Chapter 10Managerial Planning and ControlDiscussion Questions Solutions1.Four critical dimensions of long-range planning are:∙Identifying key drivers of a company’s future progress.∙Develop forecasts of key developments and assess the company’s ability to capitalize on these developments.∙Develop the information systems to support strategic choices.∙Translate strategic choices into actions.2. A standard costing system has as its objective the notion of cost control. It estimates annuallywhat costs should be under ideal operating conditions. Actual results are then compared with standard costs with variances reported to those responsible for incurring the variances. Kaizen costing has as its objective continuous cost reductions based on continuous manufacturing improvements. Cost reduction targets are set monthly with variances based on constant cost reductions; i.e., were costs this month lower than last month? If not, why?3.Financial managers must be prepared to evaluate foreign investments from multiple reportingperspectives. This significantly complicates the information requirements for decisions on foreign investment. Management’s objective from a parent company perspective is to maximize shareholder wealth. To do this, management must select investment opportunities that promise the highest risk-adjusted net present values. Therefore, management accountants must identify cash flows that can be repatriated to the parent company, taking into consideration future exchange rate changes. Because only after-tax cash flows are relevant, the timing and amounts of taxes payable on foreign source income must be estimated.A project evaluated from a host country s point of view necessitates an increase in the quantity ofinformation supplied. The social costs and benefits of investment proposals must supplement traditional cash flow information. Quantification of risk and the identification of acceptable rates of return to sovereign governments call for measurement techniques new to internal accounting tool kits.4.Many variables must be considered when measuring a multinational entity’s cost of capital. Thesevariables include:a. Differential interest rates between national marketsb. Foreign business riskc. Foreign exchange riskd. Political riske. Investor valuation models in different countriesf.International taxesg. International financial reporting and disclosure practicesh. Governmental restrictions on fund remittancesi. Joint venture arrangementsj. National financial normsk. Differential inflationl. Different financial institutions and instrumentsm. International diversification effectsn. National savings patterns5. A major complexity in designing multinational information and control systems is culture.Cultural differences in attitudes towards risk and authority, need achievement levels, and language often result in misunderstood directives, lower tolerance to criticism, unwillingness to seek assistance when in doubt, unwillingness to delegate authority, and reluctance to assume responsibility. As a result, performance standards and incentive structures must often be adjusted for foreign nationals. Global competition also means that a firm’s production, marketing, and financing strategy must be truly international in scope. The likely result is that foreign subsidiaries will be viewed as parts of an integrated network. To coordinate parent and subsidiary decisions, management will need information that enables it to plan, coordinate, and control global production, marketing, and financial strategies.6.The first variance holds exchange rates constant and examines how the local manager performedin terms of his or her primary operating responsibilities. In effect, the local manager is not held accountable for exchange rate changes. The second variance examines what portion of the local managers actual results were attributable to exchange rate changes. This exchange rate variance will hopefully be offset by other exchange rate exposures encountered by sister affiliates which the international division manages. The final variance looks at the original budget and says, if the budgeted performance were actually achieved, how successful was Treasury in forecasting foreign exchange rates for that particular country.7.An examination of the seven caveats near the end of the chapter will highlight some of the majorissues involved in designing and implementing international performance evaluation systems.We illustrate two major issues raised by these caveats.First, foreign subsidiaries should not be evaluated as independent profit centers when they are really strategic components of a multinational system. Company-wide return-on-investment criteria should be replaced by performance measures more in line with the specific objectives and environments of each foreign subsidiary being evaluated. One example of a dysfunctional evaluation system is the practice of appraising international financial subsidiaries in terms of traditional rate-of-return criteria. These subsidiaries should be evaluated according to their intended mission, which is to increase the supply of funds to the multinational enterprise at the lowest possible cost. Rate-of-return statistics should be replaced by measures reflecting the quantity and cost of funds secured domestically. Another approach would be to evaluate the overseas financing subsidiary in terms of the benefits that its operations make possible for the multinational system as a whole as opposed to the costs it incurs in securing the necessary funds.Second, to protect the value of assets located in devaluation-prone countries, headquarters management often will remove surplus funds from foreign operating subsidiaries by increasing the transfer prices the subsidiaries must pay for imported components. Evaluating foreign managers in terms of their reported profits is grossly unfair when artificial transfer prices are imposed. It is more appropriate to discount the effects of strategic pricing actions on subsidiary management performance, that is, measure performance in terms of physical production statistics or value-added.8.Money loses purchasing power every day in a highly inflationary economy. To properly measureeconomic performance, transactions should be recorded in hard currency equivalents on the day the transaction is settled. If a sale is made for cash, its value is its hard currency equivalent on that date. Recording the sale at any other date distorts the transaction by introducing changes in the purchasing power of money (or implicit interest) into the analysis; that is, the recorded amount will not reflect the transaction s true value.9.We favor the budgetary exchange rate combination that uses a projected rate to set the budget andthe end-of-period rate to track performance. Use of a projected rate to set the budget encourages managers to incorporate the effects of anticipated exchange rate changes into their operating plans and decisions. Use of the ending rate to monitor performance motivates managers to respond to unanticipated exchange rate changes. Where local managers have the authority and means to hedge currency changes, it is justifiable to hold them accountable for unexpected rate changes. While they cannot control exchange rate changes, they can counter their adverse effects some before and some after the rate change. We think that making local managers accountable for unexpected exchange rate changes when they do not have the necessary hedging authority is unjustified.10.This discussion question is designed to get students to think outside the box, so their suggestionsshould not be constrained but supported by their analysis. A good tack would be to break the class into small discussion groups and have each group select a spokesperson to report back on alternative strategies they identified.11.For:a. There is a reduced cost of implementation.b. Financial control may not be a critical problem during the initial phase of operationsc. There are fewer problems related to preparing and analyzing consolidated reports of domesticand foreign operations.d. The financial control system can be installed more quickly as system testing and design havealready been completed.e. Headquarters personnel assigned abroad will feel comfortable with a familiar control system.f. The system facilitates centralized control from corporate headquarters.Against:a. The organization and environment of foreign operations may be sufficiently different towarrant tailor-made control systems.b. Foreign personnel may become frustrated and demoralized in having to adapt to an unfamiliarcontrol system.c. Reconciliation of data generated by two different but parallel control systems may not be aserious problem given extant data processing technology.d. Local managers adapting to the transplanted control system may engage in decisions that aredysfunctional to the success of local operations.e. It is the mission of the foreign unit and not the executives need to feel comfortable that shoulddictate the type of control system employed.f. Successful implementation of the transplanted control system may dictate the sole use ofdomestic company personnel, which may sour relations with the host government.12.Value reporting is forward looking whereas the traditional financial reporting model studentslearn is historical in its orientation. Those who favor value reporting will appreciate its focus on what financial statement analysis is trying to achieve. Moreover, it provides a way of eliminating the arbitrary distinction that is drawn between managerial and financial accounting. Thoseopposed to value reporting will argue that the information is less objective and leaves too much to management discretion.Discussion Questions1. €2,250/100 units = €22.50 X 1.10 = €24.75.2. Slovenia’s target c ost is derived as follows:Selling price = €21.50 X 100 units = €2,150Allowable costs = €2,150 - .10X = XX = €1,955This calculation implies that Glasgow Corporation needs to reduce production costs by €295 [€2,250 - €1,955].3. The following analysis ignores Russian withholding taxes on dividends remitted to the U.S. parent. Chapter 11 treats this aspect of international taxation.Cash FlowsRussian Subsidiary Year 1 Year 2a. Pre-tax earnings RUB 55,600,000 RUB 130,332,000b. Income tax at 40% 22,240,000 52,132,800c. Net income RUB 33,360,000 RUB78,199,200d. Dividend to U.S. parent(line c X 70%) RUB 23,352,000 RUB 54,739,440U.S. Parente. Income RUB 23,352,000 RUB 54,739,440f. Dividend gross-up(line d./line c. X line b) 15,568,000 36,492,960g. Taxable income RUB 38,920,000 RUB 91,232,400h. U.S. tax at 34% 13,232,800 31,019,016i. Less: Foreign tax credit(line f) 15,568,000 36,492,960j. U.S. taxes payable(line h - line i) -0- -0-k. Net cash flow (rubles)(line e - line j) RUB 23,352,000 RUB 54,739,440l. Net cash flow (dollars) $ 1,167,600 $ 2,606,6404. This exercise should make for interesting discussion and should be used to highlight the many measurement issues surrounding foreign investment decisions.Year Cash Flow Exchange Cash Flow PV factor Present Value(Rubles) Rate (Dollars) at 20% equivalent0 -8,000,000 1.000 -8,000,0001 23,352,000 R20 = $1 1,167,600 .833 $ 972,6112 54,739,440 R21 = $1 2,606,640 .694 $1,809,0083 57,476,412 R23 = $1 2,498,974 .579 $1,446,9064 60,350,232 R25 = $1 2,414,009 .482 $1,163,5525 63,367,743 R25 = $1 2,534,710 .402 $1,018,9536 66,536,130 R25 = $1 2,661,445 .335 $ 891,584Net present value $ (697,386) Because the net present value is negative, the investment might not appear attractive. However, students will quickly and rightly begin to question the exercise s assumptions. Points that students should raise include:1. The measurement of cash flow: Should one ignore cash flows beyond year 6?2. Do accounting principles differences affect the measurement of income and cash flow?3. What is the terminal value (including the recapture of working capital at the end of the 6-year investment horizon)?4. Is it wise to penalize all future cash flows by a 10 percent premium? One could argue that the risk premium might be partly offset by an international diversification discount. How does one quantify risk ina multinational setting?5. How reasonable are exchange rate forecasts?6. Tax rates are seldom constant.7. How valid are the strategic dimensions of the investment decision?5. This question should generate useful ideas and discussion on the importance of strategic thinking and analysis.6. Y TL1,000,000 Expenses in Month 1Varying Invoice Dates and Payment Dates_____________________________________________________________________________________ Invoice Payment Conventional ProposedDay Day Measure Measure Difference________________________________________________________________1 Cash 7,692 10,000 2,3085 15 days 7,692 8,361 669 5 25 days 7,692 7,692 0.0 7. The answer will depend on the student s domicile. The purpose of this exercise is to force students to think about how environmental considerations affect the measurement and interpretation of accounting-based performance measures. Political considerations such as legally required capital infusions from the parent company (e.g., Mexico) will increase the denominator of the ROI ratio and reduce that statistic relative to a company that can fill most of its financial needs by local borrowing (Singapore). Economic considerations such as inflation and currency devaluation (Mexico) will tend to lower the numerator of the ROI statistic relative to a strong currency country (Singapore) with lower rates of inflation. Social and cultural considerations would affect a firm s operating leverage (i.e., the ratio of fixed costs to variable costs in a firm s operating cost structure). This, in turn, would magnify changes in income or lossesrelative to a change in sales for that company. Finally, legal considerations (such as the impact of tax law on financial reporting) would tend to impart a conservative bias to reported earnings where generous depreciation allowances, such as accelerated and excess depreciation, are permitted.8.Unit(attributable items)Sales $4,000,000Other income 120,000Costs and expenses:Cost of Sales 3,200,000Selling and administrative 330,000Depreciation 160,000Interest 162,000Exchange gains & losses ------Income before taxes 268,000Performance evaluation metrics of a foreign unit should reflect its mission in relation to overall corporate goals. Accordingly, all revenues and expenses attributable to the foreign unit are germane. As FX risk and taxation are managed by corporate headquarters, one could argue that these should not be included in the performance of the unit.9. Manager(controllable items)Sales $4,000,000Other income 120,000Cost and expenses: 4,120,000Cost of sales 3,050,000Selling and administrative 280,000Depreciation 160,000Interest 42,000Exchange gains & losses ------Income before taxes $588,000Income taxesThe inclusion of select items of revenue and expense in the performance report of the manger of Compagnie de Calais reflects the general principle that a manager should only be held accountable for items over which he or she has some control.Sales Exchange $ Equivalent VarianceRateLocal currency MXP8,000,000 CAD.00032 CAD 2,560operating variance(foreign management) -9,000,000 CAD.00032 2,880 CAD 320Parent currency 9,000,000 CAD.00032 CAD 2,880operating variance(headquarters mgt.) -9,000,000 CAD.00024 2,160 CAD (720)Expenses Exchange $ Equivalent VarianceRateLocal currency MXP6,400,000 CAD.00032 CAD2,048operating variance -7,000,000 CAD.00032 2,240 CAD (192)Parent currencyoperating variance MXP7,000,000 CAD.00032 CAD2,2407,000,000 CAD.00024 1,680 CAD 560If we ignore the effects of unanticipated exchange rate changes, the local manager appears to have performed well. Although his expenses, from a local currency perspective, exceeded his budget by CAD192,000, his actual sales performance exceeded his budget by CAD320,000, resulting in a net positive contribution of CAD128,000.11. If the local currency is deemed the functional currency, the exchange rate variance in Exhibit 10.10 will change to negative 239. The difference in currency effects is due to the use of the current instead of the temporal currency translation method (i.e., the use of the current rate to translate inventories and fixed assets and their associated expenses).Analysis of variance procedures would be the same as under the temporal method using the beginning-of-year exchange rate as our benchmark. Thus, the volume price/cost and expense variances would reflect the same relationships after translation to the parent currency as before with the exception of the currency variance. The favorable exchange variance of PC456 in operating earnings would be attributed to the following factors:Higher sales volume PC +400Lower selling price -300Lower production cost +720Higher operating expenses -75Higher Interest expense -50Exchange rate changes -239PC +45612.Sub Nominal Country Risk-adjustment Actual ROI Risk ROI ROICoefficientX 10% 30/60 = 50% .10/.50 = 20% 25%Y 10% 21/60 = 35% .10/.35 = 28.6% 30%Z 10% 15/60 = 25% .10/.25 = 40% 40% On this analysis, Subsidiary X performed best.Case 10-1Foreign Investment Analysis: A Tangled AffairFollowing is a comparison of the translation adjustment with MBI’s exposure:2007 $1.698 billion - $1.917 billion$15.034 billion = -1.46%2008 $3.266 billion - $1.698 billion$15.443 billion = +10.15%Changes in the trade-weighted index:2007: -1.0%2008: +10.6%As can be seen, the trade-weighted index is a reasonable proxy for MBI’s exchange rate experience. Assuming that 90 percent of MBI s net assets abroad are also in local currencies, the impact of foreign currency (FC) changes on net assets employed (a measure of MBI s foreign currency exposure per the current rate translation method) follows:2008 2007 2006Non-U.S. net assets (billions) $18.985 $17.159 16.704Local currency =Functionalcurrency (90%) $17.086 $15.443 $15.034Cumulative translation Adjustment $ 3.266 $ 1.698 $ 1.917Real Change in Net Assets:Year Reported Change Change in Real ChangeTranslationAdjustment2007 $ 455 $(219) $6742008 1,826 1,568 258The impact of foreign currency (FC) changes on revenues is determined as follows (in millions):2008 2007 2006Non-U.S. revenues $41,886 $36,965 $34,361Non-$ FC revenues (90%) 37,697 33,268 30,925Percent increase +13.3% +7.6% ---Dollar index 89.1 98.6 92.7FC revenues FC33,588 FC32,802 FC28,667Percent increase 2.4% +14.4%The impact of foreign exchange changes on net income is determined as:2008 2007 2006Foreign pre-tax income(bil.) $7.844 $7.496 $7.088Non-$ FC income (90%) 7.059 6.746 6.379Percent increase 4.6% 5.8% ---Dollar index 89.1 98.6 92.7Adj. Pre-tax income 6.289 6.651 5.913Percent increase -5.4% +12.5% ---When the effect of exchange rate changes have been eliminated, we see a completely different picture than that portrayed by the unadjusted consolidated figures. Investments in earnings assets have actually been declining, which is mirrored in the local currency earnings stream. On the basis of this analysis, MBI does not look attractive, barring other strategic considerations.Case 10-2Assessing Foreign Subsidiary Performance in a World of Floating Exchange RatesA useful pedagogical approach to this case analysis is to have your students participate in a team debate. One team should advocate the merits of ICI s method of evaluating its foreign managers in a world of floating exchange rates; the other should make a case for GE s method. At the conclusion of the team debate, students should be asked to individually reflect on the strengths of all arguments made and decide for themselves which approach they feel is best. A good way to personalize the issue is to ask them to vote for the company for which they would prefer to work as a foreignsubsidiary manager, and why.The following summarizes selected responses of some of our students to this performance evaluation comparison.General ElectricMerits:1. Focuses on returns most germane to U.S. investors.2. Develops exchange risk management capabilities of local managers.3. Fixes responsibility with appropriate authority to carry out that responsibility.4. Local manager knows exactly what is expected.Limitations:1. Emphasis on dollar profits after exchange gains and losses could encourage local managers to hedge accounting exposure as opposed to economic exposure.2. Morale problems could surface if local managers feel that hedging accounting exposure, which is important from a corporate standpoint, reduces their ability to effectively compete in the local market.ICIMerits:1. Encourages local managers to focus on economic as opposed to accounting exposure.2. Holds local managers accountable only for controllable items Minimizes potential morale problems associated with inattention to local competitive pressures.Limitations:1. Easy for local mangers to pass the buck.2. Downplays accounting exposure, which could be germane to accounting user groups who are sensitive to currency effects on reported earnings.3. Difficult to implement as performance standards are often fuzzy (i.e., it is very difficult to measure economic exposure in practice).。
