Unit VIII Text I. Accounting information and the capital flows

Accounting has often been referred to as “the language of business”. This language finds expression in profit and loss statements, balance sheets, budgets, investment analysis, and tax financial position to the providers of capital: investors, creditors, and government. It enables the providers of capital to assess the value of their investments, or the security of their loans, and to make decisions about future resource allocations. Accounting information 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 the means by which the firm can evaluate its performance, control its internal expenditures, and for future expenditures and income. Thus, it is no exaggeration to say that a good accounting function is critical to the smooth running of the firm.

International businesses are confronted with a number of accounting problems that do not confront purely domestic businesses. Accounting is shaped by the environment in which it operates. Just as different countries have different political systems, economic systems, and cultures, so they also have different accounting systems. In each country the accounting system has evolved in response to the demands for accounting information in that country.

Five main factors seem to influence the type of accounting system a country has: the relationship between business and the providers of capital, political and economic ties with other countries, the level of inflation, the level of a country’s development, and the prevailing culture in a country. National differences in accounting and auditing standards have resulted in a general lack of comparability in countries’ financial reports. 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).

The most significant push for harmonization of accounting standards across countries has come from the International Accounting Standards Committee (IASC). Consolidated financial statements provide financial accounting information about a group of companies that recognizes the companies’ economic interdependence. Transactions among the members of a corporate family are not included on consolidated financial statements: only assets, liabilities, revenues, and expenses generated with external third parties are shown.

Foreign subsidiaries of a multinational firm normally keep their accounting records and prepare their financial statements in the currency of the country in which they are located. When the multinational prepares its consolidated accounts, these financial statements must be translated into the currency of its home country.

Under the current rate translation method, the exchange rate at the balance sheet date is used to translate the financial statements of a foreign subsidiary into the home currency. This has the drawback of being incompatible with the historic cost principle.

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 selectively in its operations when shortfalls occur.