Accounting 4570/5570

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

2. 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

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

4. 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.

5. 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

6. 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

7. 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?

8. 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

9. 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

10. 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

11. 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?

12. 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

13. 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

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

15. 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

16. 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

17. 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

18. 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?

19. 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

20. 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

21. 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.

22. 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

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