Meriwether Company is a large, multi division firm with several plants in each division. Rate of return on capital employed is used to measure the performance of divisions and plants. The asset base for a division consists of all assets assigned to the division, including its working capital, and an allocated share of corporate assets. The asset base for each plant includes the assets assigned to the plant plus an allocated portion of the division and corporate assets. Only limited control over plant assets is exercised at the plant level.
The plant managers exercise control only over the cost portion of the plant profit budget because the divisions are responsible for sales. Even with respect to costs, plant-level control is limited because of cost decisions made at higher levels, because the division profit budgets include allocated corporate costs, and because plant profit budgets include allocated division and corporate costs.
Recommendations for promotions and salary increases for the executives of the divisions and plants are influenced by how well the actual rate of return on capital employed compares with the budgeted rate.
The Dexter Plant is a major plant in the Huron Division of Meriwether. During 20A, the property adjacent to the Dexter Plant was purchased by Meriwether. This expenditure was not included in the 20A capital expenditure budget. Corporate management decided to divert funds from a project at another plant because the property appeared to be a better long-term investment. This expenditure was added to the Dexter Plant's capital employed.
Also, during 20A, Meriwether Company experienced depressed sales. In an attempt to achieve budgeted profit, corporate management announced in August that all plants were to cut their annual expenses by 6%. To accomplish this expense reduction, the Dexter Plant manager reduced preventive maintenance and postponed needed major repairs. Employees who quit were not replaced unless absolutely necessary. Employee training was postponed whenever possible. The raw materials, supplies, and finished goods inventory were reduced below normal levels.
Required:
(1) Is the Meriwether Company's use of rate of return on capital employed to evaluate the performance of the Dexter Plant appropriate? Explain.
(2) Analyze and explain the Dexter Plant manager's behavior during 20A.