ACCT 2302

Fundamentals of Accounting II

Spring 2011

Lecture 14

Professor Jeff Yu

Review: Flexible Budget

Flexible budget is prepared based on the actual activity level and is used for performance evaluation (control) purpose.

Activity Variance = Flexible budget amount – planning (static) budget amount

Spending Variance = Actual cost – flexible budget cost Spending variance is unfavorable if positive, favorable if negative;

Spending variance captures the efficiency of cost control.

Revenue Variance = Actual revenue – flexible budget revenue

Revenue variance is favorable if positive, unfavorable if negative;

Review: Standard Cost

Standard vs. Budget: • A budget is set for total costs;• A standard is set for per unit cost;

Quantity standards are set for each unit of production (How much units of input are needed for each unit of output?)

SQ = standard quantity of materials allowed for the actual output

SH = standard hours allowed for the actual output

Price standards are set for each unit of input (How much should be paid for each unit of input?)

Standard Price (SP) for materialsStandard Rate (SR) for labor and overhead

Review: Variance Analysis

Materials Price Variance

AQ(AP - SP)

Labor/VOH Rate Variance

AH(AR – SR)

Materials Quantity Variance

SP(AQ - SQ)

Labor/VOH Efficiency Variance

SR(AH – SH)

AP (AR)= Actual Price (Actual Rate): the amount actually paid foreach unit of the materials (labor or VOH).

SP (SR)= Standard Price (Standard Rate): the amount that should Have been paid for each unit of the materials (labor or VOH).

AQ (AH)= Actual Quantity (Actual Hour): the amount of materials(labor or VOH activity) actually used in the production.

SQ (SH)= Standard Quantity (Stan. Hour) allowed for the actual output = actual production in units * standard quantity (hours) per unit

When material purchased ≠ material used

To compute the PRICE variance, use the total quantity of raw materials PURCHASED.

To compute the QUANTITY Variance, use only the quantity of raw materials USED.

Review: Materials Variances

Bella has the following direct labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $6.00 per direct labor hour.

Last week 1,550 direct labor hours were worked at a total labor cost of $9,610 to make 1,000 Zippies.

Q: (1)What was Bella’s actual rate for labor for the week? (2) What was Bella’s labor rate variance for the week? (3) What is the standard hours of labor that should have been worked to produce 1,000 Zippies? (4)What was Bella’s labor efficiency variance for the week?

Example: Labor Variances

Responsibility for Labor Variances

Production Manager

Production managers areusually held accountable

for labor variancesbecause they can

influence the:

Mix of skill levelsassigned to work

tasks. Level of employee

motivation.

Quality of production supervision.

Quality of training provided to employees.

Osborne Co. has the following DL standards to produce each unit of horn: 5 direct labor hours at $20 per hour. In May, the actual hourly rate for direct labor is $22, with the labor variances reported below:

Labor rate variance $30,400 ULabor efficiency variance $4,000 U

Q: How many horns did Osborne Co. produce in May?

Practice Problem: Labor Variances

Foster Inc.’s direct labor standard for each unit of product is 3 hours at $8 per hour. In April, total direct labor cost of $240,000 was paid to make 10,000 units of product. Labor rate variance is $16,000 F.

Q: What is Foster Inc.’s labor efficiency variance in April?

Practice Problem: Labor Variances

Cola Co’s Variable OH is applied based on machine hours. The standard allows for 3,200 machine hours for the actual production in March. In March, actual machine hours worked were 3,300, actual variable OH incurred was $6,740, and the variable OH efficiency variance was $200 U.

Q: What is the amount of variable OH rate variance?

Example: Variable OH Variances

Chapter 12 Segment Reporting

Learning Objectives– Understand performance evaluation tools for cost

center, profit center and investment center– Prepare a segmented income statement– Compute ROI and Residual Income– Understand the pros and cons of performance

evaluation using ROI, Residual Income and the Balanced Scorecard.

Decentralization and Segments

A segment is any part or activity of an

organization about which a manager seeks cost, revenue, or profit

data. A segment can be . . .

Quick MartQuick Mart

An Individual Store

A Sales Territory

A Service Center

Evaluating Managers’ Performance

Cost Center(controls costs only) Flexible Budget Variances;

Standard Cost Variances

Profit Center(controls costs & revenues)

SegmentedIncome Statement(Segment Margin)

Investment Center(controls costs & revenues

& Investments)

Return on Investment (ROI);Residual Income

Evaluation Tool

Segmented Income Statement

There are two keys to building segmented income statements:

A contribution format should be used because it separates fixed from variable costs and it enables the

calculation of a contribution margin.

Traceable fixed costs should be separated from common fixed costs to

enable the calculation of a segment margin.

Identifying Traceable Fixed Costs

Traceable fixed costs arise because of the existence of a particular segment and would disappear if the segment itself disappeared.

No computer division means . . .

No computer divisionmanager.

Identifying Common Fixed Costs

Common fixed costs arise because of the overall operation of the company and would not disappear

if any particular segment was eliminated.

No computer division but . . .

We still have acompany president.

Sales - Variable ExpensesContribution Margin

- Traceable Fixed costsSegment Margin

Do NOT subtract Common fixed costs!!

Segment margin is a valuable tool for performance evaluation and is also useful in decisions such as dropping or retaining a segment.

Segmented Income Statement

Example: Segmented Income Statements

Segment margin is Television Division’s

contributionto profits.

Segment margin is Television Division’s

contributionto profits.

Segment reporting uses the contribution format.

Income StatementTelevision Division

Sales 300,000$ Variable COGS 120,000 Other variable costs 30,000 Total variable costs 150,000 Contribution margin 150,000 Traceable fixed costs 90,000 Segment margin 60,000$

Contribution marginis computed by

taking sales minus variable costs.

Contribution marginis computed by

taking sales minus variable costs.

Example: Segmented Income Statements

Income StatementCompany Television Computer

Sales 500,000$ 300,000$ 200,000$ Variable costs 230,000 150,000 80,000 CM 270,000 150,000 120,000 Traceable FC 170,000 90,000 80,000 Segment margin 100,000 60,000$ 40,000$

Common FC 25,000 Net operating income 75,000$

Common fixed costs should not be allocated to the divisions. These costs would remain even if one of the

divisions were eliminated.

Common fixed costs should not be allocated to the divisions. These costs would remain even if one of the

divisions were eliminated.

Practice Problem

CompanyFamily Law

DivisionCommercial Law Division

Revenue from Clients $1000,000 $400,000 $600,000Variable expenses  220,000    100,000  120,000Contribution margin 780,000 300,000 480,000Traceable fixed expenses    670,000    280,000    390,000Segment margin $ 110,000 $   20,000 $ 90,000Common fixed expenses    60,000  24,000  36,000Net operating income $   50,000 $   (4,000) $ 54,000

In the above reports, staff of the law firm FDS allocated common fixed expenses the two segments proportionally based on their revenues.

Q: (1) Would the firm be better off financially if family law division were dropped? Prepare segmented income statements to support your answer. (2) Managers propose that an ad campaign costing $20,000 will increase family law revenue by $100,000. If other expenses and revenues remain constant, how would this proposal affect the family law segment margin and the firm’s overall NOI?

Bolvine Co. had a net loss of $10,000 in May. The CEO asked for a segmented monthly income statement to isolate the problem.

Q: (1) Prepare a segmented income statement by divisions.

(2) What is the amount of common fixed costs for the company?

(3)The manager of Division B proposes that an increase of $20,000 in the division’s monthly advertising costs will increase Division B sales by 10%. If this plan is adopted, what would be the new segment margin for Division B?

Practice Problem

Division A Division B

Sales $400,000 $600,000

Variable expense ratio 50% 30%

Traceable fixed expenses $240,000 $330,000

For Next Class

Continue on Chapter 12 Cover ROI, RI and the Balanced Scorecard

Xavier Co. applies MOH based on direct labor hours. The standard costs for one unit of product are as follows:

Direct Material: 6 ounces at $0.50 per ounceDirect Labor: 1.8 hours at $10 per hourVariable MOH: 1.8 hours at $5 per hour

2,000 units were produced in June with the following cost data:Material purchased: 18,000 ounces at $0.6 per ounceMaterial used in production: 14,000 ouncesDirect labor: 4,000 hours at $9.75 per hourVariable MOH cost: $20,800

Q: Compute materials, labor and VOH variances.

Homework Problem 1

Homework Problem 2

Company Store A Store B

Sales $300,000 $100,000 $200,000

Variable expenses  192,000    72,000  120,000

Contribution margin 108,000 28,000 80,000Traceable fixed expenses    76,000    21,000    55,000

Segment margin 32,000 $   7,000 $ 25,000

Common fixed expenses    27,000

Net operating income $   5,000

Q: (1) Store B Sales will increase by $30,000 if its advertising costs increase by $7,000. How would store B’s segment margin change?

(2) Managers propose that an increase of $8,000 in traceable fixed costs will lower variable expense ratio in Store A to 62%. If sales and everything else remain constant, how would this proposal affect overall company’s NOI?