Summit Equipment specializes in the manufacture of medical equipment, a field that has become increasingly competitive. Approximately two years ago, Ben Harrington, president of Summit, decided to revise the bonus plan (based, at the time, entirely on operating income) to encourage division managers to focus on areas that were important to customers and that added value without increasing cost. In addition to a profitability incentive, the revised plan includes incentives for reduced rework costs, reduced sales returns, and on time deliveries. Bonuses are calculated and awarded semiannually on the following basis: A base bonus is calculated at 2% of operating income; this amount is then adjusted as follows:

a. (i) Reduced by excess of rework costs over and above 2% of operating income
    (ii) No adjustment if rework costs are less than or equal to 2% of operating income
b. (i) Increased by $5,000 if more than 98% of deliveries are on time, and by $2,000 if 96% to 98% of deliveries are on time
    (ii) No adjustment if on-time deliveries are below 96%
c. (i) Increased by $3,000 if sales returns are less than or equal to 1.5% of sales
    (ii) Decreased by 50% of excess of sales returns over 1.5% of sales

Results for Summit’s Charter division and Mesa division for 2012, the first year under the new bonus plan, follow. In 2011, under the old bonus plan, the Charter division manager earned a bonus of $27,060 and the Mesa division manager, a bonus of $22,440.

                        

Required
1. Why did Harrington need to introduce these new performance measures? That is, why does Harrington need to use these performance measures in addition to the operating-income numbers for the period?
2. Calculate the bonus earned by each manager for each six-month period and for 2012.
3. What effect did the change in the bonus plan have on each manager’s behavior? Did the new bonus plan achieve what Harrington desired? What changes, if any, would you make to the new bonus plan?