Absorption costing, standard costs, management ethics. Industrial Engineering Company

(IEC) is a multinational business selling metal products used in the assembly of many cars, trucks, and planes. IEC has more than 50 manufacturing divisions worldwide and is listed on the Toronto htock Exchange. IEC has consistently reported annual earnings growth rates of 15 % or more for each ofthe past ten years.

Division managers at IEC receive an annual bonus of 30% oftheir annual salary ifthe plant operating income increases 15% or more over the previous year’s operating income. Division managers who increase operating income more than 10% but less than 15% receive a bonus of 5% of their annual salary. Division managers who do not achieve a 10% increase in operating income receive no bonus. Instead, they receive a visit from the IEC corporate consulting team.

Bob Wood is manager ofthe Mississauga, Ontario, division, which manufactures crankshafts for sale to automobile manufacturers. Wood has just received a 30% bonus for 2007. Mary Easson,

head of the IEC corporate consulting team, is less than impressed by Wood’s performance. She suspects him of producing for inventory and collects the following information on the Mississauga division for 2007:
Unit data in crankshafts:
Beginning inventory 0 Production 480,000 Ending inventory 30,000 Sales 450,000 Selling price per unit $ 79.20 Cost data:
Standard variable costs per crankshaft:
Direct materials $ 24.00 Direct manufacturing labour 6.00 Manufacturing overhead 14.40 Variable marketing 4.80 Standard fixed costs:
Manufacturing overhead $10,800,000 Marketing 1,200,000 Manufacturing overhead is allocated to each crankshaft based on standard machine-hours.
Each crankshaft has a standard machining time of 30 minutes. The denominator level in 2007 was the master-budget capacity utilization for the Mississauga plant, 500,000 crankshafts. A standard absorption costing system is used for each IEC plant. All variances are recorded as a cost of the period in which they are incurred.
All auto companies require suppliers to deliver on a just-in-time basis (that is, just before the crankshafts are required for assembly). The last four months of 2007 saw a reduc¬
tion in the orders auto companies placed for crankshafts.
The price, spending, and efficiency manufacturing variances for 2007 were $360,000, unfavourable. The total marketing variances were $187,200, favourable (variable $156,000 favourable and fixed $31,200 favourable).
Operating income for the Mississauga division in 2006 was $1,712,412.
Required 1. Compute the absorption costing operating income for the Mississauga division in 2007.
2. Why might Easson believe that in 2007 Wood engaged in behaviour not in the best inter¬
ests ofIEC? How might Wood respond to any charges Easson might make about produc¬
ing for inventory?
3. Is the problem Easson raised likely to be eliminated by her talking to Wood about man¬
agement ethics? Explain.