C1

1. The standard cost is target cost that management believes should be incurred to produce
goods or services under efficient conditions. The standard is stated per unit while the
budgeted cost is usually stated in total. On the basis of standard cost components like direct
material, direct labor, and overhead are calculated and at the end of the production period, the
standards are compared with actual results to determine variances.
2. A participative approach includes communication, bargaining, interaction among relevant
parties e.g. product line managers, immediate supervisors, accountants, and engineers while
developing standards. It is generally considered to be the most effective method of budget
preparation and is also called the bottom-up approach.

3. The fixed overhead volume variance (also called the fixed overhead production-volume
variance) is the budgeted amount of fixed overhead (in the static budget) minus the amount of
fixed overhead applied (standard rate × standard input for the actual level of output). The
budgeted amount of fixed overhead is what was projected as the total amount of fixed
overhead to be incurred during the period at the beginning of the year when the budget was
developed. Traditionally, overhead is applied to individual products throughout the year using
some standard allocation basis, usually direct labor hours, machine hours, materials cost, units
of production, or some similar measure that can be measured and calculated. The measure
used is called the activity base. A predetermined rate is calculated by dividing the budgeted
amount of manufacturing overhead by the budgeted activity level. The budgeted activity level
is the number of units of the activity base (labor hours, machine hours, etc.) allowed for the
expected production during the coming year. As production continues throughout the year,
the amount of the activity base allowed for the amount of product actually produced is
multiplied by the predetermined rate to calculate the amount of overhead to be applied. The
fixed overhead volume variance is caused by the actual production level is different from the
production level (called the denominator level) used to calculate the budgeted fixed overhead
rate. If the amount of overhead applied is greater than the budgeted amount, the variance will
be favorable because it means that the actual level of production was greater than the
budgeted level of production. That is good because it means the facilities are being more fully
utilized. If the amount of overhead applied is less than the budgeted overhead, the variance
will be unfavorable because it means that actual production was lower than the budgeted
production level.

4. When circumstances change, standards should be adjusted to reflect the changed situation. In
this case, there is nothing the company can do about the price increase because it has only one
available supplier. Therefore, the company has no choice but to pay the higher price and it
should adjust its standards accordingly.

5. “Management by exception” refers to a system whereby only significant variances between

actual results and the budget or plan are brought to the attention of management. Management
by exception focuses management on the things that have the highest priority, defined as the
greatest variances, both favorable and unfavorable.

6. The flexible budget is the budget developed for the actual level of output. When preparing a
performance report, the actual results need to be compared to what the expected results were
for the actual level of production. The actual results need to be compared to the flexible
budget.

7. In the budgeting process, the company must determine the level of activity to use. This level
of activity is also called the denominator level. The fixed overhead production volume
 variance is caused by the actual production level being different from the production level
that was used to calculate the budgeted fixed overhead rate.

8. There is no such thing as a fixed overhead efficiency variance because fixed costs are not
related to levels of output and therefore are unable to be used efficiently or inefficiently.

9. The actual sales volume of the product will not impact the materials efficiency variance. The
materials efficiency variance, also called the direct materials quantity variance, is a
manufacturing input variance that measures the difference in cost between the actual material
used in production at the standard price and the standard usage allowed for the level of actual
output at the standard price. It is not affected by the amount of the finished good that is sold.

10. The direct labor efficiency variance is (AQ − SQ) × SP, or (AQ × SP) − (SQ × SP). If the
variance is favorable, the first number will be lower than the second number and the variance
will be negative because AQ is lower than SQ; and it means the actual quantity of labor used
was lower than the standard quantity allowed for the actual output.
The variable overhead efficiency variance is budgeted variable overhead based on inputs
actually used minus standard variable overhead applied to production. So if the actual
quantity of labor used was lower than the standard quantity allowed for the actual output, then
the first number will be lower than the second number and the variance will be negative.
So if the direct labor efficiency variance is favorable, the variable overhead efficiency
variance will also be favorable.

11. An unfavorable material efficiency variance indicates more material is used than planned. It is
normally caused by the use of low quality material, improper training of production staff,
frequent machine breakdowns etc and is not likely to be caused by lower-than-planned
production.

12. The flexible budget variance is the difference between the actual results and the flexible
budget amount based on the actual level of activity achieved in the budget period.

13. The use of lower-skilled workers could not be a cause of these three favorable variances.
Lower-skilled employees will make more mistakes than highly-skilled employees. That will
result in more materials being used than the standard (an unfavorable direct material quantity
variance). It will also result in a greater amount of direct labor time required than the standard
(an unfavorable direct labor efficiency variance). And it will result in an unfavorable fixed
overhead production-volume variance because lower-skilled employees would require more
time to produce each unit. In addition, a greater number of units would be rejected as
defective. Both of these would lead to a lower production volume than was planned which
creates an unfavorable fixed overhead production volume variance.

14. The purchase of higher quality materials could cause all three variances. The use of higher
quality materials could lead to a favorable material quantity variance because less direct
material would need to be discarded due to defects, so less direct materials would be used.
The purchase of higher quality materials could also lead to a favorable direct labor efficiency
variance because employees would be able to produce more units of finished goods when
fewer units are rejected as defective due to defective materials. The purchase of higher quality
materials could also cause a favorable fixed overhead volume variance, for the same reason.
The fixed overhead volume variance is a measurement of actual production volume compared
with expected production volume. If a greater number of units is produced than was expected,
 the fixed overhead production-volume variance will be favorable, and that could happen if
higher quality materials are being used because fewer units would be rejected as defective due
to defective materials.

15. A bottom-up philosophy or commonly called the participative approach is the most well-
defined method of setting standards. Under bottom-up approach, the standards are set by
holding a discussion among the relevant managers of the company where various relevant
factors are considered such as ideal time, breaks, spoilage etc. while determining the most
realistic and attainable standards. As per the independent consultant's view, the direct labor
standards were too tight, thus, it is highly unlikely that the bottom-up approach was used to
set the standards.

16. A static budget is developed for one specific activity (sales or production) level. When
variance reports comparing actual results to budgeted results in the static budget are prepared
and causes for the variances are reported, one of the causes will always be that actual volume
was different from planned sales volume, because actual activity will never be exactly equal
to the budgeted activity. Since variances due to volume variations are expected, it does not
make much sense to continue reporting them on the variance report as causes of variances. It
is more important to focus on variances caused by other factors. For example, a variance
caused by an increase in the cost of direct labor above what is expected for the actual
production could signal a problem in production and should be investigated. But an increase
in the cost of direct labor above what is expected for the budgeted production that is caused
by increased production is not a production problem, if the cost of the direct labor per unit is
equal to the budgeted amount per unit for the number of units actually produced. The use of a
static budget can create difficulty in isolating the causes of variances that need to be
investigated from those that need no investigation.

17. Material usage variance measures the difference between the standard quantity allowed and
the actual quantity used to produce each unit of inventory. An unfavorable raw material usage
variance indicates inefficiency in the manufacturing process due to excess usage of raw
material than required. Therefore, the manufacturing department is fully responsible for the
inefficiency and the cost should be charged to this department.

18. Direct materials usage variance (DMUV) represents the difference in the standard and actual
quantity by the standard price. Thus, DMUV = SP x (SQ - AQU).

19. The fixed overhead volume variance is the difference between the budgeted amount of fixed
overhead and the amount of fixed overhead applied (standard rate × standard input for the
actual level of output). It is not very much involved with performance of employees, as in
most cases top management is responsible for this variance. This variance could be caused by
different reasons: the economic situation, weather or change in planned output as it is in this
question. So this variance is least significant from a behavioral control perspective. From a
behavioral control perspective, the goal is to influence employee actions and improve
performance. The first three variances (A, B, C) are related to operational factors like material
usage, labor efficiency, and wage rates—areas where employees and supervisors have direct
influence.
However, fixed overhead volume variance (D) is driven by management's strategic decision,
not the behavior or performance of workers. Since this variance reflects a change in budgeted
 output rather than employee actions, it is less significant from a behavioral standpoint.
Employees cannot control or influence this outcome directly.

20. An unfavorable direct labor efficiency variance means that more time was spent in production
than the standard time allowed for the actual output. A number of reasons could cause this:
poor performance of production employees, poor product design, waste, theft, poor material
quality, etc. An unfavorable material usage variance means that more material was spent to
produce units of finished product. Poor material quality could cause an unfavorable material
usage variance. The poor quality material could also require more time to be spent by
production workers to perform their tasks. That is why an unfavorable direct labor efficiency
variance could be caused by unfavorable material usage variance.

21. An unfavorable direct labor efficiency variance means that more time was spent in production
than the standard time allowed for the actual output. A number of reasons could cause this:
poor performance of production employees, poor product design, waste, theft, poor material
quality, etc. An unfavorable material usage variance means that more material was spent to
produce units of finished product. Poor material quality could cause an unfavorable material
usage variance. The poor quality material could also require more time to be spent by
production workers to perform their tasks. That is why an unfavorable direct labor efficiency
variance could be caused by unfavorable material usage variance.

22. The fixed overhead volume variance is the difference between the budgeted amount of fixed
overhead and the amount of fixed overhead applied (standard rate × standard input for the
actual level of output). It does not reflect any differences between actual costs and budgeted
costs. This variance concerns only the level of production. If the actual level of production is
lower than the budgeted level, the fixed overhead volume variance will be unfavorable. If the
actual production level is higher than the budgeted level, the fixed overhead volume variance
will be favorable. Because this variance arises from a variance in the level of production, it is
not very significant for cost control purposes.

23. The variable overhead efficiency variance is calculated as follows:

Budgeted variable overhead based on inputs actually used
− Standard variable overhead applied to production
= Variable overhead efficiency variance
The variable overhead efficiency variance is a comparison of a budgeted amount of variable
overhead calculated using direct labor hours actually used with the standard amount of
variable overhead calculated using direct labor hours allowed for the actual production. So, it
is essentially a calculation of the effect of a difference between the number of direct labor
hours used with the number of direct labor hours allowed.
A favorable variance means fewer labor hours were used than were allowed for the actual
output. This could be caused by the use of labor that was more skilled than anticipated and
was thus able to work more quickly.

24. Material usage variance and labor efficiency variance are most likely to be related. For
example, if the material quality is compromised, it may result in higher usage of material or
more wastage which will result in a negative material usage variance. It may also cause
additional labor hours and will result in unfavorable labor efficiency variance.

25. The direct materials price variance is calculated as follows: (Actual Price − Standard Price) ×
Actual Quantity. All the components of the formula are in the data given. The actual price is
$28. The standard price is $24. The actual quantity is 190,000. Therefore, the direct materials
 price variance is ($28 − $24) × 190,000 = $760,000 unfavorable. Because the actual price was
higher than the standard, the variance is unfavorable.

26. Standard costs are predetermined units costs which companies use as measures of
performance. There are many advantages of a standard cost system. However, it is based on
quantitative factors and not qualitative characteristics e.g. standards are determined for direct
material rate and usage, direct labor rate and usage and overhead rate and quantity.

27. The difference between standard hours at standard wage rates and actual hours at standard
wage rate calculates the labor hour usage/efficiency variance.

28. A fixed overhead volume variance is the difference between the budgeted and actual fixed
production cost. The variance is the result of change in level of output attained in a period
compared to the planned level of output. If actual production is less than budgeted, an
unfavorable volume variance will result.

29. A reduction in reliance on advance planning is not a result of the use of management by
exception. Advance planning is important regardless of whether management by exception is
being used or not being used

30. To solve this question, we need to calculate all the suggested variances possible from this set
of data. It's better to start with most simple ones. The labor efficiency variance is: (Actual
Hours − Standard Hours for Actual Output) × Standard Rate, or (Actual Hours × Standard
Rate) − (Standard Hours for Actual Output × Standard Rate). The actual hours times the
standard rate is $9,800. The standard hours times the standard rate is $8,820. The difference is
$980 unfavorable.

31. Labor efficiency variance is the difference between the actual hours worked and the standard
hours allowed for actual production. Inadequate maintenance of machinery leads to downtime
for machinery repairs and increased work hours than budgeted, thus resulting in an overall
unfavorable variance.

32. The labor price or rate variance is calculated as: (Actual Rate − Standard Rate) × Actual
Hours. The only figure union contracts can influence is the actual labor rate. The standard rate
is set by the budget at the beginning of the year. As union contracts are approved before the
budgeting cycle begins, the information about potential changes in wages and salaries is
already included in the budget and standards. Therefore, a union contract approved before the
budgeting cycle cannot be the cause of a labor rate variance.

33. Sales that are higher than expected will result in positive variances on a static budget report
for both revenues and expenses/costs, because both actual revenue and actual expenses or
costs will be greater than budgeted. For a revenue item, a positive variance (actual revenue is
greater than budgeted revenue) is a favorable variance. For an expense or cost item, a positive
variance (actual is greater than budgeted) is an unfavorable variance.
34. The performance of the shipping employees is not connected with the production process.
Therefore, neither good nor bad performance of them can affect the materials efficiency
variance.
Material efficiency or usage variance is the difference between the actual quantity used and the
standard quantity allowed for actual production. It is computed as:
(Standard quantity allowed x Standard rate) - (Actual quantity x Standard rate)
= (8,500 x $2) - (9,000 x $2)
= $1,000 Unfavorable.

35. The total fixed overhead variance is the difference between the actual total fixed overhead
cost incurred and the applied fixed overhead. That difference is also the amount of the under-
applied or over-applied fixed overhead costs.

36. Using practical capacity has the desired motivational impact on employees. The level is based
on what should be achieved in normal efficient but not perfect conditions, but it is difficult to
achieve. Such a level will motivate workers while at the same time requiring them to work
diligently.

37. The material price variance is the difference between the actual price and the standard price
times the actual quantity of materials consumed by production. The purchasing manager is
usually responsible for the material price variance, as the price is determined during the
purchasing activity.

38. In this question we are asked to calculate the fixed cost variance. It is simply the difference
between the actual fixed costs and the budgeted fixed costs. For Folsom, the fixed cost
variance is $84,000 − $80,000 = $4,000 unfavorable. Because the actual fixed cost was
greater than the budgeted fixed cost, the variance is unfavorable.

39. If management has made a strategic decision to pursue kaizen, the Japanese term for
continuous improvement, that decision will impact the standards. The standards will be set at
the most challenging level and they will become more challenging as time passes in order to
effect continuous improvement. The continuous improvements may be accomplished by
developing new manufacturing methods and techniques. Development of new methods and
techniques entails an ongoing search for new ways to do things better, resulting in reduced
costs and continuous improvement, which is the heart of the kaizen concept.

40. The materials quantity variance is unfavorable, indicating that more ingredients are being
used on each pizza than the standard amount. New employees still learning the recipes would
explain the variance in quantity used. The favorable labor rate variance supports that
conclusion as well, as new employees would be paid a lower wage rate than experienced
employees.

41. Top management is primarily involved in formulating strategy plans and budgets.
Establishing standard costs for evaluation purposes is a task of management of a lower level.
These standards are used to estimate what costs should be under normal conditions of
operations. Industrial engineers, budgetary accountants, quality control personnel and
employees who will be evaluated using these criteria are involved in the process.

42. A standard cost is an estimate of the cost the company expects to incur in the production
process. Without a standard cost, the analysis of actual activities and results is very difficult
because there is no standard to measure the performance against. Standard costs are best used
with a flexible budgeting system in order to provide the most useful variance analysis. The
flexible budget will enable the company to identify differences from the budget that is not
simply due to the actual quantity produced or sold being different from the budgeted quantity.
43. Under variable costing system, fixed Selling and Administrative Expenses (SG&A) are
recognized as expense in the period incurred. Fixed manufacturing overhead costs are also
expensed as incurred. Only variable expenses including DM, DL overhead and variable
SG&A are deducted from sales to arrive at contribution margin. Operating income is the
difference between contribution margin and the fixed manufacturing and fixed selling and
administrative expenses.
Therefore, it can be said that fixed selling and administrative expenses are used only in the
computation of operating income and not contribution margin under the direct costing
method.

44. Industrial engineers are involved in designing product and setting the standards of material
usage, thus bearing a part of the responsibility for the efficiency of material usage. Production
workers are those who actually convert materials into the finished product and directly
responsible for efficiency of material usage. Therefore, both of these parties will have some
responsibility for the materials efficiency variance.

45. The direct labor efficiency variance is (Actual Hours − Standard Hours for Actual Output) ×
Standard Labor Rate.
The variable overhead efficiency variance is (Actual Activity Level of VOH allocation base
used for Actual Output − Standard Activity Level of VOH allocation base allowed for Actual
Output) × Standard Application [Link] direct labor hours is the allocation base, the
"actual" and "standard" will be the same in both formulas. The only difference between the
direct labor efficiency variance and the variable overhead efficiency variance will be the
hourly rate that the difference between "actual" and "standard" is multiplied [Link], if
the direct labor efficiency variance is unfavorable, the variable overhead efficiency variance
will also be unfavorable. (And if the direct labor efficiency variance is favorable, the variable
overhead efficiency variance will also be favorable.)

46. When more than one input is used for either direct materials or direct labor, the total material
quantity (efficiency) or labor efficiency variances can be broken down into two sub
variances: the mix and the yield variances. The mix variance is the part of the quantity
variance that results because the mix of material actually used was different from the mix that
was supposed to have been used. (For example, including more corn and less wheat in the
cereal than the standard called for). The yield variance results from the difference between the
total quantity of the inputs that were actually used to produce the actual output and the total
standard quantity that should have been used to produce the actual output.

47. Variable overhead variance is actual variable overhead less current budgeted amount i.e.
actual input times budgeted rate. Historical budgeted amount is not considered to arrive at
spending variance, however the same can be considered while deriving the budgeted rate per
unit for the current period.

48. Under 2-variance approach, the variance analysis is broken into controllable variance and
non-controllable variance. The controllable variance consists of spending variance and
efficiency variance while the non-controllable variance is production volume variance. As a
result, the controllable or budget variance has both variable and fixed overhead elements (See
chart below for clear understanding).

49. Budgeted costs for a given output level can be compared with actual costs for the same level
of output.
 This statement is somewhat backwards, but it is the best answer choice from among those
given. Flexible budget amounts for variable revenues and costs are adjusted to the actual level
of activity that has occurred before actual revenues and costs are compared with them. So the
"given" output level is derived from the actual activity level, not the other way around.

50. The behavior of the variance (negative or positive) should not influence the decision of
whether to investigate or not to investigate the variance. The variance is the measure of how
much the actual results vary from the budgeted (expected) results. All significant variances
should be investigated. It is also critical that benefits from variance investigation exceed its
costs.

51. All three departments i.e. Marketing, Production and Purchasing department would bear the
responsibility for unfavorable material usage variance. Marketing department is responsible
because it accepted a rush order without analyzing the current production capacity.
Production department is responsible because it allowed for bypassing of the normal
inspection process. Purchasing department is responsible for delay in ordering the raw
material.

52. The vice president of production made the decision about the substitution of the regular
materials for the special-order materials. Thus, the unfavorable direct labor efficiency
variance resulting from the substitution of the purchased part in inventory would best be
assigned to the vice president of production.

53. Flexible budgets are preferable for both planning purposes and performance reporting as the
flexible budget can be based on the actual amount of output and then compared to the actual
revenue and costs.

54. The production-volume variance (or the volume variance) is the flexible/static budgeted fixed
overhead minus the amount of fixed overhead applied. The flexible/static budget fixed
overhead amount is given as $400,000. The predetermined application rate for fixed overhead
is $400,000 ÷ 10,000 DLH, or $40 per DLH. With standard costing, overhead is applied to
production on the basis of the amount of the application base that is allowed for the actual
output. The amount of DLH allowed for the actual output is given as 9,900 hours. Therefore,
the amount of fixed overhead applied to production is $40 per DLH multiplied by the 9,900
DLH allowed for the actual output, or $396,000. The Volume Variance is $400,000 −
$396,000, which equals $4,000. Since the amount is positive, the variance is unfavorable. It is
unfavorable because it means the facilities were not used to the extent planned.

55. Fixed overhead efficiency is not usually measured in a standard cost system

56. The objective of allocating cost to departments, products and services is to reduce misuse of
available resources, to take more informed and appropriate decisions, to encourage
department managers to evaluate their efficiency and to finally arrive at the full cost of the
product. Use of budgeted rates and standard direct labor hours for determining the budgeted
variable cost for the attained output and use of budgeted rates and available capacity for
determining the fixed cost will ensure that all the departments are aware of their standards in
terms of material and labor hours and work more efficiently towards achieving those
standards.

57. The variable overhead efficiency variance is calculated as follows:

 Budgeted variable overhead based on inputs actually used
− Standard variable overhead applied to production
= Variable overhead efficiency variance
The variable overhead efficiency variance is a comparison of a budgeted amount of variable
overhead calculated using direct labor hours actually used with the standard amount of
variable overhead calculated using direct labor hours allowed for the actual production. So it
is essentially a calculation of the effect of a difference between the number of direct labor
hours used with the number of direct labor hours allowed.
A favorable variance means fewer labor hours were used than were allowed for the actual
output. This could be caused by the use of labor that was more skilled than anticipated and
was thus able to work more quickly.

58. A company’s "value chain" is its chain of activities for transforming inputs into the outputs
that customers value. This process of transformation includes all of the primary activities
(business functions) that add value to the product or service, as well as support activities. It
involves functions from R&D through production to marketing and sales, and on to customer
service, including the activities that play supporting roles such as information systems,
materials management, and human resources.
When a company has a favorable labor price (rate) variance, it is because the company has
paid hourly wage rates that are lower than the standard wage rates. Usually, that occurs when
the company has employed workers who are less qualified than the workers the company's
management expected to have. Use of less qualified workers can lead to a higher probability
that the products produced and sold will be of lower quality and have more defects. Lower
quality products and higher defective rates will lead to increased costs for customer service,
as the customers who buy the products will have more difficulty with them. It can also lead to
higher warranty costs, because more products will need to be repaired or replaced for
customers during the warranty period.
The amount gained from the favorable labor price variance, and possibly even more, may be
lost through greater unfavorable variances further down the value chain.

59. Using the master budget capacity as the denominator-level of activity would result in an
unfavorable volume variance. The FOH production-volume variance is Budgeted FOH minus
FOH applied. The amount of fixed overhead applied under master budget capacity during the
prior year would have been less than the budgeted fixed overhead cost because the number of
standard direct labor hours allowed for the actual production (210,000) would have been less
than the numbe

60. r of standard direct labor hours allowed for the budgeted production (220,000). That would
have led to a positive fixed overhead production-volume variance, which is unfavorable.
The amount of fixed overhead applied under normal capacity during the prior year would
have been greater than the budgeted fixed overhead cost because the number of standard
direct labor hours allowed for the actual production (210,000) would have been greater
than the number of standard direct labor hours allowed for the budgeted production (200,000).
That would have led to a negative fixed overhead production-volume variance, which is
favorable.

61. The quantity of materials purchased would not have any effect on efficiency of labor.
Inexperienced workers, inefficient scheduling of production, and breakdowns of equipment
can all be causes of an unfavorable labor efficiency variance.

62. Ideal, or theoretical, standards are the level of activity that will occur if the company produces
at its absolute most efficient level at all times, with no allowances made for idle time or
 downtime. Ideal standards cannot be achieved in the long run. Practical standards are the ideal
capacity reduced by allowances for idle time and [Link] practical standards are
achievable, they are a better target to motivate manufacturing employees. Knowing the
volume that both can and should be produced gives employees a realistic guideline that can be
applied to everyday working conditions. Practical standards are reasonable, not impossible.

63. The materials price variance is the difference between the actual price and the standard price
of the material multiplied by the quantity actually consumed by production. The purchasing
manager is responsible for purchasing activity where the price is negotiated and is therefore
usually held responsible for the material price variance.

64. As the employees are directly involved in developing the computer programs, the salary paid
to them should be treated as direct cost. The work of the employees is adding value to the
product by meeting the special requirements of the customers; therefore, it will also be treated
as value adding cost.

65. he direct labor rate variance is the price variance for labor, while the direct labor efficiency
variance is the quantity variance for labor.

66. Producing more units than planned in the master budget will not affect the quantity of the
materials used for each unit

67. An unfavorable material usage variance means that more materials were consumed by
production than had been budgeted. This can result from a number of reasons: poor
production employees' performance, product design, waste, theft, poor material quality, etc.
Thus, the investigation of this variance should begin either with the production manager or
the purchasing manager but should ultimately involve both.

68. The production supervisor will not be able to contest the fact that variance calculations fail to
properly reflect that actual production exceeded normal production capacity as both material
usage and price variance have been adjusted to consider that the actual production was more
than budgeted production i.e. while budgeted production was 900 units; the actual production
was 1,000 units which was adjusted to reflect a change based on actual material usage.

69. Standard costing is a tool for planning budgets, managing and controlling costs, and
evaluating cost management. Companies in any industry, including manufacturing and
service industry, can use standard costing system for efficient operation.
 C2
1. A cost center is a type of center in responsibility accounting classifications that is responsible
only for the incurrence of costs. A cost center does not have any revenue, and therefore does
not have any profit. Thus, performance evaluation based on variance analysis of costs is the
best basis for performance evaluation of a cost center manager.

2. This is not a reason to allocate service and support costs to divisions and departments. The
managers of the service departments should not be held accountable to the user departments
to control their costs but rather to top management.

3. In order for the transfer price to be beneficial to both divisions when there is available
capacity for the producing division, the transfer price needs to be higher than the cost of
production of the producing division and lower than the market price that the purchasing
division would pay in the open market.
In this question, the cost of the producing division is $1,200 and the market price of the
purchasing division is $1,300.
This is the range in which the transfer price will be beneficial to both divisions. For example, if
the price is $1,240 the selling division will receive more than if they sold that lumber to an
external customer and the purchasing division will pay less than if they bought on the open
market.

4. Responsibility accounting is a system in which costs are allocated to managers and/or

departments based on who is responsible for the incurrence of the costs. This is the method
described in the question.

5. Functional accounting allocates costs according to the function they represent. Functional
accounting does not use the responsibility for the incurrence of cost to allocate the costs.

6. Reciprocal allocation is a method of allocating the costs of service departments to other

service departments and the production departments.

7. Transfer price accounting is related to the determination of the price to charge for
intercompany sales.

8. When there is an external market for the product, that is almost always the best transfer price
to use for profitability and performance measurement, because it is objective.

9. By definition, an investment center is a part of the business that has the authority to make
decisions affecting the major determinants of profit including the power to choose its markets
and sources of supply and significant control over the amount of invested capital.

10. In accordance with responsibility accounting, a manager should be held responsible only for
those factors that he or she can control. Costs of the fixed assets and depreciation methods
and policies are not under the control of the knitting department manager, because those
things are decided at a higher level. The manager would be responsible for the labor, material,
and repair costs for maintaining the equipment.

11. Contribution margin analysis focuses on the variable revenues and costs and their behavior as
activity levels change. The selling price minus variable costs is the contribution margin. Fixed
costs are then subtracted from the contribution to determine the profit.
12. A profit center is responsible for both revenues and costs.
13. A revenue center is responsible only for revenues and not for costs.

14. Goal congruence is defined as "aligning the goals of two or more groups." As used in this
question, it means the goals of the individual managers are aligned with those of the other and
with the goals of the organization as a whole. In other words, the managers, while each acting
in their own best interests, will also be acting in the best interest of each other and of the
organization as a whole. With respect to transfer pricing, it is in the best interest of the
organization that the products or services be bought and sold internally rather than from
outside. The cost to the organization as a whole will be lower because it will not include a
profit paid to the outside firm over and above its costs. The organization can essentially get
the goods or services at cost. Thus, anything that encourages the organization's divisions to
buy from one another instead of from outside will be good for the firm. A dual rate transfer
price provides both the buying and the selling division with an advantageous price. The
selling division receives the market price for the sale, while the buying division gets a
purchase price that is lower than it would be if it were to purchase outside. Thus, the use of a
dual-rate transfer price promotes goal congruence between the two managers and also
between the two managers and the organization as a whole.

15. Dual rate pricing is a transfer pricing method in which the internal selling and the purchasing
departments each record the transaction at different prices. There is nothing in this
arrangement that would provide an incentive for the supplying subunit (the seller) to control
costs because the transfer price on the seller's side will probably be the market price the
company would charge an outside customer.

16. When the transfer price is based on the costs of production, the producing department has no
incentive to control costs. Therefore, because there is no need to control costs, inefficiencies
may creep into the process over time.

17. A corporation’s remuneration policy is not a factor that inhibits divisional comparison.

18. Depreciation on the manufacturing facility is a cost that is dependent upon past decisions
made at a higher level of the organization, as well as on the accounting policies adopted by
management. Therefore, it is outside of the control of an assembly line manager and would
not be included on the manager's performance report.

19. Negotiated transfer prices are not usually simple or quick to implement. Negotiation can be
time-consuming and require frequent revision of transfer prices due to changing costs and
market conditions. In contrast, a transfer price set by management would be simple and quick
to implement.

20. Lower-level management reports are likely to contain more quantitative data and less
financial data. This is because lower-level management is responsible for day-to-day
operations and their reports contain information about units of production, the number of
hours worked, etc. Top management, on the other hand, is concerned about the company's
strategic goals, objectives, and overall financial results.

21. An investment center is the most like an independent business because it is responsible for
revenues, costs and investment; and it is measured on its return on investment as well as on its
level of profit.
22. A profit center is responsible for both revenues and costs (and therefore profit). A transfer
price, whether received as revenue or paid as a cost, does affect a profit center; and a profit
center is the most fundamental (basic) responsibility center that would be affected. An
investment center, which is responsible for revenues, costs and investment, would also be
affected by transfer prices; but an investment center is not the most basic, or fundamental,
responsibility center to be affected by transfer prices.

23. A service center provides specialized support services to other departments of the
organization.

24. One of the reasons to choose a specific transfer price is to minimize total income taxes for the
company. The lowest allowable transfer price that does this is the transfer price to use when
the exporting country's effective income tax rate is higher than that of the importing country.
However, the most important word in that sentence is "allowable." To prevent transfer price
abuse, virtually all the countries' taxing authorities monitor the transfer prices used by
multinational companies to make sure they are within the range of market prices. At one time,
multinational companies took extreme advantage of the ability to use transfer prices to "shift"
profits to their divisions in the lower-tax-rate countries to minimize taxes. But the taxing
authorities began closely monitoring the transfer prices used, and now the multinationals'
ability to do that is extremely limited.

25. When the exporting country's effective income tax rate is higher than that of the importing
country, the lowest allowable price is the price that will minimize total income taxes for the
company, not the highest price. However, the most important word in that sentence is
"allowable." To prevent transfer price abuse, virtually all the countries' taxing authorities
monitor the transfer prices used by multinational companies to make sure they are within the
range of market prices. At one time, multinational companies took extreme advantage of the
ability to use transfer prices to "shift" profits to their divisions in the lower-tax-rate countries
to minimize taxes. But the taxing authorities began closely monitoring the transfer prices
used, and now the multinationals' ability to do that is extremely limited.

26. The basic issue of transfer prices is how much should one unit of a company charge another
unit of the same company for its goods or services. The goal in setting a transfer price is that
the method used will stimulate the department managers to do what will provide the greatest
benefit to the company as a whole, rather than to act in their own interest. Since an outside
market exists for padding produced in which all padding produced can be sold, the best
transfer price is the market price.

27. In a responsibility accounting system, managers are responsible for the costs that they control.
Costs over which a manager has significant influence are costs that they control.

28. The transfer price should be between the variable costs of production ($12) and the market
price ($20). $18 is the best answer because it is the only answer choice that is in between
these amounts. PART17112013

29. The basic issue of transfer prices is how much should one unit of a company charge another
unit of the same company for its goods or services. The goal in setting a transfer price is that
the method used will stimulate the department managers to do what will provide the greatest
 benefit to the company as a whole, rather than to act in their own interest. A transfer price
based on actual cost does not motivate managers to use resources more efficiently, which can
lead to suboptimal decisions for the company as a whole.

30. The maintenance department of a hotel would be considered a cost center. A cost center is
responsible only for the incurrence of costs. It does not earn any revenue and therefore
generates no profit. A maintenance department is an example of a cost center because it
incurs costs but does not earn revenue for the hotel.

31. This is a description of a profit center. A profit center is a department responsible for both
revenues and expenses. Since the plant manager controls manufacturing costs and sets prices
for the products manufactured, the plant is a profit center and the manager should be
evaluated on both costs and revenues generated.

32. Unfortunately, not everything that impacts a firm's performance is controllable by someone in
the firm. A good example of this type of exogenous variable is the economy. As the economy
itself improves or weakens, the company will also be affected. But no person in the company
is in a position to influence the economy. Therefore, this statement is not true.

33. In a profit center, the manager is responsible for both revenues and costs, but not investments.

34. A transfer price is not a price charged by the company to external customers, so this is an
incorrect description of transfer pricing. A transfer price is the price charged by one unit of
the company to another unit of the same company for the services or goods produced by the
first unit and "sold" to the second unit.

35. Responsibility accounting is a system in which costs are allocated to managers and/or
departments based on who is responsible for the incurrence of the costs. This is the method
described in the question.

36. Controllable costs are the costs that can be controlled by a manager. Therefore, the more time
a manager devotes to them, the more the cost will change.

37. A revenue center is responsible only for revenues. This is a sales department, and the
"billings" are invoices issued to customers for charges they have incurred for
telecommunications services provided, which is revenue. A sales department is a revenue
center.

38. The difference between segment manager performance and segment performance is
noncontrollable fixed costs that are traceable. These are fixed costs that are controlled by
others. In evaluating segment performance and the segment manager’s performance, it is
important to distinguish between the performance of the manager and the performance of the
segment the manager manages. Costs that are traceable to a segment but controlled by
someone other than the segment manager are used in evaluating the performance of the
segment, but they should not be used in evaluating the performance of the segment manager.

39. The transfer price is the price charged by one unit of the company to another unit of the same
company for the services or goods produced by the first unit and "sold" to the second unit.
 The goal in setting a transfer price is that the method used will stimulate the department
managers — both selling and buying — to do what will provide the greatest benefit to the
company as a whole, rather than to act in their own interest. When there is an external market
for the product, market price is almost always the best transfer price to use.

40. Because the alpha division is operating at capacity, the minimum price it will charge an
internal division is the market price. The market price per unit is $50. If they were to charge
less than the market price they would be losing money since they could sell that same unit to
a different customer at a higher price.

41. In any investment measure, the unique features of, or situations faced by an individual
investment center may make a comparison between investment centers difficult.

42. A manager's performance valuation should be based on the factors controllable by the
manager. A contribution income statement that presents net revenue minus controllable
division costs can be used to isolate the controllable costs of a business unit from its non-
controllable costs such as depreciation or allocated central costs. According to the
contribution income statement approach to evaluation, a division manager usually controls the
division's revenues, variable costs and a portion of its fixed costs.

43. The market price, including transportation, is $220. Since the transfer price that has been set
is the market price, this is market-based transfer pricing.

44. "Long-term cost per unit" is not a metric that is used in analyzing allocated costs. The closest
concept to that term is "long-run average total cost," which is an economics concept. In
economics, "long-run average total cost" refers to the average cost per unit of output over the
long run, where all inputs are considered to be variable. It is not an issue that should be
considered in evaluating performance when common costs are allocated to business segments.
Allocated costs are common costs such as administrative costs (the CEO's salary, for
example) that cannot be allocated on the basis of usage by the individual business segments.

45. If selling the product internally enables the selling division to avoid paying sales commissions
and collection costs that it would have to pay to sell outside, then it is justified to deduct an
amount up to the amount of the saved routine sales and collection costs from the market price
to establish the transfer price. The selling division will not be hurt by doing that, and the
buying division can benefit from a lower price. The company as a whole will benefit from the
saved sales commissions and collection costs.
 C3

1. Total monetary amount of claims processed per month is not an accurate way of measuring the
speed of processing because some claims will be for high amounts and others will be for lower
amounts. That is not something the manager of claims processing can control, so the manager's
performance should not be measured on it.
Furthermore, evaluating the manager's performance on the monetary amount of claims
processed could lead to the manager's giving priority to processing the larger claims. That would
lead to larger claims being approved before smaller claims, and larger sums of cash would be
paid out earlier to settle those larger claims. More cash paid out earlier would increase cash
outflow, resulting in lower cash balances and higher cost of capital. Giving priority in
processing would also result in poor customer service to the filers of the smaller claims.

2. Division B's actual return on investment exceeded its target return on investment by the greatest
amount, among the divisions that did exceed their targets. In addition, among the divisions that
exceeded their targets, Division B had one of the highest returns on sales. (Division D had a
higher return on sales, but Division D did not exceed its target return on investment.) Therefore,
Division B is the division with the best overall performance.

3. ROI measures the percentage return generated on the assets available (i.e. investment).
To calculate ROI, we use the formula:
ROI=Net Income/Avg. Investment.
ROI for year 3 = Net Income Year 3/ Avg. Investment of Year 2 and 3
($1,100,000-$700,000)/[($1,200,000+$2,000,000)/2].
ROI=$400,000/$1,600,000 = 25%. CMA133187

4. Return on investment is calculated by dividing net income by total assets. Thus, return on
investment in the given scenario will be 0.5% (i.e. $75,000 / $15,000,000). CMA133201

5. The "customers" of the Repair and Maintenance Department are internal. They are the users of
the production equipment that the Repair and Maintenance Department is responsible for
keeping in good working order. The response time and degree of satisfaction among the Repair
and Maintenance Department's customers is an appropriate measurement for evaluating the
performance of the Repair and Maintenance Department.

6. The most effective way to measure performance is to include both financial and nonfinancial
measures and to focus on multiple dimensions of the business, such as quality, customer
satisfaction, and market performance. ROI is calculated at a high level of aggregation; it is not a
basis for easy and quick comparisons.

7. While using ROI we may sometimes reject a project with a lower ROI than its current average
even though the project has positive RI.

8. The new investment would lead to a lower overall return on investment (ROI), it implies that the
expected ROI for the new project is lower than the division's current ROI. For the residual
income (net income - cost of capital) to increase, the expected ROI for the new project has to be
higher than the firm's cost of capital.

9. Residual Income is operating income less (assets × required rate of return). Since the projected
ROI for the project is 10% and the assets invested in the project equal $1,000,000, the project’s
 projected annual operating income must be $100,000. The company’s required rate of return is
8% per year. Thus, the project’s projected Residual Income is $100,000 – ($1,000,000 × 0.08),
which equals $20,000. PART17112054

10. If Green Division has excess capacity and its external sales are not affected because of the sale
to Red division, it can transfer the product to the Red Division as it would be able to recover its
cost and get a profit of 10%.

11. Transfer pricing is the price that is set for inter company sales to encourage goal congruence
among the division managers involved in the transfer. There are four methods of transfer
pricing: Market based, Cost Based, Negotiated prices and Dual prices.

Market based transfer pricing is the normal market price that would be paid in an intermediate
market between independent buyers and sellers. This method is preferred when the following
conditions are satisfied:The market for the intermediate product is perfectly competitive - Implies
that the market price for the product can be easily determined and market prices can show the real
economic profit of the company as a whole Selling division has no unused capacity - If the selling
unit has unused production capacity, its variable costs would be lower. The buying division will
not have incentive to buy from the internal division at market price, if the costs associated with
the product is low. Interdependencies of subunits are minimal

There are no additional costs or benefits to the company as a whole from buying or selling in the
external market instead of transacting internally.

On the other hand, cost-based transfer pricing is used when when external market for the product does
not exist or the external market prices are not easily available. Cost based transfer pricing may be
based on variable manufacturing costs, total manufacturing costs or full product cost. The
disadvantage with this system is that often only one division bears the cost of the product and while it
maximizes the profit of one division, it creates losses for the other.

Additional Information: The other methods of transfer pricing are briefly explained below:

Negotiated Price - A price is negotiated between the buying and the selling division and the
resulting transfer price should fall within a range limited by a ceiling and floor.

Dual Pricing - Transfers are recorded by the selling division at one price while the purchasing
division records the transfer at a different price.

12. Return on investment is calculated by dividing net income by total assets or average invested
capital. It can also be calculated by multiplying return on sales (which is net income divided by
net sales) and asset turnover (which is net sales divided by total assets) because the result will be
net income divided by total assets.

13. Residual income is the amount of return after a certain required return on the assets in use by the
division. The calculation of the required return is based on an imputed interest rate for the cost
of funds represented by the assets in use. This describes the situation in the question.

14. Customer returns, manufacturing throughput time, and training hours are all non-financial
measurements that could be used in a balanced scorecard. Return on investment is a financial
measurement, and the number of manufacturing plants is not a meaningful metric.
15. When division managers are evaluated on the basis of residual income, they are more likely to
embark upon projects that will be in the best interests of the overall corporation. Residual
income is not a rate, but instead, it is an amount of income. As long as the expected net income
before taxes from the project is greater than the target monetary return in (calculated as a
percentage of invested capital), the project will be in the best interests of the overall corporation
and it will also have positive residual income. Using residual income overcomes a weakness
inherent in using return on investment for manager evaluation. If return on investment is used, a
project that would have a higher return than the company's cost of capital and thus would be
good for the company may be rejected by the division manager because its return on investment
is lower than the division's current return on investment and thus it would bring the division's
return on investment down.

16. Return on investment is income (operating income unless otherwise stated) of the business unit
divided by total assets of the business unit (investment). Before the investment, Business Unit A
had a return on investment of 10% and income for the year of $40,000. Thus, the total assets of
Business Unit A must have been $400,000 ($40,000 ÷ $400,000 = 10%). After making a new
investment of $100,000, the assets of the business unit will increase to $500,000 and its income
is expected to increase by $15,000 to $55,000. After the investment, ROI is expected to become
$55,000 ÷ $500,000, or 11%, an increase of 1%.Residual income is income of the business unit
less the product of assets of the business unit multiplied by the required rate of return, which
may be the opportunity cost of investments. The opportunity cost is 8%. Before the investment,
the residual income of Business Unit A was $40,000 − ($400,000 × 0.08), or $8,000. After
making the new $100,000 investment, when income is expected to increase to $55,000, residual
income is expected to become $55,000 − ($500,000 × 0.08), or $15,000. Thus RI is expected to
increase by the difference between $15,000 and $8,000, or by $7,000.

17. Since the firm is profitable, revenue is greater than expenses, so increasing both revenue and
expenses by the same percentage will cause the increase in revenue to be larger than the increase
in expenses. As a result, net income will increase and, since investment would not change, ROI
will increase.

18. Residual income is the excess of income over cost. The manager of Construction Equipment
Division is evaluated based on residual income and would undertake a project if the project has
a positive residual income. Thus, as long as the return on investment is greater than the cost of
capital, there will be a positive residual income and the manager would undertake the project.
The project under consideration has an expected return of 14% and a cost of capital of
only 12%. As the return is greater than cost, the manager would undertake the project.
The manager of Household Appliances Division is evaluated based on return on investment.
This manager would undertake a project only if the return on the new project is equal to or
greater than the existing return of 16% for the two divisions. The project under consideration
is expected to give a return of only 14%, the manager would not undertake this project.
CMA133197

19. ROI = Net Income/Investment.

RI= Net Income-Interest on Investment.
Purchasing an asset increases the average investment, increasing the ROI denominator. This in
turn will decrease the computed ROI. The purchase of a long-term asset will increase the
average invested capital, which increases the interest on investment and in turn resulting in a
decrease in residual income.

20. Cost considerations: One of the most important factors in product / service pricing.
Long-run pricing - All costs (including fixed costs) are relevant and must be considered.
 Short-run pricing (e.g. special order) - Use contribution margin approach whereby only
variable costs and additional fixed costs are relevant and must be considered (note that most
fixed costs which remain unchanged are ignored).
Sunk costs are irrelevant in decision making as it is a foregone cost.

21. The four broad categories of performance indicators focused on in the balanced scorecard are
financial performance measures; customer measures; internal process measures; and learning
and growth. Competitor business strategies is not a performance indicator that is focused on in
the balanced scorecard.

22. A business unit's residual income is the business unit’s actual operating income minus its target
operating income (target return), or capital charge. The target return is the assets of the business
unit multiplied by the unit's required rate of return.
23. Residual income is
Operating income of the business unit
− (Assets of business unit × required rate of return)
= Residual Income

24. Residual income is income minus cost of invested capital. Residual income will increase as the
difference between the rate of return earned and the cost of invested capital increases. Thus, by
choosing a project which earns a higher return on capital invested, residual income will increase.

25. Any of the accounting policies for inventory listed has the potential to reduce the comparability
of ROI between two similar divisions. However, the accounting policy difference that would
reduce comparability the most is a difference in cost flow assumptions used. ROI is the income
of the business unit divided by the assets of the business unit. The inventory cost flow
assumption used affects both the income of the business unit and the assets of the business unit.
Assuming increasing costs, the use of LIFO will increase the cost of goods sold, thereby
decreasing net income while also decreasing total assets, because the units on hand in inventory
will be costed at lower prices. The use of FIFO will decrease the cost of goods sold, thereby
increasing net income while also increasing total assets, because the units on hand in inventory
will be costed at higher prices. The two ROIs would not be comparable because the bases on
which they would be calculated would be different.

26. Residual income = Net income – Interest on investment = Net income – (Required rate of return
× Invested capital). It deducts all capital costs.

27. The current cost method of measurement will provide the best basis of comparison

28. The market-based transfer price is the market price of an item in an uncontrolled market.
Market-based transfer prices should be used only when market prices are available for the goods
or services being [Link]-based transfer pricing is a method of setting prices when
selling products to divisions within the same company. Several factors affect the price,
including: Production costs. Managers' [Link] the market is perfectly competitive for
the intermediate product, and the selling division has no unused capacity.

29. The required rate of return used in calculating Residual Income is an interest rate assigned by
management. It is the rate of return that management desires. It is not a cash interest charge but
rather it is an interest charge that is assigned for the purpose of analysis. The required rate of
return may be the company’s weighted average cost of capital, or it may be another rate.
30. Receipt of more 5-star ratings from customers, for example on an Internet review site or in a
tourist guide, will lead to a greater volume of reservations. A greater volume of reservations
should lead to an increase in profit. Thus, there is a cause-and-effect relationship between
receiving more 5-star ratings from customers and an increase in profit. The number of 5-star
ratings received during a given period would be an effective Customer perspective key
performance indicator for a balanced scorecard used by a hotel.

31. The hot line manager's responsibility is to see that customers are assisted with problems by
receiving the correct answer quickly. Number of calls to the hot line for a new release of
software is not something the manager of the hot line department can control. The volume of
calls is determined by how "buggy" a new release is, and that is the responsibility of the
software developers. Therefore, number of calls to the hot line for each new release of software
would not be an appropriate measure of the hot line manager's performance.

32. Since return on investment uses a percentage of return as the measurement, Sanders would not
accept this proposal. That is because the expected return on this investment (12%) is less than
the return that Sanders' division has earned in the past (14%). Therefore, accepting this
investment would decrease Sanders' return on investment so he would reject it. On the other
hand, Carolina would accept the project because the return of this project is greater than the 8%
required by the company.

33. If the expected rate of return on a new investment is greater than the required rate of return
(usually the cost of capital), residual income will increase, even if the expected return on the
new investment is lower than the current return on investment.

34. The shipping manager is responsible for filling customer orders efficiently and accurately and
delivering them quickly, at the lowest possible cost without negatively impacting customer
service.
Percentage of orders filled on time, percentage of orders filled accurately and average cost to fill
and deliver an order are determined by comparing actual performance with established standards
for those performance measures. These are appropriate measurements for aligning the shipping
manager's goals with those of the company, because as the manager strives to attain those
standards, he will be fulfilling his responsibilities.

35. ROI uses many of the same measures that other methods use and is therefore susceptible to the
same manipulation as other methods are.

36. The question asks which allocation method would lead to negative (dysfunctional) behavior on
the part of managers. If costs are allocated on the basis of sales revenue, a division with
increased sales will receive more allocated costs. This could serve as a demotivator for the
manager of the division with increased sales. Also, using ROI to measure divisional
performance is probably not the best choice of method. Use of ROI to evaluate divisional
performance could lead to managers' rejecting profitable new investments if the new
investments' ROIs are lower than the divisions' historical ROIs, since the new investments could
bring down their future ROIs.
 Revenue ($170 x 120 total audit $ 20,400
1. hours)
+ reimbursed costs 1,550
Total client revenue $ 21,950
Costs:
Senior auditor ($150 x 15 hours) $ 2,250
Junior auditors ($52 x 105 hours) 5,460
Traveling costs 1,550
Total client customer-level operating profit $12,690

The administrative and other overheads are common costs and they would not be used when
calculating client customer-level profitability. Relevant costs are costs that would go away if the
customer were no longer a client. The administrative and other overheads would continue if this
customer were no longer a client.
Note: Since the traveling costs are reimbursed, they could be omitted from both revenue and costs and
the client profit would be the same.

2. Negotiated transfer prices are not usually simple or quick to implement. Negotiation can be
time-consuming and require frequent revision of transfer prices due to changing costs and
market conditions.
In contrast, a transfer price set by management would be simple and quick to implement.

3. Financial performance measures are lagging indicators of the firm’s performance because
they focus on short-term, historical performance rather than long-term, future performance.
Non-financial and operational indicators that measure the basic performance of the company
and improvements it is making in those indicators are leading indicators because they provide
the prospect of increased future economic value for shareholders. Financial, non-financial,
and operational indicators all are important for measuring perform

4. The four broad categories of performance indicators focused on in the balanced scorecard are
financial performance measures; customer measures; internal process measures; and learning
and growth. Competitor business strategies is not a performance indicator that is focused on
in the balanced scorecard.

5. The fixed overhead production volume variance is Budgeted Fixed Overhead − Fixed
Overhead Applied. Fixed Overhead Applied is the fixed overhead application rate per unit
multiplied by the number of units actually produced. The fixed overhead application rate per
unit is $600,000 budgeted FOH ÷ 200,000 budgeted production or $3 per unit. A total of
190,000 units were produced, so the amount of fixed overhead applied was $3 × 190,000 =
$570,000. The budgeted Fixed Overhead was $600,000. Thus, the Fixed Overhead
Production-Volume Variance was $600,000 − $570,000 = $30,000. Because the budgeted
fixed overhead was greater than the applied fixed overhead, this means that the actual volume
produced was lower than the budgeted volume and so the variance is unfavorable.

6. Residual income is the amount by which income exceeds a certain target level of income,
which is the company's required rate of return on the invested capital. In this question, the
target level is 10% of AED 1,000,000, or AED 100,000. A net income of AED 250,000
provides a residual income of AED 150,000.

7. The basic issue of transfer prices is simply how much should one unit of a company charge
another unit of the same company for its goods or services. The goal in setting a transfer price
is that the method used will stimulate both the buying and selling department managers to do
 what will provide the greatest benefit to the company as a whole, rather than to act in their
own interest. When there is an external market for the product, the market price is almost
always the best transfer price to use. Thus, the market price is at the maximum of the natural
range. When the company has idle capacity, the variable cost approach to determining the
transfer price also works well. Since the Fabricating Division has enough capacity to fulfill
the demand of the Assembling Division without any over-time, the variable cost approach is
also acceptable and is at the minimum of the natural range.

8. The materials mix variance equals the actual total quantity used multiplied by the difference
between the weighted average standard price for the actual mix per unit of direct materials,
which in this question is kilograms (waspAM) and the weighted average standard price for
the standard mix per kilogram (waspSM).
(waspAM − waspSM) × AQ
The weighted average total standard price for the actual mix is (21,000 × $0.75) + (14,000 ×
$0.90) = $28,350, and the weighted average standard price per kilogram for the actual
mix (waspAM) is $0.81 ($28,350 ÷ 35,000 kg).
The weighted average standard price for the standard mix (waspSM) is $0.80 per kilogram
($240 standard total cost per batch ÷ 300 standard total kg per batch).
The mix variance is ($0.81 − $0.80) x 35,000 = $350 Unfavorable.

9. Statements I and IV are correct. Both ROI and RI utilize revenues, costs, and level of
investments and are critical for decision-making (I). Both can be manipulated because they
are both based on accounting numbers, and accounting numbers can be manipulated (IV).
However, II and III are not correct:
• Neither ROI nor RI avoids all of the goal congruency issues in a company (II).
• ROI and RI both have a short-term, rather than a long-term focus (III)

10. Using three-way overhead variance analysis, the spending variance is equal to the variable
overhead spending variance plus the fixed overhead spending variance.
The variable overhead spending variance formula is (AP – SP) × AQ.
VOH Spending Variance = ($0.55 − $0.50) × 125,000 hours
= $6,250 unfavorable
The fixed overhead spending variance is Actual Fixed Overhead Incurred – Budgeted Fixed
Overhead.
The fixed overhead spending variance is 10,000 unfavorable ($130,000 actual − $120,000
budgeted).
Therefore, $6,250 unfavorable VOH spending + $10,000 unfavorable FOH spending =
$16,250 unfavorable spending variance.

11. When financial results are used to evaluate managers on their performance for rewards such
as bonuses, the only costs charged to each manager for purposes of the evaluation should be
costs each manager can control. Other costs may be allocated to each manager's responsibility
center in the accounting system, but they should be excluded from the amounts used in the
managers' evaluations. The best allocation basis and one that will permit the allocated costs to
be validly used in manager evaluation is one where the managers are able to control the
incurrence of costs by their departments. An allocation based on the actual usage of the item
being allocated is an appropriate method of allocation for responsibility accounting purposes
and manager evaluation because that is something the manager can control. In this case,
variable computer operational costs charged to each segment according to actual hours used is
a charge the manager can control by controlling the usage. Managers of individual segments
cannot control the overall incurrence of the computer operational costs, but they can control
their usage of the computer services and thus they can control how much of the cost is
allocated to their segments. Therefore, these variable computer costs can be included in the
 managers' performance reports. The other answer choices all represent costs that segment
managers are not able to control.

12. Goal congruence is defined as "aligning the goals of two or more groups." As used in this
question, it means the goals of the individual managers are aligned with those of the other and
with the goals of the organization as a whole. In other words, the managers, while each acting
in their own best interests, will also be acting in the best interest of each other and of the
organization as a whole.
With respect to transfer pricing, it is in the best interest of the organization that the products
or services be bought and sold internally rather than from outside. The cost to the
organization as a whole will be lower because it will not include a profit paid to the outside
firm over and above its costs. The organization can essentially get the goods or services at
cost.
Thus, anything that encourages the organization's divisions to buy from one another instead of
from outside will be good for the firm. A dual rate transfer price provides both the buying and
the selling division with an advantageous price. The selling division receives the market price
for the sale, while the buying division gets a purchase price that is lower than it would be if it
were to purchase outside. Thus, use of a dual rate transfer price promotes goal congruence
between the two managers and also between the two managers and the organization as a
whole.

13. The quantity variance (also called the efficiency or usage variance) is calculated as: (Actual
Quantity − Standard Quantity for Actual Output) × Standard Price. The actual quantity of
material used was 58 lb. per unit of finished product or 95,700 units in total (1,650 × 58 lb.).
The standard quantity to produce 1,650 units equals 99,000 units (1,650 × 60 lb.). The
standard price is $1.50. Therefore, the quantity variance is (95,700 − 99,000) × $1.50 =
$(4,950) favorable. The actual quantity used was less than the standard quantity for the actual
output, which means that the variance is favorable.

14. Programs B, C and D have projected ROIs that are higher than the firm's 15% cost of capital.
Therefore, assuming no restrictions on expenditures, all three of those programs would add
value to KHD Industries. Note that the problem asks for which programs would add value to
the company, not which programs would maximize the manager's bonus. If, as the manager
projects, the company does earn an ROI equal to 24% on operations other than these new
programs next year, then the addition of B and C would cause the division's ROI to decrease
because their individual projected ROIs are below 24%. That would, in turn, cause the
manager's bonus to be lower than it would be with a 24% or higher ROI. However, since the
projected ROIs for B and C are higher than the company's cost of capital, those programs
should be undertaken since they will add value to the company.

15. The master budget variance is the static budget variance, or the difference between the actual
results and the static budgeted amount. The operating income variance is the difference
between the actual and the static budget operating incomes, each calculated as revenue minus
variable costs minus fixed costs.
Actual operating income is ¥650,000,000 revenue minus ¥375,000,000 variable costs minus
¥195,000,000 fixed costs, or ¥80,000,000. Master budget operating income is ¥750,000,000
revenue minus ¥400,000,000 variable costs minus ¥255,000,000 fixed costs, or ¥95,000,000.
The operating income variance is the actual ¥80,000,000 operating income minus the
budgeted ¥95,000,000 operating income, or (¥15,000,000). When the actual amount precedes
the budgeted amount in the variance calculation, a negative variance for a revenue or net
income amount is an unfavorable variance. It means actual income was less than budgeted
income.
16. The minimum transfer price between the two divisions is the selling division's variable cost
per unit, or $50.

17. Earnings per share projections and actual earnings per share are calculated for the company as
a whole. There is no such thing as earnings per share for an individual division. Therefore,
earnings per share projections are not considered an appropriate goal for measuring a division
manager's efficiency for a budgeting period.

18. The current cost method of measurement will provide the best basis of comparison.
Book value is not a good basis to use for comparison because ROI will be impacted by the
age of the assets in each of the divisions being compared.

Historical cost is not a good basis to use for comparison because ROI will be impacted by the
age of the assets in each of the divisions being compared.

Depreciated cost is not a good basis to use for comparison because ROI will be impacted by
the age of the assets in each of the divisions being compared.

19. The special order will be generating a contribution per unit of

$130 - $80 = $50
As 400 units of the product would be produced ( 200 units for each month).
Total contribution generated by the special order would be 400 x $50 = $20,000.
As the company is utilizing excess capacity, no additional fixed costs are assumed to have
been incurred.
Increase in profit would be $20,000.

20. Residual income for Zee can be calculated based on formula below:
Residual income = Net income - Interest on investment
= $200,000 - $50,000
= $150,000
Aggregate net income, dividends paid on common and preferred stock is irrelevant in
computing residual income.

21. The formula for the price variance is (AP – SP) × AQ. Because this is asking for the purchase
price variance, we use the actual quantity purchased, not the actual quantity used, for AQ.
The actual price is $583,200 ÷ 108,000 = $5.40 per unit of raw material.
The standard price is $16.50 per completed product unit ÷ 3 units of raw material used per
completed product unit = $5.50
The actual quantity purchased is 108,000.
The purchase price variance = ($5.40 – $5.50) × 108,000 = $(10,800) favorable.

22. The labor efficiency variance is a quantity variance, calculated as follows: (Actual Hours −
Standard Hours for Actual Output) × Standard Rate. A total of 5,000 direct labor hours were
actually used in production. We know that 19,000 units of product were manufactured during
the period. The standard direct labor hours allowed for production of one unit is 0.25 hours.
Therefore, the standard direct labor hours allowed for the production of the period is 19,000 ×
0.25 = 4,750 hours. The standard rate is $8. Therefore, the direct labor efficiency variance is
(5,000 − 4,750) × $8 = $2,000 unfavorable. Because the actual hours used were greater than
the standard hours allowed for the actual output, the variance is positive and unfavorable.
23. Segment margin includes sales, variable costs, controllable fixed costs and traceable fixed
costs. The allocation of the president's salary is an untraceable fixed cost and should not be
included in segment margin of this division.

24. 1. Using the 10,000 standard direct labor hours allowed for production of 5,000 units as the
standard quantity (SQ) in the direct labor efficiency variance formula instead of using the
standard quantity of hours allowed for the actual output of 6,000 units.
2. And one of the following additional errors:
• Using the efficiency variance formula with a negative variance amount to calculate the
actual quantity (AQ) of direct labor hours used. The variance is unfavorable, and for a cost, an
unfavorable variance is a positive amount; so the variance amount used with the formula
should be positive.
• Alternatively, this answer may result from using a positive (correct) variance amount in the
formula but reversing the AQ and the SQ in the formula and putting the incorrect SQ amount
first.

25. Responsibility accounting is a system in which cost and revenue data is reported based on
who (manager or division) is able to control them or is responsible for them. This is the
system described in the question.

26. Segment reporting is the reporting of results by segment: product line, geography or some
other distinguishing characteristic. This is not descriptive of the method used by this
company.

27. When there is an external market for the product, that is almost always the best transfer price
to use for profitability and performance measurement, because it is objective.

28. To ensure that a divisional vice president places appropriate focus on both the short-term and
the long-term objectives of the division, the best approach would be to evaluate the vice
president’s performance by using both financial and non-financial measures, including the
evaluation of quality, customer satisfaction, and market performance.

29. The shipping manager is responsible for filling customer orders efficiently and accurately and
delivering them quickly, at the lowest possible cost without negatively impacting customer
service. Percentage of orders filled on time, percentage of orders filled accurately, and the
average cost to fill and deliver an order are determined by comparing actual performance with
established standards for those performance measures. These are appropriate measurements
for aligning the shipping manager's goals with those of the company because as the manager
strives to attain those standards, he will be fulfilling his responsibilities.

30. A cost center is the least complex of the different types of centers. It is responsible only for
the incurrence of costs

31. Purchase of new assets benefits a business in the long run and has a positive impact on the
residual income. But a company that solely depends on ROI as a performance measure may
forgo the investment based on decrease in its average even though it might result in positive
residual income, which benefits the company as a whole.
32. There are two important points to note in this question. One, the Fabrication Division has
excess capacity that is adequate to manufacture all of the 4,500 units of UT-371 that the
Electronic Assembly wants to purchase. And two, the question asks for the minimum price,
not the best price. "Minimum" means the very lowest price that the Fabrication Division must
receive to avoid having a loss on the internal sale. The Fabrication Division will not have any
variable selling and distribution costs on the internal order, and its total fixed manufacturing
cost will be the same whether it accepts the internal order or not. Since the Fabrication
Division has enough excess capacity to produce the order without having to give up any
external orders, there will be no opportunity cost. Therefore, the very lowest price that the
Fabrication Division must receive is its variable manufacturing cost of $21. The Fabrication
Division will break even if the price it receives for the internal order from the Electronic
Assembly Division is equal to its variable manufacturing cost.

33. Motivation is the basic purpose of a responsibility accounting. According to responsibility

accounting, managers are responsible for those factors that they can control. Their
performance is evaluated on how well they manage the areas over which they exercise
influence, whether they are costs, revenues or both.

34. ROI = Operating profit/ Investment.

Passenger ROI= $40,000/$250,000 = 16%
Cargo ROI= $50,000/$500,000=10%
Based on ROI, Passenger division's performance is better than the Cargo division.
External borrowing rate or financing rate is irrelevant in calculating ROI.

35. Penguin's return on investment is 18% ($2,520,000 ÷ $14,000,000), which exceeds the
required rate of return of 15%, so it is acceptable. Joker's return on investment is 16.5%
($1,650,000 ÷ $10,000,000), which also exceeds the required rate of return. However, the
total investment amount available is $20,000,000, and the investment in Penguin and Joker
combined is greater than $20,000,000. Therefore, only Penguin, the project with the higher
return on investment, can be accepted. PART17112073

36. The variable overhead spending variance is the difference between actual variable overhead
incurred and budgeted variable overhead based on the inputs (labor or machine hours)
actually used. The budgeted variable overhead based on the inputs actually used is the
budgeted rate per labor hour or machine hour (whichever is being used as the allocation base)
multiplied by the actual number of hours used for the actual output.

37. Residual income (RI) is calculated as the amount of return (operating income of a business
unit) that is in excess of a targeted amount of return on the investments that are employed by
that business unit (calculated as assets of the business unit multiplied by the required rate of
return). RI is focused on the monetary amount of income that is in excess of a targeted
amount. It is not focused on a percentage of return as ROI is. When using RI to evaluate
investment opportunities, any project that has a positive RI will be accepted even if it will
reduce the overall company's or business unit's ROI. Thus, desirable investment decisions will
not be neglected by high return business units.

38. The formula for the variable overhead efficiency variance is: (Actual Activity Level of VOH
Application Base actually used − Standard Activity Level of application base allowed for
actual output) × Standard Application Rate. In standard costing, overhead is applied on the
basis of some activity such as machine hours or direct labor hours. It is applied on the basis of
the amount of that activity (machine hours, direct labor hours) that is allowed according to the
 standard for the actual output, not the actual amount of hours used. When normal costing is
being used, overhead is applied instead on the basis of units of the activity base actually
used for the actual output. When overhead is applied on that basis, overhead is applied on the
basis of actual activity, not the standard activity allowed. Therefore, if overhead is applied on
the basis of units of the activity base actually used for the actual output, there will be no
difference between the actual activity level (the first number in the parentheses in the
formula) and the activity level used to apply the overhead (the second number in the
parentheses in the formula), so the variance will be equal to zero.

39. The balanced scorecard is not derived from scientific management theories. Scientific
management was a theory developed in the late 1800s. It focused primarily on the efficiency
of individual workers and improving their productivity. Its principles were responsible for the
development of "efficiency experts" and the use of time and motion analysis.
The balanced scorecard is a strategic management tool which developed as a response to
problems caused by evaluating managers only on the quarterly or annual financial
performance of their business units.
The balanced scorecard encourages managers to focus on elements of long-term success,
which are non-financial and operational indicators, instead of only on short-term financial
performance. It does this by rewarding managers for improvements in those elements of long-
term success. Improvements in these non-financial measures provide the prospect of
increased future economic value for shareholders. When managers are evaluated and
rewarded based on non-financial indicators as well as financial indicators, it leads to long-
term financial performance improvements. This again comes back to the idea of goal
congruence and making sure that everyone is working toward the same goals.

40. Division B's actual return on investment exceeded its target return on investment by the
greatest amount, among the divisions that did exceed their targets. In addition, among the
divisions that exceeded their targets, Division B had one of the highest returns on sales.
(Division D had a higher return on sales, but Division D did not exceed its target return on
investment.) Therefore, Division B is the division with the best overall performance.

41. ROI is calculated as operating income of the business unit divided by total assets (or
investments) of the business unit. Operating income equals net sales minus COGS and G&A
expenses, or $400,000 ($4,000,000 − $3,525,000 − $75,000). Total assets are equal to the sum
of current assets and property, plant, and equipment, or $2,400,000 ($625,000 + $1,775,000).
ROI thus equals $400,000 ÷ $2,400,000 = 16.67%. Note that usually average total assets
would be used to calculate ROI. Assuming the information on assets given in the question is
year-end balances and not average balances, information on average total assets is not
available and cannot be calculated from the information given, so the information that is
available is used.

42. A transfer price is not a price charged by the company to external customers, so this is an
incorrect description of transfer pricing. A transfer price is the price charged by one unit of
the company to another unit of the same company for the services or goods produced by the
first unit and "sold" to the second unit.

43. This is a very general, but true, statement. A market-based transfer price will lead to the
greatest good for the company in the long term. Other, artificial, transfer prices will lead to
behavior that is not in the best interest of the company as a whole.

44. The sales volume variance formula is: (Actual Sales Volume − Budgeted Sales Volume) ×
Budgeted Contribution per Unit. The budgeted contribution per unit is defined at the
 beginning of the year using the master budget. The budgeted sales volume is also defined at
the beginning of the year and it is a master budget figure. Actual sales volume is the same
thing as the flexible budget sales volume, because the flexible budget uses the actual level of
output. Thus, the sales volume variance is the difference between the flexible budget and
master budget sales volume, times master budget unit contribution margin.

45. Basing the allocation of service department cost on anticipated usage forces using department
managers to realistically assess their projected needs. Waiting until actual usage levels are
known unfairly penalizes departments that had unforeseen emergency needs arise.

46. The full cost transfer price is above the selling division's variable costs since it includes an
overhead allocation. Furthermore, the selling division has enough excess capacity that it
would not need to lose any outside business by producing for and selling to the buying
division. Therefore, the full cost transfer price provides an incentive to the selling division to
sell the goods internally. Since the transfer price is above the selling division's variable costs,
the selling division's contribution margin will be increased by the internal sale. Since the
question says that the selling division could sell the goods to outside customers at a higher
price, the market price must be higher than the full cost transfer price. Therefore, the transfer
price provides an incentive to the buying division to source the goods internally from the
selling division. The buying division's operating income will be increased by the internal
purchase. Since the selling division's variable cost to produce the goods sold to the buying
division is lower than the market price for the same goods, it benefits the organization as a
whole to have the buying division purchase the goods internally. Goal congruence within the
company has been achieved because what is good for the organization as a whole is also good
for both of the divisions involved in the transfer.

47. Economic value-added is not an example of the customer perspective in a balanced scorecard.
Economic Value Added (EVA) is a more developed version of RI. It is a calculation similar
to Residual Income in that it involves calculating the excess income over a certain threshold.
However, the calculation of economic value added uses after-tax income (instead of operating
income, as does Residual Income), and the calculation of the threshold is a little more
involved. Operating income after taxes is compared to total assets less current liabilities
multiplied by the weighted average cost of capital (WACC). (Economic value-added is not
tested on the CMA exam.)

48. Overhead spending variance is the difference between the actual overhead incurred and the
budget allowance, based on actual quantity of variable overhead cost allocation base used for
actual production. Since actual quantity is used in the calculation, level of activity at 80% or
100% of practical capacity will not be considered. Therefore, the spending variance will
remain unchanged.
Volume variance is the difference between actual production and budgeted production. Since
there is an unfavorable volume variance with production budgeted at 80% of capacity, the
variance would be even greater if the budget were for 100% of capacity.

49. A favorable direct labor price variance indicates that the cost of labor was less expensive than
planned which could be a result of using low-skilled labor. Hiring low-skilled labor than
planned may adversely affect the labor efficiency variance, material usage variance and other
variances in the value chain which may more than offset the favorable price variance.

50. The manager of the Construction Equipment Division would have an incentive to undertake
the project because the manager is evaluated on the basis of residual income, and a project
 with a 14% rate of return would increase residual income. The manager of the Household
Appliances Division would not have an incentive to undertake the project because the
manager is evaluated on the basis of return on investment, and a project with a 14% rate of
return would decrease the 16% return on investment the division is currently achieving.
However, since both projects have rates of return that are greater than the company's cost of
capital, both projects will increase the value of the company, so both should be accepted by
their respective managers.

51. Variable cost for NEFT 23 produced by CORD for PRD is $73.50 per unit ($75 + $5.00 –
$6.50). The contribution margin lost on each NEFT 25 that cannot be produced if production
of NEFT 23 is increased is $65 ($155 − $90). Therefore, the total contribution margin that is
lost by CORD for the 750,000 units of NEFT 25 that would not be produced if it sells NEFT
23 to PRD is $48,750,000 (750,000 × $65 contribution margin per unit).

The contribution margin for NEFT 25 that will be given up by CORD for the production of
each unit of NEFT 23 for PRD is $48.75 ($48,750,000 ÷ 1,000,000 units of NEFT 23
produced for PRD). Since the fixed costs presently being allocated to NEFT 25 would
continue and would be allocated to other products, they are not relevant. Adding the variable
costs per unit and the lost contribution per unit together, we get the minimum transfer price of
$122.25 ($73.50 per unit variable costs + $48.75 per unit lost contribution). The market price
for NEFT 23 is $130.00, so the optimal transfer price for all parties must be between $122.25
and $130.00. Any price lower than $122.25 would not be acceptable for CORD and any price
higher than $130.00 would not be acceptable to the PRD because it could buy the product
cheaper on the open [Link], the price range for the transfer price should be $122.25 -
$130.00.

52. Common costs are the costs that are shared by more than one cost object. A cost object is
anything for which costs are accumulated for managerial purposes: a specific product, job,
product line, a market, or certain customers.

53. Nanjones applies overhead based on planned machine hours using a predetermined annual
rate. The amount of planned variable manufacturing overhead was $2,400,000 and amount of
planned machine hours were 240,000. Thus, the application rate for variable manufacturing
overhead was $10 per hour ($2,400,000 / 240,000). Under standard costing -- which is being
used here because the problem tells us that overhead is applied based on planned machine
hours -- overhead to be applied is calculated by multiplying the predetermined rate by the
amount of (in this case) machine hours that should have been used for the amount actually
produced. The problem tells us that the planned machine hours based on output was 21,000,
and therefore, the amount of variable overhead applied was $10 × 21,000, or $210,000. The
actual variable overhead incurred was $214,000. Therefore, variable manufacturing overhead
was underapplied by $4,000.

54. Management by exception means that management focuses on areas where there are
problems, as identified by the fact that there is a variance from the standard. In order for a
company to use management by exception, standards must be set and there must be a system
whereby variances are identified and reported to the appropriate level of the company.
55. The fact pattern of the question requires us to first identify the contribution of composite units
before determining the breakeven units of first product sold
The ratio of sales of the two products is 75 :25 or 3 :1
Contribution margin of
First product = ($10- $6) = $4
Second product = ($25-$13) = $12
Composite contribution margin = (3x $4) + (1 x $12) = $24
Total Fixed costs = first product $100,000 + Second product $212,000 = $312,000.
Number of Composite units to Break even = Total Fixed Costs / Composite Contribution
= $312,000 / $24
= 13,000 composite units
Finally, the number of units of First product at the Breakeven point is determined by
multiplying the composite units by the number of units of First product (i.e.) 13,000 x 3 =
39,000 units. CMA2315

56. In accordance with responsibility accounting, a manager should be held responsible only for
those factors which he or she can control. Costs of fixed assets and depreciation methods and
policies are not under the control of an assembly line manager, because those things are
decided at a higher level. Therefore, equipment depreciation expense would not normally be
included in a performance report for the assembly line manager under responsibility for
accounting.

57. The minimum cost that Roger, Inc must cover is the opportunity cost that is forgone when
production capacity is put to alternate use.
The opportunity cost or contribution margin for 1,000 components can be calculated as
($5,000/1,000) = $5 per unit. Additionally the variable cost of the product must be
considered.
The variable cost is calculated as DM $3 + DL $3 + OH $3 = $9.
Hence the lowest unit price per unit should be $14($9+$5).

58. A definition of a controllable cost is a cost that the manager is able to influence in the time
period under consideration.

59. The direct labor efficiency variance is calculated as follows: (Actual Hours − Standard Hours
for Actual Output) × Standard Rate. The standard hours for the actual output were 6,500 (1.25
DLH × 5,200 actual units produced). The standard rate is $12. Thus, the direct labor
efficiency variance is (6,600 − 6,500) × $12/DLH = $1,200 unfavorable. Since the actual
hours were greater than the standard hours for the actual output, the variance is unfavorable.
PART17111862

60. The fixed overhead spending (or flexible budget) variance is actual fixed overhead incurred
minus the flexible budget amount of fixed overhead (which for fixed overhead is the same as
the static budget amount). A positive variance amount is unfavorable, and a negative variance
amount is favorable, because fixed overhead is a cost. The actual fixed overhead incurred was
$28,000. The budgeted (static budget and flexible budget) amount of fixed overhead for the
month was $27,000 ($324,000 ÷ 12). Thus, the fixed overhead spending (flexible budget)
variance is $1,000 unfavorable ($28,000 − $27,000).
61. When selling internally, costs such as selling commissions and collection costs are not
incurred. Also other costs such as advertising costs and promotions costs are also avoided.
Thus selling to internal divisions at a price lower than the market based transfer price is
justified.

62. The question says "A company isolates its raw material price variance in order to provide the
earliest possible information to the manager responsible for the variance." This is the
definition of the purchase price variance. The question is worded this way to find out whether
you know what the purchase price variance is and what it is used [Link] formula for the price
variance is (AP – SP) × AQ. Because this is asking for the purchase price variance, we use the
actual quantity purchased, not the actual quantity used for [Link] actual price is given in the
question as $2.02 per pound of raw [Link] standard price is given in the question as
$2.00 per pound of raw [Link] actual quantity purchased is given as 500,000
[Link] purchase price variance = ($2.02 – $2.00) × 500,000 = $10,000 unfavorable.

63. Residual income is the operating income earned after the required charge for the funds
invested by the company in its operations (usually the cost of capital) has been covered. If the
expected rate of return on a new investment is greater than the required rate of return, residual
income will increase as a result of the new investment even if the expected return on
investment (ROI) for the new project is lower than the division's current return on investment.
When evaluating a potential project for investment, any project that has a positive RI will be
accepted, even if it will reduce the overall company’s or unit’s ROI. Therefore, an investment
that may have been rejected on the basis that its ROI was lower than the existing ROI would
instead be accepted, and the company would benefit from the new investment.

64. A cost center is responsible only for the incurrence of costs. This production manager is
accountable only for controlling costs and that makes this a cost center.

65. Purchasing, marketing and production all have some responsibility for the variance. The
purchasing department is responsible for misplacing the paperwork and not ordering the raw
materials in a timely manner, necessitating the search for a new supplier. The marketing
department is responsible because they accepted a rush order for a nonstock item without
checking first with the production department about whether it was feasible to fulfill the order
under the terms the customer required. The production department supervisor is responsible
for rushing the raw materials received into production without inspecting them first.

66. As long as the producing division has excess capacity and so will not need to forego
providing any goods to outside customers, a transfer price should be a minimum of the
variable costs to produce the item and a maximum of the market price that the buying division
would need to pay if it were to purchase the item from an outside supplier.
The minimum transfer price that Segment A should charge Segment B is its variable cost, $11
per unit.

67. The purpose of identifying manufacturing variances and assigning their responsibility to a
person/department is to use the knowledge about the variances to promote learning and
continuous improvement. One of the main purposes for responsibility centers and
responsibility accounting is to enable evaluation of subunits' performance and contribute to
measuring the performance of the subunits' managers. This provides motivation for managers
of the subunits. By knowing what they are responsible for and controlling those items,
 managers should be more motivated than if they were evaluated on something outside of their
control.

68. When financial results are used to evaluate managers on their performance for rewards such
as bonuses, the only costs charged to each manager for purposes of the evaluation should be
costs each manager can control. Other costs may be allocated to each manager's responsibility
center in the accounting system, but they should be excluded from the amounts used in the
managers' [Link] best allocation basis and one that will permit the allocated costs to
be validly used in manager evaluation is one in which the managers are able to control the
incurrence of costs by their department. An allocation based on the actual usage of the item
being allocated is an appropriate method of allocation for responsibility accounting purposes
because that is something the manager can control. In this case, variable computer operational
costs charged to each segment based on actual hours used is a charge the manager can control
by controlling the usage. Managers of individual segments cannot control the overall
incurrence of the computer operational costs, but they can control their usage of the computer
services and thus they can control how much of the cost is allocated to their segments.
Therefore, these variable computer costs can be included in the responsibility accounting
report. The other answer choices all represent costs that segment managers are not able to
control.

69. The identification of who is responsible for the costs being incurred and the control over the
costs themselves is critical to the effectiveness of a responsibility accounting system. This can
be done through the proper delegation of responsibility and authority.

70. The sales volume variance can be calculated in several different ways:

It is the difference between the flexible budget amount and the static budget amount. The flexible
budget amount is the actual number of units sold multiplied by the budgeted sales price: 585,000
× $12, or $7,020,000. The static budget amount is the budgeted units multiplied by the budgeted
sales price: 600,000 × $12, or $7,200,000. The sales volume variance is $7,020,000 − $7,200,000
= $(180,000). A negative variance for a revenue is unfavorable.
It is the difference between the static budget variance and the flexible budget variance. The static
budget variance is (585,000 × $12.50) − (600,000 × $12) = $112,500 favorable. The flexible
budget variance is (585,000 × $12.50) − (585,000 × $12) = $292,500 favorable. The sales volume
variance is $112,500 − $292,500 = $(180,000) unfavorable.
It is (AQ − SQ) × SP, where AQ = the actual quantity sold, SQ = the static budget quantity, and
SP = the budgeted average price per unit. (585,000 − 600,000) × $12 = $(180,000).

Even though the static budget variance and the flexible budget variance were both favorable, the
sales volume variance was unfavorable because fewer units were sold than had been budgeted to
be sold.

This is the actual sales volume minus the budgeted sales volume, the difference multiplied by the
actual sales price.
The sales volume variance can be calculated in several different ways:

71. It is the difference between the flexible budget amount and the static budget amount.

It is the difference between the static budget variance and the flexible budget variance.

It is (AQ − SQ) × SP, where AQ = the actual quantity sold, SQ = the static budget quantity,
and SP = the budgeted average price per unit.
72. Programs B, C and D have projected ROIs that are higher than the firm's 15% cost of capital.
Therefore, assuming no restrictions on expenditures, all three of those programs would add
value to KHD Industries.
Note that the problem asks for which programs would add value to the company, not which
programs would maximize the manager's bonus. If, as the manager projects, the company
does earn an ROI equal to 24% on operations other than these new programs next year, then
the addition of B and C would cause the division's ROI to decrease because their individual
projected ROIs are below 24%. That would, in turn, cause the manager's bonus to be lower
than it would be with a 24% or higher ROI. However, since the projected ROIs for B and C
are higher than the company's cost of capital, those programs should be undertaken since they
will add value to the company.

73. Generally, with time, as the workers gain experience their performance improves, time taken
per unit reduces and, the productivity goes up. This improvement in productivity is due to the
learning effect. Thus, a constant monitoring and revision of standards to reflect learning curve
becomes necessary as it facilitates a better use of standard costs and variance analysis which
helps in improving managerial decision-making.

74. A material usage variance can be caused by labor factors, and a labor efficiency variance can
be caused by material quality factors. If employees are new or untrained, an unfavorable labor
efficiency variance can result. The untrained employees may also cause more direct material
spoilage, which will result in an unfavorable material usage variance. It can work the other
way, as well. Knowledgeable and efficient employees can create both a favorable labor
efficiency variance and a favorable material usage variance.
Furthermore, an unfavorable material usage variance can be caused by inferior materials. The
inferior materials that the employees have to work with can also cause an unfavorable labor
efficiency variance as well, because it may take longer to produce the product using inferior
materials.

75. The flexible budget overhead variance equals the difference between the total actual overhead
incurred and the flexible budget total overhead (variable and fixed).
The flexible budget fixed overhead equals the master budget amount of $27,000. The
budgeted variable factory overhead rate is $3 per labor hour, the standard hours to produce
one unit of product is 3 hours, and 1,650 units were produced. Thus, the flexible budget
variable factory overhead was $14,850. The actual overhead costs were $39,930. The total
flexible budget variable factory overhead is $41,850 ($14,850 + $27,000). Therefore, the
flexible budget overhead variance is ($1,920) favorable ($39,930 − $41,850). Since the actual
overhead is less than the budgeted overhead, the variance is favorable.

76. Breakeven point is the amount of contribution margin (sales minus variable costs) required to
cover the fixed costs or the point at which the profit is zero and the contribution margin is
exactly equal to the fixed costs.
Margin of Safety is the sales dollars or units over and above the break-even sales.
Margin of Safety = Total Sales - Break even sales
$130,000 =Total Sales - $780,000
Total Sales = $ 910,000.
Contribution Margin% = 100% - Variable cost %
= 100%-60% = 40%
Therefore,
Contribution Margin = Total Sales x Contribution Margin Ratio
 = $910,000 x 40%
= $364,000.

77. The hot line manager's responsibility is to see that customers are assisted with problems by
receiving the correct answer quickly. Number of calls to the hot line for a new release of
software is not something the manager of the hot line department can control. The volume of
calls is determined by how "buggy" a new release is, and that is the responsibility of the
software developers. Therefore, number of calls to the hot line for each new release of
software would not be an appropriate measure of the hot line manager's performance.

78. The variable manufacturing overhead spending variance is like a price variance and is
calculated using the following formula: (AP – SP) × AQ. The “AP” represents the actual
variable overhead rate, calculated as the actual, incurred variable overhead divided by the
actual number of direct labor hours used to produce the actual output. That calculation has
also already been done, and the actual rate is given as $11.50 per direct labor hour used. The
“SP” represents the standard application rate of $12 per direct labor hour, calculated as the
budgeted variable overhead divided by the amount of the cost base (DLH) allowed for the
budgeted output (0.35 hours per unit × 9,500 units). That calculation has already been done,
and the question gives the rate of $[Link] “AQ” represents the actual quantity of direct labor
hours used to produce the actual output, which is given as 3,550 hours. Therefore, the variable
overhead spending variance is ($11.50 − $12.00) × 3,550 hours = $(1,775) favorable
The negative amount means the actual cost was lower than the planned cost, which for a cost
is a good thing, so the variance is favorable.

79. The simple formula to calculate revenue is Revenue = Quantity × Price. Variances in revenue
come from either variances in quantity of product sold or variances in selling price. A flexible
budget is a budget that is prepared using the standard costs and the actual level of activity
(sales or production). It is essentially what the budget would have been if the company had
known when it developed the budget what the actual level of activity would be. The flexible
budget variance (or total flexible budget variance) is the actual results minus the flexible
budget amount. Since the actual results are being compared with the flexible budget and the
flexible budget amount is adjusted to the actual sales volume, there will be no difference in
revenue due to a difference between actual sales volume and budgeted sales volume. The
difference between the actual revenue and the flexible budget revenue can be caused only by
a difference between the actual and budgeted selling prices.

80. Variable overhead efficiency is similar to labor efficiency as it measures the difference
between actual and the budgeted hours worked multiplied by the predetermined variable
overhead rate. The formula for variable overhead efficiency variance:
(Standard hours for actual production x predetermined overhead rate) - (Actual Hours x
predetermined overhead rate).
Variable overhead efficiency variance can be calculated using the following steps:
Step 1: Compute the predetermined variable overhead rate, given the total budgeted costs and
the fixed budget costs:
Fixed overhead budget = (200,000 units x 2 DLH) x $1.5 = $600,000
Variable overhead budget = $900,000(Total overhead costs) - $600,000(Fixed overhead
costs) = $300,000.
Predetermined Variable overhead rate = $300,000/400,000 hours = $0.75
Step 2: Compute the Variable overhead efficiency variance using the above formula, where
Standard Hours for actual production = 198,000 Actual Units x 2 Standard Hours = 396,000
hours,
Predetermined overhead rate = $0.75 (from Step 1),
 Actual direct manufacturing labor hours = 425,000 Hours (given)
Variance = (396,000 x $0.75) - (425,000 x $0.75) = $21,750 Unfavorable.

90. The transfer price is the price charged by one unit of the company to another unit of the same
company for the services or goods produced by the first unit and "sold" to the second unit. The market
price is determined purely by the forces of supply and demand without interference from an outside
source. This concept assumes that markets are efficient, which is not always true in practice. The
market price is one of many possible approaches to determining a transfer price.

The outlay price is one approach to determining a transfer pric

The distress price is a reduced price (sometimes significantly) that occurs in urgent sales. Distress
price is not an approach to determining a transfer price.

91. The amount the customer is charged for the order should include an additional charge for the
overtime required to meet the three-day delivery requirement. On the expense side, the additional
overtime cost should be charged to the sales department, if the sales department operates as a profit
center and has expenses. The variances caused by the additional income and the additional expense
will offset one another in the sales department's variance reporting. If the sales department does not
operate as a profit center, then both the additional income from charging the customer for the
overtime and the overtime expense should be allocated to a department that does operate as a profit
center, so the variances caused by the additional income and the additional expense will offset one
another.

92. In calculating the effect on the company's profit as a result of adding this burger to the menu, we
ignore the allocated fixed direct costs because these are already incurred by the restaurant and will
continue to be incurred by the restaurant even if this item is not added to the menu.
The items that we need to take into account are sales ($550,000), less variable costs ($375,000), and
less product advertising ($180,000). The net of these three items is a $5,000 loss. Therefore, the effect
on the company's profit because of the addition of this new product was to decrease income by
$5,000.

93. "Tight" standards are standards that are very demanding. For example, if a job can be done in two
hours only if everything works perfectly and absolutely nothing goes wrong, then a labor standard of
two hours may be too tight because things can go wrong. Machines can break down, jobs can get
interrupted, there could be a power failure, or any number of things could delay the completion of the
job. Whether the budgeting process was well-defined or not well defined is not relevant to the
standards being used within the company. Furthermore, if the standards were developed using a
bottom-up philosophy, there is little chance that they will be too tight. If anything, they might be too
loose, because the people closest to the production process might build more extra time than
necessary into the labor standards, in order to make sure the standards can be met. Therefore, a
bottom-up philosophy of budgeting would not result in too-tight labor standards, so this is
inconsistent with the consultant’s conclusion.

94. Each area office should be evaluated as a profit center. A profit center is a department responsible
for both revenues and expenses. Each office of Accountants for Hire has both revenues and costs. The
manager of each office controls the type of accounting services offered to clients as well as the hiring
of necessary staff to provide those services. Therefore, the manager is responsible for both revenues
and expenses. Since the managers do not make decisions about investment in the geographical offices,
the geographical offices would not be considered investment centers.

95. By definition, a profit center is a segment of the organization that has authority to make decisions
affecting the major determinants of profit, i.e., revenues and expenses. This includes the power to
choose its markets and sources of supply.

96. This is the best evaluation of the preliminary conclusion. The operating income variance is
$65,750 unfavorable. However, this conclusion does nothing to explain why the operating income
variance is unfavorable. Was it because sales were lower than expected? Was it because the variable
cost was higher than expected? Was it because the fixed cost was higher than expected? Was it all of
these? How much of the operating income variance was attributable to each, and what was the root
cause of each? What can be done about it?

A variance report such as the following, including flexible budget amounts and flexible budget
variances along with static budget amounts and variances, should be used to pinpoint the causes of the
variance in operating income and then to investigate further what caused each individual variance.

Static Budget Flexible Budget

Variance Variance
Actual Static Budget Flexible Budget
Revenue $1,125,000 $1,230,000 $(105,000) $1,125,000 $ -0-
Variable Cost 693,750 738,000 (44,250) 675,000 18,750
Contribution $ 431,250 $ 492,000 $ (60,750) $ 450,000 $ (18,750)
Margin
Fixed Cost 285,000 280,000 5,000 280,000 5,000
Operating Income $ 146,250 $ 212,000 $ 65,750 $ 170,000 $ (23,750)

97. A cost center is responsible for costs only. A profit center is responsible for both costs and
revenues. Thus, the transfer from the cost center must, by definition, be at a cost-based figure. The
transfer should be evaluated at standard variable cost as it is a controllable cost. Fixed cost should not
be considered as it is not controllable in short run.

98. The first-line supervisor is usually responsible for productivity in terms of the number of units
produced during the period. He or she cannot control the price of inputs (materials, labor). Thus, the
best productivity measure for the first-line supervisor is the units produced per labor hour, which is
5.00 units per labor hour (1,500 units ÷ 300 labor hours).
98. he yield variance tells us the portion of the quantity variance that resulted because the total actual
amount of all the ingredients used was different from the total standard amount of all the ingredients
allowed for the actual production. The direct materials yield variance is calculated using the following
formula: (AQ − SQ) × waspSM, where AQ represents the total number of actual units of direct
materials used and SQ represents the total number of standard units of direct materials allowed for the
actual output. waspSM is the weighted average standard price of the standard mix. The total actual
number of ounces of Materials A and B used (AQ) was 105,000 + 145,000, which equals 250,000
ounces. The total number of standard ounces of Materials A and B allowed for the actual output of
25,000 units (SQ) was (4 × 25,000) + (6 × 25,000) which equals 250,000 ounces. The total actual
amount of all the ingredients used was exactly the same as the total standard amount of all the
ingredients allowed for the actual production. Since AQ and SQ are the same, (AQ − SQ) = 0. There
is no need to calculate waspSM or complete the calculation of the yield variance to answer this
question because anything multiplied by zero is zero. Since AQ minus SQ equals zero, the yield
variance is zero, regardless of what waspSM is.

99. The direct materials efficiency variance is a quantity variance. The formula for a quantity variance
is (AQ – SQ) × SP. The AQ is the actual quantity of materials used for the actual production. The SQ
is the standard quantity of materials allowed for the actual production. The SP is the standard price per
unit of direct materials. The actual quantity used for the actual production as given in the question is
25,000 feet. The standard quantity of materials allowed for the actual production must be calculated
from the information given. The standard quantity of materials allowed for one unit is 25,000 feet ÷
50,000 budgeted units, or 0.5 feet per unit. Therefore, the standard quantity of materials allowed for
the 48,000 units actually produced is 0.5 × 48,000, or 24,000 feet. The standard price per foot of
materials, given in the question, is $4. The direct materials efficiency variance is (25,000 – 24,000) ×
$4 = $4,000. Because it is a positive amount for a cost variance, it is unfavorable.

100. Delivery charges were $500,000 for the Group 2 orders. If even a portion of those costs were
reimbursed by the customers, the sales to the Group 2 customers would become profitable. Thus
charging a separate delivery fee for small orders is the best way for the company to improve its
profitability.

101. This, by itself, would not be likely to explain an unfavorable material efficiency (quantity)
variance. There is nothing about the production level that should unfavorably impact the amount of
direct materials used for each unit produced. However, inferior materials, less-skilled workers and
workers learning to use new production equipment could explain an unfavorable materials quantity
variance.

102. If the Green Division does not have to give up any external sales in order to produce the order for
Red Division, it will sell the product to the Red Division at the company's internal sales price of cost
plus 10%, even though the markup on the sale will not be as great as that of a sale to an external
customer would be. Since the Green Division does not have an external customer to use the excess
capacity, the internal sale will add to Green Division's operating income. Green Division's operating
income will be higher under the circumstances if it accepts the internal sale at the lower profit margin
than if it turns it down.

103. The market share variance is calculated as follows: [(Actual Market Share − Expected Market
Share) × Actual Market Size in Units] × Standard Weighted Average Contribution Margin per Unit. To
determine the dollar impact of a change in market share on operating income, we need to know the
actual market size in units, actual market share, budgeted market shares and standard weighted
average contribution margin per unit. In the question, we are given the actual units sold, thus, we can
calculate the actual market share if we obtain the additional information of actual market size in units.
We also can calculate the standard weighted average contribution margin per unit from the given data.
To complete the formula we also need to obtain information of budgeted (expected) market share.

104. Return on investment is calculated by dividing net income by total assets or average invested
capital. Thus, return on investment for Mesa Inc will be 33.33% (i.e. $50,000 / $150,000).

105. ROI and RI are profitability ratios and can be calculated for the project as below:
ROI = Net Income/ Avg. Invested Capital.
ROI=($80,000-$45,000-$15,000)/($100,000).
ROI= 20%
Residual Income (RI) = Net Income - Interest on investment.
Interest on investment = Invested capital x required rate of return.
RI=[($80,000-$45,000-$15,000) - ($100,000 x 18%)].
RI=$2,000.

106. Decreasing customer complaints by 10% is an example of a customer perspective key

performance indicator on a balanced scorecard for an airline.

Improving customer wait times to check bags is an example of an Internal Process perspective key
performance indicator on a balanced scorecard for an airline.

Improving the percentage of flights that arrive on time is an example of an Internal Process
perspective key performance indicator on a balanced scorecard for an airline.

Three new in-flight meals replacing existing offerings that are unpopular with customers is an
example of an Internal Process perspective key performance indicator on a balanced scorecard for an
airline.

107. Direct labor are those who are directly involved in the manufacturing of a product. From the
given table, only Loom operator's are direct labor because they are directly involved in manufacturing
of textiles. Factory foremen are responsible for supervising the manufacturing process and do not take
part in the production of textiles. Machine mechanic's are also indirect labor because they are only
responsible to ensure that the machines are up and running.

Therefore, salaries and wages of loom operators of $120,000 is direct labor cost. Salaries and wages
of factory foreman of $45,000 and machine mechanics of $30,000 constitute indirect labor cost.

108. In short, [Link] Variance → Purchased Quantity

2. Usage/Quantity Variance → Used Quantity

109. When operating below capacity, the minimum price that the producing department will sell for is
the variable cost of production. This is $7 in this question.

110. Customer retention, training hours and employee turnover are appropriate non-financial
indicators for a balanced scorecard system. Return on investment is an appropriate financial
component of a balanced scorecard, but the question asks only for non-financial measures. Number of
divisions is not a meaningful metric.
111. Return on investment for a specific investment is income expected to be generated by the
investment divided by the investment. Income expected to be generated by the planned investment is
the $175,000 increased contribution margin expected less the incremental fixed costs of $50,000, or
$125,000. The amount invested is $800,000. Thus, return on investment is $125,000 divided by
$800,000, which equals 0.15625 and is closest to 16%. PART17112053

112. Total monetary amount of claims processed per month is not an accurate way of measuring the
speed of processing because some claims will be for high amounts and others will be for lower
amounts. That is not something the manager of claims processing can control, so the manager's
performance should not be measured on it. Furthermore, evaluating the manager's performance on the
monetary amount of claims processed could lead to the manager's giving priority to processing the
larger claims. That would lead to larger claims being approved before smaller claims, and larger sums
of cash would be paid out earlier to settle those larger claims. More cash paid out earlier would
increase cash outflow, resulting in lower cash balances and higher cost of capital. Giving priority in
processing would also result in poor customer service to the filers of the smaller claims.

113. Transfer pricing is the price at which the services or products are bought and sold between
related parties. Market price refers to a price at which goods or services are bought or sold in an
intermediate market. A transfer price based on market price is justified if a competitive market exists
for the product/service. Under market-based transfer pricing, transferred goods are recorded at market
prices and divisional performance is more likely to represent the real economic contribution of the
division to total company profits. Thus, the manager of the selling division would be motivated to
increase his sales in order to show high profits.

114. In calculating the effect on the company's profit as a result of adding this burger to the menu, we
ignore the allocated fixed direct costs because these are already incurred by the restaurant, and will
continue to be incurred by the restaurant even if this item is not added to the menu.

The items that we need to take into account are sales $550,000, less variable costs ($375,000), and
less product advertising ($180,000). The net of these three items is a $5,000 loss. Therefore, the effect
on the company's profit because of the addition of this new product was to decrease income by $5,000

115. The best process for establishing a transfer price between different divisions is for the managers
of the respective divisions to negotiate the price. The best price is usually the market price when a
market price exists, but that still needs to be acceptable to both division managers. And if the market
price is not acceptable to one or both managers for some reason, a different price should be negotiated
(without violating any tax laws of the countries and/or other taxing jurisdictions involved.

116. ROI = Sales/Avg Inv * Net income/Sales

117. The favorable materials price variance means that the material was purchased for a lower price
than planned. This could happen due to a quantity discount, lower quality materials, or some other
reason. The unfavorable materials usage variance means that the production process used more
material than had been planned. This could happen due to a lower skill level of workers, poor material
quality, or some other reason. However, these two variances together are most likely caused by the
same reason. This reason could be the purchase of lower than standard quality materials.
118. The direct labor price variance is calculated as (AP − SP) × AQ or (Actual Rate − Standard Rate)
× Actual Hours. The standard labor rate per hour is $12, calculated as follows: the labor standard is 45
minutes per unit or 0.75 of an hour. 9,000 units were planned, so the total planned hours was 0.75 ×
9,000 or 6,750 hours. The total planned cost was $81,000, so the standard cost per hour was $81,000
÷ 6,750 hours, or $12 per hour. The actual labor rate was $12.20, calculated as follows: The labor
standard of 45 minutes per unit or 0.75 of an hour per unit was maintained. 8,500 units were actually
produced, so the total actual hours were 0.75 × 8,500 or 6,375 hours. The total actual cost was
$77,775, so the actual cost per hour (the actual rate) was $77,775 ÷ 6,375 hours or $12.20 per hour.
Putting the numbers into the formula, we get ($12.20 − $12.00) × 6,375 = $1,275 Unfavorable.

119. Purchasing, marketing and production all have some responsibility for the variance. The
purchasing department is responsible for misplacing the paperwork and not ordering the raw materials
in a timely manner, necessitating the search for a new supplier. The marketing department is
responsible because they accepted a rush order for a nonstock item without checking first with the
production department about whether it was feasible to fulfill the order under the terms the customer
required. The production department supervisor is responsible for rushing the raw materials received
into production without inspecting them first.

120. This question is asking for the sales volume/quantity variance on the contribution margin that is
calculated as follows: (Actual Sales Volume − Budgeted Sales Volume) × Standard Contribution per
Unit. The total budgeted contribution margin was $120,000, which gives us a $20 contribution margin
per unit ($120,000 ÷ 6,000). Now we can calculate the sales volume variance: (5,000 − 6,000) × $20
= ($20,000) unfavorable. The actual sales volume was lower than budgeted, and that caused the
negative impact of $20,000 on the contribution margin.

121. The fixed overhead production volume variance is the difference between the budgeted amount
of fixed overhead and the amount of fixed overhead applied (standard rate × standard input for the
actual level of output).

122. In the process of valuing accounts receivable, companies measure expected credit losses on the
basis of relevant qualitative and quantitative information about past events, current conditions, and
reasonable and supportable forecasts that could affect the collectability of outstanding balances.
Factors considered include the quality of the company’s credit review system and credit policies,
management’s experience, environmental factors such as market conditions, and the regulatory
environment.

123. The concept of expected credit losses (ECLs) means that companies are required to look at how
current and future economic conditions impact the amount of loss. Credit losses are not just an issue
for banks and economic uncertainty is likely to have an impact on many different receivables.

124. Transfers of financial assets can be by sales, assignments, factoring arrangements and
securitizations. These transfers often involve the transferor having some continuing involvement
either with the transferred assets or with the buyer (transferee). Call option is an example of
continuing involvement by the transferor. A sale of a financial asset together with a deep in-the-money
put or call option (that is, an option that is so far in the money that it is highly unlikely to go out of the
money before expiry).

In the case of transfer of financial assets that does not qualify for sale accounting, the transferor’s
contractual rights or obligations related to the transferred assets are not accounted for separately as it
would result in recognizing the same rights or obligations twice. As Mayter has retained a call option,
it may prevent a transfer from being accounted for as a sale. In such a case, the call option will not be
separately recognized as a derivative asset.

125. The cash basis accounting records revenue when cash is received and expenses when cash is
paid. The revenue recognized under the cash basis accounting would be equal to the cash collections
made in the year. This can be obtained by preparing a T-account for accounts receivable.

Accounts Receivable ($)

The cash collected during the year would be $100,000. This would be the sales revenue under the cash
basis accounting.

The calculation for cash collected could also be calculated as:

Collections = Sales + Opening receivables - Closing receivables – Discounts – Returns and

allowances = $100,000 + $20,000 - $15,000 - $3000 - $2000 = $100,000.

126. The aging of receivable method also known as the balance sheet method is a technique used to
determine the credit balance needed in the closing allowance for uncollectible account. Any existing
balance in the allowance account reduces the amount of bad debt expense for the year. Under this
method the accounts receivable of a company are sorted according to the dates of the unpaid invoices.
This helps the business to identify the customers who take longer to pay so that sales to such
customers can be restricted to reduce risk of bad debts. The goal of the aging method is to have the
company's balance sheet report the true amount of the receivables that will be turning to cash.

127. Whether receivables are sold with recourse or without recourse, the sold receivables need to be
written off the books. This is done with a credit to accounts receivable for $150,000.

128. Amount of loss = $140,000; Allowance for bad debts = $20,000.

The amount of loss when the receivables become worthless will be the carrying value of the
[Link] carrying value = Accounts receivables - Allowance for bad [Link] for bad
debts will be calculated as a percentage of sales as the emphasis is on the matching principle. Thus,
allowance for bad debts = Sales x 10% = 10% of $200,000 = $20,[Link] this to calculate the
carrying value The carrying value = Accounts receivables - Allowance for bad debts = $160,000 -
$20,000 = $140,[Link] the amount of loss is the carrying value of the accounts receivables, $140,000
will be the amount of loss.

129. Under the allowance method of recognizing uncollectible accounts, the entry to record the write-
off of a specific account is:

Allowance xxx

Accounts receivable xxx

Thus, the allowance account (which is a credit balance account) is debited leading to a decrease in the
allowance for uncollectible account and the accounts receivable account (which is a debit account) is
credited leading again to a decrease in the accounts receivable account.
130. Writing off an account when the current expected credit loss (CECL) model is used has no effect
on either the income statement or on current assets. The journal entry to write off the account is a
credit to accounts receivable and a debit to the allowance for credit losses account, so the net effect on
net accounts receivable and on total current assets is zero. Furthermore, the write-off does not affect
any income statement account at all. An income statement account (credit loss expense) is debited
when the allowance is booked, not when an account is written off.

131 . A change in the estimate for bad debts is a change of accounting estimate. Changes in
accounting estimates are made prospectively. That is, no change is made to previously reported results
or to opening balances. No attempt is made to “catch up” for prior periods. Instead, the effect of all
changes is accounted for in (a) the period of change if the change affects that period only; or (b) the
period of change and future periods if the change affects both. A change in the estimate for bad debts
would be accounted for in the period of the change only, as the change would affect only that period.

132. Pledging or secured borrowings borrow cash by pledging the financial assets. Pledging does not
amount to transfer of ownership of receivables. Therefore, Milton Co. retains the control for the
receivables.

133. The advantages of non-recourse factoring are:

 The company has no responsibility in case the customer defaults on the invoice.
 It can be used for customers who may not have good payment records but it can also be used
for those that have been profitable in the past and suddenly go out of business.
 Non-recourse factoring serves as a kind of insurance against all of these.

The risk of uncollectible is assumed by the factor in the case of non-recourse arrangement as a result
the factor charges a higher fee. This results in a non-recourse factoring being an expensive way of
financing receivables than recourse arrangement.

134. On the balance sheet the accounts receivable should be shown at the amount that is expected to
be collected in the future. This is also called the net realizable value.

135. If the note is reported as a non-current asset, it must be due at least one year beyond April 30,
20X3, that is, it must be due after April 30, 20X4. The interest for 8 months is a current asset and must
be due within one year from April 30, 20X3, that is before April 30, 20X4. Thus, if principal is due on
August 31, 20X4, it would be a non-current asset and the interest due on August 31, 20X3, would be a
current asset. Interest due on August 31, 20X4 would again be a non-current asset.

136. An aging schedule is used to identify how old receivables are and to then calculate what the
amount is that is expected to be collected. This is the calculation of the net realizable value of the
receivables.

137. The formula can be derived as under:

Opening accounts receivable + Sales - Collections - Accounts written off = Closing accounts
receivable.

Sales - Collections - Accounts written off = Closing accounts receivable - Opening accounts
receivable (i.e. Increase in accounts receivable balance).
Sales - Accounts written off - Increase in accounts receivable balance = Collections.

Thus, cash collections from customers equals sales adjusted for deduction of both accounts written off
and increase in accounts receivable.

138. Internal allocation of support costs is done because if a company calculates its cost of production
but does not include the costs of its service departments, it will calculate a cost of production that is
less than the actual total cost. As a result of this incorrect calculation, the company’s pricing decisions
will not be correct, and in a worst-case scenario, the company may sell the product for less than it
actually costs to produce it. Allocating service costs to divisions and departments reminds profit
center managers that earnings must be adequate to cover the indirect costs, and allocating service
costs provides the needed information to those making pricing decisions.

139. A company's return on investment is computed as Net Income/ Total assets or Average Invested
Capital. Maintaining the company's cost of capital at current levels does not affect a company's return
on investment.

140. When the variable costs plus the opportunity cost of lost outside sales for the internal supplier are
lower than the price of the external supplier, the company as a whole is better off if the buying
department buys internally, even if the transfer price is higher than an outside supplier's price. That is
because the income to the selling division is equal to the cost to the buying division. These are
called intercompany sales, and the two items are cancelled out when the company's financial
statements are consolidated. So, the only cost to the company is the variable cost to produce the item
being sold internally, if the selling division has the capacity to produce it. If the selling division has
another, outside buyer, the cost to sell to the buying division instead of to the outside buyer will also
include the lost contribution margin that could have been earned by selling to the outside buyer. In
this case, there is no opportunity cost of lost sales, because the question tells us that purchasing from
outside would idle A's facilities now committed to producing units for B, and Division A cannot
increase its sales to outsiders. Therefore, the total cost of producing the units internally is the variable
cost of $30, which is lower than the outside price of $40. Thus, from the perspective of the company
as a whole, Division B should continue purchasing from Division A, despite the increased transfer
price, because the cost to the company as a whole will be only $30 versus the $40 it would cost to
purchase outside. In reality, Department B should not simply accept the new transfer price of $50. The
managers of the two divisions should agree on a transfer price that is acceptable to both of them. It
may be that senior management will need to get involved in order to make that happen, if the two
division heads cannot agree. However, that is not given as an answer choice, and of the answer
choices given, this is the best choice. PART17112019

141. A favorable materials purchase price variance indicates that the actual price paid for the
direct materials was less than the standard price.

142. The balanced scorecard is not derived from scientific management theories. Scientific
management was a theory developed in the late 1800s. It focused primarily on the efficiency of
individual workers and improving their productivity. Its principles were responsible for the
development of "efficiency experts" and the use of time and motion analysis. The balanced scorecard
is a strategic management tool that was developed as a response to problems caused by evaluating
managers only on the quarterly or annual financial performance of their business units. The balanced
scorecard encourages managers to focus on elements of long-term success, which are non-financial
and operational indicators, instead of only on short-term financial performance. It does this by
rewarding managers for improvements in those elements of long-term success. Improvements in these
non-financial measures provide the prospect of increased future economic value for shareholders.
When managers are evaluated and rewarded based on non-financial indicators as well as financial
indicators, it leads to long-term financial performance improvements. This again comes back to the
idea of goal congruence and making sure that everyone is working toward the same goals

143.