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CHAPTER 25
REWARDING BUSINESS PERFORMANCE
Brief Learning
Exercises Topic Objectives Skills
B. Ex. 25.1 Motivating employee performance 25-1, 25-6 Analysis, judgment
B. Ex. 25.2 Evaluate business performance using ROI 25-2, 25-3 Analysis
B. Ex. 25.3 Comparing ROI and residual income 25-2, 25-4 Analysis, judgment
B. Ex. 25.4 Balanced scorecard perspectives 25-5 Analysis, judgment
B. Ex. 25.5 Computations for the DuPont model 25-3 Analysis
B. Ex. 25.6 Criticisms of ROI 25-3 Analysis
B. Ex. 25.7 Calculate residual income 25-2, 25-4 Analysis
B. Ex. 25.8 Calculate EVA 25-4 Analysis
B. Ex. 25.9 Variable vs. fixed compensation 25-6 Analysis, judgment
B. Ex. 25.10 Components of ROI 25-2 Analysis, communication
Learning
Exercises Topic Objectives Skills
25.1 Accounting terminology 25-2–25-6 Analysis
25.2 Balanced scorecard activities 25-1, 25-5 Analysis, judgment
25.3 Employee motivation 25-1 Analysis, judgment
25.4 ROI versus EVA measures 25-2–25-4 Analysis
25.5 Performance and ROI versus residual income 25-2–25-4 Analysis, judgment
25.6 Concerns about ROI 25-2, 25-3
Analysis, judgment,
communication
25.7 Compensation choices
25-1, 25-5,
25-6
Analysis,
communication,
judgment
25.8 Designing compensation schemes 25-6 Analysis, judgment
25.9 Balanced scorecard matching 25-5 Analysis
25.10 City Wide Door ROI and residual income 25-2, 25-4 Analysis, judgment
25.11 Using ROI and EVA for performance evaluation 25-2–25-4 Analysis, judgment
25.12 Finding unknowns 25-2, 25-4 Analysis
25.13 Real World: Home Depot Balanced Scorecard 25-5 Analysis
25.14 Comparing division performance 25-4, 25-5 Analysis, judgment
25.15 Real World: Home Depot’s ROI and EVA 25-4, 25-6
Analysis,
communication,
judgment, research
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Problems Learning
Sets A, B Topic Objectives
Skills
25.1 A,B Empire Hotel/Triple Creek Golf Complex 25-2–25-4
Analysis, judgment,
communication
25.2 A,B Balanced scorecard at Empire/Triple Creek
25-1, 25-5,
25-6
Analysis, judgment,
communication
25.3 A,B Evaluating business unit performance 25-1–25-4
Analysis, judgment,
communication
25.4 A,B Real World: Tootsie Roll Industries 25-2
Analysis, judgment,
research
25.5 A,B ROI and residual income 25-2–25-4
Analysis, communication,
judgment
25.6 A,B
Balanced scorecard in the assembly
dept./restaurant
25-5, 25-6
Analysis, communication,
judgment
25.7 A,B
Design of management compensation
packages
25-1, 25-6
Analysis, communication,
judgment
25.8 A,B Performance measures and transaction effects 25-2–25-4 Analysis
25.9 A,B
ROI, residual income and performance
evaluation
25-2–25-4,
25-6
Analysis, judgment
Critical Thinking Cases
25.1 Business performance and transfer pricing 25-2–4, 25-6
Analysis, communication,
judgment
25.2 Using performance measures 25-1–25-4 Analysis, communication,
judgment
25.3
Real World: Stern Stewart & Company
(Internet) EVA
25-1, 25-4,
25-5
Analysis, communication,
research
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Problems (Sets A and B)
25.1 A,B
Empire Hotel/Triple Creek Golf Complex 60 Strong
Computations show that a project that improves the ROI of a department
in the Hotel/Golf Course does not meet the minimum acceptable return
for the Hotel/Golf Course. Shows the problems that arise if incentives are
based on ROI.
25.2 A,B
Empire Hotel/Triple Creek Golf Complex 30 Medium
Students must identify measures to improve the hotel housekeeping/pro
shop staff’s performance using a balanced scorecard approach. Because
individual students’ answers will be different, this makes a good class
discussion question.
25.3 A,B
Fairfax Industries/Wilson Company 30 Medium
This problem demonstrates the impact of a choice of depreciation
method on operating earnings. Because operating earnings are
instrumental in determining the performance evaluation and resulting
bonus of the manager of a division, the ethics of the choice are
considered.
25.4 A,B
Tootsie Roll Industries 20 Medium
This problem demonstrates that information found in annual reports can
be used to evaluate business segments. Financial information for
computing ROI, capital turnover, and return on sales is included.
25.5 A,B
Fastwhere Inc./Save Some, Inc. 40 Strong
A set of potential investment projects is evaluated on both ROI and
residual income measures. The calculations demonstrate that the project
rankings are different if residual income is used rather than ROI to rank
project attractiveness.
25.6 A,B
Valance Autoparts/Eatwell Restaurant Chain 40 Strong
This problem asks students to role play as a consultant to a firm that is
having some problems with the balanced scorecard approach. It is a good
problem to be used for a group report or presentation.
25.7 A,B Hinkley Corporation/Bronson Corporation 15 Easy
Students consider management compensation plans described for each
company. Students are asked to identify the compensation design choices
made by the board of directors.
Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates
assume use of the partially filled-in working papers.
25.8 A,B Hopenstat Inc./ Frangling International 20 Medium
Students identify the effects of various transactions on computations of
ROI, residual income, and capital turnover.
25.9 A,B Marfar Industries / Warthers Corporation 30 Medium
After computing residual income and ROI for a division of the
company, students explain differences in investment choices that the
managers would make when they are evaluated with ROI or residual
income.
Critical Thinking Cases
25.1 Business Performance and Transfer Prices 30 Medium
Transfer pricing between business units can create difficulties with
allocating bonuses and create poor incentives for business unit
managers. In addition, ethical issues can arise that are highlighted by
improving personal performance at the expense of company
performance.
25.2 Big Bertha Sub Shops 60 Strong
ROI and residual income comparisons for two sub shops demonstrates to
students how evaluating sub shop managers based on ROI can lead to
poor decision making outcomes.
25.3 EVA 30 Medium
Internet
Provides a student with a perspective of the benefits of using EVA for
business performance evaluation.
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1.
2.
3.
4.
5.
6.
Companies have difficulty assessing the weights that should be placed on the numerous
It is likely that the company would want the manager of a finished goods warehouse to try to
The financial perspective lens is designed to view business performance through the eyes of
creditors and stockholders. Profitability, return on investment, and residual income are the types
of financial measures that a family owned grocery store could identify and measure. The second
Public accountants are required to undertake continuing professional education to maintain their
ear
Accounting systems help align goals of employees and the goals of the organization for which
Goals for a new restaurant might include earning a return on invested capital at least above the
7.
8.
9.
10.
11.
12.
13.
The business process perspective is the part of the balanced scorecard where standard cost
The return on sales ratio could increase even when sales remain constant if income for the
Two measures in the customer perspective category that might conflict with measures in the
financial perspective category are customer retention or customer satisfaction compared to
annual net income. For example, in order to raise customer satisfaction it might be necessary
Residual income is a measure like EVA that requires a proposed investment to have a return
If the pure bonus compensation plan presents considerable risk to the employee and if the
A dot.com retail company will have little inventory and no retail store facilities. Therefore its
The international operations of Tootsie Roll include Mexico and Canada. The board of
directors may want to emphasize long-run performance over the short-run by providing stock
options that are not exercisable for three to five years. Also, basing the performance
14.
15.
The costs of a cooperative incentive plan include the actual cost of the bonus paid out and the
In addition to the cost of the bonus, competitive incentive arrangements can have opportunity
SOLUTIONS TO BRIEF EXERCISES
B. Ex. 25.1
Because the pet shop compensation includes both a fixed (salary) and a variable
(commission) component, employees are only paying attention to the portion they
can directly affect with their actions. By keeping pets' cages clean and focusing
B. Ex. 25.4
Ricoh Company, Ltd. is a Japanese company. Their balanced scorecard appeared
in The Balanced Scorecard Collaborative, Inc. collection of best balanced
B. Ex. 25.6
If the Division 2 manager purchased the new equipment, the new ROI would be
B. Ex. 25.9
Because top managers can have significant impacts throughout the entire business,
B. Ex. 25.10
Boris could increase the auto part division’s ROI by decreasing the cost of raw
SOLUTIONS TO EXERCISES
Ex. 25.1 a. Return on sales
Ex. 25.2
Ex. 25.3
In order to create a balanced scorecard, the management accountant will need to
identify the organization’s goals and objectives related to the product lines. For
example, does the organization want to be a low-cost producer, or are they
Student answers will differ but, measures that might encourage these behaviors
would be to suggest to employees that they have complete control of their
Ex. 25.4 a. Division B is more profitable because it has a higher after tax operating income.
If the manager is evaluated on residual income then projects A and B have
positive or incremental residual income. Project C's residual income is expected
to be negative. Therefore the manager will prefer projects A and B, with A
ranked first because it has the highest residual income as shown below:
Ex. 25.6
•
Because the business seems to be growing quickly, the division managers are
likely to be shifting jobs over short time horizons. Thus, the short horizon
Ms. Baskiter should consider the following issues:
Ex. 25.5
a.
Ex. 25.7
•
The annual cash bonus focuses on current performance and neglects to
provide for a future orientation. Managers may make decisions to increase
Ex. 25.8
1)
Supervisor of the second shift will probably have an emphasis on short-term
performance, perhaps a plant level variable bonus based on accounting
Criticisms of the current performance plan include:
To remedy the problems, Bites and Bits might consider:
The five design categories are time horizon, bonus (fixed or variable), stock based
versus accounting based, local versus companywide performance, and cooperative
versus competitive plans.
Ex. 25.9 a. Direct labor efficiency variance – B
Ex. 25.10 a. If the Company uses ROI to evaluate investments:
b. If the company uses RI to evaluate investments:
Emily should select proposal B, as it will contribute a higher residual income.
c.
If ROI is used to evaluate performance, projects with potential returns higher
than the weighted average cost of capital will be rejected, even though they
Ex. 25.12 Company X
a. Return on Sales = Income ÷ Sales; thus, 32% = $220,000 ÷ Sales.
Ex. 25.13
a.
Financial Perspective — students are likely to select measures from the
following categories: Statement of Earnings Data, Balance Sheet Data and
b.
Customer Perspective — students are likely to choose from the Store Sales and
Other Data Category:
c.
Business Process Perspective — students are likely to choose both financial and
operating information for this category for example:
Student answers will vary based on their choices. In addition, it is likely that some
measures will be chosen for more than one balanced scorecard perspective. For
example, "Number of associates at year-end" might be considered by some
students to be a measure for the customer perspective (more sales personnel
Company Y
Ex. 25.12
Ex. 25.14 a.
STORES CYBER
Both EVA and ROI improved for the years reported. ROI increased primarily due
to a large increase in net earnings, althought net plant and equipment did decrease
SOLUTIONS TO PROBLEMS SET A
a.
ROI Return on Sales Capital Turnover
$1,800,000 ÷ $10,000,000 $1,800,000 ÷ $11,250,000 $11,250,000 ÷ $10,000,000
= 18% = 16% 112.50%
Return on sales is lower for the Hotel Rooms Department reflecting the small markups for rooms. In addition, the capital
turnover for rooms is high compared to the other departments because the restaurants and spa have much higher investment
bases relative to their sales revenue.
Departments
PROBLEM 25.1A
EMPIRE HOTEL
60 Minutes, Strong
Empire Hotel
Hotel Rooms
PROBLEM 25.2A
Cleanliness Change in satisfaction per
hour of housekeeping.
30 Minutes, Medium
Surveys of customer
satisfaction
a. GOALS
To improve the reputation of
the hotel rooms:
b. MEASURMENTS
and RESOURCES
c. FEEDBACK
Use surveys and resources
consumed to provide feedback:
Customer beliefs are key to
measurement:
Choosing to use only residual income suffers from many of the same problems as using ROI. That
is, the manager for the Hotel Rooms Department will want to reduce operating expenses to
improve operating earnings. Thus, the manager will still try to skimp on the housekeeping.
Assuming that a strategic goal of the Hotel is to maintain a good reputation by having high
customer satisfaction, then a balanced scorecard approach to business performance measurement
is preferred. In particular, for the Hotel Rooms Department consider the following:
EMPIRE HOTEL AND THE BALANCED SCORECARD
b.
$ 2,500,000
c.
30 Minutes, Medium
PROBLEM 25.3A
FAIRFAX INDUSTRIES
a.
The Snacks Division’s ROI and residual income (RI) are computed as follows:
The manager’s bonus is computed as follows:
The use of accelerated depreciation will increase the division manager’s current ROI and
The question of whether her use of accelerated depreciation is ethical depends on the
company’s bonus policy. If company policy specifically states that straight-line depreciation
must be used to determine bonuses, then her use of an accelerated method is unethical. If
Residual Income (part a) …………………………………………………………..
