2. Internal Control\
Zero Based Budgeting:
Zero-based budgeting is a technique of planning and decision-making which reverses the working process of traditional budgeting. In traditional incremental budgeting, departmental managers justify only increases over the previous year budget and what has been already spent is automatically sanctioned. No reference is made to the previous level of expenditure. By contrast, in zero-based budgeting, every department function is reviewed comprehensively and all expenditures must be approved, rather than only increases.[1] Zero-based budgeting requires the budget request be justified in complete detail by each division manager starting from the zero-base. The zero-base is indifferent to whether the total budget is increasing or decreasing.
The term "zero-based budgeting" is sometimes used in personal finance to describe the practice of budgeting every dollar of income received, and then adjusting some part of the budget downward for every other part that needs to be adjusted upward. It would be more technically correct to refer to this practice as
"active-balanced budgeting".
Advantages of Zero-Based Budgeting:
1. Efficient allocation of resources, as it is based on needs and benefits.
2. Drives managers to find cost effective ways to improve operations.
3. Detects inflated budgets.
4. Municipal planning departments are exempt from this budgeting practice.
5. Useful for service departments where the output is difficult to identify.
6. Increases staff motivation by providing greater initiative and responsibility in decision-making.
7. Increases communication and coordination within the organization.
8. Identifies and eliminates wasteful and obsolete operations.
9. Identifies opportunities for outsourcing.
10.Forces cost centers to identify their mission and their relationship to overall goals.
Disadvantages of Zero-Based Budgeting:
1. Difficult to define decision units and decision packages, as it is time-consuming and exhaustive.
2. Forced to justify every detail related to expenditure. The R&D department is threatened whereas the production department benefits.
3. Necessary to train managers. Zero-based budgeting must be clearly
understood by managers at various levels to be successfully implemented.
Difficult to administer and communicate the budgeting because more managers are involved in the process.
4. In a large organization, the volume of forms may be so large that no one person could read it all. Compressing the information down to a usable size might remove critically important details.
5. Honesty of the managers must be reliable and uniform. Any manager that exaggerates skews the results
Internal Control:
Internal control is defined as a process affected by an organization's structure, work and authority flows, people and management information systems, designed to help the organization accomplish specific goals or objectives.[1] It is a means by which an organization's resources are directed, monitored, and measured. It plays an important role in preventing and detecting fraud and protecting the
organization's resources, both physical (e.g., machinery and property) and intangible (e.g., reputation or intellectual property such as trademarks). At the organizational level, internal control objectives relate to the reliability of financial reporting, timely feedback on the achievement of operational or strategic goals, and compliance with laws and regulations. At the specific transaction level, internal control refers to the actions taken to achieve a specific objective (e.g., how to ensure the organization's payments to third parties are for valid services rendered.) Internal control procedures reduce process variation, leading to more predictable outcomes
Describing Internal Controls:
Internal controls may be described in terms of: a) the objective they pertain to; and b) the nature of the control activity itself.
Objective categorization
Internal control activities are designed to provide reasonable assurance that particular objectives are achieved, or related progress understood. The specific target used to determine whether a control is operating effectively is called the control objective. Control objectives fall under several detailed categories; in financial auditing, they relate to particular financial statement assertions,[5] but broader frameworks are helpful to also capture operational and compliance aspects:
1. Existence (Validity): Only valid or authorized transactions are processed (i.e., no invalid transactions)
2. Occurrence (Cutoff): Transactions occurred during the correct period or were processed timely.
3. Completeness: All transactions are processed that should be (i.e., no omissions)
4. Valuation: Transactions are calculated using an appropriate methodology or are computationally accurate.
5. Rights & Obligations: Assets represent the rights of the company, and liabilities its obligations, as of a given date.
6. Presentation & Disclosure (Classification): Components of financial statements (or other reporting) are properly classified (by type or account) and described.
7. Reasonableness-transactions or results appear reasonable relative to other data or trends.
Activity categorization
Control activities may also be described by the type or nature of activity. These include (but are not limited to):
• Segregation of duties - separating authorization, custody, and record keeping roles to limit risk of fraud or error by one person.
• Authorization of transactions - review of particular transactions by an appropriate person.
• Retention of records - maintaining documentation to substantiate transactions.
• Supervision or monitoring of operations - observation or review of ongoing operational activity.
• Physical safeguards - usage of cameras, locks, physical barriers, etc. to protect property.
• Analysis of results, periodic and regular operational reviews, metrics, and other key performance indicators (KPIs).
• IT Security - usage of passwords, access logs, etc. to ensure access restricted to authorized personnel. S
Q4 .Veena Pvt. Ltd., a small multiproduct company is taken over by a
multinational company ( e.g. Hindustan Lever.) What changes in the control system would you expect and why?
Since Veena is a small multiproduct company it would require changes in control system which would be related to transfer pricing a, as this company would generally provide inputs to HUL. Thus the domestic operations generally involve transfer of goods and services only In view of this difference many other considerations, in addition to the criteria used in domestic operations for the determination of transfer price, are involved. These include:
(a) Fair Price: This is an important factor one needs to consider while determining the transfer price for foreign operations. Companies that enter into joint ventures must ensure that the transfer price charged is fair. If such companies charge a higher transfer price, it would reduce the profits of the joint venture and as a result reduce the foreign partner's share of profits.
(b) Government Regulations: All countries have a regulatory framework under which business units operate. Where government rules and regulations regarding transfer prices are lenient, the parent company should fix a higher transfer price for
all transfers to countries with high income tax rates. This approach would enable the parent company to minimize taxes in such countries.
(c) Exchange Control Restrictions: Every country has foreign exchange control regulations.
These regulations impose a limit on the amount of foreign exchange available for the import of certain goods. To accommodate the foreign subsidiary the parent company may have a lower transfer price so that the subsidiary is able to import a larger quantity of required goods.
(d) Income Tax Regulations: The rates of income tax vary from country to country.
To overcome this difference the transfer price should be so fixed that countries with low tax rates show profits while others end up with a loss. This helps the parent company to reduce its taxes on a global basis.
(e) Desire to accumulate funds: A company that wishes to accumulate funds in a particular country may fix the transfer prices in such a manner that it facilitates shifting of funds into that country.
(I) Tariffs- and Duties: No country likes high imports. In order to restrict imports countries impose restrictions such as quantitative restrictions, high duties and tariffs and banning import of products. The general practice is to charge import duties as a percentage of the value of products imported, although a lower tariff may be levied if the import value is lower. It is seen that the impact of tariffs on the profitability of foreign operations is generally the reverse of the incidence of income taxes in transfer pricing. As such a low transfer price would lead to low import duties on transfer, the profit arising in that country would be high. This results in high income taxes in that country. It is therefore advisable that companies must compute the net effect of these factors while determining transfer prices.
In designing performance evaluation systems for acquired Veena company,HUL could use the following guidelines
Subsidiary managers should not be held responsible for translation effects. The simplest way to achieve this objective is to compare budgets and actual results using the same metric and isolate inflation-related effects through variance analysis. It is pointless for managers to worry about the appropriate metric. The MNE should choose whatever metric is more convenient.
Transaction effects are best handled through centralized coordination of the MNE's overall hedging needs. This is likely to be cheaper and simpler, and it prevents the subsidiary manager from becoming a foreign exchange rate forecaster and speculator.
The subsidiary manager should be held responsible for the dependence effects of exchange rates resulting from economic exposure.
Evaluation of the subsidiary as a basis for a decision to locate operations in a country or to relocate operations from a country should reflect the consequences of translation. Transaction and economic exposures.
SET 10