Reference no: EM132074048

Problem - Behavioral Effect of Standard Costs

Merit Inc. has used a standard cost system for evaluating the performance of its responsibility center managers for three years. Top management believes that standard costing has not produced the cost savings or increases in productivity and profits promised by the accounting department. Large unfavorable variances are consistently reported for most cost categories, and employee morale has fallen since the system was installed. To help pinpoint the problem with the system, top management asked for separate evaluations of the system by the plant manager, the controller, and the human resources director. Their responses are summarized here.

Plant Manager-The standards are unrealistic. They assume an ideal work environment that does not allow materials defects or errors by the workers or machines. Consequently, morale has gone down and productivity has declined. Standards should be based on expected actual prices and recent past averages for efficiency. Thus, if we improve over the past, we receive a favorable variance.

Controller-The goal of accounting reports is to measure performance against an absolute standard and the best approximation of that standard is ideal conditions. Cost standards should be comparable to "par" on a golf course. Just as the game of golf uses a handicap system to allow for differences in individual players' skills and scores, it could be necessary for management to interpret variances based on the circumstances that produced the variances. Accordingly, in one case, a given unfavorable variance could represent poor performance; in another case, it could represent good performance. The managers are just going to have to recognize these subtleties in standard cost systems and depend on upper management to be fair.

Human Resources Director-The key to employee productivity is employee satisfaction and a sense of accomplishment. A set of standards that can never be met denies managers of this vital motivator. The current standards would be appropriate in a laboratory with a controlled environment but not in the factory with its many variables. If we are to recapture our old "team spirit," we must give the managers a goal that they can achieve through hard work.

Required - Discuss the behavioral issues involved in Merit Inc.'s standard cost dilemma. Evaluate each of the three responses (pros and cons) and recommend a course of action.