Unit 7 Budgets, Decisions and Risks

TEXT 1

1. Make an outline of the text Managerial Accounting

The field of managerial accounting and control in a global business environment has the interesting property of being a mixture of two disciplines. The first is the relatively soft art of management which, at least as far as 'international' is concerned, finds its origins in anthropology and psychology and attempts to provide a perspective on the unique behavioural problems of controlling a business entity. The second part, 'accounting', deals with the technical side of recording and manipulating information to provide what may be described as an optimal package or set of information.

The need for management accounting and control arises from the strategy of the firm. Management accounting serves both to provide information to management and to be used by management as a tool for ensuring that employees' actions and objectives are aligned with those of the firm.

Major challenges in the management accounting and control area are affected by the two most basic problems of doing business internationally, namely that countries have different currencies and different cultures. Thus, it is necessary to select appropriate budgeting currency and exchange rate tools.

1. The path of least resistance would be to use the rate at the date of planning. However, this is often so far in advance of the actual budgeted year that actual results are significantly different from budgeted results. If managers are responsible for profit in home currency terms, this results In an unfair distribution of rewards.

2. Thus, some companies use forward rates or continuously up-dated rates. Using a special form of the traditional domestic price and volume variances, firms can ascertain what part of the problem is occurring because of movements in currency values.

3. The first question concerning control systems relates to differences in the strategic objective of the firm. Anglo-American firms generally prefer shorter term and more profit based objectives, but return on investment is declining as a measure. Asian firms, by contrast, have a longer-term objective and seem to be satisfied with more indirect objectives.

4. Culture has also been found to play a role in budgeting and control. The budget process in Asia is longer-term and less formal than that of Western countries Outside the Anglo-American world, there is resistance to formal participation, particularly in authoritarian cultures such as that of Mexico. However, cultural research has many flaws, and economic need or experience with non-national entities may lead to common global standards of control.

The budgeting process begins well before the budget year. This provides three clear choices for exchange rates: the rate at the time of budget completion; the rate at the beginning of the budget year; and an estimate of the average rate during the budget year (a forward rate). The choice may be made by looking at interim information during budget preparation and at who assumes responsibility for exchange management.

Consider a simple example of what can happen. Suppose that a company in the United States is budgeting for its subsidiary in the Republic of Ireland for the calendar year 2011. At the beginning of the budgeting process on 1 September 2011 the rate is €1.3 per dollar. This could certainly be used as the rate for the complete budgeting process. However, perhaps results have shown a steady weakening of the euro over the previous 12 months. The company could attempt to anticipate the effect of this continued depreciation by preparing several scenarios, and if this depreciation continues, both budgetary and real action may have to be taken to stabilize profits. An example of such action would be at the start of the financial year, for example, to enter into a long-term hedge until 31 December 2011 which would protect the anticipated euro profits based upon this exchange rate. This would also require a budget planning adjustment at that time.

If the US management wants the Dublin management to assume responsibility for protecting the exchange rate change, then a budget based on the beginning of 2011 rate might be appropriate. In this case, the Irish management is only responsible for exchange rate gains and losses beginning with 1 January 2011. Alternatively, the head office may budget using a September 2010 rate and should take a 90-day hedge for the period 1 October 2010 to 31 December 2010 to protect the budget until the starting point where the Irish management takes over. Once January 1 arrives the Irish management would probably enter into a hedge to protect against the exchange rate movement during the budget year.

A final strategy for selecting a budget exchange rate involves only theoretical rather than real actions in the budget process. In this case, although no foreign exchange actions are taken, the US head office's estimate of the average rate or a forward rate for the year could be used to develop the budget, and deviations from that rate actually become the responsibility of either the forecasting department or are shared with the subsidiary's management by giving them the task of managing changes beyond the forecasters' predictions.

Capital budgeting

Capital budgeting is the longer-term version of the operational budgeting. As in short-term planning or budgeting, long-range planning or capital budgeting must take into consideration anticipated exchange rate movements for discounting future cash flows. This becomes part of the risk involved in choosing the discount rate, along with any environmental uncertainty. Environmental uncertainty can be mild, such as the risk of unexpected heavier taxation, or severe, such as the risk of expropriation. In general, the risk is greater in less developed countries than in wealthier trading partners, but even in the the latter there are many adverse events that are unpredictable.