Controlling foreign subsidiaries

Richard Martin reviews monthly reporting techniques used by British multi-nationals

Techniques in management accounting have made significant advances in the last few years, and academics such as Kaplan and Hopwood have changed the way in which we understand the subject. But not all the advances are necessarily taken up by companies, nor are they always directly applicable. In 1990 a research study, (Appleyard et al), looked at reporting techniques used by British multinationals, and the object of this article is to review the main practical issues and see what changes have taken place since the Appleyard study.

A key problem in controlling foreign operations is that the subsidiary is budgeting and reporting in a currency which is different from that of the parent. Group management have to look at a group result in Sterling while understanding what is going on underneath that in terms of the actual operations. For example, the French subsidiary of a UK group might have budgeted a FF100m profit for 1997, giving a Sterling profit of £11.5m based on a budget exchange rate of £ = FF8.7, which would have been based on spot rates in (say) September 1996. Supposing that the subsidiary actually turned in a profit of FF105m (positive variance FF5m), but the average exchange rate for 1997 was £ = FF10.0. This would give a Sterling result of £10.5m (negative variance £1m). The reporting system needs to be able to identify this as a performance gain outweighed by a foreign exchange loss.

Most companies ask subsidiaries to budget in local currency and subsequently prepare the monthly management reports in the same currency. However, the Appleyard report showed that there are many approaches then used for arriving at the monthly group summary in Sterling and analysing exchange differences, and this does not seem to have changed.

Iain Lough explains that Pilkingtons establish a budget exchange rate during the annual budget exercise, and subsequent monthly budget/actual calculations are done using the budget at budget rate with actuals at the average actual rate, and exchange variances broken out at subsidiary level. At Williams Holdings, John Hargreaves says that their system involves subsidiaries reporting both budget and actual performance using the budget exchange rate, thus making a direct connection between the original budget and actual performance. The exchange difference between budget and actual rates is calculated at group level, and broken out of the summary as a one-line adjustment. The "actual" rate used is in fact a forecast of the average for the year. David Cruddance says that Tarmac, on the other hand, translate both budget and actual performance figures using the actual exchange rate.

Balanced scorecard

Although the term "balanced scorecard" (see the following article by Garry Marchant in this issue) had not been invented by Kaplan when the Appleyard survey was done, it was clear at that time that companies used some non-accounting performance measures. However Kaplan appears to have had an impact. Iain Lough remarked "We are going down the road of the balanced scorecard. But this is an on-going saga. Pilkingtons has a long and honourable history of reporting manufacturing performance."

John Hargreaves noted that non-accounting measures are used "a little, not a lot" at group level as such. Where they are much more important, is at divisional level. "Measures such as delivery times, service levels, etc, which are helpful to divisional managers to manage their businesses are reported at divisional level". There are few such measures which are uniformly meaningful across such a diversified group as Williams Holdings.

The Appleyard survey found that budget/actual comparisons were the main accounting criterion for assessing subsidiary performance, but most companies also calculated the return on investment. In recent times, one of the changes in evaluation methods has been a realisation that target rates of return should be related to the risk of a particular operation, rather than having a simple, group-wide rate. Iain Lough confirmed that Pilkingtons takes this view. "We use many rates of return. These are individually developed with each business." Tarmac uses the weighted average cost of capital, but Williams Holdings does not use standard indicators of this type.

Profit measure

One curiosity of the Appleyard survey was that most companies were found to focus on net profit before tax as a key performance indicator, with cash flow ranking much lower in their priorities. In the past, most British companies have tended to focus on before tax profits, treating tax more or less as a distribution, in line with standard teaching. However, other companies treat tax as a cost which is capable of being managed and which therefore needs to appear in performance assessment reports and to be considered in project evaluation. While a number of companies do now include a tax line in their monthly reporting package it is clear, from talking to them, that most retain a pre-tax focus in performance assessment.

One thing which has changed markedly is the emphasis on cash flow. The Appleyard survey showed that cash flow was part of the reporting package, but the companies we talked to all said that monthly cash flow is now a main focus. John Hargreaves remarked that for him the main changes in recent years have been this increased use of cash flow figures and a need to focus on foreign currency differences. He also noted that Williams still "majors on base profit - that is recurring profit as distinct from exceptional items".

The profit figure for subsidiaries is potentially affected by the group policy of re-charging any central overheads. This is always a contentious issue. Williams Holdings do not allocate group overhead back to subsidiaries. But at Pilkingtons, Iain Lough said "it is an ongoing debate. Some regional overheads are charged out within their sub-group. We are always reviewing the problem of charge outs from head office." Tarmac also allocate out some costs to subsidiaries. One of our contacts remarked that there is growing pressure from the Inland Revenue in the UK to charge out items such as research and development to foreign subsidiaries which benefit from the use of the technology.

Accounting principles

At the time of the Appleyard survey, the idea of having a uniform chart of accounts did not figure in British thinking, but since then, more groups have acknowledged the savings in training costs and software from having a group-wide uniform accounting system. Iain Lough observed that Pilkingtons use uniform accounting principles worldwide and a chart of accounts. "We want to be sure that subsidiaries are following them in their own books at a detailed level". He stressed the importance for management purposes of knowing that costs were calculated on the same basis throughout the group.

John Hargreaves, however, said that Williams Holdings do not use a uniform chart of accounts. The monthly reporting procedures involve the use of uniform UK accounting principles, but books are kept locally according to the local legal requirements. He pointed out that in some countries, expenses must appear in the books to be eligible for deduction from revenues for tax purposes, and this militates against uniform procedures across the group.

It is clear that management accounting procedures for the control of foreign subsidiaries are continuing to move forward. However one must always bear in mind that different groups face different problems; that within a group there are often different structures relevant in different operating areas and subsidiaries of different sizes, all of which makes comparability difficult.

Reference
Appleyard, A., Strong, N. & Walton, P. Management control of foreign subsidiaries, European Management Journal Vol 8 No 3 September 1990.

Richard Martin is a senior technical officer at ACCA.