Ch14 Raiborn SM

Chapter 14
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CHAPTER 14
PERFORMANCE MEASUREMENT, BALANCED
SCORECARDS, AND
PERFORMANCE REWARDS
QUESTIONS
1.
Amissionstatementexpressestheorganizationspurposesandidentifieshow
theorganizationwillmeetitscustomersneedsthroughitsproductsorservices.
Alternatively,avaluesstatementexpresses the basic organizational identity and
fundamental beliefs. The former is more shortrun oriented than the latter and
shouldchangeperiodically ascustomerpreferences change.Avalues statement
helpsprovideinformationonthefirmsorganizationalculture.Itindicatestheareas
oforganizationalimportancesothatemployeescaninternalizethesebeliefsand
values.
Organizational strategies and missions are devised to achieve the goals and
objectives of a firm. Control systems, including systems of performance
measurement,arecreatedtoimplementthemissionsandstrategiesoffirms.
2.
Performance measurement is necessary to gauge whether a firm is

pursuingitsgoalsandobjectivessuccessfully.Withoutperformancemeasurement
systems,managers,shareholders,andotherswouldhavenobasistoassessthe
successofoperationsorwhetheroperationswerebeingconductedefficientlyand
effectively.
Performancemeasuresshouldbebothqualitativeandquantitative.Themeasures
chosenmustbereasonableproxiesfortheorganizationscriticalsuccessfactors,
manyofwhicharenoteasilycapturedbyfinancialorotherquantitativemeasures.
For example, managers need to employ qualitative measures to capture
performanceinthedimensionsofcustomerservice,productandservicequality,
product innovation, advancement in job skills, and effectiveness in
communications.
In the absence of benchmarks, the performance measurements will not be
meaningful.Theperformancemeasurementscanbeinterpretedonlywhenthey
are compared to benchmark measurements such as industry performance or a
firmshistoricalperformancemeasurements.
3.
Itisexpectedthatpeoplewillactspecificallyinaccordancewithhowthey
are measured. Thus, individuals must know of and understand the performance
measures used, so that managers can make decisions in light of the effects of
alternative choices on the performance measures. Managers who are allowed to
participate in the development of the measures by which their performance is
assessedaremorelikelytoaccepttheperformancemeasuresasvalidandfairandto
understandhowtheiractionsinfluencethemeasures.
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accessible website, in whole or in part.
142
4.
Chapter 14
In selecting bases for performance measurement, managers should

consider:
whetherthemeasurescaptureprogresstowardorganizational
goals,
theinputofthosebeingevaluated,
whetherproposedmeasuresareappropriatefortheskillsand
authorityofthosebeingevaluated,and
methodstoprovideappropriatefeedbackonperformance.
Thetraditionalperformanceevaluationmeasuresforcostcentersarestandardcost
variances.Traditionalmeasuresforrevenuecentersaredeviationsfrombudgeted
revenues.Historically,thesemeasureshavebeenusedbecausetheyareconsistent
withafinancialevaluationofperformance.Themajordifferencebetweenaprofit
and an investment center is that the investment center has control over costs,
revenues, and the level of assets that is employed. Accordingly, investment
centersneedtobeevaluatedbasedontheirprofitabilityrelativetothevalueof
assetsused.Profitcentershavenoresponsibilityforassetsandcanbeevaluated
basedonprofitalone.
Because the measures must be consistent with the span of authority and
responsibilityofeachmanager,differentresponsibilitycentersmustbeevaluated
usingdifferentmeasures.Further,thechosenmeasuresmustbeconsistentwith
thetimehorizonofdecisionsmadebythemanager.
5.
Conceptually,netcashflowfromoperationsmeasuresthesamething
asnetincome.
Thus,cashflowmaybeausefulmeasureinaprofitoraninvestmentcenter.The
onlydifferencebetweennetcashflowfromoperationsandaccountingincomeare
accounting accruals. Because many accounting accruals are susceptible to
manipulation by managers, net cash flow is less prone to manipulation than
alternativeaccountingmeasures.However,itisnotbeyondmanipulationbecause
cashflowcanbeaffectedtosomeextentbyadjustingthetimingofcashreceipts
andcashdisbursements.Itisbestifbothanaccountingincomeandanetcash
flowmeasureareusedtoevaluateperformance.Eachmeasureprovidesaquality
standardfortheothermeasure.
Themostsignificantweaknessofnetcashflowfromoperationsisthatit,like
accounting income, is a shortterm measure and, thus, provides no longterm
incentives.
6.
Indefiningincome,managershaveseveralmajorconcernsthatneed
tobeaddressed:
Is the measure wholly controllable by the person being

evaluated?
Is the measure susceptible to manipulation by the person

beingevaluated?
Does the measure balance longterm and shortterm

incentives?
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143
Isthemeasuresufficiently relatedtooverallorganizational
goals?
Manipulationisanimportantconcernbecauseperformancemeasuresshouldbe
designed to capture only real performance and not manipulation of the
performancemeasure.Ifaperformancemeasurecanbemanipulatedbymanagers,
thentheycanachieveahighlevelofperformancebyeitherperformingverywell
or manipulating the measure. External measures are far superior to internal
measures in this respect because external measures cannot be internally
manipulated.
7.
Residualincome(RI)isaderivativeofreturnoninvestment(ROI).In
manyways,therelationshipbetweenRIandROIisparalleltotherelationship
betweennetpresentvalue(NPV)andinternalrateofreturn(IRR).RIprovidesa
dollar measure of divisional achievement whereas ROI provides a percentage
measure of achievement. The principal strength of RI is that it creates fewer
problemswithsuboptimizationthanROI,particularlyinanenvironmentinwhich
ROIvariessubstantiallyacrosscompanydivisions.
Economicvalueadded(EVA)issimilartoRI.ThemajordistinctionisthatEVA
usesinvestedcapitalastheassetbaseandthecompanyscostofcapitalasthe
target rate ofreturn. Thus,EVA should morenearly correlate witheffects on
shareholdervaluethanRI.AweaknessofRIisthatitistypicallycomputedusing
bookvaluesofassetsratherthanmarketvaluesandthetargetrateofreturnisnot
necessarily the cost of capital. EVA is conceptually similar to RI in its
computationsbututilizes amarketmeasureofassetvalueandappliesatarget
returnratethatreflectsthecostofcapital.EVAcomputationsalsoincludethe
effectsofincometaxes,whicharenormallyexcludedincomputingRI.
8.
By linking managerial rewards to performance, the welfare of

managers is linked to their success in achieving organizational goals and
objectives.Becauseafirmsgoalsandobjectivesarereflectedintheperformance
measurements, these measures are, in a sense, reflections of managers
contributionstotheachievementoftheorganizationsgoalsandobjectives.The
linkageforcesmanagerstobedirectlyconcernedwithachievingthosegoalsand
objectives.
The performance measurement and reward strategy for each managerial level
mustbeconsistentwiththelevelofresponsibilityandauthoritygiventoeach
level and the contribution required of each individual manager. Although the
rewardmustbeconsistentwithachievementofoverallgoals,itmustalsoconsider
theindividualcontributionsofthemanagersandhoweffectivetheywereintheir
sphereofcontrol.Also,managersathigherlevelsarerequiredtobemorelong
termorientedandmanagersatlowerlevelsarerequiredtobemoreshortterm
oriented.Theperformanceandrewardsystemmustrecognizethesedifferences.
9. The balanced scorecard (BSC) is a conceptual approach to measuring performance

that weighs performance from four perspectives. Managers choosing to apply the
BSC are demonstrating a belief that traditional financial performance measures
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Chapter 14
alone are insufficient to assess how the firm is doing and what specific actions
must be taken to improve performance. The four perspectives in the BSC are
financial, customers, learning/innovation, and internal processes. Each of these
perspectives is important because they coordinate to make a business successful:
not considering any one of these perspectives will, in the long run, cause an
organization to fail.
10.
ThebenefitofincludingsustainabilityintoaBSCisthattheorganization
canvisualizehowtheconceptaffectsitsshorttermandlongtermviability.Inclusion
also emphasizes the importance of sustainability in the organizations goals and
objectives.Byshowingperformancemeasurementsrelativetosustainabilityinthe
BSC,thevalueofthatconceptcanbeindicatedandimprovedupon.Once the effect
an intangible concept such as sustainability can be seen in relationship to an
organizations bottom line, it is less likely that the organizational employees will view
that concept as a buzzword and more likely they will see it as a natural way to
improve business.
11.
To remain competitive, there has been a shift in American industry

toward performancebased compensation for two reasons. First, workers are
becomingremovedfromtheactualproductionactivitiesbecauseofautomation,
makingitmoredifficulttobasecompensationondirectobservation.Second,there
isanefforttodevelopatighterlinkagebetweenpayandrewardtomakeworkers
moregoalorientedandmakethemmoreawareofthecontributionrequiredof
themfortheorganizationtobesuccessful.
12.
The outcome is suboptimization. When performance measures and

rewards of the individual, the organization, and its segments are compatible,
workers maximize achievement of the organizations goals while pursuing
achievement of individual goals. When performance measures and rewards of
individuals are only loosely correlated with the organizations and segments
goals,achievementoftheindividualsgoalsmaynotresultinachievementofthe
organizationsgoals.
13.
Theremustbeconsistencybetweenthetimeperspectiveofthereward
systemandtheperformancemeasurementsystem.Ifthetimeperspectiveofa
performancebased pay plan is long term, then the organization must select
performance measures that capture longterm performance. Otherwise,
suboptimizationwillresultbecauseachievementofperformancetargetswillnot
necessarilyresultinachievementofthedesiredperformanceforthedesiredtime
frame.
14.
If the organizational mission of each subunit is unique, the

performancemeasuresofeachsubunitshouldalsobeunique.Forexample,ifone
subunit has a build mission and another subunit has a harvest mission, the
formers performance measures should concentrate on market share and sales
growth.Thelattersperformancemeasuresshouldconcentrateonprofitandcash
flowperformance.
Chapter 14
Financialperformancemeasuresaremoreappropriateforshorttermperformance
measurement.Tomeasurelongtermperformance,thebettermeasuresareoften
nonfinancial. For example, profit generated is a good shortterm performance
measure,butapoorlongtermmeasure.Growthinmarketshareisoftenabetter
indicatoroflongtermperformance.
Thetimehorizonoftheperformancemeasuresislinkedtothesubunitmission.
Forexample,performancemeasuresshouldbelongtermforgrowthmissionsand
shorttermforharvestmissions.
15. Feedback is critical to improving performance. Negative or critical feedback
providesinformationaboutwhatthemanagerneedstochange.Itprovidesafocus
forimprovement.Positivefeedbackconfirmswhatthemanagerisdoingwelland
encourages continuation of behavior. Feedback provides information to (1)
improvetherewardsystemand(2)takeactiontoimprovefutureperformance.
16.
Whenemployeesholdstock,theyhavepersonalincentivestoactinthe
bestinterestofthestockholders.Byprovidingemployeeswithstock,managersare
creatinganaturalincentivecompatiblealliancebetweenafirmsemployeesandits
stockholders.Asstockholders,workersarelikelytodevelopabroadviewofthe
organization,ratherthanviewingtheorganizationrelativetotheirnarrowrolesas
employees.
Ifmanagersarealsoshareholders,thereisanaturalconsistencybetweentheiractions
asmanagersandtheiractionsasshareholders.Thissituationisnotnecessarilytrue
whenmanagersholdnostock.Consequently,performancemeasuresmustbedevised
thatcausemanagerstoactinthebestinterestofshareholders.Tobeeffective,the
performance measures must be highly correlated with shareholders objective of
wealthmaximization.
17.
Equity in the reward structure must be maintained throughout the

organization.Equityrequiresconsiderationoftherelativepayoftopmanagers
versuslowerlevelmanagersandworkers.Ultimately,anequitablepaystructure
mustbalancetheentitlementsoflabor,management,andcapital.
Aconsiderationofequityalsorequiresthattherewardsystembesensitivetolocal
differences (including living costs and tax effects) in global organizations.
Currently,itcouldeasilybearguedthatU.S.firmshaverelativelyinequitable
rewardsystems.Theinequity resultsfromthelargedisparitybetweenaverage
workerpayandtopexecutivepay.Equityisnecessaryinthelongruntokeepall
stakeholdersmotivated.
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Chapter 14
EXERCISES
18. The new division will have a mission of build. When the new division is
established, it will have only a potential customer base but no existing sales.
Accordingly,thedivisionsmajorobjectivewillbetoobtainmarketshareand
establishahighrateofsalesgrowth.Thisobjectivemustbeaccomplishedbyadding
valuetoexistingservicesprovidedtoclients.Thesameperformancemeasuresarenot
appropriateacrossadivisionsentirelifecycle.Performancemeasuresestablishedat
the outset for this new division should promote growth. Later in the life cycle,
performancemeasurementswillbeaddedordeletedtoshiftthefocustogenerationof
cashflowandprofits.Followingaremeasurementsthatwouldbeusefulinitially:
Percentage of existing clients that have video game installations. The

emphasiswouldbeonmeasuringtheannualgrowthinthisnumber.
Sales growth. Sales targets should be established and compared to actual
levelsofsalesgenerated.
Percentageofclientswhohavereceivedsalescallsprovidinginformationon
the services available from the new division. As an early lifecycle
performance measure, this measure captures the extent to which the new
divisionhasmadecontactwiththeexistingclientbase.
Numberoffacetofacesalescallsmadetoclients.Thisissimilartotheprior
measurebutemphasizespersonalcontact.
Salesandpromotionsbudget.Akeydevicetoincreasingmarketsharewillbe
theappropriateuseofadvertisingandpromotions.Budgetscanbeprepared
fortheseexpenditures,bycategory,andcanthenbecomparedagainstactual
expenditures. This is a useful tool for understanding and executing a
comprehensiveandinternallyconsistentmarketingstrategy.
19. Nosolutionprovided.Eachstudentwillhaveadifferentanswer.
22. Tosurvive,firmsneedtomanageeffectivelyforbothlongtermsurvivalandshort
termprofitability, whichareseparatemanagerial concerns.Longtermsurvivalis
relatedtoacquiringthenecessarymixofinputstoremaincompetitive.Longterm
managementinvolvesthehiringandtrainingoftalentedemployees,acquisitionof
capital improvements and technology, and the execution of strategies relative to
productsandmarkets.Shorttermmanagementisconcernedwiththeeffectiveand
efficientmanagementofresources(suchascurrentassets)overthenearterm.
Longterm and shortterm management have different objectives, so different
performancemeasuresmustbeusedtogaugesuccessineacharea.Ifnoperformance
measuresaredesignedtoevaluatelongtermsuccess,managershavenoincentiveto
be longterm oriented in their decisionmaking. Balancing performance
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147
measurementsrelativetotimehorizonsforcesmanagerstoconsiderbothshortterm
andlongtermconsequencesofdecisionsmade.
23. Division1:$320,000$2,700,000=11.9%
Division2:$450,000$2,000,000=22.5%
Division3:$4,850,000$30,200,000=16.1%
24. a.Assetturnover=SalesAverageassets
5=$3,950,000Averageassets
Averageassets=$3,950,0005
Averageassets=$790,000
b. Profitmargin=SegmentmarginSales
0.06=Segmentmargin$3,950,000
Segmentmargin=$3,950,0000.06
Segmentmargin=$237,000
c. ROI=0.065=30%
25. a. ROI=IncomeAssetsinvested
=($31,400,000$27,600,000)$8,200,000
=$3,800,000$8,200,000
=46.3%(rounded)
b. Profitmargin=IncomeSales
=$3,800,000$31,400,000
=12.1%(rounded)
c. Assetturnover=SalesAssetsinvested
=$31,400,000$8,200,000
=3.8(rounded)
d. ROI=AssetturnoverProfitmargin
=3.812.1%=46.0%(offduetorounding)
e. RI=Income(TargetrateAssetbase)
=$3,800,000(0.14$8,200,000)
=$3,800,000$1,148,000
=$2,652,000
26.Revenue
Expenses
Income
Targetreturn(0.12$14,200,000)
Residualincome
$28,000,000
(26,500,000)
$1,500,000
(1,704,000)
$(204,000)
Theresidualincomeisnegative;thus,thedivisiondidnotmeetitstargetreturn.
27.a.
Sales
Variablecosts
Fixedcosts
Division1
$5,200,000
(2,630,000)
(490,000)
Division2
$1,850,000
(330,000)
(840,000)
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Chapter 14
Income
$2,080,000
$680,000
Targetreturn:
$7,180,0000.13
(933,400)

$875,0000.13
(113,750)
Residualincome
$1,146,600
$566,250
Accordingtotheresidualincomemeasure,Division1outperformedDivision2.
b.
Sales
Variablecosts
Fixedcosts
Income
Targetreturn:
$7,180,0000.13
$875,0000.13
Residualincome
Division1
$6,240,000
(3,156,000)
(490,000)
$2,594,000
Division2
$2,220,000
(396,000)
(840,000)
$984,000
(933,400)
$1,660,600
(113,750)
$870,250
Basedontheresidualincome,Division1willoutperformDivision2inthe
absoluteamountofresidualincomegenerated.However,oneshouldnotethat
Division 2 actually had greater percentage improvement than Division 1 in
residual income from the base case in (a). Division 1s residual income
increasedby$514,000comparedtoDivision2sincreaseof$304,000.But,the
percentageincreaseinresidualincomeforDivision2was53.7percent,while
the percentage increase in residual income in Division 1 was merely 44.8
percent.
c. Division 2 has more operating leverage (relatively more fixed costs than
Division1)and,therefore,benefitstoamoresignificantextentfromanincrease
insalesvolume.Ifsalesdecreasedratherthanincreased,Division2sresidual
incomewouldhavedecreasedatafasterratethanDivision1s.
28. a. Income=SalesVariablecostsFixedcosts
=$39,000,000($39,000,0000.45)$6,750,000
=$39,000,000$17,550,000$6,750,000
=$14,700,000
ROI=IncomeAssetsinvested
=$14,700,000$25,000,000
=58.8%
b.
Income
Targetreturn(0.18$25,000,000)
Residualincome
$14,700,000
(4,500,000)
$10,200,000
c. Profitmargin=IncomeSales
=$14,700,000$39,000,000
=37.7%(rounded)
d. Assetturnover=SalesAssetsinvested
=$39,000,000$25,000,000
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149
=1.6
29. a. EVA=Aftertaxincome(CostofcapitalFMVofcapital)
$1,130,000=Aftertaxincome(0.11$29,500,000)
$1,130,000=Aftertaxincome$3,245,000
Aftertaxincome=$4,375,000
30. a. EVA=Aftertaxincome(CostofcapitalFMVofcapital)
=$2,260,000(0.11$8,900,000)
=$2,260,000$979,000
=$1,281,000
b. Determiningtheamountofcapitalinvestedinaparticulardivisionisdifficult
becausedivisionsdonotissuedebtorstockascompaniesdo.Thechallenge
facedistodividethefirmstotalvalueamongitsoperatingdivisions.
Onewouldstartbydeterminingtheamountofcapitalinvestedintheentire
companyandthenapportionthisamountamongthedivisions.Theestablished
valuewouldincludebothdebtandequity.
Thelevelofdebtinvestmentcanbeestimatedbythefaceamountofthedebtif
marketvaluescannotbeobtained.Ifthedebtispubliclytraded,themarket
valuecanbedeterminedreadily.Thestockvaluecanbefoundbymultiplying
themarketvaluepersharebythenumberofsharesoutstanding.Thisapproach
isappropriateforbothcommonandpreferredstock.
Next,thefirmstotalmarketvaluemustbedividedamongtheoperatingdivisions.
Thisstepwillinvolvesomejudgment.Oneapproachistoallocatemarketvalueto
thedivisionsbasedonrelativebookvalueofassets.Asecondapproachisto
establishthevalueofdivisionsbydeterminingthevalueofindependentcompanies
operatinginthesameindustriesasthedivisions.Themarketvalueofadivisionis
setbymultiplyingtheratioofbookvalueofthedivisiontobookvalueofthe
independentfirmbythemarketvalueoftheindependentfirm.Athirdapproach
wouldbetohireaconsultingfirmtoestablishappraisedvaluesforeachdivision.
31.
a.
b.
c.
d.
e.
f.
g.
h.
AssetTurnover
N
D
I
I
D**
N
I
I
ProfitMargin
I
I
D
D
I
N
D
?
ROI
I
?
?
I
?
N
I
?
RI
I
?
?
D*
?
I
I
?
*Aslongasthetargetreturn<100%ofassets.
**Assumingthattheautomationcreatedanincreaseintheassetbase.
32. a. MCE=ValueaddedtimeTotaltime
=6502,750
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Chapter 14
=23.6%(rounded)
b. Processproductivity=TotalunitsValueaddedtime
=742,040650
=1,141.6unitsperhour(rounded)
c. Processqualityyield=GoodunitsTotalunits
=700,000742,040
=94.3%(rounded)
d. Throughput=GoodunitsTotaltime
=700,0002,750
=254.5unitsperhour(rounded)
e. Throughput=MCEPPPQY
=0.2361,141.60.943
=254.1unitsperhour(offduetorounding)
=50,300144,000
=34.9%
=3,460,00050,300
=68.8unitsperhour
=2,923,2003,460,000
=84.5%
=2,923,200144,000
=20.3unitsperhour
e. Managementcanincreasethroughputbydecreasingnonvalueaddedactivities,
increasingtotalunitproductionandsales,decreasingtheperunitprocessingtime,
or increasing the process quality yield. These changes can be generated by
adoptingnewertechnology,reorganizingtheplant,implementingactivitybased
managementconcepts,orinvestinginpreventioncostsofquality.
=15,16025,000
=60.6%
=104,50015,160
=6.9unitsperhour
=98,400104,500
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151
=94.2%
=98,40025,000
=3.9unitsperhour
e. Throughputwouldbeusefulinajobshopbecausemostjobsaretypicallytaken
with customer agreements as to quality of production/service and time of
delivery.Calculationofthroughputwouldprovideusefulinformationforfuture
contracts.
Therewouldbeanexpectationofhighprocessqualityyieldinajobshopbecause
employees are more likely to be directly engaged in the production/service
processand,thus,abletospotandcorrectdefectsastheyoccur.
CarolinaDivisionmighthavealowMCEbecausethereisasignificantamount
ofmovedistancebetweenoperationsoridletime.
35. Eachstudentwillhaveadifferentanswer.Somesuggestionsfollow.
FinancialPerspective:
Increaserevenuefromnewcustomersby15percent
Increaserevenuefromrepeatcustomersby20percent
Lowermarketingcostsby5percent(higheruseofsocialmedia)
Increaseemployeewagesby10percent
CustomerPerspective:
Reducecustomerreturnsby10percent
Extendstorehoursonweekendsbysixhours
Offerinhousecredittocustomersbuyingover$300permonth
InternalPerspective:
Increasenumberofsuppliersbyten
Providethreehoursoftrainingtonewsalespersons
Raisesocialmediaprofileofstore(increaselikesby25percent)
Havefouremployeescreatepositiveblogsaboutstore
Reducetimetomarketofclothingpurchasesbytwoweeks
SustainabilityPerspective:
Reducetheuseofplasticbagsby75percent
Increasethenumberofproductscarriedmadefromrecycledmaterialsby10
percent
Use100percentcompactfluorescentlightbulbsinstore
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Chapter 14
Installprogrammablethermostattomanageheatingandcoolingneeds
Installlowflowtoiletsinrestrooms
39. a. Annualpretaxprofits=IncomeincreaseDepreciation
Annualdepreciation=$4,000,0005=$800,000
Year1:$300,000$800,000=$(500,000)
Year2:$500,000$800,000=$(300,000)
Year3:$760,000$800,000=$(40,000)
Year4:$3,200,000$800,000=$2,400,000
Year5:$2,900,000$800,000=$2,100,000
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b. Year1:$(500,000)0.02=$(10,000)
Year2:$(300,000)0.02=$(6,000)
Year3:$(40,000)0.02=$(800)
Year4:$2,400,0000.02=$48,000
Year5:$2,100,0000.02=$42,000
c. Whether Owan will want to invest depends largely on his personal time
horizon. Although investing in the project would reduce his compensation
duringthefirstthreeyears,thisreductionwouldbemorethanoffsetinthelast
twoyears(notconsideringthetimevalueofmoney).IfOwanstimehorizonis
threeyearsorless,heisunlikelytoinvest.Ifhistimehorizonisfouryearsor
more,heislikelytoinvest.Also,Owanmustdealwiththepossibilitythathed
be dismissed from his position in one of the first three years due to poor
performanceifheinvestsintheproject.
d. Yes.Uppermanagementwouldlikelyviewtheprojectfavorably.Usingany
reasonablediscountrate,theprojecthasapositiveNPV.
40. a. Thehighlevelofvariablepayindicatescompensationcommitteesandboards
of directors believe that CFOs are in position to substantially influence
operationsandresults.Thisisaverypositivesignalabouttherelativeinfluence
oftheCFOininfluencingfinancialandoperationalresults.
b.
TheremaybesomeriskstomakingCFOpaysodependentonoperatingand
financialresults.BecausetheCFOisinapositionofauthorityovertherecord
keepingandreportingfunctions,CFOsmaybetemptedtomanipulatereports
suchthatreportedresultsalignwiththresholdsofhigherpayoffs.Thevariable
paycreatesanincentivetoreportresultsthatprovidehigherlevelsofrewards.
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Chapter 14
PROBLEMS
41.a.
Sales
Var.costs
CM
Fixedcosts
Pretaxincome
Actual
Amounts
$39,000,000
(29,230,000)
$9,770,000
(7,230,000)
$2,540,000
Flexible
Budget
$39,000,000
(27,300,000)
$11,700,000
(7,200,000)
$4,500,000
Master
Budget
$36,000,000 100%
(25,200,000)
70%
$10,800,000 30%
(7,200,000)
$3,600,000
Actual pretax income fell short of the expected amount by $1,060,000

($3,600,000 $2,540,000), despite the fact that the actual level of sales
exceededtheexpectedlevelby$3,000,000.Thehighersalesrevenueshould
havegeneratedanadditional$900,000ofincome($4,500,000$3,600,000)if
costsandpriceshadbeenmaintainedatthebudgetedlevel.However,thiseffect
wasoverwhelmedbyeitheralowerperunitsalespriceorahigherperunit
variablecost.Budgetedcontributionmarginwas30percentofsales.
The actual CM was only 25.05 percent of sales ($9,770,000 $39,000,000).
Withoutknowingthenumberofunitsthatweresold,thepriceandvariablecost
effectscannotbedetermined.ByhavingtheactualCMdropbynearly5percent,
pretaxincomewasloweredby$1,930,000($11,700,000$9,770,000).Amore
minoreffectwastheincreaseinfixedcosts,whichexceededthebudgetedlevelby
$30,000.Thesedifferencescanbesummarizedasfollows:
Effectofincreaseinsales
Effectofincreaseinvariablecosts/pricedecrease
Effectofincreaseinfixedcosts
Neteffectonpretaxincome
$3,000,000
(4,030,000)
(30,000)
$(1,060,000)
b. Completeincomestatementsprovidemoreinformationforisolatingthecause
of differences between the budgeted and expected levels of income. By
comparingonlytheactualandbudgetedlevelsofpretaxincome,nothingis
learnedaboutthecauseofthedifference.
42. a. Analysisofthestatementrevealsastrongpositivecashflowfromoperations
thathaspermittedacquisitions,dividendpayoutsanddebtreductionsforthe
threeyears.
b.
Revised
2014Budget
NetCFfromOperatingActivities:
Netincome
Addreconcilingitems
Total
NetCFfromInvestingActivities:
Sale(purchase)ofPP&E
Sale(purchase)ofinvestments
Otherinflows(outflows)
$45,100
4,000
$49,100
$(54,600)
18,400
2,400
Original
2014Budget
$45,100
4,000
$49,100
$(4,600)
(15,800)
2,400
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Total
NetCFfromFinancingActivities:
Issuingnotesforcash
Payingdividends
Total
Netincrease(decrease)incash
155
$(33,800)
$(7,000)
(8,000)
$(15,000)
$300
$(18,000)
$(7,000)
(20,000)
$(27,000)
$4,100
c. No,thenetincreaseincashwillbeonly$300.Thecompanywouldhaveto
settleforthatorchangeplans.
d. Theabovecomparisoncanquicklygivethepresidentanoverviewoftheimpact
ofthe$50,000LANproject.Fromthecomparison,shecandecidewhethershe
issatisfiedwiththeproposedchangesincashflows.Byobservingthecashflow
effectsofaparticularprojectwithinthecontextofalloftheothercashflowsof
theentity,thedecisionmakergainsanappreciationofthesignificanceofthe
projectandoftheentitysabilitytoimplementtheproject.
43. a. Accrual accounting measures are subject to manipulation. Some of the more
commonmanipulationsinvolveincreasingordecreasingthelevelofdiscretionary
expensessuchasmaintenanceandadvertising;increasingordecreasingproduction
relativetosales;manipulatingsalesandpurchasesaroundaperiodscutoffdate;
andmanipulatingestimatesinvolvingthelifeofassets,pensionandretirement
obligations,andcostsofsettlinglegalobligations.
b. Thecashmeasureisjustassubjecttomanipulation.Forexample,cashcanbe
manipulatedbyadjustingpoliciesforcreditsales,adjustingpoliciesforretiring
accountspayable,andadvancingordelayingthepaymentofexpensesaround
cutoffdates.
c. Ifanytwomeasuresarelessthan100percentcorrelated(inotherwords,the
twoitemsmeasuredifferentthings),thenacombinationofthetwomeasures
willbelesssubjecttomanipulationthaneitherisseparately.Suchisthecase
withcashflowandaccrualincome;someofthesourcesofmanipulationcanbe
identified, and a more complete picture of segment performance will be
presented.
d. Yes.Intheory,theaccrualincomeprobablyprovidesabettergaugeoflong
termprofitabilityandisperhapsabetterpredictoroffuturecashflows.The
annual cash flow measure provides more information on liquidity, cash
management,andthepoliciesforcreditsalesandpurchases.
e. Onepossibilitywouldbetoutilizeamoredetailedbudgetedincomestatement,
whichwouldallowalinebylinecomparisonwithactual performance.This
comparison would yield more information on both performance and
manipulation.
156
Chapter 14
44. a. Actualincome:$28,250,000$25,885,000=$2,365,000
Averageassets:($10,200,000+$12,300,000)2=$11,250,000
Profitmargin=$2,365,000$28,250,000=8.4%(rounded)
Assetturnover=$28,250,000$11,250,000=2.5(rounded)
ROI=2.518.37%=21%(rounded)
IndustryROI=1.97.0%=13.3%
For 2013, the companys stores significantly outperformed the industry (21
percentversus13.3percent).Thebetterperformancewaslargelyattributableto
a higher asset turnover relative to the industry standard (2.5 versus 1.9).
Althoughtheprofitmarginalsoexceededtheindustrystandard,thedifference
wassmaller(8.4percentversus7percent).
b. Becausethestoresarealreadyoperatingsignificantlyaboveindustrynormson
asset turnover, corporate management should concentrate on improving the
profitmarginratio.Profitmargincanbeimprovedbyeitherincreasingsales
priceordecreasingcosts.However,overall,thestoresarealreadyexceedingthe
industryROI,somanagementmustbecarefulnottodecreaseassetturnover
whiletheystrivetoincreasesalespriceordecreasecosts.
c. Theadvantageofsettingperformancemeasuresatthebeginningoftheyearis
thatmanagementknowswhatthebenchmarkfiguresareastheyearunfolds.
Themaindisadvantageisthattargetssetatthebeginningoftheyeardonot
controlforindustrylevelfactorsinfluenceonresults.Consequently,managers
willbeevaluatedpartlyonfactorsthattheycannotcontrol.
45. a. Actualincome:$25,000,000$23,160,000=$1,840,000
Averageassets:($8,400,000+$9,900,000)2=$9,150,000
Assetturnover=$25,000,000$9,150,000=2.7
Actualprofitmargin:$1,840,000$25,000,000=7.4%
ActualROI=2.77.4%=20%
The division slightly missed its objective for asset turnover. However, the
divisionwassignificantlyaboveitstargetprofitmarginandROI(3.05.5%=
16.5%)levels.
b. Thedivisionneedstoimproveitsassetturnover.Partofthepoorperformance
may be caused by the large increase in assets ($9,900,000 $8,400,000 =
$1,500,000)duringtheyear.Returnsfromthenewlyacquiredassetsarelikelyto
bereapedinfutureperiodsratherthaninthepresentperiod.
c. Income[(from(a)]
Targetreturn($9,150,0000.13)
$1,840,000
(1,189,500)
Chapter 14
Residualincome
46.a.Sales(100,000$30)
CGS(5,200$9)+(94,800$10)
Grossmargin
Expenses:
Shipping(100,000$0.50)
Advertising($5,00012)
Salaries
Othercosts
Repairs
Netincomebeforetaxes
Projectedincome
Desiredreturnoninvestment
(0.13$4,500,000)
Residualincome
b.Sales(105,000$30)
CGS(15,000$9)+(90,000$10)
Grossmargin
Expenses
Shipping(105,000$0.50)
Advertising($5,00011)
Salaries[$700,000($66,0001/12)]
Othercosts
Netincome
157
$650,500
$3,000,000
(994,800)
$2,005,200
$50,000
60,000
700,000
590,000
10,000
(1,410,000)
$595,200
$595,200
(585,000)
$10,200
$3,150,000
(1,035,000)
$2,115,000
$52,500
55,000
694,500
590,000
(1,392,000)
$723,000
$723,000$4,500,000=16.07%return
c. If Sanchez actually ships the delivery to the customer, it may anger the
customer andperhaps reduce future sales to that customer. Should Sanchez
simplyaccruetherevenueandexpenseofshippingbutnotactuallyshipthe
goods, there is a possibility of misstating ending inventory and/or the
cancellation of the sale before shipment. The failure to advertise, hire a
personnel manager, and make needed repairs could adversely affect future
operations.Finally,ifSanchezssupervisordeterminesthatshehasmadesuch
decisions forthesolepurposeofobtainingherbonus,shemayfindherself
withoutajob.
47. a. LancasterDivision
ContributionMargin
FortheYearEndedNovember30,2013
($000omitted)
Sales(1,484,000units)
$25,000
Lessvariablecosts:
Costsofgoodssold
$16,500
Sellingexpenses($2,70040%)
1,080
(17,580)
Contributionmargin
$7,420
158
Chapter 14
$7,420,0001,484,000units=$5perunitCM
b. (1)Thepretaxreturnonaverageinvestmentinoperatingassetsemployedis12
percent,calculatedasfollows:
ROI=PretaxoperatingincomeAverageassets
=$1,845,000$15,375,000*
=0.12or12%
*
November30,2012assets:$15,750,0001.05=$15,000,000
Averageassetsemployed:($15,750,000+$15,000,000)2=$15,375,000
(2) RI=Pretaxoperatingincome(TargetrateAverageassets)
=$1,845,000(0.10$15,375,000)
=$1,845,000$1,537,500
=$307,500
c. Lancaster Divisionmanagement wouldhavebeen more likely toaccept the
contemplated capital acquisition if residual income were used as the
performancemeasurebecausetheinvestmentwouldhaveincreasedboththe
divisionsresidualincomeandthemanagementbonus.Usingresidualincome,
managementwouldacceptallinvestmentswithareturnhigherthan10percent
becausetheseinvestmentswouldincreasethedollarvalueofresidualincome.
WhenusingROIasaperformancemeasure,Lancastersmanagementislikely
torejectanyinvestmentthatwouldlowertheoverallROI(12percentfor2013),
eventhoughthereturnishigherthantherequiredminimum,becausethiswould
lowerbonusawards.
d. Lancaster Division must be able to control all items related to profits and
investmentifitistobeevaluatedfairlyasaninvestmentcenterusingeither
ROIorresidualincomeasperformancemeasures.Lancastermustcontrolall
elementsofthebusinessexceptthecostofinvestedcapital,whichiscontrolled
byMortonIndustrial.
(CMAadapted)
48. a. PowerboatsROI=($18,000,000$16,200,000)$15,000,000=12%
SailboatsROI=($48,000,000$42,000,000)$30,000,000=20%
b. ThePowerboatsmanageristhemostlikelytoinvestinanewproject.Suchan
investment would increase the overall ROI of the division. The Sailboats
manager wouldnotinvestbecausetheprojectedROIonthenew project is
lowerthantheprojecteddivisionalROI.
c. Suchanoutcomeisinconsistentwithoverallcorporategoals.Companywide,
the projected ROI is ($66,000,000 $58,200,000) $45,000,000 = 17%
(rounded).Thus,thecompanywouldwanttheSailboatsmanagertomakethe
investment and would prefer that the Powerboats manager reject the
Chapter 14
investment.
d. Ifthedivisionmanagerswereevaluatedonthebasisofresidualincome,they
wouldanalyzehowanewinvestmentwouldaffect theprojected overallRI
levelintheirdivisions.Theprojectedoverallchangescanbefoundasfollows:
159
160
Chapter 14
Powerboats
14%
15%
(1)%
ProjectedROIonnewproject
Requiredtargetreturn
Residualreturn
Sailboats
18%
15%
3%
TheprojectunderevaluationbythePowerboatsmanagerwouldcausehis/her
overall residual income to decline by an amount equal to 1 percent of the
investmentscost.Ontheotherhand,theprojectunderconsiderationbythe
SailboatsmanagerwouldgenerateanoverallincreaseinRIby3percentofthe
newinvestmentscost.
49. a. ProjectedEVA=$2,250,000(0.10$20,000,000)=$250,000
b. Youwouldnotinvestintheprojectifitwouldresultinadeclineinyouroverall
projectedEVA.Therefore,themaximumamountthatyouwouldinvestwould
betheamountthatwouldleaveyourprojectedEVAunchanged:
Pretaxadditionalearnings
Taxes($600,0000.40)
Aftertaxchangeinearnings
$600,000
(240,000)
$360,000
Maximuminvestment0.10=$360,000
Maximuminvestment=$360,0000.10
Maximuminvestment=$3,600,000
c. Aftertaxincome=$2,250,000+$360,000=$2,610,000
Investedcapital=$20,000,000+$3,100,000=$23,100,000
EVA=$2,610,000($23,100,0000.10)=$300,000
=18,60062,000
=30%
=1,023,00018,600
=55unitsperhour
=838,8601,023,000
=82%
=838,86062,000
e. Yes,throughputshouldonlyconsiderunitssold,notunitsproduced.Therefore,
throughput would have been considerably lower because the process yield
wouldhavebeenlower.
Throughput=GoodunitsTotaltime
Chapter 14
161
=660,00062,000
162
Chapter 14
f. TotaltimeValueaddedtime=Nonvalueaddedtime
62,00018,600=43,400
43,4000.80=34,720newNVAtime
34,720+18,600=53,320totalnewtime
=660,00053,320
g. 1,023,0000.90=920,700goodunits
Totalnewtime[(from(f)]=53,320hours
=920,70053,320
h. FawbercoulddeterminehowtheNVAtimewasbeingspentbypreparinga
processmapthatwoulddelineateallactivitiesassociatedwiththeproductionof
the product. One recommendation would be to implement an activitybased
managementsystemthatwoulddrawattentiontotheNVAactivitiesandtothe
costsassociatedwiththoseactivities.
51. a. Based on the conversation between Terry Travers and Bob Christensen, it
seemslikelythattheirmotivationwouldbestifledbythevariancereporting
systematAuroraManufacturingCompany.Theirbehaviormayincludeanyof
thefollowing:
suboptimization,aconditioninwhichindividualmanagersdisregardmajor
company goals and focus their attention solely on their own divisions
activities,and
frustrationfromuntimelyreportsandformatsthatarenotusefulintheir
dailyactivities.
b.(1) Thebenefitsthatcanbederivedbyboththecompanyanditsemployees
from a properly implemented variance reporting system include the
following:
Varianceanalysiscanprovidestandardsandmeasuresforincentiveand
performanceevaluationprograms.
Variance reporting can emphasize teamwork and interdepartmental
dependence.
Timelyreportingprovidesusefulfeedback,helpstoidentifyproblems,
andaidsinsolvingtheseproblems.Responsibilitycanbeassignedfor
theresolutionofproblems.
(2) Aurora Manufacturing Company could improve its variance reporting

system so as to increase employee motivation, by implementing the
following:
Chapter 14
163
Introduceaflexiblebudgetingsystemthatrelatesactualexpendituresto
actual levels of production on a monthly basis. In addition, the
budgetingprocessshouldbeparticipativeratherthanimposed.
Onlythosecoststhatarecontrollablebymanagersshouldbeincludedin
thevarianceanalysis.
Distribute reports on a timelier basis to allow quick resolution of
problems.
Reportsshouldbestatedintermsthataremostunderstandabletothe
users(i.e.,unitsofoutput,hours,etc.).
(CMAadapted)
52. a. Quality(InternalBusinessPerspective)
defectspermillion
costofquality(prevention,appraisal,internalandexternalfailures)
suppliercertificationorcertifieditems
reductionofsupplierbase
hoursofemployeequalitytraining
hoursofpreventivemaintenance
meantimebetweenfailures
certificationofinternaloperations
unscheduledmachinedowntime
numberofcustomercomplaints,warrantyclaims,andrecalls
unscheduledservicecall
percentageoflotsrejectedinerror
b. Cost(FinancialPerspective)
reductionindatatransactions
materialsshippedtopointofusebysupplier
dollarsofproductoutputperemployee
throughputtimesfromsuppliertocustomer
budgetingexpensetrends
projectsoperatingwithinbudget
c. Productionlineflexibility(InternalBusinessPerspective)
reductionincycletime
reductioninsetuptime
reductioninlotorbatchsize
increaseinstandardmaterialsusedperproduct
numberofpartsandlevelsinbillsofmaterial
degreeofcrosstrainingofproductionpersonnel
d. People productivity and development (Internal Business Perspective and
LearningandGrowthPerspective)
salesperperson
valueaddedperperson
employeeturnoverratios
164
Chapter 14
numberofemployeesparticipatinginimprovementteams
competitivecompensationpackages
accidentrates
absenteerates
traininghoursperemployee
employeegrievances
workdayslostduetoaccidents
percentageofappraisalscompletedontime
percentageofpositionsfilledfromwithintheorganization
percentageofemployeeswithpersonaldevelopmentplans
numberofrecognitioneventsandawards
e. Inventorymanagement(InternalBusinessPerspective)
inventoryturnoverbyproductandgroup
inventorydaysonhand
inventoryrecordaccuracy
itemsaboveorbelowtargetlimits
physicalinventoryvariances
numberofadjustmentstoinventoryrecords
f. Leadtime(InternalBusinessPerspectiveandCustomerPerspective)
deliverytimetocustomers
setupreductiontrends
inhousetransittime
supplierdeliveryperformance
throughputtimes
workinprocessinvestment
ratioofpromisedcustomerdeliveryleadtimetocumulativeproductionlead
time
administrativeprocesstimes
g. Responsiveaftersaleservice(CustomerPerspective)
numberofhoursoffieldservicetraining
averageresponsetimetoservicecalls
timetorepair
availabilityofspareparts
warrantyexpense
overstockedfieldsupplies
h. Customersatisfactionandretention(CustomerPerspective)
averagecustomerresponsetime
reductionincustomerresponsetimenumberofcompleteitemsdelivered
ontime
timefromcustomersrecognitionofneedtodelivery
quotedleadtime
customerorderprocessingtime
Chapter 14
timefromreceiptofordertostartofmanufacturing
numberofcustomerpromisesmet
percentageofcustomerordersshippedoncustomersrequestdate
customerreturnsorcomplaints
backorderrate
degreeofsatisfactionwithcomplaintresolution
numberofcustomerpartnershipsestablished
numberofcertificationsreceivedfromcustomers
enhancedcustomervalueviaaddedproductfeaturesorreducedcosts
i. Productandprocessdesign(LearningandGrowthPerspective)
timefromideatomarket
rateofnewproductintroduction
percentagefirstfirmtomarket
numberofengineeringchangesafterdesign
reductioninnewproductintroductionleadtime
newproductsalesrevenueasapercentoftotalsalerevenue
projectcompletioncycletimes
numberoferrorsfoundduringdesignreviewandevaluation
j. Manufacturingplanningprocess(InternalBusinessPerspective)
masterscheduleitemsachievedperweek
finalassemblyscheduleitemsachievedperweek
materialrequirementplansachievedperweek
manufacturingordersreleasedontime
dataaccuracyofinventory,billsofmaterials,routings,andforecast
materialandtoolingavailability
masterproductionscheduleontimeperformance
numberandtypesofchangesmadetoMPS
k. Procurementprocess(InternalBusinessPerspective)
averageprocurementcycletime
ontimeperformanceofdeliveries
reductioninpurchasingleadtime
purchaseordersreleasedontime
reductionofsupplierleadtimes
purchaseordererrors
downtimebecauseofshortages
excessinventory
percentageofpartsfromcertifiedvendors
l. Manufacturingprocess(InternalBusinessPerspective)
reductionofmanufacturingleadtime
percentagequeuetimeinmanufacturingleadtime
percentagevalueaddedtimeinmanufacturingleadtime
shoporderscompletedontime
165
166
Chapter 14
manufacturingcycletimes
unscheduledmachinedowntime
numberofpastdueoperations
yieldandscraprates
transactionsperperson
m. Managementaccomplishments(FinancialPerspective)
netincome/numberofemployees
totalsales/numberofemployees
netincome/totaldirectlaborpayroll
netincome/totalfactorypayroll
totalearnedhoursdirectlabor/totalfactorypayroll
n. Marketing/Salesandcustomerservice(CustomerPerspective)
totalsales/numberofemployees
averageleadtimeinbacklog
leadtimeperformance
premiumfreightoutbound/totalfreightoutbound
performancetosalesplan
accuracyofforecastassumptions
numberofincorrectorderentries
creditrequestprocessingtime
o. Deliveryperformance(CustomerPerspective)
timelinessandaccuracyofsupplierorderplacementanddelivery
accuracyofshopfloorscheduletocustomerrequirements
abilitytomeet,butnotexceed,MPS
correctqualityandquantitydeliverytocustomerpercustomerrequirements
analysisoflostsalesduetodeliverydeficiencies
p. Financialaccountingservices(InternalBusinessPerspective)
amountofnonvalueaddedactivity(scrap,rework,excessqueue,andmove
time)
totalvalueofusablefinishedproductproducedperperiodperemployee
totalcostandoutputvalueratios
timebasedoverheadusage
performancetobudget
percentageoflatepayments
numberofbillingerrors
numberofincorrectaccountingentries
numberofpayrollerrors
timetorespondtocustomerrequests
MeasurementexamplesinthisproblemweretakenfromAnnWillis,Aligning
PerformanceMeasurementswithOrganizationalStrategies,HospitalMaterial
ManagementQuarterly(February2001),pp.5463.
Chapter 14
167
53. Nosolutionprovided.Eachstudentwillhaveadifferentanswer,muchofwhich
will likely depend on personal experience with Subway. However, because
significant discussion is provided on the Web site about social responsibility,
students shouldbecertain tohaveasustainability element intheir discussion.
Sustainability items may be in a separate perspective or included within the
traditionalfourperspectives.Additionally,thecustomerperspectiveshouldtake
intoconsiderationthecompanysdiscussionofnutritionalleadership.
56. Nosolutionprovided.Eachstudentwillhaveadifferentanswer.However,the
followinginformationwasobtainedfromBSCsdevelopedbytheCityofWest
DesMoines.
FINANCIAL PERSPECTIVE
Strategy
Provide positive customer relationships
Pursue beneficial alliances
Strengthen sense of community
Provide sufficient infrastructure
Provide a well-maintained community
Provide a safe community
Provide sufficient service and program
delivery
CUSTOMER PERSPECTIVE
Strategy
Facilitate balanced economic
development
Maintain/Improve bond rating
Diversification of revenue sources
Measures
Approval scale in citizen survey
Number of intergovernmental
agreements
Number of hours for community
involvement
Average level of service (LOS) at
major intersections
Approval scale on citizen survey
Number of code enforcement
citizen complaints
Reduce crime statistics
Increase traffic safety
Measures
Property tax valuation
Ratio of full-time employees working
in city to the population of city
Building permit valuation
Standard and Poors and Moodys bond
rating
Maximize cost/benefit of resources
Percent of operating revenue not from
operating tax
INTERNAL PROCESSES PERSPECTIVE

Strategy
Measures
168
Chapter 14
Advance the quality initiative
Simplify customer processes
Facilitate community-based problem

solving
Percent of PATs (process action teams)

recommendations implemented
Percent of PATs completed in less
than nine months
Number of active PATs and citywide
process teams
Percent of online parks and recreation
registrations
Percent of water bills paid by
nontraditional methods
Number of hours where non-mandated
public input is sought
57. a. EVA could discourage a highgrowth strategy because this strategy almost
alwaysrequiresthatcurrentprofitabilitybereducedtoachieveaccelerationin
sales.Thereductioninprofitabilitycanbeassociatedwithincreasedcostsof
marketingandpromotionandresearchanddevelopment.
b.
Yes.Thebalancedscorecardcouldbeusedtoprovideincentivesother
thanhighcurrentprofitability.Specifically,someperformancemeasures(and
rewards)couldbedevisedforthecustomerperspective:
marketshareorgrowthinmarketshare,
customersatisfaction,
salesgrowth,
customercomplaintfrequency,and
perceivedproductquality.
Stillothermeasurescouldbedevisedfortheinnovation/learningperspective:
numberofnewproductsdeveloped,
researchanddevelopmentaccomplishments,
numberofnewproductideasgenerated,and
increaseinemployeetraining.
Thekeytoencouragingadivisiontogrow,evenifgrowthistobeachievedat
theexpenseofreducingcurrentprofits,istolinkrewardsofmanagerstothe
correctperformancemeasures.BylinkingrewardstoEVA,managersmaybe
discouraged from investing in new assets that dont provide an immediate
return.Alternatively, byfocusingmeasures oninnovationandsales growth,
incentivescanbecreatedforachievingahighgrowthrate.
59. a. Nosolutionprovided.Eachstudentwillhaveadifferentanswer.Thesevencore
areas are: beverage benefits, active healthy living, community, energy
efficiency and climate protection, sustainable packaging, water stewardship,
andworkplace.
b. Nosolutionprovided.Eachstudentwillhaveadifferentanswer.Itis,however,
likelythatstudentswillindicatetherewillbemoredifficultyinworkingtowardthe
Chapter 14
goalsinsomecountriesoverothersespeciallyinrelationshiptoissuessuchas
humanrights.
61. a. Theevaluationmeasuresareprobablyhavingalargeeffectonhisdecision.By
revealingtheinformationabouttheobsoleteinventorytothemarket,thestock
priceislikelytofall.Also,boththeincomestatementandthebalancesheetwill
sufferfromthewritedown.Boththeincomestatementeffectandthestock
marketeffectwillreducethecompensationpaidtothecompanypresident,at
leastintheshortrun.
b.
It is not an ethical treatment of either the existing shareholders or

potential shareholders. In the long run, both groups would be better off
financiallyiftheinformationabouttheobsoleteinventorywererevealedtothe
capitalmarkets.Onlyintheshortrunaretheexistingshareholdersbetteroff
from not revealing the information. However, one can easily anticipate the
lawsuitsthatwouldbefileduponthemarketdiscoveringtheobsoleteinventory
after thenewstockisissued.Afterthefallout,allpartieswouldbeworseoff
than they would have been with an honest and timely disclosure of the
inventoryinformation.Furthermore,thecompanywouldfinditverydifficultto
makecredibleassertionsaboutitsfinancialpositionwhenitneededtoreturnto
thestockmarketinthefuture.
c.
Thedecisiontodeferdisclosureuntilaftertheissuanceofthestockis
clearly an inappropriate course of action for the company. If the president
persistsinthisview,thecontrollershouldgototheauditcommitteeandreveal
the problem to them. This committee could take action to disclose the
information.Anotheralternativewouldbetotaketheinformationtothefirms
publicauditors,orasalastresortthecontrollercouldgototheSECwiththe
information.
62. Themostimportantpointtobemadeintheargumentsisthatincreasesinpay
shouldberelatedtoincreasesinperformance.Theminimumwagebestowslarger
pay without requiring a greater contribution of effort or talent. The likely
consequence is a reduction in employment because the benefits of employing
certainworkerswillnolongerexceedthecosts.Itisunreasonabletobelievethat
whenhighercostsareimposedonbusinesseswithnocompensatingbenefits,they
willmaintainthestatusquoinoperations.
Somefirmswillattempttosubstituteautomatedsystemsformanualsystemsto
reducelaborbills,andotherfirmswillfinditisnowmoredesirabletoemploy
higher skilled, more productive workers rather than lower skilled workers. In
eithercase,someoftheemployeeswhowereintendedtobebeneficiariesofthe
higherminimumwagewillbeunemployed.
Amoreproductivewaytoachievehigherincomeforworkersatthebottomofthe
wagescalewouldbetofindwaystoimprovetheirproductivityandthenreward
themforit. Forexample,subsidizedtrainingcouldbegiventominimumwage
169
170
Chapter 14
workerstoallowthemtoimprovetheirskillsandabilities.Alternatively,simply
creating an incentive structure that rewards employees for higher productivity
encouragestheworkerstoworkharder,improvetheirabilities,andacquirehigher
levelskills.Theseincentivescouldbeofferedintheformofbonuses,profitsharing,
orothertypesofvariablepay.
TwohelpfulWallStreetJournalarticlesrelatedtothisquestionwerewrittenby
GwendolynBounds:ArgumentforMinimumWageBoost(July27,2004),p.
B3;TheCaseAgainstaHigherMinimumWage(August3,2004),p.B8.
63.a. Year1:$600,000salary
Year2:$600,000salary+$75,000bonus=$675,000
Year3:$600,000salary+$350,000bonus=$950,000
b.
Iftheuniversitygoalsgosubstantiallybeyondwinningfootballgames,
conference championships, and bowl games, the coachs contract certainly
failedtopromotegoalcongruence.
c.
Indesigningcontracts,wealthmaximizingmanagerswillcommonly
attempttomaximizetheperformancemeasuresthatarethebasisofthecontract
(subjecttolegalandethicalconstraints).Iftheperformancemeasureshadbeen
differentinthecoachscontract,itisreasonabletoassumethathisbehavior
wouldhavebeendifferent.
d.
Many different performance features could be considered. For

example,wagepenaltiescouldbeincludedforanyNCAArulesinfractionor
violationofschoolpolicy.Inaddition,performancemeasurescouldbeadded
thatwouldrewardthecoachforimprovementingraduationratesandgrade
pointaveragesoffootballplayers,andinvolvementofthefootballcoachesand
players in university and other civic activities. In any case, if the coachs
compensationandjobsecurityarelessdirectlytiedtowinning,violationsof
schoolpolicyandNCAArulesaremuchlesslikelytooccur.
65. a. Whenmanagerstakeactionsthatreducelongtermgrowthandprofitabilityso
that higher shortterm profits are reported, they are stealing value from
shareholdersandotherstakeholders.Becausetheseactionsaretakentoenrich
themselvesattheexpenseofothers,theseactsareunethical.
b.
The board of directors should anticipate how various elements of

compensationwillcausemanagerstoactintheirselfinterest.Thetighterthe
incentives canbealignedbetweenmanagers andshareholders,thelessself
serving managers will behave. Thus, the board of directors should design
compensationelementsthatarebothshortterm(cash)andlongterm(stock)
oriented.
66. a. AssetturnoverisdefinedasSalesAveragetotalassets.Ifthenumeratoris
held constant and the denominator is reduced, the resulting quotient (asset
Chapter 14
171
turnover)mustbe,mathematically,larger.Dumpingcausesoneoftheassets
(rawmaterials)tobesmaller.
b.
Top management would expect the plant manager to try to recover

somethingfromtheinventoryhediscarded,ifitwereindeedobsolete.Itis
highlyunlikelythattheyintendedthatassetturnoverbeimprovedbydiscarding
assetswithoutbenefit.Itappearsthattheplantmanagerbreachedanimplied
understanding that his efforts be directed toward efficient operations. Other
ethicalconsiderationsincludeunauthorizeddumpingonpubliclandsandthe
possibilitythatthematerialsaretoxic.
c.
Jensensoptionsincludethefollowing:
Remainsilent.
Discussthematterwiththeplantmanager.
Holdaconfidentialmeetingwithsomeonehighenoughintheorganizationto
assesstheproblemandtakeanyrequiredaction.
IfJensenremainssilent,hecanbeconsideredanaccomplicetothedumping
and,thus,wouldbeasunethicalastheplantmanager.Ifhetriestotalktothe
plantmanager,Jensenmaybeabletoconvincethemanageroftheimpropriety
ofthedumping.Ofcourse,itisalsopossiblethatthemanagerwouldignore
JensensconcernsandpossiblyfireJensen.IfJensentalkstosomeonewiththe
expertiseandpowertoascertainifthereisaproblem,Jensenmaybeconvinced
thatthedumpingisacceptabletoboththecompanyand(iflegitimate)may
evenbeconsideredgoodforthepublicinthatitiscleanlandfill.Ifinstead,the
dumpingisaproblem, Jensenhasdonehis ethical duty.(Jensenshould,of
course,attempttotalktotheplantmanagerfirsttodetermineallthefactsandto
avoidtheimplicationofgoingoverthebossshead.)
67. a. For2013,FFVgeneratedanROIof25percent,ascalculatedbelow:
ROI=OperatingincomeTotalassets
=$4,000,000$16,000,000
=25%(rounded)
For2013,assumingFFVpaid$6.4millionforGGI,GGIwouldhavegenerated
anROIoflessthan20percent,ascalculatedbelow:
ROI=OperatingincomeTotalassets
=$1,200,000$6,400,000
=18.8%(rounded)
Peachwouldhaveexpectedthathisbonuswouldbelostorreducedifhehad
investedinGGI.TheinvestmentwouldhavecausedtheROIofFFVtodropas
indicatedbelow:
CombinedROI=OperatingincomeTotalassets
=$5,200,000$22,400,000
=23.2%(rounded)
172
Chapter 14
b.
Todeterminetheeffectoftheacquisition,oneonlyneedstodetermine
theamountofresidualincomegeneratedbyGGI:
Operatingincome
Targetreturn($6,400,0000.15)
ResidualincomegeneratedbyGGI
$1,200,000
960,000
$240,000
Becausetheresidualincomeispositive,theacquisitionofGGIwouldhavehad
apositiveeffectonPeachsbonusexpectations.
c.
No,itisthedutyoftopmanagementtoprovideincentivestoPeach
suchthatifitisinthebestinterestofDrummondvilleAutomotivetoinvest,itis
alsointhebestinterestofPeachtoinvest.SuchisnotthecasewiththeROI
performancemeasure.
d.
No, the present system heavily biases against new investment in

anything.ThebestwaymanagerscanprotecttheircurrentROIlevelsistonot
invest.
68. ToinducethecandidatetoaccepttheBuenosAiresassignment,sheshouldbeoffered
incentives thatmaketheassignmentattractiverelative tohercurrentassignment.
Becausesheismarriedandhaschildren,therearesignificantissuesregardingchild
care,educationofthechildren,andspousalemployment.Thecompanycouldinclude
amongtheofferedincentivesplacementservicesforthespouse,childcareandprivate
education for the children, and even maid services for the home. Further, the
company could provide housing for the family in Buenos Aires and assist the
candidateinsellingherNewYorkapartment.Inadditiontotheseincentives,the
compensation packageofferedtothecandidate shouldsignificantly exceedthe
compensationpackageshecurrentlyenjoys.
Toensurethatthecandidate wouldperformatahighlevelifsheaccepts the
position,sheshouldbeofferedincentivecompensation.Itwouldbeappropriateto
structure the compensation such that the candidate would be protected from
currencyfluctuations.Thecompensationpackageshouldbesensitivetocostof
livingdifferencesbetweenNewYorkandBuenosAires,andhercontractcould
provide forpricelevel adjustments. Someofthe payshouldbecontingent on
performancesothatthecandidatehasanincentivetoachievethegoalsofthe
company. Some of these incentives should be tied to specific performance
measuresoftheoperationinBuenosAires.
69. Each student willhave adifferent answer.Nosolution is provided. However,
studentsshouldbecertaintodiscussthefactthedifferencesbetweencountries
makesitessentialthatnonfinancialmeasurementsexist.Focusingsolelyonthe
reduced costs and, thus, increased profits, ignores the critical issues of
sweatshops,childlabor,andpollution.Also,indefendinglowerwages,students
shouldaddresstheconceptofwagesversusnowages,benefitstolocaleconomies,
andsignificantlylowercostoflivingindevelopingcountries.

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Chapter 14

Performance measurement is necessary to gauge whether a firm is

In selecting bases for performance measurement, managers should

Is the measure wholly controllable by the person being

Is the measure susceptible to manipulation by the person

Does the measure balance longterm and shortterm

By linking managerial rewards to performance, the welfare of

9. The balanced scorecard (BSC) is a conceptual approach to measuring performance

To remain competitive, there has been a shift in American industry

The outcome is suboptimization. When performance measures and

If the organizational mission of each subunit is unique, the

Equity in the reward structure must be maintained throughout the

Percentage of existing clients that have video game installations. The

Actual pretax income fell short of the expected amount by $1,060,000

(2) Aurora Manufacturing Company could improve its variance reporting

INTERNAL PROCESSES PERSPECTIVE

Advance the quality initiative

Simplify customer processes

Facilitate community-based problem

Percent of PATs (process action teams)

It is not an ethical treatment of either the existing shareholders or

Many different performance features could be considered. For

The board of directors should anticipate how various elements of

Top management would expect the plant manager to try to recover

No, the present system heavily biases against new investment in

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