CHAPTER 25

REPORTING AND EVALUATION

Changes from the Eleventh Edition
All changes to Chapter 25 were minor.
Approach
Students should get a general idea of the difference between economic and managerial performance
measurement, the nature of control reports, the criteria for good reports, and a beginning of an
understanding of how to read such reports. A full understanding of the meaning of control reports requires
years of experience and it also requires a thorough knowledge of the specific environment to which the
reports pertain, so students should not be disturbed if they do not understand all the nuances of the sample
reports included in the chapter. Nevertheless, they should acquire some ability to distinguish between
what is significant and what is not significant, as well as an ability to spot fairly obvious red flags, that
is, items requiring further investigation.
Both of the last two sections can be somewhat controversial. Whereas some companies are significantly
reducing (or even eliminating) formerly intensive variance analysis processes, most still hew to this
approach. Also, the total amounts of many executives incentive awards have prompted considerable
criticism from certain quarters in recent years.
Cases
Olympic Car Wash requires students to isolate the effects of an uncontrollable factor (rain) on the results
of a car wash company. (Note: This case was included in Chapter 21 in the Eleventh Edition. It can still
be used there.)
Armco Inc.: Midwestern Steel Division illustrates a performance measurement system with measures
cascading from strategic priorities down to the lowest organization levels.
Formosa Plastics Group describes a company that has an elaborate planning and performance
measurement system but that uses mostly subjective evaluations of performance and highly smoothed
bonus payments.

Problems
Problem 25-1: Greene Enterprises

Performance Report
(A - B)
(C)
(B - C)
Budgeted
at Actual
Budget
Actual
Difference
Volume
Difference
Sales.....................................................................................................................................................................................
$56,000
$63,000
$7,000
$63,000
$
0
Cost of goods sold................................................................................................................................................................
39,200
37,800
1,400
(b) 44,100
6,300
Gross margin........................................................................................................................................................................
16,800
25,200
8,400
18,900
6,300
Direct operating expenses:
Variable................................................................................................................................................................................
(a) 6,720
8,000
(1,280)
(c) 7,560
(440)
Fixed....................................................................................................................................................................................
10,000
10,000
0
10,000
0
Contribution to indirect costs...............................................................................................................................................
$
80
$ 7,200
$7,120
$ 1,340
$5,860
(A)

(B)

Accounting: Text and Cases 12e Instructors Manual

(a)

Anthony/Hawkins/Merchant

Direct operating expenses........................................................................................................................................................

$16,720
Less: Fixed expense.................................................................................................................................................................
10,000
Variable expense......................................................................................................................................................................
$ 6,720

(b) Cost of sales $39,200/budgeted sales $56,000 = 70%

.70 x $63,000 = $44,100, the cost of goods sold budgeted for actual volume.
(c) Budgeted variable costs $6,720/budgeted sales $56,000 = 12%
.12 x $63,000 = $7,560, the direct operating expenses budgeted at actual volume.
Sales increased substantially and were $7,000 more than expected. The indirect costs were $440 more
than expected, but the cost of sales was only 60% of sales, rather than the budgeted 70%. These two
factors account for the $5,860 difference between actual contribution to indirect costs and that expected at
the actual sales volume. (The fairness of such an appraisal depends upon whether the predicted behavior
of costs was realistic and reasonable.)
Problem 25-2: Watson Company
a.

Performance Report

Division A
Current Year
Last Year
Net sales.................................................................................................................................................................................
$252,000
$216,000
Cost of goods sold:
Variable costs.....................................................................................................................................................................
$72,000
$72,000
Division fixed costs...........................................................................................................................................................
29,000
101,000
29,000
101,000
Gross margin..........................................................................................................................................................................
151,000
115,000
Selling and administrative expenses:
Variable expense................................................................................................................................................................
22,000
19,000
Division fixed expenses.....................................................................................................................................................
25,000
47,000
22,000
41,000
Contribution to allocated costs and expenses.........................................................................................................................
$104,000
$ 74,000

b. Division A performed better in the current year than in the last year when the ratios of contribution to
allocated costs to sales are made. ($104,000/$252,000 = 41% and $74,000/$216,000 = 34%.) Division
managers cannot control allocated costs, and their performance should not be judged on the basis of
net income/sales because the net income figure includes allocated costs. By comparing division
contributions to allocated costs, the amount which each Division Manager contributes toward the
overall company profits can be clearly seen. Bonuses based on division contributions would be in the
best interest of both the managers and the company.
Problem 25-3: Machine Shop
a. If the report is meant to be a control report, the only two items strictly within the direct control of the
machine shop supervisor are probably materials handling costs and supplies. Depreciation of machine
shop equipment is a departmental direct cost, but the supervisor may not have much control over the
amount. The costs for buildings and grounds, and general plant are allocated costs and cannot be
controlled by the supervisor. Maintenance is controllable to the extent of the number of hours of
maintenance time, but the supervisor cannot control the standard rate applied to these hours. Training
costs might be similar to maintenance costs in that the supervisor might be able to control the amount
of training time, but not the cost attributed to training.

2007 McGraw-Hill/Irwin

Chapter 25

b.

Performance Report
Machine Shop
Actual
over (under)

Budget
Actual
Direct costs
Materials handling.................................................................................................................................................
$ 8,000
$ 8,150
$150
Supplies.................................................................................................................................................................
5,200
5,000
(200)
Depreciation- equipment........................................................................................................................................
6,000
6,000
0
19,200
19,150
(50)

Indirect costs
Training.................................................................................................................................................................
4,500
5,300
Maintenance..........................................................................................................................................................
5,000
5,800
Building and grounds.............................................................................................................................................
3,700
3,700
General plant expense............................................................................................................................................
2,500
2,600
15,700
17,400
Total direct and indirect costs....................................................................................................................................
$34,900
$36,550
Problem 25-4: Hopedale Company
a.

Performance Report - Month of April

Variance
Favorable or
(Unfavorable)

Actual
Budget (a)
Controllable costs:
Salaries.................................................................................................................................................................
$12,300
$12,000
$(300)
Indirect labor........................................................................................................................................................
20,500
19,640 (b)
(860)
Indirect materials..................................................................................................................................................
2,550
2,640 (c)
90
Other costs............................................................................................................................................................
9,510
9,650 (d)
140
$44,860
$43,930
$(930)
(a) Budgeted costs at actual volume of 33,000 direct machine-hours consist of both fixed costs
and variable costs calculated for the actual volume.
Fixed costs:

Salaries.............................................................................................................................................
$12,000
Indirect labor....................................................................................................................................
17,000
Other costs........................................................................................................................................
8,000

(These are the same at any volume, because they are given as a fixed amount per month.)
(b) Variable indirect labor = $.08 x 33,000=$2,640
Total indirect labor costs budgeted = $17,000 + $2,640=$19,640
(c) Variable indirect materials = $.08 x 33,000=$2,640
(d) Variable other costs = $.05 x 33,000=$1,650
Total indirect other costs budgeted = $8,000 + $1,650=$9,650
b. Total actual costs for March were $930 higher than budgeted, with salaries and indirect
labor higher than budgeted. More labor was probably used than expected, due to the
greater volume than formerly budgeted.
The increase of $300 in salaries cost probably caused the increase in indirect labor cost
also, perhaps for such as increased janitorial costs or routine maintenance.
3

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

(The expected volume was 29,000 machine-hours and was later revised to 34,000
machine-hours.) Although the actual volume of activity at 33,000 machine-hours was less
than the revised budgeted 34,000 machine-hours, the favorable variances still resulted
because the original budget was apparently based on a total yearly volume which is
proving to be low. There seems to be good cost control over indirect material cost, as less
was spent than budgeted.

Cases
Case 25-1: Olympic Car Wash
Note: This case is unchanged from the Eleventh Edition, but it has been moved from Chapter 21 in the
Eleventh Edition to Chapter 25 in the Twelfth Edition.
Assignment question: How large should the bonus pool be for the Aalst location?
Solution
Flex the budget based on number of hours of good weather.

Flexible

Controllable
variance
(actual
flex budget)

Budget

Actual

budget

184,000

124,080

108,100

15,980

Variable expenses
(50% of revenue)

92,000

62,040

54,050

(7,990)

Fixed expenses

53,820

55,000

53,820

(1,180)

145,820

117,040

107,870

(9,170)

38,180

7,040

230

6,810

Revenue

Total expenses
Profit

Size of the bonus pool = 3,000 + 681 = 3,681

Case 25-2: Armco Inc.: Midwestern Steel Division*
Note: This case is unchanged from the Eleventh Edition.
Approach
The Armco case was designed to illustrate a performance measurement system with measures
cascading from strategic priorities down to the lowest organization levels. The system is not tightly
linked with incentive compensation, although that is being discussed. Still, the focus on measured results
promises to change managerial behaviors significantly.
The case is particularly interesting because it describes a major change from an old measurement system
*

This teaching note was prepared by Professor Kenneth A. Merchant. Copyright 1998 Kenneth A. Merchant.

2007 McGraw-Hill/Irwin

Chapter 25

which was primarily designed for standard financial reporting purposes and was not perceived, at least by
top management, to be effective for management control purposes. The new performance measurement
system eliminated most of the allocations of indirect costs and helped managers understand the critical
success factors in their areas.
In this case, then, students can understand two performance measurement systems and the companys
reasons for changing from one to the other. They can evaluate the new system and decide whether the
division managers have made optimal choices in designing their new system, and they can make a
judgment as to whether the system should be used to increase the proportion of total compensation linked
to performance.
Most of the students will conclude the new system is a substantive change for the better. But then they
will get a dose of reality as they see the problems Armco is having getting managers to adapt to the new
system.
Suggested Assignment Questions
1. What was wrong with the Midwestern Steel Divisions old system? (As part of your analysis, study
Exhibit 3 carefully and figure out what the columns tell you, individually and in total.)
2. If the old system was so bad, why did the operating managers seem to like it?
3. Evaluate the new system and the way in which it was being implemented. What changes would you
recommend, if any? Why?
4. What should Rob Cushman do about the two items described in the Remaining Issues section of the
case?
Case Analysis and Pedagogy
1. What factors most determine the success or failure of the Midwestern Steel Division? In particular,
how important is cost control?
Carbon wire rod is a commodity product, so cost control is critical for this line of business.
There is some product differentiation in grinding media. Customers can measure how long the steel
balls last, and they value long-lasting balls. Armco believes it has a superior manufacturing
technology that causes its balls to last longer. Further manufacturing technology innovations would
provide additional profits to the division.
Cost control is also important for grinding media, as Armco is the high cost producer in this market.
Plant throughput (productivity) is one key to cost control. Armco can sell all the product it makes.
(The plant has been operating at capacity for three years straight.)
Among the cost control challenges in the plant are the fact that the plant has old equipment, generally
poor preventative maintenance practices (40% of the 700 hourly workers in the plant were
maintenance workers), and less than optimum worker productivity.
The people left in the plan are the most senior. They would not be hurt that much by a shutdown.
They have pensions. Cost control is not that important to them. It would cost the company about $200
million to shut down the plant (environmental clean-up, pensions, etc.).
Students might ask why Armco does not put more people or more equipment in the melt shop so it
wouldnt be a bottleneck. The answer is that they would have to add a furnace, making an investment

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

of approximately $100 million. This would add capacity which is not needed in the industry.
2. How were managers controlling performance with the old system? What were the strengths and
weaknesses of the old system?
Strengths
1. Managers express need for detail so they can track
month-to-month trends.
2. Has value in identifying problem areas.
3. Measured performance was based on managers
ability to control cost above. System gave
managers information consistent with objective
they were given.

Weaknesses
1. Too much detail. Some numbers didnt change.
Some very small.
2. System designed for inventory costing purposes.
Have to allocate costs. For performance
measurement purposes, not sure if the allocations
mean anything.
3. Source of some of the data is unclear.
4. Reports were delivered 15 days after month-end.
This is too late.
5. System too focused on cost reductions, to the
exclusion of other critical success factors.
6. Managers performances judged on things over
which they had no control. Many costs were
caused by people who did not report to the
managers (e.g., capital spending, salaries,
maintenance). Easy to blame poor performance
on uncontrollables.
7. System not encouraging managers to work
together. Much local data. Contributes to
suboptimization.
8. Not graphic.
9. Accounting accruals distort the costs. Example
annual August maintenance shutdown accruals
start in January.

It is important to walk students through Exhibit 3. Pick some representative columns and have
students talk about what they mean or dont mean. Among the useful examples to discuss are
nonmetallics, salaries, electricity, lubricants, and loco cranes. Students should see the types of costs
that make up total cost above. Which are the big items? Which items are variable and which are
fixed? (The important ones are fixed. Costs per net ton are driven by tons produced.) Point out the
distorting effect of the August maintenance shutdown.
S-orders represent extraordinary maintenance. It is accrued for. It is fixed in the short-run (a month),
but it can vary over the year.
3. Why did the operating managers seem to like the old system?

Familiarity

Reports were related to budget

Managers cant be held accountable because they always had an excuse for poor performance.
(Nenni: The traditional way we ran our operating review meetings was that the managers would
find some items that didnt make sense. Then they would discredit the report and the accountants.

2007 McGraw-Hill/Irwin

Chapter 25

We never got to the items the managers can and should control.)

Gives managers a false sense that they can control costs. Gives a global picture. (The managers
would have liked to have the information every week.)

Gives managers a sense that they are responsible for a large number (e.g., melt shop manager
responsible for $50 million per year)

After the students have had their crack at the analysis, if it hasnt come up, the instructor might
usefully point their attention to Bob Nennis quote about the problem with non-value-added chores
under the new system and the difference between value-added and non-value-added work. (Nonvalue-added work includes everything customers are not willing to pay for.) One prominent example
of the non-value-added work associated with the old system (which is Bob Nennis focus) is the
administrative burden required to keep it going. The old system took five accountants to operate. The
new system required only three, even in start-up mode; most of the accountants time was spent
designing new reports. To what extent does Bob Nenni consider accounting to be value-added
work?
4. What were the key features of the new system and what improvements did it promise?
Hit the key design choices and discuss them; for example:

Strategic (not just financial) focus. 10 key measures.

Priorities must come from the general manager and his direct reports. Priorities must cascade
from above so that everybody is working on the right things.

Everybody agrees with the top four priorities

Safety is the #1 priority because managers do not want people to get hurt. It is not #1 because
it is the largest cost.

safety, productivity, quality, and up-time.

Elimination of cost above measure

New system does not do a trend analysis (e.g., performance vs. a year ago or vs. last rolling 12
months). What is key is whether manager did in January what he said he would do (vs. agreed-to
benchmark).

Focuses attention on important categories and provides more detail on those

Focuses on controllables. For example, melt shop manager controls KWH/T, not electricity

dollars/T. Purchasing negotiates the price.

Focuses more on productivity than costs.

Standardardizes everything. Everything is not driven by tons.

Apparent reduction in the manufacturing managers financial responsibility. (The new system
reported only what the employees reporting to each manager spent. Those are the dollars that can
be controlled.)

5. What are the weaknesses of the new system?

Its not a cost system. Company still needs a cost system. The company still does not have a
handle on what costs are controllable, what are fixed and variable, etc.

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Should show consumption, not purchases. (There is still a problem with the source of the data.)

The performance standards are not benchmarked with the best in the industry. (Firms in the steel
industry do not share much operating performance information.)

Seasonal factors are ignored.

Uncontrollables still not handled well. For example, what happens if the plant shuts down for a
few hours? Should this be segregated from the managers performance reports?

The system is not complete. Three measures

inspection are not yet implemented.

Should the system focus on exception reporting, rather than provide all the detail?

maintenance, on-time delivery, and

6. The implementation process.

Division managers decided to discontinue the old system immediately? What are the advantages
and disadvantages of that decision?
Managers would never adapt to new system if old system was still running. After the switch to
the new system, they were frequently in Rob Cushmans office begging for their old reports.
(Actually the old system is still being run, for inventory valuation and product costing purposes.
But the operating managers have not been told that the old system is still running.)
The risk of the immediate switch-over is that uninformed decisions will be made: Managers dont
have their old information, and they dont yet understand the new information. But the new
system seemed to work. The periods after the switch-over to the new system were the best in the
history of the plant.

Department managers had no input into the design of the new system? Was that wise?
Ideally it should be the operating managers, not the accountants, who identify what is critical to
their areas. But the operating managers were consulted, and they said only, We want the old
system. Only three managers in the division wanted the new system the general manager, the
director of finance, and the manager of cost accounting. The other 997 people in the plant were
indifferent to overtly combative.
What can be done to get operating managers to take the lead? Training? Hiring? Should
accountants have a role in measuring quality, on-time delivery, etc.?

Why did Bob Nenni devote so much energy to the performance measurement system instead of
working on, for example, an activity-based costing system, which Armco does not yet have?
He thought the performance measurement system, with its link to strategic priorities, was much
more important than an accurate costing system.

7. Remaining issues:

When should something be considered uncontrollable?

Under the new system at Armco, the handling of uncontrollables is at the discretion of the
individual superior. The lines between controllables and uncontrollables are tough to define. The
company has a culture of making excuses.

Should larger bonuses be linked to the new system measures?

2007 McGraw-Hill/Irwin

Chapter 25

The answer to this question is complex. Among other things, it depends on the trust people have
in the measures and the companys compensation strategy (e.g., compensation competitiveness,
amount of risk they want managers to bear).
8. What has happened since the case was written?
Many things have happened since the case was written. There was significant management turnover.
First, the manufacturing cost manager (Scott Molaro) resigned. He got frustrated by the operating
managers resistance to change. Then there was significant turnover among the operating managers.
The works manager (Charlie Bradshaw) was asked to retire. The maintenance manager (Ed Graves)
was fired. The rolling/finishing manager (Paul Phillips) retired.
In April 1992, Armco Inc. acquired Cyclops Industries, Inc., another specialty steel manufacturer. The
combined company needed capital, so they spun off the Midwestern Steel Division. It is now a
privately held, freestanding business.
As of March 1993, the new performance measurement system was still operating. The three missing
measures were still not implemented. Rob Cushman was not sure the on-time delivery measures
would be worth the cost of developing them. Managers were not sure how best to develop the
maintenance measures. And they had not gotten around to developing the inspection measures.

Case 25-3: Formosa Plastics Group*

Approach
The Formosa Plastics Group (FPG) case describes the reporting and evaluation system used by the largest
private corporation in Taiwan. The case describes the companys organization and responsibility centers,
budgeting processes and, particularly, methods of evaluating the performances of profit center managers
when profit is to a large extent uncontrollable. The system is somewhat unusual in that the planning and
reporting processes are quite detailed and costly, yet performance evaluations are highly subjective, and
bonuses do not vary much from period to period.
Suggested Assignment Questions
1. Identify the major elements of Formosa Plastics Groups control system.
2. Is the Polyolefin division a profit center?
3. Managers at Formosa Plastics Group use subjectivity to eliminate some of the effects of
uncontrollable factors from performance evaluations. Evaluate this choice. Did they have any
alternatives?
4. Evaluate FPGs incentive compensation system. What are the advantages and disadvantages of
smoothing incentive compensation?
Case Analysis and Possible Discussion Questions
1. Describe the Formosa Plastics Group (FPG).
FPG is a Taiwan-based conglomerate consisting of more than 10 different companies located in
Taiwan, China, and the United States. It includes several chemical, plastics, electronic, and textile
*

This teaching note was prepared by Professor Kenneth A. Merchant. Assistance from Professors Thomas W. Lin and Dan
Elnathan is gratefully acknowledged. Copyright 1998 Kenneth A. Merchant.

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

companies, as well as a modern hospital, a nursing school, a technical college, and a medical college.
More facts about the company can be pulled from the case. Here is some more recent information:
a. In 1994, FPG completed a $2.1 billion petrochemical and plastics-making plant in Point Comfort,
Texas. This was the largest investment by a privately held corporation in Texass history.
b. Taiwanese law does not include a holding company-type organization. FPG actually has a
complex ownership structure. The dominant shareholders are a family of two brothers, Y.C. Wang
(chairman, 80 years old in 1997) and Y.T. Wang (president, about 73 years old). The two brothers
own at least 20% of all companies in FPG.
c. The case does not make it obvious, but the actual running of FPG is in the hands of the Chairman,
not the President. Staff in the Presidents Office take orders both from the Chairman and the
President directly. The Chairman has a dictatorial management style. He was raised by a poor
village family and had to quit school after the sixth grade. But he taught himself how to master a
complex company. His young brother (the FPG President) is more of a human relations-oriented
person. Most people in Taiwan believe the two brothers make an excellent management team.
d. As an indication of the centrality of FPG in the Taiwanese economy and of the significance of the
Chairman, in particular, it is interesting to note that the Taiwanese stock index fell 5% in one day
in early 1994 when a rumor circulated that Chairman Y.C. Wang had died.
2. What are the major types of financial responsibility centers in FPG?
a. Companies and Divisions: investment centers (ROI measure)
b. Plants and Product Groups: profit centers
c. Production Processes and Group of Machines: cost centers
d. Non-production-oriented units, such as sales, technology, management: revenue or discretionary
expense centers
3. What are the major problems facing FPG management in the early 1990s?
Labor shortages and rising wages. At FPG, labor costs are significant, but less than 20% of total
production cost. They are actually much smaller in some divisions (e.g., polyethylene). Labor costs in
the United States are approximately 50% higher than in Taiwan. Taiwanese wages are higher than in
other producing countries (e.g., Indonesia, Mexico), but Taiwan has higher productivity than most
developing countries.
Many FPG divisions compete on price, but they cannot raise prices because their products are
commodities. At the same time, most raw material prices (e.g., petrochemicals) are volatile and not
controllable. Thus, profits go up and down. The goal of many of the divisions is simply to produce at
full capacity.
A growing problem which is not directly relevant to this case is the radicalization of the
environmental movement in Taiwan.
At the Polyolefin division, specific problems include uncertainty in the raw material markets with
respect both to prices and availability and uncertainty in the markets for its own products.
4. Describe and evaluate the major elements of FPGs control system.
a. Each company and division has a target ROI. ROI is defined as profit before taxes but after
allocation of corporate expenses divided by divisional investment only.

10

2007 McGraw-Hill/Irwin

Chapter 25

b. FPG uses a target costing (with benchmarking from Japanese companies) approach to the budget
planning. Standard costs are revised promptly when conditions so warrant. These changing target
costs are used to motivate continuous improvement.
c. An extensive set of monthly performance reports (Exhibit 3).
d. Chairman and Presidents monthly detailed performance review meetings with 30 senior
managers.
e. Bonus plans. These plans have some unique features:
i.

FPG bonus pools are determined at the time of budgeting, not after actual profit has been
measured.

ii. The bonus potentials vary by organization level and role. Workers below section chief level
receive a performance bonus program about 20-26% of their base salaries. Management has a
special performance-based bonus fund. Technical people such as R&D have incentive
rewards for good ideas.
iii. Total FPG bonus amounts paid per year did not vary much over time due to the Reserve
Bank system. By creating reserves for bonuses, the company is smoothing the employees
bonus stream.
iv. Every employee automatically gets 3-5 months of base salary as a so-called bonus each year.
This is cultural. It is traditional in Taiwanese for every employee (even government
employees and university professors) to get a minimum of two months pay as a year-end
bonus. (Many Japanese firms give their employees at least four months pay as a year-end
bonus.) These payments are not performance-dependent.
f.

The Presidents Office

The Presidents Office (or Red Guard) is composed of 15 teams (340 employees) of specialists
whose role is to collect information and to help division management. The Presidents Office
has three levels. The top level staff usually have experience serving as division managers. The
second level staff usually have experience serving as plants or product group managers. The third
level staff usually have experience serving as department heads or section chiefs. The Presidents
Office staff and some line managers will rotate every few years.
This Office is a very costly system feature, but it serves three purposes: (1) helping the Chairman
and the President to control and evaluate line managers, (2) helping different divisions, plants,
and product groups to continuously improve their performance, and (3) serving as the training
ground for these staff persons for future higher line positions. Many Japanese companies also
rotate people through different functions in their career, so that by the time a Japanese manager
gets into a top level position, he knows almost all the companys functions/processes/products.
It is interesting to note that the Chairman and the President also have many relatives working in
different parts of FPG. Through regular family gatherings, relatives also provide some inside
information on particular divisions or departments.

5. Describe FPGs annual planning process. Is it more a top-down or bottom-up process?

a. Four-month planning process, begins in September and ends in December.
b. It starts with a bottom-up planning. Division level managers submitted their sales plan and
production plan. Then the top management made suggested revisions. The revision process
iterates two or three rounds.
c. Top management uses the targeting pricing/costing approach. Continuous improvement is

11

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

stressed. Each division is expected to use improvement projects to reduce costs each year. Funds
are available for these projects.
d. Top management is prone to reject the initial budget proposals, to ask for more profit. This
procedure adds a top-down dimension to the process, and it creates some gaming behavior. The
lower-level managers expect their initial plan to come back for revision, so they produce a
conservative plan which leaves some room for improvements in future round(s).
6. Describe FPGs performance evaluation process.
a. Primarily subjective, but objective numbers form a basis for the subjective evaluations.
b. The budget is used as the basis for evaluation. The probability of achieving targets is around 8090%. Performance targets are sometimes revised due to environmental changes.
c. Managers are evaluated by considering controllable factors, both financial and nonfinancial
measures, such as quantity of product sold, production efficiency, production schedules,
consumption of materials, cost control, inventory control, leadership, and product quality.
d. Changes in results due to activities that were approved by top management after the budget was
approved (e.g., improvement projects) are adjusted for in the evaluations.
e. Those making evaluations and assigning bonuses also take into consideration the persons ability
and potential for the future, years in the company, teamwork, cooperation, and the situation the
person faced. It is very subjective. FPG employees must trust their evaluators.
7. Is the Polyolefin division a profit center?
Yes and no. Profit of the entity is measured, but the manager, Mr. Hsaio, is not held accountable for
profit. FPG managers have concluded that he does not control significant elements in the profit
calculation. In particular, ethylene accounts for 60-65% of the divisions total product cost; there is
only one local ethylene supplier owned by the government; ethylene prices are set by the government;
ethylene prices fluctuate significantly; and prices of the divisions output (polyethylene) do not
fluctuate with the input (ethylene) prices.
8. So what is Mr. Hsaio held accountable for?
He is responsible for all aspects of his divisions performance except material price variances. In most
of FPGs chemical businesses, particularly those which sell in commodity markets, material price
variances are factored out as being largely uncontrollable.
Managers of other FPGs divisions are held substantially accountable for profits. Where the managers
have substantial control over profits, profits are used as a major component of the performance
evaluation. In such cases, the evaluations will be more transparent even though they are still
subjective.
9. Is FPGs choice to allow high subjectivity in performance evaluations a good one?
It seems to work at FPG. The managers are comfortable with the system, and the company has been
quite successful for a long period of time.
10. Are any of FPG managers control choices affected by national or cultural factors? If so, which
choices were affected and which factors affected them?
FPGs control system differs in several significant ways from most Western companies:
a. It is a large company which is substantially owned and dominated by one family. The large

12

2007 McGraw-Hill/Irwin

Chapter 25

Presidents Office and the detailed monthly performance reviews are two of the methods the top
managers use. While seemingly everyone in FPG was satisfied that the current management
control systems were effective, some managers wondered whether the system would continue to
serve the company well in the future. Most important, they were concerned about a shift in
management style if the current top-level managers retired. And many managers expected that
research and new product development would become more important to FPG in the future, and
this change could force the company to have a longer-term focus because the typical research and
development cycle in the chemical industry was 4 to 5 years.
b. The heavy use of subjectivity in performance evaluations is more common in Asian companies
than in Western companies. Most American managers and employees, for example, prefer a more
objective evaluation system. They are less comfortable with giving their superior that much
evaluation discretion and power (the power distance concept discussed in Chapter 19). They
worry that a high degree of subjectivity in evaluations will cause unfairness and bias.
c. FPGs system, with its detailed monthly performance reviews and no long-term incentive
program, appears very short-term oriented. Myopia danger is minimized, however, because most
of the employees spend their whole career with the company. Thus, they are not able to avoid the
harmful effects of their short-term actions. Further, FPG likes to have its bonus payments be
relatively constant over time. A total bonus figure is put in the budget and is not varied by the
actual amount of profit earned. As one manager explained, If this year is no good and next year
is no good, maybe we will consider a lower bonus in the third year. But it is difficult to
distinguish good and bad performance in the short-run, and we like to make the situation more
steady. This philosophy contrasts with the tendency in most Western companies to make bonus
payments ever more variable with short-term performance.
d. The use of year-end employee bonuses is traditional in Taiwan (and other Asian countries).
(Employees also receive month salary on each of two national holidays.) These bonuses are not
motivational, however, because they are not performance-dependent. Thus, they are not part of
the companys control system.
11. What happens when the chairman and president retire?
This is a major concern for FPG employees. Here is a representative comment from one manager:
As long as chairman Wang stays, fundamentally there will be no change. He is the founder, and
he knows everything very well. Our system is good, and our goals will be the same. I dont even
know how many of us have contemplated change because Chinese people believe their leaders
will be long-lived. But when our chairman changes, things will be different. One mans
leadership can have a significant effect.
If Chairman Wang retires, who will be the new leader? Would we change our strategic
direction away from commodity chemicals in favor of creation of higher value added
products? If that happened, would the system have to change? I guess it depends on the
needs of the company and the philosophy of the new managers. It is clear that the second
generation of managers will be different. They have been educated in Western Europe and
the United States and have been less influenced by the Japanese.
12. Does anything else threaten FPGs system?
Some managers were also concerned that FPGs success might be threatened, ironically, by the
advancing Taiwanese standard of living. They noted that the cost of labor was increasing, and it was
becoming harder to motivate employees. One manager said, The younger generation likes leisure,
and the older generation is getting lazy. They have more money and more time to spend it.

13