S_Session 15 - Responsibility Accounting - Post Class.pdf

1 to derive a relative performance evaluation and to

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1 To derive a relative performance evaluation and to assure that the average increase in wages is equal to the budgeted merit increase, all employees (for a given position/salary class) would be ranked relative to one another on the basis of their individual performance rating. For example, all of the consultants, within a group, might be assigned to one of five ranks as illustrated below: 1 An example of an individual performance evaluation report is presented in the Appendix to these class notes. Note that, in this case, an individual’s performance would also affect her promotability. 26
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Short-term Incentive Compensation (Bonus) Plans Most short-term incentive compensation (bonus) plans are either Pool Plans or Target (Formula) Plans. Pool Plans can be found at all levels of an organization, but are most commonly used when a bonus program is extended to lower levels within the organization. The most common example of a pool plan is a profit-sharing plan in which an amount of funds is set aside, to pay bonuses to a group (pool) of employees, based on the amount of profit earned in excess of the budget. Each employee may receive an equal share of the pool, provided that he/she has met certain criteria (e.g. with respect to absenteeism, tardiness, etc.) that may be unrelated to their job performance. Note that, in cases like this, the plan provides an incentive for all of the employees in the group, collectively, but not for any particular employee . 27
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Alternatively, to overcome the “free rider” problem, pool plans may be combined with relative performance ratings (evaluations) to distribute a larger share of the bonus to those with higher ratings. For example, an investment bank might create a bonus pool based on the firm’s profitability , and designate a portion of the pool to be paid to each of its 40 analysts so that the average bonus paid will be $25,000. But, to reward the better performing analysts, it may rank each of them from 1 to 40, based on their performance, and distribute the bonuses as follows: Performance Rank Bonus 1-5 $50,000 6-10 $40,000 11-30 $25,000 31-40 $ 5,000 In this case, each member of the group has an incentive to contribute more in order to be ranked higher and qualify for a larger share of the bonus. 28
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Target (Formula) Plans are more common at more senior management levels. In these plans, the manager is paid an incentive bonus based on the degree to which a targeted goal (such as income in the case of a profit center manager) is achieved, as illustrated below: Minimum Target Maximum Income Earned $9 mm $10 mm $11 mm Bonus as a % of Base Salary 5% 25% 35% 29 Generally, the target is based on budgeted revenue, profit goals, and/or cost goals .
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The Bonus Plan 30 0% 5% 10% 15% 20% 25% 30% 35% 40% 9 mm 10 mm 11 mm Income Earned ($) Bonus % Δ B/ Δ I = 20% / $1mm Δ B/ Δ I = 10% / $1mm
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So, how would a manager’s bonus be determined, based on the plan described on the preceding slide, if the income earned by the profit center during the bonus period was $10.5 mm ($0.5 mm in excess of the target)?
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