Evaluating Management Control Systems—Ethical Considerations
Magnolia Manufacturing makes wing components for large aircraft. Kevin Choi is the production manager, responsible for manufacturing, and Michelle Michaels is the marketing manager. Both managers are paid a flat salary and are eligible for a bonus. The bonus is equal to 1 percent of their base salary for every 10 percent profit that exceeds a target. The maximum bonus is 5 percent of salary. Kevin’s base salary is $180,000 and Michelle’s is $240,000.
The target profit for this year is $6 million. Kevin has read about a new manufacturing technique that would increase annual profit by 20 percent. He is unsure whether to employ the new technique this year, wait, or not employ it at all. Using the new technique will not affect the target.
Required
- a. Suppose that profit without using the technique this year will be $6 million. By how much will Kevin’s bonus change if he decides to employ the new technique? By how much will Michelle’s bonus change if Kevin decides to employ the new technique?
- b. Suppose that profit without using the technique this year will be $8.5 million. By how much will Kevin’s bonus change if he decides to employ the new technique? By how much will Michelle’s bonus change if Kevin decides to employ the new technique?
- c. Suppose that profit without using the technique this year will be $4.8 million. By how much will Kevin’s bonus change if he decides to employ the new technique? By how much will Michelle’s bonus change if Kevin decides to employ the new technique?
- d. Is it ethical for Kevin to consider the impact of the new technique on his bonus when deciding whether or not to use it? Explain.
- e. Assess the management
control system used at Magnolia Manufacturing and provide recommendations for changes, if any are required. Be sure to discuss: - • Decision authority
- • Performance measures
- • Compensation
a.
Calculate K’s bonus when he decides to employ the new technology.
Answer to Problem 30E
K’s bonus increases by $3,600 and M’s bonus increases by $4,800.
Explanation of Solution
Contingent compensation:
Contingent compensation is the amount paid to the employees on the basis of their performance. Unlike fixed compensation, the contingent compensation is based on the performance of the employee in their respective job profile.
Calculate the change in K’s bonus and M’s bonus when he decides to employ the new technology:
The bonus is given when profit exceeds the target level of $6 million. Hence, initially, the bonus will be zero for K and M as the profit did not exceed the target level of $6 million.
Target profit increases by 20%. The bonus is equal to 1 percent of their base salary for every 10 % profit that exceeds a target. It will be 2%
The increment in K’s bonus:
Thus, K’s bonus increases by $3,600.
The increment in M’s bonus:
Thus, M’s bonus increases by $4,800.
b.
Calculate K’s bonus when he decides to employ the new technology. It is given that the profit for the year is $8.5 million.
Answer to Problem 30E
The bonus has changed by $1,800 for K and by $2,400 for M.
Explanation of Solution
Contingent compensation:
Contingent compensation is the amount paid to the employees on the basis of their performance. Unlike fixed compensation, the contingent compensation is based on the performance of the employee in their respective job profile.
Calculate the change in K’s bonus and M’s bonus when he decides to employ the new technology:
The bonus is given when profit exceeds the target level of $6 million. The current level of profit is $8.5 million.
Change in the bonus of K:
Change in the bonus of M:
Thus, the bonus has changed by $1,800 for K and by $2,400 for M.
Working note 1:
Calculate the bonus on the revised level of profit (10.2 million):
Bonus for K:
Bonus for M:
Working note 2:
Calculate the % of incentive:
Target profit increases by 20%. The bonus is equal to 1 percent of their base salary for every 10 % profit that exceeds a target. It will be 7%
Maximum bonus allowed is 5%. So the bonus will be calculated on the basis of 5% of salary.
Working note 3:
Calculate the change in profit:
Working note 4:
Calculate the bonus on the current level of profit (8.5 million):
Bonus for K:
Bonus for M:
Working note 5:
Calculate the % of incentive:
Target profit increases by 20%. The bonus is equal to 1 percent of their base salary for every 10 % profit that exceeds a target. It will be 4%
c.
Calculate K’s bonus and M’s bonus when he decides to employ the new technology. It is given that the profit for the year is $4.8 million.
Answer to Problem 30E
There will be no change in the bonus as the bonus is zero in both the cases.
Explanation of Solution
Contingent compensation:
Contingent compensation is the amount paid to the employees on the basis of their performance. Unlike fixed compensation, the contingent compensation is based on the performance of the employee in their respective job profile.
Calculate the change in K’s bonus and M’s bonus when he decides to employ the new technology:
The bonus is given when profit exceeds the target level of $6 million. The current level of profit is $4.8 million. There will be no bonus on the current level of profit.
Revised level of profit:
Revised level of profit is $5,760,000. It is below the target level of profit of $6 million. So there will be no incentive for the revised level of profit too.
Thus, there will be no change in the bonus as the bonus is zero in both cases.
d.
Explain whether it is ethical for K to consider the impact of technology change on his incentive.
Answer to Problem 30E
No, it is not ethical for K to consider the impact of technology change on his incentive.
Explanation of Solution
Dysfunction decision making:
Dysfunction decision making is a process where subordinates decide for its benefit without considering the adverse effect of the decision on the business organization.
Considering the impact of technology:
K should not decide employing the technology on a self interest basis. He should consider the importance of the implementation of technology for the benefit of the company. It is ethically wrong to consider self-interest over the organization’s interest.
Thus, it is not ethical for K to consider the impact of technology change on his incentive.
e.
Provide recommendations for changes, if any are required.
Explanation of Solution
Recommendations to Company M:
Following are the recommendations to Company M:
- • K has control over the production of the goods in Company M. He may manipulate the production process for his bonus. So K’s activities should be evaluated on a regular basis.
- • The bonus level is restricted to 5%. It should be increased in order to make the employee more motivated.
- • M’s activity of selling should be evaluated on a regular basis as he may influence the sales to earn some bonus.
Thus, Company M should follow the above-explained recommendations to change the bonus plan.
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Chapter 12 Solutions
FUNDAMENTALS OF COST ACCOUNTING W/CONNE
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Our accounts payable department is spending 80 percent of its time resolving discrepancies between the purchase order, receiving order, and suppliers invoice. Incorrect part numbers on the purchase orders, incorrect quantities ordered, and wrong parts sent (or the incorrect quantity) are just a few examples of sources of discrepancies. A complete redesign of the process has been suggested, which will allow us to eliminate virtually all of the errors and, at the same time, significantly reduce the number of clerks needed in purchasing, receiving, and accounts payable. This redesign promises to significantly reduce costs, decrease lead time, and increase customer satisfaction. c. MANAGER: This overhead cost report indicates that we have spent significantly more on inspection, purchasing, and production than was budgeted. An investigation has revealed that the source of the problem is faulty components from suppliers. A supplier evaluation has revealed that by selecting five suppliers with the best quality records (out of 15 currently used), the number of defective components will be dramatically reduced, thus producing significant overhead savings by reducing the demand for inspections, reordering, and rework. d. MANAGER: A large local firm has approached me and has offered to sell us one of the components used in our small enginesa component that we are currently producing internally. I need to know costs that we would avoid if this component is purchased so that I can assess the economic merits of this offer. e. MANAGER: Currently, our deluxe lawn mower is losing money. We need to increase profits. I would like to know how much our profits would be if we reduce our variable costs by 50 per mower while maintaining our current sales volume. 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The management team at Wellington strives for zero defects and minimal scrap costs; current scrap levels are at 2 percent. The incentive compensation plan for Wellington management has been a 1 percent bonus based on gross margin. Renslen plans to continue to compensate the Wellington management team on this basis. The following condensed income statements are for both divisions for the fiscal year ended May 31, 20x1: Renslen, Inc. Divisional Income Statements For the Year Ended May 31, 20x1 Each division has 1,000,000 of management salary expense that is eligible for the bonus pool. Renslen has invited the management teams of all its divisions to an off-site management workshop in July where the bonus checks will be presented. Renslen is concerned that the different bonus plans at the two divisions may cause some heated discussion. Required: 1. Determine the 20x1 bonus pool available for the management team at: a. Meyers Service Company b. Wellington Products, Inc. 2. Identify at least two advantages and disadvantages to Renslen, Inc., of the bonus pool incentive plan at: a. Meyers Service Company b. Wellington Products, Inc. 3. Having two different types of incentive plans for two operating divisions of the same corporation can create problems. a. Discuss the behavioral problems that could arise within management for Meyers Service Company and Wellington Products, Inc., by having different types of incentive plans. b. Present arguments that Renslen, Inc., can give to the management teams of both Meyers and Wellington to justify having two different incentive plans.arrow_forwardLindell Manufacturing embarked on an ambitious quality program that is centered on continual improvement. This improvement is operationalized by declining quality costs from year to year. Lindell rewards plant managers, production supervisors, and workers with bonuses ranging from 1,000 to 10,000 if their factory meets its annual quality cost goals. 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