ACCT Test 3
Standard Quantity/Hours Allowed
(when computing Direct Material/DL and VOH variances) refers to the amount of an input that should have been used to manufacture the actual output of finished goods produced during the period. Computed by multiplying the actual output by the standard quantity per unit. Standard quantity allowed is then multiplied by the standard price per unit of the input to obtain the total cost according to the flexible budget
3 common approaches used to set transfer prices
1. Allow the managers involved in the transfer to negotiate the transfer price 2. set transferred prices at cost using either variable cost or full (absorption cost) 3. set transfer prices at the market price
Disadvantages of Decentralization
1. Lower level managers may make decisions without fully understanding the company's overall strategy 2. If lower level managers make their own decisions independently of each other, coordination may be lacking 3. Lower level managers may have objectives that clash with the objectives of the entire organization. 4. Spreading innovative ideas may be difficult in a decentralized organization.
Advantages of Decentralization
1. by delegating day to day problem solving to lower level managers, top manage,net can concentrate on bigger issues 2. Empowering lower level managers to make decisions puts the decision making authority in the hands of those who tend to have the most detailed and up to ate information about day to day operations. 3. By eliminating layers of decision making and approvals, organizations can respond more quickly to customers and to changes in the operating environment 4. Granting decision making authority helps train lower level managers for higher level positions 5. Empowering lower-level managers to make decisions can increase their motivation and job satisfaction
Performance measures of balanced scorecard
1. financial-> "has our financial performance improved?" 2. customer -> "do customers recognize that we are delivering more value?" 3. Internal business processes-> "have we improved key business processes so that we can deliver more value to customers?" 4. learning and growth -> "are we maintaining our ability to change and improve?"
Procedure to strengthen chain
1. identify the weakest link, the constraint. 2. Do not place a greater strain on the system than the weakest link can handle. if you do, the chain will break. 3. concentrate improvement efforts on strengthening the weakest link. 4. if the improvement efforts are successful, eventually the weakest link will improve to the point where it is no longer the weakest link
Why isolate relevant costs?
1. only rarely will enough info be available to prepare a detailed income statement for both alternatives. 2. mingling irrelevant costs with relevant costs may cause a confusion and distract attention from the information that is real critical. The danger always exists that an irrelevant piece of data may be used improperly resulting in an incorrect decision.
Advantages od negotiated transfer price
1. preserves the autonomy of the divisions and is consistent with the spirit of decentralization. 2. the managers of the divisions are limey to have much better information about the potential costs and benefits of the transfer than others in the company.
Things we can predict
1. the selling division will agree to the transfer only if it's profits increase as a result of the transfer 2. the buying division will agree to transfer only if it's profits also increase as a result of the transfer. If transfer price is below the selling division cost, selling division incurs a loss on the transaction (will refuse it) If transfer prie is set too high it will be impossible for the buying division to make any profit on the transferred item
Criticisms of ROI
1.managers may increase ROI in a way that is inconsistent with the company's strategy; or they may take actions that increase ROI in the short run but harm the company in the long run. 2. a manager who takes over a business inherits many committed costs over which the manager has no control. these costs may be relevant in assessing the performance of the business segment as an investment but they make it difficult to fairly assess the performance of the manager 3. manager evaluated based on ROI may reject investment opportunities that are profitable for the whole company but would have a negative impact on the manager's performance evaluation
Volume Variance
=Budgeted Fixed overhead - Fixed overhead applied to WIP (POHR x standard hours) Budgeted > FOH = unfavorable Bugeted < FOH = favorable =Fixed component of POHR x (Denominator hours - Standard hours allowed for the actual output) Denominator hours > standard hours for actual output = unfavorable (if actual level of activity is less than expected) Denominator hours < standard hours for actual output = favorable (if actual level of activity is greater than expected) viewed as a measure of the utilization of facilities - standard hours > denominator hours = efficient use of facilities -standard hours < denominator hours = insufficient use of facilities
Which of the following scenarios demonstrates the leverage effect on net operating income due to the existence of fixed costs?
A 25% increase in sales resulting in a 30% increase in net operating income. The percentage of increase in net operating income is ordinarily larger than the percentage of increase in activity. This is a result of the existence of fixed costs, which cause a leverage effect.
What is a revenue variance and what does it mean?
A revenue variance is the difference between the actual revenue for the period and how much the revenue should have been, given the actual level of activity. A revenue variance is easy to interpret. A favorable revenue variance occurs because the revenue is greater than expected for the actual level of activity. An unfavorable revenue variance occurs because the revenue is less than expected for the actual level of activity.
What is a spending variance and what does it mean?
A spending variance is the difference between the actual amount of the cost and how much a cost should have been, given the actual level of activity. Like the revenue variance, the interpretation of a spending variance is straight-forward. A favorable spending variance occurs because the cost is lower than expected for the actual level of activity. An unfavorable spending variance occurs because the cost is higher than expected for the actual level of activity.
Paradise Company's planning budget for 10,000 units showed sales of $500,000. The flexible budget for 12,000 units showed sales of $600,000. What is the variance of $100,000 called if this variance was due only to an increase in unit sales?
Activity variance Variances caused solely because of the differences in the level of activity are called activity variances.
Standard Quantity Allowed for Actual Output
Actual Output x Standard Quantity
What is an activity variance and what does it mean?
An activity variance is the difference between a revenue or cost item in the flexible budget and the same item in the static planning budget. An activity variance is due solely to the difference in the actual level of activity used in the flexible budget and the level of activity assumed in the planning budget. Caution should be exercised in interpreting an activity variance. The "favorable" and "unfavorable" labels are perhaps misleading for activity variances that involve costs. A "favorable" activity variance for a cost occurs because the cost has some variable component and the actual level of activity is less than the planned level of activity. An "unfavorable" activity variance for a cost occurs because the cost has some variable component and the actual level of activity is greater than the planned level of activity.
Leverage effect
Because of fixed costs, NOI does not change in proportion to changes in the level of activity. The % changes in NOI are ordinarily larger than the percentage increase in activity
Budget Solutions has determined from its flexible budget that selling costs for actual level activity for a period should have been $25,000. Actual selling costs incurred during the period were $28,000. What is the amount and direction of variance in selling costs?
Budget Solutions has determined from its flexible budget that selling costs for actual level activity for a period should have been $25,000. Actual selling costs incurred during the period were $28,000. What is the amount and direction of variance in selling costs? your answer: $0 correct answer: $3,000 Unfavorable feedback:
Fixed Cost
Cause a leverage effect. consequence of changes in the level of activity fixed costs stay the same
Revenue Variance
Difference between actual revenue and what is should have been is the difference between the actual total revenue and budgeted total revenue at the actual level of activity.
Activity Variances
Difference between flexible budget and planning budget
Predetermined overhead Rate
Estimated total manufacturing overhead cost/ Estimated total amount of the allocation base
When is Revenue variance favorable/unfavorable?
F when the average selling price is greater than expected; U when the avg selling price is less than expected.
A planning budget is prepared to determine the costs that should have been incurred for the actual level of activity during the period.
FALSE
Calculating Rev & Spending Variances
Flexible Budget vs. Actual Budget
Calculating Activity Variances
Flexible Budget vs. Planning Budget
If variable manufacturing overhead is applied to production on the basis of DLH and the direct labor efficiency is unfavorable, will the variable overhead efficiency variance be favorable, unfavorable or could it be either? Explain.
If overhead is applied on the basis of direct labor-hours, then the variable overhead efficiency variance and the direct labor efficiency variance will always be favorable or unfavorable together. Both variances are computed by comparing the number of direct labor-hours actually worked to the standard hours allowed. That is, in each case the formula is: Efficiency variance = SR(AH - SH) Only the "SR" part of the formula, the standard rate, differs between the two variances.
What effect, if any, would you expect poor-quality materials to have on direct labor variances?
If poor quality materials create production problems, a result could be excessive labor time and therefore an unfavorable labor efficiency variance. Poor quality materials would not ordinarily affect the labor rate variance.
What does a flexible budget performance report do that a simple comparison of budgeted to actual results does not do?
In a flexible budget performance report, the actual results are not directly compared to the static planning budget. The flexible budget is interposed between the actual results and the static planning budget. The differences between the flexible budget and the static planning budget are activity variances. The differences between the actual results and the flexible budget are the revenue and spending variances. The flexible budget performance report cleanly separates the differences between the actual results and the static planning budget that are due to changes in activity (the activity variances) from the differences that are due to changes in prices and the effectiveness with which resources are managed (the revenue and spending variances).
Sell or process further decisions
It is profitable to continue processing a joint product after the split off point so long as the incremental revenue from such processing exceeds the incremental processing cost incurred after the split off point.
Margin
Margin is ordinarily improved by increasing selling prices, reducing operating expenses, or increasing unit sales. --> increasing SP increases NOI and therefore margin. --> increases unit sales
Khan Corporation has budgeted the unit sales for April to be 5,000 units. The sales price is $25 per unit, and production costs are $10 per unit. Monthly utility expenses are estimated to be $2,000 plus $2 per unit, whereas selling expenses are estimated to be $12,000. The company pays a monthly rent of $2,000. What is the net operating income in the company's planning budget?
Net operating income on the planning budget for 5,000 units would be $49,000. $49,000 = $13 contribution margin × 5,000 units - fixed expenses of $16,000.
Overhead applied
Overhead applied= POHR x standard hours allowed for the actual output overhead is applied to WIP on the basis of the standard hours allowed for the actual output of the period rather than on the basis of the actual number of hours worked
Variance Analysis Cycle
Prepare performance chart -> Analyze variances -> Raise Questions -> Identify root causes -> Take actions -> Conduct next period's operations
"Our workers are all under labor contracts; therefore, our labor rate variance is bound to be zero." Discuss.
Several factors other than the contractual rate paid to workers can cause a labor rate variance. For example, skilled workers with high hourly rates of pay can be given duties that require little skill and that call for low hourly rates of pay, resulting in an unfavorable rate variance. Or unskilled or untrained workers can be assigned to tasks that should be filled by more skilled workers with higher rates of pay, resulting in a favorable rate variance. Unfavorable rate variances can also arise from overtime work at premium rates.
Standard cost per unit
Standard Quantity per unit x standard price per unit
Delivery Time Cycle
The amount of time from when a customer order is received to when the completed order is shipped. Important concern to many customers who want this time to be as short as possible. Delivery Cycle Time= Wait Time + Throughput Time
Khan Corporation has budgeted the unit sales for April to be 5,000 units. The sales price is $25 per unit, and production costs are $10 per unit. Monthly utility expenses are estimated to be $2,000 plus $2 per unit, whereas selling expenses are estimated to be $12,000. The company pays a monthly rent of $2,000. What would be the utility expenses on the company's flexible budget if actual unit sales for April were 6,000 units?
The amount of utility expenses on the flexible budget for 6,000 units would be $14,000. $14,000 = $2,000 + ($2 × 6,000 units).
If the materials price variance is favorable but the materials quantity variance is unfavorable. what might this indicate?
This combination of variances may indicate that inferior quality materials were purchased at a discounted price, but the low-quality materials created production problems.
Buyer's perspective
Transfer price <= Cost of buying from outside supplier OR Transfer price <= Profit to be earned per unit sold (not including transfer price)
Sellers Perspective
Transfer prive >= Variable Cost per unit+ (Total CM loss on sales/Number of units transferred)
Standard
a bench mark for measuring performance relate to the quantity and acquisition price of inputs used in manufacturing goods or providing services
Avoidable Cost
a cost that can be eliminated by choosing one alternative over another relevant and should not be ignored
Sunk Cost
a cost that has already been incurred and cannot be avoided regardless of what a manager decides to do -depreciation because it is a non-cash expense that spreads the cost of the truck over it's useful life Sunk costs are always the same and should always be ignored
Make or buy decision
a decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier
Operating department
a department in which the central purposes of the organization are carried out
Service department
a department that does not directly engage in operating activities; rather it provides services or assistance to the operating department
Why is it difficult to interpret a difference between how much expense was budgeted and how much was actually spent?
a difference between the budget and actual results can be due to many factors. Most importantly, the level of activity can have a very big impact on costs. From a manager's perspective, a variance that is due to a change in activity is very different from a variance that is due to changes in prices and changes in how effectively resources are managed. A variance of the first kind requires very different actions from a variance of the second kind. Consequently, these two kinds of variances should be clearly separated from each other. When the budget is directly compared to the actual results, these two kinds of variances are lumped together.
Management by exception
a management system that compares actual results to a budget so that significant deviations can be flagged as exceptions and investigated further
Special Order
a one time order that is no considered part of the company's normal ongoing business.
Economic Value Added
an adaptation of residual income. companies often modify their accounting principles in various ways
Depreciation
an assets net book value decreases over time as the accumulated depreciation increases. This decreases the denominator in the ROI calculation, increasing ROI.
Flexible Budget
an estimate of what revenues and costs should have been, given the actual level of activity for the period. compared to what should have been for the actual level of activity during the period rather than to the planning budget.
Responsibility Center
any part of an organization whose manager has control over and is accountable for cost, profit or investments.
Constraint (bottleneck)
anything that prevents you from getting more of what you want/ ex. time determined by the step that limits the total output because it has the smallest capacity
Disadvantage of the residual approach
cannot be used to compare the performance of divisions of different styles. Larger divisions often have more residual income than smaller divisions.
Balanced Scorecard
consists of an integreated set of performance measures that are derived from and support a company's strategy.
Different costs for different purposes
costs that are relevant in one decision situation are not necessarily relevant in another.
Decentralized Organization
decision making authority is spread throughout the organization rather than being confined to a few top executives.
Spending Variance
difference between how much was actually spent and what should have been spent to achieve the actual level of activity is the difference between the actual cost and budgeted cost at the actual level of activity.
Differential cost (relevant costs)
difference in cost between any two alternatives
Differential revenue (relevant benefits)
difference in revenue between any two alternatives
Key to maximizing the total CM when cutting back on a product
favor the products that provide the highest contribution margin per unit of the constrained resource
Differential Analysis
focusing on the costs and benefits that differ between the alternatives
Profit Center
has control over both costs and revenue, but not over the use of investment funds. profit center managers are evaluated by comparing actual profit to budgeted profit
Investment Center
has control over cost, revenue, and investments in operating assets. evaluated using return on investment or residual income measures
Cost Center
has control over costs, but not over revenue or the use of investment funds. ex. service departments: accounting finance, general administration, legal, and personnel expected to minimize cost while providing the level of products and services demanded by other parts of the organization. -standard cost variances and flexible budget variances are sued to evaluate cost center performance
Manufacturing Cycle Efficiency (MCE)
helps reduce the delivery cycle time from months to only weeks or hours. MCE= Process Time (value-added time)/Throughput Time
Labor rate variance
in the case of DL measures the difference between the actual hourly rate and the standard hourly rate multiplied by the actual number of hours worked during the period (AH x AR) - (AH x SR) AH= AQ used in production AR= AP (actual rate per DLH) SH= SQ of hours allowed for actual output SR= AP (standard rate per DLH) Actual > Standard = unfavorable Actual < Standard = Favorable
Variable overhead rate variance
in the case of VOH measures the difference between the actual variable overhead cost incurred during the period and the standard cost that should have been incurred based on the actual activity of the period (AH x AR) - (AH x SR)
Operating Assets
include cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes. Most companies use the net book value approach to computing average operating assets
Net Operating Income
income BEFORE interest and taxes (EBIT- earnings before interest and taxes)
Turnover
incorporates a crucial area of a managers responsibility-- the investment in operating assets. Excessive funds tied up in operating asses depress turnover and lower ROI.
Buying Divisons highest acceptable transfer price
intererst in transfer only if it's profit increases. In cases where a buying division has an outside supplier, buying division will buy from the inside supplier if the price is less than the price offered by the outside buyer
Labor Efficiency Variance
measures the difference between the actual hours used and the standard hours allowed for the actual output multiplied by the standard hourly rate (AH x SR) - (SH x SR)
Variable Overhead Efficiency Rate Variance
measures the difference between the actual level of activity and the standard activity allowed for the actual output, multiplied by the variable part of the POHR (AH x SR) - (SH x SR)
Materials Quantity Variance
measures the difference between the actual quantity of materials used in production and the standard quantity of materials allowed for the actual output. AP x SQ - SQ x SP Actual > Standard = unfavorable Actual < Standard = favorable
Return on Investment (ROI)
net operating income divided by average operating assets. =NOI/avg operating assets also =Margin x Turnover where Margin= NOI/Sales and Turnover = Sales/Avg Operating Assets The higher the ROI, the greater the profit earned per dollar invested in the segment's operating assets. manager evaluated on ROI will reject any project whose rate of return is below the current ROI even if the rate of return on the project is above the company's minimum required rate of return
suboptimization
occurs when managers do not act in the best interests of the overall company or even in the best interests of their own division.
Favorable vs Unfavorable
positive = unfavorable negative = favorable AP > SP = unfavorable price variance AP < SP = favorable price variance AQ > SQ = unfavorable quantity variance AQ < SQ = favorable quantity variance
Planning Budget
prepared before the period begins and is only valid for only the planned level of activity.
Materials Price Variance
price variance for DM measures the difference between an input's actual price and standard price multiplied by actual quantity purchased AP x AQ - AP x SQ Actual < Standard = unfavorable Actual > Standard = favorable
Negotiated transfer price
results from discussions between the selling and buying divisions.
Standard Cost Card
shoes the standard quantity (or hours) and standard price (or rate) of the inputs required to produce a unit of a specific product. Inputs: SQ SP Standard Cost DM DL VOH Total
Future Costs
should be ignored if the do not differ between alternatives.
Quantity Standards
specify how much should be paid for each unit of an input
Standard hours per unit
the amount of direct labor hors that should be used to produce one unit of finished goods. for VOH- measures the amount of allocation base from a company's POHR that is required to produce one unit of finished goods
Standard quantity per unit
the amount of direct materials that should be used for each unit of given product, including for an allowance for normal inefficiencies
Queue Time
the amount of time a product spends waiting to be worked on, to be moved, to be inspected, or to be shipped
Throughput (Manufacturing Cycle) Time
the amount of time required to turn raw materials into completed products. Throughput Time= Process Time + Inspection Time + Move Time + Queue Time
Inspection Time
the amount of time spent ensuring that the product is not defective
Process Time
the amount of time work is actually done on the product
Standard rate per hour
the company's expected direct labor wage rate per hour =Variable portion of POHR
Quantity Variance
the difference between how much of an input was actually used and how much should have been used and is stated in dollar terms using the standard price of input.
Spending Variance
the difference between the actual amount of the cost and how much a cost should have been, given the actual level of activity. Actual Cost > Budget Cost = Unfavorable Actual Cost < Budgeted Cost = Favorable
Price Variance
the difference between the actual amount paid for an input and the standard amount that should have been paid, multiplied by the actual amount of the input purchased.
Budget Variance
the difference between the actual fixed manufacturing overhead and the budgeted fixed manufacturing overhead for the period. =Actual - Budgeted Actual > Budgeted = unfavorable Actual < Budgeted = favorable
Activity Variances
the difference between the actual level of activity and the level of activity in the planning budget from the beginning of the period
Revenue Variance
the difference between the actual total revenue and what the total revenue should have bee, given the actual level of activity for the period Actual > Budgeted = Favorable Actual < Budgeted = Unfavorable
Denominator Activity
the estimated total amount of the allocation base in the formula for POHR
Residual Income
the net operating income that an investment center earns above the minimum required return on it's operating assets NOI -(avg operating assets x minimum required rate of return) encourages managers to make investments hat are profitable for the entire company but that would be rejected by managers who are evaluated using the ROI formula
Split off point
the point in the manufacturing process at which the joint products can be recognized as separate products
Opportunity Costs
the potential benefit that is given up when one alternative is selected over another. relevant and should not be ignored.
Market price
the price charged for an item on the open market
Transfer Price
the price charged when one segment of a company provides goods or services to another segment of the same company
Standard price per unit
the price that should be paid for each unit of direct materials and it should reflect the final. delivered cost of those materials.
Range of acceptable transfer prices
the range of transfer prices within which the profits of both divisions participating in a transfer would increase
Move Time
the time required to move materials or partially completed products from workstation to workstation
Common Errors
thinking all costs are fixed or all costs are variable
What is the fundamental objective in setting transfer prices?
to motivate the managers to act in the best interests of the overall company.
Joint products
two or more products that are produced from a common input
Flexible Budget
used to account for changes in cost due to changes in an activity. tells us what revenues and costs should have been for actual level of activities -measures performances -identifies discrepancies between budgeted and actual costs
Joint cost
used to describe the costs incurred up to the split off point
Vertically integrated
when a company is involved in more than one activity in the entire value chain.
Relaxing (or elevating) the constraint
when a manager increases the capacity of the bottleneck
