), and is headquartered in the Western Cape province of South Africa. Shoprite has expanded rapidly since the company’s founding by mak – ing a number of financial acquisitions, including Checkers in 1991, Sentra in 1995, OK Bazaars in 1997, Madagascar in 2002, Foodworld in 2005, and Computicket in 2005. This expansion has led to Deloitte’s Global Powers of Retailing ranking The Shoprite Group as the 94th largest retailer in the world and the largest in Africa. Some 76 percent of South Africa’s adult population shops at one of Shoprite’s supermarket brands.

Shoprite views the combination of controlling its own supply chain, investing in employee skills, investing in infra – structure, and incorporating value-added services to com- pliment the shopping experience as the recipe for financial success. And the company measures its financial success via a large set of traditional and nontraditional statistics.

Some of the nontraditional outcome measures include serv – ing a billion customers in a single year, donating food worth R109 million (about $9 million U.S. dollars), and 4.5 million free meals of soup and bread served by mobile kitchens.

The more traditional, expected outcomes include 108 new corporate stores opened in the last year, 4,833 new jobs created, sales growth of 14.4 percent, a profit increase of 15.0 percent, and an increase in return-on-shareholders’ eq – uity of 19.2 percent. But Shoprite also counts the 1.8 million training hours invested in employees as a positive perfor – mance metric that has long-term financial implications. 583 584 Part 6 International Business Functions Introduction This chapter deals with two related topics: international accounting and international fi- nance. By those topics, we focus on accounting and finance, respectively, as they apply as functions within an international business, such as a multinational corporation or small and medium-sized enterprise (SME). The goal of this chapter is to provide you with a non – technical overview of some of the main issues in international accounting and interna – tional finance that confront managers in, for example, a multinational corporation. As such, similar to the other chapters on the various international business functions (export- ing, importing, and countertrade in Chapter 16; global production and supply chain man – agement in Chapter 17; global marketing and R&D in Chapter 18; and global HRM in Chapter 19), this chapter on accounting and finance in international business integrates core materials into the course on international business. Uniquely connected to this chapter, though, is the set of chapters on global trade and the investment environment (with topics such as international trade theory in Chapter 6; government policy and international trade in Chapter 7; FDI in Chapter 8; and regional economic integration in Chapter 9) and the chapters on the global monetary system (the foreign exchange market in Chapter 10; the international monetary system in Chapter 11; and the global capital market in Chapter 12). The topics covered in these seven chapters in the text provide a foundation for what many multinational corporations can do regard – ing their international finance strategies and tactics, as well as how they structure many of their international accounting operations. As such, we encourage you to look back at some of these “macro” topics as they apply to the material and learning in this chapter on the accounting and finance functions of the company. Accounting has often been referred to as “the language of business.” 1 This language finds expression in profit and loss statements, balance sheets, budgets, investment analy – sis, and tax analysis. Accounting information is the means by which firms communicate their financial position to the providers of capital, enabling them to assess the value of their investments and make decisions about future resource allocations. Accounting infor – mation is also the means by which firms report their income to the government, so the government can assess how much tax the firm owes. It is also the means by which the firm can evaluate its performance, control its internal expenditures, and plan for future expen – ditures and income. Thus, a good accounting function is critical to the smooth running of the firm and to a nation’s financial system. In this regard, international businesses face a number of accounting problems that do not confront purely domestic businesses—most notably, the lack of consistency in the accounting standards of the more than 200 coun – tries and territories in the world. Financial management in an international business includes three sets of related deci – sions: (1) investment decisions, decisions about what activities to finance; (2) financing decisions, decisions about how to finance those activities; and (3) money management decisions, decisions about how to manage the firm’s financial resources most efficiently.

In an international business, investment, financing, and money management decisions are complicated by the fact that countries have different currencies, different tax regimes, dif- ferent regulations concerning the f low of capital across their borders, different norms re – garding the financing of business activities, different levels of economic and political risk, and so on. Financial managers must consider all these factors when deciding which activi- ties to finance, how best to finance those activities, how best to manage the firm’s finan – cial resources, and how best to protect the firm from political and economic risks (including foreign exchange risk). As we shall see, one of the money management goals that financial managers try to achieve in an international business is to minimize global tax liability. The opening case looks at Shoprite and its product assortment as a hedge against financial downturns and nurturing repeat business as a financial strategy to build the company. Much of this is done by focusing on being the lowest price retailer in most of its markets. These somewhat Did You Know? Did you know 1 percent of the people own half the world?

Visit your instructor’s Connect® course and click on your eBook or SmartBook® to view a short video explanation from the authors. Accounting and Finance in the International Business Chapter 20 585 simplistic strategies have allowed The Shoprite Group to have tremendous financial suc – cess in what many other companies consider a weak buying power market while also help – ing to socially develop the local African communities. The closing case also offers a unique take on financing globally—that of using government subsidies for a socially positive prod – uct: electric cars. We use Tesla as the case scenario given the meteoric rise to electric car stardom, but other electric car manufacturers have similar opportunities. As a road map, this chapter begins by looking at country differences in accounting stan – dards and attempts aimed at harmonizing accounting standards across nations. Next we discuss the issues that can arise when managers in a multinational corporation or interna – tional SME use accounting systems to control foreign subsidiaries. Then we move on to look at investment decisions in an international business. We discuss how such factors as political and economic risk complicate investment decisions. This is followed by a review of financing decisions in an international business. Finally, we examine money management decisions in an international business, including decisions aimed at reducing tax liabilities.

National Differences in Accounting Standards Accounting is shaped by the environment in which it operates. Just as different countries have different political systems, economic systems, and cultures, historically they have also had different accounting systems. 2 These differences had a number of sources. For exam – ple, in countries where well-developed capital markets exist, such as the United States and the United Kingdom, firms typically raised capital by issuing stock or bonds to investors.

Investors in these countries demanded detailed accounting disclosures so that they could better assess the risk and likely return on their investments. The accounting system evolved to accommodate these requests. In contrast, in Germany and Switzerland, the banks emerged as the main providers of capital to enterprises. Bank officers often sat on the boards of these companies and were privy to detailed information about their operations and financial position. As a conse – quence, there were fewer demands for detailed accounting disclosures, and public accounts tended to reveal less information. Another important inf luence has been the political or economic ties between nations. U.S.-style accounting systems were adopted in the Philippines, which was once a U.S. protectorate. Similarly, the vast majority of former colonies of the British Empire have accounting practices modeled after Great Britain’s, while former French colonies followed the French system. Diverse accounting practices were enshrined in national accounting and auditing stan – dards. Accounting standards are rules for preparing financial statements; they define what is useful accounting information. Auditing standards specify the rules for perform – ing an audit—the technical process by which an independent person (the auditor) gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable. One result of national differences in accounting and auditing standards was a general lack of comparability of financial reports from one country to another (something that is now changing). For example, (1) Dutch standards favored the use of current values for replacement assets, and Japanese law generally prohibited revaluation and prescribed his – toric cost; (2) capitalization of financial leases was required practice in Great Britain, but not practiced in France; (3) research and development costs must be written off in the year they are incurred in the United States, but in Spain they could be deferred as an asset and need not be amortized as long as benefits that will cover them are expected to arise in the future; and (4) German accountants treated depreciation as a liability, whereas British companies deducted it from assets. Such differences would not matter much if there were little need for a firm headquar – tered in one country to report its financial results to citizens of another country. However, one striking development of the past two decades has been the development of global LO 20 -1 Discuss the national differences in accounting standards. 586 Part 6 International Business Functions capital markets. We have seen the growth of both transnational financing and transna – tional investment. Transnational financing occurs when a firm based in one country enters another country’s capital market to raise capital from the sale of stocks or bonds. Transna – tional investment occurs when an investor based in one country enters the capital market of another nation to invest in the stocks or bonds of a firm based in that country. The rapid expansion of transnational financing and investment has been accompanied by a corresponding growth in transnational financial reporting. However, the lack of com – parability between accounting standards in different nations caused some confusion. For example, the German firm that issued two sets of financial reports, one set prepared under German standards and the other under U.S. standards, may have found that its financial position looked significantly different in the two reports, and its investors may have had difficulty identifying the firm’s true worth. In an example of the confusion that can arise from different accounting standards, British Airways reported a loss under British accounting rules of £21 million, but under U.S. rules, its loss was £412 million. Most of the difference could be attributed to adjust – ments for a number of relatively small items such as depreciation and amortization, pen – sions, and deferred taxation. The largest adjustment was due to a reduction in revenue reported in the U.S. accounts of £136 million. This reduced revenue was related to fre – quent f lyer miles, which under U.S. rules have to be deferred until the miles are redeemed.

But, this is not the case under British rules. In addition to the problems lack of comparability gives investors, it can give the firm major headaches. The firm has to explain to its investors why its financial position looks so different in the two accounting reports. Also, an international business may find it difficult to assess the financial positions of important foreign customers, suppliers, and competitors.

International Accounting Standards Substantial efforts have been made in recent years to harmonize accounting standards across countries. 3 The rise of global capital markets during the past three decades has added urgency to this endeavor. Today, many companies raise money from providers of capital outside their national borders. Those providers are demanding consistency in the way financial results are reported so they can make more informed investment decisions.

Also, there is a realization that the adoption of common accounting standards will facilitate the development of global capital markets because more investors will be willing to invest across borders, and the end result will be to lower the cost of capital and stimulate eco – nomic growth. It is increasingly accepted that the standardization of accounting practices across national borders is in the best interests of all participants in the world economy. The International Accounting Standards Board (IASB) has emerged as a major propo – nent of standardization. The IASB was formed in March 2001 to replace the International Accounting Standards Committee (IASC), which had been established in 1973. IASB is responsible for developing International Financial Reporting Standards (IFRS). These were prevoiusly previously known as the International Accounting Standards (IAS). IASB also promotes the use and application of these standards globally. The IASB has 16 members who are responsible for the formulation of new international financial reporting standards. To issue a new standard, 75 percent of the 16 members of the board must agree. It can be difficult to get the three-quarters agreement, particularly since members come from different cultures and legal systems. To get around this prob – lem, most IASB statements provide two acceptable alternatives. As Arthur Wyatt, former IASB chair, once said, “It’s not much of a standard if you have two alternatives, but it’s better than having six. If you can get agreement on two alternatives, you can capture the 11 required votes and eliminate some of the less used practices.” 4 Another hindrance to the development of international accounting standards is that com – pliance is voluntary; the IASB has no power to enforce its standards. Despite this, support for the IASB and recognition of its standards has been growing. Increasingly, the IASB is TEST PREP Use SmartBook to help retain what you have learned.

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LO 20 -2 Explain the implications of the rise of international accounting standards. 587 Chinese Accounting Over time, more and more Chinese companies are tap- ping global capital markets, and more and more foreigners are investing in Chinese companies. These investments also come with certain strings and need for transparency.

Basically, foreign investors want to be assured that the fi – nancial picture they are getting of Chinese enterprises is reliable. That has not always been the case and, many ar – gue, is still oftentimes not the case.

If we go back only a few years to 2003, for example, China Life Insurance successfully listed its stock on the Hong Kong and New York stock exchanges, raising some $3.4 billion. However, in 2004, the head of China’s National Audit Office let it slip that a routine audit of China Life’s state-owned parent company had uncovered $652 million in financial irregularities. The stock immediately fell, and China Life found itself the target of a class action lawsuit on behalf of investors claiming financial fraud. Soon afterward, plans to list China Minsheng Banking Corp., China’s largest private bank, on the New York Stock Exchange were put on hold after the company admitted it had faked a shareholder meeting. The stock of another successful Chinese offering in New York, Semiconductor Manufacturing International, slid when its chief financial officer made statements that contradicted those contained in filings with the U.S. Securi – ties and Exchange Commission.

The core of the problem is that accounting rules in China are not consistent with international standards, making it difficult for investors to accurately value Chinese compa – nies. Accounting in China has traditionally been rooted in information gathering and compliance reporting designed to measure the government’s production and tax goals.

The Chinese system was based on the old Soviet system, which had little to do with profit. Although the system has been changing rapidly, many problems associated with the old order still remain. Indeed, it is often said, only half in jest, that Chinese firms keep several sets of books—one for the government, one for company records, one for foreign – ers, and one to report what is actually going on. To bring its rules into closer alignment with interna – tional standards, China has signaled that it will move to – ward adopting standards developed by the International Accounting Standards Board (IASB). China has already adopted a regulation, called the Accounting System for Business Enterprises, that was largely based on IASB standards. The system is now used to regulate both local and foreign companies operating in China. Encourag – ingly, the Chinese have also decided to take it one step further. The largest 1,200 firms listed on the Shanghai and Shenzhen exchanges have to adopt a broad set of ac – counting rules that are based on, but not identical to, IASB standards. It remains to be seen whether adoption of these new rules will actually be widespread, enforced, and transparent. At present, in 2018, many large public Chinese compa – nies are reporting results according to two sets of rules:

Chinese accounting standards and IASB standards. The dif – ferences between the two are instructive. For example, China Eastern, one of the largest airlines in China, said its net profit fell 29 percent from a year earlier to 41.6 million yuan ($6.1 million) under Chinese accounting rules. Based on international standards, however, the airline incurred a net loss of 212.5 million yuan, more than five times as great! Sources: Weining Hu, “China’s Accounting Standards: Chinese GAAP vs. US GAAP and IFRS,” China Briefing, May 31 2017; Christopher Balding, “China’s Control Problem,” Bloomberg View, April 23, 2017; E. McDonald, “Shanghai Surprise,” Forbes, March 26, 2007, pp. 62–63; “Cultural Revolution: Chinese Accounting,” The Economist, January 13, 2007, p. 63; S. Hong and J. Ng, “Two Chinese Airlines Post De – clines in Profit,” The Wall Street Journal, August 27, 2008, p. B9. MANAGEMENT FOCUS regarded as an effective voice for defining acceptable worldwide accounting principles. Japan, for example, began requiring financial statements to be prepared on a consolidated basis after the IASB issued its initial standards on the topic. Japan has also opted for mandatory adoption of International Financial Reporting Standards (IFRS). Russia and China have stated their intention to adopt emerging international standards (see the next Management Focus for a discussion of accounting practices in China). By 2018, more than 100 nations had either adopted the IASB standards or permitted their use to report financial results, in – cluding three-quarters of the G20 (Group of Twenty), the world’s 20 largest economies. To date, the impact of the IASB standards has probably been least noticeable in the United States because most of the standards issued by the IASB have been consistent with opinions already articulated by the U.S. Financial Accounting Standards Board (FASB). 588 Part 6 International Business Functions The FASB writes the generally accepted accounting principles (GAAP) by which the fi – nancial statements of U.S. firms must be prepared. Nevertheless, differences between IASB and FASB standards remain, although the IASB and FASB have a goal of conver – gence. The U.S. Securities and Exchange Commission has been considering whether to allow U.S. public companies to use IASB standards, rather than GAAP, to report their re – sults, a move that some believe could ultimately spell the end of GAAP. 5 Another body that is having a substantial inf luence on the harmonization of accounting standards is the European Union. In accordance with its plans for closer economic and political union, the EU has mandated harmonization of the accounting principles of its member countries. The EU does this by issuing directives that the member states are obli – gated to incorporate into their own national laws. Because EU directives have the power of law, the EU might have a better chance of achieving harmonization than the IASB does.

The EU has required that since January 1, 2005, financial accounts issued by some 7,000 publicly listed companies in the EU were to be in accordance with IASB standards. The Europeans hope that this requirement, by making it easier to compare the financial posi – tion of companies from different EU member states, will facilitate the development of a pan-European capital market and ultimately lower the cost of capital for EU firms. Given the harmonization in the EU, and given that countries including Japan, China, and Russia are following suit, there could soon be only two major accounting bodies with dominant inf luence on global reporting: FASB in the United States and IASB elsewhere.

Under an agreement, these two bodies are trying to align their standards, suggesting that differences in accounting standards across countries may disappear eventually. In a move that indicates the trend toward adoption of acceptable international account – ing standards is accelerating, the IASB has developed accounting standards for firms seek – ing stock listings in global markets. Also, the FASB has joined forces with accounting standard setters in Canada, Mexico, and Chile to explore areas in which the four countries can harmonize their accounting standards (Canada, Mexico, and the United States are members of NAFTA, and Chile would like to join). The SEC has also dropped many of its objections to international standards, which could accelerate their adoption.

Accounting Aspects of Control Systems One role of corporate headquarters in large complex multinational enterprises is to con – trol subunits within the organization to ensure that they achieve the best possible perfor – mance. In the typical firm, the control process is annual and involves three main steps:

(1) Head office and subunit management jointly determine subunit goals for the coming year; (2) throughout the year, the head office monitors subunit performance against the agreed goals; (3) if a subunit fails to achieve its goals, the head office intervenes in the subunit to learn why the shortfall occurred, taking corrective action when appropriate. The accounting function assumes a critical role in this process. Most of the goals for subunits are expressed in financial terms and are embodied in the subunit’s budget for the coming year. The budget is the main instrument of financial control. The budget is typi – cally prepared by the subunit, but it must be approved by headquarters management. Dur – ing the approval process, headquarters and subunit managers debate the goals that should be incorporated in the budget. One function of headquarters management is to ensure a subunit’s budget contains challenging but realistic performance goals. Once a budget is agreed to, accounting information systems are used to collect data throughout the year so a subunit’s performance can be evaluated against the goals contained in its budget. In most international businesses, many of the firm’s subunits are foreign subsidiaries. The performance goals for the coming year are thus set by negotiation between corporate management and the managers of foreign subsidiaries. According to one survey of control practices within multinational enterprises, the most important criterion for evaluating the performance of a foreign subsidiary is the subsidiary’s actual profits compared to budgeted profits. 6 This is closely followed by a subsidiary’s actual sales compared to budgeted sales TEST PREP Use SmartBook to help retain what you have learned.

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LO 20-3 Explain how accounting systems affect control systems within the multinational enterprise. Accounting and Finance in the International Business Chapter 20 589 and its return on investment. The same criteria are also useful in evaluating the perfor- mance of the subsidiary managers. We discuss this point later in this section. First, how – ever, we examine two factors that can complicate the control process in an international business: exchange rate changes and transfer pricing practices.

EXCHANGE RATE CHANGES AND CONTROL SYSTEMS Most international businesses require all budgets and performance data within the firm to be expressed in the “corporate currency,” which is normally the home currency. Thus, the Malaysian subsidiary of a U.S. multinational would probably submit a budget prepared in U.S. dollars, rather than Malaysian ringgit, and performance data throughout the year would be reported to headquarters in U.S. dollars. This facilitates comparisons between subsidiaries in different countries, and it makes things easier for headquarters manage – ment. However, it also allows exchange rate changes during the year to introduce substan- tial distortions. For example, the Malaysian subsidiary may fail to achieve profit goals not because of any performance problems, but merely because of a decline in the value of the ringgit against the dollar. The opposite can occur, also, making a foreign subsidiary’s per – formance look better than it actually is.

The Lessard–Lorange Model According to research by Donald Lessard and Peter Lorange, a number of methods are available to international businesses for dealing with this problem. 7 Lessard and Lorange point out three exchange rates that can be used to translate foreign currencies into the corporate currency in setting budgets and in the subsequent tracking of performance: ∙ The initial rate, the spot exchange rate when the budget is adopted. ∙ The projected rate, the spot exchange rate forecast for the end of the budget period (i.e., the forward rate). ∙ The ending rate, the spot exchange rate when the budget and performance are being compared.

These three exchange rates imply nine possible combinations (see Figure 20.1). Lessard and Lorange ruled out four of the nine combinations as illogical and unreasonable; Figure 20.1 shows the four in color. For example, it would make no sense to use the ending rate to translate the budget and the initial rate to translate actual performance data. Any of the re – maining five combinations might be used for setting budgets and evaluating performance. FIGURE 20.1 Possible combinations of exchange rates in the control process. (II) Budget at Initial Actual at Initial Budget at Initial Actual at Projected (IE) Budget at Initial Actual at Ending Budget at Projected Actual at Initial (PP) Budget at Projected Actual at Projected (PE) Budget at Projected Actual at Ending Budget at EndingActual at Initial Budget at Ending Actual at Projected (EE) Budget at Ending Actual at Ending Initial (I) Projected (P) Ending (E) Initial (I) Projected (P) Ending (E) Rate Used to Translate Actual Performance for Comparison with Budget Rate Used for Translating Budget 590 Part 6 International Business Functions With three of these five combinations—II, PP, and EE—the same exchange rate is used for translating both budget figures and performance figures into the corporate currency.

All three combinations have the advantage that a change in the exchange rate during the year does not distort the control process. This is not true for the other two combinations, IE and PE. In those cases, exchange rate changes can introduce distortions. The potential for distortion is greater with IE; the ending spot exchange rate used to evaluate perfor – mance against the budget may be quite different from the initial spot exchange rate used to translate the budget. The distortion is less serious in the case of PE because the projected exchange rate considers future exchange rate movements. Of the five combinations, Lessard and Lorange recommend that firms use the pro – jected spot exchange rate to translate both the budget and performance figures into the corporate currency, combination PP. The projected rate in such cases will typically be the forward exchange rate as determined by the foreign exchange market (see Chapter 10 for the definition of forward rate) or some company-generated forecast of future spot rates, which Lessard and Lorange refer to as the internal forward rate . The internal forward rate may differ from the forward rate quoted by the foreign exchange market if the firm wishes to bias its business in favor of, or against, the particular foreign currency. TRANSFER PRICING AND CONTROL SYSTEMS Chapter 14 reviewed the various strategies that international businesses pursue. Two of these strategies, the global strategy and the transnational strategy, give rise to a globally dispersed web of productive activities. Firms pursuing these strategies disperse each value creation ac – tivity to its optimal location in the world. Thus, a product might be designed in one country, some of its components manufactured in a second country, other components manufactured in a third country, all assembled in a fourth country, and then sold worldwide. The volume of intrafirm transactions in such firms is very high. The firms are continu- ally shipping component parts and finished goods between subsidiaries in different coun – tries. This poses a very important question: How should goods and services transferred between subsidiary companies in a multinational firm be priced? The price at which such goods and services are transferred is referred to as the transfer price. The choice of transfer price can critically affect the performance of two subsidiaries that exchange goods or services. Consider this example: A French manufacturing subsid – iary of a U.S. multinational imports a major component from Brazil. It incorporates this part into a product that it sells in France for the equivalent of $230 per unit. The product costs $200 to manufacture, of which $100 goes to the Brazilian subsidiary to pay for the component part. The remaining $100 covers costs incurred in France. Thus, the French subsidiary earns $30 profit per unit. Before Change in Transfer Price After 20 Percent Increase in Transfer Price Revenues per unit $230$230 Cost of component per unit  100 120 Other costs per unit  100 100 Profit per unit $ 30$ 10 See what happens if corporate headquarters decides to increase transfer prices by 20 percent ($20 per unit). The French subsidiary’s profits will fall by two-thirds from $30 per unit to $10 per unit. Thus, the performance of the French subsidiary depends on the trans – fer price for the component part imported from Brazil, and the transfer price is controlled by corporate headquarters. When setting budgets and reviewing a subsidiary’s perfor – mance, corporate headquarters must keep in mind the distorting effect of transfer prices. Accounting and Finance in the International Business Chapter 20 591 How should transfer prices be determined? We discuss this issue in detail later in the chapter. International businesses often manipulate transfer prices to minimize their world – wide tax liability, minimize import duties, and avoid government restrictions on capital f lows. For now, however, it is enough to note that the transfer price must be considered when setting budgets and evaluating a subsidiary’s performance.

SEPARATION OF SUBSIDIARY AND MANAGER PERFORMANCE In many international businesses, the same quantitative criteria are used to assess the per – formance of both a foreign subsidiary and its managers. Many accountants, however, argue that although it is legitimate to compare subsidiaries against each other on the basis of re – turn on investment (ROI) or other indicators of profitability, it may not be appropriate to use these for comparing and evaluating the managers of different subsidiaries. Foreign subsidiaries do not operate in uniform environments; their environments have widely dif – ferent economic, political, and social conditions, all of which inf luence the costs of doing business in a country and hence the subsidiaries’ profitability. Thus, the manager of a subsidiary in an adverse environment that has an ROI of 5 percent may be doing a better job than the manager of a subsidiary in a benign environment that has an ROI of 20 per – cent. Although the firm might want to pull out of a country where its ROI is only 5 per – cent, it may also want to recognize the manager’s achievement. Accordingly, it has been suggested that the evaluation of a subsidiary should be kept sepa – rate from the evaluation of its manager. 8 The manager’s evaluation should consider how hostile or benign the country’s environment is for that business. Further, managers should be evaluated in local currency terms after making allowances for those items over which they have no control (e.g., interest rates, tax rates, inf lation rates, transfer prices, exchange rates). INSIGHTS BY ECONOMIC CLASSIFICATION Chapter 20 deals with international accounting and international finance. These are functions performed by an international business organization. What companies can do often depends on what country they are headquartered in, decide to operate in, or market to around the world. The globalEDGE Insights by Economic Classification focuses on market types (e.g., emerging markets, frontier markets). Emerging markets, for example, are countries that have some characteristics of a developed market, like the United States and Sweden, but are not yet a fully developed market. A wealth of information and data on emerging markets can be found at . Did you know that a key dif – ference between emerging markets and emerging economies is that emerging markets are not fully described by, or constrained to, geography or economic strength whereas emerging economies are constrained by political and geographic boundaries? TEST PREP Use SmartBook to help retain what you have learned.

Access your instructor’s Connect course to check out SmartBook or go to for help. Financial Management: The Investment Decision One role of the financial manager in an international business is to try to quantify the various benefits, costs, and risks that are likely to f low from an investment in a given loca – tion. A decision to invest in activities in a given country must consider many economic, political, cultural, and strategic variables. We have been discussing this issue throughout much of this book. Chapters 2, 3, and 4 touched on it when we discussed how the political, economic, legal, and cultural environment of a country can inf luence the benefits, costs, and risks of doing business there and thus its attractiveness as an investment site. We re – turned to the issue in Chapter 8 with a discussion of the economic theory of foreign direct investment. We identified a number of factors that determine the economic attractiveness LO 20- 4 Discuss how operating in different nations affects investment decisions within the multinational enterprise. 592 Part 6 International Business Functions of a foreign investment opportunity. We also looked at the political economy of foreign direct investment in Chapter 7, and we considered the role that government intervention can play in foreign investment. In Chapter 13, we pulled much of this material together when we considered how a firm can reduce its costs of value creation and/or increase its value added by investing in productive activities in other countries. We returned to the issue again in Chapter 15 when we considered the various modes for entering foreign markets.

CAPITAL BUDGETING Capital budgeting is the technique financial managers use to try to quantify the benefits, costs, and risks of an investment. This enables top managers to compare, in a reasonably objective fashion, different investment alternatives within and across countries so they can make informed choices about where the firm should invest its scarce financial resources.

Capital budgeting for a foreign project uses the same theoretical framework that domestic capital budgeting uses; that is, the firm must first estimate the cash f lows associated with the project over time. In most cases, the cash f lows will be negative at first, because the firm will be investing heavily in production facilities. After some initial period, however, the cash f lows will become positive as investment costs decline and revenues grow. Once the cash f lows have been estimated, they must be discounted to determine their net present value using an appropriate discount rate. The most commonly used discount rate is either the firm’s cost of capital or some other required rate of return. If the net present value of the discounted cash f lows is greater than zero, the firm should go ahead with the project. 9 Although this might sound quite straightforward, capital budgeting is in practice a very complex and imperfect process. Among the factors complicating the process for an inter – national business are these:

1. A distinction must be made between cash f lows to the project and cash f lows to the parent company. 2. Political and economic risks, including foreign exchange risk, can significantly change the value of a foreign investment. 3. The connection between cash f lows to the parent and the source of financing must be recognized.

We look at the first two of these issues in this section. Discussion of the connection between cash f lows and the source of financing is postponed until the next section, where we discuss the source of financing. PROJECT AND PARENT CASH FLOWS A theoretical argument exists for analyzing any foreign project from the perspective of the parent company because cash f lows to the project are not necessarily the same thing as cash f lows to the parent company. The project may not be able to remit all its cash f lows to the parent for a number of reasons. For example, cash f lows may be blocked from repatriation by the host-country government, they may be taxed at an unfavorable rate, or the host gov – ernment may require that a certain percentage of the cash f lows generated from the project be reinvested within the host nation. While these restrictions don’t affect the net present value of the project itself, they do affect the net present value of the project to the parent company because they limit the cash f lows that can be remitted to it from the project. When evaluating a foreign investment opportunity, the parent should be interested in the cash f lows it will receive—as opposed to those the project generates—because those are the basis for dividends to stockholders, investments elsewhere in the world, repayment of worldwide corporate debt, and so on. Stockholders will not perceive blocked earnings as contributing to the value of the firm, and creditors will not count them when calculating the parent’s ability to service its debt. But the problem of blocked earnings is not as serious as it once was. The worldwide move toward greater acceptance of free market economics (discussed in Chapters 2 and 3) has reduced the number of countries in which governments are likely to prohibit the affiliates 593 MANAGEMENT FOCUS Black Sea Oil and Gas Ltd.

Black Sea Oil and Gas Ltd., of Calgary, Canada, formed a 50–50 joint venture with the Tyumen Oil Company, Russia’s sixth-largest integrated oil company. The objective of the venture, known as the Tura Petroleum Company, was to explore the Tura oil field in western Siberia. Tyumen was 90  percent owned by the Russian government; conse- quently Black Sea negotiated directly with representatives of the Russian government when establishing the joint venture. The agreement called for both parties to contribute more than $40 million to the formation of the venture, Black Sea in the form of cash, technology, and expertise, and Tyumen in the form of infrastructure and the licenses for oil exploration and production that it held in the region.

From an operational perspective, the venture proved to be a success. Following the injection of cash and technol – ogy from Black Sea, production at the Tura field went from 4,000 barrels a day to nearly 12,000. However, Black Sea did not capture any of the economic profits flowing from this investment. Consequently, the Moscow-based Alfa Group, one of Russia’s largest private companies, purchased a con – trolling stake in Tyumen from the Russian government. The new owners of Tyumen quickly concluded that the Tura joint venture was not fair to them, and they wanted it canceled.

Their argument was that the value of the assets contributed by Tyumen to the joint venture was far in excess of $40 mil – lion, while the value of the technology and expertise con – tributed by Black Sea was significantly less than $40 million.

The new owners also found some conflicting legislation that seemed to indicate the licenses held by Tura were owned by Tyumen and that Black Sea therefore had no right to the resulting production. Tyumen took the issue to court in Russia and won, de – spite the fact that the original deal had been negotiated by the Russian government. Black Sea had little choice but to walk away from the deal. According to Black Sea, by legal maneuvering, Tyumen expropriated Black Sea’s investment in the Tura venture. In contrast, the management of Tyumen claimed it had behaved in a perfectly legal manner. Sources: S. Block, “Integrating Traditional Capital Budgeting Concepts into an International Decision-Making Environment,” The Engineering Economist 45 (2000), pp. 309–25; J. C. Backer and L. J. Beardsley, “Multinational Companies’ Use of Risk Evaluation and Profit Measure – ment for Capital Budgeting Decisions,” Journal of Business Finance, Spring 1973, pp. 34–43. of foreign multinationals from remitting cash f lows to their parent companies. In addition, as explained later in the chapter, firms have a number of options for circumventing host- government attempts to block the free f low of funds from an affiliate.

ADJUSTING FOR POLITICAL AND ECONOMIC RISK When analyzing a foreign investment opportunity, the company must consider the politi – cal and economic risks that stem from the foreign location. 10 We discuss these before look – ing at how capital budgeting methods can be adjusted to take risks into account. Political Risk The concept of political risk was introduced in Chapter 2. There we defined it as the likeli – hood that political forces will cause drastic changes in a country’s business environment that hurt the profit and other goals of a business enterprise. Political risk tends to be greater in countries experiencing social unrest or disorder and in countries where the un – derlying nature of the society makes the likelihood of social unrest high. When political risk is high, there is a high probability that a change will occur in the country’s political environment that will endanger foreign firms there. In extreme cases, political change may result in the expropriation of foreign firms’ as – sets. This occurred to U.S. firms after the Iranian revolution of 1979. In more recent de – cades, the risk of outright expropriations has become almost zero. However, a lack of consistent legislation and proper law enforcement and no willingness on the part of the government to enforce contracts and protect private property rights can result in the de facto expropriation of the assets of a foreign multinational. 594 Part 6 International Business Functions Political and social unrest may also result in economic collapse, which can render worthless a firm’s assets. In less extreme cases, political changes may result in increased tax rates, the imposition of exchange controls that limit or block a subsidiary’s ability to remit earnings to its parent company, the imposition of price controls, and government interference in existing contracts. The likelihood of any of these events impairs the attrac- tiveness of a foreign investment opportunity. Many firms devote considerable attention to political risk analysis and to quantifying political risk. globalEDGE™ reports on a series of indices by country ( globaledge.msu.

edu/global-insights/by/country) that address various country risk factors such as corrup – tion, ease of doing business, employment protection, global competitiveness, global en – abling trade, global manufacturing competitiveness, economic freedom, property rights, open budget, paying taxes, and several more. However, the problem with virtually all at – tempts to forecast political risk is that they try to predict a future that can only be guessed at—and, in many cases, the guesses are wrong. Few people foresaw the 1979 Iranian revolu – tion, the collapse of communism in eastern Europe, the dramatic breakup of the Soviet Union, the terrorist attack on the World Trade Center in September 2001, Great Britain’s exit (“BREXIT”) from the European Union, or the election of Donald Trump as the 45th president of the United States; yet all these events had a profound impact on the business environments of many countries. This is not to say that political risk assessment is without value, but it is more art than science. Economic Risk The concept of economic risk was also introduced in Chapter 3. It was defined as the like- lihood that economic mismanagement will cause drastic changes in a country’s business environment that hurt the profit and other goals of a business enterprise. In practice, the biggest problem arising from economic mismanagement has been inf lation. Historically, many governments have expanded their domestic money supply in misguided attempts to stimulate economic activity. The result has often been too much money chasing too few goods, resulting in price inf lation. As we saw in Chapter 10, price inf lation is ref lected in a drop in the value of a country’s currency on the foreign exchange market. This can be a serious problem for a foreign firm with assets in that country because the value of the cash f lows it receives from those assets will fall as the country’s currency depreciates on the foreign exchange market. The likelihood of this occurring decreases the attractiveness of foreign investment in that country. There have been many attempts to quantify countries’ economic risk and long-term movements in their exchange rates. (e.g., Euromoney ’s annual country risk rating incorpo – rates an assessment of economic risk in its calculation of each country’s overall level of risk). As we saw in Chapter 11, there have been extensive empirical studies of the relation – ship between countries’ inf lation rates and their currencies’ exchange rates. These studies show there is a long-run relationship between a country’s relative inf lation rates and changes in exchange rates. However, the relationship is not as close as theory would predict; it is not reliable in the short run and is not totally reliable in the long run. So as with political risk, any attempts to quantify economic risk must be tempered with some healthy skepticism. RISK AND CAPITAL BUDGETING In analyzing a foreign investment opportunity, the additional risk that stems from its loca- tion can be handled in at least two ways. The first method is to treat all risk as a single problem by increasing the discount rate applicable to foreign projects in countries where political and economic risks are perceived as high. Thus, for example, a firm might apply a 6 percent discount rate to potential investments in Great Britain, the United States, and Germany, ref lecting those countries’ economic and political stability, and it might use a 12 percent discount rate for potential investments in Russia, ref lecting the greater perceived political and economic risks in that country. The higher the discount rate, the higher the projected net cash f lows must be for an investment to have a positive net present value. Accounting and Finance in the International Business Chapter 20 595 Adjusting discount rates to ref lect a location’s riskiness seems to be fairly widely prac – ticed. For example, several studies of large U.S. multinationals have found that many of them routinely add a premium percentage for risk to the discount rate they used in evaluat – ing potential foreign investment projects. 11 However, critics of this method argue that it penalizes early cash f lows too heavily and does not penalize distant cash f lows enough. 12 They point out that if political or economic collapse were expected in the near future, the investment would not occur anyway. So for any investment decisions, the political and economic risk being assessed is not of immediate possibilities but at some distance in the future. Accordingly, it can be argued that rather than using a higher discount rate to evalu – ate such risky projects, which penalizes early cash f lows too heavily, it is better to revise future cash f lows from the project downward to ref lect the possibility of adverse political or economic changes sometime in the future. Surveys of actual practice within multina – tionals suggest that the practice of revising future cash f lows downward is almost as popu – lar as that of revising the discount rate upward. 13 Financial Management: The Financing Decision When considering its options for financing, an international business must consider how the foreign investment will be financed. If external financing is required, the firm must decide whether to tap the global capital market for funds or borrow from sources in the host country. If the firm is going to seek external financing for a project, it will want to borrow funds from the lowest-cost source of capital available. As we saw in Chapter 12, firms increasingly are turning to the global capital market to finance their investments.

The cost of capital is typically lower in the global capital market, by virtue of its size and liquidity, than in many domestic capital markets, particularly those that are small and rela – tively illiquid. Thus, for example, a U.S. firm making an investment in Denmark may fi – nance the investment by borrowing through the London-based Eurobond market rather than the Danish capital market. However, despite the trends toward deregulation of financial services, in some cases, host-country government restrictions may rule out this option. The governments of some countries require, or at least prefer, foreign multinationals to finance projects in their country by local debt financing or local sales of equity. In countries where liquidity is limited, this raises the cost of capital used to finance a project. Thus, in capital budget – ing decisions, the discount rate must be adjusted upward to ref lect this. However, this is not the only possibility. In Chapter 8, we saw that some governments court foreign in – vestment by offering foreign firms low-interest loans, lowering the cost of capital. Ac – cordingly, in capital budgeting decisions, the discount rate should be revised downward in such cases. In addition to the impact of host-government policies on the cost of capital and financ – ing decisions, the firm may wish to consider local debt financing for investments in coun – tries where the local currency is expected to depreciate on the foreign exchange market.

The amount of local currency required to meet interest payments and retire principal on local debt obligations is not affected when a country’s currency depreciates. However, if foreign debt obligations must be served, the amount of local currency required to do this will increase as the currency depreciates, and this effectively raises the cost of capital.

Thus, although the initial cost of capital may be greater with local borrowing, it may be better to borrow locally if the local currency is expected to depreciate on the foreign ex – change market.

Financial Management: Global Money Management Money management decisions attempt to manage the firm’s global cash resources—its working capital—most efficiently. This involves minimizing cash balances, reducing trans – action costs, and minimizing the corporate tax burden. TEST PREP Use SmartBook to help retain what you have learned.

Access your instructor’s Connect course to check out SmartBook or go to for help.

LO 20-5 Discuss the different financing options available to the foreign subsidiary of a multinational enterprise. TEST PREP Use SmartBook to help retain what you have learned.

Access your instructor’s Connect course to check out SmartBook or go to for help. 596 Part 6 International Business Functions MINIMIZING CASH BALANCES Every business needs to hold some cash balances for servicing accounts that must be paid and for insuring against unanticipated negative variation from its projected cash f lows. The critical issue for an international business is whether each foreign subsidiary should hold its own cash balances or whether cash balances should be held at a centralized depository. In general, firms prefer to hold cash balances at a centralized depository for three reasons. First, by pooling cash reserves centrally, the firm can deposit larger amounts. Cash bal – ances are typically deposited in liquid accounts, such as overnight money market accounts.

Because interest rates on such deposits normally increase with the size of the deposit, by pooling cash centrally, the firm should be able to earn a higher interest rate than it would if each subsidiary managed its own cash balances. Second, if the centralized depository is located in a major financial center (e.g., London, New York, or Tokyo), it should have access to information about good short-term invest – ment opportunities that the typical foreign subsidiary would lack. Also, the financial ex – perts at a centralized depository should be able to develop investment skills and know-how that managers in the typical foreign subsidiary would lack. Thus, the firm should make better investment decisions if it pools its cash reserves at a centralized depository. Third, by pooling its cash reserves, the firm can reduce the total size of the cash pool it must hold in highly liquid accounts, which enables the firm to invest a larger amount of cash reserves in longer-term, less liquid financial instruments that earn a higher interest rate. For example, a U.S. firm has three foreign subsidiaries—one in Korea, one in China, and one in Japan. Each subsidiary maintains a cash balance that includes an amount for dealing with its day-to-day needs plus a precautionary amount for dealing with unanticipated cash demands.

The firm’s policy is that the total required cash balance is equal to three standard deviations of the expected day-to-day needs amount. The three-standard-deviation requirement ref lects the firm’s estimate that, in practice, there is a 99.87 percent probability that the subsidiary will have sufficient cash to deal with both day-to-day and unanticipated cash demands. Cash needs are assumed to be normally distributed in each country and independent of each other (e.g., cash needs in Japan do not affect cash needs in China). The individual subsidiaries’ day-to-day cash needs and the precautionary cash balances they should hold are as follows (in millions of dollars): LO 20-6 Understand how money management in the international business can be used to minimize cash balances, transaction costs, and taxation. Day-to-Day Cash One Standard Required Cash Needs ( A) Deviation ( B) Balance ( A + 3 × B) Korea $ 10 $ 1 $ 13 China 6 2 12 Japan 12 3 21 Total $28 $6 $46 Thus, the Korean subsidiary estimates that it must hold $10 million to serve its day-to- day needs. The standard deviation of this is $1 million, so it is to hold an additional $3 million as a precautionary amount. This gives a total required cash balance of $13 million. The total of the required cash balances for all three subsidiaries is $46 million. Now consider what might occur if the firm decided to maintain all three cash balances at a centralized depository in Tokyo. Because variances are additive when probability dis – tributions are independent of each other, the standard deviation of the combined precau – tionary account would be Standard derivation = √$1,000,000 2 + $2,000,000 2 + $3,000,000 2 = √$14,000,000 = $3,741,657 Accounting and Finance in the International Business Chapter 20 597 Therefore, if the firm used a centralized depository, it would need to hold $28 million for day-to-day needs plus (3 × $3,741,657) as a precautionary amount, or a total cash bal – ance of $39,224,971. In other words, the firm’s total required cash balance would be re – duced from $46 million to $39,224,971, a saving of $6,775,029. This is cash that could be invested in less liquid, higher-interest accounts or in tangible assets. The saving arises sim- ply due to the statistical effects of summing the three independent, normal probability distributions. However, a firm’s ability to establish a centralized depository that can serve short-term cash needs might be limited by government-imposed restrictions on capital f lows across bor – ders (e.g., controls put in place to protect a country’s foreign exchange reserves). Also, the transaction costs of moving money into and out of different currencies can limit the advan – tages of such a system. Despite this, many firms hold at least their subsidiaries’ precaution – ary cash reserves at a centralized depository, having each subsidiary hold its own cash balance for day-to-day needs. The globalization of the world capital market and the general removal of barriers to the free f low of cash across borders (particularly among advanced in – dustrialized countries) are two trends likely to increase the use of centralized depositories. REDUCING TRANSACTION COSTS Transaction costs are the cost of exchange. Every time a firm changes cash from one cur – rency into another currency it must bear a transaction cost—the commission fee it pays to foreign exchange dealers for performing the transaction. Most banks also charge a transfer fee for moving cash from one location to another; this is another transaction cost.

The commission and transfer fees arising from intrafirm transactions can be substantial; according to the United Nations, 40 percent of international trade involves transactions between the different national subsidiaries of transnational corporations. The volume of such transactions is likely to be particularly high in a firm that has a globally dispersed web of interdependent value creation activities. Multilateral netting allows a multinational firm to reduce the transaction costs that arise when many transactions occur between its sub – sidiaries by reducing the number of transactions. Multilateral netting is an extension of bilateral netting . Under bilateral netting, if a French subsidiary owes a Mexican subsidiary $6 million and the Mexican subsidiary simul – taneously owes the French subsidiary $4 million, a bilateral settlement will be made with a single payment of $2 million from the French subsidiary to the Mexican subsidiary, the remaining debt being canceled. Under multilateral netting , this simple concept is extended to the transactions be – tween multiple subsidiaries within an international business. Consider a firm that wants to establish multilateral netting among four Asian subsidiaries based in Korea, China, Japan, and Taiwan. These subsidiaries all trade with each other, so at the end of each month a large volume of cash transactions must be settled. Figure 20.2 shows how the payment Japanese Subsidiary $4 Million $3 Million $2 Million $1 Million $4 Million $5 Million $3 Million $5 Million $2 Million $3 Million Korean Subsidiary Chinese Subsidiary Taiwanese Subsidiary $6 Million $5 Million FIGURE 20.2 Cash flows before multilateral netting. 598 Part 6 International Business Functions schedule might look at the end of a given month. Figure 20.3 is a payment matrix that summarizes the obligations among the subsidiaries. Note that $43 million needs to f low among the subsidiaries. If the transaction costs (foreign exchange commissions plus trans- fer fees) amount to 1 percent of the total funds to be transferred, this will cost the parent firm $430,000. However, this amount can be reduced by multilateral netting. Using the payment matrix (Figure 20.3), the firm can determine the payments that need to be made among its subsidiaries to settle these obligations. Figure 20.4 shows the results. By multi – lateral netting, the transactions depicted in Figure 20.2 are reduced to just three; the Korean subsidiary pays $3 million to the Taiwanese subsidiary, and the Chinese subsidiary pays $1 million to the Japanese subsidiary and $1 million to the Taiwanese subsidiary. The total funds that f low among the subsidiaries are reduced from $43 million to just $5 million, and the transaction costs are reduced from $430,000 to $50,000, a savings of $380,000 achieved through multilateral netting.

MANAGING THE TAX BURDEN Different countries have different tax regimes. For example, among developed nations the top rates for corporate income tax varies from a high of 35 percent in several countries, including the United States, to a low of 12.5 percent in Ireland. In Germany and Japan, the tax rate is lower on income distributed to stockholders as dividends (36 and 35 percent, respectively), whereas in France the tax on profits distributed to stockholders is higher (42 percent). In the United States, the rate varies from state to state. The federal top rate is 35 percent, but states also tax corporate income, with state and local taxes ranging from 0 percent to 12 percent, hence the average effective rate is really 40 percent. FIGURE 20.4 Cash flows after multilateral netting. Pays $1 Million Pays $1 Million Pays $3 Million Japanese Subsidiary Korean Subsidiary Chinese Subsidiary Taiwanese Subsidiary Paying Subsidiary Receiving Net Receipts Subsidiary Korea China Japan Taiwan Total Receipts (payments) Korean — $ 3 $4 $5 $ 12 ($3) Chinese $  4 —   2   3   9 (2) Japanese    5    3 —   1   9 1 Taiwanese    6    5   2 — 13 4 Total payments $15 $11 $8 $9 $43 $5 FIGURE 20.3 Calculation of net receipts (all amounts in millions). Accounting and Finance in the International Business Chapter 20 599 Many nations follow the worldwide principle that they have the right to tax income earned outside their boundaries by entities based in their country. 14 Thus, the U.S. govern – ment can tax the earnings of the German subsidiary of an enterprise incorporated in the United States. Double taxation occurs when the income of a foreign subsidiary is taxed both by the host-country government and by the parent company’s home government. How – ever, double taxation is mitigated by tax credits, tax treaties, and the deferral principle. A tax credit allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. A tax treaty between two countries is an agreement specifying which items of income will be taxed by the authorities of the country where the income is earned. For example, a tax treaty between the United States and Germany may specify that a U.S. firm need not pay tax in Germany on any earnings from its German subsidiary that are remitted to the United States in the form of dividends. A deferral principle specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. For the international business with activities in many countries, the various tax regimes and the tax treaties have important implications for how the firm should structure its internal payments system among the foreign subsidiaries and the parent company. As we will see in the next section, the firm can use transfer prices and fronting loans to minimize its global tax liability. In addition, the form in which income is remitted from a foreign subsidiary to the parent company (e.g., royalty payments versus dividend payments) can be structured to minimize the firm’s global tax liability. Some firms use tax havens such as the Bahamas and Bermuda to minimize their tax liability. A tax haven is a country with an exceptionally low, or even no, income tax. Inter – national businesses avoid or defer income taxes by establishing a wholly owned, nonoper – ating subsidiary in the tax haven. The tax haven subsidiary owns the common stock of the operating foreign subsidiaries. This allows all transfers of funds from foreign operating subsidiaries to the parent company to be funneled through the tax haven subsidiary. The tax levied on foreign source income by a firm’s home government, which might normally be paid when a dividend is declared by a foreign subsidiary, can be deferred under the de – ferral principle until the tax haven subsidiary pays the dividend to the parent. This divi – dend payment can be postponed indefinitely if foreign operations continue to grow and require new internal financing from the tax haven affiliate. Many U.S. multinationals maintain large tax balances in foreign tax havens because they do not want to pay U.S. corporate taxes when those earnings are repatriated to the United States. Estimates suggest that American multinationals have more than $2 trillion in accumulated foreign earnings parked in foreign tax havens. Companies with large cash holdings in tax-sheltered subsidiaries include Apple, Cisco Systems, Microsoft, and Google. Apple alone has roughly 70 percent of its short-term securities on its balance sheet held overseas. Microsoft has 88 percent of its “cash” held in subsidiaries located in tax havens. 15 Some argue that holding such cash balances overseas to avoid tax is counterproductive and that shareholders would benefit more if the cash was repatriated to the United States, tax paid on it, and the remaining funds returned to shareholders in the form of dividend payouts and stock buybacks. Due to tax credits, for example, Microsoft would probably pay a U.S. corporate tax rate of about 30 percent on the money held overseas if it decided to send it back to the United States. But the argument is that lots of cash would be remain – ing after the taxes are paid that should be distributed to shareholders.

MOVING MONEY ACROSS BORDERS Pursuing the objectives of utilizing the firm’s cash resources most efficiently and minimiz – ing the firm’s global tax liability requires the firm to be able to transfer funds from one location to another around the globe. International businesses use a number of techniques to transfer liquid funds across borders. These include dividend remittances, royalty pay – ments and fees, transfer prices, and fronting loans. Some firms rely on more than one of LO 20 -7 Understand the basic techniques for global money management. 600 Part 6 International Business Functions these techniques to transfer funds across borders—a practice known as unbundling. By us- ing a mix of techniques to transfer liquid funds from a foreign subsidiary to the parent company, unbundling allows an international business to recover funds from its foreign subsidiaries without piquing host-country sensitivities with large “dividend drains.” A firm’s ability to select a particular policy is severely limited when a foreign subsidiary is part-owned either by a local joint-venture partner or by local stockholders. Serving the legitimate demands of the local co-owners of a foreign subsidiary may limit the firm’s abil – ity to impose the kind of dividend policy, royalty payment schedule, or transfer pricing policy that would be optimal for the parent company.

Dividend Remittances Payment of dividends is the most common method by which firms transfer funds from foreign subsidiaries to the parent company. The dividend policy typically varies with each subsidiary depending on such factors as tax regulations, foreign exchange risk, the age of the subsidiary, and the extent of local equity participation. For example, the higher the rate of tax levied on dividends by the host-country government, the less at – tractive this option becomes relative to other options for transferring liquid funds. With regard to foreign exchange risk, firms sometimes require foreign subsidiaries based in “high-risk” countries to speed up the transfer of funds to the parent through accelerated dividend payments. This moves corporate funds out of a country whose currency is ex – pected to depreciate significantly. The age of a foreign subsidiary inf luences dividend policy in that older subsidiaries tend to remit a higher proportion of their earnings in dividends to the parent, presumably because a subsidiary has fewer capital investment needs as it matures. Local equity participation is a factor because local co-owners’ de – mands for dividends must be recognized.

Royalty Payments and Fees Royalties represent the remuneration paid to the owners of technology, patents, or trade names for the use of that technology or the right to manufacture and/or sell products un – der those patents or trade names. It is common for a parent company to charge its foreign subsidiaries royalties for the technology, patents, or trade names it has transferred to them.

Royalties may be levied as a fixed monetary amount per unit of the product the subsidiary sells or as a percentage of a subsidiary’s gross revenues. A fee is compensation for professional services or expertise supplied to a foreign subsid – iary by the parent company or another subsidiary. Fees are sometimes differentiated into “management fees” for general expertise and advice and “technical assistance fees” for guidance in technical matters. Fees are usually levied as fixed charges for the particular services provided. Royalties and fees have certain tax advantages over dividends, particularly when the corporate tax rate is higher in the host country than in the parent’s home country. Royal – ties and fees are often tax-deductible locally (because they are viewed as an expense), so arranging for payment in royalties and fees will reduce the foreign subsidiary’s tax liability.

If the foreign subsidiary compensates the parent company by dividend payments, local in – come taxes must be paid before the dividend distribution, and withholding taxes must be paid on the dividend itself. Although the parent can often take a tax credit for the local withholding and income taxes it has paid, part of the benefit can be lost if the subsidiary’s combined tax rate is higher than the parent’s.

Transfer Prices Any international business normally involves a large number of transfers of goods and services between the parent company and foreign subsidiaries and between foreign subsid – iaries. This is particularly likely in firms pursuing global and transnational strategies be – cause these firms are likely to have dispersed their value creation activities to various “optimal” locations around the globe (see Chapter 13). As noted earlier, the price at which Accounting and Finance in the International Business Chapter 20 601 goods and services are transferred between entities within the firm is referred to as the transfer price. 16 Transfer prices can be used to position funds within an international business. For ex- ample, funds can be moved out of a particular country by setting high transfer prices for goods and services supplied to a subsidiary in that country and by setting low transfer prices for the goods and services sourced from that subsidiary. Conversely, funds can be positioned in a country by the opposite policy: setting low transfer prices for goods and services supplied to a subsidiary in that country and setting high transfer prices for the goods and services sourced from that subsidiary. This movement of funds can be between the firm’s subsidiaries or between the parent company and a subsidiary. At least four gains can be derived by adjusting transfer prices:

1. The firm can reduce its tax liabilities by using transfer prices to shift earnings from a high-tax country to a low-tax one. 2. The firm can use transfer prices to move funds out of a country where a signifi – cant currency devaluation is expected, thereby reducing its exposure to foreign exchange risk. 3. The firm can use transfer prices to move funds from a subsidiary to the parent company (or a tax haven) when financial transfers in the form of dividends are re – stricted or blocked by host-country government policies. 4. The firm can use transfer prices to reduce the import duties it must pay when an ad valorem tariff is in force—a tariff assessed as a percentage of value. In this case, low transfer prices on goods or services being imported into the country are required. Since this lowers the value of the goods or services, it lowers the tariff.

However, significant problems are associated with pursuing a transfer pricing policy. 17 Few governments like it. 18 When transfer prices are used to reduce a firm’s tax liabilities or import duties, most governments feel they are being cheated of their legitimate income.

Similarly, when transfer prices are manipulated to circumvent government restrictions on capital f lows (e.g., dividend remittances), governments perceive this as breaking the spirit—if not the letter—of the law. Many governments now limit international businesses’ ability to manipulate transfer prices in the manner described. The United States has strict regulations governing transfer pricing practices. According to Section 482 of the Internal Revenue Code, the Internal Revenue Service (IRS) can reallocate gross income, deduc – tions, credits, or allowances between related corporations to prevent tax evasion or to re – f lect more clearly a proper allocation of income. Under the IRS guidelines and subsequent judicial interpretation, the burden of proof is on the taxpayer to show that the IRS has been arbitrary or unreasonable in reallocating income. The correct transfer price, accord- ing to the IRS guidelines, is an arm’s-length price—the price that would prevail between unrelated firms in a market setting. Such a strict interpretation of what is a correct transfer price theoretically limits a firm’s ability to manipulate transfer prices to achieve the bene – fits we have discussed. Many other countries have followed the U.S. lead in emphasizing that transfer prices should be set on an arm’s-length basis. Another problem associated with transfer pricing is related to management incentives and performance evaluation. 19 Transfer pricing is inconsistent with a policy of treating each subsidiary in the firm as a profit center. When transfer prices are manipulated by the firm and deviate significantly from the arm’s-length price, the subsidiary’s performance may depend as much on transfer prices as it does on other pertinent factors, such as man- agement effort. A subsidiary told to charge a high transfer price for a good supplied to another subsidiary will appear to be doing better than it actually is, while the subsidiary purchasing the good will appear to be doing worse. Unless this is recognized when perfor – mance is being evaluated, serious distortions in management incentive systems can occur.

For example, managers in the selling subsidiary may be able to use high transfer prices to mask inefficiencies, while managers in the purchasing subsidiary may become disheart – ened by the effect of high transfer prices on their subsidiary’s profitability. 602 Part 6 International Business Functions Despite these problems, research suggests that not all international businesses use arm’s-length pricing but instead use some cost-based system for pricing transfers among their subunits (typically cost plus some standard markup). A survey of 164 U.S. multina – tional firms found that 35 percent of the firms used market-based prices, 15 percent used negotiated prices, and 65 percent used a cost-based pricing method. (The figures add up to more than 100 percent because some companies use more than one method.) 20 Only mar – ket and negotiated prices could reasonably be interpreted as arm’s-length prices. The op – portunity for price manipulation is much greater with cost-based transfer pricing. Other more sophisticated research has uncovered indirect evidence that many corporations do manipulate transfer prices in order to reduce global tax liabilities. 21 Although a firm may be able to manipulate transfer prices to avoid tax liabilities or cir – cumvent government restrictions on capital f lows across borders, this does not mean the firm should do so. Since the practice often violates at least the spirit of the law in many countries, the ethics of engaging in transfer pricing are dubious at best. Also, there are clear signs that tax authorities in many countries are increasing their scrutiny of this prac – tice in order to stamp out abuses. A survey of some 600 multinationals undertaken by ac- countants at Ernst & Young found that 75 percent of them believed they would be the subject of a transfer pricing audit by tax authorities in the next two years. 22 Some 61 per – cent of the multinationals in the survey stated that transfer pricing was the top tax issue that they faced. Fronting Loans A fronting loan is a loan between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank. In a direct intrafirm loan, the parent com – pany lends cash directly to the foreign subsidiary, and the subsidiary repays it later. In a fronting loan, the parent company deposits funds in an international bank, and the bank then lends the same amount to the foreign subsidiary. Thus, a U.S. firm might deposit $100,000 in a London bank. The London bank might then lend that $100,000 to an Indian subsidiary of the firm. From the bank’s point of view, the loan is risk-free because it has 100 percent collateral in the form of the parent’s deposit. The bank “fronts” for the parent, hence the name. The bank makes a profit by paying the parent company a slightly lower interest rate on its deposit than it charges the foreign subsidiary on the borrowed funds. Firms use fronting loans for two reasons. First, fronting loans can circumvent host- country restrictions on the remittance of funds from a foreign subsidiary to the parent company. A host government might restrict a foreign subsidiary from repaying a loan to its parent in order to preserve the country’s foreign exchange reserves, but it is less likely to restrict a subsidiary’s ability to repay a loan to a large international bank. To stop payment to an international bank would hurt the country’s credit image, whereas halting payment to the parent company would probably have a minimal impact on its image. Consequently, international businesses sometimes use fronting loans when they want to lend funds to a subsidiary based in a country with a fairly high probability of political turmoil that might lead to restrictions on capital f lows (i.e., where the level of political risk is high). A fronting loan can also provide tax advantages. For example, a tax haven (Bermuda) subsidiary that is 100 percent owned by the parent company deposits $1 million in a London- based international bank at 8 percent interest. The bank lends the $1 million to a foreign operating subsidiary at 9 percent interest. The country where the foreign operating subsidiary is based taxes corporate income at 50 percent (see Figure 20.5). Under this arrangement, interest payments net of income tax will be as follows: 1. The foreign operating subsidiary pays $90,000 interest to the London bank. Deducting these interest payments from its taxable income results in a net after-tax cost of $45,000 to the foreign operating subsidiary. 2. The London bank receives the $90,000. It retains $10,000 for its services and pays $80,000 interest on the deposit to the Bermuda subsidiary. 3. The Bermuda subsidiary receives $80,000 interest on its deposit tax-free. Accounting and Finance in the International Business Chapter 20 603 The net result is that $80,000 in cash has been moved from the foreign operating sub- sidiary to the tax haven subsidiary. Because the foreign operating subsidiary’s after-tax cost of borrowing is only $45,000, the parent company has moved an additional $35,000 out of the country by using this arrangement. If the tax haven subsidiary had made a direct loan to the foreign operating subsidiary, the host government may have disallowed the interest charge as a tax-deductible expense by ruling that it was a dividend to the parent disguised as an interest payment. Pays 9% Interest (Tax-Deductible) Deposit $1 Million London Bank Loan $1 Million Pays 8% Interest (Tax-Free) Foreign Operating Subsidiary Tax Haven Subsidiary FIGURE 20.5 An example of the tax aspects of a fronting loan. TEST PREP Use SmartBook to help retain what you have learned.

Access your instructor’s Connect course to check out SmartBook or go to for help. accounting standards, p. 585 auditing standards, p. 585 internal forward rate, p. 590 money management, p. 595 transaction costs, p. 597 transfer fee, p. 597 bilateral netting, p. 597 multilateral netting, p. 597tax credit, p. 599 tax treaty, p. 599 deferral principle, p. 599 tax haven, p. 599 Key Terms CHAPTER SUMMARY This chapter focused on accounting and financial man – agement in the international business. It explained why accounting practices and standards differ from country to country and surveyed the efforts under way to harmonize countries’ accounting practices. We reviewed several is – sues related to the use of accounting-based control sys – tems within international businesses. We discussed how investment decisions, financing decisions, and money management decisions are complicated by the fact that different countries have different currencies, different tax regimes, different levels of political and economic risk, and so on. This chapter made the following points:  1. Each country’s accounting system evolved in re – sponse to the local demands for accounting in- formation. National differences in accounting and auditing standards resulted in a general lack of comparability in countries’ financial reports.  2. This lack of comparability has become a problem as transnational financing and transnational investment have grown rapidly in recent decades (a consequence of the globalization of capital markets). Due to the lack of comparability, a firm may have to explain to investors why its financial position looks very different on financial reports that are based on different accounting practices.  3. The most significant push for harmonization of accounting standards across countries has come from the International Accounting Standards Board (IASB). 604 Part 6 International Business Functions  4. In most international businesses, the annual budget is the main instrument by which headquarters controls foreign subsidiaries.

Throughout the year, headquarters compares a subsidiary’s performance against the financial goals incorporated in its budget, intervening se- lectively in its operations when shortfalls occur.  5. Most international businesses require all budgets and performance data within the firm to be ex- pressed in the corporate currency. This enhances comparability, but it distorts the control process if the relevant exchange rates change between the time a foreign subsidiary’s budget is set and the time its performance is evaluated. According to the Lessard–Lorange model, the best way to deal with this problem is to use a projected spot ex- change rate to translate both budget figures and performance figures into the corporate currency.  6. Transfer prices can introduce significant distor – tions into the control process and thus must be considered when setting budgets and evaluating a subsidiary’s performance.  7. When using capital budgeting techniques to eval – uate a potential foreign project, the firm needs to recognize the specific risks arising from its for – eign location. These include political risks and economic risks (including foreign exchange risk).

Political and economic risks can be incorporated into the capital budgeting process by using a higher discount rate to evaluate risky projects or by forecasting lower cash f lows for such projects.  8. The cost of capital is lower in the global capital market than in domestic markets. Consequently, other things being equal, firms prefer to finance their investments by borrowing from the global capital market.  9. Borrowing from the global capital market may be restricted by host-government regulations or demands. In such cases, the discount rate used in capital budgeting must be revised upward to ref lect this. 10. The firm may want to consider local debt fi – nancing for investments in countries where the local currency is expected to depreciate. 11. The principal objectives of global money man – agement are to utilize the firm’s cash resources in the most efficient manner and to minimize the firm’s global tax liabilities. 12. By holding cash at a centralized depository, the firm may be able to invest its cash reserves more efficiently. It can reduce the total size of the cash pool that it needs to hold in highly liquid accounts, thereby freeing cash for investment in higher-interest-bearing (less liquid) accounts or in tangible assets. 13. Firms use a number of techniques to transfer funds across borders, including dividend remit- tances, royalty payments and fees, transfer prices, and fronting loans. Dividend remittances are the most common method used for transferring funds across borders, but royalty payments and fees have certain tax advantages over dividend remittances. 14. The manipulation of transfer prices may be used by firms to move funds out of a country to mini- mize tax liabilities, hedge against foreign ex- change risk, circumvent government restrictions on capital f lows, and reduce tariff payments.

However, manipulating transfer prices in this manner runs counter to government regulations in many countries, it may distort incentive sys- tems within the firm, and it has ethically dubi- ous foundations. 15. Fronting loans involves channeling funds from a parent company to a foreign subsidiary through a third party, normally an international bank.

Fronting loans can circumvent host-government restrictions on the remittance of funds and pro- vide certain tax advantages. Critical Thinking and Discussion Questions  1. Why do the accounting systems of different coun – tries differ? Why do these differences matter?  2. Why might an accounting-based control system provide headquarters management with biased in – formation about the performance of a foreign sub – sidiary? How can these biases best be corrected?  3. You are the CFO of a U.S. firm whose wholly owned subsidiary in Mexico manufactures com- ponent parts for your U.S. assembly operations.

The subsidiary has been financed by bank borrowings in the United States. One of your analysts told you that the Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange markets over the next year.

What actions, if any, should you take?  4. You are the CFO of a Canadian firm that is considering building a $10 million factory in Russia to produce milk. The investment is ex – pected to produce net cash f lows of $3 million each year for the next 10 years, after which the investment will have to close because of techno- logical obsolescence. Scrap values will be zero.

The cost of capital will be 6 percent if financing is arranged through the Eurobond market. How – ever, you have an option to finance the project by borrowing funds from a Russian bank at 12 per – cent. Analysts tell you that due to high inf lation in Russia, the Russian ruble is expected to depre – ciate against the Canadian dollar. Analysts also rate the probability of violent revolution occur – ring in Russia within the next 10 years as high.

How would you incorporate these factors into your evaluation of the investment opportunity?

What would you recommend the firm do? research task Use the globalEDGE website ( to complete the following exercises:  1. The inf lation rate of a country can affect finan – cial planning in multinational corporations since the value of receivables in each country can face significant devaluation if the inf lation rates are high. Your company has operations in the follow – ing countries: Belarus, Costa Rica, Finland, Ice – land, Paraguay, Thailand, and Zimbabwe. Use the Country Comparator on the globalEDGE site to rank the risk of devaluation of your company’s receivables from highest to lowest, based on the most recent data available for each country. What precautions can your company take in the coun – tries at the top of this list to minimize the risk?  2. The top management of your company has requested information on the tax policies of Argentina. Using the country guide for Argentina on Deloitte International Tax and Business Guides —a resource that provides information on the investment climate, operating condi – tions, and tax systems of major trading countries— prepare a short report summarizing your findings on business taxation in Argentina. Accounting and Finance in the International Business Chapter 20 605 CLOSING CASE Tesla, Inc.—Subsidizing Tesla Automobiles Globally Tesla Inc. ( is an American automobile manu – facturer, energy storage producer, and solar panel manu – facturer headquartered in Palo Alto, California. Tesla specializes in electric cars, lithium-ion batteries, and resi – dential solar panels via its subsidiary SolarCity. But most people know the company as the maker of electric cars, of – ten still referring to the old name of Tesla Motors. Tesla Inc.

was founded as Tesla Motors in 2003 by Martin Eberhard and Marc Tarpenning. However, both the company and the general public also consider Elon Musk, J.B. Straubel, and Ian Wright as co-founders. From its beginnings in 2003, the company now has sales north of $7 billion, assets of some $25 billion, and more than 30,000 employees.

Tesla became a well-known entity following its produc – tion of the Tesla Roadster in 2008, the world’s first electric sports car. The second vehicle, an electric luxury sedan labeled Model S, hit the market in 2012. More than 150,000 cars of Model S type have been sold. This ranks Model S as the world’s second best-selling plug-in after the Nissan Leaf. After Model S, Tesla went to market with Model X in 2015, a crossover SUV, and Model 3 in 2017 (code name “Tesla BlueStar” in the original business plan). Model 3 was unveiled in 2016 but introduced into the market in the latter part of 2017 at a base price of $35,000 before any government incentives. Government incentives are really at the core of this Tesla case. Normally, our focus in a case for this chapter would be on the financing of a company or accounting practices globally (as in the scenarios played out in the opening case on Shoprite and the integrated case at the back of the book on Microsoft). However, financing and accounting practices worldwide come in many forms, and companies like Tesla have taken advantage of tremendous country governments’ subsidies to sell their products in the marketplace and be competitive with traditional car manu – facturers such as Volkswagen, Toyota, and General Motors, to mention a few of the top automobile makers in 2017.

For example, according to the latest data from the Eu – ropean Automobile Manufacturers Association (ACEA), sales of electric cars (including plug-in hybrids) in 2017 606 Part 6 International Business Functions were brisk across much of Europe. Sales of these kinds of cars rose by 80 percent compared with last year in eco- friendly Sweden, 78 percent in Germany, and 40 percent in Belgium. Across all European Union countries, electri- cal car sales grew by roughly 30 percent. However, the major exception was in Denmark, where sales went down by more than 60 percent. There was one simple reason for this drop: The Danish government phased out tax- payer subsidies to buy electric cars. Basically, the take on it from the Danish experience is that clean-energy vehi – cles are not attractive enough to (at least) the Danish cus – tomers to compete with more established traditional car brands without some form of taxpayer-backed subsidy.

This may set the tone for how to market electric cars in the future. If it can’t be done in Denmark, can these cars really be marketed globally? Denmark is one of the more progressive countries in the world when it comes to clean air, clean energy, and clean everything! Add to that, Den – mark’s infatuation with “green” electrical automobiles is globally well known. The country’s bicycle-loving popula – tion bought more than 5,000 of these electrical cars last year, more than double the number sold in Italy, and Italy is about 10 times the size of Denmark. Perhaps these amazing sales were more due to the customers being spared the hefty 180 percent that the Danish government applies on vehicles fueled by a traditional combustion engine than the electri- cal vehicles actually being a preference of customers. So, losing the government subsidy also meant a loss of electric car sales in the country in favor of more traditional cars.

Sources: Tyler Durden, “It’s Confirmed: Without Government Subsidies, Tesla Sales Implode,” Zero Hedge, June 12, 2017; European Automobile Manufacturers Association, “Overview of Tax Incentives for Electric Vehi- cles in the EU,” accessed June 20, 2017; Peter Levring, “Denmark Is Kill- ing Tesla (and Other Electric Cars),” Bloomberg Markets, June 2, 2017; “Tesla Increases Deliveries of Electric Cars,” The Economist, April 6, 2017; “Electric Cars Are Set to Arrive Far More Speedily Than Anticipated,” The Economist, February 18, 2017. Case Discussion Questions 1. Should companies like Tesla rely on government subsidies in selling their cars since they are better for the environment than traditional cars based on the old technology of traditional combustion engines? Basically, should the environmental issues be built into the competitiveness of the car pricing of electrical cars, or should supply and demand be the driver of the electrical cars’ prices? 2. Some governments are more likely to subsidize electrical cars (and many other products) than other governments. Denmark took a stand to not subsidize (for now) electrical cars. Should such subsidies be up to each country or region in a country (e.g., California in the United States), or should there be a world standard enforced perhaps via the World Trade Organization, United Nations, or a similar organization? 3. Tesla made a remarkable sales growth—from a startup (albeit with great financing) to $7 billion in sales with some $25 billion in assets. Does this mean that the Tesla business model was good and the market reacted positively, govern – ment subsidies were generous, and the market favored the car brand because of it, or a combination? 4. If all government subsidies went away worldwide to electrical cars, will Tesla be as successful in five years as it is now? (Will Tesla even exist in 10 years?) Design Elements: Implications (idea): ©ARTQU/Getty Images; Problem (jigsaw): ©ALMAGAMI/Shutterstock; All Others: ©McGraw-Hill Education. Endnotes  1. G. G. Mueller, H. Gernon, and G. Meek, Accounting: An Interna- tional Perspective (Burr R idge, IL: R ichard D. Irwin, 1991).  2. S. J. Gary, “Towards a Theory of Cultural Inf luence on the De – velopment of Accounting Systems Internationally,” Abacus 3 (1988), pp. 1–15; R. S. Wallace, O. Gernon, and H. Gernon, “Frameworks for International Comparative Financial Account – i n g ,” Journal of Accounting Literature 10 (1991), pp. 209–64.  3. R. G. Barker, “Global Accounting Is Coming,” Harvard Business Review, April 2003, pp. 2–3.  4. P. D. Fleming, “The Growing Importance of International Ac – counting Standards,” Journal of Accountancy , September 1991, pp. 100–6.  5. D. Reilly, “SEC to Consider Letting Companies Use International Accounting Rules,” The Wall Street Journal, April 25, 2007, p. C3. Accounting and Finance in the International Business Chapter 20 607  6. F. Choi and I. Czechowicz, “Assessing Foreign Subsidiary Per- formance: A Multinational Comparison,” Management Interna – tional Review 4, 1983, pp. 14–25.  7. D. Lessard and P. Lorange, “Currency Changes and Manage – ment Control: Resolving the Centralization/Decentralization D i lem ma ,” Accounting Review, July 1977, pp. 628–37.  8. Mueller et al., Accounting: An International Perspective .  9. For details of capital budgeting techniques, see R. A. Brealey and S. C. Myers, Principles of Corporate Finance (New York: McGraw-Hill, 1988). 10. D. J. Feils and F. M. Sabac, “The Impact of Political R isk on the Foreign Direct Investment Decision: A Capital Budgeting A na ly si s ,” The Engineering Economist 45 (2000), pp. 129–34. 11. See S. Block, “Integrating Traditional Capital Budgeting Concepts into an International Decision-Making Environment,” The Engineering Economist 45 (2000), pp. 309–25; J. C. Backer and L. J. Beardsley, “Multinational Companies’ Use of R isk Evaluation and Profit Measurement for Capital Budgeting Decisions,” Journal of Business Finance, Spring 1973, pp. 34–43. 12. For example, see D. K. Eiteman, A. I. Stonehill, and M. H. Moffett, Multinational Business Finance (Reading, MA: Addison-Wesley, 1992). 13. M. Stanley and S. Block, “An Empirical Study of Management and Financial Variables Inf luencing Capital Budgeting Deci – sions for Multinational Corporations in the 1980s,” Manage- ment International Review 23 (1983), pp. 61–71. 14 . “Taxing Questions,” The Economist, May 22, 1993, p. 73. 15. J. Sommer, “How to Unlock That Stashed Foreign Cash,” The New York Times, March 23, 2013. 16 . S. Crow and E. Sauls, “Setting the R ight Transfer Price,” Man – agement Accounting, December 1994, pp. 41–47. 17. V. H. Miesel, H. H. Higinbotham, and C. W. Yi, “International Transfer Pricing: Practical Solutions for Inter- company Pric – ing ,” International Tax Journal 28 (Fall 2002), pp. 1–22. 18 . J. Kelly, “Administrators Prepare for a More Efficient Future,” Financial Times Survey: World Taxation, February 24, 1995, p. 9. 19. Crow and Sauls, “Setting the R ight Transfer Price.” 20. M. F. Al-Eryani, P. Alam, and S. Akhter, “Transfer Pricing De – terminants of U.S. Multinationals,” Journal of International Business Studies, September 1990, pp. 409–25. 21. D. L. Swenson. “Tax Reforms and Evidence of Transfer Pric – i n g ,” National Tax Journal, March 2001, pp. 7–25. 22. “Transfer Pricing Survey Shows Multinationals Face Greater S c r ut i ny,” The CPA Journal, March 2000, p. 10.


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