SAGE SAGE Business Cases Maria Gee 2019 Abstract Kan Enterprises is a case about management accounting and control, and the problems that may arise when businesses are large, and divisions managed at a distance. The case, presented in three parts that build on each other, is viewed from the perspective of the CEO of a holding company in Hong Kong, and the directors of a recently-acquired business based in the UK. The technical accounting covered includes cost behaviour, standard costing and variance analysis, and return on assets. The discursive questions cover management incentives and other performance measures, and issues surrounding management behaviour and management decision-making. The case tests the abilities of students to manipulate accounting data and work in groups to propose solutions to management problems. Case Learning Outcomes Students should gain improved skill and understanding of the following areas by working through Parts A, B, and C in turn: - Management incentive schemes and management decision-making. Calculations of prots as sales output changes, calculations of a performance measure (return on assets), and of bonuses based on performance. Alternatives to nancial performance measures. Interpretation ofexed budgets and variances. Controllability and responsibility accounting. Part A: Background In January, Gloria Kan, CEO of Kan Enterprises, sat in her corner ofce overlooking Hong Kong harbour, puzzling over the group's most recent acquisition, Maple Products ("MP"). This business, which operates out of Leeds, UK, should have resulted in a good return for the Kan group, but something did not seem quite right. Kan Enterprises is a conglomerate with subsidiaries and joint ventures in more than 60 countries; its operations include construction, manufacturing, and telecommunications. The primary business of MP is to sell air conditioning pumps, which it does throughout Europe. MP also sells accessories to repair and maintain the pumps, but around 90% of turnover and prots are from the pumps themselves. MP purchases kits for making the air conditioning pumps, mainly from East Asia, and assembles them at its factory in Leeds. Kan Enterprises purchased MP 15 months ago and agreed on budgets with the managing director shortly after that. Gloria Kan had expected the business to generate annual prots of between 10 and 12 million GBP. 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. RCA is calculated as the prot 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. Kan Enterprises: Accounting, Control, Management Decision-Making, and Page 3 0f 13 Performance in a Newly-Acquired Business SAGE businesscases SAGE SAGE Business Cases 9 Maria Gee 2019 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 58,925,0 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) Per unit Total Sales revenues - Europe 25.00 97,500,000 Variable costs Page 4 of 13 Kan Enterprises: Accounting, Control, Management Decision-Making, and Performance in a Newly-Acquired Business SSAGE businesscasesSAGE SAGE Business Cases 9 Maria Gee 2019 Direct materials 1.68 18,252,000 Direct labour 5.90 23,010,000 Variable production overhead 3.90 15,210,000 Variable selling expenses 2.00 7,800,000 Total variable costs 16.48 64,272,000 Income Contribution from pumps 8.52 33,228,000 Net income from repairs and maintenance 1,050,000 Profits before fixed costs 34,278,000 Fixed costs Fixed production overhead 5,551,000 Fixed selling expenses 8,567,000 Fixed administration costs 9,585,000 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 esponsible 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. Page 5 of 13 Kan Enterprises: Accounting, Control, Management Decision-Making, and Performance in a Newly-Acquired Business SSAGE businesscasesThe 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. Part A Discussion Questions