Question

C13.42 Financial performance measures; behavioural Issues: manufacturer LO13.9 Enginuity Ltd is a large and successful manufacturer of engines. The company consists of two divisions: the 13.11 automotive engine division and the outboard motor division. Enginuity has recently acquired a company which 13.12 will become a third division. The new Domestic Applications division is a small manufacturer of lawnmower 13.13 motors. It has been owned and managed by the one person for 40 years. The prior owner treated all employees as part of his family. The company was noted for the lack of a them and us' attitude between employees and management, and there was free and open communication between all staff. Unfortunately, Domestic Applications is not a strong performer, the lawnmower market is in decline and profits have slipped. Enginuity is known for its modern management systems and would like all managers at Domestic Applications to participate in the performance-related pay system that is used in the other two divisions. The profit-sharing plan applies to senior divisional managers only. It is based on placing 10 per cent of Enginuity's profits before interest and income tax into a pool, which is then shared by the senior divisional managers in direct proportion to their base salaries. The senior managers in the two original divisions received bonuses of 11 per cent and 12 per cent of their salaries for the last two years before the acquisition of Domestic Applications, The profit results for the first financial year following the acquisition of the Domestic Applications division are provided below: Outboard S47 400 000 Sales revenue Cost of goods sold Gross margin 15 000 000 S32 400 000 17 700 000 11 100.000 S28 800 000 $ 3 600 000 Administrative costs Marketing and selling costs Total costs Profit before interest and taxes Automotive $63 000 000 36 000 000 $27 000 000 11 100 000 9.300.000 $20 400 000 $ 6600000 Domestic $14 250 000 6 750 000 $ 7 500 000 5 400 000 1 800 000 $ 7 200 000 $ 300 000 Senior management salaries included in the above costs, and divisional assets at the end of that year, are as follows: Senior management salaries Divisional assets Outboard $4 000 000 8 000 000 Automotive $2 800 000 8 000 000 Domestic SI 400 000 1 600 000 Prior to the acquisition by Enginuity, all Domestic Applications employees, including the senior managers, participated in a gainsharing program. Under this program, the financial impact of improvements in labour productivity and delivery performance were quantified each quarter, and 50 per cent of this amount was accumulated in a pool. At the end of each year, each employee received an equal share of the pool. The scheme was discontinued when Enginuity purchased Domestic Applications, Page 5 of 11 Required: 1. Which division has the best performance in the first year after the acquisition? 2. Determine the bonus pool available for that year, and calculate the percentage bonus that each senior manager would receive. 3. Discuss the behavioural problems that could arise among the senior managers of the outboard motor and automotive engine divisions as a result of the bonuses. 4. Discuss the behavioural problems that may arise within the Domestic Applications division from the changes in the performance-related pay system. 5. Suggest some changes that could be made to improve Enginuity's performance-related pay system and alleviate some of the problems identified in requirements 3 and 4.

Answer 1

1.

	Particulars	Outboard Motor	Automotive engine	Domestic applications
A	Profit	$     3,600,000.00	$            6,600,000.00	$                     300,000.00
B	Assets	$     8,000,000.00	$            8,000,000.00	$                 1,600,000.00
C=A/B	Return on Investment (ROI)	45%	82.50%	19.00%

Based on both profit and ROI, the automotive engine division outperformed the remaining two divisions.

2.

Bonus pool = ($3,600,000 +$6,600,000+$300,000) *1/10 Bonus % = $1,050,000/($4,000,000+$2,800,000+$1,400,000) = $1,050,000/$8,200,000 = 12.80%

3.

The senior managers of the outboard motor and automotive engine divisions have an existing performance-related pay system already in place. However, the management's act of acquisition of Domestic Applications by Enginuity and the entry of its senior managers into the scheme could cause some dissatisfaction among the managers in the other two existing divisions since the profitability of the newly acquired Domestic Applications division is lower than the other two divisions, so that the inclusion of Domestic Applications will bear the effect of reduced bonuses. The bonus percentage that has been paid to the new division managers, 15 percent, more than the 11 per cent and 12 percent bonuses of the previous two years. Bonus % without Domestic Applications division = ($3,600,000 + $6,600,000) x 10%/ ($4,000,000 + $2,800,000) = 15%

4.

The Domestic Applications division which was newly acquired by Enginuity was, earlier, a small, family- owned business that was noted for its lack of a 'them and us' attitude between employees and management. Under the previous management allemployees participated in a gainsharing program that yielded equal bonuses forevery employee. The introduction of a performance bonus for the senior managers of Domestic Applications and discontinuance of the gain sharing program is against the culture of Domestic Applications and may cause some dissatisfaction among those Domestic Applications employees who are not senior managers since they are losing their additional earnings.

5.

The gain sharing system could be retained within Domestic Applications and senior managers of that division might not participate in the company-wide bonus pool. Such action will satisfy the employees in Domestic Applications and the senior managers in the othertwo divisions also. However, the existing non-management employees in the other two divisions may lobby for a similar gain sharing program, so that the head office management may consider the possibility to do so. Another potential issue is that the senior managers of Domestic Applications may see themselves as not being treated on par with the senior managers in the other two divisions. This can be very much evident if some of the existing managers are transferred to the new Domestic Applications division. Enginuity may decide that it is preferable to include all the senior managers in a performance- related bonus scheme and specify some separate percentage bonuses for each division. This will have some positive effect because each manager's bonus depends on their own division's performance only. The major disadvantage for Enginuityis that no part of the bonus is based on company-wide employee performance. Some managers believe that it is good practice to have at least some proportion of a divisional manager's bonus based on company-wide performance, as this encourages managers to consider the impact of decisions on both the division and the company. This is a goal congruence issue.