Accounting homework help

Accounting homework help. Industrial Electronics
My division had another great year last year. We all worked hard, and the results were there.
But again we got no reward for our hard work. It’s very frustrating.
– Division Manager, General Products Division
Industrial Electronics, Inc.
Industrial Electronics, Inc (IE) produced a wide range of electronic equipment, including signal
sources, test equipment, communications systems, and various piece parts and subassemblies
such as motors, generators, and probes. Total annual sales were in excess of $8 billion.
The company’s objective was to maximize shareholder value. In most of its business areas, IE
had to be innovative to stay ahead of the competition. However, price competition was also
significant, so the company also had to maintain tight control over costs.
The company was organized by product line. Its 16 relatively autonomous divisions were
managed as profit centers. The division managers reported to one of four Business Group
managers who, in turn, reported to the company’s CEO.
Twenty-five managers, including all managers at the level of division manager and above, were
eligible for an annual bonus award. (Many lower-level employees were included in a separate
“management-by-objectives” incentive plan.) The management bonuses were based on
company-wide performance. Each year, a bonus pool equal to 10 percent of the corporation’s
profit after taxes in excess of 12 percent of the company’s book net worth was set aside for
assignment as bonuses to managers. This amount was divided by the total salary of all the
executives eligible for a bonus. This yielded an “award per dollar of salary.” The maximum
bonus paid was 150 percent of salary.
Historically IE’s managers had been earning bonuses that ranged from 30-120 percent of salary,
with the average approximately 50 percent. But because of the recession, in the yeas 2000-
2001, the bonus pool was zero.
Complaints about the management bonus system had been growing. Most of them stemmed
largely from division managers whose divisions were performing well, even while the
corporation as a whole was not performing well. These managers believed that the current
bonus system was unfair because it failed to properly recognize their contributions. The quote
cited above was representative of these complaints.
In response, top management, with the assistance of personnel in the corporate Human
Resources and Finance departments, proposed a new management bonus plan with the
following features:
1. Bonuses would be determined by the performance of the entity for which each manager was
responsible. That is, division manager bonuses would be based 100 percent on division
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performance; group manager bonuses would be based 100 percent on group performance; and
corporate manager bonuses would be based 100 percent on corporate performance.
2. For bonus award purposes, actual performance would be compared with targets negotiated
during IE’s annual budgeting process. IE’s philosophy was to try to set budget targets so that
they were 80-90 percent achievable by effectively performing management teams Corporate
managers knew that IE was a “high tech” company that operated in many business areas in
which it was difficult to forecast the future accurately. They thought that the relatively highly
achievable budget targets provided the operating managers with some insurance against an
operating environment that might turn out to be more harsh than that seen at the time of
budget preparation.
3. Each division would be given an “economic profit” objective equal to budgeted operating
profit minus budgeted operating assets multiplied by 12 percent, which was assumed to be
approximately IE’s weighted average cost of capital. For example, a division with an operating
profit budget of $100,000 and budgeted operating assets of $500,000 would be given an
economic profit objective of $100,000 – $60,000 = $40,000.
4. The actual investment base was calculated as follows:
Cash Assumed to be 10 percent of cost of sales
Receivables and inventories Average actual month-end balances
Fixed assets Average actual end-of-month net book values
5. If an entity’s actual economic profits were exactly equal to its objective, the manager would
earn a bonus equal to 50 percent of salary. The bonus would increase linearly at a rate of five
percentage points for each $100,000 above the objective and be reduced linearly by five
percentage points for each $100,000 below the objective. The maximum bonus would be 150
percent of salary. The minimum bonus would be zero.
000’s
Division Budgeted
Operating Profit
Budgeted
Operating Assets
Actual
Operating Profit
Actual
Operating Assets
A $1,000 $8,000 $1,150 $7,000
B 1,000 8,000 4,500 7,000
C 50 1,000 300 800
D (700) 4,000 (300) 4,200
E 600 2,000 100 1,800
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Questions
1. Evaluate (i.e., discuss the pros and cons of) the current bonus system.
2. Calculate the bonus award (percent of base salary) that would be given to the manager of
each of the following four divisions under the proposed new bonus system. These divisions are
representative of the range of divisions within IE.
3. Evaluate the proposed bonus system.
4. Propose a bonus system that you believe is optimal for IE. Why do you think your proposed
system is optimal? Explain.
Copyright © by Kenneth A. Merchant.
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