Standard Cost Systems Can Have Motivational Effects;some Are Desirable,some Are

question 24

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.An unfavorable price variance reduces any net favorable variance that may have arisen during the year.A sufficient number of such events could cause the net material price variance to be unfavorable and would eliminate the bonus to the materials purchasing manager.
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.The use of the variance in this way would lead to an undesirable behavioral outcome.The materials purchasing manager is a gatekeeper;that is,this manager observes the purchasing opportunities available and determines whether or not the company will follow them.In this case,the manager would be unlikely to pursue the grade 4A material because of the negative effect on the bonus calculation.As a result,the overall possibility of offsetting higher purchase costs with savings in yield and productivity would not occur.
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:

Carrying Costs

The expenses incurred by holding inventory, including storage, insurance, and taxes.

Current Assets

Assets owned by a company that are expected to be converted into cash, sold, or consumed within one year or within the normal operating cycle of the business, whichever is longer.

Carrying Costs

Expenses associated with holding or storing inventory over a period.

Cash Budget

An estimation of cash inflows and outflows over a specific period, used to manage and plan for any potential surplus or deficit in cash.