 Hello and welcome to the session. This is Professor Farhad and this session we're going to be looking at foreign direct investments We're gonna define it and look at opportunities and challenges when it comes to foreign direct investments This topic is covered in an international accounting course International accounting course and it could be also covered on the CPA exam as always I would like to remind you my viewers to connect with me on LinkedIn if you don't have a LinkedIn account You should create one LinkedIn is very important for your professional image and professional networking YouTube is what house all my lectures. Please Subscribe to my channel like my videos share them put them in the playlist Let the world know about them if they're benefiting you if you're listening to me It means they may benefit other people. Please share the wealth. It's free for everyone. I am growing my followers on Instagram, please follow me on Instagram and like my Facebook page if you want any premium CPA material Please go to my gumroad account. I also have a website where I organize some of my lectures over there So foreign direct investment. What is foreign direct investments as we talked earlier? What happened is it? We might have the US company and what they would do they would buy They would sell and they would buy from a Foreign company, so that's what they do They would buy in the cell from a foreign company Well another way to get involved in an international account international business Which was which when I get a give you which when I get you into international accounting It's to go ahead and move the you part of the US company into the foreign The territory into the foreign territory. So this is called foreign direct investments Now, how would you conduct? How would you carry on foreign direct investments? It's when you own and control for an asset you go to that foreign country and you operate in that foreign country How would you do it? You either buy an existing company like you would buy Another manufacturers another retailer another software company you would buy you invest in an existing operation You would buy them or you would start your own company. It's called greenfield investments You will just start your own your own branch over there So no operation in the foreign country Those are the two ways then you would do it. Now, how would you do it? But all depends on What is your objective? What are your resources that you study the market so on and so on and so forth? And you have to do what's called a net present value analysis, okay? To make sure it's worth moving into that country Or that territory know what are the reasons for foreign direct investments? Obviously the reason we do business is to make profit. So one thing is to increase sales and profit You might have a larger market You might have a larger market where you can sell more you can you can obtain new technology You might want to enter this rapidly growing or emerging market For example the rate of growth in a foreign in a foreign country might be higher than the rate of growth in your local country So you want to gain a foothold because the early you are generally speaking the early you start something the better off are the Results in a business. Why because you are an early starter You have more experience people are coming to you because you existed there longer than others generally speaking So you're gonna get a foothold as early as possible You might be able to reduce your cost you might be able to get your production closer to the supplier So basically rather than shipping product shipping components from overseas You can take your production overseas that's eliminating transportation cost and it could be cheaper to operate those So you could have a lower means of production if you operate in a foreign country Gain a foothold and economic blocks. What are the economic blocks? Well, it could be NAFTA, which again this might change NAFTA might change It could be the EU and who knows the EU might change down the road or you could be part of the agent block And basically what is the agent block? You're talking about China and Malaysia the Philippines all these countries and once you get a foothold there and One of these countries then you have access to the whole to the whole block Okay, so you would reduce Restriction on your product on your buying on your selling and you might be able to Remove some tariffs tariffs, which is in turn make your product more competitive Okay, also another way to move overseas is to protect your domestic market What you do is you go to the competitor and you will try to weaken your international Competitor by entering their home market and what happened is you put them on the defense now they need to Now they need to defend their market. They may not even move into your foreign market anymore So that's another way to go with that foreign direct investments or to protect your market So what you do is you want what you do is you want to protect your established market in that country So you keep on adding investments in that foreign country because you need to Protect your foreign market because you have a foreign market and the last is you want to acquire technology and manage managerial Know-how maybe you can conduct research and development at lower cost in those countries or maybe hire experience management or employee from competitors Once you are there, you know what the market looks like and those are all positives So this is why you would want to operate or go and make foreign direct investments It's either you buy an existing company overseas or you start your own company Now obviously there are challenges and opportunities to foreign direct investments So we're gonna list some of the challenges and I'm gonna go over each one briefly The first one is financial reporting for foreign operation. You have to follow certain guidance international taxation international income taxation international transfer pricing performance evaluation for foreign operation international auditing and Sustainability report. So we're gonna go well a few listen to my lectures every time I have a list That means I'm gonna go over these lists separately. The first one is financial reporting for foreign operation What does that mean? It means you have to translate and you have to convert your financial Operation into us again. I'm talking us as the home country. So what you have to do Steps in that for an operation is you have to convert from local to us gap So you have to go from the local accounting method to the US method So you have to prepare your financial statement using Using using us gap then you have to translate from local currency to us dollar. Okay So now you have to record our prepared use of local currency what you have to do you have to translate That currency and we're gonna learn more about translation down the road. Those are just I'm just giving you an overview This is the challenges that you're gonna have to have sometime this process is easy Sometimes it's more challenging Sometimes the currency that the foreign country is using it could be the US dollar makes it easier sometime You could be operating in a country where they're using a local currency other than that country itself So it gets a little bit more complicated. Don't worry about this for now We're gonna talk about translation and conversion later on how you convert financial statements how you translate Transactions, so but this is a challenge that you have to deal with another challenge is income international income taxation The question becomes how much do you pay taxes in the local country and how much you pay taxes in your home jurisdiction? For example, if you are a US company that's operating in Ireland, what's gonna happen is You have to pay taxes in Ireland and you have to pay taxes in the US What does that mean? It means you're gonna have you might have double taxation So you're gonna have foreign income taxes Well, when you make a profit in Ireland, you have to pay taxes there Then the US says well, you have to pay taxes on your worldwide income So you have to pay taxes on your foreign based income now bear in mind There are tax treaties that relieve this double taxation and this is where You need experts at your side to make sure you understand when you are moving to a certain country What are the tax consequences or if there's no treaties you might have to pay both taxes But most of the time for the US we do have treaties, but you cannot always count on this So the objective is to legally minimize tax in a foreign country Okay to maximize your cash flow and what happened in most places for example in the US when you buy when you pay Taxes overseas you'll get a foreign tax credit simply put They'll give you credit for the taxes you paid overseas and there are specific rules again There's one whole chapter about this. We'll talk about this later, but this is what we need to know Okay, so you want to have expertise on your side when you are dealing with Taxes actually you have to have expertise even if you're not international even if you are domestic Okay, another issue we have to deal with is international transfer pricing and what is international transfer pricing? It's when one company sells or buy product from a sister company. For example, we are in the US So this is a US company US of a and we have a subsidiary in Ireland and What happened is we're gonna be the subsidiary in Ireland need some sort of a product parts from the US So we manufacture the parts in the US We manufacture the parts in the US and we sell them to the Ireland company and what they do They manufacture the product in Ireland the question becomes how much do we charge? How much do we charge the hour? How much do we charge the Irish company? Well, guess what? Here are the facts. So just give you an example. Just see Why this is important in the real world. Let's assume in Ireland. We have a low Tax rate and in the US we have a high Tax rate So the US company pay high taxes On their profit the Irish the Irish company. They pay low taxes in Ireland. Okay, so what's gonna happen is we're gonna Have to find a way to minimize our taxes. So what does that mean? Well, what do you think should happen here? Well, the US company should sell at low Prices why because for the US company every time they make a sale, they have a revenue and They want to minimize their revenue Okay Generally speaking, they don't want to minimize the revenue But you want to minimize your revenue because you're selling to a sister company to a subsidiary So if you're selling to your subsidiary their cost is lower too So what let's assume you sold on something for a thousand dollar their cost is a thousand dollar their cost becomes a thousand dollar Your revenue to you is a cost to them. But what you want to do You want to sell them at the lowest selling prices Why because you don't want to be taxed too much on this revenue because it's that whatever you sold them It's gonna come back and the Irish company will have to pay taxes with the US as well So what happened is you'd let the taxes be paid in Ireland, which is they have a lower tax rate That's what transfer pricing is in a nutshell Not this is what it is. This is a basic application of it We're gonna have a whole chapter about transfer pricing, but this is what we have to deal with okay So when the issue for international companies made making intercompany sales one company sells the other company uses discretionary transfer pricing discretionary means It's it's what they want to charge each other. Okay price negotiation between buyer and seller may not be feasible due to Not feasible due to tax rate differences. So what's gonna happen is they're gonna have to find the best way to reduce their taxes Okay, so what's gonna happen companies will shift from countries from high tax rate to countries with low tax rate And this is the example of what I'm trying to say here What you do is when you sell to the Irish company you sell them the US company will sell them at a low prices This way they don't have to show a lot of revenue in the US and The Irish company will have low cost low cost means higher profit higher profit means they'll pay more taxes in Ireland because More taxes relative to the more taxes but relative to the US. It's lower taxes because it's a lower tax rate Okay, now bear in mind that countries are aware that companies do so so countries regulate international transfer pricing to ensure Companies pay their fair share of local taxes and again, we'll talk about this topic much more about transfer pricing But this is basically in a sense an introduction or topics that we're gonna be dealing with down the road International transfer pricing is one whole chapter I believe another issue that we have to deal with is performance evaluation of foreign operation What does that mean? It means making sure the units the the foreign Unit the foreign unit is achieving their objective. How do we how do we make sure it's it's it's achieving its objective? We go through evaluation through periodic report on individual unit performance So we just basically evaluate their performance and this is what you learn in managerial accounting. How do we you know? We have to make sure They're meeting their objective in terms of sales in terms of a gross profit return on investments So on and so forth. Okay, so when we have when we are dealing with those type of situation We have to make sure we're aware of the translation from one currency into the other Are we using the euro the euro to to to judge them are we using the US dollar? You know, what about the transfer pricing? Are we using inflated prices on purpose? Are we selling them? Are we selling them parts with high prices on purpose because of transfer pricing? So we have to make sure we take into those We took we take those issues into consideration when we are evaluating the performance of a foreign Foreign operation also there might be some issues you need to that foreign operation International auditing same concept in a sense You want to make sure that the that the that the company is that the foreign subsidiary is following policies and procedures You might have an internal auditing component of them of the management to control the process Basically, you have people inside the company doing internal control making sure they are following companies policies companies procedures You want to make sure the internal internal auditing is uncovering errors inefficiencies and possible fraud and you want to make sure they are Following the FCPA, which is the foreign corruption practice act This is very important in the US. For example, you cannot bribe officials if you are a US company, okay? Some countries, they're okay with this basically some come in some countries I Didn't make some companies. I made some countries They accept the bribes as a form of business if you if you're a US company, that's a violation Of the foreign corrupt practice act. You cannot use it. You cannot use You cannot use bribe to conduct your business now issues faced by internal and external auditors The issues could be numerous if you are if they send you as an external auditor if you're an internal auditor sent from the US It could be different in language Cultures many other things. I mean I will tell you as an auditor as a former auditor Even in the US within the same town you will find differences and challenges when you are conducting an audit So let alone if you go to audit a foreign subsidiary at the language the culture the business customs so on and so forth There's so much so much differences. Okay, also after that differences in accounting standard and auditing standard the way we do accounting in the US It's different the way they we do auditing. It's different. It's not that much different, but there are major differences Okay, also another challenge for direct financial reporting is cross-listing What does cross-listing mean? It means you want to be for example the US company Well, let's assume Apple they can raise money in the US, but let's assume they want to raise money on the in Europe Cack 40 like the or footsie 100 in England what they have to do before you are listed You have to translate your financial statement to whatever regulation that the that the stock Stock exchange would like you to comply with okay, so listen regulation differ from for foreign companies So if you are the US company trying to list your company in Japan, you have to follow their policies and procedures Well, if you're using gap you might you have to use IFRS and some come in some countries They might accept cats some companies you have to convert to IFRS before you list your Your company under exchange Also sustainability reporting or sustainability value report or corporate social responsibilities or corporate responsibility report Those are voluntary report that are required in several countries They may not be required in your home country for example the US for example Information about the environmental impact, which is we are already starting to do so and integrate that information in our annual reports labor practices a product safety innovation depending on the country that you are in For example Product safety is very important in Europe. I know my wife works with Johnson and Johnson and They are much much stricter when it comes to medical devices than the US. So you have to disclose this information In your in your report What could solve all of that not solve but make this much easier is global accounting standard Basically required countries to adopt common set of accounting rules. So if there is only one sets of rules Let's assume an international gap then all countries will follow the same rules This will avoid conversion from one Method to another and it'll be easier to evaluate foreign investment opportunities Because now you don't need to convert and make adjustments before you make a decision If we are all using the same accounting method, then it's easier to evaluate the performance and profitability of a company This is basically a notch in a nutshell foreign direct investments If you have any questions about this recording email me if you're studying for your CPA exam Make sure you study hard if you happen to visit my website for additional lectures, please consider donating. Good luck and study hard