Advance Accounting Homework

ILUNGA ELIYA

Homework 12

Problem 7-1

1. When Krispy Kreme opens new doughnut shops that gain a rate of return on invested capital and it exceeds the company’s cost of capital; shareholders profit from it. This is the only time when the new doughnut shop is a positive net present value project. The other thing that could alarm shareholders is the bonus plan reward manager if they increase earnings. The reason for this is because it only considers the return on invested capital and ignores the ROIC denominator invested capital. This will encourage managers to open negative net present value doughnut stores which means stores that gain a profit but not ROIC greater than cost of capital.

2. It will be important for the bonus plan to use the EBITDA in a company because it helps to ensure that managers pay incentives are adjusted with the company’s debt covenant consent incentives. This path lessens potential incentive conflicts.

3. Change in accounting methods, change in accounting estimates, and other accrual manipulations can lead to accounting abuses. Other techniques such as forcing franchisees to by doughnut mix and supplies before they are really needed can lead to accounting abuses.

C7-2

Different reasons can cause Magee to feel uneasy about Maxcor’s computation of 2011 operating profits. R&D expenses are seen above the operating profit line and some are seen under the line as R&D. for instance, approximately 72% of total R&D was charged to COGS back in 2006 when the operating profits were still higher than the level required which 200%. But in 2011, 34% only of total R&D was charged to COGS, operating profit that year were scarcely above the bonus verge of $4 million. The other reason would be the fact that the plant closing cost decreased the net income of the year. In this case, we should see decided if we have to penalize management or remunerate management for their business decisions.

Magee should not approve the...