Question

Operations

Brony’s Bikes was incorporated more than 30 years ago to manufacture ten-speed touring bikes. An exercise bike and mountain bikes later added to the product line. Currently, the company manufactures the following products:

Grand Prix:   Ten-speed touring bike
Phoenix:          Deluxe eighteen-speed racing bike
Pike’s Peak:     Twelve-speed mountain bike
Himalaya:        Eighteen-speed deluxe mountain bike
Waistliner:       Stationary exercise bike

All of these products are manufactured in a single facility, which is located in eastern Texas. Derailleurs (front and rear) comprise a major portion of the parts inventory. Other purchased parts consist of tires, handle grips, pedals, wheels, and spokes. Materials and supplies consist primarily of paint and steel. Brony’s Bikes manufactures the frames and handlebars, and assembles and paints the bikes.

The factory, which employs 2,000 workers, was built when the company was incorporated but was extensively refurbished and updated five years ago. Increased automation enabled Brony’s Bikes to decrease its number of factory workers from 3,000 ten years ago to 2,000 workers two years ago. The vice president of production observed that automation enabled Brony’s Bikes to significantly increase worker productivity. The marketing vice-president agrees and predicts revenue and profit growth for at least the next two to three years. In addition to the 2,000 production workers, the company employs 200 salaried administrative employees, including the corporate management staff, warehouse superintendents, and regional sales managers. In addition, the regional units employ 100 warehouse personnel and 120 salespersons.

Hourly employees, consisting of the production workers and warehouse personnel, are paid weekly; salaried employees are paid biweekly. Salespersons receive a salary plus 5 percent commission, based on gross sales.

Brony’s Bikes’ administrative offices are located in another building in the same complex. The company has ten regional distribution locations in various parts of the United States; each location consists of a warehouse headed by a warehouse superintendent and a sales office directed by a regional sales manager. Products are shipped to the warehouses upon product completion, and from the warehouses they are shipped to licensed dealers in the respective regions. The dealer network consists of approximately 1,500 outlets located throughout the United States and Canada.

All products carry a full one-year warranty covering parts and labor. The company is known for the quality of its products and for its strong service support. As of the end of 20X9, the company had a total of 60 customer accounts ranging in amounts from $2,200 to approximately $1,350,000. The cumulative accounts receivable at year-end December 31, 20X9, was $12 million.

Brony’s Bikes experienced steady growth in sales and profitability of all product lines from the date of incorporation until about four years ago. From about four years ago until the current year, competition from international manufacturers has had a significant impact on Brony’s Bikes’ revenue and net profit.

However, Brony’s Bikes has experienced significant growth in sales and profitability for the current year (see Exhibit BB.1).

In an attempt to combat the strong competition from foreign bicycle producers, managers at Brony’s Bikes, particularly those responsible for marketing and controlling production costs, have been given demanding performance targets in recent years. While the financial rewards for meeting or exceeding these targets are great, the targets may not be achievable. In response to the demanding performance targets, many marketing and production-control managers have left the firm for opportunities elsewhere, leaving Brony’s Bikes relatively understaffed in some key areas. In addition, many recent hires to the management team have not been provided with sufficient descriptions of or training for the tasks, knowledge, and skills needed to succeed.

Audit Engagement

Your firm, Vaughan & Co., Certified Public Accountants, has audited Brony’s Bikes since its incorporation. Denise Vaughan, daughter of the founder of Vaughan & Co. is presently the partner in charge of the engagement and Carolyn Volmar is the audit manager. The audit team consists of Richard Derick, senior auditor in charge of the Brony’s Bikes audit; Cheryl Lucas, assistant auditor, in her third year with the firm and her third year on the Brony’s Bikes audit; Shelly Ross, assistant auditor in her second year with the firm and her second year on the Brony’s Bikes audit; and a student (you), assistant auditor, newly hired. Brony’s Bikes will be your first audit. Derick has been in charge of the Brony’s Bikes audit fieldwork for the past two years. Prior to that time, he had been a part of the Brony’s Bikes audit team as an assistant. He is very familiar with the client’s operations and internal controls and works well with Brony’s Bikes’ personnel. Richard Derick and his audit team were present to observe Brony’s Bikes’ 20X9 year-end physical inventory counting process.

Brony's Bikes Personnel

In 20X1, Trevor Lawton assumed control of Brony’s Bikes after the retirement of his father, the founder of the company. The Lawton family presently owns 25 percent of the outstanding Brony’s Bikes common stock; the remaining 75 percent is held by nonfamily members. Brony’s Bikes is not subject an issuer thus does not report to the U.S. SEC. Lawton managed conservatively when first becoming CEO and president of Brony’s Bikes. In recent years he has become increasingly aggressive, believing that strategic changes must be bold, frequent, and swift in order to prevail in the highly competitive bicycle industry. He has worked to make his management perspective the basis of Brony’s Bikes’ corporate culture. Lawton believes that success can be achieved via aggressive marketing and containment of production costs. As a result of devoting most of his attention to sales and production, he is relatively detached from financial reporting matters including controls over financial reporting. Lawton generally views the accounting function as a necessary evil conducted by “bean counters” that do not seem to understand the need for Brony’s Bikes’ financial statements to “look good.” Consistent with these views, the accounting group has received modest allocations of resources in recent years, and operates with a relatively small, but seemingly competent and trustworthy staff.

Reflecting Lawton’s preference for centralized management, Lawton and the vice presidents of production and marketing determine Brony’s Bikes’ objectives and strategic plan with little input from other managers. Once determined, the objectives and strategic plan are not widely disseminated to employees, but are presented for feedback and approval at board of directors’ meetings. Privately, some managers and board members believe the financial objectives to be overly optimistic and unlikely to be achieved. In addition, many middle and lower-level managers feel the supporting budgets lack the necessary resources to meet financial objectives.

For the past couple of years, Lawton has been unable to devote the time he would like to identifying and managing an increasing array of risks. To address this problem, Lawton has begun forming an enterprise risk management team comprised of managers with finance, marketing, and production expertise. The team would manage risks from both internal and external sources, and report directly to Lawton. Because of heavy demands on his time, Lawton has not been able to finalize formation of the risk management team. Currently, the mechanisms in place for identifying, analyzing, and acting on risk matters are unstructured and vary in quality from department to department. For example, risk management in production and procurement is known to be rather weak, while the corporate controller is thought to be doing quality risk management regarding financial reporting and information systems matters.

Gerald Groth, the corporate controller of Brony’s Bikes, has been with the company since receiving his MBA ten years ago. Groth is also a CPA and was a staff accountant with Vaughan & Co. for five years just prior to joining Brony’s Bikes. Other Brony’s Bikes personnel include:

• Elmer Fennig, vice president, production;
• Charles Gibson, vice president, marketing;
• Marlene McAfee, treasurer;
• Laura Schroeder, director of human resources;
• John Mesarvey, chief accountant;
• Glenn Florence, director of internal auditing; and
• Malissa Rust, director of Computer Based Information Systems (CBIS).

Mesarvey, Florence, and Rust report to Groth. Emil Ransbottom, the director of purchasing, as well as the plant manager and the factory supervisors, report to Fennig. Three personnel officers report to the director of human resources. Brony’s Bikes has three product managers: one for touring bikes, one for mountain bikes, and one for stationary bikes. The sales staff reports to the product managers and the product managers report to Gibson. Under Mesarvey, the chief accountant, are Harriet Smith, transaction processing; Oliver Perna, cost accounting; and Janice Hollins, financial statements.

The reporting relationships at Brony’s Bikes have changed little since the company’s incorporation even though Brony’s Bikes has experienced considerable growth in production volume and the warehouse distribution network, as well as a major transformation of its information system. However, over time, responsibilities and authority for decision-making have become more centralized.

Board of Directors and Audit Committee

Lawton is the chairman of the board of directors. Also on the board are two of Lawton’s siblings, neither of whom is engaged in day-to-day management of Brony’s Bikes. The rest of the board is comprised of Brony’s Bikes’ treasurer and vice presidents of production and marketing, as well as a number of external members that were longtime business associates of Lawton’s father. The external members of the board have considerable financial expertise in their respective industries (insurance, road construction, banking, health care, and software). The board meets quarterly (March, June, September, and December). At the December meeting, Brony’s Bikes’ top managers present the board with the budget for the upcoming year and analyses of budget variances for the current year through November. Board members receive the budget and variance analyses approximately two weeks prior to the meeting. Given their limited financial expertise in the bicycle industry, board members question or challenge the upcoming budget on very few matters and seldom have probing questions regarding budget variances.

The audit committee (one of three committees including the compensation and nomination committees) is made up exclusively of external members. At the June and December board meetings, the audit committee holds a joint meeting with the external audit partner, director of internal audit, and controller to be briefed on audit findings and approve the scope of planned audit activities. In addition, significant changes in internal control over financial reporting are presented and explained. The audit committee, in joint consultation with the compensation committee, approves the recommendations of the controller regarding the annual appointment of the external auditor, and the compensation and retention of the director of internal audit.

Accounting and Information Systems

Transaction processing is divided into the following sections: General ledger, accounts receivable, accounts payable, and payroll. The managers of these sections report to Smith. Three staff auditors report to the director of internal auditing. Harold Cannon, information technology manager, and Nancy Karling, management information systems manager, report to the CBIS director. Cannon’s department is divided into four sections: data entry, data processing, control, and systems analysis/programming. Karling’s department is divided into three sections: statistical analysis, budget coordination, and report generation. Reporting to the treasurer are Lawrence White, credit manager; Paula Penelee, portfolio manager; and Mark Wilkins, cashier.

Brony’s Bikes closes its general ledger on a calendar-year basis. Unaudited financial statements are prepared quarterly and are reviewed by Vaughan & Co. The accounting information system, including the general ledger, inventories, receivables, payables, and plant assets, was initially computerized more than 20 years ago, and it was upgraded to a real-time system about three years ago. After extensive “debugging,” the real-time system seems to be functioning smoothly.

The company has provided the auditors with a year-end adjusted trial balance and a complete set of financial statements, together with supporting schedules (see Exhibits BB.2−BB.6).

Brony’s Bikes’ internal audit staff of three members plus the director is viewed by our external audit firm as competent. The internal audit group conducts evaluations of important processes (e.g., sales, purchases, and payroll) on a recurring basis, usually once every ten to fourteen months. In addition, the group works on special projects as warranted. Any weaknesses in accounting and information systems are reported immediately to Groth and the responsible function manager. The director of internal audit reports directly to Groth and also makes periodic presentations of recommendations and findings to Lawton and the audit committee.

QUESTION: Identify the major strengths and weaknesses within the organizational structure.

Answer 1

Strength –

Automation

The vice president of production observed that automation enabled Brony’s Bikes to significantly increase worker productivity

Quality + Geography wise spread -   

The company is known for the quality of its products and for its strong service support

Competition challenges still growth in revenue and profit and increase customer base

Brony’s Bikes experienced steady growth in sales and profitability of all product lines from the date of incorporation until about four years ago. From about four years ago until the current year, competition from international manufacturers has had a significant impact on Brony’s Bikes’ revenue and net profit.

However, Brony’s Bikes has experienced significant growth in sales and profitability for the current Year

Change in management , culture , more competitiveness

Lawton managed conservatively when first becoming CEO and president of Brony’s Bikes. In recent years he has become increasingly aggressive, believing that strategic changes must be bold, frequent, and swift in order to prevail in the highly competitive bicycle industry.

Centralized decision making system

Maintain excellent Internal control process , accounting records , real time basis of accounting , Upgrade Information system

Weakness –

Employee Knowledge, target pressure , loosing key manpower , which will create bad impact on Quality in future

While the financial rewards for meeting or exceeding these targets are great, the targets may not be achievable. In response to the demanding performance targets, many marketing and production-control managers have left the firm for opportunities elsewhere, leaving Brony’s Bikes relatively understaffed in some key areas. In addition, many recent hires to the management team have not been provided with sufficient descriptions of or training for the tasks, knowledge, and skills needed to succeed.

   

Financial Objective achievement –

Privately, some managers and board members believe the financial objectives to be overly optimistic and unlikely to be achieved. In addition, many middle and lower-level managers feel the supporting budgets lack the necessary resources to meet financial objectives.

Not proper risk Management team maintained

Lawton has not been able to finalize formation of the risk management team. Currently, the mechanisms in place for identifying, analyzing, and acting on risk matters are unstructured and vary in quality from department to department. For example, risk management in production and procurement is known to be rather weak, while the corporate controller is thought to be doing quality risk management regarding financial reporting and information systems matters.

Knowledge of Board member is not sound in relates to Bike Business –

Given their limited financial expertise in the bicycle industry, board members question or challenge the upcoming budget on very few matters and seldom have probing questions regarding budget variances.