1. ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 14 Professor Jeff Yu

2. Review: Flexible Budget Flexible budget is prepared based on the actual activity level and is used for performance evaluation (control) purpose. Activity Variance = Flexible budget amount – planning (static) budget amount Spending Variance = Actual cost – flexible budget cost Spending variance is unfavorable if positive, favorable if negative; Spending variance captures the efficiency of cost control. Revenue Variance = Actual revenue – flexible budget revenue Revenue variance is favorable if positive, unfavorable if negative;

3. Review: Standard Cost  Standard vs. Budget: A budget is set for total costs; A standard is set for per unit cost;  Quantity standards are set for each unit of production (How much units of input are needed for each unit of output?) SQ = standard quantity of materials allowed for the actual output SH = standard hours allowed for the actual output Price standards are set for each unit of input (How much should be paid for each unit of input?) Standard Price (SP) for materials Standard Rate (SR) for labor and overhead

4. Review: Variance Analysis Materials Price Variance AQ(AP - SP) Labor/VOH Rate Variance AH(AR – SR) Materials Quantity Variance SP(AQ - SQ) Labor/VOH Efficiency Variance SR(AH – SH) AP (AR)= Actual Price (Actual Rate): the amount actually paid for each unit of the materials (labor or VOH). SP (SR)= Standard Price (Standard Rate): the amount that should Have been paid for each unit of the materials (labor or VOH). AQ (AH)= Actual Quantity (Actual Hour): the amount of materials (labor or VOH activity) actually used in the production. SQ (SH)= Standard Quantity (Stan. Hour) allowed for the actual output = actual production in units * standard quantity (hours) per unit

5. When material purchased ≠ material used To compute the PRICE variance, use the total quantity of raw materials PURCHASED. To compute the QUANTITY Variance, use only the quantity of raw materials USED. Review: Materials Variances

6. Bella has the following direct labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $6.00 per direct labor hour. Last week 1,550 direct labor hours were worked at a total labor cost of $9,610 to make 1,000 Zippies. Q: (1)What was Bella’s actual rate for labor for the week? (2) What was Bella’s labor rate variance for the week? (3) What is the standard hours of labor that should have been worked to produce 1,000 Zippies? (4)What was Bella’s labor efficiency variance for the week? Example: Labor Variances

7. Responsibility for Labor Variances Production Manager Production managers are usually held accountable for labor variances because they can influence the: Mix of skill levels assigned to work tasks. Level of employee motivation. Quality of production supervision. Quality of training provided to employees.

8. Osborne Co. has the following DL standards to produce each unit of horn: 5 direct labor hours at $20 per hour. In May, the actual hourly rate for direct labor is $22, with the labor variances reported below: Labor rate variance $30,400 U Labor efficiency variance $4,000 U Q: How many horns did Osborne Co. produce in May? Practice Problem: Labor Variances

9. Foster Inc.’s direct labor standard for each unit of product is 3 hours at $8 per hour. In April, total direct labor cost of $240,000 was paid to make 10,000 units of product. Labor rate variance is $16,000 F. Q: What is Foster Inc.’s labor efficiency variance in April? Practice Problem: Labor Variances

10. Cola Co’s Variable OH is applied based on machine hours. The standard allows for 3,200 machine hours for the actual production in March. In March, actual machine hours worked were 3,300, actual variable OH incurred was $6,740, and the variable OH efficiency variance was $200 U. Q: What is the amount of variable OH rate variance? Example: Variable OH Variances

11. Chapter 12 Segment Reporting Learning Objectives – Understand performance evaluation tools for cost center, profit center and investment center – Prepare a segmented income statement – Compute ROI and Residual Income – Understand the pros and cons of performance evaluation using ROI, Residual Income and the Balanced Scorecard.

12. Decentralization and Segments A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be... Quick Mart An Individual Store A Sales Territory A Service Center

13. Evaluating Managers’ Performance Cost Center ( controls costs only ) Flexible Budget Variances; Standard Cost Variances Profit Center (controls costs & revenues) Segmented Income Statement (Segment Margin) Investment Center (controls costs & revenues & Investments) Return on Investment (ROI); Residual Income Evaluation Tool

14. Segmented Income Statement There are two keys to building segmented income statements: A contribution format should be used because it separates fixed from variable costs and it enables the calculation of a contribution margin. Traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin.

15. Identifying Traceable Fixed Costs Traceable fixed costs arise because of the existence of a particular segment and would disappear if the segment itself disappeared. No computer division means... No computer division manager.

16. Identifying Common Fixed Costs Common fixed costs arise because of the overall operation of the company and would not disappear if any particular segment was eliminated. No computer division but... We still have a company president.

17. Sales - Variable Expenses Contribution Margin - Traceable Fixed costs Segment Margin  Do NOT subtract Common fixed costs!!  Segment margin is a valuable tool for performance evaluation and is also useful in decisions such as dropping or retaining a segment. Segmented Income Statement

18. Example: Segmented Income Statements Segment margin is Television Division’s contribution to profits. Segment margin is Television Division’s contribution to profits. Segment reporting uses the contribution format. Contribution margin is computed by taking sales minus variable costs. Contribution margin is computed by taking sales minus variable costs.

19. Example: Segmented Income Statements Common fixed costs should not be allocated to the divisions. These costs would remain even if one of the divisions were eliminated.

20. Practice Problem Company Family Law Division Commercial Law Division Revenue from Clients$1000,000$400,000$600,000 Variable expenses 220,000 100,000 120,000 Contribution margin780,000300,000480,000 Traceable fixed expenses 670,000 280,000 390,000 Segment margin$ 110,000$ 20,000$ 90,000 Common fixed expenses 60,000 24,000 36,000 Net operating income$ 50,000$ (4,000)$ 54,000 In the above reports, staff of the law firm FDS allocated common fixed expenses the two segments proportionally based on their revenues. Q: (1) Would the firm be better off financially if family law division were dropped? Prepare segmented income statements to support your answer. (2) Managers propose that an ad campaign costing $20,000 will increase family law revenue by $100,000. If other expenses and revenues remain constant, how would this proposal affect the family law segment margin and the firm’s overall NOI?

21. Bolvine Co. had a net loss of $10,000 in May. The CEO asked for a segmented monthly income statement to isolate the problem. Q: (1) Prepare a segmented income statement by divisions. (2) What is the amount of common fixed costs for the company? (3)The manager of Division B proposes that an increase of $20,000 in the division’s monthly advertising costs will increase Division B sales by 10%. If this plan is adopted, what would be the new segment margin for Division B? Practice Problem Division ADivision B Sales$400,000$600,000 Variable expense ratio50%30% Traceable fixed expenses$240,000$330,000

22. For Next Class  Continue on Chapter 12  Cover ROI, RI and the Balanced Scorecard

23. Xavier Co. applies MOH based on direct labor hours. The standard costs for one unit of product are as follows: Direct Material: 6 ounces at $0.50 per ounce Direct Labor: 1.8 hours at $10 per hour Variable MOH: 1.8 hours at $5 per hour 2,000 units were produced in June with the following cost data: Material purchased: 18,000 ounces at $0.6 per ounce Material used in production: 14,000 ounces Direct labor: 4,000 hours at $9.75 per hour Variable MOH cost: $20,800 Q: Compute materials, labor and VOH variances. Homework Problem 1

24. Homework Problem 2 CompanyStore AStore B Sales$300,000$100,000$200,000 Variable expenses 192,000 72,000 120,000 Contribution margin108,00028,00080,000 Traceable fixed expenses 76,000 21,000 55,000 Segment margin32,000$ 7,000$ 25,000 Common fixed expenses 27,000 Net operating income$ 5,000 Q: (1) Store B Sales will increase by $30,000 if its advertising costs increase by $7,000. How would store B’s segment margin change? (2) Managers propose that an increase of $8,000 in traceable fixed costs will lower variable expense ratio in Store A to 62%. If sales and everything else remain constant, how would this proposal affect overall company’s NOI?