Motivational Effects of Standard Cost Systems

question 43

Essay

Motivational effects of standard cost systems
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 favourable materials price variance. Generally, this bonus amounts to 30 to 40 per cent 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 AA, usually purchased for $56 per tonne. Because of the bankruptcy, the company can obtain grade AAAA for $62 per tonne. While the quality of the final product will be the same regardless of the grade of raw material used, there will be substantial savings in production if the grade AAAA material is used. These savings are expected to be two to three times the additional cost of $6 per tonne.
i. How would an unfavourable price variance on a particular purchase affect the overall price variance for the year?
ii. Will the use of the materials price variance to provide a bonus to the purchasing manager lead to a desirable or undesirable behavioural outcome? Explain.

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Definitions:

Customize Features

The ability or option to modify or personalize specific functionalities of a software or system to suit individual or business needs.

Accounts Payable

Amounts owed by a business to its suppliers or vendors for goods and services received but not yet paid for.

Accounts Receivable

Money owed to a business by its clients or customers for goods or services delivered but not yet paid for.

Account Balances

The amounts of money held in financial accounts at a specific point in time, reflecting the net result of all completed transactions.