Lecture Accounting: What the numbers mean (5/e) - Chapter 15: Cost analysis for control

After reading this chapter, you should be able to answer the following questions: Why are all costs controllable by someone at some time, but in the short run some costs may be classified as noncontrollable? How does performance reporting facilitate the management-by-exception process? How can the operating results of segments of an organization be reported most meaningfully?...

CHAPTER 15

COST ANALYSIS FOR

CONTROL

Learning Objectives

1 Why are all costs controllable by

someone at some time, but in the

short run some costs may be

classified as noncontrollable?

2 How does performance reporting

facilitate the

management-by-exception process?

3 How can the operating results of

segments of an organization be

Learning Objectives

4 What is a flexible budget, and how is

it used?

5 How and why are the two

components of a standard cost

variance calculated?

6 What are the specific names assigned

to variances for different product

inputs?

Learning Objectives

7 How do the control and analysis of

fixed overhead variances and variable cost variances differ?

8 What are the alternative methods of

accounting for variances?

Learning Objective 1

• Why are all costs controllable by

someone at some time, but in the short run some costs may be

classified as noncontrollable?

Performance Reporting

• Involves the comparison of actual

results with planned results

• The objective is highlighting those

activities where planned and actual

results differ

• Appropriate actions may be taken to

address the causes of the favorable

or unfavorable variances

Strategic, Operational, and Financial Planning

Planning and Control Cycle

Relationship of Total Costs to

Volume of Activity

• Any differences between achieved and

planned performances should be evaluated

• As the level of activity changes from the

planned activity, total variable costs should

change

• The total amount of fixed costs should not

change with changes in levels of activity

+/-Cost Classification According

to a Time-Frame Perspective

• A noncontrollable cost is one which the

manager can do nothing to influence

the amount of the cost

• Noncontrollable costs occur in the short

run

• In the long run every cost is controllable

by someone in the organization

Learning Objective 2

• How does performance reporting

facilitate the

management-by-exception process?

Characteristics of the Performance Report

• A performance report compares actual

results to budgeted amounts

• It is an integral part of the control process

• The general format is as follows:

Budget Actual Activity Amount Amount Variance Explanation

• Variances are usually described as either

favorable or unfavorable

• A favorable variance occurs when results

exceed planned activities in a positive

manner – revenues are larger than expected

• An unfavorable variance occurs when results exceed planned activities in a negative

manner – expenses are larger than expected

+/-Responsibility Reporting

• The explanation column in the performance report is to communicate to upper-level

management the causes of variances

• In responsibility reporting, higher levels of

management receive less details regarding lower levels in the chain of command

• Managers want to eliminate unfavorable

variances and retain favorable variances

Management by Exception

• Managers concentrate their efforts only on

those activities that are not performing

according to the plan

• To aid in this effort, variances are often

expressed in percentages

• Only those variances that exceed a

predetermined percentage are investigated

Frequency of Performance Reports

• Performance reports should be issued soon after the period in which the activity takes place

• If later, actions are forgotten or confused

• A question regarding performance reports is

whether noncontrollable expenses should be

reported

• May want managers to be aware of all costs, or

may want managers to deal only with controllable

Reporting for Segments of

an Organization

• A segment is a division, product line, or

other organizational unit

• Using the contribution margin format,

sales, variable expenses, contribution

margin, fixed expenses, and operating

income are calculated for each segment

• Fixed expenses should be divided into

direct fixed expenses and common fixed expenses

Segment Fixed Expenses

• Direct fixed expenses would be

eliminated if the segment were eliminated

• Common fixed expenses are an allocated portion of the organization’s fixed

expenses

• Common fixed expenses would not be

eliminated if the segment were eliminated

Types of Segments

• A responsibility center is an element of

the organization over which a manager

has responsibility and authority

– Cost center – does not generate revenue

for the organization

– Profit center – generates revenue for the

organization

– Investment center – generates revenue

and controls assets of the organization

Evaluating Segments

• Cost centers are evaluated by comparing

actual costs incurred to budgeted costs

• Profit centers are evaluated by comparing

actual segment margin to budgeted

segment margin

• Investment centers are evaluated by

comparing actual and budgeted return on

investment based on segment margin and

assets controlled by the segment

Learning Objective 4

• What is a flexible budget, and

how is it used?

Flexible Budget

• A flexible budget is one that reflects

budgeted amounts for actual activity

• Flexible budgeting does not affect the

predetermined overhead application

rate

• Therefore, fixed overhead will be

overapplied or underapplied

Learning Objective 5

• How and why are the two

components of a standard cost

variance calculated?

Analysis of Variable

Cost Variances

• The total variance for a cost component is

called the budget variance

• The budget variance is caused by two

Variance Terminology

• Different variances are the responsibility

of different managers

• Must separate total variances so that

each manager can take appropriate

Direct Labor Variances

• Direct labor efficiency variance is the quantity

variance for direct labor

• The direct labor efficiency variance is the difference between standard hours allowed and actual hours worked

• Direct labor rate variance is the cost per unit of

input variance

• The direct labor rate variance is the difference

Learning Objective 6

• What are the specific names

assigned to variances for different product inputs?

Variance Names

Cost per unit

Input Quantity of Input

Raw materials Usage Price

Direct labor Efficiency Rate

Variable overhead Efficiency Spending

General Variance Model

• Quantity variance =

Standard Actual Standard

quantity - quantity X cost per

allowed used unit

• Cost per unit of input variance =

Standard Actual Standard

quantity - quantity X cost per

allowed used unit

Graphical Representation

Actual quantity used Actual quantity used Standard quantity allowed

Actual cost per unit Standard cost per unit Standard cost per unit

Cost per unit of Input variance

Quantity variance

Variance Analysis Objectives

• Objective is to highlight deviations from planned results

• Want to eliminate unfavorable variances and

capture favorable variances

• Need to analyze variances for each standard

• Usually raw materials usage variances and direct labor efficiency variances are reported frequently

Raw Materials Purchase Variance

• Many firms calculate and report raw

materials price variances at the time the

materials are purchased rather than when they are used

• Modified purchase price variance:

Standard Actual Actual

cost per - cost per X quantity

unit unit purchased

Learning Objective 7

• How do the control and analysis

of fixed overhead variances and

variable cost variances differ?

Analysis of Fixed Overhead

• Analyzed differently from variable cost

variances

• The focus is on the difference budgeted

fixed overhead and actual fixed

overhead expenditures

• This difference is divided into a budget

variance and a volume variance

Fixed Overhead Volume Variance

• Volume variance is the difference

between the amount of fixed overhead

applied to production and that planned to

be applied

• It is not appropriate to make per unit fixed overhead variance calculations because fixed costs do not behave on a per unit

basis

Fixed Overhead Budget Variance

• The budget variance is the difference

between budgeted fixed overhead for the period and the actual fixed overhead for

Learning Objective 8

• What are the alternative methods

of accounting for variances?

Accounting for Variances

• If the total of all of the variance is not

significant, it is included with cost of goods

sold in the income statement

• Standard costs also are released to cost of

goods sold

• Therefore, cost of goods sold reports the

actual cost of the items

• If variances are large, the variances are

allocated between inventory and cost of