12-1 Performance Assessment C hapter 12 Prepared by Douglas Cloud Pepperdine University

Explain responsibility accounting and differentiate between financial and nonfinancial performance measures. 2.Differentiate between static and flexible budgets used in performance reporting. 3.Determine and interpret direct materials and direct labor cost variances. 4.Prepare a performance report for a revenue center. ObjectivesObjectives After studying this chapter, you should be able to:

12-3 Responsibility Accounting Responsibility accounting may focus on specific units within the organization... …or on various aspects of the value chain that are accountable for the accomplishment of specific activities or objectives.

12-4 Responsibility accounting on a poorly designed system can lead to unethical practices by managers in key positions if too much pressure is placed on meeting performance targets. Performance Responsibility Accounting

12-5 Organizational Structure Organizational structure is the arrangement of lines of responsibility within the organization.

12-6 GE’s Six Sigma Program The program has five basic steps: 1.Define problem—Generally teams work to define problems related to some process or customer satisfaction. 2.Measure—Determine what is wrong with the existing process or service. 3.Analyze—Determine reasons for what is wrong. 4.Improve—Define and develop a plan of action. 5.Control—To ensure that changes are installed and used effectively, measures are implemented to keep problem from recurring.

12-7 Actual Cost Allowed Cost Variance Vice President Operations Mall 1$ 55,000$ 54,800$ 200U Mall 269,60068,4001,200U Vice president’s office 10,900 12,000 1,100F Total$135,500$135,200$ 300U From Manager: Mall 2 Financial Measures

12-8 Actual Cost Allowed Cost Variance Manager: Mall 2 Maintenance Department$ 25,400$ 24,700$ 700 U Advertising Department17,50018, F Security Department20,50019, U Mall manager’s office 6,200 5, U Total$ 69,600$ 68,400$1,200 U To Vice President Operations From Head: Security Department Financial Measures

12-9 Financial Measures Actual Cost Allowed Cost Variance Head: Security Department Supplies$ 3,000$ 2,000$ 1,000U Staff wages9,50010, F General overhead 8,000 7, F Total$135,500$135,200$ 600 U To Manager: Mall 2

12-10 Nonfinancial Measures as Percentages

12-11 Nonfinancial Measures Other measures include assessments of: productivity quality innovation Common measures are:  unit sales volume  unit production output  quantity of material used  labor and/or machine hours

12-12 Actual Expected Activity Activity Variance Head: Security Department Absenteeism rate12%6%6% U Security complaints per store per week462 F To Manager: Mall 2 Nonfinancial Measures

12-13 Manager: Mall 2 Percentage occupancy87%94%7% U Absenteeism rate10%5%5% U Complaints per week: General440F Maintenance761U Security 4162F Total complaints15161F To Vice President Operations From Head: Security Department Actual Expected Activity Activity Variance Nonfinancial Measures

12-14 Vice President Operations Percent occupancy92%98%6%U Absenteeism rate8%4%4%U Complaints per week45505F From Manager: Mall 2 Actual Expected Activity Activity Variance Nonfinancial Measures

12-15 Performance Reports Performance reports show expanded authority and responsibility for operating costs Performance reports show expanded authority and responsibility for operating costs

12-16 Types of Responsibility Centers Cost Center Revenue Center Profit Center Investment Center

12-17 Types of Responsibility Centers A cost center is a responsibility center whose manager is responsible only for managing costs; there is no revenue responsibility.

12-18 Cost Center Manufacturing Plant Tooling department Assembly activities Types of Responsibility Centers

12-19 Retail store Inventory control function Maintenance department Types of Responsibility Centers Cost Center

12-20 TV station Audio/video engineering Building and grounds Types of Responsibility Centers Cost Center

12-21 College History department Student registering activities Types of Responsibility Centers Cost Center

12-22 City government Public safety (police and fire) Road maintenance Types of Responsibility Centers Cost Center

12-23 Types of Responsibility Centers A revenue center is a responsibility center whose manager is responsible for the generation of sales revenues. A profit center is a responsibility center whose manager is responsible for revenues, costs, and resulting profits. An investment center is a responsibility center whose manager is responsible for the relationship between its profits and the total assets invested in the center.

12-24 Manufacturing Budget McMillan Company Manufacturing Budget For the Month of July Manufacturing costs: Unit level: Direct materials (10,000 x 2 pounds X $5)$100,000 Assembly (10,000 x 0.25 hours x $24)60,000 Waterproofing and Inspection (10,000 x $8)80,000 Batch level: Setup (10 batches x $400)4,000 Test run (10 batches x $100)1,000 Product level20,000 Facility level 32,000 Total$297,000

12-25 Static Budget McMillan Company Production Department Performance Report For the Month of July Original Static Budget Actual Budget Variance Volume 11,000 10,000 Unit level: Direct materials$108,000$100,000$ 8,000 U Assembly70,00060,00010,000 U Waterproofing and Inspection81,00080,0001,000 U Batch costs: Setup4,000 Test runs1,000 ContinuedContinued

12-26 Batch costs: Total5,600 5, U Fixed overhead: Product22,00020,0002,000 U Facility 31,000 32,000 1,000 F Totals$317,600$297,000$20,600 U McMillan Company Production Department Performance Report For the Month of July Original Static Budget Actual Budget Variance Volume 11,000 10,000 Static Budget

12-27 Flexible Budget Volume 11,000 10,000 Unit level: Direct materials$108,000$110,000$ 2,000 F Assembly70,00066,0004,000 U Waterproofing and Inspection81,00088,0007,000 F Batch costs: Setup4,400 Test runs1,100 McMillan Company Production Department Performance Report For the Month of July Original Static Budget Actual Budget Variance ContinuedContinued

12-28 Batch costs: Total5,600 5,500100U Fixed overhead: Product22,00020,0002,000U Facility 31,000 32,000 1,000F Totals$317,600$321,500$3,900F McMillan Company Production Department Performance Report For the Month of July Original Static Budget Actual Budget Variance Volume 11,000 10,000 Flexible Budget

12-29 Standard Costs A standard cost indicates what it should cost to provide an activity or produce one batch or unit of product under planned and efficient operating conditions. Traditionally, standard costs are developed from an engineering analysis or from an analysis of adjusted historical data. Flexible budgets are based on standard costs.

12-30 Relational and Discretionary Cost Centers What is a relational cost center? It is a center that has clearly defined relationships between effort and accomplishment.

12-31 Standard and Discretionary Cost Centers A discretionary cost center is just the opposite. It doesn’t have clearly defined relationships between effort and accomplishment.

12-32 Direct Material Standards and Variances Standard price indicates how much should be paid for each input unit of direct materials. Materials price variance is the difference between actual and standard cost of materials inputs. Standard quantity indicates the amount of direct materials allowed to produce one unit of output. Materials quantity variance is the difference between standard cost of actual materials inputs and flexible budget cost for materials.

12-33 Standard Material Variances Actual Cost Actual quantity (AQ) 24,000 Actual price (AP) x $4.50 $108,000 Standard Cost of Actual Inputs Actual quantity (AQ) 24,000 Standard price (SP) x $5 $120,000 Material price variance, $12,000 F

12-34 Standard Cost of Actual Inputs Actual quantity (AQ) 24,000 Standard price (SP) x $5 $120,000 Material quantity variance, $10,000 U Flexible Budget Cost Standard quantity (AQ) 22,000 Standard price (SP) x $5 $110,000 11,000 units x 2 pounds per unit Standard Material Variances

12-35 Total flexible budget materials variance $2,000 F Standard Cost Actual Costs of Actual Inputs Flexible Budget Cost (AQ) 24,000 (AQ) 24,000 (SQ) 22,000 (AP) x $4.50 (SP) x $5 (SP) x $5 $108,000 $120,000 $110,000 Materials price Materials quantity variance $12,000 F variance $10,000 U Standard Material Variances

12-36 Interpreting Material Variances Favorable materials price variance indicates that management paid less per unit than the price allowed by the standard Possible Explanations: Receiving discounts for purchasing larger than normal quantities Effective bargaining by the employee Purchasing substandard quality materials Purchasing from a distress seller

12-37 Interpreting Material Variances Unfavorable materials price variance means that the purchasing employee paid more per unit for material than the price allowed by the standard. Possible Explanations: Failure to buy in sufficient quantities to get normal discounts Purchase of higher quality material than called for in the product specs Failure to place material orders on a timely basis Failure to bargain for better prices

12-38 Interpreting Material Variances Favorable materials quantity variance means that the actual quantity of raw materials used was less than the quantity allowed for the units produced. Possible Explanations: Less materials waste than allowed by the standards Better than expected machine efficiency Direct materials of higher quality than required by the standards More efficient use of direct materials

12-39 Interpreting Material Variances Unfavorable materials quantity variance occurs when the quantity of raw materials used exceeds the quantity allowed for the units produced. Possible Explanations: Incurring more waste than provided for in the standards Poorly maintained machinery requiring larger amounts of raw materials Raw materials of lower quality than required by the standards Poor trained employees

12-40 Standard Labor Variances Actual Cost Actual hours (AH)2,800 Actual rate (AR)x $25 $70,000 Standard Cost of Actual Inputs Actual hours (AH) 2,800 Standard rate (SR) x $24 $67,200 Labor rate variance, $2,800 U

12-41 Actual hours (AH) 2,800 Standard rate (SR) x $24 $67,200 Standard Cost of Actual Inputs Labor efficiency variance, $1,200 U Flexible Budget Cost Standard hours (SH) 2,750 Standard rate (SR) x $24 $66,000 11,000 units x 1/4 hour per unit Standard Labor Variances

Standard Cost Actual Costs of Actual Inputs Flexible Budget Cost (AH) 2,8000 (AH) 2,8000 (SH) 2,750 (AR) x $25 (SR) x $24 (SR) x $24 $70,000 $67,200 $66,000 Labor rate Labor efficiency variance $2,800 U variance $1,200 U Total flexible budget labor variance, $4,000 U Standard Labor Variances

12-43 Interpreting Labor Variances  Unfavorable assembly rate variance may be caused by the use of higher paid laborers than provided for by the standards.  Favorable assembly rate variance occurs if lower paid workers are used.  Unfavorable labor efficiency variances occur whenever workers require more than the number of hours allowed by the standards.  Favorable labor efficiency variance occurs when fewer labor hours are used than are allowed by the standards

12-44 Performance Reports for Revenue Centers Performance reports for revenue centers include a comparison of actual and budgeted revenues. Assume that McMillan Company’s July sales budget called for the sale of 10,000 units at $40 each. If McMillan Company actually sold 11,000 units at $39 each, what would be the total revenue variance?

12-45 Revenue Variance Actual revenues (11,000 x $39) $429,000 Budgeted revenues (10,000 x $40) - 400,000 Revenue variance $29,000 F Actual volume x Actual price Budget volume x Budgeted price

12-46 Sales Price Variance Sales price variance =(Actual selling price – Budgetingselling price) x Actual sales volume Sales price variance =($39 – $40) x 11,000 units Sales price variance =$11,000 U

12-47 Sales volume variance =(Actual sales volume – Budgeting sales volume) x Budgeted selling price Sales volume variance =(11,000 units –10,000 units) x $40 Sales volume variance =$40,000 F Sales Volume Variance

12-48 Sales price variance$11,000 U Sales volume variance 40,000 F Revenue variance$29,000 F The net of the sales price and sales volume variances is equal to the revenue variance. The net of the sales price and sales volume variances is equal to the revenue variance. Actual revenue$429,000 Budgeted revenues 400,000 Revenue variance$ 29,000F

12-49 Inclusion of Controllable Costs Controllable costs should also be considered when evaluating the overall performance of revenue centers. Order getting costs are costs incurred to obtain customers’ orders. Order filling costs are costs incurred to place finished goods in the hands of purchasers.

12-50 Net Sales Volume Variance Sales$40.00 Direct materials$10.00 Assembly6.00 Variable manufacturing overhead: Unit level$8.00 Batch level Selling Contribution margin$10.50

12-51 Net sales volume variance = (11,000 – 10,000) x $10.50 Net sales volume variance = $10,500 F Net Sales Volume Variance

12-52 Appendices Click button to skip Appendices

12-53 Variable Overhead Variances Actual Costs $81,000 Standard Cost of Actual Inputs Actual pound (AP)24,000 Standard rate (SR) x $4 Total$96,000 Variable overhead spending variance, $15,000 F

12-54 Standard Cost of Actual Inputs Actual pound (AP)24,000 Standard rate (SRP)x $4 Total$96,000 Flexible Budget Cost Pounds allowed (SP)22,000 Standard rate (SRP)x $4 Total$88,000 Variable overhead effectiveness variance, $8,000 U Variable Overhead Variances

12-55 Actual Costs $81,000 Standard Cost of Actual Inputs AP20,000 SRPx $4 Total$80,000 Flexible Budget Cost SP22,000 SRPx $4 Total$88,000 Total flexible budget variable overhead variance, $7,000 F Variable Overhead Variances

12-56 Fixed Overhead Variances Actual Costs $31,000 Budgeted Cost Budgeted hours (BH)4,000 Standard price (SP)x $8 Total$32,000 Fixed overhead budget variance, $1,000 F

12-57 Budgeted Cost Assigned SH allowed (SH)4,400 Standard rate (SP)x $8 Total$35,200 Fixed overhead volume variance, $3,200 F Budgeted Cost Budgeted hours (BH)4,000 Standard price (SP)x $8 Total$32,000 11,000 units x 0.40 Fixed Overhead Variances

12-58 Actual Costs $31,000 Budgeted Cost $32,000 SH4,400 SPx $8 Total$35,200 Budgeted Cost Assigned Total fixed manufacturing overhead variance, $4,200 F Fixed Overhead Variances

12-59C hapter 12 The End

12-60