Reference no: EM13937077

Relevant costs, performance evaluation, goal congruence.

Mikkeli Oy has three operating divisions. The managers of these divisions are evaluated on their divisional operating profit, a figure that includes an allocation of corporate overhead proportional to the revenues of each division. The operating profit statement (in thousands) for the first quarter of 2005 is as follows:

	Tampere Division	Oulu Division	Kotka Division	Total
Revenues	€2000	€1200	€1600	€4800
Cost of goods sold	1050	540	640	2230
Gross profit	950	660	960	2570
Division overhead	250	125	160	535
Corporate overhead	400	240	320	960
Divisional operating profit	€300	€295	€480	€1075

The manager of the Tampere Division is unhappy that his profitability is about the same as the Oulu Division's and is much less than the Kotka Division's, even though his revenues are much higher than either of these other two divisions'. The manager knows that he is carrying one line of products with very low profitability. He was going to replace this line of business as soon as more profitable product opportunities became available, but he has kept it because the line is marginally profitable and uses facilities that would otherwise be idle. That manager now realises, however, that the sales from this product line are attract- ing a fair amount of corporate overhead because of the allocation procedure and maybe the line is already unprofitable for him. This low-margin line of products had the following characteristics for the most recent quarter (in thousands):

Revenues                               €800
Cost of goods sold                   600
Avoidable division overhead       100

Required

1. Prepare the operating profit statement for Mikkeli Oy for the second quarter of 2005. Assume that revenues and operating results are identical to the first quarter except that the manager of the Tampere Division has dropped the low-margin product line from his product group.

2. Is Mikkeli Oy better off from this action?

3. Is the Tampere Division manager better off from this action?

4. Suggest changes for Mikkeli's system of division reporting and evaluation that will motivate division managers to make decisions that are in the best interest of Mikkeli Oy as a whole. Discuss any potential disadvantages of your proposal.