Accounting for Decision Making and Control 7th Edition by Jerold Zimmerman

Exercise 34

Magee Inc.
Magee Inc. pays its sales manager a bonus of $10,000 if the manager meets the sales quota. The sales manager can exert either high effort or low effort. The additional disutility of the manager in exerting high effort relative to low effort to meet the sales quota is $1,500. Management can set a tight quota that is extremely difficult to achieve even with a great deal of effort, a loose quota that is achieved easily, or a medium-tight quota. The probability of achieving the sales figure under each quota is summarized in the accompanying table. The sales manager can either achieve the sales quota or not. Because each quota affects the total number of units sold and thus the gross margin earned by the firm, the following table outlines the gross margin earned by the firm when each quota is reached and is not reached. Should management set a loose, medium-tight, or tight quota?
SOURCE: R Magee, Advanced Managerial Accounting (New York: Harper Row, 1986), pp. 286-87.