SUMMARY OF FINDINGS AND RECOMMENDATIONS

the independent CPA's opinion to this information is essential. Responses show a majority of company representatives prefer to report it elsewhere than in the financial statements, yet the results of the Corporate Questionnaire also suggest that a number of companies will submit the extended disclosures to their auditors for review and, as experience accumulates, more companies will probably choose to do so. For the present, however, this can scarcely be viewed as a requirement.

59. The importance of freedom to experiment with a variety of methods of presentation is apparent. Individual companies will seek ways to present their diversified activities as effectively as possible and may employ a number of presentations before settling on the one they find most useful. Because the disclosure of the results of diversified activities on a less than total company basis will represent an innovation in the reports of many companies, there exists the possibility that some readers will utilize the data in ways for which they were never intended. To reduce this possibility as much as possible, the grouping of such disclosures with a warning note to those who read them should be beneficial.

Recommendations

1. Companies which are unitary in nature, that is, which operate almost completely within a single broadly-defined industry, or which are highly integrated, should not be expected to fractionalize themselves for reporting

purposes.

A. Unless a company has components which (1) operate in different industries, broadly-defined, and (2) experience rates of profitability, degrees of risk, or opportunities for growth independent of other components, and (3) meet the test of materiality (as stated in 2-b), the company should be considered unitary in nature.

B. Companies, or parts of companies, whose segments transfer substantial amounts of products to or receive substantial amounts of products from, or render substantial services to, other segments with which they are integrated in a product sense, should be considered unitary in nature rather than diversified.

2. Companies which to a material degree have activity in more than one broadly-defined industry should meet the extended disclosure requirements in (3) following:

A. Activity in more than one broadly-defined industry exists when a company either (a) receives gross revenue from, (b) derives income from, or (c) utilizes assets in industries subject to significantly different rates of profitability, diverse degrees of risk, or varying opportunities for growth.

No present system of industry or product classification appears ideally suited to the identification of broad industry groups for reporting purposes. If any of the existing systems (including the Standard Industrial Classification at the two-digit level) is applied without consideration of a company's historical development and the inter-related nature of its established activities, the disadvantages to shareholders may be substantial. Considerable discretion to management in defining broad industry groupings for the purpose of meeting the disclosure requirements in (3) is essential.

FINANCIAL REPORTING BY DIVERSIFIED COMPANIES

B. Ordinarily, a “material degree," as the term is used here, means 15% or more
of a company's gross revenue. If the amounts of gross revenue are significantly
disproportionate to the amounts of income from, or the assets employed in,
diversified components, as compared to other components of the company, a
more representative test of the materiality of the diversification should be used.
3. Management, because of its familiarity with company structure, is in the
most informed position to separate the company into realistic components
for reporting purposes. Therefore, management should determine the number
and scope of a diversified company's reporting components and report the
activities of those components within the following guidelines:

A. Identify and describe the components which are subject to separate reporting.
B. Disclose any significant changes from the previous period in the composition
of the reporting components.

C. For each reporting component:

1. Disclose sales or other gross revenue.

2. Disclose the relative contribution made by each component to the income
of the enterprise. The contribution to income made by each component may
be calculated before or after the allocation of common or corporate costs
but in any case should be clearly described. In the event of a change in the
method of computing or reporting either gross revenue or the relative con-
tribution to income of the reporting components, the change should be clearly
described.

or

D. If the method of pricing intra-company transfers or allocating common
corporate costs significantly affects the reported contribution to income of the
reporting components, the method used should be disclosed in general terms
similar to the following:

1. "Corporate expenses were allocated to the reporting components on the basis
of a formula giving approximately equal weight to assets employed, sales,
and number of employees."

2. "Intra-company transactions are priced at close approximations of open
market prices for similar products and services."

4. Disclosures recommended under (3) may be included in parts of the
annual report other than the formal financial statements at the discretion of
management. Whether in narrative or tabular form, they should be grouped
and should carry a clear indication of the limitations of their usefulness.
Words similar to the following may prove useful: "The data supplied in
(specify pages, paragraphs, or schedules) present certain information rela-
tive to the nature, principal types, and results of the company's diversified
activities. No assurance can be or is given that they have been prepared on
a basis comparable with similar data for other companies."

5. Because of the innovative nature of these recommendations and the innate
complexities of reporting diversified activities, the recommendations should
be applied with judgment and flexibility by all concerned. In those cases
where management sincerely believes the recommended disclosures, if fol-
lowed, would have a significantly adverse effect upon the interest of share-
holders, a statement to this effect should be made in lieu of extended
disclosures.

158

NOTE. Chapter VII, appendixes A through F, the bibliography and index have been omitted. Please see the table of contents, above, for the subjects of the omitted chapter and appendixes.- Committee editor.

F. EXCERPTS FROM FINANCIAL CONTROL OF MULTINATIONAL OPERATIONS, BY EDWARD C. BURSK, JOHN DEARDEN, DAVID F. HAWKINS AND VICTOR M. LONGSTREET

FINANCIAL CONTROL

OF

MULTINATIONAL OPERATIONS

A research study
prepared for

FINANCIAL EXECUTIVES
RESEARCH FOUNDATION

by

Edward C. Bursk

Editor, Harvard Business Review, and
Chairman, International Management and
Marketing Group

John Dearden

Herman C. Krannert Professor of Business
Administration, Harvard Business School

David F. Hawkins, Professor of Business
Administration, Harvard Business School

Victor M. Longstreet, Vice President
International Management and Marketing Group

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Financial Control of Multinational Operations
Copyright 1971

Financial Executives Research Foundation

50 West 44th Street, New York, N.Y. 10036

Library of Congress Catalog Card Number 75-153410

Printed in the United States of America

$6.00

First Printing

As the research arm of Financial Executives Institute, the basic objective of the Research Foundation is to sponsor fundamental research and publish authoritative material in the fields of business management with particular emphasis on the principles and practices of financial management and its evolving role in the management of business.

Publication of a research study should not be interpreted as constituting endorsement by the Board as a whole, or by individual Trustees.

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