Question

Discuss why might it be important to separate the evaluation of the performance of a foreign subsidiary from that of its manager, including items such as controllable and uncontrollable items of the parent company, host government or others.

Answer 1

Answer.

It is important to separate the performance of a subsidiary from that of its managementfor evaluation purposes, mainly because the performance of a subsidiary can beinfluenced by decisions made by corporate management and other parties, events thatare beyond the control of subsidiary management. Examples of items that are notcontrollable by local management are transfer-pricing decisions made by corporate headquarters and a general labor strike, which can affect both the costs and revenues ofthe 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 non controllable 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.

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

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

Whether corporate overhead allocations should be included or excluded from themeasure 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 theircurrent values. Lower asset values result in higher profits through lower depreciationand cost-of-goods-sold expenses. Lower asset values also results in a lower base forcalculating rates of return. The combined effect of these two factors is a higher rate ofreturn on assets based on historical costs than if assets were adjusted to their currentvalues. This could distort the evaluation of the performance of foreign subsidiaries,especially when comparisons are made across subsidiaries located in different countriesexperiencing different levels of inflation.