Management Incentives Bonuses for the directors of MP were set at the start of the budget year based on return on assets (ROA), as shown in Table 1 ROA is calculated as the profit for the year divided by the average of the opening and closing asset base (total assets less current liabilities), as recorded in the management accounts Maple Products owns its premises in Leeds outright and the land and buildings were revalued three years ago the revalued amount is recorded in the management accounts (net of depreciation) The plant and machinery in Leeds is old but serviceable and currently has a very low net book value Due to frequent shipping delays, MP holds high levels of raw materials inventory trade receivable levels are also high because MP sells to major wholesalers who negotiate long periods of credit All these factors contribute to the asset base used in the calculation of ROA ROA is the standard measure used by Kan Enterprises for all its divisions The median ROA in the air conditioning sector is 14 The top quartile reports a ROA of 17 or more Table 1 Return on Assets Asset GBP Budgeted profits for the year 10,575,000 Asset base at the start of the year 58,925,000 Budgeted asset base at the end of the year 69,500,000 Average asset base 64,212,500 ROA (using average of opening and closing assets) 16 5 Note ROA Return on assets Bonus Ratchet The agreement Kan Enterprises established with the team at MP was that when the ROA exceeds 15 , the Maple Products directors receive a bonus equal to 10 of salary There is also an incentive ratchet, with a bonus of 15 of salary if ROA exceeds 18 5 , or a bonus of 20 of salary if ROA exceeds 22 The base bonus (10 of salary) results in directors' total remuneration being around the median for the sector A bonus of 15 of salary puts the directors just below the top quartile for the sector, while a bonus of 20 of salary puts the directors just below the top decile for the sector Detail of Budgeted Profit for the Year Gloria Kan inspected the detailed original budget for Maple Products (Table 2), prepared the previous January Table 2 Original Budgeted Profit for Year Ended 31 December Units sold 3,900,000 Budget item (GBP) Sales revenues Europe 25 00 per unit 97,500,000 total Variable costs Direct materials 4 68 per unit 18,252,000 total Direct labour 5 90 per unit 23,010,000 total Variable production overhead 3 90 per unit 15,210,000 total Variable selling expenses 2 00 per unit 7,800,000 total Total variable costs 16 48 per unit 64,272,000 Income Contribution from pumps 8 52 per unit 33,228,000 total Net income from repairs and maintenance 1,050,000 total Profits before fixed costs 34,278,000 total Fixed costs Fixed production overhead 5,551,000 total Fixed selling expenses 8,567,000 total Fixed administration costs 9,585,000 total Total fixed costs 23,703,000 Budgeted profit for the year 10,575,000 The managing director of MP has overall responsibility for achieving the profit for the year this director is also responsible for MP investment decisions EMEA Regional Report The team in charge of businesses in the EMEA (Europe, the Middle East, and Africa) region also prepared business notes, which include details on Maple Products Some events had occurred after the original budget was drawn up and were not reflected in the figures in Table 2 The EMEA report noted that a new sales office had been set up in April for Maple Products using unoccupied space at Kan Enterprises' headquarters in Hong Kong, to take advantage of Kan Enterprises' contacts in the Asia Pacific region The estimate for sales in the Asia Pacific region at the time of this development was in the order of 300,000 units from April to December (this would have resulted in 4,200,000 total units sold for the year) However, the sales office had been enormously successful, resulting in 600,000 units sold in the Asia Pacific region, and therefore worldwide sales of 4,500,000 units for the year Questions 1 Using the budgeted data in Table 2, calculate (a) the total budgeted profits for sales of 4,200,000 units and 4,500,000 units and (b) the sales volume variance (differences in profits from the original budgeted profits) for sales of 4,200,000 units and 4,500,000 units Note Net income from repairs and maintenance is not expected to change with the increase in output because most new units do not require repairs or maintenance in the first year 2 Calculate the budgeted ROA for sales outputs of 4,200,000 and 4,500,000 units Assume that any additional profits over the original budget will be invested in the business and therefore increase the budgeted closing asset base

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Management Incentives Bonuses for the directors of MP were set at the start of the budget year based on return on assets (ROA), as shown

Management Incentives

Bonuses for the directors of MP were set at the start of the budget year based on return on assets (ROA), as shown in Table 1. ROA is calculated as the profit for the year divided by the average of the opening and closing asset base (total assets less current liabilities), as recorded in the management accounts.

Maple Products owns its premises in Leeds outright and the land and buildings were revalued three years ago; the revalued amount is recorded in the management accounts (net of depreciation). The plant and machinery in Leeds is old but serviceable and currently has a very low net book value. Due to frequent shipping delays, MP holds high levels of raw materials inventory; trade receivable levels are also high because MP sells to major wholesalers who negotiate long periods of credit. All these factors contribute to the asset base used in the calculation of ROA.

ROA is the standard measure used by Kan Enterprises for all its divisions. The median ROA in the air conditioning sector is 14%. The top quartile reports a ROA of 17% or more.

Table 1. Return on Assets

Asset

GBP

Budgeted profits for the year

10,575,000

Asset base at the start of the year

58,925,000

Budgeted asset base at the end of the year

69,500,000

Average asset base

64,212,500

ROA (using average of opening and closing assets)

16.5%

Note: ROA: Return on assets

Bonus Ratchet

The agreement Kan Enterprises established with the team at MP was that when the ROA exceeds 15%, the Maple Products directors receive a bonus equal to 10% of salary. There is also an incentive ratchet, with a bonus of 15% of salary if ROA exceeds 18.5%, or a bonus of 20% of salary if ROA exceeds 22%.

The base bonus (10% of salary) results in directors' total remuneration being around the median for the sector. A bonus of 15% of salary puts the directors just below the top quartile for the sector, while a bonus of 20% of salary puts the directors just below the top decile for the sector.

Detail of Budgeted Profit for the Year

Gloria Kan inspected the detailed original budget for Maple Products (Table 2), prepared the previous January.

Table 2. Original Budgeted Profit for Year Ended 31 December

Units sold 3,900,000
Budget item (GBP)
Sales revenues - Europe 25.00 per unit 97,500,000 total
Variable costs
Direct materials 4.68 per unit 18,252,000 total
Direct labour 5.90 per unit 23,010,000 total
Variable production overhead 3.90 per unit 15,210,000 total
Variable selling expenses 2.00 per unit 7,800,000 total
Total variable costs 16.48 per unit 64,272,000
Income
Contribution from pumps 8.52 per unit 33,228,000 total
Net income from repairs and maintenance 1,050,000 total
Profits before fixed costs 34,278,000 total
Fixed costs
Fixed production overhead 5,551,000 total
Fixed selling expenses 8,567,000 total
Fixed administration costs 9,585,000 total
Total fixed costs 23,703,000
Budgeted profit for the year 10,575,000

The managing director of MP has overall responsibility for achieving the profit for the year; this director is also responsible for MP investment decisions.

EMEA Regional Report

The team in charge of businesses in the EMEA (Europe, the Middle East, and Africa) region also prepared business notes, which include details on Maple Products. Some events had occurred after the original budget was drawn up and were not reflected in the figures in Table 2.

The EMEA report noted that a new sales office had been set up in April for Maple Products using unoccupied space at Kan Enterprises' headquarters in Hong Kong, to take advantage of Kan Enterprises' contacts in the Asia-Pacific region. The estimate for sales in the Asia-Pacific region at the time of this development was in the order of 300,000 units from April to December (this would have resulted in 4,200,000 total units sold for the year). However, the sales office had been enormously successful, resulting in 600,000 units sold in the Asia-Pacific region, and therefore worldwide sales of 4,500,000 units for the year.

Questions

Using the budgeted data in Table 2, calculate (a) the total budgeted profits for sales of 4,200,000 units and 4,500,000 units and (b) the sales volume variance (differences in profits from the original budgeted profits) for sales of 4,200,000 units and 4,500,000 units. Note: Net income from repairs and maintenance is not expected to change with the increase in output because most new units do not require repairs or maintenance in the first year.

Calculate the budgeted ROA for sales outputs of 4,200,000 and 4,500,000 units. Assume that any additional profits over the original budget will be invested in the business and therefore increase the budgeted closing asset base.