Evaluate Performance Evaluation System: Behavioral Issues
Several years ago, Seville Company acquired Salvador Components. Prior to the acquisition, Salvador manufactured and sold automotive components products to third party customers. Since becoming a division of Seville, Salvador has manufactured components only for products made by Seville’s Luxo Division.
Seville’s corporate management gives the Salvador Division management considerable latitude in running the division’s operations. However, corporate management retains authority for decisions regarding capital investments, product pricing, and production quantities.
Seville has a formal performance evaluation program for all division managements. The evaluation program relies substantially on each division’s ROI. Salvador Division’s income statement provides the basis for the evaluation of Salvador’s management. (See the following income statement.)
The corporate accounting staff prepares the divisional financial statements. Corporate general services costs are allocated on the basis of sales dollars, and the computer department’s actual costs are apportioned among the divisions on the basis of use. The net divisional investment includes divisional fixed assets at net book value (cost less depreciation), divisional inventory, and corporate working capital apportioned to the divisions on the basis of sales dollars.
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SEVILLE COMPANY |
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Salvador Division |
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Income Statement |
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For the Year Ended October 31 |
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($000) |
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Sales revenue |
$32,000 |
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Costs and expenses |
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Product costs |
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Direct materials |
$ 4,000 |
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Direct labor |
8,800 |
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Factory overhead |
10,400 |
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Total |
$23,200 |
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Less increase in inventory |
2,800 |
$20,400 |
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Engineering and research |
960 |
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Shipping and receiving |
1,920 |
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Division administration |
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Manager’s office |
$1,680 |
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Cost accounting |
320 |
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Personnel |
656 |
2,656 |
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Corporate cost |
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General services |
$1,840 |
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Computer |
384 |
2,224 |
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Total costs and expenses |
$28,160 |
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Divisional operating profit |
$ 3,840 |
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Net plant investment |
$12,800 |
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Return on investment |
30% |
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Required
a. Discuss Seville Company’s financial reporting and performance evaluation program as it relates to the responsibilities of Salvador Division.
b. Based on your response to requirement (a), recommend appropriate revisions of the financial information and reports used to evaluate the performance of Salvador’s divisional management. If revisions are not necessary, explain why.