5 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 divisions 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 Division N
$’000 $’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.
Note: There are 3 marks available for calculations and 2 marks available for discussion. (5 marks)

(b) Based on your calculations in part (a), calculate each manager’s bonus for the year ended 31 August 2015. (3
marks)

(c) Discuss whether ROI is providing a fair basis for calculating the managers’ bonuses and the problems arising
from its use at CIM Co for the year ended 31 August 2015. (7 marks)

(15 marks)

6
5 Jump has a network of sports clubs which is managed by local managers reporting to the main board. The
local managers have a lot of autonomy and are able to vary employment contracts with staff and offer
discounts for membership fees and personal training sessions. They also control their own maintenance
budget but do not have control over large amounts of capital expenditure.
A local manager’s performance and bonus is assessed relative to three targets. For every one of these three
targets that is reached in an individual quarter, $400 is added to the manager’s bonus, which is paid at the end
of the year. The maximum bonus per year is therefore based on 12 targets (three targets in each of the four
quarters of the year). Accordingly the maximum bonus that could be earned is 12 x $400 = $4,800, which
represents 40% of the basic salary of a local manager. Jump has a 31 March year end.
The performance data for one of the sports clubs for the last four quarters is as follows

Qtr to Qtr to Qtr to Qtr to

30 June 2009 30 September 2009 31 December 2009 31 March 2010
Number of members 3,000 3,200 3,300 3,400
Member visits 20,000 24,000 26,000 24,000
Personal training sessions booked 310 325 310 339
Staff days 450 480 470 480
Staff lateness days 20 28 28 20
Days in quarter 90 90 90 90
Agreed targets are:
1. Staff must be on time over 95% of the time (no penalty is made when staff are absent from work)
2. On average 60% of members must use the clubs’ facilities regularly by visiting at least 12 times per quarter
3. On average 10% of members must book a personal training session each quarter

Required:
(a) Calculate the amount of bonus that the manager should expect to be paid for the latest financial year.
(6 marks)

(b) Discuss to what extent the targets set are controllable by the local manager (you are required to make a case
for both sides of the argument). (9 marks)

(c) Describe two methods as to how a manager with access to the accounting and other records could unethically
manipulate the situation so as to gain a greater bonus. (5 marks)

(20 marks)

7 [P.T.O.
ALL FOUR questions are compulsory and MUST be attempted

1 Pace Company (PC) runs a large number of wholesale stores and is increasing the number of these stores all
the time. It measures the performance of each store on the basis of a target return on investment (ROI) of
15%. Store managers get a bonus of 10% of their salary if their store’s annual ROI exceeds the target each
year. Once a store is built there is very little further capital expenditure until a full four years have passed.
PC has a store (store W) in the west of the country. Store W has historic financial data as follows over the past
four years:
2005 2006 2007 2008
Sales ($’000) 200 200 180 170
Gross profit ($’000) 80 70 63 51
Net profit ($’000) 13 14 10 8
Net assets at start of year ($’000) 100 80 60 40
The market in which PC operates has been growing steadily. Typically, PC’s stores generate a 40% gross profit margin.

Required:
(a) Discuss the past financial performance of store W using ROI and any other measure you feel appropriate
and, using your findings, discuss whether the ROI correctly reflects Store W’s actual performance.
(8 marks)

(b) Explain how a manager in store W might have been able to manipulate the results so as to gain bonuses
more frequently. (4 marks)

PC has another store (store S) about to open in the south of the country. It has asked you for help in calculating the
gross profit, net profit and ROI it can expect over each of the next four years. The following information is provided:
Sales volume in the first year will be 18,000 units. Sales volume will grow at the rate of 10% for years two and
three but no further growth is expected in year 4. Sales price will start at $12 per unit for the first two years but
then reduce by 5% per annum for each of the next two years.
Gross profit will start at 40% but will reduce as the sales price reduces. All purchase prices on goods for resale
will remain constant for the four years.
Overheads, including depreciation, will be $70,000 for the first two years rising to $80,000 in years three and four.

Store S requires an investment of $100,000 at the start of its first year of trading.
PC depreciates non-current assets at the rate of 25% of cost. No residual value is expected on these assets.

Required:
(c) Calculate (in columnar form) the revenue, gross profit, net profit and ROI of store S over each of its first four
years. (9 marks)

(d) Calculate the minimum sales volume required in year 4 (assuming all other variables remain unchanged) to
earn the manager of S a bonus in that year. (4 marks)

(25 marks)

2
5 The Biscuits division (Division B) and the Cakes division (Division C) are two divisions of a large,
manufacturing company. Whilst both divisions operate in almost identical markets, each division operates
separately as an investment centre. Each month, operating statements must be prepared by each division and
these are used as a basis for performance measurement for the divisions.
Last month, senior management decided to recharge head office costs to the divisions. Consequently, each division
is now going to be required to deduct a share of head office costs in its operating statement before arriving at ‘net
profit’, which is then used to calculate return on investment (ROI). Prior to this, ROI has been calculated using
controllable profit only. The company’s target ROI, however, remains unchanged at 20% per annum. For each of the
last three months, Divisions B and C have maintained ROIs of 22% per annum and 23% per annum respectively,
resulting in healthy bonuses being awarded to staff. The company has a cost of capital of 10%.
The budgeted operating statement for the month of July is shown below:

B C
$’000 $’000
Sales revenue 1,300 1,500
Less variable costs (700) (800)
–––––– ––––––
Contribution 600 700
Less controllable fixed costs (134) (228)
–––––– ––––––
Controllable profit 466 472
Less apportionment of head office costs (155) (180)
–––––– ––––––
Net profit 311 292
–––––– ––––––
Divisional net assets $23·2m $22·6m

Required
(a) Calculate the expected annualised Return on Investment (ROI) using the new method as preferred by senior
management, based on the above budgeted operating statements, for each of the divisions.
(2 marks)

(b) The divisional managing directors are unhappy about the results produced by your calculations in (a) and
have heard that a performance measure called ‘residual income’ may provide more information.

Calculate the annualised residual income (RI) for each of the divisions, based on the net profit figures for the
month of July. (3 marks)

(c) Discuss the expected performance of each of the two divisions, using both ROI and RI, and making any
additional calculations deemed necessary. Conclude as to whether, in your opinion, the two divisions have
performed well. (6 marks)

(d) Division B has now been offered an immediate opportunity to invest in new machinery at a cost of $2·12
million. The machinery is expected to have a useful economic life of four years, after which it could be
sold for $200,000. Division B’s policy is to depreciate all of its machinery on a straight-line basis over the
life of the asset. The machinery would be expected to expand Division B’s production capacity, resulting in
an 8·5% increase in contribution per month.

Recalculate Division B’s expected annualised ROI and annualised RI, based on July’s budgeted operating
statement after adjusting for the investment. State whether the managing director will be making a decision
that is in the best interests of the company as a whole if ROI is used as the basis of the decision.
(5 marks)

(e) Explain any behavioural problems that will result if the company’s senior management insist on using solely
ROI, based on net profit rather than controllable profit, to assess divisional performance and reward staff.
(4 marks)

(20 marks)

6
 (b) After preparation of the flexed budget, you are informed that the following variances have arisen in
relation to total food and drink sales:
Sales mix contribution variance $1,014 Adverse
Sales quantity contribution variance $11,700 Favourable

Required:
BRIEFLY describe the sales mix contribution variance and the sales quantity contribution variance. Identify
why each of them has arisen in Noble’s case. (4 marks)

(c) Noble’s owner told the restaurant manager to run a half-price drinks promotion at Noble for the month of May
on all drinks. Actual results showed that customers ordered an average of six drinks each instead of the usual
four but, because of the promotion, they only paid half of the usual cost for each drink. You have calculated the
sales margin price variance for drink sales alone and found it to be a worrying $11,700 adverse. The restaurant
manager is worried and concerned that this makes his performance for drink sales look very bad.

Required:
Briefly discuss TWO other variances that could be calculated for drinks sales or food sales in order to ensure that
the assessment of the restaurant manager’s performance is fair. These should be variances that COULD be
calculated from the information provided above although no further calculations are required here.
(4 marks)

(20 marks)

4 (a) Brace Co is an electronics company specialising in the manufacture of home audio equipment. Historically,
the company has used solely financial performance measures to assess the performance of the company
as a whole. The company’s Managing Director has recently heard of the ‘balanced scorecard approach’
and is keen to learn more.

Required:
Describe the balanced scorecard approach to performance measurement. (10 marks)

(b) Brace Co is split into two divisions, A and B, each with their own cost and revenue streams. Each of the
divisions is managed by a divisional manager who has the power to make all investment decisions within
the division. The cost of capital for both divisions is 12%. Historically, investment decisions have been
made by calculating the return on investment (ROI) of any opportunities and at present, the return on
investment of each division is 16%.
A new manager who has recently been appointed in division A has argued that using residual income (RI)
to make investment decisions would result in ‘better goal congruence’ throughout the company.
Each division is currently considering the following separate investments:
Project for Division A Project for Division B
Capital required for investment $82·8 million $40·6 million
Sales generated by investment $44·6 million $21·8 million
Net profit margin 28% 33%
The company is seeking to maximise shareholder wealth.

Required:
Calculate both the return on investment and residual income of the new investment for each of the two
divisions. Comment on these results, taking into consideration the manager’s views about residual income.
(10 marks)

(20 marks)

5 [P.T.O.
3 The Rotech group comprises two companies, W Co and C Co.
W Co is a trading company with two divisions: The Design division, which designs wind turbines and supplies the
designs to customers under licences and the Gearbox division, which manufactures gearboxes for the car industry.
C Co manufactures components for gearboxes. It sells the components globally and also supplies W Co with
components for its Gearbox manufacturing division.
The financial results for the two companies for the year ended 31 May 2014 are as follows:

W Co C Co
Design division Gearbox division
$’000 $’000 $’000
External sales 14,300 25,535 8,010
Sales to Gearbox division 7,550
–––––––
15,560
–––––––
Cost of sales (4,900) (16,200)* (5,280)
Administration costs (3,400) (4,200) (2,600)
Distribution costs – (1,260) (670)
––––––– ––––––– –––––––
Operating profit 6,000 3,875 7,010
––––––– ––––––– –––––––
Capital employed 23,540 32,320 82,975
* Includes cost of components purchased from C Co.

Required:
(a) Discuss the performance of C Co and each division of W Co, calculating and using the following
three performance measures:
(i) Return on capital employed (ROCE)
(ii) Asset turnover
(iii) Operating profit margin
Note: There are 4·5 marks available for calculations and 5·5 marks available for discussion. (10 marks)

(b) C Co is currently working to full capacity. The Rotech group’s policy is that group companies and divisions
must always make internal sales first before selling outside the group. Similarly, purchases must be made
from within the group wherever possible. However, the group divisions and companies are allowed to
negotiate their own transfer prices without interference from Head Office.
C Co has always charged the same price to the Gearbox division as it does to its external customers. However,
after being offered a 5% lower price for similar components from an external supplier, the manager of the
Gearbox division feels strongly that the transfer price is too high and should be reduced. C Co currently
satisfies 60% of the external demand for its components. Its variable costs represent 40% of revenue.

Required:
Advise, using suitable calculations, the total transfer price or prices at which the components should be
supplied to the Gearbox division from C Co. (10 marks)

(20 marks)