International Budgeting and Performance Evaluation

International Budgeting and Performance Evaluation




  1. Introduction
  2. The Strategic Control Process
  3. Empirical Studies of Differences in Management Accounting and Control Practices Across Nations
  4. Setting Objectives: A Global Overview
  5. Studies of U.S. Multinationals
  6. Studies of U.K. Multinationals
  7. Studies of Japanese Multinationals
  8. Studies of APEC Multinationals
  9. The Budget Process Across Countries: Basics
  10. Cross National Studies of Participation in Budgeting
  11. Studies of Mexican Companies
  12. Studies of APEC Multinationals
  13. Other Issues in the Budgeting Process
  14. U.S./Japan Comparisons
  15. Studies of APEC Multinationals
  16. Challenges of Control in the Global Firm
  17. Planning and Budgeting Issues
  18. Ways to Bring Foreign Exchange into the Budgeting Process
  19. Budgeting and Currency Practices
  20. Capital Budgeting
  21. Intracorporate Transfer Pricing
  22. Matching Price to Market Conditions
  23. Allocation of Overhead
  24. Cross-national Allocation of Expenses
  25. Costing
  26. Target Costing
  27. Quality
  28. Performance Evaluation
  29. Separating Managerial and Subsidiary Performance
  30. Properly Relating Evaluation to Performance
  31. Emerging Trends in Performance Evaluation
  32. Economic Value Added (EVA)
  33. The Balanced Scorecard
  34. Summary


This chapter is a potpourri of management accounting issues. The chapter begins with planning and budgeting issues. Then, the chapter covers product costing topics including transfer pricing, allocation of overhead, target costing, and accounting for quality. The chapter concludes with coverage of the major issue of performance evaluation. None of these issues is international alone, but the international dimensions make these issues interesting. In addition, some of the best lessons we have learned in these areas have come from the international arena -- principally from the Japanese. In some respects, the discussion in this chapter surrounds how accounting can strongly influence competitiveness. The end-of-chapter material gives opportunity for discussion of the full range of management accounting issues. The chapter should be divided in several segments.

Topic 1:Control and Budgeting. This would cover pp. 372-387. The issue is fairly complex, so you could assign problem 1 at the end of the chapter.

Topic 2:Product Costing. This would cover pp. 387-394. Niessen Apparel and Uplift International Ltd. (United Kingdom cases deal with transfer pricing issues. The Niessen Apparel case demonstrates how tariff laws and tax differences can influence managerial decisions in a negative way.

Topic 3.Performance Evaluation. This would cover pp. 394-399 and can be discussed in the context of the Niessen Apparel and Global Telecom cases at the end of the chapter. You could also introduce the EVA discussion on pp. 396-397, which will also help you with the Global Telecom case.



II.The Strategic Control Process

A.Stages in the formal strategic control system

1.Periodic strategy reviews for each business

2.Annual operating plans

3.Formal monitoring of strategic results

4.Personal rewards and central intervention

B.Benefits to a formal process

1.Greater clarity and realism in planning

2.More "stretching" of performance standards

3.More motivation for business unit managers

4.More timely intervention by central management

5.Clearer responsibilities

C.Benchmarking of global competitors is helpful, but it is difficult to get good data

D.Need to balance the need for solid plans that can push management with the opportunity for creative thinking

1.See P&G objectives approach in Exhibit 14.1

III.Empirical Studies of Differences in Management Accounting and Control Practices Across Nations

A.Setting Objectives: A Global Overview

B.Targets – should fit with focus of the unit

1.Return on investment


3.Cost reduction

4.Quality targets

5.Market share


7.Budget to actual

C.Studies of U.S. Multinationals

1.Robbins and Stobaugh (1973)

a.Based on survey of 200 U.S.-based MNEs

b.Intangible issues considered in the investment process are rarely covered in performance evaluation

c.Foreign and domestic subsidiaries are judged on the same basis

d.ROI is most utilized measure

e.Supplementary devices are used for foreign operations; budget is most common

2.Morsicato (1980)

a.Study of U.S.-based chemical MNEs

b.Focused on use of local and parent currencies for performance evaluation measures- multiple measures applied

3.Abdallah and Keller (1985)

a.64 U.S.-based MNEs

b.See Exhibit 14.2; budgets, profits, and ROI dominate the list

D.Studies of U.K. Multinationals

1.Appleyard survey of 11 British MNEs: budget/actual, ROI; same ROI measure for domestic and foreign operations

E.Studies of Japanese Multinationals

1.Shields, Japanese and U.S. MNE study in 1991

a.See Exhibit 14.3

b.Japanese rely on sales criteria, whereas U.S. rely on ROI

2.Bailes and Assada Japanese and U.S. MNE study 1991

a.See Exhibit 14.4

b.Japanese focus on sales volume, whereas U.S. rely on ROI and controllable profit; Japanese avoid ROI

3.Demirag study

a.Japanese companies

b.Focus on strategic planning

c.Emphasis on overall corporate performance; profitabilty measures becoming more important over time

F.Studies of APEC Multinationals

1.Harrison and Harrell 1994

a.Anglo-American managers prefer shorter term quantifiable measures

b.Asian countries take longer term market dominance perspective

G.The Budget Process Across Countries: Basics

1.Formal budget process

2.Budget participation

3.Formal vs informal communication

4.Setting budget objectives

5.Time frame short vs long

6.Quantified vs non-quantified objective

H.Cross National Studies of Participation in Budgeting

1.”locus of control” insider/outsider issue

2.Budget participation makes anglo-American managers satisfied and work harder

3.Studies of Mexican Companies Frucot and Shearon (1991)

a.Mexican managers performance relates to participation and locus of control

b.Mexican managers satisfaction does not relate to insider/outsider dimension

4.Studies of APEC Multinationals

a.Asian managers also prefer participation

I.Other Issues in the Budgeting Process

1.U.S./Japan Comparisons (cultural roots)

a.U.S. firms take longer to prepare budgets than do Japanese firms

b.Division managers of U.S. firms are more likely to participate in budget committee discussions and influence the budget committee than are Japanese managers

c.Japanese managers are more likely to use budget variances to recognize problems on a timely basis and use budgets to improve the next period's budget

d.American managers are more likely to be evaluated by the budgets

e.The bonus and salary of an American manager are much more likely to be influenced by budget performance than is the case with Japanese managers

f.U.S. budgets have more slack

g.Japanese take longer timeframe view

2.Studies of APEC Multinationals

a.long-term planning vs US short decision making

IV.Challenges of Control in the Global Firm

A.Planning and Budgeting Issues

1.Need to determine the currency of evaluation

2.Need to determine whether performance will be judged before or after translation; partly an issue of controllability of currency movements

3.Value of using the local currency

a.Management operates in that currency

b.The local currency is indicative of the local environment

c.The exchange rate is not controllable

4.Value of the parent currency

a.Top management understands it better

b.Better comparison

5.Approaches to exchange rates

a.Allow operating managers to hedge exposures

b.Adjust actual performance for variations in the real exchange rate after the end of the period

c.Adjust performance plans in line with variations in the real exchange rate

B.Ways to Bring Foreign Exchange into the Budgeting Process

1.Lessard, Lorange model in Exhibit 14.5

2.Three exchange rates: the actual rate at the time the budget is established, the projected rate at the time of the budget, the actual exchange rate at the end of the period

3.Various combinations can be used for establishing the budget and monitoring performance See example Exhibit 14.6


a.Some combinations (A-1, P-2, and E-3) eliminate any exchange rate variance

b.If an exchange rate variance exists, who is responsible

c.Using a projected rate to establish the budget is a better planning technique

C.Budgeting and Currency Practices

1.Wide US variation – less than half of subs evaluated on translated dollars

2.British subs of Japanese not even aware of translated numbers

D.Capital Budgeting - Many complexities in capital budgeting for MNEs

1.Project cash flows vs. parent cash flows

2.Country impact on remittances to parent

3.Variety and complexity of cash flows

4.Inflation rates

5.Unanticipated exchange rate changes

6.Political risk

V.Intracorporate Transfer Pricing


1.The pricing of goods and services transferred between members of a corporate family

2.Political sensitivity of arbitrary transfer pricing – taxation avoidance

3.Multiple reasons for arbitrary transfer prices: taxes, competition, import duties, national controls, profitability of subsidiary

B.Matching Price to Market Conditions

1.See Exhibit 14.7 for factors driving transfer prices

2.Problems of multiple objectives

VI.Allocation of Overhead

1.Tax issue

2.Performance issue

A.Cross-border Allocation of Expenses

1.Cross-national: the allocation of corporate overhead to foreign SBUs

2.National: the allocation of overhead affecting product costs

3.Different tax rates complicate the cross-national allocation of overhead

4.The U.S. IRS has rules (Sec 861) on how to allocate corporate overhead to foreign revenues

5.Allocating overhead according to tax law ignores corporate strategy.

6.Cost drivers: something that drives the creation ( and thus the allocation) of overhead, such as direct labor hours or machine hours

7.The Japanese use allocation techniques to motivate managers, not to allocate costs

8.Example: Hitachi allocating overhead based on direct labor hours in a capital-intensive production process in order to drive out direct labor hours

9.Example: Hitachi allocating overhead on the number of parts, with a surcharge applied on non-standard parts

10.Overhead can't be reduced over the long run by cutting costs; the entire manufacturing process needs to be redesigned



1.Prices are usually a function of costs and market conditions

2.Drive down costs by driving production offshore; problems of quality, supply lines, speed, transportation costs, etc.

3.Use standard costing as a benchmark for performance; appropriate for stable products not as susceptible to innovation

4.Caterpillar example

a.Standard costs are used for inventory valuation

b.Product costs are established on an activity-based system; product costs are based more on cost rates for different activities that the product must pass through than the standard costs for materials, labor, and overhead

c.Cost rates may vary from country to country, but all countries use the same process to establish cost rates and assign them to products

B.Target Costing

1.The firm establishes a price for the product based on market conditions

2.Determine a profit margin consistent with the firm's long-range strategy

3.Cost is the difference between price and profit margin

4.Production departments determine a standard cost assuming no innovation

5.The target cost is somewhere between 3 and 4

6.Production tries to ratchet down production cost to the ideal in 3

7.Example situation of Japanese in their target costing mode in British sub


1.U.S. approach has historically been Acceptable Quality Level (AQL)

2.Japanese use of Total Quality Management (TQM) assumes zero defects, not a tolerable level of defects; continuous improvement; be the best at what you can do, don't just benchmark

3.U.S. AQL quality: a product meets or exceeds engineering standards

4.Japanese TQM quality: the product is so good that the customer wouldn't think of buying anything else

5.Four costs with TQM

a.Prevention costs

b.Appraisal costs

c.Internal failure costs

d.External failure costs

6.According to zero-defects users, long-run production costs decrease as defects decrease

7.Three aspects of zero-defects reporting

a.Determine what percentage of production makes it all the way through the production process without rework

b.Determine the impact of an increase in quality and a decrease in defects on the cost of manufacturing

c.Include in the capital equipment decision the savings in manufacturing cost from the improvement in quality and decrease in defects

VIII.Performance Evaluation

1.Different measurement bases, noncontrollable events, and strategic differences among subsidiaries result in different performance evaluation measures

2.Global innovators and integrated players need relatively flexible performance evaluation systems; rely more on behavioral controls and less on outcome controls

3.Global innovators need more autonomy than do implementors

4.Global innovators tend to rely more on internal than external controls (powerful others, luck)

5.Basis of measurement -- some foreign operations are sales bases, others are production; some units are in countries for tax minimization rather than profit maximization purposes

6.Multiple measures are costly and create difficulties for comparison

7.Interdependencies of MNE operations; transfer pricing issues

A.Separating Managerial and Subsidiary Performance

1.Sub performance and manager may not correlate because of general economic circumstances

2.Managers in charge of companies that are global innovators and integrated players are better able to deal with ambiguity than implementors and local innovators

B.Properly Relating Evaluation to Performance

1.Problems with ROI: transfer prices, techniques to max ROI may suboptimize the firm, not appropriate where profit max is not the goal of the foreign operation

2.Using the same measure for all foreign operations is complicated by the fact that objectives for foreign affiliates are based on the reasons for their creation and the particular operating environment

3.Comparison of performance with plan is the only globally applicable evaluation method

4.Comparison of budget to plan is only as good as the plan

5.It is neither realistic nor advisable for most firms to treat all subsidiaries as independent, autonomous operations

6.The method of performance evaluation should be clearly understood by the managers and actually utilized by the company

C.Emerging Trends in Performance Evaluation

1.Focus on specific strategies – quality, efficiency

2.Shift in focus from subsidiaries to Strategic Business Units

a.Concentrate on competitors in the same line of business

b.More use of ratios -- profits, Return on Sales, Return on Assets, Return on Equity, Return on Investment

c.More use of cash flows -- good indicator of shareholder value; discounted long-term cash flows

d.More use of non-financial criteria -- market share, volume, productivity, quality

D.Economic Value Added (EVA)

1.Used to measure performance

2.EVA is after-tax operating profit minus the total annual cost of capital

3.See example on p. 397 and Exhibit on 398

E.The Balanced Scorecard

1.Longer-term strategic view

2.Value creation from



c.Internal business processes

d.Learning and growth

3.Shows drivers and facilitates communication of objectives


Learning Objectives (LO)

1. Identify the major stages in the strategic control process

2. Describe different ways to evaluate the performance of managers and companies in the international context

3. Present the results of different studies on performance evaluation by U.S. and non-U.S. firms

4. Discuss how foreign currencies impact on the budgeting and performance evaluation process

5. Review the problems involved with setting intra-corporate transfer price

6. Analyze costing issues including target costing

7. Examine the major issues and trends in performance evaluation


1.How can management accounting play a role in the strategic planning process? (LO1)

Management accounting needs to be closely tied to the strategic planning process of a firm. The planning process involves giving strategic direction to the firm and providing an operational plan to achieve the end result of the firm's strategy. The management accountant must work with top management to identify the criteria of performance and to monitor achievements against these criteria.

2.MNEs often transfer their domestic performance evaluation systems into the international environment. Why is that the case? What problems could they run into by using the same system? (LO2,3)

MNEs often transfer their domestic performance evaluation into the international environment because of the difficulty in comparing the performance of different units measured under different criteria, and because it is more expensive to establish and operate a multiple-criteria system. However, the MNE may encounter several problems in using the same system. First, different bases of measurement result in different measures of performance . In addition, many events affecting performance, such as domestic inflation, foreign exchange rates, wars, insurrections, and natural disasters are not controllable by the individual or unit being evaluated. Also, strategic differences in subsidiaries may result in different performance evaluation measures (ie. a production units vs. a sales subsidiary).

3.Should the local currency or the parent currency be used for performance evaluation? Explain your answer.(LO4)

The MNE should resolve the dilemma of which currency to use by considering the main purpose of the foreign operation. If the operation is to provide a return to parent-company shareholders that maximizes their domestic purchasing power, the parent currency (after-translation basis) should be used. If the firm seeks global optimization or wants to leave autonomy to each foreign operation, the local currency (before-translation basis) should be used.

The issue of controllability should also be raised. The rise and fall of the local currency in value is beyond the control of a single MNE or any one of its parts. Therefore, performance evaluations should be judged on local currency. However, if the local manager is given the authority and responsibility to hedge against foreign exchange losses, then the performance evaluation should be based on the parent currency.

4.Which of the methods of setting the budget and monitoring performance as discussed by Lessard and Lorange eliminate the impact of foreign exchange variances? Which of those approaches would you prefer to use and why? (LO4)

There are three exchange rates that can be used: the actual rate in effect when the budget is set, the projected rate when the budget is set, and the actual rate at the end of the period. Whichever rate you select, make sure it is the same one that you use to translate the budget and actual results. The choice is a matter of preference. Using Exhibit 14.5 on p. 382, that would be A-1, P-2, and E-3.

5.Most companies use the same reports to evaluate the performance of the subsidiary and of subsidiary management. What are some of the dangers in doing this? (LO2)