The board of Zeros plc assesses divisional performance within the company primarily on the basis of a return on investment ratio. This is computed as follows:

Operating profit/BV 100 = ROI

The figure of operating profit is obtained from a standard-costing-based profit statement (see Exhibit 301.1 for the two most recent such statements).

The Blank Division

In terms of turnover the Blank Division is the second largest division within the company. The divisional manager is Joe Cool who has worked in the division for over 30 years, initially as a management accountant and then as manager from 1998. He is 63 years old and will retire in 18 months' time. In accordance with a board policy introduced to improve motivation at divisional level, his current remuneration contains a substantial bonus element based on divisional operating profit. In addition, his retirement pension will be based upon his average total earnings in his last three working years. The Blank Division was resituated in a town-centre freehold site which was purchased in 1992. A custom-built factory was erected on the site with considerable financial aid from the government, and was equipped with what were, at the time, the most modern machines available. It is a matter of considerable pride to Joe that much of this equipment has been conscientiously maintained and is still in use today. In the accounting records the freehold site and factory building are still valued at historic cost.

The Blank Division produces a wide range of sizes of surgical needles, although all are sold at a standard price (see Exhibit 301.2). Although the market is growing the competition is intense, being based on both price and, particularly, product quality.

Case study problems

Standard costs are revised at the start of each financial year (see Exhibit 301.2) and are based on the middle-range size of surgical needle produced in the division.

It is frequently pointed out at board meetings by Joe Cool that the Blank Division can still achieve a 33% mark-up on its standard unit cost, and that no competing firm can approach this level of margin.

In recent years the Blank Division has produced highly satisfactory return-on investment figures and a reasonable profit growth. The board has, however, been concerned by the large unfavorable variances which have been consistently reported. The normal retort of the Blank Division manager to queries on the size of variances has been to state unequivocally that 'it is the bottom line that matters; if that's OK you can forget the rest'. He has also consistently promoted the performance of his division during 2006 and 2007 to the board as 'excellent' and rebuffed any judgements to the contrary. Results for the last two years are given in Exhibits 301.1 and 301.3.

20062007

(000)(000)

Budgeted sale800010940

Selling price variance--

Sales volume variance(1600) U(2735) U

Actual sales64008205

Standard cost of sales48006150

Standard operating profit16002055

Cost variances

Direct material price(100) U(80) U

Direct material usage(220) U(280) U

Labour rate(150) U(130) U

Labour efficiency(200) U(300) U

Variable overhead spending(180) U(300) U

Variable overhead efficiency(250) U(275) U

Fixed overhead spending(120) U(150) U

Fixed overhead volume--

Operating profit 380540

20062007

Unit standard cost

Direct material0.500.60

Direct labour0.750.90

Variable overheads0.500.60

Fixed overheads1.252.00

Actual unit selling prices4.005.47

This case requires the analysis of budgeted versus actual performance for different organizational functions and considers strategic versus operational issues. David Jones, president and principal shareholder of Instrumental Ltd, sat at his desk reflecting on the 2007 results (Exhibit 302.1). For the second year in succession the company had exceeded its profit target. David was obviously happy with the 2007 results. All the same, he wanted to get a better feel for the relative contributions of the R&D, manufacturing and marketing departments in this overall success. With this in mind, he called his assistant, Jennifer, a recent graduate of the London Business School, into his office.

'Jennifer,' he started, 'as you can see from our recent financial results, we have exceeded our profit target by 622 000. Could you please make analysis showing how much R&D, manufacturing and marketing contributed to this?' Jennifer, flushed with all the fervour and enthusiasm of a total convert to professional management, got down to work immediately. She collected all the data in Exhibit 302.2 and then wondered somewhat disconsolately what her next step should be. Instrumental's products can be grouped into two main lines of business: electric motors (EM) and electronic instruments (EI). Both EM and EI are industrial measuring instruments and perform almost identical functions. However, EM is based on mechanical and electrical technology, whereas EI is based on the microchip.

Instrumental Ltd uses a variable costing system for internal reporting purposes.

Exhibit 301.3 Records of production and sales

2006 2007

('000 units) ('000 units)

Opening stock200600

Production20002000

Sales(1600)(1500)

Closing stock6001100

Questions

1 What criticism would you make of the approach to divisional-performance assessment employed by the board of Zeros plc?

2 Would you agree with Joe Cool's assessment that his division's performance was 'excellent' during 2006 and 2007?

3 What suggestions would you make for improving the divisional-performance measure