Standard Cost Systems Can Have Motivational Effects; Some Are Desirable

question 75

Essay

Standard cost systems can have motivational effects; some are desirable, some are not. Consider the following situation:
The materials purchasing manager is paid a salary plus a bonus based on the net favorable materials price variance. Generally, this bonus amounts to 30 - 40% of the manager's total compensation. Due to the bankruptcy of a company in a related field, there is an opportunity to buy a key raw material. The standards for this material call for grade 2A, usually purchased for $56 per ton. Because of the bankruptcy, the company can obtain a higher grade, 4A, for $62 per ton. While the quality of the final product will be the same regardless of the grade of material used, there will be substantial savings in material yield and labor productivity if 4A is used. These savings are expected to be two-to-three times the additional cost of $6 per ton.
Required:
A. How would an unfavorable price variance on a particular purchase affect the overall price variance for the year and the manager's bonus?
B. Would the use of the materials price variance as a basis for the manager's bonus lead to a desirable or undesirable behavioral outcome? Explain being sure to note whether the manager would likely pursue acquisition of the grade 4A material.

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Definitions:

Zero Production Costs

The hypothetical situation in which a good or service can be produced with no expenditure or effort, leading to an unlimited supply.

Profit-Maximizing Monopolist

A monopolist that sets its output and price levels to achieve the highest possible profit, given its unique position as the sole supplier in the market.

Demand Schedule

A chart or table that shows the quantity of a good or service that consumers are willing and able to purchase at various prices.

Elastic Segment

refers to a portion of the market where demand is highly sensitive to changes in price.