Background

Spotclean Ltd is a multinational company that manufactures and markets household cleaners in a batch-process manufacturing environment. Activity-based costing (ABC) is used to allocate overhead costs to production. Recently Spotclean has undergone a major structural reorganisation to assist it to compete more effectively in the Asia-Pacific region.

Structuring of business units

In the old structure, the Asia-Pacific region was divided into 15 business units along geographical lines. Each business unit had amanaging director(MD), who was responsible for manufacturing as well as marketing and selling operations of the business unit's products. Each MD was evaluated and remunerated on thebusiness unit profitability, as reported in a monthly business unit profit statement.Managersreport to the MD and within each business unit were evaluated and remunerated according to their personal, department and business unit performance.

The new structure was introduced a year ago. The number of manufacturing plants in the Asia-Pacific region was reduced from 15 to 4 The 15 business units continue to exist, except that 9are now responsible only for the marketing and selling of products. Only 4 business units continue to include manufacturing plants and are now responsible for supplying all of the business units in the Asia-Pacific region. Each business unit with a manufacturing plant has a manufacturing manager.

While, in the new structure theMDsof these 4 business units have ultimate responsibility for themarketingandsales operationsand all other aspects of the business unit, in practice the MD does not interfere with the manufacturing manager, who is given full responsibility for manufacturing. The MD is principally evaluated and remunerated onthe profit generated from marketing and sales activities.Marketing profit reflects actual sales revenues less standard manufacturing costs and actual sales and marketing costs. The manufacturing manager is evaluated onthe profit from manufacturing. Manufacturing profit consists of sales revenue less actual manufacturing costs. There is also a manufacturing director for the region, who has ultimate responsibility for all the manufacturing managers.

With the new company structure, monthly profit statements are prepared for each business unit. In addition to these reports, a manufacturing profit statement is prepared for the region and a total-company profit statement is prepared. The transfer price for goods transferred between the manufacturing and marketing areas within the same business unit isat standard manufacturing cost.The transfer price for goods transferred between manufacturing and marketing, not within the same business unit, isat standard cost plus 7%.

Concerns raised by business unit managers

Some business unit managers have raised concerns about some of the decisions that have been made since the restructure and wonder if the right incentives are in place. Some specific examples and issues follow:

Marketing and sales managers are in the best position to influence the level of slow-moving and obsolete inventory, through choosing whether to sell off these products or to allow them to be scrapped. In recent months there have beenhigh levels of obsolete inventory. This affects the manufacturing profit statement. There is little incentive for marketing staff to sell off or manage slow or old inventory, as they simply purchase goods atstandard costfrom manufacturing as required.

Inventory shipping and transportation is managed by manufacturing staff and the cost of this is charged to the manufacturing profit. However, the cost of these activities is heavily influenced by the deals that the sales force makes with its customers. Sales staff can negotiate three shipping and transportation options: the purchaser can pick up the inventory from Spotclean's warehouse, the inventory can be shipped by Spotclean to a central warehouse of the customer, or Spotclean can transport the inventory to the customer's supermarkets. Each of these options attracts different costs, which are treated as a component of the manufacturing profit.

When there is a change in product or raw material sourcing, the business units that include manufacturing areas absorb the manufacturing variances from standard cost (favourable or unfavourable). This results in an adjustment to standard cost in subsequent periods and affects the profit of the marketing units. For example, if a favourable purchasing variance results from the activities of the manufacturing company, the transfer price will decrease.

Another issue of concern is the role of the business unit MD in the capital expenditure approval process. It is the manufacturing director, not the MD of each business unit, who initiates all capital expenditure requests. Capital expenditure decisions affect business unit profits through the timing of cash flows, depreciation on assets, maintenance cost and so on.

Some business unit managers believe that there may be a problem in the alignment between business unit responsibility, transfer pricing policy, performance evaluation systems and management remuneration. The profits of some business units are below budget and, in the current competitive environment, head office management is concerned.

outlining any problems with the current performance measurement and incentive systems in the business units. In your report, identify clearly any underlying problems and recommend a solution that considers the following:

1.Appropriate responsibility centre type,

2.Transfer pricing policy, and

3.Performance evaluation system and management and remuneration package