[Nancy]

The Medford Mug Company is an old-line maker of ceramic coffee mugs. It imprints company logos and other sayings on mugs for both commercial and wholesale markets. The firm has the capacity to produce 50 million mugs per year, but the recession has cut production and sales in the current year to 15 million mugs. The accompanying table shows the operating statement for 2010.
Medford Mug Company Income Statement
For Year Ending 2010 $’ Million $’ Million
Sales (15 Millions @ $2) 30.00
Less: Cost of goods sold
Variable Cost (15 Millions @ $0.50) (7.50)
Fixed Costs (20.00) (27.50)
Gross Margin 2.50
Less: Selling and Administration (4.00)
Operating Profit (1.50)

At the end of 2010, there was no ending inventory of finished goods. The board of directors is very concerned about the $1.5 million operating loss. It hires an outside consultant who reports back that the firm suffers from two problems.

First, the president of the company receives a fixed salary, and since she owns no stock, she has very little incentive to worry about company profits. The second problem is that the company has not aggressively marketed its product and has not kept up with changing markets. The current president is 54 and the board of directors makes her an offer to retire one year early so that they can hire a new president to turn the firm around. The current president accepts the offer to retire and the board immediately hires a new president with a proven track record as a turnaround specialist.
The new president is hired with an employment contract that pays a fixed wage of $50, 000 a year plus 15% of the firm’s operating profit, if any. Operating profits are calculated using absorption costing. In 2011, the new president doubles the selling and administration budget to $8 million (which includes the president’s salary of $50, 000).
He designs a new line of ‘politically correct’ sayings to imprint on the mugs and expands inventory and the number of distributors handling the mugs. Production is increased to 45 million mugs and sales climb to 18 million mugs @ $2 each. Variable costs per mug remain at $0.50 and fixed costs at $20 million in 2011.
At the end of 2011, the president meets with the board of directors and announces he has accepted another job. He believes he has successfully gotten Medford Mug back on track and thanks the board of directors for giving him the opportunity. His new job is helping to turn around another struggling company.
Required:
(a) Calculate the new president’s bonus for 2011
(b) Evaluate critically the performance of the new president in 2011
(c) How does your evaluation in (b) above relate to the disadvantages of traditional costing methods and briefly provides how an alternative system can work.

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