Hello please provide an answer for Case 23-2 No. 1: Evaluate (i.e. discuss the pros and const of) the current bonus system.
Chapter 23 Control. The Managment Control Process 701 Case 23-2 ustrial Electronics, Inc.* My division had sorked hard and por no reward for our had another great year last year. We all and the results were there. But again ward for our hard work. It's very frustrating Division Manager, General Products Division Industrial Electronics, Inc. Electronics, Inc. (IE) produced a wide range actronic equipment, including signal sources uipment, communications systems, and vario s and subassemblies such as motors, genera- drobes. Total annual sales were in excess of Industrial Electronic piece parts and wis, and probes. Total annual shillion The company's objective was to maximize share der value. In most of its business areas, IE had to be wative to stay ahead of the competition. However, se competition was also significant, so the company also had to maintain tight control over costs. The company was organized by product line. Its 16 relatively autonomous divisions were managed as profit centers. The division managers reported to one of four Business Group managers who, in turn, re- ported to the company's CEO. Twenty-five managers, including all managers at the level of division manager and above, were eligi- ble for an annual management bonus award. (Many lower-level employees were included in a separate management-by-objectives" incentive plan.) The man- agement bonuses were based on company-wide per- formance. Each year, a bonus pool equal to 10 percent of the corporation's profit after taxes in excess of percent of the company's book net worth was set wide for assignment as bonuses to managers. This dunt was divided by the total salary of all the execu- cligible for a bonus. This yielded an award per of salary." The maximum bonus paid was Complaints about the management bonus system had been growing. Most of them stemmed largely from division managers whose divisions were performing well, even while the corporation as a whole was not performing well. These managers believed that the current bonus system was unfair because it failed to properly recognize their contributions. The quote cited above was representative of these complaints In response, top management, with the assistance of personnel in the corporate Human Resources and Finance departments, proposed a new management bonus plan with the following features: 1. Bonuses would be determined by the performance of the entity for which each manager was responsi- ble. That is, division manager bonuses would be based 100 percent on division performance group manager bonuses would be based 100 percent on group performance; and corporate manager bonuses would be based 100 percent on corporate performance. 2. For bonus award purposes, actual performance would be compared with targets negotiated during IE's annual budgeting process. IE's philosophy was to try to set budget targets so that they were 80-90 percent achievable by effectively performing management teams. Corporate managers knew that IE was a "high tech company that operated in many business areas in which it was difficult to forecast the future accurately. They thought that the relatively highly achievable budget targets provided the operat- ing managers with some insurance against an operat- ing environment that might turn out to be more harsh than that seen at the time of budget preparation. 3. Each division would be given an "economic profit objective equal to budgeted operating profit minus budgeted operating assets multiplied by 12 percent, which was assumed to be approximately IES weighted average cost of capital. For example, a division with an operating profit budget of $100,000 and budgeted operating assets of $500,000 would be given an economic profit objec- tive of $100,000 - 60,000 - $40,000 150 percent of salary. Historically IES M bonuses that ranged with the average cally IE's managers had been earning that ranged from of 30-120 percent of salary, average approximately 50 percent. But be- e recession, in the years 2000 and 2001, the Case of the recession s pool was zero. wright by Kenneth A. Merchant. Resiched home 702 Part 2 Management Accounting Questions 4. The actual investment base was calculated as follows: Cash Assumed to be 10 percent of cost of sales Receivables and Average actual month-end inventories balances Fixed assets Average actual end-of-month net book values 1. Evaluate (i.e., discuss the pros and cons of the cur rent bonus system. 2. Calculate the bonus award (percent of base salary that would be given to the manager of each of the following four divisions under the proposed new bonus system. These divisions are representative of the range of divisions within IE. 3. Evaluate the proposed bonus system. 4. Propose a bonus system that you believe is optimal for IE. Why do you think your proposed system is optimal? Explain. 5. If an entity's actual economic profits were exactly equal to its objective, the manager would earn a bonus equal to 50 percent of salary. The bonus would increase linearly at a rate of five percentage points for each $100,000 above the objective and be reduced linearly by five percentage points for each S100,000 below the objective. The maximum bonus would be 150 percent of salary. The minimum bonus would be zero. Division Budgeted Operating Profit $1,000 1,000 (5000) Budgeted Operating Assets $8,000 8,000 1,000 4,000 2,000 Actual Operating Profit $1,150 4,500 300 (300) 100 Actual Operating Assets $7,000 7,000 800 4,200 1,800 50 (700) 600 Case 23-3 Las Ferreteras de Mxico, S.A. de C.V.* We had been operating our company like a family, but maybe we're too big to operate that way. I think some of our people have gotten lazy, and our performance has suffered. That is why I asked for the design of a new incentive compensation plan. We need to be more competitive to survive. I want our people to focus on what they can do to improve company performance, and if we're successful, I am quite willing to share a good proportion of the proceeds of our success. --- Fernando Gonzalez Chairman and CEO. Las Ferreterias de Mxico, S.A. de C.V. THE COMPANY Las Ferreterias de Mxico, S.A. de C.V. (Ferreter was the second largest retailer of lumber, buik materials, and home improvement products equipment in Mexico. Ferreterias operated in Mexico City and throughout most of the regions of Mexico. Each of Ferreterias' stores between 10,000 to 20.000 stock keeping un in a retail sales area, an outside lumberyan a garden center. The total store areas 10,000 to 35,000 square feet. Ferreterias was founded in 1902 in a has operated 82 stores most of the norther stores offered Wing units (SKU) beryard area, and cas ranged from in a suburb of her Chor Chapter 23 Control. The Managment Control Process 701 Case 23-2 ustrial Electronics, Inc.* My division had sorked hard and por no reward for our had another great year last year. We all and the results were there. But again ward for our hard work. It's very frustrating Division Manager, General Products Division Industrial Electronics, Inc. Electronics, Inc. (IE) produced a wide range actronic equipment, including signal sources uipment, communications systems, and vario s and subassemblies such as motors, genera- drobes. Total annual sales were in excess of Industrial Electronic piece parts and wis, and probes. Total annual shillion The company's objective was to maximize share der value. In most of its business areas, IE had to be wative to stay ahead of the competition. However, se competition was also significant, so the company also had to maintain tight control over costs. The company was organized by product line. Its 16 relatively autonomous divisions were managed as profit centers. The division managers reported to one of four Business Group managers who, in turn, re- ported to the company's CEO. Twenty-five managers, including all managers at the level of division manager and above, were eligi- ble for an annual management bonus award. (Many lower-level employees were included in a separate management-by-objectives" incentive plan.) The man- agement bonuses were based on company-wide per- formance. Each year, a bonus pool equal to 10 percent of the corporation's profit after taxes in excess of percent of the company's book net worth was set wide for assignment as bonuses to managers. This dunt was divided by the total salary of all the execu- cligible for a bonus. This yielded an award per of salary." The maximum bonus paid was Complaints about the management bonus system had been growing. Most of them stemmed largely from division managers whose divisions were performing well, even while the corporation as a whole was not performing well. These managers believed that the current bonus system was unfair because it failed to properly recognize their contributions. The quote cited above was representative of these complaints In response, top management, with the assistance of personnel in the corporate Human Resources and Finance departments, proposed a new management bonus plan with the following features: 1. Bonuses would be determined by the performance of the entity for which each manager was responsi- ble. That is, division manager bonuses would be based 100 percent on division performance group manager bonuses would be based 100 percent on group performance; and corporate manager bonuses would be based 100 percent on corporate performance. 2. For bonus award purposes, actual performance would be compared with targets negotiated during IE's annual budgeting process. IE's philosophy was to try to set budget targets so that they were 80-90 percent achievable by effectively performing management teams. Corporate managers knew that IE was a "high tech company that operated in many business areas in which it was difficult to forecast the future accurately. They thought that the relatively highly achievable budget targets provided the operat- ing managers with some insurance against an operat- ing environment that might turn out to be more harsh than that seen at the time of budget preparation. 3. Each division would be given an "economic profit objective equal to budgeted operating profit minus budgeted operating assets multiplied by 12 percent, which was assumed to be approximately IES weighted average cost of capital. For example, a division with an operating profit budget of $100,000 and budgeted operating assets of $500,000 would be given an economic profit objec- tive of $100,000 - 60,000 - $40,000 150 percent of salary. Historically IES M bonuses that ranged with the average cally IE's managers had been earning that ranged from of 30-120 percent of salary, average approximately 50 percent. But be- e recession, in the years 2000 and 2001, the Case of the recession s pool was zero. wright by Kenneth A. Merchant. Resiched home 702 Part 2 Management Accounting Questions 4. The actual investment base was calculated as follows: Cash Assumed to be 10 percent of cost of sales Receivables and Average actual month-end inventories balances Fixed assets Average actual end-of-month net book values 1. Evaluate (i.e., discuss the pros and cons of the cur rent bonus system. 2. Calculate the bonus award (percent of base salary that would be given to the manager of each of the following four divisions under the proposed new bonus system. These divisions are representative of the range of divisions within IE. 3. Evaluate the proposed bonus system. 4. Propose a bonus system that you believe is optimal for IE. Why do you think your proposed system is optimal? Explain. 5. If an entity's actual economic profits were exactly equal to its objective, the manager would earn a bonus equal to 50 percent of salary. The bonus would increase linearly at a rate of five percentage points for each $100,000 above the objective and be reduced linearly by five percentage points for each S100,000 below the objective. The maximum bonus would be 150 percent of salary. The minimum bonus would be zero. Division Budgeted Operating Profit $1,000 1,000 (5000) Budgeted Operating Assets $8,000 8,000 1,000 4,000 2,000 Actual Operating Profit $1,150 4,500 300 (300) 100 Actual Operating Assets $7,000 7,000 800 4,200 1,800 50 (700) 600 Case 23-3 Las Ferreteras de Mxico, S.A. de C.V.* We had been operating our company like a family, but maybe we're too big to operate that way. I think some of our people have gotten lazy, and our performance has suffered. That is why I asked for the design of a new incentive compensation plan. We need to be more competitive to survive. I want our people to focus on what they can do to improve company performance, and if we're successful, I am quite willing to share a good proportion of the proceeds of our success. --- Fernando Gonzalez Chairman and CEO. Las Ferreterias de Mxico, S.A. de C.V. THE COMPANY Las Ferreterias de Mxico, S.A. de C.V. (Ferreter was the second largest retailer of lumber, buik materials, and home improvement products equipment in Mexico. Ferreterias operated in Mexico City and throughout most of the regions of Mexico. Each of Ferreterias' stores between 10,000 to 20.000 stock keeping un in a retail sales area, an outside lumberyan a garden center. The total store areas 10,000 to 35,000 square feet. Ferreterias was founded in 1902 in a has operated 82 stores most of the norther stores offered Wing units (SKU) beryard area, and cas ranged from in a suburb of her Chor
