Leo’s Four-Plex Theater

Questions 1. Where is the theater’s control system lacking? Are the controls themselves weak or
incomplete, or are the theatre’s problems caused primarily because of lack of discipline in using the
existing controls? 2. What control improvements would you suggest for Leo’s Four-Plex?

List the controls discussed in the case and the purpose of each.
Controls Purpose
Color-coded and dated tickets Ensure that the individual (4) theaters will not be
oversold for any given showing
Serial numbered tickets plus cash count Allow reconciliation between tickets sold and
cash collected
Turnstile Controlled access to theater. Allow for ticket
collection.
Locked stub box Allow for reconciliation between tickets collected
and attendance counts.

Analysis of the problems and possible solutions:

1. The cashier’s collect less cash than the value of the tickets sold (or missing). The common solution is
to make the cashier’s pay for the shortage, or at least have shortages comprise a significant portion of
the employees’ performance evaluation.
2. Some refreshment stands sales seem to be lost because the attendants do not collect cash from the
customers (perhaps their friends). There are several possibilities here. One is better direct supervision.
Another is separation of duties between the person who rings up the sale and the person who delivers
the refreshments to the customer. (The delivery would not be made unless the customer had a receipt.)
A third is to hire more attendants from a different town because they would be less likely to know, and
thus to collude, with the customers.
3. Tickets of the wrong color or wrong date are found in the stub boxes. The ticket-takers must be
reminded of the importance of looking at the colors and dates, and they must be held accountable for
implementing the control properly.
4. The manager is giving away too many passes, including some for unacceptable purposes. The pass
policy must be clarified, and the manager must be warned not to abuse the privilege. If the manager
cannot be trusted, then he should probably not be the manager. The owner could get involved in
approving the issuance of passes, but this is probably more costly than beneficial.
5. The ticket collectors are apparently admitting some friends who had not bought tickets. Supervision,
or even better undercover surveillance, is probably the best solution. If ticket collectors are caught, they
should be dealt with harshly to discourage others from engaging in the practice.

How could each of the control problems at Leo’s Theatre be solved with the use of Cultural Controls?
- Code of conduct
- Group rewards
- Employee rotation
- Tone at the top
Private Fitness Case

Addressing the Specific Problems

Students must first recognize that there are two problems to be solved—the theft of cash and the
unrecorded revenue. There are a lot of internal control options, most of which involve options that go
far beyond the accounting. I like to divide the options into three categories, (1) action controls—those
that limit the manager’s ability to perform the specific bad actions, (2) results controls—those that
improve the pay-for-performance system, and (3) personnel/cultural controls—those that encourage
either more employee honesty (self-control) or encourage employees to monitor each other’s behaviors
(social control).

1. Action controls—e.g., hire a supervisor (accomplish “separation of duties”), camera with videotaping
capability, locked cash box, use of receipts and reconciliations with cash in the drawer/cash register.

2. Results controls—Students must recognize that providing Kate a bonus of, say, 10% of revenues or
profits does little to reduce her motivation to pocket 100% of the revenue through theft of cash or direct
pocketing of revenues. Revenue-based bonus systems could be effective motivators if Rosemary is sure
that every client is recognized on the system, but by themselves they won’t ensure that every client is
recognized. There are some more creative and better possibilities. For example, should instructors be
set up as “little entrepreneurs”? Let them keep all the revenue, but charge them a fixed fee for access to
the facility. If this alternative is chosen, then Rosemary would have to develop a fee schedule that could
be based on a cost accounting.

3. Personnel/cultural controls—stricter hiring criteria (e.g., background checks), building a strong

“family” culture, group rewards (which encourage mutual monitoring). Establish ethical standards etc.

The Platinum Pointe Land Deal Case

Issues:
1. Whether Harry Hepburn should make the projection on the specific project more optimistic or
not.
2. Evaluate what can be done to either decrease the required IRR benchmark related to this
project or to increase the expected IRR of the project.
Both equally important, however it seems that IRR issue should be attempted to be resolved first:
Alternatives:
- Increase IRR
- Decrease required IRR (risk)
- Don’t change
Ethical Problem:
1. Harry submits the forecast as planned – Consequences: project will be rejected, and the division
will be downsized.
2. Harry makes the forecast more optimistic – Consequences: project gets funded and employee
layoff could be averted. RBH would lose credibility with joint venture partner if the project earns
less than forecast.
Way to increase IRR/decrease required IRR:
As Harry directly supervise the executives and the issue is about financial returns, results control is the
most appropriate for this issue. 1) Let VPs know about the problem and the fact this project is critical for
the continuity of the division as is. This understanding will help establish the link between performance
and compensation. 2) Together, they should come up with ideas and set specific goals for increasing IRR
and/or lowering risk of the project in their functional areas. The targets set for VPs should be aligned
with their functional areas/responsibilities as much as possible. If some targets involve more than one
area, they should know specifically with whom should they cooperate to achieve success on that mutual
goal. The idea behind it is that VPs should know specifically how can they influence the project’s IRR and
risk, so they would feel responsibility and ability to influence and achieve their own specific targets.
Second, the goals have to be specific as possible, so that VPs would know how much more effort should
put to succeed.
Specific solutions:
- By not making the purchase (investment) until all political issues are resolved, the political risk can be
decreased to minimum saving 1.5% in required IRR
- With the appropriate goals and strict incentives are set for VPs the risks in development, market, and
financial areas may be reduced by further cumulative 1.5%. Measures to be taken may include: hedging
the interest rate risk with derivatives (financial), making early sales (market), securitization of debt
(financial), overseeing the construction process thoroughly to ensure timeliness (development), etc. It is
important that other projects of this division, which are currently on the way, would not be neglected or
paid less attention to. They are also crucial for the divisions success. Harry should oversee their work in
order to ensure that no risk manipulation and unjustified assumption/forecasts take place.
 

Case Study Control at Bellagio Casino Resort

Key Issues: According to my view following are the key issues with the Bellagio management control
system:

 Bellagio follows a combination of action, people and result control to achieve the desire
objectives. However, in few cases it is observed that the management could not establish tight
result control. For example, drop is one of the gaming revenue indicators for Blackjack, but the
management don’t track the drop data or the hold percentage for each table at the end of each
shift. Instead, they check the data at the end of the day and face difficulty to find the root cause
in case of any deviation.
 It seems that the Bellagio management is too lenient to establish the customer
centric performance oriented culture. Whereas, customer satisfaction is the key for success in
the gaming business, management does not take any harsh decision against a dealer
who performs consistently poor (evaluated by the mystery shoppers) despite giving sufficient
training and chances.
 Tips are equally distributed amongst the dealers although all of them do not perform equally
well. This would demotivate the dealers who get more tips because of their professional and
customer centric behavior and discourage the non-performers to perform better.
 Bonus was paid only to the management personnel. No other casino personnel were entitled to
receive the cash bonus except tips.

Recommendations:
  The drop and hold percentage of the table to be tracked for each table at the end of each shift.
To facilitate that a pilot project with RFID chips may be introduced. A money scanner may be
installed with the drop box to ensure the record of customers’ money deposit. These data will
also help to verify actual versus estimated drop data frequently and identify the root cause of
variance.
 Bellagio management should be strict in ensuring the customer centric performance oriented
culture. Despite giving sufficient training and warning, dealers consistently performing poor
should be removed from the floor.
 Tips offered to a dealer should be enjoyed solely by that dealer. A dealer receiving more tips
means customers are very satisfied upon him. So these tips should not be equally distributed to
all other dealers whereas everyone does not perform the same.
 All employees (floor manager, pit bosses) should be entitled to receive the bonus. Apart from
the intrinsic reward this will also help them to remain motivated.

Zumwald Case

Zumwald AG Management Accounting Background:

Zumwald AG, headquartered in Cologne, Germany, produced and sold a range of medical diagnostic
imaging systems and biomedical test equipment and instrumentation. The company was organized into
six operating divisions. Total annual revenues were slightly more than €3 billion. Zumwald manages ran
the company on a highly decentralized basis. The managers of each division were allowed considerable
autonomy if their performances were at least on plan.

Performance was evaluated, and management bonuses were assigned, based on each division’s
achievement of budgeted targets for return on invested capital (ROIC) and sales growth. Even though
the company was partly vertically integrated, division managers were allowed to source their
components from external suppliers if they so choose. In August 2002, a pricing dispute arose between
the managers of 3 of the divisions of Zumwald AG: Imaging Systems Division (ISD), the Heidelberg
Division (Heidelberg), and the Electronic Components Division (ECD).

The case describes a transfer pricing issue that is common in decentralized, divisionalized firms. The case
raises issues about internal pricing and, more generally, the operation of a decentralized management
structure. Analysis 1: If we see the facts that came out in ensuing the discussion: It is obvious why ISD
take Display tech as their supplier, a total cost difference of € 39,500. Thus, Heidelberg price would
result in ISD negative gross margin. Even though if we look in terms of contribution margin, ISD will still
get positive numbers if they took the display monitor from Heidelberg, but looking at the objective of
having the X73 as the next best thing in a competitive market, longer term it would not be viable for ISD
to continue having a negative gross margin. Analysis 2: Now if we try to analyze further on Heidelberg
and ECD facts: Looking at the top part, look like Heidelberg applies standard markup policy for their
customers (33. 3% from its total cost). This makes the price not competitive to Display tech. As a
newcomer in the industry that look for growing its market share, obviously Display tech are willing to
compete in price.
Furthermore, if we look on bottom part, with Heidelberg still having excess capacity, especially in
bidding process, it should apply the contribution margin concept, which they should only consider
relevant cost. In this case relevant cost would be € 50,000. With the target price of €140,000 Heidelberg
would get €90,000 contribution margin. The context of X-73 project was clear, that it wants to acquire
share in the competitive market, and it can’t compete if the price isn’t match with what customer are
willing to pay.

Answering the questions: 1. What sourcing decision for the X73 materials is in the best interest of? a.
The Imaging Systems Division? It is better for ISD to focus on marketing the X-73 in pricing that is
competitive. It is obvious that Display tech can give better price to offer for the X-73 display monitor. If
we look at ISD contribution margin in analysis 1, it still shows a contribution (€101,700) even though
they buy the display from Heidelberg, however in a long term; X-73 may not be a profitable product to
market. b. The Heidelberg Division? Mr Halperin says that he needs full margin business in order to
achieve his plan. In my opinion, this is the way Mr Halperin manage his division and been emphasizing
this to his salespeople. This can be illustrated with below hypothetical figures: [pic] Maybe because of
market conditions and customer price sensitivities, Heidelberg is better of giving up some business to
retain higher margins, even though they are operating in a below capacity mode.

If this is the principal that Mr Halperin apply, then he should understand Mr Bauer Argument, that his
quoted price can’t compete with display tech. but if this is not case, he should have to reduce his price
by only putting relevant cost to ISD and get that bid. Strangely, he also implied that Heidelberg engineer
had helped ISD develop the X-73, and Heidelberg was reimbursed for the cost of the engineers, but
earned no profit for this work. He should’ve considered that this assistantship does not mean that ISD
will buy the display from them at any price quote.

The other option that Heidelberg might consider to bring down the cost is: looking for source other than
ECD, or asking ECD to lower down their price, but I doubt this would bring down much of the cost. c. The
Electronic Components Division? ECD was originally established as a captive supplier to other Zumwald
divisions, so in this case eventhough ECD could quote price based on their relevant cost, and still make a
contribution, but it has established that internal pricing policy of full manufacturing cost + 20% mark up.

Overruling this policy for a 5% business could jeopardize ECD policy. zumwald other 5 division could ask
the same from ECD d. Zumwald AG? In the perspective of overall Zumwald AG, I would say is better off if
Heidelberg supplying to ISD, considering Heidelberg and ECD are not working in full capacity. Looking at
analysis 2, Zumwald could get a contribution margin of €90,000 from Heidelberg and €12,600 from ECD,
which is a total of €102,600. This is can be foregone if ISD order from Display tech.

In a sense, for Zumwald as a whole, getting it vertically integrated would be better off, since opening a
new market that can absorb most of the internal sourcing would benefit the whole organization, in
addition, also can close out Display tech act as Zumwald competitor in getting more shares in monitor
display market. But again, I don’t think this would create goal congruence between the 3 divisions, as
this would forfeit the decentralization that has been build by the company and also need to be
recognized that transfer pricing are just moving profits from one divison to another.

Need to be considered what is fair to all parties 2. What should Mr. Fettinger do regarding the X73
sourcing issue? I had to advice to Mr. Fettinger to not intervene in this dispute. If the managing directors
are all making rational arguments and Zumwald is operating in a decentralized environment, then let the
managing directors have their autonomy and freedom of sourcing. We’re talking about a small fraction
(less than 5%) of the 3 division’s business. If Fettinger intervening this, then he would be involved in
many similar disputes of all the Zumwald 6 divisions.

If the deal were a more substantial part of Zumwald’s overall business, then a stronger argument can be
made for Fettinger intervention. 3. Can a system be designed to motivate each of Zumwald’s division
managing directors to take actions that are not only in the interest of their division but also in the best
interest of Zumwald? Yes, it can, there is a possibility to establish transfer pricing policy within internal
organization (for example at variable cost plus normal markup if still have excess capacity), to induce
better sourcing decision.

Of course, this need to be followed by adjusted KPI for the managing directors; otherwise this would
lead to more complex dispute between them, hence goal congruence would be hard to achieve. In
addition, of course there is also a possibility to vertically integrate some of the relevant division to
achieve optimum result for Zumwald. However, the questions remain: would those kinds of policy really
leads to better organizational decision making? It really needs to be strategically decided weighing all
risks and benefits associated

AirTex Case – bookmarks bar under Homework Assignment

Executive Summary

Two managers recently graduated purchase Air Tex Aviation, a firm on the verge of bankruptcy.
In front of the discrepancies of the current control system, Ted Richards and Frank Edwards decide to
implement a system which improves transfer pricing, cost allocation and autonomy. Therefore, this case
wonders about the difficulties to implement it and the steps to change the management style. It What
appears to be the problem in Air Tex is linked to business which is linked with the state of mind of the
staff: there is a lack of motivation. The company is on the verge of bankruptcy because of Sarah Arthur’s
accounting system and accounting statements. We know that it is a problem because of the self-
interested behavior of Sarah Arthur in the company for 20 years. She monopolizes the decisions and the
power. The issues of autonomy, cost allocations and transfer pricing are those which have an important
impact on Air Tex profitability and its strategic vision. The issue for Ted and Frank, future managers of
Air Tex is to establish a growth over the long-term for the firm with a new strategic view.

The problem statement can be summarized as follows: How can Air Tex grow in the first five
year-period? Data analysis

There are a number of issues before Franck and Ted set up the decentralized control system,
which will be analyzed now. First, there were problems for Ted with the accounting department: over
importance of the accountant Sarah Arthur, inexistence of accounting system, a non-clear and defined
financial statements, retention of information, great power in the same hands and lack of management
skills. It provoked a lack of information for the departments and of a motivation because they are not
involved in the decision-making process. Decisions are taking arbitrarily, without the search of a
consensus. Then, Ted felt a problem linked to the personnel work ambiance, their seriousness and more
over their professionalism. This entails again a lack of information and motivation, important causes of
the issue. There is also a lack of innovative spirit, because staff is for a long time in the company and
there is no turnover or flexibility, which don’t encourage him. There is a static hierarchy, without
possibility of evolution. Ted and Frank faced a problem when they take decisions of acquiring the
company because of a lack of skills: they have a poor knowledge about the aviation business and
structural errors were made in the projections (running out of money for the end of the year). Then,
there is a difficulty to understand the accounting system and the economic situation is exigent. Indeed,
the figures in the balance sheet for Air Tex aviation appear to be very disorganized. Cost allocation for
the accounting department and the volume of expenses are not very justified ($392,350). Moreover, all
the departments have a negative net income except the fuel line activity which employed unskilled
employees. We notice that inventory is a budget item too much important, mainly aircraft inventories
(515,000$) which will not enable to invest in the future. Key Decision Criteria We saw the different
issues about the old management control system. To change it and implement a new system, Ted
Richards and Frank Edwards took few key decisions on: The strategic view with new owners, the
strategic view of AirTex Aviation must be redefined. Because the firm is near of the bankruptcy, Ted and
Franck design a new long term strategy which reduces costs, decentralizes management decision
process; implements new management styles and defines clear way to growth and move in the aviation
market.

The objectives One of the first steps is to identify Specific, Measurable, Acceptable, Realizable,
and Timetable objectives at each level of the enterprise (divisional and top level). At the top level, one of
these new objectives is to improve profitability of 20% on the next five years and increase return on
investment rate. The goal is to make objectives in correlation with the management decision process.
Other intention is to work with a cost control system, more efficient than easy to implement, in order to
change the current financial situation of the firm. Corporate Governance One of the most important
decisions is to decentralize management decision. This resolution suggests limiting the power of the
accountant. Each divisional manager will be more autonomous and can directly impact their future
performances. The decentralization of the decision process is a good way to facilitate it and help to
develop relationship between stakeholders and staff. Moral Each division is an autonomous profit
center. Each divisional manager has the possibility to take decisions on labor, supplies and material,
product mix and selling price of his department’s product. This decision right is a variable to affect the
moral of the managerial team and motivate them. It’s a start for an incentive program. New control
system implemented With the new control system, the leadership is divided between Ted Richards and
Frank Edwards as equal partners and as best friends and they try to encourage staff to take desirable
actions by decentralizing the power and involving the staff. The objective of the two partners was to
look younger the management of Air Tex, to create a new control system provision support and
information needed, and to lower the power of the accountant Sarah Arthur. We are going to analyze
the advantages and the disadvantages of this new control system. Advantages: First, the new control
system aims at providing accurate financial information to each divisional manager in order to
encourage managers to make all the decisions themselves, by creating a feedback of their operations. To
motivate managers, there is also the creation of incentives for managers: they can receive a bonus of
10% of their profit centres profit Another source of motivation for the departments consists in offering
them to manage cash by giving them receivables: the new management control system gives them a
credit granting authority, a responsibility for collections and systems of charges for delay payment.
Furthermore, autonomy is the capacity to act by oneself and it’s an inner freedom, and ability to choose
oneself to increase the motivation of managers. Its autonomy is strengthened because managers can
hire, fire and manage the salary schedule. The new management control system modifies the transfer
pricing, which refers to the pricing of assets, services and funds that transferred within an organization.
It’s simply the act of pricing of goods and services or intangibles when the same is given for use or
consumption to a related party ». 1 So, it’s the price at which products or services are transferred
between profit centres or subunits, which affects the allocation of the total profit among the parts of the
company. There can be internal (motivate managers and monitor performance) and external (taxes or
tariffs) reasons for transfer pricing. So, it decentralizes operations to make each activity a profit centre
and group them by departments. It’s a typical Activity Based Costing (ABC) method with a new cost
allocation, which consists in determining the cost of services provided to users of that service. Each
department is responsible of its results, revenues and Disadvantages: However, some disadvantages and
disturbances can result from the implementation of this new management control system. The latter
need to reduce three basic issues: lack of motivation, lack of direction and personal limitations. First,
Frank Edwards and Ted Richards didn’t know the aviation business, when they made the choice of the
purchase. They didn’t have the knowledge and the time to analyze results. Furthermore, they
implemented a very changing control system without having time to train people. They need a lot of
time to educate divisional managers and it requires a deep change in the management skills. To move
from a system where they are assisted and have without responsibility to a system which gives them
more autonomy, take a long time. That observation explained the controversy which appeared about
the management of receivables by the divisions. Furthermore, divisional managers are out of control,
because incoming cash will be managed by “amateurs”. So, an important information control is
necessary to improve the reliability of Daily Department Reports. In fact, divisional managers don’t have
the skills to draft accounting statements. There is also an issue to implement the new accounting
system, because Sarah Arthur decided to limit her work in the company and they hire a new accounting
clerk without experience. So, there is a difficulty to understand how Sarah Arthur built the financial
statement and to replace an employee with an important role in the functioning of Air Tex. So, Ted
Richards and Frank Edwards need to be very adaptive and proactive. Finally, this new control system
requires some additional costs, because each department can hire a new employee to deal with the
Daily Department Report. There is also to educate staff by creating seminars of information, and there is
a contradiction because there is a need of money. Then, they decided to create an administrative sector
which forces them to review the organization of the company, which have a cost. There is a kind of
contradiction because Air Tex tries to implement a new control system which is very costly, whereas the
firm is on the verge of bankruptcy. They decided to gamble by implementing a new control system of
course expensive, but with a long-term return on investment. It’s a bet on the future, very risky but
necessary to right the helm. Recommendations First, we think that Ted and Frank need to improve their
knowledge about the plane sector. Then, we hire as soon as possible in each department an accountant
to create a Department Daily Report and accentuate the autonomy of each division. Furthermore, a
training and development program will be interesting to improve the management skills of the staff. In
fact, we believe that division managers are not correctly trained to take vital decision in a first time. In
the future, an incentive program more accurate can be developed to motivate and attract staff. It will be
easy to implement it with the policy which consists in decentralizing the decision process. The control
process gives performance results of divisions each month. It’s why, after months, Ted and Richards will
analyze it and focus on few activities to avoid the scattering of the strengths. An effort must be made to
strengthen the links with stakeholders, in the goal to be in position to negotiate with them.

Las Ferreterias de Mexico – bookmarks bar under Accounting Text and Cases
Introduction To find out whether or not Mr. Gonzales should implement the new compensation plan, we
will initiate with a valuation of the proposed bonus plan that he is considering. This evaluation will
include an analysis of the key decisions and the persons responsible for making the decision as well as a
discussion of the proposed plan. Upon this analysis we will conclude whether it is a good idea to
implement it and state our suggestions for a modification of the plan. Valuation of the proposed bonus
plan

Included in the new bonus plan are the store managers (SM), the regional managers (RM), and the
corporate staff managers (CM). Not included are the CEO (Mr. Gonzalez) and the COO; their bonuses
would be decided by the compensation committee of the board of directors. Furthermore all other
employees not included in the plan would continue as before with a bonus in the range of 2%-5% of
base salary. Each of the company’s 82 stores is operated by a SM, who has a lot of autonomy. The 82
store are organized into 9 geographical regions.

The RMs are responsible for providing oversight and advice to the SMs, whom had little formal
education. On the top of these two manager levels are the CMs, who are responsible for a range of
centralized functions including purchasing, human resources, marketing, real estate, and investor
relations. The proposed bonus plan consists of 4 million pesos plus 8 percent of the corporate income
before bonuses and taxes in excess of 120 million pesos. The total bonus pool will be divided between
the managers as following: SMs – 70%, RMs – 15%, and CMs – 15%.

This year, the bonus pool will amount to 8,498,400 million pesos (all calculations: cf. the calculations for
the Whiz Kids questions on the last page), meaning that the bonus pool will be divided by the different
manager levels as following: •Store Managers5,948,880. 00 million pesos •Regional Managers1,274,760.
00 million pesos •Corporate Staff Managers1,274,760. 00 million pesos The SMs’ bonus pool will be
divided among the store managers based in their relative proportion of bonus units earned. The
maximum number of bonus units are 6, with a lower cutoff level at 5% ROI and a upper cutoff level at
11%

ROI. These cutoffs stipulate an acceptable minimum performance, while restricting superior
performance. Denying bonuses for exceptionally good efforts can be justified by the fact that the
performance results can be good luck. Moreover it, to a certain degree, ensures that the managers will
not be myopic, which again ensures that the company will show a more steady performance
improvement over time. Another reason for the upper cutoff level on the incentive payments might be a
desire of not paying lower-level mangers more than upper level managers.

In this case, a SM gets 72,547. 32 pesos in average, RMs get 141,640. 00 pesos, and CMs get 254,952. 00
pesos. A top-performing SM cannot earn more than 118,189. 68 pesos in bonus. This is less than the
CM’s bonus, so in this case the upper cutoff definitely ensures that the lower-level managers cannot
earn more than the upper-level managers. The bonus pools will be assigned to managers based on their
entity’s ROI, given by following formula: ROI = (bonus eligible revenues – expenses) / total store
investments.

Using ROI as the central measurement of performance causes some problems: •Accounting profit does
not reflect the total value of the company and is therefore not a completely fair method •Management
myopia: a ROI-focus stimulate shortsightedness, and can undermine long-term focus, which may not be
in the interest of the corporation •Suboptimization – it may not be in the interest of the enterprise that
individual regions will focus solely on the success of themselves rather than on the overall success of the
company •Regional differences in e. . investment prices, local expenses etc. All bonuses will be paid in
cash as soon as financial statements have been prepared. Beside the problems of using ROI as the
central measurement element we see following problems with the new incentive plan: •Not all people
are motivated by cash payment. Furthermore, cash bonuses can generate durability issues, i. e. eople
spent the money right away and quickly forgets the joy of having performed well •The reward is not
timely, as it is not necessarily given upon successes, but when the financial statement has been
prepared which in the end of the day may reduce the motivational effect •The geographical location
also has an important role in determining the success of the different stores; some stores have more
favorable locations than other, and therefore enjoy higher bonuses An issue is also whether or not all
stores should have the same performance standards.

On one hand, motivational incentives are highly individual, and preferences may vary greatly across the
regions. Tailoring reward packages to the individual employee’s preferences will undoubtedly have the
highest motivational effect, but will not keep the incentive system at the lowest possible cost. It is
difficult to implement such a tailored plan due to the vast scope of the project: it will require a huge
amount of analysis and date to map down differences.

So even though the motivational effect might be higher for an individual tailored incentive program, a
single strategy with common performance standards for all stores may be much easier and cost-efficient
to implement. The new bonuses are greater than before, and should therefore stipulate improved
operating efficiencies. Since ROI is the central element in calculating the bonuses, there is a risk of
suboptimization, but since the bonus is partially determined through the corporate profit, the managers
should also be concerned with the overall operating efficiency of the company.

Ultimately an improvement within operating efficiency should lead to an increase in market shares. By
tieing the rewards of the employees to the overall performance of the company, it would inevitably
commit them – given that the employees have sufficient possibilities for influencing the results. In this
case, the managers have a lot of responsibility and have many channels by which they can control and
influence the results.

Nevertheless, basing the bonuses partly on a group effort enforce cultural controls, as the employees
are more alert of what their colleagues are doing, hence controlling whether they are working efficiently
enough; “get to work; you’re hurting my profit sharing”. In this way, it makes good sense to base the
bonuses on a proportion of corporate profit. Proposals for modification of the compensation plan The
SMs have a lot of responsibility which is not corresponding to their level of education and their level of
bonus. Compared to the RMs and CMs, who are better educated and have more experience, however,
the bonus levels are fair.

Thus it will be difficult to justify a higher bonus-level for the SMs, based on their current educational
level. A possible solution will be to make a compulsory training program in finance and management.
When the SMs have passed the courses, they will be qualified to receive a larger bonus. The training
program will be an overall gain for the whole enterprise, since they will have more competent
employees. So even though this extension does not make the incentive plan cheaper, it will be a gain for
the company in the long run. Moreover, the further-training program will be personally satisfying for the
managers.
Another solution to what we see as the too-much responsibility-compared-to-bonus-problem, would be
to enhance the upper cutoff level. Since Mr. Gonzales is concerned about the increased compensation
expenses he should consider to lower the bonus pool and implement some non-monetary rewards, as
they are often more motivating and durable. An example could be to recognize and communicate
particular good performance throughout the company. An alternative idea to pay cash directly could be
to reward the managers by some sort of stock option.

This would further commit the managers to the company, and would probably be motivating since they
have sufficient authority to influence the actual performance of the company. To find a solution for the
personnel not included in the plan, i. e. store employees and regional sales and corporate purchasing
staff, we suggest modifying the current discretionary bonus awards. Instead of Gonzales being
responsible for giving these rewards, we suggest that this authority is delegated to the store managers
and regional managers, respectively.

These managers are in daily contact with the “neglected” employees, and it therefore seems more fair
that they delegate the rewards. In this way the bonus system will be more motivating for the personnel.
Whiz Kids Competition Number of managers% of bonus pool Store Managers:8270% Regional
Managers:915% Corporate Managers:515% Bonus Pool 4. 000. 000+(8% of corporate income before
taxes and bonuses in excess of 120000000) 4. 000. 000+(0,08*(176. 230. 000-120. 000. 000)) 8. 498. 400
The bonus pool is then divided between the different groups: Store Managers:70%*8. 498. 400= 5. 948.
880,00 Regional Managers:15%*8. 98. 400= 1. 274. 760,00 Corporate Managers:15%*8. 498. 400= 1.
274. 760,00 To find the average amount per manager we divide the pools by the number of managers in
the specific group Store Managers:5. 948. 880/82= 72. 547,32 Regional Managers:1. 274. 760/9= 141.
640,00 Corporate Managers:1. 274. 760/5= 254. 952,00 The bonus pool for the top performing store
managers: Total units in the bonus plan 6*1+9*2+11*3+20*4+15*5+8*6+4*6+3*6= 302,00 Average pay
per unit:5. 948. 880/302= 19. 698,28 Store top performing managers (6 units)= 118,189,68

Short Case – Harwood Medical Instruments PLC

Approach Students should get a general idea of the difference between economic and managerial
performance measurement, the nature of control reports, the criteria for good reports, and a beginning
of an understanding of how to read such reports. A full understanding of the meaning of control reports
requires years of experience and it also requires a thorough knowledge of the specific environment to
which the reports pertain, so students should not be disturbed if they do not understand all the nuances
of the sample reports included in the chapter. Nevertheless, they should acquire some ability to
distinguish between what is significant and what is not significant, as well as an ability to spot fairly
obvious “red flags,” that is, items requiring further investigation. Both of the last two sections can be
somewhat controversial. Whereas some companies are significantly reducing (or even eliminating)
formerly intensive variance analysis processes, most still hew to this approach. Also, the total amounts
of many executives’ incentive awards have prompted considerable criticism from certain quarters in
recent years. Cases Harwood Medical Instruments PLC allows students to consider how a change in a
bonus plan affects two divisions with quite different operating characteristics. Armco Inc.: Midwestern
Steel Division illustrates a performance measurement system with measures “cascading” from strategic
priorities down to the lowest organization levels. Formosa Plastics Group describes a company that has
an elaborate planning and performance measurement system but that uses mostly subjective
evaluations of performance and highly “smoothed” bonus payments. Problems Problem 25-1: Greene
Enterprises Performance Report (A) (B) (A - B) (C) (B - C) Budget Actual Difference Budgeted at Actual
Volume Difference Sales $56,000 $63,000 $7,000 $63,000 $ 0 Cost of goods sold 39,200 37,800 1,400 (b)
44,100 6,300 Gross margin 16,800 25,200 8,400 18,900 6,300 Direct operating expenses: Variable (a)
6,720 8,000 (1,280) (c) 7,560 (440) Fixed 10,000 10,000 0 10,000 0 Contribution to indirect costs $ 80 $
7,200 $7,120 $ 1,340 $5,860 (a) Direct operating expenses $16,720 Less: Fixed expense 10,000 Variable
expense $ 6,720 (b) Cost of sales $39,200/budgeted sales $56,000 = 70% .70 x $63,000 = $44,100, the
cost of goods sold budgeted for actual volume. (c) Budgeted variable costs $6,720/budgeted sales
$56,000 = 12% .12 x $63,000 = $7,560, the direct operating expenses budgeted at actual volume. Sales
increased substantially and were $7,000 more than expected. The indirect costs were $440 more than
expected, but the cost of sales was only 60% of sales, rather than the budgeted 70%. These two factors
account for the $5,860 difference between actual contribution to indirect costs and that expected at the
actual sales volume. (The fairness of such an appraisal depends upon whether the predicted behavior of
costs was realistic and reasonable.) Problem 25-2: Watson Company a. Performance Report(Division A
Current Year Last Year Net sales $252,000 $216,000 Cost of goods sold: Variable costs $72,000 $72,000
Division fixed costs 29,000 101,000 29,000 101,000 Gross margin 151,000 115,000 Selling and
administrative expenses: Variable expense 22,000 19,000 Division fixed expenses 25,000 47,000 22,000
41,000 Contribution to allocated costs and expenses $104,000 $ 74,000 b. Division A performed better
in the current year than in the last year when the ratios of contribution to allocated costs to sales are
made. ($104,000/$252,000 = 41% and $74,000/$216,000 = 34%.) Division managers cannot control
allocated costs, and their performance should not be judged on the basis of net income/sales because
the net income figure includes allocated costs. By comparing division contributions to allocated costs,
the amount which each Division Manager contributes toward the overall company profits can be clearly
seen. Bonuses based on division contributions would be in the best interest of both the managers and
the company. Problem 25-3: Machine Shop a. If the report is meant to be a control report, the only two
items strictly within the direct control of the machine shop supervisor are probably materials handling
costs and supplies. Depreciation of machine shop equipment is a departmental direct cost, but the
supervisor may not have much control over the amount. The costs for buildings and grounds, and
general plant are allocated costs and cannot be controlled by the supervisor. Maintenance is
controllable to the extent of the number of hours of maintenance time, but the supervisor cannot
control the standard rate applied to these hours. Training costs might be similar to maintenance costs in
that the supervisor might be able to control the amount of training time, but not the cost attributed to
training. b. Performance Report Machine Shop Budget Actual Actual over (under) Direct costs Materials
handling $ 8,000 $ 8,150 $150 Supplies 5,200 5,000 (200) Depreciation- equipment 6,000 6,000 0 19,200
19,150 (50) Indirect costs Training 4,500 5,300 Maintenance 5,000 5,800 Building and grounds 3,700
3,700 General plant expense 2,500 2,600 15,700 17,400 Total direct and indirect costs $34,900 $36,550
Problem 25-4: Hopedale Company a. Performance Report - Month of April Actual Budget (a) Variance
Favorable or (Unfavorable) Controllable costs: Salaries $12,300 $12,000 $(300) Indirect labor 20,500
19,640 (b) (860) Indirect materials 2,550 2,640 (c) 90 Other costs 9,510 9,650 (d) 140 $44,860 $43,930
$(930) (a) Budgeted costs at actual volume of 33,000 direct machine-hours consist of both fixed costs
and variable costs calculated for the actual volume. Fixed costs: Salaries $12,000 Indirect labor 17,000
Other costs 8,000 (These are the same at any volume, because they are given as a fixed amount per
month.) (b) Variable indirect labor = $.08 x 33,000=$2,640 Total indirect labor costs budgeted = $17,000
+ $2,640=$19,640 (c) Variable indirect materials = $.08 x 33,000=$2,640 (d) Variable other costs = $.05 x
33,000=$1,650 Total indirect other costs budgeted = $8,000 + $1,650=$9,650 b. Total actual costs for
March were $930 higher than budgeted, with salaries and indirect labor higher than budgeted. More
labor was probably used than expected, due to the greater volume than formerly budgeted. The
increase of $300 in salaries cost probably caused the increase in indirect labor cost also, perhaps for
such as increased janitorial costs or routine maintenance. (The expected volume was 29,000 machine-
hours and was later revised to 34,000 machine-hours.) Although the actual volume of activity at 33,000
machine-hours was less than the revised budgeted 34,000 machine-hours, the favorable variances still
resulted because the original budget was apparently based on a total yearly volume which is proving to
be low. There seems to be good cost control over indirect material cost, as less was spent than
budgeted. Cases Case 25-1: Harwood Medical Instruments PLC Note: This case is new for the Thirteenth
edition.. Approach The Harwood Medical Instruments case was written in response to requests from
instructors who want more short cases. It is also useful in an exam setting where multiple cases are used
to test different subject materials. The case describes a company whose manager is concerned that the
operating profit measure included in the company’s bonus plan was too narrowly focused. He
implemented a new bonus plan that reduced the weighting of importance placed on operating profit
and that included more measures, including on-time deliveries, sales returns, patent applications, scrap
and rework costs, and customer satisfaction. Presumably these factors were considered as critical
success factors. Suggested Assignment Questions 1. What was the purpose of the change? 2. Calculate
the bonus earned by each manager for each six-month period and for the year 2007. 3. Evaluate the
new plan. Is there any evidence that it produced the desired effects? What changes to the new plan
would you suggest, if any? Case Analysis and Pedagogy 1. The change was made because managers
believed that operating income was not a good summary measure of short-term financial performance.
2. The calculation of the bonuses earned in each division is shown in the tables below. (£000) Surgical
Instruments Ultrasound Diagnostic Equipment 1 2 Total 1 2 Total Base bonus 46.2 44.0 34.2 40.6
Delivery adjustment 2.0 2.0 2.0 - Sales returns adjustment (15.0) 5.0 (3.0) 5.0 Patents - 1.0 4.0 8.0
Scrap/rework (4.9) (1.0) (5.5) - Customer Satisfaction (5.0) (5.0) (5.0) - Total 23.3 46.0 69.3 26.7 53.6
80.3 Sales returns: Surgical Instruments Ultrasound Diagnostic Equipment (£000) 1 2 1 2 Std.: 1% sales
returns 420 440 285 290 Actual 450 420 291 287 Δ (30) 20 (6) 3 Bonus (15) 5 (3) 5 Scrap/rework: Surgical
Instruments Ultrasound Diagnostic Equipment (£000) 1 2 1 2 Std.: 1% of operating profit 46.2 44.0 34.2
40.6 Actual 51.1 45.0 39.7 38.2 Δ (4.9) (1.0) (5.5) 2.4 Bonus (4.9) (1.0) (5.5) - 3. There is evidence that the
plan is producing some of the desired effects. In both divisions, as managers have gotten accustomed to
the new bonus plan (2nd half of 2007), sales returns have declined, patent applications have increased,
scrap and rework costs have declined, and customer satisfaction has increased. On-time deliveries have
increased in the surgical instruments division, but not in the ultrasound diagnostic equipment division.
As a result, the bonuses to be paid increased significantly in the second half of the year. Is this
improvement good? It is if the performance factors added to the plan are truly critical success factors.
The small incremental bonuses paid would seem to be money well spent. The money should be quite
meaningful to the managers and, hence, quite motivating, yet not very expensive for the company. But
the two divisions seem to so different. Someone should consider whether the same factors should apply
to both divisions and in the same weightings of importance. Each of the individual factors should be
subjected to critical scrutiny. For example, are patents important in a division that sells such mundane
products as scissors and clamps? And for that matter, does including patents applications in a bonus
plan just encourage patent applications that never get approved, or even if they do, that never provide
any real economic benefit to the division and company. And several of the factors have very specific
performance constraints. Should the payoff functions be linear, rather than based on perhaps arbitrary
performance constraints, such as 95% deliveries on time or 90% average customer satisfaction? The case
does not provide enough information to answer these questions, but students should be able to identify
the issues

Short Case – Olympic Car Wash