ACM 702 (2021-22) LESSON 1

UNIT–I
LESSON 1
CONCEPT & SCOPE OF INTERNATIONAL ACCOUNTING

LEARNING OBJECTIVE(S):

To familiarise with the concept of ‘International Accounting’

To provide an outline of different facets of ‘International Accounting’

1.1 CONCEPT OF INTERNATIONAL ACCOUNTING

Accounting ‘the language of business’ works as bridge between the ‘Providers of Information’ i.e.
(Businesses) & the ‘Users of such Information’ i.e. (concerned Stakeholders).It acts as the basic
source of information for business and economic decisions. This information (communicated through
accounting) could be:
Operating Required for effective conduct of the day-to-day business operations.
Information
Financial Accounting Required for the internal stakeholders, such as the managers, employees, owner,
Information and the external parties like the creditors and government agencies.
Management Required for effective planning, implementation, evaluation and control of the
Accounting Information firm's strategic and tactical operations.
Tax Accounting Required for effective tax planning and meeting the legal requirements.
Information

As long as the business continues to operate within its national boundaries, generating ‘accounting
information’is not an issue, as same accounting standards/principles have to be followed while
preparation of accounts & disseminating the information contained therein,as other businesses would
have been following in the country (reason being business operates in the same business environment
as its counterparts within the domestic boundary). However, with the increasing pace of globalization
and economic liberalization, particularly towards the end of the twentieth century, executives are
called upon to make decisions based on financial information originating from other countries. These
decisions range from evaluating the performance of foreign subsidiary(ies), affiliates, joint ventures to
making credit decisions on customers belonging to other countries, and making investment and
financing decisions based on opportunities in other countries. Since countries have their own set of
socio-economic, political, legal cultural, technological and linguistic environment, financial reporting
diversities are quite eminent. With diverse financial reports in hand, decision makers find it difficult
to make effective decisions. To overcome this difficulty and to have a more uniform and harmonized
reporting across the globe, the concept of ‘international accounting’ gained momentum.

1
ACM 702 (2021-22) LESSON 1
In few words, ‘International Accounting’ is that branch of accounting, which has diverse
dimensions,ranging from '‘recording and translation of foreign transactions, preparation and
presentation of consolidated foreign financial statements, and presentation of international financial
reporting in accordance with international GAAP and auditing practices.

INTERNATIONAL ACCOUNTING: DEFINITIONS

Below are some definitions as given by different scholars highlighting different facets of
international accounting:

“There is nothing new about international accounting, accounting has always been
international, from the time it emerged some thousands of years ago, because of its
concern with international trade and because of the spread of ideas across countries.”

“The heritage of accounting is indisputably international. So, today's concern with

multinational accounting is more a renaissance than a new idea”

“International accounting extends general-purpose nationally oriented accounting in

its broadest sense to (a) international comparative analysis, (b) accounting
measurement and reporting issues unique to multinational enterprises, (C) accounting
needs of international financial markets (d) harmonization of worldwide accounting
and financial reporting diversity via political, organizational, professional and
standard-setting activities.”

“International accounting would involve accounting for international transactions, the

operational aspects of international firms, comparison of accounting principles and
practices found in foreign countries and the procedures by which they were
established.”

International accounting is 'that branch of accounting which analyses the different

accounting principles and practices prevalent around the globe, deals with die specific
technical problems encountered b) individuals and MNCs in international operations
and as its ultimate goal, attempts to develop a universal system of accounting that
would receive acceptance the world over.”

2
ACM 702 (2021-22) LESSON 1

1.2 SCOPE OF INTERNATIONAL ACCOUNTING: DIFFERENT FACETS DISCUSSED

Multinational transfer pricing

Budgeting and performance evaluation

Foreign transactions
of foreign subsidiaries
Accounting for new financial
Foreign currency translation instruments
Exchange risk management

Consolidated financial reporting Environmental and social

Analysis of foreign financial disclosure
and disclosure
statements

Segment reporting
International Taxation

A) FOREIGN TRANSACTIONS
A transaction, in relation to importing, exporting, foreign borrowings and lending, and forward
contracts, taking place between parties belonging to two different countries, is said to be an
international (foreign) transaction. ‘International accounting essentially begins with the recording of
foreign transactions. For example,If a British firm, decides to import goods from an Indian
counterpart and agrees to pay in pounds, then the transaction becomes an international one for the
Indian firm as foreign currency is involved. The same transaction, however, does not amount to a
foreign transaction for the British firm as the payment by the said firm is made in pounds, the firm’s
own currency.

B) FOREIGN CURRENCY TRANSLATION

Foreign currency translation refers to the change in the monetary expression of the financial data
contained in the financial statements. For example, figures of the balance sheet and income statement
expressed in rupees when/restated in dollar equivalent or in other similar foreign currency, a foreign
currency translation is said to have occurred.

NEED/REASONS FOR TRANSLATION

a) To Consolidatefinancial statements of the subsidiary(ies) located in countries other than the
parent country of domicile with the financial statements of the parent company(ies).
b)To facilitate performance evaluationof the subsidiaries globally by restating their financial data
into a common currency, i.e. the currency of the parent country.
c)To facilitate decision making by the stakeholders. Independent company, domiciled in one
country, may also undertake translation of financial statements in a view to reach out to the global
audience of interest.

3
ACM 702 (2021-22) LESSON 1

C) CONSOLIDATION OF FINANCIAL STATEMENTS

Consolidation refers to the preparation and presentation of ‘integrated financial statements’, popularly
known as consolidated statements, by incorporating the financial data of the subsidiary(ies), to the
extent of the controlling interest, in the financial statement of the parent company with a view to give
the stakeholders information as regards the economic resources being controlled by the group.
Consolidated financial statements essentially convey the results of operations and the financial
position of group companies as if they were a single economic entity regardless of any legal
distinctions that exist among the separate corporate entities. The purpose of consolidation is to report
to the users of the financial statement the economic resources controlled by the group and also the
group’s obligations.

D) SEGMENT REPORTING
Segment reporting refers to the reporting of financial information in relation to different business
activities of the firm classified as business segment or geographical segment. The purpose of such
classification and reporting is to disclose all relevant facts, the non-availability of which will
adversely affect the quality of investors’ decisions.

E) TRANSFER PRICING
Transfer pricing relates to the pricing of goods and services that change hands between entities
engaged in inter-firm trade. Transfer price is the price at which goods or services are transferred
between affiliated entities within an organization. IAS 14 on segment reporting defines transfer
pricing as “the pricing of products or services between industry segments or geographic areas”. The
need for transfer pricing system arises primarily to communicate data that will lead to goal-congruent
decisions. Appropriate evaluation of segment vis-a-vis managerial performance and avoidance of
foreign currency restrictions and quotas, minimization of taxes and tariffs, minimization of exchange
risks, avoidance of profit repatriation restrictions and enhancement of shares of profits in joint
ventures are some of the other important objectives that are accomplished through transfer pricing
mechanism.

F) BUDGETING AND PERFORMANCE EVALUATION

Firms use budgeting and performance evaluation as tools for strategic planning and control. For
multinational corporations, it is essential that these budgeting and performance evaluation tools are
chosen appropriately so as to fit to the environment of the country(ies) of their own domicile and also
of the foreign country(ies). The budget should be prepared in a manner as would lead to employees’
motivation and goal congruence between the employees and the organization. Performance evaluation
should also be appropriately designed keeping in view the domestic and the international environment
in which the subsidiaries and affiliates operate.

G) EXCHANGE RISK MANAGEMENT

Exchange risk management aims at monitoring and managing the firm’s foreign exchange exposure
so as to maximize its profitability, cash flow and market value. Foreign exchange exposure primarily
assumes three forms: Translation exposure, transaction exposure and economic exposure.

4
ACM 702 (2021-22) LESSON 1

Translation exposure Refers to the potential of an increase or decrease in the parent company’s net
worth and reported net income due to fluctuations in the exchange rates
Translation exposure arises from (1) buying and selling on credit goods or
services whose prices are contractually denominated in foreign currency, (2)
borrowing and lending funds in foreign currency, (3) forward exchange
contracts, (4) acquisition or disposal of assets denominated in foreign
currency, and (5) settlement of liabilities denominated in foreign currency.
Transaction exposure Arises due to the sensitivity of the firm’s contractual cash flows
denominated in foreign currency to exchange rate fluctuations
Economic exposure Refers to the extent to which the value of the firm would be impacted by
unexpected changes in the exchange rates.

H) FOREIGN FINANCIAL STATEMENT ANALYSIS

Financial statement analysis refers to an information processing system that is meant for providing
financial data which are appropriate and useful to decision makers who are concerned with evaluating
the economic situation of the firm and predicting its future course. The information in context is
derived basically from the published financial statements such as the income statement and the
balance sheet of the firm. Non-accounting information like stock prices and economic indicators are
also used in the process of financial statement analysis. The purpose of financial statement analysis,
from the users or decision makers’ perspective, be it a domestic or a foreign company, is the same.
Therefore, tools used for analyzing the financial statements of domestic company and for the MNCs
would be basically the same.

I) INTERNATIONAL TAXATION
International taxation is a complex phenomenon that affects all the aspects of multinational operations
including foreign investments, transfer pricing, marketing of product and services, cost of capital and
capital structure. It is therefore imperative for multinational corporations in particular to understand
the diversities that exist in relation to corporate tax laws in different countries for better (tax) planning
and decision making.

J) ACCOUNTING FOR NEWER FINANCIAL INSTRUMENTS (Such as Derivatives)

Derivatives are financial contracts whose value is dependent on an underlying asset or group of assets.
The commonly used assets are stocks, bonds, currencies, commodities and market indices. The value
of the underlying assets keeps changing according to market conditions. The basic principle behind
entering into derivative contracts is to earn profits by speculating on the value of the underlying asset
in future. The four major types of derivative contracts are options, forwards, futures and swap*.

*1) Options:Options are derivative contracts which gives the buyer a right to buy/sell the underlying
asset at the specified price during a certain period of time. The buyer is not under any obligation to
exercise the option. The option seller is known as the option writer. The specified price is known as
strike price.
2) Futures: Futures are standardised contracts which allow the holder to buy/sell the asset at an
agreed price at the specified date. The parties to the future contract are under an obligation to perform
the contract. These contracts are traded on the stock exchange. The value of future contracts are
marked-to-market everyday. It means that the contract value is adjusted according to market
movements till the expiration date.

3)Forwards: Forwards are like futures contracts wherein the holder is under an obligation to perform
the contract. But forwards are un-standardised and not traded on stock exchanges. These are available
over-the-counter and are not marked-to-market. These can be customised to suit the requirements of
the parties to the contract.

5
ACM 702 (2021-22) LESSON 1

4)Swaps:Swaps are derivative contracts wherein two parties exchange their financial obligations. The
cash flows are based on a notional principal amount agreed between both the parties without exchange
of principal. The amount of cash flows is based on a rate of interest. One cash flow is generally fixed
and the other changes on the basis of a benchmark interest rate. Interest rate swaps are the most
commonly used category. Swaps are not traded on stock exchanges and are over-the-counter contracts
between businesses or financial institutions.

K)ENVIRONMENTAL DISCLOSURES
Environmental disclosures by companies have increasingly become a matter of interest not only to the
environmentalists but also to stakeholders like the investors, employees, customers, regulatory
agencies and the society at large. The nature and extent of environmental disclosures, however, vary
from country to country depending upon the strength of each country’s own environmental
regulations and the pressure exerted by the stakeholders.

SELF-CHECK QUESTIONS

Define ‘International Accounting’.

Write a brief note on different dimensions of ‘International Accounting’