Lipton Case Review – Mba Managerial Accounting Essay Example
Lipton Case Review – Mba Managerial Accounting Essay Example

Lipton Case Review – Mba Managerial Accounting Essay Example

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Executive Summary

The detailed analysis of Lipton's current Economic Profit model has led to immediate changes in the recording of profit on the Product Line level. The proposed changes to the current Economic Profit model include leaving the Working Capital Cost and CRV Depreciation Adjustment in the profit analysis.

The proposed changes aim to eliminate the Fixed-Asset Charge and OI;D III, and only apply New Product Development charges to new products. The goals of these changes are to ensure product line managers focus on improving the value of their product rather than just profit/loss numbers, allow upper management to analyze product line performance on a fair basis, provide divisional management with the authority to allocate fixed asset costs impartially, enable upper management to make decisions about a product line's value to their division and the overall value of Lipton, and report req


uired performance metrics to Unilever.

Background: Unilever's Evaluation Criteria include Capital Turnover (Net Sales / Ave Gross Capital Expenditure), Return on Sales (Profit Before Tax / Net Sales), and Return on Capital (After Tax Return on Ave Gross Capital Employed). Their Financial and Operating Objectives consist of achieving sales growth of 10.5% per year, improving after-tax profit margin by 6%, attaining a 15% after-tax return on average invested capital (ATRIC), and maintaining an AA Bond rating.

While the resulting Economic Profit addresses certain issues with the original Trading Profit, we believe that some changes are unnecessary. Furthermore, the new Economic Profit evaluation could confuse product line managers as profit will be underestimated. Hence, we propose the following modifications to the Economic Profit structure.

The corporate financial department correctly included a negative adjustmen

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to trading profit in order to hold product line managers accountable for their liquid assets. By assigning a cost of capital to the total working capital of the product line, managers are penalized for maintaining excessive cash reserves. Instead, they are incentivized to use their dormant working capital to improve the economic profit by increasing product line efficiency. This excess cash can be utilized for updating fixed assets with new technology, improving customer service, boosting product marketability, or reducing debt.

The aim of reducing short and long-term liabilities is to align the overall company's interests with Unilever's goal of maintaining a AAA Bond rating. By meeting these liabilities, the company decreases the risk of default in the eyes of debt holders, resulting in higher scores from rating agencies for Lipton. This incentivizes product managers to reinvest their working capital for the betterment of the entire company. The CRV Depreciation Adjustment considers the disparity between the "current replacement value" and the historical depreciation value of assets, assigning replacement value to depreciated assets.

By deducting the opportunity cost of these assets from a specific product line's profit, the challenge of allocating a percentage of fixed assets to that product line arises. We will discuss the allocation issue of fixed assets below (Fixed-Asset Charge), which follows the same method implemented by the corporate finance department. Accounting for CRV depreciation in performance measures allows corporate managers to benefit from factoring in this opportunity cost. However, product line managers should be cautious about fixed asset costs due to the negative impact of the CRV depreciation adjustment on economic profit.

The estimation and allocation of Fixed Asset charges pose challenges, particularly when assigning them

to specific product lines. The previous Economic Profit system often resulted in product lines incurring losses because of substantial fixed cost allocations. This would understandably cause panic among managers when losses were linked to product lines. As a solution, we propose that the evaluation of all fixed assets should take place on an Operating Division Level. At Lipton, the company has three main operating divisions: Beverage, Food, and General Management.

By assessing the impact of each product line on fixed asset costs, the management team of the Operating Division can subtract the Total Fixed Costs from the overall economic profitability. In addition, they can collaborate with product line managers to determine the varying levels of fixed asset utilization across different product lines. This shifts the burden of fixed assets onto the management team, freeing up product line managers to concentrate on tasks other than enhancing profit margins. Lastly, attributing fixed asset costs to specific product lines enables product managers to accurately report the CRV adjustment value.

The analysis of economic profit should exclude the "other income and deductions" related to product lines. The impact of these benefits and costs on the brand is unclear and can fluctuate significantly on a monthly basis. Additionally, compared to normal variable costs and overall profit, these benefits and costs are typically minimal. Instead of product managers emphasizing the increase of their "other income" to enhance profitability, they should prioritize enhancing productivity and reducing operating expenses.

Our team suggests collecting these OI&D numbers monthly and reporting them to Divisional Management. The financial team of Divisional Management can then summarize this data and offer insights to any product line that may have

concerning numbers. Additionally, senior management has the opportunity to acknowledge the product line with the highest OI&D as a percentage of economic profit, such as by granting an extra day of vacation per quarter. This approach would encourage each product line to enhance the brand's value without excessively prioritizing these activities.

Unilever evaluates the performance of Lipton based on improving sales and return on investments. While tax benefits, payment discounts, and operations income are beneficial in terms of income for a specific period, the responsibility for the overall profitability of the product should be assigned to the product line managers. Our team firmly believes that the New Product Development Charge should only be applicable to new products. Therefore, it should not have been included in the original Trading Profit. The only exception would be for newly developed products, where the associated costs would be considered in the evaluation of that specific product line's profit and loss.

This way, the costs of the development are directly reported to the appropriate product responsible for the costs. As a result, pre-existing product line profits will not be lowered by new product development. Furthermore, the product manager can better estimate how long a product line will take to increase profit margins based on their initial product development investment.

Revised Economic Profit XYZ Product Line

Economic Profit and Loss(in thousands of dollars)

Sales $30,274

Historical cost trading profit $ 4,526

Working capital charge (2,416)

CRV depreciation adjustment (547)

Fixed-asset charge (2,821)

OI&D and other 148

New product development charge 244

Economic Profit $ (866)

| XYZ Product Line

NEW Economic Profit and Loss(in thousands of dollars)

Sales $30,274

Historical cost trading profit $ 4,770*

Working capital charge (2,416)

CRV depreciation adjustment (547)

Economic Profit $ 1807

| *Trading Profit

adjusted positively to reflect the elimination of the New product development charge for existing product lines. It doesn’t make sense to deduct something and then add it back later. Using Product Line XYZ as an example, it is clear that the revised Economic Profit model paints a very different picture.

By eliminating the Fixed-asset charge, OI&D, and New product development charge, XYZ's financial situation has significantly improved. In fact, they now have a profit of $1,807,000, compared to the previous loss of $866,000. This change carries great significance for both product line managers and the company as a whole. If XYZ's manager had been reporting losses based on the previous economic profit model, their main objective would be to increase profits. Consequently, this could potentially lead to making unsound business decisions in an attempt to reduce costs. For instance, layoffs, utilizing cheaper packaging, and downsizing facilities might be considered as measures to counteract the reported negative profit.

According to the new Economic Profit model, Product XYZ seems to be doing well after removing fixed assets from consideration. By eliminating the need to focus solely on improving profit, the product line manager can now concentrate on enhancing other crucial factors for the product line's success. These factors include managing raw materials and scrap, inventory, machine efficiency and improvements, product quality, customer development and management (including delivery, customer service, sales, and marketing), and overall innovation. Previously, under the economic profit analysis, product managers would have been encouraged to reduce fixed asset allocation or invest less in expanding production capabilities to boost profit. Moreover, upper management can now evaluate the performance of all product lines on an equitable basis.


certain products are facing challenges, it will be clear that their difficulties do not stem from an excessive allocation of fixed costs. Senior management can ascertain, at the appropriate level, whether a product line is economically profitable for the overall value of the company. Ultimately, senior management must meet Unilever's performance standards.

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