MAA262 – Management Accounting Assessment Task 2

Question 4

In addition to the tables and chairs provided by the Furniture Division, New Stone Manufacturing (NSM) also manufactures a wide range of products, including household appliances, recreational products, and electronic games. Marathon is a division under New Stone Manufacturing (NSM) that focuses on electronic games. Under COV-19, electronic games that involve physical exercises are gaining popularity. New Stone Manufacturing (NSM) thus has been encouraging Marathon to diversify the lines of electronic games. Attraction is a start up company that focuses on electronic sport games and it is looking for a friendly buyer. New Stone Manufacturing (NSM)’s top management believes that Attraction would be a valuable addition to their existing portfolio and has strongly urged William Crook, the divisional manager of Marathon, to consider acquiring Attraction. William has reviewed the financial statements of Attraction and he believes that the acquisition may not be in the best interests of Marathon.

New Stone Manufacturing (NSM) has always evaluated the divisions on the basis of division ROI. The management team of any division that reports an annual increase in their ROI is given a bonus, but the managers of divisions where the ROI declines must provide a very convincing explanation as to why they should get a bonus. Where ROI has declined, the bonus is limited to only 50 per cent of the bonus that is paid
to the divisions that report an increase in ROI. William thus explains his concerns to his divisional management team: ‘If only we could convince them to base our bonuses on something other than ROI, this acquisition would look more attractive. If only our bonuses were based on residual income, using the company’s required rate of return of 15 percent.
The following data relate to the most recent financial year:

                                                               Attraction                                                    Marathon
Sales revenue                                        4,550,000                                                   15,250,000
Less
Variable expense                                  1,850,000                                                  9,000,000
Fixed expense                                        1,800,000                                                  3,250,000
Operating profit                                   900,000                                                     3,000,000
Total assets in the division               5,000,000                                                  12,000,000

Required:

a) Calculate the ROI for Attraction Division, Marathon Division before the acquisition separately; calculate the ROI for the entire division after merger and acquisition (i.e. combing Attraction with Marathon). Explain why William may be reluctant to acquire Attraction. Provide calculations based on the compensation plan discussed above. (Chapter 19, 10 marks)
b) If Division managers were evaluated based on divisional residual income, would William be more motivated to acquire Attraction? Provide calculations to support your answer. (Chapter 19, 10 marks)