Managerial accounting and introduction to concepts methods and user 11e by maher chapter 12

CHAPTER GOALChapter 12 discusses issues in design and use of management performance evaluation and incentive plans to motivate managers to act in the organization’s best interests.. Good

Incentive Issues

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CHAPTER GOAL

Chapter 12 discusses issues in design and use of

management performance evaluation and

incentive plans to motivate managers to act in

the organization’s best interests Good

performance evaluation and incentive plans

induce “win-win” results if they avoid

incentives for fraudulent financial reporting

PAY INCENTIVES

Managers receive bonuses for performance

that may be based on divisional or

corporate results Bonuses may be based

on annual performance or on performance

over several years and may be paid

immediately or deferred and spread over

Managers receive bonuses for performance

that may be based on divisional or

corporate results Bonuses may be based

on annual performance or on performance

over several years and may be paid

immediately or deferred and spread over

LO 1

stock or stock options as deferred compensation; and

special awards.

How will performance

be evaluated?

Performance can be evaluated based on accounting numbers,

DESIGNING INCENTIVE

COMPENSATION

Management must ascertain two things in

designing incentive systems:

 What behavior does the system motivate?

What behavior does management desire?

LO 1

WARNING! Rewarding managers for

INCENTIVES and PRODUCT LIFE

CYCLE

A major problem with short-run incentive

plans is that managers are penalized for developing products that might produce long-run benefits Under U.S.GAAP,

firms write off research and development costs when incurred

IFRSs do not require as much write-off

as U.S GAAP

A major problem with short-run incentive

plans is that managers are penalized for developing products that might produce long-run benefits Under U.S.GAAP,

firms write off research and development costs when incurred

IFRSs do not require as much write-off

as U.S GAAP

PRODUCT LIFE CYCLE : Stages

Four stages of the product life cycle are:

Design and development: low sales but high

research, design and development costs

Maturity

Decline

LO 1

they wish to avoid.

AGENCY THEORY: Definition

Deals with relations between supervisors and workers and assumes employees will not necessarily behave as their

employers desire

LO 2

The objective of a good incentive compensation is to

minimize agency

costs

The objective of a good incentive compensation is to

minimize agency

costs

What are extrinsic

from outside the individual, i.e., the supervisor, etc.

LO 2

MANAGERS WANT TO KNOW!

What are intrinsic

measures.

BALANCED SCORECARD

PERSPECTIVES

Four perspectives of the balanced

scorecard approach are:

 Learning and growth

Internal business and production process

perspective

LO 3

INCENTIVE QUESTION 1

Should rewards be based on current or future

performance?

An advantage to basing on future performance

is the “golden handcuffs” that tie

managers to the company Most

companies use a combination of current

and deferred rewards

Should rewards be based on current or future

performance?

An advantage to basing on future performance

is the “golden handcuffs” that tie

managers to the company Most

companies use a combination of current

and deferred rewards

INCENTIVE QUESTION 2

Should rewards be based on division or

company-wide performance?

When based on the manager’s responsibility

center alone, it focuses the attention

without considering the impact of their

actions on the whole company Most

Should rewards be based on division or

company-wide performance?

When based on the manager’s responsibility

center alone, it focuses the attention

without considering the impact of their

actions on the whole company Most

LO 3

INCENTIVE QUESTION 3

Should rewards use a fixed formula or

subjective judgment in providing rewards?

The advantage of a formula-based plan is that

managers know what is expected and what

reward they will get if they meet

expectations

Should rewards use a fixed formula or

subjective judgment in providing rewards?

The advantage of a formula-based plan is that

managers know what is expected and what

reward they will get if they meet

expectations

INCENTIVE QUESTION 4

Should rewards be based on accounting

results or stock performance?

Tying managers’ compensation to stock

performance loads uncontrollable risk on

them Using EVA both focuses managers

on creating value for shareholders and

Should rewards be based on accounting

results or stock performance?

Tying managers’ compensation to stock

performance loads uncontrollable risk on

them Using EVA both focuses managers

on creating value for shareholders and

LO 3

INCENTIVE QUESTION 5

Should rewards be based on absolute or

relative performance evaluation?

Relative performance compares divisional

performance with other divisions in the

same industry with less than optimum

comparisons

Should rewards be based on absolute or

relative performance evaluation?

Relative performance compares divisional

performance with other divisions in the

same industry with less than optimum

comparisons

INCENTIVE QUESTION 6

Should rewards be cash, stock or prizes?

Many companies use a combination because

of the different (current vs deferred)

methods of reward Expectancy theory

finds prizes more attractive and more

motivating

Should rewards be cash, stock or prizes?

Many companies use a combination because

of the different (current vs deferred)

methods of reward Expectancy theory

finds prizes more attractive and more

motivating

LO 3

TYPES OF FRAUD

Fraudulent financial reporting usually falls

into two categories:

 Improper revenue recognition

Firm reports profit in wrong accounting period

Overstating inventory

Increases reported earnings in period of

LO 4

INTERNAL CONTROL: Definition

Is a process designed to provide reasonable assurance that an organization will achieve its objectives in (a) operating effectiveness and efficiency; (b) reliability of financial reporting; and (c) compliance with applicable laws

and regulations.

INDEPENDENT AUDITORS

Independent audits

Are required by the SEC for firms selling

securities across state lines

Help prevent fraud through reviews of

internal controls

LO 5

According to economists, three elements that

must be present for corruption to occur are:

 Individual must have discretionary power to award contract or rights

Economic benefits are associated with

discretionary power

 Legal system must be unlikely to detect

wrongdoing

End of CHAPTER 12