1
The assessment of financial performance of the division managers in each subsidiary can be obtained by taking a difference between budgeted profits and actual profits in US dollars. It can be understood from the table provided below.
The table provided above summarizes the information regarding the actual and budget performance of each subsidiary in 2004 . All amounts are expressed in US dollars that are helpful in comparison among them. It can be seen from Table 1 that the subsidiary of Japan has performed below budgeted profits that in dollars but it might have increased its profits as compared to past year . The comparison is based on the actual and budgeted performance to entitled managers for their respective bonuses.
Bonuses According to Performances
It can be noticed in Table 1 that the manager of Denmark division has performed well as compared to others, so he is entitled to get the highest bonus. On the other hand, the manager of Japan has not proved to be efficient in obtaining budgeted profit so he should be rewarded the lowest bonus.
2
The real exchange rate and its calculation for each of the three countries are provided. Note: The US nominal exchange rate is 0.023.
Mexico
Nominal rate: 10.72
Inflation rate: 0.05
Calculation: 10.72*1.05/1.023
Result: 11.00
Denmark
Nominal rate: 6.88
Inflation rate: 0.043
Calculation: 6.88*1.043/1.023
Result: 7.014
Japan
Nominal rate: 119.8
Inflation rate: 0.0225
Calculation: 119.8*1.0225/1.023
Result: 119.74
The budgets of 2003 are calculated by an exchange rate of 2003 . The common metric should be used for subsidiary evaluation, and 2004 budgets can be calculated by using an exchange rate of 2004 . The return on investment (ROI) method should be used to assess the performances of each division’s manager as it also involves external risks that are associated with the specific project.
3
The performance ranking would be similar in ROI method except the element that the performance would be shown in percentage as the method is used to obtain change in percentage . Following are the advantages and limitations of ROI using as a performance indicator.
Advantages
Following are the main advantages of using ROI as a performance indicator.
It better measures the profitability
Comparative analysis is possible
Simple and reliable method without any changes
Reflection of every component of financial statements
Easy calculations
Help in achieving desired objectives
Limitations
The limitations of using ROI as a performance indicator are.
It creates difficulties due to the differences in accounting policies and principles of two or more divisions.
It covers only short-term returns of investment
It pressurizes the investor to select the investment that can provide high return .
4
Falcon, Inc. should change the entire system immediately to help managers who are unable to perform better as compared to others. The manager should not be entitled to get fewer bonuses if they cannot perform according to company’s budgeting . Falcon, Inc. should use common metric to compare the performance of managers of each division to avoid any difficulty in measuring and comparing performances. Hedging of currency can be used to mitigate the risks of fall in prices of foreign currency. Various traders adopt the method to safe from market currency exchange rate risks. The risk is also known as forex risk .
5
Although Japan’s subsidiary performance cannot be observed in ROI and yearly profits, its performance is increasing in real that is after compensating inflation. The decision of shutdown cannot be made solely on the fact that it is performing lower than budgeted profits, but it should also consider other factors that are the efficiency of management in increasing sales as compared to past years . The subsidiary in Japan is producing a high-quality product at a relatively low price that is the main positive point that is an obstacle in the shutdown of this subsidiary. Hence, it should not be closed as long-term profitability is also expected to this subsidiary rather than focusing on budgeted profits .
6
Falcon, Inc. has a reliable flow of various exchange rates for the formation and tracking of the budget. It allows them to measure the performance in real by applying different exchange rates method . However, the system does not include a common metric tool that is comprised of different parameters and it is helpful in measuring the performance of each division accurately . Moreover, it should also calculate ROI to measure the actual return on investments. It will help in comparing the performance of each division regarding return on investment.
Reference
Gujarathi, M. R., & Govindarajan, V. (2007). Falcon, Inc.: Performance Evaluation of Foreign Subsidiaries. Issues in Accounting Education, 22 (2), 233-245.
