Final Review

Chapter Required Learning Objectives

9 Prepare a planning budget and a flexible budget and understand how they differ from one another
9 Calculate and interpret activity variances
9 Calculate and interpret revenue and spending variances
9 Prepare a performance report that combines activity variances and revenue and spending variances
10 Compute the direct materials price and quantity variances and explain their significance
10 Compute the direct labor rate and efficiency variances and explain their significance
10 Compute the variable manufacturing overhead rate and efficiency variances and explain their significance
10A Compute and interpret the fixed overhead budget and volume variances
11 Compute return on investment (ROI) and show how changes in sales, expenses, and assets affect ROI
11 Compute residual income and understand its strengths and weaknesses
11 Determine the range, if any, within which a negotiated transfer price should fall
12 Identify examples of performance measures that are appropriate for each of the four balanced scorecard categories
12 Identify the four types of quality costs and explain how they interact
Understand how to calculate throughput (manufacturing cycle) time, delivery cycle time, manufacturing cycle efficiency
12 (MCE), and overall equipment effectiveness (OEE)
12 Understand how to construct and use a balanced scorecard
13 Identify relevant and irrelevant costs and benefits in a decision
13 Prepare an analysis showing whether a product line or other business segment should be added or dropped
13 Prepare a make or buy analysis
13 Prepare an analysis showing whether a special order should be accepted
13 Determine the most profitable use of a constrained resource

1
13 Prepare an analysis showing whether joint products should be sold at the split-off point or processed further

2
CH9 (P9-20, P9-21, P9-22, P9-23, Vermont Case)

Planning Budgets. The term planning budget refers to the budget that is set at the
beginning of a budgeting period and that is geared to only one level of activity—the
budgeted level of activity.

Flexible Budgets. A flexible budget is geared to all levels of activity within the relevant
range and is used to plan and control spending. A flexible budget is an estimate of what
revenues and costs should have been, given the actual level of activity for the period.

Please note:
(1) Planning budgets and flexible budgets use the same set of formulas.
(2) Flexible budgets can only be prepared at the end of the accounting period when the
actual level of activity is determined.

Activity variances. An activity variance arises solely due to the difference in the level of
activity included in the planning budget and the actual level of activity. The activity
variance is calculated as the flexible budget amount minus the planning budget amount.
An increase in activity leads to favorable activity variance for revenues and unfavorable
activity variance for variable expenses. There is no activity variance for fixed expenses.

Revenue and spending variances. A revenue variance is the actual total revenue minus
what the total revenue should have been, given the actual level of activity for the period.
A spending variance is the actual amount of the cost minus how much a cost should have
been, given the actual level of activity. A revenue variance is favorable if actual revenues
are greater than budgeted, and a spending variance is favorable if actual expenses are less
than budgeted,

3
 CH10 and Appendix (E10-4, P10-11, P10-14, P10A-5, P10A-11, Vermont Case)

Spending variances can be broken down into price and quantity variances.
Price variance (favorable if AP or AR is smaller):
Material price variance = AQ purchased (AP – SP)
Labor rate variance = AH (AR – SR)
VOH rate variance = AH (AR – SR)

Quantity variance (favorable if AQ or AH is smaller):

Material quantity variance = SP (AQ used – SQ)
Labor efficiency variance = SR (AH – SH)
VOH efficiency variance = SR (AH – SH)

Budget Variance. The budget variance is the difference between the actual fixed
overhead costs incurred during the period and the budgeted fixed overhead costs
contained in the flexible budget. It is favorable if actual FOH is smaller.

Volume Variance. The volume variance is the difference between the total budgeted
fixed overhead and the fixed overhead applied to production. It is favorable if budgeted
FOH is smaller.
Alternatively, it can be expressed as follows:

4
CH11 E11-3, E11-7, E11-9, P11-21, Review Problem 1 on Page 518, and Review
Problem 2 on Page 519)

ROI

or
ROI = Margin  Turnover
or

Residual income
Residual income = Net operating income – (Average operating assets * minimum
required rate of return)

Residual income motivates managers to pursue investments with an ROI higher than the
company’s minimum required return but lower than the existing ROI.

The range of acceptable negotiated transfer prices

From the selling division’s perspective, the lowest acceptable transfer price is:

There are two special cases:

(1) If the selling division has enough idle capacity, the lowest acceptable transfer price is
variable cost per unit.
(2) If the selling division has no idle capacity, the lowest acceptable transfer price is
selling price per unit on the outside market.

From the buying division’s perspective, the highest acceptable transfer price is:

Transfer price ≤ Cost of buying from outside supplier

The profits of the entire company will increase if there exists a range of acceptable
transfer price that increases both the buyers’ and seller’s profits.

The increase in the profits of the entire company = (the highest acceptable transfer price
from the buying division’s perspective - the lowest acceptable transfer price from the
selling division’s perspective) * Total number of units transferred

5
CH12 (E12-1, E12-2, E12-3, E12-4, 12-5, E12-8, E12-9, and Review Problem on Page
553)

Cost of Quality (See Exhibit 12-6 on Page 542)

There are four types of quality costs: prevention costs, appraisal costs, internal failure
costs, and external failure costs.

Delivery Cycle Time, Throughput Time, and MCE (See Exhibit 12-8 on Page 545)
Throughput time = Process time + Inspection time + Move time + Queue time

MCE = Process time ÷ Throughput time

Delivery cycle time = Wait time + Throughput time

OEE (Overall equipment effectiveness)

OEE = Utilization rate x Efficiency rate x Quality rate, where:
(1) Utilization rate = Actual run time ÷ machine time available;
(2) Efficiency rate = Actual run rate ÷ ideal run rate;
(3) Quality rate = Defect-free output ÷ total output.

Balanced Score Card

A balanced scorecard consists of an integrated set of performance measures that are
derived from and support a company’s strategy. Companies typically adopt one of the
three following strategies to distinguish themselves from competitors: customer intimacy,
operational excellence, and product leadership.

There are four categories of performance measures: financial, customer, internal business
processes, and learning and growth. (See Exhibit 12-2, Exhibit 12-3, Exhibit 12-4, and
Exhibit 12-5 on Pages 538-540)

The four categories of performance measures are linked to one another in a cause-and-
effect fashion: employees’ continuous learning is necessary to improve internal business
processes; improving business processes is necessary to improve customer satisfaction;
and improving customer satisfaction is necessary to improve financial results. (See
Exhibit 12-1 on Page 537)

6
CH13 (E13-3, E13-4, E13-12, E13-13, E13-17)

Identifying relevant costs: Only those costs and benefits that differ between alternatives
are relevant in a decision. Any cost that is avoidable is potentially relevant. Any cost or
benefit that does not differ between the alternatives is irrelevant and can be ignored. For
example, all sunk costs (i.e., costs already irrevocably incurred) and future costs that do
not differ between the alternatives are irrelevant.

Opportunity cost: The potential benefit that is given up when one alternative is selected
over another.

Dropping a Segment
A segment should be dropped if the decrease in total contribution margin is less than the
decrease in fixed cost.

Make or Buy
Continue to make parts if the incremental (unavoidable) costs to make parts internally are
less than the incremental costs to buy them from the outside supplier. Don’t forget that
the opportunity cost of making plays a role in this decision.

Special Order
Special orders are one-time orders that do not affect a company’s normal sales or
capacity (so the regular selling price and fixed costs do not matter). As long as the
incremental revenue from the order exceeds its incremental costs, the order should be
accepted.

Utilization of a Constrained Resource

To maximize profit with a constrained resource, rank products on the basis of their
contribution margins per unit of the constrained resource. Starting at the top of the list,
produce up to demand or to the point where the constrained resource is exhausted—
whichever comes first.

Sell or process further

Joint costs are irrelevant in decisions regarding what to do with a joint product from the
split-off point forward. 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 costs.