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Chapter 14The Flexible Budget: Factory Overhead Teaching Notes for Cases 14.1: Budgeting and Performance Evaluation at the Berkshire Toy Company ABSTRACT: This case provides an opportunity to study budgets, budget variances, and performance evaluation at several levels. As a purely mechanical problem, the case asks for calculations of various price, efficiency, spending, and volume variances from a set of budgets and actual results. The case is also an interpretive exercise. After the variances have been computed, the next step is to develop plausible conjectures about their likely causes. Finally, it is a case about performance evaluation and responsibility accounting. The company has an incentive plan, based on the budget variances, that needs to be analyzed and critiqued. TEACHING NOTES In a recent survey of U.S. accounting and financial executives, Siegel and Sorensen (1994) identified a “preparation gap” between the expected and actual level of the employees’ accounting knowledge, skills, and abilities. Among the top preparation gaps reported, budgeting ranked first and performance evaluation ranked fourth. Subsequent studies in the practice of management accounting confirmed the importance of analytical skills and long-term planning (Siegel and Sorensen 1995, 1999). This case is designed to help instructors address an important aspect of the preparation gap in budgeting and performance evaluation. Berkshire Toy Company complements and supports topic coverage in a range of popular textbooks and provides an opportunity to integrate concepts from these closely related subjects. An example of a poorly designed reward system is used to help the student identify basic problems created when the system does not support goal congruence between the managers and the owners of the firm. A related issue concerns the coordination of the efforts of the managers within the firm. The case also involves calculating and interpreting variances. It is designed for an upper-division, undergraduate cost accounting course or an M.B.A.-level managerial accounting course. This Teaching Notes section uses an agency framework for analysis of the case questions. Jensen and Meckling (1976, 308) define an agency relationship as one in which a principal delegates decision-making authority to an agent who is expected to act on behalf of the principal in performing assigned tasks. In the modern corporation, the delegation of authority and responsibility flows through a hierarchy of command from the stockholders to the board of directors to top management to lower-level managers and employees. Each link in the chain of command can be viewed as a separate agency “contract” between a principal and an agent. At Berkshire Toy Company for example, Janet McKinley is both an agent of the Quality Products Corporation stockholders and a principal to lower level managers. However, all Berkshire Toy Company personnel are agents of the stockholders. A general assumption in agency theory is that both principals and agents act in their own self-interest. A manager who has no guarantee of future employment with a given firm has incentives to make short-term decisions. Some decisions may maximize bonuses and compensation for the manager in the short term but reduce the value of owners’ investment in the long term. Other decisions may maximize leisure, perquisites, or other non-pecuniary benefits for the manager and also decrease the value of the owners’ investment. Effective performance evaluation plans and incentive systems will produce an agency contract under which managers may profit from decisions that are beneficial to owners. Blocher, Stout, Cokins, Chen: Cost Management 4e 14-1 ©The McGraw-Hill Companies, Inc., 2008 Principals hire agents (managers) to obtain the benefit of the agent’s knowledge and expertise. Information asymmetry results when managers do not disclose to their principals the full extent of their private information about the operations of the firm. A failure to fully disclose information has implications for budgeting and performance evaluation. The construction of a realistic and accurate operating budget requires managers to reveal their private information about operating costs and revenues. In performing their information task, managers provide the firm with valuable direction in market and production activities. However, the information that would benefit the firm’s owners may impair the managers’ prospects for favorable variances, good performance evaluations, and large year-end bonuses (Kaplan and Atkinson, 1998, p. 769). Accordingly, self-interest may perpetuate information asymmetry. Because of Janet McKinley’s extensive background and expertise in Berkshire Toy Company operations, the problem of information asymmetry is not critical in preparing a budget or evaluating her subordinate managers. For the majority of companies, however, management’s disclosure of information is crucial. In such cases, the firm’s top management may seek or purchase outside information from consultants and benchmark studies (Horngren et al. 2000, 196). The benchmark information could be shared with internal managers to reduce potential budgetary slack. Compensation plans might also incorporate comparisons between a firm and its benchmark counterparts as a part of a manager’s overall evaluation. The teaching notes are organized as follows. Implementation of the case in the classroom is presented first. The next section covers the calculation of the variances and bonuses for Berkshire’s top management. Following the presentation of the variance calculations, the note provides explanations of the variances in the context of the case facts related to sales volume, materials, labor, and overhead. Relevant textbook approaches to incentive systems and performance evaluations, budgets as a performance measure, responsibility accounting, and the use of a balanced scorecard for performance evaluation are discussed. Implementation of the Case in the Classroom The Berkshire Toy Company case fits well with a discussion of agency theory as it pertains to budgets, performance evaluation, incentives, and compensation in a corporate environment. In addition, the case is designed to allow students to work with variances at both the mechanical and interpretive levels. To use the case for a classroom discussion, some background reading in performance evaluations is essential to a meaningful dialogue. However, the case is intended to be primarily an outside-the-classroom project. An earlier version of this case worked well as an individual assignment and as a group project. The calculation of variances fits well into a spreadsheet assignment. One successful strategy has been to assign the variance and bonus calculations to the entire class and then have one group of students lead the discussion of the interpretation of the variances and the evaluation of the incentive plan. This approach has led to some lively classroom discussions. Generally, students have found the computation of the variances to be fairly straightforward. Graduate students have typically had an easier time than undergraduates. In the interpretation of the variances, most students were quick to spot the effects of raw materials stock-outs and inferior quality materials on production efficiency. They also generally recognized the deleterious effect of high volume on production costs. However, many students were less willing than the authors to assign responsibility for these costs to Marketing Manager Smith. They placed at least an equal burden on Production Manager Wilford for attempting to keep up with Smith’s demands without giving due regard to the effect this would have on the productivity of his workers. Students have tended to save their harshest criticisms for Janet McKinley. As a general rule, the greater the students’ appreciation for the interactions among departments, the more they criticized McKinley’s leadership. According to the prevailing view among these students, it is natural to expect the department managers to focus on their own domains. If interactions cause conflicts among the departments, it is McKinley’s job to step in and arbitrate for the greater good of the entire division. These students felt that she failed to perform this crucial role. Requirement 1a: Calculation of Berkshire Toy Company Variances Blocher, Stout, Cokins, Chen: Cost Management 4e 14-2 ©The McGraw-Hill Companies, Inc., 2008 In the present case. The total flexible budget variance for fiscal year 1998 was an unfavorable $2. and variable overhead (based on actual direct labor hours) are multiplied by standard prices for the inputs. and the adequacy of maintenance performed in the current and prior years. and 45.965. and the variable and fixed overhead spending variances.145.596 is consistent with her report. Through the aggressive marketing efforts of Rita Smith. The flexible budget (Column 3) is based on standard input prices and standard input quantities allowed for the actual level of output achieved.3510. Price and efficiency variance computations are required also to explain the flexible budget variance of $2. Inc. combined with other information gathered from the conversation with McKinley. 105. Table 6 also shows also the computations for the sales mix variance and the sales volume variance. an investigation of the larger variances should focus on the high volume of sales in fiscal 1998. The standard cost sheet (Table 2) shows an historical average for accessories and does not include any additional labor time for appliqués or monograms.556) multiplied by the budgeted mix percentages (85. Information in Table 5 shows an increase in catalogs. Moreover. is calculated as the actual total number of units sold in all channels (325. retail and catalog sales decreased overall.101. The flexible budget revenue (based on the actual sales channel mix) is calculated as the actual number of units sold in each sales channel (174. McKinley reported that Smith achieved the high volume primarily by offering a special Internet sales price discount. 2008 .192 unfavorable fixed selling expense variance (Table 6) suggests that Smith also increased her direct selling efforts and advertising expenditures. the quality and availability of production materials and labor. provide clues about the causes of the troubles at Berkshire Toy. The student should know that sales volume equals production volume because inventories are unchanged. Total fixed costs will be identical in both the flexible and master budgets. the company’s sales and production volumes were significantly over budget in fiscal 1998. Actual quantities used of direct materials. 0. The unfavorable sales mix variance of $675.000.145.101. The flexible budget variable selling cost is calculated as the actual total number of units sold (325. or 48 percent of the total flexible budget variance. the Internet sales promoted units that required elaborate costumes and labor-intensive embellishments such as tattoos. It seems doubtful that these cost increases were considered in establishing the discount price of $42. The standard variable selling cost per unit may be derived from the master budget in Table 1 and the budgeted sales units of 280.100 unfavorable flexible budget variance in variable selling expenses and $560.162) multiplied by the appropriate budgeted selling prices of $49.006 above the budgeted amount.192) total $1. Requirement 2a: Discussion of the Berkshire Toy Company Variances Marketing Manager The variances presented in Tables 6 and 7.006 indicates that. Cokins. The unfavorable variances in variable selling expense ($443. Bill Wilford will receive no bonus because his bonus base is unfavorable. Requirement 1b: Calculation of Bonuses at Berkshire Toy Company The bonuses for the department heads are presented in Table 8.116.00 per bear. His bonus base is computed as the sum of the efficiency (usage or quantity) variances for materials. Alternatively. and samples consistent with an Blocher. brochures. The notes to Table 7 provide the supporting calculations.727 (unfavorable).The calculation of variances begins with the preparation of the flexible budget shown in Table 6. Chen: Cost Management 4e 14-3 ©The McGraw-Hill Companies. This is reflected in the $2. and variable overhead. based on the budgeted sales channel mix (Column 5). direct labor. holding everything else constant.100) and fixed selling expense ($560. and 15.003. The sales volume variance is important to the extent that it captures a portion of the master (static) budget variance that results when actual sales volume is more or less than planned. The flexible budget revenue. multiplied by planned selling prices. students may prefer to use formulas. Stout. At a minimum. Table 7 shows also the variances calculated using the formula approach. and $32.292.556 units would have caused operating income to be $1. the increase in sales volume of 45. The $443.556) multiplied by the unit selling cost of $4. $42. the labor rate variance. However. labor. respectively).083 favorable sales volume variance for total revenue. Although these sales increased. Table 7 presents the tabular approach to calculate the variances..429. the favorable sales volume variance of $1.727 (Table 6). The resulting numbers are compared to the actual costs to obtain price variances and to the flexible budget amounts to calculate efficiency variances. 015. The company’s policy on commissions did not change in the current year.971) to $4.74 ($1.556) during the current year. Inc. This matter should be investigated further. shipping and packing increased from $3.913 ÷ 271. However.580.089 ÷ 325. On a unit basis. Chen: Cost Management 4e 14-4 ©The McGraw-Hill Companies. Possible explanations are rate increases by carriers or Berkshire’s absorption of shipping charges on deliveries that were later than promised. Cokins..expanded advertising campaign. 2008 . the decrease in total commissions indicates a shift from retail and wholesale activity to catalog and Internet sales on which commissions were not paid.85 ($1. Stout. Blocher. Cokins. 2008 . Inc.Blocher. Chen: Cost Management 4e 14-5 ©The McGraw-Hill Companies.. Stout. . Chen: Cost Management 4e 14-6 ©The McGraw-Hill Companies. Inc. Stout. 2008 .Blocher. Cokins. . Inc.Blocher. Chen: Cost Management 4e 14-7 ©The McGraw-Hill Companies. Stout. Cokins. 2008 . Inc.Blocher. Stout.. 2008 . Cokins. Chen: Cost Management 4e 14-8 ©The McGraw-Hill Companies. 51. The case facts do not contain sufficient data to determine whether this is true. the use of direct labor to manufacture accessories.12 per unit.556 units produced). One assumption is that fixed costs remain constant in total. McKinley stated that production was close to capacity in 1998. frequent machine breakdowns and operating inefficiencies. However. unit costs will increase. The budgeted price was an average of $0. Several factors mentioned in the case are important in explaining the variance.702 units. The unfavorable direct materials efficiency variances for the fabric and eyes might also be explained by materials of substandard quality. Stout. Finally. However. The unfavorable direct labor efficiency variance of $466.188 (Table 7) represents excess usage of 51.164 pounds at a standard cost of $1. The variance may also indicate a shift from the historical mix of accessories to more expensive accessories such as sunglasses. the net of the production variances is an unfavorable $1. including: the reduced morale and efficiency of laborers resulting from high volume and overtime pressure. He obtained favorable price variances for fabric. The unfavorable efficiency variances for the fiber filling might be partially explained by the storm drain overflow in July 1997. With respect to the designer box. Production Manager It is evident that the high volume of activity in 1998 had consequences outside the marketing department. It is doubtful that all of this filling could be ruined at one time. Materials of inferior quality could have affected both the quantity of materials used and the number of labor hours used in production. Chen: Cost Management 4e 14-9 ©The McGraw-Hill Companies. Therefore. the company must have substituted a different package for the designer box. Table 3 indicates that on an average unit basis. This matter should also be investigated. Therefore.. a practice that would likely have long-run consequences for the product’s image.2 hours per bear (Table 2). The variance might be explained by unexpected temporary or permanent price increases or the costs of rush orders or special orders of the imported items.997 hours ÷ 325. When a facility operates for an extended time at a volume greater than its long-run optimum.164 pounds would require a volume of Blocher. Cokins. Table 3 shows that only 315. and specialty outfits that were promoted in the advertising and the Internet sales program. Some of the units may have been shipped without any box perhaps in a plastic bag and shipping carton.171. For example.639. although 325. which is another indication that production volume was approaching the boundary of the relevant range. Inc. Changing consumer tastes may have also been a factor. the variance of $74. the actual direct labor hours per bear increased to 1. the increase in total accessories cost may be correlated to a change in the mix of distribution channels. Based on information in the case the decreased prices may have resulted from purchases of inferior materials. The marketing department’s high sales volume in 1998 may be a principal cause of the production department’s unfavorable efficiency variances in its variable costs.556 bears were sold during the year. Hall’s bonus basis included also an unfavorable price variance for accessories. Another is that total variable costs increase (decrease) proportionally with increases (decreases) in production and sales volume. As shown in Table 8. it is also quite possible that the labor cost problems related to high volume were exacerbated by inferior raw materials.Purchasing Manager Approximately 50 percent of the total unfavorable flexible budget variance can be traced to the activities of the managers of purchasing and production. David Hall. and fiber filling. for at least 9. Product quality and image are policy issues for management. the same factors will explain the unfavorable variable overhead efficiency variance of $181.859. plastic joints. The case facts suggest that excessive overtime hours were needed to meet demand. Therefore. and poor-quality direct materials. It is also possible that the standard costs used in the calculations may have been inaccurate and need to be revised. the standard for direct labor is 1.4 hours (448. was responsible. the factory was operating at or beyond the edge of the relevant range for which production standards were determined.45 per pound. regardless of changes in volume. the assumptions that underlie the formulation of standard costs may no longer be valid. The matter should be investigated further. Thus. The variable overhead efficiency variance is strictly proportional to the direct labor efficiency variance because variable overhead is applied on the basis of direct labor hours.638 is a prominent component of the total variance and includes the regular wages paid on overtime hours. Table 8 lists the materials price variances for which the purchasing manager. In this case. 2008 . jeans. At approximately one cubic foot of space for each two pounds of filling.854 boxes were used. However. Second. The controllability principle (Horngren et al. while the purchasing and production departments are treated as cost centers. Cokins. Stout. Requirement 2b: Discussion of Berkshire Toy Company’s Bonus Plan Many of the troubles at Berkshire Toy Company can be attributed directly to the misaligned incentives created by the incentive compensation plan. the factory may have been operating outside of its relevant range in the current year.1 This means that the factory produced over 325. and then decrease during the heaviest selling months from November through May.556].944) ÷ 271. 2000.971] to $1. First. Inventories of raw materials and finished goods generally increase significantly during the early months of the company’s fiscal year.329 can be explained by the replacement of factory laborers at higher-than-budgeted wage rates. maintenance costs rose from $1.00 per unit produced in fiscal 1997 [($256.488. they are not equal at all times during the year.000 units during the year although its normal capacity was 280. possibly because of inferior materials. possibly because of overworked production workers. The compensation plan ignores the impact of the company’s high sales volume on its production costs.373) ÷ 325. It ignores entirely the interactions among departments and the ways in which the actions of one department can affect the performance of the others. compared with the $1. The marketing department is evaluated as a revenue center. The variance is primarily caused by the large increase in overtime premiums paid in fiscal 1998 and the resulting proportional increase in employer taxes and fringe benefits. Then it suggests several alternative methods of measuring and rewarding performance. it is also likely that many joints were destroyed in production.224 + $27. 195. This section of the Teaching Notes discusses first the dysfunctional aspects of the bonus plan.. It is more likely that operators of the stuffing machine overstuffed the units over a reasonably long period of time and/or large amounts of stuffing were discarded because of quality problems. 1 Although the annual production and sales volumes are equal.14 per unit produced.36 per unit produced in fiscal 1998 [($415. maintenance may have been neglected in prior years.294 on the plastic joints represents 309.582 cubic feet or a space larger than a 40-foot-square room with a 15-foot ceiling. the incentive compensation plan appears to be a sensible one. it rewards the marketing manager for all increases in revenues (net of selling expenses) without regard to whether the increased sales volume made a contribution to profit.14 per joint. failing to take account of interactions among departments. The unfavorable direct labor wage rate variance of $76. At first glance. Because this case focuses on the annual budget and the associated performance evaluations. Further investigation should be performed.25. annual production volume must approximate annual sales volume. 2008 . Table 4 provides some clues about the unfavorable variable overhead spending variance of $327. Dysfunctional Aspects of the Compensation Plan There are two major dysfunctional aspects of the Berkshire Toy Company’s incentive compensation plan. In addition. Blocher. Chen: Cost Management 4e 14-10 ©The McGraw-Hill Companies.243 joints (16 percent of the total joints used) at a standard cost of $0. the compensation plan at Berkshire focuses exclusively on the areas of responsibility under each manager’s direct control. However. Because Berkshire’s inventories were negligible at the beginning and end of the year. The predictable result was that production costs—especially direct labor and variable overhead—departed significantly from standards. The higher level of maintenance may have become necessary as a result of pushing the factory to produce beyond its normal capacity. The unfavorable efficiency variance of $43. Inc. 170) states that each manager should be evaluated and rewarded based on aspects of the company’s performance that are under his or her control.883 + $15. Thus. Areas of responsibility are divided among the department managers and each manager receives a bonus based on the performance in his or her area of responsibility. it treats the departments as self-contained units.000 units (Table 2). Notice that average maintenance costs in fiscal 1994 and 1995 were approximately $1. Moreover.00 per unit incurred in 1996 and 1997. Zimmerman 1995. it ignores the calculation of interim variances (which are computed under an assumption of unequal production and sales volume) and the related issue of month-to-month inventory management. Part of this variance may be explained by the box of joints that was accidentally discarded. 596 (unfavorable) sales mix variance indicates a shift from the retail and catalog channel to Internet and wholesale channels that offered more attractive selling prices. stock-outs can cause managers to reassign workers to produce the missing components. The purchasing and marketing departments also have interactions that are not taken into account by the compensation plan.956 unfavorable price variance in accessories. However. to unexpected sales demand. Blocher. Although further investigation of the accessories variance is needed. marketing. Smith. It may restrict output to normal capacity. The plan promoted specialty bears on the Internet with a price discount. the $675. there was minimal sharing of information among managers. A capacity expansion may be warranted if management believes that the current year’s demand is a long-range trend. Also. labor. Another important interaction ignored by the compensation plan is that between purchasing and production. Smith’s bonus formula should be based on divisional contribution margin. The unfavorable variance might be the result of one or a combination of factors as discussed previously in the “Marketing Manager” section of Requirement 2a. Similarly. sales. Smith is encouraged to consider only sales and the related selling costs.. and production managers or that she provided any feedback on the company’s operating results during the year. If the investigation of variances confirms that a large number of units were shipped in standard shipping cartons without the designer box. this occurred when Wilford responded to the shortage of bear outfits by having workers produce them in-house. not on gross revenue. Sales volume and total revenues increased over the master (static) budget amount (Table 1). she should be in a position to approve and implement a budget to plan operations and to measure the performance of her subordinates. the compensation plan can serve as a control mechanism if it encourages managers to think in terms of overall company profitability instead of discrete areas of managerial responsibility. Accordingly. Table 8 shows that David Hall’s bonus was reduced for a $26. The effect on the bottom line was an operating loss of $843. actions in the purchasing department can have an impact on marketing’s performance. marketing. No effect on sales is evident in fiscal 1998. 2008 . or is acquiring them in insufficient quantities. this could negatively affect the product’s image and. At Berkshire Toys. production will be affected. Coping with raw materials stock-outs can create inefficiencies on the factory floor by stopping production and idling workers. Classical economic theory predicts that a profit-maximizing firm will increase output until marginal revenue (net of distribution and selling costs) equals marginal production costs. the compensation plan is effectively telling her to expand output until net marginal revenue is zero. Inc. The second dysfunctional aspect of the compensation plan is that the sales manager is rewarded on the basis of revenues (net of selling costs) rather than divisional contribution margin. at least in part. Berkshire Toy Company’s marketing plan evolved after the budget was planned for the current year. Janet McKinley has extensive experience. A compensation plan should encourage a sales manager to consider the effects of a marketing plan on both total revenues and costs. The case facts do not provide any evidence that McKinley tried to coordinate the efforts of the purchasing. ultimately. It seems clear that she received feedback from the individual managers.Management has several strategic options in rectifying the problem. In the short term. The result may be excessive waste of materials due to spoilage and extra labor hours required for rework. the variable production costs of materials. having acquired purchasing. However. and production expertise. it is apparent that marketing activities could produce an increase in the accessories cost. but customer satisfaction may have been diminished. However. or make capital expenditures to increase the productive capacity. Cokins. By omitting the variable production costs from Smith’s bonus formula. For all department managers. and overhead were higher than planned and related. If the purchasing department is acquiring inferior raw materials. Thus. Unfortunately. Suggestions for Improving the Compensation Plan Budget variances can be used as short-term performance measures to reward Hall. increase prices to decrease demand and/or increase profitability. and Wilford. Chen: Cost Management 4e 14-11 ©The McGraw-Hill Companies. Stout. reducing their efficiency. the bonus formula should include a component based on total divisional profit to encourage managers to share information and cooperate in order to maximize overall profit.745. it must be concerned about innovation. consistency in quality by the number of units requiring rework. measured over the long term by the number of new channels developed. management should articulate the business unit’s goals for customer concerns. However. Short-term financial performance Blocher. 686). The BSC necessitates an internal perspective to support the customer perspective. and the financial perspective. From the customer perspective. Also part of the internal perspective is the company’s ability to advertise and market effectively. BSC data are not generally included in public disclosures (Kaplan and Norton 1993. Chen: Cost Management 4e 14-12 ©The McGraw-Hill Companies. The BSC is particularly appropriate for segments and business units as opposed to entire corporations. and cost (Kaplan and Norton 1992.Long-term performance might be enhanced by providing stock options as an element in the managers’ compensation. Web-site surveys could be conducted to measure the product’s image with the public. and productivity (Kaplan and Norton 1992. Management should evaluate internal processes related to cycle time. which addresses how the company appears to its shareholders. and 1996) proposed a “balanced scorecard” that augments the traditional financial performance measures with nonfinancial measures and includes both short-term and long-term indicators. Productivity can be measured by factory labor hours per unit produced. Berkshire will primarily be concerned with product quality and product image. the option price should be at least as high as the current market price of the stock (Kaplan and Atkinson 1998. and performance measures should be chosen to emphasize them. 1993. stock options mitigate the effects of separation of ownership and control by giving managers incentives to increase the future market value of the firm. Although the Berkshire Toy Company produces a very traditional product that appeals to old-fashioned values. they will not change the fact that the incentives are based only on financial performance measures. The final BSC perspective is the financial perspective. 73). These modifications will help to alleviate the most egregious examples of misaligned incentives. the innovation and learning perspective. quality. because information in the BSC is related to a business unit’s competitive advantage. These include timeliness of delivery. the Berkshire Toy Company will be concerned with both its long-term and short-term contribution to the financial health of the Quality Products Corporation. 2008 . Inc. product or service quality. The internal perspective of Berkshire’s BSC will be concerned with the company’s productivity on the factory floor and its consistency in maintaining product quality. and create value. Requirement 3 (Optional): Discussion of Balanced Scorecard Measures Kaplan and Norton (1992. To provide the proper incentive. which is concerned with the company’s ability to innovate. improve. Stout. These factors could be measured by the number of defective units returned by customers and the number shipped in nonstandard containers. the internal perspective. For example. 141). This portion of the scorecard will identify the core competencies of the business. cash flow. 75). However. employee skills. Important also are the company’s ability to create new product generations and product accessories (measured by the time required to develop and implement a new accessory line). The third perspective in a BSC is the innovation and learning perspective. Finally.. or new markets opened. and effectiveness in communication with customers by the number of catalogs mailed and the number of visits to the company’s Internet site. and return on investment (ROI). In theory. Measures of innovation and learning should focus on such factors as new products created. In using a BSC to address the customer perspective. from the financial perspective. a BSC can be incorporated into evaluation and compensation plans. Of particular interest will be the company’s ability to develop new marketing channels. The balanced scorecard (BSC) reports on the performance of a business from four interrelated perspectives: the customer perspective. and Berkshire’s ability to improve its production processes (measured by improvements in production costs and/or quality). Berkshire might monitor the prices of its collectible bears in the secondary market to measure image and quality. and over the short term by the fraction of sales volume attributable to the newest channels. Common financial measures are operating income. Cokins. new processes developed. and ———. Kaplan. D. Mowen. M. Fort Worth. Horngren. Burton. ———. 3rd edition. IL: Irwin. Inc. Jensen. TX: The Dryden Press. Cincinnati. Theory of the firm: Managerial behavior. 1997. Montvale. Second.. Stickney. 1999. NJ: The Institute of Management Accountants.. and ———. Montvale. Stout. Managerial Accounting: An Introduction to Concepts. 1993.. and J. Meckling. Cost Accounting: A Managerial Emphasis. Methods. Journal of Financial Economics 3 (October): 305–360. 2000. Harvard Business Review 74 (January-February): 75–85. the requirement will sensitize each manager to areas of concern for future decisions. 1998. Implementing ABC and the balanced scorecard at a publishing house. G. Weil. Counting Less—Transformations in the Management Accounting Profession. Cost Management: Accounting and Control. Datar.can be measured by the annual operating profit (segment margin) of the division. Hansen. Management Accounting Quarterly 1 (Fall): 10–18. OH: SouthWestern College Publishing. and R. J. Montvale. Counting More. Chen: Cost Management 4e 14-13 ©The McGraw-Hill Companies. 1995. MA: Irwin/McGraw-Hill. and S. C. 10th edition. K. Inc. One advantage of the requirement is that it will encourage each manager to examine the consequences of recent decisions on overall company welfare. J. Chen. NJ: Prentice Hall. and Uses. R. and M. 1996. and ———. ———. ———. ———. Cokins. E. 6th edition.. and W. Advanced Management Accounting. Upper Saddle River. Using the balanced scorecard as a strategic management system.to ten-year period.. C. Lin. 3rd edition. Upper Saddle River. and E. Atkinson. Cost Management: A Strategic Emphasis. Inc. The long-term contribution can be measured by sales growth over a five. 1976. and T. G. What Corporate America Wants in Entry-Level Accountants. Bunch... Norton. The Practice Analysis of Management Accounting. NJ: The Institute of Management Accountants. 1994. Maher. Harvard Business Review 71 (SeptemberOctober): 134–147. Putting the balanced scorecard to work. Forsythe. The balanced scorecard—Measures that drive performance. 1999. Foster. 2008 . Blocher.. Sorensen. and D. 1999. Chicago.. and ———. 1999. REFERENCES Blocher. The narrative reports should be reviewed by McKinley as part of the department managers’ performance evaluations. NJ: The Institute of Management Accountants. ———. Boston. M. Zimmerman. R. NJ: Prentice Hall. agency costs and ownership structure. Siegel. 1995. Berkshire managers should be required to provide a narrative report and summary of the year’s activities as those activities relate to the BSC. 1992. and A. Harvard Business Review 70 (January-February): 71–79. Accounting for Decision Making and Control. 404 $5.615 $6.715 4.556 -63.725.624.428.230.000 $6.662.810 1.805.067 $1.637 246.338 170.290 $661.123.463.162 325.668.463.889 59.00 $0.745 $658.324 106.859.840 3.594 $8.556 Sales Volume Variance Master Budget 174.428.445.897 5.624.688.286 123.508 $7.851 16.000 0 42.000 280.280 $5.000 49 42 32 $256.305 1.962.965 105.088.181.083 $256.305 1.805.422 69.429 45.013 $1.344.125. Stout.8333 $0.184 $14.523.739 $6.023..248.037.897 5.418.446.745 $661.487 0 0 0 0 $8.488 66.14 $1.665 $6.750.192 1.9 1 1 $35.445.002 450.573.637 246.739 $6.400 14.856 16.429 45.920 4.090 895.027.45 $0.573.488 66.2 1.228 1.000 67.234 $772.184 $14.19 $0.230.2 $8.725.862 0 0 0 0 $990.000 1.124.338 1.400 196.862 -322.216.000 $6.197 $990.810 1.665 $450.556 238.10 Quantity Allowed Standard Cost 0.3050 $0.828 -$843.487 $11.Actual Units: Retail & Catalog Internet Wholesale Total Units Sales dollar: Retail & Catalog Internet Wholesale Total Sales Variable Production Costs: Direct materials Acrylic pile fabric 10-mm acrylic eyes 45-mm plastic joints Polyester fiber filling Woven label Designer box Accessories Total direct materials Direct labor Variable overhead Total variable production costs Variable selling expenses Total variable expenses Contribution margin Fixed costs: Manufacturing overhead Selling expenses Administrative expenses Total fixed costs Operating income Flexible Budget Variance Flexible Budget 174.428.200 33.2400 $0.962 17.24 1.013 $1.124.6000 $3.192 1.705 $8.304 $4.018 1.000 365.856 16.162 325.000 1.1200 $3.572 Blocher.083 $271.429 3.422 125.487 -3.00 $3.422 125.889 424.215 3.000 0 1.0500 $0. Inc.968.7368 $658.133 39.3800 $0.162 45.920 $1.828 -$843.018 101.962.290 $233.665 $6.248.11 .778.600 $1.002 450.023.000 $13.859.015.285 4.000 Budget Price or Cost $8.711 227. Chen: Cost Management 4e 14-1 ©The McGraw-Hill Companies.446.278 78.123.782 $37.023809 2 5 0.035 105.046.451 2.492 $0.965 105.933 5.840 3.538 $5.924 2.311 31.184 1.285 4.422 69.006.668.000 1.920 4.291 437. Cokins.05 $0.484.6283 $9.018 1.484.440.920 $788.278 10.218.7000 $1.404 $5.467 $165. 2008 $0.594 $8. . Chen: Cost Management 4e 14-1 ©The McGraw-Hill Companies. 2008 .14. Cokins. Inc.2: The Mesa Corporation Blocher. Stout. Blocher.. Inc. Cokins. Stout. Chen: Cost Management 4e 14-2 ©The McGraw-Hill Companies. 2008 . Stout.. Chen: Cost Management 4e 14-3 ©The McGraw-Hill Companies. 2008 . Inc. Cokins.Blocher. Chen: Cost Management 4e 14-4 ©The McGraw-Hill Companies. Inc. 2008 . Cokins. Stout..Blocher. 2. Treated as fixed costs: No variance. and are variable above that level. classifying a mixed cost as a variable cost may lead to decreases in operating resources such as lay-off of employees when the amounts of work needed to sustain the operations do not decrease proportionally. As a result. Actual operating level above the budgeted level Treated as variable costs: Favorable or unfavorable (efficiency) variance. and jump to a higher level of cost that is fixed over a range of volumes until another point is reached at which costs jump again to a higher level. financial managers need to develop cost models that reflect how costs actually behave. Actual operating level above the budgeted level Treated as variable costs: Favorable (efficiency) variance. pp. Inc. Treated as fixed costs: unfavorable (volume) variance. and so on. Stout. as will the quality of work performed. 3. Treated as fixed costs: Unfavorable (volume) variance. Discussion Questions: 1.. For this reason. When volume drops. misclassifications of cost behavior patterns make variance analyses “paper tigers. Step-fixed costs are fixed up to a certain level of volume. treating a mixed cost as a fixed cost may lead to a failure to provide sufficient operating resources to sustain the required operating level. Chen: Cost Management 4e 14-5 ©The McGraw-Hill Companies. Describe the implications on operating decisions of analyzing an operation with mixed costs as either a variable or fixed cost. Semi-variable costs are fixed below a certain level of volume. Wing. These costs are sometimes referred to as “semi-fixed costs.1: Kennard T. “Using Enhanced Cost Models in Variance Analysis for Better Control and Decision Making. Blocher.” Management Accounting Quarterly (Winter 2000).” For variance reporting to be useful. Describe the implications for variance analysis of analyzing a semi-variable cost as either a variable or fixed cost.Teaching Strategies for Articles 14. This article points out that oversimplifications of fixed and variable costs can result in the standard costing system not being used or. these costs are also referred to as “mixed costs. employee morale of the remaining employees may plummet (as indicated in the case example cited in the article). Cokins. can lead to bad decisions. if used. That is.” Actual operating level below the budgeted level Treated as variable costs: Unfavorable (efficiency) variance. Treated as fixed costs: Favorable (volume) variance. Workers and other resources will likely be overworked. 2008 . Morale of overworked workers will likely decrease. When volume increases. 1-9. Describe the implications for variance analysis of analyzing a step-fixed cost as either a variable or fixed cost.” Actual operating level below the budgeted level Treated as variable costs: Unfavorable (efficiency) variance. 2: Jean C. This article illustrates analyses of full costs of selected medical procedures of a healthcare organization. Discussion Questions: 1. Standard costs are determined for a hypothetical “Procedure 101" and there is an illustration of how variances can be obtained and interpreted. given example of actual results for the procedure over a year’s time. Blocher. Suver. Inc. This variance also is the amount of over (or under) absorbed fixed overhead. Cooper and James D. relative to staffing levels and other fixed costs. Stout. “Variance Analysis Refines Overhead Cost Control. 3. Based on the analysis in this article. at 150 patients x $20 each) explains why the reported profit of $5. the use of activity analysis is implied. The common theme in this article and the next (14. The volume variance is a reflection of the gain (or loss) due to an excess (or shortfall) of the actual number of patients relative to the budget.2. Why are expenses improperly matched and the reported income overstated? The effect is due to the volume variance. Cokins. The analysis shows the effect of volume changes on overhead recovery and on contribution to profits. Explain how the two variances included in Exhibit 3 are developed and interpreted.. what is the key driver of profitability in the discussion example? Since most of a healthcare organization’s costs are fixed relative to the source of revenue. The profit margin variance is the gain (or loss) due to an excess (or shortfall) of the actual number of patients relative to the budget. A key feature of the analysis is how the overhead variances are handled. the key driver of profitability is the volume of patient demand. and the cost at the pre-determined fixed overhead rate.800.3) is that variance analysis can be modified and adapted to the specific situation to provide useful information. Chen: Cost Management 4e 14-6 ©The McGraw-Hill Companies. which implies a focus on volume. In reading 14.14.800 is $3.” Healthcare Financial Management (February 1992). in the second article. 2.000 greater than the budgeted profit of $2. computed at the contribution margin per patient. the context is healthcare. 2008 . and in particular how to develop an understanding of the volume variance and how it affects profitability. The volume variance (unbilled overhead. Consider the example in Exhibit 4. Chen: Cost Management 4e 14-7 ©The McGraw-Hill Companies. What are the limitations of standard cost overhead analysis? The article points out that overhead variances may have little. “Overhead Control Implications of Activity Costing. as measured by the variances. useful interpretation. The variances measure the cost drivers that workers have control over. Blocher. the different elements of overhead can be identified and tied to the relevant cost drivers. Moreover. Regression is used to identify the cost drivers.. An example problem from the CMA exam is used as an illustration. The problem is solved both in a traditional format and also using ABC drivers. 2008 . Cokins. the interpretation of the variances has real significance for control and performance evaluation.” Accounting Horizons (December 1991) pp. This article points out some of the limitations of the traditional treatment of standard cost overhead variances. The use of labor as the base may be in some cases irrelevant in representing what are the true cost drivers. except to provide some information to management regarding the efficiency of labor usage (the typical base for determining the variances). Malcolm.3: Robert E. Stout. 69-78.14. The assumption that all overhead costs can be represented by a single cost driver (the homogeneity assumption) is rarely true. Discussion Questions: 1. How does the activity approach improve upon the standard cost analysis of overhead? By using the activity approach. if any. and a revised solution is derived. a typical variance analysis is done at a far too aggregate level for the information to be useful. In this way. Inc. 2. and thus the employees can be motivated to improve the usage of costs.
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