Strategic Accounting Issues in Multinational Corporations

Strategic Accounting

Issues in Multinational

Corporations

PROGRAM STUDI AKUNTANSI

EBA 604

Strategic Accounting Issues in

Multinational Corporations

Chapter Topics

• _{Accounting and the formulation of multinational}

business strategy.

• _{Multinational capital budgeting.}

• _{Accounting and the implementation of}

multinational business strategy.

• _{Performance evaluation systems in a}

Strategic Accounting Issues in

Multinational Corporations

Learning Objectives

1. Explain the role played by accounting in

formulating multinational business strategy.

2. Demonstrate and understanding of multinational capital budgeting.

3. Describe the factors that infuence strategy implementation within a multinational

Strategic Accounting Issues in

Multinational Corporations

Learning Objectives

4. Discuss the role of accounting in implementing multinational business strategy.

5. Identify the issues involved in the design and implementation of an efective performance evaluation system within a multinational

Strategy

• _{Strategies are large scale plans that refect the}

desired direction of the company.

• _{Strategy formulation involves determining}

organizational goals and strategies to achieve those goals.

• _{Strategy implementation involves managerial}

eforts to infuence employees to attain organizational goals.

• _{Managerial infuence is also referred to as}

management control.

Accounting and Strategy

Formulation

• _{Information is a key ingredient in the strategy}

formulation process providing information about both internal and external factors.

• _{This involves analysis of customer, market, and}

competitor information, risk assessment.

• _{It also includes fnancial expressions of frm}

strategy and preparation of budgets.

• _{Capital budgeting is an important part of strategy}

Accounting and Strategy

Formulation

Budgeting

• _{Budgeting is the primary use of accounting}

information in strategy formulation.

• _{Budgeting assists in strategy formulation by}

providing managers with information about short-term and long-short-term planning responsibilities.

• _{Budgeting also provides expectations against}

Capital Budgeting

Overview

• _{The fundamental concepts of capital budgeting}

are the same in either a domestic or international context.

• _{Large, long-term investments are referred to as}

capital investments.

• _{Capital budgeting is a key activity in selecting}

capital investments.

• _{Capital budgeting involves three steps: project}

Capital Budgeting

Steps in capital budgeting

• _{Project identifcation and defnition provides a}

clear basis for understanding the project and predicting the associated cash fows.

• _{Evaluation and selection involves identifying cash}

fows and then using one or more of the capital budgeting methods to evaluate the project.

• _{Monitoring and review involves updating the}

Capital Budgeting

Capital budgeting techniques

• _{Payback period.}

• _{Return on investment.} • _{Net present value.}

Capital Budgeting

Payback period

• _{Represents the length of time it takes to recoup}

the initial investment.

• _{Equal to the initial investment amount divided by}

the annual after-tax cash fows.

• _{The project will be accepted if the payback period}

does not exceed a predetermined length.

• _{The primary weaknesses of this method are that}

Capital Budgeting

Return on investment

• _{Represents an average annual return on the}

initial investment.

• _{Equal to the average annual net income divided}

by the initial investment.

• _{The project will be accepted if the return on}

investment exceeds a predetermined rate.

• _{The primary weaknesses of this method are that}

it ignores the time value of money, and it ignores possible cash outlays subsequent to initial

Capital Budgeting

Net present value

• _{Equal to the present value of net future cash}

fows less the initial investment.

• _{Requires the estimate of minimum rate of return}

to be used as the discount rate.

• _{The project will be accepted if the net present}

value is equal to or greater than zero.

• _{The primary weaknesses of this method are that}

Capital Budgeting

Internal rate of return

• _{Represents the discount rate that results in a net}

present value of zero.

• _{It is equal to the discount rate that causes the net}

present value of future cash fows to equal the initial investment.

• _{The project will be accepted if the IRR is greater}

than the companies desired rate of return (hurdle rate).

• _{The primary weaknesses of this method are that}

Multinational Capital Budgeting

• _{Capital budgeting in an international context is}

complicated by several factors.

• _{These factors relate primarily to the risk}

associated with future cash fows.

• _{These risks are generally categorized as political}

risk, economic risk, and fnancial risk.

• _{Taxes, import duties, dividend restrictions, and}

Multinational Capital Budgeting

Political Risk

• _{This refers to the likelihood that political events}

will impact cash fows.

• _{Nationalization and expropriation of assets is an}

extreme type form of political event.

• _{Political risk is also associated with changes in}

foreign exchange controls, repatriation restrictions, tax rules, and labor laws.

• _{This risk can vary signifcantly from one country}

Multinational Capital Budgeting

Economic Risk

• _{This refers to the likelihood that changes in the}

host country economy will impact cash fows.

• _{Infation is the most signifcant of economic risks.} • _{Infation afects the ability of the local population}

to purchase goods and also impacts the overall cost structure of a business.

• _{There are also costs associated with manager}

Multinational Capital Budgeting

Financial Risk

• _{This refers to the likelihood that changes currency}

values, interest rates and other fnancial factors will impact cash fows.

• _{Foreign exchange risk is also a component of}

fnancial risk.

• _{Whether to evaluate the project based on host}

Strategy Implementation

Management control

• _{The management control system is the primary}

mechanism for implementing and evaluating the efectiveness of strategy.

• _{Accounting is involved in management control}

primarily through its role in operating budgets and performance evaluation.

• _{Operating budgets provide a link between}

strategy and performance.

• _{A number of organizational and cultural factors}

Strategy Implementation

Factors afecting strategy

implementation

• _{Organizational structure afects strategy}

implementation.

• _{Diferent forms of organizational structures}

include: ethnocentric, polycentric, and geocentric.

• _{Ethnocentric frms use an approach that assumes}

that the cultural background of the frm is universal.

• _{Polycentric frms consider the culture of the host}

Strategy Implementation

Factors afecting strategy

implementation

• _{Geocentric frms often consist of units that play}

very distinct roles. These roles include: global innovator, integrated player, implementer, and local innovator.

• _{Levels of control and delegation are factors that}

infuence management control system type.

• _{One major type of management control system is}

bureaucratic control which employs a signifcant amount of structure.

Performance Evaluation

Major aspects of performance

evaluation

• _{The measure or measures of performance.}

• _{Classifcation of the foreign operation as cost,}

proft or investment center.

• _{Joint or separate evaluation of the foreign}

operation and the manager of the operation.

Performance Evaluation

Performance evaluation measures

• _{Financial measures are based directly on fnancial}

statement data.

• _{Examples include net proft, return on investment}

and comparison of budgeted to actual proft.

• _{Nonfnancial measures are based on data not}

obtained directly from fnancial statements.

• _{Examples include market share, relationship with}

Performance Evaluation

Performance evaluation – Balanced

scorecard

• _{This approach gives “balanced” consideration to}

both fnancial and nonfnancial measures.

• _{It considers the perspectives of four stakeholder}

groups.

• _{Shareholder’s perspectives are considered by}

fnancial performance measures.

• _{The internal business perspective is refected in}

business process measures.

Performance Evaluation

Responsibility centers

• _{The idea of responsibility centers is to identify the}

activities that individual units perform and for which they should be held accountable.

• _{Cost centers are responsible for producing output}

using a certain amount of resources.

• _{Proft centers are responsible for costs and}

revenues.

• _{Investment centers have the responsibilities of a}

proft center plus responsibility for investment decisions.

Performance Evaluation

Separating managerial and unit

performance

• _{In an international context a number of factors}

exist that cause a disconnect between manager performance and unit performance.

• _{These factors that the manager cannot control}

are known as uncontrollable items.

• _{Responsibility accounting implies that managers}

should not be held accountable for uncontrollable items.

• _{Uncontrollable items include those controlled by}

Performance Evaluation

Choice of currency in measuring proft

• _{Proft can be measured in either the local}

currency or parent currency.

• _{Local currency is appropriate if the subsidiary is}

not expected to pay parent currency dividends.

• _{Otherwise, parent currency is appropriate.}

• _{When parent currency is used, the company also}

must choose a translation method.

• _{Further, a decision must be made about whether}

Performance Evaluation

Translation to parent currency

• _{Since the translation is for internal purposes,}

fnancial accounting standards need not be followed.

• _{Likewise, the inclusion of the translation}

adjustment in the proft measure is based on

internal needs rather than accounting standards.

• _{One factor in this decision is whether the}

adjustment refects the impact of exchange rates on parent currency cash fows.

• _{A second factor whether the local manager has}

Performance Evaluation

Choice of currency in operational

budgeting

• _{Operational budgets often include}

budget-to-actual comparisons.

• _{The international context adds an element of}

complexity due to exchange rate fuctuations.

• _{Exchange rates may change during the period}

between making the budget and recording profts.

• _{The three available exchange rates are: actual at}

Performance Evaluation

Budget and actual rate combinations

• _{Lessard and Lorange (1977) illustrated fve}

budget and actual exchange rate combinations.

• _{Three combinations involve using the same}

exchange rate for both budget and actual translations.

• _{A fourth combination translates the budget at the}

actual rate at the time of budget and translates actual results using the actual rate at the end of period.

• _{A ffth combination translates the budget using a}

Performance Evaluation

Implementing performance evaluation

• _{The success of a performance evaluation system}

depends on a number of factors. These include:

– _{Integration of the system with the overall business}

strategy.

– _{Feedback of actual results and revision of budget.} – _{Comprehensiveness of the set of performance}

measures.

– _{Organizational buy-in.}

– _{Reasonableness of budgeted measures.}

Performance Evaluation

Cultural considerations in management

control

• _{One of the objectives of a management control}

system is to infuence human behavior.

• _{People in diferent cultures will react diferently to}

aspects of management control systems.

• _{Japan is a more collectivist than the United}

States.

• _{Management control mechanisms designed in the}

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