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Same yet different
Gaps in tax-based transfer pricing are filled by a second
managerial system in measuring divisional profits better.
The CFO of Hewlett-Packard corp's Enterprise Computing
Organisation is faced with a problem, demanding his
immediate attention. International companies like HP having
many divisions spread across different geographical regions
face the problem of varying interdivisional transfer-pricing
mechanisms, based on various financial and tax-accounting regulations.
Such varying reporting mechanisms complicate the profit recording
and compensation systems at the individual branches of the company.
Transfer prices, the charges recorded by a company while its
units do business with each other, serve to establish the internal
profit structure on which taxes are paid. Due to the varying
tax regulations prevalent across countries, transfer price reporting
in the individual accounts of the branches also vary. This creates
major hurdles in consolidating management accounts at the central
hub of big international companies.
Accounting made difficult…
In addition to the non-uniformity of tax laws pertaining to
accounting and reporting of transfer prices in the books of
the branches, regulations allowing managerial discretion in
deciding basic factors like charges for general and administrative
costs and intangibles among the branches make accounting difficult.
"The biggest problems are when the measured profitability
of a business unit has more to do with the skill of its manager
in negotiating his transfer prices within the company than its
economic profits and the factors that drive shareholder-value
creation", says Jay Tredwell, director of CEO Solutions.
Subjective decisions of the manager add to the uncertainty
in management reporting. In the past, companies could adjusted
their transfer-pricing requirements by yielding the tax rules
to suit their business needs. Inadequate monitoring on the part
of the regulators made this possible. However, today the regulators,
seeking to increase their revenues from taxes have tightened
the transfer-pricing policies and tax strategies of companies.
r of the Accounts are also monitored regularly.
Owing to the change in the regulators' policies regarding account
monitoring procedures, companies are adopting a separate-reporting
approach, wherein a second managerial set of transfer-pricing
numbers for interdivisional purposes is generated.
Separate reporting approach…
In such a system of reporting, the company maintains two sets
of accounts for the transfer pricing transactions, one in compliance
with the statutory rules and policies, reflecting the statutory
profits, and the other showing the actual profits without reflecting
the statutory tax requirements.
Pros…
Such a separate accounting system benefits the overall company,
as the managers have a correct picture of individual branch
profits and performance. This would then form a base for deciding
on the compensation package for the individual branches and
managers.
The actual profitability of branches enables the managers at
the head office to formulate strategies that would enhance overall
branch and company performance.
As an additional benefit, companies with separate management
reporting systems findit easier to channel newer, non-traditional
income streams to the appropriate products. For instance, at
HP, the managers want this new system of reporting to include
the increasing flow of transaction-fee type or pay-for-performance
models that do not fit into their current transfer pricing and
compensation systems. Such increased information in the company
accounts gives managers a better picture of the business transactions,
enabling further planning and implementation of policies.
Cons…
Small and medium sized companies often cannot afford such a
system of separate reporting as the expenditure involved in
implementing a parallel accounting system is substantial and
could strain the finances of the company. Hence, only financially
sound companies can enjoy the above-mentioned benefits.
Certain companies are hesitant in implementing a parallel accounting
system as such a system would result in changes to the compensation
and divisional bonus systems that may not be accepted by the
employees. Non-acceptance of such changes would lead to a resistance
on their part thereby affecting their performance.
A case in point…
Microsoft Corp., the software giant, implemented
this separate accounting system. This system draws data from
a new base of managerial numbers designed to help its leadership
team make better decisions on utilisation of its marketing resources,
timing of product launch, and minimisation of production costs.
The company called its parallel accounting system as Microsoft
Accounting Principles (MAPs).
The company basically wanted to make its local marketing managers
accountable for the actual profitability of their products,
and to establish appropriate marketing spending levels for every
line. Hence, they created MAPs, which gives the company a detailed
P&L account for each branch. This projects the branch profitability
position based on which improvement policies can be framed or
managers responsible can be adequately compensated.
Conclusion
Having such a reporting system would help international companies
to draw accounts that give a clear picture of their global operations.
Related reading:
"Separate but unequal": Springsteel.I: CFO Magazine.
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