QUESTION 16 (35 Marks)

LWF Corp. was a medium sized manufacturer of fixtures for home and industrial use. Established in 1994, the firm designed, manufactured, and distributed its products throughout Canada. Until 2006, all activities had been conducted from the plant located in Toronto. With the high level of building activity in the west and the increasing cost of transportation, a new fully modern plant had been built in Edmonton to service the country west of Ontario.

Prior to the addition of the plant in Edmonton, LWF Corp. had experienced only moderate success in penetrating the Western Canadian market. Management hoped that the existence of a plant in Alberta would assist marketing efforts to gain a larger share of the residential market for fixtures. Due to the intense competitive pressure in Ontario from imported fixtures made of plastics, management believed that the major source of future sales growth for LWF lay in expansion in Western Canada.

Currently, both plants manufactured and sold the same full line of company products. The headquarters and research and development department were still located at the Toronto plant. In anticipation of future expansion, the new plant had been built to handle a larger production capacity than the older Toronto plant.

The addition of the Edmonton plant added a new dimension to the control problems of the firm. Previously, all activities had occurred at the one site. The functional structure of the firm allowed management to use a conventional responsibility accounting system in which the production function was controlled by variance analysis of actual versus standard, while the sales activities were being evaluated on the basis of sales quotas. Now, acting on the advice of a consulting firm, a profitability accounting system was being employed. This system emphasized decentralized management by delegating decision-making responsibility to the plant managers and their staffs. This system required each plant to develop and submit an annual profit plan for approval to the top managers. In addition, the system sought to make each plant an independent profit center with its own budget, financial reports, sales staff and plant staff. Both plant managers, who were very ambitious and had worked for LWF since its inception, accepted the new system very willingly.

In the initial evaluation of performance, Corporate management at head office lauded the efforts of the Toronto manager and the results attained under the new system (see Exhibit 1). They also complimented the efforts of the manager in Edmonton, particularly with respect to the profit margin, but expressed some concern about the level of ROI that had been achieved.

After one year, top management had some concerns regarding the effects of the new system. The plant managers were proposing several changes to the system relating to performance measurement such as percentage increases in profits and sales, creativity, market position, and pre-tax profit figures. Initially, top management had been concerned with two basic ratios of plant performance, namely:

1. return on investment (net income after taxes divided by total assets on the plant balance sheet), and

2. profit margin (net income after taxes divided by net sales)

as shown in Exhibit 1.

There was disagreement among the two plant managers regarding the suitability of the performance measure. Since top management was about to review the plans of both plants for the coming year, it seemed an appropriate time to raise these issues and establish some realistic policies.

The Toronto manager indicated that he was concerned about the way in which overall performance of the plant and himself were being measured. He commented on the fact that the plant in Toronto was relatively old and, as a consequence, required much heavier expenditures of maintenance than did the Edmonton plant. He also noted that his plant would be less efficient than a new plant. He was concerned that the existing practice of using after-tax profit was not useful. The after-tax profit was influenced strongly by selling prices, over which he had very little control. In summary, he thought that the most appropriate test of performance was the ability of the manager to operate his resources efficiently in light of his existing circumstances. He recommended that Corporate management consider using pre-tax total dollar profits, pre-tax return on assets, and market position as indicators of performance.

The Edmonton manager also expressed concern about the manner in which his performance was being measured. He noted that he newer assets resulted in much higher depreciation charges for his plant than for Toronto and this resulted in a low return on assets. Since he was busy trying to break into a new market and the economics of the business were such that the company had to build the plant to the current size, he felt that he should not be penalized for having excess capacity. He recommended that in order to avoid having either of the plant managers concentrating on short-run results, the evaluation system should incorporate measures such as percentage increases in dollar profits, percentage increases in sales, and contribution margin.

It was clear from the history and size of the company that only one of these managers could eventually become the president in the future. Thus, both managers were working hard to influence the design of the new system in such a way that their chances of promotion would be increased. It therefore becomes important to evaluate the system being used to measure the performance of the plants and their managers.

REQUIRED:

Comment and make recommendations that you feel are appropriate. Substantiate your answer.

EXHIBIT 1 LWF Corp. Data
	2007 Actual (000s)	2008 Budget (000s)
Toronto
Current Assets	$230	$320
Plant (cost)	7,500	7,500
Accum. Dep'n	(4,200)	(4,500)
Other Assets	470	530
Total Assets	$4,000	$3,850
Sales	$2,800	$2,860
Fixed Costs*	969.2	1,006
Variable Costs	646.2	$669
Profits (after-tax)	$616	$600.6
ROI	15.4%	15.6%
Profit Margin	22.0%	21.0%
Productive Capacity Utilized	93.3%	95.3%
Edmonton
Current Assets	$450	$370
Plant (cost)	10,000	10,500
Accum. Dep'n	(800)	(1,200)
Other Assets	350	540
Total Assets	$10,000	$10,210
Sales	$1,540	$1,631.7
Fixed Costs*	500.8	510
Variable Costs	270	297
Profits (after-tax)	$400	$428.8
ROI	4.0%	4.2%
Profit Margin	26.0%	26.3%
Productive Capacity Utilized	38.5%	40.8%
*Depreciation included - 25 year life.