Current us Practice

US-based multinational firms must follow the requirements of Statement 52, "Foreign Currency Translation," issued by the Financial Accounting Standards Board in 1981. Under Statement 52, a foreign subsidiary is classified either as a self-sustaining, autonomous subsidiary or as integral to the activities of the parent company. (A link can be made here with the material on strategy discussed in Chapter 12. Firms pursuing multidomestic and international strategies are most likely to have self-sustaining subsidiaries, whereas firms pursuing global and transnational strategies are most likely to have integral subsidiaries.) According to Statement 52, the local currency of a self-sustaining foreign subsidiary is to be its functional currency. The balance sheet for such subsidiaries is translated into the home currency using the exchange rate in effect at the end of the firm's financial year, whereas the income statement is translated using the average exchange rate for the firm's financial year. But the functional currency of an integral subsidiary is to be US dollars. The financial statements of such subsidiaries are translated at various historic rates using the temporal method (as we did in the example), and the dangling debit or credit increases or decreases consolidated earnings for the period.

Accounting Aspects of Control Systems

Corporate headquarters' role is to control subunits within the organization to ensure they achieve the best possible performance. In the typical firm, the control process is annual and involves three main steps:

1. Head office and subunit management jointly determine subunit goals for the coming year.

2. Throughout the year, the head office monitors subunit performance against the agreed goals.

3. If a subunit fails to achieve its goals, the head office intervenes in the subunit to learn why the shortfall occurred, taking corrective action when appropriate.

The accounting function plays a critical role in this process. Most of the goals for subunits are expressed in financial terms and are embodied in the subunit's budget for the coming year. The budget is the main instrument of financial control. The budget is typically prepared by the subunit, but it must be approved by headquarters management. During the approval process, headquarters and subunit managements debate the goals that should be incorporated in the budget. One function of headquarters management is to ensure a subunit's budget contains challenging but realistic performance goals. Once a budget is agreed to, accounting information systems are used to collect data throughout the year so a subunit's performance can be evaluated against the goals contained in its budget.

In most international businesses, many of the firm's subunits are foreign subsidiaries. The performance goals for the coming year are thus set by negotiation between corporate management and the managers of foreign subsidiaries. According to one survey of control practices within multinational enterprises, the most important criterion for evaluating the performance of a foreign subsidiary is the subsidiary's

Table 19.1

Importance of Financial Criteria Used to Evaluate Performance of Foreign Subsidiaries and Their Managers^*

Item	Subsidiary	Manager
Return on investment (ROI)	1.9	2.2
Return on equity (ROE)	3.0	3.0
Return on assets (ROA)	2.3	2.3
Return on sales (ROS)	2.1	2.1
Residual income	3.4	3.3
Budget compared to actual sales	1.9	1.7
Budget compared to actual profit	1.5	1.3
Budget compared to actual ROI	2.3	2.4
Budget compared to actual ROA	2.7	2.5
Budget compared to actual ROE	3.1	3.0

^*Importance of criteria ranked on a scale from: 1 = very important to 5 = unimportant.

Source: F. Choi and I. Czechowicz, "Assessing Foreign Subsidiary Performance: A Multinational Comparison," Management International Review 4 (1983), p. 16.

actual profits compared to budgeted profits (see Table 19.1).¹⁴ This is closely followed by a subsidiary's actual sales compared to budgeted sales and its return on investment. The same criteria were also useful in evaluating the performance of the subsidiary managers (see Table 19.1). We will discuss this point later in this section. First, however, we will examine two factors that can complicate the control process in an international business: exchange rate changes and transfer pricing practices.