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Berkshire Controls Analysis for Management Accounting
Berkshire Controls Analysis for Management Accounting

Berkshire Controls Analysis for Management Accounting

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  • Pages: 5 (2410 words)
  • Published: October 2, 2019
  • Type: Research Paper
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Founded in 1852, Berkshire Industries PLC grew from a brewery serving local pubs to a medium-sized publicly held corporation focused on the beverages and snack foods industry. The brewery used a decentralized strategy in terms of the structure of its operations, focusing on four divisions; beer, spirits, soft drinks and snack foods. Up until 2000, the company’s annual planning process related to the incentive systems was a bottom-up process where each operating divisions proposing their earning targets and how they will achieve them. Each division was united under a common goal: maximize shareholders’ value. Berkshire’s Objectives of its Incentive Plan

Ever since Berkshire went public, it instituted an incentive plan for division and lowel-level managers. The system was built to achieve three objectives; to ensure the congruence between management and shareholders’ interest, to provide additional motivation for managers to work harder and to provide a simple and objective performance evaluation. In comparison, division and lowel-level managers’ objectives are maximizing their annual revenue and having the necessary power and understanding to influence their yearly compensation. It is senior management’s responsibility to make sure there are sufficient incentives for the managers to behave in the company best interest and maximize shareholder value. Unfortunately, this was not the case under both the old and new incentive plan.

The Desired Characteristics of an Incentive Plan

An incentive must fulfill several important criteria to be considered effective; it should be valued, understandable, timely, durable, reversible, cost-efficient and congruent. However, on the case of Berks

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hire, the employees and management explicitly prioritized some of the criteria. Berkshire is a 150 year-old company. With its established brand, it is reasonable to assume that management must have a definite long-term plan for the company. Management prioritizes the durability and the reversibility of the incentive plan. Also, because of the current recession, it must ensure that the incentive plan is cost-effective for the company.

Finally, it was explicitly expressed by the board that they valued an accurate, simple and objective performance measurement that “goes up when shareowner value is created and goes down when value is destroyed” It was explicitly expressed by the managers that they want to understand how their compensation was determined in order for them to have maximum control over their division. Also, a significant and timely compensation will ensure their full cooperation in aligning the firm with their own objective. It is crucial that the incentive plan can provide for both the needs of the Board and managers in order for the incentive plan to work properly.

Issue I – Old Incentive Plan Based on EPS The lack of shareholder value creation at Berkshire can be traced back to their old incentive plan based on EPS. The main issue regarding EPS as a performance measure was its lack of congruency towards the company’s objective of maximizing shareholder value. EPS is not a very comprehensive performance measure as it neglects a division’s cost of capital and investment, leading to a minimal effect on the company’s share price. The lack of shareholder value creation was noticed by senior management as “EPS had been improving steadily (9% annual) over the last decade but th

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share price had increased slightly during that time frame”.

Secondly, the EPS incentive plan was very subjective as the plan was influenced by an annual incentive compensation group of forty members, all of which were senior managers at Berkshire. This lack of objectivity allowed managers at Berkshire to significantly impact the compensation committee headed by members of the Board of Directors. The lack of independence was further noticed as division managers were able to set their own goals with little intervention from the compensation committee. These inventions also created “politicking” over manager’s evaluations leading to misspend time and a loss of productivity. The issue led the Board to believe that management had too much power in overriding decisions as “too many bonuses where being made, giving managers bonuses even in years where their entity did not perform well”.

Lastly, the use of the profit reserve actually demotivated division managers and stunted shareholder value creation. The profit reserve acted as a protective cushion for division managers as it filled any gap caused by the manager’s inability to meet his performance targets. The reserve is a form of manipulation and creates a lack of accountability as divisional managers’ performance is hidden from financial statement users such as shareholders. Even with the cushion, shareholders were not seeing any value being created. Issue II – New Incentive Plan Based on “Economic Profit”

By viewing the new incentive plan using “Economic Profit”, senior management has noticed that a lot of the same problems with the old plan are still present. The main issue with the new plan is that there is still a lack of congruency between “economic profit” and shareholder value. As “economic profit” increased from the beginning of 2000 to the end of 2002, the share price of Berkshire actually decreased consistently over that time frame. The causation of this incongruence might steam from the consulting firm’s decision to make only two out of their a hundred suggested adjustments to the new plan in order to make it simpler. The new incentive plan could therefore be missing all the necessary components in order to create shareholder value.

Even though the plan is more precise and objective than the old plan, there is a lack of understandability from managers as to how it works, even after training sessions. The consulting firm considers the performance measurement “simple” but the managers still do not understand how to compute “economic profit” and some even continue to manage their division under the old EPS system. With Berkshire paying for expensive training sessions and consulting fees, management may need to consider the cost-effectiveness of the new plan.

It can be argued that the incentive plan lacks controllability in terms of management influence on “economic profit” with the absence of external factor considerations. This issue is of significance to the Spirits Division at Berkshire as the recession caused a shift in demand and lowered “economic profit” which was out of the division manager’s control. This scenario creates discouragement and a lack of motivation among division managers as they cannot control their performance targets due to the current economic climate. These bad attitudes can also lead

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