LECTURE NOTES Three objectives of management accounting: 1. To provide information for costing services, products, and other objects of interest to management. 2. To provide information for planning, controlling, evaluation, and continuous improvement. 3. To provide information for decision making. Three roles of management accountants ‘+ Problem-solving: comparative analysis for decision making + Scorekeeping: accumulating data and reporting reliable results ‘+ Attention directing: The function of managerial- accounting information in pointing out to managers Issues that need their attention, thereby helping ‘managers properly focus their attention. Distinctions Between Management Accounting and Financial Accounting ‘Management Accounting rgeted user: Internal users managers Restrictions: ‘no mandatory rules for preparing reports ‘Types of information: financial and nonfinancial information ‘Time orientation: ‘emphasizes the future (planning and decision making) ‘Aggregation: detailed information about product line, departments, etc. In general, accounting information needed by internal users differs from that needed by external users in the following ways: a. More flexible b. Does not have to comply with GAAP or other rules . Forward looking d. Timely e. Emphasizes segments, not necessarily the entire organization ‘The Work of Management and the Planning and Control Cycle. The work of managers can be usefully classified into three major categories: planning, directing and motivating, and controlling. All of these activities involve making decisions. 2. Planning consists of strategic planning and developing more detailed short-term plans. Most of what we refer to below is with reference to the more detailed short-term plans. 2, Directing and motivating involves mobilizing people to implement the plan. Control is concerned with ensuring that the plan Is followed. Accountants maintain the databases and prepare the reports that provide feedback to managers. The feedback can be used to reward particularly successful employees, but more importantly the feedback can be used to identify potential problems and opportunities that were not anticipated In the plan. . Decision-making is an integral part of the other three management activities. HOW MANAGERIAL ACCOUNTING ADDS VALUE + Provides managers with information (e.g., product costs, budgets, cash flows). The Information Financial Accounting external users stockholders and creditors must follow GAAP when preparing financial statements, financial information istorical orientation (reports what has already occurred) Information about overall firm performance includes financial and nonfinancial data to help managers with strategic planning and decision making. Assists in directing and controlling (analyzing and comparing actual performance to budgeted plans; attention-directing to highlight successful or problem areas). Motivates managers to achieve the organization's goals by communicating the plans, providing a measurement of how well the pian was achieved, and prompting an explanation of deviations from plans. Measures performance not only for the entire organization, as in financial accounting, but also for many ' subunits (divisions, departments, managers). Assesses the organization's competitive position in the rapidly changing business environment. Looks at how well the firm is doing internally, in the eyes of its customers, from the standpoint of innovation and continuous improvement, and financially. ‘The Changing Business Environment 1. ‘Just-In-Time - The term JIT means that materials are received just in time to be used in production, manufactured parts are completed just in time to be assembled into products, and products are ‘completed just in time to be shipped to customers. As a result, inventories are virtually eliminated in a JIT system. Key Elements of IT + Improved plant layout © Reduced setup time © Low defect rates+ Flexible workforce Benefits of IT * Inventories are reduced. ‘+ Space is freed up. Throughput time is reduced. * Defect rates are reduced. 2. Total Quality Management (TQM) - Total Quality Management means different things to different People. Nevertheless, most TQM programs seem to share at least two common elerents—a focus on the customer and systematic problem-solving using ‘teams made up largely of front-line workers. Process Reengineering - involves completely redesigning a business process from the ground up. In this respect, it can be differentiated from TQM which tends to emphasize small, incremental improvements. The process is redesigned with a focus on simplification and elimination of non-value- added activities. 4. Theory of Constraints (TOC) - The goal in the Theory of Constraints is not to eliminate all constraints; there is always a constraint somewhere in the system if the goal is to make more money. However, constraints determine the performance of the entire system, so they should be intelligently managed. 5. Organizational Structure + Centralization vs. decentralization * Line and staff relationships. + The controller Strategic decisions and management accounting - key to a company’s success in creating value for customers while differentiating itself from its competitors. * Providing a quality product or service at a lower price than competitors * Providing a unique product or service at a higher price than competitors. Role of Accountants and Treasurer ‘The chief financial officer (CFO) or controller is the chief accountant responsible for: + the supervision of the accounting department * preparation of reports + the interpretation of information to line ‘managers. ‘The treasurer is responsible for: raising capital safeguarding assets ‘managing investments insurance coverage credit policy of an organization. Line personnel are directly involved in carrying out the mission of the organization (e.g., assembly workers in a factory, doctors in a hospital, teachers in a school). ‘Staff personnel (accountants, lawyers, personnel directors, and other administrative positions) provide support for the organization's mission. Value Chain - The value chain is a set of value- adding functions or processes that convert inputs into products and services for the organization's customers: Research and Development—experimenting to reduce costs or improve quality. 2. Design—developing alternative service, or process designs. 3. Supply—managing raw materials received from vendors to reduce costs and improve quality. 4. Production—acquiring and _——_ assembling resources to produce @ product or render a service. 5. Marketing—promoting @ product or service to ‘current and prospective customers. 6. Distribution—celivering a product or service to a customer. 7. Customer Service—supporting customers after the sale of a product or service. Corporate governance Corporate governance is designed to compensate for the agency problem resulting from the fact that corporations are managed by _professional management that may not operate them in the best interest of the shareholders. product, ‘Components of Corporate governance Policies, procedures and mechanism that are established to control management. These major controls over management include: ‘= compensation systems, © boards of — directors committees), © external auditors, internal auditors, attorneys, regulators, creditors, securities analysts. and Internal control systems. (including major Forms of Executive Compensation A key objective in setting executive compensation is to align management's decisions and actions with the long-term interests of shareholders (e.g., long- term stock price). If managers are given too much fixed ‘compensation, they may become too complacent and not take appropriate risks to increase share price. If managers are given too much incentive compensation based on operating profit or short-term stock price, they have incentives to manage profit or take excessive risks to maximize their compensation. Common types of management compensation a. Base salary and bonuses. Using this system, ‘managers are compensated based on performance which is typically measured by accounting profit. Compensation systems based on accounting measures of profit are problematic because accounting profit can be manipulated or managed. b. Stock options. The use of stock options as a form of compensation provides managers with an incentive to manage the corporation to increase the stock price, which is consistent with the goal of shareholders. A disadvantage of stock options is that managers may have an incentive to increase the stock price in the short-term at the expense of long- term stock value, even by manipulating accounting income to increase stock price. In addition, stock options may encourage management to take on risks that are that are in excess of shareholders’ risk appetite.EXCEL PROFESSIONAL SERVICE! INC. . Stock grants- Stock grants involve issuing shares of stock as part of management's compensation. Two ‘common types of stock grants: (4) Restricted stock. The issuance of stock that cannot be sold by the manager for a specific period of time, usually about 10 years. This form ‘of compensation is effective because it encourages managers to undertake operations that increase the long-term value of the corporation's stock price. (2) Performance shares. The issuance of stock to management if certain levels of performance are met. If the price of the corporation's stock increases, the value of the manager's ‘compensation increases. d. _ Executive perquisites (perks). Management also may get various perquisites such as retirement benefits, use of corporate assets, golden parachutes, and corporate loans. fe. The best forms of executive compensation-It is generally believed that the best compensation systems include a combination of fixed compensation and incentive compensation that is related to long- term stock price, Audit committee - a "committee established by and amongst the board of directors of an issuer for the purpose of overseeing the accounting and financial reporting processes of the issuer, and audits of the financial statements of the issuer." A major responsibility of the audit committee is the appointment, ‘compensation and oversight of the corporation's external auditor, including the resolution of any disagreements between management and the external auditor Other important characteristics of an audit committee (@) At least one member should be a "financial expert.” The names of the financial experts must be disclosed. financial expert is one that possesses all of the following attributes: 1] An understanding of _ generally accepted ‘accounting principles and financial statements; 2] Experience in preparing, auditing, analyzing, or evaluating financial statements of the breadth and complexity expected to be encountered with the company; 3] An understanding of internal controls and procedures for financial reporting: and 4] An understanding of audit committee functions. Enterprise risk management: Enterprise risk management is a process, effected by an entity's board of directors, management and other personnel, applied ina strategy-setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives. ERM helps align the risk appetite of the organization with its strategy, enhances risk response decisions, reduces operational surprises and losses, identifies and manages cross-enterprise risks, provides integrated responses to ‘multiple risks, helps the organization seize opportunities, and improves the deployment of capital. A key aspect of ERM is the identification and management of events that have a negative impact, positive impact, or both. Events with negative impact represent risks. Events with positive impact may offset negative impacts or represent opportunities. The risk management process. involves (1) identifying risks, assessing risks, prioritizing risks, determining risk responses. and monitoring risk responses. Interrelated components of ERM (1) internal environment (2) objective setting (3) event identification (4) risk assessment (5) risk response (6) control activities (7) information and communication (8) monitoring. TERMINOLOGIES Benchmarking (or competitive benchmarking) - The continual search for the most effective method of accomplishing a task, by comparing existing methods and performance levels with those of other organizations or with other subunits within the same organization. Continuous improvement - The constant effort to eliminate waste, reduce response time, simplify the design of both products and processes, and improve quality and customer service. Empowerment - The concept of encouraging and authorizing workers to take the initiative to improve operations, reduce costs, and improve product quality and customer service. Line position - Position held by managers who are directly involved in providing the goods or services. that constitute an organization's primary goals. Non-value-added costs - The costs of activities that can be eliminated without deterioration of product quality, performance, or perceived value. Reengineering - The complete redesign of @ process, with an emphasis on finding creative new ways to accomplish an objective. Total quality management (TQM) - The broad set of management and control processes designed to focus an entire organization and all of its employees on providing products or services that do the best possible job of satisfying the customer. ‘Treasurer - An accountant in a staff position who is responsible for managing an organization's relationships with investors and creditors and maintaining custody of the organization's cash, investments, and other assets. Theory of constraints - A management approach that focuses on identifying and relaxing the constraints that limit an organization's ability to reach a higher level of goal attainment. Type of Cost Out-of-pocket costs require a cash outlay. Opportunity costs are the benefits you give up when you choose one alternative over another. Direct costs can be directly and conveniently traced to a specific cost abject. Indirect costs either cannot be traced to a specific ‘cost object or are not worth the effort of tracing. Variable costs change, in total, in direct proportion to changes in activity. Fixed costs remain the same, in total, regardless of activity.EXCEL PROFESSIONAL SERVICES, INC. Manufacturing costs are associated with making a physical product. They can be classified as direct materials, direct labor, or manufacturing ‘overhead. Nonmanufacturing costs are associated with selling @ product or service or running the overall business. Product costs are assigned to a product as it is being produced; they accumulate in inventory accounts until the product is sold. Period costs are reported as expenses as they are incurred. Relevant costs are future oriented costs that differ ‘among decision alternatives. Irrelevant costs are those that remain the same regardless of the alternatives and thus will not affect the decision. IMA Standards of Ethical Conduct for Management ‘Accountants 1. Competence = Maintain an appropriate level of professional ‘competence by ongoing development of their knowledge and skills. ‘= Perform their professional duties in accordance with relevant laws, regulations, and technical standards. ‘= Prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information. 2. Confidentiality ‘© Refrain from disclosing confidential information ‘acquired in the course of their work except when ‘authorized unless legally obligated to do so. ‘+ Inform subordinates as appropriate regarding the confidentiality of information acquired in the course of their work and monitor their activities to assure the maintenance of that confidentiality. ‘+ Refrain from using or appearing to use confidential information acquired in the course of their work for ‘unethical or illegal advantage either personally or through third parties. 3 Integrity + Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. + Refrain from engaging in any activity that would prejudice their ability to carry out their duties ethically. + Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions. ‘+ Refrain from either actively or passively subverting the attainment of the organization/s legitimate and ethical objectives. + Recognize and communicate _ professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity. ‘+ Communicate unfavorable as well as favorable information and professional judgments or opinions. ‘+ Refrain from engaging in or supporting any activity that would discredit the profession. 4 Objectivity © Communicate information fairly and objectively. ‘© Disclose full all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, ‘comments, and recommendations presented. Resolution of Ethical Conflict, In applying the standards of ethical conduct, ‘management accountants may encounter problems in identifying unethical behavior or in resolving an ethical conflict. When faced with significant ethical issues, management accountants should follow the established polies of the organization bearing on the resolution of such conflict. If these polies do no resolve the ethical conflict, management accountants should consider the following courses of actions: © Discuss such problems with the immediate superior except when it appears that the superior is involved, in which case the problem should be presented initially to the next higher management level. If satisfactory resolution cannot be achieved when the problem is initially presented, submit the issues to the next higher managerial level. ‘+ If the immediate superior is the chief executive officer, or equivalent, the acceptable reviewing authority may be a group such as the audit committee, executive committee, board of directors, board of trustees or owners. Contact ‘with levels above the immediate superior should be initiated only with the superior's knowledge, assuming the superior is. not involved. ‘= Clarify relevant concepts by confidential discussion with an objective advisor to obtain an understanding of possible courses of action. = If the ethical conflict exists after exhausting all levels of internal review, the management accountant may have no other recourse on significant matters that to resign from the organization and to submit an Informative memorandum to an appropriate representative of the organization. Except where legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate. Exercise No. 1 Indicate whether each of the following pertains to financial accounting or managerial accounting. 1, The report is verifiable and reliable. 2. It provides reasonable and timely estimates. 3, The reports are generally delayed and historical. 4, The scope tends to be highly aggregated. 5. Reliance on the criterion of usefulness rather than formal guidelines or restrictions for gathering and reporting information. Contribution approach income statement. The audience tends to be stockholders, creditors, and tax authorities. 8. External users of financial report.EXCEL PROFESSIONAL SERVICE: INC. 9. Focuses on estimating future revenues, costs, and other measures to forecast activities and their results 10. Emphasizes relevance and flexibility rather than precision. 11. Complies with Securities and Exchange Commission rules and regulations. 12. Uses cost-benefit analysis to determine the amount of detail presented. Exercise No. 2 Classify each of the following as either line manager or staff manager. 1. Chief financial officer (CFO). Vice-president for government relations Controller Manager of food and beverage services Flight attendant Exercise No. 3 MULTIPLE CHOICE QUESTIONS 1 3. ‘Which of the following is not an objective of managerial accounting? a. Providing information for decision making and planning. b. Assisting in operations. c. Maximizing profits and minimizing costs. d. Measuring the performance of managers and subunits. . All of the above are objectives of managerial accounting directing and controlling ‘Which statement about the degree of detail in a report is true? a. It depends on the level of the manager receiving the report. b. It may depend on the frequency of the report. c. It depends on the type of manager receiving the report. 4, All of the above. ‘The unit of measurement used in management accounting is primarily the historical peso. - usually current replacement cost. any measurement unit that is useful in a particular situation. d. the measurement unit used by competing ‘companies. ‘The following characteristics refer to Financial ‘Accounting, except ‘a, Provides information to external users b. Emphasizes on objective data c. Has no externally Imposed standards 4d. Generates general purpose financial statement Which of the following characteristics does not relate to management accounting? ‘A. Accounting reports may include non-monetary information B. Itis subject to restrictions imposed by GAAP. C. Reports are often based on estimates and are seldom useful for anything other than the purpose for which they are prepared. D. It provides data for internal users within the business organization. Which of the following groups would be LEAST likely to receive detailed management accounting reports? 10. ret 12. 13. 14. 1s. A. Stockholders . Production supervisors. B, Sales representatives D. Managers Which of the following does not relate to management services by CPAs? ‘A. Design and/or installation of accounting systems. B. Financial analysis for project feasiblity studies. : Cost analysis of major investment dec D. None of the above Which of the following managerial functions involves a detailed financial and operational description of ‘anticipated operations? Decision making. b. Planning. cc. Directing operational activities. 4. Controlling. Trio Company has set various goals, and management Is now taking appropriate action to ‘ensure that the firm achieves these goals. One such action is to reduce outlays for overhead, which have exceeded budgeted amounts. Which of the following functions best describes this process? ‘a. Decision making. b. Planning. . Coordinating. 4. Controlling. Which of the following functions is best described as choosing among available alternatives? a. Decision making, b. Planning. . Directing operational activities. 4. Controlling. Which of the functions of management involves overseeing day-to-day activities? Planning - Directing and motivating . Controlling 4. Decision making The professional certification most relevant for managerial accountants is the a. CMA ©. CSA b. CPA 4. MAS Who is the manager In charge of raising cash for operations and managing cash and near-cash assets? Chief financial officer. . Controller. . Treasurer. 4. Internal auditor. ‘The functions of planning for control, evaluating and consulting, and governmental reporting are typically assumed within organizations by: the company treasurer b. the company controller cc. the company vice-president of marketing 4. external auditors The linked set of activities that increases the usefulness (or value) of the products or services of an organization is the a. direct chain b. indirect chain . value chain d. variable chainEXCEL PROFESSIONAL SERVICE! INC, 16. 47. 18. 19. 20. 21. 24. Which of the following reflects the correct order in 2 value-chain? Research & Development, Design, Production b. Distribution, Customer Service, Marketing . Design, Research & Development, Production d. Distribution, Marketing, Research & Development AA just-in-time manufacturer is more conventional manufacturer to a. receive more frequent deliveries of materials . spend less money on advertising . need workers with fewer skills d. all of the above ly than a A conventional manufacturer Is more likely than a just-in-time manufacturer to a. have a short production cycle . produce goods in small batches cc. hold large inventories to serve as buffers. d. none of the above After careful planning, Jammu Manufacturing Corporation has decided to switch to a just-in-time inventory system. At the beginning of this switch, Jammu has 30 units of product in inventory. Jammu hhas 2,000 labor hours available in the first month of this switch. These hours could produce 500 units of product. Customer demand for this first month is 400 units. If just-in-time principles are correctly followed, how many units should Jammu plan to produce in the first month of the switch? a. 370 c. 430 b. 400 d. 470 ‘A company has a bottleneck operation that slows Production. Which of the following tools or approaches could the firm use to determine the ‘most cost-effective ways to eliminate this problem? a. Linear programming. b. Theory of constraints. c. Decision-tree diagrams. d. Strategic path analysis (SPA). Benchmarking allows managers to: ‘determine who in the industry performs similar Processes most effectively. b. determine the processes that have high value- to-cost relationships. €. compare certain internal processes, services and activities to those of other companies in ‘order to identify strengths and weaknesses. d. reproduce another company’s product design and manufacturing processes to eliminate competitive advantage. ‘An approach to developing new ways to perform existing activities is called a. process value analysis b. re-engineering . caveat analysis d. benchmarking Process Reengineering Includes all of the following steps except: a. constructing a diagram flowchar ‘current process. . redesigning the process. . elimination of non-value-added activities. 4. elimination of all constraints. 9 the ‘An advantage of downsizing is 25. 26. 27. 28. 29. 30. 31. . decreased costs in the long run, b. layoffs. c. one-time losses. 4d. reduced communication. Which of the following are two generic strategies that a company can use? a. growth and product differentiation . price recovery and growth . product differentiation and cost leadership 4. cost leadership and price recovery ‘Which item Is not an IMA Standard for Ethical Conduct? a. Integrity b. Competence c. Loyalty 4. Objectivity ‘A managerial accountant who prepares clear reports ‘and recommendations after analyzing relevant facts Is exercising which of the following standards? a, Objectivity c. Competence b. Integrity d. Confidentiality This principle imposes the obligation on all professional accountants to be fair, intellectually honest, and free of conflicts and interests. a. Integrity b. Objectivity c. Maturity d. Independence in mental attitude Which ethical standard is violated when an ‘accountant uses information from a financial statements he is preparing to advise a relative of a stock purchase? a, Competence b. Confidentiality «. Integrity 4. Credibility Which of the following statements relating to ‘Standards of Ethical Conduct for Management Accountants is correct? a. A management accountant should refuse all gifts and hospitality offered by one of the ‘company’s suppliers. A management accountant should inform his superiors regarding the confidentiality of Information acquired in the course of their work and monitor their activities to assure the maintenance of that confidentiality. A management accountant should prepare complete and clear reports and recommendations before appropriate analyses of relevant and reliable information. d. Management accountants have a responsibility to disclose fully all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, comments, and recommendations presented. ‘The Standards of Ethical Conduct for Management ‘Accountants developed by the Institute of Management Accountants state that when faced with significant ethical issues, management accountants should first: a. discuss such problems with the immediate superior except when it appears that the superior is involved. . clarify relevant concepts by confidential discussion with an objective advisor to obtain an understanding of possible courses of action.EXCEL PROFESSIONAL SERVICE! INC. c. follow the established policies. of the organization bearing on the resolution of such conflict. 4d. submit an informative memorandum describing the ethical issue to an appropriate representative of the organization and resign if nto action is taken as a result of the memorandum. 32. The Standards of Ethical Conduct for Management Accountants developed by the Institute of ‘Management Accountants states that significant ethical issues should be discussed with an immediate superior unless the superior is involved. If satisfactory resolution cannot be achieved when. the problem is initially presented, then the issues should b a. submitted to the next higher managerial level. . submitted to the chief executive officer. . submitted to the audit committee, executive ‘committee, board of directors, or owners. d. submitted to outside legal counsel. 35. 33. Samantha Galloway is a managerial accountant in the accounting department of Mustang Industries, Inc. Samantha has just discovered evidence that some of the corporation's marketing managers have been wrongfully inflating thelr expense reports in order to obtain higher reimbursements from the firm. According to the Institute of Management ‘Accountants’ Standards of Ethical Conduct, what should Samantha do upon discovering this evidence? a. notify the controller. . notify the marketing managers involved. . notify the president of the corporation. d. ignore the evidence because she is not part of the Marketing Department. ‘The performance measurement tool generally associated with the display of information evaluating multiple dimensions of business ‘outcomes is referred to as the: . Balanced scorecard. _c, Kaizen, . Return on Investment. d. Market value added Which of the following best identifies the reason that effective corporate governance is important? |. The separation of ownership from management. . The goal of profit maximization. c. Excess management compensation. d. Lack of oversight by boards of directors. “There Is only one difference between dream and aim. Dream requires soundless sleep to see whereas alm requires sleepless effort to achieve.” - Anonymous @-end-@LECTURE NOTES Cost classifications are used to define costs in terms of their relationships to the following four items: * Time of incurrence = Reaction to changes in activity '* Classification on the financial statements * Impact on decision-making L. Cost behavior refers to the way costs respond to changes in volume or activity. Il. _ Cost object is anything for which management wants to collect or accumulate costs II. Managers use assumptions about cost behavior in almost every decision they make. * When planning, managers use cost behavior to determine how many units of products or services must be sold to generate a targeted amount of profit and how changes in planned activities will affect operating income. ‘= When performing their duties, managers use cost behavior to determine the impact of their decisions on operating income. + When evaluating and reporting on performance, managers analyze how changes in costs and sales affect profitability. IV. _ The behavior of costs . Variable costs. Tota/ costs that change in direct proportion to changes in productive output (or other volume measures). However, on a per unit basis, variable costs remain constant as volume changes. The traditional definition of variable costs assumes that a linear relationship exists between costs and the measure of capacity chosen. 2. Fixed costs are total costs that remain constant within a relevant range of volume or activity. Fixed unit costs vary inversely with changes in activity or volume. 3. Mixed (semi-variable) costs have both variable and fixed cost components. ‘Separating mixed costs into their variable and fixed 1. Engineering method. Separates costs by performing step-by-step analysis of tasks, costs and processes involved. It is also called a time and motion study. 2. Scatter diagram or visual fit method + Used when there is doubt about the behavior pattern of a particular cost. + If the diagram suggests a linear relationship, a cost line can be imposed. ‘The use of scatter diagram (visual fit) usually reveals the presence of outliers. . High-low method + Its disadvantage is that if one or both data points are not representative of the remaining data set, the estimate of variable and fixed costs may not be accurate. + Its advantage is that it can be used when 4. Regression analysis or the least-squares method. ‘+ Mathematically describe the relationship between costs and activities ‘+ Because all data observations are used, the resulting linear equation is more representative of cost behavior than either the high-low or scatter diagram methods. Contribution margin income statements ‘A. Acontribution margin income statement is formatted to emphasize cost behavior rather than organizational functions. Contribution margin (CM) is the amount that remains after all variable costs are subtracted from sales. Operating leverage or cost structure. As part of, planning, the management should consider the operating leverage, L.e., the relationship of fixed costs to variable costs. ‘© Low operating leverage - It is characterized of relatively lower amount of total fixed costs and higher variable costs per unit. This cost relationship involves less operating risk because of having a lower amount of fixed costs. However, because the amount of unit variable cost is higher, the profit potential is lower as the contribution margin per unit when aggregated for the recovery of fixed cost and generation of profit is relatively lower. + High operating leverage - It refers to cost relationship whereby the amount of fixed costs is relatively higher with lower amount of variable cost per unit. Hence, the profit potential is higher but the operating risk is also higher. Note: The high operating leverage is suited for higher activity level. If the company can only operate at a lower level of activity, It Is better to ‘employ low operating leverage because It so risky to have higher amount of fixed costs that may not be fully recovered by the amount of contribution margin. Indifference point. It is the level of volume at which total costs, and hence the amount of profits, are the same under both operating leverage. Based on the indifference point, the manager can choose between the cost-structure alternatives. If the anticipated volume would exceed the indifference point, the manager Is likely to choose higher operating leverage.EXCEL PROFESSIONAL SERVICES, INC. ‘STRAIGHT PROBLEMS PROBLEM NO. 1. Handy Inc. is studying the costs of several clients and has found that the accompanying graphs appear as follows: (Unless told otherwise, assume that the horizontal axis represents total activity and the vertical axis represents total cost). 1. A straight line that gradually slopes upward to the right 2. A curvilinear line that gradually slopes upward to the right 3. A straight line that is parallel to the graph's horizontal axis 4. Astraight line that gradually slopes downward to the right 5. A curvilinear line that gradually slopes downward to the right 6. A straight line that gradually slopes upward to the right and then, at a specific point, flattens out to run parallel to the horizontal axis 7. Aseries of straight lines that appear to resemble a set of steps Requirement: For items A-E, which graph listed above best represents the cost behavior pattern described. ‘A. The salary cost of lab technicians employed at 2 clinic. One technician is needed for every 1,500 patients serviced. B. The cost of glass used by a manufacturer of, ‘automobile windshields. C. A profit-sharing bonus that is paid to the ‘associate director of a firm that conducts professional-development courses for executives. ‘The bonus is based on revenues from courses that are being run, subject to a maximum amount each year. D. Flood insurance premiums that are paid by Reliable Manufacturing, which operates a Production facility close to a river. E. The paper cost that is used in the production of a textbook. Note: Assume that for this part only, the graph's vertical axis represents the cost per unit rather than total cost. PROBLEM NO. 2. Bronze Products has presented the _ following information for the past eight months operations: Month = Units April 8,000 P30,400 May 6,400 25,800 June 3,800 18,300 Buly 5,600 23,200 ‘August 7,000 26,000 September 8,400 29,800 October 7,800 26,500 November 6,800 25,700 Requirement 1. Using the high-low method, calculate the fixed cost per month and variable cost per unit. 2. What would total costs be for a month with 5,000 units produced? PROBLEM NO. 3. Prima Mover Co. operates a fleet of delivery trucks in Manila. The company has determined that if a truck is driven 120,000 kilometers during a year, the average operating costs is P4.80 per kilometer. if a truck is driven only 80,000 kilometers during a year, the average operating cost increases to P5.20 per kilometer. Requirements: 1. Using the high-low method, estimate the variable and fixed cost elements of the annual cost of truck operation. 2. Express the variable and fixed costs in the form Y = a+ bx. 3. If a truck were driven 110,000 kilometers during a year, what total cost would you expect Prime to incur? PROBLEM NO. 4. 2) Movers Inc. documented the miles driven and total moving van costs for the past five months as follows: Number of miles January 2,000 4,800. February, 2,500. 5,050. March '5,000. 6,100. ‘April 4,000. 5,600. May 5,000 6,000. In order to budget total vehicle costs for the upcoming summer months, 2) wishes to estimate total vehicle costs using the high-low method. Requirements: 1. What is the equation to predict estimated total vehicle costs? 2. If the company expects to drive 7,500 miles in June, what will be the estimated total vehicle costs? PROBLEM NO. 5. St. Dominic's Hospital contains 450 beds. The average occupancy rate is 80% per month. In other words, on average, 80% of the hospital's beds are ‘occupied by patients. At this level of occupancy, the hospital's operating costs are P32 per occupied bed per day, assuming a 30-day month. This P32 figure contains both variable and fixed cost elements. During the month of June, the hospital's occupancy rate was only 60%. A total of P326,700 in operating cost was incurred during the month, Requirements: 1. Using the high-low method, estimate the variable cost per occupied bed on a dally basis and the total fixed operating costs per month. 2. Assume an occupancy rate of 70% per month. What amount of total operating cost would you expect the hospital to incur? PROBLEM NO. 6. Sulucan Medical Center has collected data on all of its activities for the past seven months. Data for the cardiac nursing care follo Cost Hours of Nursing Care September 2022 69,500 3,700 October 2022 64,250 1/550 November 2022 52,000 1,200 December 2022 66,000 1,600 January 2023, 83,000 1,800 February 2023 66,550 1,330 March 2023 79,500 1,700EXCEL PROFESSIONAL SERVICES, INC. Requirements: 1. Using the high-low method, calculate the variable rate per hour and the fixed cost for the nursing care activity. 2. Upon looking into the events that happened at the end of 2022, you find that the cardiology ward bought a cardiac-monitoring machine for the nursing station. A decision was also made to add ‘a new supervisory position for the evening shift. Monthly depreciation on the monitor and the salary of the new supervisor totals P10,000. Calculate the fixed cost and variable ‘rate applicable to November 2022 and the fixed cost and variable rate applicable to March 2023? What is the expected cost for the month of April 2017 assuming that the center operates at 75,000-patient level with 1,750 hours of nursing care? PROBLEM NO. 7. Below are cost and activity data for a particular cost over the last four periods. Your boss has asked you to analyze this cost so that management will have 2 better understanding of how this cost changes in response to changes in activity. Activity Cost Period i 41 [468 Period 2 43 | 484 Period 3 48 520 Period 4 46 | 499) Using the least-squares regression method, estimate the cost formula for this cost. PROBLEM NO. 8. Airline, Inc. used Excel to run a least-squares regression analysis, which resulted in the following output: Regression Statistics Multiple R 0.7225 R Square 0.8500 Observations 30 Constant 38,000 Coefficient 5.75 Standard error 0.4641 Requirement . What is Newport's total fixed cost? 2. What is Newport's variable cost per unit? 3. What total cost would Newport predict for a month in which they sold 5,000 units? 4. What proportion of variation in Newport's cost is explained by variation in production? PROBLEM NO. 9. Indie, Inc. uses a semi-automated process in its Production. It is faced with a proposal to completely automate its production. Below are data for these alternative methods: Complete Semi-Automated ‘Automation Materials cost per unit P12.00 P10.50 Labor cost per unit 3.00 15.00 Other variable cost/unit 4.50 3.00 Lease cost per year 75,000 30,000 Maintenance cost/year 15,000 6,000 What is the indifference point? PROBLEM NO. 10. Total production costs for Jorrel, Inc. are budgeted at 2,300,000 for 50,000 units of budgeted output and 2,800,000 for 60,000 units of budgeted output. Because of the need for additional facilities, budgeted fixed costs for 60,000 units are 25 percent more than budgeted fixed costs for $0,000 units. How much is Jorrel’s budgeted variable cost per unit of output? MULTIPLE CHOICE QUESTIONS 1. Variable costs within the relevant range a. stay constant on a per unit basis as output ‘changes. b. increase in total as output increases . decrease in total as output decreases d. all of these are correct 2. When a mixed cost is graphed the slope of the line equals tthe fixed cost per unit of output b. the total cost per unit c. the sales price per unit d. the variable cost per unit of the activity driver 3. Advantages of the high-low method include all of the following except ‘only two observations are required to develop the cost function . any two observers will arrive at the same ‘conclusion . the method is quick to use and easy to understand d. the data points used represent a typical cost- activity relationships 4, Advantages of the method of least squares over the high-low method include all of the following except 2, a statistical method is used to mathematically derive the cost function b, only two points are used to develop the cost function . the squared differences between actual ‘observations and the line (cost function) are minimized 4d, all the observations have an effect on the cost function 5. In regression analysis, which of the following correlation coefficients ‘represents the strongest direct relationship between the independent and dependent variables? a. 1.03 c -89 b. -.02 d. 75 6. Cost structure refers to the relative proportion of: a. variable costs to contribution margin. b. total costs to sales. . fixed costs to variable costs. d. sales price per unit to variable costs per unit. 7. Stella, Inc. must perform maintenance on its production machinery after every 10,000 units Produced. Production varies between 12,000 and 30,000 units a year. The cost of this maintenance would be classified as a. variable cost b. fixed cost c. step cost d. mixed cost 8. Norman Company pays a sales commission of 5% fon each unit sold. If a graph is prepared, with the vertical axis representing per-unit cost’ and the horizontal axis representing units sold, how would a line that depicts sales commissions be drawn?EXCEL PROFESSIONAL SERVICES, INC. 10. A. 12. 1B. 14 45. a. As a straight diagonal line, sloping upward to the right. b. As a straight diagonal line, sloping downward to the right. . Asa horizontal line. d. Asa vertical line. Fixed costs that cannot be reduced within a short period of time are a. committed. b. variable. c. avoidable. d. unnecessary. Which cost is least likely to be direct to a particular product? a. Salaries of salespeople who sell all of the company's products. b. Advertising of the product. c. License fees paid to the designer of the product, d. Cost of materials used to make the product. Which of the following is assigned to goods that were either purchased or manufactured for resale? a. Relevant cost. . Opportunity cost. b. Period cost. d. Product cost. Ifa cost can be reduced to zero in the short run without significantly harming the organization, the cost isa a. variable cost. b. committed cost. ¢. discretionary cost. d. product cost. In managerial accounting, the term “relevant range” Is often used to describe a. The theoretical maximum and minimum ranges the company could operate in. b. The range over which costs fluctuate. c. The range over which relevant costs are incurred. d. The range over which cost relationships are valid. ‘The following data have been collected for four different cost items. Cost Item Cost at 100 units Cost at 140 units w 8,000 10,560 x 5,000 5,000 Y 6,500 9,100 Zz 6,700 8,580 Which of the following classifications of these cost items by cost behavior is correct? Cost W CostX CostY CostZ a. variable fixed mixed variable b. mixed fixed variable mixed variable fixed variable variable d. mixed fixed mixed — mixed The following production and average cost data per unit for two levels of monthly production volume have been supplied by a company that produces a single product: Production volume 2,000 units 4,000 units Direct materials P88.40 88.40 Direct labor 20.60 20.60 Manufacturing OH 86.90 55.30 ‘The best estimate of the total monthly fixed manufacturing cost is: a. P221,200 S b. P391,800 a. 173,800 126,400 16. The following data pertains to activity and costs for ‘two months June: July ‘Activity level in 10,000 720,000 units. Variable costs 20,000 Pp? Fixed costs 15,000 2 Mixed costs 10,000 2 Total costs 45,000 70,000 ‘Assuming that these activity levels are within the relevant range, the mixed costs for July were: ‘A. P10,000. 8B. P35,000. C. P15,000. 1D. P40,000. 17. At an activity level of 10,000 units, variable costs totaled P35,000 and fixed costs totaled P20,800. If 16,000 units are produced and this activity is within the relevant range, then: A. total cost would equal P89,280. B. total unit cost would equal P4.80. . fixed cost per unit would equal P5.58. D, total costs would equal P55,800. 18. In the course of your analysis of the maintenance cost for 3 levels of activity (months) using the “least squares method", you came up with the following summations: ‘Sum of hours 690 Sum of costs 2,625 Sum of hours x cost 607,250 ‘Sum of hours squared 160,100 What would be the estimated maintenance cost at a normal capacity of 400 hours per month? a. P1,000 c. P1,500 b. P1,300 d. P2,000 19. Sender, Inc. estimates parcel mailing costs using data shown on the chart below. P 75,000 15,000 0 Parcels 20,000 What is Sender's estimated cost for mailing 15,000 parcels? ‘A. P36,000 B. P45,000 c. P51,000 1D. P60,000 Use the following information for the next two questions. Castelo, Villasin and Barrera Is a large, local accounting firm located in Cebu. Belle Castelo, one of the Firm's founders, appreciates the success her firm has enjoyed and wants to give something back to her community. She believes that an inexpensive accounting services diinic could provide basic accounting services for small businesses located in the province. She wants to price the services at cost. Since the clinic is brand new, it has no experience to go on. Belle decided to operate the clinic for two months before determining how much to charge per hour on an ongoing basis. As a temporary measure, the dinicEXCEL PROFESSIONAL SERVICES, INC. adopted an hourly charge of P50, half the amount charged by Castelo, Villasin and Barrera for professional services. ‘The accounting services clinic opened on January 1. During January, the clinic had 120 hours of professional service. During February, the activity was 150 hours. Costs for these two levels of activity usage are as follows: Professional hours: 20 hours | 150 hours | Salaries ‘Senior accountant P2,500 P2,500 Office assistant 1,200 1,200 Internet and software "700 850 subscriptions Consulting by senior 7,200 1,500 partner Depreciation 2,400 2,400 (equipment) ‘Supplies ‘305, 1100 ‘Administration 500 ‘500 Rent (offices) 2,000 2,000 Utilities 332 365 20. The clinic's monthly fixed costs amount to: 8,600 - P9,025 c. P425 d. P12,189 21. Apple Baby, the chief paraprofessional of the clinic, has estimated that the clinic will average 140 professional hours per month. If the clinic is to be operated as a nonprofit organization, how much will it need to charge per professional hour? a. P97.81 b. P87.06 c. P82.77 d. P22.60 Use the following information for the next four questions. A local church wants to rent a hall for P3,000 a day to hold a Bingo fundraiser. Every session of bingo requires a caller for P200. There are supplies that are needed that cost P3 per person playing bingo. On average each bingo player spends P20 and 1,000 people attend each session. P10,000 in prizes are awarded each session. 22. Total costs for 1 session can be classified as: Fixed Costs Variable Costs a. P13,200 P3 b. —_P3,000 P13,200 c. —-P13,200 P3,000 4. P10,000 P3,200 23. The church conducts 1 Bingo session per month. Over the course of the year, which cost would not act as a variable cost based on just holding one more session? a. Hall Rental b. Cost of Supplies c. Caller Salary d. Prize Money 24, If the church conducts 12 sessions and 1,000 People attend in each session, then the average cost per session is? a. 9,600 b. 14,700 €. 15,200 d. 16,200 25. The church is thinking of holding 2 Bingo sessions per day with 1,000 people attending each session. If they hold the 2 sessions, then the average cost per session is? a. 9,600 b. 14,700 ¢. 15,200 d. 16,200Cost-volume-profit (C-V-P) analysis as a tool for and control. ‘A. a procedure that examines changes in costs and volume levels and the resulting effects on profit. B. Sales Revenue - Variable Costs - Fixed Costs = Profit €. Tool for both planning and control. 1. Can calculate net income when sales volume is known 2. Can determine the level of sales need to reach a targeted amount of income. D. Only used under certain conditions and when certain assumptions hold true, 1. The behavior of variable and fixed costs can be measured reasonably. 2. Costs and revenues have a close linear ‘approximation. 3. Efficiency and productivity hold steady within the relevant range. 4. Cost and price variables hold steady during the period being planned, 5. The product sales mix does not change during the period being planned. 6. Production and sales volume are approximately equal. Break-even sales is the point or sales volume where total Fevenues equal total costs. This is the level of activity where there neither profit nor loss. At break-even point, the total contribution margin ‘equals total fixed expenses. Methods of Computing Break-even Point 1 i. 3. Equation method or algebraic approach Contribution margin methad or formula approach Graphical calculation Contribution Margin. Unit contribution is the difference between the unit selling price and the unit variable ‘expenses. Total contribution margin is difference between the total revenues and the total variable expenses. Sales Mix. The composition of total sales in terms of various products, i-e., the percentage of each product included in total sales. ‘Margin of Safety ~ Indicates the amount by which actual or planned sales may be reduced withaut incurring a loss. It is the excess of actual or planned sales volume over break-even sales. This can be expressed in terms of units or in pesos. Margin of safety is the percentage of margin of safety to total actual or planned sales. Factors Affecting Break-even Point awNe Selling price per unit Variable cost per unit Fixed cost Sales mix Operating Leverage. A measure of the extent to which fixed costs are being used in an organization. The greater the fixed costs in relation to variable cost, the greater is the operating leverage available and the greater is the sensitivity of net income to change in sales. Degree of Operating Leverage. A measure, at a given level of sales, of how a percentage change in sales volume will affect profits. DOL is computed: DOL = Total contribution margin/Net income % Increase in Net Income = (% Increase in Sales x Bot) STRAIGHT PROBLEMS PROBLEM NO. 1. ‘The following data are available for Marina Company's one product. Unit selling price P 800 Unit variable cost ‘Manufacturing 400 Selling and Administrative 240 Fixed costs ‘Manufacturing 1,640,000 Selling and Administrative 920,000 Unit Volume 24,000 Requirements: 1. Unit contribution margin and Contribution margin, ratio 2. Total contribution margin 3. Break even volume in units and pesos Margin of safety in units, pesos and margin of safety ratio . Degree of operating average . Selling price that Marina must charge to double the operating profit based on the given cost structure, still selling 24,000. PROBLEM NO. 2. Cindy, Inc., sells a single product. The company's most recent income statement Is given below. Sales (5,000 units) 750,000 Less variable expenses 300,000 Contribution margin ‘450,000 Less fixed expenses 270.000 ‘Operating income P180,000 Requirements: 1. If 1,500 more units are sold, how much increase in profit is expected? If sales volume increases 15 percent compute the ew profit. 3, If the firm were able to increase its sales volume by 15 percent without a change in its selling price, variable costs, or fixed costs, would this change the breakeven point? 4. If the firm were able to increase both its selling price and variable cost by 20 percent, would the breakeven point in units or in pesos change? 5. Prepare comparative income statements at sales level of 4,000 and 6,000 units. 2.PROBLEM NO. 3. ‘After its cost Structure (variable costs P11.25 per unit ‘and monthly fixed costs of 90,000) and potential ‘market, Boni Company established what it considered to bbe a reasonable selling price. The company expected to ssell 50,000 units per month and planned its monthly ‘results as follows: ‘Sales 750,000 Variable costs 362,500 ‘Contribution margin 187,500 Fixed costs — 20,000 Income before taxes 97,500 ‘Income taxes 39,000 Net income 58,500 Requirements: 1. If the company determined that a particular advertising campaign had a high probability of increasing sales by 3,000 units, how much could it pay for such a campaign without reducing its planned profits? 2. If the company wants a P90,000 before-tax profit, how many units must it sell? 3. If the company wants a 10% before-tax return on sales, what level of sales, in pesos, does it need? 4. If the company wants a P90,000 after-tax profit, how many units must it sell? 5. If the company wants an after-tax return on sales of 9%, how many units must it sell? ‘6. The company is considering offering its salespeople 25% commission on sales. What would the total sales, in pesos, have to be in order to implement the commission plan and still eam the planned bbefore-tax income of P65,000? PROBLEM NO. 4, Mercy Company has, for the coming year, budgeted sales of P2,000,000\ with contribution margin of 60 percent and fixed costs of P700,000. The company’s ‘only one product line sells for P40. The company is ‘Subject to 30 percent tax bracket. Requirements: 1. If the company determined that a particular advertising campaign had a high probability of increasing sales by P150,000, how much could it Pay for such a campaign without reducing its planned annual profits? 2. A plan includes an increase in advertising cost of P120,000. What is the minimum increase in peso sales to compensate for the Increase in advertising cost? 3. The operations manager believes that the variable cost will increase to P18 per unit. The sales manager believes the selling price can be Increased. What is the new selling price that will give the same contribution margin ratio of 60%? 4, Assume that the amount of total fixed cost Increases by 15%. What Is the effect of this increase on each of the following? a, Break-even sales volume b, Before-tax profit . Contribution margin d. Required sales to earn same amount of profit PROBLEM NO. 5. ‘The Color Company manufactures and sells two products. The selling prices and variable costs of the products are as follows: Biujets Blupens Selling prices P20 P40 Variable costs 8 24 ‘The sales for the year were in the ratio of 3 Blujets to 1 Blupen. Sales volume for the year was P1 million. Fixed costs for amounted to P390,000. Requirements: 1. Compute the number of units sold for each product. 2. Compute the breakeven sales in pesos and in units. 3. Compute the composite breakeven for the company. 4. If the sales mix was to change to 2 units of Blujets to 1 unit of Blupen, would this have any effect on the breakeven sales? If s0, what would be the new breakeven sales? 5. Assuming that the sales volume would remain at PA million, what net income would be generated Using the Sales mix in number (4) above? ‘What sales revenue would be required if the firm wishes to generate a net income of P328,900 if the original mix of 3:1 prevailed? 6 PROBLEM NO. 6. Bruno Company and Berto Company both make rocking chairs. They have the same production capacity, but Bruno is more automated than Berto. At an output of 4,000 chairs per year, the two companies have the following costs: uno Berto Fixed costs 400,000 200,000 Variable costs at P100 per 100,000 chair Variable costs at P300 per 300,000 chair Total cost 500,000 _P500,000 Unit cost (1,000 units) P50 500 Requirements: ‘Assuring that both companies sell chairs for P700 each and that there are no other costs or expenses for the ‘two firmas, complete the following: 1. Which company will lose the least money if production and sales fall to 500 chairs per year? 2. How much would each company lose at production and sales level of 500 chairs per year? 3. How much would each company make at production and sales levels of 2,000 chairs per year? PROBLEM NO. 7. Cabuyao Hospital operates a general hospital but rents space and beds to separate entities for specialized treatment such as pediatrics, maternity, psychiatric, etc. Cabuyao charges each separate entity common services to its patients like meals and laundry and for all administrative services such as billings, collections, etc. All uncollectible accounts are charged directly to the entity. Space and bed rentals are fixed for the year. For the entire year ended June 30, the Pediatrics Department at Cabuyao Hospital charged each patient an average of PESO per day, had a capacity of 60 beds, operated 24 hours per day for 365 days, and had revenue of P10,676,250. Expenses charged by the hospital to the Pediatrics Department for the year ended June 30 were:LECTURE NOTES A standard Is @ benchmark or “norm” for measuring performance. In managerial accounting, standards relate to the cost and quantity of inputs used in manufacturing goods or providing services. A standard cost Is the expected or budgeted cost of materials, labor, and manufacturing overhead required to produce ‘one unit of product. ‘Two reasons for adopting a standard cost system are: To improve planning and control. A standard cost system compares actual amounts with standard amounts to determine variances from the standard. To faciitate product costing. Standard costing uses standard costs for direct materials, direct labor, and overhead. Standard cost systems provide readily available unit cost information that can be used for pricing decisions. Setting Standard Costs. Standards should be set so that they encourage efficient operations. Ideal versus practical standard. Standards tend to fall into one of two categories—either ideal or practical. ‘* Ideal standards allow for no machine breakdowns or work interruptions and require that workers operate at peak efficiency 100 percent of the time. Since ideal standards are rarely met, most managers believe they tend to discourage even the most diligent workers. * Practical standards are “tight, but attainable.” They allow for normal machine downtime and employee rest periods and can be attained through reasonable, but highly efficient, efforts by the average worker. ‘A General Model for Variance Analysis. A variance Is the difference between standard prices and quantities on the one hand and actual prices and quantities on the other hand. A general model can be used to describe the variable cost variances. ‘The total budget variance is the difference between actual cost of inputs and the standard (or planned) cost of inputs. ‘There are two variances for variable production costs: 1. Price or rate variances—the difference between actual costs of inputs and what the inputs should have cost (standard prices). 2. Usage or efficiency varlances—the difference between the actual quantity used and the standard ‘quantity allowed for units produced. Alternative methods. As an alternative to the general model, variances can be computed by formulas. The formulas for the price variance are: Price (rate) variance = (AQ x AP) - (AQ x SP) or Price (rate) variance = AQ (AP - SP) ‘The formulas for the quantity variance are Quantity (efficiency) variance = (AQ x SP) ~ (SQ x SP) or Quantity (efficiency) variance = SP (AQ - SQ) Where: ‘AQ = Actual quantity of inputs purchased (or used) ‘AP = Actual price per unit of inputs purchased ‘SP = Standard price per unit of input ‘SQ = Standard input allowed for the actual output Computation and Interpretation of Standard Cost Variances. Since direct material, direct labor, and variable overhead are all variable manufacturing costs, the process of computing price and quantity variances for each cost category is the same. The general model can be used in each case to compute the variances. The only complication is deciding in each case whether the actual quantity of inputs refers to the actual quantity purchased or the actual quantity used. Static Budgets. The term static 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. The flexible budget will show the cost formula for each variable cost and total cost (possibly including fixed costs) at various levels of activity. Applying Overhead in a Standard Cost System. Overhead can be applied to units based on actual hours or standard hours allowed for the actual output. In a standard cost system it is simplest to apply ‘overhead on the basis of the standard hours allowed for the actual output. This results in each unit being assigned the same overhead cost—regardless of how many hours were actually required to make the unit. 1, Variable overhead variances. a. The variable overhead spending variance is computed as follows when the variable overhead rate is expressed in terms of direct labor-hours: Variable overhead spending variance = (Actual overhead cost - Actual input hours) x Variable overhead rate ‘The variable overhead spending variance compares actual spending on variable overhead to the amount of spending that would be expected, given the actual direct labor-hours for the period. b. The variable overhead efficiency variance is computed as follows when the variable overhead rate is expressed in terms of direct labor-hours: Variable overhead efficiency variance = (Actual hours - Standard hours allowed) x Variable overhead rate 2. Fixed Overhead Variances in a Standard Cost System. Two variances are computed for fixed overhead—a budget variance and a volumevariance. These variances are quite different from the variances computed for variable overhead. ‘a. 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. This variance Is very useful in that it indicates how well spending on fixed items was controlled. b. Volume Variance. The volume variance is the difference between the total budgeted fixed overhead and the fixed overhead applied to production. Alternatively, it can be expressed as the difference between the denominator level of activity and the standard hours allowed for the output of the period, multiplied by the fixed portion of the predetermined overhead rate. The volume variance occurs because the denominator level of activity differs from the standard hours allowed for production. Thus, an unfavorable variance means that the ‘company operates at an activity level below the denominator level of activity. Conversely, a favorable variance means that the company operates at an activity level greater than the denominator level of activity. c. Fixed Overhead Rate based on Practical Capacity. Although fixed overhead are often based on budgeted production levels, it may be a better approach if it is based on practical capacity. Practical capacity is the volume that could be achieved under normal (not ideal) operating conditions. It allows some downtime for necessary activities such as employee training, shift changes, breaks, and preventive maintenance. Using the capacity supplied as the denominator when calculating the fixed overhead rate (as opposed to the amount of capacity actually used) prevents the rate from fluctuating due to changes in demand. It also highlights the cost of unused capacity for management attention. PROBLEM NO. 1. May, Inc. prepared the following master budget items for the month of November: Production and sales (units) 30,000 Variable manufacturing costs Direct materials 75,000 Direct labor 60,000 Variable manufacturing OH 45,000 Fixed manufacturing OH 120,000 Total manufacturing costs -_—P300,000 Requirement: During November, May actually produced and sold 32,000 units. Prepare a flexible budget for May based on actual sales. PROBLEM NO. 2. Martina Company manufactures a powerful cleaning solvent. The main ingredient in the solvent is a raw material called Echol. Information on the purchase and use of Echol follows: Purchase of Echol: Echol is purchased in 15-gallon container at a cost of P115 per container. A discount of 5% is offered by the supplier for payment within 10 days, ‘and Martina Company takes all discounts. Shipping costs, which Martina Company must pay, amount to P130 for an average shipment of 100 15-galion containers of Echol. Use of Echol: The bill of materials calls for 14.25 quarts of Echol per bottle of cleaning solvent. (There are four quarts in a gallon.) About 5% of all Echol used is lost through spollage or evaporation (the 14.25 quarts above is the actual content per bottle.) In addition, statistical analysis has shown that every 31% bottle is rejected at final inspection because of contamination. Requirements: 1. Compute the standard purchase price for one quart of Echol. 2. Compute the standard quantity of Echol (in quarts) Per salable bottle of cleaning solvent. PROBLEM NO. 3. ‘The following standard costs were developed for one of the products of LT Inc. Materials: 2.5 Ibs. x P6 per Ib. pis Direct labor: 1.5 hours x P12 per hour 18 Variable OH: 1.5 hours x P4 per hour 6 Fixed OH: 1.5 hours x P8 per hour 42 Total standard cost per unit PSL The following information is available regarding the ‘company's operations for the period: Units produced: 52,000 Materials purchased: 150,000 Ibs. @ P5.90 per Ib. Materials used: 136,000 Ibs. Direct labor: 80,000 hours costing 944,000 Manufacturing OH incurred: Variable 325,000 Fixed 640,000 Budgeted fixed manufacturing overhead for the period |s P600,000, and the standard fixed overhead rate is based on expected capacity of 75,000 direct labor hours. Requirements: 1. Materials price variance 2. Materials usage variance 3. Direct labor rate variance 4. Direct labor efficiency variance 5. Total overhead variance 6. Two-way overhead variance analysis 7. Three-way overhead variance analysis 8. Four-way overhead variance analysis PROBLEM NO. 4. Father & Son Corporation manufactured 22,000 helmets during September. The overhead cost-allocation base is P8 per machine-hour. The following variable overhead data pertain to September: Actual Budgeted Production (units) 22,000 20,000 Machine-hours 28,000 25,000 Variable OH per MH: 9.00 8.00 Requirements: 1. What is the actual variable overhead cost? 2, What is the variable overhead flexible-budget amount? 3. What is the variable overhead spending variance? 4. What is the variable overhead efficiency variance? PROBLEM NO. 5. Macao's Corporation manufactured 12,000 golf bags during March. The fixed overhead cost-allocation rate is P15.00 per machine-hour. The following fixed ‘overhead data pertain to March:Actual t 10,000 units Production 12,000 units Machine-hours 8,200 hours 8,000 hours Fixed OH cost 122,000 120,000 Requirements: 1. What is the flexible-budget amount? 2. What is the amount of fixed overhead allocated to production? 3. What is the fixed overhead budget and production-volume variance? PROBLEM NO. 6. The flexible budget formula for total overhead for Star Division of Waterous Company is P360,000 + P8 per direct labor hour. The combined overhead rate is P20 per direct labor hour. The following data have been recorded for the year: ‘Actual total overhead 580,000 Total overhead spending variance 16,000 U Volume variance 24,000 U Requirements: Using a three-variance approach, determine the number of standard hours allowed and actual hours of direct labor hours worked. PROBLEM NO. 7. ‘Sharp Company manufactures a product for which the following standards have been set: SQorsH SPorSR Direct materials" 3feet PS per ft. PAS, Direct labor hours? per hr. 2 During March, the company purchased direct materials at 2 cost of P55,650, all of which were used in the production of 3,200 units of product. In addition, 4,900 hours of direct'labor time were worked on the product during the month. The cost of this labor time was 36,750. The following variances have been computed for the month: Materials quantity variance 4,500 U ‘Total labor variance 1,650 F Labor efficiency variance ‘800 U Requirements: 1. For direct materials: 2.Compute the actual cost per foot for materials for March. b.Compute the materials price variance and a total variance for materials. 2. For direct labor: 2.Compute the standard direct labor rate per hour. b.Compute the standard hours allowed for the ‘month's production. ¢.Compute the standard hours allowed per unit of Product. PROBLEM NO. 8. Jacinto Metal works has provided the following informatio Standards: Per unit Materials, 5 m. @ P20 100 Direct labor, 3 hours @ P32 96 Variable OH, 3 hours @ PB 24 ‘xed OH, 3 hours @ P25 75 Budgeted production = 6,000 units Actual results: Materials purchased, 36,000 m. 774,000 Materials used, 28,875 m. Direct labor, 16,650 hours 524,475 Variable OH 134,865 Fixed OH Units produced & sold 445,000 5,500 units Requirements: 1. Analyze all the manufacturing cost variances 2. Prepare the journal entries to record the following transactions. Assume Metals does not maintain inventories other than direct materials. a. purchase of direct materials on account b. issuance of direct materials to production c. incurrence of direct labor d. incurrence of variable overhead e. incurrence of fixed overhead f. application of overhead 9. closing of overhead to cost of goods sold PROBLEM NO. 9. Energy Products produces a gasoline additive, Gas Gain. This product increases engine efficiency and improves gasoline mileage by creating a more complete burn in the ‘combustion process. Careful controls are required during the production process to ensure that the proper mix of Input chemicals is achieved and that evaporation is controlled. If the controls are not effective, there can be loss of output and efficiency. The standard cost of Producing a 500-liter batch of Gas Gain is P13,500. The standard materials mix and related standard cost of each chemical used in a 500-liter batch are as follows: ‘Chemical Mix SP Echo! 200 liters P20.00 4,000 Protex 100lliters 42.50 4,250 Benz 250 liters 15.00 3,750 cT-40 —_S0lliters 30.00 —1:500 600 liters, P13,500 ‘The quantities of chemicals purchased and used during the current production period are shown in the schedule below. A total of 140 batches of Gas Gain were manufactured during the current production period. Energy Products determines its cost and chemical usage variations at the end of each production period. ‘Chemical ‘Quantity Used Echo! 26,600 liters Protex 12,880 liters Benz 37,800 liters cT-40 2.140 liters 184,420 liters Requirements: ‘Compute the total materials usage variance and then break down this variance into its mix and yield ‘components. PROBLEM NO. 10. Basic Foods expected to sell 30,000 of its fishcharon at P300 each. It actually sold 29,000 at P298. Variable ‘cost per pack is P140. Determine the sales price variance and sales volume variance. MULTIPLE CHOICE QUESTIONS Which of the following would produce a labor rate variance? ‘a. Poor quality materials causing breakage and work interruptions. b. Use of persons with high hourly wage rates in tasks that call for low hourly wage rates. c. Excessive number of hours worked in completing a job. d. An unfavorable variable overhead spending variance.Which of the following factors would cause an unfavorable material quantity variance? a. using poorly maintained machinery b. using higher quality materials . using more highly skilled workers d. receiving discounts for purchasing larger than ‘normal quantities Using more highly skilled direct laborers might affect which of the following variances? a. direct materials usage variance . direct labor efficiency variance . variable manufacturing overhead efficiency variance d. all of the above ‘A company would most likely have an unfavorable labor rate variance and a favorable labor efficiency if a. the mix of workers used in the production process was more experienced than the normal mix b. the mix of workers used in the production process was less experienced than the normal mix © workers from another part of the plant were used due to an extra heavy production schedule d. the purchasing agent acquired a very high quality of material that resulted in less spoilage The primary difference between a fixed (static) budget and a variable (flexible) budget is that a fixed budget: a. cannot be changed after the period begins; while a variable budget can be changed after the period begins is a plan for a single level of sales (or other measure of activity); while a variable budget consists of several plans, one for each of several levels of sales (or other measure of activity) . includes only fixed costs; while variable budget includes only variable costs 4. is concerned only with future acquisitions of fixed assets; while a variable budget is concerned with expenses that vary with sales b. ‘The term “standard hours allowed” measures a, budgeted output at actual hours. b. budgeted output at standard hours. . actual output at standard hours. 4. actual output at actual hours. ‘At the end of a period, a significant material ‘quantity variance should be a. closed to Cost of Goods Sold. b. allocated among Raw Material, Work in Process, Finished Goods, and Cost of Goods Sold. ¢. allocated among Work in Process, Finished Goods, and Cost of Goods Sold. d. carried forward as a balance sheet account to the next period. ‘An unfavorable price variance for direct materials might indicate: a. that the purchasing manager purchased in smaller quantities due to a change to just-in- time inventory methods b. congestion due to scheduling problems . that the purchasing manager skillfully negotiated a better purchase price 4. that the market had an unexpected oversupply of those materials 10. Lm 12. 13. 14. 15. ‘An unfavorable efficiency variance for direct manufacturing labor might indicate that: a. work was efficiently scheduled b. machines were not properly maintained c. budgeted time standards are too lax d. more higher skilled workers were scheduled than planned One of the primary reasons for using cost variances re a. they diagnose the cause of a problem and what. should be done to correct it b. for superiors to communicate expectations to lower-level employees . to administer appropriate disciplinary action 4. for financial control of operating activities and understanding why variances arise The fixed overhead cost variance can be further subdivided into the: a. price variance and the efficiency variance b. spending variance and flexible-budget variance c. production-volume variance and the efficiency Variance 4. flexible-budget variance and the production- volume variance ‘A favorable fixed overhead spending variance might indicate that: a. more capacity was used than planned b. the denominator level was less than planned . the fixed overhead cost-allocation base was not used efficiently 4. a plant expansion did not proceed as originally planned The variance least significant for purposes of controlling costs is the ‘2. material quantity variance. b. variable overhead efficiency variance. c. fixed overhead spending variance. 4d. fixed overhead volume variance. Which of the following statements about the selection of standards Is true? a. Ideal standards tend to extract higher Performance levels since they give employees something to live up to. b. Currently attainable standards may encourage operating inefficiencies. c. Currently attainable standards discourage ‘employees from achieving their full performance potential. 4. Ideal standards demand maximum efficiency which may leave workers frustrated, thus causing a deciine in performance. e. None of the above statements Is true Which of the following statements regarding standard cost systems is true? ‘a. Favorable variances are not necessarily good variances. b. Managers will investigate all variances from standard. c The production supervisor is responsible for material price variances. 4. Standard costs cannot be used for planning purposes since costs normally change in the future. @. None of the above statements is true generally