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

CHAPTER 12

PowerPoint Presentation by

Incentive
Issues

LuAnn Bean
Professor of Accounting
Florida Institute of Technology
© 2012 Cengage Learning. All Rights Reserved. May
not be copied, scanned, or duplicated, in whole or in
part, except for use as permitted in a license
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classroom use.

Managerial Accounting 11E
Maher/Stickney/Weil

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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.

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LO 1

PAY INCENTIVES
Managers
Managers receive
receive bonuses
bonuses for
for performance
performance
that
that may
may be
be based
based on
on divisional
divisional or
or
corporate
corporate results.
results. Bonuses
Bonuses may

may be
be based
based
on
on annual
annual performance
performance or
or on
on performance
performance
over
over several
several years
years and
and may
may be
be paid
paid
immediately
immediately or
or deferred
deferred and
and spread
spread over
over
several
several years.
years.
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LO 1

MANAGERS WANT TO KNOW!

What forms do
divisional incentives
take?

How will performance
be evaluated?

Divisional incentives can be
cash or profit sharing for
short-term performance;
stock or stock options as
deferred compensation; and
special awards.

Performance can be
evaluated based on
accounting numbers,
returns to stockholders or
both.

4


DESIGNING INCENTIVE
COMPENSATION

LO 1

Management must ascertain two things in
designing incentive systems:
What behavior does the system motivate?
What behavior does management desire?
WARNING! Rewarding managers for
performance reflected in annual accounting
numbers gives managers incentives to
take actions that make the numbers look
good but not actions that benefit
the organization.

5


INCENTIVES and PRODUCT LIFE
CYCLE

LO 1

A
A major
major problem
problem with
with short-run
short-run incentive
incentive
plans

plans is
is that
that managers
managers are
are penalized
penalized for
for
developing
developing products
products that
that might
might produce
produce
long-run
long-run benefits.
benefits. Under
Under U.S.GAAP,
U.S.GAAP,
firms
firms write
write off
off research
research and
and
development
development costs
costs when
when incurred.
incurred.
IFRSs

IFRSs do
do not
not require
require as
as much
much write-off
write-off
as
as U.S.
U.S. GAAP
GAAP
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LO 1

PRODUCT LIFE CYCLE: Stages
Four stages of the product life cycle are:
Design and development: low sales but high
research, design and development costs
Growth
Maturity
Decline

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LO 2

EXPECTANCY

EXPECTANCY THEORY:
THEORY:
Definition
Definition

Maintains that people act in
ways to obtain rewards they
desire and prevent penalties
they wish to avoid.

8


LO 2

AGENCY
AGENCY THEORY:
THEORY: Definition
Definition
Deals with relations between
supervisors and workers and
assumes employees will not
necessarily behave as their
employers desire.

9


LO 2

The
Theobjective
objectiveof
ofaa
good
goodincentive
incentive
compensation
compensationisistoto
minimize
minimizeagency
agency
costs.
costs.

EXHIBIT 12.2
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LO 2

MANAGERS WANT TO KNOW!

What are extrinsic
rewards ?

What are intrinsic
rewards ?

Extrinsic rewards come

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

Intrinsic rewards come
from inside the individual
such as satisfaction for a
job well done.
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LO 3

BALANCED
BALANCED SCORECARD:
SCORECARD:
Definition
Definition

Is a model of lead and lag
indicators of performance
including both financial and
nonfinancial performance
measures.

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BALANCED SCORECARD
PERSPECTIVES

LO 3

Four perspectives of the balanced
scorecard approach are:
Learning and growth
Internal business and production process
perspective
Customer
Financial
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LO 3

INCENTIVE QUESTION 1
Should
Should rewards
rewards be
be based
based on
on current
current or
or future
future
performance?
performance?
An
An advantage
advantage to

to basing
basing on
on future
future performance
performance
is
is the
the “golden
“golden handcuffs”
handcuffs” that
that tie
tie
managers
managers to
to the
the company.
company. Most
Most
companies
companies use
use aa combination
combination of
of current
current
and
and deferred
deferred rewards.
rewards.

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LO 3

INCENTIVE QUESTION 2
Should
Should rewards
rewards be
be based
based on
on division
division or
or
company-wide
company-wide performance?
performance?
When
When based
based on
on the
the manager’s
manager’s responsibility
responsibility
center
center alone,
alone, itit focuses
focuses the
the attention
attention
without

without considering
considering the
the impact
impact of
of their
their
actions
actions on
on the
the whole
whole company.
company. Most
Most
companies
companies use
use both.
both.

15


LO 3

INCENTIVE QUESTION 3
Should
Should rewards
rewards use
use aa fixed
fixed formula
formula or

or
subjective
subjective judgment
judgment in
in providing
providing rewards?
rewards?
The
The advantage
advantage of
of aa formula-based
formula-based plan
plan is
is that
that
managers
managers know
know what
what is
is expected
expected and
and what
what
reward
reward they
they will
will get
get ifif they
they meet
meet

expectations.
expectations.

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LO 3

INCENTIVE QUESTION 4
Should
Should rewards
rewards be
be based
based on
on accounting
accounting
results
results or
or stock
stock performance?
performance?
Tying
Tying managers’
managers’ compensation
compensation to
to stock
stock
performance
performance loads
loads uncontrollable

uncontrollable risk
risk on
on
them.
them. Using
Using EVA
EVA both
both focuses
focuses managers
managers
on
on creating
creating value
value for
for shareholders
shareholders and
and
relies
relies on
on nonstock
nonstock performance
performance measures.
measures.

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LO 3

INCENTIVE QUESTION 5

Should
Should rewards
rewards be
be based
based on
on absolute
absolute or
or
relative
relative performance
performance evaluation?
evaluation?
Relative
Relative performance
performance compares
compares divisional
divisional
performance
performance with
with other
other divisions
divisions in
in the
the
same
same industry
industry with
with less
less than
than optimum

optimum
comparisons.
comparisons.

18


LO 3

INCENTIVE QUESTION 6
Should
Should rewards
rewards be
be cash,
cash, stock
stock or
or prizes?
prizes?
Many
Many companies
companies use
use aa combination
combination because
because
of
of the
the different
different (current
(current vs.
vs. deferred)

deferred)
methods
methods of
of reward.
reward. Expectancy
Expectancy theory
theory
finds
finds prizes
prizes more
more attractive
attractive and
and more
more
motivating.
motivating.

19


LO 4

FRAUDULENT
FRAUDULENT FINANCIAL
FINANCIAL
REPORTING:
REPORTING: Definition
Definition
Is intentional conduct resulting
in materially misleading

financial statements.

20


LO 4

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
overstatement
In absence of continuing overstatement, must
result in reduced earnings in next period
21


LO 5

INTERNAL
INTERNAL CONTROL:
CONTROL: Definition
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.
22


LO 5

INDEPENDENT AUDITORS
Independent audits
Are required by the SEC for firms selling
securities across state lines
Help prevent fraud through reviews of
internal controls

23


LO 5

CORRUPTION
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
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End of CHAPTER 12

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