EXERCISE 7-9 (20 MINUTES)

6. The Board of Directors, with their bonus plan, has unintentionally cre-

ated a situation that is very difficult for the new CEO. Whenever such a

bonus plan is based on absorption costing net operating income, the

temptation exists to manipulate net operating income by changing the

amount that is produced. This temptation is magnified when an all-or-

nothing bonus is awarded based on meeting target profits. When actual

profits appear to be within spitting distance of the target profits, the

temptation to manipulate net operating income to get the all-or-nothing

bonus becomes almost overpowering. Ideally, managers should resist

such temptations, but this particular temptation can be easily avoided.

Bonuses should be based on variable costing net operating income,

which is less subject to manipulation. And, all-or-nothing bonuses

should be replaced with bonuses that start out small and slowly grow

with net operating income.

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Solutions Manual, Chapter 7 391

Case 7-20 (90 minutes)