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Chapter 10

Management Accounting Issues in

Multinational Corporations
Timothy Doupnik | Mark Finn Giorgio Gotti

© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill
 Learning Objectives
• Demonstrate an understanding of multinational capital
budgeting.
• Describe issues involved in designing a management
control system for foreign operations.
• Identify issues involved in the design and implementation
of an effective performance evaluation system within a
multinational corporation.
• Understand different approaches for incorporating
exchange rate changes in operational budgeting within a
multinational corporation.
• Explain the impact of cultural diversity on strategic
accounting issues within a multinational corporation.

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 Management Control
Two control activities:
• Preparing operating budgets.
• Plans for the future expressed in quantitative terms.
• Evaluate performance of decentralized operations.
• Ascertaining the extent to which organizational goals have
been achieved.
• The accounting function within an organization:
• Capital budgeting.
• Operational budgeting.
• Performance evaluation.

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 Capital Budgeting
Three steps of capital budgeting:
1. Project identification and definition.
2. Evaluation and selection.
3. Monitoring and review.
Project identification and definition is CRITICAL
• Estimate associated revenues, expenses, and cash flows.
Evaluation and selection.
• Using capital budgeting techniques to determine if the
project is acceptable.
Monitoring and review.
• Alter the initial plan in response to changing circumstances.
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 Capital Budgeting Techniques
Common techniques:
• Payback period.
• Return on investment.
• Net present value.
• Internal rate of return.

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 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.

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 Net Present Value 1

Net present value (NPV): the difference between the initial

investment and the sum of the present values of all future
after-tax net cash inflows from the investment.
Requires:
• Estimate of minimum rate of return.
• Used as discount rate.

Project accepted if:

• The net present value is equal to or greater than zero.
Primary weaknesses:
• Not used for comparing projects of different sizes.
• Biased toward large investments.
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 Net Present Value 2

Calculation of NPV requires knowledge of:

• The amount of the initial investment.
• An estimation of the future cash flows to be derived from
the investment.
• An estimation of cash flows to be received upon the
termination of the investment.
• An appropriate discount rate based on the desired rate of
return on the investment.

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 Net Present Value 3

U.S. companies commonly use discounted methods

Japanese companies prefer payback period.
• Large investments in technology, so it is necessary to
recoup the investment quickly.
• Technology investments have short product life cycles.
• Difficult to predict cash flows in the distant future.

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 Multinational Capital Budgeting
Requires:
1. The amount of initial capital invested.
2. Estimated future cash flows.
3. An appropriate discount rate for determining present values.

Complicated factors with foreign investments.

• Risk associated with future cash flows:
• Political risk.
• Economic risk.
• Financial risk.

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 Political Risk
Political events may adversely affect cash flows.
Most extreme forms:
• Nationalization.
• Expropriation of assets.
Additional aspects:
• Changes in foreign exchange controls.
• Profit expatriation restrictions.
• Local content laws.
• Changes in tax or labor rules.
• Requirements for additional local production.

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 Economic Risk
Impact on cash flows.
• Host country economy changes.
• Inflation and balance of payments.
• Most significant risk.
Affects local population’s purchasing power.
• Impacts business’s overall cost structure.
• Costs associated with:
• Managers’ time and resources.
• Effort to respond to inflation.

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 Financial Risk 1

• Impact on cash flows.

• Unexpected changes in:
• Currency values.
• Interest rates.
• Other financial circumstances.

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.

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 Financial Risk 2

Three types of exposure to foreign exchange risk:

• Balance sheet exposure.
• Transaction exposure.
• Economic exposure.
Second and third have a direct impact on cash flows.

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 Project Perspective versus Parent Company
Perspective 1

Factors considered:
• From a project perspective (local currency cash flows):
1. Taxes.
2. Rate of inflation.
3. Political risk.
• From a parent company perspective (parent company cash
flows):
1. Form of cash remittance to parent company.
2. Foreign exchange risk.
• Changes in the exchange rate over the project’s life.

3. Political risk.

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 Project Perspective versus Parent Company
Perspective 2

• Two ways to incorporate these factors.

1. The factors are incorporated into estimates of expected
future cash flows.
2. The discount rate is increased to compensate for the
extra risk of foreign investment.

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 Management Control Issues in MNCs
Management control involves:
• Planning what the organization should do to effectively
implement strategy.
• Coordinating organization activities.
• Communicating with organizational members.
• Evaluating information.
• Deciding what action should be taken.
• Influencing organizational members.
• Change their behaviour.
• Consistent with organization’s strategy.

• Important issue:
• Delegation of decision-making authority.
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 Organizational Structures in MNCs 1

• Factors influencing an 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 should be adopted.
• Geocentric.
• Synergy of ideas from different countries.

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 Organizational Structures in MNCs 2

Global innovator
• Serves as source of knowledge for other firms.
• Self-sufficient.

Integrated player
• Serves as source of knowledge for other firms but also relies on other
firms.

Implementer
• Little knowledge creation.
• Relies heavily on knowledge inflows from peers or parent company.

Local innovator
• Local responsibility for the creation of relevant know-how in the local
context.
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 Types of Management Control Systems 1

Two dominant types:

• Bureaucratic.
• Cultural.

Bureaucratic (output):
• More common with U.S. firms.
• Monitors subsidiary outputs.
• Relies heavily upon frequently reported performance data.
• Extensive use of rules, regulations, and procedures.
• More centralized control.
Cultural (behavioral):
• More common with European firms.
• Broad organizational culture.
• More qualitative aspects.
• More decentralized control.
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 Types of Management Control Systems 2

Five categories of control:

1. Control.
• Bureaucratic: quantifiable.
• Cultural: qualitative aspects.

2. Control
• Bureaucratic: precise plans/budgets.
• Cultural: company-wide agreement.

3. Control
• Bureaucratic: large central staffs.
• Cultural: large cadre of capable expatriate managers who spend
long periods abroad.

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 Types of Management Control Systems 3

4. Control
• Bureaucratic: centralized control.
• Cultural: decentralization of operating decisions.

5. Control
• Bureaucratic: large vertical spans of reporting channels.
• Control transfers well across levels of corporation.
• Cultural: short vertical spans of reporting channels.
• Substantial control loss.

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 Performance Evaluation
Monitors organization’s effectiveness in fulfilling objectives.
Evaluates management performance.
Assess the profitability of current operations.
Identify areas that need closer attention.
Allocate scarce resources efficiently.
Motivate organization members to behave in a manner consistent with
the organization’s goals.
No single criterion can be used to evaluate performance of all
subsidiaries.
Most MNCs use a mixture of:
• Financial and nonfinancial.
• Formal and informal.
• Formula-based and subjective.
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 Exhibit 10.2—Influences Affecting the Operating
Environment of Subsidiaries in Foreign Countries

Access the text alternative for slide images.

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 Evaluating the Performance of Foreign
Operations
Major aspects for evaluating foreign operations:
1. The type of performance evaluating measures.
2. The classification of foreign operations as:
• Revenue,
• Cost,
• Profit, or.
• Investment center.
3. Issues:
• Evaluation of the foreign operating unit.
• Evaluation of the manager of that unit.

4. The profit measurement method.

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 Performance Measures
Financial measures.
• Measures based on accounting information.
• Net profit.
• Return on investment.
• Comparison of budgeted to actual profit.
• Sales growth.
• Reduction in costs.
• Nonfinancial measures.
• Measures not based directly on financial statements.
• Market share.
• Relationship with host country government.
• Quality control.
• Productivity improvement.
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 Financial versus Nonfinancial Measures

National differences with respect to the prominence of financial

and nonfinancial measures.
• Japan: market share is less important than sales.
• U.S.: the two are about equal.

• U.K., Germany, and Canada: profit measures are most

important.
• Japan: profit measures are fourth most important.

• Sales growth is #1 in Japan.

• Sales growth is #2 in the U.K, Germany, and Canada.

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 Responsibility Centers 1

1. Revenue Center:
• Least amount of responsibility.
• No right to sell or acquire assets.
• Only generate revenues, not control expenses.

2. Cost Center (R&D, accounting):

• Produce as much as possible with given resources.
• Low amount of responsibility.
• No right to sell or acquire assets.

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 Responsibility Centers 2

3. Profit Center
• Profit will be used to determine if the unit is achieving
objectives.
• Transfer pricing can impact profit.
• Given a fixed amount of assets, must control costs and
revenues.
4. Investment Center:
• All responsibilities of profit center and responsibility for
investment decisions.

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 Separating Managerial and Unit Performance

Separating performance evaluation by:

• Managerial performance.
• Unit performance.

Uncontrollable items.
• Local manager has no control.
• No permission to attempt to manage.
• Controlled by the parent.
• Controlled by the host government.
• Controlled by others.

Responsibility accounting.
• Managers not responsible for uncontrollable items.

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 Uncontrollable Items
Controlled by the parent company.
• Sales revenue and cost of goods sold 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.
• Power outages.
• War, riots, and terrorism.
• Foreign exchange losses.
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 Choice of Currency in Measuring Profit

Profit measured in:

• Local currency.
• Subsidiary not paying parent currency dividends.
• Subsidiary supplies affiliated company with raw materials.

• Parent currency.
• Subsidiary paying parent currency dividends.
• Choice of a translation method.
• Whether translation adjustment included in profit.

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 Foreign Currency Translation
Translation for internal purposes.
• Financial accounting standards not followed.

Issues influencing translation adjustment in the profit:

1. Does the adjustment reflect the impact of a change in
rates on the parent currency cash flows?
2. Does the local manager have authority to hedge their
translation exposure?

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 Choice of Currency in Operational Budgeting
1

Operational budgets
• Include budget-to-actual comparisons.
• If “actual” is compared to “budget”:
• In local currency:
• The overall budget variance will be a function of:
• Sales volume variance.
• Local currency price and quantity variances.
• In parent currency:
• The overall budget variance will be a function of:
• The difference in exchange rates.
• Sales volume variance.
• Local currency price and quantity variances.

• Exchange rates
• Actual at the time of budget.
• Projected at the time of budget.
• Actual at end of the budget period.

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 Choice of Currency in Operational
Budgeting 2

Five meaningful combinations of exchange rates:

1. Translate budget and actual results using the exchange rate when the
budget prepared.
• Budget variance is a function of sales volume, and price and quantity
variances.
• Equivalent to using local currency.
2. Translate budget and actual results using the exchange rate at the
end of the budget period.
• The comments related to Combination 1 apply equally to this combination.
3. Translate budget and actual results using a projected ending
exchange rate.
• Budget variance is a function of sales volume, and price and quantity
variances.
• Managers have incentive to incorporate expected rates in operating
decisions.
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 Choice of Currency in Operational
Budgeting 3

4. Translate budget at the initial exchange rate and translate

actual results using the ending exchange rate.
• Budget variance is a function of sales volume, price and quantity
variances, AND the change in exchange rates whether it is
anticipated or not.
• Local managers will want to hedge (may not be needed at MNC
level).
5. Translate budget at the projected ending exchange rate and
translate actual results using the actual ending rate.
• Budget variance is a function of sales volume, price and quantity
variances, AND the unanticipated change in exchange rates.

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 Incorporating Economic Exposure into the
Budget Process 1

Three types of exposure to foreign exchange risk:

• Transaction exposure.
• The risk that changes in exchange rates will have a negative effect
on cash flows related to foreign currency payables/receivables.
• Translation (or balance sheet) exposure.
• The translation of foreign currency financial statements of
subsidiaries will cause a negative translation adjustment (or
remeasurement loss) on consolidated financial statements.
• Economic exposure.
• Changes in exchange rates will have a negative impact on cash
flows.
• Differs from transaction exposure since it goes beyond financial
statements.

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 Incorporating Economic Exposure into the
Budget Process 2

• Transaction and translation exposure can be mitigated with

hedging transactions.
• Economic exposure can be mitigated through operating
and strategic decisions based on exchange rate changes.

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 Culture and Management Control 1

Six factors for a successful performance evaluation system.

1. Integration with overall business strategy.
• Tied into organization objectives.
2. Measuring factors that actually contribute to company success.
3. Comparing actual results with the original plan.
4. Employee support of the system.
5. Fair and achievable goals.
• If they are unachievable, there is no incentive to work towards
achieving them.

For MNCs, the system must also be sensitive to national culture.

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 Culture and Management Control 2

Objectives:
• Influence human behavior.

People in different cultures react differently to control

systems.
• Japan is a more collectivist society than the United States.
• Culture affects:
• Management style.
• Capital budgeting decisions.
• Short versus long payback.

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