1. Welcome Back
Atef Abuelaish

2. Welcome Back
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3. Master Budget Process for a Manufacturer
This slide summarizes the master budgeting process for a company that manufacturers a product. The master budgeting process typically begins with the sales budget and ends with a cash budget and budgeted financial statements. The master budget includes individual budgets for sales, production (or purchases), various expenses, capital expenditures, and cash.
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4. Sales Budget Sales Budget
The first step in preparing the master budget is the sales budget, which shows the planned sales units and the expected dollars from these sales.
Sales Budget
Estimated Unit Sales
Estimated Unit Price
The first step in preparing the master budget is the sales budget, which shows the planned sales units and the expected dollars from these sales. The sales budget is the starting point in the budgeting process because plans for most departments are linked to sales. The marketing department is usually responsible for developing the sales budget. A company’s sales personnel are usually asked to develop predictions of sales for each territory and department. Companies may also take a broader view by using economic forecasting models.
Analysis of economic and market conditions + Forecasts of customer needs from marketing personnel
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5. Production Budget
A manufacturer prepares a production budget, which shows the number of units to be produced in a period.
The production budget is based on the unit sales projected in the sales budget, along with inventory considerations.
A manufacturer prepares a production budget, which shows the number of units to be produced in a period.
The production budget is based on the unit sales projected in the sales budget, along with inventory considerations.
This slide depicts the general computation for the production required for a period. We start with budgeted ending inventory. Then, we add the budgeted sales units for the period which came from the Sales budget. This will give us the required units needed for the period. Then, we subtract the number of units in beginning inventory and we are left with the total units to be produced in the period.
A production budget does not show costs; it is always expressed in units of product.
Note: A production budget does not show costs; it is always expressed in units of product.
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6. NEED-TO-KNOW 7-1
A manufacturing company predicts sales of 220 units for May and 250 units for June. The company wants
each month’s ending inventory to equal 30% of next month’s predicted unit sales. Beginning inventory for
May is 66 units.
Compute the company’s budgeted production in units for May.
Budgeted ending inventory for May 75
30% of 250 (June’s expected sales)
Plus: Budgeted sales for May
220
Required units of available production
295
Less: Beginning inventory (units)
(66)
Total units to be produced
229
A manufacturing company predicts sales of 220 units for May and 250 units for June. The company wants each month’s ending inventory to equal 30% of next month’s predicted unit sales. Beginning inventory for May is 66 units. Compute the company’s budgeted production in units for May.
The budgeted ending inventory for May equals 30% of 250 units, June's expected sales. 75 units need to be on hand as of May 31.
They also need to produce enough units to cover the budgeted sales for May, 220 units. The total required units of available production is 295.
We subtract the number of units that are already on hand in beginning inventory, 66, to calculate the total number of units to be produced, 229.
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7. NEED-TO-KNOW 7-2
A manufacturing company budgets production of 800 units during June and 900 units during July. Each
unit of finished goods requires 2 pounds of direct materials, at a cost of $8 per pound. The company maintains
an inventory of direct materials equal to 10% of next month’s budgeted production. Beginning direct
materials inventory for June is 160 pounds. Each finished unit requires 1 hour of direct labor at the rate of
$14 per hour.
Compute the budgeted (a) cost of direct materials purchases for June and (b) direct labor cost for June.
Budgeted production (units)
800
Materials requirements per unit (lbs.) 2
Materials needed for production (lbs.)
1,600
Add: Budgeted ending inventory (lbs.)
180
(July production of 900 units x 2 lbs. per unit x 10%)
Total materials requirements (lbs.)
1,780
Less: Beginning inventory (lbs.)
(160)
Materials to be purchased (lbs.)
1,620
Material price per pound $8
Total cost of direct materials purchases
$12,960
A manufacturing company budgets production of 800 units during June and 900 units during July. Each unit of finished goods requires 2 pounds of direct materials, at a cost of $8 per pound. The company maintains an inventory of direct materials equal to 10% of next month’s budgeted production. Beginning direct materials inventory for June is 160 pounds. Each finished unit requires 1 hour of direct labor at the rate of $14 per hour.
Compute the budgeted (a) cost of direct materials purchases for June and (b) direct labor cost for June.
The company requires 800 units to be produced during June. Each unit will require 2 pounds of direct materials.
The company requires a total of 1,600 pounds of direct materials for the current month's production.
They also require an ending inventory equal to 10% of next month's budgeted production.
July's production of 900 units multiplied by 2 pounds per unit, 1,800 pounds, multiplied by 10% is 180 pounds in ending inventory.
Total materials requirements, 1,780 pounds.
We subtract the number of pounds in beginning inventory, 160, to calculate the number of pounds to be purchased, 1,620.
Each pound of direct materials costs $8.
The total cost of direct materials purchases, 1,620 pounds at $8 per pound, is a total cost of $12,960.
Budgeting the direct labor cost is simpler, as there is no beginning or ending inventory of labor hours to consider.
The budgeted production in units is Each of the 800 units requires 1 hour of direct labor, a total of 800 direct labor hours are required.
We multiply by the labor rate, $14 per hour, to calculate the total cost of direct labor, $11,200.
Budgeted production (units)
800
Labor requirements per unit (hrs.) 1
Total direct labor hours needed
800
Labor rate (per hour)
$14
Total cost of direct labor
$11,200
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8. NEED-TO-KNOW 7-3
A manufacturing company budgets sales of $70,000 during July. It pays sales commissions of 5% of sales
and also pays a sales manager a salary of $3,000 per month. Other monthly costs include depreciation on
office equipment ($500), insurance expense ($200), advertising ($1,000), and office manager salary of
$2,500 per month. For the month of July, compute the total (a) budgeted selling expense and (b) budgeted
general and administrative expense.
Budgeted selling expense
Total
Sales commissions
($70,000 x 5%)
$3,500
Sales manager's salary
3,000
Advertising expense
1,000
Total budgeted selling expense
$7,500
Budgeted general and administrative expense
Total
Depreciation on office equipment
$500
Insurance expense
200
Office manager's salary
2,500
Total budgeted and administrative expense
$3,200
A manufacturing company budgets sales of $70,000 during July. It pays sales commissions of 5% of sales and also pays a sales manager a salary of $3,000 per month. Other monthly costs include depreciation on office equipment ($500), insurance expense ($200), advertising ($1,000), and office manager salary of $2,500 per month. For the month of July, compute the total (a) budgeted selling expense and (b) budgeted general and administrative expense.
Selling expenses are costs that are targeting the customer, vs. general and administrative expenses which are non-customer related.
Sales commissions are selling expenses. 5% of $70,000 is $3,500.
The sales manager's salary is also a selling expense.
Depreciation on office equipment is non-customer related; it's considered a general and administrative expense.
Insurance expense is also considered general and administrative expense.
Advertising expense is customer related; it's included as part of the budgeted selling expense.
And the office manager's salary is a general and administrative expense.
Total budget selling expenses; $7,500.
Total budgeted general and administrative expense; $3,200.
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9. NEED-TO-KNOW 8.1
A manufacturing company reports the fixed budget and actual results for the year as shown below. The
company’s fixed budget assumes a selling price of $40 per unit. The fixed budget is based on 20,000 units
of sales, and the actual results are based on 24,000 units of sales. Prepare a flexible budget performance
report for the year.
Fixed Budget
Actual Results
(20,000 units)
(24,000 units)
Sales
$800,000
$972,000
Variable costs
160,000
240,000
Fixed costs
500,000
490,000
Budget assumptions:
Selling price per unit
$40.00
($800,000 divided by 20,000 units)
Variable cost per unit
$8.00
($160,000 divided by 20,000 units)
Budget Assumptions
Flexible Budget
(24,000 units)
A manufacturing company reports the fixed budget and actual results for the year as shown below.
The company’s fixed budget assumes a selling price of $40 per unit.
The fixed budget is based on 20,000 units of sales, and the actual results are based on 24,000 units of sales.
Prepare a flexible budget performance report for the year.
First, let’s look at the assumptions that were used to create the fixed budget (20,000 units).
The selling price per unit is $40 per unit ($800,000 divided by 20,000 units).
The variable cost per unit is $8 per unit ($160,000 in variable costs divided by 20,000 units).
We use these budget assumptions to create the flexible budget for the actual number of units sold, 24,000 units.
Had the company known they were going to sell 24,000 units, total sales would have been budgeted at $960,000 ($40.00 per unit multiplied by 24,000 units).
Variable costs would have been budgeted at $192,000 ($8.00 per unit multiplied by 24,000 units).
Fixed costs remain constant, regardless of the production volume, $500,000.
Sales
$40.00 x 24,000 units =
$960,000
Variable costs
$8.00 x 24,000 units =
192,000
Fixed costs
500,000
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10. NEED-TO-KNOW 8.1
A manufacturing company reports the fixed budget and actual results for the year as shown below. The
company’s fixed budget assumes a selling price of $40 per unit. The fixed budget is based on 20,000 units
of sales, and the actual results are based on 24,000 units of sales. Prepare a flexible budget performance
report for the year.
Fixed Budget
Actual Results
(20,000 units)
(24,000 units)
Sales
$800,000
$972,000
Variable costs
160,000
240,000
Fixed costs
500,000
490,000
Budget Assumptions
Flexible Budget
(24,000 units)
Sales
$40.00 x 24,000 units =
$960,000
Variable costs
$8.00 x 24,000 units =
192,000
Fixed costs
500,000
FLEXIBLE BUDGET PERFORMANCE REPORT
The flexible budget performance report compares the company's actual results with the predicted results from the flexible budget.
$960,000 of sales in the flexible budget vs. $972,000 in actual sales is a $12,000 favorable variance, as additional sales increase net income.
$192,000 of variable costs in the flexible budget vs. $240,000 in actual variable costs is a $48,000 unfavorable variance, as additional costs decrease net income.
Contribution margin, Sales minus Variable Costs, $768,000 per the flexible budget vs. $732,000 actual is a $36,000 unfavorable variance.
$490,000 in actual fixed costs vs. budget fixed costs of $500,000 is a $10,000 favorable variance.
Net income $242,000 actual vs. $268,000 in the flexible budget is an overall unfavorable variance of $26,000.
Flexible Budget
Actual Results
(24,000 units)
(24,000 units)
Variances
Sales
$960,000
$972,000
$12,000
Favorable (F)
Variable costs
192,000
240,000
48,000
Unfavorable (U)
Contribution margin
768,000
732,000
36,000
Unfavorable (U)
Fixed costs
500,000
490,000
10,000
Favorable (F)
Net income
268,000
242,000
26,000
Unfavorable (U)
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11. Cash Budgets
After developing budgets for sales, manufacturing costs, expenses, and capital expenditures, the next step is to prepare the cash budget, which shows expected cash inflows and outflows during the budget period.
The general formula for a cash budget is:
After developing budgets for sales, manufacturing costs, expenses, and capital expenditures, the next step is to prepare the cash budget, which shows expected cash inflows and outflows during the budget period. The cash budget is especially important because it helps the company maintain a cash balance necessary to meet ongoing obligations. Let’s prepare TSC’s budgets for cash receipts and cash disbursements.
The cash budget is especially important because it helps the company maintain a cash balance necessary to meet ongoing obligations.
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12. Cost Variance Computation
Management needs information about the factors causing a cost variance, but first it must properly compute the variance. In its most simple form, a cost variance (CV) is computed as:
Cost Variance (CV) = Actual Cost (AC) - Standard Cost (SC)
where:
Actual Cost (AC) = Actual Quantity (AQ) x Actual Price (AP)
Standard Cost (SC) = Standard Quantity (SQ) x Standard Price (SP)
Actual quantity (AQ) is the input (material or labor) used to manufacture the quantity of output.
Standard quantity (SQ) is the standard input for the quantity of output.
Actual price (AP) is the actual amount paid to acquire the input (material or labor).
Standard price (SP) is the standard price.
Management needs information about the factors causing a cost variance, but first it must properly compute the variance. In its most simple form, a cost variance (CV) is computed as: Actual Cost (AC) minus Standard Cost (SC). We can break the formula down even further by defining how to calculate Actual Cost and how to calculate Standard Cost. The formulas for both are listed on this screen.
A cost variance is further defined by its components. Actual quantity (AQ) is the input (material or labor) used to manufacture the quantity of output. Standard quantity (SQ) is the standard input for the quantity of output. Actual price (AP) is the actual amount paid to acquire the input (material or labor), and standard price (SP) is the standard price.
Price variances result when we pay an actual price for a resource that differs from the standard price that should have been paid. Quantity variances are caused by using an actual amount of a resource that differs from the standard amount that should have been used.
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13. Cost Variance Computation
Standard quantity is the quantity that should have been used for the actual good output.
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance
Quantity Variance
Standard price is the amount that should have been paid for the resources acquired.
Here’s a general model for computing standard cost variances. We multiply the actual quantity times the actual price and compare that to the actual quantity times the standard price. The difference is the price variance. Then we compare the actual quantity times the standard price to the standard quantity at the standard price. The difference is the quantity variance.
The standard quantity is the standard quantity for one unit multiplied times the number of good units produced. It is the amount of a resource that should have been used given the actual good output achieved.
The standard price is the amount we should pay for the resource acquired.
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14. Cost Variance Computation
Actual Cost
Standard Cost
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance
Quantity Variance
We can reduce these relationships to mathematical equations. For example, we can determine the material price variance by multiplying the actual quantity times the difference between the actual price and the standard price, and we can determine the material quantity variance by multiplying the standard price times the difference between the actual quantity and the standard quantity.
(AP - SP) x AQ (AQ - SQ) x SP
AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity
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15. Materials Cost Variances
SQ = 3,500 units × 0.5 lb. per unit = 1,750 lbs.
Actual Cost
Standard Cost
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
1,800 lbs ,800 lbs ,750 lbs × × × $21.00 per lb $20.00 per lb $20.00 per lb.
$37, $36, $35,000
Now you can check your work. The total actual price paid for the material was $37,800. Since the standard price was $20.00 per pound, G-Max should have paid only $36,000 for the material. The difference between $37,800 and $36,000 is the $1,800 unfavorable price variance. G-Max actually used 1,800 pounds of material, 50 pounds more than the standard quantity of 1,750 pounds. Using an extra 50 pounds resulted in the $1,000 unfavorable quantity variance. If we add the unfavorable price variance of $1,800 plus the unfavorable quantity variance of $1,000, we get a total cost variance of $2,800.
Price Variance $1,800 Unfavorable +
Quantity Variance $1,000 Unfavorable
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$2,800 Total Cost Variance (U)

16. NEED-TO-KNOW 8.2
A manufacturing company reports the following for one of its products. Compute the direct materials
(a) price variance and (b) quantity variance and indicate whether they are favorable or unfavorable.
Direct materials standard
8 $6.00 per pound
Actual direct materials used
83,000 $5.80 per pound
Actual finished units produced
10,000 AQ
83,000
lbs. AP
$5.80
per lb. SQ
80,000
lbs.
(10,000 units x 8 lbs. per unit) SP
$6.00
per lb.
Actual Cost
Standard Cost
AQ X AP
AQ x SP
SQ x SP
83,000 x $5.80
83,000 x $6.00
[10,000 x 8] x $6.00
$481,400
$498,000
$480,000
$16,600 Favorable
$18,000 Unfavorable
A manufacturing company reports the following for one of its products. Compute the direct materials price variance and quantity variance, and indicate whether they are favorable or unfavorable.
Variance analysis compares the total actual cost of inputs with the total standard cost.
The actual cost is equal to the actual quantity purchased multiplied by the actual price per pound.
The total standard cost is the standard quantity of materials multiplied by the standard price per pound.
In between these two values, we'll standardize the pricing first:
Actual quantity multiplied by the standard price. The actual quantity of materials is 83,000 pounds. The actual price is $5.80 per pound.
The standard quantity is 80,000 pounds, because each of the 10,000 units produced should have used exactly 8 pounds of materials. The standard price is $6.00 per pound.
83,000 pounds of materials purchased, at an actual rate of $5.80 per pound, is a total actual cost of $481,400.
The actual quantity, 83,000, multiplied by $6.00 per pound is $498,000. The difference between the actual quantity at the actual price and the actual quantity at the standard price is the materials price variance, $16,600.
This variance is favorable, as the company paid $0.20 less per pound for each of the 83,000 pounds purchased.
The standard quantity, 80,000 pounds, (10,000 units multiplied by 8 pounds per unit) multiplied by the standard price of $6.00 per pound, is a total standard cost of $480,000.
The difference between the actual quantity at the standard price and the standard quantity at the standard price is the materials quantity variance.
The difference is $18,000, and this variance is unfavorable, as the actual quantity used, 83,000 pounds, exceeded the standard quantity of 80,000 pounds.
3,000 additional pounds at $6.00 per pound is an $18,000 unfavorable materials quantity variance.
The total materials variance, the difference between the actual cost, $481,400, and the total standard cost, $480,000, is a $1,400 unfavorable total direct materials variance.
Notice that when we combine the $16,600 favorable materials price variance with the $18,000 unfavorable materials quantity variance, the total variance is $1,400 unfavorable.
Materials Price Variance
Materials Quantity Variance
$1,400 Unfavorable
Total Direct Materials Variance
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17. Labor Cost Variances *Rate Variance *Efficiency Variance
Instead of price and quantity, for direct labor we use the terms rate and hours.
Standard Cost
Actual Cost
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate
*Rate Variance
*Efficiency Variance
*NEW
Instead of price and quantity, for direct labor we use the terms rate and hours. Also, instead of price and quantity variances, for labor, we use the terms rate and efficiency variances. The underlying concepts are the same as we saw for material. The standard rate is the amount we should pay per hour for the work performed. Standard hours are the hours that should have been worked for the actual good output achieved. Just as with material, we can reduce these relationships to mathematical equations. For example, we can determine the labor rate variance by multiplying actual hours times the difference between the actual rate and the standard rate, and we can determine the labor efficiency variance by multiplying the standard rate times the difference between actual hours and standard hours.
AH(AR - SR) SR(AH - SH)
AH = Actual Hours SR = Standard Rate AR = Actual Rate SH = Standard Hours
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18. Labor Cost Variances
SQ = 3,500 units × 1.0 hour per unit = 3,500 hours.
Actual Cost
Standard Cost
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate
3,400 hours ,400 hours ,500 hours × × × $8.30 per hour $8.00 per hour $8.00 per hour.
$28, $27, $28,000
Now you can check your work. The total actual wages paid for 3,400 hours were $28,220. Since the standard rate was $8.00 per hour, G-Max should have paid only $27,200 for 3,400 hours. The difference between $28,220 and $27,200 is the $1,020 unfavorable rate variance. G-Max employees actually worked 3,400 hours; 100 hours less than the standard of 3,500 hours. Working 100 hours less than allowed by the standard for labor time resulted in the $800 favorable efficiency variance.
If we add the unfavorable rate variance of $1,020 minus the favorable efficiency variance of $800, we get a total unfavorable labor cost variance of $220.
Rate Variance $1,020 Unfavorable +
Efficiency Variance $800 Favorable
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$220 Total Cost Variance (U)

19. NEED-TO-KNOW 8.3
The following information is available for York Company.
Actual direct labor cost (6,250 per hour)
$81,875
Standard direct labor hours per unit
2.0 hours
Standard rate per hour
$13.00
Actual production (units)
2,500
Budgeted production (units)
3,000
Compute the direct labor rate and efficiency variances. SQ
(2,500 units x 2 hrs. per unit = 5,000 standard hrs. )
Actual Cost
Standard Cost
AQ X AR
AQ x SR
SQ x SR
6,250 x $13.10
6,250 x $13.00
(2,500 x 2) x $13.00
$81,875
$81,250
$65,000
$625 Unfavorable
$16,250 Unfavorable
Labor Rate Variance
Labor Efficiency Variance
The following information is available for York Company.
Compute the direct labor rate and efficiency variances. Variance analysis identifies the reasons for the differences between total actual cost and total standard cost.
The actual cost is calculated by multiplying the actual number of direct labor hours by the actual rate. The standard cost is equal to the standard number of direct labor hours multiplied by the standard rate.
And, in between these two values, we standardize the rate first.
The actual number of direct labor hours is 6,250 hours. The actual rate is $13.10 per hour.
The total actual cost of direct labor is the $81,875.
If we multiply the actual number of hours, 6,250, by the standard rate of $13.00 per hour the total is $81,250.
The difference between these two values is the direct labor rate variance, a $625 unfavorable variance, as the company paid $0.10 per hour more for each of the 6,250 direct labor hours.
The standard number of direct labor hours is calculated based on the number of units produced.
Each of the 2,500 units produced should have required exactly 2 hours of direct labor, a total of 5,000 standard direct labor hours.
When we multiply the standard hours, 5,000, by the standard rate, $13.00 per hour, the total standard cost of direct labor is $65,000.
The difference between the actual quantity at the standard rate and the standard quantity at the standard rate is the labor efficiency variance. In this case, it's a $16,250 unfavorable variance, as the company used 1,250 more direct labor hours than was budgeted.
1,250 additional hours at $13.00 per hour explains the $16,250 unfavorable efficiency variance.
The total direct labor variance is $16,875 unfavorable; the $81,875 actual cost minus the $65,000 standard cost.
Notice that when we combine the $625 unfavorable labor rate variance with the $16,250 unfavorable labor efficiency variance, it explains the $16,875 unfavorable total direct labor variance.
$16,875 Unfavorable
Total Direct Labor Variance
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20. Budgetary Control and Reporting
Budgets are an important cost control tool. Actual results are compared with budgets and differences are investigated and analyzed.
Revise objectives and prepare a new budget.
Management uses budgets to monitor and control operations.
Develop the budget from planned objectives.
Compare actual to budget and analyze any differences.
Take corrective and strategic actions.
Budgets are an important cost control tool. Actual results are compared with budgets and differences are investigated and analyzed. This process may result in corrective action to restore progress toward budgeted objectives. If the operating environment has changed the investigation and analysis may lead to budget revisions. Budget reports are sometimes viewed as progress reports, or report cards, on management’s performance in achieving planned objectives. These reports can be prepared at any time and for any period. The budgetary control process involves at least four steps: (1) develop the budget from planned objectives, (2) compare actual results to budgeted amounts and analyze any differences, (3) take corrective and strategic actions, and (4) establish new planned objectives and prepare a new budget.

21. Overhead Standards and Variances
Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR):
Estimated total overhead costs Estimated activity
POHR =
Recall from our work in previous chapters that the predetermined overhead rate is calculated by dividing estimated overhead costs for the operating period by the estimated activity for the operating period. We then use the predetermined overhead rate to assign overhead costs to products as they are manufactured.
Assigned Overhead = POHR × Standard Activity
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22. NEED-TO-KNOW 8.4
A manufacturing company uses standard costs and reports the information below for January. The company
uses machine hours to allocate overhead, and the standard is two machine hours per finished unit.
Predicted activity level
1,500 units
Variable overhead rate
$2.50 per machine hour
Fixed overhead budgeted
$6,000 per month ($2.00 per machine hour at predicted activity level)
Actual activity level
1,800 units
Actual overhead costs
$15,800
Compute the total overhead cost variance, overhead controllable variance, and overhead volume variance
for January. Indicate whether each variance is favorable or unfavorable.
Actual Overhead
Flexible Budget
1,800 units
Standard Cost
SQ x SR
VOH [(1,800 x 2) x $2.50] + FOH $6,000
(1,800 x 2) x $4.50
$15,800
$15,000
$16,200
$800 Unfavorable
$1,200 Favorable
Controllable Variance
Overhead Volume Variance
A manufacturing company uses standard costs and reports the information below for January.
The company uses machine hours to allocate overhead, and the standard is two machine hours per finished unit.
Compute the total overhead cost variance, overhead controllable variance, and overhead volume variance for January. Indicate whether each variance is favorable or unfavorable.
The difference between total actual overhead and the amount of overhead in the flexible budget is the controllable variance.
The difference between the flexible budget and the total amount of overhead applied is the overhead volume variance.
The actual overhead incurred is $15,800. The flexible budget is the amount that would have been budgeted had they known that they were going to produce 1,800 units rather than the 1,500 units predicted.
The flexible budget includes both variable and fixed overhead.
Variable overhead is equal to 3,600 standard machine hours (2 machine hours per unit for each of the 1,800 units produced) multiplied by the variable overhead rate of $2.50 per machine hour; a total of $9,000 of variable overhead.
Fixed overhead is constant, regardless of the amount of production. Fixed overhead in the flexible budget is $6,000. The total flexible budget for 1,800 units is $15,000.
The difference between the flexible budget, $15,000, and the actual costs, $15,800, is an $800 unfavorable controllable variance.
Overhead is applied based on the 3,600 machine hours at the total overhead rate of $4.50 per machine hour (the fixed overhead rate of $2.00 per hour plus the variable rate of $2.50 per hour) Work in process is charged for the total standard cost: 3,600 machine hours multiplied by $4.50 per machine hour, $16,200.
The difference between the flexible budget, $15,000, and the standard cost, $16,200, is a $1,200 favorable overhead volume variance.
Whenever the actual activity level exceeds the predicted activity level, the volume variance is favorable.
The total overhead variance is a $400 favorable variance, as total actual costs are $400 less than the total standard cost.
$400 Favorable
Total Overhead Variance SQ
3,600
MHs
(1,800 units x 2 MHs per unit = 3,600 standard hrs. ) SR
$4.50
per MH
(FOH $ VOH $2.50 = $4.50 per MH)
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23. NEED-TO-KNOW
The media division of a company reports income of $600,000, average invested assets of
$7,500,000, and a target income of 6% of invested assets. Compute the division’s
(a) return on investment and (b) residual income.
Return on Investment (ROI) represents the earnings power of invested assets.
Return on investment = Net Income
Average Invested Assets
$600,000
$7,500,000 8%
The media division of a company reports income of $600,000, average invested assets of $7,500,000, and a target income of 6% of invested assets.
Compute the division’s return on investment and residual income.
Return on Investment (ROI) represents the earnings power of invested assets.
It's calculated by taking net income and dividing by average invested assets. $600,000
divided by $7,500,000 is 8%.
Every $1.00 of invested assets yields $.08 in net income.
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24. NEED-TO-KNOW
The media division of a company reports income of $600,000, average invested assets of
$7,500,000, and a target income of 6% of invested assets. Compute the division’s
(a) return on investment and (b) residual income.
Residual income is the amount earned above a targeted amount.
Net income $600,000
Target income ($7,500,000 x .06) ,000
Residual income $150,000
Residual income is the amount earned above a targeted amount.
Net income is $600,000.
Targeted income is calculated as 6% of the average invested assets of $7,500,000,
$450,000.
Residual income is the amount earned above 6%, $150,000.
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25. Investment Center Profit Margin and Investment Turnover
Return on investment (ROI) =
Profit Margin
Investment turnover ×
Investment center income
Investment center sales
Investment center sales Investment center average assets
We can further examine investment center (division) performance by splitting return on investment into two measures: profit margin and investment turnover.
Profit margin measures the income earned per dollar of sales. Investment turnover measures how efficiently an investment center generates sales from its invested assets. It is calculated as investment center sales divided by investment center average assets. Profit margin is expressed as a percentage, while investment turnover is interpreted as the number of times assets were converted into sales. Higher profit margin and higher investment turnover indicate better performance. To illustrate, consider Walt Disney Co., which reports results for two of its operating segments: Media Networks and Parks and Resorts.
Disney's Media Networks division generates cents of profit for every dollar of sales, while its Parks and Resorts division generates cents of profit per dollar of sales. The Media Networks division (0.71 investment turnover) is slightly more efficient than the Parks and Resorts division (0.66 investment turnover) in using assets. Top management can use profit margin and investment turnover to evaluate the performance of division managers. The measures can also aid management when considering further investment in its divisions.
Let’s review what you have learned in the following NEED-TO-KNOW Slide.
Media Networks ROI = 23.78%
Parks and Resorts ROI= 10.4%
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26. NEED-TO-KNOW
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.
Profit margin measures the income earned per dollar of sales.
Profit margin = Net Income
Sales
$2,000
$50,000 4%
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.
sales.
Profit margin measures the income earned per dollar of sales. It's calculated by taking net income and dividing by
Net income of $2,000 divided by $50,000 in sales is 4%.
$0.04 of every $1.00 of sales is profit.
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27. Need to Know (24-2b) NEED-TO-KNOW
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.
Investment turnover measures how efficiently an investment center generates sales from its invested assets.
Investment turnover = Sales
Average Invested Assets
$50,000
$10,000 5
Investment turnover measures how efficiently an investment center generate sales from its invested assets. It's calculated by taking sales and dividing by average invested assets.
$50,000 in sales divided by average invested assets of $10,000 is an investment turnover of 5.
Every $1.00 of invested assets yields $5.00 in sales.
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28. NEED-TO-KNOW Need to Know (24-2c)
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.
Return on Investment (ROI) represents the earnings power of invested assets.
Return on investment = Net Income
Average Invested Assets
$2,000
$10,000
20%
Return on investment represents the earnings power of invested assets.
It's calculated by taking net income and dividing by the average invested assets.
Net income of $2,000 divided by average invested assets of $10,000 is a return on investment of 20%.
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29. NEED-TO-KNOW Need to Know (24-2d)
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.
Return on Investment (ROI) represents the earnings power of invested assets.
Return on investment = Profit Margin x Investment Turnover
Net Income = Net Income Sales
Average Invested Assets Sales Average Invested Assets
20% = % x
An alternative way to calculate return on investment is to take the profit margin and multiply by the investment turnover.
Because if we divide by sales in the profit margin and multiply by sales in the investment turnover, we're left with net income divided by average invested assets.
The 20% return on investment is equal to the 4% profit margin multiplied by the investment turnover of 5.
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30. Performance Evaluation
The accounting system provides information about resources used and outputs achieved. Managers use this information to control operations, appraise performance, allocate resources, and plan strategy. The type of accounting information provided depends on whether the department is a . . .
Evaluated on ability to control costs.
Cost center
Evaluated on ability to generate revenues in excess of expenses.
Profit center
Evaluated on ability to generate return on investment in assets.
Investment center
All departments, whether production, sales, or service, use resources to achieve a desired output. If our decentralized accounting system is properly designed and implemented, we can control operations, appraise performance, allocate resources, and plan strategy. One of top management’s objectives for this type of system is to be able to allocate more resources to those departments who are performing at the highest level.
Financial information used to evaluate a department depends on whether it is evaluated as a cost center, profit center, or investment center. Cost centers incur costs without directly generating revenues. Cost centers are evaluated on their ability to control costs. Profit center managers are judged on their ability to generate revenues in excess of the profit center’s costs. In addition to generating revenues and controlling costs, investment center managers make asset investment decisions and are evaluated based on the investment return on those investments.
A responsibility accounting system can be set up to control costs and evaluate managers’ performance by assigning costs to the managers responsible for controlling them. We will look at responsibility accounting and cost control in the next section of this presentation.

31. Balanced Scorecard Collects information on several key performance indicators within each of the four perspectives.
Customer Perspective
How do our customers see us?
Performance Indicators
Innovation/Learning How can we continually improve and create value?
Internal Processes
In which activities must we excel?
A balanced scorecard consists of an integrated set of performance measures that are derived from and support a company’s vision and strategy. The balanced scorecard is used to assess company and division manager performance. The balanced scorecard requires managers to think of their company from four perspectives:
1. customer perspective: What do customers think of us?
2. internal processes: Which of our operations are critical to meeting customer needs?
3. innovation and learning: How can we improve?
4. financial: What do our owners think of us?
In the balanced scorecard approach, we continually develop indicators that help us analyze or answer questions such as: how do we appear to our owners; how do we appear to our customers; what kind of continual innovation and learning is taking place; and which processes within the organization are excellent and which need improvement?
The key sequence of events in the balanced scorecard approach is that learning improves business processes. Improved business processes translate to improved customer satisfaction. When we have a high degree of customer satisfaction, we have improved financial results.
Financial Perspective
How do we look to the firm’s owners?
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32. Process Time + Inspection Time + Move Time + Wait Time
Cycle Time and Cycle Efficiency A metric that measures the time involved in manufacturing a product.
Order Received
Production Started
Goods Shipped
Process Time + Inspection Time + Move Time + Wait Time
Manufacturing Cycle Time
Total time is the elapsed time from when a customer order is received to when the completed order is shipped. The manufacturing cycle time is the amount of time required to turn raw materials into completed products. This includes process time, inspection time, move time, and wait time. Process time is the time spent producing the product and it is the only value-added activity of the four components of cycle time because it is the only activity in cycle time that adds value to the product form the customer’s perspective.
Total Time
Process time is the time spent producing the product and it is the only value-added time!
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33. Cycle Time and Cycle Efficiency
Order Received
Production Started
Goods Shipped
Process Time + Inspection Time + Move Time + Wait Time
Manufacturing Cycle Time
Companies strive to reduce non-value-added time to improve cycle efficiency (CE), which is a measure of production efficiency. Cycle efficiency (CE) is computed by dividing value-added time by cycle (throughput) time. A CE less than one indicates that non-value-added time is present in the production process and they need to evaluate it to identify ways to reduce non-value-added activities.
Total Time
Cycle
Efficiency
Value-added time Cycle time =
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34. Responsibility Accounting System
An accounting system that provides information . . .
Relating to the responsibilities of individual managers.
To evaluate managers on controllable items.
A responsibility accounting system uses the concept of controllable costs to evaluate a manager’s performance. Responsibility for controllable costs is clearly defined and performance is evaluated based on the ability to manage and control those costs. Prior to each reporting period, a company prepares plans that identify costs and expenses under each manager’s control. These responsibility accounting budgets are typically based on the flexible budgeting approach covered in chapter 8.
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35. Responsibility Accounting Performance Reports
Amount of detail varies according to the level in the organization.
The amount of detail in performance reports varies according to the level in the organization. The number of controllable costs reported varies across management levels. At lower levels, managers have limited responsibility and thus few controllable costs. Responsibility and control broaden for higher-level managers; therefore, their reports span a wider range of costs. In general, lower-level managers receive detailed reports, but the level of detail decreases at higher levels. Top management receives reports that are highly summarized. If a problem arises, top management can request greater detail to look into the problem.
A store manager receives summarized information from each department.
A department manager receives detailed reports.
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36. Thank you and Good Luck, Take Care
Atef Abuelaish