A retail company begins operations late in $2000$ by purchasing $$600,000$ of merchandise. There are no sales in $2000.$ During $2001,$ additional merchandise of $$3,000,000$ is

purchased. Operating expenses $($excluding management bonuses$)$ are $$400,000,$ and sales are $$6,000,000.$ The management compensation agreement provides for incentive bonuses

totaling $1\%$ of after$-$tax income $($before the bonuses$).$ Taxes are $25\%,$ and accounting and taxable income is the same.

The company is undecided about the selection of the LIFO or FIFO inventory methods. For the year ended $2001,$ ending inventory is $$700,000$ and $$1,000,000,$ respectively, under

LIFO and FIFO.

Required:

a$.$ How are accounting numbers used to monitor this agency contract between owners and managers?

b$.$ Evaluate management incentives to choose LIFO versus FIFO.

c$.$ Assuming an efficient capital market, what effect can the alternative policies have on security prices and shareholder wealth?

d$.$ Why is the management compensation agreement potentially counterproductive as an agency$-$monitoring mechanism?

e$.$ Devise an alternative bonus system to avoid the problem in the existing plan.