Enager Industries

Enager Industries, Inc. was a relatively young company, which had grown rapidly to its 1993 sales level of over $222 million. (See Exhibits 1 and 2 for financial data for 1992 & 1993). The company has three divisions which were treated as independent companies because of their differing nature of activities. The corporate office of Enager consists only of few managers and staff. The function of the corporate unit is to coordinate the activities of the three divisions. One aspect of this coordination was to that all new project proposals requiring investment in excess of $1.

5M had to be reviewed by CFO. One of these proposals was submitted by Ms. Sarah McNeil, which was rejected by the CFO, Mr. Henry Hubbard. (See Exhibit 3 for the details of Ms. McNeil’s proposal). Enager had three divisions: ?Consumer Products The oldest of the three divisions, designs & manufactures a line of house ware items, primarily for use in the kitchen. ?Industrial Products Builds customized machine tools, a typical job takes months to complete. ?

Professional Services

The newest of the three divisions, had been added to Enager by acquiring a large firm that provided land planning, landscape architecture, structural architecture, and consulting engineering services. STATEMENT OF THE PROBLEM: The problem occurred when the president was unsatisfied with the ROA (Return of Assets) of Industrial Products Division and tried to put pressure on the General Manager of the Division. ?To develop and understanding of process and systems for management control ?

To discuss the nature of Management control process ?To elaborate how accounting information facilitates management control MANAGEMENT CONTROL SYSTEM: STRUCTURE Prior to 1992, divisions are treated as profit center, but in 1992 Enager’s president had decided to begin treating each division as an investment center. This is to be able to relate each division’s profit to the assets used to generate its profits. CRITERIA OR MEASURE BY WHICH PERFORMANCE WAS APPRAISE ?Return on Assets (ROA) Each division is measured based on its return on assets (ROA) which was defined to be the division’s net income divided by its total assets.

Net income was calculated by taking the division’s direct income before taxes, the subtracting the share of corporate administrative expenses (allocated on the basis of divisional revenues) & its share of income tax expense. This method made the sum of divisional expenses equal to the corporate expenses. Assets are also subdivided among three divisions, attributing assets to divisions that use them. The corporate-office assets were also allocated on the basis of divisional revenues. ?GROSS RETURN HUBBARD DEFINED THIS AS THE EARNINGS BEFORE INTEREST & TAXES (EBIT) DIVIDED BY ASSETS.

TO CONSIDER THE INTEREST RATES THE COMPANY PAYS FOR ITS RECENT BORROWINGS, THE GROSS (EBIT) RETURN ON ASSETS WAS SET TO AT LEAST 12 PERCENT. IN ORDER TO ACHIEVE THIS LEVEL INVESTMENT PROPOSALS WOULD HAVE TO SHOW A RETURN OF AT LEAST 15 PERCENT IN ORDER TO BE APPROVED. MEASUREMENT, REPORTING & REVIEW PROCESS RELATIVE TO CRITERIA IT WAS NOT MENTIONED IN THE CASE HOW THE CRITERIA IS MEASURED AND REPORTED. REWARDS & INCENTIVES IT WAS NOT MENTIONED IN THE CASE IF ENAGER GIVES REWARDS & INCENTIVES OR PENALTIES FOR GOOD/BAD PERFORMANCE. ANSWERS TO CASE QUESTIONS: Question 1.

Why was McNeil’s new product proposal rejected? Should it have been? Explain. Mc Neils proposal was rejected because it did not meet the 15% return required by Hubbard. So Enager Industries Inc. , had missed the opportunity to increase its earnings per share of the company due to incorrectly setting a target rate for all three divisions. PARTICULARS PRODUCT A PRODUCT B PRODUCT C No. of units sold 100,000 75,000 60,000 S. P. per unit $18 $21 $24 Total sales($) 1,800,000 1,575,000 1,440,000 Variable cost per unit $9 $9 $9

Total variable cost 900,000 675,000 540,000 Total fixed cost 510,000 510,000 510,000 Cost of goods sold($) 1,410,000 1,185,000 1,050,000 Net income 390,000 390,000 390,000 Total asset base($) 3,000,000 3,000,000 3,000,000 Return from proposal* 13% 13% 13% * return = net income / total asset base Question 2. What inferences do you draw from a cash flow statement for 1993? Is a breakdown by divisions useful? (See Exhibit 4 for the calculation of Gross Return on Assets). INFERENCES: ?The professional services division exceeded the 12% gross return target but the other two divisions failed to do so.

?Consumer division could have underemployed the assets in order to boost the gross ROA. ?Cost of Goods Sold & other expenses of industrial division in comparison to consumers division could be high to which its EBIT has fallen down. Question 3. What inferences do you draw from the comparative balance sheets and income statements for 1992 and 1993? 19961997Inference ROA5. 67%5. 37%More assets employed in ’97 to boost sales Gross ROA9. 49%9. 43%More assets employed in ’97 to boost sales ROS5. 13%5. 45%More income earned in ’97 due to boost in sales ROE4. 69%4.

74%ROE has improved which is of great importance for the stakeholders. Formulas: • ROA : (Net income) / (Total asset base) • Gross ROA: (EBIT) / (Total asset base) • ROS: (Net income) / (Total sales) • ROE: (Net income) / (Total Equity) Question 4. Evaluate the manner in which Randall & Hubbard have implemented their investment center concept. What pitfalls did they apparently not anticipate? A shift from profit centre concept to investment centre concept because: ?Comparing absolute differences in profit is not meaningful. ?Difficult to compare profit performance unless assets employed is taken into account.

?Business unit managers have 2 performance objectives: 1. To generate profits from resources used. 2. To invest in additional resources only if it produces an adequate return. Hubbard and Randall used ROI to measure the assets employed. The Pitfalls ? ROI provides different incentives for investments across business units. ? Decisions that increase a centre’s ROI may decrease its overall profits. Question 5&7. What if anything, should Randall do now about his investment center approach? What other advice do you have for Randall & Hubbard? In regard with the investment center measurement approach:

?Randall and Hubbard must use Economic Value Added (EVA) for measuring and controlling the assets employed. EVA = Capital employed * (ROI – Cost of Capital) ?Advantages of EVA: ?All business units have same profit objective for comparable investments. ?Different interest rates may be used for different types of assets. ?It has a stronger positive correlation with changes in company’s market value. Question 6. Design a balanced scorecard for Consumer, Industrial & Professional Products Divisions of Enager Industries. Be specific for each division. PROPOSED BALANCED SCORECARD FOR ENAGER INDUSTRIES: