Ethics, manager's performance evaluation.
Serra-Mica Srl is a maker of ceramic coffee cups. It imprints company logos and other say- ings on the cups for both commercial and wholesale markets. The firm has the capacity to produce 3 000 000 cups per year, but the recession has cut production and sales last year to 1 500 000 cups. The summary operating statement for 2004 was as follows:
Sales (1 500 000 × €2) €3 000 000
Cost of goods sold 2 700 000
Gross profit 300 000
Marketing, distribution and administration costs (fixed) 400 000
Operating profit €(100 000)
Cost of goods sold consists of variable costs of €750 000 (or €0.50 per cup) and fixed costs of €1 950 000 (or €1.30 per cup). There was no opening and no closing stock of finished goods in 2007.
Concerned about the loss, the board of directors hired a new CEO, Antonio Pirelli, and offered him an incentive-based compensation contract rather than the fixed-salary con- tract of the previous CEO. Pirelli's contract paid €50 000 per year in salary plus a 15% bonus on the firm's operating profits (if any) before deducting the bonus. Operating profits are calculated using full absorption costing - that is, fixed manufacturing costs per unit manu- factured are inventoried and expensed only when the goods are sold.
Pirelli took the following actions for 2008:
a. Increased production to 2 500 000 cups.
b. Increased sales to 1 800 000 cups.
c. Increased marketing, distribution and administration costs to €650 000. (Pirelli's salary of €50 000 is included in these costs.)
The selling price per cup in 2008 of €2, the variable manufacturing costs per cup of €0.50 and total fixed manufacturing costs of €1 950 000 were all unchanged from 2007.
At the end of 2008, Pirelli met with the board of directors and announced that he had accepted another job. He noted that he had put Serra-Mica successfully on track and thanked the board for the opportunity. His new job was to turn around another struggling company.
Required
1. Calculate Pirelli's bonus for 2008.
2. Evaluate Pirelli's performance. Did he do as good a job as the numbers in requirement 1 suggest? Explain.
3. Did Pirelli behave ethically? Explain your answer.