Gaming for a bonus, absorption costing; dcf; scorecard
Learning Community: In the past several weeks, you have been exposed to fundamental managerial accounting problems and were tasked to complete various calculations and comment on their application. We've covered topics such as: the nature of costs, capital budgeting, organizational architecture, flexible budgeting, cost allocation, and absorption costing. lhe ability to understand and demonstrate the application of these tools are critical to not only your professional success but to the financial success of the organization that you will manage.
1.
You have just been hired by the Board of Directors as COO of a mid-sized manufacturing company.The Board, as well as the stakeholders, are eager to see the company grow and have found two similar organizations that they want you to consider purchasing. These same Board members are not familiar with discounting future cash flows and rely on the payback method to choose investments.
2.
Another area of concern is that senior management does not understand nor do they support a Balanced Scorecard approach to performance measurement. They do not know the four measurement perspectives in the Balanced Scorecard or how it fits into long range strategic planning.
3.
To compound matters, you have noticed that the organization uses static budgets to gauge the effectiveness of its operations. Admittedly they are frustrated that actual vs. budget comparisons never line up due to the changes in units sold.
4.
Two other issues keep you up at nights. The head of the cost accounting department doesn't understand the intricacies of direct vs. step down cost allocation of overhead departments or the impact that switching to absorption cost system.
You have decided to call a meeting of all management personnel and explain in detail, with examples such as charts and/or numerical tables why; discounted cash flow is the best way to choose between two mutually exclusive projects, a Balanced Scorecard is a preferred method for strategic planning and performance review, using flexible budgets can be adapted to show price and efficiency variances when sales units change from initially budgeted levels, and finally how costs can be accumulated and allocated. You are keenly aware that you must point out to the bean counters that you know how absorption costing can be gamed to achieve bonuses and that is something that you just will not tolerate.