Question

BeGood Baking Supply is a small bakery supply company formed as a closely held corporation. The company supplies raw baking materials, paper goods, and equipment to restaurants and bakeries in three states in the upper mid-west. Most of its business, however, is located in a large metropolitan area. BeGood wants to increase its presence in the region and serve five states. In fact, the owners of BeGood would like 75% of their business to come from throughout the region rather than the current metropolitan area. In order to do this, the owners understand they must diversify offerings and lines of business.

Currently, BeGood has a phone center where customer orders are taken; these orders are then sent to shipping where the order is filled in its large warehouse and shipped within four days. BeGood outsources its shipping to a local trucking company. Once the order ships, all paperwork goes to the accounting department where it is entered into the accounting system. BeGood still uses the same accounting system it has used since the inception of the company. All aging of receivables and other analysis is done using Excel spreadsheets. Purchasing and tracking of inventory are done solely by the warehouse manager. Invoices for inventory purchasing are sent to the accounting department when goods are received.

The owners at BeGood are wondering how they can utilize an online presence and further automate its systems in order to facilitate its growth and diversify its business. The owners may also like to expand into the retail business.

You have been hired as a full-time staff accountant at BeGood Baking Supply and have been given the task of evaluating and recommending a viable accounting information system for the accounting and financial data of BeGood in order to facilitate expansion and diversification. As you begin your research, you realize that many departments are involved in the information system, and communication is key.

BeGood Baking Supply is considering adding an automated ordering module to their current AIS system. As the accountant pushing for this change, you are in charge of the analysis and presentation of the information and recommendation for the new system. In performing the analysis for your presentation, you have identified two possible modules that will fill the needs of the company. Both modules return a positive NPV.

Module Vendor	A	B
Useful Life	5 years	5 years
Acquisition Cost	300,000	250,000
Yearly Operating Costs	95,000	100,000
Yeaerly Benefits	205,000	150,000
Cost of Capital	10%	10%
Payback	1.5 years	2.5 years

Instructions

Your task is to present to management a proposal outlining your analysis and recommendation of which system to purchase. Write a proposal to management outlining the decision-making process and the system you recommend. Include in your proposal:

1. The steps necessary in evaluating and recommending an AIS module. Note: these are the steps you would take to educate yourself on the need for a new model, the options available, and the choice of the best module.
2. List of needs BeGood has with respect to this automated ordering module. Include present needs as well growth needs
3. List of criteria you used in choosing a module. Include financial criteria, expansion and growth criteria, and current needs. Be sure to address internal control and audit needs.

Answer 1

STRATEGIC ACCOUNTING ISSUES IN MULTINATIONAL CORPORATIONS

I.       The strategic issues faced by a MNC are related to strategy formulation and strategy implementation.

         A.   Strategy formulation is the process of deciding on the goals of the organization and plans for attaining those goals, whereas strategy implementation refers to the process by which managers influence others within the organization to behave in accordance with those goals.

         B.   Capital budgeting is an important activity associated with strategy formulation, and strategies are implemented mainly through operational budgeting and performance evaluation. Accounting plays a major role in these activities as a source of information.

II.      Accounting provides quantitative information about (a) opportunities and threats as well as strengths and weaknesses, and (b) costs and benefits needed for long-term investment (or capital budgeting) decisions.

         A.   Techniques such as payback period, return on investment (ROI), net present value (NPV), and internal rate of return (IRR) are employed in making long-term investment decisions.

         B.   All capital budgeting techniques compare estimates of future cash flows with the cost of the investment.

         C. NPV and IRR take the time value of money into consideration by calculating the present value of future cash flows in evaluating potential capital investments.

         D. Preferences for using particular capital budgeting techniques vary across countries due to cultural and other reasons.

         E.   In calculating future cash flows from foreign investments, MNCs should consider various risks associated with them, namely, political risk, economic risk, and financial risk.

         F.   MNCs tend to evaluate foreign investments from both project and parent viewpoints.

III.     Accounting provides tools for implementing strategies and monitoring their effectiveness through the development of operating budgets.

         A.   Operating budgets help express a firm’s long-term strategy within shorter time frames and specify criteria for monitoring progress.

         B.   It is important for MNCs to translate operating budgets of foreign subsidiaries using an appropriate exchange rate.

IV.     Accounting provides tools for evaluating organizational effectiveness in fulfilling its objectives, and at the same time for motivating organizational members to behave in a manner consistent with the organization’s goals.

         A.   The level of performance depends on many factors, and no single measure can incorporate all of them. Therefore, it is common for MNCs to use a mixture of measures, financial and non-financial, formal and informal, and formula-based and subjective in evaluating performance.

         B.   MNCs do not seem to use any particular measure consistently for evaluating performance.

V.      Performance evaluation in MNCs is complicated by exchange rate fluctuations, varying rates of inflation in foreign countries, international transfer pricing, and cultural and environmental differences that exist across countries.

         A.   A potential problem for MNCs is the tendency for headquarters to rely on simple financial control systems, often designed for home country operations and extend them to foreign subsidiaries.

         B.   The financial measures used to evaluate performance, such as sales growth, cost reduction, profit and return on investment, are provided through the accounting system.

         C. MNCs also use non-financial measures, such as market share, relationship with host     country government, to evaluate performance, and such measures are not based on information obtained directly from financial statements.

VI.     The method of evaluation used depends largely on the type of subsidiary involved, for example, its strategic role within the MNC and its organizational culture.

VII.    The importance of non-financial measures in evaluating performance is reflected in the growing popularity of the balanced scorecard approach, focusing on integrating the key elements of a business, vision strategy, and four perspectives, namely, financial, customer, internal business process, and learning and growth.

VIII.   In evaluating the performance of a foreign subsidiary, important questions include: whether             to separate managerial performance from the unit performance; and how to separate controllable items and non-controllable items.

        

Answers to Questions

A strategy indicates the general direction in which a firm plans to move to attain its goals. The strategies of any business organization, whether purely domestic or multinational, are determined by matching two key ingredients: core competencies and available opportunities. Internal factors relate to the identification of core competencies of a firm focusing on strengths and weaknesses with regard to the expertise available within the firm in the areas of technology, manufacturing, distribution, and logistics.

A strategy indicates the general direction in which a firm plans to move to attain its goals. The strategies of any business organization, whether purely domestic or multinational, are determined by matching two key ingredients: core competencies and available opportunities. The external factors relate to the identification of the opportunities available to the firm, the second key ingredient in formulating strategy. Identification of opportunities also includes the threats facing the firm in the areas of competitors, customers, suppliers, regulatory bodies, as well as socio-political circumstances.

Accounting provides the skills necessary to quantify in financial terms the factors that influence strategy formulation -- strengths, weaknesses, opportunities and threats --, and to develop projections of costs and benefits as financial expressions of strategy.   Capital budgets are a prime example of the contribution accounting makes in strategy formulation. Further, organizational goals are often expressed in financial terms, for example, to achieve a particular level of return on investment.

Both NPV and IRR are discounted cash flow techniques (recognizing the time value of money) used for evaluating capital investment proposals. The NPV method uses a discount rate (usually, the firm’s cost of capital) to restate all future net cash inflows in terms of their present values to be compared with the initial investment, while the IRR method identifies the discount rate that equates the cash outflows and inflows of a proposed investment project. In other words, the NPV method indicates whether or not a particular proposed investment is capable of generating a desired rate of return, and the IRR method indicates the exact return that can be expected from a proposed investment. The NPV method allows the use of a realistic discount rate for reinvestment, whereas the IRR method might not. The IRR method facilitates comparison of projects requiring different amounts of investments, whereas the NPV method is not helpful in comparing projects requiring different amounts of investments. Another weakness of the NPV method is that it tends to favor large investments. A weakness of the IRR method is that its assumption on reinvestment rate of return could be unrealistic.

The organizational structure of a MNC is determined to a considerable extent on the roles assigned to its subsidiaries. Some subsidiaries play the role of a producer of products for the parent company, where as others have catering for the needs of the host country market as their main role. There are also subsidiaries that operate as part of a global network. Attainment of corporate goals is the main objective of implementing strategy. The subsidiary managers’ contributions towards this end will depend on the roles assigned to each subsidiary within the organizational structure. For example, the contribution expected from the manager of a subsidiary that plays the role of an integrated player would be different from that expected from the manager of a subsidiary that focuses mainly on catering for the host country market.

Due to cultural differences across countries, corporate managers may have to tailor the manner in which strategy is implemented in a specific country in order to achieve the desired results. For example, a management control tool such as standard costing that assumes that the responsibility for specific tasks lies with the individual who is traceable may not be effective in a cultural context such as Japan where a group, rather than an individual, is assigned responsibilities.   Further, the managers of a subsidiary located in a strong uncertainty avoidance society can be expected to create more slack in preparing budgets as a method of dealing with future uncertainty, compared to managers of a subsidiary located in a weak uncertainty avoidance society. In implementing multinational strategy it is important to ensure that the managers and other members of foreign subsidiaries are motivated to behave in accordance with corporate goals. However, people from different cultural backgrounds may respond differently, for example, to financial incentives.

The role of accounting in implementing multinational business strategy is to assist the process by which managers influence other members of the organization. Accounting fulfills this role primarily through the budgeting process, in particular, operational budgeting. An operating budget is a financial expression of a firm’s long-tern strategy within a shorter time frame, usually one year. It helps plan what the organization should do to effectively implement strategy, coordinate the activities of several parts of the organization, communicate information to organizational members, and evaluate information. Budgeting also offers tools for monitoring progress. In addition, accounting provides the skills necessary to deal with the effects of exchange rate changes and foreign inflation in implementing corporate strategy. Performance evaluation is a part of the process by which managers influence other members of the organization. Accounting plays an important role in this regard in providing targets which are used in evaluating performance.

One of the main issues in designing an appropriate performance evaluation system for a foreign affiliate relates to the selection of the criteria to be used in evaluating performance. This is critical because correctly selected criteria can act as a motivating factor within the unit. However, if not done carefully, evaluation criteria can have dysfunctional effects. Firms often use a mixture of financial measures, such as profit and ROI, and nonfinancial measures, such as market share and customer satisfaction, in evaluating the performance of foreign operations.

      When profit is used as part of the measure of performance, a decision has to be made as to how it should be calculated. For example, should it be calculated using host country or parent company accounting principles.

Another issue that must be resolved is how to treat a foreign unit for performance evaluation purposes. For example, the measures used to evaluate the performance of a unit treated as a cost center would be different from those used for a unit that is treated as an investment center, because the level of responsibility given to the manager of an investment center is much higher compared to that given to a cost center manager. A related issue is whether to evaluate the unit and the manager using the same criteria or to use different sets of criteria to evaluate the manager and the unit. The main concern here is that the manager of a unit should not be held responsible for decisions, which are beyond his or her control. This is often known as the controllability principle. It is possible that the manager has performed well despite the poor performance of the unit.

All these issues are also common to a group that only has local affiliates. However, each one of the issues mentioned above is complicated by changes in exchange rates and interest rates as well as other issues related to foreign inflation.

Survey results clearly show that there are variations in the evaluation methods adopted by Japanese and U.S. MNCs. These variations are most likely due to cultural differences. For example, Bailes and Asada’s 1991 survey found that the most frequently used performance measure by U.S. MNCs was ROI, whereas ROI was relatively unimportant for Japanese MNCs. On the other hand, the most frequently used measure by Japanese MNCs was sales volume, whereas it was relatively much less important for U.S. MNCs. Another interesting finding of that survey is the high importance given to production costs by Japanese MNCs as a performance evaluation measure, in contrast to how it was viewed by U.S. MNCs.

MNCs often use financial measures in evaluating foreign subsidiary performance, mainly due to the fact that the information is readily available from the financial statements. However, now there is increasing recognition that focusing on financial information alone is not sufficient in evaluating a firm’s performance. Nonfinancial measures that can be used to evaluate the performance of a foreign subsidiary include (but are not limited to): growth in market share, relationship with host country government, cooperation with corporate management and peer units, ability to maintain an appropriate level of employee morale and to retain skilled employees, improvement in productivity, product innovation, customer service, research and development, and social/environmental sensitivity.

The factors that influence the manner in which a particular subsidiary should be treated include the strategic role assigned to the subsidiary, and the level of responsibility given to its management. For example, if the role assigned to a particular subsidiary only requires it to produce as much as possible at a specified level of quality with a fixed amount of resources, then it would be treated as a cost center as its main focus would be cost control. If the subsidiary’s managers were expected to determine product prices, market the products, and achieve sales growth, then their responsibilities would be greater. In this case, the subsidiary would have the responsibility for both costs and revenues, and as such it should be evaluated as a profit center. If, in addition to managing costs and revenues, the subsidiary manager were also given the responsibility for making investment decisions, then such a subsidiary would be treated as an investment center. Investment center managers have the highest level of responsibility.

It is important to separate the performance of a subsidiary from that of its management for evaluation purposes, mainly because the performance of a subsidiary can be influenced by decisions made by corporate management and other parties, events that are beyond the control of subsidiary management. Examples of items that are not controllable by local management are transfer-pricing decisions made by corporate headquarters and a general labor strike, which can affect both the costs and revenues of the subsidiary. It would not be fair to include the effects of these factors in measuring the performance of the subsidiary manager, as the manager has no control over these factors. This is consistent with the concept of responsibility accounting, which suggests that a manager should not be held responsible for costs over which he/she has no control. Because of noncontrollable items, it is possible to have good management performance despite poor performance of the subsidiary, and vise versa. Separating the two would be important in rewarding and retaining good managers. The main purpose of performance evaluation is to motivate managers and other employees to achieve organizational goals. Managers are likely to be more highly motivated if they know that their performance is fairly measured, appreciated, and rewarded.

Several issues must be addressed in measuring the profit of a foreign subsidiary for performance evaluation purposes. These include:

Whether the effect of corporate transfer pricing policy on costs and revenues should be included or excluded from the measure of proflt.

Whether corporate overhead allocations should be included or excluded from the measure of profit.

Whether foreign subsidiary profit should be measured in local currency or parent company currency. If parent company currency, whether translation adjustments should be included in profit or not.

Whether profit should be based on historical cost accounting or some current value accounting method.

During a period of inflation, asset values based on historical costs often understate their current values. Lower asset values result in higher profits through lower depreciation and cost-of-goods-sold expenses. Lower asset values also results in a lower base for calculating rates of return. The combined effect of these two factors is a higher rate of return on assets based on historical costs than if assets were adjusted to their current values. This could distort the evaluation of the performance of foreign subsidiaries, especially when comparisons are made across subsidiaries located in different countries experiencing different levels of inflation.

Multinational firms arise because capital is much more mobile than labor. Since cheap labor and raw material inputs are located in other countries, multinational firms establish subsidiaries there. They are often criticized as being runaway corporations.

Economists are not in agreement as to how multinational or transnational corporations should be defined. Multinational corporations have many dimensions and can be viewed from several perspectives (ownership, management, strategy and structural, etc.)

The following is an excerpt from Franklin Root,International Trade and Investment