Financial and nonfinancial performance measures, goal-congruence. (CMA, adapted)

Summit Equipment specializes in the manufacture of medical equipment, a field that has become increasingly competitive. Approximately two years ago, Ben Harrington, president of Summit, decided to revise the bonus plan (based, at the time, entirely on operating income)

to encourage division managers to focus on areas that were important to customers and that added value without increasing cost. In addition to a profitability incentive, the revised plan also includes incentives for reduced rework costs, reduced sales returns, and on-time deliver¬

ies. Bonuses are calculated and awarded semiannually on the following basis. A base bonus is calculated at 2% of operating income. The bonus amount is then adjusted by the following amounts:

a. i. Reduced by excess of rework costs over 2% of operating income, ii. No adjustment ifrework costs are less than or equal to 2% of operating income.

b. Increased by $6,000 if over 98% of deliveries are on time, by $2,400 if 96-98% of deliveries are on time, and by $0 if on-time deliveries are below 96%.

c. i. Increased by $3,600 ifsales returns are less than or equal to 1.5% ofsales, ii. Decreased by 50% of excess ofsales returns over 1.5% ofsales.

Note: If the calculation of the bonus results in a negative amount for a particular period, the manager simply receives no bonus, and the negative amount is not carried forward to the next period.

Results for hummit’s Charter and Mesa Divisions for the year 2007, the first year under the new bonus plan, follow. In the previous year, 2006, under the old bonus plan, the Charter Division manager earned a bonus of $32,472 and the Mesa Division manager a bonus of $26,928.

Charter Division Mesa Division January 1, 2007 to June 30, 2007 July 1, 2007 to December 31, 2007 January 1, 2007 to June 30, 2007 July 1, 2007 to December 31, 2007 fiales Operating income On-time delivery Rework costs $ales returns $5,040,000 $ 554,400 95.4%
$ 13,800 $ 100,800 $5,280,000 $ 528,000 97.3%
$ 13,200 $ 84,000 $3,420,000 $ 410,400 98.2%
$ 7,200 $ 53,700 $3,480,000 $ 487,200 94.6%
$ 9,600 $ 51,000 Required 1. Why did Harrington need to introduce these new performance measures? That is, why does Harrington need to use these performance measures over and above the operating income numbers for the period?
2. Calculate the bonus earned by each manager for each six-month period and for the year 2007.
3. What effect did the change in the bonus plan have on each manager’s behaviour? Did the new bonus plan achieve what Harrington desired? What changes, if any, would you make to the new bonus plan?