[TUTORING SESSION KÌ I - 2021] Final Handbook MA.pdf

INTERNATIONAL SCHOOL OF BUSINESS
1
Revision on
Managerial Accounting
BY ISB ACADEMIC TEAM
For further infomation and step – by – step guide to solving problems, please kindly refer to
Tutoring Videos uploaded on ISB Academic Team Facebook fanpage.
Undo no circumstances should one copy this document without author’s permission

Chapter 2 – ISB Academic Team
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CHAPTER 2: COST CONCEPTS
LO1: Identify and give examples of each of the three basic manufacturing cost
categories
1. Manufacturing costs: Most manufacturing companies separate MC into three broad
categories
Direct Materials:
- The materials that go into the final product are called raw materials. They refer to any
materials that are used in the final product, and the finished product of one company
can become the raw material of another company.
🡺 Sometimes the term is misleading to learners because it seems to imply
unprocessed natural resources like wood pulp or iron ore.
- Raw materials may include both direct and indirect materials
- Direct materials are those materials that become an integral part of the finished
product and whose costs can be conveniently traced to the finished product.
Direct Labor:
- Consists of labor costs that can be easily (i.e., physically and conveniently) traced to
individual units of products.
- It is sometimes called touch labor because direct labor workers typically touch the
product while it is being made.
- Labor costs that cannot be physically traced to particular products, or that can be
traced only at great cost and inconvenience, are termed indirect labor. (labor costs of
janitor, supervisors, materials handlers, and night security guards)
Manufacturing overhead:
- Includes all manufacturing costs (except DM, DL)
- Can be classified into three categories: (1) indirect materials such as glue and product
wrappers; (2) indirect labor such as payroll for factory supervisors and product
inspectors; and (3) others (depreciation on factory facilities, property taxes on factory
building, utilities, and insurance relating to manufacturing activities.
- Can be classified into variable and fixed manufacturing costs. VMO includes the
variable element of utility costs which will go up as more products are manufactured.
FMO includes depreciation or rents on manufacturing facilities which will remain
unchanged regardless of the level of production.
- MO’s synonyms = indirect manufacturing cost, factory overhead, and factory burden.
2. Nonmanufacturing costs: are often divided into two categories: (1) selling costs and
(2) administrative costs.
- Selling costs (order-getting and order-filling costs): include all costs that are incurred
to secure customer orders and get the finished product to the customer (advertising,
shipping, sales travel, sales commissions, sales salaries, and cost of finished goods
warehouses).
- Administrative costs: include all costs associated with the general management of
an organization rather than with manufacturing or selling (executive compensation,
general accounting, secretarial, public relations…).

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- NMC’s synonyms = selling, general, and administrative (SG&A) costs or just selling
and administrative costs.
LO2: Understand cost classifications used to prepare financial statements: product
costs and period costs
1. Cost Classifications for Preparing Financial Statements
Product Costs:
- Includes all costs involved in acquiring or making a product.
- In the case of manufactured goods, these costs consist of direct materials, direct labor,
and manufacturing overhead.
- When the goods are sold, the costs are released from inventory as expenses (called
cost of goods sold) and matched against sales revenue.
- Product costs that are initially assigned to an inventory account on the balance sheet
are called product costs
Period Costs:
- Are all the costs that are not product costs (sales commissions and the rental costs of
administrative offices are period costs)
- Are not included as part of the cost of either purchased or manufactured goods;
instead, period costs are expensed in the income statement in the period in which
they are incurred using the usual rules of accrual accounting.
- As suggested above, subject to the rules of accrual accounting, all selling and
administrative expenses are considered to be period costs.
Prime Cost and Conversion Cost:
- Prime cost is the sum of direct materials cost and direct labor cost.
- Conversion cost is the sum of direct labor cost and manufacturing overhead cost.

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2. Cost Classifications on Financial Statements
The Statement of Financial Position (or Balance Sheet)
- Raw materials are the materials that are used to make products.
- Work in process consists of units of product that are only partially complete and will
require further work before they are ready for sale to a customer.
- Finished goods consist of completed units of product that have not yet been sold to
customers.
LO3: Prepare an income statement including calculation of the cost of goods sold
1. Income Statement
Basic Equation for Inventory Accounts
Beginning balance + Additions to inventory = Ending balance + Withdrawals from
inventory.
Cost of Goods Sold in a Merchandising Company
Beginning merchandise inventory + Purchase = Ending merchandise inventory +
COGS.
COGS = Beginning merchandise inventory + Purchases – Ending merchandise
inventory.

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Cost of Goods Sold in a Manufacturing Company
Beginning finished goods inventory + Cost of Goods manufactured = Ending finished
goods inventory + COGS.
COGS = Beginning finished goods inventory + Cost of goods manufactured – Ending
finished goods inventory.
LO4: Prepare a schedule of cost of goods manufactured (textbook GNBCY 2015 - Page
95)
LO5: Understand cost classifications used to predict cost behavior: variable costs and
fixed costs
1. Variable Cost
- A cost that varies, in total, in direct proportion to changes in the level of activity.
- The activity can be expressed in many ways, such as units produced, units sold, miles
driven, beds occupied, lines of print, hours worked…
- Total variable costs change as the activity level changes, it is important to note that
a variable cost is constant if expressed on a per unit basis. For example, the per unit
cost of batteries remains constant at 24$ even though the total cost of the batteries
increases and decreases with activity.

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Purpose of Cost Classification:
2. Fixed Cost
- A cost that remains constant, in total, regardless of changes in the level of activity.
- Fixed costs are not affected by changes in activity.
- Consequently, as the activity level rises and falls, total fixed costs remain constant
unless influenced by some outside force, such as price change.
- When we say a cost is fixed, we mean it is fixed within some relevant range.
- Relevant range is the range of activity within which the assumptions about variable
and fixed costs are valid.
- Fixed costs can create confusion if they are expressed on a per unit basis. Because
the average fixed cost per unit increases and decreases inversely with changes in
activity.
Summary of Variable and Fixed Cost Behavior
Behavior of the Cost (within the relevant range)
Cost In Total Per Unit
Variable cost Total variable cost increases and
decreases in proportion to changes in the
activity level.
Variable cost per unit remains
constant.
Fixed cost Total fixed cost is not affected by changes
in the activity level within the relevant
range.
Fixed cost per unit decreases
as the activity level rises and
increases as the activity level
falls.
LO6: Understand cost classifications used for assigning costs to cost objects: direct
costs and indirect costs

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- For purposes of assigning costs to cost objects, costs are classified as either direct or
indirect.
1. Direct Cost
- Is a cost that can be easily and conveniently traced to a specified cost object.
- The concept of direct cost extends beyond just direct materials and direct labor. For
example, if Reebok is assigning costs to its various regional and national sales offices,
then the salary of the sales manager in its Tokyo office would be a direct cost of that
office.
2. Indirect Cost
- Is a cost that cannot be easily and conveniently traced to a specified cost object.
*Key steps to establish whether a particular cost is a direct or an indirect cost:
- Step 1: Identify the cost object.
- Step 2: Determine whether cost under considerations can be easily and conveniently
traced to the cost object identified in step 1.
- Step 3: Analyze the cost and benefit of the classification by taking into account the
concept of materiality.
LO7: Understand cost classifications used in making decisions: differential costs,
opportunity costs, and sunk costs
1. Cost Classification for Decision Making
- Every decision involves a choice between at least two alternatives
- Only those costs and benefits that differ between alternatives are relevant in a
decision. All other costs and benefits can and should be ignored.
Differential Cost and Revenue:
- Cost and revenues that differ among alternatives.
*Example: You have a job paying $1,500 per month in your hometown. You have a job
offer in a neighboring city that pays $2,000 per month. The commuting cost to the city
is $300 per month.
Differential revenue is: Differential cost is:
$2,000 - $1,500 = $500 $300
Opportunity Cost:
- The potential benefit that is given up when one alternative is selected over another.
*Example: If you were not attending college, you could be earning $15,000 per year.
Your opportunity cost attending college for one year is $15,000.
Sunk Cost:
- Sunk costs have already been incurred and cannot be changed now or in the future.
These costs should be ignored when making decisions.
*Example: You bought an automobile that cost $10,000 two years ago. The $10,000
cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change
the $10,000 cost.

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EXERCISE
E2-3(GNBCY): Classification of Costs as Period or Product Cost
Suppose that you have been given a summer job as an intern at Issac Aircams, a company
that manufactures sophisticated spy cameras for remote-controlled military reconnaissance
aircraft. The company, which is privately owned, has approached a bank for a loan to help it
finance its growth. The bank requires financial statements before approving such a loan. You
have been asked to help prepare the financial statements and were given the following list of
costs:
1. Depreciation on salespersons’ cars.
2. Rent on equipment used in the factory.
3. Lubricants used for machine maintenance.
4. Salaries of personnel who work in the finished goods warehouse.
5. Soap and paper towels used by factory workers at the end of a shift.
6. Factory supervisors’ salaries.
7. Heat, water, and power consumed in the factory.
8. Materials used for boxing products for shipment overseas. (Units are not normally boxed.)
9. Advertising costs.
10. Workers’ compensation insurance for factory employees.
11. Depreciation on chairs and tables in the factory lunchroom.
12. The wages of the receptionist in the administrative offices.
13. Cost of leasing the corporate jet used by the company’s executives.
14. The cost of renting rooms at a Florida resort for the annual sales conference.
15. The cost of packaging the company’s product.
Required:
Classify the above costs as either product costs or period costs for the purpose of
preparing the financial statements for the bank.
Instructions:
1. Period cost 6. Product cost 11. Product cost
2. Product cost 7. Product cost 12. Period cost
3. Product cost 8. Period cost 13. Period cost
4. Period cost 9. Period cost 14. Period cost
5. Product cost 10. Product cost 15. Product cost
E2-4(GNBCY): Constructing an Income Statement

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Last month Cyber Games, a computer game retailer, had total sales of $1,450,000, selling
expenses of $210,000, and administrative expenses of $180,000. The company had
beginning merchandise inventory of $240,000, purchased additional merchandise inventory
for $950,000, and had ending merchandise inventory of $170,000.
Required:
Prepare an income statement for the company for the month.
Instructions:
INCOME STATEMENT
Sales 1,450,000
Cost of goods sold
Beginning inventory 240,000
Purchase 950,000
Goods available for sale 1,190,000
Less: Ending inventory (170,000)
Cost of goods sold 1,020,000
Gross profit 430,000
Selling and administrative expense
Selling expense 210,000
Administrative expense 180,000
Total Selling and administrative expense 390000
Operating income 40000
E2-7(GNBCY): Identifying Direct and Indirect cost
Northwest Hospital is a full-service hospital that provides everything from major surgery and
emergency room care to outpatient clinics.
Required:

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For each cost incurred at Northwest Hospital, indicate whether it would most likely be
a direct cost or an indirect cost of the specified cost object by placing an X in the
appropriate column.
Instructions:
Cost Cost object Direct
Cost
Indirect
Cost
Ex: Catered food served to patients X A particular patient x
1. The wages of pediatric nurses The pediatric department x
2. Prescription drugs A particular patient x
3. Heating the hospital The pediatric department x
4. The salary of the head of pediatrics The pediatric department x
5. The salary of the head of pediatrics A particular pediatric patient x
6. Hospital chaplain’s salary A particular patient x
7. Lab tests by outside contractor A particular patient x
8. Lab tests by outside contractor A particular department x
E2-8(GNBCY): Differential, Opportunity, and Sunk Costs
Northwest Hospital is a full-service hospital that provides everything from major surgery and
emergency room care to outpatient clinics. The hospital’s Radiology Department is
considering replacing an old inefficient X-ray machine with a state-of-the-art digital X-ray
machine. The new machine would provide higher quality X-rays in less time and at a lower
cost per X-ray. It would also require less power and would use a color laser printer to produce
easily readable X-ray images. Instead of investing the funds in the new X-ray machine, the
Laboratory Department is lobbying the hospital’s management to buy a new DNA analyzer.
Required:
For each of the items below, indicate by placing an X in the appropriate column whether
it should be considered a differential cost, an opportunity cost, or a sunk cost in the
decision to replace the old X-ray machine with a new machine. If none of the categories
apply for a particular item, leave all columns blank.
Instructions:

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Item Differential
Cost
Opportunity
Cost
Sunk Cost
Ex: Cost of X-ray film used in the old machine x
1. Cost of the old X-ray machine x
2. The salary of the head of the Radiology Department
3. The salary of the head of the Pediatrics Department
4. Cost of the new color laser printer x
5. Rent on the space occupied by Radiology
6. The cost of maintaining the old machine x
7. Benefits from a new DNA analyzer x
8. Cost of electricity to run the X-ray machines x
Note: The costs of the salaries of the head of the Radiology Department and Laboratory
Department and the rent on the space occupied by Radiology are neither differential costs,
nor opportunity costs, nor sunk costs. These costs do not differ between the alternatives and
;therefore, are irrelevant in the decision, but they are not sunk costs because they occur in the
future.

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CHAPTER 4: COST - VOLUME - PROFIT RELATIONSHIP
LO1: Understanding the basics of CVP concepts
1. The contribution income statement: this statement is helpful to managers in judging
the impact on profits of changes in selling price, cost, or volume. The emphasis is on
cost behavior.
Example: let's look at a hypothetical
contribution income statement for
Racing Bicycle Company (RBC).
Notice the emphasis on cost behavior.
Variable costs are separate from fixed
costs.
Contribution Margin:
- The amount remaining from sales revenue after variable expenses have been
deducted.
- CM is used first to cover fixed expenses. Any remaining CM contributes to net
operating income.
2. The Contribution Approach:
Sales, variable expenses, and contribution margin can also be expressed on a per-unit basis.
If Racing sells an additional bicycle,
$200 additional CM will be generated
to cover fixed expenses and profit.
Each month, RBC must generate at
least
$80,000 in total contribution margin to
break-even (which is the level of sales
at which profit is zero).

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Each month, RBC must generate at
least
$80,000 in total contribution margin to
break-even (which is the level of
sales at which profit is zero).
If Racing sells 400 units a month, it will
be operating at the break-even point.
Total sales will be 400 units times
$500 each or $200,000, and total
variable expenses will be 400 units
times $300 each for $120,000.
contribution margin is exactly equal to
total fixed expenses.
If RBC sells one more bike (401
bikes), net operating income will
increase by $200.
You can see that the sale of one unit
above the break-even point yields a
net operating income of $200, which is
the contribution margin per unit sold.
If we develop equations to calculate break-even and net income, we will not have to prepare
an income statement to determine what net income will be at any level of sales. Simply multiply
the number of units sold above break-even by the contribution margin per unit.
For example, we know that if Racing Bicycle sells 430 units, net operating income will be
$6,000. The company will sell 30 units above the break-even unit sales and the contribution
margin is $200 per unit, or $6,000.
3. CVP Relationships in Equation Form
Profit = (Sales – Variable expenses) – Fixed
expenses
Profit = (P × Q – V × Q) – Fixed expenses

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Part I:
We begin by gathering the information for the variables in the equation.
Part II:
We have now entered all the known amounts into the equation and solve for the unknown
profit.
Part III:
As you can see, our net operating income or profit is once again determined to be $200.
This equation can also be used to show the $200 profit RBC earns if it sells 401 bikes.
→ $200 = ($500 × 401 – $300 × 401) – $80,000
In terms of the unit contribution margin (Unit CM)
Unit CM = Selling price per unit – Variable expenses per
unit
Unit CM = P – V
Profit = (P × Q – V × Q) – Fixed expenses
Profit = (P – V) × Q – Fixed expenses
Profit = Unit CM × Q – Fixed expenses
4. Contribution margin ratio (CM ratio)
The CM ratio is calculated by dividing the total contribution margin by total sales.
The contribution margin ratio is
calculated by dividing the total
contribution margin by total sales
($100,000 / $250,000). In the case
of Racing Bicycle, the ratio is
40%. Thus, each $1.00 increase
in sales results in a total
contribution margin increase of
40%.

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The CM ratio can also be calculated by dividing the contribution margin per unit by the selling
price per unit:
CM ratio = CM per unit / SP per unit
A $50,000 increase in sales
revenue results in a $20,000
increase in CM. ($50,000 × 40%
= $20,000)
The variable expense ratio is the ratio of variable expenses to sales. It can be computed by
dividing the total variable expenses by the total sales, or in single product analysis, it can be
computed by dividing the variable expenses per unit by the unit selling price.
At Racing Bicycles the variable
expense ratio is 60%.
5. Changes in elements
Change in Fixed Costs and Sales Volume
- What is the profit impact if Racing Bicycle can increase unit sales from 500 to 540 by
increasing the monthly advertising budget by $10,000?
- Would you recommend that the advertising campaign be undertaken?

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As you can see, even if sales
revenue increases to $270,000,
RBC will experience a $12,000
increase in variable costs and a
$10,000 increase in fixed costs (the
new advertising campaign). As a
result, net operating income will
drop by $2,000.
$80,000 + $10,000 advertising =
$90,000
→ The advertising campaign certainly would not be a good idea.
- By doing this, we can help management see the problem before any additional monies
are spent.
- There is a shortcut solution using incremental analysis:
Increase in CM (40 units x $ 200)
Increase advertising expenses
Decrease in net operating
income
$ 8,000
10,000
$ (2,000)
Change in Variable Costs and Sales Volume
- What is the profit impact if Racing Bicycle can use higher quality raw materials, thus
increasing variable costs per unit by $10, to generate an increase in unit sales from
500 to 580?
- Would you recommend the use of higher-quality raw materials?
Revenues will increase by $40,000 (80
bikes times $500 per bike), and
variable costs will increase by $29,800.
Contribution margin will increase by
$10,200. With no change in fixed costs,
net operating income will also increase
by $10,200.
580 units × $310 variable cost/unit =
$179,800
→ The use of higher quality raw materials appears to be a profitable idea.

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Change in Fixed Cost, Sales Price and Volume
- What is the profit impact of RBC: (1) cuts its selling price by $20 per unit, (2) increases
its advertising budget by $15,000 per month, and (3) increases sales from 500 to 650
units per month?
650 units × $480 = $312,000
Sales increase by $62,000, fixed costs
increase by $15,000, and net operating
income increase by $2,000.
→ This appears to be a good plan because net operating income will increase by $2,000.
Change in Variable Cost, Fixed Cost, and Sales Volume
- What is the profit impact of RBC: (1) pays a $15 sales commission per bike sold instead
of paying salespersons flat salaries that currently total $6,000 per month, and (2)
increases unit sales from 500 to 575 bikes?
575 units × $315 = $181,125
Sales increase by $37,500, fixed
expenses decrease by $6,000. Net
operating income increases by
$12,375.
*Notice that sales revenue and variable expenses increased as well. Fixed expenses
were decreased as a result of making sales commissions variable in nature.
Change in Regular Sales Price
- If RBC has an opportunity to sell 150 bikes to a wholesaler without disturbing sales to
other customers or fixed expenses, what price would it quote to the wholesaler if it
wants to increase monthly profits by $3,000?
- What selling price should RBC quote to the wholesaler?

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If we desire a profit of $3,000 on the sale
of 150 bikes, we must have a profit of $20
per bike. The variable expenses
associated with each bike are $300, so we
would quote a selling price of $320.
You can see the proof of the quote. If we
quote a price of $320 per unit and sell an
additional 150 units, sales will go up by
$48,000. Variable costs for the 150 units
are $45,000, so net operating income
increases by the difference, $3,000.
LO2: Determine the break-even point, the number of sales required for a target profit,
the margin of safety, and the degree of operating leverage
1. Break-even Analysis
The equation and formula methods can be used to determine the unit sales and dollar sales
needed to achieve a target profit of zero
Example: Use the Racing Bicycle
information to complete the break-
even analysis.
Break-even Point in Terms of Unit Sales
Unit sales = $ 80,000 / $ 200 = 400

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Break-even Point in Terms of Dollar Sales
Dollar sales = $ 80,000 / 40% = $
200,000
2. Target Profit Analysis
Target Profit Analysis in Terms of Unit Sales
Unit sales = ($ 100,000 + $ 80,000) / $ 200 = 900
Target Profit Analysis in Terms of Dollar Sales
- We can calculate the dollar sales needed to attain a target profit (net operating profit)
of $100,000 at Racing Bicycle.
Dollar sales = ($ 100,000 + $ 80,000) / 40% = $ 450,000
3. Preparing the CVP graph
The break-even point is where the total revenue and total expenses lines intersect.
In the case of Racing Bicycle, break-even is 400 bikes sold or sales revenue of
$200,000.
The profit or loss at any given sales level is measured by the vertical distance between
the total revenue and the total expenses lines.

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4. The margin of safety
In terms of Dollars
- The margin of safety in dollars is the excess of budgeted (or actual) sales over the
break-even volume of sales.
RBC is currently selling 500
bikes and producing total
sales revenue of $250,000.
Sales at the break-even point
are $200,000, so the
company’s margin of safety is
$50,000.
Margin of safety in dollars = Total sales - Break-even
sales
In terms of Percentage
- We can express the margin of safety as a percent of sales. The margin of safety
percentage is equal to the margin of safety in dollars divided by the total budgeted (or
actual) sales in dollars.

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The margin of safety is 20%
($50,000 / $250,000).
In terms of the number of units sold
- The margin of safety at Racing is $50,000, and each bike sells for $500, so the margin
of safety in units is 100 bikes.
→ Racing Bicycle is selling 100 more bikes than are needed to break even.
Margin of Safety in units = $ 50,000 / $ 500 = 100 bikes
5. Operating Leverage
Operating leverage is a measure of how sensitive net operating income is to percentage
changes in sales. It is a measure, at any given level of sales, of how a percentage change in
sales volume will affect profits.
DOL = Degree Of Operating Leverage = Contribution Margin / Net Operating
Income **
** Profit Before Tax is a commonly used alternative to Net Operating Income in
the degree of operating leverage calculation
DOL = $ 100,000 / $ 20,000 = 5

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With operating leverage of 5, if RBC
increases its sales by 10%, net
operating income would increase by
50%.
Verification
- A 10% increase in sales would increase bike sales from the current level of 500 to 550.
Look at the contribution margin income statement and notice that income increased
from $20,000 to $30,000. That $10,000 increase in net income is a 50% increase.
→ So it is true that a 10% increase in sales results in a 50% in net income. This is powerful
information for a manager to have.
High Operating Leverage Ratio
- signals the existence of high fixed costs.
- increases the risk of making a loss in adverse market conditions.
- increases opportunity to make a profit when higher demand exists.
- has a lower margin of safety percentage (MoS%)
LO3: Understand the underlying assumptions and limitations of the CVP analysis tool
1. The concept of Sales Mix
- Sales mix is the relative proportion in which a company’s products are sold.
- Different products have different selling prices, cost structures, and contribution
margins.
- When a company sells more than one product, break-even analysis becomes more
complex as the following example illustrates. Let’s assume Racing Bicycle Company
sells bikes and carts and that the sales mix between the two products remains the
same.

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Multi-Product Break-even Analysis (The BE% Method)
There are multiple methods to calculate the breakeven points for different products within a
multi-product company:
- Using the Breakeven percentage to sales (BE%) method is straightforward and simple.
We only need to recall the MoS% equation being 1/DOL = Net Operating
Income/Contribution Margin
- Then calculate BE% by 1- MoS%
- Use the BE% to multiply the original sales dollars and sales units to get the break-even
sales dollars and sales units respectively.
- When extending the RBC example to sell two different products, Bicycle, and Carts,
using the BE% method, we can calculate the MoS% by using its relations with 1/DOL
where DOL = Net Operating Income / Contribution Margin. The calculation gives
rise to MoS% as 35.85%, implying BE% as 64.15%.
- Multiplying 64.15% to the existing sales dollars of the two products provides the
respective break-even sales dollars of two products
The breakeven points
would be $352,825 in total
with $160,375 and
$192,450 from bicycles
and carts respectively.

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→ The number of breakeven units can also be obtained by multiplying the BE% with the current
sales units of the respective products. The Breakeven % reduces the complications and number of
times in handling different sets of data.
Multi-Product Break-even Analysis (The CM Ratio Method)
Bikes comprise 45% of RBC’s total sales revenue and the carts comprise the remaining 55%.
RBC provides the following information:
The combined contribution margin ratio = $ 265,000 / $ 550,000 = 48.2% (rounded)

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- Break-even in sales dollars is $352,697. We calculate this amount in the normal way.
We divide total fixed expenses of $170,000 by the combined contribution margin ratio.
- We begin by allocating total break-even sales revenue to the two products. 45% of the
total is assigned to the bikes and 55% to the carts.
- The variable costs-by-product is determined by multiplying the variable expense
percent times the assigned revenue. The contribution margin is the difference between
the assigned revenue and the variable expenses. Once again, we subtract fixed
expenses from the combined total contribution margin for the two products. Because
we used a rounded contribution margin percent, we have a rounding error of $176.
→ The more products a company has, the more complex the break-even analysis
becomes.
2. Key Assumptions of CVP Analysis
- The selling price is constant.
- Costs are linear and can be accurately divided into variable (constant per unit) and
fixed (constant in total) elements.
- In multiproduct companies, the sales mix is constant.
- In manufacturing companies, inventories do not change (units produced = units sold).

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EXERCISE
E7-60B(Braun):
Gamma Manufacturing manufactures 256GB SD cards (memory cards for mobile phones,
digital cameras, and other devices). Price and cost data for a relevant range extending to
200,000 units per month are as follows:
1. What is the company's contribution margin per unit? contribution margin percentage?
Total contribution margin?
2. What would the company's monthly operating income be if the company sold 130,000
units?
3. What would the company's monthly operating income be if the company had sales of
$4,500,000?
4. What is the breakeven point in units? In sales dollars?
5. How many units would the company have to sell to earn a target monthly profit of
$259,700?
6. Management is currently in contract negotiations with the labor union. If the
negotiations fail, direct labor costs will increase by 10% and fixed costs will increase
by $23,500 per month. If these costs increase, how many units will the company have
to sell each month to break even?
7. Return to the original data for this question and the rest of the questions. What is the
company's current operating leverage factor (round to two decimals)?
8. If sales volume increases by 7%, by what percentage will operate income increase?
9. What is the company's current margin of safety in sales dollars? What is its margin of
safety as a percentage of sales?
10. Say the company adds a second size SD card (512GB in addition to 256GB). A 512GB
SD card will sell for $50 and have the variable cost per unit of $28 per unit. The
expected sales mix is four of the 256GB SD cards for every one of the 512GB SD
cards. Given this sales mix, how many of each type of SD card will the company need
to sell to reach its target monthly profit of $259,700? Is this volume higher or lower than
previously needed (in Question 5) to achieve the same target profit? Why?

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Instruction
1.
Contribution margin per unit = Sale price per unit — Variable cost per unit
= $25.00 - $7.50 - $5.00 - $3.30 - $2.20
= $25.00 - $18.00
= $7
Contribution margin ratio = Contribution margin per unit / Sales price per unit x 100
= $7.00 / $25.00 x 100 = 28%
Total contribution margin = Sales revenue - Variable expenses
= 100,000 units x $25 per unit - 100,000 units x $18.00 per unit
= $2,500,000 - $1,800,000 = $700,000
2.
Company monthly operating income = CM per unit * number of units sold - fixed expense
= 7*130,000 - 241,600 - 357,600
= 310,800
3.
Contribution margin = Sales * CM ratio = 4,500,000 * 28%
= 1,260,000
Company monthly operating income = CM - fixed expense
= 1,260,000 - - 241,600 - 357,600
= 660,800
4.
Break-even point in unit = Fixed expense / CM per unit = 599,200/7 = 85,600 (units)
Break-even point in dollars = BE in unit * Sale price = 85,600 * 25 = 2,140,000
5.
Sell to earn the target profit = (fixed expense + operating income) / CM per unit
= (599,200 + 259,700)/7
= 122,700 (units)
6.
New BE in units = New fixed expense / New CM per unit
= (599,200 + 23,500) / (7 - 5*10%)
= 95,800 (units)

27
7.
Operating income = 700,000 - 599,200
= 100,800
Operating leverage factor = CM / Operating income
= 700,000/100,800
= 6.94
8.
Operating income increases in percentage = Increase in volume * Operating leverage factor
= 7%*6.94
= 48.6%
9.
Margin of safety in sales dollars = Sales - Sales at BE
= 2,500,000 - 2,140,000
= 360,000
Margin of safety in percentage of sales = Margin of safety in sales dollars / Sales * 100
= 360,000/2,500,000 * 100
= 14.4%
10.
Particular 256GB 512GB Total
Sales 25 50
Variable cost 18 28
Contribution margin 7 22
Sales mix 4 1 5
Total CM 28 22 50
Weighted average CM per unit $10.00
Needed to target sales = (Fixed expense + OI) / (Weighted average CM per unit)
= (599,200 + 259,700) / 10 = 85,890

28
Particular Total BE sales (in units) Sales mix
in units
BE sales (in
units)
BE sales of 512GB 85,890 1 17,178
BE sales of 256GB 85,890 4 68,712
Total memory cards 85,890
E4-5(GNBCY):
Data for Hermann Corporation are shown below:
Per Unit Percent of Sales
Selling price $90 100%
Variable expenses 63 70
Contribution margin $27 30%
Fixed expenses are $30,000 per month and the company is selling 2,000 units per month.
The marketing manager argues that a $5,000 increase in the monthly advertising budget
would increase monthly sales by $9,000. Should the advertising budget be increased?
Instruction:
Increase in contribution = 9000 * CM ratio = 9000 * 30% = 2700
Increase in fixed expense = 5000
The NOI decrease by = 2700 - 5000 = (2300)
So we should now increase the advertising budget.

29
E4-10(GNBCY):
Lucido Products markets two computer games: Claimjumper and Makeover. A contribution
format income statement for a recent month for the two games appears below:
Claimjumper Makeover Total
Sales 30,000 70,000 100,000
Variable
expenses
20,000 50,000 70,000
Contribution
margin
10,000 20,000 30,000
Fixed
expenses
24,000
Net operating
income
6,000
1.
The overall CM ratio = total CM / total sales = 30,000 / 100,000 = 30%
2.
The overall break-even = Total fixed expenses / Overall CM ratio
= $24,000/30%= $80,000
3.
Claimjumper Makeover Total
Original dollar
sales
30,000 70,000 100,000
Percent of total 30% 70% %100
Sales at break-even 24,000 56,000 80,000
Variable expenses:
Claimjumper variable expenses: ($24,000/$30,000) × $20,000 = $16,000
Makeover variable expenses: ($56,000/$70,000) × $50,000 = $40,000

30
E4-13(GNBCY):
1.
Income statement
Contribution approach Amount
Sales (20,000*115%) 345,000
Variable expense (23,000*9) (207,000)
Contribution margin 138,000
Fixed expense (70,000)
NOI 58,000
2.
Income statement
Sales (20,000*125%) * (15-1.5) 337,500
NOI 42,500

31
3.
Income statement
Sales (20,000*95%) * (15+1.5) 313,500
NOI 52,500
4.
Income statement
Sales (20,000*90%) * (15*112%) 302,400
Variable expense (18,000*9.6) (172,800)
NOI 59,600

32
CHAPTER 7: ACTIVITY-BASED COSTING: A TOOL TO AID
DECISION MAKING
LO1: Activity-Based Costing - An Overview
Activity-based costing is designed to provide managers with cost information for strategic
and other decisions that potentially affect capacity and therefore affect “fixed” as well as
variable costs.
In activity-based costing:
- Nonmanufacturing as well as manufacturing costs may be assigned to products, but
only on a cause-and-effect basis.
- Some manufacturing costs may be excluded from product costs.
- Numerous overhead cost pools are used, each of which is allocated to products and
other cost objects using its unique measure of activity.
By identifying the underlying cost driver that affects the cost behavior of the key resources in
each activity, we can further allocate the activity cost to each customer group based on the
participation levels of these activities.
1. How Costs Are Treated under Activity-Based Costing:
ABC differs from traditional cost accounting in 3 ways:
- ABC assigns both types of costs to products.
- ABC does not assign all manufacturing costs to products.
- ABC uses more cost pools.
Cost Pools, Allocation Bases, and Activity-Based Costing:
- In ABC, an activity is any event that causes the consumption of overhead resources.
- An activity cost pool is a “bucket” in which costs are accumulated that relate to a
single activity measure in the ABC system.
- An activity measure is an allocation base in an activity-based costing system.
- The two most common types of activity measures are transaction drivers and duration
drivers.

33
● Transaction drivers are simple counts of the number of times an activity
occurs.
● Duration drivers measure the amount of time required to perform an activity.
→ Duration drivers are more accurate measures of resource consumption than transaction drivers.
ABC defines 5 levels of activity that largely do not relate to the volume of units produced:
- Unit-Level Activities are performed each time a unit is produced.
- Batch-Level Activities are performed each time a batch is handled or processed,
regardless of how many units are in the batch.
- Product-Level Activities relate to specific products and typically must be carried out
regardless of how many batches are run or units of product are produced or sold.
- Customer-Level Activities relate to specific customers and include activities such as
calls, catalog mailings, and general technical support.
- Organization-Sustaining Activities are carried out regardless of which customers
are served, which products are produced, how many batches are run, or how many
units are made.
2. Designing an Activity-Based Costing (ABC) System
Three essential characteristics of a successful activity-based costing implementation:
- Top managers must strongly support the ABC implementation.
- Top managers should ensure that ABC data is linked to how people are evaluated
and rewarded.
- A cross-functional team should be created to design and implement the ABC
system.
- The implementation process is broken down into 5 steps:
Step 1: Define activities, activity cost pools, and activity measures.
- Customer Orders: assigned all costs of resources that are consumed by taking and
processing customer orders.
- Design Changes: assigned all costs of resources consumed by customer-requested
design changes.
- Order Size: assigned all costs of resources consumed as a consequence of the
number of units produced.
- Customer Relations: assigned all costs associated with maintaining relations with
customers.
- Other: assign all organization-sustaining costs and unused capacity costs.

34
3. Direct Labor-Hours as a Base
- Plantwide Overhead Rate: A single overhead rate used throughout an entire factory.
- Direct labor has often been used as the allocation base for overhead because:
1. Direct labor information was already being recorded.
2. Direct labor was a large component of product costs.
3. Managers believed direct labor and overhead costs were highly correlated.
- Today, direct labor may no longer be a satisfactory base for the allocation of overhead.
● Most companies sell a large variety of products that consume differing amounts
of overhead.
● As a percentage of total costs, direct labor has been shrinking and overhead
has been increasing. Many of the new overhead costs may not be correlated
with direct labor.
● Technology advancements have reduced the cost and complexity of gathering
diverse sources of data.
⇒ A plantwide overhead allocation system may not be optimal for many companies
in today’s business environment.
Example:
- Total manufacturing overhead costs for the current year are estimated to be
$10,000,000. The company develops the following overhead rate based upon labor
hours:
- Predetermined overhead rate =
$10,000,000
500,000 𝐷𝐿𝐻𝑠
= $20 per DLH
Note: Using a traditional predetermined overhead rate based on direct labor hours.
- Since each product requires two hours of direct labor, $40 of overhead is assigned to
each product.
LO2 & LO3 & LO4 & LO5: The Mechanism of Activity-Based Costing
Step 2: Assign overhead costs to activity cost pools.
Step 3: Calculate activity rates.
Step 4: Assign overhead costs to cost objects using the activity rates and activity
measures.
Step 5: Prepare management reports (product and customer profitability reports).

35
1. Comparison of Traditional and ABC Costs:
There are three reasons why the reported product margins for the two costing systems differ
from one another:
Traditional costing ABC costing
Allocates all manufacturing overhead to
products.
Only assigns manufacturing overhead costs
consumed by-products to those products.
Allocates all manufacturing overhead costs
using a volume-related allocation base.
Also uses non-volume-related allocation
bases.
Disregards selling and administrative
expenses because they are assumed to be
period expenses.
Directly traces shipping costs to products
and includes non-manufacturing overhead
costs caused by-products in the activity cost
pools that are assigned to products.
2. Activity-Based Costing and Customer Profitability Analysis
- With the activity cost driver set, we can work out the costs associated with each
customer group based on their participation in each activity.
- Examining the logic behind the activity cost by customer groups will also help check
whether the correct drivers and costs have been identified.
- Growth potential including cross-selling on other products of the company.
- Customer relation and loyalty as well as the barrier of entry to the industry may
determine the likelihood of customer’s choice and loyalty.
- Customer lifetime value.
3. Activity-Based Management: Targeting Process Improvements.
- Activity-based management is used in conjunction with ABC to identify areas that
would benefit from process improvements.
- While the theory of constraints approach is a powerful tool for targeting improvement
efforts, activity rates can also provide valuable clues on where to focus improvement
efforts.
- Benchmarking can be used to compare activity cost information with world-class
standards for performance achieved by other organizations.
4. Activity-Based Costing and External Reports.
Most companies do not use ABC for external reporting because:
- External reports are less detailed than internal reports.
- It may be difficult to make changes to the company’s accounting system.
- ABC does not conform to GAAP.

36
- Auditors may be suspect of the subjective allocation process based on interviews
with employees.
5. The Limitations of Activity-Based Costing.
- Substantial resources are required to implement and maintain.
- Resistance to unfamiliar numbers and reports.
- Desire to fully allocate all costs to products.
- Potential misinterpretation of unfamiliar numbers.
- Does not conform to GAAP. Two costing systems may be needed.

37
EXERCISE
P6-71B (Braun):
Requirement-1
As per Absorption As per Variable
Jan Feb Jan Feb
Variable Manufacturing cost $5.00 $5.00 $5.00 $5.00
Fixed Manufacturing cost ($700/2000
meal) (700/1400 meal)
$0.35 $0.50 - -
Unit Product cost $5.35 $5.50 $5.00 $5.00

38
Requirement 2(a) The Absorption Costing Income Statement
Jan Feb
No. of Unit Sold 1400 1600
Sales $8 $9,800 $11,200
Less: Cost of Goods sold $7,490 $8,710
Gross Margin $2,310 $2,490
Less: Other Expense
Operating expense $1,900 $2,100
Net operating income $410 $390
Requirement: 2(b): The Variable Costing Income Statement
Jan Feb
Sales $9,800 $11,200
Variable expense
Variable COGS $7,000 $8,000
Sales Commission $1,400 $1,600
CM $1,400 $1,600
Fixed expense:

39
Fixed Manufacturing cost Overhead $700 $700
Fixed Selling & Admin Cost $500 $500
Net operating Income $200 $400
Requirement 3
In January, Absorption cost Operating income higher under variable costing Income. The is
because the Unit produced was greater than the Unit sold. Absorption Costing Deferes some
of January's Fixed manufacturing Cost in the Unit Ending Inventory. This cost will not be
expensed until those units are sold.
E7-2(GNBCY):
Travel Pickup
and
Delivery
Customer
Service
Other Total
Driver and
guard wages
$360,000 $252,000 $72,000 $36,000 $720,000
Vehicle
operating
expense
196,000 14,000 0 70,000 280,000
Vehicle
depreciation
72,000 18,000 0 30,000 120,000
Customer
representative
salaries and
expenses
0 0 144,000 16,000 160,000
Office
expenses
0 6,000 9,000 15,000 30,000
Administrative
expenses
0 16,000 192,000 112,000 320,000

40
Total cost $628,000 $306,000 $417,000 $279,000 1,630,000
E7-3(GNBCY):
Activity Cost
Pool
Estimated
Overhead
Cost
Expected Activity Activity Rate ( Estimated
Overhead Cost/ Expected
Activity)
Caring for
lawn
$72,000 150,000 square feet of
lawn
$0.48 per square
foot of lawn
Caring for
garden beds -
low
maintenance
$26,400 20,000 square feet of
low
$1.32 per square
foot of low
maintenance
beds
Caring for
garden beds–
high
maintenance
$41,400 15,000 maintenance
beds
$2.76 per square
foot of high
maintenance
beds
Travel to jobs $3,250 12,500 miles $0.26 per mile
Customer
billing and
service
$8,750 25 customers $350 per customer
E7-4(GNBCY):
K425
Activity Cost
Pool
Activity Rate Activity ABC Cost
Labor-related $6 per direct labor-hour 80 direct labor-hours 480

41
Machine
processing
$4 per machine-hour 100 machine-hours 400
Machine
setups
$50 per setup 1 setup 50
Production
orders
$90 per order 1 order 90
Shipments $14 per shipment 1 shipment 14
Product
sustaining
$840 per product 1 product 840
Total $ 1,874.00
M67
Activity Cost Pool Activity Rate Activity ABC Cost
Labor-related $6 per direct labor-
hour
500 direct labor-
hours
3,000
Machine processing $4 per machine-hour 1,500 machine-
hours
6,000
Machine setups $50 per setup 4 setup 200
Production orders $90 per order 4 order 360
Shipments $14 per shipment 10 shipment 140
Product sustaining $840 per product 1 product 840
Total $ 10,540

42
Total cost (a) $1,874 $10,540
Number of units produced (b) 200 2,000
Average cost per unit (a) ÷ (b) $9.37 $5.27

Chapter 10 – ISB Accademic Team
43
CHAPTER 10 - MASTER BUDGETING
LO1: Why organizations budget and the processes they use to create a budget
Budget - the detailed plan for acquiring and using resources over a specified time period.
Used for 2 distinct purposes - planning (developing goals and preparing a various budget to
achieve), control (steps taken to achieve goals)
Advantages of Budgeting:
- Communicate plans
- Define goals and objectives
- Think about and plan for the future
- Means of allocating resources
- Uncover potential bottlenecks
- Coordinate activities
Advantages of Bottom-up:
- Individuals at all levels of the organization are viewed as members of the team whose
judgments are valued by top management.
- Budget estimates prepared by front-line managers are often more accurate than
estimates prepared by top managers.
- Motivation is generally higher when individuals participate in setting their own goals
than when the goals are imposed from above.
- A manager who is not able to meet a budget imposed from above can claim that it was
unrealistic. Self-imposed budgets eliminate this excuse·

44
Advantage of Top-down:
- Avoid the potential budgetary slack (budget padding).
- Provide clearer performance goals and expectations from the top management.
- May provide better budget due to top management’s access to privileged/confidential
market and organization information.
- Provide an efficient budgetary process.
Top Management Attitude: Human Factors in Budgeting:
The success of a budget program depends on three important factors:
- Top management must be enthusiastic and committed to the budget process.
- Top management must not use the budget to pressure employees or blame them when
something goes wrong.
- Budget targets should be challenging but achievable to have good motivational effects.
The Budget Committee: A standing committee responsible for
- Overall policy matters relating to the budget
- Coordinating the preparation of the budget
- Resolving disputes related to the budget
- Approving the final budget
LO2: The master budget: OVERVIEW
The sales budget: The individual months of April, May, and June are summed to obtain the
total budgeted sales in units and dollars for the quarter ended June 30th

45
Expected Cash collection:
All sales are on account.
Royal’s collection pattern is:
- 70% collected in the month of sale,
- 25% collected in the month following sale,
- 5% uncollectible.
The March 31 accounts receivable balance of $30,000 will be collected in full
The production budget: The production budget must be adequate to meet budgeted sales
and to provide for the desired ending inventory.
Example: The management at Royal Company wants ending inventory to be equal to 20% of
the following month’s budgeted sales in units. On March 31, 4,000 units were on hand.

46
The direct materials budget:
- At Royal Company, five pounds of material are required per unit of product.
- Management wants materials on hand at the end of each month equal to 10% of the
following month’s production.
- On March 31, 13,000 pounds of materials are on hand. Material cost is $0.40 per
pound.
Expected Cash Disbursement for materials:
- Royal pays $0.40 per pound for its materials.
- One-half of a month’s purchases are paid for in the month of purchase; the other half
is paid in the following month.
- The March 31 accounts payable balance is $12,000.

47
The direct labor budget:
- At Royal, each unit of product requires 0.05 hours (3 minutes) of direct labor.
- The Company has a “no layoff” policy so all employees will be paid for 40 hours of
work each week.
- For purposes of our illustration assume that Royal has a “no layoff” policy, workers
are paid at the rate of $10 per hour regardless of the hours worked.
- For the next three months, the direct labor workforce will be paid for a minimum of
1,500 hours per month.
Manufacturing Overhead Budget:

48
- At Royal, manufacturing overhead is applied to units of product based on direct labor
hours.
- The variable manufacturing overhead rate is $20 per direct labor hour.
- Fixed manufacturing overhead is $50,000 per month, which includes $20,000 of non-
cash costs (primarily depreciation of plant assets).
Ending finished goods and inventory budget:
Selling and administrative expenses budget:
- At Royal, the selling and administrative expense budget is divided into variable and
fixed components.
- The variable selling and administrative expenses are $0.50 per unit sold.
- Fixed selling and administrative expenses are $70,000 per month.
- The fixed selling and administrative expenses include $10,000 in costs – primarily
depreciation – that are not cash outflows of the current month.

49
The format of Cash Budget:
The cash budget is divided into four sections:
- Section 1: Cash receipts section lists all cash inflows excluding cash received from the
financing;
- Section 2: Cash disbursements section consists of all cash payments excluding
repayments of principal and interest;
- Section 3: Cash excess or deficiency section determines if the company will need to
borrow money or if it will be able to repay funds previously borrowed; and
- Section 4: The Financing section details the borrowings and repayments projected to
take place during the budget period.
The cash budget:
Assume the following information for Royal:
- Maintains a 16% open line of credit for $75,000
- Maintains a minimum cash balance of $30,000
- Borrows on the first day of the month and repays loans on the last day of the month
- Pays a cash dividend of $49,000 in April
- Purchases $143,700 of equipment in May and $48,300 in June (both purchases paid
in cash)
- Has an April 1 cash balance of $40,000

50
The budgeted income statement: With interest expense from the cash budget, Royal can
prepare the budgeted income statement.
The budgeted balance sheet:
Royal reported the following account balances before preparing its budgeted financial
statements:

51
- Land - $50,000
- Common stock - $200,000
- Retained earnings - $146,150 (April 1)
- Equipment - $175,000

52
Cost and Benefits of Budget:
- Cost: time-consuming and costly, many steps, often inaccurate
- Benefits: help to plan and coordinate activities, useful for the top manager to express
company strategies and missions

53
EXERCISE
E10-4(GNBCY): Direct Labor Budget
Rordan Corporation
Direct Labor Budget
1st
Quarter
2nd
Quarter
3rd
Quarter
4th
Quarter
Year
Required Production
in units
8,000 6,500 7,000 7,500 29,000
Direct labor time in
units (hours)
0.35 0.35 0.35 0.35 0.35
Total direct labor-
hours needed
2,800 2,275 2,450 2,625 10,150
Direct labor cost per
hour
$12 $12 $12 $12 $12
Total direct labor
cost
$33,600 $27,300 $29,400 $31,500 $121,800
Rordan Corporation
Direct Labor Budget
1st
Quarter
2nd
Quarter
3rd
Quarter
4th
Quarter
Year
Total direct labor-
hours needed
2,800 2,275 2,450 2,625 10,150
Regular hours paid 2,600 2,600 2,600 2,600 2,600

54
Overtime hours paid 200 0 0 25 225
Wages for regular
hours
12 12 12 12 12
Overtime wages 18 18 18 18 18
Total direct labor
cost
34,800 31,200 31,200 31,650 128,850

55
E10-9(GNBCY): Budgeted Balance Sheet
MeccaCopy
Budgeted Balance Sheet
Dr. Cr.
Assets
Current assets
Cash 12,200
Accounts receivable 8,100
Supplies inventory 3,200
Total current assets: 23,500
Plant and equipment
Equipment 34,000
Accumulated depreciation (16,000)
Plant and equipment, net 18,000
Total assets: 41,500
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable 1,800
Stockholders' equity
Common stock 5,000
Retained earnings (1) 34,700

56
Total stockholders' equity: 39,700
Total liabilities and stockholders' equity: 41,500
Explanation (1):
Retained earnings, beginning balance.. $28,000
Add net income......................................$11,500
Deduct dividends....................................$4,800
Retained earnings, ending balance ...... $34,700
E10-11(GNBCY):
Graeber Industries
Production Budget
1st
Quarter
2nd
Quarter
3rd
Quarter
4th
Quarter Year
Budgeted unit sales 8,000 7,000 6,000 7,000 28,000
Add desired ending
inventory
1,400 1,200 1,400 1,700 1,700
Total units needed 9,400 8,200 7,400 8,700 29,700
Less beginning
inventory
1,600 1,400 1,200 1,400 1,600
Required production 7,800 6,800 6,200 7,300 28,100

57
2.
Gaeber Industries
Direct Materials Budget
1st
Quarter
2nd
Quarter
3rd
Quarter
4th
Quarter Year
Required production 7,800 6,800 6,200 7,300 28,100
Raw materials per unit x2 x2 x2 x2 x2
Production needs 15,600 13,600 12,400 14,600 56,200
Add desired ending inventory
2,
720
2,4
80 2,920 3,140
3,
140
Total needs 18,320 16,080 15,320 17,740 59,340
Less beginning inventory
3,
120
2,7
20 2,480 2,920
3,
120
Raw materials to be purchased 15,200 13,360 12,840 14,820 56,220
Cost of raw materials to be
purchased at $4.00 per pound $60,800 $53,440 $51,360 $59,280 $224,880
Schedule of Expected Cash Disbursements for Materials

58
Accounts payable, beginning
balance $14,820 $ 14,820
1st Quarter purchases 45,600 $15,200 60,800
2nd Quarter purchases 40,080 $13,360 53,440
3rd Quarter purchases 38,520 $12,840 51,360
4th Quarter purchases 44,460 44,460
Total cash disbursements for
materials $60,420 $55,280 $51,880 $57,300 $224,880
E9-35A (Braun):
1. The sales budget
KC shopee
Sale budget
Particular Nov Dec
Sales 280,000 364,000
Cash sales (20%) 56,000 72,800
Credit sales (80%) 224,000 291,200
Total sales 280,000 364,000

59
2. The cost of goods sold, inventory and purchases budget
KC shopee
Sale budget
Particular Nov Dec
Cost of goods sold 210,000 273,000
Desired Ending factory 55,950 43,125
Total Inventory required 265,950 316,125
Beginning Inventory 46,500 55,950
Amount of Inventory to
purchase
219,450 260,175
3. The operating expense budget
KC shopee
Sale budget
Particular Nov Dec
Wage Expense 9,200 9,200
Utilities Expense 1,000 1,500
Property tax Expense 2,000 2,000
Property and Liabilities
insurance Expense
500 500
Depreciation Expense 6,500 6,500

60
Credit/Debit card free
Expense
4,480 5,824
Total Operating Expense 23,680 25,524
4. The budgeted income statement
KC shopee
Sale budget
Particular Nov Dec
Sales Revenue 280,000 364,000
Cost of goods sold 210,000 273,000
Gross profit 70,000 91,000
Operating Expenses 23,680 25,524
Operating Income 46,320 65,476

61
CHAPTER 11: FLEXIBLE BUDGETS AND OVERHEAD ANALYSIS
LO1: Differences of the static planning budget
1. Static budget:
A static budget is a budget prepared for a single level of activity that remains
unchanged even if the activity level subsequently changes.
2. Flexible budget:
A flexible budget provides estimates of what revenues and costs should be for any
level of activity, within a specified range. When used for performance evaluation purposes,
actual costs are compared to what the costs should have been for the actual level of activity
during the period. This enables “apples-to-apples” cost comparisons. A flexible budget can be
adjusted to reflect any level of activity. By contrast, a static budget is prepared for a single
level of activity and is not subsequently adjusted.
3. Favorable vs unfavorable:
Revenue variances are labeled favorable when actual revenues exceed budgeted
revenues, and they are labeled unfavorable when actual revenues are less than budgeted
revenues.
Expense variances are labeled favorable when actual expenses are less than
budgeted expenses, and they are labeled unfavorable when actual expenses exceed
budgeted expenses.
Flexing a budget involves two key assumptions about cost behavior:
- First, total variable costs change in direct proportion to changes in the activity
- Second, total fixed costs remain unchanged within a specified activity range.
The fixed overhead budget variance is the difference between the total budgeted fixed
overhead cost and the total amount of fixed overhead cost incurred. If actual costs exceed
budgeted costs, the variance is labeled unfavorable.
The volume variance is favorable when the activity level for a period, at standard, is
greater than the denominator activity level. Conversely, if the activity level, at standard, is less
than the denominator level of activity, the volume variance is unfavorable. The variance does
not measure deviations in spending. It measures deviations in actual activity from the
denominator level of activity

62
LO2: How a flexible budget works
1. Activity variance
An activity variance arises solely due to the difference in the level of activity included
in the planning budget and the actual level of activity.
Part of the discrepancy between the budgeted net operating income and the actual net
operating income is because the actual level of activity is higher than the planned activity.
2. Revenue and spending variance
A revenue variance is a difference between what the total revenue should have been,
given the actual level of activity for the period, and the actual total revenue.
A spending variance is a difference between how much a cost should have been, given the
actual level of activity, and the actual amount of the cost.
3. Flexible budgets with multiple cost drivers
It is unlikely that all variable costs within a company are driven by a single factor such
as the number of units produced, labor hours, or machine hours. More than one cost driver
may be needed to adequately explain all of the costs in an organization. The cost formulas
used to prepare a flexible budget can be adjusted to recognize multiple cost drivers.

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EXERCISE
E11-8(GNBCY):
Lavage Rapide
Static Budget
For the Month Ended August 31
Budgeted number of cars 9000
Budgeted variable overhead costs:
Cleaning supplies ($0.80 SFr per car) 7200
Electricity ($0.15 SFr per car) 1350
Maintenance ($0.20 SFr per car) 1800
Administrative expense 900
Wages 2700
Total variable overhead cost 13,950
Budgeted fixed overhead cost
Operator wages 5000
Electricity 1200
Depreciation 6000
Rent 8000
Administrative expenses 4000
Total fixed cost 24,200
Total budgeted cost 38,150

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E11-9(GNBCY):
Budgeted number of cars 9000
Actual number of cars 8800
Overhead cost Cost
formula
(per car)
Actual costs
incurred for
8,800 cars
Budget based
on 9000 cars
Variance
Cleaning supplies 0.8 7040 7200 160 F
Electricity 0.15 1320 1350 30 F
Maintenance 0.2 1760 1800 40 F
Administrative
expense
0.1 880 900 20 F
Wages 0.3 2640 2700 60 F
Total variable cost 1.55 13640 13950 310 F
Fixed overhead
costs
Operator wages 5000 5000 0
Depreciation 6000 6000 0
Rent 8000 8000 0
Electricity 1200 1200 0
Administrativ
e expenses
4000 4000 0
Total cost 34,240 38,150 3,910

65
Students may question the variances for fixed costs. Operator wages can differ from what was
budgeted for a variety of reasons including an unanticipated increase in the wage rate;
changes in the mix of workers between
Those earning lower and higher wages; changes in the number of operators on duty; and
overtime. Depreciation may have increased because of the acquisition of new equipment or
because of a loss on equipment that must be scrapped—perhaps due to poor maintenance.
(This assumes that the loss flows through the depreciation account on the performance
report.)
E11-15(GNBCY):
REVENUE & SPENDING VARIANCES
Budgeted number of gelato 6000
Actual number of gelato 6200
Actual Budgeted Variance
Revenue 71540 72000 460 F
Raw materials 29230 27900 1330 U
Wages 13860 14000 140 F
Utilities 3270 2830 440 U
Rent 2600 2600
Insurance 1350 1350
Miscellaneous 2590 2750 160 F
Total expenses 52900 51430 1470 U
NOI 18640 20570 1930 U

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CHAPTER 12: STANDARD COSTS AND VARIANCES
Variance Analysis Cycle
The variance analysis cycle is a continuous process used to identify and solve problems:
LO1: Standard Costs
Standards are benchmarks or “norms” for measuring performance.
In managerial accounting, two types of standards are commonly used:
- Quantity standards specify how much of an input should be used to make a product
or provide a service.
- Price standards (related to cost or acquisition price) specify how much should be paid
for each unit of the input.
Actual quantities and actual costs of inputs are compared to these standards. If there are
significant differences, managers need to investigate the problem and eliminate it.
Setting price and quantity standards require the combined expertise of everyone who has
responsibility for purchasing and using inputs. In a manufacturing setting, this might include
accountants, engineers, purchasing managers, production supervisors, line managers, and
production workers.
Standards should be designed to encourage efficient future operations, not just a repetition
of past inefficient operations.
Standard cost per unit = standard quantity (hours, amounts) x standard price (costs, rate)
Price and quantity standards are determined separately for two reasons:
- Different managers are usually responsible for buying and for user inputs. For
example, The purchasing manager is responsible for raw material purchase prices and
the production manager is responsible for the quantity of raw material used.

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- The buying and using activities occur at different points in time. For example,
Raw material purchases may be held in inventory for a period of time before being
used in production.
The standard cost card is a detailed listing of the standard amounts of direct materials,
direct labor, and variable overhead inputs that should go into a unit of product, multiplied by
the standard price or rate that has been set for each input.
1. Setting direct material standards:
- Standard price per unit for direct materials: reflects the final, delivered cost of the
materials, net of any discounts taken.
- Standard quantity per unit for direct materials: reflects the amount of material
required for each unit of finished product, as well as an allowance for unavoidable
waste, spoilage, and other normal inefficiencies.
- Bill of materials: a list that shows the quantity of each type of material in a unit of finished
product → summary of Quantity Standards.
2. Setting direct labor standards:
- The standard rate per hour for direct labor includes wages earned, employee taxes,
fringe benefits, and other labor costs. Many companies prepare a single rate for
all employees within a department that reflects the “mix” of wage rates earned.
- The standard hours per unit: reflects the labor hours required to complete one unit
of product. Standards can be determined by using available references that estimate
the time needed to perform a given task, or by relying on time and motion studies.
3. Setting variable manufacturing overhead standards:
- The standard rate per hour for variable manufacturing overhead comes from the
variable portion of the predetermined overhead rate.
- The standard hours per unit for variable manufacturing overhead are expressed in
either direct labor hours or machine hours depending on which is used as the
allocation base in the predetermined overhead rate.
LO2: A General Model for Standard Cost Variance Analysis
The act of computing and interpreting variances (differences between standard and actual) is
called variance analysis. Standard cost variance analysis decomposes spending variances
from the flexible budget into:
- Price variance: Differences between standard prices and actual prices, multiply by
the actual amount of input purchased.
- Quantity variance: Differences between standard quantities and actual quantities an
input is used.
Price variances and quantity variances usually have different causes.

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Price and quantity variances can be computed for all three variable cost elements – direct
materials, direct labor, and variable manufacturing overhead.
In equation form, price and quantity variances are calculated as shown:
LO3: Direct Materials Variances
Consider an example:
Glacier Peak Outfitters has the following direct material standard for the fiberfill in its
mountain parka: 0.1 kilograms of fiberfill per parka at $5.00 per kilograms.
Last month 210 kilograms of fiberfill were purchased and used to make 2,000 parkas.
The material cost a total of $1,029.
Compute price and quantity variance of materials.
Solution:

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The materials price variance is $21 favorable, which means the actual price is less than
the standard price by $0.10 per kilogram. While the quantity variance is $50 unfavorable
because the actual quantity is more than the standard quantity by 10 kilograms.
Another way to compute direct material variances is by using basic mathematical equations:
Materials price variance:
MPV = AQ (AP - SP)
= 210 kgs ($4.90/kg - $5.00/kg)
= 210 kgs (-$0.10/kg)
= $21 F
Materials quantity variance:
MQV = SP (AQ - SQ)
= $5.00/kg (210 kgs-(0.1 kg/parka × 2,000 parkas))
= $5.00/kg (210 kgs - 200 kgs)
= $5.00/kg (10 kgs)
= $50 U
The materials price variance when materials are purchased, using the entire amount of
material purchased during the period.
The materials quantity variance after materials is used in production, using only the portion
of materials that were used in production during the period.
The purchasing manager and production manager are usually held responsible for the
materials price variance and materials quantity variance, respectively. The standard price is
used to compute the quantity variance so that the production manager is not held
responsible for the performance of the purchasing manager.
LO4: Direct Labor Variances
Glacier Peak Outfitters has the direct labor standard for its mountain parka as 1.2
standard hours per parka at $10.00 per hour.
Last month, employees worked 2,500 hours at a total labor cost of $26,250 to make
2,000 parkas.
Compute labor rate and efficiency variances.

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Solution:
The labor rate variance (difference between the actual average hourly wage paid and the
standard hourly wage) is $1,250 unfavorable because the actual average wage rate was
more than the standard wage rate by $0.50 per hour.
The labor efficiency variance (difference between the actual quantity of labor hours and the
standard quantity) is $1,000 unfavorable because the actual quantity of hours exceeds the
standard quantity allowed by 100 hours.
- Labor rate variance
LRV = AH (AR - SR)
= 2,500 hours ($10.50 per hour – $10.00 per hour)
= 2,500 hours ($0.50 per hour)
= $1,250 unfavorable
- Labor efficiency variance
LEV = SR (AH - SH)
= $10.00 per hour (2,500 hours – 2,400 hours)
= $10.00 per hour (100 hours)
= $1,000 unfavorable
Labor variances are partially controllable by employees within the Production Department
by influencing:
- The deployment of workers on tasks consistent with their skill levels.
- The level of employee motivation.
- The quality of production supervision.
- The quality of the training provided to the employees.
However, labor variances are also affected by other factors. For example:

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- The Maintenance Department may do a poor job of maintaining production
equipment. This may increase the processing time required per unit, thereby
causing an unfavorable labor efficiency variance.
- The purchasing manager may purchase lower quality raw materials resulting in
an unfavorable labor efficiency variance for the production manager.
LO5: Variable Manufacturing Overhead Variances
Glacier Peak Outfitters has the following direct variable manufacturing overhead labor
standard for its mountain parka: 1.2 standard hours per parka at $4.00 per hour.
Last month, employees worked 2,500 hours to make 2,000 parkas. The actual variable
manufacturing overhead for the month was $10,500.
Compute variable manufacturing overhead rate and efficiency variances.
Solution:
The variable overhead rate variance (difference between the actual variable overhead costs
and the standard cost that should have been incurred) is $500 unfavorable because the
actual variable overhead rate was more than the standard variable overhead rate by
$0.20 per hour.
The variable overhead efficiency variance (difference between the actual activity of a period
and the standard activity allowed, multiplied by the variable part of the predetermined
overhead rate) is $400 unfavorable because the actual quantity of the activity (hours)
exceeds the standard quantity of the activity allowed by 100 hours.
- Variable manufacturing overhead rate variance
VMRV = AH (AR - SR)
= 2,500 hours ($4.20 per hour – $4.00 per hour)
= 2,500 hours ($0.20 per hour)
= $500 unfavorable

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- Variable manufacturing overhead efficiency variance
VMEV = SR (AH - SH)
= $4.00 per hour (2,500 hours – 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable
LO6: Fixed Overhead Variances
The budget variance is the actual fixed manufacturing overhead cost minus the
budgeted fixed manufacturing overhead.
The volume variance is budgeted fixed overhead minus the fixed overhead applied to
work in process.
The volume variance can also be computed by the fixed portion of the predetermined
overhead rate (FPOHR) times the difference between denominator hours (DH) and
standard hours (SH).
Volume variance = FPOHR x (DH - SH)
LO7: Managerial Implications
All variances are not worth investigating. Methods for highlighting a subset of variances as
exceptions include:
- Looking at the size of the variance.
- Looking at the size of the variance relative to the amount of spending.
Plotting variance analysis data on a statistical control chart is helpful for invariance
investigation decisions. Variances are investigated if:

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- They are unusual relative to the normal level of random fluctuation.
- An unusual pattern emerges in the data.
Advantages of standard costs:
- The key element of the management by exception approach helps managers
focus their attention on the most important issues.
- Standards that are viewed as reasonable by employees can serve as
benchmarks that promote economy and efficiency.
- Greatly simplify bookkeeping.
- Fit naturally into a responsibility accounting system.
Potential problems with standard costs:
- Standard cost variance reports are usually prepared monthly and are often
released days or weeks after the end of the month; hence, the information can
be outdated.
- If variances are misused as a club to negatively reinforce employees, morale
may suffer and employees may make dysfunctional decisions.
- Labor variances make two important assumptions. First, they assume that the
production process is labor-paced; if labor works faster, the output will go up.
Second, the computations assume that labor is a variable cost. These
assumptions are often invalid in today’s automated manufacturing environment
where employees are essentially a fixed cost.
- In some cases, a “favorable” variance can be as bad or worse than an
unfavorable variance.
- Excessive emphasis on meeting the standards may overshadow other
important objectives such as maintaining and improving quality, on-time
delivery, and customer satisfaction.
- Just meeting standards may not be sufficient; continual improvement using
techniques such as Six Sigma may be necessary to survive in a competitive
environment.

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EXERCISE
E11-35B(Braun):
1.
Actual Cost per gram of Special Alloy = Total Actual Cost / AQ Used
= $577,800 / 9,000 (gram)
Actual Cost per gram of Special Alloy = $64.2 per gram
2.
Direct Material Price Variance = (Standard Price - Actual Price) X Actual Quantity Purchased
= ($64.5 - $64.2) X 9000 grams
= $2,700 (F)
3.
Direct Material Quantity Variance = (Actual Quantity - Standard Quantity) X Standard Price
= (8,600 - 8,000) X $64.5
= $38,700 (U)
4.
In the last month, the company may have purchased of inferior material at a low price and it
resulted in lower production as the material is waste during the production process. Thus, it
can be the result of unfavorable quantity variance.
E11-36B(Braun):
Medium speed
bump
Large speed bump
Standard pounds per unit
Standard price per pound
Actual quantity purchased and used per unit
Actual price paid for material
15
$ 3.5
14
$ 4.10
17
$ 3.9
16
$ 4.7

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Direct materials price variance
Direct materials quantity variance
Total direct material variance
Number of units produced
$ 2,520 U
$ 1,050 F
$ 1,470 U
300
$ 7,680 U
$ 2,340 F
$ 5,340 U
600
● MPV = AQ(AP - SP) = AQ(4.1 - 3.5) = 2,520
=> Total AQ = 4,200 => AQ per unit = 4,200/300 = 14
● Total Direct Material Variance = Price variance + Quantity Variance
= $2,520 U + $1,050 F
● Quantity Variance = SP (AQU - SQA)= [AQU - (Quantity variance / SP)] SQA
= [16*600 - (-2,340/3.9)]
SQA = 9,600 + 600
SQA = 10,200 pounds
SQA per unit = 10,200/600 = 17 pounds
● Total Direct Material Variance = Price variance + Quantity Variance
=> Quantity Variance = Total DM Variance - Price variance
Quantity Variance = $5,340 U - $7,680 U = $1,125 F

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CHAPTER 13: PERFORMANCE MEASUREMENT IN
DECENTRALIZED ORGANIZATIONS
LO1: Decentralization in organizations
In a decentralized organization, decision-making authority is spread throughout the
organization rather than being confined to a few top executives.
Advantages:
- Lower-level managers gain experience in decision-making
- Lower-level decisions often based on better information
- Top management freed to concentrate on strategy
- Decision-making authority leads to job satisfaction
- Lower-level managers can respond quickly to customers.
Disadvantages:
- Maybe a lack of coordination among autonomous managers
- Lower-level managers may make decisions without seeing the “big picture”
- Lower-level manager’s objectives may not be those of the organization
- May be difficult to spread innovative ideas in the organization.
1. Responsibility Accounting
Responsibility center: is used for any part of an organization whose manager has control over
and is accountable for cost, profit, or investments.
Three primary types: cost centers, profit centers, and investment centers.
● Cost center: has control over costs. The managers of cost centers are
expected to minimize costs while providing the level of products and services
needed by other parts of the organization.
● Profit center: has control over both costs and revenue. Profit center managers
are often evaluated by comparing actual profit to targeted or budgeted profit.
● Investment center: has control over cost, revenue, and investments in
operating assets. Investment center managers are often evaluated using
return on investment (ROI) or residual income measures.
LO2: Evaluating Investment Center Performance - Return on Investment
1. The Return on Investment (ROI) Formula:

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The higher a business segment’s return on investment (ROI), the greater the profit earned
per dollar invested in the segment’s operating assets.
2. Net Operating Income and Operating Asset Defined
- Net operating income: income before interest and taxes and is sometimes referred
to as EBIT (earnings before interest and taxes). Net operating income is used in the
formula because the base (i.e., denominator) consists of operating assets.
- Operating assets include cash, accounts receivable, inventory, plant and equipment,
and all other assets held for operating purposes. Non-operating assets include land
held for future use, an investment in another company, or a building rented to someone
else.
3. Understanding ROI
- ROI can also be expressed in terms of margin and turnover as follows:
- Margin is ordinarily improved by increasing selling prices, reducing operating
expenses, or increasing unit sales.
- Excessive funds tied up in operating assets (e.g., cash, accounts receivable,
inventories, plant and equipment, and other assets) depress turnover and lower ROI.

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- Three ways to increase ROI: Increase sales, reduce expenses, reduce assets
4. Criticisms of ROI
- In the absence of a balanced scorecard, management may not know how to increase
ROI.
- Management often inherits many committed costs over which they have no control.
- Managers evaluated on ROI may reject profitable investment opportunities.
LO3: Residual Income
Residual income is the net operating income that an investment center earns above the
minimum required return on its operating assets.
Formula:
Let’s consider an example:
The Retail Division of Zephyr, Inc. has average operating assets of $100,000 and is required
to earn a return of 20% on these assets. In the current period, the division earns $30,000.
Let’s calculate residual income.

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Solution:
1. Motivation and Residual Income
The residual income approach encourages managers to make investments that are
profitable for the entire company but that would be rejected by managers who are evaluated
using the ROI formula.
A manager who is evaluated based on ROI will reject any project whose rate of return is below
the division’s current ROI
Managers who are evaluated using residual income will pursue any project whose rate of
return is above the minimum required rate of return
2. Divisional Comparison and Residual Income
The major disadvantage of residual income: It can’t be used to compare the performance of
divisions of different sizes.

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EXERCISE
E13-2(GNBCY): Compute the Return on Investment (ROI)
1. Compute the margin for Alyeska Service Company
Margin =
𝑁𝑒𝑡 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
𝑆𝑎𝑙𝑒
=
$600,000
$7,500,000
= 0,08 = 8%
2. Compute the turnover for Alyeska Service Company
Turnover =
𝑆𝑆𝑆𝑆
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑎𝑠𝑠𝑒𝑡𝑠
=
$7,500,000
$5,000,000
= 1,5%
3. Compute the return on investment (ROI) for Alyeska Service Company
ROI = Margin x Turnover = 8% x 1,5 = 12%
E13-6(GNBCY): Contrasting Return on Investment (ROI) and Residual Income
1. For each division, compute the return on investment (ROI) in terms of margin
and turnover. Where necessary, carry computations to two decimal places.
ROI = Margin x Turnover
Osaka Division:
ROI =
$210,000
$3,000,000
x
$3,000,000
$1,000,000
= 7% x 3 = 21%
Yokohama Division:
ROI =
$720,000
$9,000,000
x
$9,000,000
$4,000,000
= 8% x 2.25 = 18%

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2. Assume that the company evaluates performance using residual income and
that the minimum required rate of return of any division is 15%. Compute the
residual income for each division.
Osaka Yokohama
Average operating assets (a) $1,000,000 $4,000,000
Net operating income $210,000 $720,000
Minimum required return on
average operating assets
15% x (a)
$150,000 $600,000
Residual income $60,000 $120,000
3. Is Yokohama’s greater amount of residual income an indication that it is better
managed? Explain.
No. The Yokohama Division is simply larger than the Osaka Division and for this
reason, one would expect that it would have a greater amount of residual income.
Residual income can’t be used to compare the performance of divisions of different
sizes. Larger divisions will almost look better. In fact, in the case above, the Yokohama
Division does not appear to be as well managed as the Osaka Division. Note from Part
(1) that Yokohama has only an 18% ROI as compared to 21% for Osaka.
P10-45A(Braun):
1. Calculate each division’s ROI:

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The calculation includes:
B4 C4
$555,300/$1,970,000 $176,000/$2,000,000
The ROI for paint stores and consumer division is 28% and 8.8%.
2. Calculate each division’s sales margin. Interpret your results.
The calculation includes:
B4 C4
$555,300/$3,950,000 $176,000/$1,100,000
The sales margin for paint stores and consumer division is 14% and 16%. The consumer
division is more profitable than the paint stores division.
Calculation of each division’s capital turnover. Interpret your results.

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B4 C4
$3,950,000/$1,975,000 $1,100,000/$2,000,000
The capital turnover for paint stores and consumer division is 2 and 0.55 respectively. The
paint store of the company is more effective in generating sales out of the available total
assets.
4. Use the expanded ROI formula to confirm your results from Requirement 1.
Interpret your results.
The expanded ROI formula for paint stores is as followed:
Expanded ROI = Capital Turnover x Sales Margin
= 2 x 14% = 28%
The expanded ROI formula for consumers is as followed:
Expanded ROI = Capital Turnover x Sales Margin
= 0.55 x 16% = 8.8%
Since the Paint Stores division is utilizing its assets properly and can generate more sales
than the Consumer division. Therefore it is the reason for expanded ROI being more in the
Paint Stores.

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5. Calculate each division’s RI. Interpret your results and offer recommendations for
any divisions with negative R
B5 C5
$553,000 – (21% x $1,975,000) $176,000 – (21% x $2,000,000)
The Paint Store division of the company is working appropriately with the target rate of
return of the company. However, the Consumer Division of the company should try to
increase its
Capital Turnover so that the utilization of assets is done properly so that residual income in
the division is no longer negative.
6. Total asset data was provided in this problem. If you were to gather this
information from an annual report, how would you measure total assets?
Describe your measurement choice? And some of the pros and cons of those
choices
In the market, the maximum of companies chooses to use the average value of
the assets from the balance sheet because the ROI of the company is calculated
for the entire year. In the given case, it is managerial to decide whether to use
the net assets or to use the gross value of assets.
Gross value can be taken directly from the balance sheet but the effect of
depreciation will be dispensable. On taking net assets, the decision in terms of
considering non-productive assets also plays a vital role.
7. Describe some of the factors that management considers when setting its
minimum target rate of return
The management should take into account the risk involved in the business of the division,
expectation of the investor from the investment, rate of return of the competitors, the
interest rate being paid by the on acquiring the debts, and economic conditions of the
market while setting its minimum target rate of return.
8. Explain why some firms prefer to use RI rather than ROI for performance
measurement
Some firms prefer to use Residual Income rather than Return on Investment because
in the RI approach capital turnover of the company is also taken into account but in the
ROI approach capital turnover of the company is dispensable.

85
9. Explain why budget versus actual performance reports are insufficient for
evaluating the performance of investment centers
Budget versus actual performance reports is insufficient for evaluating the performance
of investment centers because they do not care about the actual use of assets made
by the investment centers for creating the revenues of the company.
P10 – 47A (Braun):
1. What is the highest acceptable transfer price for the divisions?
The highest acceptable transfer price for the divisions is $30, the market price of the
product; since the small component division of the company can find it easy to sell.
2. Assuming the transfer price is negotiated between the divisions of the
company, what would be the lowest acceptable transfer price? Assume
variable selling expenses pertain to outside sales only
Transfer price = Direct Material + Direct Labor + Variable Manufacturing Overhead
=$12+$9+$7=$28
Therefore, the lowest acceptable transfer price should be $28.
3. Which transfer price would the manager of the Small Components
Division prefer? Which transfer price would the manager of the
Computer Division prefer?
The manager of the small component division should prefer $30 as their transfer price
to get more prices.
On the other hand, the manager of the computer division should prefer $28 as the transfer
price to spend a lesser amount for getting the video card.
4. If the company’s policy requires that all in-house transfers must be priced
at full absorption cost plus 9%, what transfer price would be used? Assume
that the increased production level needed to fill the transfer would result
in fixed manufacturing overhead decreasing by $2.00 per unit. (Round your
answer to the nearest cent)
Full absorption cost = Direct Materials + Direct Labor + Variable Manufacturing
Overhead + Fixed Manufacturing Overhead – Decrease in Manufacturing Overhead
=$12+$9+$7+$6-$2=$32
Transfer price = Manufacturing Cost + 9% of Manufacturing Cost
=$32 + (9% x $32) = $34.88
Therefore, the transfer price is $34.88

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5. What is the highest acceptable transfer price for the divisions?
The highest acceptable transfer price for the divisions is $30, the market price of the
product; since the small component division of the company can find it easy to sell.
6. Assuming the transfer price is negotiated between the divisions of the
company, what would be the lowest acceptable transfer price? Assume
variable selling expenses pertain to outside sales only
Transfer price = Direct Material + Direct Labor + Variable Manufacturing Overhead
=$12+$9+$7=$28
Therefore, the lowest acceptable transfer price should be $28.
7. Which transfer price would the manager of the Small Components
Division prefer? Which transfer price would the manager of the
Computer Division prefer?
The manager of the small component division should prefer $30 as their transfer price
to get more prices.
On the other hand, the manager of the computer division should prefer $28 as the transfer
price to spend a lesser amount for getting the video card.
at full absorption cost plus 9%, what transfer price would be used? Assume
that the increased production level needed to fill the transfer would result
in fixed manufacturing overhead decreasing by $2.00 per unit. (Round your
Full absorption cost = Direct Materials + Direct Labor + Variable Manufacturing
Overhead + Fixed Manufacturing Overhead – Decrease in Manufacturing Overhead
=$12+$9+$7+$6-$2=$32
Transfer price = Manufacturing Cost + 9% of Manufacturing Cost
=$32 + (9% x $32) = $34.88
at total manufacturing variable cost plus 18%, what transfer price would be
used? Assume that the company does not consider fixed manufacturing
overhead in setting its internal transfer price in this scenario. (Round your
Transfer price = Variable Manufacturing Cost + 18% of Variable Manufacturing Cost
= $28 + (18% x $28) = $33.04 Therefore, the transfer price comes to be
$33.04.

87
10. Assume now that the company does incur variable selling expenses on
internal transfers. If the company policy is to set transfer prices at 107% of
the sum of the full absorption cost and the variable selling expenses, what
transfer price would be set? Assume that the fixed manufacturing overhead
would drop by $2.00 per unit as a result of the increased production
resulting from the internal transfers. (Round your answer to the nearest
cent)
Revised absorption cost = Absorption cost + Variable
Selling Expense =$32+$7=$39
Transfer price = Revised absorption cost + 107% of Revised Absorption Cost
= $39 + (107% x $39) = $80.73
11. Manufacturing overhead would drop by $2.00 per unit as a result of the
increased production resulting from the internal transfers. (Round your
Revised absorption cost = Absorption cost + Variable
Selling Expense =$32+$7=$39
Transfer price = Revised absorption cost + 107% of Revised Absorption Cost
= $39 + (107% x $39) = $80.73

88
CHAPTER 14:
DIFFERENTIAL ANALYSIS: THE KEY TO DECISION MAKING
LO1: Cost Concepts for Decision Making
A relevant cost is a cost that differs between alternatives.
- Avoidable costs: is a cost that can be eliminated in whole or in part by choosing one
alternative over another.
Irrelevant cost:
- Sunk costs.
- Future costs do not differ between alternatives.
→ The key to successful decision-making is to focus on relevant costs and benefits as well as
opportunity costs while ignoring everything else.
The concept of “Different Cost for Different Purposes” is basic to managerial accounting.
Relevant Cost Analysis
1. Eliminate costs and benefits that do not differ between alternatives.
2. Use the remaining costs and benefits that differ between alternatives in making the
decision. The costs that remain are the differential, or avoidable, costs.
LO2: Adding and Dropping Product Lines and Other Segments.
In this scenario, the two alternatives under consideration are keeping the housewares
product line and dropping the housewares product line. However, in deciding whether to
drop houseware, it is crucial to identify which costs are relevant and irrelevant.

89
With this information, management can determine that $15,000 of the fixed expenses
associated with the housewares product line are avoidable and $13,000 are not.
In this case, dropping the housewares product line would result in a $5,000 reduction in
net operating income.
→ The housewares line should not be discontinued unless a more profitable use can be found for
the floor and counter space.
LO3: The Make or Buy Decision
All of the activities, from development to production, to after-sales service are called a value
chain.
When a company is involved in more than one activity in the entire value chain, it is vertically
integrated.
A decision to carry out one of the activities in the value chain internally, rather than to buy
externally from the supplier, is called a make or buy decision.

90
1. Opportunity Cost:
- An opportunity cost is a benefit that is foregone as a result of pursuing some course
of action.
- Opportunity costs are not actual cash outlays and are not recorded in the formal
accounts of an organization.
2. Value to Business (Deprival Value):
Recoverable value refers to either:
- Net Realizable Value (NRV)
[i.e., how much we can get from selling the asset, after taking into account all relevant
selling costs]; or
- Value In Use (VIU) (which can be determined by the Economic Value (EV) or Present
Value (PV) of the asset)
[i.e., the Economic Value to the owner, including opportunity cost and expected
income/ expenses, if any; or the Present Value of the asset’s cash flows to the owner].
LO4: Special Orders
A special order is a one-time order that is not considered part of the company’s normal
ongoing business.
When analyzing a special order, only the incremental costs and benefits are relevant.
Since the existing fixed manufacturing overhead costs would not be affected by the order, they
are not relevant.
1. Utilization of a Constrained Resource:
- When a limited resource of some type restricts the company’s ability to satisfy demand,
the company is said to have a constraint.

91
- The Theory of Constraints (TOC) is based on the insight that effectively managing
the constraint is a key to success.
- The machine or process that is limiting overall output is called the bottleneck – it is
the constraint.
- The procedure to follow to strengthen the chain is clear:
Step 1: Identify the weakness link - the constraint.
Step 2: Do not place a greater strain on the system than the weakest link can handle.
Step 3: Concentrate improvement efforts on strengthening the weakest link.
Step 4: If the improvement efforts are successful, eventually the weakest link will improve to
the point where it is no longer the weakest link.
LO5: Contribution Margin per Unit of the Constrained Resource.
When a limited resource of some type restricts the company’s ability to satisfy demand, the
company has a constraint.
Fixed costs are usually unaffected in these situations, so the product mix that maximizes the
company’s total contribution margin should ordinarily be selected.
- A company should not necessarily promote those products that have the highest unit
contribution margins.
- Rather, the total contribution margin will be maximized by promoting those products or
accepting those orders that provide the highest contribution margin to the constraining
resource.
1. Managing Constraints:
- Effectively managing an organization’s constraints is a key to increased profits.
- It is often possible for a manager to increase the capacity of the bottleneck, which is
called relaxing (or elevating) the constraint.
LO6: Joint Product Costs and the Contribution Approach
Two or more products that are produced from a common input are known as joint products.
The split-off point is the point in the manufacturing process at which the joint products can
be recognized as separate products.
The term joint cost is used to describe the costs incurred up to the split-off point.

92
Example:
- Sawmill, Inc. cuts logs from which unfinished lumber and sawdust are the immediate
joint products.
- Unfinished lumber is sold “as is” or processed further into finished lumber.
- Sawdust can also be sold “as is” to gardening wholesalers or processed further into
“presto-logs.”
- Data about Sawmill’s joint products include:
→ The lumber should be processed further and the sawdust should be sold at the split-off point.

[TUTORING SESSION KÌ I - 2021] Final Handbook MA.pdf

[TUTORING SESSION KÌ I - 2021] Final Handbook MA.pdf

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