Multinational Organizations

• Most of the practices of control foreign operations are similar to those for controlling domestic operations. One important differences, hhowever, is that even if a foreign operations is an expense center or a revenue center for control purposes, it is often a profit center for accounting purposes. There are special problems in global organizations; cultural differences, transfer pricing and exchange rates.

Objectives

• To understand the differences in cultures• Transfer pricing and its impact• Use of different transfer pricing methods• Exchange rates and types of exposures• Subsidiary units, its performance and

management.

A . Cultural Differences

• One of the important contextual variable that influence management control within a multinational enterprise is a cultural differences across countries. By definition, a multinational organizations operates in multiple countries and therefore has to contend with cultural differences as head office coordinates and control its subsidiaries.

Cultural differences• Cultural difference can not affect the control system directly

but they affect the information used for the control system.• The cultural difference can be classified into four parts, they

are1. collectivism: refers to the degree to which employees place

the collective interest of their firm ahead of their personal interest. For eg. Guatemala, Ecuador, Panama. While, in Individualism people focus on their own interest and the people close to them. Tasks more important than relationships. E.g. U.S., UK, Canada

2. Uncertainty avoidance: the degree to which employees feel uncomfortable with uncertainty.

Contd. 3. Power distance: the degree to which employees accept centralized

decisions.Large Power Distance:• Society accepts the unequal distribution of power. Respect for

authority. Emphasis on titles and ranks. Subordinates want to be told what to do. Centralization emphasized.

Small Power Distance:• Society less accepting of power. Employees are more open to

discussion with the superior. Less emphasis on authority, titles, and ranks. Inequality minimized. Decentralization emphasized.

4. Masculinity vs. femininity: material success vs. quality of life.5. LONG-TERM ORIENTATION• Characterized by hard work and perseverance. • Savings drivenSHORT-TERM ORIENTATION• Less emphasis of hard work and perseverance. Consumption driven.

B. Transfer Pricing

• Transfer pricing for goods, services, and technology represent one of the major differences between management control of domestics and foreign operations. In foreign operations, have a several other consideration are important in arriving at the transfer pricing.

Taxation• A transfer price system that result in assigning profits

to low-tax countriescan reduce total worlwide income taxes.

Goverment Regulation• In the absence of goverment regulations, the firm

would set the transfer price to minimize taxable income in the countries with high income tax rates.

Tariff• Thus, the net effect of these factor must be calculated

in deciding inthe appropriate transfer price. Because income taxes are typically a larger amount than tariffs, international transfer pricing usually driven more by income tax than by tariff considerations.

Foreign Exchange Control• Some countries limit the amount of foreign

exchange available to import certain commodities.

Funds Accumulation• Transfer pricing are a way of shifting funds into or

out of a particular country. Joint Ventures• Joint venture create additional complications in

transfer pricing.• 1. Use the Transfer Pricing metod• 2. Legal Considerations

• Almost all countries place some constraint on the flexibility of companies to set transfer price for transaction with foreign subsidiaries. The reason is to prevent the multinational company from avoiding the host country ‘s income taxes.

• Acceptable intercompany pricing methods, listed in descending order of priority, are as follows:

Comparable uncontrolled price method Resale price methodCost-plus method

3. Implication of Section 482

There are two important implications of Sections 482:

• Although there are legal restriction on a company’s flexibility in transfer pricing, there is considerable latitude within these restriction.

• In some instances, the legal constraint may dictate the type of transfer prices that must be employed.

4. Minority Interest

• Whenever minority interest are involved, top management’s flexibility in distributing profit between subsidiaries can be severely restricted because the minority parties have a legal right to a fair share of the corporation’s profits.

Transfer pricing methods1. Comparable uncontrolled price method: Transfer price = price paid in comparable uncontrolled sales +/-

adjustments- In a controlled sale the transaction between two members of

controlled group and uncontrolled sales means two parties are not member of the controlled group.

2. Resale price method: Transfer price = applicable resale price – appropriate markup +/-

adjustmentsApplicable resale price is the price where the property is

purchased in the controlled and resold in the uncontrolled group.

Contd.

3. Cost plus method: Transfer price= cost + appropriate mark up +/- adjustmentsLegal consideration on transfer pricing systems.

Exchange rate mechanism

• Exchange rate mechanism• Different types of exchange rate exposure:1. Transaction exposure2. Translation exposure3. Economic exposure

Performance of the subsidiaryManagement of the subsidiary