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Performance Management
Performance Management
This section is 25% of the Part 1 Exam
The main topics within Section B are:
Variance Analysis
Variance analysis is the comparison between the
actual results for the period and the budgeted
results.
Variance analysis is an attempt to determine why
the actual results were different from the budgeted
results.
Either the quantity sold (or purchased), or the price
received (or paid), was different than expected, or both.
Standard Costs
A standard cost is an estimate of the cost the
company expects to incur in the production
process. It is the standard against which to
measure the actual performance.
Standard costs are calculated at the beginning of
each year and are based on the estimated costs
and the expected level of activity or production.
Standard costs are determined through the use of
accounting and production estimates.
Standard costs are used to control costs. A large
variance between actual cost and standard cost is
an alert to management.
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Sources of Standards
Standards can be set using several sources:
Activity analysis:
Identifying, delineating or outlining, and evaluating all the
activities necessary to complete a job, a project or an operation
Considers everything required to complete the task efficiently and
involves personnel from several areas including engineers,
management accountants and production workers
Time consuming and expensive.
If properly executed, it is the most precise way to determine
standard costs.
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Strategic decisions:
Strategic decisions may affect a products standard cost. For
instance, a decision to replace an obsolete machine with a new,
computer-controlled machine would require an adjustment to the
standard cost for the process.
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Management by Exception
Variance reporting enables management by
exception which permits management to focus on
areas where there are problems, as identified by
the variance from the standard.
Disadvantages of management by exception:
Negative trends may be overlooked at earlier stages,
before they show up as variances.
If too many deviations from the standards occur, it
becomes a very confusing and involved process because
management is trying to fix all of the problems at once.
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Types of Variances
Manufacturing Input Variances
Direct Materials Variances
Price Variance
Quantity or Efficiency Variance
Mix Variance
Yield Variance
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Sales Variances
Sales Price Variance
Sales Volume Variance
Quantity Variance
Mix Variance
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Variance Abbreviations
The formulas for the different variances all have
common elements to them. The following
abbreviations are used:
AQ Actual Quantity
SQ Standard Quantity for the actual level of output
AP Actual Price
SP Standard Price
WASPAM The weighted average standard price of the
actual mix
WASPSM The weighted average standard price of the
standard mix
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$603,000
540,000 1
$ 63,000 U
50
$603,000
675,000 1
$ (72,000) F
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$(72,000) F
135,000 U
$ 63,000 U
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$1,200,000
1
900,000
$ 300,000 U
1$2.50/MH
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$1,200,000
1,000,000
$ 200,000 U
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$1,000,000
900,000
$ 100,000 U
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$200,000 U
100,000 U
$300,000 U
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Efficiency
Variance
$135,000 U
Spending
Variance
($72,000) F
Prod.-Volume
Variance
$100,000 U
Prod.-Volume
Variance
$100,000 U
$128,000 U
Controllable Variance
$263,000 U
2010 CMA Part 1 Section B Performance Management
Prod.-Volume
Variance
$100,000 U
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Total Variances
$603,000
540,000
$ 63,000
Fixed
Total
$1,200,000 $1,803,000
1,000,000
1,540,000
$ 200,000 $ 263,000
1Note:
For fixed overhead, the flexible budget and the static budget
amounts are the same, because fixed overhead does not change with
changing activity levels.
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Sales Variances
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Sales Variances
Variance analysis can be used to assess the selling
department as well as the production department.
Sales variances are used to explain the differences
between actual and budgeted amounts of revenue,
variable costs, and contribution margin caused
by differences between actual sales results and
planned or budgeted sales results.
These variances can be caused by differences in
sales prices charged, differences in sales volume,
differences in variable cost per unit, and by
differences in the mix of products sold.
They are called Sales Variances to differentiate
them from manufacturing input variances.
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(AQ SQ) SP
The detail by product for this variance tells us the effect
on income and expense of the differences between the
actual units sold and budgeted amounts for each
product. The sum is the net effect.
The total Sales Price Variance and the total Sales
Volume Variance together make up the total Static
Budget Variance.
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Market Variances
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Market Variances
The Sales Quantity Variance can also be analyzed
as to why it occurred.
The difference between actual and expected sales
units may be connected to two potential areas
related to the market.
1. The actual market was bigger or smaller than was
expected,
2. The companys market share was bigger or smaller
than expected.
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Standard Weighted
Average Contribution
Margin per Unit
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Standard Weighted
Average Contribution
Margin per Unit
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Contd
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Contd
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Responsibility Centers
A responsibility center is any part of an organization. It may be a product line, a geographical area,
or any other meaningful unit.
The main classifications of centers, from the most
fundamental (basic) to the least fundamental, are:
A cost center is responsible only for the incurrence of
costs (any revenue it may earn is immaterial).
Cost centers are measured on their efficiency (obtaining
the most with the least use of resources).
Training and maintenance are examples of cost centers.
A service center is a type of cost center that provides
services to other departments.
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Contribution Margin
Manufacturing contribution margin
Variable nonmanufacturing costs
= Contribution margin
This is the amount that is available to cover fixed
costs after all variable costs are covered, and leave
some for profit.
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Controllable Margin
This is also called short-term segment manager
performance.
Contribution margin
Controllable fixed costs
= Controllable margin
Controllable fixed costs are the costs the segment
manager can control.
This is important because it is a measurement of all the
revenues and expenses (variable and fixed) that are
controllable by the individual managers on a short-term
(less than one year) basis.
The controllable margin is a good measure of a
managers short-term performance.
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Segment Margin
This is also called contribution by strategic business
unit.
Controllable margin
Noncontrollable, traceable fixed costs
= Segment Margin
Noncontrollable, traceable fixed costs are costs the
segment manager cannot control over the short term,
such as depreciation, but they can be traced to that
department.
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Net Income
Segment margin
Noncontrollable, untraceable fixed costs
= Net income
Noncontrollable, untraceable fixed costs are the
costs that are incurred at the company level and
would continue even if the individual segment were
discontinued.
Because they would continue if any individual segment
was discontinued, these costs should not be allocated
to the individual departments or segments.
Rather, they are subtracted from the sum of the
segment margins to calculate the companys net
income.
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Transfer Pricing
The transfer price is the price charged by one unit of
the company to another unit of the same company
for the services or goods produced by the first unit
and sold to the second unit.
Profit and investment centers use transfer pricing
to calculate the costs of services received from
service departments and revenues when selling a
product that has an outside market to another
department.
Transfer pricing is most common in firms that are
vertically integrated, i.e., they are engaged in several
different value-creating operations for a product.
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Performance Measures
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Performance Measures
Performance needs to be measured and rewarded
in a way that motivates managers to achieve the
companys strategic objectives and operational
goals.
Goal congruence Individuals and organization
segments are all working toward achieving the
organizations goals. Managers should be evaluated on
their achievement of goals that benefit the company, not
on their achievement of goals that benefit their own
department or division.
Short-term versus long-term focus Emphasis on
short-term profits endangers long-term success because
managers will eliminate or postpone activities that are
vital for the firms long-term success.
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Performance Measurement
In addition to the contribution income statement,
there are other tools for financial and performance
measurement that you need to be familiar with:
Return on Investment (ROI), and
Residual Income (RI).
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Return on Investment
ROI is the key performance measure for an
investment center.
It provides the measure of the percentage of return
that was provided on the dollar amount of the
investment (i.e., assets).
The formula is:
Net income of the Investment Center
Average Total Assets (Investment Base) of the Investment Center
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Residual Income
Residual Income provides a $ based measure
instead of a % measure. It measures the amount of
income the company achieved in excess of a
determined target income.
Two terms that are involved in RI are:
The targeted amount of return is usually some
percentage of the total assets of the division or the
invested capital in the division, and
The percentage used in the calculation is the target
rate that management has set.
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