Variance and Bonus Behaviour at Halden Medical Components
Halden Medical Components uses a standard cost system. The standard for one sterile connector is 2.5 kg of polymer at $8.00/kg and 0.8 direct labour hours at $22.00/hour. The 2025 budget was 12,000 connectors. Actual output was 11,400. Purchasing bought and used 29,500 kg at $7.40/kg, for $218,300. Production used 9,000 labour hours at $23.10/hour, for $207,900. The purchasing manager's annual bonus is based solely on the material price variance. The production manager is blamed for the material usage variance. Quality records show that the cheaper polymer caused more jams and rework costing $15,000, and that 1,000 kg of the excess usage was due to the inferior material. Labour rate rose because of unplanned overtime after a machine breakdown. The CFO wants to know whether the bonus plan is driving the right behaviour and whether the variances should be investigated.
1. Calculate the material price and usage variances and the labour rate and efficiency variances. Reconcile the total material and labour variances against the flexible budget for actual output.
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Material price variance = (AP - SP) x AQ purchased = ($7.40 - $8.00) x 29,500 = $17,700 favourable. Material usage variance = (AQ used - SQ allowed) x SP. SQ allowed = 11,400 x 2.5 = 28,500 kg. Variance = (29,500 - 28,500) x $8 = $8,000 unfavourable. Total material variance = $17,700 F - $8,000 U = $9,700 F. Labour rate variance = ($23.10 - $22.00) x 9,000 = $9,900 unfavourable. Labour efficiency variance = (9,000 - 9,120) x $22 = $2,640 favourable. Total labour variance = $9,900 U - $2,640 F = $7,260 U. Reconciliation: flexible budget material at actual output = 28,500 x $8 = $228,000; actual = $218,300; variance = $9,700 F. Flexible budget labour = 9,120 x $22 = $200,640; actual = $207,900; variance = $7,260 U. Net material plus labour variance is $2,440 favourable. The rework cost of $15,000 is not in the standard variance; if treated as a quality cost, the material-related outcome becomes $9,700 F - $15,000 = $5,300 U.
2. Assess the purchasing manager's performance and the fairness of the bonus. What behaviour does the current scheme encourage?
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The purchasing manager earns a bonus on a $17,700 favourable price variance, but the cheaper polymer caused $8,000 of excess usage and $15,000 of rework, a total cost of $23,000. The net effect is $5,300 unfavourable, not a success. The production manager is blamed for the $8,000 usage variance even though quality records attribute 1,000 kg of the excess usage to the inferior material. The bonus scheme encourages purchasing to minimise price at the expense of quality, delivery reliability and total cost of ownership. It also encourages blame-shifting between purchasing and production rather than joint problem solving. A fair assessment should separate the purchase price variance from the usage and quality consequences, and should evaluate purchasing on total cost, supplier quality, on-time delivery and inventory. The production manager should be assessed on controllable usage after adjusting for defective material. If the bonus remains unchanged, the company should expect more low-quality purchases and more hidden rework.
3. Recommend how Halden should revise its standard costing and variance investigation policy. Include the labour overtime and the material quality issue.
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Halden should calculate the material price variance at the point of purchase and the usage variance at the point of use, so responsibility is not confused when purchase quantity differs from usage. It should add quality measures such as rework, scrap, yield and supplier defect rates, and investigate material usage because the $8,000 unfavourable variance is partly explained by 1,000 kg of inferior material. The standard itself should be reviewed: if $7.40 polymer is acceptable only with higher rework, the standard cost should reflect the total cost of the quality level chosen, not just the invoice price. Labour rate variance should be split into normal rate changes and overtime premium. The $9,900 unfavourable rate variance is largely due to unplanned overtime after a machine breakdown, so the production manager should be assessed on the avoidable portion. The company should set investigation thresholds based on size, trend and controllability rather than blame. Finally, the bonus should include total material cost, quality and delivery, with a team element to encourage purchasing and production to solve the supplier problem together.