Advanced: Impact of various transactions on divisional performance measures XYZ pic operates a divisional organisation struc¬ ture. The performance of each division is assessed on the basis of the Return on Capital Employed (ROCE) that it generates.

For this purpose the ROCE of a division is calculated by dividing its ‘trading profit’ for the year by the ‘book value of net assets’ that it is using at the end of the year. Trading profit is the profit earned excluding extraordinary items. Book value of net assets excludes any cash, bank account balance or overdraft because XYZ pic uses a common bank account (under the control of its head office) for all divisions.

At the start of every year each division is given a target ROCE. If the target is achieved or exceeded then the divisional executives are given a large salary bonus at the end of the year.

In 2000, XYZ pic’s division A was given a target ROCE of 15%. On 15 December 2000 A’s divisional manager receives a forecast that trading profit for 2000 would be £120 000 and net assets employed at the end of 2000 would be £820 000. This would give an ROCE of 14.6% which is slightly below A’s target.

The divisional manager immediately circulates a memorandum to his fellow executives inviting proposals to deal with the problem. By the end of the day he has received the following proposals from those executives (all of whom will lose their salary bonus if the ROCE target is not achieved):

(i) from the Works Manager: that £100 000 should be invested in new equipment resulting in cost savings of £18 000 per year over the next fifteen years;

(ii) from the ChiefAccountant: that payment of a £42 000 trade debt owed to a supplier due on 16 December 2000 be deferred until 1 January 2001. This would result in a £1000 default penalty becoming immediately due;

(iii) from the Sales Manager: that £1500 addi¬ tional production expenses be incurred and paid in order to bring completion of an order forward to 29 December 2000 from its previous scheduled date of 3 January 2001. This would allow the customer to be invoiced in December, thereby boosting 2000 profits by £6000, but would not accelerate customer payment due on 1 February 2001;

(iv) from the Head of Internal Audit: that a re¬ gional plant producing a particular product be closed allowing immediate sale for £120 000 of premises having a book value of £90000. This would result in £50000 immediate redundancy payments and a reduction in profit of £12 600 per year over the next fifteen years;

(a) You are required to assess each of the above four proposals having regard to -their effect on divisional performance in 2000 and 2001 as measured by XYZ pic’s existing criteria;

-their intrinsic commercial merits;

-any ethical matters that you consider rel¬ evant.

You should ignore taxation and inflation.

(20 marks)

(b) You are required to discuss what action XYZ pic’s Finance Director should take when the situation at division A and the above four proposals are brought to his attention.

(5 marks) (Total 25 marks) CIMA Stage 4 Management Accounting-

Decision Making