Question

Cardale Industrial Metal Co (CIM Co) is a large supplier of industrial metals. The company is split into two divisions: Division F and Division N. Each division operates separately as an investment centre, with each one having full control over its non-current assets. In addition, both divisionns are responsible for their own current assets, controlling their own levels of inventory and cash and having full responsibility for the credit terms granted to customers and the collection of receivables balances. Similarly, each division has full responsibility for its current liabilities and deals directly with its own suppliers.

Each divisional manager is paid a salary of $120,000 per annum plus an annual performance-related bonus, based on the return on investment (ROI) achieved by their division for the year. Each divisional manager is expected to achieve a minimum ROI for their division of 10% per annum. If a manager only meets the 10% target, they are not awarded a bonus. However, for each whole percentage point above 10% which the division achieves for the year, a bonus equivalent to 2% of annual salary is paid, subject to a maximum bonus equivalent to 30% of annual salary.

The following figures relate to the year ended 31 August 2015:

	Division F $000	Division N $000
Sales	14,500	8,700
Controllable profit	2,645	1,970
Less: apportionment of Head Office costs	(1,265)	(684)
Net profit	1,380	1,286
Non-current assets	9,760	14,980
Inventory, cash and trade receivables	2,480	3,260
Trade payables	2,960	1,400

During the year ending 31 August 2015, Division N invested $6.8m in new equipment including a technologically advanced cutting machine, which is expected to increase productivity by 8% per annum. Division F has made no investment during the year, although its computer system is badly in need of updating. Division F's manager has said that he has already had to delay payments to suppliers (i.e. accounts payables) because of limited cash and the computer system 'will just have to wait', although the cash balance at Division F is still better than that of Division N.

Required:

(a) For each division, for the year ended 31 August 2015, calculate the appropriate closing return on investment (ROI) on which the payment of management bonuses will be based. Briefly justify the figures used in your calculations.

(b) Based on your calculation in (a), calculate each manager's bonus for the year ended 31st August 2015.

Answer 1

Division F Controllable profit $2,645 Total assets less Trade payables-$9,760+$2,480-$2,960 $9,280 ROI-controllable profit/Total Assets less trade payables-$2,645/$9,280-28.50% a) Division N Controllable profit-$1,970 Total assets less trade payables-$14,980+$3,260-$1,400 $16,840 ROI $1,970/$16,840-11.70% In both calculations controllable profit has been used to reflect profit, rather than net profit. This is because the managers do not have any control over the Head Office costs and responsibility accounting deems that managers should only be held responsible for costs which they control. The same principle is being applied in the choice of assets figures being used. The current assets and current liabilities figures have been taken into account in the calculation because of the fact that the managers have full control over both of these.

b) Bonus to be paid for each percentage points $1,20,000 x 2%-$2,400 Maximum bonus $1,20,000 x 0.3 $36,000. Division F R01-28.5 f 10%. 18 x $2,400: $43,200. Therefore manager will be paid the maximum bonus of $36,000 % 18 whole percentage points above minimum ROI 0 Division N ROI 11.70% 1 whole percentage point above minimum. Therefore bonus $2,400.

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