CHAPTER 10

PROFIT AND COST CENTER PERFORMANCE EVALUATION Questions, Exercises, Problems, and Cases: Answers and Solutions 10.1 10.2 10.3 10.4 See text or glossary at the end of the book. b. a. A responsibility centers variances are calculated holding all other things constant. Marketing.

It is difficult to evaluate performance without a budget. Organizations might use nonfinancial performance measures as discussed in the chapter such as on- time deliveries, production- cycle efficiency, and percent of errors in products. 1. Some responsibility centers are responsible only for costs. The assembly unit of a manufacturing plant would be a good example. On the other hand, some responsibility centers, such as sales offices, are responsible for revenues. Other responsibility centers such as corporate divisions are responsible for both revenues and costs. Finally, some responsibility centers are responsible for revenues, costs, and investment in company assets. The designation of responsibility centers depends on the specific organizational structure and management system in the organization. 2. The percentage of positions filled from within the company may indicate whether or not employees are committed enough to the company to want to advance and employee perception of advancement possibilities. It may also indicate employee commitment by the quality of employee performance. For instance, if positions are not filled internally it may be because the employees are not performing well enough to be promoted. 3. A standard is related to a cost per unit. Budgets focus on totals.

10.8 10.9

a.

Marketing.

Management must weigh the trade- offs between the costs of an investigation and the costs of letting the process remain out of control for at least one more reporting period (i.e., the benefit of correction).

10- 1

Solutions

10.10

Responsibility reporting systems identify variances from budget plans and relate those exceptions to the manager responsible for them.

Solutions

10- 2

10.11

The action that management can take in response to materials price variances is probably quite different than the action that can be taken in response to efficiency variances. The latter is generally more subject to management control. Also, different departments may be responsible for each variance. For example, purchasing may be responsible for the materials price variance, and production for the materials efficiency variance. The fixed cost variances differ from variable cost variances because fixed costs do not vary with the level of production activity. Therefore, the fixed costs in the flexible budget will be the same as in the master budget (within the relevant range). Additionally, there are no efficiency variances for fixed costs because there is no input-output relationship that can be applied. An efficiency variance for fixed overhead is not calculated because the figure is meaningless. Efficiency variances require an input/output relationship such as the number of hours (input) per unit of output. Fixed costs provide the capacity to generate output, but there is no input component for fixed costs. a. 1. 2. AQ X (AP SP). Actual overhead is less than budget. Fixed overhead was overapplied, compared to budget, because actual production volume exceeded the estimated volume.

10.12

10.13

10.14 10.15

10.16

By involving the workers in the standard setting process NUMMI gains the benefit of using the workers practical experience and knowledge, which can increase the accuracy of the standards. Also, this involvement creates an atmosphere of employee ownership in what is occurring in production, which can increase motivation, efficiency, and quality. A coffee shop would use labor variance information to determine if the scheduling of waitpersons is matching the customer demand. Materials variances would be used to monitor the efficiency of cooks and wait persons and control shrinkage. Under normal circumstances, the purchasing department will acquire all the raw materials it was requested to purchase during the period. It would normally be incorrect to calculate and attribute a materials efficiency variance to the purchasing department because it is not responsible for the actual quantity used in production. 1. If variable overhead is applied on the basis of output, there is no measure of efficiency possible. An efficiency variance measures input-output relations and requires both inputs and outputs in the measure.

10.17

10.18

10.19

10- 3

Solutions

10.19 continued. 2. 10.20 The cost of dividing the variable overhead components might exceed the benefits. variance into its

From past cost data and expectations of future prices, the managers could establish standard prices and quantities for the period based on mileage. A typical standard price and quantity could be dollars per mile and miles per period, respectively. A flexible budget (SP X SQ) could be determined for both wages and automobile costs. After the period, actual inputs at Standard (SP X AQ) could be compared to the flexible budget to determine the efficiency variances. Actual inputs at standard could then be compared to actual costs (AP X AQ) to determine the price variances. (Appendix 10.1) The mix variances could tell if the professionals are using the level of staff budgeted for the job. For example, are managers doing work budgeted for junior staff?

10.21

10.22

(Profit variance analysis.)

Actual (14,20 0 Units) Sales Price Variance $ 2,130 F Flexible Budget Sales (14,20 0 Volume Units) Variance $170,400 c $ 2,400 F Master Budget (14,00 0 Units) $

Sales Revenue ......... ..............168,000 d Less Variable Costs ...................... Contribution Margin................... Less Fixed Costs ...................... Operating Profit......................

$172,530 a

Cost Variances

83,780 b $ 88,750 20,000 $ 68,750

$ 12,780 U $12,780 U $ 2,130 F 1,000 F $ 11,780 U $ 2,130 F

71,000 $ 99,400 21,000 $ 78,400

1,000 U $ 1,400 F -$ 1,400 F

70,000 $ 98,000 21,000 $ 77,000

a $172,530 = 14,200 Units X $12.15. b $83,780 = 14,200 Units X $5.90. c $170,400 = 14,200 Units X $12. d $168,000 = 14,000 Units X $12.

Solutions

10- 4

10.23

(Analyzing period to period change in contribution margin)

Change in Profits from Analysis Change in Year 2 Costs Sales $1,500 Variable costs 1,050 $ 33.3F d Contribution margin $450 $ 33.3F d

In thousands.

Change in Profits from Change in Sales Price $166.7F c $166.7F c

Change in Profits from Change in Sales Volume $266.7U a 216.7F b $50.0U

Baseline Year 1 $1,600 1,300 $300

a $133.33 sales price in Year 1 =.$1,600,000/12,000 units 2,000 unit decrease in volume between years 1 and 2 x $133.33 = $266,667 b $108.33 variable cost in Year 1 = $1,300,000/12,000 2,000 unit decrease in volume x $108.33 = $216,667 c Solve for the change in profits from change in sales price as follows: $1,600 sales in Year 1 - $266.7 effect of unfavorable sales volume $1,500 sales in Year 2 = $166.7 favorable change due to sales price. d Solve for the change in profits from change in costs as follows: $1,300 variable costs in Year 1 - $216.7 reduction in costs due to reduce sales volume - $1,050 variable costs in Year 2 = $33.3 favorable change due to change in costs between Years 1 and 2.

10- 5

Solutions

10.24 (Profit variance analysis.)

Marketing and Sales Flexible Sales Master Actual Manufacturing Administrative Price Budget Volume Budget (170 Units) Variances Variances Variance (170 Units) Variance (200 Units) Sales Revenue ....................... $18,400 $1,400 F $17,000 $3,000 U $20,000 Variable Costs: Manufacturing ..................... 6,880 $ 250 U 6,630 1,170 F 7,800 Marketing ............................. 2,060 $ 190 U 1,870 330 F 2,200 Contribution Margin............. $ 9,460 $ 250 U $190 U $1,400 F $ 8,500 $1,500 U $10,000 Fixed Costs: Manufacturing ..................... 485 15 F 500 -500 Marketing ............................. 1,040 40 U 1,000 -1,000 Administrative .................... 995 5 F 1,000 -1,000 Operating Profit..................... $ 6,940 $ 235 U $ 225 U $ 1,400 F $ 6,000 $ 1,500 U $ 7,500

Solutions

10- 6

10.25

(Estimating flexible selling expense budget and computing variances.) a.

Fixed Costs Office] = $30,000 [Salaries] + $60,000 [Advertising] + $3,750 [Sales

= $93,750. Variable Costs as a Function of Revenue Variable Costs as a Function of Units Sold Total Selling Expenses = (.05 [Commissions] X Revenue) + (.03 [Travel] X Revenue).

= ($.05 [Office] X Units Sold) + ($.10 [Shipping] X Units Sold).

= $93,750 + (.08 X Revenues) + ($.15 X Units Sold).

b. and c. Profit Variance Analysis

Actual (50,00 0 Units) $300,000 Selling Expense Variances Sales Flexible Price Budget Vari(50,00 0 ance Units) $25,000 F $275,000 29,500 a $25,000 F $245,500 Master Sales Budget Volume (65,000 Variance Units) $82,500 U $ 38,350 b

Sales Revenue ......... .................357,500 Less Variable Selling Costs ........ Contribution Margin................... .................319,150 Less Fixed Selling Costs ........ Profits from Selling................... .................225,400

30,000 $270,000

$ $

500 U 500 U

8,850 F

$73,650 U $

80,000 $ 190,000

13,750 F

93,750

-$ 73,650 U $

93,750

$ 13,250 F $ 25,000 F $ 151,750

a $29,500 = (.08 X $275,000) + ($.15 X 50,000) = $22,000 + $7,500. b $38,350 = (.08 X $357,500) + ($.15 X 65,000) = $28,600 + $9,750.

10.26

(Materials and labor variances.) Price Variance Efficiency Variance

Materials pds)] Labor X 1 hour)]

$105,500 - ($.50 x 200,000 pds) = $5,500 U $905,000 - ($9.00 x 99,200 hrs) = $12,200 U

$.50 X [200,000 pds - (97,810 units X 2 = $2,190 U $9.00 X [99,200 hrs -(97,810 units = $12,510 U

10- 7

Solutions

10.27

(Evaluate cause of materials and labor variances.) The unfavorable materials variances resulted from paying more than anticipated for the materials ($0.53 actual price versus $0.50 standard price), and from using more pounds of material than anticipated (200,000 actual quantity used versus 195,620 standard quantity). The unfavorable labor variances resulted from paying more than anticipated for labor ($9.12 actual rate versus $9.00 standard rate), and from using more labor hours than anticipated (99,200 actual hours versus 97,810 standard hours.)

10.28

(Materials and labor variances.) Price Variance Efficiency Variance

Materials pd)] Labor 1.5 hour)]

$127,500 - ($2.50 x 49,000 pds) = $5,000 U $214,000 - ($3.00 x 70,000 hrs) = $4,000 U

$2.50 X [49,000 pds - (48,000 batches x 1 = $2,500 U $3.00 X [70,000 hrs - (48,000 batches X = $6,000 F

10.29

(Evaluate cause of materials and labor variances.) The $7,500 unfavorable materials variance resulted from paying more than anticipated for the materials ($2.60 actual price versus $2.50 standard price), and from using more pounds of material than anticipated (49,000 actual quantity versus 48,000 standard quantity). The $2,000 favorable labor variance resulted from using less labor hours than anticipated (70,000 actual hours versus 72,000 standard hours). However, the favorable variance resulting from this efficient use of labor hours was somewhat offset by the higher rate of pay than anticipated ($3.06 actual hourly rate versus $3.00 standard rate).

Solutions

10- 8

10.30

(Solving for materials quantities and costs.) Chemical A a. Price variance is $.20 F per pound. Total price variance is $42,000 F. Pounds Purchased and Used = $42,000/$.20 = 210,000. b. Standard pounds 200,000. allowed for 100,000 units (pools cleaned) =

210,000 pounds 200,000 pounds = standard. Efficiency variance = $40,000 U.

10,000 pounds used over

So, $40,000/10,00 pounds = $4.00 = the standard unit price. Chemical B a. b. Pounds Purchased and Used = $25,000/$.10 = 250,000. Standard Unit Price = $30,000/(250,000 220,000 pounds) = $1.00.

Chemical C a. b. 10.31 Pounds Purchased and Used = $21,000/$.07 = 300,000. Standard Unit Price = $48,000/(300,000 250,000 pounds) = $.96.

(Maxums Sales; nonmanufacturing variances.)

Actual Cost Price Efficiency Standard Cost (SP X SQ) b

May................................... June................................... July....................................

(AP X AQ) Variance (SP X AQ) a $ 900,000 $ 60,000 U $ 840,000 1,000,000 40,000 U 960,000 800,000 20,000 U 780,000

Variance $ 30,000 U $ 810,000 120,000 F 1,080,000 240,000 U 540,000

a $840,000 = $6 X 140,000 sales calls; $960,000 = $6 X 160,000 sales calls; $780,000 = $6 X 130,000 sales calls. b $810,000 = $6 X 9 calls per unit sold X 15,000 units sold; $1,080,000 = $6 X 9 calls per unit X 20,000 units sold; $540,000 = $6 X 9 calls per unit X 10,000 units sold.

10- 9

Solutions

10.32

(Labor and variable overhead variances.) Price Variance Efficiency Variance

Direct Labor Variable Overhead

$43,400 ($3.00 x 14,000 hrs) = $1,400 U $22,900 ($1.50 x 14,000 hrs) = $1,900 U

$3.00 X (14,000 hrs 15,000 hrs) = $3,000 F $1.50 X (14,000 hrs 15,000 hrs) = $1,500 F

10.33

(Overhead variances.) Actual Costs $13,600 $3,500 = $10,100 $3,500 Flexible Budget $3.00 X 3,500 hours = $10,500 $3,300 Variance $400 F $200 U

Variable Overhead Fixed Overhead 10.34

(Finding purchase price.) Actual Costs (AP X AQ) AP X 1,600 = $5,760 Price Variance Input at Standard Prices (SP X AQ) $3.60 X 1,600

> $240 F < 1,600 X AP = $5,760 $240 AP = $5,520/1,600 AP = $3.45.

Solutions

10- 10

10.35

(Solving for labor hours.) Inputs at Standard Prices (SP X AQ) $15 X AQ = $24,000 Flexible Production Budget (SP X SQ) $15 X 1,600 hours

Efficiency Variance

> $860 U < $15 X AQ = $24,000 + $860 AQ = $24,860/15 AQ = 1,657 hours. 10.36 (Overhead variances.) a. $300,000/60,000 units = $5.00 per Unit $5.00 + $2.50 = $7.50 per Unit. b. Fixed Overhead Applied = $5.00 per Unit X 65,000 Units = $325,000. Variable Overhead Applied = $2.50 per Unit X 65,000 Units = $162,500. Total Applied Overhead = $325,000 + $162,500 = $487,500 or c. $7.50 X 65,000 units = $487,500.

$487,500 Applied $400,000 Actual = $87,500 Overapplied.

10- 11

Solutions

10.37

(Overhead variances.) a. b. Budgeted Fixed Costs = $2.00 per Unit X 45,000 Units = $90,000. Applied Overhead = Variable of ($1.00 X 40,000) + Fixed of ($2.00 X 40,000) = $120,000 in total.

$140,000 Actual $120,000 Applied = $20,000 Underapplied. c. Fixed Overhead Variance Analysis: Price Variance > $0 < Production Volume Variance > $10,000 U <

Actual $90,000

Budget $90,000

Applied $80,000

10.38

(variance investigation.) Investigate if P X B > C: Where: P = Probability process is out of control; B = Dollar amount of savings from correcting problem; and C = Cost of investigation. .35 X ($45,000 $20,000) = $8,750 > $7,000. Yes, this process should be investigated since the value of the expected savings exceeds the cost of investigation.

Solutions

10- 12

10.39

(Variances from activity-based costs.) Actual Inputs at Standard Prices $.50 X 42,000 minutes = $21,000 Flexible Production Budget (Standard Allowed) $.50 X 40,000 minutes = $20,000

Quality Testing

Actual Costs $20,000

Price Variance

Efficiency Variance

> $1,000 F < Energy $40,000 > $2,000 U < Indirect Labor $56,800 > $4,200 F < $1.00 X 61,000 hrs. = $61,000 $1.00 X 38,000 hrs. = $38,000

> $1,000 U < $1.00 X 40,000 hrs. = $40,000 > $2,000 F < $1.00 X 60,000 hrs. = $60,000 > $1,000 U <

10- 13

Solutions

10.40

(Variance investigation.) Investigate if P X B > C: Where: P = Probability process is out of control; B = Dollar amount of savings from correcting problem; and C = Cost of investigation. .30 X ($40,000 - $10,000) = $9,000 $9,000 > $7,000 cost. This process should be investigated because the expected value of the savings is greater than the cost of investigation.

Solutions

10- 14

10.41

(Year to year analysis in a service organization.)

Analysis Period Year 2 Revenue Professional salaries Other variable costs Contribution margin General admin. Operating profits $ $3,400,000 1,850,000 470,000 1,080,000 680,000 400,000

Change in Operating Change in Operating Change in Operating Profits due to Change Profits due to Change Profits due to Change in Production Costs in Gen. Admin. Costs in Sales Price $200,000U b $ 50,000U e 10,000F f

Change in Operating Profits due to Change Baseline Period, in Sales Volume Year 1 a $3,000,000 $600,000F 1,500,000 300,000U c 80,000U d 220,000F 400,000 1,100,000 700,000 $ 400,000

$40,000U

$40,000U

$20,000F g $20,000F

$200,000U $200,000U

$ 220,000F

a $120 sales price in Year 1 =.$3,000,000/25,000 hours 5,000 unit increase in volume between years 1 and 2 x $120 = $600,000 b Solve for the change in profits from change in sales price as follows: $3,000,000 sales in Year 1 + $600,000 effect of favorable sales volume - $3,400,000 sales in Year 2 = $200,000 unfavorable change due to sales price. c $60 variable cost per hour in Year 1 = $1,500,000/25,000 5,000 unit increase in volume x $60 = $300,000 d $16 variable cost per hour in Year 1 = $400,000/25,000 5,000 unit increase in volume x $16 = $80,000 e Solve for the change in profits from the change in professional salaries as follows: $1,500,000 professional salaries in Year 1 + $300,000 increase in professional salaries due to increased sales volume - $1,850,000 professional salaries in Year 2 = $50,000 unfavorable change due to change in professional salaries between Years 1 and 2. fSolve for the change in profits from the change in other variable costs as follows: $400,000 other variable costs in Year 1 + $80,000 increase in other variable costs due to increased sales volume - $470,000 other variable costs in Year 2 = $10,000 favorable change due to change in other variable costs between Years 1 and 2. g Solve for the change in profits from the change in general administrative costs by comparing the Year 1 and Year 2 costs: $700,000 - $680,000 = $20,000 favorable change.

10- 15

Solutions

10.42

(Profit variance analysis in a service organization) Profit Variance Analysis (1) Actual (based on actual activity of 20,000 hours) Sales Revenue ....................... $2,300,000 Less: Professional Salaries ......... 1,550,000 Other Variable Costs ......... 250,000 Contribution Margin............. $ 500,000 Less: General Administrative Costs.................................. 400,000 Operating Profits................... $ 100,000 (2) (5) (6) (7) Flexible Master Budget Budget (based on (based on General Sales actual activity Sales a prediction Administrative Price of 22,0 0 0 Volume of 20,0 0 0 Variances Variance hours) Variance hours) a -$100,000 F $2,200,000 $200,000 F $2,000,000 -260,000 U --0-1,320,000 a 120,000 U 1,200,000 220,000 a 20,000 U 200,000 $100,000 F $ 660,000 $ 60,000 F 400,000 260,000 -$ 60,000 F $ 400,000 200,000 (3) (4)

Production Variances -$230,000 U 30,000 U $ -$ 260,000 U

$ 100,000 F

a Increase master budget sales revenue and variable costs by the 10% increase in units, actual over budget

Solutions

10- 16

10- 17

Solutions

10.43

( Comprehensive problem.)
Profit Variance Analysis (1) (2) (3) (4) (5) Actual Flexible (based on Budget actual (based on activity Marketing and Sales actual activity of 14,000 Manufacturing Administrative Price of 14,0 0 0 units sold) Variances Variances Variance units sold) Sales Revenue ....................... $308,000 a --$28,000F $280,000 b Less: Variable Manufacturing Costs.................................. 162,000 $ 8,000 U --154,000 b Variable Marketing and Administrative Costs ....... 17,000 -$ 3,000 U -14,000 b Contribution Margin............. $129,000 $ 8,000 U $3,000 U $28,000 F $112,000 Less: Fixed Manufacturing Costs.................................. 42,000 2,000 U --40,000 Fixed Marketing and Administrative Costs ....... 68,000 -2,000 F -70,000 Operating Profits................... $ 19,000 $ 10,000 U $1,000 U $ 28,000 F $ 2,000 (7) Master Budget (based on Sales a prediction Volume of 16,0 0 0 Variance units sold) $40,000 U $320,000 22,000 F 2,000 F $16,000 U --$ 16,000 U 176,000 16,000 $128,000 40,000 70,000 $ 18,000 (6)

To tal Variance fro m Fle xible Budg e t = $17,000 F To tal Variance fro m Maste r Budge t = $1,000 F a $308,000 = $22 X 14,000 units. b Decrease master budget sales revenue and variable costs by the 12.5%decrease in actual units from budgeted units.

Solutions

10- 18

10.44 (Comprehensive problem.) Profit Variance Analysis (1) (2) (3) (4) (5) (6) (7) Actual Flexible Master (based on Budget Budget actual (based on (based on activity Marketing and Sales actual activity Sales a prediction of 20,000 Manufacturing Administrative Price of 20,0 0 0 Volume of 18,0 0 0 units sold) Variances Variances Variance units sold) Variance units sold) a Sales Revenue ....................... $420,000 --$20,000F $400,000 $40,000 F $360,000 Less: Variable Manufacturing Costs.................................. 230,880 $30,880 U --200,000 b 20,000 U 180,000 Variable Marketing and Administrative Costs ....... 22,000 -$2,000 U -20,000 b 2,000 U 18,000 Contribution Margin............. $167,120 $30,880 U $2,000 U $20,000 F $180,000 $18,000 F $ 162,000 Less: Fixed Manufacturing Costs.................................. 82,000 2,000 U --80,000 -80,000 Fixed Marketing and Administrative Costs ....... 18,000 -2,000 F -20,000 -20,000 Operating Profits................... $ 67,120 $ 32,880 U $ 0 $ 20,000 F$ 80,000 $ 18,000 F$ 62,000

To tal Variance fro m Fle xible Budg e t = $4,880 U To tal Variance fro m Maste r Budge t = $5,120 F a $420,000 = $21 X 20,000 units.

10- 19

Solutions

10.45 (Finding missing data.)

a. b. c. d. e. f. g. h. i. j. k. l. 750 Units. $65U. $135U = budget).
X

50 units (= 800 in master budget 750 in flexible

$2,160 (= $2,025/750 units) X 800 units $570 (= X 750 units). $510 (= $570 $60). $608 (= X 800 units). $200 (= $1,960 $510 $1,250). $202.5 (= X 750 units). $2.5F (= $202.5 $200). $13.5F (= $216 $202.5). $60F.

m. $2.5F. n. o. p. q. $65U. $1,252.5 (= $2,025 $570 $202.5). $83.5U (= $135U $38F $13.5F). $1,336 (= $2,160 $608 $216).

10.46 (Finding missing data.)

a. 12,000 (= 10,000 units in master budget + 2,000 units favorable sales volume).

Solutions

10- 20

b. c. d. e. f. g. h. i. j. k. l.

12,000. $20,000 (= $150,000 $80,000 $50,000). $25,000 (= $60,000 $15,000 $20,000). $25,000. $15,000. $10,000 (= $50,000 $25,000 $15,000). $180,000 (= $60,000 + $24,000 + $96,000). $198,000 (= $180,000 + $18,000). $30,000F (= $180,000 $150,000). $16,000U (= $96,000 $80,000). $10,000F (= $60,000 $50,000).

m. $10,000F. n. o. p. q. r. s. t. u. $105,000 (= $96,000 + $9,000). $2,400F (= $24,000 $21,600). $71,400 (= $198,000 $105,000 $21,600). $23,000 (= $25,000 $2,000). $11,400F (= $18,000 $9,000 + $2,400). $30,400 (= $71,400 $23,000 $18,000). $3,000U (= $18,000 $15,000). $10,400F (= $30,400 $20,000).

10- 21

Solutions

10.47 (Assigning responsibility.)

a. The raw materials variance appears to be the result of poor quality inputs. In assigning responsibility, therefore, management must discern the reason why poor quality inputs were used. The poor quality raw materials could be the responsibility of any one of a number of areas. It may have been due to poor performance in the purchasing department, or to poor production planning by the production supervisor. Possibly, management was responsible by placing demands on the Assembly Division that required an emergency purchase of materials that did not meet normal quality standards. Finally, the poor input quality may have been the result of factors outside the control of any responsibility center in the firm, such as a general decline in the quality of a particular raw material. The idle time in the Finishing Division was the result of fewer units than expected being transferred out of the Assembling Division, which in turn was the result of poor quality raw materials input. In such a case ultimate responsibility should be placed on the center responsible for the poor quality raw materials. Management may, however, feel that the idle labor hours could have been used productively in other areas. In such a case, responsibility would be placed on the supervisor of the Finishing Division.

b.

10.48 (Controls over planning function.)

It is virtually impossible to design a quantitative measure that captures the relevant aspects of performing the planning activity. Alternative performance evaluation procedures must therefore be used. One approach is to have either the external or internal auditors conduct a management audit of the planning activity. Standards might be set relative to the use of appropriate statistical planning tools, the participation of line and staff personnel in generating inputs for the planning models, and the effective communication of budgeted amounts to the employees affected by the budgets. Statistical consultants could be used to evaluate the appropriateness of the statistical tools used. Line and staff personnel could be interviewed to determine the extent they participated in the planning process and their reaction to the activity of the planning department. The management audit would also evaluate the qualifications of the personnel in the planning department and the quality of continued training and supervision they receive. Given the cost of such a management audit, it would probably be conducted every two or three years rather than annually.

Solutions

10- 22

10.49

(Computing variances for marketing costs.) Flexible Budget $2,70 0 , 0 0 0 Sales $ 270,000 810,000 d 27,000 d 162,000 d 121,500 d 94,500 d 411,500 $ 1,896,500 Master Sales Budget Volume $3,2 4 0 , 0 0 0 b Variance Sales $ 54,000 F $ 324,000 162,000 F 972,000 5,400 F 32,400 32,400 F 194,400 24,300 F 145,800 18,900 F 113,400 -0411,500 $ 297,000 F $ 2,193,500

Sales Commissions c .......... Cost of Sales ....................... Telephone Time .................. Delivery Services ............... Uncollectible Accounts ...... Other Variable Costs ......... Fixed Costs .......................... Total Costs .......................

Actual $2,70 0, 0 0 0 Sales $ 270,000 810,000 32,200 161,100 121,500 112,700 409,000 $ 1,916,500

Cost Variance a $ -0-05,200 U 900 F -018,200 U 2,500 F $ 20,000 U

aDifference between actual and flexible budget. b$450 X 180 hours X 40 callers = $3, 40,000. c10! of the sales figure. d"he re#aining $ariable costs%cost of sales through other $ariable costs%e&ual the #aster budget a#ount ' $ ,(00,000)$3, 40,000. *or exa#+le, $810,000 = $,( ,000 ' $ ,(00,000)$3, 40,000. .

10- 23

Solutions

10.50

(Analysis of cost reports [CMA adapted].) Three possible changes that could make the cost information more meaningful are: 1. Use a flexible budget, rather than a static budget, for measuring performance. This would enable the reporting process to recognize changed conditions, such as volume changes, and fixed versus variable costs. Separate variable costs from fixed costs. Also, identify those elements of the report for which the production manager is directly responsible. Separate excess cost into price and efficiency variances for variable costs.

2.

3. 10.51

(Change of policy to improve productivity [CMA adapted].) Improved profit margins will not be achieved. The production manager fails to understand that by tightening the standards (all else equal) variances will be negative. Simply lowering the standard time allowed per operation does not reduce the cost of manufacturing the product, unless an actual reduction in the processing time occurs. The tightening of the standards will probably decrease morale and motivation resulting in increased processing time. This will decrease productivity and increase the costs of production. Currently the assembly personnel rarely complete the operations in less time than the standard allows. Assuming that the assembly department is working efficiently, it is not likely that the tightening of the standards (reducing the allowed time per operation) will result in increased productivity. More likely, the assembly personnel will resent having the standards tightened without their input. They currently view the standards as achievable, since they do achieve them occasionally. Tightening the standards will result in decreased motivation and morale, as they will be striving for what they will view as an unrealistic standard.

10.52

(Ethics and standard costs [CMA adapted].) Joes behavior is unethical. The unofficial CMA answer to this question cites violations in the areas of competence, integrity, and objectivity with regard to the Standards of Ethical Conduct for Management Accountants. Basically, Joe has an obligation to communicate information fairly and objectively. He must prepare complete and clear reports and recommendations. By misrepresenting the costs of the strawberries, he is hoping to benefit his friends strawberry farm at the expense of Western Farms. Joe should avoid such conflicts of interest and advise all parties of potential conflicts. He should not be setting the standards and mandating from whom Western should purchase strawberries.

Solutions

10- 24

10- 25

Solutions

10.53

(Hospital variances.) Actual Costs (AP X AQ) $40 X 8,000 units = $320,000 Price Variance Inputs at Standard Prices (SP X AQ) $50 X 8,000 units = $400,000 Efficiency Variance

Material X

Flexible Production Budget (SP X SQ) $50 X (5 X 1,500 units) = $375,000

> $80,000 F < Material Y $76 X 14,000 units = $1,064,000 > $14,000 U < Total Variances $66,000 F $75 X 14,000 units = $1,050,000

> $25,000 U < $75 X (10 X 1,500 units) = $1,125,000 > $75,000 F < $50,000 F

Solutions

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10.54

(Labor variances.) Actual Costs (AP X AQ) Skilled Labor $9,600 > $600 U < Unskilled Labor $14,000 > $200 U < Total Variances $800U $6 X 2,300 hours = $13,800 > $1,200 F < $2,200 F Actual Inputs at Standard Prices (SP X AQ) $10 X 900 hours = $9,000 Flexible Production Budget (SP X SQ) $10 X 1,000 hours a = $10,000

Price Variance

Efficiency Variance

> $1,000 F < $6 X 2,500 hours b = $15,000

a 1,000 hours = 6 minutes per equivalent meals X 10,000 equivalent meals = 60,000 minutes or 1,000 hours. An alternative method of calculation is to determine the cost per equivalent meal: ) $1
X X

$10 per hour = $1 per equivalent meal 10,000 meals = $10,000.

b 2,500 hours = 15 minutes per equivalent meal X 10,000 equivalent meals = 150,000 minutes = 2,500 hours. The alternative method:
() X

$6 = $1.50 per equivalent meal

$1.50 X 10,000 equivalent meals = $15,000.

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Solutions

10.55

(Appendix 10.1; hospital supply variances.)

AP X AQ $40 X 8,000 pieces = $320,000 Price Variance SP X AQ $50 X 8,000 pieces = $400,000 Mix Variance SP X ASQ $50 X X 22,000 pieces a = $366,667 Yield Variance SP X SQ $50 X 5 X 1,500 surgeries = $375,000

Item X

> $80,000 F < Item Y $76 X 14,000 pieces = $1,064,000 > $14,000 U < Total $1,384,000 > $66,000 F < $1,450,000 $75 X 14,000 pieces = $1,050,000

> $33,333 U < $75 X X 22,000 pieces = $1,100,000 > $50,000 F < $1,466,667 > $16,667 F <

> $8,333 F < $75 X 10 X 1,500 surgeries = $1,125,000

> $25,000 F < $1,500,000 > $33,333 F <

a 22,000 = 8,000 + 14,000; 5/15 and 10/15 are the standard ratios of X and Y pieces, respectively, to total pieces.

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10.56 (Appendix 10.1) (Labor variances.)

AP X AQ Skilled $9,600 > 600 U < Unskilled $14,000 > 200 U < Total $23,600 > 800 U < a 3,200 hours = 900 hours + 2,300 hours; = . $22,800 > 57 F < $6 X 2,300 hours = $13,800 > 86 U < $22,857 > 2,143 F < Price Variance SP X AQ $10 X 900 hours = $9,000 Mix Variance SP X ASQ $10 X X 3,200 hours a = $9,143 Yield Variance SP X SQ $10 X X 10,000 meals = $10,000

> $143 F < $6 X X 3,200 hours = $13,714

> 857 F < $6 X X 10,000 meals = $15,000 > 1,286 F < $25,000

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Solutions

10.57 (Comprehensive cost variances.)

a. Actual Costs (AP X AQ) $1.05 X 1,525 lbs. = $1,601 Actual Inputs at Standard Prices (SP X AQ) $1 X 1,525 lbs. = $1,525 Flexible Budget (SP X SQ) $1 X 1,500 a lbs. = $1,500

Price Variance

Efficiency Variance

Direct Materials

> $76 U <

> $25 U <

Direct Labor

$10 X 800 hrs. = $8,000 > 0 <

$10 X 800 hrs. = $8,000 > $500 U <

$10 X 750 b hrs. = $7,500

Variable Overhead

$1,750 > $250 U <

$0.50 X 3,000 lasagnas = $1,500

a 1,500 lbs. = .5 lb. per lasagna X 3,000 lasagnas. b 750 hrs. = .25 hr. per lasagna X 3,000 lasagnas. Fixed Costs: Marketing and Administrative Actual $3,250 > $750 U < Manufacturing $5,500 > $500 U < $5,000 Budget $2,500

Solutions

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10.57 continued. b. Re: Variable Cost Variances for the Month of July Direct materials, pasta, had unfavorable variances for both price and efficiency. The price variance might be lessened by taking purchase discounts, investigating to be sure youre getting the best price in the market. If not, increasing order size may provide a quantity discount. The efficiency variance may be lessened by examining the amount of pasta being used per lasagna and the amount of waste from the production. (Also, check into how much food is eaten by employees.) Direct labor had an unfavorable efficiency variance. This might be reduced by providing training for production employees. Also, schedule employees to decrease labor in low volume times, if there is unused labor capacity. Variable overhead had an unfavorable variance. Examine how the overhead is applied to determine if the cost driver is appropriate, and what the appropriate rate should be. Then, with this additional data, determine price and efficiency variances for particular variable overhead items, such as energy costs, to establish what can be done to minimize the costs.

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Solutions

10.58

(Performance evaluation in a service industry.) Actual Costs $495,000 $15,000 U Policy Maintenance $55,000 $8,333 U $14,000,000 X ($5/$1,500) = $46,667 $6,667 U Flexible Production Budget

Item New Policies

Variance

Variance between Master Master and Flexible Budget Budget $100 X 4,800 policies $100 X 5,000 policies = $480,000 = $500,000 $20,000 F $12,000,000 X ($5/$1,500) = $40,000

Solutions

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10.59

(Solving for materials and labor.) a. b. c. d. = 100,000 pounds [from price variance = (SP AP)AQ]. = 5,000 pounds [from efficiency variance = SP(AQ SQ)]. Standard Hourly Wage Rate = $450,000/75,000 hours = $6.00 per hour. Standard Variable Overhead Rate = $1.00 per Direct Labor Hour. $20,000 V.O.H. Efficieny Variance/$1.00 = 20,000 hours worked in excess of standard. $400,000 $6.50 = 61,538 actual direct labor hours. 61,538 hrs. 20,000 hrs. = 41,538 standard direct labor hours allowed. = $75,000/75,000 hours

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Solutions

10.60

(Controlling labor costs.) a. The variances arose because the guaranteed minimum wage was treated as a fixed cost, when it was really a mixed cost. This error led to a budget formula for direct labor of $200,000 per month plus $14.00 per hour: Fixed Portion: $2,400,000 12 months = $200,000 Variable Portion: ($8 million - $2.4 million)/400,000 hrs. = $14.00 This is erroneous because the monthly cost behavior pattern assumed is:

Dollars of Direct Labor Cost Direct Labor Hours while the correct cost pattern is: Dollars of Direct Labor Cost 10,000 Direct Labor Hours

} } } }

V = $14.00 per hour F = $200,000

V = $20.00 per hour F = $200,000 which operates only under a strict set of low-volume conditions

The erroneous formula provides a budget allowance that is too generous when volume is less than 33,333 hours per month and too tight when volume is higher. b. No, this budget does not reflect actual cost behavior and, thus, does not provide a basis for controlling direct labor cost. To facilitate cost control and performance evaluation, a budget must be realistic. This budget is not realistic because it reflects cost behavior at only one level of activity, 33,333 direct labor hours per month. The budget formula which should be used to reflect monthly direct labor cost for all possible activity levels is: $200,000 + $20.00 (direct labor hours worked 10,000). A simplified alternative would be to use a rate of $20.00 per hour for budgeting purposes for all volumes. In this case, no variance would appear when direct labor hours worked were

Solutions

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10,000 or more per month. Such a budget would apparently justify or support the production manager's belief that control was good; however, for performance evaluation he also needs an output standard to determine whether his labor inputs were used efficiently. The use of the $20.00 rate at levels at which the guarantee would be effective would help focus upon the amount of unutilized labor and would produce a variance that would measure the cost of such idle time. For example, suppose only 5,000 hours were utilized in a month: Budget, 5,000 Hours at $20.00 .................... $ 100,000 Actual, Guaranteed 10,000 Hours at $20.00 .......................................................... 200,000 Unfavorable Variance ..................................... $ 100,000 The cost of the guaranteed minimum clause would be $100,000 for the month. If periods of low volume could be anticipated, there could be a planned discrepancy (a budgeted variance) between the control budget and the budget used for cash planning purposes: Budget for Control Purposes ......................... $ 100,000 Expected Variance .......................................... 100,000 Budget for Cash Planning Purposes ............ $ 200,000

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Solutions

10.61

(Evaluating nonmanufacturing performance.) Actual Results New Policies $430,000 $66,000 F Policy Maintenance $27,000 $1,000 U a 0.002 = $2 per $1,000 face amount of insurance. $13,000,000 X 0.002 a = $26,000 $2,000 U Flexible Budget Variance between Master and Flexible Budgets Master Budget

Variance

6,200 policies X $80 = $496,000

6,000 policies X $80 = $480,000 $16,000 U $12,000,000 X 0.002 a = $24,000

Solutions

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10.62

(Behavioral adapted].) a.

impact

of

implementing

standard

cost

system

[CMA

Standard costing allows for management by exception. Timely reporting of variances allows management to take corrective action before costs get out of control. The breakdown of variances into price and efficiency components helps management trace the source of potential cost problems. Standard costing may also motivate employees to operate more efficiently if they are allowed to participate in setting the standards. The standard cost system can have a negative impact on the motivation of employees if the standards are too easily attained or too difficult to reach. If the standards are too easy, then employees tend to reduce productivity. If they are too difficult, then production workers become frustrated and ignore the standards. Also, standards that are set without production employee input may not be accepted by employees as legitimate.

b.

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Solutions

10.63

(Comprehensive problem.)
Variances Actual 1,000 $ 940,000 312,550 60,000 $ 567,450 205,000 $ 320,000 42,450 Production Marketing & Administrative Sales Price $ 60,000 U $ 12,550 U $ 10,000 U $ 10,000 U Flexible Budget 1,000 $ 1,000,000 300,000 50,000 b 650,000 200,000 30,000 F $ 20,000 F $ 60,000 U $ 350,000 100,000 Sales Volume Variance $ 100,000 F 30,000 U 5,000 U $ 65,000 F --$ 65,000 F $

Units............................................. Revenue ...................................... Variable Costs: Manufacturing ......................... Marketing & Administrative ......................................... Contribution Margin.................. Fixed Costs: Manufacturing ......................... Marketing & Administrative ......................................... Operating Profit.........................

Master Budget 900 $ 900,000 270,000 a 45,000 $ 585,000 200,000 350,000 35,000

$ 12,550 U 5,000 U $ 17,550 U

$ 60,000 U

a $270,000 = 900 X ($200 + $60 + $40). b $50,000 = $50 X 1,000.

Actual

Cost Variance Analysis: Actual Inputs at

Flexible Production

Direct Materials

Costs (AP X AQ) $19 X 11,000 lbs. = $209,000

Price Variance

Standard Prices (SP X AQ) $20 X 11,000 lbs. = $220,000

Efficiency Variance

Budget (SP X SQ) $20 X (10 lbs. X 1,000 units) = $200,000

> $11,000 F < Direct Labor $31 X 2,050 hrs. = $63,550 > $2,050 U < Variable Manufacturing Overhead Total $245,000 total $205,000 fixed = $40,000 > $4,000 F < 12,950 F > 12,550 U < $80 X 550 hrs. = $44,000 $30 X 2,050 hrs. = $61,500

> $20,000 U < $30 X (2 hrs. X 1,000 units) = $60,000 > $1,500 U < $80 X (.5 hrs. X 1,000 units) = $40,000 > $4,000 U < 25,500 U

10.64

(Comprehensive problem.) Variances

Units................................................... Revenue ............................................. Actual 10,000 620,000 Production Marketing & Administrative Sales Price $ 20,000 F $ Flexible Budget 10,000 600,000 Sales Volume Variance $ 60,000 U

Master Budget 11,000 $ 660,000

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Variable Costs: Manufacturing ............................... Marketing & Administrative ............................................... Contribution Margin........................ Fixed Costs: Manufacturing ............................... Marketing & Administrative ............................................... Operating Profit................................ 304,100 $ 55,000 260,900 81,000 $ 45,000 134,900 $ $ $ 4,100 U 4,100 U 1,000 U 5,100 U $ 5,000 F -0$ 20,000 F $ $ $ 5,000 U 5,000 U $ 20,000 F $ 300,000 50,000 250,000 80,000 50,000 120,000 $ $ 30,000 F 5,000 F 25,000 U --25,000 U $ $

330,000 a 55,000 275,000 80,000 50,000 145,000

a $330,000 = 11,000 units X ($20 + $6 + $4).

Direct Materials

Actual Costs (AP X AQ) $19 X 10,100 kits = $191,900

Price Variance

Cost Variance Analysis: Actual Inputs at Standard Prices (SP X AQ) $20 X 10,100 kits = $202,000

Efficiency Variance

Flexible Production Budget (SP X SQ) $20 X (1 kit X 10,000 units) = $200,000

> $10,100 F < Direct Labor $31 X 2,200 hrs. = $68,200 > $2,200 U < Variable Manufacturing Overhead Total $125,000 total $81,000 fixed = $44,000 > -0- < 7,900 F > 4,100 U < $20 X 2,200 hrs. = $44,000 $30 X 2,200 hrs. = $66,000

> $2,000 U < $30 X (0.2 hrs. X 10,000 units) = $60,000 > $6,000 U < $20 X (0.2 hrs. X 10,000 units) = $40,000 > $4,000 U < 12,000 U

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Solutions

10.65

(Safety Auto Accessories; cost data for multiple purposes.) We present the following comparison to provide more information about the difference between the original budget and actual results. Actual First Six Months Flexible Budget Master Budget

Sales Units............................. Sales Revenue ...................... Manufacturing Costs: Variable Materials............. Variable Labor.................... Variable Overhead ............ Fixed Overhead ................. Total........................................ Nonmanufacturing Costs: Variable ............................... Fixed .................................... Total........................................ Operating Profits..................

Actual Prices Planned Prices Planned Prices and and and Actual Costs Planned Costs Planned Costs Total Unit* Total Unit* Total Unit* 108,000 108,000 90,000 $ 7,020,000 $65 .00 $ 7,560,000 $ 70 .00 $ 6,300,000 $ 70 .00 $2,160,000 $20 .00 1,134,000 10 .50 324,000 3.00 1,026,000 9.50 $ 4,644,000 $ 648,000 650,000 $ 1,298,000 $ 1,078,000 $ 6.00 6.02 $2,160,000 $ 20 .00 1,080,000 10 .00 216,000 2.00 1,081,200 10 .01 $ 4,537,200 $ 540,000 630,000 $ 1,170,000 $ 1,852,800 $ 5.00 5.83 $1,800,000 $ 20 .00 900,000 10 .00 180,000 2.00 1,081,200 12 .01 $ 3,961,200 $ 450,000 630,000 $ 1,080,000 $ 1,258,800 $ 5.00 7.00

*(Unit amounts rounded to the nearest cent.) Even without considering manufacturing cost variances, profits will be lower than expected because the revenue increase of $720,000 is nearly offset by the expect ed increase in variable costs of $666,000 ($576,000 manufacturing plus $90,000 nonmanufacturing). The excess of actual over expected costs amount to another $234,800 ($106,800 manufacturing plus $128,000 nonmanufacturing), which gives the net unfavorable profit variance of $180,800 (= $666,000 + $234,800 $720,000). Sales apparently cut prices from $70 to $65 per unit and increased marketing costs in order to sell more units. (The sales department's performance is probably evaluated on the basis of sales revenue.) In response to the increased sales demand, production appears to have incurred increased unit labor and variable overhead costs. In order to control costs, the production manager could have trimmed total fixed costs, since production is probably evaluated as a cost center. The president should coordinate the sales and production activities better so that individual departments' actions are not detrimental to the firm as a whole. In discussing the case, we emphasize that variable costs are best managed on a unit cost basis while fixed costs are best managed on a total cost basis.

10.66 (River Beverages; Performance evaluation) 1. Answers will vary. The performance evaluation process at River Beverages appears to be effective in that managers are proactive in reviewing variance reports several times a month. Over-budget variances are investigated by management monthly, and plant managers are required to submit written reports in response to over- budget problems.

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The fact that specialists are dispatched to plants that are having particularly significant problems is further evidence that management takes this evaluation process seriously. 2. Is this behavior in the best interest of the organization? Rather than reviewing all over- budget amounts, management should review over- budget amounts greater than a specific percentage of the total budget (for example, all overages greater than 5 percent), or greater than a certain dollar amount (for example, all overages over $20,000). This would eliminate having to address insignificant overbudget amounts. Management should consider reviewing all over- and under -budget amounts greater than a specific percentage of the total budget, or greater than a certain dollar amount. It is possible that standards are too tight in certain areas, or that operations have become more efficient. Management should be aware of the reasons for all significant variances from budget both over and under.

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Solutions

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