Chapter 23 - Control: The Management Control Process

CHAPTER 23
CONTROL: THE MANAGEMENT CONTROL PROCESS
Changes from Twelfth Edition
All changes to Chapter 23 were minor.
Approach
The management control cycle deserves emphasis. The hardest part to understand is strategic planning,
ecause it tends to e less precise and systematic than udgeting. !et, strategic planning is a "ey step in
strategy implementation, since it involves the trans#ormation o# road strategies into speci#ic product
plans.
Most students #ind the material on ehavioral aspects interesting and important. $ome, however, regard
any statements aout human ehavior as %manipulative,& and hence, unethical. They have the impression
that managers spend their time e'ploiting wor"ers and view ehavioral principles as assisting in this
e'ploitation. A counter to this impression, i# it should arise, is that it is important that managers
understand how people ehave, not #or the purpose o# e'ploiting them ut, rather so that they can reduce
#rustrations and provide an atmosphere that will permit employees to release their #ull potential. The
e'ample o# computer costs is a way o# showing that the purpose is not to e'ploit, ut rather to motivate
people to act in a way that helps the organi(ation without, in any way, harming the individual.
Cases
Tru-Fit Parts, Inc. deals with prolems caused y not giving enough thought to the ehavioral
implications o# measurement systems.
Industrial Electronics, Inc. raises a numer o# issues, including per#ormance measurement, per#ormance
standards, #unctions lin"ing per#ormance with incentive awards, and the ehavioral responses y
managers and employees to incentives. )t also ma"es a nice e'am case when the e'amination time is
limited.
Las Ferreteras De Mxico, S.A. de C.V. illustrates some o# the prolems managers commonly #ace when
they use the return on investment *+,)- measure o# per#ormance.
er!s"ire Industries PLC illustrates the advantages o# and the prolems #aced in uilding a per#ormance
measurement and incentive system around an %economic pro#it& measure.
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Chapter 23 - Control: The Management Control Process
Problems
Problem 23-1: Sandalwood Company
a. /ivisions 0 *111s-
Total 2 3 4 $
$ales..................................................................................................................................................................................................... 03,511 0.,621 0671 0.,.81 0671
9ess: Avoidale costs........................................................................................................................................................................... 2,:76 536 238 .,3;2 2.8
/ivisional contriution......................................................................................................................................................................... .,.26 :56 33: *262- 36:
Corporate head<uarters cost................................................................................................................................................................. ;76 3;1 .8: 2;3 .8:
0 .61 0 2;6 0.;1 0 *686- 02.1
/ivision
$ales
+evenue
= o#
$ales
*.-
Allocated
Costs
*2-
Total
Costs
*2- - *.-
Avoidale
Costs
2 0.,621 81= 03;1 0.,226 0 536
3 671 .6 .8: 351 238
4 .,.81 31 2;3 .,:56 .,3;2
$ 671 .6 .8: 3:1 2.8
03,511 .11= 0;76 03,:61 02,:76
>nless its pro#itaility can e improved in some way, the 4eston /ivision should e closed ecause
it does not appear to e ale to cover its own costs nor contriute to the total overall pro#itaility. The
$outhoro /ivision does not cover its share o# Corporate ?ead<uarters cost, ut it does cover its own
costs and ma"es a contriution to overall pro#itaility.
. @usiness may e seasonally in#luenced y geographic location. ?owever, the long-run #uture outloo"
should e the guideline. )n the long-run, all costs are considered variale and all divisions are
e'pected to ear a #air urden o# corporate administration costs. 3ven though the $outhoro /ivision
is ma"ing a contriution, some adAustments must e made in the long-run. ,ne other consideration
may e the in#luence o# one divisionBs output on anotherBs pro#it. Cor e'ample, some o# 3dgewood
/ivisionBs sales may e a direct result o# some sales o# the $outhoro /ivision.
9astly, other variales include human #actors and hardships endured y employees. All o# these
#actors must e accounted #or in the decision to close certain divisions.
Problem 23-2: Tarrell Company
a. The Tarrell Company sales compensation plan provides #inancial motivation to the sales #orce to
ma"e pro#itale sales. Cirst, sales commissions are contingent upon the collection o# accounts
receivale. Thus, salespersons are discouraged #rom selling to high credit-ris" customers simply to
generate sales volume *a doule-edged conditionD see part -. The sales commission is ased upon
product pro#itaility. This motivates memers o# the sales #orce to direct their e##orts toward the most
pro#itale products in the line. Third, salespersons are not penali(ed i# price concessions are
considered necessary and desirale to attract certain customers. Cinally, the sustantial year-end
onus provides a strong economic stimulus to sales persons to meet their annual sales <uota.
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Chapter 23 - Control: The Management Control Process
.
c. The Tarrell CompanyBs sales compensation plan has several maAor de#iciencies. Most notaly, the #lat
.6 percent onus #or meeting or e'ceeding the annual sales <uota does not stimulate a salesperson to
e'ceed the <uota y more than a slight sa#ety margin. $alespersons are #urther discouraged #rom
ma"ing sales #ar in e'cess o# the <uota due to the method o# setting sales <uotas. @y setting the
annual <uota at 61 percent o# prior yearBs sales, a salesperson increases his or her <uota #or the
#ollowing year y ma"ing sales well in e'cess o# the current yearBs <uota. )# a salesperson has
achieved his or her <uota near the end o# the year, he or she would e motivated to hold ac" sales
until the #ollowing year. $econd, the commissionEcollection policy could discourage the sales #orce
#rom contacting prospective customers who would e classi#ied as slow, ut collectale. Third, the
standard gross margin is not necessarily a good measure o# product pro#itaility. Product contriution
margin would e a etter measure o# product pro#itaility. The standard gross margin does not re#lect
cost-volume-pro#it relationships. 2or does it consider directly traceale mar"eting costs. Cinally, the
reward system is apparently limited to monetary rewards. The system does not provide #or higher
order rewards such as peer or superior recognition.
Problem 23-3: Aleander Company
a. $tandards are o#ten classi#ied into three typesideal *tight-, attainale *reasonale-, or easy *loose-.
$tandards that are too loose or too tight will generally have a negative impact on wor"er motivation.
)# standards are too loose, wor"ers will tend to set their goals at this low rate, thus reducing
productivity elow what is otainale. )# the standard is too tight, wor"ers will reali(e that it is
impossile to attain the standard. They will ecome #rustrated and will not attempt to meet the
standard. An attainale or reasonale standard that can e achieved under normal wor"ing conditions
is li"ely to contriute to the wor"erBs motivation to achieve the designated level o# activity.
The plant management can participate in the setting o# standards, or top management can impose
standards. 4or"ers and plant management will tend to react negatively in the long-run to imposed
standards ecause they will #eel threatened. )# they participate in setting the standard, they can
identi#y with the standard procedure and the standard could ecome one o# their personal goals.
)n the case o# Ale'ander, it appears that the standard was imposed on the plant. )n addition,
management used an ideal standard to measure per#ormance. @oth o# these actions appear to have had
a negative impact on output over the #irst si' months.
. Ale'ander made a poor decision to use dual standards. 4hen the wor"ers learn o# the dual standard,
the companyBs entire measurement system will ecome suspect and crediility will e lost. Company
morale could su##er ecause the wor"ers would not "now #or sure how the company evaluates their
per#ormance. As a result, total disregard #or the present and any #uture cost control system is li"ely to
develop.
Problem 23-!: Concord P"blications
a. *.- The academic and administrative units will e'perience important operational changes. They will
now have the decision-ma"ing power to select the pulications to e issued, the <uality and
character o# pulication, and the <uantity o# the pulication. Concomitant with this increased
decision power will e the responsiility #or the #inancial conse<uences o# their acts through the
inclusion o# pulication costs in their udget and %charge-ac"& #rom CP #or services used. 2ow
academic and administrative units will e motivated y a desire to get the most value #rom their
pulications relative to the udgeted amount #or pulications. These units should e'perience
higher morale as a result o# these changes.
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Chapter 23 - Control: The Management Control Process
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*2- Concord Pulications will lose the decision-ma"ing power over the choice o# pulications to e
issued and the <uality and <uantity o# the pulications. CP essentially has ecome a production
shop, rather than a complete pulication service, and as a result, #inancial responsiility is
diminished to only cost control. The management and pro#essional sta## o# CP will li"ely have
lower morale due to its change #rom a pro#essional pulication shop to a production shop, and
they may e less motivated to produce #ine pulications ecause they no longer have a signi#icant
amount o# in#luence on the pulication decision.
*3- The operational change #or the college will e the shi#t in pulication responsiility #rom CP to
the other units. The udget system will need to e revised to include responsiility #or pulication
costs in the academic and administrative unit udgets. Also, a method to calculate and record the
charge-ac"s must e developed. The academic and administrative units may e more care#ul in their
selection o# pulications ecause they will e charged with the costs. CP may e less concerned aout
cost control ecause the costs are allocated, and there could e a reduction in the <uality o#
pulications. More con#licts etween CP and the other units are li"ely to arise due to the lessened
power o# CP comined with the inevitale disputes over the proper charges.
c. The president used a unilateral approach to introduce organi(ational change. This approach relies
very heavily on the presidentBs hierarchical position in the college. The de#inition and solution to the
prolem were speci#ied y the president and directed downward. )n addition, the presidentBs
memorandum tends to e impersonal, #ormal, and tas"-oriented. This approach assumes that people
are highly rational and est motivated y authoritative directions.
Cases
Case 23-1: Tru-Fit Parts, Inc.
*

#ote: T"is case is unc"an#ed $ro% t"e T&el$t" Edition.
Approach
This case, ased on my contacts with an actual 2!$3 company, enales students to gain insights in two
areas o# control system design. Cirst, it illustrates *in the trans#er pricing area- that some prolems are not
completely solule, and that a system with only a #ew prolems may e etter than an evident alternative.
$econd, the case illustrates how a myopic view o# control systems can create prolemsD in two instances
the company considered a speci#ic ehavioral aspect o# a measurement scheme ut neglected to recogni(e
the possiility o# undesirale side e##ects o# its approach.
) have used this case also as a ;1-minute e'am, with this assignment
Assume you are a consultant to Tru-Cit Parts, )nc. The in#ormation given in the case was collected y
you during a visit to the company. !ou are to analy(e that in#ormation and then lin" your analysis to
speci#ic recommendations. Cor e'am purposes, assume you are presenting your analysis and
recommendations to me, rather than to an o##icer o# Tru-CitD this means you can tell me things you
would choose not to tell the company, ut you are still in the role o# a consultant.
@y my standards, the elow-average students overreact to the trans#er pricing prolem and #ail to see the
plant manager onus system adAustmentBs role in AM-Manu#acturing relations. Almost all students
understand the reason that inventories are e'cessive #or most o# the year.
*
This teaching note was prepared y pro#essor Fames $. +eece. Copyright G y Fames $. +eece.
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Chapter 23 - Control: The Management Control Process
)n class, ) let students deal with the three issues in whatever order they wish. Their discussion will tend to
lead to the summary comments )Bve put at the end o# this note.
Comments on $"estions
Trans$er 'rice dis'utes. Case #igures on sales indicate that AM Mar"etingBs purchases #rom the
manu#acturing divisions total 0211 million annually, compared with 0881 million sales o# those divisions
outside the company. The comination o# this 0211 million internal sales amount and the nature o# Tru-
CitBs products causes students to reali(e that there must e thousands o# parts #or which trans#er prices
must e estalished. The procedure #or pricing parts with ,3M e<uivalents was as oAective and #air as
#easile, in my view, and %caused virtually no disputes.&
Cor parts with no Tru-Cit ,3M e<uivalents, ) #eel that %a #ew disputes& which %usually were resolved y
the two divisions involved& and which only %occasionally& were aritrated is the est the company could
hope #or, given the lac" o# oAective data #or setting these prices. *This is not to say the company didnBt
try to identi#y other suppliersB prices #or these partsD ut those prices, eing #rom manu#acturer to
distriutor rather than at later channels in the distriution chain, were not that easy to learn since AM
Mar"eting didnBt uy and distriute other manu#acturersB parts.- Thus, in my Audgment, no change is
called #or here. *This was also Tru-CitBs CC,Bs #eeling, ut he welcomed an outsiderBs rati#ying it. As a
result o# our conversation, one segment o# a management training program we developed #or the company
dealt with the notion that there is no such thing as a per#ect, dispute-#ree trans#er pricing system.-
AM-Manu$acturin# relations. This causes students the most di##iculty o# the three stated prolems. Many
students will argue that changing company policy and letting AM Mar"eting uy on the outside will solve
the prolem. This proposal overloo"s the #act that the present onus scheme adAustment would not cause
the manu#acturing pro#it centers to e penali(ed i# AM Mar"eting shi#ted some purchases to outside
suppliers, Aust as they are not penali(ed now i# they #avor ,3M customers over AM when the plants are
operating at or near capacity. *The proposal also does not recogni(e how strongly and validly held such
policies aimed at protecting company image can e.- )t seems, then, that the plant manager onus
adAustment #or sales volume variances associated with AM, while meeting its intended oAective o#
e<uitaility, is causing an undesirale side e##ect. Hiven that top management wants to increase the AM
portion o# total outside sales, this is a serious prolem. *A sharp student will note the reason #or wanting
to increase AM sales: at present AM sales are 03:1 million, with a cost o# goods soldi.e., purchases
#rom the other divisions at ,3M mar"et priceso# 0211 million, giving a gross margin #or AM o# 88
percentI-
,ne proposal to deal with this prolem is to ma"e the plants e'pense centers. To me, this egs the issue,
ecause someone in the manu#acturing division will still have to decide how to allocate capacity at times
when comined ,3M and AM demands e'ceed that capacity. 4ith the ,3M mar"eting tradition in two
o# the three divisions, it is not evident that AM Mar"eting would get any more #avored treatment i# the
division top management made these capacity allocation decisions.
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Chapter 23 - Control: The Management Control Process
Another option is to do away with the onus system adAustment, so that AM Mar"etingBs purchases a##ect
the manu#acturing divisions in the same way that ,3M customersB purchases do. This should at least
ma"e the divisions indi##erent as etween selling to AM or ,3M, whereas now they are motivated to
#avor ,3M. This is the approach ) #avor, e'cept it doesnBt go #ar enough. $ince AM sales are so
pro#itale, top management proaly wants AM Mar"eting to e a more #avored customer. This could e
achieved y a small across-the-oard premium added to all trans#er prices, or y having a multitiered
onus plan that enales plant managers to share a part o# AM pro#its *i.e., ase part o# the onus on plant
pro#it and part on total company pro#it-. ) pre#er the latter over an in#lation o# now-realistic trans#er
prices.
In(entor) le(els. Top management was concerned that productivity-improving capital e'penditures,
whose savings might not materiali(e during the #irst #ew months, would not e aggressively proposed y
the divisions unless the short-run negative impact such proAects would have on +,) was somehow
cushioned. That was the rationale ehind #ree(ing the investment ase at the Fanuary . level. This is an
e'ample o# the #i'ed-asset #i'ation in some managersB minds when it comes to designing investment
center measurement schemesD rather, investment center schemes have the most impact on controllale
current assetsin this case, inventories. Juite oviously the near Christmas draw-down o# inventories
had little *i# anything- to do with vacations, ut rather was to reduce the denominator o# the +,) #raction
at year-end so as to increase accounting +,). )n e##ect, the plants were pro#it centers, not investment
centersD and controllale current assets will tend to increase relative to sales *i.e., collection period and
inventory turnover will decline- with a pro#it center measurement approach, since increased current assets
will provide some additional sales at the margin, and there is no charge levied on these assets.
The company could achieve its intended motivational goal i# it were to #ree(e Aust the #i'ed assets portion
o# the investment ase, and ase +,) calculations on the average o# <uarterly or monthly current asset
measurements. A etter approach, ) #eel, is to ma"e it clear to managers that +,) targets will e adAusted
downward i# an otherwise attractive capital udgeting re<uest is approved ut it will have a short-run
negative impact on +,).
*t"er issues. Henerally, discussion o# the three stated prolems will raise some <uestion aout the
appropriateness o# Tru-CitBs organi(ation structure. )n particular, consolidation o# the three separate ,3M
sales groups is li"ely to e proposed, and perhaps even consolidation o# all manu#acturing activities under
a single manager. )n this regard, to me the two "ey #acts in the case are: *.- %each divisionBs ,3M
mar"eters tended to wor" with di##erent people in a given customerBs organi(ationD& and *2- %two o# the
three divisions had een independent companies e#ore eing ac<uired y Tru-Cit.& 2ote that ,3M sales
personnel are not %sellers& in the usual sense o# the word. They are more li"e adAuncts to the ,3M
companiesB own design departmentsD wor"ing with di##erent people in the ,3M companies thus means
wor"ing with di##erent engineering and design departments, not Aust di##erent purchasing agents. $ince
there is no evidence in the case that there is any need #or interplay etween Tru-Cit manu#acturing
divisions, ut there proaly is a need #or sales-production interplay within a division, ) would leave the
structure as it is and capitali(e on the perceived autonomy o# these three divisions.
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Chapter 23 - Control: The Management Control Process
Also, some students usually are critical o# the discretionary adAustment in the onus scheme. *$uch
students also tend to pre#er my grading them using an e<uation that weights their written wor", with no
discretion on their classroom contriutions.- Certainly, this discretion can ma"e it possile #or a superior
to %play #avorites.& ?owever, the companyBs intent was to reduce the emphasis on short-term measured
accounting results, and to ta"e into account longer-term perspectives, community activities, development
o# suordinates, and the li"e. )t might well e pre#erale to do this with a more #ormal M@, systemD ut
asent such a system, ) thin" that having the discretionary aspect o# the onus is etter than having a .11-
percent accounting #ormula-ased onus.
Also, there may e criticism that the higher a person was in the hierarchy, the more standard onus points
he or she had. )# one assumes that salary is related to the organi(ational hierarchy, the e##ect o# this was to
e<uali(e potential onus as a percentage o# salary. 4hen this is clearly understood y students, some o#
the criticism is eliminated, though it is still a valid issue whether the C3, o# an organi(ation should
more-or-less automatically receive the largest onus.
Cinally, with coverage in the usiness press the past #ew years aout 3P$-ased onus pools, there may
well e discussion o# tying the annual onus pool si(e y #ormula to annual 3P$ Certainly, this would
seem to lead to a short-run results emphasis. Crom top managementBs perspective, it is di##icult to Austi#y
to shareholders not having the onus pool tied to each yearBs results. Many companies are struggling with
this issue today, with stoc" options o#ten seen as providing a etter short-run versus long-run alance. )t is
interesting to note that in many large Fapanese companies, the accepted culture is that i# earnings #all in a
given year, everyoneBs onus is lowered *or even eliminated-D and everyone ta"es a salary cut i# itBs a
really ad year. ThatBs certainly a short-run approach, yet other aspects o# the Fapanese usiness and
economic culture rein#orce an overall longer-term perspective.
Su%%ar) Co%%ents. )n using this case as an e'am, the student responses caused me to provide the
#ollowing comments as overall #eedac":
.. @e#ore you suggest a solution to a prolem, e sure that you have thought aout what is causing the
prolem. Many so-called usiness %prolems& are really dilemmas, where one may e pleased with
minor improvement ecause a true %solution& is not possile. *$ome students propose residual income
to deal with the e'cess inventoriesD ut that doesnBt help i# the investment ase remains #ro(en as o#
Fanuary ..-
2. )# you are con#ident a change is needed, anticipate the di##iculties in %selling& it, especially i# your
proposal is li"ely to e viewed as %radical& or %academic& *e.g., residual income, two-step or shadow-
price trans#er prices, etc.-.
3. )# management elieves there is a prolem, you must address that elie#, even though you #eel the
prolem is either minor or insolule *e.g., the trans#er pricing disputes-D ut addressing it does not
mean proposing change #or changeBs sa"e.
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Chapter 23 - Control: The Management Control Process
8.
Case 23-2: Industrial Electronics, Inc.
*

#ote: T"is case is c"an#ed $ro% t"at a''earin# in t"e T&el$t" Edition. T"e nu%+ers "a(e +een %odi$ied
to 'ro(ide #reater di$$erentiation a%on# t"e di(isions.
P"rpose of Case
This case, which is really a short vignette, was written primarily #or e'am purposes in situations where
the e'amination time is short. @ut the case can also e used as the asis #or a class discussion.
The case raises a numer o# issues, including per#ormance measurement, per#ormance standards,
#unctions lin"ing per#ormance with incentive awards, and the ehavioral responses y managers and
employees to incentives.
S"ggested Assignment $"estions
?ere are the <uestions used in the e'am setting *importance weightings assigned to each <uestion are
shown in parentheses-:
*21=- .. Calculate the onus award *as a percent o# ase salary- that would e given to the manager o#
each o# the #ollowing #ive divisions under the proposed new onus system. These divisions
are representative o# the range o# divisions within )3.
*0111-
%i&ision
'"dgeted
(perating Profit
'"dgeted
(perating Assets
Act"al
(perating Profit
Act"al
(perating Assets
A 0.,111 05,111 0.,.61 07,111
@ .,111 5,111 8,611 7,111
C 61 .,111 311 511
/ *711- 8,111 *311- 8,211
3 :11 2,111 .11 .,511
*21=- 2. 3valuate *i.e., discuss the pros and cons o#- the current onus system.
*31=- 3. 3valuate the proposed onus system.
*31=- 8. Propose a onus system that you elieve is optimal #or )3. 4hy do you thin" your proposed
system is optimalK 3'plain.
%isc"ssion
The case starts y descriing an ine##ective incentive system. The old system was replaced y a new
system that is <uite di##erent, ut still not without prolems.
L
Pro#essor Menneth A. Merchant wrote this teaching note. Copyright G Menneth A. Merchant.
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Chapter 23 - Control: The Management Control Process
,uestion -
Juestion one #orces the students to apply the description o# the new system to a hypothetical situation.
The purpose is to help them understand a "ey detail in the new system. Most students have no prolem
solving <uestion one. The onus awards *as a percent o# ase salary- in /ivisions A through 3,
respectively, are :3.6=, .61= *the #ormula says 23.=, ut the ma'imum is .61=-, :3.7=, :5.5=, and
2:.2=.
,uestion .
Juestion two as"s #or an evaluation o# the current *old- onus system. This system provided managers
with onuses ased on a share o# overall corporate pro#it a#ter ta'es in e'cess o# .2= o# oo" net worth.
Advantages o# the current system
.. )t is a wealth sharing system. )# the company does well, all managers do well, and vice versa. The
company has to ma"e larger payouts when it is est ale to do so.
2. The system might encourage teamwor" ecause everyone is rewarded on the same measure o#
group per#ormance.
3. The per#ormance targets are #i'ed and timeless. Thus there are no politics in the negotiation o#
per#ormance targets.
8. The system is easily understandale.
/isadvantages o# the current system
.. 3'cept #or the highest level o# managers, corporate per#ormance is largely uncontrollale.
/ivision managersB onus awards are little a##ected i# their division has an outstanding or a poor
year.
2. The timeless goal *.2=- does not re#lect the economic situation or changes in the situation.
3. Pro#it a#ter ta' is not a good re#lection o# value creation.
8. There is no charge #or the use o# assets that are #inanced y det. The asset and the det net to
(ero in the e##ect on oo" net worth.
6. The onus cuto##s, oth at the ottom *corporate per#ormance elow .2=- and the top *ma'imum
onus o# .61= o# salary-, are potentially ad.
a. The current situation, in which corporate per#ormance is elow the minimum
per#ormance level, has discouraged some o# the managers. This discouragement could
lead to demotivation and turnover.
. There are per#ormance regions where there is no lin" etween per#ormance and onus
awards. This can adversely a##ect motivation. The cuto##s also provide motivations #or
gamesmanship *i.e., moving income and assets etween per#ormance periods-.
,uestion /
Juestion three as"s #or an evaluation o# the proposed new system.
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Chapter 23 - Control: The Management Control Process
Advantages o# the proposed new system
.. The measures are more controllale. /ivision managers will e held accountale #or division
resultsD group managers #or group resultsD and corporate managers #or corporate results.
2. The awards are ased on an economic pro#it, or residual income, per#ormance measure. Managers
would e charged #or tying up assets in their usiness.
3. The type o# #inancing used to ac<uire the assets would not a##ect the measure.
8. The per#ormance targets would e tailored to each usiness unit. Presumaly they would e more
realistic and more e<uitale and would engender greater commitment #rom each o# the managers.
/isadvantages o# the proposed new system
.. The per#ormance measures, which are accounting-ased, are short-term oriented. This could
e particularly costly in a high technology usiness where innovation is a critical success #actor.
$hort-term accounting measures discourage research and development-related investments.
2. The measures are Aust uni#orm, summary results indicators. They are not at all lin"ed with
strategy, and they provide no operating guidance #or managers as to how to accomplish the
results.
3. Cash is aritrarily assigned to the operating units. 4hyK
8. Charging #or #i'ed assets ased on net oo" values causes well "nown prolems. Among
other things, returns go up Aust with the passage o# time and, hence, 2@N-related measures
motivate managers not to replace older, more depreciated assets.
6. There seems to e no adAustments made ased on whether the company leases or owns #i'ed
assets.
:. The costs o# capital does not vary across operating units, and it seems not to change over
time, such as with interest rate changes.
7. There is a scalaility prolem that may e perceived y some managers to e un#air. That is,
the onus earned on, say, each 0.11" o# economic pro#it is di##erent across divisions.
5. @udget targets are di##icult to set e<uitaly in uncertain environments such as )3 operates in.
;. The system provides room #or gamesmanship *e.g., window dressing, creation o# udget
slac"-.
.1. >nder the new system, onuses will proaly e paid even when an operating unit is not
ma"ing target. )s this desirale, particularly when the targets are set to e highly achievaleK
... ,rgani(ational interdependency seems to e small, ut to the e'tent that divisions have to
cooperate, there is a chance here o# suoptimi(ation. The division-level per#ormance measures
reward solely division per#ormance.
.2. )s the new plan too comple'K 4ill the a##ected managers understand itK
,uestion 0
23-.1
Chapter 23 - Control: The Management Control Process
Juestion #our as"s #or student recommendations. )n answering <uestion #our, students must try to address
as many o# the wea"nesses o# the new system as they can while retaining the advantages. They must also
consider the costs o# their suggestions, as well as the ene#its. There is no per#ect solution here. The
purpose o# the e'ercise is to e'pose students to some issues #irms commonly #ace and to get them
thin"ing aout various alternatives, and their costs and ene#its.
Pedagogy
This is a short case. ?owever, ecause it contains descriptions o# two incentive plans and raises so many
issues, the discussion o# it can easily consume an entire class period o# 76 minutes or even more.
Collowing the ordering o# the student assignment <uestions provides a logical way to develop the
material. ?owever, completing the discussion o# the old system *<uestion two- might use#ully e
completed e#ore starting the discussion o# the new system *<uestions one and three-.
Case 23-3: Las Ferreteras de Mico, !.". de C.#.
*

#ote: T"is case is unc"an#ed $ro% t"e T&el$t" Edition.
P"rpose of Case
This case was written to illustrate some o# the asic prolems with the return on investment *+,)-
measure o# per#ormance. The prolems arise in oth the numerator *pro#it- and denominator *investment-
o# the +,) measures. The case provides su##icient detail to allow students to discuss oth how to measure
the asic elements o# pro#its and investments and the ehavioral implications o# the use o# these
measures. $tudents should also consider alternatives to the use o# +,) measures.
The case also allows #or discussion o# some other issues that managers #ace in the design and
implementation o# incentive systems. These include decisions aout what employees to include in the
plan, what target onus to set #or each type o# employee included, whether to use a onus pool #eature,
how to design the #unction lin"ing per#ormance measures and incentive awards, and how to set #air
per#ormance standards #or all employees.
S"ggested Assignment $"estions
.. 3valuate the proposed onus plan that Mr. Hon(ale( is considering.
2. ?ow, i# at all, would you modi#y the proposed planK
Case Analysis
ac!#round
)t is use#ul to start the discussion y clari#ying some "ey #acts. CerreterOas is a pulicly held company. )ts
managers aspire to have the company e a Me'ican e<uivalent o# ?ome /epot or 9oweBs.
*
Pro#essors Menneth A. Merchant and 4im A. Nan der $tede wrote this teaching note. Copyright G 2113 y Menneth A.
Merchant and 4im A. Nan der $tede.
23-..
Chapter 23 - Control: The Management Control Process
CerreterOas is not a small usiness. )t operates 52 stores, organi(ed into nine geographical regions. 4ith
most student groups, it is proaly use#ul to clari#y the "ey recurring decisions in the usiness, and then
to identi#y who in the organi(ational hierarchy ma"es these decisions. Tale T2-. presents such a list:
Table T#-1
)ey *ec"rring %ecisions
)ey rec"rring decisions
Person+s, responsible
for ma-ing the decision
,rder right items in the right <uantities
$
$ta##ing with right numers o# good people
$
Pricing
$
Hranting credit
$ *with corporate chec" on large decisions-
$elling
$, + *large contractors only-
$tore location and design
C
Advertising
$
Control e'penses $
Mey:
$ P store
+ P region
C P corporate
This tale ma"es it ovious how important the store manager role is in the company. The store managers
have considerale autonomy, so they play a "ey role in a##ecting the success o# each store location.
*ld Incenti(e Plan
@e#ore this new proposal, per#ormance-dependent incentives were not an important part o# the CerreterOas
management system. @onuses were small *2-6=- o# ase salary, and they were ased on the companyBs
overall pro#its, so they were not controllale to any signi#icant e'tent y any e'cept the companyBs very
top managers. Mr. Hon(ale( also provided some suAective onuses #or e'emplary per#ormance.
These wea" incentives seem to have caused some employees to ecome la(y and to e not #ocused on the
aspects o# per#ormance important to the companyBs success. These prolems are indicated in the <uote
that opens the case.
1e& Incenti(e Plan
23-.2
Chapter 23 - Control: The Management Control Process
A consulting #irm designed the new incentive plan. A numer o# issues might e discussed. ,ne is the
decision to e'clude all employees e'cept the store, regional, and corporate managers. Clearly the lower-
level employees create value #or the company, ut the consulting #irm decided to e'clude them with the
reasoning that CerreterOas could not measure e##ectively the per#ormances o# these individuals. )#
prompted, some students will undoutedly e ale to suggest things that could have een done. Cor
e'ample, sales people could have een rewarded #or ringing pro#its #rom new sales or #or increasing
sales #rom e'isting customers. !ard wor"ers could have een rewarded #or receiving positive customer
#eedac".
Another issue is the division o# the onus pool. Corporate managers are to e given, on average, 3=
*.6=/6 people- o# the onus pool. +egional managers get ..:7= each. $tore managers get 1.56= each. )n
comparison, the corporate onus awards seem too high, particularly given that the top two managers, the
C3, and C,,, are e'cluded #rom this plan.
A third issue is the #unction lin"ing the measures with the onus awards. There is a lower-level cuto## o#
6=D no manager o# a store earning an +,) o# less than 6= earns any onus. There is also an upper cuto##
at ..=. )n 2112, then, si' store managers earned no onuses, and .6 managers earned the ma'imum.
$tudents should e as"ed to consider the ehavioral implications o# these cuto##s. The managers elow
the 6= cuto## and aove the ..= cuto## will e motivated to incur all the worthwhile e'penses they can
in the current period and de#erring all the revenues possile to the suse<uent period ecause these shi#ts
will have no e##ect on their onus. Thus, a gameplaying environment is created.
A #ourth issue is controllaility. The per#ormance standards are the same #or all the stores, ut their
per#ormance prospects are almost assuredly not e<ual. $ome stores have etter locations, and some
proaly have more e##icient layouts. )deally, per#ormance standards should vary y individual location.
This could e done through a #ormal udget negotiation process or more mechanically, such as y
adAusting the goals #or di##erences in local construction activity.
A related prolem: are the si' managers earning no onuses really the worst managersK Maye they are
good managers who were trans#erred to poor per#orming stores and have not yet had a chance to turn
around that per#ormanceK There is no provision #or ma"ing allowances #or this contingency. That may
ma"e it di##icult #or the company to induce good managers to move to poor-per#orming outlets.
CerreterOas may want to distinguish the evaluation o# the store location #rom the evaluation o# the
manager.
Cinally, the logic o# asing onuses on a proportion o# corporate pro#its can e <uestioned. The onus
pool #eature does limit the companyBs e'posure. This is a wealth-sharing #eature o# the plan. )# the
corporation does not do well, then payouts to employees are reduced. @ut corporate per#ormance is
essentially uncontrollale, even y managers at the store and regional levels, so this onus pool #eature
Aust suAects these employees to uncontrollale ris". The yards do not seem to e greatly interdependent,
so there is no need to have a %group reward& to motivate teamwor".
The #ocus o# the discussion, though, should e on the technical aspects o# the +,) calculation and the
ehavioral impacts o# ma"ing +,) the central measurement in a onus plan. The te't reading provides a
summary o# some o# the advantages and disadvantages o# using +,) as a criterion #or evaluating and
rewarding managerial per#ormance. )nstructors can remind students o# this list i# that is deemed desirale.
23-.3
Chapter 23 - Control: The Management Control Process
T"e Calculation o$ Pro$it
The accounting treatment o# revenues seems un#air in part. $tores are not given credit #or sales orders
written y personnel at regional or corporate levels, yet the store has to provide the good #or that sale.
Thus the stores incur the stoc"ing and handling costs. Customer service on these sales may also su##er
ecause the stores are not dealing with their own customers.
The stores are charged with all their local e'penses, direct charges #rom regional and corporate
head<uarters, and allocations o# all indirect costs. $ome o# even the local epenses may not e
controllale y the store manager. The rental and depreciation amounts may result #rom decisions made
y managers in the corporate o##ice. The same arguments apply to the advertising material, catalogs, and
other materials. 4ill managers have the opportunity to reAect such material i# they #eel they can
accomplish their oAectives with less e'pensive advertising that doesnBt con#orm to corporate policy or
corporate imageK 4ill that e allowedK $ome o# the direct charges may have a ehavioral impact. Cor
e'ample, will charges #or credit chec"s discourage their useK The case does not provide much in#ormation
aout the allocations o# indirect e'penses, ut these raise some <uestions. /o the allocation ases have
any economic meaningK And why are the allocations o# actual e'penses, not standard. This allocation
method ma"es the yards ear the cost o# any corporate udget overruns.
T"e Calculation o$ In(est%ent
The calculation o# investment similarly raises a numer o# measurement issues. )ncluding month-end cash
alances as investment will encourage managers to get rid o# their cash at the end o# the month. 3nd-o#-
period gameplaying li"e this is commonly re#erred to as window dressing. 4hat purpose is served y
holding managers accountale #or cash alances and what ehavioral e##ects are produced should e o#
concern.
9i"ewise, including month-end inventory at cost creates an opportunity #or mangers to manipulate their
inventories in such a way that their investment is reduced. The e##ect o# such reductions, however, will
inevitaly e on the level o# service they can provide to customers. CerreterOasB system does not enale
the calculation o# a cost o# stoc"-outs.
Month-end receivales also provide opportunities #or discretionary action y yard managers in allowing
credit, or y di##erent managers adopting di##erent policies and, hence, encouraging consumers and
customers to deal with one yard as opposed to another simply ecause o# their credit policies.
Most students will <uic"ly recogni(e the arguments against including investment in automoiles, truc"s,
e<uipment, #urniture and #i'tures at their depreciated *net oo" value- cost. To illustrate the point,
instructors can draw a #igure showing that +,) o# any entity eing evaluated in terms o# the return on the
net oo" value o# assets will increase over time, Aust with the passing o# time. >se o# net oo" value can
have some perverse ehavioral e##ects. )t can cause managers to delay replacing assets and to operate with
older, less e##icient or less attractive, e<uipment and #acilities. )n the event e'tra e<uipment is availale,
yard managers might have a tendency to dispose o# the newer rather than the older e<uipment ecause o#
the e##ect it will have on the investment ase. >sing net oo" value also causes prolems in comparing
per#ormance across yards ecause the yardsB assets are o# di##erent ages. A related issueQleases at
CerreterOas are not capitali(ed.
23-.8
Chapter 23 - Control: The Management Control Process
I%'le%entation Issues
4hile little in#ormation is given aout the process y which the plan has een developed, students can
in#er that the managers who will e greatly a##ected y the plan seem to have had little or no input into the
design. At the end o# the case, Mr. Hon(ale( is lamenting that he will have to e the one to announce the
implementation o# the plan. This lac" o# participation can e costly oth ecause the e'pertise o# the
people at the operating levels was not tapped and ecause participation itsel# reduces resistance to
implementation.
Pedagogy
This teaching note has een written in roughly the order in which we suggest discussing the issues. At the
start o# class, it is desirale to clari#y oth what is important #or CerreterOas and who in the organi(ation is
responsile #or the various "ey decisions.
@e#ore evaluating the new plan, it is use#ul to clari#y the "ey elements o# the plan. 4e li"e to have the
students descrie the plan along many o# the common plan dimensions, including the #orm o# the awards
*here cash-, per#ormance measures, degree o# discretion allowed in ma"ing the awards, the shape o# the
resultsEreward #unction, the si(e and #re<uency o# the awards, the degree o# uni#ormity o# awards
throughout the organi(ation, and the source o# the #unding *onus pool-.
Then students can e as"ed to evaluate the new plan and to suggest possile improvements. )nstructors
should #ocus on the ehavioral impacts o# the plan and other plan alternatives. )t is the induced ehavior
o# the employees in the company that will produce value, or not.
Case 23-$: %er&s'ire Industries PLC
*

#ote: T"is case is unc"an#ed $ro% t"e T&el$t" Edition.
P"rpose of Case
The @er"shire )ndustries P9C case was written to illustrate the use o# %economic pro#it& in a per#ormance
measurement system. Consulting #irms have developed various measures o# economic pro#itD 3NA
R
,
developed y $tern $tewart S Co. is proaly the est "nown. All o# these economic pro#it measures are
modi#ied versions o# the concept that accountants have traditionally called %residual income.& )n this case,
students are as"ed to evaluate an economic pro#it measure that involves two common measurement
adAustments, capitali(ation and amorti(ation o# advertising e'penses and the elimination o# goodwill
amorti(ation.
The case also raises some related results control system issues. The system proposed in the case includes
automatic ratcheting o# per#ormance targets, a resultsEreward #unction without thresholds and caps, and a
%onus an"& that smoothes out the onus awards. 3ach o# these system elements can e evaluated.
$tudents must also consider some implementation issues.
S"ggested Assignment $"estions
*
Pro#essors Menneth A. Merchant and 4im A. Nan der $tede wrote this teaching note. Copyright G y Menneth A. Merchant and
4im A. Nan der $tede.
23-.6
Chapter 23 - Control: The Management Control Process
.. 4ere @er"shireBs motivations #or a new incentive system reasonaleK )# so, what were their main
options #or a new systemK 4as an economic pro#it-#ocused system a reasonale choiceK
2. >se the data pertaining to the $nac" Cood /ivision, as shown in 3'hiit T2-., to calculate:
a. The economic pro#it #or the division #or 2111 and 211.
. The economic pro#it target #or the division #or 211.
c. The division managerBs onus payout *= o# salary- #or 2111 and 211.. *Assume that the
slope o# the payo## line #or 2111 was aritrarily set y @er"shire management to e<ual
..1.-
3. Assume the ase salary o# the manager o# the $nac" Coods /ivision was T.21,111 in oth 2111
and 211.. ?ow much cas" would the manager receive #rom his onus payouts in 2111 and 211.K
8. 3valuate the @er"shire )ndustriesB new incentive plan. 4hat changes would you recommend, i#
anyK
6. $hould Mr. 3mleton ma"e special adAustments o# the economic pro#it #igures or the onus
payouts #or personnel in the $pirits /ivision in 2111 and 211.K 4hy or why notK
)nstructors should use <uestion 2 only i# they want to get into the details o# the economic pro#it
calculation. @eware: 4hile the concept is straight#orward, students who are not com#ortale with
accounting have considerale di##iculty with the calculations.
Case Analysis
The companyBs motivation #or a new incentive system arises #rom two concerns. Cirst, the oard was
concerned that @er"shire managersB interests were not aligned with those o# shareowners. The oard
memers were particularly concerned that 3P$ was not a good measure since growth in 3P$ did not
translate into stoc" price appreciation.
$econd, the oard wanted to introduce more oAectivity into the per#ormance evaluation and reward
system. $ome oard memers elieved that too much suAectivity in the reward system results in a wea"
correlation etween onus awards and actual operating per#ormance. Curthermore, the suAective part o#
the onus system caused managers to spend more time negotiating their onus rather than worrying aout
generating pro#it.
)n general, the ene#its o# an economic pro#it-type system include the #ollowing:
)t introduces alance sheet accountaility to managers, some o# whom are accustomed to
thin"ing only aout income #igures.
)t aligns managersB actions with shareowner values y encouraging managers to invest
only in proAects that generate a return greater than the cost o# capital.
23-.:
Chapter 23 - Control: The Management Control Process
An economic pro#it system is not the only alternative #or holding managers accountale #or capital usage.
,ther ottom-line, summary per#ormance measures, such as +,), +,2A, +,3, +,C, can e used #or
that purpose. $o can any o# several comination-o#-measures systems, such as those #ocused on %"ey
per#ormance indicators,& management-y-oAectives *M@,- systems, and @alanced $corecards. These
latter systems can hold managers accountale #or capital-related measures, such as asset turnover,
inventory turnover, and days receivales.
3conomic pro#it measures are intuitively appealing ecause they are consistent with #inance theory. They
signal to managers that they should ma"e all investments promising returns greater than the companyBs
cost o# capital.
?owever, there is evidence in the case, and also in some academic research studies, that economic pro#it
measures are not highly correlated with stoc" price changes and, hence, shareholder value. The
correlation etween economic pro#it measures and shareholder returns is proaly higher in good
economic times, when most per#ormance indicatorsQshareholder returns and economic pro#its, as well as
accounting returns, pro#its and salesQare all generally trending upward. )t is lower when the economic
cycle is changing.
The prolem is that shareholder value is ased on mar"et estimates o# the $uture, while economic pro#it,
li"e accounting pro#it, is a ac"ward-loo"ing measure. 3conomic pro#it measures do not provide the
measurement panacea that their lael implies.
The second and third assignment <uestions, which will e time consuming #or the students, are clearly
optional. They are designed to #orce students to get into the detail o# the economic pro#it and onus
calculations. 4ithout the numerical e'ample, many students will gloss over the details o# the calculations,
assuming that they understand how the system wor"s. @ut, there are a lot o# comple'ities to comprehend.
The completed tale is shown in 3'hiit T2-2. To do these calculations, students must prepare the
advertising e'penditure amorti(ation schedule, as shown in 3'hiit T2-3. The economic pro#it
calculation is shown in 3'hiit T2-8.
The answer to assignment <uestion U3 is shown in 3'hiit T2-6.
The #ourth <uestion as"s students #or an evaluation o# the new system. 3ach o# the elements o# the system
can e evaluated separately. 3ach element has its advantages and disadvantages. $tudents should
understand that there is no per#ect system.
Are econo%ic 'ro$it %easures con#ruent &it" c"an#es in s"are"older (alue2 There is indication in the
case that it is not. @ut it may not e any worse than the various accounting measures, and it is etter than
Aust accounting pro#it, which does not have an asset #ocus in it.
The auto%atic ratc"etin# o$ 'er$or%ance tar#ets has the advantage o# ta"ing politics and gamesmanship
out o# the target negotiation processes. @ut a ratcheting system does not use any "nowledge aout
changing usiness conditions and prospects. The prolem in the $pirits /ivision illustrates this prolem.
)s the 76= ratcheting parameter appropriately responsive to improving or declining per#ormanceK
23-.7
Chapter 23 - Control: The Management Control Process
The elimination o# 'a)out t"res"olds and ca's is generally a good idea. The lower and upper payout
constraints create ranges where there is no lin" etween per#ormance and rewards. Thus they can
undercut motivation and stimulate gamesmanship in those per#ormance ranges. @ut companies that use
such constraints argue that they should not have to pay onuses #or per#ormance that is not aove minimal
levels. And they worry that e'tremely high payouts are li"ely to e more due to uncontrollale luc"
andEor poor onus plan caliration than they are to e'traordinarily good management per#ormance.
The +onus +an! idea is good in that it smoothes out the onus payouts. This can e help#ul to managers
#aced with paying a largely #i'ed set o# personal e'penses *e.g., mortgage-. The onus an" also provides
an employee retention ene#it. )# managers leave the company, they #or#eit all the remaining alances in
their onus an". @ut the onus an" ma"es the payouts less responsive to changes in per#ormance. This
can e seen in 3'hiit T2-6. Thus it can dilute the motivational messages that the incentive system is
trying to provide to the managers.
A general criticism that students can ma"e o# the system, too, is that it is relatively co%'lex. Can
managers understand all the elements o# the system, which is <uite di##erent #rom what they were
accustomed toK )# they do not understand all the details, does it really matterK )s all the comple'ity
necessaryK
The #i#th <uestion as"s whether Mr. 3mleton should ma"e some "ind o# special allowance #or the $pirits
/ivision o# @er"shire )ndustries in 2111 and 211.. This is a controlla+ilit) issue. The poor economic
conditions seem to e out o# the control o# the managers o# the $pirits /ivision. )# udgets were prepared
#or this division, the udgets could re#lect the poor conditions. >se o# a ratcheting system #or setting
per#ormance targets does not ta"e economic conditions into consideration. $hould Mr. 3mleton have
empathy #or the $piritsB managersK ,ne purpose o# implementing the economic pro#it system was to
reduce the amount o# discretion in the assignment o# onuses. ,n the other hand, i# the division will truly
su##er signi#icant employee turnover ecause o# the loss o# onuses, perhaps some intervention is called
#or.
Pedagogy
The teaching o# this case will depend signi#icantly on how much the instructor wants to get into the
calculation o# economic pro#it and the onus awards. )# the instructor wishes to have the students develop
all the numerical answers to the assignment <uestions as posed, a reasonale timing #or a 76-minute class
is as #ollows:
The company and its need #or change .1 minutes
The economic pro#it and onus calculations 31
3valuate the system and possile alternatives 26
The issue in the $pirits /ivision .1
76 minutes
23-.5
Chapter 23 - Control: The Management Control Process
Ehibit T#-1
(perating %ata from 'er-shire .nd"stries/ Snac- 0oods %i&ision +1222,
1334 1335 1336 1333 2222 2221
0rom the income statement:
2et operating pro#it e#ore the
#ollowing items:
.37,16. .:2,81. .58,5;5 .;8,32.
Consumer advertising e'pense *21,::.- *23,731- *2:,8.1- *3.,117- *8.,6:5- *3;,.;.-
Hoodwill amorti(ation 1 1 1 *.6,111- *31,111- *31,111-
2et operating pro#it e#ore ta'es ..1,:8. ..:,3;8 ..3,331 .26,.31
)ncome ta' payments *8.,2;3- *6.,61.- *68,.3.- *:1,327-
2et operating pro#it a#ter ta'es
*2,PAT-
:;,385 :8,5;3 6;,.;; :8,513
0rom the balance sheet:
2et operating assets *oo"-: 6;3,181 :31,2:5 651,;21 6:5,..3
Accumulated amorti(ation o# goodwill 1 1 1 .6,111 86,111 76,111
3conomic pro#it 7 7
3conomic pro#it per#ormance target 25,111
.
7
/ivision managerBs onus:
Target onus 61=
.
61=
.
@onus payout *= salary- 7 7
2ote:
.- Cumulative advertising e'pense through the end o# .;;7 is V.5.,8.1.
2- Cumulative advertising amorti(ed through the end o# the .;;7 is V.:7,617.
1
3stalished y management.
23-.;
Chapter 23 - Control: The Management Control Process
3-
Ehibit T#-2: 'er-shire .nd"stries/ Snac- 0oods %i&ision8Completed Table +1222,
1334 1335 1336 1333 2222 2221
2et operating pro#it e#ore the
#ollowing items:
.37,16. .:2,81. .58,5;5 .;8,32.
Consumer advertising e'pense *21,::.- *23,731- *2:,8.1- *3.,117- *8.,6:5- *3;,.;.-
Hoodwill amorti(ation 1 1 1 *.6,111- *31,111- *31,111-
2et operating pro#it e#ore ta'es ..1,:8. ..:,3;8 ..3,331 .26,.31
)ncome ta' payments *8.,2;3- *6.,61.- *68,.3.- *:1,327-
2et operating pro#it a#ter ta'es
*2,PAT-
:;,385 :8,5;3 6;,.;; :8,513
2et operating assets *oo"-: 6;3,181 :31,2:5 651,;21 6:5,..3
Accumulated amorti(ation o# goodwill 1 1 1 .6,111 86,111 76,111
3conomic pro#it 32,26: 2;,31;
3conomic pro#it per#ormance target 25,111 3.,.;2
2
/ivision managerBs onus:
Target onus 61= 61=
@onus payout *= salary- :6.2=
3
83.;=
8
Ehibit T#-3: Cons"mer Ad&ertising Amorti9ation Sched"le for Snac- 0oods %i&ision +1222,
1336 1333 2222 2221
Consumer advertising e'pense 2:,8.1 3.,117 8.,6:5 3;,.;.
Amorti(ation *3-year period-:
.;;: e'pend. :,557
.;;7 e'pend. 7,;.1 7,;.1
.;;5 e'pend. 5,513 5,513 5,513
.;;; e'pend. .1,33: .1,33: .1,33:
2111 e'pend. .3,56: .3,56:
211. e'pend. .3,1:8
Amorti(ation o# advertising e'penditures
under economic pro#it
23,:11 27,18; 32,;;6 37,26:
Cumulative advertising e'pense since
company was #ounded
217,521 235,527 251,3;
6
3.;,65:
9ess cumulative advertising amorti(ed
through end o# .;;5 i# economic pro#it had
een used
.;.,.17 2.5,.6: 26.,.6
.
255,817
2
25,111 W *32,26:-25,111- L 1.76
3
1.61 W X*32,26: Y 25,111- 25,111Z L . P 1.:62 *i.e., :6.2=-
4
1.61 W X*2;,31; Y 3.,.;2- 3.,.;2Z L . P 1.83; *i.e., 83.;=-
23-21
Chapter 23 - Control: The Management Control Process
2et capitali(ation o# advertising #or
economic pro#it calculation o# capital
.:,7.3 21,:7. 2;,288 3.,.7;
23-2.
Chapter 23 - Control: The Management Control Process
Ehibit T#-!
Economic Profit Calc"lation for Snac- 0oods %i&ision +1222,
2222 2221
2,PAT:
2et operating income
e#ore ta'es
..3,331 .26,.31
Add ac": Consumer
advertising e'pense
8.,6:5 3;,.;.
$utract: Amorti(ation o#
advertising e'penditures
under economic pro#it
*32,;;6- *37,26:-
Add ac": goodwill
amorti(ation
31,111 31,111
AdAusted net operating
pro#it e#ore ta'es
.6.,;13 .67,1:6
Current yearBs income ta'
payments *#rom 3'hiit
T2-.-
*68,.3.- *:1,327-
Ad:"sted #(PAT 35;552 34;536
Capital:
2et operating assets
*oo"-
651,;21 6:5,..3
Add: Capitali(ed
advertising e'penditures
2;,288 3.,.7;
Add: Accumulated
goodwill amorti(ation
86,111 76,111
Ad:"sted Capital 4<<;14! 45!;232
Capital charge *.1=- :6,6.: :7,82;
Economic profit 32;2<4 23;323
23-22
Chapter 23 - Control: The Management Control Process
Ehibit T#-<
'on"s 'an- 'alance Calc"lation for =anager of Snac- 0oods %i&ision +1222,
2222 2221
@eginning alance in onus an" 1 .3,:51
6
%3'cess onus& earned .5,281
:
*7,321-
7
@alance in onus an" .5,281 :,3:1
3'cess onus paid to manager 8,6:1 .,6;1
Target onus :1,111 :1,111
@onus paid to manager :8,6:1
5
:.,6;1
5
.5,281 Y 8,6:1
6
.6.2= ' .21,111
7
-:..= ' .21,111
8
:1,111 W 26= L .5,281
23-23