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- Advanced Management Accounting Case:
Harwood Medical Instruments PLC (HMI), based just outside ofBirmingham, England, manufactured specialty medical instruments andsold them in market niches that were becoming increasinglycompetitive and price sensitive because of pressures toreducehealth care costs. HMI was organized into nine divisions each runby a general manager. Over the years, HMI had gorwn bothorganically and by acquisition. Six of the divisions had beenacquired by HMI within the past decade. All of HMI's divisions soldmedical products to hospital, laboratories, and/or doctors, so theneed for product quality and reliability was high. The divisionsvaried significantly, however, in terms of the degree to whichtheir success depended on, for example, development of newproducts, efficiency of production, and/or customer service.Bonuses for division general managers were paid semi-annually. Upto the year 2009, these bonuses were calculated as 1% of divisionoperating profits. HMI's managing director, Andy Guthrie, hadconcerns though that the operating profit measure was too narrowlyfocused. He had been reading articles about performance measurementand decided to implemnt a "more balanced" scorecard. In November2009, just before introducting a new bonus plan, Mr. Guthrieexplained to his chief financial officer that he was willing to payout higher bonuses than had been paid historically if improvedperformance warrantd doing so. The new plan provided a base bonusfor division general managers of 1% of division operating profitsfor the half-year period. this base bonus was adjusted asfollows:
Ā
Increased by $5,000 if over 99%of deliveries were on time; by $2,000 if 95-99% of deliveries wereon time; or by zero if less than 96% of deliveries were ontime.
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Increased by $5,000 if sales returnswere less than or equal to 1% of sales, or decreased by 50% of theexcess of sales returns over 1% of sales.
Ā
Increased by $1,000 for every patentapplication filed with the UK Intellectual Property Office.
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Reduced by the excess of scrap and rworkcosts over 1% of operating profit
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Reduced by $5,000 if average customersatisfaction rating were below 90%.
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If the bonus calculation resulted in a negative amount for aparticular period, the maanger received no bonus. Negative amountswere not carried forward to the next period. Exhibit 1 showsresults for two representative HMI divisions for the year 2010, thefirst year under the new bonus plan. The surgical InstrumentsDivision (SID), one of HMI's original businesses, sold a variety ofsurgical instruments, including scissors, scalpels, retractors, andclamps. The markets for these products were mature, so growth wasrelatively slow. Not much innovation was needed, but controllingcosts was critical. The Ultrasound Diagnosti Equipment division(Ultrasound), which was acquired in 2007, sold and servicedultrasound probes, transducers, and diagnostic imaging systems. Theultrasound market promised excellent growth and profits if thedivision could keep its sophisticated products on the cutting edgetecnologically and control both product development and productioncosts effectively. In 2009, the total annual bonuses for the yearearned by the managers of SID and Ultrasoundn were approximately$85,000 and $74,000, respectively.
Ā
Operating results for the Surgical Instruments andUltrasound Diagnostic Equipment Div, 2010 ($ in 000s)
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Surgical InstrumentsDiv. Ultrasound Diagnostic Equip. Div
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1st half of2010 2nd half of2010 1st half of2010 2nd half of 2010
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Sales $42,000 $44,000 $28,600 $29,000
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Operatingprofit $4,620 $4,400 $3,420 $4,060
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On-timedeliveries 95.4% 97.3% 98.2% 94.6%
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Salesreturns $450 $420 $291 $289
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Patent applicationsfiled 0 1 4 8
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Scrap and reworkcosts $51.1 $45.0 $39.7 $28.2
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Customer satisfaction(average) 78% 89% 81% 91%
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The case describes a company whose manager is concerned that theoperating profit measure included in the companyĆ¢ĀĀs bonus plan wastoo narrowly focused. He implemented a new bonus plan that reducedthe weighting of importance placed on operating profit and thatincluded more measures, including on-time deliveries, salesreturns, patent applications, scrap and rework costs, and customersatisfaction.
Ā
1. What was the purpose of the change?
2. Calculate the bonus earned by each manager for each 6-monthperiod and for the year 2010.
3. Evaluate the new plan. Is there any evidence that it producedthe desired effects? What
changes to the new plan would you suggest, if any?
š·ļøĀ
- Advanced Management Accounting Case:
Harwood Medical Instruments PLC (HMI), based just outside ofBirmingham, England, manufactured specialty medical instruments andsold them in market niches that were becoming increasinglycompetitive and price sensitive because of pressures toreducehealth care costs. HMI was organized into nine divisions each runby a general manager. Over the years, HMI had gorwn bothorganically and by acquisition. Six of the divisions had beenacquired by HMI within the past decade. All of HMI's divisions soldmedical products to hospital, laboratories, and/or doctors, so theneed for product quality and reliability was high. The divisionsvaried significantly, however, in terms of the degree to whichtheir success depended on, for example, development of newproducts, efficiency of production, and/or customer service.Bonuses for division general managers were paid semi-annually. Upto the year 2009, these bonuses were calculated as 1% of divisionoperating profits. HMI's managing director, Andy Guthrie, hadconcerns though that the operating profit measure was too narrowlyfocused. He had been reading articles about performance measurementand decided to implemnt a "more balanced" scorecard. In November2009, just before introducting a new bonus plan, Mr. Guthrieexplained to his chief financial officer that he was willing to payout higher bonuses than had been paid historically if improvedperformance warrantd doing so. The new plan provided a base bonusfor division general managers of 1% of division operating profitsfor the half-year period. this base bonus was adjusted asfollows:
Ā
Increased by $5,000 if over 99%of deliveries were on time; by $2,000 if 95-99% of deliveries wereon time; or by zero if less than 96% of deliveries were ontime.
Ā
Increased by $5,000 if sales returnswere less than or equal to 1% of sales, or decreased by 50% of theexcess of sales returns over 1% of sales.
Ā
Increased by $1,000 for every patentapplication filed with the UK Intellectual Property Office.
Ā
Reduced by the excess of scrap and rworkcosts over 1% of operating profit
Ā
Reduced by $5,000 if average customersatisfaction rating were below 90%.
Ā
If the bonus calculation resulted in a negative amount for aparticular period, the maanger received no bonus. Negative amountswere not carried forward to the next period. Exhibit 1 showsresults for two representative HMI divisions for the year 2010, thefirst year under the new bonus plan. The surgical InstrumentsDivision (SID), one of HMI's original businesses, sold a variety ofsurgical instruments, including scissors, scalpels, retractors, andclamps. The markets for these products were mature, so growth wasrelatively slow. Not much innovation was needed, but controllingcosts was critical. The Ultrasound Diagnosti Equipment division(Ultrasound), which was acquired in 2007, sold and servicedultrasound probes, transducers, and diagnostic imaging systems. Theultrasound market promised excellent growth and profits if thedivision could keep its sophisticated products on the cutting edgetecnologically and control both product development and productioncosts effectively. In 2009, the total annual bonuses for the yearearned by the managers of SID and Ultrasoundn were approximately$85,000 and $74,000, respectively.
Ā
Operating results for the Surgical Instruments andUltrasound Diagnostic Equipment Div, 2010 ($ in 000s)
Ā
Surgical InstrumentsDiv. Ultrasound Diagnostic Equip. Div
Ā
1st half of2010 2nd half of2010 1st half of2010 2nd half of 2010
Ā
Sales $42,000 $44,000 $28,600 $29,000
Ā
Operatingprofit $4,620 $4,400 $3,420 $4,060
Ā
On-timedeliveries 95.4% 97.3% 98.2% 94.6%
Ā
Salesreturns $450 $420 $291 $289
Ā
Patent applicationsfiled 0 1 4 8
Ā
Scrap and reworkcosts $51.1 $45.0 $39.7 $28.2
Ā
Customer satisfaction(average) 78% 89% 81% 91%
Ā
The case describes a company whose manager is concerned that theoperating profit measure included in the companyĆ¢ĀĀs bonus plan wastoo narrowly focused. He implemented a new bonus plan that reducedthe weighting of importance placed on operating profit and thatincluded more measures, including on-time deliveries, salesreturns, patent applications, scrap and rework costs, and customersatisfaction.
Ā
1. What was the purpose of the change?
2. Calculate the bonus earned by each manager for each 6-monthperiod and for the year 2010.
3. Evaluate the new plan. Is there any evidence that it producedthe desired effects? What
changes to the new plan would you suggest, if any?
Related questions
Division A manufactures electronic circuit boards. The boardscan be sold either to Division B of the same company or to outsidecustomers. Last year, the following activity occurred in DivisionA:
| Selling priceper circuit board | $ | 181 | |
| Variable costper circuit board | $ | 127 | |
| Number ofcircuit boards: | |||
| Produced duringthe year | 21,900 | ||
| Sold to outsidecustomers | 14,100 | ||
| Sold to DivisionB | 7,800 | ||
Sales to Division B were at the same price as sales to outsidecustomers. The circuit boards purchased by Division B were used inan electronic instrument manufactured by that division (one boardper instrument). Division B incurred $280 in additional variablecost per instrument and then sold the instruments for $600each.
Required:
1. Prepare income statements for Division A, Division B, and thecompany as a whole.
divisionA Division B Totalcompany
sales:
Expenses:
added by the division
transfer price paid:
total expenses
net operating income:
2. Assume that Division AĆ¢ĀĀs manufacturing capacity is 21,900circuit boards. Next year, Division B wants to purchase 8,800circuit boards from Division A rather than 7,800. (Circuit boardsof this type are not available from outside sources.) What shouldDivision A do from the standpoint of the company as a whole?
| A | Continue to sell the circuit boards to outside customers. |
| B | Sell the 1,000 additional circuit boards to Division B. |
Colonial Pharmaceuticals is a small firm specializing in newproducts. It is organized into two divisions, which are based onthe products they produce. AC Division is smaller and the life ofthe products it produces tend to be shorter than those produced bythe larger SO Division. Selected financial data for the past yearis shown below. Divisional investment is as of the beginning of theyear. Colonial Pharmaceuticals uses a 9 percent cost of capital anduses beginning-of-the-year investment when computing ROI andresidual income. Ignore income taxes.
| ACDivision | SODivision | |||||
| Allocated corp. overhead | $ | 600 | $ | 1,800 | ||
| Cost of goods sold | 3,200 | 7,000 | ||||
| Divisional investment | 9,000 | 80,000 | ||||
| R&D | 2,000 | 3,600 | ||||
| Sales | 8,000 | 20,000 | ||||
| SG&A | 700 | 1,530 | ||||
R&D is assumed to have a two-year life in the AC Divisionand a nine-year life in the SO division. All R&D expendituresare spent at the beginning of the year. Assume there are no currentliabilities and (unrealistically) that no R&D investments hadtaken place before this year.
Al, the manager of the AC Division, complains that thecalculation of EVA is unfair, because a much longer life is assumedfor the SO Division in calculating EVA. Sean, the manager of SO,responds that EVA is supposed to reflect economic reality and thatthe reality is that R&D investments in SO Division do have alonger life.
Required:
a. Assume that the economic life of R&Dinvestments is two years in the AC Division. What economic lifewould the R&D investments in the SO Division have to make EVAin the two divisions equal?