United States: International Risks For U.S.- Based Global Companies: A Guide For The Chief Accounting Officer

Given the continued sluggishness in the U.S. economy, many U.S.-based companies are pinpointing the international marketplace (particularly emerging markets) as the best place for growth, either organically or through business acquisitions. Although the business strategy may be sound, there are numerous risks that U.S.-based companies should understand in dealing with international subsidiaries, global transactions, foreign personnel and unique business environments. This article is focused on the business and accounting risks faced by a chief accounting officer or controller of a U.S.-based global company and the leading practices that should be utilized to mitigate some of these risks.

INTERNATIONAL BUSINESS AGREEMENTS

One of the more challenging aspects of capturing international transactions is identifying any unusual aspects contained within international business agreements. Whether partnership agreements, purchase and sale agreements, leases or management contracts, among others, business agreements negotiated and documented outside the United States are structured to conform to business models different from what we typically see at home. These differences frequently are driven by country-specific laws or regulations, expectations of the local business community, foreign investor rules or a wide range of tax implications. Also, international agreements sometimes can merge several business concepts within one business document (such as a lease and management agreement), which is not typical in the United States. As such, it is vitally important for a chief accounting officer to review all new and existing business agreements, particularly older agreements with lengthy terms, pertaining to revenue recognition and off-balance sheet risks in particular. International growth through acquisition can be a challenge in this regard, and a thorough review should be performed during the purchase accounting phase of any acquisition.

U.S. GAAP KNOWLEDGE AT INTERNATIONAL SUBSIDIARIES

Another often overlooked risk involving global U.S. companies is accounting risk resulting from lack of expertise in U.S. generally accepted accounting principles (GAAP). Although seemingly obvious, international accounting personnel and department heads tend to view their roles with more of an operational focus toward financial close timing and upstream reporting. Many times, balance sheet analysis, particularly off-balance sheet risk, is not a priority for accounting departments outside the United States. In addition, differences between U.S. GAAP and any local GAAP reporting (such as International Financial Reporting Standards or country-specific GAAP) easily can be overlooked due to lack of management attention on compliance with U.S. rules. In other words, it is a mistake to assume globally based accountants have expertise in U.S. GAAP or knowledge surrounding our rules-based accounting literature, which uses terminology, language and concepts with which international personnel may be unaccustomed.

International accounting groups may have visibility into financial balances and results that reside only within their sphere of influence. For example, international regions may be aware of intercompany balances recorded exclusively at the international subsidiary. In that regard, it is essential at the U.S. parent level to confirm and reconcile all intercompany accounts (balances that exist among international subsidiaries, as well as those among international subsidiaries and the U.S. parent). Areas of additional scrutiny may include revenue recognition (particularly with regard to whether collectibility is reasonably assured¹, lease classification, consolidation involving variable interest entities, timing of liability recognition and foreign currency accounting (discussed later).

INTERNAL CONTROL DOCUMENTATION

The amount of time, effort and cost needed for compliance with rules and regulations surrounding internal control compliance; namely, the Sarbanes-Oxley Act (SOX), can be staggering for an international organization. While U.S.-based companies have seen unprecedented changes in this area over the past decade, the establishment and documentation of an organization's internal control environment has not been given the same concentration in many overseas areas (particularly in the Asia region). Although certain controls may be in place, though undocumented, most auditors, regulators and other stakeholders will assume that controls do not exist unless fully documented. This simply is the state of affairs with which we are dealing in today's U.S. regulatory environment.

In that regard, it is important for a chief accounting officer to assess the need for the establishment of business process teams outside the United States. This may help assure that all business processes, accounting controls and risk assessments at the international level have been fully inventoried. Additionally, consideration should be given to the creation of sub-certifications, similar to SOX Rule 302 certifications, for international finance and accounting department leadership. Although more of a symbolic gesture, having international personnel sign sub-certifications may stimulate attention toward the seriousness of the U.S. regulatory environment. Generally, creating a process to regularly review the strength of accounting-based controls at the international level can help eliminate the risk of a material weakness and, at a minimum, track progress toward compliance with U.S. rules.

COMPLEXITY OF FOREIGN CURRENCY ISSUES

Foreign currency accounting is another area that may appear simple at first but actually can have complex implications. Foreign currency issues are broken down into two key concepts:

-          Cumulative Translation Adjustment (CTA or Translation): CTA captures the impact from fluctuations in foreign currency exchange rates after translating (into U.S. dollars) a foreign subsidiary's assets and liabilities (held in local currencies) at end-of-period rates and holding retained earnings constant. The resulting CTA adjustment amount is recorded on the balance sheet as part of other comprehensive income.

-          Foreign Currency Cash Flow Exposure (Re-measurement): Re-measurement captures the impact from fluctuations in foreign currency exchange rates as applied to business transactions (such as loans or receivables) denominated in currencies other than the functional currency of the entity involved. These transactions ultimately will require settlement in cash, and, as such, the Re-measured amounts are recorded as a foreign currency gain or loss on the income statement.

Leadership at a U.S.-based global company needs to be aware of the distinctions between these concepts since they sometimes overlap. For instance, loans funded from a U.S. parent to a foreign subsidiary are subject only to Translation when such loans are not anticipated to be settled in cash (e.g., they are deemed long term). Long-term loans necessitate documentation (as to the intent not to settle in cash) at inception to obtain Translation accounting. Otherwise, Re-measurement accounting is required, which may expose the U.S. parent to extreme income statement volatility. Additionally, it is critical to ensure that foreign subsidiaries (as well as the U.S. parent) are using the same sources to obtain currency rates, as fractional amounts ultimately can create large differences in this area during either a Translation or Re-measurement. Certain industries that utilize a large number of individual reporting units to capture financial data and results (such as hospitality, energy, real estate and retail companies) also may warrant additional scrutiny with regard to foreign currency issues.

HUMAN RESOURCES CONSIDERATIONS

Although traditionally not on the radar of a chief financial officer in the United States, human resources and personnel considerations may require more focus internationally than back home. In many countries, employee rights such as workday and workload limitations, job security and position elimination notice, among others, are commonplace. This results in the inability to make swift corrective action when dealing with personnel issues or headcount challenges. With the type of employment climate currently in existence, it is important to be proactive when establishing or acquiring international accounting departments. When changes to an international accounting department are made, they should be done collectively after careful consideration of country-specific laws and in coordination with local and U.S. parent human resources personnel. Having a long-term strategic vision for international accounting departments is vital.

FOREIGN CORRUPT PRACTICES ACT IMPLICATIONS

International accounting departments are on the frontlines with respect to ensuring compliance with the Foreign Corrupt Practices Act (FCPA). Effectively, the FCPA mandates comprehensive anti-corruption and anti-bribery rules that include topics such as facilitation payments, proper and improper gifts to foreign offices, and travel and entertainment expenses and specifies recordkeeping provisions. The recordkeeping provisions of the FCPA require internal controls that are strong enough to detect any violation, which is a relatively broad requisite. Both the U.S. Department of Justice (DOJ) and the U.S. Securities and Exchange Commission (SEC) have been aggressively pursuing some of the largest global U.S.-based companies and bringing significant charges. These charges frequently include criminal and civil penalties for both companies and individuals. Application of the FCPA may be best handled generally by a company's general counsel and regulatory compliance officers but shouldn't be overlooked by finance and accounting personnel. While a chief accounting officer doesn't necessarily need to be an expert on the nuances of all FCPA provisions, one certainly should be aware of the key provisions, internal control requirements and risks surrounding this hot button issue. The FCPA was enacted by Congress more than three decades ago, and it's apparent that this legislation is not going away anytime soon.

CONCLUSION

In order to effectively prioritize resources, time and effort within a global organization, leadership first must identify the primary risk factors. Although all organizations are different and have unique risk profiles, it is important to understand the key drivers and react accordingly. Many of the risks have been outlined here, but in an ever changing world, it is imperative to stay vigilant in an effort not only to survive but also to prosper.