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Unformatted text preview: Chapter 20 - Management Compensation, Business Analysis, and Business Valuation CHAPTER 20 : MANAGEMENT COMPENSATION, BUSINESS ANALYSIS, AND BUSINESS VALUATION QUESTIONS 20-1 The key objective of the firm is to develop management compensation plans that support the firms strategic objectives: 1. To motivate managers to exert a high level of effort to achieve the firms goal. 2. To provide the right incentive for managers, acting autonomously, to make decisions that are consistent with the firms goals. 3. To fairly determine the rewards earned by the manager for their effort and skill, and for the effectiveness of their decision making. 20-2 Management compensation includes one or more of the following: salary, bonus, and benefits or perquisites (perks). Salary is a fixed payment, while a bonus is based upon the achievement of performance goals for the period. Perks include special services and benefits for the employee, such as travel, membership in a fitness club, life insurance, medical benefits, tickets to entertainment events, and other extras paid for by the firm. 20-3 Risk aversion is the tendency to prefer decisions with assured outcomes over those with uncertain outcomes. It is a relatively common decision-making characteristic of managers. A risk-averse manager is biased against decisions that have an uncertain outcome, even if the expected outcome is favorable. The risk-averse manager prefers choices with certain outcomes to choices with more favorable outcomes which are not certain. The effect is that certain decisions that would be preferred by top management might be rejected by the manager because of the managers risk aversion. Compensation plans can be adapted to deal with risk aversion by, for example, making sure that a significant part of total compensation is salary, which is not subject to risk. Other means include rewarding the manager for achievement of critical success factors, such as an investment in a promising new research area, in addition to the financial measures which compensation is typically based upon (such as earnings or earnings per share). 20-4 Management compensation plans designed to motivate managers can have undesired unethical effects. The presence of very strong motivation due to a compensation plan, without compensating accounting controls designed to detect and prevent fraud, can lead to unethical behavior. The best method to reduce the potential for unethical behavior is explained in chapter 1: adopting and adhering to the Institute of Management Accountants Code of Ethics. 20-1 Chapter 20 - Management Compensation, Business Analysis, and Business Valuation 20-5 From a financial reporting standpoint, the most desirable form of compensation is deferred payment plans, which delay the expense on the income statement....
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This note was uploaded on 03/09/2012 for the course ACCT 310 taught by Professor Achem during the Winter '12 term at DeVry Addison.
- Winter '12