Comparing entry modes and accounting issues

Accounting Ahead | Original study resource | accountingahead.com.au

Comparing entry modes and accounting

issues

MODULE 4 | 4.6.3 | STUDENT COMPANION

There is no single best entry mode. Organisations usually expand in steps, deciding again at each stage

how many resources to commit, how much risk to accept, how much control they need and how much profit

they could make, often graduating from one mode to the next.

Comparing entry modes: speed and control

Speed of entry: slow to fast

High

control

Low

control

Exporting

Licensing

Franchising

Strategic alliance

Joint venture

AcquisitionGreenfield

Higher leakage risk

Others use your know-how:

licensing, franchising, alliances,

joint ventures

Lower leakage risk

You keep the know-how in-house:

exporting and full ownership

Criteria for comparing modes

Criterion Question to ask

Upfront investment How much money and management time does it need?

Speed of entry How quickly does it get us into the market?

Market penetration How deeply can we reach customers?

Control How much control, and direct customer knowledge, do we keep?

Political risk How exposed are we to expropriation or sudden rule changes?

Technology leakage How likely is our know-how to reach others?

Managerial complexity How hard is it to run?

Return and payout What percentage return, and what total dollars, could it earn?

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Accounting Ahead | Original study resource | accountingahead.com.au

Worked example: return versus payout (imagined)

Return is the percentage earned on the money invested; payout is the total dollar amount.

Licence Own subsidiary

Investment $100,000 to set up the licence $5,000,000

Annual income 5% royalty on $4m of sales = $200,000 $1,000,000 profit

Return (percentage) 200% 20%

Payout (dollars) $200,000 $1,000,000 (five times more)

Accounting issues in market expansion

Entering new markets or diversifying brings accounting challenges the organisation hasn't faced before. Their

costs must be anticipated and built into the business case and budget, because they can change whether entry

makes sense at all. Some surface in the external analysis (tax, governance); others in the internal analysis (can

the finance team cope?).

Six accounting issues in market expansion

Build the costs into the

business case

Before the expansion is approved

Foreign exchange risk

Transactions, translation and costing

Multiple sets of reports

Entities, jurisdictions, year ends, audits

Incompatible systems

Integration cost, consolidation, data

integrity

Business conduct standards

Company, consumer and bribery laws

Taxation

Income and consumption taxes, losses,

expertise

Transfer pricing

Prices between related entities at arm's

length

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Accounting Ahead | Original study resource | accountingahead.com.au

Where foreign exchange risk comes from

IAS 21 governs the accounting for transactions in foreign currencies and for foreign operations.

Strategy How the risk shows up

Selling or buying abroad, without a

local presence

Gains and losses between the date of a sale or purchase and the date of

payment

A wholly owned business abroad Runs in the local currency; the risk appears when results are translated and

consolidated into the parent's accounts, and in costs such as expatriate

salaries

New products made overseas Uncertain production costs that complicate every costing decision

One invoice, two exchange rates

Invoice, payable in ninety days US$500,000

Rate on the day of the sale A$1 = US$0.65

Value on the day of the sale A$769,231

Rate when the money arrives A$1 = US$0.70

Value when the money arrives A$714,286

Exchange loss A$54,945

A forward exchange contract could have locked in the rate on the day of the sale

Different financial year ends

Each entity and country usually needs its own accounts, often the basis of its tax return. Different year ends

make inter-entity transactions, loans and dividends harder to reconcile; larger foreign entities may need their

own audits.

Country Usual year end

Australia 30 June (substituted accounting periods are possible)

New Zealand 31 March (standard balance date)

India 31 March

China 31 December

Incompatible systems: add the cost of integrating an acquired business's systems to its price; avoid

re-keying figures by hand; moving to one package means licences, upgrades, implementers and training, and

puts data integrity at risk.

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Accounting Ahead | Original study resource | accountingahead.com.au

Business conduct standards: each country's company and consumer laws apply, with heavy penalties.

Some home laws reach overseas: US foreign bribery law, and Australia's offence (since 2024) of a company

failing to prevent foreign bribery by its associates.

Taxation: income tax rates and rules, and consumption taxes such as GST and VAT (national or state by

state), vary widely. Get expert help; favour countries that let start-up losses be carried forward; align year

ends where possible.

Case note: Chevron Australia and transfer pricing

Transfer prices, charged between related entities in different countries, must reflect what independent parties

would charge. Chevron's Australian business borrowed the Australian-dollar equivalent of US$2.5 billion from a

related US company at around 9% interest, while that company raised the money at little more than 1%. The

Australian Taxation Office argued the rate was far above an arm's length rate, and in 2017 the Full Federal Court

upheld tax assessments of about A$340 million, including penalties and interest, for 2004 to 2008; Chevron then

settled with the Tax Office and withdrew its appeal. Transfer pricing isn't a strategy to pursue; it's a risk to

manage from the start.

Source: Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC 62.

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Practice questions

MODULE 4 | 4.6.3 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Return or payout?

Calculate the return and the payout for each option, and discuss which suits a company with limited capital and

little international experience.

Option for Kookaburra Kitchens (imagined cookware

maker) in Korea

Data

Licence a Korean manufacturer Set-up cost $150,000; licensee sales $6 million a year;

royalty 4%

Build its own subsidiary Investment $8 million; expected profit $1.2 million a year

Question 2 - Exchange gains and losses

Calculate each invoice's value in Australian dollars at both dates, the gain or loss, and how it could have been

hedged.

Invoice Rate at the transaction

date

Rate at the payment date

(a) Export sale of EUR 200,000 (receivable) A$1 = EUR 0.60 A$1 = EUR 0.58

(b) Import purchase of US$150,000 (payable) A$1 = US$0.66 A$1 = US$0.62

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Question 3 - Spot the accounting issues

Imagine Riverside Group, an Australian company with a 30 June year end, buys a Singapore engineering firm

with a 31 December year end that uses different accounting software and invoices customers in Singapore

dollars. Riverside will charge the new subsidiary a management fee for head-office services. Identify the

accounting issues Riverside must plan for.

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Accounting Ahead | Original study resource | accountingahead.com.au

Worked answers

MODULE 4 | 4.6.3 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Kookaburra Kitchens

Licence Subsidiary

Annual income $6m x 4% = $240,000 $1.2m

Return $240,000 / $150,000 = 160% $1.2m / $8m = 15%

Payout $240,000 a year $1.2m a year (five times more)

With limited capital and little experience, licensing suits a first step: a high return, little capital at risk and local

know-how from the licensee, though it earns a smaller payout, teaches Kookaburra little about the market and

risks technology leakage. A subsidiary could follow once the market is proven.

Question 2 - Exchange rates

Invoice At transaction At payment Result

(a) EUR 200,000 receivable 200,000 / 0.60 = A$333,333 200,000 / 0.58 = A$344,828 Gain A$11,495

(b) US$150,000 payable 150,000 / 0.66 = A$227,273 150,000 / 0.62 = A$241,935 Loss A$14,662

Hedging: forward exchange contracts on the transaction date would have fixed both rates (for (a), a forward

sale of euros; for (b), a forward purchase of US dollars), removing the uncertainty at a cost.

Question 3 - Riverside Group

Foreign exchange: SGD revenue and balances must be translated and consolidated; consider hedging.

Multiple reports and year ends: 30 June versus 31 December complicates consolidation, inter-entity

balances and dividends; consider aligning the subsidiary's year end; Singapore accounts and audit.

Systems: integrating different accounting software; avoid manual re-keying; protect data integrity.

Conduct standards: Singapore company law; Australian foreign bribery laws apply to dealings in the region.

Taxation: Singapore corporate tax and GST compliance; local tax expertise.

Transfer pricing: the management fee must reflect an arm's length price, with documentation.

GLOBAL STRATEGY AND LEADERSHIP | M4 | 4.6.3 | WORKED ANSWERS

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