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MANAGERIAL ACCOUNTING Eighth Canadian Edition GARRISON, CHESLEY, CARROLL, WEBB Prepared by: Robert G. Ducharme, MAcc, CA University of Waterloo, School.

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Presentation on theme: "MANAGERIAL ACCOUNTING Eighth Canadian Edition GARRISON, CHESLEY, CARROLL, WEBB Prepared by: Robert G. Ducharme, MAcc, CA University of Waterloo, School."— Presentation transcript:

1 MANAGERIAL ACCOUNTING Eighth Canadian Edition GARRISON, CHESLEY, CARROLL, WEBB
Prepared by: Robert G. Ducharme, MAcc, CA University of Waterloo, School of Accounting and Finance

2 Reporting for Control Chapter Eleven
11-2 Reporting for Control Chapter Eleven Managers in large organizations have to delegate some decisions to those who are at lower levels in the organization. This chapter explains how responsibility accounting systems, segmented income statements, and return on investment (ROI) and residual income measures are used to help control decentralized organizations.

3 Decentralization in Organizations
11-3 Decentralization in Organizations Benefits of Decentralization Top management freed to concentrate on strategy. Lower-level managers gain experience in decision-making. Decision-making authority leads to job satisfaction. A decentralized organization does not confine decision-making authority to a few top executives; rather, decision-making authority is spread throughout the organization. The advantages of decentralization are as follows: It enables top management to concentrate on strategy, higher-level decision- making, and coordinating activities. It acknowledges that lower-level managers have more detailed information about local conditions that enable them to make better operational decisions. It enables lower-level managers to quickly respond to customers. It provides lower-level managers with the decision-making experience they will need when promoted to higher level positions. It often increases motivation, resulting in increased job satisfaction and retention, as well as improved performance. Lower-level decisions often based on better information. Lower level managers can respond quickly to customers.

4 Decentralization in Organizations
11-4 Decentralization in Organizations May be a lack of coordination among autonomous managers. Lower-level managers may make decisions without seeing the “big picture.” Disadvantages of Decentralization Lower-level manager’s objectives may not be those of the organization. The disadvantages of decentralization are as follows: Lower-level managers may make decisions without fully understanding the “big picture.” There may be a lack of coordination among autonomous managers. The balanced scorecard can help reduce this problem by communicating a company’s strategy throughout the organization. Lower-level managers may have objectives that differ from those of the entire organization. This problem can be reduced by designing performance evaluation systems that motivate managers to make decisions which are in the best interests of the company. It may difficult to effectively spread innovative ideas in a strongly decentralized organization. This problem can be reduced through the effective use of intranet systems, which enable globally dispersed employees to electronically share ideas. May be difficult to spread innovative ideas in the organization.

5 11-5 Learning Objective 1 Differentiate among responsibility centres such as cost centres, profit centres, and investment centres, and explain how performance is measured in each. Learning objective number 1 differentiate among responsibility centres such as cost centres, profit centres, and investment centres, and explain how performance is measured in each.

6 Cost, Profit, and Investments centres
11-6 Cost, Profit, and Investments centres Cost centre Profit centre Investment centre Cost, profit, and investment centres are all known as responsibility centres. Responsibility accounting systems link lower-level managers’ decision-making authority with accountability for the outcomes of those decisions. The term responsibility centre is used for any part of an organization whose manager has control over, and is accountable for cost, profit, or investments. The three primary types of responsibility centres are cost centres, profit centres, and investment centres. Responsibility centre

7 Cost centre A segment whose manager has control over costs,
11-7 Cost centre A segment whose manager has control over costs, but not over revenues or investment funds. The manager of a cost centre has control over costs, but not over revenue or investment funds. Service departments such as accounting, general administration, legal, and personnel are usually classified as cost centres, as are manufacturing facilities. Standard cost variances and flexible budget variances, such as those discussed in Chapters 10 and 11, are often used to evaluate cost centre performance.

8 11-8 Profit centre Revenues Sales Interest Other Costs Mfg. costs Commissions Salaries A segment whose manager has control over both costs and revenues, but no control over investment funds. The manager of a profit centre has control over both costs and revenue. Profit centre managers are often evaluated by comparing actual profit to targeted or budgeted profit. An example of a profit centre is a company’s cafeteria.

9 11-9 Investment centre Corporate Headquarters A segment whose manager has control over costs, revenues, and investments in operating assets. The manager of an investment centre has control over cost, revenue, and investments in operating assets. Investment centre managers are often evaluated using return on investment (ROI) or residual income (discussed later in this chapter). An example of an investment centre would be the corporate headquarters.

10 Responsibility centres
11-10 Responsibility centres Investment Centres Cost Centres Part I Superior Foods Corporation provides an example of the various kinds of responsibility centres that exist in an organization. Part II The President and CEO, as well as the Vice President of Operations, manage investment centres. Part III The Chief Financial Officer, General Counsel, and Vice President of Personnel all manage cost centres. Superior Foods Corporation provides an example of the various kinds of responsibility centres that exist in an organization.

11 Responsibility centres
11-11 Responsibility centres Profit Centres Each of the three product managers that report to the Vice President of Operations (e.g., salty snacks, beverages, and confections) manages a profit centre. Superior Foods Corporation provides an example of the various kinds of responsibility centres that exist in an organization.

12 Responsibility centres
11-12 Responsibility centres Cost Centres The bottling plant manager, warehouse manager, and distribution manager all manage cost centres that report to the Beverages product manager. Superior Foods Corporation provides an example of the various kinds of responsibility centres that exist in an organization.

13 11-13 Learning Objective 2 Determine the range, if any, within which a negotiated transfer price should fall and explain other approaches to setting the transfer price. Learning objective number 2 is to determine the range, if any, within which a negotiated transfer price should fall and explain other approaches to setting the transfer price.

14 Key Concepts/Definitions
11-14 Key Concepts/Definitions A transfer price is the price charged when one segment of a company provides goods or services to another segment of the company. The fundamental objective in setting transfer prices is to motivate managers to act in the best interests of the overall company. A transfer price is the price charged when one segment of a company provides goods or services to another segment of the company. While domestic transfer prices have no direct effect on the entire company’s reported profit, they can have a dramatic effect on the reported profitability of a division. The fundamental objective in setting transfer prices is to motivate managers to act in the best interests of the overall company. Sub optimization occurs when managers do not act in the best interests of the overall company or even their own divisions.

15 Three Primary Approaches
11-15 Three Primary Approaches There are three primary approaches to setting transfer prices: Negotiated transfer prices; Transfers at the cost to the selling division; and Transfers at market price. There are three primary approaches to setting transfer prices, namely negotiated transfer prices, transfers at the cost to the selling division, and transfers at market price.

16 Negotiated Transfer Prices
11-16 Negotiated Transfer Prices A negotiated transfer price results from discussions between the selling and buying divisions. Upper limit is determined by the buying division. Lower limit is determined by the selling division. Range of Acceptable Transfer Prices Advantages of negotiated transfer prices: They preserve the autonomy of the divisions, which is consistent with the spirit of decentralization. The managers negotiating the transfer price are likely to have much better information about the potential costs and benefits of the transfer than others in the company. A negotiated transfer price results from discussions between the selling and buying divisions. Negotiated transfer prices have two advantages. First, they preserve the autonomy of the divisions, which is consistent with the spirit of decentralization. The managers negotiating the transfer price are likely to have much better information about the potential costs and benefits of the transfer than others in the company. Second, the range of acceptable transfer prices is the range of transfer prices within which the profits of both divisions participating in the transfer would increase. The lower limit is determined by the selling division. The upper limit is determined by the buying division.

17 Harrison Ltd – An Example
11-17 Harrison Ltd – An Example Assume the information as shown with respect to Cumberland Beverages and Pizza Place (both companies are owned by Harrison Ltd). Assume the information as shown with respect to Cumberland Beverages and Pizza Place (both companies are owned by Harrison Ltd).

18 Harrison Ltd – An Example
11-18 Harrison Ltd – An Example The selling division’s (Cumberland Beverages) lowest acceptable transfer price is calculated as: Let’s calculate the lowest and highest acceptable transfer prices under three scenarios. The buying division’s (Pizza Place) highest acceptable transfer price is calculated as: The selling division’s (Cumberland Beverages) lowest acceptable transfer price is calculated as shown. The buying division’s (Pizza Place) highest acceptable transfer price is calculated as shown. If Pizza Place had no outside supplier for ginger beer, then its highest acceptable transfer price would be equal to the amount it expects to earn by selling the ginger beer, net of its own expenses. Let’s calculate the lowest and highest acceptable transfer prices under three scenarios. If an outside supplier does not exist, the highest acceptable transfer price is calculated as:

19 Harrison Ltd – An Example
11-19 Harrison Ltd – An Example If Cumberland Beverages has sufficient idle capacity (3,000 barrels) to satisfy Pizza Place’s demands (2,000 barrels), without sacrificing sales to other customers, then the lowest and highest possible transfer prices are computed as follows: Selling division’s lowest possible transfer price: Buying division’s highest possible transfer price: Therefore, the range of acceptable transfer price is $8 – $18. Part I If Cumberland Beverages has sufficient idle capacity (3,000 barrels) to satisfy Pizza Maven’s demands (2,000 barrels) without sacrificing sales to other customers, then the lowest and highest possible transfer prices will be computed as follows. Part II The lowest acceptable transfer price, as determined by the seller, is $8. Part III The highest acceptable transfer price, as determined by the buyer, is $18. Therefore, the range of acceptable transfer prices is $8 to $18.

20 Harrison Ltd – An Example
11-20 Harrison Ltd – An Example If Imperial Beverages has no idle capacity (0 barrels) and must sacrifice other customer orders (2,000 barrels) to meet Pizza Maven’s demands (2,000 barrels), then the lowest and highest possible transfer prices are computed as follows: Selling division’s lowest possible transfer price: Buying division’s highest possible transfer price: Therefore, there is no range of acceptable transfer prices. Part I If Cumberland Beverages has no idle capacity and must sacrifice other customer orders (2,000 barrels) to meet the demands of Pizza Place (2,000 barrels), then the lowest and highest possible transfer prices will be computed as follows. Part II The lowest acceptable transfer price, as determined by the seller, is $20. Part III The highest acceptable transfer price, as determined by the buyer, is $18. Therefore, there is no range of acceptable transfer prices. This is a desirable outcome for Harrison Ltd because it would be illogical to give up sales of $20 to save costs of $18.

21 Harrison Ltd – An Example
11-21 Harrison Ltd – An Example If Imperial Beverages has some idle capacity (1,000 barrels) and must sacrifice other customer orders (1,000 barrels) to meet Pizza Maven’s demands (2,000 barrels), then the lowest and highest possible transfer prices are computed as follows: Selling division’s lowest possible transfer price: Buying division’s highest possible transfer price: Therefore, the range of acceptable transfer price is $14 – $18. Part I If Cumberland Beverages has some idle capacity (1,000 barrels) and must sacrifice other customer orders (1,000 barrels) to meet the demands of Pizza Place (2,000 barrels), then the lowest and highest possible transfer prices will be computed as follows. Part II The lowest acceptable transfer price, as determined by the seller, is $14. Part III The highest acceptable transfer price, as determined by the buyer, is $18. Therefore, the range of acceptable transfer prices is $14 to $18.

22 Evaluation of Negotiated Transfer Prices
11-22 Evaluation of Negotiated Transfer Prices If a transfer within a company would result in higher overall profits for the company, there is always a range of transfer prices within which both the selling and buying divisions would have higher profits if they agree to the transfer. If managers are pitted against each other rather than against their past performance or reasonable benchmarks, a no cooperative atmosphere is almost guaranteed. If a transfer within the company would result in higher overall profits for the company, there is always a range of transfer prices within which both the selling and buying divisions would have higher profits if they agree to the transfer. Nonetheless, if managers are pitted against each other rather than against their past performance or reasonable benchmarks, a no cooperative atmosphere is almost guaranteed. Thus, negotiations often break down even though it would be in both parties’ best interests to agree to a transfer price. Given the disputes that often accompany the negotiation process, most companies rely on some other means of setting transfer prices. Given the disputes that often accompany the negotiation process, most companies rely on some other means of setting transfer prices.

23 Transfers at the Cost to the Selling Division
11-23 Transfers at the Cost to the Selling Division Many companies set transfer prices at either the variable cost or full (absorption) cost incurred by the selling division. Drawbacks of this approach include: Using full cost as a transfer price and can lead to suboptimization. The selling division will never show a profit on any internal transfer. Cost-based transfer prices do not provide incentives to control costs. Many companies set transfer prices at either the variable cost or full (absorption) cost incurred by the selling division. The drawbacks of this approach include: Using full cost as a transfer price can lead to suboptimization because it does not distinguish between variable costs, which may be relevant to the transfer pricing decision, and fixed costs, which may be irrelevant. If cost is used as the transfer price, the selling division will never show a profit on any internal transfer. The only division that shows a profit is the division that makes the final sale to an outside party. Cost-based transfer prices do not provide incentives to control costs. If the actual costs of one division are passed on to the next, there is little incentive for anyone to work on reducing costs.

24 Transfers at Market Price
11-24 Transfers at Market Price A market price (i.e., the price charged for an item on the open market) is often regarded as the best approach to the transfer pricing problem. A market price approach works best when the product or service is sold in its present form to outside customers and the selling division has no idle capacity. A market price approach does not work well when the selling division has idle capacity. A market price (i.e., the price charged for an item on the open market) is often regarded as the best approach to the transfer pricing problem. It works best when the product or service is sold in its present form to outside customers and the selling division has no idle capacity. With no idle capacity the real cost of the transfer from the company’s perspective is the opportunity cost of the lost revenue on the outside sale. It does not work well when the selling division has idle capacity. In this case, market-based transfer prices are likely to be higher than the variable cost per unit of the selling division. Consequently, the buying division may make pricing and other decisions based on incorrect, market-based cost information rather than the true variable cost incurred by the company as a whole.

25 Divisional Autonomy and Sub optimization
11-25 Divisional Autonomy and Sub optimization The principles of decentralization suggest that companies should grant managers autonomy to set transfer prices and to decide whether to sell internally or externally, even if this may occasionally result in suboptimal decisions. This way top management allows subordinates to control their own destiny. The principles of decentralization suggest that companies should grant managers autonomy to set transfer prices and to decide whether to sell internally or externally. While subordinate managers may occasionally make suboptimal decisions, top managers should allow their subordinates to control their own destiny – even to the extent of granting subordinate managers the right to make mistakes.

26 International Aspects of Transfer Pricing
11-26 International Aspects of Transfer Pricing Transfer Pricing Objectives Domestic Greater divisional autonomy Greater motivation for managers Better performance evaluation Better goal congruence International Less taxes, duties, and tariffs Less foreign exchange risks Better competitive position Better governmental relations The objectives of domestic transfer pricing include: creating greater divisional autonomy; providing greater motivation for managers; enabling better performance evaluation; and establishing better goal congruence. The objectives of international transfer pricing include: lessen taxes, duties and tariffs; lessen foreign exchange risks; improve competitive position; and improve relations with foreign governments.

27 Analyze the return on investment (ROI).
11-27 Learning Objective 3 Analyze the return on investment (ROI). Learning objective number 3 is to analyze the return on investment (ROI).

28 Return on Investment (ROI) Formula
11-28 Return on Investment (ROI) Formula Income before interest and taxes (EBIT) ROI = Operating income Average operating assets An investment centre’s performance is often evaluated using a measure called return on investment (ROI). ROI is defined as operating income divided by average operating assets. Operating income is income before taxes and is sometimes referred to as earnings before interest and taxes (EBIT). Operating assets include cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes. Operating income is used in the numerator because the denominator consists only of operating assets. The operating asset base used in the formula is typically computed as the average operating assets [(beginning assets + ending assets)/2]. Cash, accounts receivable, inventory, plant and equipment, and other productive assets.

29 Net Book Value vs. Gross Cost
11-29 Net Book Value vs. Gross Cost Most companies use the net book value of depreciable assets to calculate average operating assets. Most companies use the net book value (i.e., acquisition cost less accumulated depreciation) of depreciable assets to calculate average operating assets. With this approach, ROI mechanically increases over time as the accumulated depreciation increases. Replacing a fully-depreciated asset with a new asset will decrease ROI. An alternative to using net book value is the use of the gross cost of the asset, which ignores accumulated depreciation. With this approach, ROI does not grow automatically over time, rather it stays constant; thus, replacing a fully-depreciated asset does not adversely affect ROI.

30 Average operating assets Average operating assets
11-30 Understanding ROI ROI = Operating income Average operating assets Margin = Operating income Sales Turnover = Sales Average operating assets DuPont pioneered the use of ROI and recognized the importance of looking at the components of ROI, namely margin and turnover. Margin is computed as shown and is improved by increasing sales or reducing operating expenses. The lower the operating expenses per dollar of sales, the higher the margin earned. Turnover is computed as shown. It incorporates a crucial area of a manager’s responsibility – the investment in operating assets. Excessive funds tied up in operating assets depress turnover and lower ROI. ROI = Margin  Turnover

31 There are three ways to increase ROI . . .
11-31 Increasing ROI There are three ways to increase ROI . . . Reduce Operating Expenses Increase Sales Reduce Operating Assets Any increase in ROI must involve at least one of the following – increased sales, reduced operating expenses, or reduced operating assets.

32 Increasing ROI – An Example
11-32 Increasing ROI – An Example Regal Company reports the following: Operating income $ 30,000 Average operating assets $ 200,000 Sales $ 500,000 Operating expenses $ 470,000 What is Regal Company’s ROI? Assume that Regal Company reports operating income of $30,000; average operating assets of $200,000; sales of $500,000; and operating expenses of $470,000. What is Regal Company’s ROI? ROI = Margin  Turnover Operating income Sales Average operating assets × ROI =

33 Increasing ROI – An Example
11-33 Increasing ROI – An Example ROI = Margin  Turnover Operating income Sales Average operating assets × ROI = $30,000 $500,000 × $200,000 ROI = Given this information, its current ROI is 15%. 6%  2.5 = 15% ROI =

34 Increasing Sales Without an Increase in Operating Assets
11-34 Increasing Sales Without an Increase in Operating Assets Regal's manager was able to increase sales to $600,000, while operating expenses increased to $558,000. Regal's operating income increased to $42,000. There was no change in the average operating assets of the segment. The first way to increase ROI is to increase sales without any increase in operating assets. Assume the following. First, Regal's manager was able to increase sales to $600,000 (an increase of 20%). Second, operating expenses increased to $558,000 (an increase of 18.7%). Third, operating income increased to $42,000. Fourth, average operating assets remained unchanged. Let’s calculate the new ROI. Let’s calculate the new ROI.

35 Increasing Sales Without an Increase in Operating Assets
11-35 Increasing Sales Without an Increase in Operating Assets ROI = Margin  Turnover Operating income Sales Average operating assets × ROI = $42,000 $600,000 × $200,000 ROI = In this case, the ROI increases from 15% to 21%. Notice, for ROI to increase, the percentage increase in sales must exceed the percentage increase in operating expenses. 7%  3.0 = 21% ROI = ROI increased from 15% to 21%.

36 Let’s calculate the new ROI.
11-36 Decreasing Operating Expenses with no Change in Sales or Operating Assets Assume that Regal's manager was able to reduce operating expenses by $10,000, without affecting sales or operating assets. This would increase operating income to $40,000. Regal Company reports the following: Operating income $ 40,000 Average operating assets $ 200,000 Sales $ 500,000 Operating expenses $ 460,000 The second way to increase ROI is to decrease operating expenses with no change in sales or operating assets. Assume that Regal's manager was able to reduce operating expenses by $10,000 without affecting sales or operating assets. Let’s calculate the new ROI. Let’s calculate the new ROI.

37 11-37 Decreasing Operating Expenses with no Change in Sales or Operating Assets ROI = Margin  Turnover Operating income Sales Average operating assets × ROI = $40,000 $500,000 × $200,000 ROI = In this case, the ROI increases from 15% to 20%. 8%  2.5 = 20% ROI = ROI increased from 15% to 20%.

38 Let’s calculate the new ROI.
11-38 Decreasing Operating Assets with no Change in Sales or Operating Expenses Assume that Regal's manager was able to reduce inventories by $20,000 using just-in-time techniques, without affecting sales or operating expenses. Regal Company reports the following: Operating income $ 30,000 Average operating assets $ 180,000 Sales $ 500,000 Operating expenses $ 470,000 The third way to increase ROI is to decrease operating assets with no change in sales or operating expenses. Assume that Regal's manager was able to reduce inventories by $20,000 by using just-in-time techniques without affecting sales or operating expenses. Let’s calculate the new ROI. Let’s calculate the new ROI.

39 11-39 Decreasing Operating Assets with no Change in Sales or Operating Expenses ROI = Margin  Turnover Operating income Sales Average operating assets × ROI = $30,000 $500,000 × $180,000 ROI = In this case, the ROI increases from 15% to 16.7%. 6%  2.78 = 16.7% ROI = ROI increased from 15% to 16.7%.

40 Investing in Operating Assets to Increase Sales
11-40 Investing in Operating Assets to Increase Sales Assume that Regal's manager invests in a $30,000 piece of equipment that increases sales by $35,000, while increasing operating expenses by $15,000. Regal Company reports the following: Operating income $ 50,000 Average operating assets $ 230,000 Sales $ 535,000 Operating expenses $ 485,000 The fourth way to increase ROI is to invest in operating assets to increase sales. Assume that Regal's manager invests $30,000 in a piece of equipment that increases sales by $35,000 while increasing operating expenses by $15,000. Let’s calculate the new ROI. Let’s calculate the new ROI.

41 Investing in Operating Assets to Increase Sales
11-41 Investing in Operating Assets to Increase Sales ROI = Margin  Turnover Operating income Sales Average operating assets × ROI = $50,000 $535,000 × $230,000 ROI = In this case, the ROI increases from 15% to 21.8%. 9.35%  2.33 = 21.8% ROI = ROI increased from 15% to 21.8%.

42 Criticisms of ROI In the absence of the balanced
11-42 Criticisms of ROI In the absence of the balanced scorecard, management may not know how to increase ROI. Managers often inherit many committed costs over which they have no control. Managers evaluated on ROI may reject profitable investment opportunities. Just telling managers to increase ROI may not be enough. Managers may not know how to increase ROI in a manner that is consistent with the company’s strategy. This is why ROI is best used as part of a balanced scorecard. A manager who takes over a business segment typically inherits many committed costs over which the manager has no control. This may make it difficult to assess this manager relative to other managers. A manager who is evaluated based on ROI may reject investment opportunities that are profitable for the whole company but that would have a negative impact on the manager’s performance evaluation.

43 11-43 Learning Objective 4 Compute residual income and describe the strengths and weaknesses of this method of performance measurement. Learning objective number 4 is to compute residual income and describe the strengths and weaknesses of this method of performance measurement.

44 Residual Income - Another Measure of Performance
11-44 Residual Income - Another Measure of Performance Operating income above some minimum return on operating assets Residual income is the operating income that an investment centre earns above the minimum required return on its assets. Economic Value Added (EVA) is an adaptation of residual income. We will not distinguish between the two terms in this class.

45 Calculating Residual Income
11-45 Calculating Residual Income ( ) This computation differs from ROI. ROI measures operating income earned relative to the investment in average operating assets. Residual income measures operating income earned less the minimum required return on average operating assets. The equation for computing residual income is as shown. Notice that this computation differs from ROI. ROI measures operating income earned relative to the investment in average operating assets. Residual income measures operating income earned less the minimum required return on average operating assets.

46 Residual Income – An Example
11-46 Residual Income – An Example The Retail Division of Zephyr, Inc. has average operating assets of $100,000 and is required to earn a return of 20% on these assets. In the current period, the division earns $30,000. Assume the information for a division of Zephyr, Inc. is as follows. The Retail Division of Zephyr, Inc. has average operating assets of $100,000 and is required to earn a return of 20% on these assets. In the current period, the division earns $30,000. Let’s calculate residual income. Let’s calculate residual income.

47 Residual Income – An Example
11-47 Residual Income – An Example The residual income of $10,000 is computed by subtracting the minimum required return of $20,000 from the actual income of $30,000.

48 Motivation and Residual Income
11-48 Motivation and Residual Income Residual income encourages managers to make profitable investments that would be rejected by managers using ROI. The residual income approach encourages managers to make investments that are profitable for the entire company but that would be rejected by managers who are evaluated using the ROI formula. This occurs when the ROI associated with an investment opportunity exceeds the company’s minimum required return but is less than the ROI being earned by the division manager contemplating the investment.

49 11-49 Quick Check  Redmond Awnings, a division of Wrap-up Corp., has an operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s ROI? a. 25% b. 5% c. 15% d. 20% Redmond Awnings, a division of Wrap-up Corp., has a operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s ROI?

50 11-50 Quick Check  Redmond Awnings, a division of Wrap-up Corp., has an operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s ROI? a. 25% b. 5% c. 15% d. 20% The ROI is 20%. ROI = OI/Average operating assets = $60,000/$300,000 = 20%

51 11-51 Quick Check  Redmond Awnings, a division of Wrap-up Corp., has an operating income of $60,000 and average operating assets of $300,000. If the manager of the division is evaluated based on ROI, will she want to make an investment of $100,000 that would generate additional operating income of $18,000 per year? a. Yes b. No If the manager of the division is evaluated based on ROI, will she want to make an investment of $100,000 that would generate additional operating income of $80,000 per year?

52 This lowers the division’s ROI from 20.0% down to 19.5%.
11-52 Quick Check  Redmond Awnings, a division of Wrap-up Corp., has an operating income of $60,000 and average operating assets of $300,000. If the manager of the division is evaluated based on ROI, will she want to make an investment of $100,000 that would generate additional operating income of $18,000 per year? a. Yes b. No No, she would not want to invest in this project because its return is 18%, which would reduce her division’s ROI from 20% to 19.5%. ROI = $78,000/$400,000 = 19.5% This lowers the division’s ROI from 20.0% down to 19.5%.

53 11-53 Quick Check  The company’s required rate of return is 15%. Would the company want the manager of the Redmond Awnings division to make an investment of $100,000 that would generate additional operating income of $18,000 per year? a. Yes b. No The company’s required rate of return is fifteen percent. Would the company want the manager of the Redmond Awnings division to make an investment of $100,000 that would generate additional operating income of $18,000 per year?

54 Quick Check  ROI = $18,000/$100,000 = 18%
11-54 Quick Check  The company’s required rate of return is 15%. Would the company want the manager of the Redmond Awnings division to make an investment of $100,000 that would generate additional operating income of $18,000 per year? a. Yes b. No ROI = $18,000/$100,000 = 18% The return on the investment exceeds the minimum required rate of return. Yes, she would want to invest in this project because the return on the investment exceeds the minimum required rate of return.

55 11-55 Quick Check  Redmond Awnings, a division of Wrap-up Corp., has an operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s residual income? a. $240,000 b. $ 45,000 c. $ 15,000 d. $ 51,000 Review this question. What is the division’s residual income?

56 11-56 Quick Check  Redmond Awnings, a division of Wrap-up Corp., has an operating income of $60,000 and average operating assets of $300,000. The required rate of return for the company is 15%. What is the division’s residual income? a. $240,000 b. $ 45,000 c. $ 15,000 d. $ 51,000 The residual income is $15,000. Operating income $60,000 Required return (15% of $300,000) (45,000) Residual income $15,000

57 11-57 Quick Check  If the manager of the Redmond Awnings division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional operating income of $18,000 per year? a. Yes b. No If the manager of the Redmond Awnings division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional operating income of $18,000 per year?

58 11-58 Quick Check  If the manager of the Redmond Awnings division is evaluated based on residual income, will she want to make an investment of $100,000 that would generate additional operating income of $18,000 per year? a. Yes b. No Operating income $78,000 Required return (15% of $400,000) (60,000) Residual income $18,000 Yields an increase of $3,000 in the residual income. Yes, she would want to invest in this project because it will increase the residual income by $3,000.

59 Divisional Comparisons and Residual Income
11-59 Divisional Comparisons and Residual Income The residual income approach has one major disadvantage. It cannot be used to compare performance of divisions of different sizes. The residual income approach has one major disadvantage. It cannot be used to compare the performance of divisions of different sizes.

60 11-60 Zephyr, Inc. - Continued Recall the following information for the Retail Division of Zephyr, Inc. Assume the following information for the Wholesale Division of Zephyr, Inc. Recall that the Retail Division of Zephyr had average operating assets of $100,000, a minimum required rate of return of 20%, operating income of $30,000, and residual income of $10,000. Assume that the Wholesale Division of Zephyr had average operating assets of $1,000,000, a minimum required rate of return of 20%, operating income of $220,000, and residual income of $20,000.

61 11-61 Zephyr, Inc. - Continued The residual income numbers suggest that the Wholesale Division outperformed the Retail Division because its residual income is $10,000 higher. However, the Retail Division earned an ROI of 30% compared to an ROI of 22% for the Wholesale Division. The Wholesale Division’s residual income is larger than the Retail Division simply because it is a bigger division. The residual income numbers suggest that the Wholesale Division outperformed the Retail Division because its residual income is $10,000 higher. However, the Retail Division earned an ROI of 30% compared to an ROI of 22% for the Wholesale Division. The Wholesale Division’s residual income is larger than the Retail Division simply because it is a bigger division.

62 Criticisms of Residual Income
11-62 Criticisms of Residual Income RI is based on historical accounting data which can lead to inflated amounts for residual income in periods of rising prices (i.e.. values for capital assets). RI does not indicate what earnings should be (need comparison of external benchmark or trends). Calculating RI requires numerous adjustments to GAAP increasing the cost of preparing information. Compared to ROI, the use of residual income can lead managers to make decisions more consistent with shareholders’ objectives. Further, some claim that residual income is more closely related to shareholder returns than other metrics such as sales growth, net income or ROI. However the following criticisms of residual income, are worth noting: 1. Residual income is based on historical accounting data, which means that in particular, the accounting values used for capital assets can suffer from being out of date when costs are rising. This can lead to inflated amounts for residual income. 2. The residual income approach does not indicate what earnings should be for a particular business unit. A means of comparison is needed, which could involve using external benchmarks based on key competitors or evaluating trends in residual income over time (e.g., tracking the percentage change over several periods). 3. Calculating residual income requires numerous adjustments to financial information recorded using generally accepted accounting principles that can increase the cost of preparing the information. 4. Residual income is a financial metric that does not incorporate important leading non-financial indicators of success such as employee motivation or customer satisfaction. RI does not incorporate important leading non-financial indicators.

63 Explain the use of balanced scorecards to assess performance.
11-63 Learning Objective 5 Explain the use of balanced scorecards to assess performance. Learning objective number 5 is to explain the use of balanced scorecards to assess performance.

64 The Balanced Scorecard
11-64 The Balanced Scorecard Management translates its strategy into performance measures that employees understand and accept. Customers Financial Performance measures A balanced scorecard consists of an integrated set of performance measures that are derived from and support a company’s strategy. Importantly, the measures included in a company’s balanced scorecard are unique to its specific strategy. The balanced scorecard enables top management to translate its strategy into four groups of performance measures – financial, customer, internal business processes, and learning and growth – that employees can understand and influence. Learning and growth Internal business processes

65 The Balanced Scorecard: From Strategy to Performance Measures
11-65 Exhibit 10-11 The Balanced Scorecard: From Strategy to Performance Measures Performance Measures Financial Has our financial performance improved? What are our financial goals? What customers do we want to serve and how are we going to win and retain them? Vision and Strategy Customer Do customers recognize that we are delivering more value? Internal Business Processes Have we improved key business processes so that we can deliver more value to customers? What internal busi- ness processes are critical to providing value to customers? The premise of these four groups of measures is that learning is necessary to improve internal business processes. This in turn improves the level of customer satisfaction, thereby improving financial results. Note the emphasis on improvement, not just attaining some specific objective. Learning and Growth Are we maintaining our ability to change and improve?

66 The Balanced Scorecard: Non-financial Measures
11-66 The Balanced Scorecard: Non-financial Measures The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons: Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance. Top managers are ordinarily responsible for financial performance measures – not lower level managers Non-financial measures are more likely to be understood and controlled by lower level managers. The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons:  Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance.  Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers.

67 The Balanced Scorecard for Individuals
11-67 The Balanced Scorecard for Individuals The entire organization should have an overall balanced scorecard. Each individual should have a personal balanced scorecard. While the entire organization has an overall balanced scorecard, each responsible individual should have his or her own personal scorecard as well. A personal scorecard should contain measures that can be influenced by the individual being evaluated and that support the measures in the overall balanced scorecard. A personal scorecard should contain measures that can be influenced by the individual being evaluated and that support the measures in the overall balanced scorecard.

68 The Balanced Scorecard
11-68 The Balanced Scorecard A balanced scorecard should have measures that are linked together on a cause-and-effect basis. If we improve one performance measure . . . Another desired performance measure will improve. Then A balanced scorecard, whether for an individual or the company as a whole, should have measures that are linked together on a cause-and-effect basis. Each link can be read as a hypothesis in the form “If we improve this performance measure, then this other performance measure should also improve.” In essence, the balanced scorecard lays out a theory of how a company can take concrete actions to attain desired outcomes. If the theory proves false or the company alters its strategy, the measures within the scorecard are subject to change. The balanced scorecard lays out concrete actions to attain desired outcomes.

69 The Balanced Scorecard and Compensation
11-69 The Balanced Scorecard and Compensation Incentive compensation should be linked to balanced scorecard performance measures. Incentive compensation for employees probably should be linked to balanced scorecard performance measures. However, this should only be done after the organization has been successfully managed with the scorecard for some time – perhaps a year or more. Managers must be confident that the measures are reliable, not easily manipulated, and understandable by those being evaluated with them.

70 The Balanced Scorecard Jaguar Example
11-70 Exhibit 10-13 The Balanced Scorecard Jaguar Example Profit Financial Contribution per car Number of cars sold Customer Customer satisfaction with options Assume that Jaguar pursues a strategy as shown on this slide. Examples of measures that Jaguar might select with their corresponding cause-and-effect linkages include those shown on the next four slides. Internal Business Processes Number of options available Time to install option Learning and Growth Employee skills in installing options

71 The Balanced Scorecard Jaguar Example
11-71 The Balanced Scorecard Jaguar Example Profit Contribution per car Number of cars sold Results Customer satisfaction with options Satisfaction Increases Strategies If “employee skills in installing options” increases, then the “number of options available” should increase and the “time to install an option” should decrease. If the “number of options available” increases and the “time to install an option” decreases, then “customer satisfaction with options available” should increase. Increase Options Number of options available Time to install option Time Decreases Increase Skills Employee skills in installing options

72 The Balanced Scorecard Jaguar Example
11-72 The Balanced Scorecard Jaguar Example Profit Contribution per car Results Cars sold Increase Number of cars sold Customer satisfaction with options Satisfaction Increases If the “customer satisfaction with options available” increases, then the “number of cars sold” should increase. Number of options available Time to install option Employee skills in installing options

73 The Balanced Scorecard Jaguar Example
11-73 The Balanced Scorecard Jaguar Example Profit Results Contribution per car Contribution Increases Number of cars sold Customer satisfaction with options Satisfaction Increases If the “time to install an option” decreases and the “customer satisfaction with options available” increases, then the “contribution per car” should increase. Number of options available Time to install option Time Decreases Employee skills in installing options

74 The Balanced Scorecard Jaguar Example
11-74 The Balanced Scorecard Jaguar Example Results Profit Profits Increase If number of cars sold and contribution per car increase, profits increase. Contribution per car Contribution Increases Number of cars sold Cars Sold Increases Customer satisfaction with options If the “number of cars sold” and the “contribution per car” increases, then the “profits” should increase. Number of options available Time to install option Employee skills in installing options

75 Advantages of Graphic Feedbck
11-75 Advantages of Graphic Feedbck When interpreting its performance, Jaguar will be looking for a trend of continual improvement. These trends are better identified with graphic feedback. For example: Assume that Jaguar’s “time to install an option” performance over ten weeks is as shown. It is much easier to spot trends or unusual performance if these data are presented graphically as shown. When interpreting its performance, Jaguar will look for continual improvement. It is easier to spot trends or unusual performance if these data are presented graphically.

76 Delivery Performance Measures
11-76 Delivery Performance Measures Order Received Production Started Goods Shipped Process Time + Inspection Time + Move Time + Queue Time Wait Time Throughput Time Delivery cycle time is the elapsed time from when a customer order is received to when the completed order is shipped. Throughput (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 queue time. Process time is the only value-added activity of the four times mentioned. Delivery Cycle Time Process time is the only value-added time.

77 Delivery Performance Measures
11-77 Delivery Performance Measures Order Received Production Started Goods Shipped Process Time + Inspection Time + Move Time + Queue Time Wait Time Throughput Time Manufacturing cycle efficiency (MCE) is computed by dividing value-added time by manufacturing cycle (throughput) time. An MCE less than one indicates that non-value-added time is present in the production process. Next, we will look at a series of questions dealing with delivery performance measures. Delivery Cycle Time Manufacturing Cycle Efficiency Value-added time Manufacturing cycle time =

78 11-78 Quick Check  A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the throughput time? a days b days c days d days Here’s your first question on delivery performance measures asking for a computation of throughput time.

79 11-79 Quick Check  A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the throughput time? a days b days c days d days Throughput time is the sum of process time, inspection time, move time, and queue time. The total for these four times is 10.4 days. Throughput time = Process + Inspection + Move + Queue = 0.2 days days days days = 10.4 days

80 11-80 Quick Check  A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the Manufacturing Cycle Efficiency? a. 50.0% b % c. 52.0% d % Here’s your second question on delivery performance measures asking for a computation of manufacturing cycle efficiency.

81 11-81 Quick Check  A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the Manufacturing Cycle Efficiency? a. 50.0% b % c. 52.0% d % Manufacturing cycle efficiency is found by dividing value-added time by throughput time. Process time is the only value-added time. Process time of 0.2 days divided by throughput time of 10.4 days results in a manufacturing cycle efficiency of 1.9 percent. MCE = Value-added time ÷ Throughput time = Process time ÷ Throughput time = 0.2 days ÷ 10.4 days = 1.9%

82 11-82 Quick Check  A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the delivery cycle time? a days b days c days d days Here’s your third question on delivery performance measures asking for a computation of delivery cycle time.

83 11-83 Quick Check  Delivery cycle time = Wait time + Throughput time = 3.0 days days = 13.4 days A TQM team at Narton Corp has recorded the following average times for production: Wait days Move days Inspection 0.4 days Queue days Process days What is the delivery cycle time? a days b days c days d days Delivery cycle time is the sum of wait time plus throughput time. The total for these two times is 13.4 days.

84 ROI and the Balanced Scorecard
11-84 ROI and the Balanced Scorecard It may not be obvious to managers how to increase sales, decrease costs, and decrease investments in a way that is consistent with the company’s strategy. A well constructed balanced scorecard can provide managers with a road map that indicates how the company intends to increase ROI. Which internal business process should be improved? It may not be obvious to managers how to increase sales, decrease costs, and decrease investments in a way that is consistent with the company’s strategy. A well-constructed balanced scorecard can provide managers with a road map that indicates how the company intends to increase ROI. A scorecard can answer questions such as: Which internal business processes should be improved? and Which customers should be targeted and how will they be attracted and retained at a profit? Which customers should be targeted and how will they be attracted and retained at a profit?

85 11-85 Learning Objective 6 Identify the four types of quality costs, explain their interaction, and prepare a quality cost report. Learning objective number 6 is to identify the four types of quality costs, explain their interaction, and prepare a quality cost report.

86 Quality of Conformance
11-86 Quality of Conformance When the overwhelming majority of products produced conform to design specifications and are free from defects. The term quality has many meanings. Quality can mean that a product has many features not found in other products; it can mean that it is well-designed; or it can mean that it is defect-free. In this appendix, the focus is on the presence or absence of defects. Quality of conformance is the degree to which the actual product or service meets its design specifications. Anything that does not meet design specifications is a defect and is indicative of low quality of conformance. There are four broad categories of quality costs: prevention costs, appraisal costs, internal failure costs, and external failure costs.

87 Prevention and Appraisal Costs
11-87 Prevention and Appraisal Costs Prevention Costs Support activities whose purpose is to reduce the number of defects Prevention costs are incurred to support activities whose purpose is to reduce the number of defects. Appraisal costs are incurred to identify defective products before the products are shipped to customers. Appraisal Costs Incurred to identify defective products before the products are shipped

88 Internal and External Failure Costs
11-88 Internal and External Failure Costs Internal Failure Costs Incurred as a result of identifying defects before they are shipped Internal failure costs are incurred as a result of identifying defects before they are shipped to customers. External failure costs are incurred as a result of defective products being delivered to customers. External Failure Costs Incurred as a result of defective products being delivered to customers

89 Examples of Quality Costs
11-89 Examples of Quality Costs Prevention Costs Quality training Quality circles Statistical process control activities Appraisal Costs Testing & inspecting incoming materials Final product testing Depreciation of testing equipment Internal Failure Costs Scrap Spoilage Rework External Failure Costs Cost of field servicing & handling complaints Warranty repairs Lost sales Here are some examples of each type of quality cost.  Prevention costs include: quality training, quality circles, and statistical process control activities. Appraisal costs include: testing and inspection of incoming materials, final product testing, and depreciation of testing equipment. Internal failure costs include: scrap, spoilage, and rework. External failure costs include: the cost of field servicing and handling customer complaints, warranty repairs, and lost sales arising from reputation of poor quality.

90 Distribution of Quality Costs
11-90 Distribution of Quality Costs When quality of conformance is low, total quality cost is high and consists mostly of internal and external failure. Total quality costs drop rapidly as the quality of conformance increases. Companies reduce their total quality costs by focusing their efforts on prevention and appraisal because the cost savings from reduced defects usually overwhelm the costs of additional prevention and appraisal. Here are four key concepts about the relationship between the four types of quality costs. When the quality of conformance is low, total quality cost is high and most of this cost consists of internal and external failure costs. Total quality costs drop rapidly as the quality of conformance increases. Companies reduce their total quality costs by focusing their efforts on prevention and appraisal because the cost savings from reduced defects usually overwhelm the costs of additional prevention and appraisal. Total quality costs are minimized when the quality of conformance is slightly less than 100%. This is a debatable point in the sense that some experts believe that total quality costs are not minimized until the quality of conformance is 100%. Total quality costs are minimized when the quality of conformance is slightly less than 100%.

91 11-91 Quality cost reports provide an estimate of the financial consequences of the company’s current defect rate. A quality cost report details the prevention, appraisal, internal failure, and external failure costs that arise from a company’s current quality control efforts. When interpreting a cost of quality report managers should look for two trends. First, increases in prevention and appraisal costs should be more than offset by decreases in internal and external failure costs. Second, the total quality costs as a percent of sales should decrease.

92 Quality Cost Reports in Graphic Form
11-92 Quality Cost Reports in Graphic Form Quality reports can also be prepared in graphic form. Quality cost reports can also be prepared in graphic form. Managers should still look for the same two trends whether the data are presented in a graphic or table format.

93 Uses of Quality Cost Information
11-93 Uses of Quality Cost Information Help managers see the financial significance of defects. Help managers identify the relative importance of the quality problems. Uses of quality cost information include the following. It helps managers see the financial significance of defects. It helps managers identify the relative importance of the quality problems faced by the company. It helps managers see whether their quality costs are poorly distributed. In general, costs should be distributed more toward prevention and to a lesser extent appraisal than toward failures. Help managers see whether their quality costs are poorly distributed.

94 Limitations of Quality Cost Information
11-94 Limitations of Quality Cost Information Simply measuring quality cost problems does not solve quality problems. Results usually lag behind quality improvement programs. Limitations of quality cost information include the following. Simply measuring and reporting quality cost problems does not solve quality problems. Results usually lag behind quality improvement programs. Initially, prevention and appraisal cost increases may not be offset by decreases in failure costs. The most important quality cost, lost sales arising from customer ill-will, is often omitted from quality cost reports because it is difficult to estimate. The most important quality cost, lost sales, is often omitted from quality cost reports.

95 11-95 ISO 9000 Standards ISO 9000 standards have become international measures of quality. To become ISO 9000 certified, a company must demonstrate: A quality control system is in use, and the system clearly defines an expected level of quality. The system is fully operational and is backed up with detailed documentation of quality control procedures. The intended level of quality is being achieved on a sustained basis. The International Organization for Standardization, based in Geneva, Switzerland, has established quality control guidelines, known as the ISO 9000 standards. For a company to become ISO 9000 certified by a certifying agency, it must demonstrate that: 1. A quality control system is in use, and the system clearly defines an expected level of quality, 2. The system is fully operational and is backed up with detailed documentation of quality control procedures, and 3. The intended level of quality is being achieved on a sustained basis. Although the ISO 9000 standards were developed in Europe, they have become widely accepted elsewhere, throughout the world, including the United States.

96 Profitability Analysis
11-96 Profitability Analysis Appendix 11A Appendix 11A: Profitability Analysis

97 Analyze variance from sales budgets.
11-97 Learning Objective 7 Analyze variance from sales budgets. Learning objective number 7 is to analyze variances from sales budgets.

98 Sales Variance Analysis
11-98 Sales Variance Analysis Consider the following example for CardCo: Budget Actual Sales in units Deluxe cards 14, ,000 Standard cards 6, ,000 Price per unit Deluxe cards $ $16 Standard cards $ $10 Market volume Deluxe cards 75, ,000 Standard cards 95, ,000 Variable cost per unit Deluxe cards $ $ 8 Standard cards $ $ 3 Consider the following example for CardCo and sales variances analysis.

99 Sales Variance Analysis
11-99 CardCo Actual and Budgeted Results Actual results are based on the actual quantity sold multiplied by the actual selling price or variable cost As illustrated, CardCo’s actual results are based on the actual quantity sold multiplied by the actual selling price or variable cost.

100 Sales Variance Analysis
11-100 CardCo Actual and Budgeted Results Flexible budget results are based on the actual quantity sold multiplied by the budgeted selling price or variable cost As illustrated, CardCo’s flexible budget results are based on the actual quantity sold multiplied by the budgeted selling price or variable cost.

101 Sales Variance Analysis
11-101 CardCo Actual and Budgeted Results Master budget results are based on the budgeted quantity sold multiplied by the budgeted selling price or variable cost As illustrated, CardCo’s master budget (static budget) results are based on the budgeted quantity sold multiplied by the budgeted selling price or variable cost.

102 Sales Variance Analysis
11-102 CardCo Actual and Budgeted Results CardCo’s sales price variance is the difference between the actual revenues and the flexible budget revenues. Sales Price Variance $29,000 U

103 Sales Variance Analysis
11-103 CardCo Actual and Budgeted Results $29,000U The sales price variance for CardCo can also be calculated using the formulas. or Sales Price Variance=(Actual - Budgeted price)x Actual sales volume Deluxe =($16-$18) x 17,000 units = $34,000 U Standard =($10-$9) x 5,000 units = $ 5,000 F Total sales price variance = $29,000 U

104 Sales Variance Analysis
11-104 CardCo Actual and Budgeted Results CardCo’s sales volume variance is the difference between the flexible budget contribution margin and the master budget contribution margin. Sales Volume Variance $24,000 F

105 Sales Variance Analysis
11-105 CardCo Actual and Budgeted Results $24,000F The sales volume variance for CardCo can also be calculated using the formulas. or Sales Volume Variance=(Actual - Budgeted quantity) x Budgeted CM Deluxe =(17,000-14,000) x ($18-$8) units = $30,000 F Standard =(5,000-6,000) x ($9-$3) = $ 6,000 U Total sales volume variance = $24,000 F

106 Sales Variance Analysis
11-106 Sales Variance Analysis The Sales Volume Variance can further be broken down into the: Market Volume Variance = Market Share Variance { } Actual market volume Budget market volume Expected market share % Budgeted CM per unit - x x Here are the general model equations to further break down the sales volume variance into the market volume variance and the market share variance. [ ] Actual market share - Expected market share } { Actual sales quantity Budgeted CM per unit - x

107 Sales Variance Analysis
11-107 For CardCo, the Sales Volume Variance of $24,000 F breakdown further as follows: Market Volume Variance Deluxe=(85,000-75,000) x (14,000/75,000) x (18-8) = 18,667 F Standard=(90,000-95,000) x (6,000/95,000) x (9-3) = 1,895 U Total Market Volume Variance (1) 16,772 F Market Share Variance Deluxe=[17,000-(85,000 x 14,000/75,000)] x (18-8) = 11,333 F Standard=[5,000-(90,000 x 6,000/95,000)] x (9-3) = 4,105 U Total Market Share Variance (2) 7,228 F Sales Volume Variance = (1) + (2) = 24,000 F Let’s compute the market volume variance and the market share variance for CardCo. Notice that the sales volume variance is the sum of the market volume variance and the market share variance.

108 Sales Variance Analysis
11-108 Sales Variance Analysis The Sales Volume Variance can also be broken down into the: Sales Mix Variance = Sales Quantity Variance Actual sales quantity Actual sales quantity at expected sales mix Budgeted CM per unit - { } x Here are the general model equations to further break down the sales volume variance into the sales mix variance and the sales quantity variance. Actual sales quantity at expected sales mix - Anticipated sales quantity } Budgeted CM per unit x {

109 Sales Variance Analysis
11-109 For CardCo, the Sales Volume Variance of $24,000F is made up of: Sales Mix Variance Deluxe=[17,000-(22,000 x14/20)] x (18-8) =16,000 F Standard=[(5,000-22,000 x 6/20)] x (9-3) = 9,600 U Total Sales Mix Variance (1) 6,400 F Sales Quantity Variance Deluxe=[(22,000 x 14/20)-14,000] x (18-8) =14,000 F Standard=[(22,000 x 6/20)-6,000] x (9-3) = 3,600 F Total Sales Quantity Variance (2) 17,600F Sales Volume Variance = (1) + (2) = 24,000F Let’s compute the market volume variance and the market share variance for CardCo. Notice that the sales volume variance is the sum of the sales mix variance and the sales volume variance.

110 11-110 Marketing Expense Appendix 11B Appendix 11B: Marketing Expense

111 Analyze marketing expenses using cost drivers.
11-111 Learning Objective 8 Analyze marketing expenses using cost drivers. Learning objective number 8 is to analyze marketing expenses using cost drivers.

112 Costs Factors to Consider in a Marketing Strategy
11-112 Costs Factors to Consider in a Marketing Strategy Transport Warehousing Marketing Strategy Advertising Knowledge of the nature and behaviour of marketing expenses provides managers with information about the costs of their marketing endeavours. Such information represents a significant aspect of marketing efforts, one that is needed to complement the pricing strategy previously discussed. Transport, warehousing, selling, advertising, and credit are some of the key factors managers need to consider in their marketing strategy. Accurate cost behaviour and allocation by the accounting function can assist marketing decision makers. Selling Credit

113 Order Getting and Order Filling
11-113 Order Getting and Order Filling More Discretionary Accountants typically decompose marketing expense into two general categories, order-getting and order-filling. Order-getting costs are the pure marketing costs such as advertising, selling commissions, and travel. Order-filling includes the costs of warehousing, transportation, packing, and credit. Order-getting costs tend to be somewhat more discretionary than order-filling because order-filling occurs after the sale rather than to obtain the sale. Nevertheless, marketing managers need to understand the cost behaviour associated with both sets of costs so that analysis can be conducted to decide what should be done and how.

114 11-114 End of Chapter 11 End of chapter 11.


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