Question 5: Decentralisation and Segment Reporting
Sparky Electrical Services is organised into three divisions: Metro, Suburban and Regional. The company uses a responsibility accounting system to evaluate the performance of its divisions and divisional managers. Data for the divisions for the last year were as follows:
Metro
Suburban
Regional
Service revenue
$950,000
$750,000
$350,000
Variable expenses
150,000
100,000
50,000
Fixed expenses controllable by divisional manager
350,000
270,000
100,000
Fixed expenses traceable to division but controllable by others
180,000
150,000
40,000
In addition to the expenses listed above, the company had $450,000 of common fixed expenses which it allocated to each division based on their percentage of total service revenue earned.
Required
Prepare a segmented income statement for Sparky Electrical Services that highlights
the profitability/performance of the three divisions and the divisional managers.
Question 6: Measuring Performance (19 Marks)
NZ Lawn Care Ltd sells a range of garden tools and fertilisers. Due to the differences in the market segments that they cater for, both garden tools and the fertilizer division operate independently, where divisional managers are responsible for investment and operating decisions of their own divisions. The performances of managers are evaluated against the target return on investment (ROI) of the company which is set at 10% and by the residual income (RI) each division generates. Managers who exceed this target are rewarded with a bonus.
The following financial information relates to the divisional performance for the year ended April 2012.
Garden tools($)
Fertiliser($)
Operating profit
1,356,000
1,840,500
Sales revenue
8,475,000
10,225,000
Invested capital
16,950,000
20,450,000
During the last financial year, both divisions were severely affected by the global economic downturn and the managers have suggested the following strategies to overcome the problem:
· The manager of the Garden tools division proposes to cut the work force by 10% by which the divisions operating expenditure can be reduced by 30% without sacrificing sales revenue. In addition, he also hopes to implement a Just-in-time (JIT) system for inventories which would reduce the capital invested in the division by $2,500,000.
· The manager of the Fertiliser division reckons that the main problem with his division is the lack of sales volume due to the stiff competition that it faces. He proposed to acquire a competitor, paying $10,000,000 to consolidate the market and to increase sales. The following are the financial data pertaining to the competitor:
Competitor ($)
Operating profit
980,000
Sales revenue
8,000,000
In addition, both managers expressed their dissatisfaction over the companys preference to evaluate their performance based on ROI and RI. They argue that an approach based on economic value added (EVA®) would provide a better measure.
Required:
1. Compute the ROI for both divisions showing the return on sales and investment turnover for the year ended April 2012.
2. Evaluate the impact that the proposed strategies would have on ROI and RI for each division assuming that NZ Lawn Care Ltds minimum required rate of return is 9%. (In each instance show the return on sales and investment turnover). Comment also on the validity of adopting the strategies in the short and long term.
3. Explain why EVA®is considered a superior performance evaluation method in comparison to ROI and RI?