AFM102 Exam-Aid Session

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4/9/12

Chapter 10
Good to edit Master subtitle style Click to Know DM, DL, VMO, FMO variances Overhead Cost Analysis

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Management by Exception
Definition

System of management in which standards are set for various operating activities which are periodically compared to actual results Significant differences

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Variance Analysis Cycle

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Prepare standard cost performance report Analyze variances Identify Questions Receive explanations Take corrective actions Conduct next periods operations

2) 3) 4) 5) 6)

Ideal vs. Practical Standards

Allows for no machine breakdowns or other work interruption Require peak efficiency Motivational value

PROS

CONS

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Ideal Standards

Ideal vs. Practical Standards

Practical Standards

Allows for normal machine breakdowns and other work interruption Attained through reasonable but highly efficient efforts by average employees

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Direct Materials Standards

Standard Price per Unit (SP) price paid for single unit of material

Includes allowances for quality, shipping, net of discounts

Standard Quantity per Product (SQ) amount of materials required to complete single unit of

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Direct Labour Standards

Standard Rate per Hour (SR) labour rate that should be incurred per hour

Includes employment tax, employee benefits

Standard Hours per Product (SH) amount of labour time required to complete single unit of product

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Variable Manuf. Ohead Standards

Standard Rate per Hour (SR) variable portion of predetermined overhead rate Standard Hours per Product (SH) amount of labour time required to complete single unit of product

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Variance Analysis

Variance Difference between standard price and quantities and actual price and quantities

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Variance Analysis
Actual Quantity At Actual Price AQ x AP Actual Quantity At Standard Price AQ x SP Standard Quantity At Standard Price SQ x SP
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Price Variance

Quantity Variance

Total Flexible Budget Variance

Variance Analysis
Actual Quantity At Actual Price AQ x AP Actual Quantity At Standard Price AQ x SP Standard Quantity At Standard Price SQ x SP
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Price Variance

Quantity Variance

Total Flexible Budget Variance

Direct Materials Variance Materials Price Variance = AQ (AP SP) Measure of difference between actual unit price and standard unit price Responsibility

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Variance Analysis
Actual Quantity At Actual Price AQ x AP Actual Quantity At Standard Price AQ x SP Standard Quantity At Standard Price SQ x SP
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Price Variance

Quantity Variance

Total Flexible Budget Variance

Direct Materials Variance Materials Quantity Variance = SP (AQ SQ) Measure of difference between actual quantity used and standard quantity allowed Best isolated when

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Variance Analysis
Actual Quantity At Actual Price AQ x AP Actual Quantity At Standard Price AQ x SP Standard Quantity At Standard Price SQ x SP
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Price Variance

Quantity Variance

Total Flexible Budget Variance

Direct Labour Variance Labour Rate Variance = AH(AR SR) Measure of diff. b/w actual rate and standard rate Can arise from way labour used ie. Highskilled worker doing duty

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Variance Analysis
Actual Quantity At Actual Price AQ x AP Actual Quantity At Standard Price AQ x SP Standard Quantity At Standard Price SQ x SP
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Price Variance

Quantity Variance

Total Flexible Budget Variance

Direct Labour Variance Labour Efficiency Variance = SR(AH SH) Measure of diff. b/w actual hours and standard hours allowed (measures productivity) Most important to management

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Variance Analysis
Actual Quantity At Actual Price AQ x AP Actual Quantity At Standard Price AQ x SP Standard Quantity At Standard Price SQ x SP
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Price Variance

Quantity Variance

Total Flexible Budget Variance

Variable Manuf. Ohead Variance VMO Spending Variance = AH(AR SR) Measure of diff. b/w actual VMO cost and standard cost Can occur if:
a)

Actual purchase price

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Variance Analysis
Actual Quantity At Actual Price AQ x AP Actual Quantity At Standard Price AQ x SP Standard Quantity At Standard Price SQ x SP
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Price Variance

Quantity Variance

Total Flexible Budget Variance

Variable Manuf. Ohead Variance VMO Efficiency Variance = SR(AH SH) Measure of diff. b/w actual activity and standard activity allowed Indirectly measures efficiency of activity

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Variance Analysis
AQ x AP AQ x SP SQ x SP
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Quantity Price Variance Variance Favourable Favourable AP < SP AQ < SQ Unfavourabl Unfavourabl e AP > SP e AQ > SQ Total Flexible Budget Variance

Further Analysis
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AQ x AP

AQ x SP

Actual Quantity At Std. Mix & Std.x SP M Price

SQ x SP

Mix Yield Varianc Varianc Price e e Quantity Variance Varian

ce Total Flexible Budget Variance

Quantity Variance
= SP(AQ M) = SP(AQ Budgeted% x Total Input)
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Mix Variance

Difference between actual mix of materials and budgeted mix of materials

Quantity Variance
= SP(M SQ) = Mix Variance Quantity Variance
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Yield Variance

Favourable: Mix Var. < Quantity Var. Unfavourable: Mix Var >

Quantity Variance
Process:

Calculate a Mix Variance and Yield Variance for every type of material, labour, etc Total Mix Variance = Sum of Mix Variances Total Yield Variance =

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Overhead Rates
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Predetermined overhead rate Variable Element

=
SR used in VMO variance calculations

Overhead Cost Application

In a standard cost system, total overhead cost applied based on standard hours, not actual hours Total Overhead Cost

= Predet. Ohead Rate x Standard Hours

Keeps unit costs from being

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Fixed Manuf. Ohead Variance Budget Variance = Actual FMO cost Flexible budget FMO cost Represents difference between how much should have been spent

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Fixed Manuf. Ohead Variance Volume Variance = Fixed Portion of Predet. Ohead Rate x (Denominator Hours Std. Hours Allowed) Measures utilization of plant facilities

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Graphic Analysis of FMO Variance Denom.

Fixed Ohead Cost

Hours

Std. Hours

Volume Variance (F) Budget Variance (U)

Applie d Actual Budget

Applied
Applied-Cost Line

Budgete d
Variable Ohead Cost

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Cautions in FMO Analysis

Total fixed cost is not a variable cost, but we act as if it is Volume variance expressed in units as opposed to $ to avoid confusion

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Under/Overapplied Ohead Cost

Sum of:

VMO Spending Variance

VMO Efficiency Variance FMO Budget Variance FMO Volume Variance

= Total Overhead Variance

Favourable Variance:

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Management by Exception If Actual close to Budget/Standards Managers can focus on other issues If Variance occurs Managers alerted of exception

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Evaluation of Standard Costs Advantages 1. Key element in management by exception. 2. Reasonable standards can promote economy and efficiency.

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Evaluation of Standard Costs Disadvantages

1. 2.

Variance reports often outdated. Morale may suffer if reports used to lay blame. Assumes output is labour-paced (but often depends on speed of machine). Assumes labour hours are variable; in fact, fixed. In some cases, favourable is actually unfavourable; ie. Harveys: less meat = substandard burger
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3.

4.

5.

Question

A)

Paying higher hourly wages for indirect labour than planned Paying more for indirect supplies than planned Using more indirect supplies than planned Paying more for insurance on

B)

C)

D)

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Which of the following is not a possible cause of an unfavourable variable overhead spending variance

Question

A)

Paying higher hourly wages for indirect labour than planned Paying more for indirect supplies than planned Using more indirect supplies than planned Paying more for insurance on

B)

C)

D)

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Which of the following is not a possible cause of an unfavourable variable overhead spending variance

Question 10-26
Haliburton Mills Inc. is a large producer of mens and womens clothing. The company uses standard costs for all of its products .The standard costs and actual costs for a recent period are given: Direct Materials: Standard Actual Standard: 4.0m at $3.60 Actual: 4.4m at $3.35/m Direct Labour: Standard: 1.6hr at $4.50/hr Actual: 1.4hr at $4.85/hr Standard: 1.6hr at $1.80/hr Actual: 1.4hr at $2.15/hr $7.20 $6.79 $2.88 $3.01 /m $14.40 $14.74
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Variable Manufacturing Overhead:

Question 10-26
During this period, the company produced 4,800 units of product. There was no inventory of materials on hand to start the period. During the period, 21,120 metres of materials were purchased and used in production. The denominator level of activity for the period was 6,860 hours.
1.

For direct materials:

a)

Compute the price and quantity variances for the period. Prepare journal entries to record all activity relating to direct materials for the period.

b)

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2006 Final Question

Budgeted direct labour mix at standard rate, for actual output achieved: Skilled labour per hr Unskilled labour $24 per hr 7,650 hours at $32 2,550 hours at
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Analysts at Spring Break Ltd. have gathered the following data:

2006 Final Question contd

Calculate the mix and yield variances for direct labour. (8 marks)
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Required

Chapter 11
Good to edit Master subtitle style Click to Know Negotiated Transfer Pricing ROI/RI calculations 4 Cost of Quality Groups

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Responsibility Centre
Definition Any part of an organization whose manager has control over and is accountable for cost, profit or investments
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Responsibility Centre 3 types of responsibility centres 1) Cost Centre

Evaluated using standard cost and flexible budget variances

1)

Profit Centre

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Transfer Pricing
Definition Price charged when division provides good or service to another division of organization
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Transfer Pricing 3 common approaches: 1) Allow managers to negotiate. 2) Set at cost using variable/full absorption costing. 3) Set at market price.

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Negotiated Transfer Price

Preserves autonomy of division. Managers have better information about costs and benefits

Selling Division

Transfe r Price

Purchasi ng Division

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Advantages

Upper Limit (Purchasing Division) Transfer Price Cost of buying from Supplier

If no outside suppliers, purchasing division should be willing to pay

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Lower Limit (Selling Division)

VC/unit + 3 scenarios:
1) 4/9/12

Transfer Price

Selling Division with Idle Capacity Selling Division with no Idle Capacity

2)

Lower Limit (Selling Division)

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Selling Division with Idle Capacity Transfer Price VC/unit + VC/unit +

Lower Limit (Selling Division)

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Selling Division with no Idle Capacity Transfer Price VC/unit +

VC/unit +

Lower Limit (Selling Division)

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Selling Division with some Idle Capacity Transfer Price VC/unit + VC/unit +

Evaluation of Negotiated Transfer Prices

If transfer results in higher overall profits, there will always be a range of acceptable transfer prices Sometimes managers arent cooperative Most companies set transfer prices using other

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Transfers to Selling Division at Cost

Set price at variable cost or full absorption cost incurred by selling division.

Major defects:

May lead to suboptimization. Selling division will never show profit. No incentives to control costs.

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Transfers to Selling Division at MV

Appropriate when no idle capacity. When idle capacity present, purchasing division might regard market price as cost

Major defects:

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Set price to match price charged on open market.

Evaluation of Investment Centre 2 methods: 1) Return on Investment 2) Residual Income

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1) Return on Investment
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ROI = Operating Income

Earnings before Interest and Tax (EBIT) Includes cash, A/R,

Average Operating Assets

1) Return on Investment
Side Note Advantage of calculating P&E using: Net Book Value

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Consistent with balance sheet value

Gross Cost

1) Return on Investment
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ROI Turnover =

= Margin x

Increase in ROI must involve at least one of following:

1) 2)

Increased Sales Reduced operating expenses

1) Return on Investment Criticisms 1) Increasing ROI inconsistent with company strategy.

May increase ROI in short run but harm in long run ie. cut R&D costs.

2)

Managers may inherit

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2) Residual Income
Residual Income = Operating Income
(Average Operating Assets x Minimum Required Rate of Return)
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2) Residual Income Advantage Encourages manager to make investment that is profitable for entire company but rejected by managers evaluated with ROI. Disadvantage

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2) Residual Income Criticisms 1) Based on historical data. 2) Doesnt indicate what earnings should be for business unit.

Must compare to competitor/past

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Balanced Scorecard
3 Strategic Approaches to Outperforming Competitors:
1) 2) 3) 4/9/12

Cost Leadership Differentiation Focus/Niche

Balanced Scorecard
Illustrates theory of how company can attain desired outcome with concrete actions. Advantage Can be used continually to test theories underlying

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Balanced Scorecard
Advantages of Timely Feedback Cause can be tracked down and action taken quickly. Managers can focus on trends.
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Measures of Internal Business Process Performance Time Delivery Cycle

Amount of time required from receipt of order to shipment of good

Throughput (Manufacturing Cycle) Time

Amount of time required to turn raw material to

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Cost of Quality

Degree to which product/service meets design specifications and is free of defects

Objective: High Quality of Conformance

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Quality of Conformance

Cost of Quality
4 Groupings:
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Prevention Costs incurred to keep defects from occurring Appraisal Costs incurred to identify defective products before shipping Internal Failure Costs costs incurred as result of

2)

3)

Cost of Quality

When quality of conformance low, cost of quality high. Reduce cost of quality by focusing on appraisal and prevention costs.

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International Standards Organization

ISO 9000 Standards Quality control requirements issued by the ISO. ISO 4000 Standards Requirements for environmental

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Question
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Which of the following statements is true?

A)

If a divisions net operating income is positive, its residual income will also be positive.

B)

Residual income should be used to evaluate profit center managers.

Question
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Which of the following statements is true?

A)

If a divisions net operating income is positive, its residual income will also be positive.

B)

Residual income should be used to evaluate profit center managers.

Question
Vision Inc. reported actual return on investment of 24% and average operating assets of $1,500,000 for the month of September. If the required rate of return is 20%, what was Visions residual income in September?
A) A) B) C)

$360,000 $300,000 $60,000 $0

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Question
Vision Inc. reported actual return on investment of 24% and average operating assets of $1,500,000 for the month of September. If the required rate of return is 20%, what was Visions residual income in September?
A) A) B) C)

$360,000 $300,000 $60,000 $0

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Galati Products Inc. has just purchased a small company that specializes in the manufacture of electronic tuners that are used as component part of TV sets. Galati Products Inc. is a decentralized company and it will treat the newly acquired company as an autonomous division with full profit responsibility. The new division called Tuner Division has the following revenue and costs associated with each tuner that it manufactures and sells:

11-24

Selling Price Expenses:

$20

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Galati Products also has an Assembly Division that assembles TV sets. This division is currently purchasing 30,000 tuners per year from an overseas supplier at a cost of $20 per tuner, less a 10% purchase discount. The president of Galati Products is anxious to have the Assembly Division begin purchasing its tuners from the newly acquired Tuner Division in order to keep the profits within the corporate family.

11-24

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Assume the Tuner Division can sell all of its output to outside TV manufacturers for $20.
1.

11-24

Are the managers of the Tuner and Assembly Division likely to voluntarily agree to a transfer price for 30,000 tuners each year? Why or why not? If the Tuner Division meets the price that the Assembly Division is currently paying to its overseas supplier and sells 30,000 tuners to the Assembly Divison each year, what will be the effect on the profits of the Tuner Division, the Assembly Division and the company as a whole?

2.

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Assume the Tuner Division is currently selling only 60,000 tuners to outside TV manufacturers.
3.

11-24

Are the managers of the Tuner and Assembly Divisions likely to voluntarily agree to a transfer price for 30,000 tuners each year? Why or why not.

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2006 Final Question Folk Companys Audio Division (AD) produces a speaker used by manufacturers of various audio products. Sales and cost data on the speaker are as follows: Selling price per unit to external customers $60 Variable manufacturing costs per unit $40

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2006 Final Question

Selling price per unit to external customers $60 Fixed overhead per unit (based on capacity) $2 Variable selling costs per unit
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Variable manufacturing costs per unit $40

$2

Fixed selling and administrative costs per unit $8 Total capacity 25,000 units

2006 Final Question

Assume now that the AD is currently selling 25,000 speakers per year to external customers. Further assume that the HTD will use the speaker in a product with the following details:

Selling price per unit Direct material costs per unit cost) Direct labour costs per unit Fixed overhead costs per unit Variable selling costs per unit

$400 $300 (excl. speaker $ 20 $8 $2

Variable overhead costs per unit $ 10

Also assume that the HTD can only manufacture and sell this product if they are able to buy the

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Chapter 12
Good to edit Master subtitle style Click to Know Relevant vs. Irrelevant Costs Various Decision Analyses Cost-Plus Pricing

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Relevant vs. Irrelevant Costs

Avoidable Costs any cost that can be eliminated by choosing one alternative over another
(aka relevant cost, differential cost)

Irrelevant Costs

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Relevant Costs

Why Isolate Relevant Costs? 1) Only rarely will enough information be available for detailed income statement. 2) Combining R and IR costs may cause confusion and distract

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Analysis of Decisions
Make or Buy Accept or Reject Special Order Sell or Process Further
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Add or Drop Product Line

4)

1) Adding/Dropping Product Lines

Avoidable Fixed Costs

< Contribution Margin Drop product line if:

Avoidable Fixed Costs

> Contribution Margin

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Add product line if:

2) Make or Buy Decision

Less dependent on suppliers. Smooth flow of parts and materials for production. Control quality better.

Advantages of External

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Advantages of Making

2) Make or Buy Decision

1) 2)

Avoidable Costs Opportunity Costs

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Consider:

2) Make or Buy Decision

Make if:

Avoidable Costs < Purchase Price Avoidable Costs > Purchase Price

Buy if:

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Avoidable Costs

2) Make or Buy Decision

Opportunity Costs

If space idle, opportunity cost =0

Make

If space used for something else, opportunity cost = CM

from best alternative use of space.

Make: Opp. Cost < Make/Buy

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3) Special Orders

Idle Space:

Incremental Revenue > Incremental Costs Incremental Revenue > Incremental Costs + CM forgone

No Idle Space:

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Take special order if:

4) Sell or Process Further

Keep Processing if: Incremental Revenue > Incremental Processing Cost
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Maximizing CM with Constrained Resources

Choose products that have highest unit CM. Choose products with highest profitability index.

With Bottleneck

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Without Bottleneck

Cost-Plus Pricing
Selling Price = Cost + (Markup % x Cost) 2 Approaches: 1) Absorption Costing Approach
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1) Absorption Costing Approach

1)

= DM + DL + VMO + FMO
2)

Markup Percentage

= Problems
)

Relies on forecast of unit

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Compute Unit Product Cost

2) Variable Costing Approach

1)

= DM + DL + VMO
2)

Markup Percentage

= Advantages
1)

Consistent with CVP

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Compute Unit Variable Cost

Target Costing
Process of determining maximum allowable cost for developing new product. Target Cost = Anticipated Sell Price Desired Profit

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Question
Which of the following items will not be relevant when deciding whether to keep or drop a product line?
A)

Contribution margin of the product line Avoidable fixed costs of the product line Depreciation on equipment used

B)

C)

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Question
Which of the following items will not be relevant when deciding whether to keep or drop a product line?
A)

Contribution margin of the product line Avoidable fixed costs of the product line Depreciation on equipment

B)

C)

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Tanner Computing, a retailing company, has two departments, Hardware and Software. Results from the most recent month of operations are as follows: Total Hardware Software Total Software

2006 Final Question

Hardware

Sales

$4,000,000 $3,000,000

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2006 Final Question

Sales CM

$4,000,000 2,700,000

$3,000,000

$1,000,000 400,000
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Variable expenses 1,300,000 900,000 Fixed expenses 2,200,000 Operating income $500,000 $(200,000)

2,100,000 600,000 $700,000

1,400,000 800,000

40% of the Software Dept. fixed costs are common costs $50,000 relates to Software Manager, who will be transferred If the Software department is dropped, sales in the Hardware department will drop by 10% with no

Chapter 13
Good to edit Master subtitle style Click to Know 3 Screening Decisions 2 Preference Decisions CCA tax shield calculation

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Capital Budgeting
2 Broad Categories of Capital Budgeting Decisions: 1) Screening Decision decision as to whether proposed investment meets
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Capital Budgeting Decisions 3 Screen Decision Approaches: 1) The Payback Method 2) The Simple Rate of Return 3) Discounted Cash Flows

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1) The Payback Method

Payback Period =

Advantages Used in industries where product obsolete quickly Important for cash poor companies Disadvantages

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Simple Rate of Return =

2) The Simple Rate of Return

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Accept: Simple Rate > Target Rate Reject: Simple Rate < Target Rate

Advantage

3) Discounted Cash Flows

1)

= PV of Cash Inflows PV of Cash Outflows

)

If NPV is Positive Project If NPV is Zero Project

Accept Accept

If NPV is Negative Reject

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Net Present Value

3) Discounted Cash Flows

1) )

Net Present Value

Incremental revenues Reduction in costs Salvage value Release of working capital

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Cash Inflows:

3) Discounted Cash Flows

1) )

Net Present Value Initial investment

(depreciation not deducted)

Increased working capital

(=current assets current liabilities)

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Cash Outflows:

3) Discounted Cash Flows

2) )

Internal Rate of Return

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Discount rate that makes NPV = 0 Can only be calculated through trial-and-error or financial calculator IRR compared to Required Rate of Return:

3) Discounted Cash Flows

NPV Advantages over IRR IRR assumes internal rate is rate of return (whereas it should be the discount rate)
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NPV simpler to calculate

If NPV and IRR disagree, use NPV IRR Advantage over NPV

Capital Budgeting Decisions 2 Preference Decisions: 1) Net Present Value 2) Internal Rate of Return

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1) Net Present Value

NPV cant be compared unless investments are of equal size Profitability Index

Higher PI More desirable project

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2) Internal Rate of Return

Higher IRR More Desirable Project

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Comparing Preference Rules Profitability Index preferred because it always gives the correct signal as to relative desirability of alternatives, even if different lives/patterns of earning

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After-tax Cost and Benefit After-Tax Cost = Tax Deductible Cash Expense x (1 tax rate) After-Tax Benefit = Taxable Cash Receipt x (1 tax rate)

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Capital Cost Allowance

Amount of depreciation allowed by Canada Revenue Agency for tax purposes Undepreciated Capital Cost (UCC) remaining book value of asset under CCA Maximum amount that can be deducted as depreciation

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CCA Tax Shield Present value of infinite stream of tax savings from CCA
CCA Tax Shield =
where:

C = the capital cost of the asset

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Adjustment for Salvage Value Salvage Value = where: S = salvage value d = CCA rate t = firms tax rate k = Cost of Capital

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PV of CCA tax shield

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PV of CCA tax shield =

Question
Which of the following indicates an UNACCEPTABLE capital project?
A)

The internal rate of return exceeds the cost of capital. The net present value of a project is 10. The profitability index of a project is 0.97.

B)

C)

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Question
Which of the following indicates an UNACCEPTABLE capital project?
A)

The internal rate of return exceeds the cost of capital. The net present value of a project is 10. The profitability index of a project is 0.97.

B)

C)

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Question
Periods 01234 100
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Project A: Cash flows (50) 0 0 0

If Project B has an IRR of 10%, which project would you prefer using the IRR

Good Luck!
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Click to edit Master subtitle style Roanna

roanna.shen@gmail.com