Chapter 19 – Multinational Accounting and Tax Functions

 

Multiple Choice Questions

 

WHAT ARE THE MAJOR FACTORS INFLUENCING THE DEVELOPMENT OF ACCOUNTING STANDARDS AND PRACTICES AROUND THE WORLD?

 

1.      An organization responsible for setting accounting standards in the United States is known as the:

a.      Financial Accounting Standards Board. (easy, page 573)

b.      American Institute of Certified Public Accountants.

c.       Federal Reserve Board.

d.      International Accounting Standards Committee.

 

2.      An organization made up of accountants from around the world that sets accounting standards is known as the:

a.       International Federation of Accountants.

b.      International Accounting Standards Committee. (moderate, page 573)

c.       Financial Accounting Standards Board.

d.      Intergovernmental Group of Experts in Accounting (United Nations).

 

3.      What is the major source of influence on accounting in the United States?

a.       creditors

b.      the federal government

c.       investors (easy, page 573)

d.      banks

 

4.      Which of the following is true concerning influences on accounting practices?

a.       Equity markets are the most important source of influence on accounting in Germany and Switzerland.

b.      Banks are an important source of influence on accounting in the United States and the United Kingdom.

c.       Culture influences accountants, but not accounting.

d.      Taxation is a major source of influence on accounting in Japan and France. (difficult, page 573)

 

5.      Accounting standards or principles established in each country that must be followed by companies when generating their financial statements for external users are known as:

a.      generally accepted accounting principles. (easy, page 574)

b.      international accounting standards.

c.       ethical values in accounting.

d.      generally accepted auditing standards.

 

HOW DO THE CULTURAL VALUES OF OPTIMISM VERSUS CONSERVATISM AND TRANSPARENCY VERSUS SECRECY AFFECT COUNTRY DIFFERENCES IN ACCOUNTING SYSTEMS?

 

6.      The accounting principle that relates to issues such as how to present financial information and discuss financial results is known as:

a.       conservatism.

b.      disclosure. (easy, page 574)

c.       optimism.

d.      measurement.


 

7.      The accounting principle that relates to more, rather than less, extensive footnotes in reports is known as:

a.       secrecy.

b.      measurement.

c.       transparency. (moderate, page 574)

d.      conservatism.

 

8.      Which of the following most accurately reflects the values of secrecy and transparency in accounting?

a.       Japan is more similar to the Anglo-Saxon countries than the Germanic countries in terms of secrecy.

b.      Germanic countries tend to be less transparent than are Anglo-Saxon countries. (difficult, page 574)

c.       Secrecy and transparency refer to the principle of measurement.

d.      None of these is true.

 

9.      The degree of caution companies display in valuing assets and recognizing income is known as:

a.      conservatism. (moderate, page 574)

b.      transparency.

c.       harmonization.

d.      measurement.

 

10.        ______________ is how companies value assets.

a.        Conservatism

b.       Measurement (moderate, page 574)

c.        Transparency

d.       Optimism

               

11.        The cultural values that determine the degree to which companies disclose information to the public are:

a.        secrecy and optimism.

b.       transparency and conservatism.

c.        optimism and conservatism.

d.       secrecy and transparency. (moderate, page 575)

 

12.        How would you classify companies from the Anglo-Saxon countries in terms of their measurement and disclosure of financial information?

a.        transparent and optimistic (difficult, page 575).

b.       secret and conservative

c.        transparent and conservative

d.       secret and optimistic

 

13.   How would you classify companies from the Germanic countries in terms of their measurement and    disclosure of financial information?

a.    transparent and optimistic (difficult, page 575).

b.    secret and conservative

         c.    transparent and conservative

d.     secret and optimistic

 

14.    The emergence of the importance of capital markets are forcing MNEs from countries like Germany and    France to become more:

a.     secret.

b.     conservative.

c.     secret and conservative.

d.     optimistic and transparent. (difficult, page 575)


 

EXPLAIN THE DIFFERENCE BETWEEN MACRO-UNIFORM AND MICRO-BASED ACCOUNTING SYSTEMS?  WHAT ARE SOME EXAMPLES OF COUNTRIES THAT FIT EACH SYSTEM?

 

15.    According to the text, which of the following systems are shaped more by governmental influence?

a.       micro-based systems

b.      macro-uniform systems (moderate, page 576)

c.       multidomestic based systems

d.      global-based systems

 

16.    The major accounting influences on countries that fit into the _______________ category are a strong legal system and tax law.

a.       micro-based systems

b.      multidomestic based systems

c.       macro-uniform systems (moderate, page 576)

d.      global-based systems

 

17.    Which of the following systems tend to be more conservative and secretive about disclosure?

a.       Micro-based systems

b.      Multidomestic based systems

c.       Global-based systems

d.      Macro-uniform systems (moderate, page 576)

 

IN WHAT WAYS DO FINANCIAL STATEMENTS IN ONE COUNTRY DIFFER FROM THOSE IN ANOTHER COUNTRY?

 

18.    Japan and Germany are based primarily on which of the following types of systems?

a.      legal-based system (difficult, page 577)

b.      tax-based system

c.       cash-based system

d.      asset-based system

19.       Spain and France are based primarily on which of the following types of systems?

a.       Legal-based system

b.      Tax-based system (difficult, page 577)

c.       Cash-based system

d.      Asset-based system

 

20.    Centrally planned economies would fit into which of the following types of systems?

a.       Micro-based systems

b.      Multidomestic based systems

c.       Macro-uniform systems (moderate, page 577)

d.      Global-based systems

 

21.    _______________ include features that support pragmatic business practice and have evolved from the British system.

a.       Macro-uniform systems

b.      Multidomestic based systems

c.       Global-based systems

d.      Micro-based systems (moderate, page 577)


 

WHAT ARE THE MAJOR FORCES LEADING TO AND MAJOR INSTITUTIONS INVOLVED IN THE INTERNATIONAL HARMONIZATION OF ACCOUNTING PRACTICES?

 

22.    Which of the following is NOT one of the major forces leading to harmonization?

a.      The movement for MNEs to provide information compatible with the needs of their own home markets (difficult, page 578)

b.      The need of MNEs to raise capital outside their home-country markets

c.       Regional political and economic harmonization

d.      The movement to provide information compatible with the needs of investors

 

23.    The most ambitious effort to harmonize accounting standards on a regional as well as an international level is taking place in:

a.       NAFTA.

b.      the European Union. (moderate, page 578)

c.       MERCUSOR.

d.      ASEAN Nations.

 

24.    Which of the following reflects the European Union's approach to accounting harmonization?

a.       EU accounting will not affect other European countries until they decide to join the EU.

b.      The EU requires all countries to use the same accounting standards.

c.       The EU has issued a directive on the form and content of financial statements. (difficult, page 578)

d.      The EU is dealing with trade issues, not accounting issues.

 

 

HOW MUST U.S. COMPANIES RECORD FOREIGN-CURRENCY RECEIVABLES AND PAYABLES?  HOW MUST THEY TREAT THEM WHEN PAID?

 

25.    For U.S. companies, foreign currency receivables and payables give rise to exchange gains and losses:

a.       only if the exchange rate weakens against the parent currency.

b.      only if the exchange rate strengthens against the parent currency.

c.       at the beginning of each month.

d.      at the end of each accounting period, such as a month. (difficult, page 580)

 

 

26.    In the case of foreign currency receivables and payables for U.S. companies, a foreign exchange gain or loss would be:

a.      recognized immediately in the income statement. (difficult, page 580)

b.      recognized if it were a gain, but not a loss.

c.       recognized if it were a loss, but not a gain.

d.      taken to the balance sheet as an accumulated translation adjustment.

 

27.    At which exchange rate does a firm initially record a foreign currency transaction according to U.S. GAAP?

a.       the rate changes to reflect the new rate at the end of the month

b.      the spot rate at the date of the transaction (moderate, page 580)

c.       the forward exchange rate

d.      the average exchange rate


 

WHAT IS MEANT BY THE TRANSLATION AND CONSOLIDATION OF FOREIGN-CURRENCY FINANCIAL STATEMENTS?

 

28.    The process of restating foreign currency financial statements from one currency into another is known as:

a.       conversion.

b.      functional currency restatement.

c.       translation. (easy, page 582)

d.      consolidation.

 

29.    The process of combining financial statements of different subsidiaries into one statement is known as:

a.       conversion.

b.      functional currency restatement.

c.       translation.

d.      consolidation. (easy, page 582)

 

30.    The choice of a method to translate foreign currency financial statements into the parent currency is dependent on the:

a.      functional currency. (moderate, page 582)

b.     average exchange rate.

c.       consolidation practice.

d.      spot exchange rate.

 

31.    The currency of the primary economic environment in which that entity operates is called the:

a.       primary currency.

b.      functional currency. (moderate, page 582)

c.       exchange currency.

d.      secondary currency.

 

WHAT ARE THE TWO MAJOR APPROACHES USED TO TRANSLATE FOREIGN CURRENCY FINANCIAL STATEMENTS, AND HOW ARE TRANSLATION GAINS AND LOSSES REPORTED UNDER THESE TWO APPROACHES?

 

32.    The translation method used when the functional currency is the local currency is the:

a.       consolidation method.

b.      monetary method.

c.       current-rate method. (moderate, page 582)

d.      temporal method.

 

33.    The _______________ provides that only monetary assets and liabilities are translated at the current exchange rate.

a.       consolidation method

b.      current-rate method

c.       monetary method

d.      temporal method (moderate, page 582)

 

34.    According to the current-rate method of translating financial statements,:

a.      all balance sheet accounts, except owners' equity, are translated at the current exchange rate. (difficult, page 582)

b.      income statement accounts are translated at year-end rates.

c.       the parent currency is the functional currency.

d.      translation gains and losses are taken to income.


 

35.    According to the temporal method of translating financial statements,:

a.       all income statement accounts are translated into dollars at the average exchange rate.

b.      the parent currency is the functional currency. (moderate, page 582)

c.       all assets are translated into dollars using the current rate.

d.      translation gains and losses are taken to the balance sheet.

 

IN WHAT WAYS DOES TAXATION AFFECT COMPANIES’ INTERNATIONAL OPERATING DECISIONS?

 

36.    Which of the following statements regarding international taxation is FALSE?

a.       Tax planning is crucial for any business because taxes can profoundly affect profitability and cash flow.

b.      The international tax specialist must be familiar with both the home country’s tax policy on foreign operations and the tax laws on each country in which the international company operates.

c.       International taxation is simpler than domestic taxation.  (moderate, page 586)

d.      Taxation has a strong impact on location of the initial investment.

 

37.    Taxation has a strong impact on all of the following company choices EXCEPT:

a.       location of the initial investment

b.      choice of operating form

c.       legal form of the new enterprise

d.      all selections have a strong impact on company choices (difficult, page 586)

 

38.    Which of the following statements is FALSE regarding the effect of taxation on companies’ international operating decisions?

a.      It is necessary for the international tax specialist to be familiar with only the home country’s tax policy since all U.S. tax rules apply to all U.S. companies and subsidiaries operating abroad.  (difficult, page 586)

b.      Taxation has a strong impact on method of financing, such as internal or external sourcing, and debt or equity.

c.       International taxation is more complex than domestic taxation.

d.      Taxation has a strong impact on method of setting transfer prices.

 

WHAT ARE FOREIGN SALES CORPORATIONS, AND WHY ARE THEY USEFUL?

 

39.    In order to qualify as a foreign sales corporation, a company must do all of the following EXCEPT:

a.       maintain a foreign office

b.      operate under home-country management (moderate, page 587)

c.       conduct foreign economic processes

d.      be a foreign corporation

 

40.    A foreign corporation that qualifies to have a portion of its income exempt from U.S. corporate income tax is known as a:

a.       controlled foreign corporation.

b.      mailbox corporation.

c.       foreign sales corporation. (moderate, page 587)

d.      passive income corporation.


 

WHAT ARE SOME FACTORS THAT U.S. FIRMS MUST CONSIDER IN DETERMING THE TAXATION OF EARNINGS FROM FOREIGN BRANCHES AND SUBSIDIARIES?

 

    41.    Foreign branch income:

a.                           is directly included in the parent’s taxable income. (moderate, page 587)

b.                           is deferred from U.S. taxation until a dividend is remitted to the parent company.

c.   is taxed if it is active income but not if it is passive income.

d.                          is taxed only if more than 50% of the stock is owned by the parent company.

 

 

 42.   A _______________ is an independent legal entity set up in a country according to the laws of incorporation of that country.

a.       foreign branch

b.      foreign sales office

c.       foreign distributor

d.      foreign corporation (moderate, page 587)

 

43.     Tax deferral means that:

a.   income is not taxed until it is earned by the subsidiary.

b.   income is not taxed until it is remitted to the parent company as a dividend. (moderate, page 587)

c.   income is taxed to the parent company as soon as it is earned.

d.   income is never earned by the parent company from foreign operations.

 

44.    A controlled foreign corporation is:

a.      a foreign corporation in which more than 50% of the voting stock is owned by qualified U.S. shareholders. (difficult, page 587)

b.      unable to defer either passive or active income from taxation.

c.       allowed to defer passive but not active income from taxation.

d.      a foreign corporation that earns only passive income.

 

45.     Income that is derived from the direct conduct of a trade or business is known as

a.    passive income.

b.    direct export income.

c.    deferred income.

d.    active income (easy, page 587)

 

46.     Subpart F income:

a.   is derived from the active conduct of a trade or business.

b.   is taxed to the parent company as soon as a dividend is remitted.

c.   is passive and is usually derived from the operations in a tax-haven country. (difficult, page 587)

d.   is never declared as taxable to the parent company.

 

 

DEFINE TRANSFER PRICING AND EXPLAIN WHAT OPERATING CONCERNS COMPANIES SHOULD CONSIDER WHEN DETERMINING INTERNATIONAL TRANSFER PRICES.

 

47.     A transfer price is:

a.       usually high on goods shipped from the parent to the subsidiary if the subsidiary is in a low-tax country.

b.      a price on goods and services sold by one member of a corporate family to another. (difficult, page 589)

c.       usually low on goods shipped from the parent to the subsidiary if the subsidiary is in a country where there are restrictions on the flow of forward exchange.

d.      a price on goods sold from a parent to a subsidiary, but not from a subsidiary to a parent.

 

48.    A price between two companies that do not have an ownership interest in each other is called:

a.       transfer price.

b.      tax credit.

c.       arm’s-length price. (moderate, page 589)

d.      extended price.

 

49.    Which of the following statements regarding transfer pricing is FALSE?

a.       A transfer price is a price on good and services sold by one member of a corporate family to another.

b.      Companies establish arbitrary transfer prices primarily because of differences in taxation between countries.

c.       A price between two companies that do not have an ownership interest in each other is called arm’s-length price.

d.      A transfer price is more likely than an arm’s-length price to reflect the market accurately.  (difficult, page 589)

 

WHAT IS MEANT BY A TAX CREDIT?

 

50.    The principle whereby the Internal Revenue Service allows firms to reduce their tax liability by the amount of income taxes paid to foreign governments is called:

a.      tax credit. (moderate, page 590)

b.      tax deduction.

c.       tax exclusion.

d.      tax deferral.

 

51.    According to the tax credit,:

a.       income can be excluded from U.S. taxation.

b.      firms can reduce their tax liability by the amount of income taxes paid to foreign governments. (difficult, page 590)

c.       credits can be given to active, but not passive, income.

d.      companies are allowed to defer the recognition of income until the foreign corporation has declared a dividend.

 

 

CONTRAST A SEPARATE ENTITY APPROACH AND AN INTEGRATED SYSTEMS APPROACH TO TAXATION.

 

52.    In the separate entity approach to taxation of corporate income,:

a.       dividends are taxed at a rate that is different from the rate applied to retained earnings.

b.      there is an attempt to avoid double taxation through split tax rates or tax credits.

c.       each company is taxed only on the value added to the product.

d.      each entity is taxed when it earns income. (moderate, page 590)

 

53.    In the integrated approach to taxation of corporate income,:

a.      there is an attempt to avoid double taxation through split tax rates or tax credits. (difficult, page 590)

b.      each entity is taxed when it earns income.

c.       each company is taxed only on the value added to the product.

d.      dividends are taxed at the same rate that is applied to retained earnings.


 

54.    Which of the following statements regarding the separate entity approach and integrated systems approach to taxation is FALSE?

a.       The United States uses the separate entity approach.

b.      The integrated systems approach is also known as the classical approach.  (difficult, page 590)

c.       In the separate entity approach to taxation of corporate income, each entity is taxed when it earns income.

d.      In the integrated approach to taxation of corporate income, there is an attempt to avoid double taxation through split tax rates or tax credits.

 

WHAT IS THE PURPOSE OF INTERNATIONAL TAX TREATIES?

 

55.    The primary purpose of _______________ is to prevent international double taxation or to provide remedies when it occurs.

a.       tax credits

b.      transfer prices

c.       tax treaties (moderate, page 591)

d.      secondary prices

 

56.    Which of the following country's taxes has unremitted earnings in the form of Subpart F income?

a.       Canada

b.      Germany

c.       China

d.      The United States (moderate, page 591)

 

57.    With the value-added tax,:

a.      each company is taxed only on the value added to the product. (moderate, page 591)

b.      each entity is taxed when it earns income.

c.       dividends are taxed at the same rate that is applied to the value added by the firm.

d.      there is an attempt to avoid double taxation through split tax rates or tax credits.

 

Essay Questions

 

58.    How do the cultural values of optimism versus conservatism and transparency versus secrecy affect country differences in accounting systems?

 

Answer

A major source of influence on accounting standards and practices is culture. Of special interest to international inventors are the differences in measurement and disclosure practices among countries. With respect to accounting, secrecy and transparency indicate the degree to which companies disclose information to the public. Countries such as Germany, Switzerland, and Japan tend to have less disclosure than do the United States and the United Kingdom. Optimism and conservatism are the degree of caution companies exhibit in valuing assets and recognizing income. Countries more conservative from an accounting point of view tend to understate assets and income, whereas optimistic countries tend to be more liberal in their recognition of income.

(moderate, page 574)

 

59.  Discuss five major forces that influence accounting practices.

 

         Answer

         Pick from among the following list of factors – enterprise users, accounting profession, international influences, government, academic influences, characteristics of the local environment, the nature of the enterprise, and other external users.  (moderate, page 573-574)

 

60.    Explain the difference between macro-uniform and micro-based accounting systems.  What are some examples of countries that fit in each system?

 

Answer

Macro-uniform systems are shaped more by governmental influence than are micro-based systems. The major accounting influences on countries that fit into the macro-uniform category are a strong legal system, specifically a codified legal system, and tax law. These systems also tend to be more conservative and secretive about disclosure. Japan and Germany are legal-based systems, and Spain and France are tax-based systems. The former and current centrally planned economies would also fit in the macro category. Micro-based systems include features that support pragmatic business practice and have evolved from the British system. The United States is an example of a country that fits in the "micro" category. It exhibits more optimism and transparency than countries in the "macro" category, and it also relies less on legal and tax requirements than Germany, France, and Japan.

         (difficult, page 576)

 

61.    In a short essay, discuss the major forces leading to a harmonization of differences in accounting standards.

 

Answer

Despite the many differences in accounting standards and practices, a number of forces are leading to harmonization, such as:

a.       a movement to provide information compatible with the needs of investors.

b.      the global integration of capital markets, which means that investors have easier and faster access to investment opportunities around the world and therefore need financial information that is more comparable.

c.       the need of MNEs to raise capital outside of their home-country capital markets while generating as few different financial statements as possible.

d.      regional, political, and economic harmonization, such as the efforts of the EU, which affects accounting as well as trade and investment issues

e.       pressure from MNEs for more uniform standards to allow greater ease and reduced costs in general reporting in each country.

               (moderate, page 578)

 

62.    What are the two major approaches used to translate foreign currency financial statements, and how are translation gains and losses reported under these two approaches?

 

Answer

Statement No. 52 allows companies to use either of two methods when translating foreign currency financial statements into dollars:  the current-rate method or the temporal method. The method that the company chooses depends on the functional currency of the foreign operation, which is the currency of the primary economic environment in which that entity operates. If the functional currency is that of the local operating environment, the company must use the current-rate method. The current-rate method provides that companies translate all assets and liabilities at the current exchange rate, which is the spot exchange rate on the balance sheet date. All income statement items are translated at the average exchange rate, and owners’ equity is translated at the rates in effect when the company issued capital stock and accumulated retained earnings. If the functional currency is the parent’s currency, the MNE must use the temporal method. The temporal method provides that only monetary assets and liabilities are translated at the current exchange rate. The company translates inventory and property, plants, and equipment at the historical exchange rates, the exchange rates in effect when the assets were acquired. In general, the company translates most income statement accounts at the average exchange rate, but it translates cost of goods sold and depreciation expenses at the appropriate historical exchange rates.

         (difficult, page 582)


 

63.    Explain how companies prepare and investors use environmental reports.

 

Answer

Typically, the environmental report is separate from the annual report and is not part of the financial statements or footnotes. Although it provides a general statement on its environmental programs, it does not provide a significant amount of quantitative information. Environmental reporting varies from company to company and country to country, especially because it is voluntary information.

         (easy, page 585)

 

64.    In what ways does taxation affect companies’ international operating decisions?

 

Answer

Tax planning is crucial for any business because taxes can profoundly affect profitability and cash flow. This is especially true in international business. The international tax specialist must be familiar with both the home country’s tax policy on foreign operations and the tax laws of each country in which the international company operates.

 

Taxation has a strong impact on several choices:

a.       location of the initial investment

b.      choice of operating form, such as export/import, licensing agreement, overseas investment

c.       legal form of the new enterprise, such as branch or subsidiary

d.      method of financing, such as internal or external sourcing and debt or equity

e.       method of setting transfer prices

               (moderate, page 586)

 

65.    In a short essay, discuss the qualifications to set up a foreign sales corporation.

 

Answer

To qualify for a foreign sales corporation (FSC), a company must be engaged in the exporting of either merchandise or services, such as engineering or architectural services. Also, substantial economic activity must occur outside the United States. An FSC cannot be a mailbox company in Switzerland that simply passes documents from the United States to the importing country. It must:

a.       maintain a foreign office.

b.      operate under foreign management.

c.       keep a permanent set of books at the foreign office.

d.      conduct foreign economic processes.

e.       be a foreign corporation.

 

If a foreign corporation qualifies as an FSC, a portion of its income is exempt from U.S. corporate income tax. Also, any dividends that the FSC gives to its parent company are exempt up to 15% of export earnings from U.S. income taxation as long as the income is foreign trade income.

         (moderate, page 587)

 

66.    What is a transfer price, and why is it used?

 

Answer

A major tax challenge, as well as impediment to performance evaluation, is the extensive use of transfer pricing in international operations. A transfer price is a price on goods and services sold by one member of a corporate family to another, such as a parent to its subsidiary in a foreign country. Because the price is between related entities, it is not necessarily an arm’s-length price, that is, a price between two companies that do not have an ownership interest in each other. Companies establish arbitrary transfer prices primarily due to differences in taxation between countries. Companies also may set arbitrary transfer prices for competitive reasons or because of restrictions on currency flows.

         (easy, page 589)


 

67.    In a short essay, discuss value-added tax.

 

Answer

A value-added tax (VAT) is computed by applying a VAT tax rate on total sales. However, any company that purchased materials or other inputs into its manufacturing process from companies that might have already paid a VAT on their sales, only needs to pay the tax on the difference between its sales and inputs that have already been taxed. As the name implies, VAT means that each independent company is taxed only on the value it adds at each stage in the production process. For a company that is fully vertically integrated, the tax rate applies to its net sales because it owns everything from raw materials to finished product. The VAT does not apply to exports, as the tax is rebated to the exporter and is not included in the final price to the consumer. This practice results in an effective stimulus for exports. In addition, it is considered by U.S. tax officials and MNEs to be a subsidy to European exports, because the export price can be lower than the domestic price of goods by the amount of the VAT.

         (moderate, page 590)

 

68.    In a short essay, discuss the elimination of double taxation using tax treaties.

 

Answer

The primary purpose of tax treaties is to prevent international double taxation or to provide remedies when it occurs. The United States has active tax treaties with more than 48 countries. The general pattern between two treaty countries is to grant reciprocal reductions on dividend withholding and to exempt royalties and sometimes interest payments from any withholding tax. The United States has a withholding tax of 30% for owners (individuals and corporations) of U.S. securities that are issued in countries with which it has no tax treaty. However, interest on portfolio obligations and on bank deposits is normally exempted from withholding. When a tax treaty is in effect, the U.S. rate on dividends generally is reduced to 15% and the tax on interest and royalties is either eliminated or reduced to a very low level.

         (moderate, page 591)