Chapter 14 - International Budgeting and Performance Evaluation Accounting 4570/5570 Chapter 14 - International Budgeting and Performance Evaluation

Overview Strategic Control Process Strategy - decisions about which businesses to be in, where to locate operations, and how to be competitive as well as the firm’s response to changes in the global business environment Setting Objectives Choosing a suitable target varies among countries Best measures are those which focus on the purpose for which the business unit is intended

Common Performance Measures Return on investment (ROI) Sales Cost reduction Quality targets Market share Profitability Budget to actual

Research on Performance Evaluation Most foreign subsidiaries evaluated on the same basis as domestic subsidiaries U.S. firms - ROI most used U. K. firms - Comparison to budget and ROI Japanese firms - other measures than ROI; particularly sales, sales volume, and long-term measures. ROI generally not important.

Research on Performance Evaluation ROI - highly criticized due to potential suboptimization Nearly all MNEs used some supplementary device to gauge foreign subsidiaries’ performance Most widely used supplementary measure - comparison to budget

Practical Suggestions on Performance Evaluation Evaluate foreign subsidiaries on how well they are meeting their intended purpose Separate the evaluation of the manager and the overall subsidiary performance Include translation adjustments only if manager has authority to hedge Compare performance with plan Method of evaluation should be understood by the foreign managers

Budget Process Formal or informal process? Who participates? Style of communication? (formal vs. informal) How are objectives set? Should budgeting process differ for foreign subsidiaries? Time period covered? (Short versus long-term?) Financial or nonfinancial objectives? Or both? How does volatility in the industry/country affect the budget?

Studies on Budgeting Top-level Mexican managers generally liked to participate in budget process However, lower-level Mexican managers did not like to participate Mexican managers of entirely foreign-owned subsidiaries did not like to participate due to feeling powerless. Australian and Singaporean managers preferred to participate in budget process

Studies on Budgeting Japanese used budgets to plan increased sales volume Japanese budgets prepared and used in a more timely manner American managers more likely to participate and be evaluated and compensated by budgets

Interaction of Culture and Geographic Distance Hassel and Cunningham (2004) studied how the combination of culture and geographic distance (psychic distance) influence the budgeting process. Subsidiaries that are culturally similar and geographical close (low psychic distance) tend to show greater financial performance than budget Subsidiaries that are culturally distinctive and located far away (high psychic distance) will show weaker financial performance than budget

Problems Related to International Business in Budgeting Enhanced coordination and communication Foreign currency reporting Which currency to use Difficult for top management to interpret statements outside their domestic currency Responsibility for forex translation gains/losses Authority for hedging? Do we want the subsidiary to think in terms of the parent company profitability?

Problems Related to International Business in Budgeting Degree of Autonomy Purpose of subsidiary Should externalities in the foreign country (wars, disasters, government intervention) be included? Exchange Rates to use Actual rate at time budget is prepared Projected rate at time budget is prepared Actual exchange rate at end of period

Exchange Rates Exhibit 14.4, page 392 A1, P2, E3 only combination that eliminates all exchange rate variances Exhibit 14.5, page 393 survey shows how many companies use the different exchange rate combinations. P2 (same rate used = projected exchange rate at time of budget) most common P3 second most common

Other Issues Capital Budgeting - consider the risk factor of foreign currency exchange in discount rates and cash flows

Intracorporate Transfer Pricing Definition Theoretical price: Costs incurred + lost contribution margin Perfect market conditions Market price charged if producing at full capacity Variable costs charged if producing at less than full capacity Real world: Price somewhere between the two

Intracorporate Transfer Pricing International Complications Taxes Competition Import duties National controls (currency rationing, limits on amount of cash taken out of country) Profitability of subsidiary Local partners Exhibit 14.8, page 401

Overhead Allocation Cross-national allocation of overhead and expenses Behavioral issues Foreign issues Foreign currency translation Taxation Lessons from the Japanese Cost drivers Motivation to reduce costs

Costing Issues Role of management accounting in corporate strategy Standard Costing - should same standards or procedures be used throughout the world or should they be tailored to individual locations?

Emerging Trends in Performance Evaluation Focus of evaluation shifted to strategic business units (SBUs) More use of ratios More use of cash flows More use of non-financial criteria Economic Value Added (EVA) Balanced Scorecard

Economic Value Added (EVA) EVA = [ROIC – WACC] x AIC ROIC = Return on invested capital (operating profit minus cash taxes paid) WACC = after-tax weighted average cost of capital AIC = average invested capital = average stockholders’ equity + average debt

EVA Positive EVA requires that a company earn a return on its assets that exceeds the cost of debt and equity. It is an actual monetary amount of value added. It measures changes in value for a period.

Balanced Scorecard Approach to performance measurement that links the strategic and financial perspectives of a business Four perspectives: Financial measures Customer measures Internal business processes Learning and growth

Cases Korean Subsidiary (Exercises 1-2) Lucas Inc. (Exercises 3-5) Uplift International Ltd. (Exercise 10) Niessen Apparel (website)