Strategic Managerial Accounting

Assignment: CakesCo
CakesCo manufactures Kitchen Aid Mixers for use in cafes, bakeries and
domestic use. It has been successful over the last ten years and has built and
maintained a loyal customer base by making a
high-quality Kitchen Aid Mixers backed by
three-year warranty. The warranty states that
CakesCo will recover and repair any mixer that
breaks down in the warranty period at no cost.
Additionally, CakesCo always maintains
sufficient spare parts to be able to quote for a
repair of any of its mixers made within the
previous 10 years.
CakesCo is structured into two divisions: Production and Sales (P/S) and
Maintenance (M). The board are now considering ways to improve coordination
of the activities of the divisions for the benefit of the company.
The company’s mission is to maximise shareholders wealth. Currently, the
board use total shareholder return as an overall corporate measure of
performance and return on investment ROI as their main relative measure of
performance between the two divisions.
The board’s main concern is that the divisional managers’ performance is not
being properly assessed by the divisional performance measure used. They now
want to consider another measure of divisional performance. Residual income
(RI) has been suggested.
A colleague has collected the following data which will allow calculations of
ROI and RI.
Production and Sales Maintenance
$m $m
Revenue 880 17
Operating costs 494 11
Operating profit 386 6
Apportioned head office costs 85 1
Profit before tax 301 5
Capital employed 1294 38
Cost of capital 9%
In addition to the divisional performance measures, the board want to consider
the position of the Maintenance division. The standard costs within the
Maintenance division are as follows:
Repair $
Variable conversion costs per hour 30
Parts per repair 75
Fixed divisional overhead per hour 25
Currently, the Maintenance division does two types of work. There are repairs
that are covered by CakesCo’s warranty and there are repairs done outside
warranty at the customer’s request. The Maintenance division is paid by the
customer for the out of warranty repairs while the repairs under warranty
generate an annual fee of $10m, which is a recharge from the P/S division.
CakesCo sells 440,000 units per year and in the past approximately 9% (39,600
units) of these have needed a repair within the three-year warranty. A repair
takes two hours, on average, to complete.
The board are considering amending this existing $10m internal recharge
agreement between P/S and Maintenance. There has been some discussion of
tailoring one of the two transfer pricing approaches mentioned below to meet
the company’s objectives:
1. Market Price
2. Cost Plus
Although the Maintenance division has the capacity to cover all the existing
work available, it could outsource the warranty service work, as it is usually
straightforward. It would retain looking for other opportunities to earn revenue
using its engineering experience. A local engineering firm has quoted a flat
price of $200 per warranty service repair provided that they obtain a contract for
all of the warranty repairs from CakesCo. This is deemed as current market
price.
Finally, the board are also considering a change to the information systems at
CakesCo. The existing systems are based in the individual functions
(production, sales, maintenance, finance and human resources). The board are
considering the implementation of a new system based on an integrated, single
database that would be accessible at any of the company’s five sites. The
company network would be upgrade to allow real-time input and update of the
database. The database would support a detailed management information
system and allow non-financial input and comparisons as well as financial.
The Board is unsure why non-financial data could be helpful and has asked
several questions about the usefulness of external non-financial information and
how a balanced scorecard with complimenting financial and non-financial
metrics could be achieved.

Required
Write a report to the board of directors to:
a) Evaluate the performance of CakesCo and critically discuss the two
measures of divisional performance (ROI and RI) at CakesCo. (Perform
appropriate calculations)
Hint: Split this into two sections discussing the performance of CakesCo,
which should include discussion on which numbers to use. The second
section of the discussion of the two measures used, considering the
overall mission of the company as a whole.
b) Briefly evaluate the current transfer pricing method then continue to
evaluate the two proposed methods discussed of calculating the transfer
price between the Maintenance and P/S divisions. (Perform appropriate
calculations).
Hint: Split into three sections discussing the current and two proposed
methods, including calculations where necessary. Remember to consider
what the objectives of a good transfer pricing model are and are these
being conflicted/represented by the measures.
c) Describe two types of external non-financial information which the new
system should seek to capture and provide examples.
Hint: Split into the two suggestions: Discussing the type of external data,
examples of the external data linked to Cakes Co and how it may benefit
Cakes Co.
d) Critically evaluate the strengths and weaknesses of the balance scorecard
as a mechanism to formulate strategy and measure performance. Only use
the reading list provided.

Reading
Kaplan RS, Norton DP. Using the balanced scorecard as a strategic management system.
Harv Bus Rev. 1996;74(1):75-85.
http://search.ebscohost.com.ezproxy01.rhul.ac.uk/login.aspx?direct=true&db=bth&AN=96
01185348&site=ehost-live.

Kaplan RS, Norton DP. The balanced scorecard–measures that drive performance. Harv
Bus Rev. 1992;70(1):71-79.
http://search.ebscohost.com.ezproxy01.rhul.ac.uk/login.aspx?direct=true&db=bth&AN=92
05181862&site=ehost-live.

Ahn H. Applying the balanced scorecard concept: An experience report. Long Range
Planning. 2001;34(4):441-461.
http://www.sciencedirect.com.ezproxy01.rhul.ac.uk/science/article/pii/S0024630101000577
. doi: //doi-org.ezproxy01.rhul.ac.uk/10.1016/S0024-6301(01)00057-7