Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 13: Strategic Accounting Issues in Multinational Corporations

Learning Objectives  Explain the role played by accounting in formulating multinational business strategy.  Demonstrate an understanding of multinational capital budgeting.  Describe the factors that influence strategy implementation within a multinational corporation. 13-2

Learning Objectives  Discuss the role of accounting in implementing multinational business strategy.  Identify issues involved in the design and implementation of an effective performance evaluation system within a multinational corporation.  Explain the impact of cultural diversity on strategic accounting issues within a multinational corporation. 13-3

Strategy  Large scale plans  Reflect future direction  Categories  Strategy formulation  Determining organizational goals  Strategies to achieve goals  Strategy implementation  Managerial efforts  Attain organizational goals  Performance evaluation  Extent of goals achieved  Accounting  Significant role  Strategy formulation  Implementation 13-4

EXHIBIT 13.1 Strategy formulation 13-5

Strategy Formulation  Analysis of information  Internal factors  Culture, skills and know-how  External Factors  Customer, market, and competitor  Regulatory, social, and political factors  Financial expressions  Firm strategy  Preparation of budgets  Capital budgeting  Important part of strategy formulation 13-6

Budgeting  Primary contribution of accounting  Assists in strategy formulation  Information to managers  Short-term responsibilities  Long-term planning responsibilities  Provides future expectations  Future results can be judged 13-7

Capital Budgeting  Key activity in selecting capital investments  Capital investments  Involve large amount of resources  Cost and benefit over large periods of time  Three steps  Project identification and definition,  Evaluation and selection  Monitoring and review 13-8

Capital budgeting techniques  Four techniques  Payback period  Return on investment  Net present value  Internal rate of return 13-9

Payback period  Length of time  Recoupment of initial investment  Knowledge required  Initial investment amount  Annual after-tax cash flows  Project accepted  Payback period within predetermined length  Primary weaknesses  Ignores time value of money  Ignores total profitability of project 13-10

Return on investment  Average annual return  On initial investment  Equals  Average annual net income divided by  Initial investment  Project accepted if  Return on investment over predetermined rate  Primary weaknesses  Ignores time value of money  Ignores possible cash outlays subsequent to initial investment 13-11

Net present value  Present value of net future cash flows less  The initial investment  Requires  Estimate of minimum rate of return  Used as discount rate  Project accepted if  Net present value is equal to or greater than zero  Primary weaknesses  Not used for comparing projects  Of different sizes  Biased toward large investments 13-12

Internal rate of return  Discount rate  Causes net present value of future cash flows to equal  Initial investment  Results in zero net present value  Project accepted if  IRR more than desired rate of return  Primary weaknesses  Requires unrealistic reinvestment assumptions  Difficult manual calculation 13-13

Multinational Capital Budgeting  Requires  Initial investment required  Estimated future cash flows  Discount rate for present values  Complicated factors  Risk associated with future cash flows  Political risk  Economic risk  Financial risk  Taxes, import duties  Dividend restrictions  Cash flow limitations imposed by governments 13-14

Political Risk  Political events impact cash flows  Extreme form  Nationalization  Expropriation of assets  Changes in foreign exchange controls  Repatriation restrictions  Tax rules  Labor laws  Varies significantly from one country to another 13-15

Economic Risk  Impact on cash flows  Host country economy changes  Inflation  Most significant risk  Affects local population’s purchasing power  Impacts business’s overall cost structure  Costs associated with  Manager time  Effort to respond to inflation 13-16

Financial Risk  Impact on cash flows  Changes in currency values  Interest rates  Other financial factors  Foreign exchange risk  Important component of financial risk  Foreign exchange risk affects  Evaluation of project based on  Host country cash flows  Parent country cash flows 13-17

Evaluation of foreign project  Factors considered  Project perspective  Taxes  Rate of inflation  Political risk  Parent company perspective  Form of cash remittance to parent company  Expected changes in exchange rate  Over project life  Political risk 13-18

EXHIBIT 13.4 Framework for Strategy Implementation 13-19

Management control  Planning  Effectively implements strategy  Coordinating organization activities  Communicating with organizational members  Information Evaluating  Action decision  Influencing organizational members  Change their behavior  Consistent with organization’s strategy  Important issue  Delegation of decision-making authority 13-20

Management control  Factors influencing effective control system  Organizational structure  Strategic role assigned to subsidiaries  Forms of organizational structures  Ethnocentric  Assumes universal cultural background of firm  Polycentric  Host country culture is important and adopted  Geocentric  Synergy of ideas of different countries 13-21

Operational Budgeting  Expresses long-term strategy within shorter time frames  Provides mechanisms to  Translate organizational goals in financial terms  Assign responsibilities  Assign scarce resources  Monitor actual performance  Targets to achieve 13-22

Exhibit 13.6—Influences Affecting the Operating Environment of Subsidiaries in Foreign Countries 13-23

Performance Evaluation  Major aspects for evaluating foreign operations  Performance evaluating measures  Classification of foreign operations  Cost  Profit  Investment center  Issues  Evaluation of the foreign operation  Evaluation of manager of operation  The profit measurement method 13-24

Performance evaluation measures  Financial criteria  Measures based directly on financial statement data  Net profit  Return on investment  Comparison of budgeted to actual profit  Nonfinancial criteria  Measures not based directly on financial statements  Market share  Relationship with host country government  Labor turnover 13-25

Performance evaluation  Balanced scorecard  Balanced consideration to  Financial  Nonfinancial measures  Four perspectives  Financial perspective  Customer perspectives  Internal business process perspective  Innovation and learning perspectives 13-26

EXHIBIT 13.12—Basic Model of a Balanced Scorecard Performance System 13-27

Responsibility centers  Foreign affiliate held accountable as  Cost centers  Produce output using available resources  Profit centers  Responsible for costs and revenues  Investment centers  Responsibilities of profit center plus  Responsibility for investment decisions  Return on investment (ROI)  Most common performance measure 13-28

Separating managerial and unit performance  Separating performance evaluation  Managerial performance  Unit performance  Uncontrollable items  Local manager has no control  No permission to manage  Controlled by the parent  The host government  Controlled by others  Responsibility accounting  Managers not accountable  For uncontrollable items 13-29

Uncontrollable items  Controlled by the parent company  Sales and cost  Determined by transfer pricing  Allocation of corporate expenses  Interest expense  Controlled by the host government  Foreign exchange spending restrictions  Price controls  Local content laws  Controlled by others  Labor strikes  Foreign exchange loss  Power outrages  War, riots, and terrorism 13-30

Choice of currency in measuring profit  Profit measured in  Local currency  Subsidiary not paying parent currency dividends  Parent currency  Subsidiary paying parent currency dividends  Choice of a translation method  Whether translation adjustment included in profit 13-31

Foreign Currency Translation  Translation for internal purposes  Financial accounting standards not followed  Factor influencing translation adjustment in the profit  Adjustment reflects the impact of change in rates on parent currency cash flows  Local manager has authority to hedge translation exposure 13-32

Choice of currency in operational budgeting  Operational budgets  Include budget-to-actual comparisons  If actual compared to budget  In local currency  Functions of overall budget variance  Sales volume variance  Local currency price variances  In parent currency  Functions of overall budget variance  Change in exchange rates  Sales volume variance  Local currency price variances  Exchange rates  Actual at time of budget  Projected at time of budget  Actual at end of budget period 13-33

EXHIBIT 13.17—Combinations for translation of budget and actual results 13-34

Implementing performance evaluation  Success of system depends on  Integration of system and business strategy  Feedback and review  Comprehensive measures  Ownership and support throughout organization  Fair and achievable measures  Simple, clear, and understandable system 13-35

Culture and management control  Objectives  Influence human behavior  People in different cultures  React differently to control systems  Japan more collectivist society than the United States  Culture affects  Management style  Capital budgeting decisions  Short vs. long payback 13-36

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