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Doing business internationally: Accounting implications

Mar 12, 2020

More and more companies are finding themselves involved in international business. Some because it aligns with their strategic plan, others because of relationships with certain suppliers or customers, and yet others because they are testing the waters of doing business internationally.

Wherever you are in the spectrum and however you got there, it is imperative to understand the accounting implications of doing business internationally.

Foreign currency transactions

One of the first things to understand is the basics of a foreign currency transaction. This is equivalent to International Accounting 101. Because you are entering into a transaction that will likely be settled at a later date, you will have to account for fluctuations in foreign currency. Another level of accounting is added when a reporting period falls between the transaction date and the settlement date.

For example, let’s say that on December 15, you enter into a sale transaction with a company in Great Britain, where they use the pound sterling as their currency (GBP). If the exchange rate on the date of the sale is .88 (meaning that 1 U.S. Dollar, or USD, is worth .88 GBP) and their purchase order is for 10,000 GBP worth of goods, you would make the initial sale entry in your own currency (USD). In this case, the entry would be (10,000 GBP / .88 = $11,363.64):

Account

Debit

Credit

Accounts Receivable

$11,363.64

 

Sales

 

$11,363.64

 

Now let’s say that on December 31, this account receivable is still outstanding. Since December 31 is a reporting date for your company, you must adjust the accounts receivable for any fluctuations in the GBP exchange rate between December 15 and 31. For our example, let’s say the exchange rate at December 31 is .82. So that means on December 31, while the customer still owes you 10,000 GBP, now the value of those 10,000 GBP is $12,195.12. We would have to account for this fluctuation ($12,195.12 - $11,363.64 = $831.48) via the journal entry below:

Account

Debit

Credit

Accounts Receivable

$831.48

 

Foreign currency translation gain

 

$831.48

 

Finally, when the transaction is settled on January 15, let’s assume the exchange rate is .77. So while the British company still pays the 10,000 GBP, that 10,000 is now worth $12,987.01. Our entry to record this payment is as follows:

Account

Debit

Credit

Cash

$12,987.01

 

Foreign currency translation gain

 

$791.89

Accounts receivable

 

$12,195.12

 

While this seems simple, it does get tricky where there are several transactions with several different countries.

Additionally, the reporting element of foreign currency transactions is also important to be aware of. While the balance sheet is relatively unchanged (except for the entries above), the presentation of the foreign currency transaction gains and losses may be presented in the income statement as other income or directly to the equity section of the financial statements, depending on the nature of the transaction and the policy elections of the company.

For example, if you have a foreign subsidiary company and you need to prepare consolidated financial statements at the parent level, you will have to record the foreign currency translation effect directly to the equity section of the financial statements, as other comprehensive income.

For presentation on the statement of cash flows, the effect of the foreign currency translation in the parent financial statements should be reported as a separate part (not operating, investing or financing) of the cash flow statement in the reconciliation of change in cash during the period.

Entity structure

If foreign currency transactions are equivalent to International Accounting 101, then entity structure is probably International Accounting 201.

Once a company finds that they are increasing the volume of transactions in other countries, it may be time to start looking at the current entity structure. Some countries require that there be a location with a local owner or a physical presence in their country. Other countries may require capitalization requirements or minimum equity requirements.

In the United States, we are familiar with entity structures such as an LLC, a partnership, an S corporation or a C corporation. However, many foreign jurisdictions also offer a number of different structural entities such as an agency relationship, a representative office, a branch, a foreign subsidiary or a joint venture with a foreign entity.

Each has its pros and cons, so when deciding to market overseas or plan for foreign operations, business owners need to decide which entity structure is most appropriate.

Regulatory considerations

Multinational contracts can present a host of problems thanks to the many factors that can affect them. It is critical to understand and comply with the local laws that can help ensure a valid contract.

For instance, some countries require contracts to be in their national language in order to be binding and enforceable. To help with this, business owners often familiarize themselves with terms like the UN Convention on Contracts for the International Sales of Goods (CISG), Carriage by Goods by Sea Act (COGS), Hauge Rules, Uniform Commercial Code (UCC), free on board (FOB), etc.

Additionally, doing a certain volume of business in various countries may trigger the requirement to obtain a statutory audit. Statutory audits vary significantly between different jurisdictions, so it is important to be aware of the thresholds and requirement of different countries before you get an unwanted surprise. Statutory audits are typically only applicable when you have an actual entity in another country, but you should be aware of the requirements nonetheless.

Banking considerations

Part of the contract should obviously specify with what currency the business will be paid. Some countries have strict foreign direct investment (FDI) requirements. As such, if the contract spells out payment in U.S. dollars, it can be valuable to hire additional local government representatives to verify compliance with their FDI rules.

While global markets are within easier reach for companies that wish to expand, banking in other countries hasn’t gotten any easier. Besides the complications of U.S. regulations, many countries strongly regulate the inflow and outflow of currency to foreign investors. For example:

  • India requires that many transactions be registered with the Reserve Bank of India.
  • Brazil requires capital contributions and that loans be registered with the central bank.
  • China has very strict FDI regulations. Its currency, the RMB, does not freely float; it is a fixed float. All capital injections are deposited in a separate bank account in China that generally needs an authentication audit by a local Chinese firm in years of balance change. Operating in China may require a U.S. company to have two or three different types of bank accounts based on currency uses and the country’s restrictions.

 

As you can see from these examples, foreign jurisdictions often have unique banking requirements. When business owners know what they are, they can properly register money going in and avoid potential restrictions of money going out and back to them in the United States.

Tax and cash flow implications

The kind of entity a business owner establishes will certainly have tax and accounting repercussions and may trigger additional filing requirements. Yet no matter what kind of entity they choose, they need to be diligent and cognizant of how their foreign and U.S. entities are structured and how they interact.

Overseas expansion can be a significant investment and an important priority, which is why many companies send their top-performing employees to run operations. They recognize the personal tax impact on their employees and consider establishing an equalization agreement. It spells out who’s financially responsible for everything from foreign taxes to housing to the number of trips back to the United States. There are ways to structure the agreement to make things more tax efficient for all.

Other impacts to cash flow are the variety of local tax laws and registration requirements, such as business income or entity tax, gross receipts tax and branch profit tax. Even without a separate entity, business owners can still be subject to various sales taxes like value-added tax (VAT), goods and services tax (GST) or harmonized sales tax (HST; in Canada). Add to these import and export taxes, employment taxes and duty taxes, and it’s clearly necessary to review and plan accordingly.

In addition, the ability to take tax deductions in some countries is dependent on proper documentation. That includes using proper invoices — in form and format. In some cases, specific invoices are required on purchases in Brazil and India. Business owners who fail to comply with a country’s required invoices and invoicing protocol find that their supporting tax return expenses could be disallowed under tax laws.

When it comes to pricing cross-border goods and services, the concept of transfer pricing applies, and it varies by country. Basically, if a business is going to do anything cross-border with a related party, most countries want them to operate at an arms’ length and conduct business as if the two are not related. That means a transfer price should be the same as if the two entities were unrelated and simply negotiating in a normal market.

Is your accounting team ready to handle the implications of going global?

To be sure, there are many challenges to exportation, as described above. Yet there are also incredible growth opportunities waiting. Understanding all of the necessary considerations is imperative to success. Many other U.S. businesses have successfully expanded internationally, and educating yourself on how they did so and what may work best for your business is crucial.

Keep reading on:

By the numbers: A look at overseas expansion

Recorded webinar: Tax Cuts and Jobs Act: What businesses need to know

Learn more: International tax

Author(s)

Jordan_Steve
Steven A. Jordan, CPA
Senior Manager
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