CHAPTER 15 Cost Analysis for Control. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 15-2 Decision Making Strategic, Operational,

CHAPTER 15

Cost Analysis for Control

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

15-2

Decision Making

Strategic, Operational,and Financial Planning

Planning and control cycle

Executing operational

activities (Managing)

Data collection andperformance feedback

Implement plansRevisit plans

Performance analysis: Plans vs.

actual results (Controlling)


15-3

Cost Classification Accordingto a Time-Frame Perspective

Time

Deg

ree

of

Co

ntr

ol

Costs that may notcontrollable in the

short run are controllablein the long run.

Costs that may notcontrollable in the

short run are controllablein the long run.


15-4

Performance Report Characteristics

ActivityBudgetAmount

ActualAmount Explanation– =

Favorable•Actual revenues > Budget revenues•Actual costs < Budget costs

Unfavorable•Actual revenues < Budget revenues•Actual costs > Budget costs

Favorable•Actual revenues > Budget revenues•Actual costs < Budget costs

Unfavorable•Actual revenues < Budget revenues•Actual costs > Budget costs

Variance


15-5

Pro

du

ct C

ost

BudgetAmount

This variance is unfavorablebecause the actual cost

exceeds the budget cost.

A cost variance is the amount by which actualamount differs from the budget amount.



15-6

Responsibility ReportingAmount of detail varies according

to level in organization.



A department manager receives detailed reports.

A store manager receives summarized information from each department.



15-7

The vice president of operations receives summarized

information from each store.

Management by exception:

Upper-level management does not receive operating detail

unless activities are not performing according to plan.







15-8

The Flexible Budget

Improve performance evaluation.

May be prepared for any activity level in the relevant range.

Show revenues and expensesthat should have occurred at theactual activity.

Reveal variances due to good costcontrol or lack of cost control.


15-9

To a budget for different activity levels, we must know how costs behave with changes in activity levels.

• Total variable costs changein direct proportion to changes in activity.

• Total fixed costsremain unchangedwithin the relevantrange.

FixedVaria

ble

The Flexible Budget


15-10

First, let’s compareactual results withthe original budget.

The Flexible Budget


15-11

Original ActualBudget Results Variances

Unit sales 10,000 8,000 2,000 U

Sales revenue 100,000$ 80,000$ $ 20,000 ULess variable costs: Manufacturing 30,000 25,500 4,500 F Marketing and admin. 20,000 17,100 2,900 FContribution margin 50,000 37,400 12,600 ULess fixed costs: Manufacturing 12,000 12,000 0 Marketing and admin. 13,000 13,000 0

Operating income 25,000$ 12,400$ $ 12,600 U

Cost variances have little meaning since actual costsare at a different activity than the budgeted activity.

The Flexible Budget


15-12

Now, let’s compareactual results with

a flexed budgetprepared at the

actual levelof activity.

The Flexible Budget


15-13

Original Flexed ActualBudget Budget Results Variances

Unit sales 10,000 8,000 8,000 0

Sales revenue 100,000$ 80,000$ 80,000$ 0Less variable costs: Manufacturing 30,000 24,000 25,500 1,500 U Marketing and admin. 20,000 16,000 17,100 1,100 UContribution margin 50,000 40,000 37,400 2,600 ULess fixed costs: Manufacturing 12,000 12,000 12,000 0 Marketing and admin. 13,000 13,000 13,000 0

Operating income 25,000$ 15,000$ 12,400$ $ 2,600 U

The Flexible Budget


15-14

The Flexible Budget


Unit sales 10,000 8,000 8,000 0



A flexible budget is prepared for thesame activity level as actually achieved.

Note: There is no flexin the fixed costs.


15-15


Unit sales 10,000 8,000 8,000 0



Variable costs have unfavorable variances

because actual costs are more than the flexible

budget costs.

The Flexible Budget


15-16

Standard Cost Variance Analysis

Standard Costs are

Based on carefullypredetermined amounts.

Used for planning labor, material,and overhead requirements.

The expected levelof performance.

Benchmarks formeasuring performance.


15-17

Price Variance

Standard Cost Variances

The difference betweenthe actual price and the

standard price

Usage Variance

The difference betweenthe actual quantity andthe standard quantity



15-18

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance Usage Variance

Standard price is the amount that should have been paid for the resources acquired.



15-19



Standard quantity is the quantity that shouldhave been used for the output achieved.



15-20

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity





15-21

Calculating Material Priceand Usage Variances

Let’s apply what we have learned to calculate standard

cost variances, starting with

material.


15-22

Cruisers, Inc. has the following material standards for fiberglass cloth used to make

one SeaCruiser boat hull:

218 yards per hull at $2.10 per yard

Last month 22,500 yards of material were purchased and used to make 100 hulls. The

material cost a total of $46,125.



15-23

What is the actual price per yard paid for the material?

a. $2.00 per yard.

b. $2.10 per yard.

c. $2.05 per yard.

d. $2.25 per yard.


a. $2.00 per yard.

b. $2.10 per yard.

c. $2.05 per yard.

d. $2.25 per yard.



15-24


a. $2.00 per yard.

b. $2.10 per yard.

c. $2.05 per yard.

d. $2.25 per yard.


a. $2.00 per yard.

b. $2.10 per yard.

c. $2.05 per yard.

d. $2.25 per yard.

AP = $46,125 ÷ 22,500 yds.AP = $2.05 per yd.



15-25


The material price variance (MPV) for the month was:

a. $1,125 unfavorable.

b. $1,125 favorable.

c. $1,255 unfavorable.

d. $1,255 favorable.







15-26










d. $1,255 favorable. MPV = AQ(AP - SP) MPV = 22,500 yds. × ($2.05 – $2.10) MPV = $1,125 Favorable



15-27

The standard quantity of material thatshould have been used to produce100 hulls is:a. 22,500 yards.b. 21,600 yards.c. 21,800 yards.d. 22,000 yards.




15-28


The standard quantity of material thatshould have been used to produce100 hulls is:a. 22,500 yards.b. 21,600 yards.c. 21,800 yards.d. 22,000 yards. SQ = 100 hulls × 218 yds. per hull

SQ = 21,800 yds.



15-29


The material usage variance (MUV) for the month was:a. $1,250 unfavorable.b. $1,250 favorable.c. $1,470 unfavorable.d. $1,470 favorable.



15-30




MUV = SP(AQ - SQ) MUV = $2.10(22,500 yds. – 21,800 yds.) MUV = $1,470 unfavorable


15-31

Material Variances Summary

Price variance$1,125 favorable

Usage variance$1,470 unfavorable

22,500 yds. 22,500 yds. 21,800 yds. × × × $2.05 per yd. $2.10 per yd. $2.10 per yd.

= $46,125 = $ 47,250 = $45,780



15-32

Calculating Labor Rateand Efficiency Variances

Now let’s calculate standard cost variances for

labor.


15-33


Cruisers, Inc. has the following direct labor standard to manufacture one boat hull:

26 standard hours per hull at $12.80 perdirect labor hour

Last month 2,540 direct labor hours were worked at a total labor cost of $32,893 to

make 100 hulls.


15-34


What was the actual rate (AR) for labor for the month?

a. $12.95 per hour.

b. $12.80 per hour.

c. $12.50 per hour.

d. $12.25 per hour.


a. $12.95 per hour.

b. $12.80 per hour.

c. $12.50 per hour.

d. $12.25 per hour.


15-35


a. $12.95 per hour.

b. $12.80 per hour.

c. $12.50 per hour.

d. $12.25 per hour.


a. $12.95 per hour.

b. $12.80 per hour.

c. $12.50 per hour.

d. $12.25 per hour.


AP = $32,893 ÷ 2,540 hours AP = $12.95 per hour


15-36


The labor rate variance (LRV) for the month was:

a. $381 unfavorable.

b. $381 favorable.

c. $462 unfavorable.

d. $462 favorable.



b. $381 favorable.


d. $462 favorable.


15-37




b. $381 favorable.


d. $462 favorable.



b. $381 favorable.


d. $462 favorable.

LRV = AH(AP - SP) LRV = 2,540 hrs($12.95 - $12.80) LRV = $381 unfavorable


15-38


The standard hours (SH) of labor that should have been worked to produce100 hulls is:

a. 2,500 hours.

b. 2,600 hours.

c. 2,700 hours.

d. 2,800 hours.


a. 2,500 hours.

b. 2,600 hours.

c. 2,700 hours.

d. 2,800 hours.


15-39



a. 2,500 hours.

b. 2,600 hours.

c. 2,700 hours.

d. 2,800 hours.


a. 2,500 hours.

b. 2,600 hours.

c. 2,700 hours.

d. 2,800 hours. SH = 100 hulls × 26 hours per hulls SH = 2,600 hours


15-40


The labor efficiency variance (LEV) for the month was:


b. $694 favorable.


d. $768 favorable.



b. $694 favorable.


d. $768 favorable.


15-41




b. $694 favorable.


d. $768 favorable.



b. $694 favorable.


d. $768 favorable.

LEV = SR(AH - SH) LEV = $12.80(2,540 hrs. - 2,600 hrs.) LEV = $768 favorable


15-42

Rate variance$381 unfavorable

Efficiency variance$768 favorable

Actual Hours Actual Hours Standard Hours × × × Actual Price Standard Price Standard Price

2,540 hours 2,540 hours 2,600 hours × × × $12.95 per hr. $12.80 per hr. $12.80 per hr.

= $32,893 = $32,512 = $33,280

Labor Variances Summary


15-43

Calculating Variable Overhead Spending and Efficiency Variances

Now let’s calculate standard cost

variances for the last of the variable production costs –

variable overhead.


15-44


Cruiser, Inc. has the following variable overhead standard to manufacture one boat hull:

26 standard hours per hull at$3.20 per direct labor hour

Last month 2,540 hours were workedto make 100 hulls, and actual

variable overhead was $8,128.


15-45


What was the actual rate (AR) for variable overhead rate for the month?

a. $3.00 per hour.

b. $3.11 per hour.

c. $3.20 per hour.

d. $4.30 per hour.


a. $3.00 per hour.

b. $3.11 per hour.

c. $3.20 per hour.

d. $4.30 per hour.


15-46



a. $3.00 per hour.

b. $3.11 per hour.

c. $3.20 per hour.

d. $4.30 per hour.


a. $3.00 per hour.

b. $3.11 per hour.

c. $3.20 per hour.

d. $4.30 per hour.

AR = $8,128 ÷ 2,540 hours AR = $3.20 per hour


15-47


The spending variance (SV) for variable overhead for the month was:

a. $0.

b. $400 favorable.


d. $300 favorable.


a. $0.

b. $400 favorable.


d. $300 favorable.


15-48



a. $0.

b. $400 favorable.


d. $300 favorable.


a. $0.

b. $400 favorable.


d. $300 favorable.

SV = AH(AR - SR) SV = 2,540 hrs($3.20 - $3.20) SV = $0


15-49


The efficiency variance (EV) for variable overhead for the month was:


b. $438 favorable.


d. $192 favorable.



b. $438 favorable.


d. $192 favorable.


15-50




b. $438 favorable.


d. $192 favorable.



b. $438 favorable.


d. $192 favorable. EV = SR(AH - SH) EV = $3.20(2,540 hrs. - 2,600 hrs.) EV = $192 favorable

100 hulls × 26 hrs. per hull


15-51

Spending variance$0

Efficiency variance$192 favorable

2,540 hours 2,540 hours 2,600 hours × × × $3.20 per hour $3.20 per hour $3.20 per hour

= $8,128 = $8,128 = $8,320

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate

Variable OverheadVariances Summary


15-52

Analysis of FixedOverhead Variances

Now let’s turn our attention

to fixed overhead.


15-53


Estimated Fixed OverheadPOHAR =

Overhead costs are applied to products and services using a predetermined overhead

application rate (POHAR):

Applied Overhead = POHAR × Standard Activity

Estimated Total Direct Labor Hours


15-54


Budget Variance

VolumeVariance

POHAR = Fixed Overhead Application RateSH = Standard Hours Allowed

SH × POHAR

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied


15-55


Cruiser, Inc. has the following budgeted and actual fixed overhead information

for the year:

Calculate the fixed overhead budgetand volume variances.

Planned Production 1,250 Units × 240 hours each = 300,000 hoursActual Production 1,288 UnitsEstimated Fixed Overhead $3,240,000Actual Fixed Overhead $3,327,500Standard Hours 1,288 Units × 240 hours each = 309,120 hoursPredetermined Overhead Rate $3,240,000 ÷ 300,000 hours = $10.80 per hour


15-56


Budget variance$87,500 unfavorable

Volume variance$98,496 favorable

309,120 hours

× $10.80 per

hour $3,327,500 $3,240,000 $3,338,496

SH × POHAR

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied


15-57


Budget Variance

Results from paying moreor less than expected for

overhead items.

Volume Variance

Results from operatingat an activity leveldifferent from theplanned activity.


15-58

VolumeVariance

Unfavorablewhen standard hours

< planned hours

Favorablewhen standard hours

> planned hours

Results when standard hoursallowed for actual output differs

from the planned activity.

Volume Variance – A Closer Look


15-59

VolumeVariance

Unfavorablewhen standard hours

< planned hours

Favorablewhen standard hours

> planned hours

Results when standard hoursallowed for actual output differs

from the budgeted activity.

Does not measure over- or under spending

Explainable by and controllable only through

activity



15-60


Let’s look at a graph showing the volume variance.

We will use Cruisers’ annual numbers from the previous example.


15-61

Volume Variance

Volume

Cost

$3,338,496 applied fixed OH

$3,240,000 budgeted fixed OH

309,120Standard

Hours

300,000 Budgeted

Hours

Fixed overhead

applied to products

309,120 hours × $10.80 fixed overhead rate

{



15-62

Total Company

Sailboat Division

Motorboat Division

Repair Parts

DivisionSales 560,000$ 320,000$ 160,000$ 80,000$ Variable expenses 240,000 128,000 72,000 40,000 Contribution Margin 320,000 192,000 88,000 40,000 Fixed expenses 282,000 164,000 72,000 46,000 Operating income 38,000$ 28,000$ 16,000$ (6,000)$

Income Statement

Reporting for Segmentsof an Organization

Cruisers, Inc. reports the following for a recent quarter:

Should the Repair Parts Division be discontinued?Let’s take a closer look at fixed expenses before we decide.


15-63


Analysis of fixed expenses shows:

Direct fixed expenses are incurred within a division.Direct fixed expenses are incurred within a division.

Common fixed expenses are incurred elsewhereand would continue even if a division is discontinued.

Common fixed expenses are incurred elsewhereand would continue even if a division is discontinued.


15-64

Total Company

Sailboat Division

Motorboat Division

Repair Parts

DivisionSales 560,000$ 320,000$ 160,000$ 80,000$ Variable expenses 240,000 128,000 72,000 40,000 Contribution Margin 320,000 192,000 88,000 40,000 Direct fixed expenses 170,000 100,000 40,000 30,000 Segment margin 150,000 92,000$ 48,000$ 10,000$

Common fixed expenses 112,000 Operating income 38,000$

Income Statement


Cruisers, Inc. would be worse off by $10,000if the Repair Parts Division is discontinued.

Segment margin is the Repair Parts Division’s contribution to overall operations.


15-65


Cost Cost Center

A business section that has control

over the incurrence of costs, but no

control over revenues or

investment funds.


15-66


Profit Center A part of the

business that has control over both

costs and revenues, but no control over investment funds.

RevenuesSalesInterestOther

CostsMfg. costsCommissionsSalariesOther


15-67


Corporate Headquarters

Investment Center A profit center

where management also

makes capital investment decisions.


15-68

CostCenter

Actual costs compared to budgeted costs

ProfitCenter

InvestmentCenter

Actual return on investmentcompared to budgetedreturn on investment

Evaluation Measures

Actual segment margincompared to budgetedsegment margin

Methods of Evaluating Segments

Segment


15-69

Analysis of Investment Centers

Return on investment (ROI) is the ratio ofsegment margin to the investment used to

generate the segment margin.

ROI =

Segment margin Divisional operating assets


15-70


SalesOperating assets

ROI = Segment marginOperating assets

ROI = Segment margin

Sales ×

MarginMargin TurnoverTurnover


15-71



Total Company

Sailboat Division

Motorboat Division

Repair Parts

DivisionSales 560,000$ 320,000$ 160,000$ 80,000$ Segment margin 150,000 92,000$ 48,000$ 10,000$ Operating assets 1,200,000 600,000 500,000 100,000

Margin ? ? ? ?Turnover ? ? ? ?ROI ? ? ? ?

Let’s compute the margin, turnover, and ROI for Cruisers.


15-72



Total Company

Sailboat Division

Motorboat Division

Repair Parts

DivisionSales 560,000$ 320,000$ 160,000$ 80,000$ Segment margin 150,000 92,000$ 48,000$ 10,000$ Operating assets 1,200,000 600,000 500,000 100,000

Margin 26.8% 28.8% 30.0% 12.5%Turnover 0.47 0.53 0.32 0.80 ROI 12.50% 15.3% 9.6% 10.0%


15-73


Increase Sales Prices

Decrease Expenses

Lower Invested Capital

Three ways to improve ROI


15-74

As Sailboat Division Manager at Cruisers, Inc., your compensation package includes a salary plus bonus based on your division’s ROI -- the higher your ROI, the bigger your bonus.

The company ROI is 12.5%, but your division is producing an ROI of 15.3%.

You have an opportunity to invest in a new project that will produce an ROI of 13.5%.

As division manager, would you As division manager, would you invest in this project?invest in this project?

ROI and Dysfunctional Behavior


15-75

As division manager,I wouldn’t invest in

that project becauseit would lower my pay!

Gee . . .I thought we were

supposed to do what was best for the

company!

ROI and Dysfunctional Behavior


15-76

Segment marginless required returnon operating assets

Residual Income – Another Measure


15-77

Segment margin– Required return = Residual income

Operating assets× Required ROI = Required return

Residual Income

Let’s calculate the residual income for Cruisers, Inc. using total company information and a 10 percent required return.Let’s calculate the residual income for Cruisers, Inc. using

total company information and a 10 percent required return.


15-78

Residual Income

Segment margin = $150,000– Required return = 120,000 = Residual income = $ 30,000

Operating assets = $1,200,000× Required ROI = × 10%= Investment charge = $ 120,000

Let’s calculate the residual income for Cruisers, Inc. using total company information and a 10 percent required return.Let’s calculate the residual income for Cruisers, Inc. using

total company information and a 10 percent required return.


15-79

Residual Income

Total Company

Sailboat Division

Motorboat Division

Repair Parts

DivisionOperating assets 1,200,000$ 600,000$ 500,000$ 100,000$

Segment margin 150,000$ 92,000$ 48,000$ 10,000$ Require return 120,000 ? ? ?Residual income 30,000$ ? ? ?

Now, let’s find residual incomefor each of the divisions.

Now, let’s find residual incomefor each of the divisions.


15-80

Residual Income

Total Company

Sailboat Division

Motorboat Division

Repair Parts

DivisionOperating assets 1,200,000$ 600,000$ 500,000$ 100,000$

Segment margin 150,000$ 92,000$ 48,000$ 10,000$ Require return 120,000 60,000 50,000 10,000 Residual income 30,000$ 32,000$ (2,000)$ -$


15-81

Residual income encourages managers to make profitable investments that would

be rejected by managers using ROI.

Residual Income


15-82

An integrated set of performance measures that show an organization’s performance in meeting its responsibilities to various

stakeholders.

EmployeeEmployeeStakeholderStakeholder

GroupGroup

InvestorInvestorStakeholderStakeholder

GroupGroup

The Balanced Scorecard


15-83

Financial PerspectiveHow do we look

to the firm’s owners?

Learning and Growth Perspective

How can we continuallyimprove and create value?

Internal BusinessProcess Perspective

In which activities must we excel?

Customer PerspectiveHow do our

customers see us?

Integratedmeasures

The Balanced Scorecard


15-84

End of Chapter 15

Documents

CHAPTER 15 Cost Analysis for Control. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 15-2 Decision Making Strategic, Operational,