STRATEGIC ACCOUNTING ISSUES IN

MULTINATIONAL CORPORATIONS

Chapter 12

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

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 multinational corporation
Culture and management control

12-2

Strategic Accounting Issues in

Multinational Corporations

Learning Objectives

1. Explain the role played by accounting in formulating multinational

business strategy.
2. Demonstrate an understanding of multinational capital budgeting.
3. Describe the factors that influence strategy implementation within
a multinational corporation.

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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
effective performance evaluation system within a multinational
corporation.

12-4

Strategy
Strategies are large scale plans that reflect the desired direction of
the company.
Strategy formulation involves determining organizational goals and
strategies to achieve those goals.
Strategy implementation involves managerial efforts to influence
employees to attain organizational goals.
Managerial influence is also referred to as management control.
Accounting has a significant role to play in strategy formulation and
implementation.

12-5

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, as well as risk assessment.
It also includes financial expressions of firm strategy and
preparation of budgets.
Capital budgeting is an important part of strategy formulation.

Learning Objective 1

12-6

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-term planning
responsibilities.
Budgeting also provides expectations against which future results
can be judged.

Learning Objective 1

12-7

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 identification and
definition, evaluation and selection, and monitoring and review.

Learning Objective 2

12-8

Capital Budgeting
Steps in capital budgeting
Project identification and definition provides a clear basis for
understanding the project and predicting the associated cash flows.
Evaluation and selection involves identifying cash flows and then
using one or more of the capital budgeting methods to evaluate the
project.
Monitoring and review involves updating the analysis and project
plan during the implementation stage.

Learning Objective 2

12-9

Capital Budgeting
Capital budgeting techniques

Payback period
Return on investment
Net present value
Internal rate of return

Learning Objective 2

12-10

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 aftertax cash flows
The project will be accepted if the payback period does not exceed
a predetermined length.
The primary weaknesses of this method are that it ignores the time
value of money, and it ignores the total profitability of the project.

Learning Objective 2

12-11

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 investment.

Learning Objective 2

12-12

Capital Budgeting
Net present value
Equal to the present value of net future cash flows 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 it cannot be used
for comparing projects of different sizes and that it tends to be
biased toward large investments.
Learning Objective 2

12-13

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 flows 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 it sometimes
requires unrealistic assumptions about reinvestment of funds, and
manual calculation is difficult.
Learning Objective 2

12-14

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
flows.
These risks are generally categorized as political risk, economic
risk, and financial risk.
Taxes, import duties, dividend restrictions, and cash flow limitations
imposed by governments also must be considered.

Learning Objective 2

12-15

Multinational Capital Budgeting

Political Risk
This refers to the likelihood that political events will impact cash
flows.
Nationalization and expropriation of assets is the most extreme
form of political risk.
Political risk is also associated with changes in foreign exchange
controls, repatriation restrictions, tax rules, and labor laws.
This risk can vary significantly from one country to another.

Learning Objective 2

12-16

Multinational Capital Budgeting

Economic Risk
This refers to the likelihood that changes in the host country
economy will impact cash flows.
Inflation is the most significant of economic risks.
Inflation affects 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 time and effort to
respond to inflation.

Learning Objective 2

12-17

Multinational Capital Budgeting

Financial Risk
This refers to the likelihood that changes in currency values,
interest rates, and other financial factors will impact cash flows.
Foreign exchange risk is also a component of financial risk.
Whether to evaluate the project based on host country or parent
country cash flows is affected by foreign exchange risk.

Learning Objective 2

12-18

Strategy Implementation
Management control
The management control system is the primary mechanism for
implementing and evaluating the effectiveness 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 influence
management control.

Learning Objectives 3 and 4

12-19

Strategy Implementation
Factors affecting strategy implementation
Organizational structure affects strategy implementation.
Different forms of organizational structures include: ethnocentric,
polycentric, and geocentric.
Ethnocentric firms use an approach that assumes that the cultural
background of the firm is universal.
Polycentric firms consider the culture of the host country to be most
important and adopt it.

Learning Objectives 3 and 4

12-20

Strategy Implementation
Factors affecting strategy implementation
Geocentric firms 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 influence
management control system type.
One major type of management control system is bureaucratic
control which employs a significant amount of structure.
The other major type is cultural control which is more informal and
less structured.
Learning Objectives 3 and 4

12-21

Performance Evaluation
Major aspects of performance evaluation
The measure or measures of performance
Classification of the foreign operation as cost, profit or investment
center
Joint or separate evaluation of the foreign operation and the
manager of the operation
The profit measurement method

Learning Objective 5

12-22

Performance Evaluation
Performance evaluation measures
Financial measures are based directly on financial statement data.
Examples include net profit, return on investment, and comparison
of budgeted to actual profit.
Nonfinancial measures are based on data not obtained directly
from financial statements.
Examples include market share, relationship with host country
government, and labor turnover.

Learning Objective 5

12-23

Performance Evaluation
Performance evaluation Balanced scorecard
This approach gives balanced consideration to both financial and
nonfinancial measures.
It considers the perspectives of four stakeholder groups.
Shareholders perspectives are considered by financial
performance measures.
The internal business perspective is reflected in business process
measures.
Innovation and learning perspectives and customers perspectives
are also considered.
Learning Objective 5

12-24

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.
Profit centers are responsible for costs and revenues.
Investment centers have the responsibilities of a profit center plus
responsibility for investment decisions.
Return on investment (ROI) is the most common performance
measure for an investment center.
Learning Objective 5

12-25

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 the parent, the
host government, or controlled by others.

Learning Objective 5

12-26

Performance Evaluation
Choice of currency in measuring profit
Profit 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 to include the
translation adjustment in the profit measure.
Learning Objective 5

12-27

Performance Evaluation
Translation to parent currency
Since the translation is for internal purposes, financial accounting
standards need not be followed.
Likewise, the inclusion of the translation adjustment in the profit
measure is based on internal needs rather than accounting
standards.
One factor in this decision is whether the adjustment reflects the
impact of exchange rates on parent currency cash flows.
A second factor is whether the local manager has the authority to
hedge against exchange rate changes.
Learning Objective 5

12-28

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 fluctuations.
Exchange rates may change during the period between making the
budget and recording profits.
The three available exchange rates are: actual at time of budget,
projected at time of budget, actual at end of budget period.

Learning Objective 5

12-29

Performance Evaluation
Budget and actual rate combinations
Lessard and Lorange (1977) illustrated five 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 fifth combination translates the budget using a projected end of
period rate and translates actual results using the actual rate at the
end of period.
Learning Objective 5

12-30

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
Understandability and simplicity of the system

Learning Objective 5

12-31

Performance Evaluation
Cultural considerations in management control
One of the objectives of a management control system is to
influence human behavior.
People in different cultures will react differently to aspects of
management control systems.
Japan is a more collectivist society than the United States.
Management control mechanisms designed in the U.S. to assign
individual responsibility will not work as effectively in Japan.
Culture affects management style.
Culture influences capital budgeting decisions (e.g. short vs. long
payback)
Learning Objective 5

12-32