International Finance and Accounting Handbook

(ii) Conversion of Income Statement to U.S. Basis. The next step is to convert the LC-
based local income statement into one that is based upon the parent company’s in-
come statement, in our case, U.S. “generally accepted accounting principles.” By this
time, the parent company, division, and region have determined the currency ex-
change rate to be used for individual affiliates. After having converted the LC-based
local income statement into a PC-based income statement based on U.S. generally ac-
cepted accounting principles (the parent company’s currency is the U.S. dollar), one
final step may be necessary. Frequently, there are charges by the parent company that
need to be allocated to the affiliate, and these have to be incorporated, both before
and after tax, in the PC-based income statement.
To give us a basis for comparing results with profit plan, let us assume that Affil-
iate B’s planned net income is LC 285, as shown in Exhibit 25.8. This exhibit shows
functional pretax income, for which each function’s general manager is responsible;
income tax is then applied on a total affiliate basis. An alternative method would be
to calculate the tax for each function; this can lead to some distortions due to allo-
cated expenses, headquarters charges, and so on, and the need to cope with tax cred-
its arising from loss operations in one function, creating credits that can be offset
against taxes arising from profitable operations of other functions. (For a further dis-
cussion of international tax considerations, see Chapter 30.)

(iii) An Affiliate’s Profit Plan. Affiliates prepare detailed underlying plans, one of
which is illustrated in Exhibit 25.9. To facilitate the analysis of results later in this
chapter, the exhibit shows a conventional income statement, and we will refer to the
marketing function, a profit center of Affiliate B, as LC Company. In both Exhibits
25.8 and 25.9, we have assumed a planned exchange rate of LC 1 = PC 1.

25.8 PROFIT PLANNING CONTROLS

(a) Periodic Income Reports. Throughout the year, control reports are prepared at
intervals required by the various levels of management and the corporate parent.

25 • 12 MULTINATIONAL BUDGETING AND CONTROL SYSTEMS

AFFILIATE B

Profit Plan

Year ended December 31, 20X0

Exchange

PC Rate LC

Before-tax income:
Manufacturing 310 PC 1 = LC 1 310
Marketing 225 225
Transportation 75 75
Administration (40) (40)
Total 570 570
Income tax (285) (285)

Net income ____ (^285) ____ 285
Exhibit 25.8. Profit Plan.