Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 41

Compensation Pools; Residual Income; Review of Chapter 19 Great Brands Inc. (GBI) is a retailer of consumer products. The company made two acquisitions in previous years to diversify its product lines. In 2008, GBI acquired a consumer electronics firm producing computers. GBI now (2010) has three divisions: consumer electronics, cameras, and computers. The following information (in thousands) presents operating revenue, operating income, and invested assets of the company over the last three years.

	Revenue	Income	Assets
Consumer Electronics
2008	$115,400	$14,560	$66,356
2009	110,450	8,900	45,750
2010	123,500	11,200	51,250
Cameras
2008	45,600	1,950	22,500
2009	38,500	1,350	22,400
2010	49,800	2,100	22,200
Computers
2008	98,900	2,350	11,250
2009	92,500	1,650	10,800
2010	106,450	2,675	11,200

The number of executives covered by GBI’s current compensation package follows:

	2008	2009	2010
Consumer Electronics	300	350	375
Cameras	40	40	37
Computers	120	140	175

The current compensation package is an annual bonus award. Senior executives share in the bonus pool, which is calculated as 10 percent of the company’s annual residual income. Residual income is defined as operating income minus an interest charge of 8 percent of invested assets.

Required

1. Use asset turnover, return on sales, and ROI to explain the differences in profitability of the three divisions.

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2. Compute the bonus amount to be paid during each year; also compute individual executive bonus amounts.

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3. If the bonuses were calculated by divisional residual income, what would the individual bonus amounts be?

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4. Discuss the advantages and disadvantages of basing the bonus on GBI’s residual income compared to divisional residual income.

Step 1 of 7

Management Compensation

Management compensation includes salary, bonus and other perquisites or benefits paid by the organisation to its managers. Salary is in the form of fixed payment and bonus are based on performance and achievement of targets. Apart from them perquisites such as free travel, health benefits, social service benefits are also given. Management compensation is an important as aspect for consideration as an organisation needs to retain its quality personnel and at the same time motivate them towards achievement of organisations goals and objectives.