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Price Variance and Standard Cost Systems

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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?
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

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Required:
A. How would an unfavorable price variance on a particular purchase affect the overall price variance for the year?

Brief discussion on variance

A variance is the difference between standard and the actual. With regard to the costing one can find variance in both price and quantity. A price standard is the amount that should be paid for some input--direct material, direct labor, or overhead. A quantity standard relates to how much of the input should be used--direct material, direct labor, overhead. This is then compared with the actual to find out either favorable or unfavorable variance. It helps in management by exception--depending ...

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