Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 11

Evaluating Management Control Systems—Ethical Considerations

Magnolia Manufacturing makes wing components for large aircraft. Kevin Choi is the production manager, responsible for manufacturing, and Michelle Michaels is the marketing manager. Both managers are paid a flat salary and are eligible for a bonus. The bonus is equal to 1 percent of their base salary for every 10 percent profit that exceeds a target. The maximum bonus is 5 percent of salary. Kevin’s base salary is $150,000 and Michelle’s is $200,000.

The target profit for this year is $5 million. Kevin has read about a new manufacturing technique that would increase annual profit by 20 percent. He is unsure whether to employ the new technique this year, wait, or not employ it at all. Using the new technique will not affect the target.

Required

a. Suppose that profit without using the technique this year will be $5 million. By how much will Kevin’s bonus change if he decides to employ the new technique? By how much will Michelle’s bonus change if Kevin decides to employ the new technique?

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b. Suppose that profit without using the technique this year will be $7 million. By how much will Kevin’s bonus change if he decides to employ the new technique? By how much will Michelle’s bonus change if Kevin decides to employ the new technique?

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c. Suppose that profit without using the technique this year will be $4 million. By how much will Kevin’s bonus change if he decides to employ the new technique? By how much will Michelle’s bonus change if Kevin decides to employ the new technique?

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d. Is it ethical for Kevin to consider the impact of the new technique on his bonus when deciding whether or not to use it? Explain.

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e. Assess the management control system used at Magnolia Manufacturing and provide recommendations for changes, if any are required. Be sure to discuss:

•         Decision authority

•         Performance measures

•         Compensation

Step 1 of 5

a. Income with the new technique will be $6 million (= $5 million x 1.20) or 20% above target. Without the new technique, there will be no bonus. With the new technique, Kevin’s bonus will be 2% (= 20% ÷ 10) of salary, or $3,000 (= 2% x $150,000). Michelle’s bonus will be 2% or $4,000 (=2% x $200,000).