Essentials Of Cost Accounting

Business

Quiz 16 :

Performance Evaluation and Incentive Compensation

Quiz 16 :

Performance Evaluation and Incentive Compensation

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Why have an executive incentive plan?
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Incentive Compensation
Incentive compensation refers to the proportion of the salary that an employee gets as a reward of his performance during the specific period, if an employee performs efficiently and out performs task than the company provides reward for the extra effort made by the employees.
Executive Incentive plans are used by small-business owners as a reward to their employees. It encourages employees to work efficiently. This benefit is in addition to the salary.
1. Employees of the organizations get motivated.
2. Employees put extra efforts to reach the targets as the bonus payments are target based.
3. Improves production capacity of the Organization.
4. Improves sales of the organization.
5. Improves attendance of the employees.
6. Reduces attrition of the Organization.
7. It creates happy work place for the employees.

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Why do we have responsibility centers?
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Responsibility Center
A responsibility center is a unit where managers are given responsibility and control over expenses, revenues and Investments. The unit has its own policies and procedures and financial reports.
We have responsibility center due to below reasons:
It enables middle level management to delegate responsibity to lower level management.
It compels individual manager to take right decisions. It forces management to delegate authority.
It encourages comparison between actual achievements and budget achievements.
It helps to do variance analysis and know the root cause analysis of the problem and take corrective action.
It increases ownership of the managers as they are answerable to the deviations.

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What is an alternative to a bonus system that still gives incentive to managers?
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Bonus payments are payment system designed to enhance the performance of the employees. These are the rewards given to the employees for enhancing their efficiency by the organization. Bonus payments is also based on company performance.
Bonus arrangement can be classified into two categories: Individual merit: under this, performance of each individual is evaluated and bonuses are given according to their individual performance and the other system under which employees share in a bonus pool irrespective of their individual performance.
Company also uses other alternatives to bonus system to enhance the performance of their managers in order to achieve the desired targets. The alternatives to bonus system are as follows:
1.
Incentive plans : Incentive plans are extensively used to reward managers for doing what is in the best interest of the organization. It is a formal plan used to motivate or encourage specific behavior or actions of the managers to exceed the growth expectations of the organization.
Incentive plans are usually tied either to the value of profits or to the value of company's stocks.
2.
Profit sharing plans : It is an incentive plan introduced by organizations to provide employees a share in the company's profits based on its earnings. These plans are generally based on some target profits and if the set target is achieved or exceeded, a percentage of profits is distributed to the managers.
Example: A corporate health care organization is expected to make a profit of $3 million in a year and trustees decide that the executives' incentive pool is $150,000. So, by comparing the $150,000 with the $ 3 million would give 5% of profits. Thus, the organization establish the pool of 5% profits each year.
3.
Stock option plan : It is a stock option under which executives received the right to buy a certain number of shares in the company at a discounted price from the market price for a specified period of time.
Corporate health care organization have alternative options in developing incentive plans for their executives. They provide stock option plan, under which managers buy shares at specified prices as a part of their incentive compensation.
The managers will be benefitted when they buy the shares at a lower price and then sell at a higher price in the market.

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What are the three key measures of an investment center? What are their relative merits?
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City Hospital last year appointed Max Smith as Director of Nonhospital Investments. In his first year, Smith did an excellent job of investing hospital endowment funds. He opened a physician referral service, bought an ambulance company, and arranged several joint ventures in the ambulatory area. These initiatives were all quite profitable. In total, the hospital put up $15 million of its own money and borrowed $15 million of additional money for the investments. The preinterest income from all the ventures was $6 million. The interest rate was 10 percent, and the loan was outstanding for one full year. City Hospital is now faced with specifying the basis for Smith's evaluation for the next year. They want to be sure to give him incentives to continue his good performance. Smith has no control over whether money invested comes from existing hospital funds or is borrowed by the hospital from a bank. a) Calculate the ROI. b) Calculate the ROA. c) Calculate the RI, assuming the hospital demands a 15 percent return on all assets invested, before consideration of interest cost. d) Suppose that next year projects will be available that will earn a profit of $2.7 million on an investment of $15 million. Which of the above methods will be the most appropriate for next year's evaluation of Max Smith? The hospital would like to undertake projects with a 15 percent or better preinterest return. Ignore the effect of income taxes in this problem. Solve this problem using either a calculator or a spreadsheet computer program.
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What is the principal weakness of a bonus system based on an organization wide sharing arrangement?
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What are the four types of responsibility centers?
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Why would a health care organization use a bonus system?
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What are some weaknesses of decentralization?
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What are the advantages and problems of a bonus system based on individual merit?
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What is responsibility accounting?
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Is the highest residual income reflective of the best manager or the best unit?
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What are several characteristics of good performance measures?
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What are some advantages of decentralization?
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