Topic 2: Strategy and Responsibility Accounting - Profit centre control over both cost and revenue - Analysis of historical

th cost and revenue - Analysis of historical data (past method) - Recurring variances variance occurs repeatedly or only infrequently VOSV = AH(AVR SVR) VOEV = SVR(AH SH)
Goals: profitability; maximising shareholder value; risk; others: organizational - Investment centre control over profits and invested capital - Engineering methods (task analysis) analyse the process of manufacturing a - Trends unfavourable and favourable occur continuously VOSV = AVR (AH x SVR) VOEV = $2(3,300 3,200)
effectiveness; high productivity; good organizational leadership; organizational Controllability is the degree of influence that a manager has over costs, revenues, product to determine what it should cost - Controllability investigate the variance for a cost that is controllable by VOSV = $6,740 (3,300 x $2) VOEV = $200, unfavourable because
reputation, etc. or related items for which he is being held responsible. The segregation of - In practice, both historical cost analysis and engineering method may be used in organization, such as direct labour, efficiency variance or direct-material, VOSV = $6,740 $6,600 AH>SH
Strategy is the means by which an organization plans to achieve its objectives. controllable and non-controllable costs in a responsibility accounting system is combination quantity variance VOSV = $140, U because AVR>SVR
Strategy formulation involves managers analysing the external environment and important for performance evaluation. - Participation in setting standards: standards should not be set by accountants - Favourable variance **The $140 unfavourable spending variance and the $200 unfavourable efficiency
the internal resources of the organisation to formulate potential courses of action. Topic 3: Budgeting alone; any manager who plays an integral part in an operation or process should - Costs and benefits of investigation investigation favourable variance provides variance result in a $340 unfavourable flexible budget variance.
Firms strategies Budgeting is a process of planning the activities of the organizations participate in setting standards for that area management to learn about the improvement method Fixed overhead variances
Fit internal competencies with external opportunities responsibility centres for the next period, usually the next year. There are two types of standards, which are perfection standards that reflect on Qs. Calculate standard cost with direct material Actual Fixed Overhead Fixed Overhead Budget Fixed Overhead
Opportunities and threats: Strength and weaknesses: Budget is equal to profit plan equal to a detailed plan expressed in quantitative, the minimum attainable costs under nearly perfect operation conditions, and Hanson Inc. has the following direct material standard to manufacture one Zippy: Incurred Applied
Identify opportunities Identify core competencies usually/mostly in monetary terms, covering specific period of time, usually one practical standards that reflects on the minimum attainable costs under normal 1.5 kg per Zippy at $4.00 per kg. Last week 1,700 kg of material were purchased
SH x PFOHR
External analysis: Competitor, Internal analysis: Technology, year. operating conditions, with allowances made for downtime and wastage. and used to make 1,000 Zippies. The material cost a total of $6,630.
Budget Variance Volume Variance
customer, supplier, regulatory and manufacturing, marketing, distribution It is prepared along responsibility accounting lines. Managers of departments Benchmarking of costs may involve identifying companies that have the best-cost DMPV = AQ(AP SP) DMQV = SP(AQ SQ)
PFOHR = Predetermined fixed overhead rate
social/ political and logistics develop their own budget estimates for cost, revenue or profits for their areas and performance, assessing their level of costs, and identifying the cost performance DMPV = 1,700[($6,630/1,700) $4] DMQV = $4[1,700 (1.5 x 1,000)]
SH = Standard hours allowed
are held responsible for meeting those budget targets. gap that needs to be closed. DMPV = 1,700($3.90 $4) DMQV = $4(1,700 1,500)
Level of strategies FO budget variance = Actual FO incurred Fixed overhead budget
A budget should help the organization achieve its strategic goals and objectives by Cost standards may be formulated to achieve external performance standards over DMPV = $170, favourable AP<SP DMQV = $800, unfavourable AQ>SQ
Corporate strategies for the whole organization FO volume variance = Fixed overhead budget Fixed overhead applied
utilizing the organizations strengths and taking full advantage of it opportunities the medium to long-term. Qs. Calculate standard cost with direct material when the materials are used
Business strategies for business units within the organization
as well as ensuring that projects and initiatives that are crucial to achieving results Cost variance Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 kg Fixed Overhead (FO)
Strategic choices are different at different hierarchical levels; there is a need for Recall that FO costs are applied to products and services using a PFOHR:
are adequately funded. If the actual > standard, the variance is unfavourable, whereas if the actual < per Zippy at $4.00 per kg. Last week 2,800 kg of material were purchased at a total
consistency in strategies across business and corporate levels.
Strategic use of budgets standard, the variance is favourable. cost of $10,920 and 1,700 kg were used to make 1,000 Zippies. Fixed overhead applied = PFOHR x Standard hours
In formulating an organizations strategy, the following decisions must be made: !"#$%&%# !"#$% !"#$%#&'
- Depends on the strategic position of the responsibility centres. Question: I see that there is an unfavourable variance. But why are variances DMPV = PQ(AP SP) DMQV = SP(AQ SQ) PFOHR = !"#$$%& !"#$%$#& !" !"#$%
What business will we operate in? How should we compete in that business?
- Less reliance on meeting the budget in responsibility centres in build strategic important to me? First, they point to causes of problems and directions for DMPV = 2,800[($6,630/1,700) $4] DMQV = $4[1,700 (1.5 x 1,000)]
What systems and structures should we have in place to support our business Ex. ColaCo used the following predetermined fixed overhead rate:
position. improvement. Second, they trigger investigations in departments having DMPV = 2,800($3.90 $4) DMQV = $4(1,700 1,500) !"#$%&%# !"#$% !"#$%#&' $",!!!
strategy? PFOHR = = = $3.00 per machine hour
- Knowledge of managers in responsibility centres in harvest strategic position responsibility for incurring the costs. DMPV = $280, favourable AP<SP DMQV = $800, unfavourable AQ>SQ !"#$$%& !"#$%$#& !" !"#$% !,!!! !"#$%&' !"#$%
Corporate strategy:
less important. Cost variance analysis Lecture illustration: Variance I Qs. Compute the fixed overhead budget variance and volume variance
- Where will we compete? instead of how will we compete?
Functions of Budgets There are two types of standard cost variances that are price variance, which is the Gandolph Game Company has established the following standards for the prime ColaCos actual production required 3,200 standard machine hours. Actual fixed
- What business will we operate in?
- Planning difference between the actual price and the standard price and quantity variance, costs of one unit of its chief products, dartboards. overhead was $8,450. Budgeted fixed overhead was $9,000. The POHR, calculated
- Issues dealt with are: 1) Definition of businesses in which firm will participate.
- Forecasts which is the difference between the actual quantity and the standard quantity. Standard Cost Standard Quantity Standard price/rate earlier is $3.00.
2) Deployment of resources among those businesses.
- Facilitating communication and coordination across the organization. A general model for variance analysis Direct material $14.00 8 kilograms $1.75 per kilogram Actual Fixed Overhead Fixed Overhead Budget Fixed Overhead
It concerned with: the types of businesses in which the company as a whole
- Allocating resources Actual Quantity Actual Quantity Standard Quantity Direct labour $2.00 0.25 hours $8.00 per hour Incurred Applied
operates; decisions about which businesses to emphasise or de-emphasis; decisions
- Consider alternative uses of limited resources X X X 3,200 hours x $3 per
about what businesses to invest or acquire; and how to best structure and finance Total $16.00
- Controlling profit and operations Actual Price Standard Price Standard Price hour
the company. During September, they purchased 320,000 kilograms of direct material at a total
- Comparison of budget and actual financial result Price variance Quantity Variance $8,450 $9,000 $9,600
It can be classified into three categories: cost of $608,000. The total wages for September were $84,000, 90% of which were
- Evaluating performance and providing incentive Standard price is the amount that should have been paid for the recourses required.
- Single industry firm uses core competencies to pursue growth within that for direct labour. They manufactured 38,000 dartboards during September, using Budget variance Volume variance
- Motivational tools Standard quantity is the quantity allowed for the actual good output.
industry 285,000 kilograms of direct material and 10,000 direct labour hours. $550 favourable $600 favourable
Managerial use of budgetary information AQ(AP SP) or PQ(AP SP) SP(AQ SQ)
- Related industry firm firms that operate in a number of industries and their Compute the following variances for Sept., & indicate whether each is F or U. Budget variance results from paying more or less than expected for overhead items.
Budgets serve multiple and conflicting purposes. AQ = Actual Quantity SP = Standard price
businesses are connected to each other through operating synergies 1. DMPV = PQ(AP SP) Volume variance results from the inability to operate at the activity level planned
Problem arises because of how managers use the information provided by the AP = Actual Price SQ = Standard quantity
- Unrelated diversified firm firms that operate in a number of industries and DMPV = (PQ x AP) (PQ x SP) for the period. It has no significance for cost control.
budget system and how the effects of such use feedback on the information that is Based on quantity purchased not the Based on quantity of material used in
their businesses do not share common core competencies or resources DMPV = $608,000 (320,000 x $1.75) Lecture illustration: Variance II
entered into the budget. Commonly, conflict arises when budgets are used as: quantity actually used in production. production.
Business strategy DMPV = $608,000 $560,000 Qs 1. The childrens hospital
forecasts; targets; and standard for performance evaluation.
- How should we compete in that business? **PQ is used when inventory is purchased, whereas AQ is used when the inventory DMPV = $48,000, unfavourable because AP>SP The financial controller for the Childrens Hospital estimates that the hospital uses
Budget as forecast
- Also called competitive strategy purchased stock is still being used. 2. DMQV = SP(AQ SQ) 25 kilowatt-hours of electricity per patient-day, and that the electric rate will be
- Predicting most likely outcome rather than expected outcome
- Deals with how to create and maintain competitive advantage in each of the Reasons for material variances DMQV = $1.75[285,000 (8kg x 38,000)] $0.13 per kilowatt-hour. The hospital also pays a fixed monthly charge of $2,000 to
- Past performance used as a basis of setting future targets
industries that the company has chosen to participate. Price variance: DMQV = $498,750 $532,000 the electric utility to rent emergency backup electric generators.
- Issues of budgetary slack
- Competition in diversified firms occurs at the business unit level. - Scheduling DMQV = $33,250, favourable because AQ<SQ Required: Construct a flexible budget for the hospitals electricity costs using each
- Optimistic targets to motivate but need accurate estimates for planning < need
It depends on: its mission (what are its overall objectives?); its competitive - Inflation the rise in the general price level may increase the input costs of the 3. DLRV = AH(AR SR) of the following techniques.
to ensure budget process fits different situations. For ex., corporate planning
advantage (how should the business unit compete in its industry to accomplish its vendor and as a result vendor may increase the price of the materials. The rise DLRV = (AH x AR) (AH x SR) 1. Formula flexible-budget
should use forecasting models unrelated to budgets.
mission?). in price is very common reason of an unfavorable variance. DLRV = ($84,000 x 90%) (10,000 x $8) y = total costs; a = fixed costs; b = variable costs; x = patient-days
Budget as targets
Business unit mission - Negotiation skills to negotiate the price better than other is favourable DLRV = $75,600 $80,000 y = a + bx
- Budget standard is the target to aim for
Boston Consulting Group identified four business unit strategies, which will be whereas if you have no negotiation skills are unfavourable. DLRV = $4,400, favourable because AR<SR y = $2,000 + [($0.13 x 25 kilowatt) x number of patient-days]
- Defined, quantitative targets lead to better performance than no target or do
determined by the BUs mission: - Quality of materials a favourable price variance may be the result of 4. DLEV = SR(AH SH) y = $2,000 + ($3.25 x number of patient-days
your best.
- Build increase market shares purchasing low quality materials and an unfavorable variance may be the result DLEV = $8(10,000 (0.25 x 38,000) 2. Columnar flexible budget for 30,000, 40,000 and 50,000 patient-days of
- Needs to be challenging attainable vs. unattainable goals
- Hold protect the market shares/competitive advantage of purchasing high quality materials. DLEV = $80,000 $76,000 activity. List variable and fixed electricity costs separately.
- Managers need to be involved in setting the targets (goal acceptance)
- Harvest maximize the short term return/earnings - Order quantity some suppliers allow discount on large orders. The materials DLEV = $4,000, unfavourable because AH>SH Number of patient days 30,000 40,000 50,000
- Senior managers attitude towards adverse variance is important.
- Divest withdraw the business/ close down to open another purchased in large quantities may reduce the unit price and a favorable price Topic 5: Variance II Variable electricity costs 97,500 130,000 162,500
- Motivating budgets are no good for planning
Generic competitive advantage variance may occur. Flexible budgets: Static budgets are prepared for a single, planned level of activity. Fixed electricity costs 2,000 2,000 2,000
Budgets as standards for performance evaluation
2 types of competitive advantage: low cost and differentiation. Using skilful purchasing practices, an expert purchasing manager can obtain the The performance evaluation for overhead is difficult when actual activity differs Total overhead costs 99,500 132,000 164,500
- Rewards linked directly with budget achievement
Low cost best prices for purchased goods and services. To achieve this goal, the purchasing from the planned level of activity. Qs 2. The Supply Company
- Getting managers to achieve targets are not difficult getting managers
- Providing goods or services at the lowest cost while providing acceptable manager may buy materials in large quantities to gain discounts, negotiate purchase Advantages of flexible budgets: The Supply Company uses a standard costing system. The firm estimates that it will
achieving it the right way is!
features. contracts, compare prices among suppliers and use global sourcing. - Show revenues and expenses that should have occurred at the actual level of operate its manufacturing facilities at 600,000 machine hours for the year. The
- Behaviour is difficult to specify and reward
- Economies of scale, tight cost control, cost minimisation. Quantity variance: activity. estimate for total budgeted overhead is $1,500,000. The standard variable-overhead
- Therefore, reward performance. If rewarding performance, then budget
- Minimal expenditure in R&D, marketing and overhead. - Worker training a favourable material variance include training and - May be prepared for any activity level in the relevant range rate is estimated to be $2 per machine hour or 6 per unit. The actual data for the
standard comes under pressure (slack), accounting information may be
- Serves as an entry barrier to potential competitors development of workforce to improve productivity and an unfavourable - Reveal variances due to good cost control or lack of cost control year are presented below:
manipulated (fraud) and actual performance may be manipulated (undesirable
Differentiator variance is the use inexperienced or untrained workers are unfavourable - Improve performance evaluation Actual finished units 187,500
methods).
- Providing non-standardised goods or services to customers with unique needs, - Machinery maintenance the use of advanced and maintained machinery is Choices of activity measure: Actual machine hours 573,000
Behavioural issues in budgeting
usually at a premium price. favourable whereas the use of out-dated machinery is unfavourable - Variable overhead and the activity measure should vary in a similar pattern. Actual variable overhead $1,275,750
A budget affects virtually all staff in an organization: those who prepare the
- Examples: - Quality of material purchase of materials of higher quality than the standard - Identify variable overhead cost drives. Ex, machine hours, labour hours, Actual fixed overhead $294,000
budget, those who use the budget for decision-making and those whose
- Design: Porsche motorcars is favourable whereas purchase of materials of lower quality than the standard process time Compute the following variances. Indicate whether each is favourable or
performance is evaluated using the budget. There are three main behavioural
- Technology: Apple Mac is unfavourable. - Dollar measures should be avoided as they are subject to price-level changes unfavourable, where appropriate.
issues, which are budget participation, budgetary slack and budget difficulty.
- Image: Dick Smith Food delivers the promise as Australian as you can get Skilful supervision of production employees, coupled with the careful use and Preparing a flexible budget 1. Variable-overhead spending variance = Actual Variable OH (SVR x AH)
Participative budgeting: Top-down/authoritative budgeting where senior
against rival Australian, but US owned Kraft Company. handling of materials, contribution to minimal waste. Using a low-grade material To flex a budget for different activity levels, we must know how costs behave with = $1,275,750 ($2 x 573,000)
managers impose budget targets on more junior managers. Bottom-
- Key: customers should be willing to pay for perceived value added. may result in greater waste than using high-grade material. changes in activity levels. = $1,275,750 $1,146,000
up/participative budgeting where people at the lower managerial and operations
To determine which to develop we use: industry analysis; value chain analysis. Reasons for labour variances - Total variable costs change in direct proportion to changes in activity. = $129,750 Unfavourable
levels play an active part in setting their own budgets.
Industry analysis Rate variance the difference between actual rate and standard rate - Total fixed costs remains unchanged within the relevant range. 2. Variable-overhead efficiency variance = SVR(AH SH)
Participative budgeting may encourage coordination and communication between
- Industry conditions: firm performance - Work assignment The formula for flexible budget is: y = a + bx, where y = total cost, a = fixed = $2[573,000 ($3 x 187,500)]
managers and a greater understanding and appreciation of the wider organization;
- Porter five forces: 1) threat of new entrant, 2) bargaining power of customers, - Inflation cost, b = variable cost and x = unit level cost drive (no. of machine hours). = $2(573,000 562,500)
lead to more accurate budget estimates as those close to the operations have the
3) bargaining power of supplier, 4) threat of substitutes and 5) intensity of - Wage rate changes Total budgeted overhead cost = (Budgeted variable overhead cost per activity = $21,000 Unfavourable
best knowledge of the likely sales or costs in their area; can lead to individual
rivalry among existing competitors. DLRV usually result from using a mix of employees that is different from the mix unit x Total activity units) + Budgeted fixed overhead cost **Recall that SH is defined as the standard allowed for actual output. Since one
identifying more closely with the budget targets. Disadvantages: expensive and
Value chain analysis anticipated when the standards were set. Wage rate is differ among employees Indirect labour and indirect material have unfavourable variances because actual unit requires $6, then the standard allow is 3 hours ($6/$2)
time consuming; can lead to delays; may aggravate differences and disagreements;
Start Securing raw materials Research & Product design according to the their different skills. Using employees who are more highly skilled costs are more than the flexible budget cost, whereas power has a favourable 3. Fixed-overhead budget variance = Actual fixed OH Budgeted fixed OH
provides opportunities for padding the budgets (budget slack); conflict between
and other resources Development than a task requires can result in unfavourable DLRV. variance because the actual cost is less than the flexible budget cost. = $294,000 [$1,500,000 ($2 x 600,000)]
interdepartmental.
Customer Distribution Marketing Production Efficiency variance the difference between actual hours and standard hours Variable overhead variances = $294,000 $300,000
Budget slack is the difference between the estimated revenue or cost projections,
service - Worker training The variable overhead flexible-budget variance measures the difference between = $6,000 Favourable
and a realistic estimate of the revenue cost by underestimating the revenue or
Centralization vs. Decentralization - Supervision actual variable overhead cost and the flexible-budget variable overhead cost. Total budgeted OH = Total budgeted fixed OH + Total budgeted variable OH
overestimating the cost.
In centralized organization, decisions are handed down from the top echelon of - Quality of materials There are two types of variable overhead flexible budget variance: Therefore, budgeted FOH = Total OH Variable OH
Reasons for budgetary slack: performance can look better if you can beat the
management and subordinates carry them out, whereas in decentralization - Machinery maintenance Spending variance the difference between actual amount of variable overhead 4. Fixed-overhead volume variance = Budgeted Fixed OH Applied Fixed OH
budget; a way of coping with uncertainty; to insulate against initial budget requests
organization, decisions are made at divisional and departmental levels. Creating a work environment encourages employees to work towards production incurred and the budgeted amount allowed for the actually quantity of the overhead = $300,000 $281,250
being cut back by management. Undesirable results: waste of resources; employees
Benefits and costs of a decentralized organization goals. Through designing effective work schedules the efficiency of employees can allocation base used for the actual output units produced. Spending variance results = $18,750 Unfavourable
do not try as hard to meet or exceed the budget.
Benefits Costs be maximised. This is because if the employees are not well trained, they tend to from paying more or less than expected for overhead items and from excessive or Applied Fixed OH = SH x Fixed OH rate
Budget difficulty
spend more hours than the hours estimated. under usage of overhead items. Fixed OH rate = $300,000/ 600,000 = $0.50
Delegating = Time Relief Lack of big picture view Budget acceptance is more likely when targets are developed with employees
Responsibility for variances Efficiency variance measures the efficiency with which the cost-allocation base Therefore, applied fixed OH = $0.50 x (3hrs x 187,500) = $281,250
Empowering Employees = Lack of coordination participation, targets are considered achievable, there is frequent feedback on
The production manager is responsible for the direct-material quantity variance, is used. Results from using more or less activity measure than the standard quantity Revision question
Knowledge & expertise performance, employees are held responsible for activities that are within their
direct-labour rate variance and direct-labour efficiency variance. The purchasing given actual output. It does not reflect overhead control. Qs 1. Glitzy Company produces several products in its factory, including a
Delegating = Timely responses to Narrow focus control and achievement of targets is accompanied by rewards that are valued.
manager is responsible for the direct-material price variance. AH = Actual Hours of Activity; AR = Actual Variable Overhead Rate; wedding gown. The company uses a standard costing system to assist in the control
Opportunities & Problems Budgets must be set at a level that provides challenge and stretch, but not
Behavioural impact of standard costing SVR = Standard Variable Overhead Rate; SH = Standard Hours Allowed of costs. According to the standards that have been set for wedding gowns, the
Decision Making Autonomy = Transferring of knowledge difficult attainable.
Standard costing can be used to evaluate the performance of employees and Actual Variable Flexible Budget for Flexible Budget for factory should work 780 direct-labour hours each moth and produce 1,950 gowns.
Managerial Training Topic 4: Variance 1
departments. Comparing individuals performance with standards or budgets is Overhead incurred Variable Overhead at Variable Overhead at The standard costs associated with this level of production activity are as follows:
Decision Making Autonomy = Standard costs are based on carefully predetermined amounts. It is used for
used to determine salary increases, bonuses and promotions. These can profoundly Actual Hours Standard Hours Total Per unit of product
Greater Motivation planning labour and material requirements. It is the expected level of performance.
influence behaviour. AH x AR AH x SVR SH x SVR Direct materials $35,490 $18.20
Its purpose is to use benchmarks for measuring performance, by comparing the
Responsibility accounting refers to the concepts used to measure the performance Cost control through assigning responsibility Spending Variance = Efficiency Variance = Direct labour $7,020 $3.60
actual with the estimated performance.
of people and departments in order to foster goal congruence. The basis of a It is important that managers held responsible for achieving certain cost standards Variable Manufacturing Overhead (DLH) $2,340 $1.20
Standard performance level Actual performance level AH(AVR SVR) SVR(AH SH)
responsibility accounting system is the designation of each subunit in the where they can control these outcomes and are involved in setting the standards. $23.00
Comparison between standard and actual performance level Qs. Calculate the variable overhead spending variance and efficiency variance
organization as a particular type of responsibility centre. Interactions between variances may make it difficult to assign responsibility for During June, the factory worked only 760 direct-labour hours and produced 2,000
Cost variance CocolaCos actual production for the period required 3,200 standard machine
A responsibility centre is a subunit in an organization whose manager is held particular variances. wedding gowns. The following actual costs were recorded during the month:
hours. Actual variable overhead incurred for the period was $6,740. Actual
accountable for specified results. There are 4 types of responsibility centres: Managers focus on quantities and costs that exceed standards, a practice known as Significance of cost variances Total Per unit of product
management by exception. machine hours worked were 3,300. CocaCos variable overhead rate is $2 per
- Cost centre control over the incurrence of cost To determine the variances for investigation: Direct materials (6,000 yards) $36,00 $18.00
Setting standards machine hour. Compute the variable overhead spending and efficiency variance.
- Revenue centre responsible for the revenue of a unit - Size of variance dollar amount/ percentage of standard Direct labour $7,600 $3.80
A variety of methods may be used to set cost standards, which are: