Gray, Salter & Radebaugh Chapter 4 GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS Sidney J. Gray, University of New South Wales Stephen B

Gray, Salter & Radebaugh Chapter

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GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS

Sidney J. Gray, University of New South Wales

Stephen B. Salter, University of Cincinnati

Lee H. Radebaugh, Brigham Young University


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CHAPTER FIVE

PLANNING AND PERFORMANCE EVALUATION IN

MULTINATIONAL ENTERPRISES


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INTRODUCTION

This chapter deals with: special problems faced by MNE

management; control in the global environment; the planning process and operational

plan with respect to strategic direction.


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THE STRATEGIC CONTROL PROCESS

Gupta & Govindarajan (1991) identify the following stages in a formal strategic control system:• Periodic strategy reviews• Annual operating plans• Formal monitoring of strategic results• Personal rewards and central intervention.


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THE STRATEGIC CONTROL PROCESS Continued

Benefits of a formal strategic process:• Greater clarity and realism in planning;• “Stretching” of performance standards;• Motivation for business unit managers;• Timely intervention by central management;• Clearer responsibilities.


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For this system to work, we need to:• Select the right strategic objectives;

• Set suitable targets:– for a full-fledged strategic business unit - ROI.

– standards benchmarked on the performance of key competitors.

• Design a system to put pressure on management to perform;

• Ensure the process does not become too “big”.


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Control problems unique to a global company/environment include:• different operating environments• culture; legal systems; political differences


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CHALLENGES OF CONTROL IN THE GLOBAL FIRM

Planning and Budgeting Issues:• Determining the currency in which

the budget should be prepared: –local currency or

–parent currency?


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Acme Brush of Brazil

Cooper Grant is president of Acme Brush of Brazil the wholly ownedsubsidiary of U.S.-based Acme Brush Inc. Cooper Grant’scompensation package consists of a combination of salary and bonus.His annual bonus is calculated as predetermined percentage of thepretax annual income earned by Acme Brush of Brazil. A condensedincome statement for Acme Brush of Brazil for the most recent year isas follows:

Sales …………………. BRL 10,000Expenses …………….. 9,500Pretax income ………. BRL 500

After translating the Brazilian Real income statement into U.S.dollars, the condensed income statement for Acme Brush of Brazilappears as follows:

Sales …………………. USD 3,000Expenses …………….. 3,300Pretax income (loss)…. USD ( 300)


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Acme Brush of Brazil

The BRL pre-tax income becomes a USD pre-tax loss because sales and expenses are translated at different exchange rates.

Specifically, Sales are translated at an exchange rate of USD 0.30/BRL and Expenses are translated at an exchange rate of USD 0.347368/BRL.

The question is whether Acme Brush should use BRL income or USD income to evaluate Cooper Grant’s performance.

There is no unequivocally correct answer to this question. Issues that might be discussed include:

• What is the Brazilian subsidiary’s objective? To generate profits that can be distributed to U.S. stockholders?

• Does Cooper Grant have the ability to “control” USD income?• Do the translation procedures that result in a USD pre-tax loss

make economic sense?


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CHALLENGES OF CONTROL IN THE GLOBAL FIRM Continued

Planning and Budgeting Issues:• Currencies fluctuating in value is beyond the

control of the MNE:–managers should not be held accountable for the

results of events over which they have no control.– e.g., hedging against potential foreign exchange

losses if they have no responsibility to hedge.– If the manager is given the authority, then that

manager should be evaluated in terms of translated profitability.


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Planning and Budgeting Issues:• It is difficult for senior managers to

understand budgets generated in different currencies. Thus:– Translating budgets into home currencies allows

consolidation of budgets into a firm wide view.

–Management might want shareholders to see parent country profitability.


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Budget and Currency Practices of MNEs:• Robbins and Stobaugh (1973) found that:– less than half of MNEs judged subsidiary

performance in terms of translated dollar amounts.– Only 12% used both local currency & dollar

standards–Many use local currency budget and actual

figures.• Morsicato (1978) found many used both

dollar and local currency budgets.


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Capital Budgeting: • This is the longer-term relation of operational

budgeting.• Must consider a variety of factors:– Project subsidiary cash flows vs. parent cash flows– Taxation– Inflation rates– Unanticipated exchange rate changes– Political risk


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Capital Budgeting: • May require more judgment than

operational budgeting because when environmental factors are used in long term strategic decisions, the outcome may be at odds with a desire for strong ROIs.


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INTRA-CORPORATE TRANSFER PRICING

This refers to pricing of goods and services transferred between members of a corporate family.

Different corporate units may transfer:• raw materials; semi-finished and finished

goods.


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INTRA-CORPORATE TRANSFER PRICING Continued

Home office units may allocate:• fixed costs• interest on loans• fees• royalties for use of trademarks, copyrights.

Such prices should be based on production costs but often they are not.


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Why internal transfers may be priced with little consideration for market prices:• taxation,• competition/market share,• circumventing national controls,• boosting subsidiary profits.


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Prices are arbitrarily established because of taxation:• different tax rates complicate things, e.g., high tax

countries cause incentive to charge many expenses against parent company income.

• some authorities provide specific guidelines on how to allocate expenses.

• this likely eliminates selecting an allocation method consistent with manufacturing strategy.

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Gray, Salter & Radebaugh Chapter 4 GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS Sidney J. Gray, University of New South Wales Stephen B